Private ruling: Unit trust investment
Published: June 2013
Ruling period: Year ending 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Questions and Answers: | Is your loss on disposal of units in an investment trust of a revenue nature? | No. | Is your loss on disposal of units in the investment trust of a capital nature? | Yes.

Relevant facts and circumstances: In late 200X, together with a related family trust, you invested in the unlisted unit trust. You purchased Y% and the related family trust purchased Z% of the investment. The investment was part of a remuneration incentive arrangement related to your employment. You were offered and took out a loan with your employer for your share of the investment. The loan was a limited recourse loan, with recourse for repayment of the loan limited to distributions made by the fund from income earned and from proceeds of realisation of investments. Interest on the loan was to be repaid solely from future annual employment bonuses earned by you and from income earned by the trust. The trust was set up as a profit-making incentive mechanism. The information memorandum for the trust stated the fund's primary objective was to invest in growth opportunities, where priority would be given to maximising growth in the investee businesses. The promoters of the trust intended to fully invest within 2 years of the first investment, to grow such Investments and then to sell such investments. You asserted the trust was carrying on an investment business. In late 20YY, you left your employment. Subsequently, you transferred one third of your investment interest to the related family trust at the current market value. At the time of transfer, a loss crystallised on that part of the investment disposed.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 104-60

Reasons for decision: Summary: Your loss on your transfer of units is of a capital nature and will result in a CGT loss under section 104-60 of the Income Tax Assessment Act 1997 (ITAA 1997). Your loss on your transfer of units is not an loss of a revenue nature under section 8-1 of the ITAA 1997 because your holding of units was a passive investment for the following reasons: (i) the absence of an investment style which envisages an exit point, i.e., you adopted a 'buy and hold' style of investment; (ii) it was held for a significant number of years; and (ii) the existence of a family, as distinct from a commercial, explanation for the dealing, in that your "disposal", i.e, transfer, was to a related family trust. Also, that your acquisition of units was connected with your employment does not result in a loss of a revenue nature. The Commissioner has published decisions explaining rights exercised and the shares surrendered in relation to employee limited recourse loan schemes are done so in respect of the exercise of these rights (which are CGT assets) and not in respect of employment. For example, shares acquired and disposed of under employee share schemes are accounted for under CGT legislation (such as sections 109-5, 115-25 and specifically 130-80 of the ITAA 1997) rather than as ordinary income and deductions. The broad principles here would apply to you. There are no tax principles, including the Commissioner's view in Taxation Determination TD 2011/21 , which deem that a profit making (i.e., revenue) intention of a company or trust applies equally to their respective share and unit holders. It is the common and ordinary understanding that shares or units held, in an entity carrying on a revenue business, are generally of a capital nature. | Detailed Reasoning - General deductions: Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are necessarily incurred in for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature. Section 104-60 of the ITAA 1997 states CGT event E2 happens if you transfer a CGT asset to an existing trust; that you make a capital gain if the capital proceeds from the transfer are more than the asset's cost base; that you make a capital loss if those capital proceeds are less than the asset's reduced cost base. Taxation Ruling TR 92/4 is about when losses on isolated transactions are deductible under section 8-1 of the ITAA 1997 (i.e., the former subsection 51(1)). It states: 8. If an isolated transaction results in a loss…that loss may fall within the first limb of subsection 51(1) if, in entering that transaction, the taxpayer intended or expected to derive a profit which would have been assessable income. 9. If a taxpayer which carries on a business enters into an isolated transaction, that transaction is only on revenue account if the intention or purpose of profit-making exists in relation to the transaction in question. 11. If an isolated transaction was expected to produce a capital profit, a loss incurred in that transaction is not deductible under subsection 51(1). Such a loss is expressly excluded from deduction as being a loss of capital or of a capital nature, regardless of whether the transaction also produced, or was expected to produce, income. In your case, whether your loss on the transfer of your units is deductible under section 8-1 of the ITAA 1997 or is a capital loss under section 104-60 of the ITAA 1997 depends on whether it is of a revenue nature or of a capital nature. | Detailed Reasoning - Isolated transactions: In your private ruling application, you proposed your transfer crystallised income according to ordinary concepts, which includes isolated transactions, where there is an intention to make a profit. Taxation Ruling TR 92/3 explains whether profits on isolated transactions are income and includes the following principles and examples: 36. The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme… 41. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. 47. For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character... Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case. 49. In very general terms, a transaction or operation has the character of a business operation or commercial transaction if the transaction or operation would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions or operations. Some factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following: (a) the nature of the entity undertaking the operation or transaction…For example, if the taxpayer is a corporation with substantial assets rather than an individual, that may be an indication that the operation or transaction was commercial in nature. However, if the taxpayer acts in the capacity of trustee of a family trust, the inference that the transaction was commercial or business in nature may not be drawn so readily; (b) the nature and scale of other activities undertaken by the taxpayer…; (c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained; (d) the nature, scale and complexity of the operation or transaction; (e) the manner in which the operation or transaction was entered into or carried out. This factor would include whether professional agents and advisers were used and whether the operation or transaction took place in a public market; (f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction. For example, the relationship between the parties may suggest that the operation or transaction was essentially a family dealing and not business or commercial in nature; (g) if the transaction involves the acquisition and disposal of property, the nature of that property…. For example, if the property has no use other than as the subject of trade, the conclusion that the property was acquired for the purpose of trade and, therefore, that the transaction was commercial in nature, would be readily drawn; and (h) the timing of the transaction or the various steps in the transaction... For example, if the relevant transaction consists of the acquisition and disposal of property, the holding of the property for many years may indicate that the transaction was not business or commercial in nature. Example 1 Ms Donovan, a public servant, purchased 10,000 shares in a listed public company at a price of $1 each and sold them 18 months later for $2 each. During that period, the company paid one small dividend. Donovan was not carrying on a business of trading in shares. A significant purpose of Donovan in acquiring the shares was to make a profit from an increase in the value of the shares. The profit made on the sale of the shares is not income. The transaction was merely an investment, not a business operation or commercial transaction. Example 4 Mr Goldfinger purchased a number of gold bars for $100,000 and, following a sharp rise in the price of gold, sold the gold bars one week later for $110,000. Goldfinger did not carry on a business and had no previous dealings in gold. The profit of $10,000 is income and assessable under subsection 25(1). It can be inferred from the objective circumstances (especially the quick sale following a rise in price and the fact that the asset had no immediate use other than as an object of trade) that profit-making was a significant purpose of Goldfinger in acquiring the gold bars. Furthermore, the substantial amounts of money involved and the nature of the asset traded lead to the conclusion that the transaction was commercial in nature. Taxation Determination TD 2011/21 , which is about the characterisation of trust income, also discusses isolated transactions. Paragraph 56 of TD 2011/21 states factors which tend to support a capital account conclusion would include: § the absence of an investment style which envisages an exit point - for example the trustee adopts a 'buy and hold' style of investment; § a low average annual turnover - that is, less than in London Australia where turnover had been in the order of 10%; § a lack of regularity in the particular sale activity; § a high proportion of those stocks that are sold have been held for a significant number of years (see AGC Investments where 75% of stocks sold was held more than 5 years). However, if a high proportion of the remainder are then also turned over, this tends to support the opposite conclusion; § a low level of sales transactions compared with the number of stocks in the portfolio; § profits on sale normally only constitute a small percentage of total income; § significant percentage of 'aged' stocks remain in the portfolio; and § the existence of a family as distinct from a commercial explanation for the dealing. In your case, the relevant transaction was merely the transfer of an investment and not a business operation or commercial transaction because: (a) you were an individual employee when entering into the investment; (b) you did not generally trade in financial products at when entering into the investment; (c) the magnitude of the profit sought was undefined, i.e., there was the absence of an investment style which envisaged an exit point, i.e., you adopted a 'buy and hold' style of investment; (d) the nature, scale and complexity of the investment was unsophisticated, i.e., passive and outside of your control in respect to the timing, accrual and realisation of potential profit; (e) the manner in which the investment was entered into or carried out was unsophisticated, namely, connected with the offer of a limited recourse loan, in the course of employment, which mitigated the potential for capital loss; (f) the nature of any connection between you and any other party to the investment was unsophisticated, i.e., similar to the passive nature of an employee share plan; (g) the investment had use other than as the subject of trade, namely, earning regular distribution income and capital gain; and (h) the timing of the investment, i.e., holding it for many years and subsequently indirectly retaining it by transferring it to a family trust indicates that your transfer (i.e., "disposal") was not business or commercial in nature. As indicated in TD 2011/21 , there was the existence of a family, as distinct from a commercial, explanation for the ending of your ownership interest, namely, transferring it to a related family trust. It follows, based on the principles about isolated commercial transactions, your loss on your transfer of units is of a capital nature and will result in a CGT loss under section 104-60 of the ITAA 1997. | Detailed Reasoning - Taxation Determination TD 2011/21: In your private ruling application, you referred to Taxation Determination TD 2011/21 and proposed the same profit making intention of the trustees of the trust applies to you. TD 2011/21 is about the characterisation of trust income. In summary, it provides the mere fact that a gain or loss from an investment is made by an entity in its capacity as trustee of a trust is not conclusive as to whether the gain or loss is on revenue or capital account for tax purposes. TD 2011/21 follows the general principles established by case law in relation to characterising whether a gain or loss has been made on revenue or capital account. As previously mentioned, paragraph 56 of TD 2011/21 lists factors which tend to support a capital account conclusion. Section 108-5 of the ITAA 1997 is about CGT assets and includes shares in a company and units in a unit trust as examples of CGT assets. In your case, the principles established in TD 2011/21 do not apply directly to you because you are not an investment trust but, instead, a unit holder in an investment trust. TD 2011/21 does not offer any support for your proposition that the same profit making intention of the trustees of the trust applies to you. In general, where a shareholder does not carry on a business of share trading, the shares of a shareholder in a company that carries on a business are CGT assets. The same profit making intention of a company does not implicitly apply to its shareholders. In the same way, even if the income of the trust is characterised on revenue account (which remains undetermined), your passive long term investment, in itself, deems your units to be CGT assets. It follows, based on the principles discussed in TD 2011/21, your loss on your transfer of units is of a capital nature and will result in a CGT loss under section 104-60 of the ITAA 1997. | Detailed Reasoning - Limited recourse employee loans: In your private ruling application, you proposed a loss was incurred in the expectation of earning assessable income and the character of that loss was in connection with your employment remuneration package; that you were investing on a revenue basis at all times. You relied in the concept of "value to the taxpayer", found in the High Court of Australia case Scott v. Federal Commissioner of Taxation [1966] HCA 48; (1966) 117 CLR 514; 40 ALJR 205, where it was said: As I read s. 26 (e) its meaning and purpose is to ensure that certain receipts and advantages which are in truth rewards of a taxpayer's employment or calling are recognized as part of his income. In other words the enactment makes it clear that the income of a taxpayer who is engaged in any employment or in the rendering of any services for remuneration includes the value to him of everything that he in fact gets, whether in money or in kind and however it be described, which is a product or incident of his employment or a reward for his services. If, instead of being paid fully in money, he is remunerated, in whole or in part, by allowances or advantages having a money value for him they must be taken into account. The enactment does not bring within the taxgatherer's net moneys or moneys' worth that are not income according to general concepts. Rather it prevents receipts of moneys or moneys' worth that are in reality part of a taxpayer's income from escaping the net. The Commissioner has published some decisions, which include the topic of limited recourse employee loans, including those in the following paragraphs: When the employee is provided with a limited recourse loan the non-recourse feature of the loan protects the employee from loss, should the value of the shares be below the loan balance when the loan is discharged. This protection is commonly referred to as downside risk protection (DRP). [ATO ID 2003/315] … when the employee enters into the loan agreement they obtain the right to transfer the shares to the lender in full satisfaction of the debt. If these rights are subsequently exercised and the shares surrendered, any benefit would be in respect of the exercise of these rights, and not in respect of employment . At the time the shares are surrendered, the rights given up are considered to have a value equal to the loan balance. [ATO ID 2003/316; emphasis added] Thus, the benefit that arises to the employee upon the surrender of the shares, does not give rise to a fringe benefit as no benefit has been provided to the employee 'in respect of' the employment relationship. [ATO ID 2003/316] Also, the tax treatment of shares acquired and disposed of under employee share schemes falls under CGT legislation (such as sections 109-5, 115-25 and specifically 130-80 of the ITAA 1997) rather than as ordinary income and deductions. In your case, decisions of the Commissioner, which include the topic of limited recourse employee loans, do not offer any support for your proposition that a loss was incurred in the expectation of earning assessable income and that the character of that loss was in connection with your employment remuneration package. Instead, any benefits gained in relation to your limited recourse loan are in relation to your investment rights, which are CGT assets. Also, your case would broadly follow the principles that guide the CGT rules as found in relation to employee share schemes. It follows, based on the Commissioner's published views about limited recourse employee loans, your loss on your transfer of units is of a capital nature and will result in a CGT loss under section 104-60 of the ITAA 1997. | Detailed Reasoning - Conclusion: In conclusion, various basic taxation principles show your loss on your transfer of units is of a capital nature, crystallising as CGT event E2 under section 104-60 of the ITAA 1997. It follows a deduction for your loss is prohibited under section 8-1 of the ITAA 1997.