Third Dimension - Draft ruling on the 'in Australia' requirement for deductible gift recipients and charitable tax exemptions

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By Clarissa Sukkar, Law Graduate

On 4 July 2018, the Australian Taxation Office (ATO) released a draft taxation ruling (TR 2018/D1) providing the Commissioner’s view on the following conditions in the Income Tax Assessment Act 1997 (ITAA 97):

  • the condition that certain deductible gift recipients (DGRs) be ‘in Australia’ before a gift or contribution to them is tax deductible;
  • the condition that certain entities have a ‘physical presence in Australia’ before their income is exempt from tax (under division 50 of the ITAA 97); and
  • the condition that a registered charity or DGR have ‘physical presence in Australia’ before it qualifies for a refund of franking credits.

The effect of the draft ruling is that:

  • A DGR, depending on whether it is a trust, authority or institution, has some flexibility with regard to physical storage of assets and the location of purposes or beneficiaries, provided that the entity is established and legally recognised in Australia;
  • regarding entities which must have a ‘physical presence in Australia’, compliance action will only be taken where evidence shows that more than 50% of expenditure (less disregarded amounts) is incurred in Australia – this affords entities some flexibility as to their overseas expenditure in a particular income year;
  • to be entitled to the refund of franking credits for a franked distribution received during an income year, a registered charity or DGR must at all times during that income year have physical presence in Australia and, to that extent, incur its expenditure and pursue its objectives principally in Australia; and
  • there is new guidance on how the Commissioner treats disregarded amounts as well as the tracing of gifts and government grants.

DGR ‘in Australia’ condition

A DGR is required to be ‘in Australia’ in order to retain its DGR endorsement.

The term ‘in Australia’ has it natural meaning and will be satisfied if the DGR (being a fund, authority or institution) meets the following two requirements:

  • Established or legally recognised in Australia:
    • fund: will or instrument established in Australia by obtaining an ABN for a trust or registering as a charity;
    • authority: must be established and recognised by the Commonwealth or state government; and
    • institution: registered under the Corporations Act 2001, established by instrument or trust, an incorporated association under state or territory legislation, an Australian government agency, unincorporated association or registered charity or corporation; and
  • Operates in Australia at that time:
    • fund or trust: all or a substantial part of its store of assets or money is established and legally owned or held by a trustee or other entity in Australia, and managed by a trustee or other entity located in Australia – it does not matter where the assets or money of the fund are located;
    • authority: must exercise control, power or command for public advantage in Australia, or execute a function in the public interest in Australia; and
    • institution: must be managed on a day-to-day basis by a local committee of management or similar structure located in Australia – though purposes or beneficiaries need not be located in Australia.

This means that in some cases, a DGR’s charitable activities can occur substantially or even wholly overseas, so long as the day-to-day activities of that DGR are conducted in Australia. Using the example of a public benevolent institution (PBI), this draft ruling clarifies that a PBI can conduct all of its work overseas, so long as its board and administration are located in Australia. This was not always clear in the law.

Division 50 ‘physical presence in Australia’ condition

An entity which is not a DGR needs to satisfy the ‘physical presence in Australia’ condition in order to be exempt from income tax.

An entity will satisfy this condition if it meets the following two requirements:

  • Has a physical presence in Australia:
    • the physical place of operations must be in Australia;
    • the entity can be conducting these operations either as a separate legal personality or through a division, subdivision or branch; and
    • mere ownership of property in Australia, or the conduct of some operations by the agents for the entity would be insufficient.
  • Where an entity had a physical presence in Australia, it must also, to that extent, incur its expenditure and pursue it objects principally in Australia:
    • the words ‘to that extent’ requires examination of the degree to which the entity’s expenditure and objectives are sourced or result from the conduct of Australian operations (all of the entity’s operations and objectives must be identified and compared);
    • where physical presence is in Australia only, expenditure must be incurred, and objectives pursued, principally in Australia;
    • where physical presence is in Australia and also overseas, only the expenditure incurred and objectives pursued that are attributable to an entity’s physical presence in Australia are examined;
    • the word ‘principally’ depends upon the facts, however, more than 50% would generally satisfy the requirement;
    • the words ‘ incur its expenditure and pursue its objectives’ takes into consideration the following:
      • it does not require that an entity actually incur its expenditure principally in Australia for a particular income year – rather that, at a particular time, the entity can be described as having incurred expenditure principally in Australia for a particular income year;
      • characterisation of the past and current activities of the entity, as well as its objective intentions for the future (current activities are given greater weight);
      • the place where an entity ‘incurs its expenditure’ will depend on the whole of the circumstances including where the decision to make the expenditure is made, where the expenditure is made, where the recipient of the expenditure is located and where the goods or services are consumed;
      • ‘objectives are pursued’ where an entity does things in an attempt to realise those objectives in Australia (the things can be done overseas if they are just the means for that attempt); and
      • certain distributions can be disregarded, such as gifts or government grants that it has received (known as “disregarded amounts”).

The following entities do not need to meet this condition to be income tax-exempt:

  • a DGR which is a registered charity, scientific institution, public educational institution or hospital;
  • a society, association or club, if it meets the qualifying conditions to be a DGR;
  • a “prescribed institution”, society, association or club located outside Australia and exempt from income tax in the country in which it is resident, and a registered charity that is a prescribed institution that has a physical presence in Australia but which incurs its expenditure and pursues its objectives principally outside Australia; and
  • certain “prescribed institutions” which are registered as charities.

Therefore, the requirements for organisations which are not DGRs to be income tax-exempt are stricter, in that the test looks at the location of their beneficiaries, as well as where they are physically located. An entity must continue to test the requirements of this condition in each income year for which a tax exemption is sought.

Refund of franking credits condition

To be entitled to the refund of franking credits for a franked distribution received during an income year, a registered charity or DGR must at all times during that income year:

  • have physical presence in Australia, and;
  • to that extent, incur its expenditure and pursue its objectives principally in Australia (within the same meaning as discussed for the Division 50 ‘physical presence in Australia’ condition); and
  • disregarded amounts do not apply to the refund of franking credits condition.

Therefore, while a DGR is generally not required to satisfy the Division 50 ‘physical presence in Australia’ condition in order to retain its DGR endorsement, it will in order to obtain refunds of franking credits.

Date of effect

When the final ruling is issued, it is proposed to apply prospectively and retrospectively. However, the ruling will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date the final ruling is issued.

Appendix 1 – compliance approaches 

This appendix sets out the practical approach the Commissioner will take in relation to some of the conditions discussed above:

  • Division 50 ‘physical presence in Australia’ condition:
    • continuous test which considers the state of an entity at a particular time, having regard to its overall operations, including past, current and intended actions; and
    • no compliance action will be taken where evidence shows that more than 50% of expenditure (less disregarded amounts) is incurred in Australia.
  • Disregarded amounts (tracing gifts and government grants):
    • no compliance action will be taken where evidence shows that an entity treats the proceeds of a gift or government grant as having been distributed overseas, and that treatment is not inconsistent with the factual circumstances and conditions in which that gift or grant has been made.

Summary 

The call for written submissions on the draft ruling has closed. While the ruling is in draft form, it is still an indication of the likely approach that the ATO will take regarding overseas operations of DGRs, charities and other income tax-exempt entities.

For more information, visit the webpage here.

For further information, please do not hesitate to contact us.

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