Edited version of private advice

Authorisation Number: 1051980050896

Date of advice: 11 May 2022

Ruling

Subject: Assessability of gains derived from holding revenue assets

Question

Will the tax deferred distributions (TDDs) and Capital Returns received by Company X be assessable to Company X under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period(s):

A number of income years

The scheme commences on:

An income year

Relevant facts and circumstances

1.    Company X is a resident of Australia as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and is a listed investment company on the Australian Stock Exchange.

2.    Company X carries on a business and its principal activities are in the investment of cash and securities for the purposes of:

•         short term trading

•         profit-making ventures

•         holding securities for long term capital appreciation and dividend returns

•         generating an on-going return.

3.    Some of the assets that Company X invest or hold include:

•         trading stock

•         revenue assets other than trading stock

•        capital assets.

4.    In relation to the revenue assets (other than trading stock), Company X invests in the following for a profit:

•         units in unit trusts (other than attribution managed investment trusts (AMITs)[1] for the purposes of this Ruling) in which Company X regularly receives TDDs from the trusts which are not assessable to Company X under section 97 of the ITAA 1936

•        shares in companies in which Company X regularly receives return of share capital from the companies which are not assessable to Company X under section 44 of the ITAA 1936 (Capital Returns).

5.    Company X has historically treated the TDDs and Capital Returns as ordinary income and assessable under section 6-5 of the ITAA 1997 at the time of receipt. When the units and shares are eventually sold, the initial cost of the investment has been taken into account in working out the ultimate gain or loss on disposal.

Relevant legislative provisions

subsection 6(1) of the ITAA 1936

section 97 of the ITAA 1936

section 44 of the ITAA 1936

section 6-5 of the ITAA 1997

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise specified.

Subsection 6-5(1) provides that the assessable income of an Australian resident entity includes income according to ordinary concepts derived from all sources during the income year.

The ITAA 1936 or ITAA 1997, however, does not provide any specific guidance on what is meant by or considered to be 'income according to ordinary concepts'. However, over the years, a substantial amount of judicial cases have identified various factors that should be taken into account in determining when an amount or receipt is 'income according to ordinary concepts' for the purpose of section 6-5.

In Scott v Federal Commissioner of Taxation [1966] HCA 48, Windeyer, J said whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

In GP International Pipecoaters v Federal Commissioner of Taxation [1990] HCA 25, the High Court of Australia (High Court) held that:

To determine whether a receipt is of an income or of a capital character, various factors may be relevant. Sometimes, the character of receipt will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

In determining whether a receipt is of an income or of a capital character, one has to 'make both a wide survey and an exact scrutiny of the taxpayer's activities': Western Gold Mines No Liability v Commissioner of Taxation (WA) [1938] HCA 5.

In Federal Commissioner of Taxation v Myer Emporium Ltd [1987] HCA 18, the High Court spoke of profits or gains made in the ordinary course of carrying on a business being income:

Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income.[2]

In Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3)[3]^, the Commissioner ruled at paragraph 15 that:

15. If a taxpayer carrying on a business makes a profit from a transaction or operation, that profit is income if the transaction or operation:

(a) is in the ordinary course of the taxpayer's business (see paragraph 32 for an explanation of the circumstances in which a transaction is in the ordinary course of business) - provided that any gross receipt from the transaction or operation is not income...

At paragraph 32 of TR 92/3, the Commissioner provides guidance in relation to 'profits or gains made in the ordinary course of carrying on a business'. It explained that two types of profits or gains would come within that description:

(i)            a profit or gain arising from a transaction which is itself a part of the ordinary business of a taxpayer (judged by reference to the transactions in which the taxpayer usually engages) - provided that the gross receipts from the transaction lack the character of income...

(ii)           a profit or gain arising from a transaction which is an ordinary incident of the business activity of the taxpayer, although not a transaction entered into directly in its main business activity e.g. profits of insurance companies and banks on the sale of investments are generally income...

Taxation Ruling TR 96/4 Income tax: valuing shares acquired as revenue assets (TR 96/4) provides the Commissioner's view in relation to the treatment of assets (shares) that are held as revenue assets but not as trading stock. TR 96/4 reiterated the principle in cases such as Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation [1946] HCA 60 and Chamber of Manufacturers Insurance Ltd v The Commissioner of Taxation of the Commonwealth of Australia [1984] FCA 119 that in instances where the investments such as shares are held by banks and insurance companies, the shares held are generally considered as revenue assets, but not as trading stock. In this context, if a bank or insurance company who invests in and disposes of shares, the gross receipt is not assessable income. Rather, any profit on the sale of the shares are assessable as ordinary income under former subsection 25(1) of the ITAA 1936 (now subsection 6-5(1)).

Furthermore, in ATOID 2011/100, the Commissioner considered that net proceeds from the issue of the relevant security were employed in the general operations of the taxpayer's business and not for the purpose of strengthening the profit-making structure of the taxpayer. The gain was made in the course of and as an incident of repaying the borrowed money with which the taxpayer carried on its business as a financial institution. Accordingly, the gain made from the buying back of the securities at a discount to its face value was assessable income under subsection 6-5(1).

Company X is an active investment company with one of its principal activities being investing for profit. In the circumstances, it is without doubt that the investment transactions by Company X were entered into with the intention or purpose of profit-making and an ordinary incident of carrying on its investment business.

It is through the holdings of units in non-AMIT unit trusts and of shares in companies that enables Company X to regularly receive the TDDs and Capital Return, which forms part and parcel of its business as an investment company to make a profit, obtain higher yields or generate an on-going return or distributions on its assets.

Consequently, the TDDs and Capital Returns are characterised as revenue receipt and as such included in Company X's assessable income under section 6-5. The fact that the TDDs are derived from trusts does not alter that result as the Commissioner's view is that Division 6 of the ITAA 1936 does not operate as an exclusive code for the taxation of beneficiaries and the distribution of trust income.[4]

For completeness, the ATO's compliance approach outlined in https://www.ato.gov.au/general/trusts/in-detail/managed-investment-trusts/managed-investment-trusts---overview/?page=42 does not apply to Company X's circumstances. This is because Company X has not taken the TDDs fully into account in working out revenue gains and losses. Rather, when the units (or shares) are eventually sold, the initial cost of the investment has been taken into account in working out the ultimate gain or loss on disposal.

Conclusion

For the reasons outlined above, the TDDs and Capital Returns received by Company X have the character of ordinary income in the hands of Company X and are therefore assessable to Company X under section 6-5.

[1] Trusts that have elected to apply the attribution rules in Division 276 of the ITAA 1997.

[2] Federal Commissioner of Taxation v Myer Emporium Ltd [1987] HCA 18 at 14.

[3] Whilst TR 92/3 relates mostly to isolated transactions, the principles set out in the ruling in respect of whether a business makes a profit or gain from a transaction or operation as part of its ordinary course of business is relevant.

[4] Taxation Ruling IT 2512 Income tax: financing unit trust, Taxation Ruling TR 2018/7 Income tax: employee remuneration trusts; see also Commissioner of Taxation v Belford [1952] HCA 73 and Union Fidelity Trustee Co of Australia Ltd v Federal Commissioner of Taxation [1969] HCA 36.