Edited version of your written advice

Authorisation Number: 1051357496002

Date of advice: 6 April 2018

Ruling

Subject: Management of gifted funds

Question 1

Does a Charitable Trust that may arise from a gift for a specific purposes related to the Entity require registration at the Australian Charities and Not-for-profits Commission (ACNC) and endorsement by the Commissioner for its income to be exempt from income tax?

Answer

Yes

Question 2

If the answer to Question 1 is yes – Is the income of the Entity’s Common Fund, which is derived from investment of funds originating from the Charitable Trusts, exempt income of the Entity?

Answer

Yes, if the funds originating from charitable gifts are invested in the Entity’s Common Fund, the income earned is exempt income of the Entity.

Question 3

Do the Entity’s charitable trusts derive assessable income?

Answer

No

This ruling applies for the following period(s)

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

1. The Entity is registered as a charity with the ACNC and is endorsed by the ATO as an income tax exempt charitable entity.

2. The Entity holds a significant proportion of its portfolio of gifts and bequests as trustee on charitable trusts. These charitable trusts typically arise because the Entity accepts a gift subject to a condition which has been expresses by a donor in his or her will or under the terms of an inter vivos gift. The trust which then arises often does so by operation of law rather than express words of trust.

3. There are a wide range of instruments and circumstances for gifts, ranging from execution of formal trust instruments by both the Entity and donor but also including:

● Gifts in wills on express terms that the Entity is to hold the gifted property on trust and which have been accepted on that basis

● Bequests, deeds of gift or gift agreements which specify purposes to which the gift is to be applied, and which may or may not say that the gift is to be applied in perpetuity, but which do not mention the word trust

● Simple letters to the Entity from donors enclosing a cheque

Not all gifts may involve the creation of a charitable trust

4. The Entity has not catalogued all the relevant instruments, as to whether they impose a trust in each case. The Entity’s policy is to comply with donor wishes whether bound as trustee to do so or not.

5. Where the gifts have resulted in the creation of trusts (the Charitable Trusts) the Entity, as trustee, has not obtained registration of the Charitable Trusts with the Australian Charities and Not-for-profits Commission (ACNC).

6. The Entity appoints a delegate to manage the investment and spending of donated moneys in accordance with donor purpose.

7. The Entity manages the funds donated to it, from both charitable and non-charitable gifts, in a pooled investment fund.

8. There are a number of common funds (collectively referred to as the Common Fund) each designed to have different liquidity. The most liquid is a bank account that acts as an operating account for the Entity. There are additional investment funds:

● Short term fund - operational funds that can be drawn down at any time

● Medium term fund – invested over a 4-7 year period

● Long term fund – invested from 7 years to perpetuity

9. The operating account and short term fund are administered by calculating the proportion of the pool income for each donor purpose and is allocated annually for spending for the given purpose.

10. The medium and long term funds are administered by notionally unitising the fund allowing for tracking the value of each co-mingled investment.

11. The return from invested funds accrues by increasing the value of the relevant common fund, increasing the funds available for the delegate to spend in respect of all donor charitable purposes collectively and proportionally to each charitable purpose’s investment.

12. The funds of the Charitable Trusts are held in the Common Fund and payments are made from the Common Fund directly to the objects of the Charitable Trusts.

Relevant legislative provisions

Australian Not-for-profits Commission Act 2012

Charities Act 2013

Income Tax Assessment Act 1936, subsection 6(1)

Income Tax Assessment Act 1936, section 254

Income Tax Assessment Act 1997, division 6

Income Tax Assessment Act 1997, section 6-1(1)

Income Tax Assessment Act 1997, section 6-5(1)

Income Tax Assessment Act 1997, subsection 6-5(2)

Income Tax Assessment Act 1997, section 6-10(2)

Income Tax Assessment Act 1997, section 6-25

Income Tax Assessment Act 1997, section 11-5

Income Tax Assessment Act 1997, division 30

Income Tax Assessment Act 1997, section 30-15

Income Tax Assessment Act 1997, division 50

Income Tax Assessment Act 1997, subdivision 50-B

Income Tax Assessment Act 1997, section 50-1

Income Tax Assessment Act 1997, section 50-5

Income Tax Assessment Act 1997, section 50-50

Income Tax Assessment Act 1997, section 50-55 of the

Income Tax Assessment Act 1997, paragraph 108-5(1)(b)

Income Tax Assessment Act 1997, subsection 116-20(1)

Income Tax Assessment Act 1997, section 960-100

Reasons for decision

Issue 1 - Management of gifted funds

Question 1

Does a charitable trust that may arise from a gift for a specific purposes related to the Entity require registration at the Australian Charities and Not-for-profits Commission (ACNC) and endorsement by the Commissioner for its income to be exempt from income tax?

Answer

Yes

Summary

The Entity’s trusts are charitable trusts; each must be registered with the ACNC and endorsed by the Commissioner to be tax exempt.

Detailed reasoning

The Entity has stated it:

‘…holds a significant portion of its portfolio of gifts and bequests as trustee on charitable trusts.’

Under section 50-1 of ITAA 1997 the income of an ‘entity’ will only be exempt from income tax if it covered by one of the tables of exempt entities in Division 50 of ITAA 1997. The definition of ‘entity’ in subsection 960-100(1) of ITAA 1997 includes a trust. Therefore, each charitable trust that has been created as a result of a gift to the Entity is a separate entity and each entity will be exempt from income tax if it is covered by one of the exempt categories in Division 50 of ITAA.

Further, under section 50-47 of ITAA if an entity is an ‘ACNC type of entity’ it will only be exempt from income tax if it registered under the Australian Charities and Not-for-profits Commission Act 2012 (ACNCA 2012). Section 995-1 of the ITAA 1997 provides that an ‘ACNC type of entity’ is an entity that meets the description in column 1 of the table in subsection 25-5(5) of the ACNCA 2012. The type of entity described in column 1 of the table in subsection 25-5(5) of the ACNCA 2012 is ‘a charity’. Therefore, an ‘ACNC type of entity’ is a charity.

The Charitable Trusts meet the description of an ‘ACNC type of entity’ under section 50-47 of ITAA 1997 and therefore can only be exempt from income tax if they are a ‘registered charity’ under item 1.1 of section 50-5 of the ITAA 1997.

None of the Charitable Trusts have been registered with the ACNC and therefore any income derived by the Charitable Trusts will not be exempt.

To be exempt from income tax each of the Charitable Trusts will need to be registered with the ACNC and endorsed by the Commissioner of Taxation under section 50-105 of ITAA 1197.

Question 2

If the answer to Question 1 is yes – Is the income of the Entity’s Common Fund, which is derived from investment of funds originating from the Charitable Trusts, exempt income of the Entity?

Answer

Yes, if the funds originating from the Charitable Trusts are invested in the Entity’s Common Fund, the income earned is exempt income of the Entity.

Summary

The Entity is a charity registered with the ACNC and endorsed by the Commissioner as income tax exempt; under section 50-1 of ITAA 1997 all income derived by the Entity is exempt from income tax.

Detailed reasoning

Funds of the Entity, Charitable Trusts and other funds are invested in the Common Fund. However, due to the operation of clauses contained in supporting documents, where funds from a Charitable Trust are invested in the Entity’s Common Fund those funds are not held for the benefit of the Charitable Trust and as a result no income accrues to the Charitable Trust. Funds are excluded from being held for the benefit of a participating trust fund or other fund and therefore the funds taken to be held on behalf of the Entity instead of the participating trust fund or other fund.

That is, all funds invested in the Common Fund are held for the benefit of the Entity, which results in all income derived from funds invested in the Common Fund being income of the Entity.

The Entity is a charity registered with the ACNC and endorsed by the Commissioner as income tax exempt, and under section 50-1 of ITAA 1997 all income derived by the Entity is exempt from income tax.

Question 3

Do the Charitable Trusts derive assessable income?

Answer

No

Summary

Withdrawal of funds from the Common Fund does not represent assessable income to the charitable trust. If withdrawals held separate from the Common Fund generate income, the Charitable Trust will not be exempt from income tax unless it is registered with the ACNC and endorsed by the Commissioner.

Detailed reasoning

As explained in Question 1 the Charitable Trusts are not income tax exempt and therefore any income or statutory income derived by the Charitable Trusts would be assessable. Additionally, as explained in Question 2, the income earned from the Charitable Trust’s funds being invested in the Common Fund is income of the Entity.

It is clear from supporting documents that investing the funds of a Charitable Trust in the Common Fund does not have the effect of extinguishing the Charitable Trust. Further supporting documents imply that the terms of the Charitable Trust are not changed by investing its funds in the Common Fund.

Charitable Trust funds are allowed to be invested and withdrawn from the Common Fund and upon withdrawal the funds (and any money attributed to them) will to be subject to the terms of the Charitable Trust. Amounts are paid directly from the Common Fund to the objects of the Charitable Trust and this is considered to be a withdrawal from the Common Fund. The amounts paid directly from the Common Fund to the charitable purpose is a withdrawal from the Common Fund by the Charitable Trust and then a distribution to the objects of the Charitable Trust under the terms of the Charitable Trust.

The amount withdrawn is equivalent to the Charitable Trust’s equity in the Common Fund (or part thereof) at the time of the withdrawal. The Entity has the authority to attribute the value of the participating Charitable Trust’s equity in the Common Fund. While supporting documents provide that the Entity must periodically distribute income among the funds participating in the common fund the Charitable Trust does not derive the income since income accrued by the Common Fund is income of the Entity. However, on withdrawal the Entity has a discretion to attribute an amount to the Charitable Trust which is equal to or greater than the Charitable Trust’s original investment.

Under the terms of the Schedule, when the Charitable Trust invests in the Common Fund, the Charitable Trust has agreed to invest its funds for no return of income and has a right to withdraw the original amount invested with the expectation that an additional amount may be attributed to its investment by the Entity.

This is evident from the terms of the agreement in the supporting documents which has the following effect:

● the income earned on the Charitable Trust’s funds when invested in the Common Fund is income of the Entity, and

● the Charitable Trust does not have a right to this income, and

● the Charitable Trust can withdraw an amount from the Common Fund that is equivalent to the Entity, in its discretion, has attributed to the Charitable Fund as its equity in the Common Fund.

The Charitable Trust has no right to income from investments in the Common Fund and therefore it has no right to an additional amount being attributed to its equity in the Common Fund. At most it is a ‘mere expectancy’ that it may receive an additional amount subject to the discretion of the Entity. Therefore, if an additional amount, above the original amount invested, is withdrawn from the Common Fund, that additional amount is not in the nature of income.

This is reinforced by supporting documents which explain that income of the Common Fund may be applied to replenish a loss in capital of the Common Fund or of another fund. Income applied in this way is plainly not available to be applied for any other purpose including as an appropriation of an additional amount to a Charitable Trust. That being the case, the Charitable Trust cannot be said to have any guaranteed right to an appropriation of an amount equal to the income derived by the Common Fund on the equity contributed by the Charitable Trust.

Under the agreement to invest in the Common Fund there is an implied right that the Charitable Trust can withdraw its investment from the Common Fund.

Supporting documents prescribe the consequences of funds withdrawn from the Common Fund. Importantly, they provide that on the withdrawal of trust funds from a common fund, the funds (or money attributed to them) continue to be subject to the trust. This suggests continuity between the original settled corpus of the Charitable Trust and any amount withdrawn from the Common Fund that is attributable to the trust. That is, the effect appears to be that a withdrawal is in the nature of a return of corpus.

This view is consistent with the effect of paragraphs within the supporting documents, which concerns entire withdrawal from the Common Fund by an Entity trust.

That an entire withdrawal by the Charitable Trust should be stamped with the character of ‘equity’ (or capital), gives weight to the view above that a partial withdrawal should have the same character (and not income).

When supporting documents are read as a whole, the better view appears to be that any income derived by the Common Fund is income of the Entity, and any amount withdrawn for the trust from the Common Fund is attributable to the equity or corpus of the Charitable Trust, either as a return of the capital initially contributed or the settling of further corpus. Neither of these withdrawn amounts represents income of the Charitable Trust.

Possible Capital Gains Tax (CGT) consequences

To the extent that there is any implied right that the Charitable Trust is entitled to withdraw its investment from the Common Fund, this right would fall within the definition of a CGT asset in paragraph 108-5(1)(b) of the ITAA 1997.

In these circumstances, when the whole of the original investment by the Charitable Trust is withdrawn from the Common Fund, and the right to receive the amount withdrawn is extinguished, CGT event C2 event would happen. However, in these circumstances:

● the capital proceeds under subsection 116-20(1) of the ITAA 1997 will be the amount of money the Charitable Trust received, or is entitled to receive in respect of the withdrawal,

● the cost base will be the amount of the original contribution by the Charitable Trust which will be equal to the amount withdrawn, and

● as the amount of the withdrawal is equal to the cost base there will be not be a capital gain.

Because any additional amounts appropriated to the Charitable Trust from the Common Fund would represent a separate settlement of corpus on the Charitable Trust, they are not subject to any right that may exist.

CGT event E2 may happen in relation to an amount settled upon the Charitable Trust. However, any capital gain or loss made on the happening of CGT event E2 would be a gain or loss to the Entity – and disregarded because of its income tax exempt status.

Conclusion

The withdrawal of funds to, or for the charitable purposes of, the Charitable Trust does not (of itself) represent assessable income (including by way of a capital gain) to the Charitable Trust.

If on the other hand withdrawals held separate from the Common Fund do generate income, the Charitable Trust will not be exempt from income tax on this income, unless it is registered with the ACNC and endorsed by the Commissioner.

ATO view documents

Taxation Ruling TR 2005/13 Income tax: tax deductible gifts - what is a gift

Taxation Ruling TR 2011/4 Income tax and fringe benefits tax: charities

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