Edited version of private advice

Authorisation Number: 1052203234842

Date of advice: 12 December 2023

Ruling

Subject: Income - income tax exemption and income v capital

Question 1

Will the Company remain exempt from income tax under section 50-1 of the Income Tax Assessment Act 1997 (ITAA 1997) if it gifts surplus funds to the Trust?

Answer

Yes

Question 2

Would the gifting of surplus funds by the Company to the Trust be a non-taxable accretion to corpus and not assessable income of the Trust for the purposes of computing net income under section 95 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

This ruling applies for the following periods:

Income year ended 31 December 20XX

Income year ended 31 December 20XX

Income year ended 31 December 20XX

The scheme commenced on:

1 January 20XX

Relevant facts and circumstances

The Trust holds investments for distribution to the Company for administration and asset protection purposes. The Trust is not eligible for income tax exemption, nor is it a deductible gift recipient. Its primary beneficiary is the Company.

The Company has self-assessed as income tax exempt under section 50-1 of theITAA 1997.

Both the Trust and the Company have substituted accounting periods and are December balancers.

The Trust distributes income to the Company. The Trust has distributed all income by the end of each income year. The Company is not subject to income tax on the distributed income as it has self-assessed as an income tax exempt organisation.

The Company receives from time to time funds from an unrelated third party source which can be surplus to operating needs and where so are gifted to the Trust as accretions of corpus.

The Trustee of the Trust is a company limited by guarantee with the object to act as trustee of, and to administer the Trust.

The operative part of the trust deed allows for the discretionary distribution of income and capital to the Company and to unspecified 'general beneficiaries' with similar objects to those of the Trustee.

The company has the ancillary power to make gifts to the Trust under its Constitution.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 50-1

Income Tax Assessment Act 1997 subsection 50-70(2)

Income Tax Assessment Act 1997 Division 6

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1936 section 95

Reasons for decision

Question 1

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

The entity must:

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

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

Further, paragraphs 22 and 23 of Taxation Ruling TR 2015/1 Income tax: special conditions for various entities whose ordinary and statutory income is exempt note that:

The income and assets condition requires an entity to 'apply its income and assets solely for the purpose for which the entity is established'.

The governing documents of the Company and the Trust are established with the same main purpose. The Trust has an ancillary and incidental purpose of the investment of assets which is ancillary and incidental to its main purpose.

The payment of funds already received and future surplus funds received by the Company to the Trust would not result in the Company ceasing to be an income tax exempt entity under section 50-1 of the ITAA 1997. The purposes of the Company and the Trust are aligned and the payments that the Company will make to the Trust will be payments towards its purpose. Provided the Company complies with the substantive requirements in its Constitution and applies its income to its purposes it will not breach the special conditions of subsection 50-70(2) of the ITAA 1997.

Question 2

The meaning of net income in section 95 of the ITAA 1936 relevantly provides:

net income, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, ...

'Assessable income' therefore imports its meaning from Division 6 of the ITAA 1997.

Of relevance here is subsection 6-5(1) of the ITAA 1997 which includes income according to ordinary concepts (ordinary income) in assessable income.

The question therefore is whether the surplus funds which are gifted to the Trust by the Company from time to time are ordinary income of the Trust in applicable income years.

The character of a receipt must be determined from the point of view of the recipient and not from the standpoint of the payer or some other person.

In McLaurin v FC of T (1961) 104 CLR 381, Dixon CJ, Fullagar and Kitto JJ, in a joint judgment of the High Court, held (at p 391):

... in point of law it would plainly be unsound to allow a determination of the character of a receipt in the hands of the recipient to be affected by a consideration of the uncommunicated reasoning which led the payer to agree to pay it.

In Scott v FC of T (1966) 14 ATD 286, Windeyer J also expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

Again, in The Federal Coke Company Pty Ltd v FC of T 77 ATC 4255, Bowen CJ stated (at p 4264):

When one is considering the character of an amount received by a taxpayer, the enquiry must start with the question: what is the character of the receipt in the hands of the taxpayer?'

The reference to income according to ordinary concepts in subsection 6-5(1) can be traced to the judgment of Jordan J of the NSW Supreme Court in Scott v C of T (NSW) (1935) 3 ATD 142, concerning the Income Tax (Management) Act 1928. His Honour stated (at pp 144-145):

The word 'income' is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income or that special rules are to be applied for arriving at the taxable amount of receipts.

In FC of T v The Myer Emporium Ltd 87 ATC 4363, the Full High Court (in a joint judgment) said (at p 4370):

The periodicity, regularity and recurrence of a receipt has been considered to be a hallmark of its character as income in accordance with the ordinary concepts and usages of mankind.

The meaning of income as used by the business community was noted as relevant by the Full High Court in Arthur Murray (NSW) Pty Ltd v FC of T (1965) 14 ATD 98 where their Honours stated (at p 101):

In so far as the Act [ITAA 1936] lays down a test for the inclusion of particular kinds of receipts in assessable income it is likewise true that commercial and accountancy practice cannot be substituted for the test. But the Act lays down no test for such a case as the present. The word income, being used without relevant definition, is left to be understood in the sense which it has in the vocabulary of business affairs. To apply the concept which the word in that sense expresses is not to substitute some other test for the one prescribed in the Act; it is to give effect to the Act as it stands.

The character of the gifts of the funds received by the Trust from time to time are one of capital (being in effect further settlements of corpus in each instance) and as such they have a non-income character. This is for the same reason a settled sum is considered capital. As such, the receipt of these gifts will not be assessable income of the Trust for the purposes of computing net income under section 95 of the ITAA 1936 in applicable income years.