Senate

Taxation Laws Amendment Bill (No. 4) 1995

Income Tax (Franking Deficit) Amendment Bill 1995

Income Tax (Deficit Deferral) Amendment Bill 1995

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)
This Memorandum Takes Account of Amendments Made by the House of Representatives to the Bill as Introduced

Chapter 10 - Trust losses

Overview

10.1 Part 1 of Schedule 7 of the Bill will insert a new Schedule 2C into the Income Tax Assessment Act 1936 (the Act) to provide new rules that have to be satisfied by trusts before prior and current year losses can be deducted. The new Schedule is inserted in a way to fit within the proposed new structure of the income tax law.

10.2 The proposed rules, other than an income injection test, will not apply to family trusts.

10.3 With the exception of the income injection test, the rules that will apply will depend on the type of trust being considered. The three basic types of trusts are fixed trusts (including widely held unit trusts), non-fixed trusts and excepted trusts.

10.4 The new regime will contain an income injection test which applies to deny a deduction to the trust for losses. In very broad terms, the test will apply where, in connection with a scheme, the losses are used to shelter assessable income from tax.

10.5 Consequential amendments will also be made to the Act. These will integrate the new measures into the income tax law.

Summary of the amendments

Purpose of the amendments

10.6 The amendments will insert rules into the Act to restrict the recoupment of current and prior year losses of trusts in order to prevent trafficking of trust losses. Under loss trafficking, a person who did not bear the economic loss at the time it was incurred by the trust obtains a benefit from the trust being able to deduct the loss. The following tables provide a broad summary of the various rules in the trust losses proposals.

Table 1 - Definitions of trusts
Type of trust Description
1. Fixed trust other than widely held unit trust the beneficiaries have fixed entitlements to all the income and capital of the trust
2. Widely held unit trust 20 or fewer individuals do not, directly or indirectly, hold 75% or more of the units (units carry fixed entitlements)
any of the units in the trust is a prescribed interest that was issued by offer for subscription or purchase in accordance with the requirements of Part 7.12 of Chapter 7 of the Corporations Law
3. Unlisted widely held trust a widely held unit trust
the units are not listed on an approved stock exchange
4. Listed widely held trust a widely held unit trust
the units are listed on an approved stock exchange
5. Unlisted very widely held trust an unlisted widely held trust (see above) with at least 1000 unit holders
compliance with other conditions as specified in section 271-70
6. Non-fixed trust a trust which is not a fixed trust
7. Family trust direct or indirect beneficiaries are restricted to family members and approved charities and paragraph 23(e) exempt bodies in certain circumstances
8. Excepted trust a family trust, a complying superannuation fund, a complying approved deposit fund, a pooled superannuation trust and certain deceased estates
Table 2 - Prior year and current year losses - tests that apply to each type of trust
Type of trust Tests to be satisfied to deduct loss
1. Fixed trust other than widely held unit trust 50% stake test and income injection test
2. Unlisted widely held trust 50% stake test and income injection test
(50% stake tested on abnormal trading and at end of accounting period)
3. Listed widely held trust 50% stake test or continuity of business test and income injection test
(50% stake and continuity of business tested on abnormal trading)
4. Unlisted very widely held trust 50% stake test and income injection test
(50% stake tested on abnormal trading)
Non-fixed trust pattern of distributions test*, 50% stake in income or capital test, continuity of control test and income injection test
6. Family trust income injection test
7. Excepted trust other than a family trust none
* this test only applies for prior year loss purposes
Table 3 - Current year losses - division of income year into periods
Type of trust Events which result in the end of a period*
1. Fixed trust other than widely held unit trust failure of 50% stake test
2. Unlisted widely held trust failure of 50% stake test
(50% stake tested on abnormal trading and at end of accounting period)
3. Listed widely held trust failure of 50% stake test unless the continuity of business test is satisfied
(50% stake tested on abnormal trading)
4. Unlisted very widely held trust failure of 50% stake test
(50% stake tested on abnormal trading)
5. Non-fixed trust failure of 50% stake in income or capital test or continuity of control test
* A period will always end at the end of the year of income.
Table 4 - Tests that apply to limit deductibility of losses
What is the 50% stake test for fixed trusts including widely held unit trusts? All trusts which are type 1 3 4 or 5 in Table 1 more than 50% fixed entitlements in income and capital of the trust are held (directly or indirectly) by same individuals at all relevant times
What is pattern of distributions test for a non-fixed trust? A trust which is type 6 of Table 1 the same individuals, between them, receive (directly or indirectly) more than 50% of relevant distributions as specified in section 267-25* in the relevant period (Note: this test only applies for prior year loss purposes).
What is the 50% stake test for a non-fixed trust with more than 50% fixed entitlements in income or capital? A trust which is type 6 in Table 1 the same individuals must maintain more than 50% of the fixed entitlements to income or capital in the trust at all relevant times**
What is the continuity of control test? All trusts which are type 6 of Table 1 no group must begin to control the trust, directly or indirectly during the test period
the terms 'control' and 'group' are defined in section 269-45.
What is the continuity of business test? A trust which is type 4 of Table 1 ** all the following are met: the trust carried on the same business as it carried on before a particular time***; ** the trust did not derive income in the income year from: ** a business of a kind that it did not carry on before a particular time***; or ** a transaction of a kind that it did not enter into in the course of its business operations before a particular time***; ** the trust did not do things for the purpose or for purposes including the purpose of being taken to have carried on the same business as it carried on before a particular time***. The things are: ** start to carry on a business it had not previously carried on; or ** enter into a transaction in the course of its business operations of a kind it had not previously entered into; ** the trust does not incur expenditure in carrying on a business of a kind that it did not carry on before a particular time; ** the trust did not incur expenditure in entering into a transaction of a kind that it had not entered into in the course of its business operations before the particular time
What is the income injection test? Applies to all types of trusts listed in Table 1 except those in category 8 (other than family trusts). the trust has a prior year loss deduction or a current year deduction under a scheme: ** an outsider provides a trustee or a beneficiary (or associates) with a benefit or assessable income is derived by the trust and the trustee, a beneficiary (or associates) provide a return benefit ** the amount of benefits provided or received or assessable income have been affected by the availability of losses or deductions in the trust
* The smallest percentage of any distribution received by a beneficiary is taken into account in determining whether this test has been satisfied. The combined smallest percentages for all beneficiaries must be greater than 50%.
** Under subsections 267-30(2) and 267-55(2) the Commissioner may treat this test as not having been failed.
*** A particular time is a reference to the time immediately before abnormal trading in units of the trust and on testing at that time the trust fails the 50% stake test.
**** This test applies for current year loss purposes only.

Date of effect

10.7 Subject to certain transitional arrangements, the proposed measures will apply to all trafficking in trust losses from 7.30 pm AEST and the equivalent time elsewhere on 9 May 1995.

10.8 However, the pattern of distributions test (see paragraphs 10.91 to 10.102 below), one of the tests that applies to non-fixed trusts for prior year losses, will apply from the date of introduction of the Bill into the Parliament.

Background to legislation

10.9 Under the Act a tax loss incurred by a taxpayer in a year of income may generally be carried forward and deducted from the taxpayer's assessable income in a later year. Losses incurred in the 1989/90 and later income years may be carried forward indefinitely until recouped. There are special rules for the carry forward and deduction of losses arising from foreign income deductions. The relevant provisions are sections 79D, 79E and 80. Film losses are treated in a similar way (sections 79F and 80AAA). In the case of companies there are provisions in the Act which limit the deductibility of prior and current year losses.

10.10 The provisions which limit carry-forward of prior year losses are sections 80A-80E. These provisions contain tests that need to be satisfied by a company before losses can be recouped in a later income year. These tests have the effect that a company can carry forward a loss if there is continuity of beneficial ownership of certain dividend, capital and voting rights of the company. Where there is a change in the beneficial ownership of shares in the company or another company which has resulted in that continuity not being satisfied, the company can carry forward a loss if it carries on the same business as when the loss was incurred. There are also additional rules to prevent the carry forward of a loss in certain circumstances.

10.11 The provisions which limit deductibility of current year losses are sections 50A-50N. Under these provisions a company may not be able to offset deductions incurred by the company which are attributable to one part of an income year against assessable income of the company which is attributable to another part of the income year. This would be the result where an event or circumstance occurs during the income year which is similar to those events or circumstances which result in the company not being able to deduct a prior year loss (see paragraph 10.10 above).

10.12 There are no provisions in the Act similar to sections 80A-80E or 50A-50N which prevent the deduction of prior and current year trust losses. This Bill will insert Schedule 2C into the Act which will place restrictions as to when prior year or current year losses can be deducted by trusts. The rules differ from those currently applicable to companies and reflect the different features of trusts as compared to companies.

Explanation of the amendments

10.13 The Bill, and the explanatory memorandum, are divided into the following divisions:

Division 265 Overview of trust loss provisions
Division 266 Income tax consequences for fixed trusts of abnormal trading or change in ownership.
Division 267 Income tax consequences for non-fixed trusts of change in ownership or control.
Division 268 How to work out a trust's net income and loss for the income year.
Divison 269 Tests applied in determining abnormal trading, 50% stake, control and continuity of business.
Division 270 Schemes to take advantage of tax loss and other deductions.
Division 271 Interpretation.

Division 265 - Overview of trust loss provisions

10.14 The provisions dealing with trust losses are intended to prevent trafficking in tax losses or other deductions which are incurred by trusts. They mainly do this by looking at whether there is a relevant change in the individuals who will benefit from any deduction for the tax losses or other deductions compared to the individuals who actually incurred and economically suffered the loss or deduction. The discussion below outlines in broad terms how the measures will apply. This is followed by a detailed explanation of the proposed amendments.

10.15 The proposed rules that are to apply to trusts will differ from those that apply to companies, reflecting the different characteristics of trusts. Accordingly, the particular rules which apply to a trust will depend on the type of trust. The three basic types of trusts which are dealt with differently in the legislation are fixed trusts (including listed and unlisted widely held trusts), non-fixed trusts and excepted trusts. Excepted trusts include family trusts.

10.16 The Bill, and this explanatory memorandum, deal with each kind of trust in a different part. While this leads to some repetition of common rules, it means that the reader can see the rules which apply to each kind of trust in one place.

10.17 Fixed trusts (other than listed widely held trusts) that are not family or other excepted trusts will have to satisfy a continuity of ownership test and an income injection test before losses can be deducted.

10.18 Special rules will apply to family trusts. In general, these rules will permit the carry forward of losses so long as distributions from the trust are only capable of flowing to members of the family. Family trusts will also be subject to the income injection test.

10.19 A fixed trust that is a listed widely held trust, but not an excepted trust, will be able to deduct prior year losses only if the trust satisfies a continuity of ownership test or the continuity of business test, and an income injection test.

10.20 Special rules for testing changes in ownership will apply to widely held trusts that are fixed trusts.

10.21 Listed widely held trusts or unlisted widely held trusts with at least 1000 unit holders and which also satisfy certain other requirements only need to test for continuity of ownership where an abnormal dealing (trading) in units occurs.

10.22 An unlisted widely held trust that has less than 1000 unit holders or does not satisfy the necessary requirements has to test for a continuity of ownership not only when there is an abnormal dealing in units but also at the end of each accounting period.

10.23 The Bill specifies some of the factors to be taken into account in deciding whether a dealing is abnormal or not. It also specifies the circumstances in which an abnormal dealing will be deemed to have occurred.

10.24 A non-fixed trust that is not a family or other excepted trust will have to satisfy a pattern of distributions test, a continuity of ownership test, a continuity of control test and an income injection test before prior year losses can be deducted. However, the pattern of distributions test and continuity of ownership test may not be applicable to the circumstances of some non-fixed trusts in which case they will not have to be met. The continuity of ownership test will only have to be satisfied by a non-fixed trust in which there are fixed entitlements to more than 50% of the income or capital of the trust.

10.25 The continuity of ownership test for fixed trusts requires that more than 50% of fixed entitlements in the income and capital of the trust be held, directly or indirectly, by the same individuals (i.e. natural persons), other than as a trustee, from the loss year to the recoupment year. Indirect entitlements can only be traced through fixed entitlements in interposed companies, trusts and partnerships.

10.26 The pattern of distributions test for non-fixed trusts, will, broadly, examine the pattern of distributions of income and capital of the trust over a period to determine whether there has been an effective change in those who benefit under the trust.

10.27 The Bill contains an income injection test which applies equally to fixed trusts, non-fixed trusts and family trusts. This test operates to disallow a deduction for a prior year loss where certain schemes are entered into. The scheme involves the trust deriving assessable income and a person obtaining a benefit which effectively represents consideration for the shelter of the assessable income from tax by the loss.

10.28 There will also be corresponding rules to restrict the deductibility of current year losses and accounting rules to determine a trust's net income or tax loss where necessary.

10.29 The new rules will not apply to complying superannuation funds, complying approved deposit funds, pooled superannuation trusts and deceased estates (within a reasonable administration period). These are all excepted trusts. However, if these trusts make investments in other trusts, the rules will apply to the deductibility of losses of those other trusts.

Division 266 - Income tax consequences for fixed trusts of abnormal trading or change in ownership

10.30 Division 266 sets out the circumstances in which a fixed trust will not be able to deduct a prior year loss or will have to calculate its net income or tax loss for the current year in a special way.

10.31 The rules that apply depend on the kind of fixed trust being considered. There are four kinds of fixed trust for the purposes of the legislation, as follows:

fixed trusts (other than widely held unit trusts);
listed widely held trusts;
unlisted very widely held trusts; and
unlisted widely held trusts.

10.32 The characteristics of each of these kinds of trust is defined in Division 271, which deals with interpretation. This is discussed at paragraphs 10.230 to 10.283 below. Broadly, a fixed trust is a trust where all of the income or capital is the subject of a fixed entitlement.

10.33 A family trust (a type of 'excepted trust') that is also a fixed trust will, however, not be affected in any way by the tests in Division 266. The rules in Division 266 will not, therefore, prevent a family trust from deducting prior or current year losses. Also, other excepted trusts (as defined - see paragraphs 10.267 to 10.269 below) are not affected by Division 266.

10.34 The tests that apply to fixed trusts to determine whether a prior or current year loss can be deducted look at three different things. They are abnormal trading of units in a trust, change in fixed entitlements and whether there is continuity of business. The last of these, continuity of business, applies only to listed widely held trusts.

10.35 The abnormal trading concept is central to determining whether listed widely held trusts and unlisted very widely held trusts can deduct losses. It is normal for units in these kinds of trusts to be traded. Trading is defined in the legislation to include all dealing in units, including redemption and issue. The rules will, therefore, only test for a change in the individuals who can benefit from the losses when there is abnormal trading. The abnormal trading concept is also used for unlisted widely held trusts.

10.36 At the heart of the tests for fixed trusts is whether there is a significant change in those individuals who have direct or indirect fixed entitlements in the trust. Fixed entitlements are readily quantifiable and will give an accurate picture of those who will receive income or capital of the trust. This in turn will be a reliable indicator of whether there has been a change in the individuals who can benefit from the losses of a fixed trust. Indirect entitlements can only be traced through fixed entitlements in interposed entities.

Subdivision 266-B - Fixed trusts (other than widely held unit trusts)

When can't a fixed trust (other than a widely held unit trust) deduct a tax loss of an earlier income year?

10.37 The Bill sets out rules to determine when a fixed trust (other than a widely held unit trust) cannot deduct a prior year tax loss. These trusts are called fixed trusts in the discussion below. The following flow chart outlines, in broad terms, when such a trust cannot deduct a prior year loss.

When a trust cannot deduct a prior year loss

10.38 A fixed trust is affected by the proposed rules, as they relate to prior year losses, if:

in the income year it has a tax loss from an earlier income year that is, ignoring the rules in the Bill, deductible;
it was a fixed trust at all times in the 'test period';
it was not a widely held unit trust at all times in the 'test period'; and
it was not an excepted trust at all times in the 'test period'.

10.39 The test period is made up of the income year in which the tax loss was incurred, the income year being examined and all intervening income years [subsection 266-25(1)] . For example, a fixed trust incurs a loss in Year 1. In Year 3 it seeks to recoup that loss. The test period in this case is Year 1 (the loss year), Year 3 (the current income year) and Year 2 (the intervening income year).

10.40 If the rules in paragraph 10.38 are met then the fixed trust cannot deduct the prior year tax loss unless it meets the condition set out in the Bill [subsection 266-25(2)] . This condition is explained at paragraphs 10.44 and 10.45 below.

When does a fixed trust (other than a widely held unit trust) have to work out its net income or tax loss in a special way? (current year losses)

10.41 The Bill also sets out rules to determine when a fixed trust (other than a widely held unit trust) cannot deduct a current year tax loss. These trusts are called fixed trusts below. These rules are intended to prevent a person unfairly gaining the benefit of tax losses generated from deductions which are properly attributable to only part of the income year. The following flow chart outlines, in broad terms, when such a trust has to work out its net income or tax loss in a special way.

When a trust has to work out its net income or tax loss in a special way

10.42 A fixed trust is affected by the proposed rules, as they relate to current year losses, if:

it was a fixed trust at all times in the income year being examined (called the test period);
it was not a widely held unit trust at all times in the 'test period'; and
it was not an excepted trust at all times in the 'test period'. [Section 266-30]

10.43 If the rules in paragraph 10.42 are met then the fixed trust must work out its net income or tax loss in a special way unless it meets the condition set out in the Bill [section 266-30] . This condition is explained at paragraphs 10.44 and 10.45 below.

What is the condition for fixed trusts (other than widely held unit trusts)?

10.44 The condition is that the same individuals must have more than 50% of the fixed entitlements (called a stake) in the trust at all times in the test period. [Paragraph 266-35]

10.45 The meaning of the 50% stake concept is set out in Division 269 and is discussed below at paragraphs 10.181 to 10.193.

When can part of a prior year tax loss be deducted by a fixed trust (other than a widely held trust)?

10.46 If a fixed trust cannot deduct a prior year tax loss because it does not meet the condition set out above (see paragraph 10.44), then it may still be able to deduct part of the tax loss which is properly attributable to part of the loss year [subsection 266-40(1)] . This will only apply if the change in ownership that leads to the inability of the trust to deduct the loss occurs in the loss year.

10.47 The trust can only deduct part of the tax loss if, assuming the part of the loss year was a whole loss year, it meets the condition discussed in paragraph 10.44. [Subsection 266-40(2)]

10.48 The following example illustrates the application of this rule. In Year 1, a fixed trust incurs a tax loss. During that year there is a change in ownership of the trust. It is thus prevented from carrying forward all the loss. During the period after the change in ownership to the end of Year 2 (the current income year) the trust meets the condition that would allow it to carry forward a tax loss. The trust may deduct the part of the loss that is attributable to the period of the loss year that occurs after the change in ownership.

Subdivision 266-C - Unlisted widely held trusts

When can't an unlisted widely held trust deduct a tax loss of an earlier income year?

10.49 The Bill sets out rules to determine when an unlisted widely held trust cannot deduct a prior year tax loss. The following flow chart outlines, in broad terms, when such a trust cannot deduct a prior year loss.

When a trust cannot deduct a prior year loss

10.50 An unlisted widely held trust is affected by the proposed rules, as they relate to prior year losses, if:

in the income year it has a tax loss from an earlier income year that is, ignoring the rules in the Bill, deductible;
it was an unlisted widely held trust at all times in the 'test period' but not an unlisted very widely held trust at those times (see paragraph 10.276); and
it was not an excepted trust at all times in the 'test period'.

10.51 The test period is made up of the income year in which the tax loss was incurred, the income year being examined and all intervening income years. [Subsection 266-55(1)]

10.52 If the rules in paragraph 10.50 are met then the unlisted widely held trust cannot deduct the prior year tax loss unless it meets the condition set out in the Bill [subsection 266-55(2)] . This condition is explained at paragraphs 10.56 and 10.57 below.

When does an unlisted widely held trust have to work out its net income or tax loss in a special way? (current year losses)

10.53 The Bill also sets out rules to determine when an unlisted widely held trust cannot deduct a current year tax loss. These rules are intended to prevent a person unfairly gaining the benefit of tax losses generated from deductions which are properly attributable to only part of the income year. The following flow chart outlines, in broad terms, when such a trust has to work out its net income or tax loss in a special way.

When a trust has to work out its net income or tax loss in a special way

10.54 An unlisted widely held trust is affected by the proposed rules, as they relate to current year losses, if:

it was an unlisted widely held trust at all times in the income year being examined (called the test period) but not an unlisted very widely held trust at those times; and
it was not an excepted trust at all times in the 'test period'. [Section 266-60]

10.55 If the rules in paragraph 10.54 are met then the unlisted widely held trust must work out its net income or tax loss in a special way unless it meets the condition set out in the Bill [section 266-60] . This condition is explained at paragraphs 10.56 and 10.57 below.

What is the condition for unlisted widely held trusts?

10.56 The condition is that the same individuals must have more than 50% of the fixed entitlements (called a stake) in the trust at the start of the test period and also every time a specified event occurs. The specified events are:

an abnormal trading in the trust's units in the test period; and
the end of the trust's accounting period in the test period. [Section 266-65]

10.57 The meaning of important concepts used in determining whether this condition is satisfied are set out in Division 269 and are discussed below at paragraphs 10.168 to 10.193. The concepts are abnormal trading and 50% stake.

When can part of a prior year tax loss be deducted by an unlisted widely held trust?

10.58 The Bill contains a provision to allow an unlisted widely held trust to deduct part of a tax loss [section 266-70] . This provision works in the same way as the corresponding provision applying to fixed trusts (see paragraphs 10.46 to 10.48 above).

Subdivision 266-D - Listed widely held trusts

When can't a listed widely held trust deduct a tax loss of an earlier income year?

10.59 The Bill sets out rules to determine when a listed widely held trust cannot deduct a prior year tax loss. The following flow chart outlines, in broad terms, when such a trust cannot deduct a prior year loss.

When a trust cannot deduct a prior year loss

10.60 A listed widely held trust is affected by the proposed rules, as they relate to prior year losses, if:

in the income year it has a tax loss from an earlier income year that is, ignoring the rules in the Bill, deductible;
it was a listed widely held trust at all times in the 'test period'; and
it was not an excepted trust at all times in the 'test period'.

10.61 The test period is made up of the income year in which the tax loss was incurred, the income year being examined and all intervening income years. [Subsection 266-85(1)]

10.62 If the rules in paragraph 10.60 are met then the listed widely held trust cannot deduct the prior year tax loss unless it meets one of two conditions set out in the Bill [subsection 266-85(2)] . These conditions are explained at paragraphs 10.66 and 10.67 below.

When does a listed widely held trust have to work out its net income or tax loss in a special way? (current year losses)

10.63 The Bill also sets out rules to determine when a listed widely held trust cannot deduct the whole or a part of a current year tax loss. These rules are intended to prevent a person unfairly gaining the benefit of tax losses generated from deductions which are properly attributable to only part of the income year. The following flow chart outlines, in broad terms, when such a trust has to work out its net income or tax loss in a special way.

When a trust has to work out its net income or tax loss in a special way

10.64 A listed widely held trust is affected by the proposed rules, as they relate to current year losses, if:

it was a listed widely held trust at all times in the income year being examined (called the test period); and
it was not an excepted trust at all times in the 'test period'. [Section 266-90]

10.65 If the rules in paragraph 10.64 are met then the listed widely held trust must work out its net income or tax loss in a special way unless it meets one of two conditions set out in the Bill [section 266-90] . These conditions are explained at paragraphs 10.66 and 10.67 below.

What are the two conditions for listed widely held trusts?

10.66 The two conditions are:

there must not be any 'abnormal trading' in the trust's units during the test period [subsection 266-95(1)] ;
if there is abnormal trading, then either

-
the same individuals must have more than 50% of the fixed entitlements (called a stake) in the trust at the start of the test period and also immediately after each abnormal trading [paragraph 266-95(2)(a)] ; or
-
if the same individuals do not have more than a 50% stake after an abnormal trading, the trust must satisfy the continuity of business test (in relation to the time immediately before the abnormal trading) in the part of the test period that occurs after the abnormal trading [paragraph 266-95(2)(b)] .

10.67 The meaning of important concepts used in determining whether these two conditions are satisfied are set out in Division 269 and are discussed below at paragraphs 10.168 to 10.206. The concepts are abnormal trading, 50% stake and continuity of business.

Example

10.68 Fifty individuals have, between them, a 100% stake in a listed widely held trust at the start of a test period. During the test period, the trust has two abnormal tradings. After the first abnormal trading, the fifty individuals hold a 65% stake in the trust. After the second, the fifty individuals hold only a 40% stake. In this case, the trust fails the 50% stake (continuity of ownership) test after the second abnormal trading.

10.69 However, the trust carries on the same business from the time after the 50% stake test is failed until the end of the test period as it carried on immediately before the second abnormal trading. The trust is, therefore, not affected by the rules preventing the deduction of prior and current year losses.

When can part of a prior year tax loss be deducted by a listed widely held trust?

10.70 The Bill contains a provision to allow a listed widely held trust to deduct part of a tax loss [section 266-100] . This provision works in the same way as the corresponding provision applying to fixed trusts (see paragraphs 10.46 to 10.48 above).

Subdivision 266-E - Unlisted very widely held trusts

When can't an unlisted very widely held trust deduct a tax loss of an earlier income year?

10.71 The Bill sets out rules to determine when an unlisted very widely held trust cannot deduct a prior year tax loss. The following flow chart outlines, in broad terms, when such a trust cannot deduct a prior year loss.

When a trust cannot deduct a prior year loss

10.72 An unlisted very widely held trust is affected by the proposed rules, as they relate to prior year losses, if:

in the income year it has a tax loss from an earlier income year that is, ignoring the rules in the Bill, deductible;
it was an unlisted very widely held trust at all times in the 'test period'; and
it was not an excepted trust at all times in the 'test period'.

10.73 The test period is made up of the income year in which the tax loss was incurred, the income year being examined and all intervening income years. [Subsection 266-115(1)]

10.74 If the rules in paragraph 10.72 are met then the unlisted very widely held trust cannot deduct the prior year tax loss unless it meets one of two conditions set out in the Bill [subsection 266-115(2)] . These conditions are explained at paragraphs 10.78 and 10.79 below.

When does an unlisted very widely held trust have to work out its net income or tax loss in a special way? (current year losses)

10.75 The Bill also sets out rules to determine when an unlisted very widely held trust cannot deduct a current year tax loss. These rules are intended to prevent a person unfairly gaining the benefit of tax losses generated from deductions which are properly attributable to only part of the income year. The following flow chart outlines, in broad terms, when such a trust has to work out its net income or tax loss in a special way.

When a trust has to work out its net income or tax loss in a special way

10.76 An unlisted very widely held trust is affected by the proposed rules, as they relate to current year losses, if:

it was an unlisted very widely held trust at all times in the income year being examined (called the test period); and
it was not an excepted trust at all times in the 'test period' [section 266-120] .

10.77 If the rules in paragraph 10.76 are met then the unlisted very widely held trust must work out its net income or tax loss in a special way unless it meets one of two conditions set out in the Bill [section 266-120] . These conditions are explained at paragraphs 10.78 and 10.79 below.

What are the two conditions for unlisted very widely held trusts?

10.78 The two conditions are:

there must not be any 'abnormal trading' in the trust's units during the test period [subsection 266-125(1)] ;
if there is abnormal trading, then the same individuals must have more than 50% of the fixed entitlements (called a stake) in the trust at the start of the test period and also immediately after each abnormal trading [subsection 266-125(2)] .

10.79 The meaning of important concepts used in determining whether these two conditions are satisfied are set out in Division 269 and are discussed below at paragraphs 10.168 to 10.193. The concepts are abnormal trading and 50% stake.

When can part of a prior year tax loss be deducted by an unlisted very widely held trust?

10.80 The Bill contains a provision to allow an unlisted very widely held trust to deduct part of a tax loss [section 266-130] . This provision works in the same way as the corresponding provision applying to fixed trusts (see paragraphs 10.46 to 10.48 above).

Division 267 - Income tax consequences for non-fixed trusts of change in ownership or control

10.81 Division 267 sets out the circumstances in which a non-fixed trust will not be able to deduct a prior year loss or will have to calculate its net income or tax loss in a special way.

10.82 Since non-fixed trusts are different in nature to fixed trusts, different rules apply to determine whether a non-fixed trust can deduct a prior year or current year loss. Non-fixed trusts are different to fixed trusts because it is not possible to determine who has a vested interest in the income or capital of the trust. This is because the trustee or some other person will generally have a discretion as to who will benefit under the trust and/or what the amount of the benefit will be. Alternatively, the interests of persons in the trust may change because the vesting of the interests is conditional. It is not, therefore, possible to apply the same traditional continuity of ownership test that applies to fixed trusts. Instead, the pattern of distributions or control of the trust are tested to give a picture of who can benefit from the trust.

10.83 Some non-fixed trusts, however, have both fixed and discretionary elements. In these circumstances it is possible to examine the fixed entitlements to determine some of those who will benefit under the trust.

10.84 A family trust (a type of 'excepted trust') that is also a non-fixed trust will not be affected in any way by the tests in Division 267. The rules in Division 267 will not, therefore, prevent a family trust from deducting prior or current year losses. Also, other excepted trusts (as defined - see paragraphs 10.267 to 10.269 below) are not affected by Division 267.

Subdivision 267-B - Non-fixed trusts and tax losses of earlier years

When can't a non-fixed trust deduct a tax loss of an earlier income year?

10.85 The Bill sets out rules to determine when a non-fixed trust cannot deduct a prior year tax loss. The following flow chart outlines, in broad terms, when a non-fixed trust cannot deduct a prior year loss.

When a non-fixed trust cannot deduct a prior year loss

10.86 A non-fixed trust is affected by the proposed rules, as they relate to prior year losses, if:

in the income year it has a tax loss from an earlier income year that is, ignoring the rules in the Bill, deductible; and
it was a non-fixed trust at any time in the 'test period'; and
it was not an excepted trust at all times in the 'test period'.

10.87 The test period is made up of the income year in which the tax loss was incurred, the income year being examined and all intervening income years. [Subsection 267-20(1)]

10.88 If the rules in paragraph 10.86 are met then the non-fixed trust cannot deduct the prior year tax loss unless it meets all three conditions set out in the Bill. Two of the conditions may not be applicable to a particular trust for a particular period. If this is the case, the trust does not need to meet the condition that is not applicable. [Subsection 267-20(2)]

10.89 The three conditions relate to:

the pattern of distributions of the trust - this test will not be applicable if relevant distributions have not been made by the trust [section 267-25] ;
fixed entitlements to income or capital of the trust - this test will not be applicable if the fixed entitlements in the trust were never above 50% of the total income or capital of the trust in the test period [section 267-30] ;
control of the trust - this condition will apply to all non-fixed trusts [section 267-35] .

10.90 The details of the three conditions are set out below. The meaning of important concepts used in determining whether the second two conditions are satisfied are set out in Division 269 and are discussed below at paragraphs 10.181 to 10.198. The concepts are 50% stake and control of a non-fixed trust.

What is the pattern of distributions condition?

10.91 The first condition in paragraph 10.89 is applicable to a non-fixed trust, and therefore must be satisfied by the trust, if the trust distributed income and/or capital in the income year and at least one of the six previous income years. [Subsection 267-25(1)]

10.92 If the condition applies, the trust cannot deduct the loss unless:

the same individuals between them receive, directly or indirectly, and for their own benefit, more than 50% of every 'test year distribution' of income; and
the same individuals between them receive, directly or indirectly, and for their own benefit, more than 50% of every 'test year distribution' of capital. [Subsection 267-25(2)]

When does a person receive income or capital for their own benefit?

10.93 A person receives something for his or her own benefit if the person receives the thing otherwise than in the capacity of a trustee.

When is a person taken to receive income or capital indirectly?

10.94 A person receives something indirectly for the purposes of the pattern of distributions condition if the person receives the thing through a chain of one or more interposed companies, trusts or partnerships (all called entities below). The amount of a 'test year distribution' of income or capital received by a person through interposed entities is determined by ascertaining what is fair and reasonable having regard to the entitlements of each successive entity in the other, and the actual distributions made by each successive entity.

What is a 'test year distribution' of income or capital?

10.95 A test year distribution of income is the total of all distributions of income made by the trust in a relevant income year. A relevant income year is:

the income year being examined (the end year);
the earlier of:

-
the income year in which the trust distributed income that is before the loss year but closest to the loss year;
-
the loss year, if the trust distributed income in that year; or
-
the income year in which the trust distributed income that is not before the loss year but is closest to the loss year;
(The earlier of these three years is called the start year below).

each intervening income year between the start year and the end year. [Subsection 267-25(4)]

10.96 The test applies in the same way to distributions of capital to determine what is a 'test year distribution' of capital. [Subsection 267-25(5)]

10.97 The percentage of any test year distribution of income or capital received by an individual in an income year is the total income or capital distribution received by the individual in that year as a percentage of the total income or capital distributions made by the trust in that year.

10.98 The percentage of a test year distribution that a person is taken to receive is the smallest percentage that the person received in the period being tested [subsection 267-25(3)] . This rule is necessary because each test year distribution will not necessarily be of the same value. The rule will, therefore, ensure some comparability between the distributions that are being tested.

An example of how the pattern of distributions condition is applied

10.99 Year 7 is the current income year. A trust has losses incurred in Year 6. The trust has made one distribution of income in Years 1, 2, 3 and 4 and two distributions in Year 7. No distributions of capital have been made in Year 7. This means it is not possible to apply the test for any distributions of capital by the trust.

10.100 In accordance with the test discussed in paragraph 10.95, the end year is Year 7 (i.e. the current income year) and the start year is Year 4. Year 4 is the start year because it has a distribution made before the loss year that is closest to that loss year. To work out the test year distribution for each year, each distribution of income made to each beneficiary in the year is totalled. The percentage of the total received by each beneficiary is that beneficiary's share of the test year distribution.

10.101 The test year distributions made by the trust are as follows:

       
Jack 50% 10% 10%
Jill 40% 10% 10%
Mary 10% 10% 10%
Bill 0% 70% 0%

10.102 In this example, the trust does not satisfy the pattern of distributions condition. This is because only 30% of each test year distribution has been received by the same persons, having regard to the fact that each beneficiary is taken to receive the smallest distribution for each test year distribution. In essence, if the total worked out by adding the smallest distribution of each person is more than 50%, the test is passed (in the above example, the smallest distributions are those in the far right column).

What is the 50% stake condition?

Income

10.103 The 50% stake condition applies for income if individuals have fixed entitlements (called a stake ) to more than 50% of the income of the trust at any time in the test period (called the test time ). If this is the case, then at all times in the period after the test time, the same individuals must continue to hold more than a 50% stake in the income of the trust. [Subsection 267-30(1)]

Capital

10.104 A 50% stake condition in the same terms applies for capital of the trust. [Subsection 267-30(1)]

Commissioner's discretion

10.105 The Commissioner has a discretion to treat a non-fixed trust as having met the 50% stake condition in certain circumstances. This discretion is intended to provide a mechanism to prevent any harsh results in particular cases.

10.106 The discretion can be exercised where:

some or all of the individuals cease to have a stake in more than 50% of the income or capital of the trust (whichever is applicable); and
the Commissioner considers it fair and reasonable to treat the trust has having met the 50% stake condition having regard to the likely way in which the trustee or any other person will exercise any discretion to distribute income or capital and to any other matter. [Subsection 267-30(2)]

Example

10.107 At the start of a test period, a non-fixed trust has fixed entitlements to income of 51% and fixed entitlements to capital of 100%. These are all held by Jack. The other 49% of income is the subject of a discretion of the trustee. During the test period, Jack sells 2% of his fixed entitlement to income to Jill. As a result, the trust fails the 50% stake condition because the same individuals no longer hold fixed entitlements to more than 50% of the income of the trust.

10.108 In this set of circumstances, the Commissioner could exercise his or her discretion to treat the trust as having met the 50% stake condition. This could be, for example, if the Commissioner was satisfied that Jill would not receive, in connection with a scheme under which the fixed entitlement was purchased, any distributions of income from the share of the trust's income that is subject to a trustee's discretion.

What is the control condition?

10.109 The control condition is that no group (i.e. a person and/or his or her associates, either alone or together) must begin to control the trust in the test period (whether directly or indirectly). [Section 267-35]

When can part of a tax loss be deducted by a non-fixed trust?

10.110 If a non-fixed trust cannot deduct a tax loss because it does not meet the 50% stake or control conditions, then it may still be able to deduct part of the tax loss attributable to part of the loss year [subsection 267-40] . This provision works in a similar way as it works for fixed trusts (see the discussion above at paragraphs 10.46 to 10.48).

Subdivision 267-C - Non-fixed trusts and current year deductions

When does a non-fixed trust have to work out its net income or tax loss in a special way? (current year losses)

10.111 The Bill also sets out rules to determine when a non-fixed trust cannot deduct a current year tax loss. These rules are intended to prevent a person unfairly gaining the benefit of tax losses generated from deductions which are properly attributable to only part of the income year. The following flow chart outlines, in broad terms, when a non-fixed trust has to work out its net income or tax loss in a special way.

When a non-fixed trust has to work out its net income or tax loss in a special way

10.112 A non-fixed trust is affected by the proposed rules, as they relate to current year losses, if:

it was a non-fixed trust at any time in the income year being examined (called the test period); and
it was not an excepted trust at all times in the 'test period'. [Section 267-50]

10.113 If the rules in paragraph 10.112 are met then the non-fixed trust must work out its net income or tax loss in a special way unless it meets both conditions set out in the Bill. One of the conditions may not be applicable to the circumstances of the trust in question. If this is the case, the trust does not need to meet that condition. [Section 267-50]

10.114 The two conditions relate to:

fixed entitlements to income or capital of the trust - this test will not be applicable if the fixed entitlements in the trust were never above 50% of the total income or capital of the trust in the test period [section 267-55] ;
control of the trust - this condition will apply to all non-fixed trusts [section 267-60] .

10.115 These two conditions apply in exactly the same way for the relevant test period as they apply for the prior year loss rules for non-fixed trusts (see paragraphs 10.103 to 10.109 above).

Division 268 - How to work out a trust's net income and loss for the income year

10.116 The following discussion sets out the provisions that apply where a trust is required to work out its net income or tax loss in a special way (i.e. the current year loss rules). In very broad terms, these provisions work by:

dividing the trust's income year into periods on the basis of when a specified event (e.g. change in ownership or control) occurs;
allocating to each period that assessable income and those deductions which can be allocated to periods and working out a notional net income or notional loss for each period; and
calculating the net income (if any) and the tax loss taking into account the notional net income and notional loss for each period and any income or deductions that cannot be allocated to periods.

Subdivision 268-B - Dividing the income year into periods

10.117 A trust that is required to calculate its net income or loss under the current year loss provisions will have its income year divided into two or more periods. An explanation of how the income year is divided into periods for the different types of trusts is set out below.

How is the income year of a fixed trust (other than a widely held unit trust) divided into periods?

10.118 The beginning of the first period will be the start of the income year. Any subsequent period starts immediately after the end of the previous period. [Subsection 268-10(2)]

10.119 The last period will end at the end of the income year. Any other period will end when, after the start of the period, the individuals who had a stake in the trust (i.e. ownership) at the start of the period no longer have more than a 50% stake. [Subsection 268-10(3)]

How is the income year of an unlisted widely held trust divided into periods?

10.120 The beginning of the first period will be the start of the income year. Any subsequent period starts immediately after the end of the previous period. [Subsection 268-15(2)]

10.121 The last period will end at the end of the income year. Any other period will end the first time after the start of the period that the individuals who had a stake in the trust at the start of the period no longer have more than a 50% stake. This will be tested at the end of an accounting period and at the time of an abnormal trading. [Subsection 268-15(3)]

10.122 In cases where a trust's accounting period is the same as the income year, a period will only ever end when there is an abnormal trading in units and the trust fails the 50% stake test. This is because, in these cases, the end of the last period will also be the end of the accounting period.

How is the income year of a listed widely held trust divided into periods?

10.123 The beginning of the first period will be the start of the income year. Any subsequent period starts immediately after the end of the previous period. [Subsections 268-20(2)]

10.124 The last period will end at the end of the income year. Any other period will end when there is an abnormal trading in units after the start of the period and the individuals who had a stake in the trust at the start of the period no longer have more than a 50% stake. [Subsection 268-20(3)]

10.125 If a trust's income year is split up into periods, successive periods will be treated as a single period if throughout these periods the trust passes the continuity of business test in relation to the time immediately before the end of the first of them [subsection 268-20(4)] . The current year loss provisions do not apply if the trust carries on at all times during the income year, the same business as the business which it carried on just before an abnormal trading. As a consequence, this provision will only ever have application where the income year is split up into at least three periods (i.e. there has been two changes in ownership which has resulted in the trust failing the continuity of ownership test).

Example

10.126 This example illustrates how what would otherwise be two or more periods would be treated as one period where the same business is carried on throughout the two or more periods. As discussed above, this situation is unlikely to arise in practice but this example is provided in order to explain how the circumstance would be dealt with.

10.127 A listed widely held trust fails the continuity of ownership test two times in the income year (shown as events (1) and (2) in the time line below). However, the trust continued to carry on the same business throughout the period of the income year between (1) and (2) as it had throughout the period from the start of the income year to (1). The trust's income year is split into two periods as shown on the time line below. If the continuity of business test did not apply, the trust's income year would have been split up into three periods, each beginning on a change in ownership (except the first which commences at the start of the income year). However, what would otherwise be periods 1 and 2 are treated as one period because the trust carried on at all times during those periods the same business before both (1) and (2).

Two or more periods are treated as one

How is the income year of an unlisted very widely held trust divided into periods?

10.128 The beginning of the first period will be the start of the income year. Any subsequent period starts immediately after the end of the previous period. [Subsections 268-25(2)]

10.129 The last period will end at the end of the income year. Any other period will end when there is an abnormal trading in units after the start of the period and the individuals who had a stake in the trust at the start of the period no longer have more than a 50% stake. [Subsection 268-25(3)]

How is the income year of a non-fixed trust divided into periods?

10.130 The beginning of the first period will be the start of the income year. Any subsequent period starts immediately after the end of the previous period. [Subsections 268-30(2)]

10.131 The last period will end at the end of the income year [subsection 268-30(3)] . The point in time that any other period will end will depend on whether there are individuals who have more than 50% fixed entitlements to the income or capital of the non-fixed trust at any time during the income year.

10.132 If a non-fixed trust is one in which persons have more than 50% fixed entitlements to income or capital at any time in the income year the 50% stake (continuity of ownership) condition will apply to the trust. If this is the case, a period (except the last) will end the first time after the start of the period that:

the individuals who had a stake in the trust at the start of the period no longer have more than a 50% stake; or
a group begins to control the trust (i.e. a change of control occurs). [Subsection 268-30(4)]

10.133 If the 50% stake condition does not apply to the non-fixed trust, a period (except the last) will end when, after the start of the period, there is a change of control of the trust. [Subsection 268-30(5)]

Subdivision 268-C - other steps in working out the net income or loss

How do you work out the trust's notional net income or notional tax loss for a period?

10.134 A notional loss or net income of a trust has to be calculated for each period of the income year [subsection 268-35(1)] . These calculations have to be made in respect of each period in the income year as if it were itself a year of income.

10.135 If there is no notional loss in any of the periods these provisions do not apply and the net income of the trust is calculated in the usual way [subsection 268-35(4)] . There is no mischief in these cases because there are no current year deductions that can be utilised by new owners or controllers of a trust in the current income year.

10.136 A notional loss will arise where certain deductions attributable to the period exceed the assessable income attributable to the same period [subsections 268-35(2)] . The notional loss may be able to be carried forward to a later year of income. If the relevant deductions do not exceed the relevant assessable income, the trust will have a notional net income for the period [subsection 268-35(3)] .

How are deductions attributed to a period?

10.137 For the purpose of allocating deductions to respective periods there are three types:

deductions that are attributed to each period in proportion to the length of the period (i.e. pro-rated);
deductions that are attributable to periods as if each period were an income year;
full year deductions.

Pro-rated deductions

10.138 The first type of deduction is one that can be pro-rated over the income year according to the length of the period being considered. These kinds of deductions are listed in subsection 268-40(2) and include, for example, depreciation which is deductible under section 54 of the Act and some deductions for expenditure which are spread over 2 or more years. [Subsection 268-40(2)]

Example 1

10.139 A fixed trust has depreciation expenses of $3000 for an' of capital equipment in the current year of income. As a result of section 268-10, the current income year of the trust is divided into 3 periods of 4 months. Depreciation expenses of $1000 are allocated to each of the 4 month periods.

Example 2

10.140 A fixed trust has taken out a three year loan. The borrowing expenses that are deductible under section 67 of the Act are $600. Pro-rated on a daily basis, $200 of this expense is applicable to the year of income. As a result of section 268-10, the income year of the fixed trust is divided into 4 periods of 3 months. The amount of deduction that is attributed to each of the periods is

$50*($200*(91.25/365))

Deductions attributed to periods as if each period were an income year

10.141 The second type of deduction is a deduction that is attributed to a period as if the period were an income year. [Section 268-40(3)]

Example 1

10.142 A non-fixed trust disposes of an' of depreciable property during a year of income. As a result of the disposal an amount of $2000 is available for deduction under subsection 59(1) of the Act. Under section 268-30, the income year of the non-fixed trust is to be divided into 2 periods. The $2000 deduction is to be allocated to the period in which the disposal took place.

Example 2

10.143 As a result of section 268-30, a non-fixed trust is required to divide its income year into 2 periods. A stock take of trading stock is carried out at the end of the first period. The value of the opening stock exceeds the value of the closing stock by $2000. A deduction for the excess is allowable under subsection 28(3) of the Act. This deduction is allocated to the first period.

Example 3

10.144 A fixed trust prepares its accounts on an accruals basis. As a result of section 268-10, the income year of the fixed trust is to be divided into 2 periods. The trust incurs a deductible expense in the first period but it is not paid for until the second period. The expense is allocated to the first period.

Full year deductions

10.145 The third type of deduction is a full year deduction. These deductions are not allocated to a particular period or dissected between the relevant periods but are brought to account in the final calculation of the trust's net income for the year. [Subsection 268-40(4)]

10.146 Full year deductions are listed fully in the Bill and include, for example, deductions allowable for bad debts, gifts, and tax losses for earlier years. [Subsection 268-40(5)]

How is assessable income attributed to a period?

10.147 For the purpose of spreading assessable income over periods of the income year there are five classes of income that are attributed to periods as set out below.

Income from other trusts

10.148 The first class is income that is included in the assessable income of the trust under section 97 (i.e. the trust's share in the net income of another trust as a presently entitled beneficiary) or section 98A (i.e. the trust is a non-resident beneficiary). This income is reasonably attributed to periods in the income year where possible. [Subsection 268-45(2)]

Pro-rated assessable income

10.149 The second class is these items of assessable income that can be pro-rated over the income year according to the length of the period being considered. These kinds of income are listed in subsection 268-45(3) and include, for example, insurance pay outs for loss of livestock or trees which, under section 26B of the Act, can be spread in equal instalments over 5 years. [Subsection 268-45(3)]

Wool clips

10.150 The third class is amounts included in the trust's assessable income under section 26BA (double wool clips). These are attributed to the period when the wool would ordinarily have been shorn. [Subsection 268-45(4)]

Assessable income attributed to periods as if each period were an income year

10.151 The fourth class is income that is attributable to periods as if each period were an income year. This income is attributed accordingly. [Subsection 268-45(5)]

Example

10.152 As a result of section 268-30, a non-fixed trust is required to divide its income year into 2 periods. A stock take of trading stock is carried out at the end of the first period The value of the closing stock exceeds the value of the opening stock by $2000. This amount is to be included in assessable income under subsection 28(2) of the Act. This income is allocated to the first period as this is the period the income would have been attributed to if the period were an income year.

Full year amounts

10.153 The fifth class is full year amounts. This is income that is included in the assessable income of the trust in the year of income under section 97 (i.e. the trust's share in the net income of another trust as a presently entitled beneficiary) or section 98A (ie. the trust is a non-resident beneficiary) but where the income cannot be reasonably attributed to a particular period. As with full year deductions, these amounts are not attributed to a period but are brought to account in the final calculation of the trust's net income for the year. [Subsection 268-45(6)]

Example

10.154 A non-fixed trust receives income as a beneficiary of a trust estate which is assessable under section 97 of the Act. As a result of section 268-30, the trust is required to divide its income year into 2 periods. It is not possible to reasonably attribute any of this trust income to a particular period of the income year. The amount is treated as a full year amount which at a later stage is added on to the trust's total net income.

How do you work out the trust's net income for the income year?

10.155 If the income year of a trust has been divided into periods under Subdivision 268-B, the net income of the trust is calculated as follows:

the sum of the notional net incomes for the relevant periods; plus
any 'full-year amounts' that are to be included in the assessable income of the trust (i.e. the income of a trust that cannot be reasonably attributed to any period);

less

certain full year deductions (those listed in paragraphs 268-40(5)(a), (b) and (c));
if any amount remains, other full year deductions in the order shown in subsection 268-40(5). [Section 268-50]

10.156 An example of how the net income of the trust is calculated is shown at paragraph 10.161 below.

How do you work out the trust's section 79E loss for the income year?

10.157 Section 79E is the general provision in the Act that allows the carry forward of losses for post-1989 income years. If the income year of a trust has been divided into periods under Subdivision 268-B, the section 79E loss of the trust is:

the sum of the notional losses of any of the periods; plus
the amount by which any full year deductions listed at paragraphs 268-40(5)(a), (b) and (c) exceed:

-
the total of the notional net incomes (if any); and
-
the full-year amounts referred to in 268-45 (i.e. trust income that is not reasonably attributable to any period in the income year).

less

if the trust has derived any exempt income, the net exempt income. [Section 268-55]

How do you work out the trust's film loss for the income year?

10.158 As a result of subsection 79E(4) of the Act film losses incurred in a post-1989 year of income (i.e. a year of income commencing on 1 July 1989 or subsequent year of income) are effectively quarantined and can only be deducted in a later year of income against film income.

10.159 A trust's section 79F film loss is essentially worked out in the same way as a general section 79E loss except only the assessable film income, net exempt film income and film deductions are taken into account. The trust's film loss is the amount worked out in this way to the extent that it does not exceed the amount of the overall section 79E loss (including film losses) incurred in the year of income. The terms 'film deductions', 'assessable film income' and 'net exempt film income' are terms defined in subsection 79F(12). [Section 268-60]

Example

10.160 A trust's section 79E losses (including film losses) from the whole of its activities, calculated under section 268-55 are $8m. A trust's losses from its film activities calculated under subsections 268-60(1),(2) and (3) are $10m. Since the section 79E losses are less than the losses from its film activities the amount of the film loss for the year is $8m.

An example of how to calculate a trust's net income or loss for an income year

10.161 The trust's income year is divided into two periods with notional net income and notional losses as follows:

Period 1 notional loss $25,000
Period 2 notional net income $30,000

1. Calculation of net income
30,000 total notional net incomes
+ 1,000 full year amount (share of net income of trust estate)
31,000
- 1,200 full year deductions (bad debts)
29,800
- 100 other full year (gifts)
- 1,200 deductions (tax losses of earlier income years)
28,500 net income

The amount remaining, $28,500, is the trust's net income for the income year.

The amount is assessable under Division 6 of the Act.

2. Calculation of section 79E tax loss
25,000 notional loss
- 3,200 net exempt income
21,800 tax loss

The amount remaining, $21,800, is the trust's tax loss for the income year.

The loss may be able to be carried forward for deduction in a later year of income.

Subdivision 268-D - Supplementary rules for partnerships

How does the trust calculate its notional loss or net income for a period when the trust is a partner in a partnership?

10.162 Subdivision 268-D applies where a trust is a partner in a partnership from which it derives a share of the net income of the partnership or is entitled to a deduction for its share of the partnership loss.

10.163 The broad aim of the Subdivision is to attribute a share of the partnership's net income or loss to the trust. To do this, a notional net income of the partnership or a notional partnership loss is calculated on the same basis as if that partnership were a trust for which a notional net income or notional loss were being ascertained in relation to a period into which the trust's income year has been divided.

10.164 The trust's share of the partnership's notional loss or notional net income is added in to the trust's notional loss and notional net income for each of the periods. [Section 268-65]

10.165 If a trust has the same accounting period as the partnership the notional income and the notional loss of the partnership is to be allocated to the relevant periods of the trust on a percentage basis, i.e. according to the percentage interest of the trust in the partnership. If the trust has no net income or loss under Division 6 of the Act, ie. breaks even in the income year, the trust's share is a percentage that is fair and reasonable, having regard to the trust's interest in the partnership. [Section 268-70]

10.166 If the trust has a different accounting period from the trust, the partnership's notional net income or notional loss will be that which can be reasonably attributed to the income year of the trust. The trust's share is then calculated on a percentage basis as set out in paragraph 10.165 above. [Section 268-75]

10.167 If the trust and the partnership have the same accounting period, the full year deductions of the partnership are allocated to the trust on a percentage basis, depending on the trust's share in the partnership. If the trust and the partnership have a different accounting period the trust's share of full year deductions is to be what ever is fair and reasonable, having regard to any relevant circumstances. If the partnership had neither a net income nor partnership loss, the percentage is to be what is fair and reasonable having regard to the percentage interest of the trust in the partnership. [Section 268-80]

Division 269 - Tests applied in determining abnormal trading, 50% stake, control and continuity of business

10.168 Division 269 defines certain important concepts used in determining whether a trust can deduct a prior year or current year loss [section 269-5] . The meaning of each of these concepts is set out below.

Subdivision 269-B - When is there abnormal trading of units in a widely held unit trust?

10.169 The abnormal trading concept is used in determining when widely held unit trusts can deduct prior or current year losses. Whether there is an abnormal trading will be determined in one of two ways.

Where the trading is abnormal on balance having regard to certain factors

10.170 The first method is a general factual test where a number of factors must be weighed to determine whether the trading is, on balance, abnormal. Trading in this context means an issue, redemption or transfer of units in the widely held unit trust or other dealing in the trust's units [section 269-10] . All relevant factors (including the four factors specified in the Bill) must be taken into account in determining whether a trading is abnormal (e.g. the price paid for units). The specific factors in the Bill are:

the timing of the trading when compared to the normal timing for trading in units of the trust;
the number of units traded by comparison to the normal number of units traded (e.g. voluminous trading in units may indicate the possibility of a significant change in the underlying beneficial ownership of the trust);
any connection between the trading in units and any other trading (e.g. two or more lots of trading may be linked and may indicate a meaningful change in underlying beneficial ownership of the trust); and
any connection between the trading and a tax loss or other deduction of the trust (e.g. where units are bought because the trust has prior year losses). [Subsection 269-15(1)]

Where abnormal trading is deemed to have occurred

10.171 Abnormal trading will automatically be taken to have occurred in four sets of circumstances, as explained below. [Subsection 269-15(2)]

Trading of 5% or more in one transaction

10.172 Firstly, there is abnormal trading if 5% or more of the units in the trust are traded in one transaction [section 269-20] . The size of such a transaction is enough to indicate that there may have been a significant change in the underlying beneficial ownership of the trust.

More than 5% trading over 2 or more transactions

10.173 Secondly, there is abnormal trading if a person and/or associates of the person have acquired and/or redeemed 5% or more of the units in the trust in two or more transactions. However, this is only where the trustee of the trust knows or reasonably suspects that the acquisitions or redemptions have occurred and that they would not have been made if the trust did not have a tax loss or other deduction. This rule is similar in nature to the first (paragraph 10.172) but looks to the situation where the possibility of a significant change in underlying ownership is disguised in a number of transactions. [Subsection 269-25(1)]

10.174 If an abnormal trading is deemed to have taken place by the rule in paragraph 10.173, the time of the trading is the time of the transaction that pushes the trading over 5%. [Subsection 269-25(2)]

Suspected acquisition or merger

10.175 Under this category, there is an abnormal trading in units where the trading is part of a proposed take over of the trust or a proposed merger with another trust. However, the trading will only be abnormal where the trustee knows or reasonably suspects this to be the case. The abnormal trading will be taken to occur at the time of the trading. [Section 269-30]

More than 20% change in a 60 day period

10.176 Lastly, there is abnormal trading if:

ownership of more than 20% of the units changes in a 60 day period [subsection 269-35(1)] ;
units are issued to new unit holders and at the end of a 60 day period they have more than 20% of the units on issue [subsection 269-35(2)] ; or
more than 20% of the trusts units are redeemed in a 60 day period [subsection 269-35(3)] .

10.177 Again, these facts are enough to indicate that there may have been a significant alteration in the underlying beneficial ownership of the trust.

10.178 If an abnormal trading is deemed to have taken place by the rule in paragraph 10.176, the time of the trading is the end of the 60 day period. [Subsection 269-35(4)]

Example

10.179 An unlisted widely held trust has 100 units owned, directly and indirectly, by 30 individuals. On a day, 50 new units are issued to Jack, Jill, Mary and Bill, none of whom are existing unit holders.

10.180 There is an abnormal trading at the time of issue because, in the sixty days to that time, the new unit holders have gained, through issue, 40% of the units on issue after that time.

Subdivision 269-C - When are there persons who have more than a 50% stake in a trust or in the income or capital of a trust? (continuity of ownership)

10.181 The 50% stake concept is used in determining whether there has been a change in ownership of a trust with fixed entitlements. Whether persons have a 50% stake in a trust is determined by looking at both fixed entitlements to income and capital of the trust.

10.182 The 'more than 50% stake in income or capital' concepts are specifically used in the 50% stake condition that applies to non-fixed trusts (see paragraphs 10.103 to 10.108 above). They are also used in the 'more than 50% stake in a trust' concept (paragraph 10.186) and also in the definition of control (see paragraph 10.195 below).

10.183 The 'more than 50% stake in a trust' concept is specifically used in the 50% stake condition that applies to all fixed trusts, whether widely held unit trusts or not (see paragraphs 10.44, 10.56, 10.66 and 10.78 above).

When do individuals have more than a 50% stake in income?

10.184 Individuals have more than a 50% stake in the income of a trust at a time if the individuals between them have fixed entitlements, directly or indirectly, and for their own benefit, to more than 50% of the income of the trust. [Subsection 269-40(1)]

When do individuals have more than a 50% stake in capital?

10.185 Individuals have more than a 50% stake in the capital of a trust at a time if the individuals between them have fixed entitlements, directly or indirectly, and for their own benefit, to more than 50% of the capital of the trust. [Subsection 269-40(2)]

When do individuals have more than a 50% stake in a trust?

10.186 Individuals have more than a 50% stake in a trust at a time if the individuals have both:

more than a 50% stake in the income of the trust; and
more than a 50% stake in the capital of the trust. [Subsection 269-40(3)]

When does a person have a fixed entitlement in income or capital?

10.187 The meaning of a fixed entitlement in the income or capital of a trust is explained at paragraphs 10.232 to 10.238 below. Broadly, a person has a fixed entitlement where he or she has a vested and indefeasible interest in the income or capital of the trust (whichever is relevant). Some interests can be included as fixed entitlements where the Commissioner makes a determination to that effect.

When does a person have a fixed entitlement to income or capital for their own benefit?

10.188 A person receives something for his or her own benefit if the person receives the thing otherwise than in the capacity of a trustee.

When does a person have a fixed entitlement to income or capital indirectly?

10.189 Fixed entitlements will be taken to be held by an individual indirectly where the entitlements are held through one or more interposed companies, trusts or partnerships. Paragraphs 10.243 to 10.253 below set out the detailed rules that apply in determining whether a fixed entitlement is taken to be held indirectly.

An example of when the individuals have a 50% stake in a trust

10.190 Trust A, a fixed trust, has a prior year loss from Year 1. In Year 2, the Trust seeks to deduct that loss. Throughout Year 1 and part of Year 2 the following persons hold the fixed entitlements set out:

Jack has a 50% fixed entitlement to income and a 30% fixed entitlement to capital on winding up;
Jill has a 50% fixed entitlement to income and a 30% fixed entitlement to capital on winding up;
Mary has a 20% fixed entitlement to capital on winding up;
Bill has a 20% fixed entitlement to capital on winding up.

10.191 During Year 2, both Jack and Jill sell half of their fixed entitlements in Trust A to James. As a result, from the time of sale, James has a 50% fixed entitlement to income and a 30% fixed entitlement to capital on winding up.

10.192 Before the sale, Jack, Jill, Mary and Bill have, between them, 100% of the fixed entitlements to both income and capital of Trust A. After the sale, Jack, Jill, Mary and Bill have, between them, a fixed entitlement to income of 50% and a fixed entitlement to capital of 70%.

10.193 Trust A fails the 50% stake test. This is because there has been a 50% change in the natural persons who hold fixed entitlements to income of the trust for their own benefit. That is, the original owners of the fixed entitlements no longer hold more than 50% of the fixed entitlements to income of Trust A.

Subdivision 269-D - When does a group control a non-fixed trust?

10.194 The concept of control of a non-fixed trust is relevant to determining whether a non-fixed trust can deduct a prior or current year loss. The relevant rules are triggered if a person and/or his or her associates (called a group), either alone or together, begin to control a non-fixed trust in the test period.

10.195 A group is to be taken to be in a position to control a non-fixed trust if the group:

had the power, by whatever means, to obtain the beneficial enjoyment of the income or capital of the trust (e.g. through obtaining a fixed entitlement to that income or capital or by ensuring the exercise of a trustee discretion in their favour);
was able to control, directly or indirectly, the application of the income or capital of the trust;
was capable, under a scheme, of gaining the enjoyment or control referred to in the first two dot points;
was in a position such that the trustee of the trust was accustomed or under a formal or informal obligation, or might reasonably be expected to act in accordance with the directions, instructions or wishes of the group;
had the ability to remove or appoint the trustee or any of the trustees of the trust;
acquired more than a 50% stake in the income or capital of the trust (i.e. gained fixed entitlements to more than 50% of the income or capital). [Section 269-45]

10.196 Whether the trustee of the trust was accustomed or might reasonably be expected to act in accordance with the directions, instructions or wishes of a group is to be determined having regard to all the circumstances of the case. For example, the mere presence in the trust deed of a requirement that the trustee should have no regard to such directions, instructions or wishes would not prevent the examination of the actual circumstances to determine whether the group controls the trust.

10.197 Some examples of the factors which might be considered are:

the way in which the trustee has acted in the past;
the relationship between the group and the trustee;
the amount of any property or services transferred to the trust;
any arrangement or understanding between the group and a settlor or persons who have benefited under the trust in the past.

Example: A group takes a 50% stake in a trust

10.198 Trust A has a tax loss in Year 1 which it seeks to deduct in Year 2. At the start of Year 1 it is a purely discretionary trust (i.e. none of the income or capital is the subject of a fixed entitlement). During Year 2, under an arrangement between the original settlor of the trust and a group, 60% of the income of the trust becomes the subject of a fixed entitlement held by the group. In this case, the group begins to control the trust in the 'test period' and the loss is not deductible (see paragraph 10.109 above).

Subdivision 269-E - When does a trust pass the continuity of business test?

10.199 The continuity of business test is relevant to determining whether a listed widely held trust can deduct a prior or current year loss. The test is split up into two parts. The first part is those rules that apply to determine whether the trust passes the continuity of business test for both prior year and current year loss purposes. The second part applies only in determining whether the trust passes the continuity of business test for current year losses.

10.200 Thus, for prior year loss purposes, the trust needs to satisfy the first part of the continuity of business test. For current year loss purposes, the trust needs to satisfy both the first and second parts of the continuity of business test.

The rules of the test that apply for both prior and current year loss purposes

10.201 A trust satisfies this part of the continuity of business test if it meets three cumulative conditions [subsection 269-50(1)] . The conditions are as set out below.

10.202 The first condition is that the trust must, at all times in the period being considered, carry on the same business as it carried on immediately before the particular time being considered. [Subsection 269-50(2)]

10.203 The mere status of a trust as a trust does not mean that it cannot carry on a business [subsection 269-50(3)] . This ensures that a trust will be taken to carry on a business where it has the usual elements of a business (e.g. profit motive, regular transactions, business records, etc.).

10.204 The second condition is that the trust must not, at any time in the period being considered, derive income from:

a business of a kind that it did not carry on before the particular time being considered; or
a transaction of a kind that it had not entered into in the course of its business operations before the particular time being considered. [Subsection 269-50(4)]

10.205 The third condition is that the trust must not, before the particular time being considered, do certain things for the purpose, or for purposes including the purpose, of being taken to have carried on, at all times in the period being considered, the same business as it carried on immediately before the particular time [subsection 269-50(5)] . The things that the trust must not do are:

start to carry on a business it had not previously carried on; or
in the course of its business operations, enter into a transaction of a kind that it had not previously entered into.

The rules of the test that apply for current year loss purposes only

10.206 A trust satisfies this part of the continuity of business test if it does not, at any time in the period being considered:

incur expenditure in carrying on a business of a kind that it did not carry on before the particular time being considered; or
incur expenditure as a result of a transaction of a kind that it had not entered into in the course of its business operations before the particular time being considered. [Subsection 269-50(6)]

Division 270 - Schemes to take advantage of tax loss and other deductions

10.207 The purpose of Division 270 is to disallow a trust a deduction for prior year losses or losses or outgoings incurred in the current year where certain schemes are involved. The test that is applied under this Division is referred to as the income injection test . The test operates objectively and does not have a tax avoidance motive as one of its elements.

10.208 The test is designed to ensure that a trust cannot deduct prior year losses or current year expenses in certain circumstances. These are where, although a trust has technically satisfied the tests set out in Divisions 266 and 267 (eg. it has continuity of ownership), the benefits from the allowance of the deductions flows to persons (or certain associates) who have, in effect, given a benefit to a trustee or beneficiary of a trust (or associates of those persons) in return for the benefit of the deductions. The test can also apply where an allowable deduction is injected into a trust to offset assessable income derived by a trust in the income year being examined. The income injection test does not apply to complying superannuation funds, complying approved deposit funds, pooled superannuation trusts and deceased estates within a reasonable administration period (see paragraph 271-50(c) of Schedule 2C ).

When does the income injection test apply?

10.209 The following flow charts set out, in broad terms, the two sets of circumstances in which a deduction for a prior year loss or a current year deduction will be disallowed under the income injection test.

The first test (subsection 270-10(1))

The first test (subsection 270-10(1)

The second test (subsection 270-10(2))

The second test (subsection 270-10(2)

Elements of the income injection test

10.210 There are a number of elements that need to be met before the test applies. The first is that the trust has a deduction for a prior year loss or a loss or outgoing that is deductible in the income year being examined. The other elements are that, under a scheme:

the trust derives assessable income in the income year;
a person not connected with the trust (the outsider), directly or indirectly provides a benefit to the trustee or a beneficiary (or their associates) and the trustee or a beneficiary (or associates) directly or indirectly provides a benefit to the outsider (or an associate who is not a family beneficiary of the trust other than under the scheme); and
it can reasonably be concluded that if the particular deduction was not available either one or both of the following events would have occurred:

-
the trust would have derived a different amount of assessable income or the value of the benefit provided to the trustee or beneficiary (or their associates) would have been different, or both; or
-
the value of the benefit provided by the trustee or a beneficiary (or associate) would have been different. [Subsection 270-10(1)]

10.211 The test set out in paragraph 10.210 can also apply where the only advantage given to the trust is assessable income or an allowable deduction and a benefit is given to any outsider. [Subsection 270-10(2)]

10.212 Where the income injection test applies, the particular deduction mentioned in the third dot point of paragraph 10.210 is not allowable in the income year being examined. However, if the deduction is a prior year loss, it may still be able to be deducted in a later year of income.

10.213 The test as outlined in paragraph 10.210 has regard to the value of any benefit provided to the trustee or a beneficiary (or associates) and the value of any benefit provided by the trustee or beneficiary (or associates) to another person. The value of benefits provided will be affected by the availability of losses or deductions in the trust. For example, a person would have to transfer a larger income stream into a non-loss trust, to be able to receive in return from the trustee the same distribution that would have been received by that person had losses been available to shelter the income stream from tax.

10.214 The overall benefit provided by the trustee or a beneficiary (or associates) will generally be an effective reduction in the outsider's (or associates') tax liability. However, the broad nature of the test ensures that the test will also apply in circumstances where benefits apart from tax benefits are received.

Terms used in the income injection test

What is a scheme?

10.215 For the purposes of this test the term scheme takes on the same meaning as in Part IVA of the Act (see paragraph 10.281 below).

What is an 'outsider'?

10.216 A person is an outsider where that person is not a trustee or specified beneficiary of the trust or is a person who became a trustee or specified beneficiary under the scheme [subsection 270-10(3)] . For this purpose, a specified beneficiary means a person who has a fixed entitlement in the income or capital of the trust or, if the trust is a family trust, a family member who is a beneficiary of the trust. Thus, the income injection test will apply where the person (the outsider) who has obtained, or whose affected associates have obtained, a benefit is unconnected to the trust or became connected to the trust under the scheme. Where income or a deduction is injected into a trust by a connected person (non-outsider), Part IVA of the Act may nevertheless be applicable to deny a deduction.

What is a benefit?

10.217 The term benefit is broadly defined. It includes any benefit within the ordinary meaning of that expression. However, it is defined to specifically include money or other property (whether tangible or intangible), rights (whether proprietary or not), services and the extinguishment, forgiveness, release or waiver of a debt or other liability. [Subsection 270-10(4)]

Examples of how the income injection test applies

Example 1

10.218 A is the trustee of a discretionary trust that has carry forward losses of $1m. Under a scheme, B:

pays a $200,000 fee to the trustee of the trust;
leases an income producing property to the trust; and
is made a discretionary object of the trust.

The income derived from the property is sheltered from tax by the losses and the trust income is distributed to B free of tax.

10.219 The trust loss is not allowable as a deduction to the trust. In terms of subsection 270-10(1) (paragraph 10.210 above) the benefit provided by B is the $200,000 fee and the income gained by leasing the income producing property for a higher rental and the benefit provided by A is the distribution of income to B. If it were not for the losses, B would have had to provide a greater benefit to A to obtain the same distribution of income from A in return and the fee would not have been paid.

Example 2

10.220 A company becomes a partner in a leveraged leasing partnership which is formed for the purpose of acquiring depreciable assets with borrowed funds and leasing the assets. In the early years of the arrangement taxable income is nil as deductions exceed assessable income (e.g. because of depreciation expenses). However, in the later years the assessable income will be much greater than the allowable deductions.

10.221 Once there is taxable income, the company assigns most of its interest as a partner by way of an Everett assignment to a unit trust. Units in that trust are then sold to trusts with losses. The taxable income flows through the unit trust to the trusts with losses to be absorbed by the losses.

10.222 The loss trusts receive a benefit, i.e., a small accounting profit derived by the unit trust from the leasing partnership. This benefit is smaller than that which would have been given at arm's length under the arrangement if there were no trust losses. This is because the trusts would have had to pay tax on the taxable income from the leases if the losses were not available. The trusts would have had to be given a higher benefit to take account of the tax payable. The income injection test, as set out in subsection 270-10(2) (paragraph 10.210 above) will apply to deny the deduction to the trust.

Example 3

10.223 A father transfers income into a family trust with losses that has the father, mother and children as beneficiaries. The trust loss will be able to be carried forward to be offset against the injected income. The transfer of the income is merely gratuitous. The income injection test will not apply to deny deductions to the trust. This will apply only in the context of a family trust.

Example 4

10.224 Two brothers, A and B, have family trusts whose beneficiaries consist of their respective families. Brother A's trust has losses while Brother B's trust is profitable.

10.225 Under a scheme Brother B's trust becomes a beneficiary of Brother A's trust. Brother B's trust then provides services through that trust. The income generated by the services is sheltered from tax by the losses. The income from Brother A's trust is distributed to the Brother B's trust free of tax (this is the return benefit). Subsection 270-10(1) (paragraph 10.211 above) will apply to deny the loss deduction to Brother A's trust.

Example 5

10.226 The same group of persons control and benefit from two non-family discretionary trusts. One trust has carry forward losses. The other trust trades profitably. The profitable trust makes a low interest loan to the loss trust. The trust with profits is made a beneficiary of the trust with losses. The loss trust derives income as a result of the low interest loan and a tax-free distribution is made to the profitable trust.

10.227 Subsection 270-10(1) (paragraph 10.210 above) will apply so that the loss trust is denied the loss deductions. The benefit provided to the loss trust is the low interest loan and the benefit provided to the profitable trust is the interest and the distribution of income. If it were not for the losses the profitable trust would have had to provide a greater benefit to the trust to obtain the same distribution of income.

Example 6

10.228 A trust has earned assessable income in the income year. Under a scheme a person transfers to the trust a subsection 51(1) deduction which reduces the trust's net income.

10.229 In return the person who transferred the deduction receives a tax-free distribution from the trust. The amount of the tax-free distribution would normally be a percentage of the tax saving made by the trust. Under subsection 270-10(1) the trust will be denied the injected deduction.

Division 271 - Interpretation

Subdivision 271-A - What is a fixed entitlement to income or capital?

10.230 The concept of a fixed entitlement is central to the operation of the trust loss measures. A fixed entitlement to income or capital is defined for each of the following:

trusts;
companies; and
partnerships.

10.231 Fixed entitlements in trusts are used to determine whether a trust is a fixed trust or a widely held unit trust, whether a trust has continuity of ownership and control and for tracing indirect entitlements in other trusts. Fixed entitlements in companies and partnerships are used in the legislation to trace whether a person has an indirect fixed entitlement to the income or capital of a trust.

What is a fixed entitlement to income or capital of a trust?

10.232 A person (the beneficiary) will have a fixed entitlement to either income or capital of a trust (whichever is applicable) where the beneficiary has a vested and indefeasible interest in a share of the income of the trust that the trust derives from time to time (i.e. current and future income), or a share of capital of the trust. [Subsection 271-5(1)]

10.233 The share that the person has an interest in is expressed as a percentage of the total income or capital (whichever is applicable) of the trust. Note that a beneficiary's vested interest in income or capital of a unit trust will not be taken to be defeased because new units are issued, or existing units cancelled.

What is a vested interest?

10.234 A person has a vested interest in something if the person has an immediate right relating to the thing. In traditional legal analysis, a person can be either said to be 'vested in possession' or 'vested in interest'.

10.235 A person is vested in possession where the person has a right to immediate possession of the thing in question. On the other hand, a person is vested in interest where the person has a present right to the future possession of the thing. In the definition of fixed entitlement, 'vested' means vested in possession or vested in interest. If an interest of a beneficiary in income or capital is the subject of a condition precedent, so that an event must occur before the interest becomes vested, the beneficiary does not have a vested interest to the income or capital.

When is a vested interest indefeasible?

10.236 A vested interest is indefeasible where, in effect, it is not able to be lost or varied. A vested interest is defeasible where it is subject to a condition subsequent that may lead to the entitlement being divested. A condition subsequent is an event that could occur after the interest is vested that would result in the entitlement being defeated, for example, on the occurrence of an event or the exercise of a power. For example, where a beneficiary's vested interest is able to be varied by the exercise of a power by the trustee or any other person, the interest will not be a fixed entitlement.

Commissioner's discretion to treat an entitlement as not being able to be varied

10.237 The Bill gives the Commissioner a discretion to determine that an interest of a beneficiary to income or capital that is not vested and indefeasible can be treated as vested and indefeasible. This in turn would mean the interest could be treated as a fixed entitlement. The Commissioner could exercise this power having regard to:

the circumstances in which the beneficiary's interest would not be vested or is not indefeasible;
the likelihood of the interest not vesting or not being indefeasible; and
the nature and type of the trust. [Subsection 271-5(2)]

10.238 This provision is intended to provide for special circumstances where there is a low likelihood of a beneficiary's vested interest being changed and, having regard to the scheme of the trust loss provisions to prevent trafficking in losses, it would be unreasonable to treat the trust as having to satisfy the additional tests required of a non-fixed trust.

What is a fixed entitlement to income or capital of a company?

10.239 A fixed entitlement in a company is defined for both income and capital.

10.240 A person has a fixed entitlement to income of a company if the person is the beneficial owner of shares in the company that carry any right to receive dividends that might be paid by the company. The extent of the entitlement is expressed as a percentage of the total dividends that might be paid by the company. [Subsection 271-10(1)]

10.241 A person has a fixed entitlement to capital of a company if the person is the beneficial owner of shares in the company that carry the right to receive any return of capital in the company to all shareholders (e.g. in the event of winding-up, or of a reduction in the capital, of the company). The extent of the entitlement is expressed as a percentage of the total capital that would be distributed. [Subsection 271-10(2)]

What is a fixed entitlement in a partnership?

10.242 A person will have a fixed entitlement to either income or capital of a partnership (whichever is applicable) where the following conditions are met:

the beneficiary is entitled to a share of the income of the partnership that the partnership derives from time to time (i.e. current and future income), or a share of capital of the partnership; and
the share is not able to be varied. [Subsection 271-15(1)]

10.243 As with trusts, the Commissioner will have a discretion to treat an entitlement to income or capital of a partnership as a fixed entitlement in special circumstances notwithstanding that the partner's share is able to be varied. [Subsection 271-15(2)]

When is a fixed entitlement held indirectly?

10.244 The concept of a fixed entitlement being held indirectly through one or more interposed companies, trusts or partnerships (all called entities for this purpose) is used in determining whether:

individuals have more than a 50% stake in the income or capital of a trust (see paragraph 10.181 to 10.193);
an individual is taken to hold units in a unit trust for the purposes of the widely held unit trust definition (paragraph 10.270 to 10.273).

Tracing through fixed entitlements in companies, partnerships and trusts

10.245 A person will be taken to have a fixed entitlement in the income or capital of a trust if the person is indirectly entitled to the income or capital through fixed entitlements in a chain of one or more interposed entities [subsection 271-20(1)] . The income or capital that a person is entitled to through interposed entities is determined by multiplying the entitlements of the person in each successive entity.

10.246 When tracing fixed entitlements to income of the loss trust, the fixed entitlements to income of the interposed entities are taken into account. When tracing fixed entitlements to the capital of the loss trust, the fixed entitlements to capital of the interposed entities are taken into account.

10.247 All relevant fixed entitlements of one entity in another are expressed as a percentage of the total fixed entitlements to income or capital of the entity concerned (whichever is applicable).

10.248 To determine one entity's fixed entitlement in an entity immediately above it, the entitlement of the lower entity in the higher entity is multiplied by the entitlement of the higher entity in the loss trust. If the higher entity is the loss trust being considered, the entitlement of the lower entity is multiplied by its fixed entitlement in the loss trust.

Example 1: A simple example of how fixed entitlements are traced

10.249 Trust A has prior year losses. Company B has a 40% fixed entitlement to the income of the trust and a 40% fixed entitlement to capital. Jack holds 60% of the shares in Company B all of which are of the same class.

10.250 Jack's fixed entitlement to the income of Trust A is 60% (his fixed entitlement to income (dividends) of Company B) multiplied by 40% (Company A's fixed entitlement in the income of Trust A). This gives Jack a 24% fixed entitlement in the income of Trust A for the purposes of the 50% stake test. Jack's fixed entitlement to capital of Trust A is worked out in the same way (also 24%) except that it is traced through Jack's fixed entitlement to capital.

Example 2: A more complex example of how fixed entitlements are traced

10.251 Jill holds an indirect fixed entitlement to the income of Trust A through the structure set out in the following diagram.

Example 2

10.252 The following steps are taken in working out Jill's fixed entitlement in Trust A.

Step 1: Partnership B's fixed entitlement to the income of Trust A is ascertained. This is 60%.

Step 2: Company C's fixed entitlement to the income of Partnership B (50%) is multiplied by Partnership B's fixed entitlement to the income of Trust A (60%). This equals 30%.

Step 3: Trust D's fixed entitlement to income (dividends) of Company C (100%) is multiplied by Company C's indirect fixed entitlement to the income of Trust A (30%). This equals 30%.

Step 4: Jill's fixed entitlement to the income of Trust D (50%) is multiplied by Trust D's indirect fixed entitlement to the income of Trust A (30%). This equals 15%.

The result is that Jill is taken to have a fixed entitlement to 15% of the income of Trust A.

Tracing through non-fixed interests in trusts

10.253 If a fixed entitlement to income or capital of a trust (the head trust) is held by a non-fixed trust in which no persons have a fixed entitlement to income or capital, there will not be individuals who have a fixed entitlement to any of the income or capital of the head trust to which the trustee of the interposed non-fixed trust has a fixed entitlement. This is because it is only possible to trace through fixed entitlements in a non-fixed trust in order to determine if an individual has a fixed entitlement to the whole or part of the income or capital of the head trust to which the trustee of the interposed non-fixed trust has a fixed entitlement.

10.254 However, where there are persons who have fixed entitlements to income or capital of a non-fixed trust which is interposed between the head trust and an individual, a fixed entitlement to income or capital of the head trust will be able to be traced through the interposed non-fixed trust to the extent of the fixed entitlement.

What if a fixed entitlement is held through a family trust?

10.255 A special rule will apply to circumstances where a fixed entitlement to the income or capital of an entity (the head entity) is held by a family trust. The trustee of the family trust will be taken to have that fixed entitlement to the income or capital of the head entity for its own benefit if the family trust is a family trust at all times being tested. [Subsection 271-20(2)]

Avoidance arrangements

10.256 The Bill contains a provision to deal with avoidance arrangements designed to ensure that persons have a fixed entitlement in a trust of a certain level. The Commissioner will be allowed to treat a fixed entitlement held by a person as not having been held by the person if certain conditions are met.

10.257 The conditions are that an arrangement must have been entered into and:

the arrangement is in some way related to, affected or dependent for its operation, whether directly or indirectly, on the fixed entitlement or the value of the fixed entitlement - this condition makes the necessary link to the entitlement that the Commissioner would treat as not being held by a person; and
the purpose, or one of the purposes, of the arrangement was to ensure that persons would have more than a 50% stake in the trust or that the trust would be a widely held unit trust - this makes it clear that the arrangement has been entered into to ensure the trust passes the continuity of ownership test or is treated under the more favourable rules applying to widely held unit trusts. [Section 271-25]

What happens if a beneficial owner of an entitlement dies?

10.258 The Bill makes special provision for the situation where the beneficial owner of a fixed entitlement in a trust dies. This is necessary to prevent a trust failing the 50% stake (continuity of ownership) test or the widely held unit trust definition merely because a stakeholder in the trust dies. Where the individual dies, the fixed entitlement is taken to continue to be owned by the individual as long as:

the entitlement is held by the trustee of the dead person's estate; or
the entitlement is held by a person who is a beneficiary of the dead person's estate. [Section 271-30]

Subdivision 271-B - Fixed trusts and non-fixed trusts

What is a fixed trust?

10.259 A fixed trust is a trust where all of the income or capital of the trust is the subject of fixed entitlements held by persons. A person in this context includes a natural person, a company, a trustee or the partners in a partnership. Thus, for example, a trust where some part of the income or capital may be distributed on the discretion of the trustee or another person is not a fixed trust. [Section 271-35]

What is a non-fixed trust?

10.260 A non-fixed trust is any trust which is not a 'fixed trust'. Thus a non-fixed trust could include a large range of trusts from those that are purely discretionary to those that are fixed but where some or all of the entitlements in the trust are defeasible. Trusts that have both fixed and non-fixed elements (hybrid trusts) are also non-fixed trusts for the purposes of the proposed legislation. [Section 271-40]

Subdivision 271-C - What is a family trust?

10.261 The definition of 'family trust' is crucial to the operation of the provisions. Family trusts will not be affected by the proposed amendments, other than the income injection test.

10.262 A trust is a family trust if an individual and his or her family are the only persons who are capable of receiving income or capital from the trust. That is, the individual and his or her family must be the only persons to whom the trustee of the trust may directly or indirectly make a distribution of income or capital of the trust whether during the life of the trust or on its vesting. However, special provision is made to ensure a family trust retains its status as such where certain bodies, such as charitable institutions, can benefit under the trust on the death of family members. [Subsection 271-45(1)]

10.263 An individual's family is defined broadly as:

a spouse or former spouse of the individual;
a parent, brother, sister, child, nephew or niece of the individual or of the individual's spouse or former spouse;
a child of any of the individuals mentioned above who could benefit under the trust on the death of the individual;
a grandparent or great-grandparent, grandchild, aunt or uncle of the individual; or
a spouse or former spouse of any of the above. [Subsection 271-45(2)]

(A reference to an individual in any of the above categories does not include an individual in the capacity of trustee).

10.264 The fact that on the death of all the beneficiaries there is a religious, scientific, charitable or educational institution which is exempt from income tax under paragraph 23(e) of the Act or a body listed in certain gift provisions of the Act that would benefit under the trust would not prevent the trust from being a family trust. [Subsection 271-45(3)]

10.265 In determining whether an individual's family are the only persons who are capable of receiving distributions indirectly from the trust, it will be possible to look through interposed companies, trusts and partnerships. If the only persons who can receive income or capital from any of the interposed entities are family members (as defined), then the trust will still be treated as a family trust. The following examples illustrate this idea.

Example 1

10.266 Trust A (a discretionary trust) has as a class of possible beneficiaries Jill (an individual), her spouse and children and Company B. Half the shares in Company B are held by Jill and the other half are held by Jill's business associate, Mary. Mary is not a family member as defined. Trust A is not a family trust because someone other than a family member (Mary) is capable of receiving distributions, indirectly, from the trust.

Example 2

10.267 The facts are the same as in Example 1 except Mary is Jill's sister. Trust A is a family trust because only family members are capable of receiving distributions, directly and indirectly, from the trust.

Subdivision 271-D - What is an excepted trust?

10.268 There are five kinds of trusts that are excepted trusts . They are family trusts (as defined above), complying superannuation funds, complying approved deposit funds, pooled superannuation trusts and deceased estates within a reasonable administration period. [Section 271-50]

10.269 The definitions of a complying superannuation fund, a complying approved deposit fund and a pooled superannuation trust are taken from sections 45, 47 and 48 of the Superannuation Industry (Supervision) Act 1993 respectively. [Paragraph 271-50(b)]

10.270 The term 'deceased estate' has its ordinary meaning. It is generally a trust formed on the death of a person, either by a will or codicil of that person or under rules applying to a person who dies intestate. For the purposes of the legislation, a deceased estate will only be treated as an excepted trust during a reasonable administration period. This period is the part of the income year from the date of death of the person and the next five full income years [paragraph 271-50(c)] . This will give the trustee of the deceased estate ample opportunity to complete the administration of the estate.

Subdivision 271-E - What is a widely held unit trust?

10.271 Listed widely held trusts, unlisted very widely held trusts and unlisted widely held trusts are all widely held unit trusts with particular characteristics.

10.272 A widely held unit trust is a fixed trust in which more than 20 individuals hold, directly or indirectly, 75% or more of the fixed entitlements to income and capital of the trust (the 20-75 test). The entitlements of the beneficiaries in the trust are evidenced by unit holdings. In addition, at least some of the units in the trust must be prescribed interests which have been offered for subscription or purchase within the meaning of Part 7.12 of Chapter 7 of the Corporations Law. This generally requires the unit trust to issue a prospectus on the sale of some units in the trust. [Subsection 271-55(1)]

10.273 For the purposes of the definition of a widely held unit trust a person and his or her relatives and nominees are treated as being one individual. This will prevent an individual circumventing the intent of the 20-75 rule by having family members or nominees holding units on his or her behalf. [Subsection 271-55(2)]

10.274 The rule that 20 or fewer persons must not hold 75% or more of the interests in income and capital of the trust is affected by an anti-avoidance provision which is similar to those contained in section 102G of the Act. This provision looks to the rights attached to units and at any arrangement, contract, etc. that would affect those rights in a way that would circumvent the 20-75 rule. If the rights attaching to units are capable of being varied or abrogated in such a way that less than 20 individuals would, directly or indirectly, hold 75% or more of the fixed entitlements to the trust's income and capital, the trust will not be a widely held unit trust. [Subsection 271-55(3)]

Subdivision 271-F - Listed and unlisted widely held trusts

What is an unlisted widely held trust?

10.275 An unlisted widely held trust is a widely held unit trust whose units are not listed for quotation in the official list of an approved stock exchange within the meaning of section 470 of the Act. [Section 271-60]

What is a listed widely held trust?

10.276 A listed widely held trust is a widely held unit trust whose units are listed for quotation in the official list of an approved stock exchange within the meaning of section 470 of the Act. [Section 271-65]

Subdivision 271-G - What is an unlisted very widely held trust?

10.277 An unlisted very widely held trust is an unlisted widely held unit trust with at least 1,000 unit holders. All of the units in the trust must carry the same rights and be redeemable at any time. The redemption price must be a true reflection of the trust's market value, i.e. based on its net asset value according to Australian accounting principles. [Subsection 271-70(1)]

10.278 The trust must engage only in investment or business activities that are set out in the trust instrument or deed and prospectus of the trust. All these activities must be carried out at arm's length. Thus, if any of the activities are not at arm's length, the trust will not be an unlisted very widely held trust. [Subsection 271-70(2)]

Subdivision 271-H - Other definitions not previously dealt with [section 271-75]

What is an associate?

10.279 The term associate has the same meaning as in section 318 of the Act. This kind of definition is commonly used in the income tax law to define who an associate of another person is.

What is an income year?

10.280 The term income year is used throughout the provisions dealing with trust losses. It is a short hand way of saying 'year of income'. The term 'year of income' is defined in subsection 6(1) of the Act.

What is a loss year?

10.281 A loss year is simply a year of income in which a tax loss was incurred.

What is a scheme?

10.282 The term 'scheme' is used mainly in the income injection test. It has the same meaning as that term has in Part IVA of the Act. Part IVA is the general anti-avoidance provision in the income tax law.

10.283 In Part IVA a scheme is defined as:

'(a)
any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b)
any scheme, plan, proposal, action, course of action or course of conduct.'

What is a tax loss?

10.284 A tax loss is defined as a loss within the meaning of sections 79E, 80 or 80AA or a film loss within the meaning of sections 79F or 80AAA. Those sections are the provisions of the Act which deal with the deductibility of losses. In general terms, a tax loss arises when a taxpayer's non-loss allowable deductions exceed assessable income and net exempt income.

Consequential amendments (Part 2 of Schedule 7)

10.285 Part 2 of Schedule 7 of the Bill makes a number of amendments consequential on the insertion in the Act of Schedule 2C. The consequential amendments integrate Schedule 2C into the loss and net income calculation rules in the Act. [Items 2, 3 and 4]

10.286 Amendments are made to sections 79E and 79F of the Act. These amendments will ensure that, before a prior year loss or film loss of a trust is deductible by the trust in calculating net income, the rules proposed in the Bill must be satisfied. [Subsections 79E(2A) and 79F(5A)]

10.287 An amendment is also made to section 95 of the Act. Section 95, among other things, outlines the method by which a trust's net income is calculated. The amendment made by the Bill to section 95 will make it clear that a trust may be required to work out its net income or loss in a special way if the relevant rules in the Bill are triggered. This integrates the proposed current year loss rules for trusts into the Act. [Subsection 95(1A)]

Application and transitional (Part 3 of Schedule 7)

10.288 Part 3 of Schedule 7 of the Bill deals with application and transitional matters. The amendments are of two kinds:

application arrangements; and
transitional arrangements for trusts that become family trusts after 1995 Budget time.

Application arrangements

10.289 In general terms, the provisions dealing with trust losses (Schedule 2C) inserted in the Income Tax Assessment Act 1936 by the Bill will apply to all trafficking in trust losses after 1995 Budget time. 1995 Budget time means 7.30 pm, by legal time in the Australian Capital Territory (i.e. Australian Eastern Standard Time), on 9 May 1995. [Item 5]

10.290 The provisions in Schedule 2C will apply where the income year in question is the 1994-95 income year or later income years [subitem 6(1)] . This provision, in part, ensures that the trust loss provisions can apply to any events that may occur between 1995 Budget time on 9 May 1995 and the end of the 1994-95 income year on 30 June 1995 (or substituted accounting period ending after 1995 Budget time).

Application of prior year loss rules

10.291 For the prior year loss provisions, the Bill ensures that the proposed measures will apply only from 1995 Budget time for the 1994-95 and later income years by saying that the 'test period' for any trust applying those measures will commence just before the Budget time [subitem 6(2)] . This will be the case where the loss was incurred in the 1994-95 income year or an earlier year. The 'test period' is the period used in determining whether certain events that will prevent the deduction of a prior year loss have occurred.

10.292 There is also a provision to ensure that the pattern of distributions test that applies for non-fixed trusts (see paragraphs 10.91 to 10.102 above) will, in effect, only apply from the date of introduction of the Bill into the Parliament. The application of this test is different because the details of the test, as they are presented in the Bill, have not previously been announced. This special application provision will ensure no retrospective operation of the test. It does this by saying at least part of the test year distribution in the 1995-96 income year must occur after the date of introduction. [Subitem 6(3)]

Application of current year loss rules

10.293 The Bill also makes similar provision for the current year loss rules by saying the following about the events that may lead to a trust having to calculate its net income or tax loss in a special way:

no abnormal trading in a trust's units and no accounting period of a trust is taken to have occurred, in the 1994-95 income year, before 1995 Budget time; and
the fixed entitlements of persons to income or capital of a trust and the control of a trust that existed just before 1995 Budget time are taken to have existed throughout the 1994-95 income year to the Budget time. [Subitem 6(4)]

Application of income injection test

10.294 The income injection test will only apply where the following happens:

the benefit (if applicable) provided to the trust, beneficiary or associates under an income injection scheme is provided after 1995 Budget time; and
the assessable income derived under the scheme is derived after 1995 Budget time. [Subitem 6(5)]

Transitional arrangements for family trusts

10.295 A special transitional provision will apply for family trusts. This provision will give some trusts which are not strictly family trusts the opportunity to alter their arrangements so that they can benefit from the concession in the proposed rules for family trusts. Essentially, these trusts will be given from 1995 Budget time to the start of the 1996/97 income year to make the necessary alterations.

10.296 The trusts affected are those that were predominantly family trusts at 1995 Budget time (i.e. 7.30 pm AEST on 9 May 1995 and equivalent time elsewhere). The provision will apply to such a trust that:

becomes a family trust after 1995 Budget time but before the start of the 1996/97 year of income; and
between 1995 Budget time and the time the trust becomes a family trust, satisfies the ordinary tests for deductibility of losses that will apply to trusts that are not family trusts (this would be the tests for fixed trusts if the trust is a fixed trust or the tests for non-fixed trusts if the trust is a non-fixed trust).

10.297 If the provision applies, the trust will be treated as having been a family trust at all times between 1995 Budget time and the time the trust became a family trust. In turn this will mean the trust cannot be prevented from deducting a prior or current year loss except by the income injection test. [Item 7]


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