Private ruling: continuation of tax exempt status under section 50-5 of the Income Tax Assessment Act 1997
Published: May 2015
Ruling period: 1 July 20xx to 30 June 20xx
Date scheme commenced: 1 July 20xx

Ruling: Q1: Will X Pty Ltd continue to maintain its tax exempt status under table item 1.1 of section 50-5 of the Income Tax Assessment Act 1997 (ITAA 1997) despite giving a loan to its head entity? | A1: Yes.

Relevant facts and circumstances: X Pty Ltd applied for and received endorsement from the Tax Office as a charitable institution under table item 1.1 of section 50-5 of the ITAA 1997. X Pty Ltd has its share capital owned by the head entity. Although the head entity is not registered as a charity but it benefits from tax exemption under table item 3.1 of section 50-15 of the ITAA 1997. The charitable purposes for which X Pty Ltd was established are stated in its constitution. X Pty Ltd's constitution includes a not-for-profit requirements which requires the income and property to be distributed solely towards promotion of its objectives and prohibits any part of the income or property to be distributed to its members. In case of winding up of X Pty Ltd, its constitution provides that the amount remaining after satisfaction of its debts and liabilities to be given to an organization which has similar objects and which prohibits distribution of assets and income to its members. Surplus funds held by the X Pty Ltd are invested with financial institutions to generate an interest return to fund meeting the company's objectives. The head entity currently has to borrow funds from financial institutions to support its operations. The interest rate paid on the loans is greater than the interest rate received on the funds invested by the charities. What is proposed is that rather than the head entity paying the higher interest cost, that it borrows the funds from X Pty Ltd. It is proposed that the loans would be documented as to their terms, bear a commercial interest rate (being the appropriate reserve bank issued interest rate plus a margin of 2%) and would be secured by way of appropriate security over the assets of the head entity. The head entity has a significant pool of assets available to secure the loans, including significant land and buildings.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 50-5 | Income Tax Assessment Act 1997 section 50-50 | Income Tax Assessment Act 1997 section 50-52 Reason for decision | Table item 1.1 of section 50-5 of the ITAA 1997 includes registered charity as an entity that is exempt from income tax subject to certain special conditions. The special conditions are included in sections 50-50 and 50-52 of the ITAA 1997. | Section 50-50 of the ITAA 1997 states as follows: | 50-50(1) An entity covered by item 1.1 is not exempt from income tax unless the entity: | (a) has a physical presence in Australia and , to that extent, incurs its expenditure and pursues its objectives principally in Australia; or | (b) is an institution that meets the description and requirements in item 1 of the table in section 30-15; or | (c) is a prescribed institution which is located outside Australia and is exempt from income tax in the country in which it is resident; or | (d) is a prescribed institution that has a physical presence in Australia but which incurs its expenditure and pursues its objectives principally outside Australia; | and the entity satisfies the conditions in subsection (2). | Subsection 50-50(2) states as follows: | 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. | In the present case, X Pty Ltd satisfies paragraph 50-50(1)(a) of the ITAA 1997 as it is an Australian resident company that incurs its expenditure and pursues its objective for the charitable purpose for which it was established and received endorsement. | Regarding the special condition of paragraph 50-50(2)(a) of the ITAA 1997, Taxation Ruling TR 2015/1 - Income tax: special conditions for entities whose ordinary and statutory income is exempt (TR 2015/1) states at paragraph 8: | Three questions must be considered to determine whether an entity satisfies the governing rules condition: | • What are the 'governing rules' of the entity? | • What are the 'substantive' requirements in the entity's governing rules? | • At what time must the entity comply with all of the substantive requirements in its governing rules? | Paragraph 9 of TR 2015/1 states: | The 'governing rules' of an entity are those rules that authorise the policy, actions and affairs of the entity. That is, governing rules of an entity consist of the rules that direct: | • What the entity is required and permitted to do, and | • What those, who control the entity, are required and permitted to do in respect of the entity. | TR 2015/1 elaborates at paragraph 18 that the substantive requirements of an entity's governing rules are those that define the rights and duties of the entity and which include rules such as those that give effect to the object or purpose of the entity, relate to the non-profit status, powers and duties of the directors and other officers, sets out the criteria for member admission, and relates to the winding up of the entity. X Pty Ltd's constitution contains all these rules. | Regarding the time that an entity is to follow the substantive requirements, TR 2015/1 states that it has to be at all times throughout the year. X Pty Ltd follows the substantive requirements of its constitution at all time during the year. | Regarding the special condition in paragraph 50-50(2)(b) of the ITAA 1997, Taxation Ruling TR 2015/1 states at paragraph 22 that: | The income and asset condition requires an entity to 'apply its income and asset solely for the purpose for which the entity is established'. | Two conditions must be considered to determine whether an entity satisfies the income and assets condition, namely | • what is the purpose for which the entity is established; and | • has the entity applied its income and assets solely for the purpose for which the entity is established? | Paragraph 24 of TR 2015/1 explains the "purpose for which the entity is established" as follows: | The purpose for which the entity is established is determined by a consideration of all of the features of the entity. The main factors to be considered are the objects in the entity's constituent documents, and the activities of the entity after its formation, up to the time at which the income and assets condition is applied. Other factors include policies and plans, administration, finances, history and control, and any legislation governing the operation of the entity. | In the case of X Pty Ltd, its purpose or object is stated in its constitution. | The second part of the income and asset condition, namely whether the entity has applied its income and assets solely for the purpose for which it is established, must to be looked at too. | Paragraph 30 of TR 2015/1 explains the meaning of 'apply as follows: | The requirement that an entity must 'apply' its income and assets means that an entity must make use of all of its income and assets, solely for the purpose for which the entity is established. | Paragraph 31 of TR 2015/1 states that: | … An entity may use some of its income to acquire assets which, in future, will produce income for its purpose or purposes, and may accumulate some of its income for later distribution | However, the income and asset must exclusively or only apply for the purpose for which it is established and this test is applied continuously throughout the income year. | In the present case, X Pty Ltd invests its surplus fund with financial institutions to generate interest return to fund its objectives. On the other hand, the head entity borrows fund from financial institutions to support its operation. All what X Pty Ltd is proposing is instead of investing its funds with other financial institutions to invest with the head entity. If X Pty Ltd invests the same fund with the head entity, it is not deviating from its object, nor applying its income or asset for purposes other than for which it was established and received endorsement from the Tax Office. Moreover, X Pty Ltd informed the Tax Office in its ruling application that the loan would be provided maintaining all standard procedures for a commercial loan. The loan will be documented as to their terms, bear a commercial interest rate and would be secured by way of appropriate security over the assets of the head entity. Therefore, giving a loan to the head entity and earning interest income from the loan will not cause X Pty Ltd to breach the special conditions contained in section 50-50 of the ITAA 1997. | Subsection 50-52(1) of the ITAA 1997 contains the other special condition for entities stated in item 1.1 of section 50-5 of the ITAA 1997. It requires that an entity covered by item 1.1 must be endorsed as exempt from income tax under Subdivision 50-B of the ITAA 1997. | X Pty Ltd was endorsed as a tax exempt entity by the Tax Office. | Therefore, since X Pty Ltd satisfies all the conditions of item 1.1 of section 50-5 of the ITAA 1997, it will continue to maintain its tax exempt status irrespective of providing loan to the head entity.

Reasons for decision: Summary: Table item 1.1 of section 50-5 of the ITAA 1997 includes registered charity as an entity that is exempt from income tax subject to certain special conditions. The special conditions are included in sections 50-50 and 50-52 of the ITAA 1997. Section 50-50 of the ITAA 1997 states as follows: 50-50(1) An entity covered by item 1.1 is not exempt from income tax unless the entity: (a) has a physical presence in Australia and , to that extent, incurs its expenditure and pursues its objectives principally in Australia; or (b) is an institution that meets the description and requirements in item 1 of the table in section 30-15; or (c) is a prescribed institution which is located outside Australia and is exempt from income tax in the country in which it is resident; or (d) is a prescribed institution that has a physical presence in Australia but which incurs its expenditure and pursues its objectives principally outside Australia; and the entity satisfies the conditions in subsection (2). Subsection 50-50(2) states as follows: 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. In the present case, X Pty Ltd satisfies paragraph 50-50(1)(a) of the ITAA 1997 as it is an Australian resident company that incurs its expenditure and pursues its objective for the charitable purpose for which it was established and received endorsement. Regarding the special condition of paragraph 50-50(2)(a) of the ITAA 1997, Taxation Ruling TR 2015/1 - Income tax: special conditions for entities whose ordinary and statutory income is exempt (TR 2015/1) states at paragraph 8: Three questions must be considered to determine whether an entity satisfies the governing rules condition: • What are the 'governing rules' of the entity? • What are the 'substantive' requirements in the entity's governing rules? • At what time must the entity comply with all of the substantive requirements in its governing rules? Paragraph 9 of TR 2015/1 states: The 'governing rules' of an entity are those rules that authorise the policy, actions and affairs of the entity. That is, governing rules of an entity consist of the rules that direct: • What the entity is required and permitted to do, and • What those, who control the entity, are required and permitted to do in respect of the entity. TR 2015/1 elaborates at paragraph 18 that the substantive requirements of an entity's governing rules are those that define the rights and duties of the entity and which include rules such as those that give effect to the object or purpose of the entity, relate to the non-profit status, powers and duties of the directors and other officers, sets out the criteria for member admission, and relates to the winding up of the entity. X Pty Ltd's constitution contains all these rules. Regarding the time that an entity is to follow the substantive requirements, TR 2015/1 states that it has to be at all times throughout the year. X Pty Ltd follows the substantive requirements of its constitution at all time during the year. Regarding the special condition in paragraph 50-50(2)(b) of the ITAA 1997, Taxation Ruling TR 2015/1 states at paragraph 22 that: The income and asset condition requires an entity to 'apply its income and asset solely for the purpose for which the entity is established'. Two conditions must be considered to determine whether an entity satisfies the income and assets condition, namely • what is the purpose for which the entity is established; and • has the entity applied its income and assets solely for the purpose for which the entity is established? Paragraph 24 of TR 2015/1 explains the "purpose for which the entity is established" as follows: The purpose for which the entity is established is determined by a consideration of all of the features of the entity. The main factors to be considered are the objects in the entity's constituent documents, and the activities of the entity after its formation, up to the time at which the income and assets condition is applied. Other factors include policies and plans, administration, finances, history and control, and any legislation governing the operation of the entity. In the case of X Pty Ltd, its purpose or object is stated in its constitution. The second part of the income and asset condition, namely whether the entity has applied its income and assets solely for the purpose for which it is established, must to be looked at too. Paragraph 30 of TR 2015/1 explains the meaning of 'apply as follows: The requirement that an entity must 'apply' its income and assets means that an entity must make use of all of its income and assets, solely for the purpose for which the entity is established. Paragraph 31 of TR 2015/1 states that: … An entity may use some of its income to acquire assets which, in future, will produce income for its purpose or purposes, and may accumulate some of its income for later distribution However, the income and asset must exclusively or only apply for the purpose for which it is established and this test is applied continuously throughout the income year. In the present case, X Pty Ltd invests its surplus fund with financial institutions to generate interest return to fund its objectives. On the other hand, the head entity borrows fund from financial institutions to support its operation. All what X Pty Ltd is proposing is instead of investing its funds with other financial institutions to invest with the head entity. If X Pty Ltd invests the same fund with the head entity, it is not deviating from its object, nor applying its income or asset for purposes other than for which it was established and received endorsement from the Tax Office. Moreover, X Pty Ltd informed the Tax Office in its ruling application that the loan would be provided maintaining all standard procedures for a commercial loan. The loan will be documented as to their terms, bear a commercial interest rate and would be secured by way of appropriate security over the assets of the head entity. Therefore, giving a loan to the head entity and earning interest income from the loan will not cause X Pty Ltd to breach the special conditions contained in section 50-50 of the ITAA 1997. Subsection 50-52(1) of the ITAA 1997 contains the other special condition for entities stated in item 1.1 of section 50-5 of the ITAA 1997. It requires that an entity covered by item 1.1 must be endorsed as exempt from income tax under Subdivision 50-B of the ITAA 1997. X Pty Ltd was endorsed as a tax exempt entity by the Tax Office. Therefore, since X Pty Ltd satisfies all the conditions of item 1.1 of section 50-5 of the ITAA 1997, it will continue to maintain its tax exempt status irrespective of providing loan to the head entity.