1 Will subsection 110-25(5) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the amounts to be contributed by XX as a unitholder of the Hold Trust by way of additional capital contributions on the existing units in the Hold Trust, to fund tender costs and approved expenses in accordance with the prevailing development budget under the heads of agreement (ZZ), such that the amounts contributed will be included in the cost base of the existing units held in Hold Trust?
1 Yes This ruling applies for the following periods : Substituted Accounting Period ending XX October 20XX Substituted Accounting Period ending XX October 20XX Substituted Accounting Period ending XX October 20XX Substituted Accounting Period ending XX October 20XX Substituted Accounting Period ending XX October 20XX The scheme commenced on: XX April 20XX
Background XX is in the business of developing assets to the point of sale. In addition, XX provides construction management, asset management, and operation and maintenance services. In the project development phase, XX: • locates and secures project sites • undertakes initial investigations and secures project approvals • selects contractors • negotiates the suite of project documents required to design, procure, construct and operate projects • identifies and negotiates relevant contracts with customers for the project, and • negotiates project financing. The development phase usually concludes with the sale of the asset to a third party. Projects are generally owned by a group entity which is used to manage a project. Project X provides a framework for the development and operation of projects. Access to development will be granted through exclusive feasibility licences, which provides a successful tenderer with rights to progress the development of a project. A tender process commenced. XX has been undertaking development activities in relation to the prospective project.
XX and YY have agreed a group structure to co-own and develop the project. The following group entities were incorporated and established for nominal value in relation to the project. • Hold Trust • XY in its own capacity and as trustee of the Hold Trust (Hold Trustee) • Asset Trust • YZ in its own capacity and as trustee of the Asset Trust (Asset Trustee) (collectively the Group Entities). XX and the Group Entities are Australian residents for tax purposes. XX and YY subscribed for units issued in Hold Trust (Hold Trust Units), at a subscription price of $XX per unit. Hold Trustee subscribed for units in Asset Trust, at a subscription price of $XX per unit. XX: • subscribed for additional Hold Trust Units at a subscription price of $XX per unit • transferred assets to Hold Trust for consideration of $XX • transferred x Hold Trust Units to YY as trustee for the YY Trust), resulting in XX having XX% ownership of the total number of Hold Trust Units
Hold Trustee subscribed for additional Asset Trust units at a subscription price of $XX, resulting in Hold Trust holding units in Asset Trust. The Asset Trust holds the project assets. Heads of agreement XX, YY, in its own capacity and as trustee, XY in its own capacity and as Hold Trustee entered into a ZZ. Under the ZZ, XX and YY propose to enter into a joint venture in respect of the project (also referred to as the transaction): • to participate in the tender process and be granted a feasibility licence in respect of the project, and • if granted a feasibility license to, amongst other things, develop the project through the relevant group entities subject to a fully termed, definitive agreement which is to replace the draft term sheet appended to ZZ in the form and on the terms agreed and entered into between parties. Under the ZZ the parties: • intended to be immediately legally bound by the terms of the ZZ and the clauses and schedules of the term sheet • propose to negotiate, finalise, agree, execute and enter into a definitive agreement
• agreed that except for certain terms, the term sheet is not agreed as between the parties and is not binding on any party • the binding terms for the term sheet are agreed between the parties and will be restated in the definitive agreement in a form which, amongst other things, will not have a different overall result with respect to those binding terms and the commercial agreement of the Parties, and • agreed to participate in the tender process, apply for a feasibility licence and otherwise pursue or develop the project and implement the transaction through the group entities, subject to and in accordance with the binding terms and the terms of the definitive agreement (once entered into). The ZZ expires on the date on which the definitive agreement is executed, amongst other dates. XX and YY (the Securityholders) must hold the same proportion of Hold Trust Units and XY shares on issue at all times and a Group Entity must not do any act, matter or thing that would result in the Securityholders not maintaining the same proportion of Hold Trust Units and XY shares at any time.
Hold Trust must procure that the Group Entities conduct their business in accordance with the initial development plan, to be agreed in accordance with the binding term sheet or as part of the definitive agreement, and initial development budget set out in ZZ. XX or YY may at any time proposes a development plan or development budget to be passed by the board of directors of XY for approval. The Securityholders agree to fund the Hold Trust pro rata in proportion to the fraction of the numerator of which is the total number of Hold Trust Units each party holds and the denominator of which is the total number of all the Hold Trust Units, expressed as a percentage (Securityholding Percentage) to enable Group Entities to meet all fees, costs and expenses incurred in accordance with the prevailing development budget and development plan, emergency costs, or which are otherwise unanimously approved by XX and YY by unanimous resolution, being approved expenses.
All approved expenses will be met from calls issued by or on behalf of the Hold Trust Trustee requiring XX and YY to make a payment of capital to Hold Trust (Equity Call) and, if applicable, the draw down of any available third party financing entered into by the Group Entities (collectively Funding Draws). Equity Calls must be issued to the Securityholders pro rata to their Securityholding Percentage and may be satisfied, at the Hold Trustee's discretion, by each of the Securityholders contributing additional capital as either: • capital contributions on existing Hold Trust Units held by the Securityholders • consideration for new Hold Trust Units to be issued by the Hold Trustee to the Securityholders. The Hold Trustee will issue a notification to each Hold Trust unitholder which sets out all material information in respect to the call, including: • the purpose of the call • whether the call is to be satisfied via an issuance of Hold Trust Units or capital contribution on existing Hold Trust Units;
• the amount being called and, in the case of capital contributions on existing Hold Trust Units, the amount to be contributed on a per Hold Trust Unit basis, which is to be equal to the amount that is the capital contribution amount on a per Hold Trust Unit basis multiplied by the total number of Hold Trust Units held by each of the Securityholders. The Hold Trustee must apply the funds received from any call in a manner consistent with the purpose of the call set out in the notice. The nature of the approved expenses to be incurred will include, but are not limited to: • travel costs in relation to the project • compliance and external communications • surveying and mapping costs • organisational design of the project • environmental assessments • labour costs, using rates agreed for the tender cost process (until formalised labour agreements are in place) • expected consulting fees under contracts transferred in accordance with an agreement between XX and the Asset Trustee • consulting fees for contract entered into post tender (or variations).
Tender costs XX incurred tender costs for the project. Under the draft binding term sheet: • the Asset Trustee must reimburse XX and YY for any tender costs incurred • an amount is only reimbursable if it was incurred in accordance with the prevailing tender costs budget, or as otherwise agreed between the Securityholders • XX and YY would issue a tax invoice to Asset Trust for any reimbursable tender costs after submission of the feasibility licence application; or • agree to the mechanism for funding of the reimbursable tender costs, under the terms of the draft binding term sheet (or such date as is agreed between XX and YY), otherwise they would reconcile the tender costs such that the tender costs would be borne by XX and YY on a XX% as to XX and XX% as to YY basis. The reimbursable tender costs have been funded, in the short term, through an interest free loan. An application for the allocation of a feasibility licence was submitted. Hold Trust
Under the terms of the Hold Trust deed, Hold Trustee holds the assets on trust for persons recorded in the register as the holder of a Hold Trust Unit that has not been redeemed (Member). The beneficial interest in Hold Trust is divided into Hold Trust Units. Each Hold Trust Unit on which the application price has been fully paid confers an equal undivided interest in the assets as a whole, subject to the Liabilities of the Hold Trust. Under the Hold Trust deed Hold Trustee may, accept the payment of a capital contribution by a Member in respect of an existing Hold Trust Unit. The amount paid will be treated as an accretion to the capital contributed to the Hold Trust Unit, and the application price for the Hold Trust Unit will be increased by the amount paid. All expenses properly incurred by the Hold Trustee in connection with the performance of its duties in respect of the Hold Trust, including amongst other things the sale, insurance, custody, development, project management, property management, and any other dealings with respect to the assets or any sub trust, are payable or reimbursable out of the assets. Other
The project has received a notice of intention to grant a feasibility licence from X. No revenue streams are anticipated during development of the project. Assumptions A feasibility licence will be granted to the Asset Trust for the project which will be developed by the Group Entities. Equity Calls will be issued to XX by the Hold Trustee, to be satisfied, as capital contributions on existing Hold Trust Units for the purpose of: • funding approved expenses • repaying the interest free loan agreed under the draft binding term sheet in respect to the reimbursable tender costs. The following journal entries will be made by Hold Trust in respect of additional amounts contributed on existing Hold Trust Units by XX, as a unitholder of Hold Trust: • Debit Cash • Credit Contributed Equity The definitive agreement will be agreed, executed and entered into under the terms of ZZ, after the issue of a feasibility licence for the project. Does IVA apply to this private ruling? Part IVA of the Income Tax Assessment Act 1936
contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement. If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax. We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidancerule for income tax'.
All legislative references are to provisions of the Income Tax Assessment Act 1997 , unless otherwise indicated. Issue 1 Question 1 Summary Subsection 110-25(5) will apply to amounts to be contributed by XX as a unitholder of the Hold Trust, by way of additional capital contributions on the existing units in the Hold Trust, to fund tender costs and approved expenses in accordance with the prevailing development budget under the ZZ, such that the amounts contributed will be included in the cost base of the existing units held in Hold Trust. Detailed reasoning The five elements of the cost base and reduced cost base of a CGT asset are set out in sections 110-25 and 110-55. The only element within which the expenditure could potentially be included is the fourth element under subsection 110-25(5). Subsection 110-25(5) provides: The fourth element is capital expenditure you incurred: (a) the purpose or the expected effect of which is to increase or preserve the asset's value; or (b)that relates to installing or moving the asset. The expenditure can include giving property: see section 103-5.
In this case, paragraph 110-25(5)(a) is relevant, as XX will make additional capital contributions on the existing units it holds in the Hold Trust, which will be credited to Hold Trust's contributed equity account. The meanings of the terms 'purpose', 'expected effect' and 'value' used in paragraph 110-25(5)(a) are not defined. However, the terms have been judicially considered in other contexts and are considered below. Asset's value The meaning of 'value' is discussed in TD 2004/2 Income tax: capital gains: is reflection in the 'value' of an asset sufficient to constitute reflection in its 'state' or 'nature' for the fourth element of cost base and reduced cost base (subsections 110-25(5) and 110-55(2) of the Income Tax Assessment Act 1997 and what are the implications of this issue for a shareholder that makes a non-scrip share capital contribution to a company? (TD 2004/2)(now withdrawn but still considered relevant for these purposes). TD 2004/2 deals with the requirements of subsection 110-25(5) in relation to a non-scrip share capital contribution to a company in effect at that time.
The current subsection 110-25(5) was amended to broaden its application, with respect to Capital Gains Tax (CGT) events happening on or after 1 July 2005 (Tax Laws Amendment (2006 Measures No. 1) Act 2006) after the majority decision of the Full Court of the Federal Court in National Mutual Life Association of Australia v. Federal Commissioner of Taxation [2009] FCAFC 96, 2009 ATC 20-124 ('National Mutual Life'). It is no longer necessary that the purpose of the expenditure be to increase the asset's value - it is sufficient in the current provision that the purpose or expected effect be to increase or preserve the asset's value. Paragraph 8 of TD 2004/2 states that the 'value' of a CGT asset is normally its 'material or monetary worth' , or its ' worth ... as measured by the amount of other things for which it can be exchanged, or as estimated in terms of a medium of exchange' .
Under the draft binding term sheet you agreed to fund Hold Trust. Hold Trust will make Funding Draws, including Equity Calls which you will be required to satisfy by contributing additional capital on existing Hold Trust Units. The contribution of capital will not result in the issue of additional Hold Trust Units or cause a change in the rights attached to the existing Hold Trust Units. The effect of the contribution will be to increase your entitlement to the interest in the assets of the Hold Trust over the same number of Hold Trust Units on issue. That is, additional capital contributions made to satisfy an Equity Call will increase or preserve the value of the existing Hold Trust Units held by you. Purpose of the expenditure In Newton v FCT (1958) 98 CLR 1 (the Newton case), the Privy Council held that the word 'purpose' means: not motive, but the effect which it is sought to achieve-the end in view. On the question of establishing the purpose of a payment, paragraph 130 of Taxation Ruling TR 2010/1 Income tax: superannuation contributions cites the decision of the Full Federal Court case Raymor Contractors Pty Ltd v Commissioner of Taxation
(1991) 91 ATC 4259; 21 ATR 1410. Hill J, at 4270 considered that: in the context of the purpose of a taxpayer in making a particular payment ... purpose is the object which the taxpayer has in view or in mind. Capital contributions on Equity Calls by the Hold Trustee will be applied as further capital contributions on the existing Hold Trust Units held by XX, to fund the tender costs and approved expenses required to fund the continued development of the project, without which the project would not be able to proceed as no revenue streams are anticipated during development. Given the facts provided by you, it is reasonable to accept that the object you had in view in incurring the expenditure was to either increase the value of existing Hold Trust Units or at least attempt to preserve the value of the units you hold in Hold Trust. The entire amount contributed will be used for this purpose. Expected effect of the expenditure In the Newton case the Privy Council held that the 'word "effect" means the end accomplished or achieved' . In Carrier Air Conditioning Pty Ltd v Kurda & Ors
(1993) 11 ACSR 247, the Supreme Court of South Australia considered the meaning of 'expect' 'is to be understood according to its usage in ordinary parlance, namely, 'to regard as likely to happen' or 'to expect to find' or 'to expect that it will turn out that'. In this case, the expected effect of the expenditure is to either increase or preserve the value of the existing Hold Trust Units held by you. Application to your circumstances The additional capital contributions made on Equity Calls, to fund tender costs and approved expenses, will satisfy the requirement of subsection 110-25(5) and will be included in the fourth element of your cost base, as the: • purpose of the payment will be to fund the ongoing capital requirements of developing the project • entire amount contributed will be credited to Contributed Equity and the expected effect of the expenditure will be to increase or preserve the value of the existing Hold Trust Units. Conclusion
The fourth element of the cost base of an existing Hold Trust Unit you hold will increase by the amount of additional capital contributions made to fund tender costs and approved expenses, under subsection 110-25(5).