Edited version of your written advice

Authorisation Number: 1051498533544

Date of advice: 26 March 2019

Ruling

Subject: Income tax – Trusts - Other

Issue 1

Question 1

Will the provision of receivables purchase facilities by the Fund constitute an ‘eligible investment business’ for the purposes of section 102M of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 2

Will the Fund be a ‘trading trust’ for the purposes of paragraph 102N(1)(a) of the ITAA 1936?

Answer

No.

Issue 2

Question 3

Is the part of the net income of the Fund which solely includes the ‘interest fee’ derived from the provision of the receivables purchase facilities distributed to non-resident unitholders ‘interest’ for the purposes of subsection 128A(1AB) of the ITAA 1936?

Answer

Yes.

Question 4

Will the Fund have a non-resident withholding tax obligation in respect of the interest component of the net income distributed to non-resident unitholders in accordance with section 12-245 of the Taxation Administration Act 1953 (TAA 1953) and subsection 128B(2) of the ITAA 1936?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

The scheme commences on:

12 January 2019

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Overview

1. This description of facts is based on the following documents. The documents form part of and are to be read with this description. The relevant documents are

(a) The private ruling application (the application);

(b) Further reasoning for the application;

(c) The Trust Deed for the Fund;

(d) An Information Memorandum;

(e) A Client Letter; and,

(f) A Receivables Purchase Facility Agreement (RPFA).

2. The Fund is an unregistered managed investment scheme settled as a unit trust on 20XX.

3. The trustee of the Fund is Company A (the trustee).

4. The Fund intends to operate an invoice factoring business under the terms of the RPFA with respect to Australian companies (Sellers).

5. The Fund intends to derive income from ‘interest’ payments made under the RPFA and the Client Letter in relation to payments paid to Sellers (Payments). The ‘interest’ accrues until the proceeds of the receivable is repaid.

6. Company B (the Manager) provides management services to the Fund and sources opportunities for the Fund to acquire receivables from third parties.

Unitholders of the Fund

7. The Fund is seeking to offer units in the Fund to ‘wholesale clients’, as defined in the Corporations Act 2001 (the Corporations Act).

8. Some of the wholesale client unitholders may be non-residents for Australian income tax purposes.

Purchasing of receivables from Sellers

9. The main elements of the Fund’s business follows:

(a) The Fund will issue to the Seller the Client Letter and RPFA, which contain the following terms:

(i) A purchase limit,

(ii) The period of the facility,

(iii) The Interest Rate expressed as a percent per annum, and

(iv) Related fees and rates.

(b) The Seller offers selected receivables for the Fund to purchase.

(c) Subject to clauses in the RPFA, the Fund pays the Payment, which is taken to be the acceptance of the offer.

(d) The Seller absolutely and irrevocably transfers and assigns to the Fund all of its right, title and interest in those receivables, free of any encumbrances. However, this assignment only forms an equitable assignment under the RPFA.

Relevant legislative provisions

Income Tax Assessment Act 1936, subsection 6(1)

Income Tax Assessment Act 1936, Division 6C

Income Tax Assessment Act 1936, Division 6C, section 102M

Income Tax Assessment Act 1936, Division 6C, subparagraph 102M(b)(ii)

Income Tax Assessment Act 1936, Division 6C, subparagraph 102M(b)(xii)

Income Tax Assessment Act 1936, Division 6C, paragraph 102N(1)(a)

Income Tax Assessment Act 1936, paragraph 159GP(1)(a)

Income Tax Assessment Act 1936, Division 11A, subsection 128A(1AB)

Income Tax Assessment Act 1936, Division 11A, subsection 128B(2)

Taxation Administration Act 1953, section 12-245

Reasons for decision

Issue 1

Question 1

Will the provision of receivables purchase facilities by the Fund constitute an ‘eligible investment business’ for the purposes of section 102M of the Income Tax Assessment Act 1936 (ITAA 1936)?

Summary

Yes. The Fund is considered to be investing in receivables originally arising between Customers and Sellers. As a result, the Fund is treated as investing in ‘other securities’ or ‘a right...in respect of such a loan, security…’. Therefore, the Fund is carrying on an eligible investment business for the purposes of section 102M of the ITAA 1936.

Detailed reasoning

Public trading trusts

1. Division 6C to Part III of the ITAA 1936 contains provisions relating to the income of certain public trading trusts.

2. The Commissioner is satisfied that the Fund is a public unit trust as the Fund intends to offer units to the public at large.

3. Section 102M of the ITAA 1936 states that, for the purposes of Division 6C of the ITAA 1936, that ‘eligible investment business’ means 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) …;

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

(iii) …;

(iv) …;

(v) …;

(vi) …;

(vii) …;

(viii) …;

(ix) …;

(x) …;

(xi) …;

(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.

Definition of ‘to invest’

4. The term ‘to invest’ is not defined in the ITAA 1936. As a result, the term will take its ordinary meaning.

5. The Macquarie Dictionary defines ‘investing’ as follows:

to put (money) to use, by purchase or expenditure, in something offering profitable returns, especially interest or income.

6. The following cases have also considered the meaning of the term ‘invest’:

(a) Mandie J in Marks and Ors v. Roe and Ors (Unreported judgement of 28 May 1996) states that:

I think that the verb ‘to invest’ when used in an investment clause may safely be said to include as one of its meanings ‘to apply money in the purchase of some property from which interest or profit is expected and which property is purchased in order to be held for the sake of income which it will yield…

(b) Lockhart J in Melville v. Mutual Life and Citizens Assurance Co Ltd (1980) 31 ALR 649 further states that ‘invest’ means to employ money in the purchase of anything from which interest or profit is expected.

7. Therefore, ‘to invest’ generally involves:

(a) Money being outlaid, applied or employed; and,

(b) An expectation of profit or interest.

Definition of ‘other securities’

8. The term ‘other securities’ is not defined in subsection 6(1) or Division 6C of the ITAA 1936. Therefore, the term will take its ordinary meaning.

9. The Commissioner is of the view that the ordinary meaning of the word ‘other security’ under paragraph 102M(b)(ii) can be derived from the same interpretation that arises when interpreting ‘other security’ for the purposes of paragraph 159GP(1)(a) of the ITAA 1936.

10. Paragraph 159GP(1)(a) of the ITAA 1936 defines ‘security’ as meaning:

stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security …

11. While the wording of paragraph 159GP(1)(a) is not identical to that provided in subparagraph 102M(b)(ii), all of the securities listed in subparagraph 102M(b)(ii) appear in the lists of securities provided in paragraph 159GP(1)(a).

12. The Commissioner’s view in this regard is outlined in Taxation Ruling TR 96/14 Income tax: Traditional Securities (TR 96/14).

13. Specifically, subparagraph 4(i) of TR 96/14 states:

… paragraph (a) of the definition of ‘security’ in subsection 159GP(1) of the Act includes securities which are generally recognised as debt instruments.

14. Further, paragraphs 24 to 26 of TR 96/14 states that paragraph (a) of the definition:

(a) refers to items that are usually taken to be a security (citing clause 13 of the Explanatory Memorandum to the Taxation Laws Amendment Act (No 2) 1986);

(b) includes the normal meaning of the word ‘security’, being to denote a debt or claim the payment of which is in some way secured: pursuant to Singer v. Williams [1920] All ER Rep Ex 819; or,

(c) may, in the context of financial markets, include written undertakings securing the payment of money.

15. Under paragraph 29 of TR 96/14, the Commissioner outlines that:

…whilst appreciating the difficulty of finding one genus in paragraph (a), it is our view that the term ‘or other security’ in the context in which it is used only encompasses instruments that evidence an obligation on the part of the issuer or drawer to pay an amount to the holder or acceptor, whether during the term of the instrument or at its maturity. We have drawn this conclusion because each of the listed instruments in paragraph (a) evidences such an obligation. These types of securities will generally be recognised as debt instruments.

Applying the law to your circumstances

Overview

16. In order to determine whether the Fund’s activities satisfy the definition of an ‘eligible investment business’ it must be determined whether the purchase of receivables is an investment in other securities or a right or option in respect of such a loan, security, share, unit, contract or policy.

‘To invest’

17. The Commissioner is satisfied that the Fund’s purchase of receivables from potential Sellers satisfies the definition of ‘to invest’ for the following reasons:

(a) The Fund outlays money in the form of the Payment to secure a right in respect of a receivable.

(b) There is an expectation that, as outlined in the Client Letter and RPFA, the Fund will derive interest in addition to the full amount of the receivable assigned.

‘Other security’

18. The next relevant consideration is whether the Fund’s purchase of receivables is an investment in ‘other securities’. As highlighted above, an instrument will be treated as an ‘other security’ if the instrument evidences an obligation on the part of the issuer or drawer to pay an amount to the holder or acceptor, whether during the term of the instrument or at its maturity.

19. The taxpayer submits that the RPFA evidences an obligation on the part of the Seller to pay amounts (being proceeds of the receivables purchased) in consideration for the Fund making the Payment.

20. In determining the substance of obligations under the RPFA and Client Letter (being the relevant instruments), the Commissioner has considered the following:

(a) The receivables arise between the Seller and their Customers. As a result, the Customers initially have an obligation to repay amounts to the Seller under the respective receivable.

(b) Under the RPFA and the Client Letter, the Fund appears to purchase the respective receivable, but the Seller only assigns equitable interests/rights in respect of the receivable. This is despite clauses in the RPFA, which state that the Seller ‘absolutely and irrevocably transfers and assigns to the [Fund] all of its rights, title and interest…’, as the Fund is prevented from perfecting legal assignment of the debt unless and until a Termination Event occurs.

21. The Commissioner has reviewed the relevant clauses of the RPFA and Client Letter.

22. The Commissioner is satisfied that the RPFA and Client Letter evidence an obligation on the part of the Seller to pay amounts to the Fund during the term of the instrument.

23. As a result, the purchase of receivables by the Fund will be an investment in ‘other securities’.

‘A right or option in respect of such a loan, security, share, unit, contract or policy’

24. Alternatively, the Commissioner is satisfied that the Fund’s purchase of receivables will be an investment in a right in respect of a security. This is because:

(a) Before the assignment of the receivable from the Seller to the Fund, the Customers have an obligation to the Seller to pay the amount identified by the receivable.

(b) For the reasons outlined above, the Commissioner is satisfied that the receivable will constitute a security for the purposes of paragraph 102M(b) of the ITAA 1936.

(c) The Fund appears to purchase the respective receivable, but the Seller only assigns equitable interests/rights in respect of the receivable. This is despite clauses in the RPFA, which state that the Seller ‘absolutely and irrevocably transfers and assigns to the [Fund] all of its rights, title and interest…’, as the Fund is prevented from perfecting legal assignment of the debt unless and until a Termination Event occurs.

(d) Therefore, the Payment is paid to secure an equitable right in respect of the receivable. In the event of a Termination Event, the Fund can acquire full legal rights in respect of the receivable.

(e) As a result, the Fund is taken to purchase equitable rights in respect of the receivable, with the potential to acquire full legal rights in the event of a Termination Event as defined under the RPFA.

Conclusion

25. The Commissioner is satisfied that the Fund’s purchase of receivables is an ‘eligible investment business’ because the nature of purchasing the receivables is an investment in ‘other securities’ or ‘rights in respect of… securities’.

Question 2

Will the Fund be a ‘trading trust’ for the purposes of paragraph 102N(1)(a) of the ITAA 1936?

Detailed reasoning

26. Paragraph 102N(1)(a) of the ITAA 1936 provides that:

[When unit trust is trading trust] For the purposes of this Division, a unit trust is a trading trust in relation to a year of income if, at any time during the year of income, the trustee:

(a) carried on a trading business; or

(b) …

27. A ‘trading business’ is defined in section 102M of the ITAA 1936:

trading business means a business that does not consist wholly of eligible investment business.

28. The definition of an ‘eligible investment business’ is defined above.

29. As highlighted above, the Fund’s purchase of receivables is an ‘eligible investment business’. Further, these activities are the sole activities conducted by the Fund.

30. As a result, the Commissioner is satisfied that the Fund is not engaged in carrying on a trading business for the purpose of section 102M of the ITAA 1936 as the Fund carries on a wholly eligible investment business.

31. Therefore, the Fund will not be a ‘trading trust’ for the purposes of paragraph 102N(1)(a) of the ITAA 1936.

Issue 2

Question 3

Is the part of the net income of the Fund which solely includes the ‘interest fee’ derived from the provision of the receivables purchase facilities distributed to non-resident unitholders ‘interest’ for the purposes of subsection 128A(1AB) of the ITAA 1936?

Summary

Yes. The interest derived from the Fund’s investment in receivables from Sellers (being the On Time Interest and Overtime Interest), which forms part of the net income of the Fund, will be interest for the purposes of subsection 128A(1AB) of the ITAA 1936.

Detailed reasoning

Overview

32. Division 11A to Part III of the ITAA 1936 contains provisions relating to dividends, interest and royalties paid to non-residents and to certain other persons.

33. For the purposes of Division 11A, subsection 128A(1AB) of the ITAA 1936 states that:

interest includes an amount, other than an amount referred to in subsection 26C(1):

(a) that is the nature of interest; or

(b) …

(c) …

(d) …

(e) …

34. It is noted that this definition is an inclusive definition but does not define the ordinary meaning of the term ‘interest’.

Ordinary meaning of ‘interest’

35. While the term ‘interest’ is given specific meaning in a number of provisions under the ITAA 1936, the term is not defined for the purposes of the ITAA 1936 generally. Therefore, the term will take its ordinary meaning.

36. The Macquarie Dictionary defines ‘interest’ as:

payment, or a sum paid, for the use of money borrowed (the principal), or for the forbearance of a debt.

37. The following cases have also considered the meaning of the word ‘interest’:

(a) Cooper J in Consolidated Fertilizers Ltd v. Commissioner of Taxation 92 ATC 4260 stated:

The word ‘interest’ is a term in ordinary English usage. In the context of the payment of money it means ‘compensation for injury “damages”’ or ‘money paid for the use of money lent (the principal) or for forbearance of a debt, according to a fixed ratio’…or ‘a charge for the use of credit or borrowed money; such a charge expressed as a percentage per time unit of the sum borrowed or used’…

(b) Lord Wright in Riches v. Westminster Bank Limited [1947] AC 390 stated:

…the essence of interest is that it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had had the use of the money, or conversely the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation.

(c) The Court referred to ‘interest’ in Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 71 ALR 28 as:

…flowing from the principal sum…and to be compensation to the lender for being kept out of the use and enjoyment of the principal sum…

(d) The Court in Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd 97 ATC 4151 provided an expanded definition:

The common meaning of interest is the money which accrues from day to day calculated according to a fixed ratio of a sum lent, agreed to be paid under a contract of loan. But the word has a wider meaning which may include the compensation or damages to be paid to a person denied the use of a sum to which that person is, or becomes, entitled. Cardinal to either meaning is that interest be referable to a principal in money or an obligation to pay money… [emphasis added]

(e) The Court held in Federal Commissioner of Taxation v. Century Yuasa Batteries Pty Ltd [1998] FCA 269; 98 ATC 4381; 38 ATR 442 that the ordinary meaning of ‘interest’ in the context of withholding tax:

…is the return, consideration or compensation for the use or retention by one person of a sum of money belonging to, or owed to, another, and that interest must be referable to a principal.

(f) The Court also highlighted in Steele v. Federal Commissioner of Taxation 99 ATC 4242 that:

…interest is ordinarily a recurrent or periodic payment which secures, not an enduring advantage, but, rather, the use of borrowed money during the term of the loan.

38. Paragraph 24 to 30 of Taxation Ruling TR 93/27 Income tax: basis of assessment of interest derived and incurred by financial institutions and paragraphs 53 to 56 of Taxation Ruling TR 2002/15 Income tax: deductibility of payments incurred on moneys raised through the issue of perpetual notes (TR 2002/15) provide the Commissioner’s view on the nature of interest.

39. As a result, the following factors appear relevant in determining the character of a payment as interest:

(a) There must be a sum of money by reference to which the payment is to be ascertained (the principal sum or principal debt);

(b) That sum must be a sum which is due to the person entitled to the interest; and,

(c) The calculation of the payment by reference to time.

Applying the law to your circumstances

40. The Commissioner is satisfied that the ‘interest’ payments under the RPFA and Client Letter satisfy the definition of ‘interest’ as outlined above because:

(a) The interest payable for both types of interest includes reference to either the Payment or the proceeds that remain unpaid from the Payment. This Payment is the principal sum transferred to the Seller who is obligated to repay the sum as outlined in the reasoning for question one above.

(b) The sum payable is due to the Fund, who is entitled to receive the sum under the RPFA and Client Letter.

(c) The interest payable is calculated with a reference to time.

41. Therefore, the ‘interest’ payments under the RPFA satisfies the definition of ‘interest’ under paragraph 128A(1AB)(a) of the ITAA 1936 as they are amounts that are in the nature of interest.

Question 4

Will the Fund have a non-resident withholding tax obligation in respect of the interest component of the net income distributed to non-resident unitholders in accordance with section 12-245 of the Taxation Administration Act 1953 (TAA 1953) and subsection 128B(2) of the ITAA 1936?

Detailed reasoning

Interest derived by a beneficiary of a trust

42. Section 128A(3) of the ITAA 1936 provides that:

For the purposes of this Division, a beneficiary who is presently entitled to…interest…included in the income of a trust estate shall be deemed to have derived income consisting of that…interest…at the time when he or she became so entitled.

43. As highlighted above, the interest payable to the Fund by potential Sellers will constitute ‘interest’ for the purpose of subsection 128A(1AB) and, therefore, Division 11A of the ITAA 1936.

44. As a result, the interest derived by the Fund to which a beneficiary of the Fund is presently entitled will be deemed to have been derived by the beneficiary at the time the beneficiary become so entitled.

Withholding obligations with respect to non-residents

45. Section 12-245 of Schedule 1 of the TAA 1953 provides:

An entity must withhold an amount from interest (within the meaning of Division 11A of Part III of the Income Tax Assessment Act 1936) it pays to an entity, or to entities jointly if:

(a) the recipient or any of the recipients has an address outside Australia according to any record that is in the payer’s possession, or is kept or maintained on the payer’s behalf, about the transaction to which the interest relates; or

(b) …

46. Further, section 128B of the ITAA 1936 concerns the liability of certain persons to pay withholding tax.

47. Specifically, subsection 128B(2) provides that:

Subject to subsection (3), this section also applies to income that:

(a) is derived, on or after 1 January 1968, by a non-resident; and

(b) consists of interest that:

(i) is paid to the non-resident by a person to whom this section applies and is not an outgoing wholly incurred by that person in carrying on a business in a country outside Australia at or through a permanent establishment of that person in that country; or

(ii) …

Conclusion

The Commissioner is satisfied that the Fund has a non-resident withholding tax obligation with respect to the interest component of the net income to which non-resident unitholders become presently entitled.