Edited version of private advice

Authorisation Number: 1051632437785

Date of advice: 4 February 2020

Ruling

Subject: Accumulation of Funds by a Charitable Trust

Question

Will the charitable fund meet the requirement under s 50-50(2)(b) of the lncome Tax Assessment Act 1997 (ITAA 1997), that its assets and income are applied solely for the purpose for which it is established, where it receives a substantial one-off distribution in the year ended 30 June 2020 which it distributes for public charitable purposes over a five year period?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

Year ending 30 June 2024

The scheme commences on:

1 July 2019

Relevant facts and circumstances

The Charitable Foundation (the Foundation) is a charity registered with Australian Charities and Not-for-profits Commission (ACNC).

The Foundation is endorsed by the Australian Taxation Office (ATO) to access the following tax concessions:

·        GST Concession

·        Income Tax Exemption

The Foundation is not endorsed as a deductible gift recipient (DGR).

The Foundation is not a private ancillary fund.

The Foundation operates under a Trust Deed and has a corporate trustee.

The founders and directors of the Foundation have accepted the practice of giving over 20% of their annual income to charitable causes both on a personal basis and through the auspices of the Foundation.

The Foundation does not solicit any contributions from third parties. All monies available for distribution have been sourced from the related entities within the group. Specifically, the Foundation's funds come from these sources:

·        personal loans made by the directors of the Trustee

·        distributions from other entities within their group of companies;

·        franking credits associated with the distributions of fully franked dividends.

Amongst other philanthropic projects, the Foundation has been supporting a religious school (the School) and a provider of religious educational services (the Provider).

The School is an education provider holding the relevant state educational authority registration. It is a charity registered with the ACNC that is exempt from income tax. The School itself is not endorsed as a DGR by the ATO, but has a number of associated funds that are DGRs, namely:

·        The School Building Fund;

·        The Public Library Fund; and

·        The Scholarship Fund.

The Provider renders religious educational services and helps to promote and advance religion. The Provider was established to support the School through the provision of religious educational services and pastoral care to its students. The Provider is a charity registered with ACNC, is exempt from income tax, and is not endorsed as a DGR by the ATO.

The majority of the School's revenue is sourced from donations and government grants, while the Provider relies heavily on donations.

The Foundation has committed to donate a substantial sum to the School and the Provider over the five year period starting in the 20XX income year.

The Foundation is also committed to making ongoing payments to other charitable organisations over the next five years.

It is proposed that a related entity will make a substantial distribution to the Foundation in 20XX-20XX financial year. This will allow the Foundation to commit to distribute that amount to the School and the Provider over a five year period.

After receiving the distribution from the related entity and prior to distributing the money to the School and the Provider, the Foundation is planning to conservatively invest the funds. lncome generated from the Foundation's investments will be applied for its charitable purposes.

The Foundation has discussed the proposed accumulation of funds with the ACNC, and the ACNC has advised that the Foundation is not required to seek approval from the ACNC to accumulate funds, as long as it is following its governing documents.

Assumption

We assume that the entity will maintain the status of a registered charity for the entire period covered by this ruling.

Relevant legislative provisions

Section 50-5 of the Income Tax Assessment Act 1997

Section 50-47 of the Income Tax Assessment Act 1997

Section 50-50 of the Income Tax Assessment Act 1997

Section 50-52 of the Income Tax Assessment Act 1997

Reasons for decision

These reasons for decision accompany the Notice of private ruling for the Foundation.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

The accumulation of funds with the view of distributing them to the School and the Provider over a period will not put the Foundation in breach of the special condition in paragraph 50-50(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997), as long as in the relevant years:

·        the Foundation's purposes remain the same as outlined in the Trust Deed;

·        the activities of the Foundation do not support any other purposes;

·        the Foundation's income and assets are applied strictly in accordance with its Trust Deed; and

·        the Foundation's income and assets are not directed or applied for any other purpose or purposes.

Detailed reasoning

In accordance with item 1.1 of the table in section 50-50 of ITAA 1997, a registered charity is exempt from income tax, if the special conditions as listed in sections 50-50 and 50-52 are satisfied.

One of the special condition, listed under paragraph 50-50(2)(b) of ITAA 1997 and referred to as the "income and assets condition", reads as follows:

...apply its income and assets solely for the purpose for which the entity is established...

Taxation Ruling TR 2015/1 Income Tax: special conditions for various entities whose ordinary and statutory income is exempt (TR 2015/1) considers the income and assets condition.

To determine whether an entity satisfies the income and assets condition, paragraph 23 of the TR 2015/1 applies the following two steps:

·        what is the 'purpose for which the entity is established', and

·        has the entity applied its income and assets solely for the purpose for which the entity is established?

What is the purpose for which the Foundation is established?

The first step is to ascertain the Foundation's establishment purposes, which are clearly stated in its Trust Deed.

Paragraph 136 of the TR 2015/1 requires the consideration of the Foundation's circumstances during the income year in which the income and assets condition is applied. This includes a number of factors: the periodic operation of the provisions in Division 50, the use of the present tense in the income and assets condition, and the interpretation of the term 'established'.

Periodic operation of the provisions in Division 50 requires the Foundation's current purpose in a particular year of income to be considered in addition to its purpose at formation: paragraph 139 of the TR 2015/1.

The use of the present tense in the phrase 'is established' under the income and assets condition means that, regard must be given to the current circumstances of the Foundation: paragraph 141 of the TR 2015/1.

The interpretation of the term 'established' by the courts further supports the view that subsequent activities of the Foundation are an important consideration for determining purpose: paragraph 143 of the TR 2015/1. It is necessary to look at circumstances of the Foundation in the relevant years of income in which the income and assets condition test is applied, as well as the circumstances surrounding the Foundation's formation: paragraph 144 of the TR 2015/1.

The Foundation proposes to distribute a substantial amount to the School and the Provider over 5 years. The School is a charity whose purpose is to advance education, and the Provider is a charity whose purpose is to advance religion. Therefore, by making distributions to the School and the Provider, the Foundation will be advancing education and religion by distributing every year a portion of the one-off payment it will receive.

The Foundation is also committed to continue with its ongoing payments to other individuals and charities, where such contributions are for a public charitable purpose.

It is considered that the proposed distributions are consistent with the Foundation's purposes set out in its Trust Deed, and the income tax exemption provided that:

·        the purposes in the Trust Deed remain the same, and

·        the activities of the Foundation do not support any different purposes

Has the Foundation applied its income and assets solely for the purpose for which it is established?

The final step is to determine whether the Foundation has 'applied' its income and assets 'solely' for the purpose for which it is established: paragraph 158 of the TR 20015/1.

In the context of the income and assets condition, 'apply' means that the Foundation must make use of all of its income and assets solely for its purpose or purposes. Consequently, income received by the Foundation must be put to use within a reasonable period of receipt: paragraph 160 of the TR 2015/1.

Meaning of the word 'apply' was considered by the High Court in Federal Commissioner of Taxation v. Bargwanna (2012) 244 CLR 655; [2012] HCA 11; 2012 ATC 20-312; (2012) 82 ATR 273 (Bargwanna), where the High Court said that the term 'applied' is used in the sense of 'so administered as to give effect to the trusts established by the relevant instrument', rejecting an argument that 'applied' means 'substantially applied' or 'on the whole, applied'.

The requirement that the Foundation must apply its income solely for the purpose for which it is established relates to both the income received during a financial year, as well as any surplus left over at the end of that year: paragraph 164 of the TR 2015/1.

In respect of accumulation of income, pursuant to paragraph 165 of the TR 2015/1, the Foundation can accumulate income provided the accumulation is consistent with the purpose or purposes for which the Foundation is established.

Paragraphs 78 - 81 of TR 2015/1 provide the following example of an arrangement where accumulation of income does not breach the income and assets condition:

78. The Papillon Society (Papillon) is an incorporated entity that meets the description of exempt entity in item 1.7 of the table in section 50-5. It is a society, association or club established for the encouragement of science.

79. The constitution of Papillon provides the objects for which the entity is established are to promote, foster, develop and assist the study of butterflies, provide a forum for presentations and to assist and arrange for butterfly researchers to travel abroad to participate in scientific forums.

80. Papillon derives income from a number of sources, including bequests and a share portfolio. For the year ended 30 June 2014, Papillon received $310,000 in income. Of this amount, $210,000 is applied towards meeting the entity's objects, and the balance of $100,000 is retained. Papillon has a plan to accumulate enough money to upgrade its research facilities and to employ another research scientist.

81. Papillon's accumulation of income in the year ended 30 June 2014 does not breach the income and assets condition. Papillon has applied its income and assets in a manner consistent with its objects, while accumulating income to further its objects in the future.

However, this does not mean that excessive or indefinite accumulation is permissible. An entity's entitlement to income tax exemption is a year by year assessment. An entity that accumulates most of its income over a number of years will need to show that this accumulation is consistent with its purpose: paragraph 169 of the TR 2015/1.

Under the 'solely' test, the Foundation must apply its income and assets exclusively or only for the purpose for which it is established. The income and assets condition requires that none of the income and assets of the Foundation be applied for purposes that are not in accordance with, or incidental or ancillary to, the purpose for which the Foundation is established: paragraph 173 of the TR 2015/1.

Taxation Ruling TR 2011/4 Income tax and fringe benefits tax: charities (TR 2011/4) provides examples of where an entity applies its income and assets solely for the purpose for which it was established, and where it does not:

Example 5 - Commercial activities in furtherance of a charitable purpose

83. S Enterprises Ltd has a purpose of encouraging the Christian faith by promoting or conducting evangelistic services and other religious gatherings, bible study for children and the production and distribution of evangelistic literature. S Enterprises Ltd itself does not undertake any of these activities. Instead, its objects state it is to carry on a commercial activity (selling musical instruments and recordings) to generate funds for S Campaigners, an unincorporated association that is an endorsed charity established for the advancement of religion. S Campaigners conducts religious services and other religious events.

84. The fact that S Enterprises Ltd raises funds by commercial means will not detract from it being considered a charitable institution. Its commercial activity is merely a means to give effect to its charitable purpose.

Example 7- Accumulation of profits consistent with charitable purpose

86. S Enterprises Ltd's (as in Example 5) constitution contains a clause enabling its directors to reserve profits in order to maintain the company's property, to meet contingencies or for any other reason consistent with its charitable purpose. S Enterprises Ltd retains all of its profits for several years to finance an evangelical event which is scheduled to be held at the end of that period of accumulation.

87. The accumulation of profits by S Enterprises Ltd to finance the scheduled evangelical event is consistent with its charitable purpose of encouraging the Christian faith.

Example 8 - Accumulation of profits not consistent with charitable purpose

88. AAA Ltd's constituent documents indicate its purpose is the relief of poverty in Australia. They also contain a power enabling the company to retain profits. AAA Ltd operates retail food stores so that any profit made can be paid to charitable institutions. After several years whilst the stores have made profits, no funds have been transferred to any charitable institution and all profits have been retained. Minutes of Directors meetings of AAA Ltd for the relevant year indicate that profits are to be retained for expansion of the stores for at least a few more years and no plans have been made for any transfer of funds to be used for charitable purposes. In these circumstances the accumulation of profits is not consistent with charitable purposes in the relevant year.

The Foundation's Trust Deed allows the Trustee, subject to the ITAA 1997 or any guidelines issued by the Commissioner or with the prior approval of the Commissioner, to either invest the Trust Fund or pay it into a bank account, if, in the Trustee's opinion, it is not desirable to apply any part of the income of the Trust Fund for the purposes of the Trust in the Accounting Period in which it is received.

The accumulation of funds with the view of distributing them to the School and the Provider over a period will not put the Foundation in breach of the special condition in paragraph 50-50(2)(b) of ITAA 1997, as long as in the relevant years:

·        the Foundation's purposes remain the same as outlined in its Trust Deed;

·        the activities of the Foundation do not support any other purposes;

·        the Foundation's income and assets are applied strictly in accordance with its Trust Deed; and

·        the Foundation's income and assets are not directed or applied for any other purpose or purposes.