19 July, 2018
One month for charities to review and comment
What you need to know
On 4 July 2018, the ATO released a draft ruling on the "in Australia" requirement for deductible gift recipients and tax exempt charitable entities
The draft ruling specifies that DGRs do not need to have purposes and beneficiaries in Australia, so long as they are established or legally recognised and operate in Australia
The draft ruling also provides guidance on the ATO's approach to the requirements for non-DGR charities to prove that their expenditure is principally incurred in Australia and to trace the distribution of gifts and grants
What you need to do
Review the draft ruling and consider the impact on your entity's eligibility for tax concessions
Submit any comments on areas of concern to the ATO by 10 August 2018
The "in Australia" requirement
On 4 July 2018, the ATO released Draft Taxation Ruling TR 2018/D1 (the Draft Ruling), which provides guidance on the meaning of the "in Australia" requirement in three contexts:
- the condition that deductible gift recipients (DGRs) be "in Australia", found in division 30 of the Income Tax Assessment Act 1997 (Cth) (ITAA97);
- the condition that registered charities and certain other entities that provide public benefits have a "physical presence in Australia" and, to that extent, incur their expenditure and pursue their objectives principally "in Australia". This is a condition for obtaining an income tax exemption under div 50 of the ITAA97; and
- the condition that registered charities and DGRs have a "physical presence in Australia", and, to that extent, incur their expenditure and pursue their objectives principally "in Australia", to obtain a refund of franking credits under section 207-117 of the ITAA97.
The sections below summarise key parts of the Draft Ruling for each of these conditions.
DGR Status
The Draft Ruling provides that a fund, authority or institution will satisfy the "in Australia" test for DGR status if two requirements are met.
First, the DGR must be established or legally recognised in Australia. An entity is legally recognised in Australia if Australian law gives it status; for example, registration as a charity in Australia, incorporation in Australia, or registration for a business name or ABN.
Second, the DGR must operate in Australia at the time that it claims DGR status. This requirement varies depending upon the type of DGR involved (eg fund, authority or institution). However, it generally requires that operational or day-to-day management occurs in Australia (even if the local management reports to a foreign entity).
Purposes and beneficiaries in Australia
Importantly, the Draft Ruling provides that the purposes and beneficiaries of an institution (eg a public benevolent institution (PBI)) do not need to be located in Australia for that institution to be a DGR.
This is a change from the ATO's previous view on this requirement. In an earlier ruling, TR 2003/5, the ATO stated that the persons a PBI assists must be in Australia.
The ATO withdrew this ruling in 2017, after announcing that the ruling was under review in 2014. In the meantime, the ATO has indicated on its website that a PBI may have purposes and beneficiaries outside Australia.
Charities that were previously denied PBI and DGR statuses due to failing the "in Australia" requirement might now be considered eligible and should reconsider their position based on the revised "in Australia" requirement.
Income tax exemption
The Draft Ruling explains that, in considering the "physical presence in Australia" test for income tax exemptions, an entity is physically present where it conducts its range of "physical operations", meaning operations that produce income and other funds for the entity.
While an entity can have a physical presence in Australia if it operates through a division, subdivision or branch, merely operating through an agent or owning property in Australia would not satisfy the test.
The Draft Ruling decomposes the additional requirement "to that extent, incur their expenditure and pursue their objectives principally in Australia" as follows.
Incur their expenditure
The Draft Ruling considers that this phrase does not require that an entity "actually incur its expenditure principally in Australia" at a given time. Instead, the test is whether the entity can be reasonably described as the type of entity that incurs its expenditure principally in Australia.
As the test is not just about actual expenditure, past and current spending activities, and objective future intentions as to spending, are relevant.
The Draft Ruling also states that where expenditure is incurred depends upon where the decision to incur the expenditure is made, where the expenditure is actually incurred, and where the recipient is located.
Pursue their objectives
The Draft Ruling adopts the position that an entity pursues its objectives where it acts to try and realise them.
Crucially, an entity can pursue its objectives by making a payment to another entity, so long as the second entity will apply the funds for a purpose that fulfils the first entity's objectives. This means that funds that distribute money in Australia to other entities that then use the money overseas still pursue their objectives "in Australia" (see example 7(b) of the Draft Ruling).
Principally
The Draft Ruling equates principally with "mainly or chiefly". The Draft Ruling indicates that it is not possible to specify a set percentage for all circumstances but something greater than 50% will generally meet the definition of "principally".
To that extent
This requires a comparison of an entity's Australian and overseas operations.
If an entity has a physical presence both in Australia and overseas, only activities of the Australian operation (eg the Australian division) must be examined.
Disregarded amounts
The Draft Ruling reiterates a requirement of section 50-75 of the ITAA97: when determining whether an entity principally spends and pursues its objectives in Australia, the entity must disregard payments made from gifts (including from activities such as raffles, dinners, auctions and jumble sales) and government grants.
This means that, for example, an entity may distribute to a foreign recipient a gift it has received without that impacting the question of whether the entity operates principally in Australia.
Franking credit refund
The Draft Ruling states that the same requirements as apply to the income tax exemption apply to the availability of the franking credit refund.
However, gifts and government grants are not disregarded in this case in determining if an entity principally incurs its expenditure and pursues its objectives in Australia.
The Draft Ruling in practice
Date of effect
The ATO proposes that, when the Draft Ruling is finalised, it will operate retrospectively and prospectively.
ATO's compliance approach
The Draft Ruling also provides some guidance as to the ATO's approach in this field.
First, it states that, if an entity shows that more than 50% of its actual expenditure is incurred in Australia for an income year, the ATO will accept that the entity "incurs its expenditure principally in Australia".
Second, the Draft Ruling provides that, if an entity treats a gift or government grant as having been distributed overseas, and that treatment is not inconsistent with the facts, the ATO will accept that. This eases the burden for charities that, ordinarily, must trace the distribution of gifts and government grants.
However, this compliance approach will not apply in determining entitlement to the franking credit refund.
Commenting on the draft ruling
The ATO is accepting comments on the Draft Ruling until 10 August 2018.
Charities and other entities who may be affected by the Draft Ruling should take the opportunity to review it and comment upon any areas of concern.
For further information, please contact:
Geoffrey Mann, Partner, Ashurst
geoffrey.mann@ashurst.com
