Edited version of your written advice

Authorisation Number: 1051427878687

Date of advice: 9 October 2018

Ruling

Subject: Deductible gift status as a private ancillary fund.

Question 1

Will the proposed Investment Option 1 be considered a suitable investment for the Trustee for X Foundation (X Foundation) to maintain its deductible gift recipient (DGR) endorsement as a private ancillary fund (PAF) described in item 2 of the table in section 30-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the proposed Investment Option 2 be considered a suitable investment for the Trustee for X Foundation (X Foundation) to maintain its deductible gift recipient (DGR) endorsement as a PAF described in item 2 of the table in section 30-15 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

The X Foundation has been registered as a charity with the Australian Charities and Not-for-Profits Commission (ACNC) from 1 January 20XX and endorsed with the ATO as a tax concession charity since 20XX. The X Foundation has also been endorsed as a DGR from 20XX as a PAF covered by item 2 of the table in section 30-15 of the ITAA 1997.

A unit trust, B Limited as trustee for the C Trust (C Trust) wholly owns vacant land.

The unit holders of C Trust are currently as follows:

XXXX units – E Pty Ltd as trustee for D Family Trust (D Trust). The directors and shareholders of E Pty Ltd are individual F and his spouse.

XXXX units – G Pty Ltd as trustee for the H Family Trust (H Trust). The directors and shareholders of G Pty Ltd are individual J and his spouse.

XXXX units – K Pty Ltd (K). The directors and shareholders of this entity are individual N and his spouse.

The beneficial owners of the units of C Trust are the D Trust, H Trust and K.

The shareholders and directors of B Limited, the trustee company of C Trust are:

Directors

● Individual F;

● Individual J; and

● Individual H

Shareholders

● E Pty Ltd – the shares held in trust for the D Trust;

● G Pty Ltd – the shares are held in trust for the H Trust;

● K – the shares are beneficially held.

The vacant land was originally part of a large parcel of land acquired in 20XX by C Trust for the following investment purposes:-

(a) To build a commercial retail complex on the larger section of land for rental purposes. Construction did occur and the complex was rented until it was sold in 20XX.

(b) To build residential apartments for rental purposes on the remaining land. This construction has not yet proceeded and the land is currently vacant awaiting development.

Two of the current unit holders of C Trust, G Pty Ltd and K, have expressed a desire to:-

(a) to either have C Trust sell the whole of the remaining land; or

(b) to sell their respective unit holdings in C Trust either to the D Trust or another party.

The D Trust does not wish for C Trust to sell the land and would prefer to have the land developed for rental purposes. Unfortunately, the D Trust is not in a financial position to acquire the units held by G Pty Ltd and K in C Trust and to undertake the development of the property on its own.

Individual F was one of three directors of the company, R Pty Limited, such company acting as trustee of X Foundation which is a trust established under a Trust Deed to be a PAF.

The Trust Deed is governed by the laws of the State of X The Trustee for the X Foundation applied for DGR endorsement for the X Foundation as a whole as a PAF, undertaking to comply with the current Private Ancillary Fund Guidelines 2009 (PAF Guidelines) as formulated under section 426-110 in Schedule 1 of the Taxation Administration Act 1953. The X Foundation was originally set up by Individual S who donated considerable sums to the Foundation.

Individual F is no longer a director or shareholder in R Pty Limited as per ASIC records provided with application for private ruling at Annexure B. He is also no longer a responsible person of the

X Foundation as per the ACNC Portal Extract also supplied, at Annexure C.

The two directors of R Pty Limited are currently two unrelated parties.

These two individuals are also the responsible persons of the X Foundation.

Proposed Investment

Investment Option 1

(a) To acquire the unit holding held by K in C Trust for its market value on an arm’s length basis; and

(b) to fund its share of the development costs of the vacant land being 33 1/3% by way of issue of additional units.

Investment Option 2

(a) To acquire the unit holdings held by K and G Pty Ltd in C Trust for its market value on an arm’s length basis; and

(b) to fund their share of the development costs of the vacant land being 66 2/3% by way of issue of additional units.

Therefore, the intentions of the Trustee of the X Foundation are as follow:-

(a) To acquire the units held by K in C Trust;

(b) to have C Trust draw up plans for the development of its vacant land;

(c) to then acquire the unit holding held by G Pty Ltd in C Trust for its market value on an arm’s length basis if G Pty Ltd lacks sufficient capital to fund its share of the development costs;

(d) to fund its share of the development costs of the vacant land being either 33 1/3% or

(e) 66 2/3%;

(f) to have either a one third or two thirds equity in C Trust which would provide good financial returns to X Foundation thereby enabling it to use its share of the returns for the purpose of its existence and establishment which is to provide funds to other Deductible Gift Recipients; and

(g) to reflect its investment in its investment strategy in accordance with its rules and guidelines, such investment strategy confirming the following:

(i) that all transactions involving this investment will be conducted strictly on an arms- length basis; and

(ii) that there will be no benefit or perceived benefit, potential or otherwise, obtained by any party connected with the Foundation, directly or indirectly; and

(iii) that there will be no conflict of interest or perceived conflict of interest between the Foundation and any party connected with X Foundation, directly or indirectly; and

(iv) that independent advice will be obtained before any investment is made where there is a benefit, perceived, potential or otherwise, obtainable by any party connected with the Foundation, directly or indirectly, as a consequence of the investment; and

(v) that independent advice will be obtained before any investment is made where there is a conflict of interest, perceived, potential or otherwise, between the Foundation and any party connected to X Foundation, directly or indirectly, as a consequence of the investment.

Independent advice from a financial adviser will be obtained prior to the X Foundation making an investment in C Trust and the investment will only proceed if the financial adviser confirms the arrangement is an appropriate investment for a PAF with prospects of a reasonable return.

A Unitholders Agreement will be prepared to limit the X Foundation’s risk and exposure to the investment. It will stipulate:

(a) a right to first mortgage over the land; and

(b) there will be a condition that the unitholders will agree to limit the X Foundation’s loss on its investment to 30% or such sum considered to be reasonable by the independent adviser, such limitation being based upon the X Foundation always being indemnified for its initial investment in the land.

A developer to build the apartments has not yet been approached. Although Individual F will be involved, benefit and take part in the development and rental of the completed apartments, his involvement will be commensurate with the D Trust’s 33 1/3% interest in C Trust. Individual F will not receive any payment from C Trust for any services he might provide.

Early indications are that the land is suitable for the construction of X number apartments.

The building costs are estimated to be $X of which the Foundation would provide from available funds either one third or two thirds depending upon whether X Foundation acquires a one third or two third’s equity in the C Trust. The C Trust will not be borrowing any funds and the land will not be used as security for any loans by the unit holders.

The net assets of X Foundation as at 30 June 20XX were $X. After completion of the apartments and allowing for charitable distributions and growth in asset values over the next two years, X Foundation’s net asset position has been estimated as $X. X Foundation’s investment in C Trust would be either $X or $XX representing X or XX% of X Foundations investments.

Based upon the net assets as at 30 June 20XX, the proposed investment, ignoring any allowance for growth, would be approximately X% or XX% of its investments. This calculation does not reflect the improved value of the completed apartments and growth of assets since 30 June 20XX.

The C Trust has no debt.

The cost of the Trustee of X Foundation acquiring its initial equity in C Trust will be either $X for a one third equity or $XX for a two third’s equity. These amounts are based on the market value of the land which is estimated to be $X. The ultimate market value would be determined by a registered valuer.

The apartments will be managed by an external un-related estate agent.

In the proposed dealings between C Trust and X Foundation, it has been confirmed that:

(a) no unitholders or directors of the entities that hold units, or associates of those entities, have any connection with the X Foundation; and

(b) none of those entities are a current trustee, or member, director, employee, agent or officer of the trustee or are a donor to the X Foundation. They are also not an associate of any of these entities including any deductible gift recipients.

The following steps are to be undertaken to ensure the purchase of units in C Trust is at arm’s length:

● The initial subscription of units (representing the value of the land) - an independent market valuation of the land will be conducted by a suitably qualified land valuer to determine the market value of the land. The units owned by either one third unitholder or two thirds unitholders will be sold to the X Foundation based upon the net assets of C trust, such net assets including the market value of the land. The net assets will consist of the land at its market value and cash at bank. There will be no liabilities as C Trust does not owe any money to any party.

● The subsequent subscription of units (representing the development costs) – the development costs will be based on a fixed price building contract. Under the building contract, the builder will require progress payments. Before payments are made and hence before any units are subscribed for, an independent valuer will assess the degree of completed works and authorise the payment. The payment will be funded by the unitholders proportionally based upon their equity in C Trust Units will be issued for each progress payment, such units being issued proportionally to each unitholder at the time each unitholder is required to contribute the funds for progress payments. The units will be issued at the respective amount needed for each unitholder to fund each progress payment.

● A Unitholders Agreement will be entered into between the unitholders of C Trust and the trustee of C Trust. This agreement will specifically state that the unit holders will unanimously agree that the Unit Trust will not undertake or engage in any activity which might be contrary to the PAF Guidelines unless a written private ruling is obtained from the Tax Office.

The following documents are relied on in this ruling and their contents, including appendices, form part of these facts:

1. Application for Private Binding Ruling.

2. Amended Annexures B, C and D of Application.

3. Deed of Trust for the X Foundation.

4. Emails from client representative of various dates.

5. Financial reports for 20XX-20XX years.

6. C Trust Deed.

7. X Foundation details of distributions 20XX-20XX financial years.

8. Minutes of S Foundation Meeting of X date and Investment Strategy as at X date.

9. Minutes of X Foundation of X date and proposed Investment Strategy.

10. H Trust Deed.

11. D Trust Deed.

12. X Foundation ASIC extract dated X

13. X Foundation ACNC responsible person extract dated X.

14. Current Investment strategy for X Foundation dated X.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 30-15

Income Tax Assessment Act 1997 Subdivision 30-B

Income Tax Assessment Act 1997 section 30-125

Income Tax Assessment Act 1997 subsection 30-125(1)

Income Tax Assessment Act 1997 paragraph 30-125(1)(d)

Income Tax Assessment Act 1997 subsection 30-125(6)

Taxation Administration Act 1953 Schedule 1 section 426-110

Reasons for decision

Question 1

Summary

It is considered that either of the proposed investment strategies of purchasing units of the C Trust by the trustee for X Foundation from one or two of the three unit holders of the C Trust and also providing funds by acquiring additional units to fund either one or two thirds of the cost of developing commercial rental apartments on the land owned by C Trust will be considered a suitable investment for X Foundation, and X Foundation will maintain its DGR endorsement as an PAF described in item 2 of the table in section 30-15 of the ITAA 1997.

Detailed reasoning

Entitlement to endorsement as a DGR is governed by section 30-125 of the ITAA 1997. Specifically, subsection 30-125(1) of the ITAA 1997 states:

30-125(1)

An entity is entitled to be endorsed as a deductible gift recipient if:

(a) the entity has an ABN; and

(b) the entity is a fund, authority or institution that:

(i) is described (but not by name) in item 1, 2 or 4 of the table in section 30-15; and

(ii) is not described by name in Subdivision 30-B if it is described in item 1 of that table; and

(iii) meets the relevant conditions (if any) identified in the column headed “Special conditions” of the item of that table in which it is described; and

(c) the entity meets the requirements of subsection (6), unless:

(i) the entity is established by an Act; and

(ii) the Act (or another Act) does not provide for the winding up or termination of the entity; and

(d) in the case of an ancillary fund:

(i) the fund complies with the rules in the … private ancillary fund guidelines … ; and

(ii) all of the trustees of the fund comply with those rules.

The X Foundation has been registered as a charity with the ACNC from 20XX and endorsed with the ATO as a tax concession charity since 20XX. The X Foundation has also been endorsed as a DGR from 20XX as a PAF covered by item 2 of the table in section 30-15 of the ITAA 1997.

Therefore, X Foundation:

(a) has an ABN;

(b) is described by item 2 of the table in 30-15 and not described by name in Subdivision 30-B; and

its trust fund deed meets the special conditions outlined in 30-15 relevant to a private ancillary fund at Clause 4; and

(c) satisfies subsection 30-125(6) by clauses 4 and 10 of the Foundations’ trust deed.

Whether the X Foundation satisfies the PAF Guidelines, as required by paragraph 30-125(d) of the ITAA 1997 is discussed below:

The PAF Guidelines set out the rules that a PAF must comply with in order to be endorsed and remained endorsed as a DGR.

Failure to comply with these guidelines will mean that:

● the trustee of the fund and directors of trustees may incur administrative penalties; and

● the PAF would cease to be entitled for endorsement as a DGR under section 30-125 of the ITAA 1997.

The most relevant PAF Guidelines as they relate to the proposed investment options are considered below.

Current Investment Strategy

Guideline 30 of the PAF Guidelines states the trustee of a PAF must prepare and maintain a current investment strategy for the fund. Specifically, Guideline 30.2 states that the strategy must reflect the purpose and circumstances of the fund and have particular regard to a number of conditions listed. Of those listed, the following is most relevant to the trustee for X Foundation’s proposed investment in the C Trust. It is as follows:

● perceived or actual material conflicts of interest in holding particular investments (including those relating to individuals involved in the decision-making of the fund).

You have supplied an amended investment strategy. The relevant changes which address the requirement to have regard to potential conflicts as per Guideline 30.2 are:

Arm’s Length Investments

All investments must be strictly on an arm’s length basis and:-

(a) there must be no benefit or perceived benefit obtainable by any party connected with the Foundation either directly or indirectly; and

(b) there must be no conflicts of interest or perceived conflict of interest between the Foundation and any party connected with the Foundation either directly or indirectly.

Independent Advice

Independent advice must be obtained before the Foundation makes any investment in the following circumstances:-

(a) where there is a benefit, perceived, potential or otherwise, obtainable by any party connected to the Foundation, either directly or indirectly as a consequence of the investment; and

(b) where there is a conflict of interest, perceived, potential or otherwise, between the Foundation and any party connected with the Foundation, either directly or indirectly, as a consequence of the investment.

Does anyone connected to the X Foundation, directly or indirectly, benefit from the development of the land?

Guideline 42 prohibits the X Foundation from providing benefits to:

● the trustee

● a member, director, employee, agent or officer of the trustee

● a donor to the fund

● a founder of the fund; or

● an associate of any of those entities (other than a DGR).

The X Foundation plans to invest in C Trust by one of the following means:

(a) to acquire the unit holding held by K in C Trust for its market value on an arm’s length basis;

(b) to have C Trust then draw up plans for the development of its vacant land;

(c) to then acquire the unit holding held by G Pty Ltd in C Trust for its market value on an arm’s length basis if G Pty Ltd lacks sufficient capital to fund its share of the development costs;

(d) to fund its share of the development costs of the vacant land being either 33 1/3% or

(e) 66 2/3% by acquiring further units in C Trust;

(f) to have either a one third or two thirds equity in C Trust which would provide good financial returns to X Foundation thereby enabling it to use its share of the returns for the purpose of its existence and establishment which is to provide funds to other Deductible Gift Recipients;

The X Foundation is purchasing units in C trust and is not undertaking any development work. The Trustee for C Trust will contract with builders to construct the units. From the information supplied, there is not any person involved with X Foundation who will benefit personally directly or indirectly from the investment by X Foundation in units of C Trust so as to invoke a breach of Guideline 42.

Carrying on a business

Guideline 40 of the PAF Guidelines prohibits the X Foundation from carrying on a business. However, a fund specifically does not contravene the guideline because of its investment activities such as investment in shares or investment properties for the purposes of deriving income that can be distributed to DGRs

You have made it clear in your investment strategy that the derivation of rental income is the purpose of your investment in C Trust and X Foundation will not be involved in the development and building of the units in any way. However, due to the fact the purchase of the units by the X Foundation may give them control over the C Trust we must consider if the X Foundation is considered to be conducting a business of either property development or of deriving rental income after entering into the relevant investments.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production?

(TR 97/11) provides the Commissioners view of the factors used to determine if a taxpayer is in business for tax purposes. Its principles are not restricted to questions of whether a primary production business is being carried on.

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

● whether the activity has a significant commercial purpose or character;

● whether the taxpayer has more than just an intention to engage in business;

● whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

● whether there is regularity and repetition of the activity;

● whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business;

● whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

● the size, scale and permanency of the activity, and

● whether the activity is better described as a hobby, a form of recreation or sporting activity.

These indicators must be considered in combination and as a whole and whether a business is being carried on depends on the large or general impression gained from looking at all the indicators, and whether these factors provide the operations with a commercial flavour. The weighting to be given to each indicator may vary from case to case.

Normally the receipt of income from the letting of property to a tenant(s) does not amount to the carrying on of a business.

Whether the letting of property activities amount to the carrying on of a business will depend on the circumstances of each case. Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual.

You have stated that neither the C Trust nor the X Foundation has any intention to sell the land or the apartments once they are constructed. You have also stated that the original intention of the existing unit holders in the C Trust was that the land be used to build residential apartments for rental purposes. This intention has not changed and is also the intention of the X Foundation. The X Foundation is not interested in developing the property for sale

The purpose of the proposed investment strategies is to develop the land by way of building apartments. The X Foundation will not be involved in the development of the apartments. This will be done by engaging an independent builder. An independent real estate agent will manage the properties once they are built and tenanted.

It is considered that based upon the factors outlined in TR 97/11, the Foundation will not be considered to carrying on a business and breaching Guideline 40 of the PAF Guidelines for the following reasons:

● The X Foundation has no intention to engage in a business activity and will enter the strategies as an investment to obtain a good return for the X Foundation to enable it to distribute to worthy recipients.

● There is no intention to sell the land or completed apartments.

● The activity is for investment purposes so there is a prospect of profit which is realistic for this type of investment.

● Your involvement is akin to that of an investor and is not done in a businesslike manner. The Trustee will appoint professionals to undertake the building of apartments and manage the rental properties.

● The size and scale of the development is small.

● The transactions will be done at arm’s length and do not have the required commercial character.

Conclusion

It is considered that either of the proposed investment strategies of purchasing units of C Trust by the trustee for X Foundation and also providing funds by acquiring additional units to fund either one or two thirds of the cost of developing commercial rental apartments on the land owned by the C Trust will be considered a suitable investment for X Foundation, and X Foundation will maintain its DGR endorsement as an PAF described in item 2 of the table in section 30-15 of the ITAA 1997.

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