ATO ID 2004/757: Income tax exemption: company established by local council
Date of decision: 27 August 2004
Year of income: Year ended 30 June 2004
Business line: Private Groups and High Wealth Individuals

Issue
Is the taxpayer, a company established by a local council, an exempt entity under item 5.1 of section 50-25 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. The taxpayer, a company established by a local council, is not an exempt entity under item 5.1 of section 50-25 of the ITAA 1997.

Facts
A local council is in the preconstruction phase of a building complex. A company will be formed for the purpose of running the complex. The council will hold all the ordinary shares in the company. The council will issue preference shares to business persons who are prepared to invest in the company.

Reasons for decision
Summary: Item 5.1 of section 50-25 of the ITAA 1997 provides that the following are exempt entities: Under section 50-1 of the ITAA 1997, the income of these entities is exempt from income tax. Therefore, if the company established by the local council is a 'municipal corporation' or a 'local governing body', it will be exempt from income tax. 'Municipal corporation' is not defined in the ITAA 1997 or the Income Tax Assessment Act 1936 (ITAA 1936). In the High Court case of Federated Engine-Drivers and Firemen's Association of Australasia v. Broken Hill Pty Co Ltd (1911) 12 CLR 398, Barton J said that 'a municipal corporation is a part of the governmental power of the State.' In the same case, Isaacs J in reference to municipal corporations said ...a corporation is constituted as a regulating agent for certain purposes, and for those purposes is entrusted with governmental powers He described the Melbourne City Council as 'primarily constituted for the purposes of municipal government and, in respect of its functions of legislation and administration, may be said to be a subordinate local agent for the purposes of government.' He then said: For the purpose of non-interference with their governmental functions, a municipal corporation might fairly claim to stand as ... "extending ... the shield of the Crown to what might more fitly be described as the public government of the country." But, on the other hand, corporate trading is none the less trading, and is on a wholly different plane. The difference is ineradicable. The meaning of 'municipal corporation' was discussed in the Administrative Appeals Tribunal Taxation Appeals Division case, AAT No. 6709 Debit Tax Administration Act , by Mrs R.A. Balmford, the Senior Member, who concluded that: ....That expression, combined with "or other local governing body" is calculated to subsume any body, wherever it is situate within the Commonwealth, and under whatever legislation it is established, which, in terms of the decision in Tribe v Salt Lake City (paragraph 15 supra) "is a body politic and corporate created to administer the internal concerns of the district embraced with its corporate limits, in matters peculiar to such place and not common to the state at large". The words "municipal" and "local" in sub-paragraph (vii)(c) indicate that that provision is concerned with bodies operating in respect of a discrete district, region or area within a State or Territory. Therefore, a municipal corporation must be constituted to exercise governmental functions and is considered to be part of the Government. In this case, the company's object and purpose will be to run a building complex. This activity is in the nature of trading or business and not a governmental function. Therefore, the new company is not constituted as a municipal corporation. 'Local governing body' is defined by section 995-1 of the ITAA 1997 as meaning 'a local governing body established by or under a State law or Territory law. The company must be established by or under a law of a State or Territory for the purpose of being a local governing body. Obviously, most entities which have legal status are constituted or established under a law of a state or territory. This does not mean that all entities so constituted are local governing bodies. Rather, the test requires that the body be constituted or established as a local governing body. The formation of a company limited by shares owned partly by a local council and partly by others only shows that the company is incorporated. It does not mean that it is 'constituted as' a local governing body. In the High Court case of Renmark Hotel Inc v. Federal Commissioner of Taxation (1949) 79 CLR 10; (1949) 9 ATD 106, Rich J said: The word 'constituted' is not the same as 'incorporated'. For the purposes of s 23(d) it is conceivable that an unincorporated body might be constituted under a State Act so as to satisfy the exemption. On the other hand, mere incorporation under an Act does not constitute the body. The word 'constituted' immediately follows 'public authority'. It means constituted as a public authority.... The company has not been given the characteristics and powers of a local governing body under a law of a State. Neither the incorporation of an entity nor the mere ownership of a corporation by a local council means the corporation is established as a local governing body. As the company is not a municipal corporation or a local governing body it is not an exempt entity under section 50-25 of the ITAA 1997, and section 50-1 of the ITAA 1997 will not apply to make the income of the company exempt from income tax.

Legislative references: Income Tax Assessment Act 1997 section 50-1 section 50-25 section 995-1
Case references: Renmark Hotel Inc v. Federal Commissioner of Taxation (1949) 79 CLR 10 (1949) 9 ATD 106
Subject references: Entities & taxpayer groups Exempt entities State and territory bodies