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Authorisation Number: 1051293704481

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Date of advice: 12 October 2017

Ruling

Subject: Income tax exemption as a not for profit organisation

Question:

Is Company X as trustee for Trust X exempt from income tax under section 50-1 of the Income Tax Assessment Act 1997 (ITAA 1997) as a society, association or club established for the encouragement of XYZ racing pursuant to item 9.1 in the table in section 50-45 of the ITAA 1997?

Answer:

No.

This ruling applies for the following periods:

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

The scheme commences on:

1 July 2015

Relevant facts and circumstances

1. Company X is the trustee for the Trust X.

2. Company X is registered as a proprietary Company.

3. The trust deed shows the trust is a fixed trust. The beneficiaries are intended for those purposes to have a fixed entitlement to an equal share of the income and capital of the Trust Fund.

4. The trust deed addresses the income issue by making provisions in relation to beneficiary entitlements.

5. The Trust deed says the trust was established for the beneficiaries of the trust described in the deed in equal shares.

6. The beneficiaries have carriage of XYZ racing and entertainment in the relevant State.

7. The listed beneficiaries are exempt from income tax as their primary purpose is to encourage XYZ racing.

8. Nothing in the trust deed requires the beneficiaries to be exempt from income tax.

9. The trust deed does not limit the number or type of beneficiaries.

10. The trust deed says that on winding up the trust a distribution will be made to the beneficiaries.

11. Neither the shareholders agreement nor the replaceable rules mention action to be taken in the event of the winding up of the trust.

12. Copies of the annual financial reports have been provided.

The winding up clauses of the trust require that the surplus be transferred or applied for the benefit of the beneficiaries who are currently exempt from tax as they were established for the encouragement of XYZ racing.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 50-45

Income Tax Assessment Act 1997 Section 50-1

Reasons for decision

Summary

● Trust X is not a club or society but may be considered to be an association

● Trust X fixed trusts activities do not constitute the encouragement of XYZ races.

● Trust X is not a non-profit organisation.

● Its object is to provide a benefit to the beneficiaries (as per the trust deed).

Is the Trust established for the encouragement of sport?

The purpose of a society, association or club is determined by reference to its constituent documents and its activities since its formation.

The Trust deed says at 2.1

2.1 Establishment of Trust

The Settlor directs, and the Trustee declares, that the Trustee will hold the Trust Fund on trust for the Beneficiaries on the trusts described in this deed in equal shares.

As the trust deed is the governing document of the trust this is the primary purpose of the Trust.

The Trust deed makes no reference to the sport other than through it’s title.

Company X’s website states its purpose is the encouragement and promotion of the Australian sport by the holding and exploitation of the certain Rights

The word ‘encouragement’ is not defined in the ITAA 1997.

The meaning of the word ‘encouragement’ is however, explained in paragraph 11 of Income Tax Ruling TR 97/22 notwithstanding the fact that paragraph 6 of that same ruling states:

Clubs that promote or encourage XYZ races are not covered by this Ruling. A separate provision of the Act, paragraph (a) of item 9.1 of the table in section 50-45, exempts such clubs.

In light of the absence of an ATO View (in respect of the word ‘encouragement’) applicable to organisations that promote or encourage XYZ races, paragraph 11 of TR 97/22 may be used as a guide to the concept of ‘encouragement’: It states

“Encouragement" means "stimulation by assistance", according to the Macquarie Dictionary. It is essential that the encouragement of a game or sport is the main or dominant purpose of a club. Encouragement can occur directly by:

Forming, preparing and entering teams and competitors in competitions in the game or sport;

Co-ordinating activities;

Organising and conducting tournaments and the like;

Improving the abilities of participants;

Improving the standard of trainers and coaches;

Providing purchased or leased facilities for the activities of the game or sport for the use of club members and visitors; or

Encouraging increased and wider participation and improved performance;

And can occur indirectly:

Through marketing; or

By initiating or facilitating research and development.

By comparing Trust X’s circumstances with the concept of ‘encouragement’ as espoused by TR 97/22 it is possible to determine whether Trust X’s activities can be considered to constitute encouragement of XYZ races in the context of TR 97/22.

Direct Encouragement

Forming, preparing and entering teams and competitors in the game or sport.

Trust X is not involved in entering competitors into racing events

Co-ordinating activities

Trust X is not involved in co-ordinating racing activities. It is involved in the provision of images and the like to various electronic and print media, for example. Pay TV, free to air TV, internet, mobile phone networks, printed publications.

Organising and conducting tournaments and the like

Trust X is not involved in conducting race meetings.

Improving the abilities of participants

Trust X is not directly involved with the improvement of participants.

Improving the standard of trainers and coaches

Trust X does provide copies of their videos to race officials to review specific races. It is not involved with the improvement of the standard of trainers and coaches

Encouraging increased and wider participation and improved Performance.

Trust X does not directly encourage participation or improved performance in XYZ racing. However through facilitating the sale of images to the media Trust X indirectly encourages and fosters an appreciation of horse racing potentially leading to increased audiences and potentially increased participation in the sport.

Indirect Encouragement

Through marketing.

Through facilitating the provision of media the Trust may indirectly foster an appreciation of the sport. However it does not directly market the participation or involvement in the sport.

By initiating or facilitating research and development

Trust X is not involved in initiating or facilitating research and development

Contrary to the stated purpose of Trust X other than the provision of media support for the race officials the activities of the Trust do not come within the examples of encouragement of sport.

The sporting clubs which benefit from Trust X’s support are separate entities in their own right and their encouragement of sport cannot be attributed to Trust X. It is the entity itself that must be covered by the tables in Division 50. Its own character or purpose is determinative. In this regard, paragraphs 24 and 30 of Taxation Ruling TR 2005/22 Income Tax: companies controlled by exempt entities explain:

24. Given it is the entity itself that must be covered by an item in the tables in Division 50, it is its character or purpose, rather than the character or purpose of a related exempt entity, that will be determinative. Several cases illustrate this point.

…

30. To focus on the character of the relevant entity itself, means that a 'look through' approach is not appropriate. A 'look through' approach would ignore the character of the relevant entity. That is, it would focus only on the controlling body and not on the relevant entity itself. Such an ignoring of the features and circumstances of the relevant entity is not consistent with the legislative requirements of Division 50. The items require that the entity itself meet the conditions. The court cases on Division 50 and its predecessor provisions have not ignored the relevant entity. Rather, they demonstrate the relevance of the entity's own features

Even if the sole or main purpose of Trust X was to donate surplus funds to the sporting clubs or organisations encouraging the sport in Australia, this alone will not qualify Trust X for income-tax exempt status.

Rich J stated in Royal Australasian College of Surgeons v. Federal Commissioner of Taxation (1943) 68 CLR 436 that:

The inclusion of an institution in the exemption clause depends upon the intrinsic character of the object which it promotes and not upon the scope of the benefits which may result from its transaction.

This statement highlights that, regardless of whether surplus funds are distributed to an organisation that encourages sport, the activities of the entity define its status

Paragraphs 43 and 49 of TR 2005/22 elaborate on the use of surplus funds:

43. Use of a company's surplus funds for exempt entities or their purposes will not, on its own, cause it to be covered by the tables in Division 50.

49. Common motives inspiring the company and associated exempt entities will not, on its own, cause it to be covered by the tables in Division 50.

Furthermore paragraph 53 of TR 2005/22 reconfirms through reference to several leading cases that it is the character of the entity in question rather than that of associates which is determinative:

53. The approach of the Full Federal Court in Council of the Dominican Sisters - which looked to the character or purpose of the entity itself, rather than that of an associated body - is to be followed rather than the approach of the Board of Review in Case B122 (1952) 2 TBRD 613; 2 CTBR (NS) Case 82 (and of JF McCaffrey in Case C57 (1952) 3 TBRD 297; 3 CTBR (NS) Case 68 ).

TR 2005/22 at paragraph 86 reinforces the view that control by an exempt entity would not cause the controlled profit making entity to be exempt.

86. The fact that a company with such a purpose [to carry on a business or commercial enterprise to generate profits] is set up and controlled by an exempt entity would not cause it to be exempt. The matters listed at paragraph 18 would not cause a different conclusion. This is clearly indicated by the cases. That is, the having of such a purpose can co-exist with control by an exempt entity, or the use of surplus to further purposes connected with exempt entities, or the having of objects in the constituent document that refer only to purposes consistent with exemption.

In the Trust’s case, its activities are geared towards earning income from the marketing of sporting coverage and content. When surpluses or profits arise, these funds can be distributed to beneficiaries (sporting clubs) by way of trust distributions.

The trust distributions do not change this character and do not satisfy the criteria for the encouragement of XYZ racing.

Is Trust X carried on for the purpose of profit or gain of its individual members?

The trust deed of the Trust makes provision for the payment of distributions to beneficiaries.

The Trust document only refers to what can be done prior to the vesting day. It does not specify anything about the distribution upon vesting.

Furthermore, dissolution or winding-up clauses are not present in the company’s shareholders agreement or supplementary rules.

The Associations Incorporation Act 1981 which contains a prohibition against the securing of pecuniary profit for members of an incorporated association has no application in this case as the entity in question is a proprietary company subject to the Corporations Act 2001. Therefore implied dissolution or winding-up clauses cannot be said to exist in the case of Trust X.

The absence of dissolution or winding-up clauses and the fact that Company X is carried on for the profit of its members combines to deny Trust X the prospect of it being considered a non-profit company under subsection 3(1) of the Income Tax Rates Act 1986.

Further TR 2005/22 provides that the company itself must meet the description and requirements of an entity under Division 50 and it is not possible “to simply ‘look through’ the company to the exempt entity, ignoring the characteristics and purposes of the trust itself.” Therefore Trust X cannot rely on any exemption its shareholders may have under Division 50.

Conclusion

1. Trust X is not a society or club, however, it may be considered to be an association.

2. Trust X’s activities do not constitute the encouragement of sport.

3. Trust X is carried on for the profit of members (shareholders).

The trust deed deals directly with the distribution of profits allowing for them to be paid in equal amounts to each of the beneficiaries.

The trust therefore relies on the provisions of each beneficiary’s constituent documents to ensure their non-profit compliance.

None of the constituent documents restrict the appointment or removal of beneficiaries, nor does it stipulate their tax status.

The winding up clauses of the trust require that the surplus be transferred or applied for the benefit of the beneficiaries who are currently exempt from tax as they were established for the encouragement of XYZ racing.

Special provisions

Trust X has a physical presence in Australia (it operates in a relevant State) and, to that extent, incur their expenditure and pursue their objectives principally in Australia.

Comply with all substantive requirements in its governing rules

Taxation Ruling TR 2015/1 Income tax: special conditions for various entities whose ordinary and statutory income is exempt sets out the Commissioner’s view on the meaning of the special conditions set out in subsection 50-70(2), and provides the following meaning of ‘substantive requirements’:

18. The ‘substantive’ requirements in an entity’s governing rules are those rules that define the rights and duties of the entity.

19. The substantive requirements in an entity’s governing rules include rules such as those that:

● give effect to the object or purpose of the entity

● relate to the non-profit status of the entity

● set out the powers and duties of directors and officers of the entity

● require financial statements to be prepared and retained

● set out the criteria for admission as a member of an entity

● require an entity to maintain a register of members, and

● relate to the winding-up of the entity.

21. The governing rules condition is applied on a continuous basis throughout an income year. The entity must consider whether, at all times throughout the income year, it has complied with all of the substantive requirements in its governing rules. In order for an entity to be exempt from income tax for all of an income year, it must (among other things) satisfy the governing rules condition at all times during that income year. While an entity is in breach of the governing rules condition, its ordinary and statutory income will not be exempt from income tax.

Based on the evidence, Trust X does not comply with the following substantive rules in its governing documents:

● the objects and purposes of the entity;

● rules that prohibit profit or gain to members;

There is no evidence that Trust X has failed to comply with other substantive requirements in its governing rules.

Apply its income and assets solely for its purpose

Paragraph 23 of TR 2015/1 provides that:

23. Two questions must be considered to determine whether an entity satisfies the income and assets condition:

● What is the ‘purpose for which the entity is established’, and

● Has the entity applied its income and assets solely for the purpose for which the entity is established?

As discussed above, the main purpose of Trust X is to provide a benefit to the beneficiaries.

The Trust has prepared annual financial reports. These confirm that they have acted in accordance with the purposes for which the entity was established.

Trust X is not an exempt entity under item 9.1(c) of the table in section 50-45 of the ITAA 1997, and its ordinary and statutory income is exempt from income tax in accordance with section 50-1 of the ITAA 1997.

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