2003Edited version of private advice

Authorisation Number: 1051893531819

Date of advice: 18 January 2022

Ruling

Subject: Division 6C trading trust

Question

Will Fund X become a "trading trust" for the purposes of Division 6C of Part III of the Income Tax Assessment Act 1936 solely by virtue of its acquisition of a limited partner interest in a Delaware Limited Partnership?

Answer

No.

This ruling applies for the following periods:

Income year ended 30 June 2022

Income year ended 30 June 2023

Income year ended 30 June 2024

Income year ended 30 June 2025

The scheme commences on:1 July 2021

Relevant facts and circumstances:

Fund X is as an Australian public unit trust (the Fund).

Trust Company Y is the trustee of the Fund (the Trustee).

Z is the unitholder of the Fund (Unitholder).

The Fund intends to acquire an interest in a partnership (TLP) as a limited partner.

TLP was established as a limited partnership in accordance with the Delaware Uniform Limited Partnership Act (DRULPA) and is governed by the terms of the Limited Partnership Agreement (LPA).

Given the investment strategy of the Fund, the Fund will only acquire an interest in a foreign hybrid limited partnership as a limited partner, and not as a general partner.

The Fund will not acquire a limited partnership interest in a foreign hybrid limited partnership unless the Trustee is satisfied that the foreign hybrid limited partnership itself, for the purposes of Division 6C:

(a) only carried on an eligible investment business; and

(b) did not control, and was not able to control, directly or indirectly, the affairs or operations of another person in respect of the carrying on by that other person of a trading business.

TLP is treated as a partnership for US federal income tax purposes. It comprises a General Partner and Limited Partners, membership of which may be amended from time to time by the General Partner.

The LPA provides that the principal purpose and investment objective of the Fund is to make Portfolio Investments in accordance with the investment objectives, and that the objective of the partnership is to achieve returns by investing in debt securities and in real estate-related investments.

Under the terms of the LPA, the General Partner is provided with the primary responsibilities for undertaking the investment activities of the TLP.

The LPA also provides the General Partner with certain specific authorities to undertake activities on behalf of the TLP. The LPA empowers the General Partner - among other things - to select which assets to acquire for inclusion in the investment portfolio, to transact with counterparties to transfer legal title in those assets to the partners, and to choose when to dispose of any of those assets.

Limited Partners on the other hand, cannot participate in the management of the TLP, or have any control over the business of the TLP, and no Limited Partner has any right or authority to act for or to bind the TLP.

Assumptions

TLP is a "foreign hybrid limited partnership" as defined in subsection 830-10(1) of the Income Tax Assessment Act 1997.

TLP will only conduct 'eligible investment business' as defined in section 102M and, in particular, does not and will not carry on a 'trading business' as defined in section 102M.

TLP does not and will not control, or be able to control, directly or indirectly, the affairs or operations of another person in respect of the carrying on by that other person of a 'trading business'.

At all times, and without taking into consideration its acquisition of a limited partner interest in TLP, the Fund does not satisfy the requirements of a 'trading trust' under section 102N.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 102M

Income Tax Assessment Act 1936 Section 102N

Income Tax Assessment Act 1936 Section 94J

Income Tax Assessment Act 1936 Subsection 94D(6)

Reasons for decision

Section 102N(1) provides:

'For the purposes of this Division, a unit trust is a trading trust in relation to a year of income if, at any time during the year of income, the trustee:

(a)  carried on a trading business; or

(b)  controlled, or was able to control, directly or indirectly, the affairs or operations of another person in respect of the carrying on by that other person of a trading business.'

'Trading business' is defined in section 102M as 'a business that does not consist wholly of eligible investment business'.

'Eligible investment business' is, in turn, defined in section 102M to include investing and trading in various financial instruments which are specified in subparagraphs (b)(i) to (xiii) of the definition. Subparagraph (b)(xiii) is more broadly worded in its description, providing for the inclusion of 'any similar financial instruments' to those listed in subparagraphs (b)(i) to (xii).

The primary issue is whether the Fund will become a "trading trust" by virtue of its acquisition of a limited partner interest in TLP.

Foreign hybrid limited partnership carrying on eligible investment business

Paragraph (b) of the definition of eligible investment business in section 102M provides that "investing or trading in any or all" of a number of prescribed items constitutes eligible investment business. Item (iii) is "shares in a company", which includes "shares in a foreign hybrid company". This item does not, however, make any reference to an interest in a foreign hybrid limited partnership. Nor is such an interest included in any other item in paragraph (b).[1] Furthermore, although section 94J requires a "corporate limited partnership" to be treated as a company, a foreign hybrid limited partnership is not a "corporate limited partnership" by virtue of subsection 94D(6).

The interest of a limited partner in a foreign hybrid limited partnership is not, therefore, one that falls under any of the items listed in paragraph (b) of the definition of eligible investment business in section 102M. In particular, it is not one that falls under item (xiii), which is "any similar financial instrument" in respect of the preceding items listed. Although it may be argued that the interest of a limited partner in a foreign hybrid limited partnership is a similar financial instrument to a share in a company or a unit in a unit trust, it is considered that there are notable legal and commercial differences between an interest in a company or trust to an interest in a partnership. In the case of a company, the company is a separate legal entity which can carry on a business in its own right and can continue to carry on that business regardless of whether its shareholders change from time to time. In the case of a unit trust, it is the trustee of the trust that carries on any business for the benefit of the unitholders, who are beneficiaries of the trust. In both cases, the shareholders/unitholders may control the company or trustee, but they do not carry on the business of the company or trust. In the case of a partnership, and as explained below, it is the partners themselves that carry on the business of the partnership.

As previously noted, paragraph (b) of the definition of eligible investment business in section 102M requires there to be "investing or trading" in at least one of a number of prescribed items. Similarly, paragraph (a) of that definition requires there to be "investing in land for the purpose ... of deriving rent". If a foreign hybrid limited partnership is carrying on eligible investment business through investing (in, say, land and secured loans) then a question arises as to which entity is the one that is actually conducting the requisite investing. There are three possibilities in this regard, being:

•                The foreign hybrid limited partnership.

•                The general partner of the foreign hybrid limited partnership.

•                The general partner and the limited partners of the foreign hybrid limited partnership (collectively).

Foreign hybrid limited partnership

The fundamental characteristic of a partnership is that of an association of persons carrying on business together as partners, so as a general proposition is it not correct to say that an entity other than the partners of a partnership carries on the business of the partnership (unlike, say, the position of shareholders in a company - who do not participate in the conduct of the business carried on by the company). If that were the case then it would be expected that an interest in a foreign hybrid limited partnership would be listed as one of the items in the paragraph (b) definition of eligible investment business in section 102M, as are shares in a company and shares in a foreign hybrid company.

It also needs to be noted, however, that as the TLP was established as a limited partnership under the DRULPA it is also accorded separate legal existence under paragraph 17-201(b) of that Act.

The apparent tension between the fundamental nature of a partnership and the separate legal existence of a limited partnership provided for under the DRULPA was remarked upon in ATOID 2008/80, where it was noted that:

An LP formed under the DRULPA has features both commonly associated with a business carried on by partners as partners and with a company. In particular, while separate legal entity status is more commonly associated with companies ... this feature of itself does not necessarily lead to characterisation as a company. Rather, the question remains as to whether the business is being carried on by the relevant persons as partners (as opposed to by the separate legal entity on its own behalf)

It was concluded in ATOID 2008/80 that a limited partnership established under the DRULPA has a number of features that favour its characterisation as a partnership - and hence as a foreign hybrid limited partnership for the purposes of section 830-10 of the ITAA 1997. These include:

•                The relationship is formalised through, and governed by, a partnership agreement (as opposed to a memorandum of association).

•                It does not have perpetual succession in the same manner as a company.

•                The business is managed by a general partner on behalf of the other partners.

•                The inclusion of additional partners requires the general partner's consent - and as the general partner is acting on behalf of the partners, this carries with it the implied consent of all partners.

•                Assignment of a partnership interest requires the consent of the general partner.

•                At the end of each accounting period the profits of the limited partnership are allocated to each partner for distribution or reinvestment, indicating that the profits belong to the partners as they arise.

Accordingly, the separate legal existence accorded to TLP under the DRULPA does not alter its essential character as a partnership, and hence it is only the partners in TLP that can engage in "investing" for the purposes of the paragraph (a) and paragraph (b) definitions of eligible investment business in section 102M.

General partner of a foreign hybrid limited partnership

In the context of commercial practice a limited partnership usually consists of a general partner and one or more limited partners. The general partner actively conducts the business activity of the partnership, whereas the limited partners contribute capital to the partnership but are otherwise not involved in carrying on the business of the partnership.

A plain reading of the word "investing" in the paragraph (a) and paragraph (b) definitions of eligible investment business in section 102M is consistent with what the general partner in the TLP is required to do under the terms of the partnership agreement. The LPA empowers the general partner - among other things - to select which assets to acquire for inclusion in the investment portfolio, to transact with counterparties to transfer legal title in those assets to the partners, and to choose when to dispose of any of those assets.

Furthermore, the LPA provides that the principal purpose and investment objective of the Fund is to make Portfolio Investments in accordance with the investment objectives and that the objective of the partnership is to achieve returns by investing in debt securities and real estate related investments.

It is considered that in these circumstances the general partner of the TLP is carrying on eligible investment business because according to the LPA it is required to:

•         Invest in land for purposes that are consistent with paragraph (a) of the definition of eligible investment business in section 102M.

•         Invest in assets that fall under items (i) and (ii) in paragraph (b) of the definition of eligible investment business in section 102M.

Limited partner(s) of a foreign hybrid limited partnership

The Trustee of the Fund intends to acquire a limited partnership interest in TLP. If the Trustee becomes a limited partner in the TLP then a question arises as to whether, as is the case with the general partner, it too can be taken to be "investing" for the purposes of the paragraph (a) and paragraph (b) definitions of eligible investment business in section 102M. This involves a consideration of whether the business carried on by the general partner in a foreign hybrid limited partnership can be attributed to the limited partners of that partnership for the purposes of Division 6C of Part III of the ITAA1936.

As noted above, the role of a limited partner in a limited partnership is passive and the business of the limited partnership is usually conducted exclusively by the general partner. The LPA is consistent with this paradigm.

Nonetheless, it is in the nature of a partnership under general law that the business of the partnership is carried on by the partnership in its entirety. The following observations on a general law partnership were made at paragraphs 14 and 15 of TR 93/32 Income Tax: rental property - division of net income or loss between co-owners:

14. Partnership is defined in the various State and Territory partnership acts as "the relation which subsists between persons carrying on a business in common with a view of profit."(The Partnership Act of 1891 (Qld; SA; TAS); The Partnership Act of 1892 (NSW); The Partnership Act of 1895 (WA); The Partnership Act of 1958 (VIC); The Partnership Ordinance of 1963 (ACT)). [emphasis added]

15. An important ingredient of the definition is "carrying on a business". Without this ingredient, there can be no partnership at general law.

A "limited partnership" is defined for income tax purposes in subsection 995-1(1) of the ITAA 1997 as an "association of persons (other than a company) carrying on business as partners or in receipt of ordinary income or statutory income jointly, where the liability of at least one of those persons is limited" [emphasis added]. There are two alternate limbs to this definition, with the first limb corresponding to the general law definition of a partnership and the second limb extending the meaning of a limited partnership for income tax purposes.[2] The activities of the TLP, as previously described, place it within the first limb of the statutory definition in subsection 995-1(1) of the ITAA 1997 as TLP can clearly be characterised as carrying on a business.

Furthermore, and as previously noted, it was recognised in ATOID 2008/80 that a limited partnership established under the DRULPA is a foreign hybrid limited partnership for the purposes of section 830-10 of the ITAA 1997 because the "business [of such a partnership] is organised and conducted more in line with how a partnership operates than a company and the profits, as they arise, belong to the partners indicating that it is the partners carrying on the business and not the separate legal entity." [emphasis added]

This principle is also reflected in certain stipulations in the LPA that support the proposition that the business of "investing" carried on by the general partner can also be imputed to the limited partners.

Conclusion

The Commissioner is of the view that if the Trustee of the Fund acquires a limited partnership interest in TLP then the acquisition and holding of that interest, by itself, will not cause the Fund to become a trading trust for the purposes of Division 6C of Part III of the ITAA1936. Importantly, this conclusion is based on the understanding that the business carried on by TLP consists of eligible investment business as defined in section 102M. Therefore, if TLP (being its general partner and limited partner collectively) ever carries on business that does not consist wholly of eligible investment business, this is likely to result in the Fund being a trading trust.

[1] Division 830 only recognises two types of foreign hybrids, being a foreign hybrid limited partnership and a foreign hybrid company. The inclusion of only one type of foreign hybrid in paragraph (b) therefore assumes significance in this context.

[2] FC of T v McDonald 87 ATC 4541 and paragraphs 24 to 32 of TR 93/32.