Edited version of your private ruling

Authorisation Number: 1012517832210

Ruling

Subject: Income Tax Exemption

Question 1

Is The Company ordinary and statutory income exempt from income tax in accordance with section 50-1 of the Income Tax Assessment Act 1997 (ITAA 1997) on the basis that it is an entity described in item 2.1 of the table in section 50-10 of the ITAA 1997?

Answer

No

Question 2

Is the Company's ordinary and statutory income exempt from income tax in accordance with section 50-1 of the ITAA 1997 on the basis that it is an entity described in item 2.1 of the table in section 50-10 of the ITAA 1997 if it amends its constituent documents to prevent profit or gain accruing to its members during the course of its activities and in the event of winding up?

Answer

Yes

Question 3

Is the Company's ordinary and statutory income exempt from income tax in accordance with section 50-1 of the ITAA 1997 on the basis that it is an entity described in item 2.1 of the table in section 50-10 of the ITAA 1997 if members' interest in X is converted to a loan and interest is paid as a return on that loan?

Answer

No

This ruling applies for the following periods

Income year ended 30 June 2008

Income year ended 30 June 2009

Income year ended 30 June 2010

Income year ended 30 June 2011

Income year ended 30 June 2012

Income year ended 30 June 2013

The scheme commences on

1 July 2007

Relevant facts and circumstances

The Company is an Australian company limited by shares.

The Company operates in a township in a State. The township is over 150 kilometres from a City.

The major banks have closed their face-to-face banking branches in the township.

The nearest banks to the township are approximately 30-40 kilometres away.

The Company was established to enter into a franchise agreement with a bank.

The Company can pay dividends to its shareholders.

On winding up, the Company can pay surplus assets to its shareholders.

To raise capital, The Company offered shares to the townships community.

The Company currently has over 400,000 shares on issue.

The Company entered into a franchise agreement with a bank Limited.

The Company has paid over $XXX,000 in dividends to its shareholders.

The Company offers grants and sponsorships to the local community.

Since 200Y the Company has paid an amount in community grants and sponsorships.

The Company has proposed a restructure of its funding arrangements, whereby shareholders will be converted to creditors.

The creditors will be entitled to receive interest.

The creditors will continue to be members of the Company, and will have the right to vote.

The Company will amend its constitution so that members do not have any rights to dividends or surplus assets on winding up.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 50-1

Income Tax Assessment Act 1997 section 50-10

Income Tax Assessment Act 1997 section 50-70

Reasons for decision

Questions 1

Summary

The Company's ordinary and statutory income is not exempt from income tax as the Company is carried on for the purpose of profit or gain of its individual members.

Detailed reasoning

1.1. The ordinary and statutory income of an entity is exempt from income tax where it is an 'exempt entity' as described in the tables in subdivision 50-A of the ITAA 1997.

1.2. To be an 'exempt entity' under item 2.1 of section 50-10 of the ITAA 1997 an entity must satisfy the following requirements:

· be a society, association or club established for community service purposes (except political or lobbying purposes); and

· satisfy the conditions contained in section 50-70 of the ITAA 1997

Society, association or club

1.3. The phrase 'society, association or club' is not defined in tax law, and is given its plain ordinary meaning. In Pro-Campo Ltd v Commr. of Land Tax (NSW) 81 ATC 4270 Lee J said the following on the meaning of society, association and club:

The three words "society, club or association" are words in frequent use in our community and societies, clubs and associations are well-known entities. One knows that many organisations which give themselves the title society or association or club are as often incorporated as they are unincorporated…

In Theosophical Foundation Pty Ltd v Commr. of Land Tax (1966-1967) 67 SR 70 … Sugerman JA stated at p.82

"A society, in the relevant sense, is 'a number of persons associated together by some common interest or purpose, united by a common vow, holding the same belief or opinion, following the same trade or profession, etc: an association.' (Oxford English Dictionary,…) A society as thus described, in which the common element pertains to areas concerned with religion, may aptly be described as a religious society."

…

The meaning of "society" as the Oxford English Dictionary shows can be the equivalent of "association" and I do not think that any relevant distinction in nature exists between the two. It merely seems to have happened that some organisations are called "associations", others are called "societies" but no meaningful difference can be detected between the two… Although clubs can in some instances be seen to be distinguishable by reason of their purposes from societies or associations, they nevertheless fall squarely within the dictionary definition of "society" set out above. In short the three words are describing bodies made up of groups of persons who have come together to implement common purposes and objects… (at 4278-4279).

1.4. Although Pro-Campo Ltd v Commr. of Land Tax (supra) was considered in the context of State land tax, it is instructive as to the meaning of the requisite expression contained in section 50-10 of the ITAA 1997.

1.5. The Company is an Australian company limited by shares. The Company was formed for the purpose of entering into a franchising agreement with the bank, to facilitate face-to-face banking services in the town. The Company is a society, association or club for the purposes of section 50-10 of the ITAA 1997.

Community service purposes

1.6. The phrase 'community service purposes' is not defined in the tax law. It is given its plain ordinary meaning. In Navy Health Ltd v Federal Commissioner of Taxation [2007] FCA 931, Jessup J said that

I consider that the essence of 'community service' is that a service is provided to the community, or a section of the community. Here the word "service" is used in the sense of 'help, benefit or advantage', particularly 'the action of serving, helping or benefiting, conduct tending to the welfare or advantage or another'… (at paragraph 83).

1.7. Jessup J went onto say that the word 'community' refers not only to the community as a whole, but also to any identifiable section of the community, and that the receipt of a service by any group of persons should not be regarded as the receipt of that service by a section of the community. In this regard, Jessup J stated that 'community service purpose':

... deals with 'service' in a much more concrete setting, and requires, in my view, the community, or a section of the community, to benefit by way of the receipt of some identifiable help, benefit or advantage... (at paragraph 84).

1.8. This approach accords with the Explanatory Memorandum of the Taxation Laws Amendment Act (No 2) 1990. This related to the precursor to the current provisions. It states:

The words 'for community service purposes' are not defined but are to be given a wide interpretation. The words are not limited to those purposes beneficial to the community which are also charitable. They extend to a range of altruistic purposes. The words would extend to promoting, providing or carrying on activities, facilities or projects for the benefit or welfare of the community, or of any members of the community who have particular need of those activities, facilities or projects by reason of their youth, age, infirmity or disablement, poverty or social or economic circumstances.

1.9. Further, in Taxation Determination TD 93/130 Income tax: what is the scope of the exemption from income tax provided by sub-paragraph 23(g)(v) of the Income Tax Assessment Act 1936?, the Commissioner acknowledges that the term 'community service purposes' has a broad meaning, and that the term extends to a range of altruistic purposes such as:

...promoting, providing or carrying out activities, facilities or projects for the benefit or welfare of the community or any members of the community who have a particular need by reason of youth, age, infirmity or disablement, poverty, or social or economic circumstances (at paragraph 3).

1.10. Finally, in Federal Commissioner of Taxation v Wentworth [2011] FCAFC 42 (Wentworth), the Full Federal Court considered whether an entity which facilitated the provision of a face-to-face banking service in a small rural community was established for community service purposes. The Court found that the activities of Wentworth were within the exemption:

… the main or dominant purpose for which it was established was a community service. Here the community service purpose was the facilitation of face-to-face banking services which provided a substantial benefit to the community of Wentworth that was both real and tangible (at paragraph 43)

1.11. In coming to that decision the Court considered the decision of the trial judge:

... his honour considered that the facilitation of the commercial supply of some services would be a community service, if the facilitation of the commercial supply of such services could be characterised as a real or tangible benefit to the community. His honour thus drew a distinction between providing face-to-face banking services in Wentworth, on the one hand, and facilitating the provision of such services by making it commercially viable for a commercial bank to operate in Wentworth, on the other hand.

The trial judge concluded that, in a town with no face-to-face banking services, the facilitation of such services provided a substantial benefit to the community of Wentworth and that that benefit was both real and tangible...The benefit consisted of the fact that local banking once again became available, increasing, in a concrete way, the amenity of Wentworth... (at paragraphs 40-41)

1.12. The Company was established for the principal purpose of entering into a franchising agreement with a Bank, to facilitate face-to-face banking services in the township.

1.13. The Company also offers grants and sponsorships to the local community from profit derived from its services.

1.14. The Company's purpose is to facilitate face-to-face banking in a community that would not otherwise have banking facilities. In accordance with Federal Commissioner of Taxation v Wentworth (supra), the Company is considered to have community service purposes.

Political or lobbying purposes

1.15. A society, association or club does not have community services purposes where it is established primarily for political or lobbying purposes.

1.16. Political or lobbying purposes are those which relate to the exercise of influence or power over party political activities, government activities, legislation or government affairs.

1.17. The question as to the nature or character of the entity is to be assessed having regard to its objects, purposes and activities in an integrated and holistic sense (see Royal Australian College of Surgeons v Federal Commissioner of Taxation (1943) 68 CLR 436; and Cronulla Sutherland Leagues Club Ltd v Commissioner of Taxation 90 ATC 4215).

1.18. On the facts, the Company does not carry out its activities for political or lobbying purposes.

1.19. The Company is considered to be established for community service purposes.

Section 50-70 ITAA 1997

1.20. As stated above, a society, association or club established for community service purposes must also satisfy the requirements of section 50-70 of the ITAA 1997 to be an exempt entity.

1.21. For the purposes of this private ruling application, section 50-70 of the ITAA 1997 requires that the society, association or club -

a. not be carried on for the purpose of profit or gain of its individual members; and

b. has a physical presence in Australia and, to that extent, incurs its expenditure and pursues it objectives principally in Australia.

Purpose of profit or gain of individual members

1.22. The phrase 'carried on for the purpose of profit or gain of its individual members' is not defined in the tax law. Accordingly, the phrase must take its meaning found in case law.

1.23. In Federal Commissioner of Taxation v Cappid Pty Ltd [1970-1971] 127 CLR 140 (Cappid), the High Court considered whether a company was private or public in nature for the purposes of ascertaining its liability to tax on profits it had failed to distribute. In doing so, it interpreted the phrase 'not been carried on for the purpose of profit or gain to its individual members' as contained in paragraph 103A(2)(c) of the ITAA36. In allowing the appeal, Barwick CJ stated the following on the meaning of 'purpose' within that phrase:

'We are not concerned here with "purposes" in the sense of the subjective intention of the shareholders or of those who caused the taxpayer to come into existence. We are concerned with the objective conclusion to be drawn from the circumstances of the operation of the company (at 154).

1.24. In its application, the Company argues that 'purpose' in the phrase 'not carried on for the purpose of profit or gain to its individual members' means the main or dominant purpose. In this context, the Company says that the main or predominant purpose for which it is carried on is 'to enable profits to be returned to the local community to deliver social and economic benefits within the community'. This being so, the Company acknowledges that it is also carried on to provide a return to members by way of dividends.

1.25. In Commissioner of Taxation v Co-operative Bulk Handling [2010] FCAFC 155 , the Full Federal Court considered whether benefits received by members of an entity as a consequence of the entity pursuing its exempting purpose would affect the entities entitlement to income tax exemption. The case was considered in the context of section 50-40 of the ITAA 1997, which provides that to be exempt, an entity 'must not be carried on for the profit or gain of its individual members. Mansfield and McKerracher JJ stated:

...if as a consequence of pursuing the purpose, the members derive a benefit or gain..., that gain or benefit will not preclude exemption unless it is a gain produced only by reason of individual membership...In all cases of exemption, it must be the position that it is not open to the body to disburse any profits or dividends to members... (at paragraph 94)

1.26. This was also the approach of the South Australian Supreme Court in Repromed Pty Ltd v Lucas and Anor (2000) 76 SASR 575 where the court considered whether Repromed Pty Ltd was exempt from pay-roll tax on the basis that it was an employer who provided health services 'otherwise than for the purpose of profit or gain'. Debelle J held that Repromed Pty Ltd was carried on for the purpose of profit or gain as its constitution did not provide barriers to individual profit, and profits could find their way into pockets of individuals (at paragraph 35).

1.27. The above authorities indicate that the phrase 'not carried on for the purpose of profit or gain to its individual members', requires an absolute prohibition against profits or gains arriving to individual members.

1.28. The Commissioner has adopted this approach in Taxation Ruling TR 2011/4 Income tax and fringe benefits tax: charities (TR 2011/4), which states the following on the phrase 'not carried on for the purpose of profit or gain to its individual members':

235. Institutions use various mechanisms to ensure they are not entitled to be carried on for the purposes of private profit or gain. The most common way is to include clauses in the constituent documents that prevent the institution from distributing its profits or assets for the benefit of particular persons while it is operating and on winding up… The courts have tended to regard these clauses as an essential aspect of the constituent documents.

…

241. An institution's actions must be consistent with a prohibition on the institution's funds or assets finding their way to particular persons such as owners, their associates or nominees, or members, in a private capacity. Such distributions... are inconsistent with the institution not being carried on for the purpose of private profit or gain.

1.29. The Company is a company limited by shares. Its constitution empowers the Board of directors to declare dividends for the benefit of shareholders, with such dividends to be paid from the profits or funds of the Company. Since its establishment, the Company has paid over $100,000 in dividends.

1.30. On winding up, the Company can divide the assets of the Company among the shareholders.

1.31. As members of the Company are entitled to enjoy in the profits of the Company while it is operating and on winding-up, the Company is considered to be carried on for the purpose of profit or gain of its individual members.

1.32. The circumstances of the Company can be contrasted with the circumstances of Wentworth District Capital Ltd in Wentworth District Capital Ltd v Federal Commissioner of Taxation (supra):

a. Wentworth District Capital Ltd was a company limited by guarantee, and was prevented by its constituent documents from paying profits or funds to its members both while it operated and on winding-up.

b. Wentworth District Capital Ltd raised capital by issuing debt to members of the Wentworth community.

1.33. The effect of these differences is that the capital contributors of Wentworth District Capital Ltd did not receive profit or gain from Wentworth District Capital Ltd as members. Instead, they received interest payments on their loans to Wentworth District Capital Ltd as creditors. Accordingly, in Wentworth District Capital Ltd in Wentworth District Capital Ltd v Federal Commissioner of Taxation (supra) it was not in dispute that Wentworth District Capital Ltd was not carried on for the profit or gain of its individual members, and the matter was not considered by the courts.

Physical presence in Australia and expenditure

1.34. It is agreed that the Company has a physical presence in Australia and, to that extent, incurs its expenditure and pursues its objectives principally in Australia as required by section 50-70 of the ITAA97.

Conclusion

1.35. The Company is not an exempt entity as described in item 2.1 of the table in section 50-10 of the ITAA 1997, as the Company is considered to be carried on for the purpose of profit or gain of its individual members. As such, the ordinary and statutory income of the Company is not exempt from income tax.

Question 2

Summary

The Company's ordinary and statutory income may be exempt from income tax where it amends its constituent documents to prevent profit or gain accruing to its members while it operates and in the event of winding-up.

Detailed reasoning

2.1. As discussed in question 1, an entity is not considered to be carried on for the purpose of profit or gain to its individual members, where its constituent documents prohibit the distribution of profits or funds to individual members while it operates and on winding-up, and the activities of the entity are consistent with such prohibition.

2.2. Currently, the constituent documents of the Company allow for its profits, funds, and capital to be distributed for the benefit of its shareholders, and the Company has paid dividends to its shareholders.

2.3. If the Company was to amend its constituent documents to prevent distribution of profit, funds or capital for the benefit of its shareholders, the Company may satisfy the requirement that it not be 'carried on for the purpose of profit or gain to its individual members', provided its behaviour is consistent with the prohibition. In effect, the capital contributors (shareholders) would have to forego any rights they have in the profits or assets of the Company, and would not be entitled to a return on their contributions.

Question 3

Summary

Under the proposed arrangement, the Company's ordinary and statutory income will not be exempt from income tax as the Company will be carried on for the purpose of profit or gain of its individual members.

Detailed reasoning

3.1. As discussed in question 1, an entity is not carried on for the purpose of profit or gain to its individual members, where it is prohibited by its constituent documents from distributing its profits or funds to individual members while it operates and on winding-up, and behaves in a manner consistent with such prohibition.

3.2. The Company has proposed an arrangement whereby the current interests of shareholders will be converted into debt interests, with members no longer having equitable interest in the profits of the Company. The creditors will be entitled to receive interest. The members of the Company will continue as members after their interest is converted.

3.3. It is proposed that the Company's constituent documents will be amended to prohibit the distribution of profits or funds to individual members while it operates and on winding-up, but will not otherwise be amended. A member will continue to have a right to vote at a general meeting of the Company.

3.4. On the face of it, the proposed arrangement will create circumstances that are more in line with the circumstances in Wentworth District Capital Ltd v Federal Commissioner of Taxation (supra), insofar as capital contributions will come from creditors.

3.5. However, under the proposed arrangement, the possible payment of interest is considered problematic. Under the arrangement, a person becomes a creditor by virtue of them being a member (i.e. previously a shareholder). Their eligibility for interest under the loan agreement is linked to their status as a member. The proposed arrangement allows the current shareholders to be entitled to interest in lieu of dividends previously available.

3.6. While, in ordinary circumstances, a member of a non-profit entity would be able to enter into an arms-length loan with the non-profit entity, and receive interest payments from the entity, without the entity's status being challenged, in the proposed arrangement there is a nexus between membership of the Company and receiving interest under the loan agreement, making it a benefit arising from membership.

3.7. Under the proposed arrangement, the Company will continue to be carried on for the purpose of profit or gain to its individual members. As such the Company would not be an exempt entity under item 2.1 of the table in section 50-10 of the ITAA 1997, and the Company's ordinary and statutory income would not be exempt from income tax.