Edited version of your written advice

Authorisation Number: 1012705994058

Ruling

Subject: Capital or Revenue

Question 1

Would any profit or gain arising from the disposal by the foreign resident entity of its investment in the shares in X Co be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

If the answer to Question 1 is Yes, does any gain arising to the foreign resident entity on a disposal of shares in X Co in an on-market trade on the Australian Securities Exchange (ASX) have an Australian source?

Answer

Not applicable.

Question 3

If the answer to Question 1 is Yes, does any gain arising to the foreign resident entity on a disposal of shares in X Co in an off-market 'block' trade between two non-resident counterparties that is notified to the ASX have an Australian source?

Answer

Not applicable.

Question 4

If the answer to Question 2 or 3 is Yes or the Commissioner is unable to rule, would the foreign resident entity be exempt from Australian income tax in respect of ordinary income or capital gains arising on the disposal of shares in X Co under the principle of sovereign immunity?

Answer

Not applicable.

The foreign resident entity

1. The principal activity of the foreign resident entity is to invest, on a long-term basis, in overseas assets.

2. The foreign resident entity does not have an office, employees, representatives or any other presence in Australia. Historically, the foreign resident entity has been a long term investor with only a small number of divestments to date.

3. The foreign resident entity is not in the business of regularly buying and selling shares listed on stock exchanges.

The transaction

4. The foreign resident entity acquired an exchangeable bond from Y Co.

5. The bond was exchangeable for shares in X Co.

6. Interest was payable by Y Co on the bond.

7. The foreign resident entity received interest payments from its holding of the exchangeable bond.

8. On the maturity date the bond was exchanged for shares in X Co.

9. The foreign resident entity received dividend payments from its holding of shares in X Co.

10. The foreign resident entity does not currently have an intention to divest its position in the shares of X Co.

11. While it holds shares in X Co, the foreign resident entity has not assigned, and has no intention to assign, its right to receive dividend payments to any entity.

X Co

12. X Co is listed on the ASX and one other stock exchange.

13. X Co's assets are not located in Australia. X Co is not 'land-rich' for Australian capital gains tax (CGT) purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 paragraph 6-5(3)(a)

Income Tax Assessment Act 1997 paragraph 6-5(3)(b)

Anti-avoidance rules

Part IVA of the Income Tax Assessment Act 1936 and other anti-avoidance provisions have not been considered.

Reasons for decision

Question 1

Would any profit or gain arising from the disposal by the foreign resident entity of its investment in the shares in X Co be assessable income under section 6-5 of the ITAA 1997?

Detailed reasoning

Section 6-5 of the ITAA 1997 provides that your assessable income includes income according to ordinary concepts, which is called ordinary income.

Pursuant to subsection 6-5(3) of the ITAA 1997, a foreign resident's assessable income includes:

• ordinary income derived directly or indirectly from all Australian sources during the income year (paragraph 6-5(3)(a) of the ITAA 1997), and

• other ordinary income that a provision includes in your assessable income for the income year on some basis other than having an Australian source (paragraph 6-5(3)(b) of the ITAA 1997).

Evidently, the common requirement in order for a foreign resident to have assessable income under section 6-5 of the ITAA 1997 is that the entity has ordinary income. The foreign resident entity, a foreign resident, will therefore have assessable income under section 6-5 of the ITAA 1997 if it has ordinary income that is derived from an Australian source, or ordinary income that a provision states is assessable income on some basis other than having an Australian source.

Profits on isolated transactions

Taxation Ruling TR 92/3 (TR 92/3) provides the Commissioner's view of whether profits on isolated transactions are ordinary income.

The term, 'isolated transaction' is defined in paragraph 1 of TR 92/3 as:

(a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

(b) those transactions entered into by non-business taxpayers.

The Commissioner considers that the correct approach in determining whether the potential profit or gain on disposal by the foreign resident entity of its shares in X Co is assessable under section 6-5 of the ITAA 1997 as ordinary income is with regard to the totality of the transaction or operation undertaken. The relevant transaction or operation will therefore include all the factors that may lead to the derivation of a profit or gain by the foreign resident entity disposing of the shares in X Co.

This approach is consistent with the decision of the Full Court of the High Court of Australia in FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363 (Myer case). where it was considered (at paragraph 31) that the two transactions in that case were seen as integral elements in one profit-making scheme.

As a result, the transaction that arises in the current situation (although not yet completed) consists of the foreign resident entity's acquirement of the exchangeable bond, its exchange into shares in X Co and the possible subsequent disposal of the shares in the future.

As will be outlined, the transaction is considered to be outside the ordinary course of business of the foreign resident entity and as such is regarded as an 'isolated transaction' in accordance with paragraph 1 of TR 92/3.

Ordinary income

Paragraph 6 of TR 92/3 provides that whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case.

In accordance with paragraphs 15 and 17 of TR 92/3, there are four ways whereby a profit or gain arising from the disposal by the foreign resident entity of its investment in the shares in X Co will be considered ordinary income under section 6-5 of the ITAA 1997. The profit or gain on disposal will be considered ordinary income if:

1. the transaction or operation is in the ordinary course of the foreign resident entity's business (subparagraph 15(a) of TR 92/3), or

2. the transaction or operation is in the course of the foreign resident entity's business, although not within the ordinary course of its business, and the foreign resident entity entered the transaction or operation with the intention or purpose of making a profit or gain (subparagraph 15(b) of TR 92/3), or

3. the transaction or operation is not in the course of the foreign resident entity's business, but the foreign resident entity's intention or purpose in entering into the transaction or operation was to make a profit or gain, and the transaction or operation was entered into, and the profit or gain was made, in carrying out a business operation or commercial transaction (subparagraph 15(c) of TR 92/3), or

4. the profit or gain made from the transaction or operation is an amount received for the transfer of a right to an income stream severed from the property to which it relates (paragraph 17 of TR 92/3).

Transaction in the ordinary course of business

The profit or gain that may arise in this instance is from a transaction or operation which is not in the ordinary course of the foreign resident entity's business judged by reference to the transactions in which the foreign resident entity usually engages.

The principal activity of the foreign resident entity is to invest, on a long-term basis, in overseas assets. The principal activity of the foreign resident entity therefore seeks to derive profits or gains from dividend/interest payments on these investments.

The profit or gain made in the current circumstance will be from the possible disposal of shares in X Co. The foreign resident entity does not regularly buy and sell shares on stock markets. A profit or gain derived from this activity is therefore not from a transaction or operation the foreign resident entity typically engages in. Further, a profit or gain made from the disposal of a long term investment is not considered to be an ordinary incident of the foreign resident entity's business

Therefore, subparagraph 15(a) of TR 92/3 does not apply to the potential disposal by the foreign resident entity of its shares in X Co.

Transaction in the course of business and with profit-making purpose

The profit or gain on disposal will be ordinary income if the transaction or operation is in the course of the foreign resident entity's business, although not within the ordinary course of its business, and the foreign resident entity entered the transaction or operation with the intention or purpose of making a profit or gain, pursuant to subparagraph 15(b) of TR 92/3.

In the course of business

As concluded above, it is the Commissioner's view that the transaction or operation will not be considered a transaction or operation in the ordinary course of the foreign resident entity's business.

However, the transaction or operation, once completed, will still be made in the course of the foreign resident entity's business as a long term investor in overseas assets.

Paragraph 11 of TR 92/3 confirms that a transaction or operation may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business.

Consequently, the profit or gain on disposal will be ordinary income under section 6-5 of the ITAA 1997 pursuant to subparagraph 15(b) of TR 92/3 if the foreign resident entity entered the transaction or operation with the intention or purpose of making a profit or gain.

Profit-making purpose

Paragraph 7 of TR 92/3 states the relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

Paragraph 8 of TR 92/3 states it is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

Paragraph 9 of TR 92/3 states the taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

Paragraph 10 of TR 92/3 goes on to state that if a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

Paragraph 36 of TR 92/3 confirms that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way.

The above paragraphs demonstrate that if, by an objective consideration of the facts and circumstances of the case, the foreign resident entity entered into the transaction with (at least) a significant purpose of profit-making held at the time of entering into the transaction in question, the profit or gain made will be ordinary income.

The foreign resident entity, as a long term investor in overseas assets, acquired the exchangeable bond. The foreign resident entity exchanged the exchangeable bond for shares in X Co. The foreign resident entity may dispose of its shares at some point in time in the future.

From an objective view of the facts, the foreign resident entity did not enter into the transaction with the significant purpose of making a profit or gain on the disposal of X Co shares.

At the time of acquiring the exchangeable bond, it is considered the requisite purpose of the foreign resident entity in respect of the investment was:

• to establish a long term strategic holding in overseas assets,

• the receipt of interest payments from the exchangeable bond, and

• in the event it chose to exchange the exchangeable bond for shares in X Co, the receipt of dividend payments from its holding of shares in X Co.

This is in line with the foreign resident entity's historical activities as a long term investor with only a small number of divestments to date. The foreign resident entity is not in the business of regularly buying and selling shares listed on stock exchanges.

Whilst a profit or gain on realisation of the potential disposal of the exchangeable bond or shares in X Co would have been a possible outcome of the investment, this is not considered to be a significant purpose of the foreign resident entity in entering into the transaction.

In line with paragraph 36 of TR 92/3, despite the foreign resident entity potentially going about the realisation in an enterprising way, the profit or gain on a mere realisation of an investment is not income according to ordinary concepts.

Therefore, subparagraph 15(b) of TR 92/3 does not apply to the potential disposal by the foreign resident entity of its shares in X Co.

Transaction not in the course of business

Subparagraph 15(c) of TR 92/3 only applies where the transaction does not occur in the course of business. Since it has been determined that the transaction would take place in the course of the foreign resident entity's business, this subparagraph is not applicable.

Therefore, subparagraph 15(c) of TR 92/3 does not apply to the potential disposal by the foreign resident entity of its shares in X Co.

Amount received for the transfer of a right to an income stream severed from the property to which it relates

Paragraph 17 of TR 92/3 only applies where an amount is received for the transfer of a right to an income stream severed from the property to which it relates.

The foreign resident entity's has not assigned, and has no intention to assign, its right to receive dividend payments to any entity and consequently will not receive a lump sum for that purpose.

Therefore, paragraph 17 of TR 92/3 does not apply to the potential disposal by the foreign resident entity of its shares in X Co.

Conclusion

The potential profit or gain that would arise from the foreign resident entity's disposal of its shares in X Co does not fall within the four alternatives contemplated by TR 92/3 for determining whether profits made from isolated transactions are ordinary income. Rather, the potential profit or gain would arise from a mere realisation of the foreign resident entity's long term investment.

Since the potential profits or gains from the relevant transaction will not be ordinary income, the profit or gain will not be assessable income under section 6-5 of the ITAA 1997.

Question 2

If the answer to Question 1 is Yes, does any gain arising to the foreign resident entity on a disposal of shares in X Co in an on-market trade on the Australian Securities Exchange (ASX) have an Australian source?

Detailed reasoning

Since the answer to Question 1 is No, this question does not apply.

Question 3

If the answer to Question 1 is Yes, does any gain arising to the foreign resident entity on a disposal of shares in X Co in an off-market 'block' trade between two non-resident counterparties that is notified to the ASX have an Australian source?

Detailed reasoning

Since the answer to Question 1 is No, this question does not apply.

Question 4

If the answer to Question 2 or 3 is Yes or the Commissioner is unable to rule, would the foreign resident entity be exempt from Australian income tax in respect of ordinary income or capital gains arising on the disposal of shares in X Co under the principle of sovereign immunity?

Detailed reasoning

Since Question 2 or Question 3 does not apply, and the Commissioner is not unable to rule, this question does not apply.