Private ruling: Income tax exemption
Date of advice: 20 December 2016
Published: June 2017
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019
Date scheme commenced: Year ended 30 June 201X

Ruling: Q1: Is the ordinary and statutory income of the Company exempt income under sections 50-1 and 50-25 of the Income Tax Assessment Act 1997 ? | A1: No. | Q2: Is the ordinary and statutory income of the Company exempt income under Division 1AB of Part III of the Income Tax Assessment Act 1936 ? | A2: No.

Relevant facts and circumstances: 1. The Company was established in the year ended 30 June 201X under the Corporations Act 2001 as a company limited by guarantee. 2. The sole member of the Company is a body politic constituted under the Local Government Act 1993 (the Council ). 3. The constitution of the Company relevantly provides that: a. the assets and income shall be applied solely in furtherance of the objects of the company and no portion of the income or assets of the company may be paid or transferred, directly or indirectly to any member, except as bona fide compensation for services rendered or expenses incurred on behalf of the company b. on winding up or dissolution of the company, any assets remaining after satisfaction of the company's debts and liabilities will be transferred to the Council for the purpose of exercising the objectives of the company c. Professional 1 and Professional 2 of the Council are directors of the company ex officio (“the Council Directors ”) d. there are X specified directors of the company in addition to the Council Directors e. the directors may appoint any natural person to be a director where there is a vacancy, including where a director is removed by the company under section 203D of the Corporations Act 2001 and that vacancy is not filled by resolution of the company f. the board (other than those seeking reappointment) is to determine who will be appointed to the board of directors at the next annual general meeting and that those so determined will be appointed by declaration of the chairman of that annual general meeting g. if unable to attend a meeting of the board, the Council Directors both have the power to appoint an alternate director from a limited pool of candidates. Professional 1 may appoint the Deputy Professional, and the Professional 2 may appoint a member of the Council's Executive Management Team h. the company may remove a director from office under section 203D of the Corporations Act 2001 and, by resolution, elect another person to the vacant office i. a member of the company has the right to vote at any general meeting of the company (subject to conditions in relation to the variation of rights in respect of a particular class of membership) j. the directors may resolve to expel a member if certain conditions are met and a member will cease to be a member if certain other conditions are met k. the directors are responsible for managing the business of the company and may exercise to the exclusion of the company in general meeting all the powers of the company which are not required by the Corporations Act 2001 or this constitution to be exercised by the company in general meeting 4. The constitution lists the objects of the Company. These are to promote the Council area as a business area and promote local business interests. 5. Professional 1 of the Council is the chairman of the board of directors. 6. Since incorporation, the Company has operated with the Council Directors having final veto on appointment and dismissal of directors. 7. The Company is funded by the Council under a Funding Agreement . 8. Under the Funding Agreement, funding for the following year is conditional upon the Company achieving reasonable outcomes measured against its strategic and operational plans, and complying with certain governance requirements. 9. The Funding Agreement requires the Company to provide strategic and operational plans of the Company to the Council, and discuss those plans with Council representatives. The Company must also provide an annual report to the Council that sets out the Company's achievements for the year measured against specified key performance indicators. 10. The governance requirements include a requirement that the Professional 1 and Professional 2 both have a seat on the board of directors, that the reports and plans required under the Funding Agreement are provided to the Council in a timely manner, and that the business of the Company be carried on as expressed in the Company's constitution and the strategic and operational plans. Breach of the governance requirements does not give rise to a cause of action by the Council but may cause the Council to reduce or terminate funding.

Relevant legislative provisions: Income Tax Assessment Act 1997 (ITAA 1997) section 50-1 ITAA 1997 section 50-25 | ITAA 1997 section 995-1 | Income Tax Assessment Act 1936 (ITAA 1936) Division 1AB of Part III ITAA 1936 section 24AM | ITAA 1936 section 24AN | ITAA 1936 section 24AS | ITAA 1936 section 24AT | Corporations Act 2001 section 203D and | Local Government Act 1993

Reasons for decision: Summary: The ordinary and statutory income of the Company is not exempt income under sections 50-1 and 50-25 of the Income Tax Assessment Act 1997 (ITAA 1997), as the Company is not a municipal corporation, a local governing body, or a public authority constituted under Australian law. | Detailed Reasoning - Detailed reasoning: 1. Section 50-1 of the ITAA 1997 provides that the total ordinary and statutory income of the entities covered by the tables in Subdivision 50-A of the ITAA 1997 is exempt from income tax. 2. The table in section 50-25 of the ITAA 1997 covers the following entities: under item 5.1 of the table, a 'municipal corporation' or a 'local governing body', and under item 5.2 of the table, a 'public authority constituted under an Australian law'. 3. 'Municipal corporation' is not a defined term and will therefore take its ordinary meaning. 4. The ordinary meaning of 'municipal corporation' was considered in ATO ID 2004/757 Income tax: Income tax exemption: company established by local council ( ATO ID 2004/757 ), which cites the High Court decision of Federated Engine-Drivers and Firemen's Association of Australasia v. Broken Hill Pty Co Ltd (1911) 12 CLR 398 in which Barton J stated that 'a municipal corporation is a part of the governmental power of the State.' 5. ATO ID 2004/757 also cites the AAT decision of Re Melbourne Western Region Commission Incorporated and Commissioner of Taxation [1991] AATA 49, in which Senior Member Balmford stated at paragraph 18 that the expression 'municipal corporation': …combined with "or other local governing body" is calculated to subsume any body, wherever it is situate within the Commonwealth, and under whatever legislation it is established, which … "is a body politic and corporate created to administer the internal concerns of the district embraced with its corporate limits, in matters peculiar to such place and not common to the state at large". The words "municipal" and "local" in sub-paragraph (vii)(c) indicate that that provision is concerned with bodies operating in respect of a discrete district, region or area within a State or Territory. 6. In that decision at paragraph 19, Senior Member Balmford concluded that a body which was established to represent the interests of certain member councils within Victoria 'ha[d] no powers of government or administration in the region, but operate[d] to supplement, assist and facilitate in a variety of ways the operations of its member Councils, which do have such powers.' 7. The Company does not have powers of government or administration. It does not operate as a regulator or administrator. Its functions are to promote the Council area as a business area and promote local business interests. Although these functions may be relevant to the Council area, they are not governmental in nature. Instead, the functions that it performs supplement the operations of the Council. 8. The Company is therefore not a municipal corporation for the purposes of item 5.1 of the table in section 50-25 of the ITAA 1997. 9. The term 'local governing body' is defined in subsection 995-1(1) of the ITAA 1997 as 'a local governing body established by or under a State law or Territory law'. Subsection 995-1(1) further defines a 'State law' as 'a law of a State'. 10. As an Australian public company limited by guarantee, the Company is incorporated under the Corporations Act 2001 , which is a Commonwealth law and not a law of a State or Territory. Further, there is no relevant State or Territory legislation applicable to the Company that grants it any further powers as a local governing body. 11. The Company is therefore not a local governing body for the purposes of item 5.1 of the table in section 50-25 of the ITAA 1997. 12. The term 'public authority' is not defined, therefore it will take its ordinary meaning. 'Australian law' is defined in subsection 995-1(1) of the ITAA 1997 as a Commonwealth law, a State law or a Territory law. 13. The meaning of the phrase 'public authority…that is constituted under [an Australian law]' was considered in Taxation Ruling IT 2632 Income tax: meaning of 'public authority' in definition of 'exempt public body' in division 16D ( IT 2632 ). The use of the phrase in Division 16D of the Income Tax Assessment Act 1936 (ITAA 1936) is in an analogous context to its use in Division 50 of the ITAA 1997. 14. Paragraph 14 of IT 2632 states that the necessary steps in deciding in particular cases whether a body answers the description of a 'public authority' within the Division 16D definition are to consider the nature of the functions of the body concerned and whether they involve the exercise of powers and functions not possessed by the ordinary citizen and which have been conferred by statute and are essentially of a public nature. The characteristics of the body should be examined to determine whether it can be seen in general to conform to the common understanding of a public authority. To so conform a body would be expected to have public duties, functions or powers to perform and these would ordinarily be carried out under statutory authority for the benefit of the public. While not essential, a distinguishing characteristic is the possession of exceptional powers conferred by statute beyond those possessed by private individuals. 15. The functions of the Company are in the nature of the promotion of the Council area as a business area and promoting local business interests. The Company has not been granted powers, functions or duties under statutory authority that are beyond those possessed by private individuals. Its activities, while carried on for the benefit of the Council area, are not beyond those which might reasonably be carried on by an ordinary citizen. 16. Considering the relevant facts and circumstances, the Company is not a public authority constituted under an Australian law. 17. Finally, when considering the meaning of 'municipal corporation' and 'public authority' within the statutory context of Division 50 of the ITAA 1997, it should be noted that specific reference is made in section 50-25 of the ITAA 1997 to Division 1AB of Part III of the ITAA 1936, which provides specific exemptions for bodies owned and controlled by municipal corporations and local governing bodies. The Council is a local governing body established under the Local Government Act 1993 , which is a State law. 18. While the Company is a corporation whose sole member meets the requirements of section 50-25 of the ITAA 1997, the Company is not a municipal corporation, a local governing body, or a public authority constituted under an Australian law. | Summary: The ordinary and statutory income of the Company is not exempt income under Division 1AB of Part III of the ITAA 1936, as the Company does not meet the requirements in section 24AS of the ITAA 1936 to be a State/Territory body. | Detailed Reasoning - Detailed reasoning: 19. Section 24AM of the ITAA 1936 states that '[t]he income of a State/Territory body (an STB) is exempt from income tax'. Sections 24AO to 24AS of the ITAA 1936 set out the five ways in which a body may be an STB. 20. The Company is not a company limited by shares; therefore section 24AO of the ITAA 1936 will not apply. The Company was not established by State or Territory legislation, therefore sections 24AP, 24AQ and 24AR of the ITAA 1936 will not apply. 21. Therefore, to be an STB, the Company must meet the requirements in paragraphs 24AS(a) to (d) of the ITAA 1936. | Detailed Reasoning - Excluded STBs: 1. Section 24AN of the ITAA 1936 provides that income is not exempt under section 24AM of the ITAA 1936 if it is derived by an excluded STB. Relevantly, the definition of 'excluded STB' in section 24AT of the ITAA 1936 includes an STB that 'is a municipal corporation or other local governing body (within the meaning of section 50-25 of the Income Tax Assessment Act 1997 )'. On the reasoning in Question 1, the Company would not fall within this exclusion. | Detailed Reasoning - Paragraphs 24AS(a), (b) and (c) are satisfied: 2. As the Company is a company limited by guarantee, not by shares, and is not established by State or Territory legislation, it will meet the requirements of paragraphs 24AS(a) and (b) of the ITAA 1936. 3. As a company limited by guarantee, there are no interests as to income, profits or dividends. On winding up or dissolution, the constitution provides that all assets of the Company will be transferred to the Council. All legal and beneficial interests are therefore held by the Council. 4. The definition of 'government entity' in section 24AT of the ITAA 1936 includes a municipal corporation or other local governing body (within the meaning of section 50-25 of the ITAA 1997). As a local governing body constituted under the Local Government Act 1993 , the Council is a government entity. Therefore, the Company will meet the requirement in paragraph 24AS(c) of the ITAA 1936, as all legal and beneficial interests in the Company are held by a government entity. | Detailed Reasoning - Paragraph 24AS(d): 5. Paragraph 24AS(d) of the ITAA 1936 requires that 'all the rights or powers (if any) to vote, appoint or dismiss its governing person or body, and direct its governing person or body as to the conduct of its affairs are held only by one or more government entities.' 6. As the sole member, all rights to vote are held by the Council. 7. The term 'governing person or body' is not defined in the legislation and will therefore take its ordinary meaning. 8. The Australian Oxford Dictionary (2nd ed.) defines 'governing body' as 'the managers of an institution'. The Oxford English Dictionary (3rd ed.) defines 'governing body' as 'a group of people who formulate the policy and direct the affairs of an institution in partnership with the managers, especially on a voluntary or part-time basis'. 9. Ordinarily, the governing body of a company will be its board of directors. However, the explanatory memorandum to the Taxation Laws Amendment Bill (No. 2) 1995 (the EM ), which introduced Division 1AB of Part III of the ITAA 1936, indicates that a governing person or body is not restricted to the board of directors. The EM states at paragraph 1.19 that: There may be cases where the concepts of 'governing person' and 'governing body' overlap. For example, where a government entity is able to appoint only one director of a governing body but that director has overriding powers (eg. power of direction of board decisions) then that government entity has the power to appoint the 'governing person' of that STB. 10. Practically, the Company has operated with the Council Directors having a final veto over the appointment and dismissal of directors. The Council has also significant influence over the decisions of the Company because of the terms of the Funding Agreement, which allows the Council to withdraw funding for the following year if certain conditions are not met. 11. However, there are no legal rights and powers that allow the Council Directors to override the decisions of the other directors. Therefore, the governing body of the Company is the board of directors. 12. The only provision in the constitution of the Company that provides a specific right or power to dismiss directors the clause that provides that the members may remove a director from office by resolution under section 203D of the Corporations Act 2001 . There are no further rights or powers that deal with the dismissal of directors. As the sole member, the Council therefore holds all rights and powers to dismiss directors. 13. Where a director is dismissed under section 203D of the Corporations Act 2001 , the constitution of the Company provides that the company may appoint a replacement director by resolution. As the sole member of the Company, the Council does have a right or power to appoint directors in that situation. 14. The constitution of the Company also provides that the Council Directors may each appoint another Council representative as an alternate director. 15. However, the constitution of the Company also grants further specific powers to appoint directors and these powers are not held by a government entity. Where there is a vacancy on the board of directors, the board has the power to appoint a new director, subject to whether the company has removed a director under section 203D of the Corporations Act 2001 and filled that vacancy under another clause in the constitution. Where directors are to be replaced, the board is to determine who is to be appointed and those persons will be appointed by declaration of the chairman at the next annual general meeting. Although the Council Directors have, in practice, had final veto over the appointment of directors, this practice is not a legal right or power. 16. Therefore, the Company does not meet the requirement in paragraph 24AS(d) of the ITAA 1936 that all the rights or powers to appoint its governing person or body are held only by one or more government entities. 17. The constitution of the Company provides that the board of directors may exercise all powers of the company to the exclusion of the company in general meeting (with the exception of powers that are required by the constitution or the Corporations Act 2001 to be exercised by the company in general meeting). 18. Although the Council has influence over the strategic direction of the Company through the Council Directors and via the terms of the Funding Agreement, the Council has no legal rights or powers to direct the governing person or body of the Company as to the conduct of the affairs of the Company. 19. The legislation provides that all 'rights or powers (if any)' must only be held by government entities to be an STB. Here, it is arguable that no rights and powers to direct the governing body or person exist. As the appointment of directors requirement is not met, and an entity must meet all the conditions in paragraph 24AS(d) of the ITAA 1936 to be an STB, it is not necessary to consider further. 20. The Company will therefore not meet the requirements in paragraph 24AS(d) of the ITAA 1936, and will not be an STB. Its ordinary and statutory income is therefore not exempt income under Division 1AB of Part III of the ITAA 1936.