Edited version of your written advice

Authorisation Number: 1051408112353

Date of advice: 10 August 2018

Ruling

Subject: Status of co-operative where there is a statutorily interposed entity

Question 1

Having regard to the imposition of a custodian over the Investor’s assets including the shares in the Taxpayer, would the Commissioner regard the Investor, rather than the custodian, as the ‘shareholder’ in the Taxpayer for the purposes of Division 9 Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

Having regard to the imposition of a custodian over the Investor’s assets:

2.1 If legal title to the Investor’s commodity vests in the custodian, would the Commissioner treat the Investor, rather than the custodian, as the entity from whom the Taxpayer acquires the commodity for the purposes of sections 117(1)(b), 118 and 120(1) ITAA 1936?

Alternatively

2.2 If legal title to the investor’s commodity passes directly from the Investor to the Taxpayer, would the Commissioner treat the Investor, rather than the custodian, as the entity from whom the Taxpayer acquires the commodity for the purposes of sections 117(1)(b), 118 and 120(1) ITAA 1936?

Answer

2.1 Yes

2.2 Yes

This ruling applies for the following periods:

Income year ended 30 June 2019

Income year ended 30 June 2020

Income year ended 30 June 2021

Income year ended 30 June 2022

Income year ended 30 June 2023

Income year ended 30 June 2024

Income year ended 30 June 2025

Relevant facts and circumstances

Background to the Taxpayer

X Ltd (the Taxpayer) is a significant Australian co-operative involving a significant number of Australia’s growers in a particular commodity.

The Taxpayer is an unlisted public company that prepares its taxation returns on the basis that it is a “co-operative company” for the purposes of Division 9 ITAA 1936.

The Taxpayer’s Constitution complies with the requirements of section 117(1) ITAA 1936.

The Investor

Y Ltd (the Investor) wishes to acquire shares in and participate in the Taxpayer’s co-operative. The Taxpayer is prepared to consent to the acquisition.

The Investor is the trustee (and “Responsible Entity” for Corporations Act 2001 purposes) of a registered managed investment scheme, specific details of which are as follows:

● Trustee and Responsible Entity: the Investor

● Trust name: Y Trust

● Trust type: Unit trust

The Investor is required to hold an Australian Financial Services License in order to be the Responsible Entity of the registered managed investment scheme, Y trust, under the Corporations Act 2001.

The Investor will conduct a business in producing the particular commodities on land it will own, and would acquire shares in the Taxpayer in order to participate in the Taxpayer’s co-operative. As set out in the Assumptions, it is assumed that the Investor together with the non-participating (or “dry”) shareholders would hold more than 10% of shares in the Taxpayer. The term “dry” shareholder describes a shareholder who holds shares in the Taxpayer but otherwise does not participate in the Taxpayer’s co-operative (by for example selling the commodity into or acquiring services from the Taxpayer).

The agreement for the supply of the commodity by the Investor to the Taxpayer would occur pursuant to a “Supply Agreement” between the Investor and the Taxpayer (the custodian will not be a party).

The Issue

In the absence of any legislative requirement to the contrary, ordinarily the Investor would be the entity which for Division 9 ITAA purposes would both:

● hold the shares in the Taxpayer; and

● sell the commodity to, and acquire services from, the Taxpayer.

However, as a condition of its Australian Financial Services Licence (as issued by the Australian Securities and Investments Commission (ASIC)) and by reason of section 912AA of the Corporations Act 2001, the Investor is required to appoint an external custodian to hold the legal title to the assets of the trust.

The appointment of the external custodian by the Investor occurs pursuant to a “Custodian Agreement”. Under the Custodian Agreement, the custodian agrees to hold certain assets under a bare trust for the Investor as Trustee/Responsible Entity and to act and deal with those assets in accordance with the directions received from the Investor. These assets would include the shares in the Taxpayer, and may also include legal title to the commodity produced by the Investor. The Taxpayer has posed questions 2.1 and 2.2 in the alternative as it does not control the relationship between the Investor and the custodian and requires certainty that, irrespective of those arrangements, its status as a Division 9 ITAA 1936 co-operative would not be compromised.

Pursuant to those custodial arrangements:

● The Investor’s custodian would hold as bare trustee legal title to the shares in the Taxpayer held by the Investor.

● Additionally, the Investor’s custodian would hold as bare trustee legal title to the land upon which the Investor’s commodities are cultivated. Depending on the arrangements between the Investor and custodian from time to time, given there is a Supply Agreement between the Investor and the Taxpayer either:

● legal title to the Investor’s commodities would pass directly from the custodian to the Taxpayer (with beneficial title passed from the Investor to the Taxpayer); or

● both legal and beneficial title to the Investor’s commodities would pass directly from the Investor to the Taxpayer.

● It is possible, although unlikely, that the Investor might hold the land upon which the commodities are cultivated. In those cases legal and beneficial title to the commodity would clearly pass from the Investor to the Taxpayer and accordingly the Taxpayer has not sought clarity on this point.

Having regard to:

● the custodial arrangements which are imposed on the Investor;

● the Supply Agreement; and

● the specific provisions of Division 9 ITAA 1936,

the holder of legal title to the shares in the Taxpayer would be the custodian. This ostensibly makes the custodian the “shareholder” for the purposes of that Division, rather than the Investor, notwithstanding that the custodian is required under the custodian agreement to deal with those shares as and only as directed by the Investor.

The Taxpayer submits this produces an incongruous result, because in relation to all other dealings relevant to Division 9 including:

● the supply of the commodity to the Taxpayer (sections 117(1)(b), 118, 120(1)(c)) – subject to the discussion above regarding legal title to the commodity;

● the storage, marketing, packing and processing of the commodity (section 117(1)(c));

● the rendering of services (section 117(1)(d)); and

● the payments of rebates, bonuses, interest and dividends (section 120(1)(a),(b)),

each of these dealings would occur directly between the Investor (as the respective “shareholder”) and the Taxpayer.

The Taxpayer wishes to confirm its view that notwithstanding the requirements of the custodian to hold legal title only to the Investor’s assets, the Commissioner would regard the Investor, rather than the custodian, as the “shareholder” and the supplier of the commodity to the Taxpayer for the purposes of Division 9 ITAA 1936.

Imposition of custodian on the Investor

ASIC Class Order [CO 13/760] (Class Order) has the effect of inserting new section 912AA “Adequate financial resources for responsible entities and IDPS operators” into the Corporations Act 2001.

Relevantly, pursuant to paragraph (4) of the Class Order, as the Responsible Entity of a managed investment scheme, the Investor must hold “NTA” (being adjusted assets minus adjusted liabilities) of the greater of $10 million or 10% of revenue. If, which is here the case, the Investor does not satisfy paragraph (4), then paragraph (5) of the Class Order must be satisfied.

A Responsible entity satisfies paragraph (5) of the Class Order if at least one of the following is satisfied:

● All scheme property and other assets of the scheme not held by members is held by either:

● a custodian;

● a sub-custodian; or

● an eligible custodian.

● All scheme property and other assets of the scheme not held by members are “tier $500,000 class assets” held by:

● the licensee;

● a custodian appointed by the licensee; or

● a sub-custodian appointed by the custodian,

provided the licensee holds $500,000 NTA if the licensee holds the assets or the custodian or sub-custodian holds $500,000 NTA if assets are held by them respectively.

● Scheme property and other assets of the scheme not held by members not covered above is held by either:

● The licensee;

● An eligible custodian; or

● A custodian or sub-custodian that holds NTA of at least the greater of $150,000, 0.5% of scheme property (up to $5,000,000) or 10% of revenue.

● A custodian or sub-custodian if the only assets held by the scheme are assets described in (a), (c) or (g) of the definition of “special custody assets”.

In relation to “special custody assets”, paragraph (b) of that definition (which is excluded above) is “currency and chattels (other than documents) that it would not be reasonably practicable for a person other than the licensee to hold”.

In this regard the holding and storage of the commodity would be undertaken by the Investor as it would not be reasonably practicable for the custodian to physically hold and store the commodity (following harvest) as the Investor as Trustee/Responsible Entity is operating the farm that produces the commodity.

Relevant paragraphs of the Custodian Agreement are as follows:

1.1 On and from the date of this document the Responsible Entity appoints the Custodian as the agent of the Responsible Entity during the term of this document to do the following:

1.1.1 Hold Assets (as bare trustee).

1.1.2 To perform other duties and obligations as specified in this document.

1.2 The Custodian accepts that appointment.

1.3 The Custodian is not required to hold Assets as bare trustee (and will instead hold Assets only as agent) in the circumstances set out in Section 912AAC(3) of the Corporations Act (as modified by ASIC Class Order 13/1410).

…

3.1 The Custodian must:

3.1.1 Hold and maintain the legal title to the Assets in the name of the Custodian unless and until directed otherwise by the Responsible Entity …

3.1.3 Upon receiving the Purchase Funds and contracts from the Responsible Entity and in accordance with the Proper Instructions of the Responsible Entity, complete, sign and deliver the contracts for the purchase of any Asset and accept transfers of any Asset in the name of the Custodian on behalf of the Fund.

3.1.4 Not sell or deal with any Asset or create any interest in an Asset unless directed by Proper Instructions of the Responsible Entity.

…

31.1 Assets means assets and properties beneficially owned by the Investors pursuant to the Fund in the custody or control of the Custodian including cash from time to time in a Bank Account.

Legal title to the commodity

In consequence of the Class Order, it is expected that legal title to the land to be acquired by the Investor will be held by the custodian.

Accordingly, it is either the case that:

● The commodity is at common law fructus naturales”, a part of the soil of which they are the natural growth and not separate chattels (Evans v. Roberts 5 Barn. & Cress. 836). Therefore without some intervening arrangement between the custodian (who holds legal title to the land) and the Investor, legal title in the commodity would pass from the custodian to the Taxpayer (with beneficial title passing from the Investor to the Taxpayer).

Or alternatively

● Owing to commercial arrangements between the Investor and the custodian, legal title in the commodity would pass to the Investor first before the Investor passed both legal and beneficial title to those commodities to the Taxpayer.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 9

Income Tax Assessment Act 1936 Section 117

Income Tax Assessment Act 1936 Section 118

Income Tax Assessment Act 1936 Section 120

Reasons for decision

Summary

The facts in this case are on all fours with the facts in Case 100 (1967) 13 CTBR(NS) (the Milk Board case), where it was held that a third party holding legal title to commodities as a consequence of the mandatory operation of a specific statute should be disregarded in determining eligibility to taxation under Division 9 ITAA 1936. In other words, the underlying commercial arrangements of a co-operative are to take precedence when analysing the co-operative’s entitlement to taxation under Division 9 ITAA 1936.

Detailed reasoning

Division 9 ITAA 1936 (Co-operative and mutual companies)

Section 117(1) ITAA 1936 provides a definition of a co-operative company, which states that:

In this Division, ``co-operative company'' means a company, not being a friendly society dispensary, the rules of which limit the number of shares which may be held by, or by and on behalf of, any one shareholder, and prohibit the quotation of the shares for sale or purchase at any stock exchange or in any other public manner whatever, and includes a company, not being a friendly society dispensary, which has no share capital, and which in either case is established for the purpose of carrying on any business having as its primary object or objects one or more of the following:

(a) the acquisition of commodities or animals for disposal or distribution among its shareholders;

(b) the acquisition of commodities or animals from its shareholders for disposal or distribution;

(c) the storage, marketing, packing or processing of commodities of its shareholders;

(d) the rendering of services to its shareholders;

(e) the obtaining of funds from its shareholders for the purpose of making loans to its shareholders to enable them to acquire land or buildings to be used for the purpose of residence or of residence and business.

Section 118 provides the rule that a company is not a co-operative if less than 90% of its business is with its members. It states that:

If, in the ordinary course of business of a company in the year of income, the value of commodities and animals disposed of to, or acquired from, its shareholders by the company, or the amount of its receipts from the storage, marketing, packing and processing of commodities of its shareholders, or from the rendering of services to them, or the amount lent by it to them, is less respectively than 90% of the total value of commodities and animals disposed of or acquired by the company, or of its receipts from the storage, marketing, packing and processing of commodities, or from the rendering of services, or of the total amount lent by it, that company shall in respect of that year be deemed not to be a co-operative company.

Section 120 provides for the deductions that are allowable to a co-operative company. Section 120(1) states:

So much of the assessable income of a co-operative company as:

(a) is distributed among its shareholders as rebates or bonuses based on business done by shareholders with the company;

(b) is distributed among its shareholders as interest or dividends on shares; or

(c) in the case of a company having as its primary object that specified in paragraph 117(1)(b) - is applied by the company for or towards the repayment of any moneys loaned to the company by a government of the Commonwealth or a State to enable the company to acquire assets which are required for the purpose of carrying on the business of the company or to pay that government for assets so required which the company has taken over from that government;

shall be an allowable deduction:

Provided that the deduction under paragraph (c) shall not be allowed unless shares representing not less than 90% of the value of the company are held by persons who supply the company with the commodities or animals which the company requires for the purposes of its business.

Milk Board case

The co-operative company in question was carrying on a business as vendors of milk and milk products. Most of its members were shareholder dairy farmers who provided the company with fresh milk for packaging and distribution.

At the relevant time the Milk Act 1931 (NSW) (Milk Act) existed to ensure that milk for use in certain prescribed areas (amounting to a majority of the state’s population) of NSW was subject to special quality control measures.

As part of the quality control process, the Milk Act created a dairy industry regulator known as the NSW Milk Board (Milk Board) that was responsible for the inspection and approval of all milk sold into the designated areas. By operation of the Milk Act, all milk produced for use in those areas was vested in and became the property of the Milk Board before it could be released for distribution.

The co-operative company in question had entered into an agency agreement with the Milk Board whereby it collected the milk on behalf of the Milk Board and processed it for distribution. This legal arrangement did not amount to any change in the commercial practice that predated the introduction of the Milk Board, as the milk still moved directly from the dairies of the shareholders to the taxpayer’s factory. It was merely a legal technicality required because of the new regime which had been imposed by operation of legislation.

However, because of the arrangement with the Milk Board, the members of the co-operative were ostensibly not the suppliers of legal title to the commodities to the co-operative.

Commissioner’s contention

The Commissioner contended that the vesting in the Milk Board meant that the co-operative company was not acquiring the milk from the shareholders, but rather was acquiring it from the Milk Board. Accordingly, the requirement in Division 9 for the taxpayer to obtain commodities from its members was not met.

Decision

The Taxation Board of Review, by majority, disagreed with the Commissioner. Importantly, Member O’Neill concluded that:

Although possession from the shareholders only becomes ownership from the Board there seems to me to be no abuse of language to say that within the scope of section 117 there has been an “acquisition” by the company of the milk “from its shareholders” notwithstanding that the legal property therein passes to the company through the Board.

Chairman Burke also said:

Having regard to the history of the revenue legislation as well as the legislation dealing with cooperatives, and keeping in mind the obvious purpose of Division 9, I am satisfied that the word acquisition should be read in a commercial rather than a strictly legal sense. So construed, an acquisition for the purposes of section 117(b) is not denied merely because regulatory marketing legislation interposes a technical legal vesting in a statutory authority placed between the producer on the one hand and the distributor, in this case the taxpayer company, on the other. If this view be correct, and adopting the approach of the High Court in A & S Ruffy v. FCT (1958) 98 CLR 637; 7 AITR 238 it is clear that the scope of the company’s activities qualifies it as a cooperative company under section 117(b) for the year in question.

Application of Milk Board to Question 1

The findings in Milk Board support the conclusion that having regard to the imposition of a custodian over the Investor’s assets, the Commissioner will regard the Investor, rather than the custodian, as the “shareholder” in the Taxpayer for the purposes of Division 9 ITAA 1936 for the following reasons:

● In Milk Board it was held that for the purposes of assessing eligibility to Division 9, the fact of an intermediary holding legal title to an asset can be disregarded in favour of a commercial approach which focuses on the holding of beneficial title to the asset. Consequently, the same analysis which was applied in Milk Board to look through the vesting of legal title in commodities can be applied to look through the vesting of legal title to the shares in this case. This is because the vesting of legal title in the shares has occurred for the same reason, being the imposition of a third party as a result of the mandatory operation of statute.

Additionally, given the Milk Board decision focused on the commercial reality of the arrangements outside of the interposed entity, it is relevant here that in relation to the shares in the Taxpayer:

● it would be the investor, and not the custodian, who would exercise all rights as shareholder in the Taxpayer (i.e. attending meetings and exercising voting rights); and

● the Investor, and not the custodian, will receive directly any rebates, bonuses, interest or dividends distributed by the Taxpayer in relation to those shares.

Application of Milk Board to Question 2.1

The findings in Milk Board supports the conclusion that having regard to the imposition of a custodian over the Investor’s assets, if legal title to the Investor’s commodity vests in the custodian, the Commissioner will regard the Investor, rather than the custodian, as the entity from whom the Taxpayer acquires the commodity for the purposes of sections 117(1)(b), 118 and 120(1) ITAA 1936 for the following reasons:

● In the Milk Board decision, the supply of commodities to the co-operative fell short of complying with Division 9 ITAA 1936 because of the statutory imposition of the entity holding legal title to the commodities. Notwithstanding, it was determined that the statutory interposed entity should be disregarded. The decision in Milk Board can be followed here to disregard the statutorily interposed entity because the facts in this case are directly analogous to the facts in Milk Board. Specifically:

● in Milk Board, the Milk Act vested legal title in milk produced by a shareholder to a third party; and

● here, the Class Order vests legal title in the Investor’s commodity to a third party by requiring that a custodian be appointed.

● In Milk Board, the Taxation Board of Review in analysing Division 9 was disregarding legal title of commodities and instead considering the commercial reality of the arrangements between the parties. Here, notwithstanding the interposed custodian, the Investor and not the custodian is the entity which for all practical purposes:

● will conduct the business of growing the commodity contributed to the Taxpayer’s co-operative;

● will supply beneficial title to the commodity to the Taxpayer;

● will supply the commodity to the Taxpayer pursuant to the Supply Agreement (where the price of commodities takes into account the packing, storage, marketing and processing costs incurred by the Taxpayer); and

● will acquire services from the Taxpayer.

Application of Milk Board to Question 2.2

In the event that question 2.2 reflects the legal arrangements between the Investor and the Taxpayer (i.e. that legal and beneficial title in the commodity will pass directly from the Investor to the Taxpayer), no adverse Division 9 consequences arise because the Commissioner would regard the Investor and not the custodian to be:

● the shareholder in the Taxpayer for Division 9 purposes (for the reasons given to Question 1); and

● the entity from whom the Taxpayer acquires the commodity grown by the Investor.