Edited version of private ruling

Authorisation Number: 1011667555276

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Ruling

Subject: Trust Fund

Question 1

Will the Fund be taxed as a public trading trust under Division 6C of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) for the year ended 30 June 2010?

Answer

No.

This ruling applies for the following period:

1 July 2009 to 30 June 2013

The scheme commences on:

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The following facts are taken from the application for private ruling, and the facsimiles from the applicant.

The Fund

The Fund has been established to provide benefits to a certain class of persons. The Fund received government approval of this activity effective 1 April 2003.

The Trustee is a private company. There are two groups of shareholders who own shares in the trustee company who are together (and in equal proportions) the Sponsors, and have the overriding control and responsibility for the Fund.

A principal consideration of the Trustee in administering the Fund is that the Fund satisfies the legal requirements to maintain its endorsement.

Contributors to the Fund

Participating Employers can make contributions to the Fund in respect of their employees.

Participating Employers must pay each month the Minimum Contribution for each Member employed by that Participating Employer. The Minimum Contribution for each Member is based on an accrual of worker entitlements at a rate equal to the greater of:

§ an amount determined by the Trustee; or

§ the amount specified under the relevant industrial instrument for the Member.

Participating Employers can also make voluntary contributions in excess of the Minimum Contribution.

Members

Employees in respect of whom contributions have been made by the Participating Employers may become a member of the Fund.

Members have a fixed entitlement to the balance of their Member Account, but no entitlement to the income of the Fund.

A person will generally cease to be a Member once all of the Member's entitlements have been paid out, forfeited or transferred to another complying fund.

The Trust Deed sets out the procedure for transferring Member entitlements from and to other similar funds.

A Member or the Member's personal representative may make a claim in respect of:

(a) retirement at the age of 55 or more;

(b) financial hardship provided the Member has been unemployed for at least 4 weeks;

(c) death;

(d) total and permanent disability; or

(e) redundancy.

The Trustee must pay the claim provided the Member satisfies any requirements under the relevant industrial instrument and payment of the claim by the Trustee would not breach the requirements to maintain the Fund's government endorsement.

In the event that a Member;

a) becomes bankrupt or otherwise loses their beneficial interest to their benefits;

b) becomes mentally or physically incapacitated; or

c) attempts to assign or charge their benefits,

the Trustee will hold the Member's benefits on trust for the Member and their Dependants, and may pay the benefit to the Dependants or the Member in any proportions.

A Member's benefits will only be entirely forfeited if:

(a) no contributions have been made by a Participating Employer in respect of that Member in the last 12 months and the Member's account balance is a Small Amount; or

(b) the Member is not contactable for 12 months.

The number of Members has been steadily increasing since the establishment of the Fund.

Upon dissolution of the Fund, any accrued benefits which had become payable must be paid to the Member, and an amount equal to the credit of each Member's Member Account must be held for the Member by the Trustee or must be transferred for that Member's benefit to another approved fund.

Income of the Fund

If it is distributed, the income of the Fund must be distributed for a purpose allowed by relevant legislation in order to maintain the Fund's approved status.

The Trustee can also decide to accumulate the income of the Fund. There are no 'takers in default' in respect of the income of the Fund. That is, the trustee must accumulate the income of the Fund in the absence of exercising its discretion.

The Properties and the Company

The Fund has acquired 3 properties during 2009 and 2010.

X Pty Ltd (the Company) was incorporated in 2010 and is 100% owned by the Fund. The Company entered into a Property Management Agreement with the Fund, commencing to operate the property management business from 1 June 2010. All three of these properties were let to tenants as at the date of the application for private ruling.

Historically the Fund has not held any form of real property. It was decided to implement the separate property management agreement structure to quarantine the business activities of the Company from the traditionally passive other investments of the Fund.

The Company, as property manager, will have responsibility to perform the duties set out in schedule 2 to the Property Management Agreement, which was an annexure to the application.

Under the Property Management Agreement the Company as property manager of the Properties is entitled to be paid a management fee calculated as 7% of the gross rent collected on behalf of the Fund as owner.

The Company was in the process of gaining the necessary approvals and ensuring compliance with all relevant legislation as the property manager for the Properties as at the date of the application for private ruling.

Relevant legislative provisions

Division 6C of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)

Section 102 R of the ITAA 1936

Does Part IVA apply to this ruling?

Part IVA of the ITAA 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936 , go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Detailed reasoning

The Fund has entered into a scheme whereby it has recently acquired real estate which it is letting through an interposed property management company that is wholly owned by the Fund. The argument put forward on behalf of the Fund is that the activities of the property management company constitute a trading business as against merely investing in the land for rental income because the land is owned by the Fund rather than the property management company. Further, as the Fund controls directly the affairs of the property management company in conducting the purported trading business, the Fund should qualify as being a trading trust for the purposes of Division 6C of Part III of the ITAA 1936.

Operative Provision of Division 6C

The provisions covering public trading trusts contained in Division 6C of Part III of the ITAA 1936 comprises sections 102M to 102T. These provisions set out a number of complex tests or conditions that have to be satisfied before an entity can be regarded as a public trading trust. If any of the conditions or tests cannot be met then the entity would not have cause to be regarded as a public trading trust under section 102R of the ITAA 1936.

The principal qualifying provision is section 102R of the ITAA 1936. The provision sets out that a unit trust is a public trading trust if certain conditions are met. The conditions to be met have definitions within them that must also be met.

Paragraph 102R(1)(b) of the ITAA 1936 is relevant for years after the 1989 year of income.

The requirements are:

(i) the unit trust is a public unit trust; (defined in sec. 102P)

(ii) the unit trust is a trading trust; (defined in sec. 102N)

(iii) either - (A) the unit trust is a resident unit trust for the relevant year (defined in sec. 102Q); or

(B) unit trust is a public trading trust in relation to a year preceding the relevant year (refer to sec. 102R) , and

(iv) the unit trust is not a corporate unit trust in terms of Division 6B.

Under the qualifying provision it must be first established that the trust estate is a unit trust. If it cannot be established that the trust estate is a unit trust there is no purpose examining the other subordinate provisions and concepts. This is because even if some of these tests are met, if the critical test of being a unit trust cannot be satisfied, then the trust will never qualify as a public trading trust for the purposes of Division 6C of Part III of the ITAA 1936.

Unit Trust

The term unit trust is not specifically defined in the taxation legislation and therefore the general legal principles need to be considered. However the term 'unit' does have a definition in Division 6C of Part III of the ITAA 1936 - in section 102M:

Unit, in relation to a prescribed trust estate, includes a beneficial interest, however described, in any of the income or property of the trust estate.

A prescribed trust estate means a trust estate that is, or has been, a public trading trust in relation to any year of income, per section 102M of the ITAA 1936 definitions.

The Fund asserts that it is a unit trust because all of the members have a fixed entitlement to the capital of the fund to the extent of their credit balances in the Members' Accounts and therefore they all have a beneficial interest in the income and property of the trust.

The Deed for the Trust

As a starting point it is necessary to examine relevant clauses of the trust deed for the Fund to see if it is appropriate to conclude that it is a unit trust.

Relevant clause from the Trust Deed for the Fund were cited.

The Applicant's argument

The applicant has made the following submission as to why the Fund satisfies the tests of being a unit trust.

1. Reference was made to the definition of 'unit' in section 102M of the ITAA 1936. In particular, the applicant has highlighted that the meaning of a unit includes a 'beneficial interest, however described, in any of the income or property of the trust estate'. It was further stated that 'The use of this wide definition is evidence of a legislative intent to give a broad application to the operation of Division 6C, including having the potential to apply to a broad range of unit trusts provided they satisfy the other requirements of section 102R(1)(b)'.

2. The following passage from Halsbury's Laws of Australia, at [430-800] was cited:

In the case of a unit trust, the unit will generally, subject to the terms of the trust deed, confer a proprietary interest in all of the property that for the time being is subject to the trust of the deed, and the extent of the unitholder's beneficial interest at any given time is that proportion that his or her units bear to the total number of units issued.

3. Reference was made to Kent v. The Vessel 'Maria Luisa' [2003] FCAFC 93 as authority for the proposition that the 'fixed' proprietary interest of a unit holder is subject to the terms of the trust deed. Reference is then made to Read v. The Commonwealth of Australia (1988) 167 CLR 57 as supporting the proposition that a unit holder in a unit trust has a proprietary interest in the property of the trust, but may be prevented by the terms of the trust deed from calling or vesting of any particular property of the trust to them.

4. Reference was made to CPT Custodian Pty Ltd v. Commissioner of State Revenue [2005] HCA 53, particularly paragraph 15:

There is 'no constant, fixed normative meaning of the term 'unit trust'. Therefore the definition of unit trust is a broad one applying to many forms of trusts and the critical determinant of the operation of any unit trust is the trust deed which establishes it.

5. The applicant points out that the Commissioner has accepted the reasoning in CPT Custodian in that the Commissioner acknowledges that although a standard commercial unit trust may allow the right of a unit holder to have their units redeemed and allow the trustee to create additional units these features are not determinative of the status of a trust as a unit trust.

6. The applicant also referred to the final paragraph in the 'Reasons for Decision' in ATOID 2010/57, which acknowledges and accepts the decision of CPT Custodian. The final paragraph states that the basic requirements for a trust to be a unit trust for the purposes of Division 6C are:

a) beneficiaries have an entitlement to a share of the beneficial interest in the trust (in either or both income and capital);

b) the entitlement is measured by reference to a fixed standard or measurement howsoever described; and

c) there is no requirement that the interests in the trust be labelled 'units'.

7. The applicant then makes a number of points to apply the above principles to the Fund, by reference to the clauses of the trust deed.

Tax Office Position

The Tax Office position is that the Fund is not a unit trust for the purposes of Division 6C of Part III of the ITAA 1936 because the members of the Fund do not have beneficial interests in the income or property of the trust as asserted by the applicant. Provisions in the Trust Deed appear to deny a Member from having a beneficial interest in the income or capital of the Fund until some qualifying event occurs to them.

Further, no clauses of the Trust Deed indicate that members or beneficiaries have an absolute indefeasible interest in both the income and corpus of the trust. In fact the above clauses of the deed indicate that Members only have an entitlement to a Benefit upon the occurring of a qualifying event, such as reaching a specified retirement age or being made redundant. While it is true that there may be a positive monetary balance in a Member's account from time to time, until such a qualifying event occurs which crystallises their entitlement, a Member does not have a right to that money in their Member Account.

In other words, entitlement to a Benefit from the Fund is contingent upon events happening in a similar way to that of superannuation funds where members have entitlements to receive benefits only when particular specified events occur.

Although there are no court decisions which have directly involved worker entitlement or redundancy funds and the standing of the members' entitlements in such funds, some guidance can be found in cases involving superannuation funds. This guidance lends support the notion that a member of a fund which receives money contributed on the member's behalf and holds that money to the credit of that member is not beneficially entitled to either the income or capital of the fund representing that credit until some qualifying event occurs.

In Re Coram; Ex Parte Official Trustee in Bankruptcy v. Inglis and Ors (1992) 109 ALR 355 it was held that members of a superannuation fund only have a contingent beneficial interest in the income and capital of the fund. Per O'Loughlin J:

Historically, a superannuation fund was a form of trust that an employer established for the benefit of his employees. A common form of benefit was a lump sum payment that was payable to the employee (or his dependants) upon the event of his retirement or earlier death; another well known benefit was a pension plan. Conceptually however, the employee was only intended to benefit upon retirement; thus he would not necessarily receive any part of the amount allocated to the credit of his account if there was an early resignation or dismissal. The emphasis on the benefit maturing upon retirement also emphasised that until retirement the member's rights to or interest in any benefit were inchoate and would not crystallise until retirement (or earlier death). Even though the benefits afforded through superannuation funds have improved materially over the years - in particular, it is common place for some reduced benefit to vest upon premature retirement and for provisions to cover illness or injury - the inchoate nature of the member's rights or interests have remained unaltered. Until the happening of a prescribed even that will crystallise his right into an actual entitlement, a member of a superannuation fund is neither the legal nor the beneficial owner of the amount that stands to the credit of his account from time to time.

Gummow J adopted similar reasoning in another case concerning a superannuation fund - Caboche and Another v. Ramsay and Others (1993) ALR 215 at 230:

The property forming the fund was settled on the trustees for the benefit of Mr Bond. Upon the constitution of the fund Mr Bond obtained an equitable proprietary interest in the fund, albeit one which did not carry an immediate right to payment. It should be noted that the existence of the power in r 7(2) to deduct amounts from the member accounts to pay expenses of administering the fund does not require any contrary conclusion. Baker v Archer-Shee [1927] AC 844, the effect of which so often has been debated, is at least clear authority to that effect.

The interest of Mr Bond was conditional in the sense that no benefit might be paid until certain conditions were satisfied. The conditions are found in rr 9-14 inclusive. Upon the occurrence of any of these conditions, Mr Bond's interest is altered. For example, if Mr Bond were to retire from the employment of an employer but not from the workforce, then under r 9(2) he would obtain two further interests, one being a right to immediate payment of so much of his member account balance as is not required to be preserved, and the other being a further conditional interest in so much of his member account balance as is required by the Standards Act or the regulations to be preserved. The conditions governing the payment of this second payment are contained in r 15.

Conclusion

The restrictions imposed on the rights of the Members by clauses in the Trust Deed are inconsistent with a conclusion that the Members have a beneficial interest in the income and capital of the Fund because of the restrictions that those clauses impose.

As the Members do not have the beneficial interest in income and capital of the trust they do not possess units in the Fund. Therefore the Fund does not satisfy the test of being a unit trust and it then follows that the Fund cannot be regarded as a public trading trust for the purposes of Division 6C of Part III of the ITAA 1936.