Edited version of private advice

Authorisation Number: 1051844737101

Date of advice: 18 November 2021

Ruling

Subject: Tax exempt entity

Question

After the proposed restructure, will Entity X be exempt from income tax pursuant to item 9.1(c) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

1 July 20xx to 30 June 20xx

1 July 20xx to 30 June 20xx

The scheme commences on:

1 July 20XXRelevant facts and circumstances

Background

Entity X originated from a club for a specific sport which was formed more than a century ago.

On DD MMM 20XX, the club changed its name to its current state (Entity X).

At extraordinary general meetings of Entity X and a related club, the respective members passed special resolutions to amalgamate the entities under Part 9 Division 2 of the Associations Incorporations Act 1981, effective from DD MMM 20XX.

On DD MMM 20XX, the Department of Justice and Attorney General approved the amalgamation and registered the new amalgamated entity.

Entity X operates in a specific location of a State within Australia.

The lease to this site was originally granted to another sporting entity as the leaseholder in 19XX. Entity X took over the lease in its own right a few years later.

In the 20XX season, Entity X conducted sporting activities by organising and running numerous different competitions

Entity X generates revenue from:

• Player registrations
• Sponsorship
• Canteen and bar
• Merchandise
• Investment income
• Function revenue
• Donations and fundraising

Notwithstanding the size increase in playing and member numbers, Entity X has struggled financially, relying heavily on playing subscriptions and the benevolence of local sponsors and benefactors.

Through the past decade, infrastructure costs, such as power, water, electricity and telecommunications has increased. Previous funding has ceased and now Entity X pays annual levies and charges to various bodies to participate in the sport. Rates of volunteerism has been decreasing.

Following the merger in 20XX, the management committee undertook a strategic plan to map the future of Entity X and seek avenues for the Entity to promote the participation of the game of the sport in a financial sustainable manner.

A key aspect to the strategic plan was to pursue a redevelopment of facilities from the very modest clubhouse and grounds, to a modern facility. A logical extension of this was the introduction of commercial tenancies and partnerships to drive passive income to Entity X.

During the course of the 20XX-20XX community consultation of the proposal occurred, a development approval was lodged with the relevant City Council in 20XX.

The proposed development will involve x commercial buildings and an upgrade of club facilities, change rooms, gym and canteen.

Proposed restructure

The current management committee are of the opinion that the proposed redevelopment requires a different structure to achieve efficiencies in the management of the Entity's assets. This structure requires a separation of the commercial aspects of the redevelopment away from sporting and club operations.

It is proposed that there be two separate entities:

• a newly incorporated entity (Entity Y) will be established to hold and manage the commercial assets, and
• Entity X will continue to manage all sporting activities.

Both entities will exist solely for the purpose to foster, promote and encourage the development of the specific sport and all forms of sport for the benefit of males and females wishing to partake in the game in all its forms.

Entity Y will have a specific objective to provide financial assistance to Entity X through the payment of a Playing Fee on an ongoing basis. The main objective for Entity Y will be to provide Entity X with all surpluses.

At the date of this ruling, there is no formal structured funding arrangement between the proposed entity, Entity Y, and Entity X regarding the payment fee.

Entity Y's constitution does not impose an enforceable obligation for the payment fee, other than the object of Entity Y to provide financial support to Entity X or to pay the Playing Fee annually.

The amount of the playing fee will be determined by the Board of Entity Y in their sole discretion and will be based on the available cashflow and surplus of Entity Y after allocating debt amortisation and capital replacement fund obligations.

It is anticipated that in years 1 to xx, after completion of construction, there will be minimal/small cash surpluses available for the payment of the playing grant. This is because the desired debt amortisation schedule has been established at xx years and the majority of the net rental return will be required to retire the debt.

Following the retirement of debt, the capital replacement fund obligations commence, in year xx. This is a relevant City Council requirement and imposes the obligation to commit xx% (of construction costs) as cash commitment to a capital replacement fund held in the name of the New Entity.

The purpose of the capital replacement fund is for Entity Y to set aside cash reserves for future improvements and upgrades.

Following year xx it is projected that greater cashflow will be available to allow the payment of the playing grant.

It is proposed that Entity X will continue to be responsible for:

1. operating sporting activities,
2. sponsorships,
3. memberships,
4. merchandise, and
5. operation of canteens and bars for game day and training nights.

It is proposed that the following assets be retained by Entity X:

1. relevant City Council lease associated with the clubhouse and playing fields
2. Sporting equipment,
3. Merchandise,
4. Office equipment, and
5. Existing investment assets.

It is proposed that Entity X will transfer its lease of commercial buildings to Entity Y. Entity Y will be responsible for the lease fees paid to the relevant City Council. Entity Y will sublease the playing fields to Entity X for an annual rental.

It is proposed that Entity Y will take the lead role in fundraising events in relation to the redevelopment activities. These events will be advertised to the general public and it is proposed that Entity Y members will receive a member discount. It is proposed that Entity Y will undertake these events in their own right or in partnership with Entity X.

It is proposed that Entity Y will have custody of the following assets:

1. Physical building assets,
2. Future surpluses, capital replacement and sinking funds,
3. Future investment assets subject to the investment strategy of Entity Y.

It is proposed that Entity Y will have custody of a long term bank debt associated with the construction of the physical building assets.

It is proposed that Entity Y will have custody of the following:

1. Management of the commercial aspects of the commercial tenancies
2. Negotiating lease agreement and collection of rents
3. Payment of rates and annual lease fees to the relevant City Council and other entities,
4. Payment of repairs and maintenance of the asset for the entire facility and allocation of funds for capital replacement and sinking fund requirements, and
5. Liability and indemnity insurances associated with the assets held.

The commercial reasons for this legal structural separation are:

1. Creating the separation of entities will allow the creation of 2 separate board of directors/management committees. The skill sets required for each entity are different. This will allow those people knowledgeable about the nuances of running a sporting club to run Entity X and those people knowledgeable about management of property assets and investment strategies can run Entity Y.
2. Each board of directors/management committee will require sufficient corporate governance to ensure the ongoing financial viability of each entity in their own right.
3. As both Entity X and Entity Y will co-exist for the sole purposes of benefitting the specific sport, it is imperative that the financial management of both entities is clearly transparent. It must be clearly demonstrable that any financial surpluses of Entity Y are clearly identified and allocated solely to Entity X in order for it to meet its objectives (being to foster, promote and encourage and development of the specific sport and all forms of sport for the benefit of males and females wishing to partake in the game in all its forms).
4. The proposed restructure is not inconsistent with what occurs in normal corporate businesses with good corporate governance principles.
5. Given the obligations and risks surrounding the servicing and repayment of the very substantial debt which the development has created, it is considered desirable to insulate the commercial and playing activities from each other to ensure that difficulties or defaults by one entity does not impact adversely on the viability or continuation of the other.

Entity X has made an application with the relevant City Council for the redevelopment of the buildings and club facilities as its home ground.

The redevelopment will compose of numerous stages

It is intended that redeveloped commercial assets of certain stages would be held by Entity Y. It is proposed that the assets of those stages will be primarily income producing to support the debt funding and provide surplus payments to Entity X.

Under the current relevant City Council guidelines they have a preference to see community assets, on leasehold land, that hold an element of debt funding to be in a separate entity, other than the operating sporting or recreation entity.

The commercial tenants have not been determined. However, the relevant City Council Sport and Recreation Zone code will limit the type of tenant to those services that hold compatible land uses to sport and recreation.

Although a tenant has not been selected for these areas there is a primary objective to select a tenant that will facilitate both direct and indirect benefit to the specific sport and other sports and to members of Entity Y and Entity X through access, services or partnering programs.

Entity X

From DD MM 20XX, Entity X is an incorporated association under the Associations Incorporation Act 1981 following the amalgamation.

Entity X is governed by its constitution which contains provisions setting out the manner in which the members have agreed to conduct the internal administration of the incorporated association.

The objects of Entity X as outlined in its constitution are to foster, promote and encourage the development of a specific sport and all form of sport for the benefit of males and females wishing to partake in the game in all its forms.

Entity X's Constitution provides the types of memberships available.

Entity X is a 'not for profit' organisation as defined by a clause in its constitution.

In the 20XX Annual Financial Report, Entity X receives income and incurs expenses as a result of the sporting activities.

From Entity X's 20XX Annual Report and their website, Entity X:

• organises/conduct sports tournaments

• provides a development program for emerging men and women to maximise their sports and career development
• provide a skills development program for children
• conducts a number of events throughout the calendar year in respect to their sporting activities.

Entity X has self-assessed as an exempt entity from income tax under item 9.1(c) of section 50-45 of the Income Tax Assessment Act 1997 (ITAA 1997) for the 2020 and earlier income years.

Relevant legislative provisions

Section 50-1 of the Income Tax Assessment Act 1997

Section 50-45 of the Income Tax Assessment Act 1997

Section 50-47 of the Income Tax Assessment Act 1997

Section 50-70 of the Income Tax Assessment Act 1997

Reasons for decision

Entity X is currently treated as an exempt from income tax entity pursuant to item 9.1(c) of section 50-45 of the ITAA 1997.

To retain this tax treatment Entity X must continue to satisfy the requirements under section 50-45 of the ITAA 1997 and special conditions under sections 50-47 and 50-70.

Section 50-1 of the ITAA 1997 exempts from income tax the total ordinary and statutory income of an entity covered by section 50-45 of the ITAA 1997.

Additionally, section 50-47 of the ITAA 1997 provides a special condition for all entities covered by section 50-1 of the ITAA 1997, it states:

An entity that:

                       (a)          is covered by any item; and

                       (b)          is an ACNC type of entity;

is not exempt from income tax unless the entity is registered under the Australian Charities and Not-for profits Commission Act 2012.

An entity is 'an ACNC type of entity' if it has a charitable purpose. Entity X does not have a charitable purpose, per the ATO Commissioner's view in Taxation Ruling TR 2011/4 Income tax and fringe benefits tax: charities, and therefore is not required to be registered with the Australian Charities and Not-for-profits Commission to be exempt from income tax.

Item 9.1(c) of the table in section 50-45 of the ITAA 1997 provides that a society, association or club established for the encouragement of a game or sport shall be an exempt entity, subject to special conditions in section 50-70 of the ITAA 1997.

Subsection 50-70(1) of the ITAA 1997 states:

An entity covered by item 1.7, 2.1, 9.1 or 9.2 is not exempt from tax unless the Entity is a society, association or club that is not carried on for the purpose of profit or gain of its individual members and that:

                      (a)          has a physical presence in Australia and, to that extent, incurs its expenditure and pursues its objectives principally in Australia; or

                      (b)          is a society, association or club that meets the description and requirements in item 1 of the table in section 30-15; or

                       (c)          is a prescribed society, association or club which is located outside Australia and is exempt from income tax in the country in which it is resident.

And the entity satisfies the conditions in subsection (2).

Subsection 50-70(2) of the ITAA 1997 states:

The entity must:

                      (a)          comply with all the substantive requirements in its governing rules;

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

Accordingly, to be an exempt entity described in item 9.1(c) of the table in section 50-45 of the ITAA 1997, an entity must:

                  (a)          be a society, association or club;

                  (b)          be established for the encouragement of a game or sport; and

                   (c)          meet the special conditions specified in sections 50-47 and 50-70 of the ITAA 1997.

(a)     Society, association, or club

The words 'society', 'association' or 'club' are not defined in the ITAA 1997 and have their ordinary meaning.

The Macquarie Dictionary defines 'club' as a 'group of persons organised for a social, literary, sporting, political, or other purpose, regulated by rules agreed by its members'.

Entity X is an incorporated association under the Associations Incorporation Act 1981 and is governed by its Constitution. The members pursue a common purpose and are governed by the rules outlined in its Constitution.

Entity X is a society, association or club for the purposes of section 50-45 of the ITAA 1997.

(b)     Established for the encouragement of a game or sport

Game or sport

The terms 'game' or 'sport' for the purposes of section 50-45 of the ITAA 1997 are not defined in the ITAA 1997 and have their ordinary meanings.

Draft Taxation Ruling TR 2021/D6 Income Tax: the games and sports exemption (TR 2021/D6) which replaces Taxation Ruling TR 97/22W Income tax: exempt sporting clubs withdrawn provides the Commissioner's view on what constitutes an exempt sporting club. TR 2021/D6 provides a non-exhaustive list of activities that are considered a 'sport' for the purposes of section 50-45 of the ITAA 1997 (at paragraph 26).

The specific sport that Entity X supports is a sport for the purposes of item 9.1(c) of the table in section 50-45 of the ITAA 1997.

Encouragement

Paragraph 29 of TR 2021/D6 provides guidance on the term 'encouragement'. 'Encouragement' is not a defined term and takes its ordinary meaning. The ordinary meaning of encouragement (or the act of encouraging) has been described as stimulating by assistance or approval, including through direct or indirect means.

Paragraph 42 of TR 2021/D6 further provides direct or indirect activities that indicate the encouragement of a game or sport can include:

• forming, preparing and entering teams and competitors in competitions in the game or sport,
• co-ordinating activities,
• organising and conducting tournaments,
• improving the abilities of participants,
• improving the standard of trainers and coaches,
• providing purchased or leased facilities for the activities of the game or sport for the use of club members and visitors, or
• encouraging increased and wider participation and improved performance,

• marketing,
• initiating or facilitating research and development, and
• facilitating the activities by making a financial or in-kind contribution to an organisation that performs them.

Entity X's objective as stated in its Constitution to foster, promote and encourage the development of a specific sport and all forms of sport.

The activities of Entity X are directly related to the specific sports including:

• to continue to manage/operate sporting activities. Entity X has formed and entered numbers of male and female, junior and senior teams in sports competitions.
• organising/conducting tournaments
• currently leases land for the sports activities for the use of club members and visiting teams. It is proposed that Entity X will transfer its lease Entity Y. Entity Y will be responsible for the lease fees paid to the City Council. Entity Y will sublease the playing fields to Entity X for an annual rental.
• to provide a development program for emerging men and women to maximise their sports and career development.
• provide a skills development program for children.
• responsible for the operation of canteens and bars for game day and training nights. It will also be responsible for merchandise.
• Conducting a number of events throughout the calendar year in respect to their sporting activities.

Entity X's activities actively encourage sport.

Therefore, the second test remains satisfied.

Main purpose

Paragraph 30 of TR 2021/D6 states that determining the main purpose of a club requires an objective evaluation of all material facts and circumstances. There is no set formula for weighing up the characteristics of a club to determine its main purpose.

Paragraph 36 of TR 2021/D6 list a number of factors that have been identified by courts and tribunals as relevant when considering purpose. This includes:

• emphasis in the club's constituent documents that the main purpose is to encourage a game or sport
• extent of sporting activities
• the conduct of activities directly related to the game or sport
• a high level of member participation in the game or sport
• promotion of the organisation to patrons and the public as one that encourages a game or sport
• involvement of the committee of management in the promotion of sport
• the use of surplus funds for encouraging the game or sport
• the provision of financial and in-kind support for encouraging the game or sport.

In this case, the factors mentioned at paragraph 36 of TR 2021/D6 are considered below to determine purpose for Entity X.

The objects of Entity X are set out in its constitution. This constituent document emphasises that the main purpose of Entity X is to foster, promote and encourage the development of a specific sport and all forms of sport for the benefit of males and females wishing to partake in the game in all its forms.

Entity X organises, conducts and participates in many tournaments and events in which members compete. Entity X promotes and advertises sports to its members and the general public on its website and social media platforms.

In the 20XX Annual Report, Entity X incurs expenses as a result of the sporting activities. The monetary figures show that the majority of Entity X's income is used to support the specific sport. It is accepted that Entity X uses a significant portion of its funds to encourage the specific sport.

Entity X is managed by the Management Committee who must be members of Entity X. Members of the Management Committee are participants in or concerned with the encouragement of the specific sport, as distinct from the day to day management of Entity X.

The Constitution sets out the voting rights of members of Entity X and their eligibility to attend general meetings. Members present will be able to vote at a general meeting. To become a member, they have to commit to Entity X's objects which includes encouraging the game or sport. Voting rights only vest in members who encourage the specific sport. A person can only apply for membership if they are committed to the objects of Entity X.

Entity X's website promotes the game or sport of the specific sport. The website contains images of players, advertisements for upcoming social events and sponsor acknowledgement. Entity X displays a list of its sporting achievements over its lifetime on its website.

Conclusion - Main Purpose

After consideration of the features discussed above, it is considered that Entity X is formed principally for the encouragement of a game or sport.

Therefore, Entity X is established for the encouragement of a game or sport.

(c)          meet the special conditions specified in sections 50-47 and 50-70 of the ITAA 1997.

Non-profit requirement

Subsection 50-70(1) of the ITAA 1997 requires that the club not be carried on for the purpose of profit or gain to its individual members. This is known as the non-profit requirement. Where members, in their individual capacity, are to receive benefits from an association it will fail the non-profit test. A club usually ensures they operate on a non-profit basis by including non-profit clauses in their constituent documents. A club's actions must also be consistent with the non-profit requirement.

Entity X's constitution work to prevent the club from distributing income or property to its members during its operation and winding up. On winding up, the surplus assets must be given to another entity having objects similar to the association's objects and the rules of which prohibit the distribution of the entity's income and assets to its members.

Entity X satisfies the non-profit requirement.

Has a physical presence in Australia and to that extent, incurs its expenditure and pursues its objectives principally in Australia

For a club to meet this condition, it must have a 'physical presence' in Australia and, to that extent, incur its expenditure and pursue its objectives principally in Australia.

Entity X has a physical presence in Australia. It incurs its expenditure and pursues its purposes in Australia.

Entity X will satisfy the physical presence in Australia requirement.

Governing rules

Taxation Ruling TR 2015/1 Income tax: special conditions for various entities whose ordinary and statutory income is exempt (TR 2015/1) provides guidance in respect of the conditions in subsection 50-70(2) of the ITAA 1997.

Paragraph 9 of TR 2015/1 provides that an entity's 'governing rules' are those rules that authorise the policy, actions and affairs of the entity. Paragraphs 18 and 19 of TR 2015/1 explain that the substantive requirements in an entity's governing rules are those rules that define the rights and duties of the entity and include rules such as those that:

• give effect to the object or purpose of the entity,
• relate to the non-profit status of the entity,
• set out the powers and duties of directors and officers of the entity,
• require financial statements to be prepared and retained,
• set out the criteria for admission as a member of an entity,
• require an entity to maintain a register of members, and
• relate to the winding-up of the entity.

The constitution of Entity X contains the following rules:

• sets out the objects for Entity X to foster, promote and encourage the development of the specific sport
• the income and property of Entity X be applied solely towards the promotion of the objects of Entity X
• there will be no distribution of income or property by Entity X to its members
• eligibility for membership to Entity X
• the powers of directors
• financial statements must be prepared, audited and maintained as required by the Act, and
• winding up provisions of which there should be no distribution to its members.

Based on a review of the constitution, the 20XX financial statements and the 20XX annual report, it is accepted that Entity X complies with the substantive requirements as set out in its constituent document.

Application of income and assets

Paragraphs 33 to 35 of TR 2015/1 provide that an entity must solely apply its income and assets for the purpose for which the entity is established. However, where the misapplication or misapplications of part of the income or assets are immaterial in amount and are a one-off misapplication or occasional misapplications, the income and assets condition will still be satisfied.

Entity X's constitution contains the following rules:

• the income and property of Entity X will be applied solely towards the promotion of the objects of Entity X
• there will be no distribution of income or property by Entity X to its members, and
• winding up provisions of which there is no distribution to its members.

Furthermore, the 20XX annual report demonstrates that the income and/or assets are being used for the purpose for which Entity X was established.

As previously determined, the activities of Entity X demonstrate that they are complying with the main purposes for which it was established. Therefore, it is accepted that Entity X applies its income and assets solely for the purpose for which it was established.

Accordingly, Entity X satisfies the 'Special Conditions' specified in section 50-70 of the ITAA 1997.

Conclusion

Based on the above, the total ordinary income and statutory income of Entity X is exempt from income tax pursuant to section 50-1 of ITAA 1997 as it is a club established for the encouragement of a game or sport, pursuant to item 9.1(c) of the table in section 50-45.

Entity X will continue to be a tax-exempt entity.