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Ruling

Subject: Trusts and transfers

Question 1

Does section 820-584 of the Income Tax Assessment Act 1997 (ITAA 1997) apply, so as to exclude each of the following Trust entities from the Consolidated Tax Group for the purpose of Division 820 of the ITAA 1997?

Trust A;

Trust B;

Trust C;

Trust D; and

Trust E.

Advice/Answers

Yes

Question 2

Could the Commissioner confirm that the following assignments and transfers:

(a) From Company C to Company D;

(b) From the Company D back to Company C;

(c) From Company C into a Warehouse Trust

(d) From a Warehouse Trust into a Securitisation Trust;

(e) From Company C into a Securitisation Trust;

(f) From a Securitisation Trust back to Company C;

are not recognised for head company core purposes in relation to Company A by virtue of the operation of the single entity rule in section 701-1 of the (ITAA 1997) with respect to the following?

i. The calculation of the income of the consolidated tax group pursuant to section 6-5;

ii. The manner in which the amount in the nature of rent is calculated for the Lease Assets;

iii. The manner in which the cost of a Lease Asset for depreciation is calculated;

iv. The calculation of interest under section 242-35;

v. The notional loan principal of Luxury Car Assets;

vi. The calculation of interest and other assessable amounts under sections 240-35, 240-60, 240-65 and 240-70;

vii. The outstanding notional loan principal amount under section 240-25 in relation to HP Assets;

viii. The manner in which interest and principal is calculated under Loan Assets.

Advice/Answers

Yes

Question 3

Are chattels, which are the subject of the Lease Assets, depreciating assets for which a deduction is allowable to the Consolidated Tax Group in respect of the decline in its value under section 40-25 of the ITAA 1997?

Advice/Answers

Yes

Question 4

Should income in respect of Hire Purchase Assets be brought to account by the Consolidated Tax Group under section 240-35 of the ITAA 1997?

Advice/Answers

Yes

Question 5

Is interest income in respect of Loan Assets assessable income of the Consolidated Tax Group under section 6-5 of the ITAA 1997?

Advice/Answers

Yes

Question 6

Do distributions of residual Income from a Trust to its Income Unitholder Company C or Company D result in either an allowable deduction under section 8-1 of the ITAA 1997 to a Ruling Trust or assessable income to the Unitholder under section 6-5 of the ITAA 1997?

Advice/Answers

No

Question 7

Are notes issued by the Trusts in accordance with the terms of the specified documents debt interests as defined by Subdivision 974-B of the ITAA 1997?

Advice/Answers

Yes

This ruling applies for the following periods:

A period of years.

The scheme commences in:

Income year ending 2008

Relevant facts and circumstances

The Consolidated Tax Group is a global provider of banking and finance services.

Company A is the head company of the Australian consolidated tax group.

Company C was incorporated as an Australian company, is a wholly owned subsidiary of the Head Company and Company A, and is a subsidiary member of the Consolidated Tax Group. Company B and Company D are also wholly owned subsidiaries of the Head Company and part of the Consolidated Tax Group, as is the Originator company.

Relevant legislative provisions

Subsection 820-583(7) of the Income Tax Assessment Act 1997

Subsection 820-300(1) of the Income Tax Assessment Act 1997

Section 820-584 of the Income Tax Assessment Act 1997

Subsection 820-39(3) of the Income Tax Assessment Act 1997

Section 820-39 of the Income Tax Assessment Act 1997

Subdivision 820-B of the Income Tax Assessment Act 1997

Subdivision 820-C of the Income Tax Assessment Act 1997

Subdivision 820-D of the Income Tax Assessment Act 1997

Subdivision 820-E of the Income Tax Assessment Act 1997

Subsection 820-39(4) of the Income Tax Assessment Act 1997

Paragraph 820-39(3)(a) of the Income Tax Assessment Act 1997

Paragraph 820-39(3)(b) of the Income Tax Assessment Act 1997

Paragraph 820-39(3)(c) of the Income Tax Assessment Act 1997

Section 701-1 of the Income Tax Assessment Act 1997

Subsection 701-1(2) of the Income Tax Assessment Act 1997

Subsection 701-1(3) of the Income Tax Assessment Act 1997

Section 40-25 of the Income Tax Assessment Act 1997

Subsection 40-25(1) of the Income Tax Assessment Act 1997

Subsection 40-25(2) of the Income Tax Assessment Act 1997

Section 6(1) of the Income Tax Assessment Act 1936

Section 40-30 of the Income Tax Assessment Act 1997

Section 40-45 of the Income Tax Assessment Act 1997

Section 40-50 of the Income Tax Assessment Act 1997

Subsection 995-1(1) of the Income Tax Assessment Act 1997

Section 6-10 of the Income Tax Assessment Act 1997

Section 10-5 of the Income Tax Assessment Act 1997

Subsection 240-35(2) of the Income Tax Assessment Act 1997

Section 240-35 of the Income Tax Assessment Act 1997

Section 6-5 of the Income Tax Assessment Act 1997

Subsection 6-5(2) of the Income Tax Assessment Act 1997

Subsection 974-15(1) of the Income Tax Assessment Act 1997

Subsection 974-20(1) of the Income Tax Assessment Act 1997

Paragraph 974-130(1)(a) of the Income Tax Assessment Act 1997

Paragraph 974-130(2)(b) of the Income Tax Assessment Act 1997

Paragraph 974-20(1)(b) of the Income Tax Assessment Act 1997

Subsection 974-160(1) of the Income Tax Assessment Act 1997

Paragraph 974-20(1)(c) of the Income Tax Assessment Act 1997

Section 974-135 of the Income Tax Assessment Act 1997

Subsection 974-135(1) of the Income Tax Assessment Act 1997

Subsection 974-135(3) of the Income Tax Assessment Act 1997

Subsection 974-85(1) of the Income Tax Assessment Act 1997

Paragraph 974-20(1)(a) of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Does section 820-584 of the Income Tax Assessment Act 1997 (ITAA 1997) apply, so as to exclude each of the following Trusts from the Consolidated Tax Group for the purpose of Division 820 of the ITAA 1997?

Trust A;

Trust B;

Trust C;

Trust D; and

Trust E.

Detailed reasoning

The object of Division 820 of the ITAA 1997 is to ensure entities do not reduce their tax liabilities by using excessive amount of debt capital to finance their Australian operations.

Subdivisions 820-FA and 820-FB sets out the specific rules for how the thin capitalisation rules apply to consolidated groups and MEC groups. Subsection 820-583(7), contained within subdivision 820FA provides:

The *head company of a *consolidated group or of a *MEC group is an outward investing entity (ADI) for a period that is all or part of an income year if, and only if:

(a) apart from Part 3-90 (about consolidation of groups) and this Subdivision, at least one *member of the group would be an *outward investing entity (ADI) for that period; or

(b) these conditions are met:

(i) at least one member of the group would, apart from that Part and this Subdivision, be an *outward investing entity (non-ADI) for that period; and

(ii) at least one member of the group is an *ADI throughout that period.

The core operative thin capitalisation rule for outward investing entities (ADI) is set out in subsection 820-300(1). Broadly, the core rule disallows all or part of the debt deductions of an entity for an income year where the entity's adjusted average capital is less then its minimum capital amount. The operative rule applies to a consolidated group or a MEC group: see Note 4 to subsection 820-300(1).

Section 820-584 provides that when an entity meets the conditions in subsection 820-39(3) the entity is not treated as part of the consolidated group for the purposes of Division 820. The note attached to section 820-584 specifies that the entity is exempt from Division 820 because of section 820-39.

Section 820-39 operates to exempt certain special purpose entities from having its debt interests disallowed under subsection 820-B, 820-C, 820-D or 820-E for the years the entity meets the criterion under subsection 820-39(3). The criterion state:

(a) the entity is one established for the purposes of managing some or all of the economic risk associated with assets, liabilities or investments (whether the entity assumes the risk from another entity or creates the risk itself); and

(b) the total value of *debt interests in the entity is at least 50% of the total value of the entity's assets; and

(c) the entity is an insolvency-remote special purpose entity according to criteria of an internationally recognised rating agency that are applicable to the entity's circumstances.

In addition subsection 820-39(4) adds the following caveat to the criterion set by 820-39(3):

The condition in paragraph (3)(c) can be met without the rating agency determining that the entity meets those criteria.

Should an entity within a consolidated group meet the criterion of 820-39(3) the entity shall be excluded from the consolidated group for thin cap purposes. These conditions can be me without a rating agency itself determining that the entity is a insolvency-remote special purpose entity (i.e. that the entity is formally rated as such by the rating agency).

Company A is the head company of the tax consolidated group and is registered by APRA as the owner of Company B. Company B is an ADI regulated by APRA. Therefore Company A is regarded as an outward investing ADI for Division 820 purposes.

The ruling trusts are contained within the Company A group. Should a trust meet the criterion set out in subsection 820-39(3) it will be not recognised as a member of the Company A group for the purposes of division 820.

a) Trust A

The assets held by Trust A were originated by the Originator, who dealt with the client for the Assets. The asset is then on occasion transferred from the Originator to Trusts for the purposes of securitisation. The Trust plays a role as a warehouse trust in this arrangement. Assets would periodically pass into Trust A as required by the Trustee. Trust A would issue notes to its sponsor funder company, in order to fund the acquisition of these assets. In acquiring these assets Trust A assumes the risks associated with these assets from Company C and clients who originally held the assets.

Trust A was established for the sole purpose of borrowing funds to buy receivables as part of a securitisation arrangement. As part of the arrangement, Trust A has assumed some or all of the economic risks associated with the underlying receivable, since the taxpayer's return is contingent on the recoverability of the receivable. In other words, at least part of the credit risk on the receivables has passed from the original debtor to Trust A. Thus, paragraph 820-39(3)(a) is satisfied.

Trust A is funded through the issuance of notes to its sponsor funder company. These notes are considered to be debt interests as discussed elsewhere in this ruling. Therefore paragraph 820-39(3)(b) is satisfied by Trust A.

An internationally recognised ratings agency considers the criterion below relevant in analysing bankruptcy-remote special-purpose vehicles (SPV).

Each condition is considered below.

i) Limited recourse and non petition provisions

Pursuant to the relevant trust documents the investors will have limited recourse against the Trustee in regard to actions it takes in conducting its business in accordance with the transaction documents.

The limited recourse provided to note holders and non petition provisions are considered to meet the criteria for Bankruptcy Remoteness of the SPV.

ii) Restrictions on activities of Trust A

The relevant trust documents state that subject to the relevant trust documents the Trustee has all powers with regard to dealing with the Assets of each of the Series Trusts (including Trust A). However the relevant trust documents restrict the trustee of Trust A to conduct any business outside the transaction documents.

The restrictions on the activities of the Trust A are considered to meet the criteria for Bankruptcy Remoteness of the SPV.

iii) Maintenance of separate business existence.

The criterion also examine whether or not Trust A has a separate existence in terms of maintenance of its own records, and if it can operate independently of the originator, owner and other affiliates. A member of the consolidated group holds the income and capital unit in Trust A and the trusts are members of the Company A tax consolidated group. However the relevant trust documents place restrictions on the noteholders, including restrictions on removing the Trustee or interfering with the Trustee's management of the Trusts assets. The relevant trust documents state that the Trustee must manage the assets and liabilities of each of the Trusts separately.

Therefore Trust A satisfies paragraph 820-39(3)(c) of the ITAA 1997 and is considered to an be insolvency-remote special purpose entity according to criteria of an internationally recognised rating agency that are applicable to the entity's circumstances.

Having satisfied each of the criteria in subsection 820-39(3) of the ITAA 1997 Trust A is exempted from being counted in the consolidated group of Company A for that group's thin capitalisation calculations by virtue of section 820-39. As a result Company A would not include Trust A in its thin capitalisation calculations by virtue of section 820-584 of the ITAA 1997.

All trust arrangements are the same in all material respects as those described above for Trust A.

Question 2

Could the Commissioner confirm that the following assignments and transfers:

(a) From Company C to the Company D;

(b) From Company D back to Company C;

(c) From Company C into a Warehouse Trust

(d) From a Warehouse Trust into a Securitisation Trust;

(e) From Company C into a Securitisation Trust;

(f) From a Securitisation Trust back to Company C;

are not recognised for head company core purposes in relation to Company A by virtue of the operation of the single entity rule in section 701-1 of the ITAA 1997 with respect to the following?

i. The calculation of the income of the consolidated tax group pursuant to section 6-5;

ii. The manner in which the amount in the nature of rent is calculated for the Lease Assets;

iii. The manner in which the cost of a Lease Asset for depreciation is calculated;

iv. The calculation of interest under section 242-35;

v. The notional loan principal of Luxury Car Assets;

vi. The calculation of interest and other assessable amounts under sections 240-35, 240-60, 240-65 and 240-70;

vii. The outstanding notional loan principal amount under section 240-25 in relation to HP Assets;

viii. The manner in which interest and principal is calculated under Loan Assets.

Detailed reasoning

Section 701-1 of the ITAA 1997 sets out the single entity rule which determines that subsidiary members of a consolidated group are taken to be parts of the head company of the group for core purposes as described in subsections 701-1(2) and (3) of the ITAA 1997.

The consequences of the single entity rule are set out at paragraph 8 of Taxation Ruling TR 2004/11. Clause (a) states 'the actions and transactions of a subsidiary member are treated as having been undertaken by the head company'

Words to the same effect are contained in the Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No. 1) 2002 New Business Tax System (Consolidation) Act (No. 1) 2002: see, inter alia, paragraphs 2.12 and 2.26.

The notion that within the consolidations regime the transactions of a subsidiary member are treated as having been carried out by the head company is a legal fiction. As a matter of fact and law, a subsidiary member continues to transact with the outside world in its own name and on its own account. For the purposes of the consolidations regime however, the Commissioner has confirmed at paragraph 30 of TR 2004/11 that this fiction, and the consequences that flow from it, are to be treated as the actual state of affairs of the head company.

The relevant assignments and transfers all occur between entities within the Consolidated Tax Group. As wholly owned members of the consolidated group, under the single entity rule they will be taken to be part of the head company. The items from i to viii all concern core purposes therefore all the mentioned assignments and transfers will be ignored under the single entity rule in section 701-1 of the ITAA 1997.

Question 3

Are the chattels, which are the subject of the Lease Assets, depreciating assets for which a deduction is allowable to the Consolidated Tax Group in respect of the decline in its value under section 40-25 of the ITAA 1997?

Detailed reasoning

Subsection 40-25(1) of the ITAA 1997 determines that a deduction will be available for the decline in value of a depreciating asset. Subsection 40-25(2) states that a taxpayer must reduce the deduction by the part of an asset's decline in value that is attributable to their use other than for a taxable purpose.

A depreciating asset is defined by section 6(1) of the ITAA 1936 as having the same meaning as in ITAA 1997. The term is defined by subsection 40-30(1) as being 'an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used.'

The taxpayer has stated that the chattel referred to in Question 3 is a depreciating asset as defined by section 40-30; an entity in the Consolidated Tax Group 'holds' the Lease Assets under one of items 4 or 10 of section 40-40; none of the Lease Assets fall within the descriptions contained in sections 40-45 or 40-50; and the chattel is the subject of a lease to entered in to which is materially the same as one of the documents referred to by the taxpayer. The taxpayer states that these assets are held for a wholly taxable purpose.

As a result the chattels, which are the subject of the Lease Assets will be depreciating assets for which a deduction is allowable to the Consolidated Tax Group in respect of the decline in its value under section 40-25 of the ITAA 1997.

Question 4

Should income in respect of Hire Purchase Assets be brought to account by the Consolidated Tax Group under section 240-35 of the ITAA 1997?

Detailed reasoning

Division 240 of the ITAA 1997 deals with hire purchase agreements entered into after 27 February 1998. This Division treats such hire purchase agreements as a sale of the relevant goods to the hirer (notional buyer) combined with a loan from the supplier (notional seller) to the notional buyer.

A 'hire purchase agreement', is defined in subsection 995-1(1) of the ITAA 1997, as:

(a) a contract for the hire of goods where:

(i) the hirer has the right, obligation or contingent obligation to buy the goods; and

Note: An example of a contingent obligation is a put option.

(ii) the charge that is or may be made for the hire, together with any other amount payable under the contract (including an amount to buy the goods or to exercise an option to do so), exceeds the price of the goods; and

(iii) title in the goods does not pass to the hirer until the option referred to in subparagraph (a)(i) is exercised; or

(b) an agreement for the purchase of goods by instalments where title in the goods does not pass until the final instalment is paid.

In the current case the 'notional seller' is Company C whereas the 'notional buyer' is the client or hirer as referred to in the supplied documents.

Statutory Income

Section 6-10 of the ITAA 1997 states:

(1) Your assessable income also includes some amounts that are not ordinary income.

(2) Amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income.

Section 10-5 of the ITAA 1997 contains a list of the types of assessable income which are affected by statutory provisions, and includes any profit on a notional sale under section 240-35(2) of the ITAA 1997.

Section 240-35 of the ITAA 1997 determines the amounts of income that the notional seller (Company C) is to include in their assessable income. Sub-section 240-35(2) states: 

If the property is not trading stock of the notional seller and the consideration for the notional sale of the property exceeds the cost of the acquisition of the property by the notional seller, the excess is included in the notional seller's assessable income of the income year of the notional sale.

As the HP Assets do not constitute trading stock belonging to Company C, any profit on the notional sale prima facie constitutes statutory income in the hands of the Originator during the income year in which the notional sale is deemed to occur. Therefore income in respect of the HP Assets should be brought to account by the Consolidated Tax Group under section 240-35 of the ITAA 1997.

Question 5

Is interest income in respect of Loan Assets assessable income of the Consolidated Tax Group under section 6-5 of the ITAA 1997?

Detailed reasoning

Under section 6-5 of the ITAA 1997 a taxpayer's assessable income is stated to include ordinary which is described as 'income according to ordinary concepts'.

In the current case interest income is received from Clients of chattel mortgages. The lender in these mortgages is Company C. Interest income is considered to be ordinary income for the purposes of subsection 6-5(2) of the ITAA 1997.

Question 6

Do the following distributions of residual Income from a Ruling Trust to its Income Unitholder result in either an allowable deduction under section 8-1 of the ITAA 1997 to a Ruling Trust or assessable income to the Unitholder under section 6-5 of the ITAA 1997?

From Trust A to Company D;

From Trust B to Company D;

From Trust C to Company D;

From the Trust D to Company C: and

From the Trust E to the Company C.

Detailed reasoning

Section 701-1 of the ITAA 1997 sets out the single entity rule which determines that a subsidiary member of a consolidated group are taken to be parts of the head company of the group for core purposes as described in subsections 701-1(2) and (3) of the ITAA 1997.

The consequences of the single entity rule are set out at paragraph 8 of Taxation Ruling TR 2004/11. Clause (a) states 'the actions and transactions of a subsidiary member are treated as having been undertaken by the head company'

Words to the same effect are contained in the Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No. 1) 2002 New Business Tax System (Consolidation) Act (No. 1) 2002: see, inter alia, paragraphs 2.12 and 2.26.

The notion that within the consolidations regime the transactions of a subsidiary member are treated as having been carried out by the head company is a legal fiction. As a matter of fact and law, a subsidiary member continues to transact with the outside world in its own name and on its own account. For the purposes of the consolidations regime however, the Commissioner has confirmed at paragraph 30 of TR 2004/11 that this fiction, and the consequences that flow from it, are to be treated as the actual state of affairs of the head company.

As with the assignments and transfers referred to in question 2, the distributions of residual income occur between entities within the Consolidated Tax Group. As wholly owned members of the consolidated group, under the single entity rule they will be taken to be part of the head company. Therefore all the mentioned assignments and transfers will be ignored under the single entity rule in section 701-1 of the ITAA 1997.

Question 7

Are notes issued by the following entities in accordance with the terms of the specified documents debt interests as defined by Subdivision 974-B of the ITAA 1997?

By the Trustee of and for and on behalf of Trust A;

By the Trustee of and for and on behalf of Trust B;

By the Trustee of and for and on behalf of Trust C;

By the Trustee of and for and on behalf of the Trust D; and

By the Trustee of and for and on behalf of the Trust E.

Detailed reasoning

Subsection 974-15(1) of the ITAA 1997 provides that a scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) of the ITAA 1997 in relation to the entity. Broadly, subsection 974-20(1) provides that the following conditions must be satisfied for a scheme to give rise to a debt interest:

(a) the scheme is a financing arrangement for the entity; and

(b) the entity, or a connected entity of the entity, receives, or will receive, a financial benefit or benefits under the scheme; and

(c) the entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities; and

(d) it is substantially more likely than not that the value provided will be at least equal to the value received; and

(e) the value provided and the value received are not both nil.

Financing arrangement

In the present case the scheme in question is the issuance of notes by the ruling trusts. Paragraph 974-130(1)(a) determines that a scheme is a 'financing arrangement' if it is entered into to raise finance for the entity. In the present case the note issuance was undertaken to raise finance for the applicant.

The notes issued would be classified as 'income securities' as set out in paragraph 974-130(2)(b) which sets out schemes generally entered into to raise finance.

Financial benefit

Paragraph 974-20(1)(b) sets out the second limb which stipulates that the entity receives a 'financial benefit' in relation to the scheme. Section 974-160 defines 'financial benefit' as anything of economic value. Under the scheme the 'financial benefit' received by the Trusts are the funds received from issuing the Notes.

The financial benefit of the noteholders is provided to them from the assets of the Trusts. These payments will satisfy the broad definition of financial benefit as prescribed in section 974-160(1) of the ITAA 1997.

Effectively non-contingent obligation

In order to satisfy paragraph 974-20(1)(c) of the ITAA 1997, the Trusts must have provided the financial benefits under an effectively non-contingent obligation. The term 'effectively non-contingent obligation' is defined in section 974-135 of the ITAA 1997. Broadly, it provides that there is an 'effectively non-contingent obligation' under a scheme if, having regard to the pricing, terms and conditions of the scheme (issue of notes), there is in substance or effect a non-contingent obligation to take that action (subsection 974-135(1)).

An obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a connected entity of that entity) other than the ability or willingness of that entity to meet the obligation (subsection 974-135(3)). This concept is elaborated on in subsection 974-85(1) which determines that a right or the amount of a return is not regarded as contingent on the economic performance of an entity merely because it is contingent on the entity's ability or willingness to meet the obligation or the entity's receipts or turnover.

The transaction documents indicate that the obligation of the Trusts to pay the economic benefit on the notes is effectively non-contingent as the noteholders' receipt of principal and interest on the Notes depends on the ability of the trust to meet their obligations to them out of the totality of the trust assets.

Value provided

In order to satisfy paragraph 974-20(1)(a) the value of the financial benefit provided must be at least equal to the financial benefit received. Under Subsection 974-35(1) the value of the financial benefit provided is calculated in nominal terms if the performance period must end no later than ten years or present value terms if the performance period must or may end more than ten years after the interest arising from the scheme is issued. The taxpayer has stated that the performance period is not for ten years or more. Therefore the financial benefit should be calculated in nominal terms.

Subsection 974-35(3) defines the performance period as 'the period within which, under the terms on which the interest is issued, the effectively non-contingent obligations of the issuer, and any connected entity of the issuer, to provide a financial benefit in relation to the interest have to be met.'

Subsection 974-35(2) determines that the value of a financial benefit received or provided under a scheme is calculated assuming that the interest arising from the scheme will continue to be held for the rest of its life. The taxpayer has provided simplified term sheets which set out interest rates for notes issued by each of the Ruling Trusts. From these it is determined that it is substantially more likely than not that the value provided will be at least equal to the value received.

As the scheme satisfies the above conditions the debt test is satisfied showing that the notes issued by the entities above are debt interests.