In a previous article, we looked at ‘External Conduct Standards’ which apply to charities that engage in activities outside Australia.
However, charities and many other categories of TaxEd subscribers need to be mindful that Australian taxation concessions are predicated on the relevant entity continuing to have an appropriate nexus with Australia.
Charities that are registered with the Australian Charities and Not-for-profits Commission (ACNC) that directly, and in some cases indirectly, pursue activities outside Australia are required to meet ‘External Conduct Standards’ administered by the ACNC. These standards were discussed in a previous article, Eligibility – Charities operating overseas: What you need to know (Part 1)
However, all charities need to be mindful that various Australian tax concessions available to charities are predicated on the charity having a sufficient nexus with Australia. As a practical matter, charities involved in activities outside Australia need to be especially aware of the required nexus in order to access/maintain access to Australian tax concessions.
The issue of nexus with Australia will also be relevant to many TaxEd subscribers that may be, but are not necessarily, charities in the technical sense – scientific institutions, public educational institutions, hospitals, ‘organisations’ established for a variety of purposes including community service purposes and the encouragement of science, sport, horse racing, art, literature, music etc.
This article draws attention to two aspects of the nexus, namely the two forms of the ‘in Australia’ requirement. The requirements are discussed in TR 2019/6 – Income tax: the ‘in Australia’ requirement for certain deductible gift recipients and income exempt entities.
The relevance of the ‘in Australia’ requirement
Two significant income tax concessions are:
- income tax exemption – relief of the charity (or certain other organisations) from the obligation to pay income tax; and
- deductible gift recipient (‘DGR’) status – the ability of a donor to claim a tax deduction for a donation/gift made to a fund, authority or institution (thereby encouraging donors to make larger donations).
Further tax concessions such as access to franking credit refunds and FBT preferential treatment are dependent on access to these concessions.
Income tax exemption is available for organisations identified in Division 50 of the Income Tax Act 1997 (ITAA 97). These include registered charities (i.e. charities registered with the ACNC) which meet certain conditions that may include being either ‘in Australia’ or having ‘a physical presence in Australia, and to that extent incurs its expenditure and pursues its objectives in Australia’.
DGR status is available for institutions/authorities/funds (‘bodies’) identified in Subdivision 30-B of the ITAA 97. However, certain of such bodies (such as registered public benevolent institutions) that are not not listed by name must be ‘in Australia’ in order to be DGRs.
In the case of a registered charity seeking access to franking credit refunds in relation to a distribution it receives, there is also an explicit requirement that it has a ‘physical presence in Australia’ and ‘to that extent, incurs its expenditure and pursues its objectives principally in Australia at all times during the income year in which the distribution is made’ (see ss. 207-115 and 207-117 ITAA 97).
The ATO’s views of the concepts of ‘in Australia’ and the separate ‘physical presence in Australia’ requirement of Division 50 are summarised below. As noted above, its views are set out in TR 2019/6.
The concept of ‘in Australia’
The ‘in Australia’ condition is concerned with the location of the fund, authority or institution as an entity or organisation, rather than the physical presence of particular assets or transactions. It therefore requires Australia to be the focal point of the fund authority or institution in a legal or organisational sense.
Whether a fund, authority or institution is located in Australia is a question of fact, to be determined based on the circumstances in each case. A fund, authority or institution would satisfy this requirement where it is established or legally recognised in Australia and makes operational or strategic decisions mainly in Australia.
The natures of funds, authorities and institutions are outlined below and examples of the foregoing principles are given in respect of each.
‘Fund’ is not a defined concept.
For DGR purposes, in essence, a ‘fund’ is ‘an arrangement where a stock of money or pecuniary resources is held or managed in accordance with a trust deed or similar instrument such as a set of fund rules’. It will be noted that the rules governing the fund may be formally set out in a trust deed (or will). However, a legal entity may also operate a fund in the sense of, basically, recognising that a stock of money/pecuniary resources which it owns is held/set aside for application in particular purposes – in this case it is the fund (as distinct from the operating legal entity) which must meet the ‘in Australia’ requirement.
In addition to principles mentioned earlier:
- In relation to funds, the ‘in Australia condition’ does not require the fund to have purposes or beneficiaries located in Australia.
- Where the decision-makers are ordinarily located in more than one place, a fund would make operational or strategic decisions mainly in Australia if the decision-making power in relation to operational or strategic matters mainly lies in Australia.
Example 1 in TR 2019/6 illustrates a fund which is ‘in Australia’:
- The Cambodian Education Society (the CES) is a not-for-profit organisation in Australia, registered as a charity by the ACNC. The CES was established by an instrument of trust settled in Australia. It is a public fund solely for providing money for the construction of a building to be used by the CES as a school for disadvantaged children in Cambodia.
- The CES public fund seeks endorsement as a DGR under table item 2.1.10 in subsection 30-25(1).
- The trustee of the CES public fund is a company and its directors manage the company in Australia. The trustee opens a bank account in Australia and receives donations from members of the Australian public and from ancillary funds. The monies received are held by the trustee in accordance with the terms of the fund’s trust deed.
- The CES public fund meets the DGR in Australia condition. It is established and legally recognised in Australia, since it is established by a trust deed in Australia and legally recognised under the ACNC Act. Further, it is managed by way of decisions made in Australia. It does not matter that the fund has purposes and beneficiaries located in Cambodia.
- Where the decision makers are ordinarily located in more than one place, a fund would make operational or strategic decisions mainly in Australia if the balance of decision-making power in relation to operational or strategic matters mainly lies in Australia.
An ‘authority’ is not a defined concept. However, it is ‘an agency or instrument of government, established to exercise control or execute a government function in the public interest’.
Example 3 in TR 2019/6 illustrates an authority which meets the ‘in Australia’ requirement in a DGR context:
- The Southern Abalone Authority (SAA) is established by a State government to manage the abalone fishery in parts of the State. The SAA engages in research and development and investment on mitigating abalone-related diseases. It operates from leased premises in a regional centre.
- The SAA funds its activities from research donations, grants, commercial abalone licences and policing fines.
- The SAA is an Australian government agency and is seeking endorsement as a DGR under table item 1.1.4 in subsection 30-20(1).
- The SAA satisfies the DGR in Australia condition. The SAA is established by a State government in Australia and is operated in Australia because it executes a function in the public interest in Australia.
An ‘institution’ is not a defined concept. The Ruling notes that it is ‘an establishment, organisation or association instituted for the promotion of some object, especially one of public or general utility’ – it is ‘called into existence to translate a defined purpose into a living or active principle’.
We envisage that most of our non-government readers would be interested in this aspect of the Ruling and commend Examples 4, 5 and 6 for attention. These illustrate the point that an institution will be in Australia where the institution:
- ‘is established or legally recognised in Australia, and
- ‘makes its operational or strategic decisions mainly in Australia’. (italics added)
Note that there are two limbs to the test and the second limb indicates that it is sufficient that either operational or strategic decisions are mainly made in Australia. It is not necessary that both operational and strategic decisions need to be made mainly in Australia.
The concept of ‘physical presence in Australia …’
Relevance of Division 50 nexus requirement
The nexus requirement (Division 50 nexus requirement) of ‘physical presence in Australia and to that extent, incurs its expenditure and pursues its objectives principally in Australia’ will be relevant to many TaxEd subscribers’ claims for exemption from income tax under Division 50.
Apart from registered charities, the Division 50 nexus requirement applies to: scientific institutions, public educational institutions, public hospitals and hospitals carried on by a society or association, societies/associations/clubs established for the encouragement of science, animal racing, art, a game or sport, literature or music, a society/association/club established for community purposes etc.
There are two basic exceptions to the need to meet the Division 50 nexus requirement and there is also an exception for entities that meet the qualifying conditions to be a DGR (including the DGR ‘in Australia’ condition discussed above. The two basic exceptions will not be relevant to most TaxEd subscribers and further information on these can be found at para 51 of the Ruling.
Summary of the Division 50 nexus requirement
In overview, the application of the Division 50 nexus requirement to an entity entails:
- Identifying whether the entity employs assets or people to conduct physical operations in Australia – This may involve an entity that is legally established in Australia operating in Australia or it may involve an entity established outside Australia operating through a division/branch in Australia. Merely operating through an agent based in Australia is not sufficient to give the entity a physical presence in Australia.
- Having identified the extent to which the entity has a physical presence in Australia, it is necessary to show that expenditure related to those physical operations is principally (basically more than 50%) incurred in Australia – i.e. the decision to make the payment is made in Australia and the payment is to occur from an Australian source (such as a bank account held with an Australian financial institution). The Ruling examples (see Example 9) indicate that the recipient of the payment (i.e. the supplier of the goods/services acquired) need not be based in Australia – the focus is on whether the purchase decision is made in Australia and the source of the funds with which the payment is made. It should be noted that expenditure excludes application of gifts/donations and (untied) government grants, so by being able to trace such moneys into non-Australian expenditure of the Australian operations of the entity, the proportion of expenditure incurred in Australia is enhanced (see Example 12).
- Having identified the extent to which the entity has a physical presence in Australia, it is also necessary to show that the objectives attributable to the entity’s physical presence in Australia are principally pursued in Australia. The Ruling notes that if an entity has a physical presence in Australia through a division, the objectives which are attributable to the Australian division must be principally pursued in Australia. The place in which objectives are pursued is the place where the entity seeks to realise its purposes (e.g. by making distributions to other entities or in supplying goods and services in the course of the entity’s operations) – see Example 7, which has one scenario of principal pursuit of objectives in Australia and a second scenario of principal pursuit of objectives outside Australia.
- The three elements noted above must be pursued continuously. However, the Ruling recognises that disruptions (for example destruction of a key Australian asset that is intended to be re-built in the longer term – see Example 11)) do not necessarily preclude present compliance with the requirement.
Example 10 will especially interest our subscribers which are academic institutions, while generally illustrating the first three of the foregoing points.
- The Melbourne-based Australian Accounting School (AAS) is a company limited by guarantee that is a public educational institution under table item 1.4 in section 50-5.
- The main objective of AAS is to provide accounting-based training to the Australian community. Due to increased demand to provide training to overseas-based students, AAS establishes a separate entity in China, the China Accounting School (CAS), from which overseas-based students will be trained.
- CAS has administrative staff only. AAS provides the educational function by sending subcontractors from Australia to China to provide training. AAS pays the fees and travel expenses for the teacher providing training in China. CAS does not reimburse AAS for this expenditure. In the 20X1 income year, this represents 60% of the total expenditure of the AAS.
- In the absence of further information about AAS’s expenditure and activities, it can be inferred that AAS does not pursue its objectives principally in Australia. AAS’s expenditure on services consumed in China indicates that it is principally pursuing its objectives outside of Australia.
We conclude with a challenge by way of an open question: Assuming AAS could make the relevant donations and any Chinese law structuring constraints did not exist, would the outcome have been different if CAS had been funded through donations which CAS received in Australia? (You might consider in which circumstances para 68 of TR 2019/6 and Example 7, especially para 88, would apply to funding CAS.)
Charities and other not-for-profit bodies need to be mindful that undertaking activities outside Australia can affect their access to income tax concessions. When considering undertaking/supporting activities outside Australia, they should consider whether the proposed action will, either of itself or in combination with other such activities, have implications for their Australian tax status.
This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. It is not intended to be, nor should it be relied upon as, a substitute for professional advice. TaxEd Pty Ltd and any person connected with its production disclaim any liability in connection with any use.