Edited version of your written advice

Authorisation Number: 1012876293220

Advice

Subject: Activities of Proposed Public Unit Trust in Investing and Trading in the Rights to a Commodity - Eligible Investment Business

Question

Will the activities of a proposed Public Unit Trust in investing and trading in the rights to a commodity constitute 'eligible investment business' as defined in section 102M of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Relevant facts and circumstances

The below facts and circumstances have been edited to remove the details of the commercial arrangements for the purposes of confidentiality.

The Proposed Public Unit Trust

It is proposed that a public unit trust (the Proposed Trust) be established for the purposes of investing and trading in the rights to a commodity.

The Proposed Trust will use subscribed funds to acquire rights to a commodity.

Each Unitholder of the Proposed Trust will be an Australian resident.

The portfolio will be purchased and managed by a Portfolio Manager (a separate entity associated with the Trustee for the Proposed Trust). 

The Trustee for the Proposed Trust

The Trustee for the Proposed Trust holds an Australian Financial Services Licence (AFSL) to carry on a financial services business including to deal in the rights to a commodity.

The Portfolio Manager will be involved in sourcing, buying and selling the rights to a commodity.

The Activities of the Proposed Trust

Once the Proposed Trust has raised initial funds from investors, the Trustee for the Proposed Trust will purchase the rights to a commodity on behalf of the Proposed Trust directly or using a broker.

The Proposed Trust will hold these rights as a long-term investment.

The income of the Proposed Trust is expected to constitute proceeds from the sale of the rights to the commodity.

Assumption

The Proposed Trust will be a public unit trust.

Summary of Advice

The activities of the Proposed Trust in investing and trading in the rights to a commodity will constitute 'eligible investment business', as defined in section 102M of the ITAA 1936.

Therefore, the Proposed Trust will not be a 'trading trust' pursuant to subsection 102N(1) of the ITAA 1936.

Detailed reasoning

Division 6C of Part III (Division 6C) of the ITAA 1936 treats a public trading trust, its Unitholders and its Trustee as if the public trading trust is a company for some tax purposes.

Subparagraph 102R(1)(a)(iii) of the ITAA 1936 provides that a public trading trust must be a 'trading trust'.

Subsection 102N(1) of the ITAA 1936 provides that a unit trust is a trading trust in relation to a year of income if, at any time during that year, its Trustee is carrying on a 'trading business'.

Section 102M of the ITAA 1936 defines a 'trading business' as:

… a business that does not consist wholly of eligible investment business.

'Eligible investment business' is defined in section 102M of the ITAA 1936 to mean one or more of:

(a) investing in land for the purpose, or primarily for the purpose, of deriving rent; or

(b) investing or trading in any or all of the following:

(i) secured or unsecured loans (including deposits with a bank or other financial institution);

(ii) bonds, debentures, stock or other securities;

(iii) shares in a company, including shares in a foreign hybrid company (as defined in the Income Tax Assessment Act 1997);

(iv) units in a unit trust;

(v) futures contracts;

(vi) forward contracts;

(vii) interest rate swap contracts;

(viii) currency swap contracts;

(ix) forward exchange rate contracts;

(x) forward interest rate contracts;

(xi) life assurance policies;

(xii) a right or option in respect of such a loan, security, share, unit, contract or policy;

(xiii) any similar financial instruments; or

(c) investing or trading in financial instruments (not covered by paragraph (b)) that arise under financial arrangements, other than arrangements excepted by section 102MA.

The contemplated activities of the Proposed Trust will incorporate the acquisition and holding of the rights to a commodity, as well as the sale of the rights to a commodity.

Each paragraph of the definition of 'eligible investment business' in section 102M of the ITAA 1936 is discussed below in terms of whether the activities of the contemplated scheme will satisfy any of the elements of this definition. With specific regard to paragraph (b) of the definition of 'eligible investment business' in section 102M of the ITAA 1936, only subparagraphs (b)(v); (b)(vi); (b)(xii); and (b)(xiii) are relevant for discussion.

Paragraph (a): Investing in land for the purpose, or primarily for the purpose, of deriving rent

Based on the relevant facts, the Proposed Trust will not be acquiring any land (or any interest in land).

Therefore, the Proposed Trust's acquisition and holding of the rights to a commodity, and the sale of the rights to the commodity is not an eligible investment business within paragraph (a) of the definition of 'eligible investment business' in section 102M of the ITAA 1936.

Subparagraph (b)(v): Investing or trading in futures contracts

A futures contract is an agreement to buy and sell a specified quantity of something at a specified future delivery date. The contracts are ordinarily highly standardised as to quantity and weight of the subject of the contract so that contracts are fungible and so that settlement by payment of difference can be facilitated, though this is not inherent in futures contracts. The contracts are ordinarily traded competitively on a centralised futures exchange, subject to the rules of the exchange. There is ordinarily a clearing house involved in the transaction. The contracts can be solely cash settlable or may be deliverable (such as on specific settlement days of the relevant Exchange).

As per the relevant facts, the activities of the Proposed Trust may involve the use of futures contracts when trading in the rights to a commodity. While a futures contract (with its subject being the rights to a commodity) may be a vehicle or mechanism for trading in the rights to a commodity, a right to a commodity is not a futures contract in itself.

Therefore, the Proposed Trust's acquisition and holding of the rights to a commodity, and the sale of the rights to a commodity itself is not an eligible investment business within paragraph (b)(v) of the definition of 'eligible investment business' in section 102M of the ITAA 1936.

However, Part 9 of Schedule 7 of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) provides that a futures contract is an example of a financial instrument that is a 'derivative'. Refer to the sub-heading entitled 'Subparagraph (b)(xiii): Investing or trading in any similar financial instrument' below which concludes that, as a right to a commodity falls within the definition of a 'derivative', and a futures contract is also a derivative (as per Part 9 of Schedule 7 of the GST Regulations), a right to a commodity would therefore be classified as a 'similar financial instrument'.

Subparagraph (b)(vi): Investing or trading in forward contracts

Butterworth Australian Legal Dictionary (Butterworth, 1997) defines a 'forward contract' as follows:

Forward Contract

An obligation to buy or sell a given asset on a specified date at a price specified at the transaction date of the contract. Such an agreement is essentially a risk-management tool; to allow a company to reduce uncertainty about future income. Agreements encompass currencies and interest rates. See 'forward delivery'.

Forward Delivery

The delivery of purchased securities at a future date. A forward delivery transaction normally provides for the delivery of securities at the expiration of six weeks from the date of the contract.

The nature of a typical and traditional forward contract is illustrated in FC of T v Woolcombers (WA) Pty Ltd 93 ATC 5170, which established that the expenses associated with purchasing wool by forward contract may be deductible at the time of making the contract. The forward contracts that Woolcombers entered into displayed all the essential features of a forward contract - a contract whereby a commodity is agreed to be delivered in the future for a price fixed at the time the contract is entered into, payable on delivery of the commodity.

Unlike futures contracts, which are ordinarily standardised and traded through an exchange, the forward contracts are likely to be over-the-counter contracts that are customised with terms and conditions tailored to suit the particular objectives of the parties. While a forward contract (with its subject being the rights to a commodity) may be a vehicle or mechanism for trading in the rights to a commodity, a right to a commodity is not a forward contract in itself.

Therefore, the Proposed Trust's acquisition and holding of the rights to a commodity, and the sale of the rights to a commodity is not an eligible investment business within paragraph (b)(vi) of the definition of 'eligible investment business' in section 102M of the ITAA 1936.

However, Part 9 of Schedule 7 of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) provides that a futures contract is an example of a financial instrument that is a 'derivative'. Refer to the sub-heading entitled 'Subparagraph (b)(xiii): Investing or trading in any similar financial instrument' below which concludes that, as a right to a commodity falls within the definition of a 'derivative', and a forward contract is also a derivative (as per Part 9 of Schedule 7 of the GST Regulations), a right to a commodity would therefore be classified as a 'similar financial instrument'.

Subparagraph (b)(xii): Investing or trading in rights or options over a loan, security, share, unit, contract or policy

The holder of a 'right', subject to its terms, has the capacity contained in those rights to lay claim to whatever is the subject of the right. An 'option' is the right to execute a transaction relating to an underlying asset. The holder of an option does not own the underlying asset, only the right to either buy or sell the underlying asset, and only for so long as the option exists or the holder owns the option.

As per the relevant facts, the scheme of the Proposed Trust may involve the use of options when trading in the rights to a commodity.

While a 'right' or an 'option' (with the rights to a commodity attached to that 'right' or 'option') may be a vehicle or mechanism for trading in the rights to a commodity, a 'right' or 'option' over a loan, security, share, unit, contract or policy is not a 'right' or 'option' over a right to a commodity.

Therefore, the Proposed Trust's acquisition and holding of the rights to a commodity, and the sale of the rights to a commodity is not an eligible investment business within paragraph (b)(xii) of the definition of 'eligible investment business' in section 102M of the ITAA 1936.

However, Part 9 of Schedule 7 of the A New Tax System (Goods and Services Tax) Regulations 1999 (GST Regulations) provides that a futures contract is an example of a financial instrument that is a 'derivative'. Refer to the sub-heading entitled 'Subparagraph (b)(xiii): Investing or trading in any similar financial instrument' below which concludes that, as a right to a commodity falls within the definition of a 'derivative', and an option is also a derivative (as per Part 9 of Schedule 7 of the GST Regulations), a right to a commodity would therefore be classified as a 'similar financial instrument'.

Subparagraph (b)(xiii): Investing or trading in any similar financial instrument

Of the financial instruments listed in paragraph (b) of the definition of an 'eligible investment business' in section 102M of the ITAA 1936, futures contracts, forward contracts, rights and options in particular are classified as 'derivatives'.

The Dictionary to the GST Regulations defines a derivative as 'an agreement or instrument the value of which depends on, or is derived from, the value of assets or liabilities, an index or a rate'.

A 'derivative' is defined in section 761D of the Corporations Act 2001 (Corporations Act) as follows:

…a derivative is an arrangement in relation to which the following conditions are satisfied:

(a) under the arrangement, a party to the arrangement must or may be required to, provide at some future time consideration of a particular kind or kinds to someone; and

(b) that future time is not less than the number of days, prescribed by regulations made for the purposes of this paragraph, after the day on which the arrangement is entered into; and

(c) the amount of the consideration, or the value of the arrangement, is ultimately determined, derived from or varies by reference to (wholly or in part) the value of the amount of something else (of any nature whatsoever and whether or not deliverable), including, for example, one of more of the following:

(i) an asset;

(ii) a rate (including an interest rate or exchange rate);

(iii) an index;

(iv) a commodity.

As such, the right to a commodity falls within the definition of a 'derivative' pursuant to section 761D of the Corporations Act on the basis that tradeable rights to a commodity reflect an arrangement under which the holder is entitled to acquire the underlying commodity at a future time, and the value of the arrangement varies by reference to the value of the commodity.

As certain financial instruments within paragraph (b) of the definition of an 'eligible investment business' in section 102M of the ITAA 1936 are derivatives - including, as discussed above, futures contracts, forward contracts and rights or options over such contracts (as per subparagraphs (b)(v), (b)(vi) and (b)(xii) respectively) - and the right to a commodity is also considered to be a derivative (as explained above), it follows that the right to a commodity would constitute a 'similar financial instrument' to those derivative financial instruments.

Once the Proposed Trust commences trading in the rights to a commodity, such tradeable rights would be considered a 'similar financial instrument' (and thus the activities of the Proposed Trust constituting 'eligible investment business') only if the more complex forms of financial instruments over the rights to a commodity are used, such as options and futures contracts (or only if the Proposed Trust's Trustee or another AFSL holder) is engaged to facilitate such investment and trading when such complex forms of financial instruments are not used.

Therefore, the Proposed Trust's acquisition and holding of the rights to a commodity and the sale of the rights to the commodity would constitute eligible investment business within subparagraph (b)(xiii) of the definition of 'eligible investment business' in section 102M of the ITAA 1936. As such, the Proposed Trust will not be a 'trading trust' pursuant to subsection 102N(1) of the ITAA 1936.

Paragraph (c): Investing or trading in financial instruments that arise under financial arrangements, other than arrangements excepted by section 102MA of the ITAA 1936

As per the above discussion, it has been concluded that the Proposed Trust's acquisition and holding of the rights to a commodity and the sale of the rights to a commodity would constitute eligible investment business pursuant to subparagraph (b)(xiii) of the definition of 'eligible investment business' in section 102M of the ITAA 1936. Therefore, it is not necessary to consider paragraph (c) of the definition of 'eligible investment business' in section 102M of the ITAA 1936.