Private ruling: Deductibility of payments to discretionary trust for the purpose of providing employee termination payments
Date of advice: 18 December 2019
Published: March 2020
Ruling period: Questions 1, 2 and 3 - 1 July 20xx to 30 June 20xx | Question 4 - 1 April 20xx to 31 March 20xx
Date scheme commenced: 20xx

Ruling: Q1: Will Company A (the "Taxpayer") obtain a deduction under section 8-1 of the Income Tax Assessment Act 1997 (Cth) ("ITAA 1997") for contributions made by the Taxpayer, to the Trustee of the discretionary trust (The "Trust") to facilitate the future payment of Employment Termination Payments ("ETPs") pursuant to the Trust Deed (the "Trust Deed") to employees of the Taxpayer? | A1: No | Q2: If the answer to question 1 is yes, is the proportion of the contribution made by Company A to the Trustee that is deductible in a relevant year of income determined in accordance with the formula set out in section 82KZMD of the Income Tax Assessment Act 1936 ("ITAA 1936")? | A2: Not applicable - see reasons for decision. | Q3: If the answer to question 1 is yes, will the Commissioner seek to make a determination that Part IVA of ITAA 1936 applies to deny, in part or in full, a deduction claimed by the Taxpayer for the contributions made by Company A to the Trustee in respect of providing for the future payments of ETPs by the Trustee, pursuant to the Trust Deed? | A3: Not applicable - see reasons for decision. | Q4: Do the contributions made by the Taxpayer to the Trustee constitute fringe benefits within the meaning of subsection 136(1) of the Fringe Benefit Tax Assessment Act 1986 ("FBTAA " )? | A4: No.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. Company A has established what it describes as an incentive plan ("the Incentive Plan"). The stated purpose of the Incentive Plan is to provide employment termination payments and encourage long tenure for certain qualifying employees. The Incentive Plan has been established through the terms of the discretionary Trust Deed (the Trust Deed). Company A contributions to the Trust Company A has claimed deductions for contributions made to the Trust in its income tax return for the relevant income years. Company A's Board of Directors have historically elected to pay a percentage of net profit after tax to the Trust each year, provided certain profit growth targets are met. The contributions are made by Company A through electronic funds transfer from the Company's bank account to the Trust bank account. Each contribution is irrevocable. The Trust The Trust, which has been established as a discretionary trust, is operated by a Trustee company. The directors of the Trustee company comprise of directors and eligible employees of Company A. The purpose of the Trust is predominately to provide long term incentive benefits for staff in the form of employment termination payments (ETPs) to eligible employees. The applicant submitted that such payments may be described as genuine 'golden handshakes'. The Trust also distributes its annual net investment earnings to eligible employees. The Trustee The directorship of the Trustee consists of a number of permanent directors, while the remaining directors are selected through a periodic anonymous ballot of staff. The directors of the Trustee meet periodically to decide how the earnings of the Trust will be distributed among eligible employees, and determine whether payments will be made to eligible employees upon termination of their employment. In making a determination whether payments will be made to an eligible beneficiary, the Trust considers whether the relevant criteria have been met. Favourable discretion is likely to be exercised if the eligible employee meets the following criteria: · Minimum period of continuous service with Company A; · has performed at a satisfactory standard of work; · receives salary and not commission as remuneration; · is not a Non-executive Director; and · the employment is not terminated due to a breach of employment contract. If an employee has been employed by Company A for a specified long-term of service, then they may cash out of the Incentive Plan. However, the employee may not then re-enter the Incentive Plan after cashing out. In making determinations as to the amount an eligible beneficiary will receive from earnings of the Trust, or as an ETP, consideration is given to the length of service of the employee and the salary of the employee. The Trust does not communicate the method of distribution calculation to eligible employees. The Trust Deed The Trust Deed states the predominant benefit of paying 'The Settlor wishes to establish a fund for the predominant benefit of paying Employment Termination Payments to Eligible Beneficiaries'. Eligible Beneficiaries are named in the Trust Deed to be "any Eligible Employee of Company A or its subsidiaries". Eligible Employee is defined in the Trust Deed to mean "an employee with at least x years continuous employment with Company A or its subsidiaries" Under the terms of the Trust Deed, the Trustee has very broad powers. It can enter into any type of commercial or other undertaking either alone or together with others, including to: (a) Invest the Trust Fund in assets of non-income producing nature or in investments of wasting or speculative nature; (b) Invest in shares, options or debentures of any company and to lend money on deposit with or without security to or in any such company; (c) Invest in real or personal property and to subdivide and build on any land and to maintain, improve, extend and demolish any buildings; (d) Loan or advance moneys forming part of the Trust Fund to any Eligible Beneficiaries (with or without security); and (e) Carry on trade or business. The Trustee has used the contributions to purchase assets to be held on trust for the beneficiaries. These assets include cash investments, shares in listed companies and bonds. The terms of the Trust Deed give the Trustee absolute discretion to accumulate, pay, apply or set aside income for one or more beneficiaries. ETPs are funded from the capital or corpus of the Trust. Company A submits that as the ETPs are paid in consequence of employment termination, they are treated as ETPs under section 82-130 of the ITAA 1997 and taxed as such. The Trustee has exercised its discretion to make determinations to pay beneficiaries the net income of the fund year on year by reference to the pool of Eligible Beneficiaries and consideration to performance related considerations. The Trust makes the payments to Eligible Beneficiaries within 12 months after termination of the Eligible Employees' employment with Company A. Company A has determined to provide cash contributions to the Trust, for the Trustee to use this money to acquire assets to facilitate annual distributions of trust income and distributions in relation to ETPs to employees of the Company in accordance with the terms of the Trust Deed. Eligible Employees As a standard position, Company A does not pay its employees bonuses. The employment contracts that employees of Company A enter into do not make any reference to the Incentive Plan. Employee eligibility to distributions from the Incentive Plan is tested on 1 July annually. The Rules of the Incentive Plan The rules of the Incentive Plan are distributed to employees upon notification that they are eligible for the scheme.


Reasons for decision: Summary: All legislative references are to ITAA 1997 unless stated otherwise. Section 8-1 is the provision that allows for general deductions from taxable income: | Detailed Reasoning - 8-1(1): You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. The provisions in paragraph 8-1(1)(a) and paragraph 8-1(1)(b) are referred to as the 'positive limbs'. Subsection 8-1(2) provides four additional 'negative limbs' that describe when a deduction is not allowed: | Detailed Reasoning - 8-1(2): However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or (d) a provision of this Act prevents you from deducting it. Section 8-1 allows a deduction for losses or outgoings to the extent that they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for that purpose. However, to the extent that the losses or outgoings are of a capital, private or domestic nature, or relate to gaining or producing exempt income or non-assessable non-exempt income, they will not be deductible. In addition, losses or outgoings will not be deductible under section 8-1 to the extent that another provision prevents a taxpayer from deducting them. Whilst in many cases losses and outgoings can factually satisfy both positive limbs, a loss or outgoing need only satisfy one of these limbs to be claimed as a general deduction pursuant to subsection 8-1(1). The conditions required to satisfy section 8-1 can be summarised as follows: Positive Limbs: i. The loss or outgoing must be incurred with sufficient nexus between a loss or outgoing and the derivation of assessable income or activities in carrying on of a business must be present Negative Limbs: ii. The loss or outgoing cannot be incurred in producing exempt income or non-assessable non-exempt income iii. The loss or outgoing cannot be capital or of a capital nature; and iv. The loss or outgoing is not of a private or domestic nature or otherwise prevented from being deductible. The conditions relevant to the Commissioner arriving at this decision are now considered. i. The loss or outgoing must be incurred with sufficient nexus between a loss or outgoing and the derivation of assessable income or activities in carrying on of a business An expense will have the relevant connection to the business when it is 'desirable or appropriate in the pursuit of the business ends of the business' ( Ronpibon Tin NL and Tongkah Compound NL v. FC of T (1949) 78 CLR 47; Magna Alloys & Research Pty Ltd v. Federal Commission of Taxation (1980) FCA 150) (" Magna Alloys " ) . In cases where the outgoing is voluntary, it is necessary to consider the purpose or motivation for the outgoing. In Magna Alloys per Deane and Fisher JJ at 208, it was found that the test for the character of an outgoing is a composite question that comprises both objective and subjective elements: · Whether the outgoing is reasonably capable of being seen as desirable or appropriate from the point of view of the business ends of the business (that is, the income generating activities of the business), and · Whether those responsible for carrying on the business view the outgoing this way. Whether the contributions are reasonably capable of being seen as desirable or appropriate to the business is the first part of the composite question. When considering the circumstances objectively, the contributions from Company A to the Trust are not desirable or appropriate in generating income for Company A's business or are not necessarily incurred in the activities of carrying on Company A's business because: (a) the standard employee contracts that Company A enters into with its employees do not mention the Incentive Plan or the Trust; (b) the contributions from Company A to the Trust are entirely voluntary and the Trust Deed does not provide the Trust with any entitlement to seek contributions from Company A; (c) the contributions made by Company A to the Trust are intended for ETPs to be provided to Company A's employees rather than as part of the overall employee remuneration costs of Company A; (d) while the notification letters that are issued to Company A employees on becoming eligible for the Incentive Plan would create an awareness among those eligible employees and the hope to be considered for the scheme, the rules of the fund and the Trust Deed assert that the Trust is administered at the sole discretion of the Trustee and the employees have no legal entitlement or 'prescribed calculation of entitlement' to the capital of the Trust (See Cameron Brae Pty Ltd v FCT 2007 ATC 4936 at 4950); (e) the discretionary nature of the benefits deny the contributions the essential character of reward for services rendered to employees of Company A and therefore did not necessarily secure benefits for Company A in the course of its business; and (f) the Trust paid the ETPs to eligible employees after their employment with Company A have ceased and not during their employment. It is difficult to see how the ETPs could incentivise eligible employees during their employment when they can only receive the ETPs when they leave Company A. The subjective element of the question is relevant to identifying the advantage a voluntary payment is intending to achieve, as observed in Magna Alloys. In answering the second part of the composite question asked in Magna Alloys, the stated primary purpose of the payments to the Trust is to provide ETPs (in the form of 'golden handshakes') to eligible employees. Company A receives the long-term intangible benefit of employee goodwill to ensure employees remain employed on good terms with Company A, in order to qualify for these payments. The Trust advised eligible employees that the ETPs may be paid on termination of their employment with Company A. While the annual distributions, which are funded by the profit generated by the Trust, may motivate employees; the ETP distributions that are funded by the capital contributed by Company A to the Trust and paid after termination of employment lack the requisite nexus with derivation of Company A's assessable income or carrying on Company A's business. Due to the strong objective indicators listed in comparison with the subjective element of the advantages being sought by Company A, it is the Commissioner's view that the contributions could not be characterised as outgoings incurred in gaining or producing assessable income of Company A or in carrying on Company A's business. i. The loss or outgoing cannot be incurred in producing exempt income or non-assessable non-exempt income On the facts provided, there is nothing to suggest that the contributions made are incurred in producing exempt income or non-assessable non-exempt income ii. Are the outgoings capital in nature? Paragraph 8-1(2)(a) prevents Company A claiming deductions for payments that are capital in nature. While we are of the view that the outgoings are not deductible as they are not incurred in gaining assessable income, or necessarily incurred in carrying on a business, if this is incorrect it is necessary to consider whether the outgoings are capital in nature. Whether a payment is revenue or capital in nature depends on the character of the payment when made by the payer. As stated in GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 90 ATC 4413 at 4419; (1990) 21 ATR 1 at 7: The character of expenditure is ordinarily determined by reference to the nature of asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid: Sun Newspapers Ltd v. F.C. of T . (1938) 61 C.L.R. 337 at p. 363. It is accepted that an entity that receives a payment that treats the payment as capital in nature does not necessarily mean that the character of the payment from the perspective of the payer is also capital. ( W Nevill & Co Ltd v FCT (1937) 56 CLR 290 ) . In British Insulated & Helsby Cables Ltd v Atherton (1926) AC 205, the House of Lords held that an initial contribution to a superannuation or pension fund to benefit employees was not deductible because it was capital. It was found that payments made "once and for all" and "with a view to bringing into existence an asset or an advantage for the enduring benefit of trade" are reasons to treat the payment as capital rather than revenue. A payment made not to meet a liability but with a general purpose of improving the position of staff is a capital outlay. While the payments made to the Trust are made on a periodic basis rather than being "once and for all", these principles are applicable to the present case. Annual contributions In the present case, the scheme relies on annual contribution from Company A being used to create capital in the Trust. This allows annual distributions being made from the profit generated from the capital in the Trust and to enable the availability of funds when determinations of employment terminations are made. Where the contributions operate to create the capital of a trust fund, the outlay to the company will ordinarily be seen as capital both because of the lasting qualities enjoyed and the fact that what is being made is a final payment to employees to secure future benefits ( Walstern Pty Ltd v FCT 2003 ATC 5076 at 5090). While there may be a recurring question of personnel, the annual distribution from the Trust may incentivise the staff to deal with that recurring question. The contributions that Company A make to the Trust take the character of providing funding to the Trust, to build capital in the trust for the purposes of providing future benefits to implement Company A's long term incentive program. As it can be seen, the contributions by Company A to the Trust are not made for transient, but long-lasting, purposes. Based on the way the scheme is established, it is clear that the contributions are intended to provide funding for the Trust to build long-term capital. This is because the contributions from Company A is based on a percentage of after-tax profits and the short-term rewards for current employees are only linked in with the income of the Trust rather than the capital of the Trust. Another observation to note is that while the Trust is operated by a Trustee company independently from Company A's board of directors, a number of the directors of the Trustee company are permanently selected from directors of Company A with long-standing positions. Due to the close relationship between the Trustee company and Company A, it is not possible to see that the Trust has independently made its decision without the tacit knowledge of Company A. In conclusion, the contributions made by Company A are capital in nature. iv. Not of a private or domestic nature or otherwise prevented from being deductible. Nothing in the facts suggests that the contributions made by Company A are private or domestic in nature, or otherwise prevented from being deducted under a specific provision of the ITAA 1997 or ITAA 1936. Therefore, the contributions made by Company A are not deductible as they do not represent expenses that have been incurred by it in gaining or producing assessable income, or necessarily incurred in carrying on Company A's business for the purpose of gaining or producing Company A's assessable income. Further, the contributions were of capital nature and therefore they are not deductible under section 8-1. | Detailed Reasoning - Question 2 Reasons for decision: Where expenditure qualifies for deduction under section 8-1, the deduction is generally allowable in full in the year the expenditure is incurred. However, the timing of deductions for certain types of expenditure is subject to the advance payment rules in sections 82KZL to 82KZO of the ITAA 1936. Relevantly, subsection 82KZMA(1) of the ITAA 1936 provides: Section 82KZMD sets the amount and timing of deductions for expenditure that a taxpayer incurs in a year of income (the " expenditure year" ), if: (a) apart from that section, the taxpayer could deduct the expenditure for the expenditure year under: (i) section 8-1; or (ii) ... of the Income Tax Assessment Act 1997 ; and (b) the requirements in subsections (2),(3), (4) and (5) are met. For the reasons given above, the contributions are not deductible under section 8-1. As such, the advance expenditure rules do not apply. | Detailed Reasoning - Question 3 Reasons for decision: Part IVA of the ITAA 1936 is a general anti-avoidance provision which gives the Commissioner the power to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA of the ITAA 1936 applies. There are four elements which must be satisfied for Part IVA to apply: The first difficulty is the question of identifying the tax benefit. Subsection 177C(1) of the ITAA 1936 defines the expression 'the obtaining of a tax benefit in connection with a scheme' as a reference to: (a)... (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme has not been entered into or carried out; or ... To apply Part IVA of the ITAA 1936 to the present arrangement, the Commissioner must be satisfied that the contributions made by Company A to the Trust were deductible pursuant to section 8-1 of ITAA 1997 for the relevant income years. Since there is no amount allowable as a deduction in any of the relevant income years, there can be no tax benefit and Part IVA cannot apply. | Detailed Reasoning - Question 4 Reasons for decision: A 'fringe benefit' is defined in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 ("FBTAA"). It must have the following features: a. be a 'benefit' provided during a year of tax; b. to an employee or an associate of an employee; c. by the employer, an associate of the employer, an arranger or a person to whom paragraph (ea) of the meaning of fringe benefit in subsection 136(1) applies; d. in respect of the employment of the employee; and e. where none of the exclusions listed in the definition apply. The Full Federal Court in Commissioner of Taxation v. Indooroopilly Children Services (Qld) Pty Ltd [2007] FCAFC 16; 2007 ATC 4236; 65 ATR 369 (" Indooroopilly" ) held that, for the purposes of determining whether there was a 'fringe benefit', it was necessary to identify, at the time a contribution was provided, a particular employee in respect of whose employment the benefit was provided. In this case, the contributions of money made by Company A to the Trustee are for the benefit of a general class of employees, and not for the benefit of any particular employee. Therefore, it is considered that the contributions provided by Company A to the Trustee for the benefit of a general class of its employees are not fringe benefits within subsection 136(1) of the FBTAA.

There must be a tax benefit, as identified in section 177C of ITAA 1936, was or would, but for subsection 177F(1), have been obtained; | The tax benefit was or would have been obtained in connection with a 'scheme' as defined in section 177A of ITAA 1936; | It must be concluded having regard to eight listed matters that a person who entered into or carried out the scheme or a part of it did so for at least the dominant purpose of obtaining a tax benefit; and | There must be a determination, which can only be made once the first three elements are satisfied.