Edited version of private advice

Authorisation Number: 1051650540076

Date of advice: 24 March 2020

Ruling

Subject: Payment on dissolution of incorporated association

Question 1

Will the lump sum payment from the Fund to X upon their resignation from the Fund, excluding the amount of interest compounded annually on their weekly contributions, be considered 'ordinary income' under subsection 6-5(1) of the ITAA 1997?

Answer

No

Question 2

Will the portion of the lump sum payment from the Fund to X upon their resignation from the Fund, representing the amount of interest compounded annually on their weekly contributions, be considered 'ordinary income' under subsection 6-5(1) of the ITAA 1997?

Answer

Yes

Question 3

Will the lump sum payment from the Fund to X upon their resignation from the Fund, excluding the amount of interest compounded annually on their weekly contributions, be considered a form of 'statutory income' under subsection 6-10(2) of the ITAA 1997 other than statutory income under section 102-5 of the ITAA 1997?

Answer

No

Question 4

Will the lump sum payment from the Fund to X upon their resignation from the Fund, excluding the amount of interest compounded annually on their weekly contributions, be taxable as a capital gain, specifically capital gains tax under section 104-25 of the ITAA 1997?

Answer

Yes

Question 5

Is the acquisition date of X's interest in the Fund, for the purposes of Division 109 of the ITAA 1997, the date on which their membership of the association commenced?

Answer

Yes

Question 6

Will X be entitled to a discount capital gain under section 115-100 of the ITAA 1997 in respect of the lump sum payment (excluding the amount of interest compounded annually on their weekly contributions) made to them upon their resignation from the Fund?

Answer

Yes

Question 7

In calculating the cost base of X's interest in the Fund, does subsection 110-40(2) apply in respect of X's contributions to the Fund as a member?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

Year ended 30 June 20XX

Relevant facts and circumstances

An unincorporated association (the Fund) was established to benefit employees of an organisation.

The association was incorporated pursuant to the Associations Incorporation Act 1984.

The Fund is registered with the Australian Charities and Not For Profit Commission (ACNC).

The taxpayer, X, joined the Fund as a member in 19XX, and is a resident of Australia for income tax purposes.

The Fund is managed by a committee that administers the Funds in accordance with the rules of the Fund (the Rules).

The Fund is audited on an annual basis and subject to actuarial review.

Membership requirements

In order to be entitled to a provision of the Fund, a member must pay a weekly contribution at the end of each week of membership.

Generally, where a member ceases to contribute payment to the Fund for in excess of 52 weeks, the member ceases to be entitled to any benefit from the Fund. A member's leave of absence from paid employment will also impact the calculation of their entitlements from the Fund in the event the Fund is required to remit a payment to that member.

X has made weekly contributions since becoming a member of the Fund, but has never claimed a tax deduction for them.

Fund benefits - general

The Fund provides for the sickness, education, death benefits and benefits for members suffering major or accidental or unforeseen events causing extreme hardship.

Withdrawal benefits

In accordance with the Rules, if a member of the Fund ceases to be a member they may be paid a withdrawal benefit, which comprises an amount equal to the total weekly contributions paid to the Fund with compound interest on the contributions, and an amount in respect of the member's period of membership.

Winding up the fund

The Fund will be wound up voluntarily.

As part of the winding up, members will resign from the Fund and will be paid the withdrawal benefit on resignation from the Fund. It is proposed the withdrawal benefits be paid by way of a lump sum.

Subsequent to the winding-up of the Fund, all members will cease to hold any rights or interests with respect to payments from the Fund.

Assumptions

Any capital gain made on the lump sum payment from the Fund to X following their resignation from the Fund will be worked out using a cost base that has been calculated without reference to indexation.

Relevant legislative provisions

Income Tax Assessment Act 1997

subsection 6-5(1)

subsection 6-10(2)

section 10-5

section 102-5

section 104-25

subsection 109-5(1)

subsection 109-5(2).

section 110-25

subsection 110-40(2)

section 115-5

section 115-10

section 115-15

section 115-20

section 115-25

section 115-100

Associations Incorporation Act 1984 (NSW)

Subparagraph 4(1)(c)

Reasons for Decision

Question 1

Summary

The lump sum payment from the Fund to X upon their resignation from the Fund, excluding the amount of interest compounded annually on their weekly contributions, is not 'ordinary income' under subsection 6-5(1) of the ITAA 1997.

Detailed reasoning

Subsection 6-5(1) of the ITAA 1997 provides:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

There is a considerable body of authority governing the definition of ordinary income. A starting point in the determination of this question is the principle that the character of the receipt must be determined from the perspective of the recipient. Therefore the question of characterisation is to be ascertained from X's - rather than the Fund's - point of view.

In assessing the facts of this case, it is the Commissioner's view that the payment from the Fund to X, excluding the amount of interest on their weekly contributions, is not ordinary income under subsection 6-5(1) of the ITAA 1997. The portion of the lump sum payment representing interest compounded annually on their weekly contributions, as provided for by Rule 26(a), is of a distinct character governed by separate considerations, and is subject to a separate determination in question 2. Therefore, with the exception of the interest component, the Commissioner's view of the lump sum payment is as follows:

·         The payment is a one-off distribution to be made in a lump sum amount and does not possess the periodicity, recurrence and regularity of receipt that is considered to be a hallmark of ordinary income: FC of T v The Myer Emporium Ltd 87 ATC 4363 (Myer).

·         It is recognised, however, that the above is not determinative of the issue given that the receipt of a lump sum does not necessarily preclude a finding of ordinary income.

·         While the payment in question may generally be considered to have a connection with employment -given that membership of the Fund is conditional on employment by the organisation - the payment is not salary or remuneration, nor is it made in substitution of salary or remuneration. X does not depend on the amount for their day-to-day living expenses in the same manner as that with which, for example, FCT v Dixon (1952) 10 ATD 82 is concerned.

·         Nor can it be said that the amount represents a return from a business activity or an isolated profit-making transaction as per Myer. While the payment is a one-off lump sum distribution, it is not borne from any profit-making endeavour undertaken by X.

·         Broadly speaking the payment, excluding the interest component, is made to X as a member of the association upon their resignation from the Fund as part of the Fund's winding-up, calculated by reference to the amount of their contributions to the Fund (in this respect, representing a return of those amounts), and partially by a flat rate for each year in which they were a member of the Fund.

As such, it is not 'ordinary income' under subsection 6-5(1) of the ITAA 1997.

Question 2

Summary

The portion of the lump sum payment from the Fund to X upon their resignation from the Fund, representing the amount of interest compounded annually on their weekly contributions, is 'ordinary income' under subsection 6-5(1) of the ITAA 1997.

Detailed reasoning

The Rules recognise and provide for the payment of interest to members upon resignation.

The amount of such interest is ordinary income under subsection 6-5(1) of the ITAA 1997. The following considerations were taken into account in reaching this view:

·         It is submitted as part of the application for this Ruling that Taxation Ruling TR 95/35 (TR 95/35) applies to the determination of this issue.

TR 95/35 concerns the tax treatment of compensation receipts. While the facts of this case do not fall squarely within the kind of matters to which TR/95/35 is concerned, we consider that the principles contained therein are nonetheless relevant and useful in the determination of this issue.

At the outset, it is noted that the component of the lump sum payment representing interest on the contributions is clearly identifiable. As such, paragraph 18 of TR 95/35 is not relevant to this case as it pertains instead to undissected lump sum payments. An 'undissected lump sum compensation receipt' is defined in paragraph 3 of the ruling as 'any amount of compensation received by the taxpayer where the components of the receipt have not been and cannot be determined or otherwise valued or reasonably estimated'.

In this case, the amount of the compound interest is itself required to be calculated as part of the withdrawal benefit payment. Consequently it cannot be regarded as indeterminable.

·         Where, as in this case, the interest component of a payment can be separately identified, the general approach adopted by the ATO is prescribed in paragraph 26 of TR 95/35 which states that 'Interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions'.

·         It is clear that the component is awarded 'as part of' the withdrawal benefit; the component is described as 'interest'; and it is clearly defined and calculable.

·         It is relevant that:

-        Interest is generally of an income nature and is income according to ordinary concepts, even if it is not directly linked to the taxpayer's earnings.

-        The fact that the interest component is not the return of actual interest accrued on the amounts contributed to the Fund is immaterial to the characterisation of the payment, which is determined as it is received 'in the hands of the taxpayer' - that is, from the perspective of the recipient. In this case, X will receive the interest due to them by the Fund, irrespective of whether such amount bears any correlation to interest accrued on the amounts held by the Fund.

-        That the taxpayer's motivation in subscribing to the Fund relates primarily to the receipt of payment in the event of illness, injury or death is also largely immaterial to the question of the characterisation of a payment made to them. While the contributions may have been made for a purpose unrelated to the accrual and return of interest, X's rights on resignation under the Rules include a specific entitlement to what bears the hallmarks of, and what is specifically described as, interest; and which, it follows, when paid to them will be interest in their hands.

Question 3

Summary

The lump sum payment from the Fund to X upon their resignation from the Fund, excluding the amount of interest compounded annually on their weekly contributions, is not a form of 'statutory income' under subsection 6-10(2) of the ITAA 1997 other than statutory income under section 102-5 of the ITAA 1997.

Detailed reasoning

Section 6-10 of the ITAA 1997 includes 'statutory income' within the scope of assessable income, being amounts that are not ordinary income, but are deemed to be assessable income by virtue of various provisions in the Act. A list of these provisions is provided in section 10-5.

The lump sum payment (excluding the interest component) may prima facie result in a 'capital gain' under section 102-5, being an item that appears under section 10-5. This is discussed further in the reasons for decision in respect of question 4, below.

The payment does not fall within the scope of any other item in section 10-5. Therefore it is not 'statutory income' under subsection 6-10(2) other than statutory income comprising capital gains under section 102-5.

Question 4

Summary

The lump sum payment from the Fund to X upon their resignation from the Fund, excluding the amount of interest compounded annually on their weekly contributions, is taxable as a capital gain, specifically capital gains tax under section 104-25 of the ITAA 1997.

Detailed reasoning

The asset

X is in possession of various rights conferred upon them as a member of the Fund. These rights include the right to payment of various amounts in the circumstances prescribed under the Rules. A question arises as to whether these rights must be dealt with as separate CGT assets, or addressed as a single bundle of rights.

As a general rule, the question depends on the facts of each case: paragraph 1 of Taxation Determination TD 93/86 (TD 93/86).

It is accepted in this case that the rights contained in the Rules constitute a single CGT asset rather than separate assets, consistently with the general approach taken by the Commissioner in respect of rights under a contract: TD 93/86.

It is persuasive in this regard that the various rights acquired by X were acquired as a single, inseparable bundle of rights upon their membership of the Fund. As they are acquired and later 'released, discharged... abandoned, surrendered..' as a whole - being rights accruing collectively to Fund membership - it is appropriate in this case that they be regarded in totality and as a single CGT asset.

CGT event C2

Subsection 104-25(1) provides, broadly, that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset 'being redeemed or cancelled'; or 'being released, discharged or satisfied'; or 'being abandoned, surrendered or forfeited'.

Upon X's resignation from the Fund as part of the dissolution of the Fund:

·         they will be paid withdrawal benefits from the Fund; and

·         after resignation from the Fund, they will not be entitled to any future provision from the Fund.

X's entitlement to the rights of the Fund (that is, their ownership of the rights as an intangible CGT asset) is effectively discharged or satisfied upon the payment of the lump sum to them. Therefore under the terms of subsection 104-25(1), CGT event C2 will happen when the withdrawal benefit is paid to X, upon which their ownership of the rights under the Fund will be 'released, discharged, or satisfied'.

Question 5

Summary

The acquisition date of X's interest in the Fund, for the purposes of Division 109 of the ITAA 1997, is the date on which their membership of the association commenced.

Detailed reasoning

As a general rule, subsection 109-5(1) provides that you acquire a CGT asset when you become its owner. The time at which you acquire the asset is when you become its owner.

Where CGT event D1 happens - that is, where 'an entity create contractual or other rights in you' - you are deemed to have acquired the asset 'when the contract is entered into or the right created': see table in subsection 109-5(2).

X acquired the rights and benefits afforded to members under the Fund when they became a member of the Fund.

It follows that X acquired the rights given to members of the Fund on the date in which their membership commenced, being the date on which the rights to them were 'created'.

Question 6

Summary

X is entitled to a discount capital gain under section 115-100 of the ITAA 1997 in respect of the lump sum payment (excluding the amount of interest compounded annually on their weekly contributions) made to them upon their resignation from the Fund.

Detailed reasoning

A discount capital gain is a capital gain that meets the requirements of sections 115-10, 115-15, 115-20 and 115-25: section 115-5.

X will be entitled to a discount capital gain in respect of the happening of CGT event C2 which occurs upon the payment of the withdrawal benefit to them. This is because:

·         X satisfies the requirement of section 115-10, which allows for an 'individual', amongst other entities, to be entitled to a discount capital gain.

·         X will satisfy the requirement in section 115-15 as the CGT event will happen after 21 September 1999.

·         The condition in section 115-20 will be met as the capital gain will be worked out using a cost base that has been calculated without reference to indexation.

·         The condition in section 115-25(1) will be met as X had acquired the asset more than 12 months before the CGT event, being the date on which she joined the Fund as a member.

As an Australian resident individual making the gain, X's discount percentage is 50% as specified under paragraph 115-100(a).

Question 7

Summary

In calculating the cost base of X's interest in the Fund, subsection 110-40(2) applies in respect of X's contributions to the Fund as a member.

Detailed reasoning

In calculating a capital gain that arises from CGT event C2, subsection 104-25(3) provides:

'you make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.'

There are 5 elements that comprise the cost base of a CGT asset: section 110-25. For present purposes, the first element of the cost base of a CGT asset is the total of 'the money you paid, or are required to pay, in respect of acquiring it...'. The third is:

the costs of owning the CGT asset you incurred (but only if you acquired the asset after 20 August 1991). These costs include:

(a) interest on money you borrowed to acquire the asset; and

(b) costs of maintaining, repairing or insuring it; and

(c) rates or land tax, if the asset is land; and

(d) interest on money you borrowed to refinance the money you borrowed to acquire the asset; and

(e) interest on money you borrowed to finance the capital expenditure you incurred to increase the asset ' s value.

As X acquired the asset in 1995, section 110-40 (which deals with assets acquired before 7.30pm on 13 May 1997), applies. Subsection 110-40(2) provides that expenditure does not form part of the second or third element of the cost base 'to the extent that you have deducted or can deduct it'.

On the facts of the case, and having particular regard to the Rules, the costs incurred in respect of the rights held by members upon joining the association are not the costs of acquisition, but 'costs of owning' (specifically, 'maintaining') that asset. That is, the weekly contributions made by a member under the Rules form part of the third element (rather than the first element) of the cost base. Therefore they must be excluded from the cost base calculation if they have been, or can still be, deducted.

The weekly contributions are deductible under section 8-1 given their connection to the members' gaining or producing of assessable income. This is consistent with the broad view taken by the Commissioner in respect of fees incurred for membership of professional associations.

Pursuant to subsection 110-40(2), these expenses will not form part of the cost base of the asset to the extent that X has deducted or can deduct it.

X has not claimed a tax deduction for the expenses. They will therefore form part of the cost base of the asset, but only to the extent that they cannot still be deducted (for example, if they are prevented by the expiry of amendment periods): Taxation Determination TD 2005/47.

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