Edited version of private advice

Authorisation Number: 1051563365994

Date of advice: 25 September 2019

Ruling

Subject: Residency of a feeder fund under section 6 or section 94T of the Income Tax Assessment Act 1936 (ITAA 1936)

Question

Is the Feeder Fund an Australian resident under section 6 or section 94T of the ITAA 1936 for Australian income tax purposes?

Answer

No.

Relevant facts and circumstances

The fund

The fund is established by an Australian independent real estate manager that provides Australian investment opportunities to Australian and international wholesale and institutional investors. The manager holds an Australian Financial Services Licence. It has a disciplined investment strategy, criteria, governance framework and risk parameters.

The fund will comprise two distinct sub-trusts - a passive arm and a trading arm.

The fund will be a 10 year fund with the possibility of extension where approved by investors. Its objective is to invest in or create a portfolio of quality income producing real estate assets. There will be a 3 year investment period from final close. The Fund will be targeting a certain overall internal rate of return ('IRR') or gross equity multiple ('GEM').

The fund will be an unlisted wholesale fund domiciled in Australia and not offered to the public.

Fund investors

Investment in the fund will be sought from the manager's existing investor base and select new investors. The new investors will be privately, specifically and directly approached by the manager as Investment Manager to scope for their interest in participating in the fund.

The expected unitholder composition of Head Trust comprises resident companies (related to the manager), resident complying superannuation funds, resident trusts, non-resident companies, non-resident trusts and non-resident limited partnerships.

The location of non-resident investors is expected to be the various foreign countries. At the time of application, there were no discussions with other potential investors which are not resident in an Exchange of Information (EoI) country. Further, it is anticipated that, other than Australian investors, only non-resident investors resident in EoI countries will invest, directly or indirectly, into Head Trust.

The investors in Head Trust will hold 'units' in the trust which represent a proportionate share, measured by reference to a fixed standard, of the income and property of the trust.

Feeder Fund

Non-resident investors have the option to indirectly invest in the fund through a 'Feeder Fund'. The Feeder Fund will take the form of either a company or a foreign corporate limited partnership incorporated or formed in a foreign jurisdiction that is an EoI country.

Where it is a limited partnership, it will be formed in a foreign jurisdiction, under which, by operation of the applicable law (and not by contract or deed), liability of at least one of the partners is limited.

The voting power of the Feeder Fund will not be controlled by Australian resident shareholders.

The purpose of the Feeder Fund is to eliminate the compliance burden for non-resident investors. As such, it will be an administrative business that undertakes administrative functions including, record keeping, and collecting and distributing funds from/to non-resident investors and returns from Head Trust. It will also manage tax compliance, legal compliance, notifications of distribution notices, pay and receive funds etc. The functions will be outsourced to a local third party service provider in the jurisdiction in which it was formed. The service provider will appoint directors, and perform all functions required to be undertaken by the Feeder Fund.

The high level decisions of the Feeder Fund will be made by the directors of the company (most of whom will not be Australian residents), and such decisions will not be exercised in Australia. To the extent that any directors of the Feeder Fund attend meetings from Australia (e.g. by phone or video conference), a majority of the directors of the Feeder Fund will not be attending from Australia. The directors of the Feeder Fund will not merely rubber stamp or mechanically follow decisions of the directors who will attend meetings from Australia, nor those of the Investment Manager or any other person or body in Australia, but will make decisions in the best interests of the Feeder Fund.

If the Feeder Fund takes the form of a corporate limited partnership, the general partner would generally take part in the management of the business of the partnership, however the general partner will not be an Australian resident and will not undertake any decision making in Australia.

Given that the shareholders of the Feeder Fund will be non-residents, it is unlikely that the shareholders' meetings will be held in Australia. The meetings of directors will mainly occur outside of Australia and the associated documents will be recorded and kept outside of Australia.

Declarations of dividends and payments of dividends will occur outside of Australia. The registered office, the company's books and register of shareholders will be kept outside of Australia.

Fund structure

The fund will comprise a head unit trust (Head Trust), which will hold approximately 99% of the units in Sub Trust A and Sub Trust B unit trusts. The remaining interests (approximately 1%) will be held by a special purpose vehicle ('SPV'), which will be a company for the purposes of this ruling. SPV will hold the units at the Sub Trust A and Sub Trust B level as performance fees will be paid to the manager at the head trust level.

The manager will be the Investment Manager for Head Trust, Sub Trust A and Sub Trust B. It will also be the trustee of Head Trust.

The trustees for Sub Trust A, Sub Trust B and all other sub-trusts will be either a special purpose trustee company or a third party trustee. Sub Trust B will have a different trustee to that of Sub Trust A and each of its sister trusts. There will be 2 directors for each trustee, with only one common director between the trustee for Sub Trust B and the trustee/s for Sub Trust A and each of its sister trusts.

The Investment Memorandum for the Fund will clearly state and differentiate the different strategies of Sub Trust A and Sub Trust B.

There will be no arrangements of any kind between Sub Trust A and Sub Trust B, including no loans, leasing or licensing arrangements between the two entities. Sub Trust A will not rely on, nor influence or impact the financial position of Sub Trust and vice versa.

The funds invested are not intended to be recycled and reinvested, in particular with regard to capital invested in Sub Trust A.

Sub Trust A and its sister trusts

Sub Trust A will hold investments of a 'passive' kind and on a long term basis. It will only conduct the business of investing in commercial, industrial and retail assets for the purpose, or primarily for the purpose, of deriving rent.

Multiple trusts may be established in order to hold the investments through wholly (or partly) owned sub-trusts (i.e. Sub Trust A and its 'sister trusts'). There may be sub-trusts that Sub Trust A owns jointly with third parties not related to the fund.

Specifically, Sub Trust A and its sister trusts will seek to acquire properties with the purpose of continuing to lease them, or improve the rental stream through value creation strategies, including leasing vacant or expiring tenancies, lease repositioning, capital expenditure including refurbishment, asset expansion and/or rehabilitation to maximise rental income over the holding period.

Key to this strategy is the obtaining of favourable prices for the assets, and proactively managing leasing strategies once the assets are acquired.

Prior to the acquisition of any asset, a 'Final Investment Proposal' ('FIP') will be issued by the Investment Manager to the Investment Committee for consideration. The FIP will include:

·        Details of the asset to be acquired;

·        The purpose of the acquisition;

·        What value-add strategies (if any) are to be implemented; and

·        The asset's alignment with the investment strategy of Sub Trust A, including intended holding period, projected rental yields etc.

Accompanying the FIP will be a detailed forecast financial model prepared for each asset proposed to be acquired.

Depending on the time of acquisition of the asset within the Fund's lifecycle, the average expected holding period of the assets will be at least six years, which may expand where an extension of the Fund's life occurs beyond the initial 10 year fund life.

Tax advice and sign-off will also be required to confirm whether an asset is eligible/suitable for Sub Trust A. Where it is unclear, a ruling with the ATO will be sought.

Sub Trust B

Sub Trust B will carry on a trading business.

Prior to the acquisition of any asset, a FIP will be issued by the Investment Manager to the Investment Committee for consideration. The FIP will outline details of the asset to be acquired, the purpose for doing so, the value-add strategies (if any) to be implemented and the asset's alignment with the investment strategy of Sub Trust B.

The assets Sub Trust B will invest in will range from commercial, retail and industrial assets in respect of which the anticipated capital gain component will exceed expected rental income to buying, renting and ultimately selling distressed completed residential housing.

Investment Management Services

The manager will enter into separate Investment Management Agreements with Head Trust, Sub Trust A and Sub Trust B. The activities the Investment Manager will be performing as part of their investment management services will be on an entity-by-entity basis. That is, the activities will reflect, distinguish and clearly delineate between the separate investment strategies (as will be outlined in the Investment Memorandum). The Investment Manager will perform their duty in respect of Sub Trust A (and its sister trusts) separately and independently from its duties to Sub Trust B, and within the parameters set by the Investment Management Agreement with each trust.

Base investment management fees for funds under management or services provided will be paid by Sub Trust A and Sub Trust B respectively.

Subject to the overall performance of the fund, a performance fee will be paid by Head Trust to the manager.

Governance

The fund's compliance with the parameters that will be contained within the Information Memorandum is ensured by way of two committees - the Investment Committee and the Investor Consultation Committee. At least two fully independent members are appointed to the Investment Committee with the other two members of the Investment Committee being members of the manager's Board.

The Investment Committee is responsible for the approval of all significant investment and governance decisions and is independent from the manager's Board. Consistent with industry practice, all acquisition, disposal and other material decisions will require unanimous approval from the Investment Committee.

The Investor Consultation Committee is comprised of investor representatives and is responsible for communicating and consulting with the Investment Committee on any matter referred to them by the Investment Committee. No related party transaction or investment outside the Investment Strategy and criteria may be entered into without first being referred to the Investor Consultation Committee for discussion. In the event that an investment opportunity is outside the Investment Strategy and criteria, specific approval needs to be sought and obtained from the Investment Committee and, ultimately Investors through the Investor Consultation Committee.

The Investment Committee and Investor Consultation Committee (where required) for Sub Trust A (and its sister trusts) and Sub Trust B, will meet and act only in the interests of the respective trusts.

There will be separate agendas, meetings, resolutions and records maintained in respect of each trust.

Neither Sub Trust A nor Sub Trust B will have the ability to appoint members to the Investment Committee. Further, Sub Trust A, the trustee for Sub Trust A, the Investment Manager in its capacity as Investment Manager of Sub Trust A, the Investment Committee and Investor Consultation Committee in their capacities as committees for Sub Trust A, will not have the ability to veto any decisions in respect of Sub Trust B (and vice versa).

Assumption

·        All trusts established as part of the fund will be unit trusts.

·        While there is no certainty as to the investor composition at the date of this ruling, the anticipated investor profile of Head Trust is currently as follows:

˗                  The four resident superannuation funds are complying superannuation funds or a pooled superannuation trust that has at least one member that is a complying superannuation fund, a fund that has at least 50 members.

˗                  The non-resident trust is recognised under a foreign law as being used for collective investment by pooling the contributions of its members as consideration to acquire rights to benefits produced by the entity and has at least 50 members, and the contributing members do not have day-to-day control over the entity's operation.

˗                  At least 95% of the membership interests in the limited partnership are owned by entities mentioned in subsection 275-20(4)(a)-(ia), or by entities that are wholly-owned by those entities; and the remaining membership interests (if any) in the limited partnership are owned by a general partner of the limited partnership that habitually exercises the management power of the limited partnership.

·        The trustees for all unit trusts in the Head Trust chain of trusts are Australian resident entities for income tax purposes.

·        The Investment Manager is an Australian resident entity and conducts all its investment management activities in relation to the fund in Australia.

·        While the Investment Manager operates or manages Sub Trust A, it will be a financial services licensee (within the meaning of section 761A of the Corporations Act 2001) that holds an Australian financial services licence, which licence covers it providing financial services (within the meaning of section 766A of that Act) to wholesale clients (within the meaning of section 761G of that Act).

·        Sub Trust A and each of its sub-trusts will be a managed investment scheme ('MIS') under section 9 of the Corporations Act 2001.

·        Sub Trust A is an unregistered wholesale trust and is not required to be registered in accordance with section 601ED of the Corporations Act 2001 because of subsection 601ED(2) of that Act.

·        Head Trust and SPV had not become members of Sub Trust A because a financial service was provided to, or acquired by, the members as a retail client (within the meaning of sections 761G and 761GA of the Corporations Act 2001).

·        Sub Trust A will carry on a business that consists wholly of eligible investment business.

·        Sub Trust A and Sub Trust B will only invest in real estate situated in Australia and will only derive Australian sourced income.

·        Head Trust is not eligible to elect into the Attribution MIT ('AMIT') regime.

Reasons for decision

The following analysis proceeds on the basis of the Feeder Fund taking the form of either a company or a corporate limited partnership, as stated in the Facts.

Company residency

The residency tests for companies are set out in section 6 of the ITAA 1936, as reproduced below:

resident or resident of Australia means:

...(b) a company which is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia.

The first test, being the incorporation test, is not relevant in the present case as the Feeder Fund will not be incorporated in Australia.

The second test is the central management and control test. It is a two part test requiring the company to not only have its central management and control in Australia, but also to carry on business in Australia. Central management and control is not necessarily exercised where the trading or investment activities of the company are carried on. However, because the central management and control of a business is factually part of carrying on that business, a company typically carries on business both where its trading and investment activities take place, and where the central management and control of those activities occurs.

Central management and control refers to the control and direction of a company's operations; the key element of which is the making of high-level decisions that set the company's general policies, and determine the direction of its operations and the type of transactions it will enter. The nature of a company's activities and business defines which acts and decisions are an exercise of central management and control.

The decision-making may be made by a person, or group of people, provided they actively consider and decide to do, or not do something based on it being in the best interests of the company. The residency of the person/s making the decision is not determinative. What matters is where they actually perform the activities to control and direct the company.

The matters that are most likely to determine where those who control and direct the operations of a company do so from are:

·        Where those who exercise central management and control do so;

·        Where the governing body of the company meets;

·        Where the company declares and pays dividends;

·        The nature of the business and whether it dictates where control and management decisions are made in practice; and

·        Minutes or other documents recording where high-level decisions are made.

Based on the facts and circumstances of the present case as it pertains to the Feeder Fund, the central management and control of the Feeder Fund will not be exercised in Australia and therefore, the Feeder Fund will not be an Australian resident for tax purposes. In particular:

·        The Feeder Fund is an administrative business that undertakes administrative functions including, record keeping, and collecting and distributing funds from/to non-resident investors and returns from Head Trust. The functions will be outsourced to a local third party service provider in the jurisdiction in which it was formed. The service provider will appoint directors, and perform all functions required to be undertaken by the Feeder Fund.

·        The high level decisions of the Feeder Fund will be made by the directors of the company (most of whom are not Australian residents), and such decisions will not be exercised in Australia. The meetings of directors will mainly occur outside of Australia. To the extent that any directors attend meetings from Australia (e.g. by phone or video conference), a majority of the directors of the Feeder Fund will not be attending from Australia.

·        The directors of the Feeder Fund will not merely rubber stamp or mechanically follow decisions of the directors who will attend meetings from Australia, nor those of the Investment Manager or any other person or body in Australia, but will make decisions in the best interests of the Feeder Fund.

·        If the Feeder Fund takes the form of a corporate limited partnership, the general partner would generally take part in the management of the business of the partnership, however the general partner will not be an Australian resident and will not undertake any decision making in Australia.

·        Given that the shareholders of the Feeder Fund will be non-residents, it is unlikely that the shareholders' meetings will be held in Australia.

·        The directors' meeting minutes and associated documents will be recorded and kept outside of Australia.

·        Declarations of dividends and payments of dividends will occur outside of Australia.

·        The registered office, the company's books and register of shareholders will be kept outside of Australia.

Corporate limited partnership residency

For corporate limited partnerships, section 94T in Division 5A of the ITAA 1936 sets out the applicable residency tests, as reproduced below:

Section 94T Residence of corporate limited partnership

94T(1) For the purposes of the income tax law, the partnership is:

(a) a resident; and

(b) a resident within the meaning of section 6; and

(c) a resident of Australia; and

(d) a resident of Australia within the meaning of section 6;

if and only if:

(e) the partnership was formed in Australia; or

(f) either:

(i) the partnership carries on business in Australia; or

(ii) the partnership's central management and control is in Australia.

The test of residence for corporate limited partnerships was intended to be 'closely comparable to the test of residence for companies.' The main difference, however, is that the mere carrying on of business in Australia is sufficient for a corporate limited partnership to be a resident for Australian tax purposes.

The formation test in paragraph 94T(1)(e) does not apply in this case as the Feeder Fund will be formed in a jurisdiction other than Australia.

In relation to the central management and control test in subparagraph 94T(1)(f)(ii), for the same reasons, and having regard to the same facts and circumstances as set out in the first part of this question 7, it is not considered that the central management and control of the Feeder Fund will be exercised in Australia.

That leaves the carrying on of a business test in subparagraph 94T(1)(f)(i) for consideration. The commentary in footnote 4 to TR 2018/5 sheds some light on this point, albeit in the context of whether a company is carrying on a business:

Whether a company is carrying on a business ultimately depends on an overall impression of the company's activities. However, where a limited or no liability company is established and maintained to make a profit for its shareholders, and invests its assets in gainful activities that have both a purpose and prospect of profit, it is likely to be carrying on business within the meaning of the central management and control test of company residency. In these circumstances, it is likely the other indicia of carrying on business will support this conclusion (Brookton Co-operative Society Ltd v. FCT (1981) 147 CLR 441 per Aicken J at 469 (Brookton); American Leaf Blending Co Sdn Bhd v. D-G of IR [1978] 3 All ER 1185 Per Lord Diplock at 1189 (American Leaf); Inland Revenue Commissioners v. Westleigh Estates Company Ltd; South Behar Railway Company Ltd; Eccentric Club Ltd [1924] 1 KB 390) (Westleigh). This is so even if the company's activities are relatively limited, and its activities primarily consist of passively receiving rent or returns on its investments and distributing them to its shareholders (Brookton per Aicken J at 469; Westleigh; Lilydale Pastoral Co. Pty. Ltd. v. FCT 87 ATC 4235; American Leaf; FCT v. Total Holdings 79 ATC 4279; FC of T v. E A Marr & Sons Sales Ltd (1984) 2 FCR 326 at 330-1; 84 ATC 4580 at 4585-4586.

As indicated in the above extract, the indicia of carrying on a business are set out in case law. It is ultimately a question of fact, and must be answered based on a wide survey, and the overall impression gained, of the activities of the entity having regard to the indicia of carrying on a business as a whole. Generally, relevant factors include whether there is an intention to carry on business, the nature of the activities, whether there is a profit-making purpose, whether the activities are repeated, regular, and organised in a business-like manner, and the size and scale of the company's activities.

Based on a holistic assessment of the facts and circumstances pertaining to the Feeder Fund, the fund is not considered to carry on business in Australia. In particular, none (or very little) of the following activities will take place, or be, in Australia:

·        The administrative functions that comprise the business of the Feeder Fund, including record keeping, and collecting and distributing funds from/to non-resident investors and returns from Head Trust. The functions will be outsourced to a local third party service provider in the jurisdiction in which it was formed. The service provider will appoint directors, and perform all functions required to be undertaken by the Feeder Fund.

·        Regular meetings among the decision-makers in which high level decisions will be made in respect of the Feeder Fund.

The decision-makers for the Feeder Fund will not merely rubber stamp or mechanically follow decisions of the Investment Manager or any other person or body in Australia, but will make decisions in the best interests of the Feeder Fund.

·        The management of the business of the partnership.

·        Shareholder meetings of the Feeder Fund.

·        The making and keeping of records of the decision-makers' meetings.

·        Declarations of dividends and payments of dividends.

·        The location of the registered office, company books and a register of shareholders.

Therefore, the Feeder Fund, whether in the form of a company or a corporate limited partnership, will not be a resident for income tax purposes pursuant to the applicable residency tests in the section 6 definition and in section 94T of the ITAA 1936.