Edited version of private advice

Authorisation Number: 1051805848961

Date of advice: 18 February 2021

Ruling

Subject: Income tax exemption and tax status

Question 1

Is the State of Australia acting through the Minister for Lands as a body corporate under an Act and the Minister for the Environment (the State) subject to Commonwealth income tax in relation to:

(a)  statutory income that might otherwise be included in assessable income as a beneficiary of the Project Trust (the Trust) under Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936), Division 115 or Division 207 of the Income Tax Assessment Act 1997 (ITAA 1997)?

(b)  does the answer change if an appointment of distributable income made in favour of the State remains unpaid?

Answer

(a) No.

(b) No.

Question 2

Will the trustee of the Project Trust (the Trust) be assessed and liable to pay tax on the Trust's net income under section 99A of the ITAA 1936 if no beneficiary has been made presently entitled to part or all of the distributable income of the Trust?

Answer

Yes.

Question 3

Is Project Owner subject to income tax on its share of the Trust's net income under section 97 of the ITAA 1936 if any part of the distributable income of the Trust to which the Project Owner is presently entitled remains unpaid at the consent of Project Owner?

Answer

Yes.

Question 4

Is the trustee of the Trust or any beneficiary entitled to a refund of excess franking credits under Division 67 of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

Year ending 30 June 2024

Year ending 30 June 2025

Year ending 30 June 2026

Year ending 30 June 2027

Year ending 30 June 2028

Year ending 30 June 2029

Year ending 30 June 2030

Year ending 30 June 2031

Year ending 30 June 2032

Year ending 30 June 2033

Year ending 30 June 2034

Year ending 30 June 2035

Year ending 30 June 2036

Year ending 30 June 2037

Year ending 30 June 2038

Year ending 30 June 2039

Year ending 30 June 2040

Year ending 30 June 2041

Year ending 30 June 2042

Year ending 30 June 2043

Year ending 30 June 2044

Year ending 30 June 2045

The scheme commences on:

30 September 2020

Relevant facts and circumstances

The Project Owner will be establishing and operating a mine, and a waste repository in a State of Australia (Project).

The Project has three phases. During the first phase, the operational phase of the project, the Project Owner will periodically contribute funds to a trust (Trust). Payment of funds into the Trust, and parties' entitlement to funds from the Trust will be governed by a Deed.Trust funds will be invested by a trustee pursuant to a Trust Deed.

The Project Owner and the State are to be the beneficiaries of the Trust. During the operational phase the only parties presently entitled to funds from the Trust will be the State.

During the second phase of the project, the parties entitles to funds from the Trust will be the State, for the certain specified purposes, and the Project Owner. The entitlement of the Project Owner to funds during the second phase is set out in an attachment to the Deed.

During the third phase of the project, the parties entitled to funds from the Trust will be the State only.

Amounts distributed to the beneficiaries of the Trust may comprise distributions of the capital (corpus) of the Trust and/or income of the Trust.

The State will be presently entitled to any distributable income of the Trust not distributed to the Project Owner (stated in the Trust Deed). The State will direct the Trustee to apply that distributable income on behalf of the State as an accretion to the corpus of the Trust. It is possible that a distribution to the State may occur without the direction applying, for example, where the State is required to step in to undertake work the Project Owner has not performed.

The Trust Deed allows the Trustee to determine that the default present entitlement provisions do not apply.

Relevant legislative provisions

Section 114 of Commonwealth of Australian Constitution Act 1901

Division 1AB of Income Tax Assessment Act 1936

Section 24AK of Income Tax Assessment Act 1936

Section 24AQ of Income Tax Assessment Act 1936

Section 24AR of Income Tax Assessment Act 1936

Division 6 of Income Tax Assessment Act 1936

Section 95 of Income Tax Assessment Act 1936

Section 97 of Income Tax Assessment Act 1936

Section 98 of Income Tax Assessment Act 1936

Section 99 of Income Tax Assessment Act 1936

Section 99A of Income Tax Assessment Act 1936

Section 36-50 of Income Tax Assessment Act 1997

Division 67 of Income Tax Assessment Act 1997

Division 115 of Income Tax Assessment Act 1997

Division 207 of Income Tax Assessment Act 1997

Section 7 Land Administration Act WA 1997

Reasons for decision

Question 1

Summary

This State of Australia has immunity from Commonwealth income tax laws under the Australian Constitution and the body corporate (should it not also have such immunity) is an income tax exempt entity.

Detailed reasoning

Absent income tax exemption, a beneficiary of a Trust might be assessable on various amounts of statutory including those worked out under:

-   Division 6 of Part III of the ITAA 1936;

-   the rules that relate to franked distributions in Division 207; and/or

-   the rules that relate to capital gains in Division 207.

Division 6 of Part III of the ITAA 1936 concerns inter alia the taxation of a beneficiary's share of a trust's taxable income (section 97 of the ITAA 1936) except for amounts dealt with by Division 207 of the ITAA 1997.

A trust's taxable income is its 'net income' as worked out under section 95 of the ITAA 1936.

The relevant share in the context of section 97 of the ITAA 1936 is determined by reference to the beneficiary's proportionate entitlement to the trust's distributable income (that is, its share of trust income for trust law purposes).

These concepts are explained further in the 'detailed reasoning' for question 3.

In the context of Division 207 of the ITAA 1997, the amount to be included in assessable income of the beneficiary depends upon whether or not the beneficiary has been made specifically entitled to the distribution. Special rules in either case determine the amount to be included by the beneficiary in assessable income (including the franking credit component in the case of a franked distribution).

In the present circumstances, the Deed stated during the operational phase, the State is the only party presently entitled to funds from the Trust. In addition, the State will direct the Trustee to apply that distributable income on behalf of the State as an accretion to the corpus of the Trust. Consequently, the standing payment direction made by the State and the reinvestment made in accordance with that direction is the payment of funds from the Trustee to the State and the reinvestment by the State of those funds in the capital of the Trust.

The State acting through both the Minister for Lands (in the capacity of a body corporate wholly owned by government) and the Minister for Environment are the named beneficiaries in the Project Trust Deed.

Section 114 of the Australian Constitution prohibits the Commonwealth from imposing any tax on property, of any kind, belonging to a State and provides as follows:

Section 114

States may not raise forces. Taxation of property of Commonwealth or State

A State shall not, without the consent of the Parliament of the Commonwealth, raise or maintain any naval or military force, or impose any tax on property of any kind belonging to the Commonwealth, nor shall the Commonwealth impose any tax on property of any kind belonging to a State.

Therefore, the State has immunity from Commonwealth income tax. It does not matter what class of statutory income to which the State might in theory otherwise be assessable as a beneficiary of a Trust, the State is not subject to Commonwealth income tax laws.

In the event the body corporate in this instance does not also enjoy immunity from Commonwealth income tax under section 114 of the Commonwealth Constitution, the rules in Division 1AB of the ITAA 1936 apply.

Section 24AK of Division 1AB of the ITAA 1936 states that a State/ Territory body (an STB) is exempt from income tax unless it is an excluded STB. Sections 24AO to 24AS of the ITAA 1936 set out the five alternate tests by which a body may be regarded as an STB. Relevant to whether a body corporate is an STB are the provisions in section 24AQ and section 24AR of the ITAA 1936. Each of these provisions is discussed below:

Section 24AQ of the ITAA 1936

For the Entity to be an STB under section 24AQ of the ITAA 1936, it must meet all of the following requirements:

(a)  be established by State or Territory legislation; and

(b)  not be a company limited solely by shares; and

(c)   the legislation gives the power to appoint or dismiss its governing person or body only to one or more government entities.

The body corporate here meets the first and second requirements of section 24AQ of the ITAA 1936, as set out above. It was established under the relevant Act (the Act) It does not have directors, members or shareholders, and it is not a company limited by shares.

Paragraph (c) of section 24AQ of the ITAA 1936 uses the term 'government entities'. Under section 24AU of the ITAA 1936, where the power to appoint, dismiss or direct the governing body of an entity is given to a Governor of a State, a Minister of the Crown or a State or Territory, or the head of a Department of a State or Territory the power is taken to be held by a government entity for the purposes of sections 24AQ, 24AR and 24AS of the ITAA 1936.

In the present circumstances, section 7 of the the Act provides that the Minister for Lands is an agent of the Crown in right of the State and enjoys the status, immunities and privileges of the Crown.

As such, the third requirement of section 24AQ is also satisfied as the power to appoint or dismiss is held by the State.

As all of the requirements in section 24AQ are satisfied, the body corporate qualifies as an STB under this test.

Section 24AR of the ITAA 1936

For the entity to be an STB under section 24AR of the ITAA 1936, it must meet all of the following requirements:

(a)       be established by State or Territory legislation; and

(b)       not be a company limited solely by shares; and

(c)       the legislation gives the power to direct its governing person or body as to the conduct of its affairs only to one or more government entities.

The entity meets the requirements of the first and second requirements of section 24AR of the ITAA 1936 as set out in paragraphs (a) and (b) above, for the same reasons set out in the above discussion on section 24AQ of the ITAA 1936.

Paragraph (c) of section 24AR of the ITAA 1936 refers to the power to direct the conduct of the affairs of the governing body by a government entity/entities.

In the Explanatory Memorandum to Taxation Laws Amendment Bill (No.2) 1995 at paragraph 1.17, it is explained that it is not necessary that the power to direct the conduct of affairs be a specific power to give operational directions, as a more general power of direction concerning the conduct of the body's affairs is sufficient.

In the circumstances here, power is given to the Minister under Section 7 and Section 10 of the Act, and so the Minister, a government entity has the power to direct the conduct the entity's affairs meaning the third requirement of section 24AR of the ITAA 1936 is also met.

Consequently, as all of the requirements in section 24AR of the ITAA 1936 are satisfied, the body corporate also qualifies as an STB under this alternative test.

An excluded STB is defined in section 24AT of the ITAA 1936 to be as follows:

excluded STB means an STB that:

(a)  at a particular time, is prescribed as an excluded STB in relation to that time; or

(b)  is a municipal corporation or other local governing body (within the meaning of section 50-25 of the Income Tax Assessment Act 1997 ); or

(c)   is a public educational institution to which any of paragraphs 50-55(1)(a) to (c) of the Income Tax Assessment Act 1997 applies; or

(d)  is a public hospital to which any of paragraphs 50-55(1)(a) to (c) of the Income Tax Assessment Act 1997 applies; or

(e)  is a superannuation fund.

The body corporate here does not fall into any of these excluded categories and so does not meet the definition of an excluded STB.

As all the requirements in section 24AK of the ITAA 1936 are satisfied and the body corporate is not an excluded STB within the meaning of section 24AT of the ITAA 1936, it is income tax exempt under section 24AM of the ITAA 1936.

Question 2

Summary

The trustee of the Trust will be assessed and liable for taxation on the Trust's net income under section 99A of the ITAA 1936 if no beneficiary has been made presently entitled to the distributable income of the Trust.

Detailed reasoning

A trustee will be assessed and liable to taxation on its net income under section 99A of the ITAA 1936 if there is no beneficiary presently entitled to any part of the trust's distributable income, or where there is a part of that income to which no beneficiary is so entitled.

Therefore, if the State and the Project Owner as beneficiaries of the Trust have not been made presently entitled to all or part of the distributable income of the Trust, the Trustee shall be assessed and liable for taxation on its net income as provided for under section 99A of the ITAA 1936.

Question 3

Summary

The Project Owner is subject to income tax each year under section 97 of the ITAA 1936 on its share of the Trust's net income.

Section 97 operates regardless of whether or not a present entitlement to distributable income has been paid.

Detailed reasoning

Under section 97 of the ITAA 1936, a beneficiary who is not under a legal disability and presently entitled to a share of the 'income of the trust estate' is assessed on 'that share' of the trust's taxable income worked out under section 95 of the ITAA 1936. That taxable income is referred to as the 'net income' of the trust estate.

In considering the meanings to be given to 'income of the trust estate' and 'share', the High Court clarified in Commissioner of Taxation v Bamford and Ors; Bamford and Anor v Commissioner of Taxation [2010] HCA 10; 240 CLR 481 (Bamford) that:

● 'income of the trust estate' in section 97 of the ITAA 1936 refers to the distributable income of the trust as determined according to trust law and in accordance with the deed; and

● 'share' means 'proportion' such that once the share of the distributable income of the trust to which the beneficiary is presently entitled is determined, the beneficiary is assessed on that same percentage share of the trust's net income as defined in section 95 of the ITAA 1936.

The High Court also found that a trustee resolution, made under a power in the trust instrument, to treat a capital receipt as income was effective to treat the capital receipt as income of the trust estate for the purposes of section 97 of the ITAA 1936.

Taxation Determination TD 2012/22 Income tax: for the purposes of paragraph 97(1)(a) of the Income Tax Assessment Act 1936 (ITAA 1936) is a beneficiary's share of the net income of the trust estate worked out by reference to the proportion of the income of the trust estate to which the beneficiary is presently entitled? provides the ATO's view on the application of the 'proportionate approach' to the assessment of trust net income.

A beneficiary is presently entitled to a share of distributable income if:

● the beneficiary has an interest in the income which is both vested in interest and vested in possession, and

● the beneficiary has a present legal right to demand and receive payment of the income, or to have the payment applied for the benefit, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.[1]

Section 97 of the ITAA 1936 operates regardless of whether or not a present entitlement to distributable income has been paid or otherwise discharged.

Question 4

Summary

Where the franking credits of the Project Owner exceed its tax liability, the excess franking credits are not refundable. Rather, the excess franking credit is converted to a tax loss that can be deducted against income in later years.

In the circumstances here, neither the State nor the body corporate are entitled to a refund of franking credits.

Detailed reasoning

The rules concerning refund of excess franking credits (being tax offsets) are contained in Division 67 of the ITAA 1997.

Trustee assessed under section 98 or section 99A ITAA 1936

Where a trustee is entitled to a tax offset under Division 207 because a franked distribution flows indirectly to the trustee and the trustee is liable to be assessed under section 98 or section 99A on a share of, or all or a part of, the trust ' s net income for that income year, the tax offset is not subject to the refundable tax offset rules (subsection 67-25(1B)).

Corporate tax entities

Generally, where a corporate tax entity is entitled to a tax offset under Division 207 because a franked distribution is made to it or flows indirectly to it, the tax offset is not subject to the refundable tax offset rules (subsection 67-25(1C), (1D)). An entity is a "corporate tax entity" at a particular time if:

(1) the entity is a company at that time, or

(2) the entity is a corporate limited partnership, corporate unit trust or public trading trust in relation to the income year in which that time occurs (s 960-115: 762-220).

However, the tax offset is subject to the refundable tax offset rules if:

(1) the entity is an " exempt institution that is eligible for a refund " within the meaning of s 207-115.

Broadly, this refers to: (i) a resident exempt entity covered by item 1.1, 1.5, 1.5A or 1.5B of the table in s 50-5 (i.e. a charitable institution or trust fund) and endorsed by the Commissioner as exempt; (ii) a resident gift deductible recipient (i.e. an institution named in Subdivision 30-B that has an ABN or an institution endorsed as such); (iii) a public fund declared by the Treasurer to be an international relief fund but not where its eligibility is denied by regulation; or (iv) an institution prescribed by the regulations as eligible for a tax offset refund.

None of the beneficiaries of the Trust are eligible for a refund of excess franking credits under these rules.

Conversion of excess franking credits to a tax loss

Section 36-50 of the ITAA 1997 states:

Amounts of tax offsets to which a corporate tax entity is entitled under Division 207 and Subdivision 210-H may in some circumstances be converted into an amount of a tax loss for the entity.

Generally, where an entity's franking credits exceed its tax liability a corporate tax entity may be able to be convert the excess franking credits to tax losses that can be deducted against taxable income. The relevant entity will need to determine whether this is applicable to their particular circumstances.

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