Edited version of your private ruling

Authorisation Number: 1051705337394

Date of advice: 24 June 2020

Ruling

Subject: Characterisation of an overseas entity

Question

Is the Fund a company for Australian taxation purposes, and therefore the trustee of Aus 1 Trust (A1T) is subject to section 98(3)(b) and tax at the corporate tax rate of 30% in relation to distributions in respect of the Fund's share of net income of A1T?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Aus 1 Trust (A1T) is an Australian resident trust. Interests in A1T are stapled with interests in the Aus 2 Trust (A2T).

4.70% of the interests in the A1T and A2T are held by the Fund.

The Fund is a Country A Collective Investment Vehicle (CIV) regulated by the Country A Financial Investment Services and Capital Markets Act (the Act).

Characteristics of the Fund

The Fund is established under a Trust Agreement (the Deed). Clause 1 gives that the Fund's collective investment service provider (CISP) is Management Co and the trustee service provider (TSP) is Service Co.

Clause 5(3) of the Deed provides that the contract term is ten years from the initial establishment date, capable of being extended provided the beneficiaries' unanimous consent. Clause 5(4) provides that the Deed will also terminate ten days after the Fund reaches the investment target given in clause 16.

Clause 3(2) provides that the Fund is of the following 'forms':

·         Investment Trust

·         Special Asset Type

·         Closed-end Type

·         Unit Type

·         Private Placement Type; and

·         Professional Investment Type.

These 'forms' are defined in clause 2:

·         Investment Trust means a "CIV in the form of a trust, by which the executor, which is a CISP, engages the TSP to invest and manage the asset entrusted therein as per the instructions of that CISP";

·         Special Asset Type "means a CIV which mainly invests more than 50/100 of the collective investment assets in special assets as defined in Article 229(3) of the Act";

·         Closed-end Type "means a CIV which is not permitted to re-sell/re-purchase";

·         Unit Type "means a CIV which is not permitted make additional payments";

·         Private Placement Type "means a CIV which issues collective investment securities only via private placement and is a CIV that has a total of less than 49 investors as defined in Article 14 of the Enforcement Decree of the Act"; and

·         Professional Investment Type Privately Placement Placed Fund CIV "is a Privately Placed Fund CIV as defined in Article 9(19)2 of the Act".

Article 9(19)2 of the Act states "A privately placed fund (hereinafter referred to as "hedge fund"), except private equity funds".

Article 9(19) of the Act defines a privately placed fund as "a collective investment scheme that issues collective investment securities only through private placement, in which the total number of the investors specified by Presidential Decree shall be not exceed the number prescribed by Presidential Decree".

Clause 3-3 provides that a "selling company" is the company which sells the collective investment securities of the Fund.

Clause 4 provides the duties of Management Co and Service Co in relation to the Fund.

Clause 4(1) provides that Management Co "carries out the establishment and dissolution of the Investment Trust and the provisions of the management instructions on and the management of the investment trust assets".

Clause 4(2) provides that Service Co "stores and manages the investment trust property, carries out the work consisting of implementation of acquisition and disposition of asset, processing of termination payments and profits, in accordance with the management instructions for investment trust property received from the CISP".

Clause 9(1) gives "the beneficiary right of this Investment Trust is to be equally divided in units of one security and are to be expressed as beneficiary certificates".

Clause 9(2) gives that beneficiaries carry equal rights in accordance with the number of units of beneficiary certificates held in relation to repayment of trust principal and distribution of the investment trust profit.

Clause 10(1) provides that Management Co "in case the issuance price of a beneficiary certificate pursuant to the initial establishment and additional establishment of the Investment Trust under regulations in Clauses 6 and 7 herein has been fully paid, shall obtain confirmation from the TSP and issue the registered beneficiary certificate, payable to the Country A Securities Depository".

Clause 10(2) provides that the selling company is to prepare an investor account registry (referred to as an ARIBC) pursuant to Article 310(1) of the Act, containing:

a.            Names and addressed of clients

b.            Class and number of units of deposited beneficiary certificates

Clause 10(3) provides that a beneficiary certificate recorded on the ARIBC are, on recording, deemed to have been deposited with the Country A Securities Depository in accordance with Article 309 of the Act.

Clause 13 allows beneficiaries to transfer their beneficiary certificates to persons that are Qualified Investors.

Clause 14(1) requires Management Co to "consign the work pertaining to the preparation of Register of Beneficiaries to the Country A Securities Depository". Clause 14(2) requires Management Co to "enter into a consignment agreement with the Country A Securities Depository for work including the preparation of Register of Beneficiaries; and the Country A Securities Depository shall carry out such work".

Responsibilities of the parties

Clause 15(1) requires Management Co to provide necessary instructions to Service Co for "operating the investment trust property" and provides that Management Co "can acquire and dispose of the investment property asset under its own name".

In carrying its duties under clause 15(1), clause 15(4) provides that Management Co "shall fairly distribute the proceeds of the acquisition, disposition and the like in accordance with the asset distribution statement pre-determined by each piece of investment trust property; and prepare, maintain and manage the books and documents on the details of asset distribution, the results of acquisition and disposition, the results of distribution and the like".

Clause 16-2 places restrictions on Management Co in giving instructions on Service Co in relation to investments.

Clause 17 gives "[Service Co] shall keep and manage the trust property and protects the interests of Beneficiaries pursuant to its fiduciary duties".

Clause 18(1) gives that Service Co cannot be an affiliate or subsidiary company of the Fund or Management Co. Clause 18(2) requires Service Co "to manage the trust property separately from its own property, other collective property or property held on trust on behalf of a third party".

Clause 19 provides that in order to sell beneficiary certificates, Management Co enters into a selling contract or a consigned sales contract with a selling company, and that investors may acquire beneficiary certificates through that selling company.

Clause 25 requires Management Co to prepare balance sheets and profit and loss statements for the Fund.

Clause 26(1) requires Management Co to distribute the "remaining profit" at the expiry of the financial period of the Fund. Remaining profit is calculated by "taking the profit generated from the operation of this investment trust property and subtracting from it the assessed profit of the collective investment property obtained pursuant to Article 238 of the Act: provided that in case the profit in accordance with Article 242 of the Act is less than 0, distribution shall be deferred".

Clause 26-2 allows Management Co to pay dividends prior to the expiry of the financial period in excess of the profit generated from the management of the investment trust property.

Clause 27 allows beneficiaries to purchase beneficiary certificates using distributed profit after deducting taxes.

Clause 28(1) requires Management Co to ensure that Service Co pays profits to beneficiaries (referred to as a repayment) on "the expiration of the Agreement or the termination of Investment Trust". If there is unanimous beneficiary consent, Management Co can pay redemption to beneficiaries using investment trust property in accordance with clause 28(2).

Remuneration of parties

Clause 30(1) provides for the remuneration of:

a.    Management Co;

b.    The selling companies;

c.     Service Co; and

d.    General office work management companies (who may be consigned the calculation of the base price of investment trust property).

Remuneration under clause 30(1) is at the rates prescribed by clause 30(3).

Clause 30-2 provides for further remuneration of Management Co depending on the performance of the management of the investment trust.

Clause 32(1) provides "expenses incurred from the management et cetera of the investment trust property shall be borne by the Beneficiaries, and the TSP shall withdraw from the investment trust property and pay the same, in accordance with the CISP's instructions". Clause 32(2) provides that the expenses referred to in clause 32(1) include those relevant to the investment trust property and:

"1. Cost of sale and purchase of assets such as securities

2. Cost of deposit and settlement of assets such as securities

3. Cost of management of the Register of Beneficiaries

4. Cost of litigation in relation to investment trust property

5. Cost of price information on assets such as securities

6. Cost of intellectual property rights required for management of investment trust property

7. Cost of various advice (legal, accounting, financial advice et cetera) relevant to projects subject to management by investment trust property

8. Cost and remuneration for overseas custody agents

9. Other similar cost incurred for management et cetera of investment trust property"

Modification and termination

Clause 33(1) provides that unanimous consent of the beneficiaries is required for the following modifications:

"1. Modification of matters decided under Clause 16 or 16(2)

2. Increase of remuneration and other fees received by CISP and TSP

3. Change of TSP (cases set forth in Clause 34(3) excepted)

4. Change of term of the Agreement (this shall not apply if the change of term is set forth in the Agreement at the time of establishment of the Investment Trust)

5. Any other significant matters relevant to Beneficiaries and profit and referred to in Article 217 of the Enforcement Decree of the Act."

Clause 34(1) provides for the replacement of Management Co and Service Co with unanimous beneficiary consent. Clause 34(2) and 34(3) provides for situations where clause 34(1) does not apply for Management Co and Service Co respectively.

Clause 35(1) gives that the Fund can be terminated if there is unanimous beneficiary consent or where approval has been received from the FSC. Clause 35(2) requires Management Co to terminate the Investment Trust and report that termination to the FSC on:

"1. Expiration of the term of Agreement as set forth therein

2. Merger of Investment Trust

3. Cancellation of registration of Investment Trust

4. When the total number of Beneficiaries becomes one: however, a case where there is no concern as to the damage to the sound order of transaction and which falls under Article 224(1) of the Enforcement Decree of the Act, is excepted.

5. When the order for termination of Investment Trust has been received in accordance with Article 249(9)1 of the Act."

Clause 36 gives that on termination of the Fund, any accounts receivable and accounts payable shall be transferred to Management Co at a fair market value.

Liability to beneficiaries

Clause 40(1) gives that Management Co and Service Co are liable to compensate beneficiaries for losses they cause "by acting in breach of the legislation or the Agreement or being negligent in carrying out their duties".

Clause 40(2) gives that Management Co, Service Co, any selling company, any general office work management company and any appraisal company in accordance with article 258 of the Act will be jointly and severally liable "to take the responsibility to pay compensation for damages to the Beneficiaries, to the extent that such damage arises out of the fault of CISP and TSP".

Other characteristics of the Fund

The Fund is a collective investment business is accordance with Article 6 of the Act.

Article 189 of the Act provides:

(1) A collective investment business entity that has created an investment trust shall divide the beneficiary interest in the investment trust equally and indicate the divided right in beneficiary certificates.

(2) Each beneficiary shall have an equal right in the redemption of the principal of the trust, the distribution of profit, etc. in proportion to the number of units of beneficiary certificates.

The Fund is not incorporated or otherwise registered in Country A. It is governed by the Deed and does not have articles of association.

The Fund does not have a separate legal personality. Service Co has legal ownership of the Fund property.

The Fund cannot enter into transactions in its own capacity. Service Co enters into transactions on behalf of the Fund however the Fund's bank account is used.

Beneficiaries have an entitlement to share in the profits of the Fund and to vote on certain matters

Sources of Law

Country A is a civil law jurisdiction. It does not have a body of law akin to the principle of equity extant in Australia.

The rights of the beneficiaries of the Fund, as well as the responsibilities of Management Co and Service Co arise from Country A legislation as well as the Deed.

Assumption

Interpretation of the Deed is based on the certified translation provided to the Commissioner.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 98

Income Tax Assessment Act 1997 Section 995-1

Trusts Act 1973 (Qld) Section 101

Financial Investment Services and Capital Markets Act (Country A)

Enforcement Decree of the Financial Investment Services and Capital Markets Act (Country A)

Commercial Act (Country A)

Income Tax Act (Country A)

Enforcement Decree of the Income Tax Act (Country A)

Further issues for you to consider

We have limited our ruling to the questions raised in your application. During our conversation of XX/XXX/XXXX you asked us to identify who would be the trustee of the Fund if our position was that the Fund was a trust including for the purpose of lodging Australian Income Tax Returns.

Our view is that this would ultimately be determined under Country A law. However, from completing this ruling it appears that Service Co ultimately fulfils the duties of a trustee and provided it has legal authority can lodge Australian Income Tax Returns on behalf of the Fund. In the alternative, the Fund could appoint an Australian nominee to do so.

Reasons for Decision

Summary

The Fund is a trust for Australian taxation purposes and therefore distributions made to it by A1T are subject to section 98(4) of the ITAA 1936.

Detailed reasoning

Division 6 of the ITAA 1936 sets out the taxation treatment of trust income.

Section 98 of the ITAA 1936 provides for the liability of a trustee to pay income tax on amounts of the net income of the trust estate.

Where a beneficiary, who is presently entitled to a share of the net income of the trust estate is a non-resident at the end of the year of income, then the trust of the trustee is liable to pay income tax on that share of the net income of the trust.

Where such a beneficiary is a company, the trustee will be taxed in accordance with subsection 98(3) of the ITAA 19977, and where such a beneficiary is a trustee of another trust, the first trustee will be taxed in accordance with subsection 98(4).

The Fund is a beneficiary of A1T.

Determining entity type

The definition of company is found in section 995-1 of the Income Tax Assessment Act (ITAA 1997), it states:

company means:

(a)          a body corporate; or

(b)          any other unincorporated association or body of persons;

but does not include a partnership or a *non-equity joint venture.

The taxation laws do not provide a definition of a 'body corporate'. The Australian Legal Dictionary, 2^nd edn, defines a body corporate in the context of company law as 'a general term for a corporation'.

The LexisNexis Concise Australian Legal Dictionary defines a 'corporation' as:

A legal entity created by charter, prescription, or legislation. The fundamental difference between a corporation and other business entities is that the law treats a corporation as a separate legal person.

The taxation laws do not provide a definition of a trust. A trust has been described as:

·                    In Ford and Lee, Principles of the Law of Trusts, 2^nd edn, as:

an obligation enforceable in equity which rests on a person (the trustee) as the owner of some specific property (the trust property) to deal with that property for the benefit of a certain person (the beneficiary) or persons"; and

·                    In Jacobs' Law of Trusts, 8^th edn, as:

"[a] relation between the trustee and beneficiary in respect of certain property... which arises when the owner of a legal or equitable interest in property is bound by an obligation recognised by and enforced in equity to hold that interest for the benefit of others'

In DKLR Holding Co (No 2) Pty Ltd v Commissioner of Stamp Duties [1980] NSWLR 510, Hope JA described the 'very nature of a trust' in terms of a personal obligation of a trustee annexed to property to hold the property for the benefit of another. Hope JA emphasised that both elements were necessary for the existence of a trust: a personal obligation not annexed to property is insufficient to constitute a trust and, conversely, a right annexed to property but without any concomitant personal obligation is likewise insufficient.

In determining whether the true character of the Fund is a trust or a company for Australian taxation purposes, it is necessary to consider what factors favours which characterisation.

This approach was taken in ATO ID 2010/27 Classification of a Korean Hapja Hoesa for Australian Income tax purposes which considered whether a Hapja Hoesa should be considered a company or partnership for Australian taxation purposes.

In considering these factors, greater weight should be given to factors that have a greater nexus to the true character of the Fund. That is, factors will be given greater weight when they go directly to the definition of a company or trust for Australian taxation purposes.

Fund's characteristics

The Fund is established under a document titled 'Trust Agreement', has beneficiaries and a 'trustee services provider'. The trust deed determines that a collective investment vehicle of the nature of the Fund is an investment trust. While the true nature of the Fund will be determined by its actual characteristics rather than the labels given in the Deed, these are all factors that suggest that the Fund is a trust.

The Deed has a contract term of ten years that can be extended with unanimous beneficiary consent, or is limited to ten days after the Funds reaches its investment target. This is a factor that suggests that the Fund is a trust.

The Fund can be terminated on unanimous consent from all beneficiaries. A company can be voluntarily wound up by members and a trust can be terminated with unanimous beneficiary consent (Saunders v Vautier (1841) 41 ER 482). This factor is equally indicative of a company and trust.

Management Co is responsible for providing 'management instructions' to Service Co. Service Co is responsible for storing and managing the investment trust property and acquiring and disposing of assets per those instructions. Service Co entered into transactions on behalf of the Fund because it had no separate legal personality and is unable to enter into transactions in its own capacity. These are all factors that suggest that the Fund is a trust.

A registry containing details of beneficiaries are required to be prepared and kept in accordance with the Act. This factor is equally indicative of a company or a trust subject to regulatory oversight.

Beneficiaries are entitled to transfer their beneficiary certificates to other persons who are Qualified Investors. This factor is equally indicative of a company and trusts that give beneficiaries tangible interests such as a unit trust.

The deed gives that Service Co owes a fiduciary duty to keep and manage the trust property and protect the interests of beneficiaries. This is a factor that suggests that the Fund is a trust.

The deed prevents Service Co from being an affiliate or subsidiary of the Fund or Management Co. This is in effect a requirement to avoid a conflict of interest. This factor is equally indicative of a company and a trust.

Distributions of profit made in accordance with the deed are considered to be dividends. Article 17 of the Country A Income Tax Act gives that amounts from '[p]rofits from collective investment schemes prescribed by Presidential Decree' are considered to be dividend income. Article 26-2(1) of the Enforcement Decree of the Income Tax Act prescribes those collective investment schemes. We accept that the Fund meets the prescribed requirements and therefore this is a factor that suggests that the Fund is a company.

Management Co is required to ensure that Service Co pays profits to beneficiaries on expiration of the Deed or on termination of the Fund. This factor is equally indicative of a company and a trust.

The Deed provides for the remuneration of the parties involved in the operation of the Fund. It also provides an incentive based payment to Management Co based on the performance of the management of the investment trust. This factor is equally indicative of a company and a trust as a trustee is allowed remuneration through an express provision in a trust instrument as well as through court awarded remuneration in certain circumstances (see for example Re Sutherland (2004) 50 ASCR 297 and for example section 101 of the Trusts Act 1973 (Qld)).

The Deed provides that certain expenses related to the operation of the Fund will be borne by the beneficiaries and in effect reimbursed out of the investment trust property. This is a factor that suggests that the Fund is a trust.

The Deed requires unanimous beneficiary consent for certain modifications regarding the Fund to be made. This factor is equally indicative of a company and a trust as both can require unanimous member consent to make modifications.

Both Management Co and Service Co can be replaced by the FSC. This factor is equally indicative of a company or a trust subject to regulatory oversight.

Both Management Co and Service Co are liable to compensate beneficiaries for damages they cause by breaching legislation, the Deed, or by being negligent in carrying out their duties. This factor is equally indicative of a company and a trust.

Article 172 of the Country A Commercial Act provides that 'A company shall come into existence upon registration for its incorporation at the location of its principal office.' The Fund is not incorporated or otherwise registered. It is established under the Deed rather than having articles of incorporation. Therefore it would not fall within this definition of a company suggesting that the Fund is a trust.

Beneficiary rights, and responsibilities of Management Co and Service Co arise from Country A legislation and the Deed. This differs from a trust in Australia where the fiduciary relationship and the rights and responsibilities arises from the body of equity. However, this is not a persuasive indicator of either a trust or a company. Because Country A does not have a body of law akin to equity, we consider that the characteristics of the Fund to be of relevance rather than the sources of law giving rise to those characteristics.

Article 189 of the Act provides that '[e]ach beneficiary shall have an equal right in the redemption of the principal of the trust, the distribution of profit, etc. in proportion to the number of units of beneficiary certificates.' While this is a broad statement, ultimately it creates a benefit available to the beneficiary certificates holders arising from the trust property, supported by clause 9(2) referring to 'repayment of the investment trust principle. This is therefore a factor that suggests the Fund is a trust.

However, the proportionality of the beneficiary rights is equally indicative of a company and trust.

Consideration of factors

The following factors favour a characterisation of the Fund as a trust:

·         The Fund is established under a Trust Agreement;

·         The Fund is referred to as an investment trust;

·         The Fund has 'beneficiaries' and a 'trustee services provider';

·         The Fund has a limited term;

·         Management Co is responsible for providing instructions to Service Co, who is responsible for storing and managing the investment trust property and acquiring and disposing of assets per those instructions;

·         Service Co entered into transactions on behalf of the Fund because it is unable to enter into transactions in its own capacity as it had no separate legal personality;

·         Service Co owes a fiduciary duty to keep and manage the trust property and protect the interests of 'beneficiaries';

·         Certain expenses related to the operation of the fund are borne by the 'beneficiaries' and are in effect reimbursed out of the investment trust property;

·         The Fund would not be considered a company under Country A statute;

·         The beneficiary certificates create a benefit available to the beneficiary certificate holders.

The following factors favour a characterisation of the Fund as a company:

·         Distributions made by the Fund are considered to be a dividend;

·         Unanimous 'beneficiary' consent is needed in order to make certain modifications to the Fund.

The following factors are either neutral to characterising the Fund as a company or a trust or have no bearing on characterisation:

·         The Fund can be terminated on unanimous consent from all beneficiaries;

·         'Beneficiaries' are entitled to transfer their beneficiary certificates;

·         A registry of beneficiary details are required to be prepared and kept in accordance with the Act;

·         Service Co is obliged to not be an affiliate or subsidiary of the Fund or Management Co;

·         Management Co is to ensure Service Co pays profits to the 'beneficiaries' on termination;

·         Relevant parties are to be remunerated under the Deed, including performance based remuneration for Management Co;

·         Management Co and Service Co can be replaced by the FSC;

·         Management Co and Service Co are liable to compensate beneficiaries for damage attributable to their actions;

·         The rights of the 'beneficiaries' and responsibilities of Management Co and Service Co arise out of Country A legislation and the Deed rather than a body of law akin to equity

·         'Beneficiaries' have rights proportionate to their units of beneficiary certificates.

Weighting of factors

The following factors have a particularly strong nexus to the characterisation of the Fund for Australian taxation purposes:

·         Management Co is responsible for providing instructions to Service Co, who is responsible for storing and managing the investment trust property and acquiring and disposing of assets per those instructions;

·         Service Co entered into transactions on behalf of the Fund because it is unable to enter into transactions in its own capacity as it had no separate legal personality;

·         Service Co owes a fiduciary duty to keep and manage the trust property and protect the interests of 'beneficiaries';

·         The Fund would not be considered a company under Country A statute.

Conclusion

The predominance of the characteristics of the Fund favours a classification as a trust rather than as a company. Therefore, distributions made by A1T to the Fund will subject to s 98(4) of the ITAA 1936.