Edited version of private advice

Authorisation Number: 1052003299121

Date of advice: 8 July 2022

Ruling

Subject: Income tax exemption - scientific institution

Question

Is the total ordinary and statutory income of the entity exempt from income tax, in accordance with section 50-1 of the Income Tax Assessment Act 1997 (ITAA1997) as an entity described in item 1.3 of section 50-5 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

22 November 20XX to 22 November 20XX

The scheme commences on:

22 November 20XX

Relevant facts and circumstances

Background

1.   The entity has previously been issued with a private ruling confirming its income tax exemption status under section 50-1 of the ITAA 1997 because it is a scientific institution pursuant to item 1.3 of section 50-5 of the ITAA 1997.

2.    The entity wishes to confirm the continuance of this status with a with a new private ruling with specific reference to whether it satisfies the requirements to incur its expenditure and pursue its objective "principally" in Australia, pursuant to section 50-55 of the ITAA 1997, having regard to its activities overseas pursuant to a contract with a government department.

Key facts

3.    The entity is an Australian government-owned public company limited by guarantee having its registered office in the ACT.

4.    Its members are government departments and authorities.

5.    The entity is a resident of Australia for income tax purposes and has a 30 June financial reporting year end.

6.    The entity is not registered as a charity with the Australian Charities and Not-for-Profits Commission (ACNC).

Objects

7.    The entity is a leading government owned, not-for-profit company supporting the environmentally sustainable management of a resource in Australia and around the world.

8.   The objects for which the entity is established are set out in its Constitution and is broadly to support the environmentally sustainable use of the resource in Australia and around the world. Activities undertaken to achieve the Objects includes, but is not limited to:

•         Developing and supplying software, and other technologies

•         Providing support to users to set up, further develop and apply software

•         Research, education and training required to maintain and improve software and software application capability

•         Providing advice to public and private organisations

•         Continuing any of the activities of its predecessors, including developing and supplying intellectual property

•         Any other activities reasonably required to meet the objects of the company.

9.   The Constitution specifies that the income and property of the entity will only be applied in furtherance of the objects and no portion shall be distributed directly or indirectly to the members of the entity except bona fide compensation for services rendered or expenses incurred on behalf of the entity.

10.         The Constitution's wind-up clause specifies, the members will approve by special majority vote the transfer of any surplus assets remaining after payment of the debts and liabilities of the entity to an organisation with similar purposes, which are not carried on for the profit or gain of its individual members. If the members cannot reach special majority agreement the matter should be determined by the president of the Law Society of the ACT.

11.         The Constitution allows payment of remuneration to directors who are appointed by government members.

Activities

12.  The entity's operations are segregated into two distinct business divisions under its strategic governance and oversight:

•         X Division - responsible for the operational delivery of the software business. This includes the delivery of products and services.

•         Y Program - responsible for the delivery of a government contract to establish and manage a program to enhance the sustainable management of a resource in a particular region. Most activities occur overseas, particularly in the region.

13.  The entity has developed tools, products, and services to support its objective of sustainable resource management.

14.  Free versions are available via the internet to educators, researchers and technical practitioners in Australian and around the world.

15.  The entity also completes focused R&D projects. The results are published on its website.

16.  The Government has funded the Y Program to achieve its development outcomes in the region. The contract stipulates that any unspent funds at the termination or end of the contract are required to be returned. The entity has at all times complied with all the substantive requirements of its governing rules and the entity has applied all its income and assets solely for the purposes of which it was established.

17.  For accounting purposes, the entity maintains separate accounting records and prepares financial statements with respect to its activities relating to the government contract. The entity provided financials for 20XX, 20XX, 20XX and 20XX.

18.  According to Y Program's annual reports (as a division of the entity) for the years ended 30 June 20XX, 20XX, 20XX and 20XX, expenses incurred in connection with performing its services under the contract equalled the amount recognised as income (i.e., the entity did not recognise any profit or gain from the services performed under the contract).

19.  The entity has confirmed that it did not incur any expenditure outside Australia except for the expenditure that related to the contract. The only payment made by the entity to a supplier located outside of Australia was software subscription fees of approximately $X per annum. The entity has confirmed that the relevant software subscription fees were incurred for the entity's Australian operations and did specifically relate to the Y Program. The decision to pay was made in Australia, and the payment was made from the entity's Commonwealth Bank of Australia account.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 50-5 item 1.3

Income Tax Assessment Act 1997 Section 50-55

Income Tax Assessment Act 1997 Section 50-75

Income Tax Assessment Act 1997 Division 995

Income Tax Assessment Act 1997 Section 995-1

Australian Charities and Not-for-profits Commission Act 2012 Subsection 25-5(5)

Charities Act 2013 Section 5

Charities Act 2013 Section 11

Charities Act 2013 Section 12

Reasons for decision

The statutory framework

Section 50 of the ITAA 1997 provides an exemption from income tax for the ordinary and statutory income of specified entities. The items in the table in section 50-5 of the ITAA 1997 refer to organisations whose primary purpose is charity, education, science or religion and notes special conditions which must be met for the exemption to apply, including section 50-47 which is applicable to all items. Specifically, section 50-1 of the ITAA 1997 exempts the ordinary income and statutory income of a scientific institution as described in item 1.3 of section 50-5 of the ITAA 1997, subject to special conditions set out in section 50-55 of the ITAA 1997. Subsection 50-55(1) of the ITAA 1997 states that an entity covered by item 1.3 is not exempt from tax unless the entity:

(a) has a physical presence in Australia and, to that extent, incurs its expenditure and pursues its objectives principally in Australia; or

(b) is an institution that meets the description and requirements in item 1 of the table in section 30-15; or

(c) is a prescribed institution which is located outside Australia and is exempt from income tax in the country in which it is resident;

and the entity satisfies the conditions in subsection (2).

Note: Certain distributions may be disregarded: see section 50-75 of the ITAA 1997.

Subsection 50-55(2) states the entity must:

a. comply with all the substantive requirements in its governing rules; and

b. apply its income and assets solely for the purpose for which this entity is established.

Section 50-75 of the ITAA 1997 provides rules for the purposes of determining whether an institution incurs its expenditure and pursues its objectives principally in Australia for the purposes of paragraph 50-55(1)(a) of the ITAA 1997. In this regard, for the purposes of determining whether an institution incurs its expenditure and pursues its objectives principally in Australia, section 50-75 of the ITAA 1997, broadly, applies to 'disregard' any amount received by an institution by way of a government grant.

Scientific institution requirements

'Institution'

The term 'institution' is not defined in the ITAA 1997 and therefore has its ordinary meaning, as explained in case law. The Court in Mayor of Manchester v McAdam (1896) 3 TC 491, at 497 concluded an "institution" is an 'undertaking formed to promote some defined purpose having in view generally the instruction or education of the public. It is the body (so to speak) called into existence to translate the purpose as conceived in the mind of the founders into a living and active principle.' Similarly, in Stratton v Simpson (1970) 125 CLR 138, following the approach in YMCA of Melbourne v FCT (1926) 37 CLR 351, the Court suggested that the term 'institution' should be understood in light of its ordinary meaning as 'an establishment, organisation, or association, instituted for the promotion of some object, especially one of public utility, religious, charitable, education etc.' This approach is confirmed at paragraph 8 of Taxation Ruling TR 2019/6 Income Tax: the 'in Australia' requirement for certain deductible gift recipients and income tax exempt entities. Paragraph 170 of TR 2011/4 Income tax and fringe benefits tax: charities recognises that whether an institution exists will depend on the circumstances. Relevant factors include an entity's activities, size, permanence and recognition.

In this case, the entity is incorporated as a public company limited by guarantee. The entity has nine members, comprising various government departments and authorities and it works towards the common goal achieving its objects pursuant to its Constitution, being the objectives of supporting the environmentally sustainable use of the resource in Australia and around the world, primarily by building capability. As such, the entity is a body of persons associated for a common purpose of promoting the environmentally sustainable use of the resource within Australia and around the world. As the resource is a public utility and recognising that the entity's Constitution requires it to achieve its objectives, at least in part, by undertaking research, education and training, as well as the development for public use of resources, the entity is an 'institution' for the purposes of Division 50 of ITAA 1997. Therefore, this requirement is satisfied.

'Scientific'

For an institution to be a scientific institution, it must be set up and operated primarily to advance science. Common ways of advancing science include research, exploration and teaching. Disseminating information will often be involved. Scientific institutions do not include organisations for the profit of their members or professional associations.

In accordance with Farmer v Juridical Society of Edinburgh (1914) 6 TC 467, whether an institution is "scientific" will be determined having regard to its objects and activities. Where the objects of an institution are partly scientific and partly professional, an institution will be "scientific" where it is mainly scientific and only incidentally professional. Based on the facts of that case, it was considered that the main objects were professional. Further, in Royal Australasian College of Surgeons v FC of T (1943) 68 CLR 436, the Court held the promotion of science must be the main, substantial or primary object of the institution for it to qualify as a scientific institution. The inclusion of an institution as scientific also depends on the intrinsic character of the object which it promotes and not upon the benefit which may result from its transaction.

The entity's objects demonstrate a focus on the creation and utilisation of technology to facilitate a resource management approach that is based on research. This is reflected in the entity's activities, with its products utilising the qualitative results of its own research to achieve their functions. The entity also completes focused R&D projects in the area. The results of which are published on its website. In addition, the results of the entity's activities are widely available to the community at large. Accordingly, the entity is a 'scientific institution' for the purposes of section 50-5 of the ITAA 1997.

Special Conditions

Physical presence in Australia

Pursuant to subsection 50-55(1), an entity is not exempt from income tax unless the entity has a physical presence in Australia and, to that extent, incurs its expenditure and pursues its objectives principally in Australia.

The term 'physical presence' is not defined in the ITAA 1997 and accordingly take its ordinary meaning. The Macquarie Dictionary Online (www.macquariedictionary.com.au), Macmillan Publishers Australia) defines the word 'physical as 'of or relating to material nature and 'presence' as 'the state or fact of being present, as with other or in a place'. Therefore, according to TR 2019/6 at paragraph 53, an entity has a physical presence in a place where it employs assets or people to conduct its range of physical operations. The entity may be legally established in Australia, or conduct its operations through a division, subdivision or branch in Australia. However, an entity would not have a physical presence in Australia merely because it operates through an agent based in Australia.

As the entity has its registered office, principal place of business and key personnel operating from its office in the ACT, it is accepted that it has a physical presence in Australia.

Incurs its expenditure and pursues its objectives 'principally' in Australia

As it has been determined that the entity

has a physical presence in Australia, it must also, to that extent, incur its expenditure and pursue its objectives principally in Australia. The words 'to that extent' require an examination of the degree to which the entity has a physical presence in Australia, as opposed to other places. Accordingly, all the entity's operations and objectives must be identified and compared. Where an entity has a physical presence in Australia only, it must incur its expenditure, and pursue its objectives, principally in Australia. Where an entity has a physical presence in Australia and also overseas, only the expenditures incurred and objectives pursued which are attributable to that entity's physical presence in Australia are examined. For example, if an entity has a physical presence in Australia through the operation of a division, the second requirement applies only to expenditure and objectives which are attributable to the Australian division.

Principally

The word 'principally' is not defined, and so carries its ordinary meaning of mainly or chiefly. While each case turns on its facts, more than 50% would ordinarily be considered to meet the 'principally' requirement.

Incurs its expenditure

The phrase 'incurs its expenditure' is not defined and so carries its ordinary meaning. Expenditure is incurred when the entity pays out or disburses money or is liable to do so. The place where an entity 'incurs its expenditure' requires a characterisation of the expenditure, based on the facts in each case. An entity does not incur expenditure in Australia merely because the expenditure relates to a physical presence of the entity in Australia. The required connection will ordinarily exist where the decision to pay is made in Australia, and payment is to occur from an Australian source, for example, an account held with an Australian financial institution.

Pursues its objectives

The phrase 'pursues its objectives' is not defined and so carries its ordinary meaning. The place where an entity 'pursues its objectives' requires a characterisation of the entity's activities, based on the facts in each case. An entity does not pursue its objectives in Australia merely because it undertakes some of its activities in Australia. An entity ordinarily pursues its objectives in the place where it seeks to realise its purposes, whether by making distributions to other entities or supplying goods or services in the course of its operations. An entity does not pursue its objectives in Australia merely because it incurs expenditure in Australia. However, the expenditure incurred by an entity may be an indication of where its objectives are being pursued.

Disregarded amounts - certain distributions may be made overseas

In determining whether an entity incurs expenditure and pursues objectives principally in Australia, section 50-75 disregards any distributions that the entity makes out of amounts (disregarded amounts) received:

•         as a gift,

•         by way of government grant, or

•         from a DGR operated by the entity.

This means that where an entity distributes disregarded amounts offshore, this will not affect whether it satisfies the Division 50 in Australia condition. In this regard, paragraph 77 of TR 2019/6 says:

The phrase 'government grants' is not defined and so takes its ordinary meaning. Government grants include payments made by government to entities for specific purposes, whether or not the entity is placed under an obligation to ensure that the grant is applied for those purposes, but do not include payments made by government by way of a fee for services.

At paragraph 78 and 79, TR 2019/6 goes on to say:

[78] When and where a gift or government grant is distributed is a question of fact, to be determined based on the circumstances in each case. [79] Section 50-75 requires an entity to determine the extent to which a distribution is sourced from an amount received by way of government grant .... For these purposes, the entity can choose to appropriate distributions from a particular source, provided it maintains records which clearly identify each source, and such a treatment is not inconsistent with any conditions attached to the gift or grant ....

Therefore, the revenue derived from the government grants can be disregarded for the purposes of determining whether the entity incurs its expenditure and pursues its objectives principally in Australia. For accounting purposes, the entity maintains separate accounting records and prepares financial statements with respect to its activities relating to the Y Program, which allows the entity to track the funds that have been disregarded under section 50-75 of the ITAA 1997. According to Y Program's annual reports (as a division of the entity) for the years ended 30 June 2018, 2019, 2020 and 2021, expenses incurred in connection with performing its services under the contract equalled the amount recognised as income (i.e., the entity did not recognise any profit or gain from the services performed under the contract). The entity has not incurred any expenditure for non-grant activities outside of Australia. The only payment made by the entity to a supplier located outside of Australia was software subscription fees of approximately $X per annum. The entity confirmed that the relevant software subscription fees were incurred for its Australian operations and did specifically relate to the Y Program. The decision to pay was made in Australia, and the payment was made from the entity's Commonwealth Bank of Australia account. Therefore, it is considered that the entity has incurred its expenditure and pursued its objectives principally in Australia.

As such, the entity satisfies the requirements of paragraph 50-55(1)(a) of the ITAA 1997.

Continuous periodic testing

To maintain Division 50 income tax exemption, an entity must continue to satisfy the Division 50 in Australia conditions, including the condition that the entity incurs its expenditure and pursues its objectives principally in Australia. Whilst the test applies continuously and requires an overall assessment of the entity's operations, it operates periodically, with a focus on the current income year. Accordingly, it may be inferred that an entity no longer incurs its expenditure and pursues its objectives principally in Australia where it chooses to incur expenditure relating to the pursuit of its objectives primarily outside of Australia in a given income year. This is discussed further in paragraphs 72 and 73 of TR 2019/6.

Comply with all substantive requirements of its governing rules

Pursuant to paragraph 9 of Taxation Ruling TR 2015/1 Income tax: special conditions for various entities whose ordinary and statutory income is exempt, the governing rules of an entity are those rules that authorise the policy, actions and affairs of the entity. That is, governing rules of an entity consist of the rules that direct:

•         what the entity is required and permitted to do, and

•         what those, who control the entity, are required and permitted to do in respect of the entity.

The 'substantive' requirements in an entity's governing rules are those rules that define the rights and duties of the entity. Pursuant to paragraph 19 of Taxation Ruling TR 2015/1, the substantive requirements in an entity's governing rules include rules such as those that:

•         give effect to the object or purpose of the entity

•         relate to the non-profit status of the entity

•         set out powers and duties of directors and officers of the entity

•         require financial statements to be prepared and retained

•         set out criteria for admission as a member of an entity

•         require an entity to maintain a register of members, and

•         relate to the winding-up of the entity.

For the purpose of paragraph 50-55(2)(a) of the ITAA 1997, the governing rules and the substantive requirements of the entity are contained in its Constitution. Based on the facts provided, the entity complies with the substantive requirements of its governing rules (i.e., Constitution) which contains, inter alia, its objects and appropriate non-profit and winding up clauses.

Apply its income and assets solely for the purpose for which it was established

According to paragraph 23 of TR 2019/6, we must consider two questions here:

•         what is the 'purpose for which the entity is established', and

•         has the entity applied its income and assets solely for the purpose for which the entity is established?

What is the 'purpose for which the entity is established'?

The 'purpose for which the entity is established' is determined by a consideration of all the features of the entity. The main factors to be considered are the objects in the entity's constituent documents, and the activities of the entity after its formation, up to the time at which the income and assets condition is applied. Other factors to consider include policies and plans, administration, finances, history and control, and any legislation governing the operation of the entity. Incidental or ancillary purposes are merely aspects of the purpose for which the entity is established. Thus, the income and assets condition will not be breached merely due to an entity having an incidental or ancillary purpose. The income and assets condition is applied on a continuous basis throughout an income year.

According to its Constitution, the entity is a not-for-profit established to support the environmentally sustainable use of a resource in Australia and around the world, primarily by building capability. It undertakes various activities to achieve its objects, including developing and supplying software and providing support to users, research, education and training and advice to organisations.

Has the entity applied its income and assets solely for the purpose for which the entity is established?

The requirement that an entity must 'apply' its income and assets means that an entity must make use of all its income and assets, solely for the purpose for which the entity is established. The income and assets condition requires an entity to apply its income and assets 'solely' for the purpose for which the entity is established. This means that the entity must exclusively or only apply its income and assets for that purpose. The income and assets condition is applied continuously throughout the income year.

The income of the entity mainly consists of income derived from the grant and software activities. The expenses of the entity are primarily incurred in respect of compensation to its workers and project operating costs. These activities directly carry out the entity's objects and therefore it is applying its income and assets solely for the purpose for which it was established. Further, the entity's Constitution prevents it from distributing profits or assets for the benefit of its individual members. As such, the income and assets condition is satisfied.

Accordingly, the entity satisfies the special conditions set out in section 50-55 of the ITAA 1997.

Section 50-47 special condition for all items

Where an entity is covered by an exempt entity category but also meets the description of an 'ACNC type of entity' (i.e.it is a 'charity'), it will not be exempt from income tax unless it is registered as a charity with the ACNC and endorsed by the ATO.

The meaning of 'ACNC type of entity' is provided in Division 995 of the ITAA 1997. Section 995-1 of the ITAA 1997 refers to column 1 of the table in subsection 25-5(5) of the Australian Charities and Not-for-profits Commission Act 2012 (ACNC Act) for the meaning of 'ACNC type of entity'. The entity type at Column 1 of the table in subsection 25-5(5) is 'charity'.

The meaning of charity is provided, for the purposes of all Commonwealth law, at section 5 of the Charities Act 2013 (CA):

'charity'means an entity:

(a)  that is a not-for-profit entity; and

(b)  all of the purposes of which are:

(i)            charitable purposes that are for the public benefit; or

(ii)           purposes that are incidental or ancillary to, and in furtherance or in aid of, purposes of the entity covered by subparagraph (i); and

(c)   none of the purposes of which are disqualifying purposes; and

(d)  that is not an individual, a political party or a government entity [emphasis added].

Section 11 of the CA concerns certain disqualifying purposes which aren't relevant here and section 12 defines 'charitable purpose' under various heads.

The entity is not registered as a charity with the ACNC.

The Commissioner has considered whether the entity might be an ACNC type of entity and has concluded in the negative because even were it within one of the heads of 'charitable purpose' in section 12 of the CA, it would nevertheless fall within the paragraph 5(d) exception to the meaning of charity; the reasons for which include that the entity's directors are appointed by Government and are eligible for remuneration under the entity's Constitution (See Re Lambie (2018) 263 CLR 601).

Conclusion

The entity satisfies all the requirements to be a scientific institution as described in item 1.3 of section 50-5 of the ITAA 1997 and therefore, its total ordinary and statutory income is exempt from income tax in accordance with section 50-1 of the ITAA 1997.

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