Income tax: Carl Zeiss Vision Group - Manager Equity Investment Program

This Ruling sets out the Commissioner's opinion on the way in which the relevant provision(s) identified below apply to the defined class of entities, who take part in the scheme to which this Ruling relates.

The relevant provisions dealt with in this Ruling are: • section 94D of the Income Tax Assessment Act 1936 (ITAA 1936); and • section 128B of the ITAA 1936; • section 485AA of the ITAA 1936; • section 497 of the ITAA 1936; • section 500 of the ITAA 1936; • section 529 of the ITAA 1936; • section 830-10 of the Income Tax Assessment Act 1997 (ITAA 1997). All legislative references in this Ruling are to the ITAA 1936 unless otherwise indicated.

The class of entities to which this Ruling applies is the individuals who: • participate in the scheme that is the subject of this Ruling; • are limited partners of the Carl Zeiss Vision Management Beteiligungs GMBH & Co. KG; and • are residents of Australia within the meaning of that term in subsection 6(1).

The Commissioner makes this Ruling based on the precise arrangement identified in this Ruling.

The class of entities defined in this Ruling may rely on its contents provided the scheme actually carried out is carried out in accordance with the scheme described in paragraphs 13 to 23 of this Ruling.

If the scheme actually carried out is materially different from the scheme that is described in this Ruling, then: • this Ruling has no binding effect on the Commissioner because the scheme entered into is not the scheme on which the Commissioner has ruled; and • this Ruling may be withdrawn or modified.

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This Ruling applies for the years ended 30 June 2006, 30 June 2007, 30 June 2008, 30 June 2009 and 30 June 2010. However, the Ruling continues to apply after this date to all entities within the specified class who entered into the specified scheme during the term of the Ruling, subject to there being no change in the scheme or in the entities involved in the scheme.

The Ruling does not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Ruling. Furthermore, the Ruling only applies to the extent that: • it is not later withdrawn by notice in the Gazette ; or • the relevant provisions are not amended.

If this Class Ruling is inconsistent with a later public or private ruling, the relevant class of entities may rely on either ruling which applies to them (item 1 of subsection 357-75(1) of Schedule 1 to the Taxation Administration Act 1953 (TAA)).

If this Class Ruling is inconsistent with an earlier private ruling, the private ruling is taken not to have been made if, when the Class Ruling is made, the following two conditions are met: • the income year or other period to which the rulings relate has not begun; and • the scheme to which the rulings relate has not begun to be carried out.

If the above two conditions do not apply, the relevant class of entities may rely on either ruling which applies to them (item 3 of subsection 357-75(1) of Schedule 1 to the TAA).

The arrangement that is the subject of this Ruling is described below. This description is based on the following documents provided by Ernst & Young. These documents, or relevant parts of them, as the case may be, form part of the arrangement described: • Class Ruling request dated 7 February 2006, including attachments thereto; • Draft Shareholders and Co-Plan Rules Regarding the Implementation of a Manager Equity Investment Program for the Carl Zeiss Vision Group ('Plan Rules'); • Draft Limited Partnership Agreement of Carl Zeiss Vision Management Beteiligungs GMBH & Co. KG ('Limited Partnership Agreement'); • Letter dated 15 May 2006 in response to the Tax Office's request for further information; and • Response from Ernst & Young dated 7 November 2006 to Tax Office's request for further information dated 23 October 2006 Note : certain information from the applicant has been provided on a commercial-in-confidence basis and will not be disclosed or released under the Freedom of Information Legislation.

Carl Zeiss and EQT ('the Investors' as described in the Plan Rules) are the owners of CZVH GmbH (CZVH), a German resident company. CZVH is the holding company of the Carl Zeiss Vision Group of companies.

A Manager Equity Investment Program (MEP) has been developed to enable selected key managers ('the Participants') of the Carl Zeiss Vision Group to become indirect shareholders of CZVH. Some of the managers who are eligible to participate in the MEP are Australian resident taxpayers. The operation of the MEP is governed by the Plan Rules. The aim of the MEP is to create a stronger link between performance and reward.

Under the MEP, some of the shares of CZVH will be offered to the Participants for a specified purchase price. The shares will be held by Carl Zeiss Vision Management Beteiligungs GMBH & Co. KG, a limited partnership formed in Germany (the German LP), where the Participants will be limited partners. The Participants' liability is limited to their capital contribution.

The German LP is a resident of Germany and no other country. It will be managed by two individuals in Germany. The general partner of the German LP is a German company. Germany imposes tax on the partners and not the German LP. The German LP holds the shares in the CZVH for the Participants and will not conduct any other activity.

A Participant who accepts an invitation to participate in the MEP pays a Subscription Price to the German LP, who in turn pays the amount to CZVH. CZVH will credit the Subscription Price to its issued capital and issue the relevant number of shares to the German LP. The German LP will hold the shares for the Participant.

The Subscription Price represents the paid up portion of the purchase price of the shares. The remainder of the purchase price (the Additional Payment) is due and payable on the happening of certain events. The Participants can pay the Additional Payment at any time before it is due and payable.

The Additional Payment will increase by an annual increment of 8% per annum compounded (the Additional Amount) until payment. The Additional Amount is treated as contributions to the share capital by CZVH. The Additional Amounts are due and payable in accordance with the Plan Rules.

Under German law, payment for subscribed equity of a company cannot be suspended. So the Plan Rules provide that the amount outstanding is owed to the Investors rather than to CVZH. It provides that 'the Investors' are joint-creditors as regards the Additional Payment and Additional Amount.

The MEP shares do not vest until certain performance targets are met. However they are entitled to dividends even before vesting and before all outstanding amounts have been paid. Any dividends paid to the German LP will be dealt with in accordance with the Limited Partnership Agreement.

If a Participant leaves the Carl Zeiss Vision Group, the Investors have the right to require the shares to be sold to the Investors, CZVH or any other nominated party for a price specified in the Plan Rules. The sale price may offset any Additional Payment and Additional Amount owing. If the sale price is less than the amount owing, the Participant will have to make-up the difference.

The Additional Amount will be subject to interest withholding tax under section 128B when it accrues under the Plan Rules.

The Participants are eligible to make an election under subsection 485AA(1) in relation to their interest in the German LP.

The Participants meet the requirements to use the Balance Sheet Method in section 500 for the purpose of determining whether they qualify for the exemption from the FIF provisions contained in section 497.

Subsection 128B(2) provides that withholding tax will apply if the Additional Amount is interest that is 'derived by' and 'paid to' a non-resident.

Under subsection 128A(1AB) interest is defined as follows: interest includes an amount, other than an amount referred to in subsection 26C(1): (a) that is in the nature of interest; or (b) to the extent that it could reasonably be regarded as having been converted into a form that is in substitution for interest; or (c) to the extent that it could reasonably be regarded as having been received in exchange for interest in connection with a washing arrangement; or (d) that is a dividend paid in respect of a non-equity share; or (e) if regulations under the Income Tax Assessment Act 1997 are made having the effect that instruments known as upper tier 2 capital instruments, or a class of instruments of that kind, are debt interests-that is paid on such a debt interest and is not a return of an investment; but does not include an amount to the extent to which it is a return on an equity interest in a company.

The above definition includes the ordinary meaning of interest. On the ordinary meaning of interest, Hill J in Macquarie Finance Ltd v. FC of T [1] said the following: Interest has variously been described as a payment made by a borrower for the use of the money borrowed: FC of T v. Century Yuasa Batteries Pty Ltd 98 ATC 4380 at 4383; (1998) 82 FCR 288 at 291 or the price of money which is borrowed: Re Farm Security Act 1944 of the Province of Saskatchewan [1947] SCR 394 cited in FC of T v. Firth 2002 ATC 4346 at 4349-4350; (2002) 120 FCR 450 at 454 or as a recompense to the lender for being kept out of his money: Lomax (Inspector of Taxes) v. Peter Dixon & Co Ltd [1943] 2 All ER 255 (editorial note). What these descriptions make clear is that there must be a borrowing before what is paid can be regarded as interest. At least ordinarily the concept of borrowing presupposes that the lender is entitled to a return of the money lent. However, there may be a question whether a 'borrowing' which is not repayable at all is really a borrowing or whether 'interest' thereon is properly to be regarded as interest.

Similarly, Cooper J said in FC of T v. Century Yuasa Batteries Pty Ltd [2] that: The word 'interest' is a term in ordinary English usage. In the context of the payment of money it means 'compensation for injury "damages"' or 'money paid for the use of money lent (the principal) or for forbearance of a debt, according to a fixed ratio'. The Oxford English Dictionary, 2nd Ed, (1980), Vol VII at 1099), or 'a charge for the use of credit or borrowed money; such a charge expressed as a percentage per time unit of the sum borrowed or used'. (Collins English Dictionary (Australian Edition (1982) at 761).

Thus for the Additional Amount to be interest, there must be a borrowing or debt owing and the Additional Amount must be to recompense the creditor for being kept out of money.

It is considered that the Additional Payment, being the unpaid portion of the Subscription Price, is the relevant debt or borrowing. The Plan Rules acknowledged that the Investors are the joint creditors as regards the Additional Payment. Further, on disposal, the Participants have to make up any shortfall if the sale price is less than the amount outstanding. This is evidence that a debt is owed even if not immediately due and payable. In Hill J's words, 'the lender is entitled to a return of the money lent'.

The fact the Participants are required to pay the Additional Payment to CZVH and that CZVH will credit the amounts to its share capital does not detract from this conclusion. The debt is not owed to CZVH but to the Investors. CZVH is simply the intermediary by which repayments are processed.

The Additional Amount also needs to be compensation to the creditor for being kept out of money. The Additional Amount is expressed to be payable as 8% per annum (compounded) of the Additional Payment. This represents 'a charge for the use of credit or borrowed money; such a charge expressed as a percentage per time unit of the sum borrowed or used' to use the words of Cooper J in Century Yuasa Batteries (see paragraph 30 of this Ruling). Thus the Additional Amount is compensation to the Investors for being kept out of the Additional Payment and is interest under its ordinary meaning. Alternately, it is interest within the meaning of subsection 128A(1AB) being 'in the nature of interest'.

The Additional Amount, being interest or in the nature of interest, accrues when an amount of Additional Payment is owed. Such amounts are deemed to be 'derived by' and 'paid to' the Investors under subsection 6-5(4) of ITAA 1997 and subsection 128A(2) of ITAA 1936 respectively even though no amount is actually paid over. So the remaining requirements of subsection 128B(2) of the ITAA 1936 are satisfied and interest withholding tax will be payable in those circumstances.

To be able to elect under subsection 485AA(1) to apply subsection 485AA(5), the following elements must be satisfied: • the German LP must be a corporate limited partnership (CLP) under Division 5A of Part III in relation to the year of income; • the German LP, being a CLP, must be a foreign investment fund (FIF) and the Participants' interest in the German LP must be 'an interest in a FIF' at the end of the year of income; • the Participants' interest must consist of a 'share in the FIF'; and • the German LP must satisfy the requirements of paragraphs 830-10(1)(a) to (d) of the ITAA 1997 in relation to the year of income.

Subsection 94D(1) of the ITAA 1936 provides that a CLP is a limited partnership that meets one of the four tests in paragraphs 94D(1)(a) to (d). The term 'limited partnership' is defined in subsection 6(1) of the ITAA 1936 to have the same meaning as in ITAA 1997. Subsection 995-1(1) of the ITAA 1997 defines 'limited partnership' to mean: (a) an association of persons (other than a company) carrying on business as partners or in receipt of ordinary income or statutory income jointly, where the liability of at least one of those persons is limited; or ...

The German LP is a limited partnership because the Participants are in receipt of dividends jointly. The German LP holds the shares for the Participants and any dividends on the shares are paid to the German LP for the benefit of the Participants. Further the Participants' liability is limited to their capital contribution. The German LP is therefore a 'limited partnership' for the purposes of subsection 94D(1).

The German LP satisfies the test in paragraph 94D(1)(a) because the income year to which the test is being applied is after the 1996 income year. Paragraph 94D(1)(b) is also satisfied because the German LP was 'formed on or after 19 August 1992' since it was formed in 2005. The German LP is therefore a CLP.

Under section 94H, because the German LP is a CLP, the income tax law has effect that the German LP is subject to the changes in Subdivision C of Division 5A of Part III (the CLP modifications). The CLP modification in section 94J is that a reference in the income tax law to 'a company' is a reference to the CLP. In other words, the CLP is treated as a company for income tax law purposes.

Under paragraph 481(1)(a), a FIF includes 'a foreign company'. As a CLP, the German LP is treated as a company under section 94J but it must also be a 'foreign' company to be a FIF.

Subsection 481(2) provides that a company is a foreign company if it is not a Part XI Australian resident. A 'Part XI Australian resident' is defined in section 470 to mean a resident within the meaning of section 6 but excludes a dual resident company whose residency tie-breaks to the other country under an Australian tax treaty.

Under the CLP modification in section 94T, a CLP is a resident within the meaning of section 6 if it: • is formed in Australia; or • carries on business in Australia or has its central management and control in Australia.

The German LP is formed in Germany. It also does not carry on any business in Australia and does not have its central management and control in Australia as no management activity occurs in Australia. Therefore the German LP as a CLP under subsection 94D(1) is not a Part XI Australian resident. Consequently, the German LP is a 'foreign company' under subsection 481(2) and is a FIF under paragraph 481(1)(a).

The Participants' interest in the German LP will be 'an interest in a FIF' in accordance with paragraph 483(1)(a), if the interest is 'a share in the company'. Due to the CLP modification in section 94P, a reference to 'a share in a company' includes a reference to an interest in a CLP. Therefore, the Participants' interest in the German LP is 'an interest in a FIF'.

As explained in paragraph 44 and 45 and consistent with the legislative note for subparagraph 485AA(1)(a)(ii) [3] , the Participants' interest in the German LP (because it is a CLP) is treated by section 94P in the CLP modifications as a 'share'. Therefore, as the German LP is a FIF, the Participants' interest in the German LP is 'a share in the FIF' for the purposes of subparagraph 485AA(1)(a)(ii).

Paragraph 830-10(1)(a) of the ITAA 1997 requires that the limited partnership be formed in a foreign country. The German LP satisfies this requirement as it was formed in Germany.

Paragraph 830-10(1)(b) of the ITAA 1997 requires that foreign tax is imposed on the partners rather than the limited partnership on income or profits of the limited partnership under the law of that foreign country. This requirement is satisfied because German law treats the German LP as a flow through entity and taxes the limited partners on the income or profits of the German LP rather than the taxing the German LP itself.

Paragraph 830-10(1)(c) of the ITAA 1997 requires that at no time during the income year is the limited partnership, for the purposes of the tax law of any foreign country, treated as resident of that foreign country. The Explanatory Memorandum to Division 830 of the ITAA 1997 explains that 'this condition requires that if there is another foreign country (apart from the country of formation) which taxes the limited partnership as a resident entity, it will not qualify as a foreign hybrid'. The German LP satisfies this requirement because no other foreign country taxes the German LP as a resident.

Paragraph 830-10(1)(d) of the ITAA 1997 requires that, disregarding subsection 94D(4) of the ITAA 1936, the limited partnership is not an Australian resident at any time during the income year. As explained above, the German LP does not satisfy any of the tests in section 94T of the ITAA 1936 and therefore is not an Australian resident.

Accordingly all the conditions of paragraphs 830-10(1)(a) to (d) of the ITAA 1997 are satisfied.

As all the elements of subsection 485AA(1) have been met, each partner in the German LP is eligible to elect that subsection 485AA(5) applies in relation to their interest in the FIF (the German LP).

Under subsection 485AA(5), the effect of a partner making an election under subsection 485AA(1) is that section 529 (the operative provision in Part XI) will not apply to the partner's interest in the German LP. Such an election also ensures, under subsection 830-10(2) of the ITAA 1997, that the German LP is a 'foreign hybrid limited partnership' for the purpose of applying the Assessment Acts on that partner's interest in the German LP from the time the election is made.

Section 497 has the effect of providing an exemption from the FIF measures to a taxpayer in relation to a foreign company, where the foreign company is taken by one of the methods in section 498 to be principally engaged in eligible activities.

CZVH is a 'foreign company', for the purposes of section 497, if it is 'not a Part XI Australian resident' under subsection 481(2).

Section 470 defines 'Part XI Australian resident' to mean a resident within the meaning of section 6 but excluding a dual resident company whose residency tie-breaks to the other country under an Australian tax treaty. CZVH is not a Part XI Australian resident as it was not incorporated in Australia nor does it meet the carry on business test in section 6 as it neither has its central management and control in Australia, nor its voting power controlled by Australian resident shareholders. CZVH is therefore a 'foreign company'.

To determine if the participants can access the FIF exemption under section 497 in relation to the German company, it first must be determined whether attributable FIF income would have been included in the Participant's assessable income by virtue of their indirect investment in the German company through the German LP.

Where the German LP is treated as a Foreign Hybrid Limited Partnership (FHLP) in relation to a year of income because of subsection 830-10(2) of the ITAA 1997 (that is, if a Participant in the German LP made a subsection 485AA(1) of the ITAA 1936 election to treat its interest in the German LP as a FHLP), the German LP is treated as a partnership for Australian taxation purposes. This is because subsection 94D(5) of the ITAA 1936 deems the German LP not to be a CLP. As a result, the normal partnership provisions will apply to the German LP.

Section 90 of the ITAA 1936 provides that the net income of a partnership means all the assessable income of the partnership, calculated as if the partnership is a taxpayer who is a resident, less allowable deductions except for deductions allowable under section 82AAT of the ITAA 1936 or Division 36 of the ITAA 1997.

Assessable income includes any FIF income that accrues to a taxpayer under section 529. However, for section 529 to apply section 485 must also be satisfied (see subsection 529(1)).

Section 485 provides that section 529 will apply where there is a FIF, the taxpayer had an interest in a FIF at the end of the income year, the income year is the 1992-1993 income year or later, and the taxpayer is a 'Part XI Australian resident' at any time in that year of income. It also provides that section 485A has effect when section 529 is applied to work out the net income of a partnership.

Section 485A provides that a reference in section 90 to a partnership being a taxpayer who is a resident is to be read as if it was a reference to the partnership being a taxpayer who is a Part XI Australian resident.

This means the German LP is considered to be a taxpayer who is a Part XI Australian resident. Accordingly, the German LP can have an interest in a FIF, and have FIF income included in its net income. (As legal owner of the shares in CZVH, the German LP has an 'interest in a FIF' in accordance with paragraph 483(1)(a).)

Although the German LP is considered a taxpayer for the purposes of applying the FIF rules to include an amount in its net income, it will not be liable for taxation. The liability for taxation rests with the Australian partners of the German LP (the Participant) on their share of the net income (section 92).

Under section 497, the German LP (as the taxpayer) will not be subject to section 529 in relation to CZVH, if CZVH is taken to be 'principally engaged in eligible activities' by satisfying either the stock exchange listing method in section 499 or the balance-sheet method in section 500. In this case, as CZVH is not a listed company, the only method available to determine whether CZVH was principally engaged in eligible activities is by reference to the balance-sheet method under section 500.

If the relevant tests in section 500 are satisfied, then section 497 will apply such that no FIF income relating to CZVH will be included in the net income of the German LP under section 529, and accordingly no FIF income will be included in the assessable income of the participants as limited partners in the German LP.

The following is a detailed contents list for this Ruling: Paragraph What this Ruling is about 1 Relevant provision(s) 2 Class of entities 3 Qualifications 4 Date of effect 8 Scheme 13 Ruling 24 Appendix 1 - Explanation 27 Withholding tax liability 27 Eligibility to make election under subsection 485AA(1) 36 The German LP is a ' corporate limited partnership' 37 The German LP, being a CLP, is a FIF and the Participants interest is 'an interest in a FIF' 41 The Participants' interest in the German LP is a 'share in the FIF' 46 The requirements of paragraphs 830-10(1)(a) to (d) of the ITAA 1997 are satisfied 47 Subsection 485AA(1) - election and implications 52 Access to the FIF exemption in section 497 54 Appendix 2 - Detailed contents list 67