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Ruling

Subject: Public trading trusts, eligible termination payments and pay as you go withholding obligations

Question 1

Will Funds 1 and 2 be treated as public trading trusts under Division 6C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

Will any payments made to workers from the Funds be subject to PAYG withholding under section 12-85 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) on the basis that such payments are treated as employment termination payments (ETPs)?

Answer

Yes

This ruling applies for the following periods

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

The scheme commenced on

1 July 2012

Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents which form part of and are to be read with this description. The relevant documents are:

· the application for private ruling;

· the consolidated Trust Deeds for Fund 1 and Fund 2 incorporating all amendments made;

· the previous ATO Private Ruling (Existing Ruling).

The applicant (trading as 'X') is the trustee of Fund 1 and Fund 2 (together the Funds).

The Funds were established in recognition of the transitory nature of employment in various industries (the Industries).

The Funds have been established to provide benefits to employees (Workers) in the Industries who become entitled to payments on termination of their employment under the terms and conditions of their employment.

The Funds are approved worker entitlement funds for the purposes of section 59PB of the Fringe Benefits Tax Assessment Act 1986 (FBTAA).

The Workers are the eligible employees of the employers who are members of the Funds.

Employers make contributions to the Funds in respect of their Workers at the rate prescribed by the trust deed, in satisfaction of their obligations under the awards and any relevant enterprise agreement.

The Workers are entitled to their share of the capital (but not the income) of the Funds.

The trust deed requires that each Worker have an individual Workers Account showing the amount contributed on their behalf.

The Workers are not entitled to any income of the Funds.

The Funds generate income by investing in publicly issued companies and trusts.

A resolution was passed by the trustee to distribute the post tax income from both Funds to another entity, the Central Fund, for the current income year and for future income years.

The trustee of the Funds is also the trustee of the Central Fund.

Each Fund holds 50% of the shares each in a company which has been called Manager Co for the purposes of the ruling.

Manager Co is responsible for managing a building owned by X.

The building is a multi-level commercial building which is partly used to house employees of various entities controlled by X and other non-related entities.

The management agreement requires Manager Co to perform the following tasks:

· marketing and advertising the leasing of space in the building;

· negotiating and managing all leases in the building;

· collection of income and payment of operating costs;

· maintenance of the building;

· managing building services and capital expenditure;

· comprehensive reporting to X.

A previous ruling issued ruled that:

1. Fund 1 and Fund 2 will be treated as public trading trusts under Division 6C of the ITAA 1936; and

2. X will be required to withhold PAYG tax under section 12-85 of Schedule 1 to the TAA from payments from the Approved Funds to workers on the basis that such payments are treated as ETPs.

There have been no material changes to the way X, Fund 1, Fund 2 or Manager Co operate since the existing ruling was issued.

Currently, payments from the Funds to Workers are treated as ETPs and X (as trustee of the Funds) withholds PAYG tax from such payments.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 102M

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

Income Tax Assessment Act 1936 section 102P

Income Tax Assessment Act 1936 section 102R

Income Tax Assessment Act 1997 subsection 82-130(1)

Income Tax Assessment Act 1997 section 82-135

Taxation Administration Act 1953 section 12-85 of Schedule 1

Reasons for decision

Summary

Funds 1 and 2 will be treated as public trading trusts under Division 6C of the ITAA 1936.

As the payments made (or to be made) to the eligible employees satisfy all the conditions under subsection 82-130(1) of the ITAA 1997, the payments are (or will be) employment termination payments.

Accordingly, any payments made to Workers from the Funds will be subject to PAYG withholding under section 12-85 of Schedule 1 to the TAA 1953 on the basis that such payments are treated as ETPs.

Detailed reasoning

Issue 1

Division 6C treats certain trusts described as 'public trading trusts' as companies, by taxing the trustees of such trusts at the company rate.

A trust is a 'public trading trust' within Division 6C of the ITAA 1936 if it satisfies four requirements (section 102R of the ITAA 1936):

(1) the trust is a public unit trust;

(2) the trust is a trading trust;

(3) either the trust is a resident unit trust or was a public trading trust of the preceding income year, that is, it was a resident in a previous year; and

(4) the trust is not a corporate unit trust within Division 6B of the ITAA 1936.

1. Public Unit trust

Unit Trust

There is no definition of a unit trust for the purposes of Division 6C of Part III of the ITAA 1936.

The joint judgment of the High Court in CPT Custodians Pty Limited v. Commissioner of State Revenue [2005] HCA 53 at paragraph 15 stated, '"unit trust", like "discretionary trust", in the absence of an applicable statutory definition, does not have a constant, fixed normative meaning'.

There is however a consistent approach to what constitutes a unit trust which can be found in authoritative works. This definition reiterates the concept that the beneficial interest of the trust is held in 'units'. Units are expressed and defined as part of the whole beneficial interest of the trust (or in some circumstances of the whole beneficial interest of a particular kind). Other than this 'unit trusts' are, like all other trusts, subject to the terms of the impressed or stated trust and to the application of the law of trusts.

The consistency of this approach can be viewed from the following extracts from commentators on the subject.

Ford : Principles of the Law of Trusts Loose-Leaf Service 2006 at [1690] states:

The expression "unit trust" is a term of convenience and not a term of art capable of having legal consequences. Its only significance is as a label for a trust under the terms of which the benefit to beneficiaries is divided into units. Such a trust does not attract rules different from those that apply to trusts in which the beneficial interest is not so divided. For example, the question whether beneficiaries under a unit trust have an equitable proprietary interest in trust property depends on the terms of the trust, as in the case of any other trust, on the terms of the particular trust: CPT Custodians Pty Limited v Commissioner of State Revenue (2005) 221 ALR 196: 70 ALJR 1724; [2005] HCA 53.

JD Heydon MJ Lemming, Jacob's Law of Trusts in Australia , LexisNexis Butterworths 7th Edition 2006 at [310]:

Unit trusts are an extension into the field of commerce of the typical family trust (where settlors transfer property to a trustee on trust for their children in equal shares). … In the case of unit trust, the scheme property is divided into a large number of units, which may, subject to their terms, be issued redeemed and traded publicly and privately.

Robert l. Pritchard, Chapter 18 'Unincorporated Joint Ventures', The Law of Public Company Finance , ed Austin and Vann, The Law Book Company Ltd 1986, p 397:

(ii) A unit trust is a variation of the ordinary trust. Its distinguishing feature is that the beneficial interest in the trust property is divided into units which may be independently dealt with by the holders.

H.A.J. Ford, Chapter 15 'Public Unit Trusts', The Law of Public Company Finance , ed Austin and Vann, The Law Book Company Ltd 1986, p 400:

The Unit Holder as a Beneficial Owner

... But in a unit trust the trustee's ownership of the property of the enterprise is not beneficial ownership. The beneficial interest is in the unit holders in fractions proportional to the number of units held by each of them. Under the terms of the deed, as usually drawn, a unit does not confer any interest in any particular part of the trust fund or any particular investment but only such interest in the trust fund as a whole as is conferred on a unit under the deed.

Features which may be found in some commercial unit trusts include rights of unitholders to have their units redeemed by the trustee (generally on payment of an amount worked out by reference to the unitholder's beneficial interest in the value of the trust assets reduced by outstanding trust liabilities, perhaps with a discount or adjustment of some kind).

Another feature often found is a right in the trustee to issue additional units for subscription (again generally for subscription of an amount per unit worked out by reference to a present unit's share value of the trust assets reduced by outstanding trust liabilities, and perhaps with a discount or adjustment of some kind).

Such features are not inherent in a trust being a unit trust for the purposes of considering the application of Division 6C of the ITAA 1936. However legislative intervention may make these or other features mandatory in a particular jurisdiction if the unit trust is not to be liable to be wound up, or if offences by the management or promotion of the trust are not to be committed. Such legislative intervention does not alter the general approach to identifying a unit trust, where no specific definition applies to the term.

Accordingly, where beneficiaries are made entitled to a share of a beneficial interest under a trust, such as an interest in the income and capital, or in either one of these, and which entitlement is measured by reference to a fixed standard of measurement howsoever described (for example a percentage or a fraction or a fixed formula), then whether or not the deed itself labels the interests 'units' the beneficial interest have been unitised and the trust would be a 'unit trust' for the purpose of considering the application of Division 6C of the ITAA 1936. As one example where the phrase 'pro-rata' is used in specifying the relative interests of beneficiaries then this will mean the interest of the beneficiary of the trust will be identified as a proportion of, or share of, the whole of a beneficial interest (or class of interest) and in most occasions of this nature the holder of the beneficial interest will be a unit holder and the trust will be a unit trust (ATO ID 2010/57).

It is accepted that both Fund 1 and Fund 2 satisfy the requirements to be considered to be unit trusts.

Public Unit Trust

Subsection 102P(1) of the ITAA 1936 sets out 3 primary tests for determining whether a unit trust is a public unit trust in relation to a financial year:

1. any of the units in the unit trust were listed for quotation in the official list of a stock exchange in Australia or elsewhere;

2. any of the units in the unit trust were offered to the public; or

3. the units in the unit trust were held by not fewer than 50 persons.

In this case, both Funds were established to provide benefits to workers in various industries ('the industries').

Potentially, the worker numbers are considerable and certainly more than the minimum of 50 that is required to satisfy subsection 102P(1) of the ITAA 1936.

However, while the qualification in subsection 102P(1) of the ITAA 1936 is met, it is subject to some more conditions. The first of these is subsection 102P(4) of the ITAA 1936. This has two conditions. The first of these is if 20 or less people held or had entitlements to hold 75% or more of the property of the trust, then the fund would not be a public unit trust. Given that the employer members are required to pay a CPI adjusted weekly amount for each Worker, and these contributions form the basis of the Worker's entitlement, it is unlikely that this is ever going to occur as each of the Workers' accounts will be similar in size, with the only variation being those who entered the fund at a later time.

The second condition is that if 20 or less people held or had entitlements to hold 75% or more of the income of the fund, then the fund would not be a public unit trust. In this case, none of the Workers are entitled to a share of the net income of the fund. Instead, the trustee of the Funds has exercised it's discretion to distribute all of the post tax income to the Central Fund. The Central Fund has no right to any of the capital contributions made to the Funds by the members on behalf of the Workers.

Entitlement to the post tax amount of the income only would indicate that the trustee has resolved not to distribute the income to any of the unit holders, but instead to accumulate the income in the first instance. Once the income is accumulated, the trustee has arranged for the portion of the trust capital that relates to the post tax income accumulation for the previous year to be distributed to the Central Fund, which is an acceptable entity for the purposes of section 58P of the FBTAA.

As long as the amount of the post tax income which has been distributed to the Central Fund does not exceed the 75% threshold of the total property of the Funds, then this condition will be satisfied. If the income is distributed out after the tax has been paid on the income each year, it is unlikely that the profits will ever exceed 75% of the total assets of the Funds. Therefore this condition has been satisfied.

Subsection 102P(5) of the ITAA 1936 allows the Commissioner to treat a unit trust that has failed subsection 102P(4) of the ITAA 1936 as a public unit trust. However, this is subject to some conditions outlined in subsection 102P(7) of the ITAA 1936.

Subsection 102P(7) will prevent a trust being a public unit trust if either of two conditions are satisfied. The first is if 75% of the total of money paid or credited was paid or credited to 20 or fewer people. The post tax income was all credited to one entity, so if that amount exceeded 75% of all of the money credited for the year, then this would be satisfied. However, this would be an unlikely occurrence.

The second condition is if the trust deed is capable of being amended so that 20 or fewer unit holders could hold 75% of either the trust property or the net income of the trust. The applicant has advised that the trust deed either would allow this scenario to happen now, or could be amended to allow this to happen. Therefore this condition could be satisfied, which would prevent the trust from being a public unit trust.

The second condition is subject to subsection 102P(8), which allows a trust to be considered to be a public unit trust if the Commissioner is satisfied that trustee intends not to vary the rights of any of the unit holders. In this case, the Funds were set up to provide the Workers with redundancy entitlements. It would therefore be very unlikely that the entitlement to the capital of the Funds would ever be varied by the trustee.

In any event, clause 31.3 (Fund 1) and clause 32.3 (Fund 2) prevents any revocation, addition, or variation of the trust deed that affects the entitlements of the Workers that have already been made, or affects the status of the fund as an approved fund.

The current trustee resolutions indicate that the net income will not be distributed to any beneficiaries, so there are no issues there. The combination of Clause 17 (Fund 1) or clause 18 (Fund 2) and clause 19 (Fund 1) or clause 20 (Fund 2) limit who can receive the income earned by the fund. The post tax profits are currently being paid to another entity that is approved for the purposes of Section 58P of the FBTAA. It is also unlikely that this entitlement will ever be varied as the FBT exemption would need to be preserved.

Therefore the Commissioner is satisfied that the rights will not be varied, which means that subsection 102P(7) will not apply to prevent the Funds from being considered to be public unit trusts.

This means that both Fund 1 and Fund 2 will be considered to be public unit trusts under subsection 102P(1) of the ITAA 1936.

2. Trading Trust

Division 6C of the ITAA 1936 governs the way the income of certain unit trusts is treated for tax purposes and applies to a unit trust that is 'public trading trust'. Paragraph 102N(1)(b) of the ITAA 1936 provides that a unit trust will be a "trading trust" if, at any time during the year of income, the trustee:

... 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.

Section 102M of the ITAA 1936 defines a trading business to be a business that does not wholly consist of eligible investment business activities. An eligible business activity is defined in section 102M to be investing in land for the purpose of rental, or investing or trading in secured or unsecured loans, bonds, debentures, stock, shares, other similar securities, units (in unit trusts), futures, forward contracts and other similar contracts, life assurance policies, rights or options in any of the above, or other similar financial instruments.

In this case, the direct investments would be in the categories listed above and so based on those investments, the Funds would not satisfy the criteria of a trading trust.

However, Fund 1 and Fund 2 each own 50% of Manager Co, who is the manager of a multi story office building. Of this space available, part is currently let to X.

There is a management agreement attached as part of the ruling request. The agreement sets out the duties of Manager Co.

These duties include:

· the collection of the rental receipts, arrears and any interest payable on those arrears,

· pay all operating costs when due, maintain proper records and accounts for the property,

· negotiate and arrange all of the leases and rental bonds,

· ensure tenants comply with their lease agreements,

· advertise any vacant space and evaluate any applications received in respect of the vacant space,

· meet regularly with tenants to discuss their requirements and issues,

· maintain a lease register including critical dates for reviews, options or expiry,

· ensure premises are well maintained,

· obtain and retain plans, specifications and drawings of the building,

· supervise and inspect tenant fit outs to ensure that the works are in accordance with the lease agreement,

· ensure tenant works do not interfere with other tenants,

· regularly inspect and service the common areas,

· regularly review all maintenance service contracts,

· implement a preventative maintenance strategy to minimise to minimise costs and ensure property is always well maintained,

· arrange and maintain adequate insurance cover over the property.

Taxation Ruling TR 97/11 considers the indicators which are to be considered when determining whether an activity constitute a business. Paragraph 13 of TR 97/11 lists some of these indicators to be as follows:

· significant commercial purpose or character,

· more than just an intention to engage in business,

· whether there is a purpose of profit as well as prospect of profit,

· repetition and regularity of the activity,

· carried on in a similar manner to other businesses of that type,

· activity is planned, organised, and carried on in a business like manner,

· size scale and permanency of the activity,

· whether the activity is a hobby, recreation or pastime.

Also, rental is merely the passive investment of an asset, which is not considered to be a business activity.

It should be noted that Manager Co does not actually own the commercial property. The rental agreement indicates that X is the other party to the agreement, and so it is the owner of the building.

When applying these factors against the duties required to be performed to manage the property, is it considered that the required duties constitute sufficient activity to be considered to be a business as outlined in TR 97/11.

Therefore, the Funds will be considered to be trading trusts as each of the Funds control, or are able to control, the affairs or operations of an entity that is carrying on a business (the business of property management) as each Fund holds 50% of the shares in Manager Co.

3. Resident Unit Trust

Section 102Q of the ITAA 1036 outlines the requirements to be a resident unit trust. These include that the property of the trust must be in Australia and the central management and control of the trust is in Australia.

These two conditions have been satisfied, so the Funds will be considered to be resident unit trusts.

4. Corporate Unit Trust

Section 102J of the ITAA 1936 defines a corporate unit trust. There are a few conditions to be satisfied before the trust can be considered to be a corporate unit trust. The first of these is a period requirement. As it is after 1 July 1983, so the rules in paragraph 102J(1)(b) apply to this request.

The next requirement is that the trust be a public unit trust. Section 102G of the ITAA 1936 defines a public unit trust in similar terms to section 102P of the ITAA 1936 above. Therefore the Funds will satisfy the definition of a public unit trust as outlined above.

The final condition is that the trust be an eligible unit trust, which is defined in section 102F of the ITAA 1936.

Section 102F of the ITAA 1936 applies if the property or business operated by the unit trust was transferred to the unit trust from either a company or another unit trust under a prescribed arrangement.

A prescribed arrangement is defined in section 102E of the ITAA 1936 to mean an arrangement under which the shareholders of the company were granted a right or option to acquire units in the unit trust because they were shareholders in the company that owned the property or business before it was transferred to the unit trust. There is a similar requirement for transfers from other unit trusts.

In this case, the property directly owned by the Funds has been contributed by the members, not transferred from a company or an eligible unit trust. The other asset is the management agreement held by Manager Co which is 50% owned by each of the Funds. This also was not transferred in to the control of the Funds, as it was created after the Funds were established. Therefore, the Funds will not satisfy the requirements of an eligible unit trust.

Therefore the Funds do not satisfy the requirements to be a corporate unit trust.

In conclusion, it is considered that Fund 1 and Fund 2 will satisfy the criteria of a public trading trust as defined in section 102R of the ITAA 1936.

Issue 2

Section 12-85 of Schedule 1 of the TAA 1953 requires that an entity must withhold an amount from an ETP made to an individual.

Subsection 82-130(1) of the ITAA 1997 states that a payment is an employment termination payment if:

(a) it is received by you:

(i) in consequence of the termination of your employment; or

(ii) after another person's death, in consequence of the termination of the other person's employment; and

(b) it is received no later than 12 months after the termination (but see subsection (4)); and

(c) it is not a payment mentioned in section 82-135.

It can be seen that a number of conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

The phrase 'in consequence of' is not defined in the ITAA 1936. However, the words have been interpreted by the courts in several cases. The Commissioner in TR 2003/13 considered the phrase 'in consequence of' as interpreted by the Courts. Paragraph 5 of TR 2003/13 states:

...the Commissioner considers that a payment is made in respect of a taxpayer in consequence of the termination of the employment of the taxpayer if the payment 'follows as an effect or result of' the termination. In other words, but for the termination of employment, the payment would not have been made to the taxpayer.

The question of whether a payment is made in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case.

The Trust Deeds for each of the Funds broadly provide for the payment of an amount to a Worker not exceeding the amount standing to the credit of the Worker's account upon the Worker's employment being terminated

It is considered that there is sufficient nexus between the making of the payments under these clauses of the Trust Deeds and the termination of the relevant Worker's employment to constitute the payments as being made in consequence of the termination of the employment as interpreted by the courts.

In the current case, all the payments by X will be made within 12 months of termination of employment. Accordingly, the requirement under paragraph 82-130(1)(b) of the ITAA 1997 will be satisfied.

The third condition for the payment to meet the criteria, as an employment termination payment is stated under paragraph 82-130(1)(c) of the ITAA 1997, is that the payment must not be specifically excluded under section 82-135 of the ITAA 1997.

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

· superannuation benefits;

· payment for unused annual leave or unused long service leave (and any other similar leave);

· the tax-free part of a genuine redundancy payment or an early retirement scheme payment; and

· reasonable capital payments for personal injury.

Another relevant exception is in subparagraph (h) of s 82-135 which includes a payment that is deemed to be a dividend by another provision of the tax law.

As the Funds satisfy the criteria for public trading trusts, the question arises as to whether payments to the workers may constitute 'unit trust dividends' as defined in s102M of the ITAA 1936.

The term 'unit trust dividend' is defined in section 102M of the ITAA 1936. It includes any distribution made by the trustee of a prescribed trust estate, whether in money or property, to a unitholder. However, later paragraphs in that definition exclude certain amounts from being a unit trust dividend as defined.

Relevantly, there are exceptions for situations where the money or property represents profits made when the entity was not a public trading trust, and also if the money or property is paid in respect of the cancellation, redemption, extinguishment of a unit if the amount represents the amount paid in relation to the purchase of that unit and the amount does not exceed the value of the amount paid to the trustee for that unit.

In this case, the Funds satisfy the criteria for public trading trusts and the amount paid to the Worker when the Worker's employment is terminated is the amount currently allocated to that particular Worker's account. This amount represents the accumulations paid to the Fund by the member at the listed rate over the period that the Worker had contributions made on his or her behalf. There can be no part of the profits earned by the Fund in the payments as the post tax portion of the profits is being allocated to the Central Fund. The payment also extinguishes the Worker from any other entitlements from the Fund, so effectively their units are extinguished by the payment from the Fund.

Therefore, the payment is not a unit trust dividend as defined by section 102M of the ITAA 1936.

On the basis of the information provided by the applicant, it is considered that the payments are not payments that are specifically excluded under section 82-135 of the ITAA 1997. Therefore the condition under paragraph 82-130(1)(c) has been met.

As the payments made or to be made to the Workers satisfy all of the conditions under subsection 82-130(1) of the ITAA 1997, the payments are ETPs for the purposes of section 82-130.

Accordingly, the payments made to Workers from the Funds will be subject to PAYG withholding under section 12-85 of Schedule 1 to the TAA 1953.