Edited version of your written advice

Authorisation Number: 1012703111788

Ruling

Subject: Cessation of public trading trust activities

Question 1

When ABC Unit Trust (the Unit Trust) sells its remaining trading stock, will it cease to be taxed as a public trading trust (PTT)?

Answer

Yes

Question 2

If the answer to Question 1 is "yes", will the date of cessation be the date of settlement of the contract?

Answer

Yes

Question 3

If the answer to Question 1 is "yes", can the date of cessation be 30th June in the following financial year to allow the income tax on the sale of the trading stock and other income to be paid and fully franked unit trust dividends (in accordance with section 102D(1) of the ITAA 1936) to be paid to clear the franking account?

Answer

No

Question 4

If the answer to Question 1 is "yes", can the Unit Trust choose to not rely on the safe harbour provisions in Sec102MB of the ITAA 1936 and therefore still continue to be taxed as a PTT?

Answer

No

Question 5

If the answer to Question 1 is "yes" can the Unit Trust elect to continue to be taxed as a PTT?

Answer

No

Question 6

In the financial year that the Unit Trust ceases to be a PTT will it be necessary to lodge a final PTT (company) tax return up to the date of cessation and a first private trust return from the date of cessation to 30 June?

Answer

No

Question 7

Will the unpaid accumulated profits of the Unit Trust be automatically deemed unit trust dividends to the unit holders at the time the trust ceases to be a public trading trust?

Answer

No.

Question 8

After the Unit Trust ceases to be a PTT is the payment to unitholders of profits accumulated prior to cessation as a PTT treated as a frankable unit trust dividend?

Answer

No

Question 9

Will any franking credits held in the franking account for the Unit Trust at the time the trust ceases to be a PTT be lost?

Answer

Yes

Question 10

If the answer to Question 9 is yes, is there any discretion available to the Commissioner to allow time after the Unit Trust ceases to be a PTT to pay its tax up to the date of cessation and to clear its franking account by way of payments of a fully franked unit trust dividend?

Answer

No

Question 11

If the answer to Question 1 is "yes" and Question 10 is "no" can the Unit Trust voluntarily pay tax (or vary a PAYG payment ) on estimated taxable income for the period up to date of cessation, and will such a payment be a credit to the Unit Trust's franking account?

Answer

No

Question 12

If the answer to Question10 is "yes" can the Unit Trust pay a fully franked unit trust dividend prior to the date of cessation to clear its franking account?

Answer

Not applicable

Question 13

If the Unit Trust pays a fully franked unit trust dividend sufficient to put its franking account into deficit by the amount of tax payable for the Unit Trust for the financial year to date of cessation will franking deficit tax be payable?

Answer

Yes

Question 14

If the answer to Question 13 is "yes" will the franking deficit tax payable reduce the tax payable by the PTT when it lodges its annual tax return some months after the end of the financial year and at the time that the trust will have changed its tax status?

Answer

Yes

Question 15

If the answer to Question 14 is "yes", will the Unit Trust's franking deficit tax offset against future tax liabilities be the full entitlement under subsection 205-70(5) of the ITAA 1997?

Answer

No

Question 16

If the answer to 14 is "yes" will any penalty or interest be charged on the franking deficit tax if it is not paid until the PTT lodges it's tax return for the income year that its tax status changes from PTT to private trust.

Answer

Yes

This ruling applies for the following periods:

Year of income ended 30 June 2015

Year of income ended 30 June 2016

The scheme commences on:

1 July 2014

Relevant facts and circumstances

ABC Unit Trust (the Unit Trust) is an Australian resident unit trust established a number of years ago.

The Unit Trust's current income is from trading activities and other non-trading income

The Unit Trust anticipates ceasing its trading activities within the next two income years. Once this happens, the Unit Trust will continue to receive other non-trading income.

The Unit Trust has been a public trading trust (PTT) and taxed as a company under Division 6C of the ITAA 1936 for a number of years.

As at 30 June 2013 the Unit Trust had accumulated profits reserve of $X and a franking account balance of $Y.

In a previous year, the Unit Trust was notified by the Commissioner that it no longer met the criteria to be a PAYG taxpayer. This is because it was in a loss position at the end of the prior income year. As such, the Unit Trust is currently not required to make any PAYG instalments.

The Unit Trust is not a corporate unit trust and does not satisfy the conditions in section 102J of the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6C

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1997 subdivision 202-B

Income Tax Assessment Act 1997 Division 205

Taxation Administration Act 1953 Schedule 1 Division 45

New Business Tax System (Franking Deficit Tax) Act 2002 section 5

Reasons for decision

Questions 1, 2, 3 and 6

Summary

The Unit Trust will cease to be a PTT and therefore taxable under Division 6C of the ITAA 1936 at the end of the year of income in which settlement of the contract of sale for the final trading stock item occurs.

The Unit Trust will only be required to lodge one income tax return (as a PTT) to cover the whole of the year of income in which it ceases to be a PTT.

Detailed reasoning

The Unit Trust will be a PTT in relation to a year of income where all of the 4 conditions in section 102R of the ITAA 1936 are satisfied:

• the trust is a public unit trust

• the trust is a trading trust

• the trust is a resident unit trust or a public trading trust in a year preceding the relevant year of income, and

• the trust is not a corporate unit trust (that is, already caught by Division 6B).

Prior to the sale of the last trading stock, it is considered the Unit Trust satisfies the definition of a PTT as follows:

• the Unit Trust is a public unit trust under the alternative test in subsection 102P(2) as 20% or more of the beneficial ownership of the trust is held by tax exempt entities (complying superannuation funds)

• the Unit Trust is trading trust under section 102N as it carries on a trading business

• the Unit Trust is a resident unit trust

• the Unit Trust is not a corporate unit trust taxable under Division 6B of the ITAA 1936.

Pursuant to section 102N of the ITAA 1936, the Unit Trust will be a trading trust if, at any time during an income year, the trustee carries on or was able to control a trading business.

A trading business is defined in section 102M of the ITAA 1936 as a business that does not consist wholly of eligible investment business.

However, this definition is read in conjunction with section 102MC of the ITAA 1936 which provides that a trust will not be carrying on a trading business in situations where the trustee derives not more than 2% of its gross revenue in an income year from sources other than an eligible investment business. However, this exception does not apply where the income is derived from a separate business activity which is not incidental or relevant to the eligible investment business.

Eligible investment business is defined in section 102M of the ITAA 1936 as including investing in land, primarily for the purpose of deriving rent, or investing or trading in specified types of assets or financial instruments (including shares, bonds, debentures, unsecured loans, units in a unit trust or rights, options in respect of those assets).

Any investment in land other than for the sole or primary purpose of deriving rent would not be an eligible investment business (that is, a business of dealing in land or developing land for resale would not be an eligible investment business).

Therefore, the Unit Trust will not be a trading trust if its business is limited to investments in land for the sole or primary purpose of deriving rent.

As a result, once the Unit Trust sells the last remaining item of trading stock, the Unit Trust's activities will consist wholly of an eligible investment business and the Unit Trust will not satisfy the definition of a trading trust under section 102N of the ITAA 1936.

As the Unit Trust will not then satisfy all the conditions in section 102R of the ITAA 1936, it will no longer be a PTT after the last day of the income year in which it ceases to be a trading trust.

Case law confirms that the proceeds from sale of your trading stock will be generally derived at settlement, not when the contract is entered into. It follows that trading stock will cease to be on hand at this time also.

There is no requirement in section 102N of the ITAA 1936 that a unit trust must carry on a trading business for the entire income year in order for the trust to satisfy the definition of a trading trust for that year.

The Unit Trust will be taken to have disposed of its last unit of trading stock at the date of settlement of the contract of sale for that unit.

Even if the last unit of trading stock is disposed of part way through an income year, the Unit Trust will still be a trading trust, and therefore be treated as a PTT, until the end of that income year.

Questions 4 and 5

Summary

The Unit Trust cannot choose to not rely on the safe harbour provisions in section 102MC of the ITAA 1936 and therefore still continue to be taxed as a PTT.

There are no provisions within Division 6C that allow a unit trust to elect to be treated and therefore taxed as a PTT.

Detailed reasoning

As explained above, section 102MC of the ITAA 1936 applies to treat a unit trust (which would otherwise be carrying on a trading business under Division 6C) as not carrying on a trading business in certain circumstances.

Section 102MC of the ITAA 1936 applies for the 2009 income year and onwards.

There was a transitional provision that was available to trustees in the year of Royal Assent (2009 income year) which provided trustees with the choice not to apply section 102MC in that income year (see history note to section 102MC). This choice was only available in the 2009 income year.

In this case, the Unit Trust wishes to continue to be taxed as a PTT after it ceases being a PTT under section 102R of the ITAA 1936. As the choice not to use safe harbour was only available to trustees in the 2009 income year, this option is not available to the Unit Trust.

Therefore, the current legislation does not provide the Unit Trust with the choice not to rely on the safe harbour provisions in section 102MC and continued to be taxed like a company under Division 6C after it ceases to be a PTT.

Further, it is noted that the Unit Trust ceases to be a trading trust for reasons other than section 102MCof the ITAA 1936. That is, the Unit Trust is not considered to be carrying on a trading business under section 102M.

There are no provisions within Division 6C of the ITAA 1936 that allow a unit trust to elect to be treated and therefore taxed as a PTT.

Question 7

Summary

Any 'accumulated profits' in the Unit Trust at the time it ceases to be treated as a PTT will not be deemed unit trust dividends paid to the unit holders.

Any distribution of trust income attributable to profits arising while the Unit Trust is a PTT will satisfy the definition of a 'unit trust dividend'.

Detailed reasoning

Distributions made by a PTT are referred to as unit trust dividends. Unit trust dividends paid by a public trading trust are included in the unit holder's assessable income under subsection 44(1) of the ITAA 1936. (This is achieved by various deeming provisions in subsections 102T(11), (12), (14) and (19) of the ITAA 1936 which modify the application of subsection 44(1) of the ITAA 1936).

A unit trust dividend is defined in section 102M of the ITAA 1936 to mean any distribution or amount credited by the trustee of a 'prescribed trust estate' to a unit holder but does not include any amounts paid or credited to the extent that the money or property is attributable to profits arising during a year of income in relation to which the PTT was not a PTT.

A prescribed trust estate is defined in section 102M to mean 'a trust estate that is, or has been, a PTT in relation to any year of income'.

Notwithstanding that Division 6C treats a unit trust to be taxed like a company in some circumstances, the trust deed will continue to bind the trustee, irrespective of the tax treatment of the trust. Therefore, it cannot be assumed that a PTT can accumulate income. Any distribution, accumulation or setting aside of the income of the trust estate will be governed by the powers conferred upon the trustee in the relevant trust deed.

Division 6C does not contain any provisions deeming unpaid accumulated profits at the time the unit trust ceases to be a PTT to be unit trust dividends paid to the unit holders. Therefore, any accumulated profits in the Unit Trust at the time it ceases to be treated as a PTT will not be deemed unit trust dividends paid to the unit holders.

Although the Unit Trust will no longer be treated as a PTT, it will continue to be a 'prescribed trust estate' under section 102M of the ITAA 1936. The effect of this being that any distribution of trust income attributable to profits arising while it was a PTT would satisfy the definition of a 'unit trust dividend'.

Question 8

Summary

After the Unit Trust ceases to be a PTT, any distributions of trust income, to the extent they are attributable to profits arising while the Unit Trust was a PTT, are unfrankable unit trust dividends.

Detailed reasoning

Unit trust dividends paid by a PTT may be franked in accordance with Part 3-6 of the ITAA 1997.

In order to pay franked dividends, the entity must satisfy the requirements in subdivision 202-B of the ITAA 1997. Section 202-15 provides that an entity that is a corporate tax entity is a franking entity.

A corporate tax entity is defined in section 960-115 of the ITAA 1997 to include a PTT. However, a 'prescribed trust estate' under section 102M of the ITAA 1936 is not a corporate tax entity.

A frankable distribution is defined in section 202-40 of the ITAA 1997 to be a distribution which is not unfrankable. Unfrankable distributions are set out in section 202-45 and do not include unit trust dividends.

As the Unit Trust will remain a PTT until the end of the income year in which it ceases to hold any trading stock, it will also be a franking entity until the end of the income year in which it ceases to hold any trading stock.

Therefore, if the Unit Trust makes any distributions to unit holders prior to the end of the income year in which it ceases to hold trading stock, those distributions are capable of being paid as franked unit trust dividends.

As discussed above, the Unit Trust will continue to be a 'prescribed trust estate' after it ceases to be treated as a PTT and any distribution of trust income attributable to profits arising while it was a PTT would be treated as unit trust dividends.

However, as the Unit Trust is no longer a PTT, it will cease to be a corporate tax entity and franking entity as defined in sections 960-115 and 202-15 of the ITAA 1997 respectively.

Accordingly, any distributions of trust income after the Unit Trust ceases to be a PTT, even if such distributions are attributable to profits arising while the Unit Trust was a PTT, would be unfrankable unit trust dividends.

Questions 9 and 10

Summary

On the day the Unit Trust ceases to be treated as a PTT it will also cease to be a franking entity. Any surplus in its franking account will be reduced to nil.

There is no discretion to allow the Unit Trust to clear its franking account by way of payments of a fully franked unit trust dividend after it ceases to be a franking entity.

Detailed reasoning

Section 205-30 item 4 of the ITAA 1997 provides that a debit arises in the franking account of an entity if the entity ceases to be a franking entity and the entity's franking account is in surplus immediately before ceasing to be a franking entity. The amount of the debit is the amount of the franking surplus, and the debit arises on the day when the entity ceases to be a franking entity.

As discussed above, on the day the Unit Trust ceases to be treated as a PTT, it will cease to be a corporate tax entity and franking entity as defined in sections 960-115 and 202-15 of the ITAA 1997 respectively.

Therefore, on the day the Unit Trust ceases to be a franking entity, if its franking account is in surplus, the balance in the account will be reduced to nil.

There is no discretion to allow the Unit Trust to clear its franking account by way of payments of a fully franked unit trust dividend after it ceases to be a franking entity.

Question 11

Summary

The Unit Trust cannot voluntarily pay tax (or vary a PAYG payment) on estimated taxable income for the period 1 July up to date of cessation.

Detailed reasoning

Under section 205-15 of the ITAA 1997, credits will arise in a franking account in several circumstances, including the payment of a PAYG instalment and payment of income tax.

The notes to subsections 205-20(1) and (3) make it clear that an entity cannot generate a credit to their franking account by voluntarily paying an amount of income tax in advance to an actual liability existing.

Section 45-15 of Schedule 1 of the Taxation Administration Act 1953 (TAA) establishes a general liability to pay instalments if the Commissioner issues an instalment rate to a taxpayer. Subsection 45-50(1) establishes a specific liability to pay an instalment for an instalment quarter in an income year if at the end of that instalment quarter the taxpayer is either a quarterly payer who pays 4 instalments annually on the basis of GDP-adjusted notional tax or a quarterly payer who pays on the basis of instalment income.

However, this is subject to subsection 45-50(4) of Schedule 1 of the TAA, which states that such a liability only arises in respect of an instalment quarter if the Commissioner has issued the taxpayer with an instalment rate that has not subsequently been withdrawn before the end of the relevant quarter. The Commissioner may withdraw an instalment rate by giving written notice to the taxpayer (subsection 45-90(a)) or by publishing a notice in the Gazette for a class of taxpayers (section 45-90(b)).

If the Commissioner withdraws the instalment rate under section 45-90 of Schedule 1 of the TAA, the taxpayer will cease to be liable to pay instalments (note 4 to section 45-15).

In this case, the Unit Trust has been notified by the Commissioner that it no longer met the criteria to be a PAYG taxpayer. As the Commissioner has withdrawn the instalment rate, the Unit Trust has ceased to be liable to PAYG instalments pursuant to subsection 45-50(4) and paragraph 45-90(1)(a) of Schedule 1 of the TAA. Therefore, the Unit Trust does not have the option of varying its instalment rate upwards (based on an estimate of tax payable on its final PTT return) to generate credits in its franking account pursuant to item 1 of the table in subsection 205-15 of the ITAA 1997.

Further, a franking credit will not arise in the Unit Trust's franking account if it chooses to make a voluntary payment of income tax prior to the end of the income year in which it ceases to be treated as a PTT. This is because the Unit Trust would be paying an amount of tax for which it was not liable at the time when the payment was made pursuant to the notes in subsections 205-20(1) and (3) of the ITAA 1997.

Question 13

Summary

Franking deficit tax will be payable if as a result of the Unit Trust paying a fully franked unit trust dividend its franking account is in debit at the time that it ceases to be a PTT.

Detailed reasoning

If the franking account of an entity is in deficit when it ceases to be a franking entity, the entity will be liable under section 205-45 of the ITAA 1997 to franking deficit tax (FDT).

Therefore, if the Unit Trust chooses to over-frank its final distribution to unit holders during the year it ceases to be treated as a PTT in anticipation of the amount of income tax payable in relation to that year, and as a result ends up with a debit balance in its franking account on the last day of that income year, the Unit Trust will be liable for FDT pursuant to section 205-45 of the ITAA 1997.

The amount of the FDT payable will be equal to the amount that the franking account is in deficit as prescribed in section 5 New Business Tax System (Franking Deficit Tax) Act 2002.

Question 14

Summary

The payment of FDT will allow the Unit Trust to claim an offset in relation to the FDT paid when calculating its income tax liability for that income year. However, the Unit Trust may not be entitled to an offset equal to the full FDT paid.

Detailed reasoning

A corporate tax entity liable for FDT may be entitled to claim a tax offset under section 205-70 of the ITAA 1997.

As a PTT is defined to be a corporate tax entity, the Unit Trust is eligible for the tax offset arising from FDT liabilities subject to the conditions expressed in section 205-70.

The amount of the offset is calculated in accordance with the method statement in subsection 205-70(2).

Where the FDT liability is more than 10% of the total franking credits arising in an entity's franking account for a year, the amount of the tax offset will be reduced by 30%.

Therefore, the payment of FDT will allow the Unit Trust to claim an offset in relation to the FDT paid when calculating its income tax liability for that income year.

However, the Unit Trust will not be entitled to an offset equal to the amount of FDT paid if its FDT liability is more than 10% of the total franking credits that arose in its franking account for that year. The FDT offset would be reduced by 30%.

Question 15

Summary

The Unit Trust is not entitled to the relief provided for in subsection 205-70(5).

If the Unit Trust's FDT liability is more than 10% of the total franking credits arising in its franking account for that year, the amount of the tax offset allowable will be reduced by 30% unless the Commissioner exercises his discretion under subsection 205-70(6) of the ITAA 1997.

Detailed reasoning

Under subsection 205-70(5) of the ITAA 1997, the 30% reduction in the tax offset will not apply if:

a) the entity is a private company for the relevant year; and

b) if the company did not have the tax offset (but had all its other tax offsets) it would have had an income tax liability for the relevant year; and

c) the company has not had an income tax liability for any income year before the relevant year; and

d) the amount of the income tax liability referred to in paragraph (b) is at least 90% of the amount of the deficit in the company's franking account at the end of the relevant year.

The tax offset provided for in subsection 205-70(2) of the ITAA 1997 applies to 'corporate tax entities'. However the relief offered by subsection 205-70(5) will only apply if, among other conditions, the entity is a 'private company'.

Under section 960-115 of the ITAA 1997 a PTT is treated as a corporate tax entity, which means the trustee of the trust is taxed at company rates and distributions to beneficiaries are treated and taxed like dividends. However, these provisions do not result in a unit trust, which is a public trading trust under Division 6C of the ITAA 1936, being a company for imputation purposes. A unit trust (which is also a public trading trust for the purposes of section 102R of the ITAA 1936) does not meet the definition of 'company' under section 995-1 of the ITAA 1997.

Therefore, as the Unit Trust is not a company it cannot be a private company. As a result, it is not necessary to consider further whether the other requirements of subsection 205-70(5) of the ITAA 1997 have been meet.

Accordingly, the Unit Trust is not entitled to the relief provided for in subsection 205-70(5) of the ITAA 1997.

Subsection 205-70(6) of the ITAA 1997 gives the Commissioner the discretion to allow a 100% tax offset where the circumstances that led to the over-franking were due to events 'outside the control of the entity'.

The Commissioner will generally consider a franking deficit to have arisen due to events outside the taxpayers control if the events that gave rise to the deficit were not readily foreseeable and could not be influenced or controlled by the company.

For a circumstance to be outside of the taxpayers or their agents control or unanticipated, there must have been an event or circumstance which:

• was unforeseeable or unexpected

• operated alone or together with other circumstances (unusual or not)

• was beyond the control of the taxpayer or their agent, and

• could not have been avoided by compliance with accepted standards of business organisation and professional conduct.

The Commissioner considers that the particular circumstances outlined in the ruling application could be circumstances 'outside of the Unit Trust's control' for the purposes of subsection 205-70(6) of the ITAA 1997.

Question 16

Summary

General interest charge may be charged on the franking deficit tax if it is not paid until the PTT lodges its tax return for the income year that its tax status changes from PTT to a private trust.

Detailed reasoning

General interest charge (GIC) is a uniform interest charge worked out daily on a compounding basis. There are several circumstances in which GIC applies, including where an amount of tax, charge, levy or penalty remains unpaid.

Therefore, should the Unit Trust choose not to pay any franking deficit tax that may be payable by the due date, GIC will accrue on any amounts outstanding until it is paid.

Other than the GIC, there are no other penalties or interest charges that are applicable to the late payment of an amount of franking deficit tax.