Private ruling: Public trading trusts
Date of advice: 24 June 2020
Published: August 2020
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is the Trust a public trading trust for the purposes of Division 6C of the Income Tax Assessment Act 1936 ? | A1: Yes. The Trust is a public trading trust for the purposes of Division 6C of the Income Tax Assessment Act 1936.

Relevant facts and circumstances: The Trust (or the Fund) is an unlisted unit trust and an unregistered managed investment scheme (as defined in section 9 of the Corporations Act 2001 ). The Trust is a public unit trust pursuant to section 102P(1) of the Income Tax Assessment Act (ITAA 1936) on the basis that the units are held by not fewer than 50 persons, and that its top 20 unitholders hold, or have the right to acquire or become the holder of less than 75% of the total units on issue. The Trustee of the Fund holds an Australian Financial Services License (AFSL) for the purpose of Part 7.6 of the Corporations Act 2001 , as well as a Water Access License, which allows it to purchase and trade in certain water assets on behalf of the Fund. The Trustee of the Fund owns a portfolio of water assets, including Water Entitlements and Water Allocations. Water Entitlements are generally held by the Trustee of the Fund as long-term investments. Water Entitlements are held by the Trustee of the Fund either outright or subject to a 'lease-back' or 'term transfer' arrangement. Where Water Entitlements are held outright, the Trustee of the Fund derives income from the sale of periodic Water Allocations. Where the Water Entitlements are held subject to a 'lease-back' or 'term transfer' arrangement, the Trustee of the Fund derives lease or rental income from the farmer, who is entitled to the Water Allocations for the term of the lease. The Trustee of the Fund does not currently own real property, nor does it currently invest in any other financial products. The Trustee of the Fund does not directly employ personnel, nor does it carry on an active primary production business (i.e. agriculture or irrigation business). The Trustee of the Fund does not currently use the water from the Water Allocations nor does it have any contact with the actual water. The Trustee of the Fund's trading activities are undertaken by means of telephone, email and online trading platforms either directly or through a broker. The Fund has been profitable since inception.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 102M | Income Tax Assessment Act 1936 section 102MA | Income Tax Assessment Act 1936 section 102N | Income Tax Assessment Act 1936 section 102P | Income Tax Assessment Act 1936 section 102Q | Income Tax Assessment Act 1936 section 102R | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: The Trust is a public trading trust for the purposes of Division 6C of the Income Tax Assessment Act 1936 . | Detailed Reasoning - Detailed reasoning: Section 102R in Division 6C of the ITAA 1936 sets out the test for a unit trust to be a 'public trading trust': | Detailed Reasoning - 102R Public trading trusts: (1) A unit trust is a public trading trust in relation to a relevant year of income if: ... (b) where the relevant year of income is the year of income commencing on 1 July 1988 or a subsequent year of income: (i) the unit trust is a public unit trust in relation to the relevant year of income; (ii) the unit trust is a trading trust in relation to the relevant year of income; (iii) either of the following conditions is satisfied: (A) The unit trust is a resident unit trust in relation to the relevant year of income; (B) The unit trust was a public trading trust in relation to a year of income preceding the relevant year of income. ... [Emphasis added] Accordingly, a unit trust will broadly be a public trading trust for the purposes of Division 6C if it is (1) a public unit trust; (2) a trading trust; and (3) a resident unit trust for a relevant year of income. | Detailed Reasoning - Public unit trust: The first requirement for the Trust to be a 'public trading trust' in relation to a relevant year of income is that it must be a 'public unit trust'. The phrase 'public unit trust' is defined in section 102P of the ITAA 1936, which provides: | Detailed Reasoning - 102P Public unit trusts: (1) [When unit trust is a public unit trust] For the purposes of this Division, but subject to succeeding provisions of this section, a unit trust is a public unit trust in relation to a year of income if, at any time during the year of income: (a) any of the units in the unit trust were listed for quotation in the official list of a stock exchange in Australia or elsewhere; (b) any of the units in the unit trust were offered to the public; or (c) the units in the unit trust were held by not fewer than 50 persons. ... (4) Subject to subsection (5), a unit trust that, but for this subsection and subsection (7), would be a public unit trust in relation to a year of income by virtue only of subsection (1) shall be deemed not to be a public unit trust in relation to the year of income if, at any time during the year of income, one person or persons not more than 20 in number held, or had the right to acquire or become the holder or holders of, a unit or units in the unit trust that entitled the holder or holders thereof to not less than 75% of: (a) the beneficial interests in the income of the unit trust; or (b) the beneficial interests in the property of the unit trust. ... The Trust is a 'public unit trust' as defined in section 102P of the ITAA 1936 on the basis that units in the Trust are held by not fewer than 50 persons, and that the Trust's top 20 unitholders hold, or have the right to acquire or become the holders of less than 75% of the total units on issue. Accordingly, it is not contentious that the Trust is a 'public unit trust' within the meaning of section 102P. | Detailed Reasoning - Trading trust: The next requirement is that the Fund is a 'trading trust' in relation to the relevant income year. The term 'trading trust' is given meaning by section 102N of the ITAA 1936: | Detailed Reasoning - 102N Trading trusts: (1) [When unit trust is trading trust] For the purposes of this Division, a unit trust is a trading trust in relation to a year of income if, at any time during the year of income, the trustee: (a) carried on a trading business ; or (b) controlled, or was able to control, directly or indirectly, the affairs or operations of another person in respect of the carrying on by that person of a trading business. ... [Emphasis added] The term 'trading business' is defined in section 102M of the ITAA 1936: | Detailed Reasoning - 102M Interpretation: In this Division, unless the contrary intention appears: ... trading business means a business that does not consist wholly of eligible investment business. ... This necessarily requires consideration of whether the Trustee of the Fund carries on a business and whether that business consists wholly of an eligible investment business. | Detailed Reasoning - Business: The first consideration of whether the Fund is a trading trust is whether the Trustee of the Fund carries on a business. 'Business' is defined in section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) as: any profession, trade, employment, vocation or calling, but does not include occupation as an employee. The question of whether a business is being carried on is a question of fact and degree. The Courts have developed a series of indicators that are applied to determine the matter on the particular facts. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) sets out the Commissioner's view of the indicators of whether a person is carrying on a business of primary production. The indicators in this ruling can be equally applied to non-primary production activities. In the Commissioner's view, the indicators that are considered important in determining the question of business activity are: · whether the activity has a significant commercial purpose or character, · whether the taxpayer has more than just an intention to engage in business, · whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity, · whether there is regularity and repetition of the activity, · whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business, · whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit, · the size, scale and permanency of the activity, and · whether the activity is better described as a hobby, a form of recreation or sporting activity. In determining whether a taxpayer is carrying on a business, no one indicator is decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour. In this case, the Commissioner is satisfied that the Trustee of the Fund is carrying on a business of investing and trading in Water Entitlements and Water Allocations, as primarily indicated by the following indicators: · The Trustee of the Fund currently has a portfolio of water assets under management, including Water Entitlements and Water Allocations, · In order to acquire and trade in water assets, the Trustee of the Fund holds both an AFSL and a Water Access License · The Trustee of the Fund does not currently own real property, nor does it currently invest in any other financial products, · The Trustee of the Fund does not carry on an active primary production business (i.e. agriculture or irrigation activities). · The Trustee of the Fund does not use the actual water from the Water Allocations nor does it have any contact with the actual water, · The Trustee of the Fund's trading activities are undertaken by means of telephone, email and online trading platforms either directly or through a broker, and · The Fund has been profitable since its inception in 2015. Accordingly, the Trustee of the Fund is considered to be carrying on a business. It is considered that this business consists of investing and trading in water assets, such as Water Entitlements and Water Allocations. | Detailed Reasoning - Eligible investment business: The next consideration is whether the Fund's business of investing and trading in water assets consists wholly of an eligible investment business. The term 'eligible investment business' is defined in section 102M of the ITAA 1936, which provides: | Detailed Reasoning - 102M Interpretation: In this Division, unless the contrary intention appears: ... eligible investment business means one or more of: (a) investing in land for the purpose, or primarily for the purpose of, deriving rent; or (b) investing in or trading in any or all of the following: (i) secured or unsecured loans (including deposits with a bank or other financial institution); (ii) bonds, debentures, stock or other securities; (iii) shares in a company, including shares in a foreign hybrid company (as defined in the Income Tax Assessment Act 1997); (iv) units in a unit trust; (v) futures contracts; (vi) forward contracts; (vii) interest rate swap contracts; (viii) currency swap contracts; (ix) forward exchange rate contracts; (x) forward interest rate contracts; (xi) life assurance policies; (xii) a right or option in respect of such a loan, security, share, unit, contract or policy; (xiii) any similar financial instruments; or (c) investing or trading in financial instruments (not covered by paragraph (b)) that arise under financial arrangements, other than arrangements excepted by section 102MA. ... In considering whether the Fund is carrying on an 'eligible investment business', Water Entitlements and Water Allocations will be analysed separately. Sub-paragraphs (v), (vi), (xii) and (xiii) of paragraph (b), and paragraph (c) of the definition of 'eligible investment business' contained in section 102M are relevant to Water Entitlements and Water Allocations. | Detailed Reasoning - Subparagraph (b)(v) - investing or trading in futures contracts: The Macquarie Dictionary defines a 'futures contract' as follows: A contract to buy or sell a fixed amount of a commodity, security or currency at a specified price on a specified future date. A futures contract is an agreement to buy and sell a specified quantity of something at a specified future delivery date. The contracts are ordinarily highly standardised as to quantity and weight of the subject of the contract, so that contracts are fungible and settlement by payment can be facilitated. Futures contracts are ordinarily traded competitively on a centralised futures exchange, subject to the rules of the exchange. There is ordinarily a clearing house involved in the transaction. The contracts may be solely cash settable or may be deliverable (such as on specific settlement days of the relevant exchange). A Water Entitlement is not an agreement to buy or sell any specific quantity of water at a specified future date. Neither is it an agreement to buy or sell any specific Water Allocation at any particular date. A Water Entitlement only gives rise to the right to receive a periodic Water Allocation. The holder of the Water Entitlement can choose to use the Water Allocation themselves (subject to certain conditions), can make the Water Allocation available for free to someone else, or can sell it. A Water Allocation is a right, arising under a Water Entitlement, to receive a specific volume of water from a particular water source during a time period (e.g. a year). A Water Allocation is not an agreement to buy or sell any specific quantity of water at a specified future date. Neither is it an agreement to buy or sell any specific Water Allocation at any particular date Therefore, Water Entitlements and Water Allocations are not futures contracts for the purposes of paragraph (b)(v) of the definition of 'eligible investment business'. While futures contracts (with its subject being Water Entitlements or Water Allocations) may be a vehicle or mechanism for trading in Water Entitlements and Water Allocations, a Water Entitlement or Water Allocation is not a futures contract in itself. Accordingly, subparagraph (b)(v) of the definition of 'eligible investment business' does not apply to the Trustee of the Fund. | Detailed Reasoning - Subparagraph (b)(vi) - investing or trading in forward contracts: The Macquarie Dictionary defines a 'forward contract' as follows: A contract in which a seller agrees to deliver to a buyer a given quantity of assets on an agreed date in the future at an agreed price. The nature of a traditional forward contract was considered by the Full Federal Court in Commissioner of Taxation v Woolcombers (WA) Pty Ltd (1993) 47 FCR 561; 93 ATC 5170 ( Woolcombers ) in the course of deciding that the amount estimated to be payable under forward contracts made during an income year for the purchase of wool in the following income year were deductible under subsection 51(1) of the ITAA 1936 (now section 8-1 of the ITAA 1997) in the income year of entering into the contract. The contracts that the taxpayer entered into displayed all the essential features of a forward contract - an agreement that a commodity was to be sold in the future for a price fixed at the time the contract was entered into, payable on or after delivery of the commodity. Forward contracts are ordinarily over the counter contracts whose terms and conditions are tailored to suit the requirements of the parties. However, they can be standardised, as in Woolcombers where '[t]he contracts were made according to standard terms contained on a printed form of contract prepared by [the taxpayer]' (at FCR 562; ATC 5171). A key characteristic of a forward contract is the role of timing - the performance of the contract on a specified date in the future. In the absence of a future date, the agreement is more likely to be a present contract for sale rather than a forward contract. Water Entitlements and Water Allocations are not forward contracts. Whilst Water Entitlements and Water Allocations can be sold, they do not require the sale of themselves or a quantity of water, at any future time. The fact that a Water Entitlement gives rise to a periodic Water Allocation, and a Water Allocation allows the use of a specific volume of water from a water source during a time period, does not make them a forward contract. Rather, these are the inherent rights that make up a Water Entitlement and Water Allocation (respectively). Whilst Water Entitlements and Water Allocations can be the subject of a forward contract for their sale, they are not themselves a forward contract. Accordingly, subparagraph (b)(vi) of the definition of 'eligible investment business' does not apply to the Trustee of the Fund. | Detailed Reasoning - Subparagraph (b)(xii) - investing or trading in a right or option in respect of such a loan, security, share, unit, contract or policy: The term 'right' (in relation to intangible assets) has a wide meaning and has the effect that the holder of the right, subject to its terms, has the contractual ability to lay claim to whatever is the subject of the right. An 'option' is a right of one party to unilaterally require another party to enter a new set of jural relations or to extend or continue an existing jural relationship ( FCT v Guy (1996) 67 FCR 68 at 76; 96 ATC 4520 at 4526). Call options, put options, options to purchase and options to renew leases are the most common types of options. The holder of an option does not own the underlying asset, only the right to either buy or sell the underlying asset, and only for so long as the option exists or the holder owns the option. Water Entitlements and Water Allocations do not involve any rights or options in respect of a loan, security, share, unit, contract or policy prescribed in the preceding subparagraphs of paragraph (b) of the definition of 'eligible investment business'. Accordingly, subparagraph (b)(xii) of the definition of 'eligible investment business' does not apply to the Trustee of the Fund. | Detailed Reasoning - Subparagraph (b)(xiii) - investing or trading in any similar financial instruments: The reference to 'any similar financial instruments' means that the asset must be: · a financial instrument; and · similar to the financial instruments prescribed in the preceding subparagraphs of paragraph (b) of the definition of 'eligible investment business'. The asset needs to be a financial instrument, and have characteristics that make it similar to those preceding financial instruments. There must be some commonality, not complete identity. The phrase 'any similar financial instruments' is not defined and, accordingly, must be construed by reference to the ordinary meaning of the words, in the context of Division 6C. Section 15AB of the Acts Interpretation Act 1901 (Cth) allows, in the interpretation of a provision of an Act, the consideration of 'any material not forming part of the Act [that] is capable of assisting in the ascertainment of the meaning of the provision... to determine the meaning of the provision when the provision is ambiguous or obscure' (subparagraph 15AB(1)(b)(i)). Subsection 15AB(2) specifically allows the consideration of 'any explanatory memorandum relating to the Bill containing the provision, or any other relevant document, that was laid before, or furnished to the members of, either House of the Parliament by a Minister before the time when the provision was enacted' (paragraph 15AB(2)(e)). Clause 46 of the Taxation Laws Amendment Act (No. 4) 1988 (Cth) inserted subparagraph (b)(xiii) into the definition of 'eligible investment business'. The Explanatory Memorandum to the introducing Bill, in the Notes on Clauses, stated: The reference to "any similar financial instruments' in subparagraph (b)(xiii) is intended to obviate the need for further amendments to the definition of the term "eligible investment business" if further acceptable variants of existing financial instruments are developed. A public unit trust will therefore be able to trade or invest in new financial instruments and not be treated as a public trading trust provided that the new financial instrument invested in or traded in is similar to any of the types of financial instruments referred to in the proposed expanded definition of "eligible investment business". The expression 'if further acceptable variants of existing financial instruments are developed' confirms a desire for flexibility. The financial instruments covered by subparagraph (b)(xiii) must be sufficiently similar, so that they are a 'variant' of pre-existing financial instruments in paragraph (b). However, the context of Division 6C creates an inherent constraint on the flexibility of subparagraph (b)(xiii). Division 6C prescribes a consequence for a trust whose business does not wholly consist of an 'eligible investment business' - classification as a 'trading business' (as defined in section 102M of the ITAA 1936), and with it the possibility of a unit trust being a 'trading trust' (as defined in section 102N of the ITAA 1936), with adverse consequences under Division 6C and other parts of the income tax legislation. Therefore, subparagraph (b)(xiii) is subject to some restrictions. Turning now to the ordinary meaning of 'financial instrument'. According to the Oxford Handbook of International Financial Terms , a 'financial instrument' has the following meaning: Generic term for those securities or contracts which provide the holder with a claim on an obligor. Such instruments include common stock, preferred stock, bonds, loans, money market instruments and other contractually binding obligations. The common feature which differentiates a financial instrument from a commercial or trade credit is the right to receive cash or another financial instrument from the obligor and/or the ability to exchange for cash the instrument with another entity (cf. NEGOTIABLE INSTRUMENT). The definition can also include instruments where the claim is contingent, as with derivatives. [Emphasis added]. The first point to note is that a financial instrument is distinguishable from a commercial or trade contract. Second, the point of distinction is the right to receive cash or another financial instrument and/or the ability to exchange for cash the instrument with another entity. Also, a derivative is a type of financial instrument. The Oxford Handbook of International Financial Terms defines 'derivative' as follows: | Detailed Reasoning - Derivative, derivative asset, derivative instrument, derivative product or derivative security: 1. A generic term for the range of exchange-traded and over-the-counter instruments that have grown up around securities, currency and commodity markets... There are four principal classes: forwards; futures; swaps; and options. They are derivatives because their price behaviour comes from the underlying asset's price movements. The price of any derivative is a function of the price or rate behaviour of the underlying and time. Different classes behave differently in relation to the underlying asset and therefore they service different economic functions... 2. A contract or instrument, such as a convertible, where the value changes in line with changes in the underlying security, future, index, or instrument... [Emphasis added] The quintessential characteristic of a derivative is that its price is derived from an underlying asset's price movements. Both Water Entitlements and Water Allocations are valuable, and (like any asset) can be sold for cash. The holder of a Water Entitlement can generate a regular income stream by 'leasing' their Water Entitlement, or by selling their periodic Water Allocations. However, to decide whether they constitute a 'financial instrument, we must consider the inherent nature of a Water Entitlement and a Water Allocation. The essence of both a Water Entitlement and a Water Allocation is the right to receive, and use (subject to satisfying other requirements), a volume of water from a particular water source in a set period of time, respectively. Neither a Water Entitlement nor a Water Allocation gives the holder the right to receive cash or any other financial instrument and/or the ability to exchange for the cash the instrument with another entity. Water Entitlements and Water Allocations are not themselves derivatives. This is because the price behaviour of the Water Entitlements and Water Allocations do not come from some other underlying asset; the rights themselves are the assets. Even if Water Entitlements and Water Allocations were each a financial instrument, they would also have to be 'similar' to the financial instruments in the preceding subparagraphs of paragraph (b). The financial instruments in the preceding subparagraphs of paragraph (b) involve either ownership interests in a company or unit trust, the provision and repayment of a sum of money, the permanent acquisition (in advance) of a definite physical asset, derivatives or life assurance policies. Water Entitlements and Water Allocations have none of these characteristics and are, therefore, not similar to the financial instruments in the preceding subparagraphs of paragraph (b). Accordingly, subparagraph (b)(xiii) of the definition of 'eligible investment business' does not apply to the Trustee of the Fund. Paragraph (c) - investing or trading in financial instruments (not covered by paragraph (b)) that arise under financial arrangements, other than arrangements excepted by section 102MA Unlike subparagraph (b)(xiii), there is no requirement that financial instruments covered by paragraph (c) be similar to those specified in paragraph (b). All that is required is that they be financial instruments. The Explanatory Memorandum to the Tax Laws Amendment (2008 Measures No. 5) Bill 2008 describes the expansive purpose of paragraph (c) of the definition of 'eligible investment business' in section 102M - 5.1 Schedule 5 to this Bill amends Division 6C of the Income Tax Assessment Act 1936 (ITAA 1936) to streamline and modernise the eligible investment business rules for managed funds. 5.2 These amendments will: ... ¢expand the range of financial instruments that a managed fund may invest in or trade; and ... 5.9 These amendments will expand the range of permitted financial instruments that a managed fund may invest in or trade by extending the scope of financial instruments covered by the eligible investment rules to include financial instruments that are not already covered by paragraph (b) of the definition of 'eligible investment business' in section 102M that arise under financial arrangements in the Income Tax Assessment Act 1997 (ITAA 1997), other than certain excepted arrangements. However, as per the note under subsection 102MA(1), nothing in paragraph (c) affects an activity that meets paragraph (a) of the definition of 'eligible investment business' in section 102M. ... | Detailed Reasoning - Eligible investment business: financial instruments: 5.18 Since the introduction of Division 6C in 1985 the number and variety of financial instruments available for investment has increased significantly. In recognition of this change, these amendments amend the list of financial instruments in section 102M to include financial instruments that arise under 'financial arrangements' as defined in the ITAA 1997 other than certain excepted arrangements. [Schedule 5, item 4, section 102M] 5.19 This amendment is to include certain financial instruments not already included in the existing list of financial instruments in the definition of 'eligible investment business'. The meaning of a financial instrument is discussed in the Australian Accounting Standards AASB 132 Financial Instruments: Disclosure and Presentation and AASB 139 Financial Instruments: Recognition and Measurement. However, just like the enactment of subparagraph (b)(xiii), the context of Division 6C creates an inherent constraint on the flexibility of paragraph (c). The Explanatory Memorandum's express reference to the discussion of the meaning of a financial instrument contained in the relevant accounting standards, in the context of the introduction of paragraph (c) of the definition of 'eligible investment business' which hinges on a thing being a financial instrument, is a highly persuasive factor in favour of relying on those accounting standards. In the absence of a legal definition of 'financial instrument' and the Explanatory Memorandum's express reference to the relevant accounting standards as discussing the meaning of a financial instrument, and given paragraph 15AB(2)(e) of the Acts Interpretation Act 1901 (Cth) allows the consideration of the Explanatory Memorandum, it is proper to rely on the accounting standards in the specific context of paragraph (c) of the definition of 'eligible investment business'. Paragraph 11 of AASB 132 Financial Instruments: Presentation (operative date - 1 January 2020) contains the following definitions - A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. A financial asset is any asset that is: (a) cash; (b) an equity instrument of another entity; A financial asset is any asset that is: (a) cash; (b) an equity instrument of another entity; (c) a contractual right: (i) to receive cash or another financial asset from another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or (d) a contract that will or may be settled in the entity's own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to receive a variable number of the entity's own equity instruments; or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own equity instruments do not include puttable financial instruments classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity's own equity instruments. A financial liability is any liability that is: (a) a contractual obligation: (i) to deliver cash or another financial asset to another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or (b) a contract that will or may be settled in the entity's own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity's own equity instruments; or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments. For this purpose, rights, options or warrants to acquire a fixed number of the entity's own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments. Also, for these purposes the entity's own equity instruments do not include puttable financial instruments that are classified as equity instruments in accordance with paragraphs 16A and 16B, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments in accordance with paragraphs 16C and 16D, or instruments that are contracts for the future receipt or delivery of the entity's own equity instruments. As an exception, an instrument that meets the definition of a financial liability is classified as an equity instrument if it has all the features and meets the conditions in paragraphs 16A and 16B or paragraphs 16C and 16D. An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. Paragraphs AG20 to AG23 of AASB 132 state: AG20 Contracts to buy or sell non-financial items do not meet the definition of a financial instrument because the contractual right of one party to receive a non-financial asset or service and the corresponding obligation of the other party do not establish a present right or obligation of either party to receive, deliver or exchange a financial asset. For example, contracts that provide for settlement only by the receipt or delivery of a non-financial item (eg an option, futures or forward contract on silver) are not financial instruments. Many commodity contracts are of this type. Some are standardised in form and traded on organised markets in much the same fashion as some derivative financial instruments. For example, a commodity futures contract may be bought and sold readily for cash because it is listed for trading on an exchange and may change hands many times. However, the parties buying and selling the contract are, in effect, trading the underlying commodity. The ability to buy or sell a commodity contract for cash, the ease with which it may be bought or sold and the possibility of negotiating a cash settlement of the obligation to receive or deliver the commodity do not alter the fundamental character of the contract in a way that creates a financial instrument. Nevertheless, some contracts to buy or sell non-financial items that can be settled net or by exchanging financial instruments, or in which the non-financial item is readily convertible to cash, are within the scope of the Standard as if they were financial instruments (see paragraph 8). AG21 Except as required by AASB 15 Revenue from Contracts with Customers, a contract that involves the receipt or delivery of physical assets does not give rise to a financial asset of one party and a financial liability of the other party unless any corresponding payment is deferred past the date on which the physical assets are transferred. Such is the case with the purchase or sale of goods on trade credit. AG22 Some contracts are commodity-linked, but do not involve settlement through the physical receipt or delivery of a commodity. They specify settlement through cash payments that are determined according to a formula in the contract, rather than through payment of fixed amounts. For example, the principal amount of a bond may be calculated by applying the market price of oil prevailing at the maturity of the bond to a fixed quantity of oil. The principal is indexed by reference to a commodity price, but is settled only in cash. Such a contract constitutes a financial instrument. AG23 The definition of a financial instrument also encompasses a contract that gives rise to a non-financial asset or non-financial liability in addition to a financial asset or financial liability. Such financial instruments often give one party an option to exchange a financial asset for a non-financial asset. For example, an oil-linked bond may give the holder the right to receive a stream of fixed periodic interest payments and a fixed amount of cash on maturity, with the option to exchange the principal amount for a fixed quantity of oil. The desirability of exercising this option will vary from time to time depending on the fair value of oil relative to the exchange ratio of cash for oil (the exchange price) inherent in the bond. The intentions of the bondholder concerning the exercise of the option do not affect the substance of the component assets. The financial asset of the holder and the financial liability of the issuer make the bond a financial instrument, regardless of the other types of assets and liabilities also created. Note that the AASB 132 definition of 'financial instrument' is essentially not dissimilar to the ordinary meaning of a financial instrument, which was discussed earlier. A Water Entitlement cannot be a 'financial instrument' within the definition in paragraph 11 of AASB 132. It is not a contract that gives rise to a financial asset (cash, or a right to receive cash) of one entity and a financial liability (a contractual obligation to deliver cash or another financial asset) of another entity. The holder of a Water Entitlement has the right to receive a periodic Water Allocation, which is not cash or a right to receive cash. The Water Allocation can be sold for cash (like any asset), but it does not have to be. Furthermore, the right to receive a periodic Water Allocation does not constitute a financial liability of another entity. The water source from which the water will be drawn (pursuant to the Water Allocation) is not a liability of a specific entity, but merely a physical repository from which a volume of water can be lawfully taken. This is consistent with the reasons given earlier in relation to subparagraph (b)(ii) of the definition of 'eligible investment business'. A Water Allocation will fall within the exclusion described in paragraph AG21 of AASB 132, being a contract that involves receipt of physical assets (the water) by the holder of the Water Allocation. Therefore, a Water Allocation does not give rise to a financial asset of one party and a financial liability of the other party. This means that a Water Allocation cannot be a 'financial instrument' within the definition in paragraph 11 of AASB 132, which is a contract that gives rise to a financial asset (cash, or a right to receive cash) of one entity and a financial liability (a contractual obligation to deliver cash or another financial asset) of another entity. As neither the Water Entitlements nor the Water Allocations are a 'financial instrument', they cannot satisfy paragraph (c) of the definition of 'eligible investment business' because they are not financial instruments that arise under financial arrangements. Accordingly, paragraph (c) of the definition of 'eligible investment business' does not apply to the Trustee of the Fund. | Detailed Reasoning - Conclusion: The Trustee of the Fund carries on a business of investing in and trading in Water Entitlements and Water Allocations. This business does not wholly consist of an eligible investment business, and is therefore a trading business for the purposes of section 102M of the ITAA 1936. Accordingly, the Fund is a trading trust as it carries on a trading business for the purposes of section 109N of the ITAA 1936. | Detailed Reasoning - Resident unit trust: The final requirement for the Fund to be a public trading trust is that the Fund is a resident unit trust. Section 102Q of the ITAA 1936 sets out when a unit trust is a resident unit trust for the purposes of Division 6C: | Detailed Reasoning - 102Q Resident unit trusts: For the purposes of this Division, a unit trust is a resident unit trust in relation to a year of income if, at any time during the year of income: (a) either of the following conditions was satisfied: (i) any property of the unit trust was situated in Australia; (ii) the trustee of the unit trust carried on business in Australia; and (b) either of the following conditions was satisfied: (i) the central management and control of the unit trust was in Australia; (ii) a person who was a resident or persons who were residents held more than 50% of: (A) the beneficial interests in the income of the unit trust; or (B) the beneficial interests in the property of the unit trust. The Trustee of the Trust is a resident of Australia that carries on the activities of the Fund of investing in Australian water assets in Australia. It is therefore considered that the central management and control of the Trust is in Australia and that the Trustee of the Fund carries on business in Australia. Accordingly, it is not contentious that the Trust is a resident unit trust within the meaning of Division 6C. | Detailed Reasoning - Conclusion: The Trust is therefore a public trading trust within the meaning of section 109R of the ITAA 1936 because it is (1) a public unit trust, (2) a trading trust, and (3) a resident unit trust. Accordingly, the Trust is a public trading trust for the purposes of Division 6C of the ITAA 1936.