Edited version of private advice

Authorisation Number: 1051554104767

Date of advice: 13 August 2019

Ruling

Subject: Management investment trust (MIT) - eligible investment business

Question 1

Will the Advances provided by the MIT constitute 'unsecured loans' for purposes of the definition of 'eligible investment business' in subparagraph 102M(b)(i) of Division 6C of ITAA 1936?

Answer

No

Question 2

If the answer in Question 1 is 'no', will the Advances provided by the MIT constitute 'other securities' for purposes of the definition of 'eligible investment business' in subparagraph 102M(b)(ii) of Division 6C of the ITAA 1936?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

1.    A unit trust was established in Australia for the purpose of inviting investors to acquire a beneficial interest in the Trust Assets for the term of the Trust.

2.    Investors will subscribe for units in the unit trust which is also a MIT pursuant to Division 275 of the Income Tax Assessment Act 1997 (ITAA 1997).

3.    The MIT will use the subscription monies to provide unsecured subordinated loans (Advances) to an unrelated non-resident entity (Entity X).

4.    Entity X will use the Advance provided by the MIT to invest in various Portfolio Investments in particular industries identified by the investment manager.

5.    The Advances provided by the MIT to Entity X have the following features:

·         are interest-free;

·         do not constitute a debt due and payable;

·         cannot be recovered by legal proceedings;

·         can only be repaid as provided by the relevant Agreement;

·         have a 10-year term;

·         repayments of the Advances will be made as and when Portfolio Investments are realised and at the discretion of Entity X or may be retained by Entity X;

·         cash proceeds from the sales will be distributed to the MIT where Portfolio Investments can be realised;

·         stock will be transferred to the MIT instead of cash proceeds where Portfolio Investments cannot be realised;

·         alternatively, at the sole discretion of Entity X, the MIT can elect to receive distributions in kind rather than cash;

·         will be taken into account for the purposes of allocating distributions of Entity X's assets prior to the dissolution of Entity X which may only take a form of cash or in kind of Marketable Securities at Entity X's discretion; and

·         after the dissolution sale, the distribution of the proceeds will be subordinated to all other creditors' claims on the dissolution of Entity X.

Reasons for decision

Question 1

Summary

The Advances will not constitute 'unsecured loans' for purposes of the definition of 'eligible investment business' in subparagraph 102M(b)(i) of Division 6C of ITAA 1936.

Detailed reasoning

Section 102M of the ITAA 1936 provides eligible investment business means one or more of:

(a) ...; 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) ...;

(iii) ...;

(iv) ...;

(v) ...;

(vi) ...;

(vii) ...;

(viii) ...;

(ix) ...;

(x) ...;

(xi) ...;

(xii) ...;

(xiii) any similar financial instruments; or

(c) ...

Subparagraph 102M(b)(i) of the ITAA 1936 relevantly provides that 'eligible investment business' means investing or trading in unsecured loans.

The word 'loan' is not a defined term in Division 6C of the ITAA 1936. Accordingly, the question of whether the Advance constitutes an unsecured loan will need to be determined by reference to its ordinary meaning.

The Macquarie Dictionary, 2001, rev. 3^rd edn, The Macquarie Library Pty Ltd, NSW defines 'loan' as follows:

...something lent or furnished on condition of being returned, especially a sum of money lent at interest.

Butterworths Concise Australian Legal Dictionary, 2004, 3^rd edn, LexisNexis, NSW defines a 'loan' as:

An advance of money; the provision of credit; the payment of any amount on behalf or at the request of a person where there is an obligation to repay the amount; or a transaction which in substance affects a loan of money.

The decision in Inland Revenue Commissioners v. Rowntree and Co. Ltd [1984] 1 All ER 482 provides that for a facility to be characterised as a loan there must exist the legal relation of lender and borrower which gives rise to a loan of money in return for which there is a promise to repay.

In Re Securitibank Ltd (No.2) [1978] 2 NZLR 136, Richardson J stated at 167 that:

... the essence of a loan of money is payments of a sum on condition that at some future time an equivalent amount will be repaid.

Sackville and Lehane JJ in Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd (1997) 72 FCR 300; (1997) 34 ATR 635; (1997) 97 ATC 4151 noted that:

A loan involves an obligation on the borrower to repay the sum borrowed.

The Commissioner is of the opinion that the above definitions and case law provides the following understanding of the ordinary meaning of the word 'loan' for the purposes of subparagraph 102M(b)(i) of the ITAA 1936 and is succinctly expressed by the definition 'loan' found in Joseph, C 1989, Chitty on Contracts, 26^th edn, Sweet & Maxwell, London (at page 3574):

A contract of loan of money is a contract whereby one person lends or agrees to lend a sum of money to another, in consideration of a promise express or implied to repay that sum on demand, or at a fixed or determinable future time, or conditionally upon an event which is bound to happen, with or without interest.

Under the arrangement, the MIT is required to provide funding to Entity X as interest free subordinated loans (Advances). Each Advance will be utilised by Entity X to invest in various Portfolio Investments. The Advance has a 10-year term during which Portfolio Investments may be realised and proceeds distributed to the MIT in accordance with the relevant Agreement. The Advance will be repaid as and when each Portfolio Investment is realised and as determined by Entity X. In accordance with the Agreement, the amount to be repaid to the MIT includes total Advances made to acquire realised Portfolio Investments plus pro-rata share of aggregate unrealised loss plus a proportionate part of Advances for expenses and fees.

However, certain features of the Advances suggest that the original amount of investment may not be received by the MIT:

·         On dissolution of Entity X, the MIT will be subordinated to all other creditors as regards repayment of any Advances then outstanding.

·         Advances do not confer any right on the MIT to claim that such Advance constitutes a debt due and payable by Entity X to it.

·         Advances do not confer any right on the MIT to bring proceedings against Entity X for payment of that debt.

·         Advances will be taken into account for the purposes of allocating the assets of Entity X as between the investors including the MIT.

·         Repayment of the Advance will occur as and when Portfolio Investments are realised and at the discretion of Entity X.

·         Entity X will determine the amount of aggregate net losses from writedowns (if any) in good faith, provided that the Fair Market Value of an unrealised Portfolio Investment will not be less than the cost unless such unrealised Portfolio Investment suffers a significant and permanent impairment in value.

·         Distributions prior to the dissolution of Entity X may take the form of cash or Marketable Securities, in Entity X's discretion.

·         With respect to all or any portion of any Portfolio Investments that Entity X had otherwise determined to liquidate and distribute as cash, Entity X may, in its sole discretion, offer the relevant investors (including the MIT) a choice to receive an in-kind distribution of Marketable Securities.

·         Where the distribution in kind of Marketable Securities would cause the MIT to be in violation of any relevant law or regulation, Entity X will use reasonable effort to dispose of on behalf of the MIT, such Marketable Securities at the price and terms as Entity X determines in good faith. However, Entity X will have no liability to the MIT for failure to obtain the best price with such sale.

Due to the possible increase or decrease of the market value of the unrealised Portfolio Investments / Marketable Securities, the amount ultimately repaid by Entity X to the MIT under the relevant Agreement may be greater than or less than the amount initially funded by the MIT to Entity X. Accordingly, in these circumstances the Advance is not considered a loan within the meaning of the definition of 'eligible investment business' within subparagraph 102M(b)(i) of Division 6C of the ITAA 1936.

Question 2

Summary

The provision of Advances by the MIT will constitute 'other securities' for purposes of the definition of 'eligible investment business' in subparagraph 102M(b)(ii) of Division 6C of the ITAA 1936.

Detailed reasoning

Section 102M of the ITAA 1936 provides eligible investment business means one or more of:

(a) ...; 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) ...;

(xiii) any similar financial instruments; or

(c) ...

Subparagraph 102M(b)(ii) of the ITAA 1936 relevantly provides that 'eligible investment business' means investing or trading in other securities.

The term 'other securities' is not a defined term in Division 6C of the ITAA 1936, and accordingly, the question of whether the Advance is properly characterised as within '...other securities' will need to be determined by reference to its ordinary meaning.

The ordinary meaning of 'security' is found in the interpretation of the statutory definition of 'security' in subsection 159GP(1) in Division 16E of the ITAA 1936 which provides:

securitymeans -

(a)  stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;

(b)  a deposit with a bank or other financial institution;

(c)  a secured or unsecured loan; or

(d)  any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

The Commissioner's views in Taxation Ruling TR 96/14 Income tax: traditional securities do not limit traditional securities to those which are for the repayment of a loan but includes securities for the payment of other amounts.

The definition of 'security' in paragraph 159GP(1)(a) of the ITAA 1936 includes securities which are generally recognised as debt instruments. Having regard to paragraphs (a), (b) and (c) of the definition, only those contracts that have debt like obligations will usually fall under paragraph (d) of the definition (paragraph 4 of TR 96/14).

The Explanatory Memorandum accompanying the Taxation Laws Amendment Act (No 2) 1986 which introduced Division 16E into the Act states (at 58):

'security' has been defines very widely, and includes items that may not be usually regarded as securities, e.g. contract, so as to encompass various arrangements that may give rise to a deferral in the payment of income.

The Commissioner's view is 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 to pay an amount to the holder whether during the term of the instrument or at its maturity. Each of the listed instruments in paragraph (a) evidences such an obligation. These types of securities will generally be recognised as debt instruments (paragraph 29 of TR 96/14).

With respect to the Advance, an obligation is imposed upon Entity X at the time of entering into the relevant Agreement to make a future payment to the MIT during the 10-year term or on the dissolution and termination of Entity X. The Advance secures a claim by the MIT for an amount which is determined upon realisation of the Portfolio Investments. In accordance with the Agreement, the amount to be repaid to the MIT includes total Advances made to acquire realised Portfolio Investments plus pro-rata share of aggregate unrealised loss plus a proportionate part of Advances for expenses and fees. As established above in Question 1, the MIT may receive stock / Marketable Securities instead of cash proceeds from the sale at the end of the term / dissolution of Entity X.

Accordingly, the Advance meets the ordinary meaning of 'security', being an instrument which evidences and secures an obligation on the part of the issuer, Entity X, to pay an amount to the MIT at the end of the term / termination of Entity X. The MIT provided the Advance as a matter of purely commercial judgment and in the reasonable expectation of achieving an overall gain from the payment due under the Agreement. Accordingly the Commissioner is of the view that when the MIT provides the Advance it invests in 'other securities' for the purposes of subparagraph 102M(b)(ii) of Division 6C of the ITAA 1936.