On Wed 4.7.2018, the ATO issued Draft Taxation Ruling TR 2018/D1 setting out the Commissioner’s view on the meaning of the “in Australia” condition for Div 30 DGR status and Div 50 income tax exemption of charities and non-profits. He seeks comments by

This is a fraught area, as the ‘in Australia’ requirement was obviously meant to achieve something, though it’s hard to know what (the way they are expressed). Many thought that, what ever they meant, the High Court ‘drove a cart through them’ in the Word Investments case [2008] HCA 55.

This provoked proposals to amend these requirements, but they never saw the light of day because, they too, were problematic.

The Commissioner, therefore, wades in ‘where angels fear to tread’, by tackling this area. And, in my opinion, he doesn’t do a good job in that there is almost no authority quoted for the ‘gloss’ he appears to be putting on various of these provisions (though, in truth, I’m guilty of the same thing, in offering this critique). I do offer, in the Conclusion, my view of why these requirements are in the Act, and why they do not attempt to limit the charitable benefit to Australian shores.

Having said this, however, I’ll go through what this draft ruling says.

The three requirements

There are three ‘in Australia’ requirements. they are:

  1. the condition that certain DGRs be “in Australia” before a gift or contribution to them is tax deductible (Div 30 of the ITAA97: s30-15, item 1, column 4);
  2. the condition that a relevant entity “has a physical presence in Australia and, to that extent, incurs its expenditure and pursues its objectives principally in Australia” physical presence in Australia’ before their income is exempt from tax (Div 50 of the ITAA97; s50-50(1)(a); 50-55(1)(a) and 50-70(1)(a)); and
  3. the residency requirement, for a charity or DGR to receive a refund of franking credits, namely: “(a) the entity has a physical presence in Australia; and (b) to that extent, incurs its expenditure and pursues its objectives principally in Australia; [both] at all times during the income year in which the distribution is made.” (Div 207 of the ITAA97: s207-117).

The DGR ‘in Australia’ condition

The Commissioner rules that the DGR be “in Australia”:

4. …To ‘be in’ is to exist; have reality; live; take place; occur; remain as before… to be found or located in [Macquarie Dictionary]. Applying the ordinary meaning of the phrase ‘be in Australia’ in the context of the DGR conditions, a fund, authority or institution will be in Australia at a particular time if:

  • it is established or legally recognised in Australia [given status by the Australian legal system]; and
  • it operates in Australia at that time.

The Commissioner notes that a DGR could be a ‘fund’, ‘authority’ or ‘institution’. He issues ‘sub-rulings’ for each of these.

Fund

He notes that a ‘fund’ is merely a ‘pool, stock or store of assets’ without any legal identify of its own. But an entity will hold the fund, at it may be that is all that entity does. Having said this he then rules:

8. It does not matter where the physical assets or money of the fund are located (see Example 2 and 3 of this draft Ruling), rather a fund is in Australia if all or a substantial part of its store of assets or money is:

  • established and legally owned or held by a trustee or other entity in Australia, and
  • managed [something less than ‘central management and control’] by a trustee or other entity located in Australia…

The Commissioner doesn’t really say how he concludes that (1) it doesn’t matter where the fund is, or (2) how he arrived at the 2nd requirement that the fund has to be ‘managed‘ in Australia. It seems to me that a fund would be relevantly ‘in Australia’ if it was held by an Australian entity and was physically in Australia (never mind where it was ‘managed’). Example 2 (below is a good example of this problem).

He then puts more flesh on the bone by a series of examples.

  1. The Commissioner says that a ‘fund’ is relevantly ‘in Australia’ if it is established by a trust settled in Australia, held in an Australian bank account and is sourced from Australian donations. It matters not, he says, that the funds are spent overseas to relieve foreigners’ hardship (Example 1).
  2. The Commissioner says that the following ‘fund’ is NOT relevantly ‘in Australia’, broadly because it is not ‘managed’ here (which I take issue with). In Example 2, a global not-for-profit sets up an Australian incorporated company, which operates a ‘public’ fund, controlled by an executive committee, a majority of whom are eminent Australians, but this committee meets in Japan, where the minority members of the Committee reside. The Commissioner says that the fact that the Committee meets outside Australia, when it exercises control of the ‘fund’, disqualifies it from being, relevantly ‘in Australia’, which seems wrong to me. It is based on his idea that the fund must be ‘managed’ in Australia (a requirement that I think he hasn’t made out, as necessary). Secondly, this idea that a fund is ‘controlled’ where the executive controllers meet, is very clearly borrowed from the law on ‘central management and control’, despite the Commissioner saying ‘managed’ is something less than this. Third, this ignores the fact that a majority of the committee are not only Australian residents, but also sufficiently eminent, to satisfy the other requirement for the ‘fund’ to be relevantly ‘public’. Whilst the place where a fund is ‘managed’ might be relevant, I think the Commissioner has ignored an ‘avalanche’ of ‘in Australia’ factors, only to disqualify it on a condition that he has unilaterally declared to be non-negotiable (which is to say: where its ‘managed’).
  3. In example 3, the Commissioner rules that the fund IS relevantly ‘in Australia – the key difference being that the management deliberations are physically done in Australia. Again, there were enough other factors, to support this ‘in Australia’ conclusion, without this place of ‘management’ being pivotal (in my opinion).

Authority

The Commissioner correctly identifies that an ‘authority’ must have the right to ‘determine, control, or command’ things and a bit more tenuously that “the body must be an agency or instrument of government.

The Commissioner rules:

11. An authority is established in Australia if it is established and recognised by the Commonwealth or a State government. It is operated in Australia if it is exercising control, power or command for the public advantage in Australia, or executing a function in the public interest in Australia (see Example 4 of this draft Ruling).

This ruling is problematic, in that he does not say why the place where the Authority is ‘established’ or ‘operated’ is the relevant test and whether it is either or both.

The facts in Example 4, do not elucidate these issues as in involves an Australian State, that legislates to create a thing called an ‘authority’, which can ‘police’ fines and ‘operates’ in Australia for an Australian public interest, namely: developing Australian abalone farming).

Institution

The Commissioner notes (correctly) that an institution “connotes a body called into existence to translate a defined purpose into a living and active principle” and is not a ‘mere fund’. It’s legal form could be various.

The Commissioner rules:

14. An institution is operated in Australia if it is managed on a day-to-day basis by a local committee of management or similar structure located in Australia [the branch is answerable to an entity in another country].

Again, the Commissioner doesn’t say how he gets to the point where the place where the institution is ‘operated’ is the one an only defining test for being relevantly ‘in Australia’. I would have thought that other things, such as the place where the ‘authority’ is legally formed, the place where it carries on the bulk of its functions, the place where the donated funds are kept or invested, would all be relevant, and could, at least collectively, over power some more theoretical place where it ‘operates’.

Examples 5 and 6 are meant to elucidate this:

  • Example 5 is one where the Commissioner says the institution is NOT ‘in Australia’. Again this is problematic. Despite setting up an Australian incorporated company, as the ‘institution’, with a majority of Australian, it is registered as a ‘health promotion charity’ with the Australian ACNC and its objective is raise awareness of a particular disease, in Australia, which it does by activity in Australia, it somehow falls short because its ‘day to day operations’ are controlled by a UK CEO and General Manager, who also manage sister organisations in the UK, Canada and the USA and the Australian Board meets only in the more geographically diffuse way – by telephone.
  • Example 6 is one where the Commissioner says the institution IS ‘in Australia’. The only material difference is that the Australian board meets in Australia. Again, this seems to lack weight and reality.

Division 50 tax emption – ‘in Australia’ conditions

The Commissioner notes that the tax exemption conditions (applying to some, not all taxpayers) are twofold.

  1. The first is that the entity have a “physical presence in Australia”.
  2. The second is that the entity “to that extent [has a physical presence in Australia], incurs its expenditure and pursues its objectives principally in Australia“.

‘Physical presence’ in Australia

The Commissioner rules:

45.  an entity has a physical presence in a place where it conducts its range of physical operations [including those by which it derives income and other funds].

The Commissioner has again, transliterated “physical presence in Australia” into “physical operations in Australia”. Put this way, it is clear they are not exactly the same (even if they largely overlap).

To that extent [has ‘a physical presence’ in Australia]

The Commissioner rules:

46.  …The words ‘to that extent’ require an examination of the degree to which the entity’s expenditures and objectives are sourced or result from the conduct of Australian operations. …

To break this out, he requires expenditure to be ‘sourced‘ from its Australian operations.

And, its Australian operations must be principally directed to pursuing its objectives.

‘Incurs its expenditure’ [principally in Australia]

The Commissioner rules:

54. The place where an entity ‘incurs its expenditure’ will depend on the whole of the circumstances, which may include:

  1. where the decision to make the expenditure is made;
  2. where the expenditure is made;
  3. where the recipient of the expenditure is located, and
  4. if the expenditure relates to goods or services, where those goods or services are consumed [citing Word Investments].

On the face of it, expenditure is ‘incurred’ in Australia, if the assets depleted, by the expenditure, are located in Australia, or the net assets, in Australia, are equivalently depleted (what item 2, above, is probably trying to get at). And the place where the decision to make the expenditure, might be relevant, as might be the place where the actions required, to make the payment (though both of these less pressing than the location of the assets depleted).

Where I think the Commissioner is wrong (in this Draft) is in points 3 & 4, where he looks to the place where the expenditure goes or where it’s used. This does not seem warranted, to me, on the face of the statutory provisions.

‘Principally’ [for expenditure]

The Commissioner rules that:

49.  … It is not possible to specify a particular percentage, however, more than 50% would generally be considered to meet the ‘principally’ requirement…

Broadly, a ‘principally’ requirement is qualitative, but for expenditure, it might reduce to a percentage over a sensible period. The Commissioner has arguably been kind, but accepting a bare majority of the expenditure amounting to ‘principally’ (it might have been higher).

‘Pursues its objectives’ principally in Australia

The Commissioner rules:

56.  An entity pursues objectives in Australia if things done by the entity attempt to realise those objectives in Australia. The things can be done overseas if they are just the means for that attempt (see Example 7 – Scenario (b) and Examples 8 and 9 of this draft Ruling).

Example 7, scenario (c) however, is disturbing, as it concludes that an Australian charity making a gift to a foreign fund, to pursue is objective of advancing a particular religion, was not pursuing its objectives in Australia (to the extent it has a physical presence in Australia) because the gift went to a foreign recipient (whereas scenario (b) said it was ok to give it to a local entity, even though it would promote that religion overseas).

The Commissioner keeps on trying to limit destination of the benefit to Australia, which is not what the provisions say.

‘Principally’ [for objectives]

The Commissioner does not really deal with the ‘principally’ issue, separately, for ‘pursuing objectives’ (though he does, for incurring expenditure). He tends to infer one, from the other (see Example 7, scenario (c), para 79.

Disregarded amounts (s50-75)

For the purposes of testing whether an entity incurs expenditure and pursues objectives principally in Australia, s50-75 requires one to disregard any distributions that the entity makes out of gifts or government grants that it has received (either directly or from a gift-deductible fund, authority or institution it operates).

Examples (for Div 50 exemption requirements)

The Commissioner gives examples (7, 8, 9 & 10) to illustrate this, but it is beyond the scope of this summary to go through them (and they may also be wayward, if what I’m saying is right).

Franking Credit conditions

The ‘franking credit’ requires that the recipient of the dividend satisfy a ‘residency requirement’ to be entitled to a refund of the franking credit (s207-117).

The requirement is the same as for income tax exemption (‘physical presence in Australia and (2) incurs its expenditure and pursues its objectives, principally in Australia). The only difference is, that it must do this at all times throughout the year in which the distribution is made (dividend is paid). For this reason, the Commissioner does not offer any further fresh analysis (in addition to that for Div 50 tax exemption).

Conclusion

In searching for what Parliament intended, when enacting these provisions, insight might be gained from the Franking Credit refund wording, which calls to ‘double pronged’ requirement a ‘residency’ requirement.

It may be that Parliament simply intended to limit its tax concessions to entities that were ‘resident’ in a slightly dismembered sense, designed to apply to things that were not necessarily legal entities and also did not have a commercial reason for being.

It might be foolish, therefore, to expect these words, to limit the destination of the charity, to Australian shores (in some way or another).

FJM 13.7.18; LTN 126, 4/7/18; Tax Month – July 2018]

 

Comprehension questions (answers available)

  1. Is there a requirement for a DGR to be ‘in Australia’?
  2. Does he offer any authority for his proposition the the fund must be ‘managed’ here (in a quasi ‘central management and control’ sense)?
  3. Does the he say why the place where an Authority is ‘established’ or ‘operated’ is the relevant test and whether it is either or both?
  4. Does he say that an ‘institution’ is ‘in Australia’ if it is ‘operated’ here?
  5. Do both the Div 50 ‘exemption’ and the Div 207 franking credit refund requirements both involve having a ‘physical presence’ in Australia and ‘to that extent, incur its expenditure and pursue its objectives principally in Australia?
  6. Does the Commissioner, in this draft, tend to stray into requiring the recipient of the expenditure or the objects of the charity to be Australian?
  7. Might it help give suitable content, to the wording of these ‘in Australia’ requirements, to think of them as a requirement, to be a resident of Australia, before they can expect its tax concessions?

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Category: Tax Month - July 2018

Author: John Morgan

John Morgan is a tax specialist lawyer of more than three decades experience now practicing at the Victorian Bar - w: www.FJMtax.com e: f.john.morgan@vicbar.com.au