Edited version of private advice

Authorisation Number: 1051965966933

Date of advice: 31 March 2022

Ruling

Subject: Public trading trusts

Question

Will a Lot Owner control the affairs and operations of the Committee for the purposes of paragraph 102N(1)(b) of the Income Tax Assessment Act 1936?

Answer

No

This ruling applies for the following periods:

Income tax year ending 30 June 20XX

Income tax year ending 30 June 20XX

Income tax year ending 30 June 20XX

Income tax year ending 30 June 20XX

Income tax year ending 30 June 20XX

The scheme commences on:

30 June 20XX

Relevant facts and circumstances

In 20XX, parcels of land (referred to as 'Lots'), were purchased by several entities ('Lot Owners'). The land was redeveloped into an office, retail, and community space referred to as the Commercial Estate.

Each Lot Owner has purchased a separate identifiable interest in the property (each individual 'Lot').

Some of the entities are Australian residents and are public unit trusts for the purposes of Division 6C of the Income Tax Assessment Act 1936 (ITAA 1936).

The Lots

The Lots are leased for retail, office, and community use.

Lots are linked together by roads and other access ways and include open space and recreation areas used by the Lot Owners.

Lots are insured by each Lot Owner individually.

The Common Space

The Common Space is comprised of several lots.

Insurance over the Common Space is procured by the Committee (see paragraphs 13 to 17 of the Relevant Facts and Circumstances for an explanation of the Committee) on behalf of the Lot Owners.

Management Contract

The Common Space and its fixtures are managed according to the terms of a Management Contract.

The Lot Owners are parties to the Management Contract.

The aim of the Management Contract is to ensure:

•              the Commercial Estate is operated as a single estate for the benefit of the community and the Lot Owners

•              the Lot Owners have a right to use and access the Common Space and its fixtures under a non-exclusive licence

•              arrangements have been made concerning the caretaking, management, maintenance, and operational services of the Common Space

•              costs of repair, maintenance, renewal and replacement of all Common Space fixtures are fairly apportioned.

The Lot Owners' obligations under the Management Contract are several and not joint. Each Lot Owner is responsible for the Lot Owner's own acts and those of that Lot Owner's representative.

The Committee

The Management Contract established a 'Committee' to make decisions in relation to the ongoing operation and maintenance of the Common Space and its fixtures.

The Committee is not incorporated as a company under the Corporations Act 2001. The Committee does not enter into contracts and it does not hold assets in its own name.

Each Lot Owner must remain a member of the Committee and must each appoint a natural person as its representative on the Committee.

The functions of the Committee are to operate and maintain the Common Space and its fixtures. This includes functions relating to procuring any services needed in relation to the Common Space and its fixtures, monitoring compliance of the parties to the management contract and managing income-producing activities undertaken in the Common Space.

The Committee, by the representatives, may do anything on the Common Space that a Lot Owner should have done under any applicable law or the Management Contract, and in the opinion of the Committee, acting reasonably, a Lot Owner has not done or not done properly, after having provided the relevant Lot Owner with notice and the relevant Lot Owner has still not rectified the failure within a reasonable time.

The Manager for the Common Space

A Manager for the Common Space is appointed to perform administrative and book-keeping functions and manage the operation and maintenance of the fixtures of the Common Space.

X Co has been appointed as the Manager. The Manager will enter into a separate manager agreement.

The manager agreement must be signed by the Lot Owners and the appointed Manager.

The duties of the Manager will include supervising the operation and maintenance of the Common Space fixtures, engaging contractors, and managing finances.

Committee Decisions

Decisions are made by the casting of votes.

A Lot Owner's voting rights are determined by mathematical formula based on their lot size.

The voting percentages changed with a number lot ownership transfers in recent years.

All decisions are made by either unanimous resolution, special resolution or majority resolution, depending on the nature of the decision.

The Committee holds meetings to decide on matters relating to the approval of the budget, the management of funds, use and maintenance of the Common Space and its fixtures, and the appointment of the Manager for the Common Space.

If a decision is not made, the matter is resolved in accordance with a set dispute resolution process, which involves a staged process that commences with negotiation between the parties and concludes with the appointment of an independent expert to determine the outcome should negotiations fail.

Costs associated with the Common Space

Currently, the costs of the Common Space and its fixtures are met by way of a financial contribution from each Lot Owner into a pooled Fund.

The Fund covers all costs relating to the security, maintenance and management of the Common Space and its fixtures.

The Committee must establish and maintain a bank account for the Fund in the name of the Manager and deposit all contributions and other money received by the Committee into the Fund. The Committee may only withdraw the money from the account to pay for things allowed by the Management Contract. Any interest earned on the account must be credited back to the relevant bank account and allocated to the Lot Owners.

Any income generated by the facilities or areas of the Common Space is deposited into the Fund.

The Committee must procure that the Manager prepares a financial statement containing details of all income arising from the Common Space during the 12-month period immediately preceding a Committee meeting, and which allocates the income to each Lot Owner in accordance with that Lot Owner's percentage holding.

The income generated by the Common Space is offset against each Lot Owner's next contribution to the pooled Fund.

If there is any surplus money in the Fund at the end of a budget period, the Committee must procure that the surplus of the relevant party or parties' contribution is distributed to the relevant party or parties or reinvest the surplus money into the Fund.

It is not expected that the Committee will ever make distributions to the Lot Owners. If they were made, they would be made according to their percentage entitlement.

The Lot Owners are considering trying to break even on the costs associated with the Common Space and its fixtures by using the Common Space as an income producing venue. The intention is to offset the cost of managing the Common Space to reduce the contributions required by Lot Owners and to enhance the attractiveness of the Commercial Estate to potential tenants.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 Division 6C

Income Tax Assessment Act 1936 paragraph 102N(1)(b)

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question

Will a Lot Owner control the affairs and operations of the Committee for the purposes of paragraph 102N(1)(b) of the Income Tax Assessment Act 1936?

Summary

No, a Lot Owner will not control the affairs and operations of the Committee for the purposes of paragraph 102N(1)(b) of the Income Tax Assessment Act 1936.

Detailed reasoning

This ruling considers only whether a Lot Owner will control the affairs and operations of the Committee for the purposes of Division 6C of Part III of the Income Tax Assessment Act 1936 (ITAA 1936). This ruling does not consider:

•                whether the Committee is conducting a trading business, or

•                whether a Lot Owner is itself conducting a trading business.

A trust that falls within the scope of Division 6C of Part III of the ITAA 1936 is treated as a corporate tax entity and is taxed as though it were a company, rather than a trust.

To fall within the ambit of Division 6C, a trust is required to be a:

•                public unit trust per section 102P of the ITAA 1936

•                a resident unit trust per section 102Q of the ITAA 1936 and

•                a 'trading trust' per section 102N of the ITAA 1936.

Subsection 102N(1) of the ITAA 1936 states:

(1) For the purposes of this Division, a unit trust is a trading trust in relation to a year of income if, at any time during the year of income, the trustee:

(a) carried on a trading business; or

(b) controlled, or was able to control, directly or indirectly, the affairs or operations of another person in respect of the carrying on by that other person of a trading business.

Broadly, subsection 102N(1) of the ITAA 1936 outlines two circumstances under which a trust will be considered a 'trading trust'. These are:

•                where the trustee carries on a trading business, or

•                where the trustee controls (directly or indirectly) the affairs and operations of another person that conducts a trading business.

This ruling only considers if paragraph 102N(1)(b) of the ITAA 1936 is satisfied.

Paragraph 102N(1)(b) of the ITAA 1936, requires the trustee to control, directly or indirectly, the 'affairs or operations of another person' [emphasis added]. A 'person' is defined in subsection 6(1) of the ITAA 1936 to have the same meaning as in the Income Tax Assessment Act 1997 (ITAA 1997). Subsection 995-1(1) of the ITAA 1997 defines 'person' as including a 'company'.

As set out in the Relevant facts and circumstances, the Committee is not incorporated as a company under the Corporations Act 2001. The Committee does not enter into contracts and it does not hold assets in its own name.

The Applicant has contended that the Committee does not have affairs and operations that are separate to the affairs and operations of its members. It does not have any assets or business affairs because it does not exist as a legal entity and is not deemed by any taxation laws to have such things.

It is agreed that the Committee does not exist as a company in a strict legal sense. The Committee does, however, exist as a 'company' for tax purposes.

Pursuant to section 995-1 of the ITAA 1997, a 'company' is defined more broadly than an incorporated entity for Australian tax purposes. Section 995-1 of the ITAA 1997 defines company to include a body corporate, or any other unincorporated association or body of persons, but does not include a partnership or a non-entity joint venture.

The term 'body of persons' is not defined in Australia's income tax legislation, however paragraph 44 of Miscellaneous Taxation Ruling MT 2006/1: The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number provides that the "...phrase 'any other unincorporated association or body of persons' is not defined and takes its meaning from the general law. It should be read as a whole, that is, the word 'unincorporated' qualifies both the terms 'association' and 'body of persons'."

MT 2006/1, at paragraph 47, goes on to state that "Broadly, an unincorporated association or body of persons may be seen as consisting of a group of persons who associate to achieve a common aim or purpose and who are bound by mutual obligations and rights."

The Lot Owners are a group of entities that own or lease the Lots in the Commercial Estate, and as a result have a common interest in the Common Space and its fixtures. The creation of the Management Contract and the establishment of the Committee reflects the shared intention of the Lot Owners to operate the development property as a coherent precinct estate. As such, the Committee can be considered a body of persons (comprising all the Lot Owners), that, pursuant to the terms of the Management Contract, contribute to costs and approve decisions relating to a common matter, that is, the ongoing operation and maintenance of the Common Space and its fixtures. Consequently, the Committee is a 'company' for tax purposes, and a 'person' for the purposes of paragraph 102N(1)(b) of the ITAA 1936.

It is not entirely clear what characteristics, or features, are attributed to the Committee as a result of it being deemed to be a company. Taxation laws are silent regarding whether a deemed company holds assets or enters into contracts, and Division 6C of Part III of the ITAA 1936 does not specify whether a deemed company has affairs and operations separate from those of its members for the purposes of paragraph 102N(1)(b) of the ITAA 1936.

In ATO Interpretative Decision ATOID 2009/134 Capital Works: your area - tax law partnership it was considered that the creation of a tax law partnership when persons are co-owners of income producing property does not 'deem' the ownership of these assets onto the partnership for the purposes of Division 40 or Division 43 of the ITAA 1997. Rather, it is each entities' individual ownership in the asset that causes it to fall within the scope of Division 43. This indicates that the deeming provisions that create tax law entities do not go so far as to deem the assets of the entities to be 'owned' by the deemed entity.

Goods and Services Tax Ruling GSTR 2004/6 Goods and Services Tax: tax law partnerships and co-owners of property states at paragraph 64 that the mere existence of a tax law partnership does not necessarily mean it will be carrying on an enterprise for GST purposes. Instead, the enterprise may be carried on by each co-owner individually and not by the partnership. The following indicia (among others) support the conclusion that an enterprise is not being carried on by the partnership:

•                Each co-owner makes independent decisions with regard to the acquisition of an interest in income producing property.

•                Each co-owner's acquisition of their interest in property is made separately.

•                The co-owners act independently of each other in making decisions about their respective investments.

•                Each co-owner does not act for the mutual benefit or on behalf of the other co-owners and is primarily concerned with securing an enhanced value or return on their investment.

•                The property is held as tenants in common, rather than joint tenants.

Many of these factors are satisfied by the Committee:

•                Each Lot Owner has purchased a separate identifiable interest in the property (each individual 'Lot').

•                Each Lot Owner is able to make their own decisions about their Lot and cast their own vote (which reflects their view) on decisions related to the Common Space.

•                Each Lot Owner aims to run the Common Space and its fixtures to make the Commercial Estate an attractive place to work, shop and spend time in for the public, thereby improving their returns on their own investment.

ATOID 2009/134 and GSTR 2004/6 suggest that a deemed entity does not necessarily hold its own assets or conduct an enterprise. Given the broad definition of 'affairs and operations', it is open to conclude that although the Committee exists as a deemed company, it does not automatically follow that it has its own affairs and operations for the purpose of paragraph 102N(1)(b) of the ITAA 1936.

Paragraph 102N(1)(b) of the ITAA 1936 was designed to be a safeguarding provision against public unit trusts that attempted to avoid the application of Division 6C of Part III of the ITAA 1936 by controlling a separate trading business, rather than conducting the trading activities itself. The purpose of section 102N of the ITAA 1936 was discussed by Logan J in the Trustee for the Michael Hayes Family Trust v Commissioner of Taxation [2019] FCA 426 (Michael Hayes). At [106], Logan J commented that section 102N 'looks to be an integrity measure' and quoted the following portion of paragraph 85 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No 4) 1985:

Paragraph (b) of section 102N is a safeguarding provision against arrangements to circumvent the operation of Division 6C by having activities that would constitute a trading business of a public unit trust carried on by an associated entity. By taking income from the associate in the form of eligible investment income, the trustee could otherwise ensure that the relevant trust did not qualify as a trading business and so avoid the operation of Division 6C.

By paragraph (b), a unit trust will be a trading trust in a year of income if, at any time during the year, the trustee of the unit trust was in a position to control the affairs or operations of another person (i.e., the associated entity) in respect of the carrying on by that person of a trading business.

In that case, Logan J accepted that the MJH Rural Trust, as a partner of the partnership, carried on a trading business in common with other partners, and the trustee of the MJH Trading Trust controlled the affairs or operations of the MJH Rural Trust. This decision protected the integrity of Division 6C of the ITAA 1936 by looking through a deemed entity where the deemed entity is interposed and the control is manipulated to circumvent the operation of Division 6C of the ITAA 1936.

While the circumstances in this ruling are distinguishable from Michael Hayes in that the latter dealt with a partnership rather than an unincorporated body of persons, both the partnership in Michael Hayes and the Committee in this case are not legal entities but are treated as such under the taxation laws.

Given the observations made by Logan J in Michael Hayes, it is considered that in the circumstances, a decision that is consistent with the underlying purpose of the law would provide the most appropriate outcome.

When considered in the context of the purpose of section 102N of the ITAA 1936, the structure of the Commercial Estate and the formation of the Committee do not appear to fit within the type of arrangement that is intended to be caught by Division 6C of Part III of the ITAA 1936. The common areas of any jointly owned buildings require management by the owners who would conduct these activities. The scale of the Commercial Estate is such that multiple owners are involved, and for administrative ease a Committee has been established by the Lot Owners to facilitate these activities rather than each Lot Owner undertaking these activities individually. A clear nexus between the Committee's actions and the Lot Owner's primary business can be established. The aim of the Committee is to ensure consistency in the operation of the common areas so as to maximise the rental returns of the Lot Owners. As a result, the actions undertaken by the Committee are a natural and necessary incidence of owning a lot in a large-scale commercial building for lease and as such, can be viewed as an extension of the Lot Owners' activities. The Committee's actions, therefore, are an extension of the Lot Owners' affairs and operations and a necessary consequence of the Lot Owners' owning their Lot(s) or entering into their leases in the Commercial Estate, and not its own affairs and operations.

Conclusion

Given the Committee does not have its own affairs and operations, a Lot Owner in this case cannot be considered to 'control, directly or indirectly, the affairs and operations of another person in respect of the carrying on by that other person of a trading business' pursuant to paragraph 102N(1)(b) of ITAA 1936.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).