House of Representatives

Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997

Family Trust Distribution Tax (Primary Liability) Bill 1997

Family Trust Distribution Tax (Primary Liability) Act 1998

Family Trust Distribution Tax (Secondary Liability) Bill 1997

Family Trust Distribution Tax (Secondary Liability) Act 1998

Medicare Levy Consequential Amendment (Trust Loss) Bill 1997

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Glossary

In this Explanatory Memorandum, the following Bills and Acts are referred to by the abbreviations indicated:

Income Tax Assessment Act 1936 ITAA 1936
Income Tax Assessment Act 1997 ITAA 1997
Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 the Bill

References in this Explanatory Memorandum to items and sections contained in the amendments are references to those in the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997, unless otherwise indicated.

Chapter 1 - General Outline

1.1 The Taxation Law Amendment (Trust Loss and Other Deductions) Bill 1997 will insert Schedule 2F, dealing with trust losses, into the ITAA 1936. This Schedule sets out rules that have to be satisfied by trusts before a deduction is allowed for prior year and current year losses and certain debt deductions.

1.2 There are also three complementary Bills. Two of these impose a special tax which may become payable under the measures. These are the Family Trust Distribution Tax (Primary Liability) Bill 1997 and the Family Trust Distribution Tax (Secondary Liability) Bill 1997. The third complementary Bill, the Medicare Levy Consequential Amendment (Trust Loss) Bill 1997, makes a consequential amendment to the Medicare Levy Act 1986. Separate Bills are necessary for constitutional reasons.

1.2 The proposed trust loss legislation was presented to the Parliament by the previous Government as part of the Taxation Laws Amendment Bill (No. 4) 1995. The Government announced in the 1996-97 Budget that it would proceed with the trust loss measures and that the general commencement date would remain as 9 May 1995, the date of the previous Government's announcement in the 1995-96 Budget.

1.3 The Bill is broadly along the same lines as the 1995 Bill. However, a number of significant changes have been made generally to reduce the adverse impact on taxpayers. Many of the changes were made having regard to representations received on the measures including submissions made on an exposure draft of the legislation which was released for public comment on 10 February 1997.

Regulation Impact Statement

Specification of policy objective

1.4 The purpose of the trust loss measures is to restrict the recoupment of prior year and current year losses and debt deductions of trusts in order to prevent the transfer of the tax benefit of those losses or deductions. The tax benefit of losses is transferred when 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 measures are intended to prevent a significant leakage of revenue that has resulted from the transfer of the tax benefit of trust losses.

1.5 The measures achieve this aim by examining whether there has been a change in underlying ownership or control of a trust or whether certain schemes have been entered into in order to take advantage of a trust's losses.

Implementation

1.6 The implementation of this measure involves amending the tax law to insert a new Schedule dealing with trust losses. This Schedule sets out tests that have to be satisfied by trusts before a deduction is allowed for prior year and current year losses and certain debt deductions.

Types of trusts

1.7 The measures apply to two broad categories of trusts referred to in the measures as fixed trusts and non-fixed trusts. Non-fixed trusts include discretionary trusts.

1.8 There are different kinds of fixed trust. These are ordinary fixed trusts and several kinds of widely held unit trust. These are unlisted widely held trusts, listed widely held trusts, unlisted very widely held trusts and wholesale widely held trusts.

1.9 There are also excepted trusts. These are family trusts, some superannuation funds, deceased estates within a reasonable administration period and unit trusts with unit holders that are exempt from income tax.

1.10 The tests apply to two different types of arrangement under which the tax benefit of trust losses can be transferred, i.e. through change in ownership or control or income injection schemes.

Change in ownership or control

1.11 The tests apply so that if certain events occur, a trust:

·
may be prevented from deducting its tax losses of earlier income years; and
·
may have to work out in a special way its net income and tax loss; and
·
may be prevented from deducting certain amounts in respect of debts (e.g. bad debts) incurred in the income year or earlier income years.

1.12 For fixed trusts, these consequences will flow if there is not continuity of majority beneficial ownership of the trust. Generally, the 50% stake test applies to determine this. Ordinary fixed trusts have to test ownership continuously. However, widely held unit trusts only have to test ownership when there is abnormal trading in their units or, in some cases, when an income year ends. Listed widely held trusts can avoid these consequences if they pass the same business test.

1.13 Widely held unit trusts with a large number of unit holders could face difficulties in testing for changes in ownership. A special rule is provided for widely held unit trusts so that the ownership test will be passed where it is reasonable to assume that the requirements have been met.

1.14 For non-fixed trusts, the consequences in paragraph 1.11 will follow if there is not continuity of majority beneficial ownership of the trust (50% stake test) or if control of the trust changes. In some cases, the consequences will also result if there is a 50% or greater change in the pattern of distributions of the income or capital of the trust.

1.15 The tests do not apply to excepted trusts, including family trusts.

1.16 In testing for ownership under the 50% stake test, interests in a loss trust must be traced through to individuals. Interests may be held directly by individuals or indirectly through an interposed company, trust or partnership.

1.17 In some cases it may be difficult to trace interests through to individuals. Special tracing rules exist in certain circumstances to overcome difficulties caused by the nature of the interests held or because of the practical difficulties in tracing through certain types of entities. For example, a special tracing rule exists where interests are held by certain complying superannuation funds. The interests are treated as being held by an individual for its own benefit. A similar concessional rule applies where an interest is held by a family trust.

1.18 An ordinary fixed trust in which the interests are held 50% or more by non-fixed trusts will not be able to satisfy the 50% stake test. This is because individuals do not own anything which is capable of being taken into account in applying the 50% stake test. A special rule applies which will allow the losses of the fixed trust to be deducted provided that certain conditions are satisfied. This includes the necessity for all the non-fixed trusts that hold interests in the fixed trust to satisfy the tests that apply to non-fixed trusts if they stood in place of the loss trust.

Income injection schemes

1.19 If a trust is involved in an income injection scheme to take advantage of deductions it may be prevented from making full use of them under the income injection test. Under these schemes, income is injected into trusts with losses or other deductions so that no tax is payable on the income.

1.20 The income injection test will only apply where an 'outsider' to the loss trust seeks to take advantage of the deduction. In general terms, the outsider must provide a benefit to the trust and a return benefit must be given to the outsider. Also, either of the benefits, or the income injected under the scheme, must have been provided or derived wholly or partly, but not merely incidentally, because of the deduction.

1.21 This test does not apply to excepted trusts other than family trusts. However, in the case of family trusts, members of the family or other entities in the family group can inject income into the family trust to take advantage of its losses.

Family trusts

1.22 Asset out above, family trusts are subject to concessional treatment and most of the trust loss provisions do not apply to them. Changes in ownership or control of a family trust do not have the consequences explained above provided the trust is a family trust at all the relevant times. However, the rules dealing with income injection schemes do apply to family trusts where persons outside the family group inject income.

1.23 A trust becomes a family trust for the purposes of the measures if it makes a family trust election. A consequence of making the election is that a special tax, called family trust distribution tax, is payable where a family trust gives income or capital to persons who are not members of the family group. This tax is levied at the top marginal rate applying to individuals, plus Medicare levy.

1.24 The family group for the purposes of the family trust rules includes companies, partnerships and trusts that have made an interposed entity election. A consequence of making an interposed entity election is that family trust distribution tax is payable where the interposed entity gives income or capital to persons who are not members of the family group.

1.25 In the case of a family trust that is a fixed trust the family trust election can be revoked provided that certain conditions are met. In the case of a fixed trust, company or partnership it is not necessary to make an interposed entity election where family members have fixed interests to all the income and capital of the entity.

1.26 The family trust distribution tax ensures that the tax benefit of losses of a family trust cannot be transferred to non-family members. This is necessary because, as discussed above, a family trust does not need to meet the tests relating to changes in ownership or control or, in many cases, the income injection test.

Non-resident entities

1.27 Special rules apply to ensure that the trust loss measures cannot be avoided where non-resident entities are concerned. For example, if a non-resident entity elects to be a family trust, the Commissioner will need to know whether the trust is meeting the distribution requirements for family trusts. The Commissioner is provided with information-gathering powers to enable the collection of information about certain non-resident entities. These provisions need only be considered by resident entities who are relevantly connected to non-resident entities.

1.28 It may be difficult to collect family trust distribution tax that is payable by non-resident entities. The Commissioner is able to collect the tax payable from connected resident entities where it is not paid after a certain period.

Date of effect

1.29 Subject to certain transitional arrangements, the proposed measures will apply to transfers of the tax benefit of trust lossesfrom 7.30 pm Eastern Standard Time (EST) on 9May 1995. The debt deduction provisions will apply to transfers of the benefit of bad debt and other relevant deductions from 7.30 pm EST on 20 August 1996. The narrower definition of family members will apply from 7.30 pm EST on 13 May 1997. An amendment to section 160AFD of the Act to prevent the transfer of the tax benefit of quarantined foreign losses applies from the date of introduction of the legislation into Parliament.

Transitional arrangements

1.30 Certain arrangements have been included to alleviate the impact of the measures in the transitional period. The transitional rules include the following:

·
rules which allow a trust to convert to a family trust as well as special rules about making family trust or interposed entity elections in the transitional period;
·
rules that apply to joint venture fixed trust arrangements that are in existence on or before the 1996-97 Budget time so that they will not unreasonably be affected by the 50% stake test where one of the parties sells their interests to the other or a third party.

Assessment of impact (costs and benefits) of the measure

Impact group identification (the following groups will be impacted by the proposed amendments)

1.31 Persons who use trusts to operate businesses or to carry on investment activities will be impacted by the proposed amendments.

1.32 The trusts that will be affected are those which have deductions including prior year losses. In the 1995-96 income year the number of trusts that lodged tax returns as at 7 July 1997 totalled 372,449. The return data shows that these trusts operate across all industry sectors. The number of trusts with prior year losses in the income year 1995-1996 from primary production income was 5,636 and 49,166 from non-primary production income. The total amount of prior year losses returned was $5,160 million.

1.33 Types of trusts that will not be required to apply the tests are excepted trusts.

1.34 The measures will impact on the ATO which will administer the measures.

Assessment of costs

Compliance Costs

1.35 There will be costs of compliance for trusts in monitoring the ownership of trust interests to ensure that the continuity of ownership test is satisfied. Before a fixed trust (including widely held unit trusts) can deduct a loss or deduction it may be necessary for the trust to apply the 50% stake test and, in the case of non-fixed trusts, to apply the pattern of distributions test or 50% stake test for changes in ownership.

1.36 In the case of fixed trusts the following rules will have the effect of reducing these costs:

·
the special tracing rules as outlined in paragraph 1.17;
·
for widely held unit trusts the concessional rules as outlined in paragraphs 1.12 and 1.13;
·
the availability of the same business test to listed widely held unit trusts.

1.37 In determining whether a fixed trust held 50% or more by non-fixed trusts is able to meet the test outlined in paragraph 1.18 there will be costs for the fixed trust in monitoring whether the non-fixed trusts pass the tests that apply to non-fixed trusts.

1.38 There will be some compliance costs during the transitional period for family trusts in lodging a family trust election and also for those entities that need to make an interposed entity election to be included in the family group. These costs will be minimal.

1.39 Apart from some initial compliance costs which will be minimal, a family trust that distributes only to members of the family group will generally not be affected by the measures.

1.40 Resident entities will incur compliance costs if the Commissioner seeks to obtain certain information from them about relevantly connected non-resident entities (see paragraph 1.27).

Administrative costs

1.41 There may be administrative costs on the ATO on the collection and recovery of the family trust distribution tax. However, the tax will only apply if trusts and relevant interposed entities fail to abide by the election they have made. It is hoped that the tax will never need to be collected.

1.42 The costs to the ATO in administering the trust loss measures may involve making amendments to tax returns.

Estimated costs

1.43 It is estimated overall that the administrative costs to the ATO will be small.

1.44 The initial estimated cost of taxpayer compliance with the measures is $9m and the recurrent costs are $1.5m.

Assessment of Benefits

1.45 The proposed measures will prevent a significant erosion of the tax base that would otherwise arise from the transfer of the benefit of trust losses. The gain to revenue is estimated to be:

1995-96 $90 million
1996-97 $185 million
1997-98 $160 million
1998-99 $75 million
1999-2000 $20 million
2000-2001 $20 million

1.46 The trust loss measures are intended to prevent leakage of revenue that was occurring through the transfer of the tax benefit of trust losses. There are no provisions in the income tax law similar to those which apply to companies which effectively regulate the deductibility of trust losses against current and future income.

1.47 These measures deal with what is considered to be an anomaly in the current treatment of trusts and will improve the efficiency and equity of the taxation system.

Consultation

1.48 After introduction into Parliament of the previous Government's trust losses legislation in September 1995, consultations with tax professional and industry bodies occurred at officer level. These consultations were taken into account before the Government announced in the 1996-97 Budget that it would proceed with the measures.

1.49 The proposed trust loss legislation was subsequently issued as an exposure draft for public comment on 10 February 1997. A large number of submissions were received from industry and professional bodies, and individual tax professionals and taxpayers. Submissions received during the consultation period were considered in the course of finalising the legislation. The Government has responded to those submissions by making certain changes to the proposed measures.

1.50 Most significantly:

·
the measures will now allow income injection schemes within a defined family group;
·
family trust elections made by fixed trusts can be revoked when the trust is disposed of;
·
fixed interest interposed entities that are wholly owned by the family do not need to make an interposed entity election to be included as part of the family group; and
·
100% owned subtrusts of widely held unit trusts will be treated in the same way as their parent trusts.

Conclusion

1.51 The trust loss measures improve the equity and efficiency of the taxation system and will prevent the transfer of the tax benefit of trust losses. While the measures will impose some compliance costs on taxpayers, this is outweighed by the benefits of improving the integrity, equity and efficiency of the taxation system.

1.52 The ATO and Treasury will monitor this taxation measure on a continuing basis. The ATO's existing consultative arrangements include the National Tax Liaison Group.

Chapter 2 - Overview

General

2.1 The Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 (called 'the Bill' is this Explanatory Memorandum) will insert new Schedule 2Finto the ITAA 1936 to provide new rules that have to be satisfied by trusts before prior and current year losses and debt deductions[F1] can be deducted. [Item1]

2.2 There are also three complementary Bills. Two of these impose a special tax which may become payable under the measures. These are the Family Trust Distribution Tax (Primary Liability) Bill 1997 and the Family Trust Distribution Tax (Secondary Liability) Bill 1997. The third complementary Bill, the Medicare Levy Consequential Amendment (Trust Loss) Bill 1997, makes a consequential amendment to the Medicare Levy Act 1986. Separate Bills are necessary for constitutional reasons.

2.3 The proposed rules will not apply to family trusts that make distributions (broadly defined) only to members of a family group. The income injection test applies to a family trust only where income is injected into it from outside the family group. A family trust is defined for the purposes of these measures.

2.4 The provisions dealing with trust losses are intended to prevent the transfer of the tax benefit of 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 deductions affected by the rules specifically include bad debt and certain debt/equity swap deductions. These are called 'debt deductions' in this Explanatory Memorandum. The discussion below outlines in broad terms how the measures will apply. This is followed by a detailed explanation of the proposed amendments.

2.5 The 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 widely held unit trusts), non-fixed trusts and excepted trusts. Excepted trusts include family trusts.

2.6 The Bill deals 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.

2.7 Each type of trust has to satisfy certain tests relating to ownership or control of the trust in order to be able to deduct prior and current year losses and debt deductions. For prior year loss and debt deduction purposes, if an applicable test is not satisfied, the loss or debt deduction cannot be deducted. For current year loss purposes, if an applicable test is not satisfied, the income year is divided into periods and the net income or tax loss of the trust is calculated for each period.

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

2.9 The new regime will apply to corporate unit trusts and public trading trusts. The income of these trusts is currently taxed in a manner similar to that of companies under Divisions 6B and 6C of the ITAA 1936.

2.10 Consequential amendments will also be made to the ITAA 1936 and other legislation including the Fringe Benefits Tax Assessment Act 1986. These will integrate the new measures into the income tax law and other relevant legislation.

2.11 While retaining the basic structure of the trust loss legislation proposed by the previous Government, the Bill contains a number of significant differences to those measures.

2.12 The tables in the Appendix provide a broad overview of the various rules in the trust loss measures.

2.13 Taxpayers may have quite properly lodged tax returns for 1994-95, 1995-96 and 1996-97 without regard to the proposed trust loss measures. However, taxpayers may be obliged to amend their returns for these income years if the commencement date of the trust loss measures affects the validity of deductions claimed in returns for those income years. The Commissioner will not seek to apply penalties and interest against any underpayments of tax provided returns are amended within a reasonable time after the measures become law. If amendments are not made promptly, the normal penalty and interest provisions may apply.

Relationship to the rewrite of the income tax law

2.14 The income tax law is currently be rewritten as part of the Tax Law Improvement Project (TLIP). The ITAA 1997, which is generally effective from the 1997-98 income year, represents the law that has been rewritten to date. The trust loss provisions are being inserted into the ITAA 1936, rather than the ITAA 1997, because they have a commencement date for most purposes that is before the commencement of the ITAA 1997.

2.15 In many cases the Bill refers to various provisions of the income tax law. Because the general commencement date of the trust loss measures is before the commencement of the ITAA 1997, it has been necessary in many cases to refer to both the old law and equivalent new law provisions when doing this. In many cases, the old law references will be able to be deleted when the trust loss measures are transferred to the ITAA 1997 at a later date.

Drafting style and structure of the Bill

2.16 The Bill is lengthy, but necessarily so. The trust loss provisions use many presentational aids such as flow charts. Of the approximately 150 pages of legislation, about 14 are for explanatory diagrams and charts, etc. Also, the drafting style contains some repetition. This was a deliberate choice. Once the taxpayer identifies the category into which a particular trust falls, the draft seeks, as much as possible, to describe all the rules applicable to that category of trust. This makes the provisions easier to follow.

2.17 The length of the provisions has been affected significantly by the Government's decision to modify the original provisions, including as announced in the 1996-97 Budget and the 1997-98 Budget. Many of these changes were made in response to representations by tax professionals and taxpayers in order to soften the impact of the provisions or clarify their operation. This has resulted in a trade off between simplicity and equity. Two examples of this are in the categorisation of trusts and the way family trusts are treated.

2.18 There are many different categories of trusts. One way of dealing with trust losses would be to have a few standard rules that apply to all trusts. This would result in the rules themselves being unfair in their impact. Instead, different rules have been applied to the different categories of trusts, depending on their nature. The result is that the size of the legislation increases, but this is matched by an increase in the fairness of treatment.

2.19 For example, four of the categories of trusts are different kinds of widely held unit trusts. They are given concessional treatment in determining the times at which they have to test for changes in ownership. As a result, they do not have to face the compliance burden of constant tests for changes in ownership.

2.20 In the 1996-97 Budget, the Government announced the introduction of a new method for determining which trusts are family trusts. This method allows a trust to elect to be a family trust but will impose a tax on any distributions outside the family group by the family trust or another entity in the family group. This change was made to eliminate the need for trust deeds to be altered with the consequent compliance costs.

2.21 Procedural sections are required to provide for the collection and recovery of the family trust distribution tax. These provisions add many pages to the legislation. However, if such trusts and entities abide by the election they have made, the provisions will never have any application.

2.22 In addition, detailed provisions have been included to ensure that the tax can be collected where it becomes payable by non-resident family trusts and family entities and that information can be gathered about these non-residents. An alternative to including these provisions dealing with non-resident entities is to say that non-resident trusts cannot be family trusts and that non-resident entities cannot be in the family group of a family trust. This would have allowed for much shorter provisions. However, in the interests of fairness, non-resident entities are included but with the stringent anti-avoidance provisions discussed above.

2.23 In the Taxation Laws Amendment Bill (No. 4) 1995, the family trust provisions were two and a half pages long. With the new method for determining family trust status, together with the associated provisions discussed above, the family trust provisions are approximately 34 pages in length. However, only a few pages of the Bill will be relevant to a trust used to run a small business that elects to be a family trust and abides by the election by not distributing income or capital outside the family group.

2.24 Finally, the provisions have been prepared having regard to the work that is being done on the high wealth individuals project. This has required more attention to the anti-avoidance aspects of the provisions, such as the non-resident entity measures discussed above.

Chapter 3 - Purpose and date of effect

Purpose of the amendments

3.1 Schedule 1 of the Bill will insert rules into the ITAA 1936 to restrict the recoupment of prior year and current year losses and debt deductions[F2] of trusts in order to prevent the transfer of the tax benefit of those losses or deductions. The tax benefit of a loss is transferred when 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.

Date of effect

3.2 Subject to certain transitional arrangements, the measures will apply to the transfer of the tax benefit of prior and current year trust losses from 7.30 pm Eastern Standard Time (EST) and the equivalent time elsewhere on 9May1995.

3.3 However, the pattern of distributions test (see paragraphs 7.12 and 7.13), one of the tests that applies to non-fixed trusts for prior year loss purposes, will apply from the date of introduction of the Taxation Laws Amendment Bill (No. 4) 1995 (the 1995 Bill) into the Parliament on 28 September 1995.

3.4 Also, the debt deduction provisions, which were not included in the 1995 Bill, will apply to the transfer of the tax benefit of debt deductions from 7.30 pm EST, 20 August 1996. This was the date that the decision was announced in the 1996-97 Budget.

3.5 The narrower definition of the family (see paragraph 5.40) will apply from 7.30 pm EST, 13 May 1997. This was the time of the 1997-98 Budget when the changes to the income injection test as it applies to family trusts were announced.

3.6 The provisions which apply to prevent the transfer of the tax benefit of quarantined foreign losses of trusts will apply from the date of introduction of this legislation into Parliament.

3.7 There are various application and transitional provisions which affect how various aspects of the measures will operate. These are discussed in Chapter 15.

Chapter 4 - Background to legislation

4.1 Under the ITAA 1936 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, 80 and 160AFD. There are also special rules for the deduction of film losses (sections 79F and 80AAA).

4.2 In the case of companies, there are provisions in the ITAA 1936 (sections 80A to 80F) which limit the deductibility of prior year losses. 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 majority 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, among other things, it carries on the same business as it carried on at the time of change. There are also additional rules to prevent the carry forward of a loss in certain circumstances.

4.3 There are also provisions which limit deductibility of current year losses of companies (sections 50A to 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 4.2).

4.4 Provisions are contained in sections 63A to 63C of the ITAA 1936 which limit the deductibility of bad debts and certain deductions in respect of debt/equity swaps (called 'debt deductions' in this Explanatory Memorandum). These provisions are similar to the prior year loss provisions applying to companies, but apply for different periods relating to the incurring and writing off of the relevant debt.

4.5 The loss and company loss provisions described above have been re-written as part of the Tax Law Improvement Project (TLIP) and are included as part of the Income Tax Assessment Act 1997 (see Divisions 36, 165, 166, 175 and 375 of that Bill). The company bad debt rules have not yet been included in the TLIP re-write but are to be inserted in Subdivision 165-C.

4.6 There are no provisions in the ITAA 1936 similar to sections 80A to 80F, 50A to 50N or 63A to 63C and equivalent provisions in the ITAA 1997 that apply to trusts. The Bill proposes to insert Schedule 2F into the ITAA 1936 to limit the deductibility of prior and current year trust losses and debt deductions. The rules differ from those currently applicable to companies reflecting the different features of trusts as compared to companies.

Chapter 5 - Family trusts

Overview of the family trust provisions

5.1 The definition of family trust is crucial to the operation of the provisions. Family trusts (as defined) that distribute only to members of the family group will normally not be affected by the proposed amendments. The income injection test applies to family trusts only where income is injected into them from outside the family group. Also, concessional tracing rules apply where a family trust is interposed between an entity and the ultimate owners of that entity (see subsection 272-30(2)).

5.2 This Chapter explains the main provisions that are relevant to family trusts.

When can a family trust deduct prior or current year losses or debt deductions?

5.3 The trust loss measures, other than the income injection test, do not prevent a family trust (as defined) from deducting prior or current year losses or debt deductions. However, this will be the case only if the trust is a family trust at all times in the test period that is relevant to the deduction.

5.4 Table 5.1 briefly summarises the test period for the various deductions.

Table 5.1 Test period for various deductions
Type of deduction Test period
Prior year loss The period from the beginning of the loss year to the end of the income year in which the loss is to be recouped (see paragraphs 6.11 and 7.8)
Current year loss The income year (see paragraphs 6.35 and 7.24)
Debt deduction If the debt is incurred in an income year before the deduction arises - the period from the time the debt is incurred until the end of the income year
If the debt is incurred in the income year in which the deduction arises - the income year
(See paragraphs 6.41 and 7.30)

5.4 The income injection test, as it applies to family trusts, is explained in Chapter 10. The income injection test does not apply where members of the family group inject income into a family trust with losses.

What is a family trust?

5.5 Subdivision 272-D sets out the rules that define a family trust and the related concepts of members of the family group and members of the family of an individual.

5.6 A trust will be a family trust where the trustee of the trust has made an election (known as a family trust election ) under section 272-80 that the trust be a family trust and the election is in effect [section 272-75] .A consequence of the family trust election system is that any distributions (broadly defined) outside the family group of the family trust by the trust or relevant interposed entities will be taxed at the top marginal rate applying to individuals plus Medicare levy.

Example

5.7 A discretionary trust has as its class of beneficiaries the following:

·
Jill, Jack (Jill's husband) and their children; and
·
any company or trust in which any of those individuals have an interest.

5.8 The trust makes a family trust election specifying Jill as the relevant individual. The trust makes distributions (as defined) only to Jill, Jack and their children. Subject to the income injection test, the trust can deduct its prior and current year losses and debt deductions. No family trust distribution tax is payable on the distributions as they are made only to Jill and members of her family group. If the trust distributed income or capital outside the family group, family trust distribution tax would be payable on the distribution.

What are the rules for making a family trust election?

5.9 If the trustee makes a family trust election the trust will be a family trust for the purposes of Schedule 2F. The election needs to specify an income year from which it is to take effect. [Subsection 272-80(1)]

How is the election made?

5.10 If the election is to be made, it must be made by the trustee in the trust's return of income for the specified income year. If the trust is not required to lodge a return in the year that the trust wants to make the family trust election, the trustee must make the election in writing to the Commissioner in an approved form. The election must be given either within 2 months after the end of the income year or such later time as the Commissioner allows.[F3] [Subsection 272-80(2)]

5.11 The family trust election must specify an individual as the individual whose family group is the subject of the election. This would be the same person as the test individual referred to in section 272-95. In addition to specifying an individualthe election must also specify such other information as the Commissioner requires [subsection 272-80(3)] . This information would include:

·
the name of the trust;
·
the address of the trust including its country of residence;
·
the beneficiaries of the trust at the time the election takes effect; and
·
any other particulars that the Commissioner may require.

The trust must be controlled by the family

5.12 A trust cannot make a family trust election unless it is controlled by the relevant family from the time the election comes into effect. To this end the trustee cannot make a family trust election if the trust does not pass the 'family control test' at least at the end of the income year [subsection 272-80(4)] . The family control test for trusts is set out in subsections 272-87(1) and (2) (see paragraphs 5.28 to 5.30).

A family trust election is irrevocable unless the trust is a fixed trust

5.13 A family trust election is generally irrevocable [subsection 272-80(5)] . However, a family trust that is a fixed trust is able to revoke a family trust election if some or all of the interests in the trust are disposed of to non-family members or if any of the persons holding them cease to be family members.

5.14 The conditions that are used to determine whether an election for a fixed trust can be revoked are set out below. [Subsection 272-80(6)]

·
At the beginning of the income year specified in the family trust election, some or all of the specified individual, members of his or her family and other family trusts of the same individual must beneficially hold, directly or indirectly, fixed entitlements to shares of all the income and capital of the trust.[F4]
·
At a time after the beginning of that income year when the trust is still a fixed trust, the individuals beneficially holding, directly or indirectly, some or all of the fixed entitlements must change. The change must mean that the specified individual, family members and relevant family trusts (or any combination of them) no longer beneficially hold, directly or indirectly, fixed entitlements to shares of all the income and capital of the trust. The time could be before the time of lodgement of the tax return containing the family trust election.

5.15 Notification of the revocation will need to be included in the trust's return of income for the income year in which the family ceases to so hold fixed entitlements to all the income and capital of the trust. If the trust is not required to lodge a return in that year, the trustee must notify the revocation in writing to the Commissioner in an approved form. In this case, the revocation must be given either within 2 months after the end of the income year or such later time as the Commissioner allows. [Subsections 272-80(7)]

5.16 The revocation must specify the time set out in the second dot point in paragraph 5.14 as the time when the revocation takes effect. [Subsections 272-80(8)]

Example

5.17 At the commencement of the 1998-99 income year, all the fixed entitlements in a fixed trust are beneficially owned by Jill and Jill's spouse, Jack. The trustee elects to be a family trust from that income year specifying Jill as the test individual. On 1 August 2000, Jack and Jill sell their fixed entitlements to Brian. Brian is not a member of Jill's family. The trustee may revoke the family trust election in the trust's 2000-01 tax return. The revocation would take effect from 1 August 2000 (the time when Jill and her family members ceased to beneficially hold all the fixed entitlements in the trust).

When is a family trust election in effect?

5.18 Table 5.2 sets out the times when a family trust election is in effect (and thus when the trust concerned is a 'family trust'). [Subsections 272-80(9) and (10)]

Table 5.2 Times when a family trust election is in effect
  The election has not been revoked The election has been revoked
The trust passes the family control test at all times in the income year specified in the election All times after the election commencement time All times from the election commencement time until the time specified in the revocation (see paragraph 5.16)
The election commencement time is the start of the income year specified in the election. The election commencement time is the start of the income year specified in the election.
The trust does not pass the family control test at all times in the income year specified in the election but does pass that test at the end of that income year All times after the election commencement time All times from the election commencement time until the time specified in the revocation (see paragraph 5.16)
The election commencement time is the first time from which the trust passes the family control test continuously until the end of the year of income. The election commencement time is the first time from which the trust passes the family control test continuously until the end of the year of income.

A trust may make both a family trust election and interposed entity elections in some cases

5.19 A trust may make both a family trust election and one or more interposed entity elections (as referred to in section 272-85) provided all elections are made in relation to the same individual as specified in the family trust election. [Subsection 272-80(11)]

What are the rules for interposed entities to make an election?

5.20 Members of the family of the individual specified in the family trust electioncan receive distributions of income and capital from the family trust through interposed companies, trusts and partnerships. Where family members (including another family trust of the same specified individual) do not have fixed entitlements, directly or indirectly, and for their own benefit, to all the income and capital of the interposed entity, it will be necessary for the interposed entity to make an election (known as an interposed entity election ) before it can be included as part of the family group. [Subsection 272-85(1)]

How is the election made?

5.21 If an interposed entity election is made, it must be made in the return of income of the interposed company, trust or partnership. It can be made for an income year that is later than the year of income in which the family trust election under section 272-80 is made. For example, a trust may commence distributing to an interposed entity in an income year later than the year in which it made a family trust election. If a partnership, company or trustee is not required to furnish a return for an income year the interposed entity election must be lodged with the Commissioner in writing in an approved form within 2 months after the end of the year of income or such later time as the Commissioner allows. [Subsection 272-85(2)]

5.22 An interposed company, trust or partnership may need to be part of the family group after a particular date in the income year (e.g. from a date when a family trust wants to commence making distributions to the entity). Because of this, the interposed entity election must specify a date in the income year from which the election takes effect. This could be the start of an income year or any day during an income year. [Subsection 272-85(1)]

5.23 The election will need to specify the family trust to which the election relates, the individual specified for the purposes of that trust and such other information that the Commissioner may require [subsections 272-85(1) and (3)] . This information would include the following:

·
the name of the entity;
·
the address of the entity including its country of residence;
·
the shareholders, partners or beneficiaries of the entity at the time the election takes effect; and
·
any other particulars that the Commissioner may require.

The interposed entity must be controlled by the family

5.24 An interposed entity election cannot be made for a company, partnership or trust unless it is controlled by the relevant family from the time the election comes into effect. To this end, the election cannot be made if the entity does not pass the 'family control test' at least at the end of the income year [subsection 272-85(4)] . The family control test is set out in section 272-87 (see paragraphs 5.28 to 5.32).

An interposed entity election is irrevocable

5.25 An interposed entity election made by the partners in a partnership, a company or trustee is irrevocable [subsection 272-85(5)] . There is no need to provide for the revocation of an interposed entity election for a fixed interest entity wholly owned by a family. This is because such entities can be members of a family group without the need to make an interposed entity election (see Table 5.4)

When is an interposed entity election in effect?

5.26 Table 5.3 sets out the times when an interposed entity election is in effect. [Subsection 272-85(6)]

Table 5.3 Times when an interposed entity election is in effect
Times when the entity passes the family control test Times when the election is in effect
The entity passes the family control test at all times from the start of the day specified in the election until the end of the income year in which that day falls All times after the start of the specified day
The entity does not pass the family control test at all times from the start of the day specified in the election until the end of the income year in which that day falls but does pass that test at the end of that income year All times after the first time from which the trust passes the family control test continuously until the end of the income year

Can more than one interposed entity election be made by an entity?

5.27 An interposed entity can make an interposed entity election in respect of more than one family trust election if the individual specified in respect of each family trust election that has been lodged is the same [subsection 272-85(7)] . An interposed entity may want to make more than one election because, for example, two family trusts of the same test individual will want to make distributions to the same interposed entity.

The family control test

When does a trust pass the family control test?

5.28 For the purposes of making a family trust election or an interposed entity election a trust passes the family control test at a particular time when certain persons control the trust at that time. The persons are some or all of the individual specified in the relevant family trust election, members of his or her family and a professional legal or financial adviser to the family. [Subsection 272-87(1)]

5.29 The control test for this purpose is essentially the same as the control test applying to non-fixed trusts (see paragraph 9.59) [subsection 272-87(2)] The test looks at, among other things, who can control the application of income or capital of the trust. This is why a professional legal or financial adviser to a family might be part of the controlling group of a family trust (e.g. the adviser might be one of the directors of the trustee company).

5.30 However, a person could only be a controller as a professional legal or financial adviser if the person became a controller because of their status as such an adviser, rather than in a personal capacity. Also, any fixed entitlements in the trust beneficially owned by the adviser will not be counted in determining whether the family control test is passed (i.e. they are not counted for the purposes of paragraph 272-87(2)(f)).

When does a company or partnership pass the family control test?

5.31 A company or partnership which proposes to make an interposed entity election passes the family control test at a particular time when certain persons beneficially hold between them, directly or indirectly, fixed entitlements to more than 50% of the income or capital of the company or partnership. The persons are some or all of the individual specified in the relevant family trust election and members of his or her family. [Subsection 272-87(3)]

5.32 Because the control test for companies and partnerships only looks at who beneficially owns interests in the entity, any control influenced by a professional legal or financial adviser to a family is not relevant to determining whether the family controls the entity.

What is a family group?

5.33 The Bill identifies those persons (including natural persons as well as a company, a trustee or partners in a partnership) who are members of the family group of the individual specified in a family trust election. Whether a person is a member of the family group is determined by reference to the distribution of income or capital that is made to that person [subsection 272-90(1)] . The distribution may be made by a family trust or by an interposed entity that has made an interposed entity election. In the discussion in this Chapter, the term 'distribution' of income or capital includes a conferral of a present entitlement to income or capital.

5.34 The members of the family group in relation to a distribution, as set out in subsections 272-90(2) to (10) , are explained in Table 5.4 on the following pages.

Table 5.4 Members of the family group
Members of the family group Comments
A member of the family of the individual specified in the family trust election The person must be such a member at the time of the distribution. A person will be a family member if, in relation to the test individual, that person is one of the persons listed in section 272-95.
Certain family controlled or owned trusts These are:

·
the family trust in relation to which the family trust election has been made;
·
any trust that has made an interposed entity election in accordance with section 272-85 and the election is effective at the time of the distribution;
·
any fixed trust if, at the time of the distribution, some or all of the individuals specified in the family trust election, the family members of that individual and family trusts of the same individual have fixed entitlements, directly or indirectly, and for their own benefit, to all the income and capital of the fixed trust.

Certain family controlled or owned companies These are:

·
any company that has made an interposed entity election in accordance with section 272-85 and the election is effective at the time of the distribution;
·
any company if, at the time of the distribution, some or all of the individuals specified in the family trust election, the family members of that individual and family trusts of the same individual have fixed entitlements, directly or indirectly, and for their own benefit, to all the income and capital of the company.

Certain family controlled or owned partnerships These are:

·
any partnership that has made an interposed entity election in accordance with section 272-85 and the election is effective at the time of the distribution;
·
any partnership if, at the time of the distribution, some or all of the individuals specified in the family trust election, the family members of that individual and family trusts of the same individual have fixed entitlements, directly or indirectly, and for their own benefit, to all the income and capital of the partnership.

Some financial institutions and their subsidiaries These are such institutions or subsidiaries to whom distributions are made by certain companies that are small or medium enterprises and that have made an interposed entity election in relation to a family trust - see the explanation in paragraphs 5.36 to 5.39.
Certain persons or bodies when the individual specified in the family trust election and all the members of his or her family are dead at the time of the distribution These are:

·
the estate of the individual specified in the family trust election or the estate of a member of his or her family;
·
any religious, scientific, charitable or public educational institution that, at the time of the distribution, is exempt from income tax (the exemption will be under paragraph 23(e), or item 1.1, 1.2, 1.3 or 1.4 of the table in section 50-5 of the ITAA 1997);
·
certain funds, authorities or institutions in Australia to whom tax deductible gifts can be made (these are those listed in the tables in subsection 78(4), covered by paragraph 78(5)(a) or mentioned under items 1 or 2 of the table in section 30-15 of the ITAA 1997.

Certain funds, authorities or institutions in Australia to whom tax deductible gifts may be made These are those listed in the tables in subsection 78(4) or covered by paragraph 78(5)(a) or mentioned under items 1 or 2 of the table in section 30-15 of the ITAA 1997. However, they will only be in the family group where section 78A would not apply to deny a deduction if one were allowable under section 78, or Division 30 of the ITAA 1997, for the distribution. Section 78 and Division 30 of the ITAA 1997 provide for the deductibility of gifts.
Certain bodies all of whose income is exempt from income tax These are:

·
some religious, scientific, charitable and public educational institutions (these are covered by paragraph 23(e), and section 50-5 of the ITAA 1997);
·
some public hospitals and non-profit hospitals (these are covered by paragraph 23(ea), and items 6.1 and 6.2 of the table in section 50-30 of the ITAA 1997);
·
the Thalidomide Foundation (this is covered by paragraph 23(ec));
·
some non-profit cultural, sporting, community service and friendly societies (these are covered by paragraph 23(g), and sections 50-5, 50-10, 50-20 and items 9.1 and 9.2 of the table in section 50-45 of the ITAA 1997); and
·
some funds established for public charitable purposes and purposes of enabling scientific research to be conducted by or with a public university or public hospital (these are covered by paragraph 23(j), and section 50-5 of the ITAA 1997).
However, they will only be in the family group where section 78A would not apply to deny a deduction if one were allowable under section 78, or Division 30 of the ITAA 1997, for the distribution.

What is section 78A?

5.35 Section 78A of the ITAA 1936, referred to in Table 5.4, is an anti-avoidance rule that applies where tax deductible gifts are given. Except in the case of death of all family members, the relevant funds, authorities or institutions covered by the gift provisions and the tax exempt bodies are included in the family group subject to compliance with section 78A. This will ensure, as far as possible, that they can not be used as a conduit to transfer the tax benefit of a family trust's losses.

Members of the family group in relation to distributions by SMEs

5.36 In the 1996-97 Budget, the Government announced that it would provide concessional income tax treatment in relation to equity investments made by lending institutions in small and medium enterprises (SMEs). A consequence of a lending institution making an equity investment in an SME is that it may receive dividends or capital from the SME. It is possible that an SME could be a company that has made an interposed entity election under the proposed trust loss measures. The SME legislation was included in the Taxation Laws Amendment Act (No. 3) 1996 and the Taxation Laws Amendment Act (No. 1) 1997.

5.37 Certain persons are included in the family group in relation to a distribution of income or capital by a company that is an SME (within the meaning of section 128TK of the ITAA 1936) where the SME has made an interposed entity election. The persons are those for which the following requirements are met:

·
the person has acquired a threshold interest in the SME (within the meaning of section 128TJ of the ITAA 1936) on or after 1 July 1996; and
·
the person is an Australian financial institution or a subsidiary (within the meaning of section 128TL of the ITAA 1936) of such an institution;
·
the person is not an associate of the SME; and
·
the distribution is in relation to a dividend or return of paid-up capital distributed to the person in respect of the ordinary shares forming part of its threshold interest in the SME. [Subsection 272-90(10)]

5.38 To be part of a threshold interest in an SME, the ordinary shares must have been issued to the person on or after 1 July 1996. Accordingly, under subsection 272-90(10), a person will not be a member of the family group in relation to dividends and returns of paid-up capital on shares issued before 1 July 1996.

5.39 An Australian financial institution is defined in section 317 of the ITAA 1936. Under this definition, an Australian financial institution is a bank within the meaning of the Banking Act 1959, a person who carries on State banking within the meaning of paragraph 51(xiii) of the Constitution, a registered corporation within the meaning of the Financial Corporations Act 1974 and a life assurance company within the meaning of section 110 of the ITAA 1936.

Who are members of the test individual's family?

5.40 The members of the family of the individual specified in the family trust election (i.e. the test individual ) are as follows:

·
the test individual's spouse;
·
a child, child of a child, parent, grandparent, brother, sister, nephew or niece of the test individual or the test individual's spouse;
·
a spouse of such a child, parent, grandparent, brother, sister, nephew or niece.[F5] [Subsection 272-95]

5.41 By virtue of the definition of 'child' in subsection 6(1) of the ITAA 1936, a child includes a step-child, adopted child or ex-nuptial child. The phrase 'child of a child' is used in defining a family member to ensure that the definition of 'child' applies to grandchildren of the test individual. Note also that the term 'spouse' is defined in subsection 6(1) of the ITAA 1936 to include a de facto spouse.

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

What are the consequences if a family trust or interposed family entity makes a distribution outside of the family group?

5.43 A special tax, called family trust distribution tax, is payable in certain circumstances by a family trust or trust, company or partnership that has made an interposed entity election. This will be the case if income or capital of the trust, company or partnership is distributed to persons other than those in the family group or if such persons become presently entitled to the income or capital. The term distribution is defined in Subdivision 272-B (see paragraphs 13.51 to 13.61).

5.44 The tax is payable at the top marginal rate applying to individuals, plus Medicare levy, on the amount or value of the income or capital. Chapter 11 provides a detailed explanation of when family trust distribution tax may become payable and how it is to be paid.

What if a family trust holds a fixed entitlement in an entity?

5.45 A family trust is given special treatment when fixed entitlements in another trust, company or partnership have to be traced to individuals who are the underlying beneficial owners of those fixed entitlements. Where a fixed entitlement is held, directly or indirectly, by a family trust, the trustee of the family trust is taken to be an individual who holds the fixed entitlement for its own benefit. This removes the need to trace fixed entitlements held through family trusts. Paragraph 13.42 provides more detail on this issue.

Information requirements relating to non-resident family trusts and interposed family entities

5. 46 There are special information requirements if a family trust or trust, company or partnership that has made an interposed entity election is a non-resident. These are explained in Chapter 12.

Chapter 6 - Fixed trusts

Overview of fixed trust rules

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

6.2 The way in which the rules apply depends on the kind of fixed trust being considered. There are five kinds of fixed trust for the purposes of the legislation, as follows:

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

6.3 The characteristics of each of these kinds of trust is described in broad terms in Table 6.1.

Table 6.1 Characteristics of different kinds of fixed trust
Type of trust Description
Fixed trust Persons have fixed entitlements to all the income and capital of the trust
Unlisted widely held trust(1) A widely held unit trust
The units are not listed on an approved stock exchange
Listed widely held trust A widely held unit trust
The units are listed on an approved stock exchange
Unlisted very widely held trust(1) An unlisted widely held trust (see above) with at least 1,000 unit holders Compliance with other conditions as specified in section 272-120
Wholesale widely held trust(1) An unlisted widely held trust (see above) where 75% or more of the units in the trust are held by certain bodies and the initial amount subscribed for units in the trust by each particular unit holder in the trust is at least $500,000
Compliance with other conditions as specified in section 272-125
Widely held unit trust A fixed trust that is a unit trust
(This term is used in the definitions of the various kinds of widely held trust) 20 or less individuals between them do not beneficially hold, directly or indirectly, 75% or more of the fixed entitlements to income or capital of the trust
(1) Note that the classification of a trust that meets the definition of unlisted widely held trust, unlisted very widely held trust or wholesale widely held trust may be affected by the nature of its parent trust (if any) (see section 272-127 discussed in paragraphs 13.91 and 13.92)

6.4 A more detailed discussion of the definitions of each kind of widely held unit trust is contained in Chapter 13.

6.5 A family trust (a type of 'excepted trust') that is also a fixed trust will 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 or debt deductions. Also, other excepted trusts (as defined - see paragraphs 13.71 to 13.74) are not affected by Division 266.

6.6 At the heart of the tests for determining whether fixed trusts can deduct losses, etc. 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 and other deductions of a fixed trust. Indirect fixed entitlements can only be traced through fixed entitlements in interposed entities.

What is a fixed trust?

6.7 A fixed trust is a trust where all of the income and capital of the trust is the subject of fixed entitlements held by persons [section 272-65] . Thus, for example, where some part of the income or capital of a trust may be distributed at the discretion of the trustee or another person, the trust is not a fixed trust.[F6]

6.8 A fixed entitlement to income or capital of a trust is a vested and indefeasible interest in the income or capital (see paragraphs 13.3 to 13.13). A person includes a natural person, a company, a trustee or the partners in a partnership.

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

6.9 The Bill sets out rules to determine when a fixed trust (including the different kinds of widely held unit trust) cannot deduct a prior year tax loss. The following flow charts outline, in broad terms, when each of the different kinds of fixed trust cannot deduct a prior year loss.

Ordinary fixed trust (i.e. fixed trust other than a widely held unit trust)

Unlisted widely held trust

Listed widely held trust

Unlisted very widely held trust and wholesale widely held trust

When do the prior year loss rules for fixed trusts have to be applied?

6.10 As set out in the above flow charts, 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 of the relevant kind or kinds at all times in the test period ;
·
it was not an excepted trust at all times in the test period. [Subsections 266-25(1), 266-75(1) and (2), 266-110(1) and 266-150(2)]

What is the test period for prior year loss purposes?

6.11 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 [subsections 266-25(1), 266-75(1) and (2), 266-110(1) and 266-150(2)] . 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).

6.12 The test period for an unlisted very widely held trust is different to what is described above in that it excludes any start-up period of the trust (see paragraphs 13.84 to 13.86 for the meaning of a start-up period). Thus, for unlisted very widely held trusts, the test period is so much of the period beginning at the end of the start-up period and ending at the end of the income year. [Subsection 266-150(2)]

When can't a fixed trust deduct a prior year loss?

6.13 If the conditions outlined in paragraph 6.10 are met then the fixed trust cannot deduct the prior year tax loss unless it passes the 50% stake test [subsection 266-25(2), 266-75(3), 266-110(2) and 266-150(1); sections 266-40, 266-90, 266-125 and 266-165] . For ordinary fixed trusts and listed widely held trusts, there are also alternative conditions which, if satisfied, will allow the trust to deduct a loss even if the 50% stake test is failed (see paragraphs 6.18 to 6.24 for ordinary fixed trusts and paragraphs 6.25 to 6.30 for listed widely held trusts).

50% stake test

6.14 The 50% stake test is used in determining whether there has been a change in ownership of a trust with fixed entitlements. A trust passes the 50% stake test if:

·
the same individuals have fixed entitlements, directly or indirectly, to more than 50% of the income of the trust at the relevant times; and
·
the same individuals (not necessarily the same as those that hold fixed entitlements to income) have fixed entitlements, directly or indirectly, to more than 50% of the capital of the trust at the relevant times. [Subsection 269-55(1)]

6.15 Where a widely held unit trust has a large number of direct or indirect unit holders, it may be practically difficult to determine with precision the identity of all individuals that hold fixed entitlements directly or indirectly for the purposes of applying the 50% stake test. A special rule is provided so that in the case of a widely held unit trust, the 50% stake test will be passed where it is reasonable to assume that the requirements of the 50% stake test are met. [Subsection 269-55(2)]

6.16 Table 6.2 shows the relevant times when the necessary stake has to be held for each kind of fixed trust.

Table 6.2 Relevant times for testing 50% stake
Type of fixed trust Relevant times for testing 50% stake
Ordinary fixed trust All times during the test period [Section 266-40]
Unlisted widely held trust Each time there is abnormal trading in the trust during the test period, or when an income year of the trust ends in or at the end of the test period, the 50% stake is tested in relation to the start of the test period and the time of the abnormal trading or end of the income year [Subsection 266-90(1)]
Listed widely held trust, unlisted very widely held trust, wholesale widely held trust Each time there is abnormal trading in the trust during the test period the 50% stake is tested in relation to the start of the test period and the time of the abnormal trading [Sections 266-125 and 266-165]

6.17 The effect of these requirements is that widely held unit trusts need to test for continuity of ownership only when there is abnormal trading in the trust's units and, in the case of unlisted widely held trusts, at the end of an income year of the trust. Further detail on the 50% stake test is provided at paragraphs 9.22 to 9.33. The meaning of the abnormal trading concept is set out in Division 269 and is discussed below at paragraphs 9.2 to 9.21.

Alternative condition for ordinary fixed trusts held 50% or more by non-fixed trusts

6.18 Where all the fixed entitlements in a fixed trust are held by a non-fixed trust in which there are no fixed entitlements, no individuals will have any fixed entitlement to the income and capital of the fixed trust (see paragraphs 13.28 and 13.29). This is because a person who is merely a potential beneficiary under a non-fixed trust does not have an entitlement to income or capital of the trust and thus does not own anything which is capable of being taken into account in applying the 50% stake test (and correspondingly, does not suffer the economic loss). The 50% stake test would also be failed in circumstances where the fixed trust is wholly owned, directly or indirectly, by another fixed trust or a company which, in turn, is held 50% or more by non-fixed trusts.

6.19 Thus, for example, where the majority of the fixed entitlements in a fixed trust are held by a non-fixed trust in which there are no fixed entitlements (e.g. a discretionary trust), the 50% stake test cannot be satisfied by the fixed trust.

6.20 The effect of this is that, in the absence of any special provision, a fixed trust (not being a family trust) which has losses may lose those losses solely because half or more of the interests in the trust are held directly or indirectly by a non-fixed trust with no or insufficient fixed entitlements. The difficulty does not arise if the non-fixed trust is a family trust. This is because a fixed entitlement held by a family trust is treated as if it were held by an individual (see subsection 272-30(2)).

When can the alternative condition be applied?

6.21 The alternative condition for ordinary fixed trusts may allow such trusts to deduct their losses even though they may not be able to pass the 50% stake test. This condition will apply where individuals do not, directly or indirectly, hold fixed entitlements to more than 50% of the income or capital of that fixed trust [subsection 266-45(4)] and either of the two conditions below are met.

·
Fixed entitlements to 50% or more of the income or capital of a fixed trust must be held by a non-fixed trust or trusts (other than family trusts). [Paragraph 266-45(2)(a)]
·
Both of the following are satisfied:

-
all the fixed entitlements to income and capital of the fixed trust are held, directly or indirectly, by another fixed trust or a company (the holding entity ); and
-
a non-fixed trust or trusts (other than family trusts) hold fixed entitlements to a 50% or greater share of the income or capital of the holding entity. [Paragraph 266-45(2)(b)]

When is the alternative condition met?

6.22 There are two requirements that must be satisfied if the alternative condition is to be met, as set out below.

·
Where the fixed trust is held directly by the non-fixed trusts, there must be no change in the persons directly holding fixed entitlements to shares of the income or capital of the fixed trust nor the percentage of their shares. Where the fixed trust is held, directly or indirectly, by a holding entity (see paragraph 6.21), this requirement is instead applied to the holding entity rather than the fixed trust. [Subsection 266-45(3)] .
·
Every non-fixed trust (that is not a family trust or other excepted trust) that holds fixed entitlements in the fixed trust, directly or indirectly, must satisfy the relevant tests that apply to non-fixed trusts if they stood in place of the loss trust [subsection 266-45(5)] .

6.23 For prior year loss purposes, the loss deductibility tests for non-fixed trusts are a 50% stake test, a control test and a pattern of distributions test. The pattern of distributions test is, however, not applicable for current year loss purposes. The tests that apply for debt deduction purposes depend on whether the debt was incurred in a prior income year or the current income year.

6.24 Where the requirements in paragraph 6.22 are satisfied, the loss can be deducted by the trust.

Alternative condition for listed widely held trusts : same business test

6.25 For listed widely held trusts only, the proposed legislation has a same business test which allows the trust to deduct a prior year loss even if the 50% stake test is not satisfied when there is abnormal trading in the trust. This means the loss is still deductible if such a trust passes the same business test (in relation to the time immediately before the first abnormal trading that results in failure of the 50% stake test) in the part of the test period that occurs after the abnormal trading [paragraph 266-125(2)(b)] . The terms of the same business test are set out in Division 269 and are discussed at paragraphs 9.70 to 9.77.

Example

6.26 A listed widely held trust with a prior year loss fails the 50% stake test after an abnormal trading. However, the trust carries on the same business from the time the 50% stake test is failed until the end of the test period as it carried on immediately before the abnormal trading. The trust also does not derive assessable income from any business or from any transaction which causes the trust to not meet the requirements of subsections 269-100(3), (4) and (5). The trust is, therefore, not prevented by Division 266 from deducting the loss.

Application of same business test to listed widely held trusts where prior year loss made up of debt deduction

6.27 Section 266-135 provides an additional condition for the deduction of a prior year loss by a listed widely held trust, where the loss is wholly or partly made up of a debt deduction. It is applicable where a listed widely held trust has failed the 50% stake test in relation to the debt deduction but has been able to utilise the deduction because the same business test is met. Section 266-135 is the equivalent of section 80F of the ITAA 1936, which applies to companies.

6.28 In the absence of a special safeguarding provision, the 50% stake test and the same business test which applies to listed widely held trusts could be manipulated in relation to debt deductions of a trust. A listed widely held trust which incurs a debt prior to failing the 50% stake test on abnormal trading of units could, for example, postpone changing its business until an income year subsequent to the one in which the debt had been written off as bad (i.e. outside the test period for bad debts). The bad debt could thus be included as the whole or part of a tax loss and be available for deduction in a subsequent year. The debt would not have been disqualified for deduction under the 50% stake test that needs to be satisfied for prior year loss purposes as the change in ownership will have occurred before the start of the test period.

6.29 To be able to deduct the whole or part of a prior year loss deduction created by a debt deduction, section 266-135 requires the listed widely held trust to satisfy the same business test from the time of the failure of the 50% stake test discussed in paragraph 6.27 to the end of the income year in which the loss is to be deducted. This requirement has to be met if the Commissioner considers that the trust satisfied the same business test in the test period that applies for debt deductions so as to secure the debt deduction. The provision effectively disqualifies the debt deduction and thus precludes it from being deducted as the whole or part of a tax loss.

Example

6.30 A listed widely held unit trust which has a debt and has failed the 50% stake test since the debt was incurred writes off the debt as bad in a later year of income. In that later income year the trust postpones entering into transactions that would be of a kind that would cause it to fail the same business test in that year. The trust would not fail the 50% stake test that applies to prior year losses as the change of ownership has occurred before the commencement of the test period for prior year losses, i.e. the beginning of the income year in which the debt is written off. The Commissioner can apply section 266-135 so that the trust is required to satisfy the same business test from the time of the failure of the 50% stake test until the end of the year in which that part of the trust's tax loss that relates to the debt is recouped. This will effectively disallow a deduction for the debt.

When can part of a prior year tax loss be deducted by a fixed trust?

6.31 If a fixed trust (including a widely held unit trust) cannot deduct a prior year tax loss because it does not meet the conditions set out above, then it may still be able to deduct part of the tax loss which is properly attributable to part of the loss year [subsections 266-50(1), 266-95(1), 266-130(1) and 266-170(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.

6.32 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 conditions discussed at paragraphs 6.14 to 6.30. [Subsection 266-50(2), 266-95(2), 266-130(2) and 266-170(2)]

Example

6.33 In Year 1, a fixed trust incurs a tax loss. During that year there is a change in ownership of the trust which results in it failing the 50% stake test. 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.

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

6.34 The Bill also sets out rules to determine when a fixed trust (including the different kinds of widely held unit trust) cannot deduct current year losses. 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.

When do the current year loss rules for fixed trusts have to be applied?

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

·
it was a fixed trust of the relevant kind or kinds 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. [Sections 266-30, 266-80, 266-115 and 266-155]

6.36 In the case of an unlisted very widely held trust, the test period excludes so much of the income year that falls within the start-up period of the trust. [Section 266-155]

When must a fixed trust work out its net income and tax loss in a special way?

6.37 If the conditions outlined in paragraph 6.35 are met then the fixed trust must work out its net income and tax loss in a special way unless it meets the conditions set out in the Bill [sections 266-30, 266-80, 266-115, 266-155] . These conditions are the same as those that apply for prior year loss purposes (refer to the discussion at paragraphs 6.14 to 6.26).

6.38 There is one exception and that is that an unlisted widely held trust only needs to meet the 50% stake test when there is abnormal trading in the trust's units (i.e. the test does not also need to be applied at the end of the income year). This is because the purpose of the current year loss rules is to split the income year up into periods and calculate a net income or tax loss for each period (see Chapter 8). It is therefore not relevant whether there has been a change in underlying majority beneficial ownership at the end of the income year.

When can't a fixed trust deduct a bad debt or deduction in respect of a debt/equity swap? (debt deductions)

6.39 The Bill sets out rules to determine when a fixed trust (including the different kinds of widely held unit trust) cannot deduct a bad debt deduction or a deduction relating to a debt/equity swap under section 63E (called 'debt deductions' in this Explanatory Memorandum). These rules are intended to prevent a person getting the deduction where the person did not economically incur the debt to which the deduction relates. (Bad debts may be deductible under sections 51 or 63 of the ITAA 1936 or sections 8-1 or 25-35 of the ITAA 1997).

When do the debt deduction rules for fixed trusts have to be applied?

6.40 A fixed trust is affected by the rules, as they relate to debt deductions, if:

·
in the income year it has, ignoring the rules in the Bill, an allowable bad debt deduction or an allowable deduction under section 63E;
·
it was a fixed trust of the relevant kind or kinds at all times during the test period ; and
·
it was not an excepted trust at all times in the test period. [Sections 266-35, 266-85, 266-120 and 266-160]

What is the test period for debt deduction purposes?

6.41 The test period for debt deduction purposes depends on when the debt is incurred. If the debt is incurred in a year before the deduction arises, the test period runs from the time the debt is incurred through to the end of the income year in which the deduction is available. If the debt is incurred in the income year in which the deduction arises, the test period is the income year. [Sections 266-35, 266-85, 266-120, 266-160]

6.42 In the case of an unlisted very widely held trust, the test period excludes so much of the period mentioned above that falls within the start up period of the trust. [Section 266-160]

When can't a fixed trust deduct a debt deduction?

6.43 If the conditions outlined in paragraph 6.40 are met then the fixed trust cannot deduct the debt deduction unless it meets the conditions set out in the Bill [sections 266-35, 266-85, 266-120, 266-160] . These conditions are the same as those that apply for prior year loss purposes (refer to the discussion at paragraphs 6.14 to 6.26).

Chapter 7 - Non-fixed trusts

Overview of non-fixed trust rules

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

7.2 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 or debt deduction. Non-fixed trusts are different to fixed trusts because it is not possible to determine who has a vested and indefeasible interest in all the income and 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 vested interests may be defeated or the vesting of the interests is conditional. It is not, therefore, possible to apply the same 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 the individuals who benefit from the trust.

7.3 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.

7.4 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 or debt deductions. Also, other excepted trusts (as defined - see paragraphs 13.71 to 13.74 below) are not affected by Division 267.

What is a non-fixed trust?

7.5 A non-fixed trust is any trust which is not a 'fixed trust' [section 272-70] . 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.

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

7.6 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

When do the prior year loss rules for non-fixed trusts have to be applied?

7.7 A non-fixed trust is affected by the 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. [Subsection 267-20(1)]

What is the test period for prior year loss purposes?

7.8 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)]

What are the conditions to be met if a prior year loss is to be deducted?

7.9 If the conditions in paragraph 7.7 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)]

7.10 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 [sections 267-30 and 267-35] ;
·
fixed entitlements to income or capital of the trust - this test will not be applicable if individuals never hold, directly or indirectly, fixed entitlements to more than 50% of the income or capital of the trust in the test period [section 267-40] ;
·
control of the trust - this condition will apply to all non-fixed trusts [section 267-45] .

7.11 The details of the three conditions are set out below. The meaning of important concepts and tests used in determining whether these conditions are satisfied are set out in Division 269 and are discussed in Chapter 9.

What is the pattern of distributions condition?

7.12 The first condition in paragraph 7.10 for non-fixed trusts examines 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. To this end, the trust must pass the pattern of distributions test for the income year [subsection 267-30(2)] . This test compares trust distributions of income and capital of the year of recoupment and the relevant years in the previous 6 years. Also, the trust must not have failed the pattern of distributions test in relation to the loss in a previous year of income [section 267-35] . The pattern of distributions test does not apply to family trusts as defined.

7.13 The condition relating to pattern of distributions must be satisfied by a non-fixed trust if the trust distributed income and/or capital in the income year (or within two months of its end)[F7] and in at least one of the six previous income years. [Subsection 267-30(1)]

What is the 50% stake condition for non-fixed trusts?

Income

7.14 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 from the test time to the end of the test period, the same individuals must hold more than a 50% stake in the income of the trust. These individuals can be some or all of those who hold fixed entitlements to income of the trust at the test time [subsections267-40(1) and (2)] . The meaning of the 50% stake concept is set out in Division 269 and is discussed below at paragraphs 9.22 to 9.33.

Example

7.15 A non-fixed trust has a loss incurred in the 1997-98 income year which it seeks to recoup in the 1998-99 income year. At the start of the 1997-98 income year, Jack and Jill each have fixed entitlements to 25% of the income of the trust. On 1 January 1998, Ben acquires a fixed entitlement to 25% of the income of the trust meaning that, from that time, 75% of the income of the trust is the subject of a fixed entitlement. The 50% stake condition for income is therefore applicable to the trust. At the end of the 1997-98 income year, Ben disposes of 20% of his share to Bill but Jack and Jill continue to hold their 25% shares, and Bill continues to hold 5%, to the end of the 1998-99 income year. The Trust passes the 50% stake condition for income because Jack, Jill and Ben have maintained more than a 50% stake in the income of the trust from 1 January 1998 to the end of the 1998-99 income year.

Capital

7.16 A 50% stake condition in the same terms applies for capital of the trust. [Subsections 267-40(1) and (2)]

Commissioner's discretion

7.17 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 unreasonable results in particular cases.

7.18 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 as 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. [Subsection267-40(3)]

Example

7.19 At the start of a test period, there are fixed entitlements to 51% of the income and to 100% of the capital of a non-fixed trust. 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.

7.20 One of the matters which it would be relevant for the Commissioner to take into account in determining whether or not to exercise the discretion is whether Jill or Jack will receive 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?

7.21 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 267-45] . The meaning of control is set out in Division 269 and is discussed at paragraphs 9.58 to 9.69.

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

7.22 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 [section 267-50] . This provision works in a similar way as it works for fixed trusts (see the discussion above at paragraphs 6.31 to 6.33).

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

7.23 The Bill also sets out rules to determine when a non-fixed trust cannot deduct current year losses.

When do the current year loss rules for non-fixed trusts have to be applied?

7.24 A non-fixed trust is affected by the 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 267-60]

When must a non-fixed trust work out its net income and tax loss in a special way?

7.25 If the conditions in paragraph 7.24 are met then the non-fixed trust must work out its net income and 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 267-60]

7.26 The two conditions relate to:

·
fixed entitlements to income or capital of the trust - this test will not be applicable if individuals never hold, directly or indirectly, fixed entitlements to more than 50% of the income or capital of the trust in the test period [section 267-70] ;
·
control of the trust - this condition will apply to all non-fixed trusts [section 267-75] .

7.27 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 7.14 to 7.21 above).

When can't a non-fixed trust deduct a bad debt or deduction in respect of a debt/equity swap? (debt deductions)

7.28 The Bill also sets out rules to determine when a non-fixed trust cannot deduct a bad debt deduction or a deduction relating to a debt/equity swap under section 63E (these are called 'debt deductions' in this Explanatory Memorandum). (Bad debts may be deductible under sections 51 or 63 of the ITAA 1936 or sections 8-1 or 25-35 of the ITAA 1997).

When do the debt deduction rules for non-fixed trusts have to be applied?

7.29 A non-fixed trust is affected by the rules, as they relate to debt deductions, if:

·
in the income year it has, ignoring the rules in the Bill, an allowable bad debt deduction or an allowable deduction under section 63E;
·
it was a non-fixed trust at any time during the test period ; and
·
it was not an excepted trust at all times in the test period. [Sections 267-25 and 267-65]

What is the test period for debt deduction purposes?

7.30 As with fixed trusts, the test period for debt deduction purposes depends on when the debt is incurred. If the debt is incurred in a year before the deduction arises, the test period runs from the time the debt is incurred through to the end of the income year in which the deduction is available. If the debt is incurred in the income year in which the deduction arises, the test period is the income year.

When can't a non-fixed trust deduct a debt deduction?

7.31 If the conditions outlined in paragraph 7.29 are met then the non-fixed trust cannot deduct the debt deduction unless it meets the conditions set out in the Bill.

7.32 If the debt is incurred in a year before the deduction arises, the conditions are those relating to the pattern of distributions, control and fixed entitlements. These are the same conditions that apply to non-fixed trusts for prior year loss purposes (see paragraphs 7.12 to 7.21) [section 267-25] . However, for the purposes of determining a 'test year distribution' of income, paragraph 9.39 should be read as though the references to the loss year were references to the year the debt was incurred.

7.33 If the debt is incurred in the year the deduction arises, the conditions are those relating to control and fixed entitlements. These are the same conditions that apply to non-fixed trusts for current year loss purposes (see paragraphs 7.14 to 7.21). [Section 267-65]

Chapter 8 - Calculation of current year net income and tax loss

Overview

8.1 The following discussion sets out the provisions that apply where a trust is required to work out its net income and 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

8.2 A trust that is required to calculate its net income and tax 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 divided into periods?

8.3 The way in which the income year of a fixed trust (including a widely held unit trust) is divided into periods depends on whether the trust is required to calculate its income and loss under Division 268 because it has failed the 50% stake test or, if it is an ordinary fixed trust, because it has failed that test and the alternative condition for ordinary fixed trusts held 50% or more by non-fixed trusts.

Fixed trust failing the 50% stake test

8.4 The first period for a fixed trust starts at the start of the income year. Each later period starts immediately after the previous period and the last period ends at the end of the income year. [Subsections 268-10(2) and (3); 268-20(2) and (3)]

8.5 If the trust is not a widely held unit trust (i.e. an ordinary fixed trust), each period (except the last) ends at the latest time that would result in the trust passing the 50% stake test for the whole of the period. [Subsection 268-10(3)]

8.6 If the trust is a widely held unit trust each period (except the last) ends at the earliest time at which there is an abnormal trading in the trust's units and the trust does not pass the 50% stake test in respect of the following times:

·
the beginning of the period; and
·
immediately after the abnormal trading. [Subsection 268-20(3)]

8.7 If a listed widely held 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 same 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 have been two changes in ownership which have resulted in the trust failing the continuity of ownership test).

Example

8.8 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.

8.9 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 same 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).

Timeline

Ordinary fixed trust failing the 50% stake test and the alternative condition

8.10 If an ordinary fixed trust fails the 50% stake test and the alternative condition in section 266-45, its income year is divided into periods as follows.

8.11 The first period for the fixed trust starts at the start of the income year. Each later period starts immediately after the previous period and the last period ends at the end of the income year. Each period (except the last) ends the first time one of the following events occurs after the start of the period:

·
when the persons holding the fixed entitlements in the fixed trust (or holding entity), or the percentages that the persons hold, changes;
·
the latest time at which all the non-fixed trusts holding a direct or indirect fixed entitlement in the fixed trust meet the 50% stake condition in relation to the start of the period;
·
the first time a group begins to control one of the non-fixed trusts that holds a direct or indirect fixed entitlement in the fixed trust. [Section 268-15]

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

8.12 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)]

8.13 The last period will end at the end of the income year [subsection 268-25(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.

8.14 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 more than a 50% 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 268-25(4)]

8.15 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 268-25(5)]

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

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

8.16 A notional loss or net income of a trust has to be calculated for each period of the income year [subsection 268-30(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. Where a trust is a partner the notional loss or notional net income for each period is worked out under section 268-70.

8.17 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 268-30(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.

8.18 A notional loss will arise where certain deductions attributable to the period exceed the assessable income attributable to the same period [subsections 268-30(2)] . A notional loss incurred in the last period in an income year 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 268-30(3)] .

How are deductions attributed to a period?

8.19 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

8.20 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 268-35(2) and include, for example, depreciation which is deductible under section 54, or section 42-15 of the ITAA 1997, and some deductions for expenditure which are spread over 2 or more years. [Subsection 268-35(2)]

Example

8.21 A fixed trust has depreciation expenses of $3,000 for an item 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 $1,000 are allocated to each of the 4 month periods.

Example 2

8.22 A fixed trust has taken out a three year loan. The borrowing expenses that are deductible under section 67 or section 25-25 of the ITAA 1997 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 2 periods of 6 months. The amount of the deduction that is attributed to each of the periods is $100 (i.e. half of $200).

8.23 The second type of deduction is a deduction that is attributed to a period as if the period were an income year. [Subsection 268-35(3)]

Example 1

8.24 A non-fixed trust disposes of an item of depreciable property during a year of income. As a result of the disposal an amount of $2,000 is available for deduction under subsection 59(1), or subsection 42-195(1) of the ITAA 1997. Under section 268-25, the income year of the non-fixed trust is to be divided into 2 periods. The $2,000 deduction is to be allocated to the period in which the disposal took place.

Example 2

8.25 As a result of section 268-25, 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 $2,000. A deduction for the excess is allowable under subsection 28(3), or subsection 70-35(3) of the ITAA 1997. This deduction is allocated to the first period.

Example 3

8.26 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

8.27 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 268-35(4)]

8.28 Full year deductions are listed fully in the legislation and include, forexample, deductions allowable for bad debts or for losses on debt/equity swaps under section 63E, gifts, and tax losses for earlier years. [Subsection 268-35(5)]

8.29 However, a deduction for the balance of capital expenditure is not a full year deduction if the deduction results from the disposal, loss etc. of property [subsection 268-35(6)] . This deduction would be of a kind that falls within subsection 268-35(3).

How is assessable income attributed to a period?

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

Income from other trusts

8.31 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 268-40(2)]

Pro-rated assessable income

8.32 The second class is those 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 268-40(3) and include, for example, insurance pay outs for loss of livestock or trees which, under section 26B, or section 385-130 of the ITAA1997, can be spread in equal instalments over 5 years. [Subsection 268-40(3)]

Wool clips

8.33 The third class is amounts included in the trust's assessable income under section 26BA or under section 385-135 (Election to defer including profit on second wool clip) of the ITAA 1997. These are attributed to the period when the wool would ordinarily have been shorn. [Subsection 268-40(4)]

Deemed dividends

8.34 The fourth class is amounts included in the trust's assessable income that are deemed to be dividends under either sections 65, 108 or 109. This income is attributed to the period when the amount was paid or credited, whichever occurred first. [Subsection 268-40(5)]

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

8.35 The fifth class is income that is attributable to periods as if each period were an income year. This income is attributed accordingly. [Subsection 268-40(6)]

Example

8.36 As a result of section 268-25, 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 $2,000. This amount is to be included in assessable income under subsection 28(2), or subsection 70-35(2) of the ITAA 1997. 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

8.37 The sixth 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 268-40(7)]

Example

8.38 A non-fixed trust receives income as a beneficiary of a trust estate which is assessable under section 97. As a result of section 268-25, 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?

8.39 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 268-45(4)(a), (b) and (c)) unless these deductions exceed the total of the notional net incomes and the full year amounts (if they equal or exceed that total, the trust does not have a net income for the income year);
·
if any amount remains, other full year deductions in the order specified in subsection 268-45(5) unless these deductions exceed the amount remaining (if they equal or exceed that amount, the trust does not have a net income for the income year). [Section 268-45]

8.40 An example of how the net income of the trust is calculated is shown at paragraph 8.47.

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

8.41 Section 79E is the general provision in the ITAA 1936 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 268-50(3)(a), (b) and (c) exceed:

-
the total of the notional net incomes (if any); and
-
the full-year amounts referred to in section 268-40 (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 268-50]

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

8.42 As a result of subsection 79E(4) of the ITAA 1936, 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.

8.43 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 268-55]

Example

8.44 A trust's section 79E losses (including film losses) from the whole of its activities, calculated under section 268-50 are $8m. A trust's losses from its film activities calculated under subsections 268-55(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.

How do you work out the trust's section 36-10 tax loss for the income year?

8.45 Section 36-10 is the provision in the ITAA 1997 that sets out how to calculate a tax loss. If the income year of a trust has been divided into periods under Subdivision 268-B, the steps for calculating the section 36-10 tax loss are essentially the same as those for calculating a section 79E loss as described in paragraph 8.41. [Section 268-60]

How do you work out the film component of the trust's tax loss for the income year for the purposes of section 375-805 of the ITAA 1997?

8.46 The steps for calculating the film component of a trust's tax loss for the purposes of section 375-805 of the ITAA 1997 are essentially the same as the steps for calculating a trust's section 79F film loss as described in paragraphs 8.42 to 8.44. The terms 'assessable film income', 'net exempt film income' and 'film deductions' are defined in section 375-805 of the ITAA 1997. [Section 268-65]

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

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

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

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 deductions (gifts)
- 1,200 (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 ITAA 1936.

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.

8.48 A trust may have derived a class of foreign income during the year of income for which there is a foreign income deduction of the same class that is reduced under section 79D. For the purposes of Division 268, the deduction will need to be calculated for the income year and then (assuming the deduction is not a full year deduction) apportioned to each of the periods according to the amount of foreign income deductions attributed to each of the periods under either subsections 268-35(2) or (3).

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?

8.49 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.

8.50 The broad aim of the Subdivision is to attribute a share of the partnership's net income or tax 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.

8.51 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 268-70]

8.52 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 tax loss under Division 6 of the ITAA 1936, 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 268-75]

8.53If the trust has a different accounting period from the partnership, 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 8.50. [Section 268-80]

8.54 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. [Section268-85]

Chapter 9 - Abnormal trading, 50% stake, pattern of distributions, control and same business

Overview

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

When is there abnormal trading of units in a widely held unit trust?

9.2 The abnormal trading concept is used in determining when widely held unit trusts can deduct prior or current year losses or debt deductions. 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

9.3 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. 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

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

Suspected acquisition or merger

9.5 Firstly, there is an abnormal trading in units where the trading is part of a proposed acquisition 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 269-20]

Trading of 5% or more in one transaction

9.6 Secondly, there is abnormal trading if 5% or more of the units in the trust are traded in one transaction [section 269-25] . 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.

5% or greater trading over 2 or more transactions

9.7 Thirdly, 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 one above (paragraph 9.6) but looks to the situation where the possibility of a significant change in underlying ownership is disguised in a number of transactions. [Subsection 269-30(1)]

9.8 If an abnormal trading is deemed to have taken place by the rule in paragraph 9.7, the time of the trading is the time of the transaction that pushes the trading over 5%. [Subsection 269-30(2)]

More than 20% change in a 60 day period

9.9 Lastly, there is abnormal trading if more than 20% of the units in a trust on issue at the end of any 60 day period are traded during that period [section 269-35(1)] . This could occur if:

·
ownership of more than 20% of the units changes in a 60 day period;
·
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; or
·
more than 20% of the trust's units are redeemed in a 60 day period.

9.10 It could also occur if there is a combination of any one or more of the above so that more than 20% of the units are traded.

9.11 Again, these facts are enough to indicate that there may have been a significant alteration in the underlying beneficial ownership of the trust. If an abnormal trading is deemed to have taken place by the rule in paragraph 9.9, the time of the trading is the end of the 60 day period. [Subsection 269-35(2)]

Example

9.12 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.

9.13 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, one third of the units on issue after that time.

Special abnormal trading rules for wholesale widely held trusts

9.14 For the purposes of wholesale widely held trusts only, there are special abnormal trading rules. A wholesale widely held trust is a kind of widely held unit trust and is defined in section 272-125 (see paragraphs 13.87 to 13.90).

9.15 Since wholesale widely held trusts have a relatively small amount of direct unit holders, some of the abnormal trading tests are not appropriate because they may be triggered on a regular basis through the normal trading of the trust's units. These are the tests that set a specific mathematical threshold (sections 269-25, 269-30 and 269-35). Accordingly, these three sections do not apply in determining whether there has been abnormal trading in the units of a wholesale widely held trust.

9.16 Abnormal trading in a wholesale widely held trust occurs:

·
when there is abnormal trading on balance (this is the same as what is discussed at paragraph 9.3);
·
when there is a suspected merger or acquisition of the trust (this is the same as what is discussed at paragraph 9.5); or
·
if the trustee knows or reasonably suspects that the persons that held more than 50% of the units in the trust at the beginning of the period did not hold more than 50% of the units at the end of the that period (where this is the case, the abnormal trading occurs immediately before the end of the period). [Section 269-40]

When does a trustee have to know or reasonably suspect that certain things have occurred?

9.17 For the purposes of the abnormal trading tests that talk about a trustee knowing or reasonably suspecting that certain things have occurred, a provision is included to clarify when that state of mind can arise. In general terms, if the state of mind arises at any time during the relevant test period, the abnormal trading will have occurred at the relevant time in the period. In the case of the current year loss provisions which require a trust to calculate its net income and tax loss for an income year in a special way, if the state of mind arises during the income year, the abnormal trading will have occurred at the relevant time in the year. [Section 269-45]

Abnormal trading where there is a holding trust

9.18 The Bill provides a special abnormal trading rule for a unit trust that is a subsidiary of another unit trust. The rule applies where a unit trust (the holding trust ) holds fixed entitlements, directly or indirectly, to all the income and capital of another unit trust (the subsidiary trust ). In this case there is abnormal trading in the subsidiary trust only when there is abnormal trading in the holding trust which is not itself a subsidiary trust of another holding trust. [Subsections 269-47(1) and (3)]

9.19 However, a transaction which causes a trust to become, or cease to be, a holding trust of a subsidiary (the bottom subsidiary trust ) is abnormal trading in that subsidiary but not where:

·
the holding trust is itself a subsidiary trust of another holding trust or trusts (each of which is a higher holding trust ); and
·
before and after the transaction the bottom subsidiary trust was a subsidiary of a higher holding trust. [Subsection 269-47(2)]

Example

Ownership structure

9.20 In the above ownership structure the A Unit Trust is a holding trust of the B Unit Trust, C Unit Trust and the D Unit Trust. As long as this is the case, there is only an abnormal trading in the latter trusts when there is abnormal trading in the A Unit Trust. If the B Unit Trust sold any of its units in the D Unit Trust, there would be abnormal trading in the D Unit Trust unless the units were sold to the A Unit Trust or the C Unit Trust or another subsidiary of the A Unit Trust.

No abnormal trading where there is a proportionate issue of units

9.21 A trust may issue units to existing units holders on a pro-rata basis such that the extent of the unit holders interest in the income and capital of the trust does not change as a result of the issue. Such an issue will not, of itself, constitute abnormal trading. To this end, there will be no abnormal trading (except in the case of a suspected takeover or merger) where, after trading, the respective fixed entitlements of unit holders to shares of income and capital of the trust continue to be held (whether beneficially or not) in the same proportions. [Section 269-49]

50% stake (continuity of ownership)

9.22 The 50% stake concept is used in determining whether there has been a change in ownership of a trust with fixed entitlements.

When do individuals have more than a 50% stake in the income or capital of a trust?

9.23 An individual or group of individuals have more than a 50% stake in the income or capital of a trust if those individuals hold, directly or indirectly, and for their own benefit, fixed entitlements to a greater than 50% share of the income or capital of the trust. [Subsections 269-50(1) and (2)]

When does a trust pass the 50% stake test?

9.24 A trust passes the 50% stake test if, at the relevant times:

·
the same individuals have more than a 50% stake in the income of the trust; and
·
the same individuals have more than a 50% stake in the capital of the trust (these individuals need not be the same as those who hold the fixed entitlements to income). [Subsection 269-55(1)]

9.25 A special rule applies in the case of widely held unit trusts under which a trust is taken to pass the 50% stake test if it is reasonable to assume that the requirements of subsection 269-55(1) are satisfied. [Subsection 269-55(2)]

9.26 The relevant times are the times during the test period when the 50% stake test has to be satisfied. For example, an ordinary fixed trust has to meet the 50% stake test at all times during the test period (see paragraph 6.16).

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

9.27 The meaning of a fixed entitlement in the income or capital of a trust is explained at paragraphs 13.3 to 13.13. 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?

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

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

9.29 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 13.17 to 13.46 set out the detailed rules that apply in determining whether a fixed entitlement is taken to be held indirectly.

An example of the application of the 50% stake test

9.30 Trust A, an ordinary 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.

9.31 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.

9.32 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%.

9.33 Trust A fails the 50% stake test and the loss is not deductible. 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 more than 50% of the fixed entitlements have not held more than 50% of the fixed entitlements to income of Trust A throughout the test period.

Pattern of distributions test

9.34 The pattern of distributions test is used in determining whether a non-fixed trust can deduct a prior year loss and some debt deductions.

What is the pattern of distributions test?

9.35 The pattern of distributions test is passed if, within two months of the end of the income year[F8]:

·
the trust has distributed, directly or indirectly, more than 50% of every 'test year distribution' of income to the same individuals for their own benefit; and
·
the trust has distributed, directly or indirectly, more than 50% of every 'test year distribution' of capital to the same individuals for their own benefit (these individuals need not be the same as those to whom income is distributed). [Section 269-60]

When is income or capital distributed to an individual for their own benefit?

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

What is a distribution of income or capital?

9.37 The term 'distribution of income or capital' has the meaning given to it by Subdivision 272-B. Under this Subdivision distributions made by a trust will include both ordinary distributions of income or capital (see section 272-45) and distributions that fall within an extended meaning as specified in section 272-60.

9.38 A distribution will also be taken to have been made to an individual where a trustee does not directly or indirectly actually make a distribution to an individual but the distribution has been made to an interposed entity in which the individual has a direct or indirect fixed entitlement (see section 269-75).

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

9.39 A test year distribution of income is the total of all distributions of income in a relevant period (generally an income year) made by the trust but excludes distributions of income in an income year which starts more than 6 years before the start of the income year in which the trust seeks to deduct the prior year loss. A relevant period is:

·
the income year being examined and the two months after the income year (the end year)[F9];
·
the earliest 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 earliest of these three years is called the start year below).
·
each intervening income year between the start year and the end year. [Subsection 269-65(1)]

9.40 The test applies in the same way to distributions of capital to determine what is a 'test year distribution' of capital. [Subsection 269-65(3)]

9.41 Where distributions prior to the 1995 Budget time have to be taken into account in applying the pattern of distributions test under the above rules, a transitional rule applies to treat the members of a particular family as one individual for the purposes of the test (see paragraph 15.6).

What is the percentage of a test year distribution distributed to an individual?

9.42 The percentage of any test year distribution of income or capital for any income year distributed by a trust to an individual is the total income or capital distributed to the individual as a percentage of the total income or capital for that year distributed by the trust.

When an individual receives different percentages

9.43 If the trust does not distribute to each of the individuals the same percentage of income or capital in every test year distribution then the percentage of a test year distribution that is taken to have been distributed by the trust is the smallest percentage that has been distributed [section 269-70] . This rule is necessary because each test year distribution will not necessarily be of the same value and there could be large swings between the percentages received by individuals which demonstrate an effective change in those benefiting from the trust. The rule will ensure some comparability between the distributions that are being tested.

Example of how the smallest percentage is used

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

9.45 In accordance with the test discussed in paragraph 9.39, 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 for the year made to any person is totalled. The percentage of the total distributed to each individual is that individual's share of the test year distribution.

9.46 The test year distributions made by the trust are as set out in Table 9.1

Table 9.1
Jack 50% 10% 10%
Jill 40% 10% 10%
Mary 10% 10% 10%
Bill 0% 70% 0%

9.47 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 distributed to the same individuals, having regard to the fact that each individual is taken to have received the smallest percentage for each test year distribution. In essence, if the total worked out by adding the smallest percentage of each individual is more than 50%, the test is passed (in the above example, the smallest percentages are those in the far right column).

Incomplete distributions

9.48 A trust may make a distribution to an interposed entity which does not subsequently make an on-distribution to individuals within two months of the end of the income year. For the purpose of tracing distributions under the pattern of distributions condition, the interposed entity will be taken to have distributed all or part of a test year distribution of income or capital to an individual. This will be the case if the individual holds (otherwise than in the capacity as trustee) a fixed entitlement (directly or indirectly) to a share of the undistributed amount held in the interposed entity at the end of two months after the income year.[F10] [Section 269-75]

9.49 For the purpose of calculating an individual's share of the distribution made to the interposed entity, the same rules as those used in tracing fixed entitlements for the 50% stake test are applied. The individual will be treated as having been distributed a portion of the distribution equal to the amount of the distribution in the interposed entity multiplied by the individual's direct or indirect fixed entitlement to the income or capital of that entity.

9.50 If there are no individuals who had a fixed entitlement in the interposed entity (e.g. it is a discretionary trust), no individuals will be taken to have been distributed any amount.

Examples of how to trace where there are incomplete distributions

Example 1

9.51 Trust A distributes $3,000 income of an income year to a beneficiary of the trust, Company B. The ordinary shares in Company B are held in equal shares by Jill, Ben and Sam at the end of two months after the end of the income year. There are no other share holdings in the company. Company B does not declare a dividend before the end of two months after the end of the income year. As Jill, Ben and Sam have fixed entitlements in the income of Company B they will be treated as each having been distributed a third of the trust income (i.e. $1,000) in the year of income.

Example 2

9.52 Trust A distributes $3,000 income of an income year to Trust B which is a discretionary trust in which no beneficiary has a fixed entitlement to income. Trust B makes no distribution attributable to the distribution from Trust A before the end of two months after the end of the income year. As there are no individuals who have a fixed entitlement to the income or capital of the discretionary trust, no individuals will be taken to have been distributed any part of the $3,000.

What if an individual can no longer receive a distribution of income or capital because of death or breakdown in a marriage?

9.53 In the absence of any special provision, the pattern of distributions condition may be failed by non-fixed trusts that are not family trusts as defined where the potential beneficiaries of the trust included natural persons who have died or who no longer benefit under the trust because of a breakdown in a marriage to which the individual is a party.[F11]

9.54 To overcome this problem distributions which have been received by a deceased person or a person whose marriage has broken down will be ignored in applying the pattern of distributions test to a trust. Also, where a deceased person beneficially had a direct or indirect fixed entitlement in the trust and that entitlement is passed on to the person's deceased estate or a beneficiary under the estate, the distributions flowing to that estate or beneficiary from the fixed entitlements will also be ignored in applying the pattern of distributions test. [Section 269-80]

When does a trust make a distribution of income or capital to an individual indirectly?

9.55 Broadly, a trust will be taken to distribute income or capital to an individual indirectly where an amount or property attributable to the income or capital is distributed through one or more interposed companies, trusts or partnerships to the individual. Paragraphs 13.62 to 13.68 set out the detailed rules that apply in determining whether income or capital is distributed indirectly.

Avoidance arrangements

9.56 The Bill contains a provision to deal with avoidance arrangements designed to ensure that persons do not enter into arrangements that ensure the pattern of distributions test is satisfied. The Commissioner will be allowed to treat a distribution as not having been made if certain conditions are met.

9.57 The conditions are that an arrangement has been entered into where:

·
the arrangement in some way (directly or indirectly) related to, affected or depended for its operation on the distribution or its amount or value; and
·
the purpose, or one of the purposes, of the arrangement was to ensure that the condition in subsection 267-30(2) was met by a trust. [Section 269-85]

When does a group control a non-fixed trust?

9.58 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 or debt deduction (see sections 267-45 and 267-75). 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.

9.59 A group is taken to control a non-fixed trust if the group:

·
has 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);
·
is able to control, directly or indirectly, the application of the income or capital of the trust;
·
is capable, under a scheme, of gaining the enjoyment or control referred to in the first two dot points;
·
is in a position such that the trustee of the trust is 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;
·
has the ability to remove or appoint the trustee or any of the trustees of the trust;
·
acquires 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). [Subsection 269-95(1)]

9.60 Whether the trustee of the trust is 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.

9.61 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 by the group;
·
any arrangement or understanding between the group and a settlor or persons who have benefited under the trust in the past.

Example

9.62 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.

Special circumstances in which control will not be taken to have changed

Death, breakdown in a marriage or incapacity of a controller

9.63 The Billprovides that the control of a trust will be taken not to have changed where a member of the controlling group has died, been a party to a marriage breakdown (separated)[F12] or become incapacitated. However, this rule will only apply where:

·
the replacement group consists of all members of the original controlling group (apart from any deceased, separated or incapacitated individual) and any individuals who are members of the family of the deceased, separated or incapacitated individual;
·
the change in the controlling group only occurs as a result of the death, marriage breakdown or incapacity of a controller; and
·
apart from any deceased, separated or incapacitated individual and replacement family members there are no changes in the beneficiaries of the trust. [Subsection 269-95(2)]

9.64 A member of the family of a person is defined in section 272-95. An incapacitated person is one who is mentally or physically disabled such that they can no longer control the trust.

9.65 If these conditions are satisfied and the new arrangements are in place within one year of the death, separation or incapacity of the individual then it will be taken that there has been no change in the control of the trust. This is done by saying that the replacement group is taken to have controlled the trust during the times when the original group controlled it and in any intervening period until the replacement group started its actual control. Also, the following are taken not to have controlled the group:

·
the original group; and
·
any person or persons (e.g. the trustee of a deceased estate) who may have controlled the trust at some time in the intervening period but only because of the death, incapacity or breakdown in the marriage and only where the control does not continue past when the replacement group begins its control. [Subsection 269-95(3)]

9.66 The one year period is intended to give reasonable time for any processes associated with the change in control to occur. For example, where an individual who has died was a controller because he or she owned all the shares in a trustee company, the one year period will allow time for the shares to be transferred to the beneficiaries of the deceased's estate by the trustee of that estate.

9.67 The Commissioner may extend the one year period where he or she considers it reasonable to do so (e.g. where the administration of the estate of a deceased is delayed). [Subparagraph 269-95(2)(b)(ii)]

Other circumstances where control will be taken not to have changed

9.68 The Bill also provides the Commissioner with a discretion to treat a group as not beginning to control a trust where, having regard to all the facts and circumstances of the case, the Commissioner considers it reasonable to do so. This will allow losses to be deducted where, because of the particular circumstances of the case, it is not fair and reasonable to treat the control of the trust as having changed. For example, it may be appropriate for the discretion to be exercised in some cases of retirement where those who can benefit under the trust have not changed. [Subsection 269-95(4)]

What is a group?

9.69 For the purpose of the control test a group is either a person, a person and one or more associates or 2 or more associates of a person. The term 'associate' is defined in section 272-140. [Subsection 269-95(5)]

When does a trust pass the same business test?

9.70 The same business test is relevant to determining whether a listed widely held trust can deduct a prior or current year loss or debt deduction. The test is split up into two parts. The first part is those rules that apply to determine whether the trust passes the same business test for all purposes. The second part applies only in determining whether the trust passes the same business test for current year loss purposes.

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

The rules of the test that apply for all purposes

9.72 A trust satisfies this part of the same business test if it meets three cumulative conditions [section 269-100] .

9.73 The first condition is that the trust must, at all times in the period being considered (called the same business test period ), carry on the same business as it carried on immediately before the particular time being considered (called the test time ). [Subsection 269-100(1)]

9.74 The mere status of a trust as a trust does not mean that it cannot carry on a business. [Subsection 269-100(2)]

9.75 The second condition is that the trust must not, at any time in the same business test period, derive assessable income from:

·
a business of a kind that it did not carry on before the test time; or
·
a transaction of a kind that it had not entered into in the course of its business operations before the test time. [Subsection 269-100(3)]

9.76 The third condition is that the trust must not, before the test time, do certain things for the purpose, or for purposes including the purpose, of being taken to have carried on, at all times in the same business test period, the same business as it carried on immediately before the test time [subsection 269-100(4)] . 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

9.77 A trust satisfies this part of the same business test if it does not, at any time in the same business test period:

·
incur expenditure in carrying on a business of a kind that it did not carry on before the test time; 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 test time. [Subsection 269-100(5)]

Chapter 10 - Income injection test

Overview of the income injection test

10.1 Division 270 deals with schemes to take advantage of tax losses and other deductions. The purpose of this Division is to prevent the use of deductions by a trust to shelter assessable income from tax where:

·
the assessable income is derived under a scheme involving the provision of benefits to and from the trust; and
·
either of those benefits are calculated with reference to the use of the deduction.

10.2 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.

10.3 The test operates to limit the trust's capacity to deduct prior year losses or current year deductions in certain circumstances, even though a trust has satisfied any relevant tests set out in Divisions 266 and 267 (e.g. it satisfies the continuity of ownership test). This is where the benefit 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.

10.4 The income injection test does not apply to income injection schemes that take place wholly within a family group. It also does not apply to complying superannuation funds, complying approved deposit funds, pooled superannuation trusts, fixed unit trusts all of whose direct or indirect unit holders are exempt from income tax, and deceased estates within a reasonable administration period (see paragraph 272-100(c)).

When does the income injection test apply?

10.5 The following flow chart outlines, in broad terms, the circumstances in which the income injection test will apply.

Circumstances in which the income injection test will apply

What are the elements of the income injection test?

10.6 There are a number of elements that need to be met before the test applies. These are explained below.

The trust must have an allowable deduction

10.7 The first element is that the trust must have an allowable deduction in the income year being examined. This can include a deduction for a prior year loss as well as current year deductions. [Paragraph 270-10(1)(a)]

There must be a scheme under which certain things happen

10.8 For the test to apply there also has to be a scheme under which the things set out below happen.

·
The trust must derive assessable income in the income year. This is referred to as the 'scheme assessable income'. [Subparagraph 270-10(1)(b)(i)]
·
A person not relevantly connected with the trust (the outsider) must directly or indirectly provide a benefit to the trustee or a beneficiary (or their associates). The terms 'benefit' and 'outsider' are defined in the Bill (see the discussion below). [Subparagraph 270-10(1)(b)(ii)]
·
The trustee or a beneficiary (or associates) must directly or indirectly provide a benefit to the outsider or an associate of the outsider. However, if the test is being applied to a family trust and this return benefit is being provided only to an associate who is not an outsider to the trust, this element will not be satisfied. This ensures that the test will not apply where benefits only flow from the family trust to members of the family group. [Subparagraph 270-10(1)(b)(iii)]

There must be a connection between the deduction and one or more of the things that happen under the scheme

10.9 The final element is that it must be reasonable to conclude that any one or more of the following is the case:

·
the scheme assessable income has been derived wholly or partly, but not merely incidentally, because the deduction is allowable; or
·
the benefit has been provided to the trustee or beneficiary (or their associates) wholly or partly, but not merely incidentally, because the deduction is allowable; or
·
the benefit has been provided by the trustee or a beneficiary (or associate) wholly or partly, but not merely incidentally, because the deduction is allowable. [Paragraph 270-10(1)(c)]

10.10 Whether a benefit has been provided merely incidentally because a deduction is allowable to the trust depends on the particular facts and circumstances surrounding the scheme entered into.

What if a person who was an outsider before the scheme ceases to be one as part of the scheme?

10.11 Where a person enters into a scheme so that the person becomes the trustee of the trust or a person holding fixed entitlements in the trust, with the consequence that the person is no longer an outsider to that trust, the person will, in effect, be taken to be an outsider for the purposes of subsection 270-10(1). [Subsection 270-10(2)]

10.12 Subsection 270-10(2) ensures that the income injection test cannot be easily avoided by, for example, the simple expedient of giving an outsider a fixed entitlement in the trust.

What are the consequences if the test is failed?

10.13 Where the income injection test is failed, no deduction is allowable in the income year being examined against the scheme assessable income, with the result that the net income of the trust for the income year is increased to equal the full amount of the scheme assessable income. In addition, to the extent the deduction of the trust may be appropriately related to the derivation of the scheme assessable income, the deduction is not allowable. However, for all other purposes, any deduction not related to the derivation of the scheme assessable income is still allowable to the trust. For example it can be deducted against other assessable income derived in the income year being examined or can be deducted in a later year of income in the form of a tax loss. [Section 270-15]

Example

10.14 A trust has a current year deduction of $120,000 in relation to which the income injection test is failed. This deduction is not related to the derivation of the scheme assessable income. The scheme assessable income of the trust is $100,000 and the non-scheme assessable income of the trust is $20,000. In the absence of the income injection test, the net income of the trust would be $0 ($120,000 assessable income less the $120,000 deduction). Under paragraph 270-15(b), the net income of the trust is increased to $100,000. In addition, in accordance with paragraph 270-15(c), the trust has a carry forward loss under section 79E, or section 36-10 of the ITAA 1997, of $100,000 ($20,000 non-scheme assessable income less the $120,000 deduction).

10.15 If the $120,000 deduction mentioned above had instead been a prior year loss, in accordance with paragraph 270-15(d), $100,000 of that loss would have been available for carry forward to future years.

Terms used in the income injection test

What is a scheme?

10.16 For the purposes of this test the term scheme takes on the same meaning as in Part IVA of the ITAA 1936 (see paragraph 13.106 and 13.107 below). [Definition of "scheme" in section 272-140]

What is a benefit?

10.17 The term benefit is broadly defined and will include any benefit or advantage within the ordinary meaning of those expressions. However, it is defined to specifically include money or other property (whether tangible or intangible), rights or entitlements (whether proprietary or not), services and the extinguishment, forgiveness, release or waiver of a debt or other liability.

10.18 The doing of anything that results in the derivation of assessable income by the trust is also specifically defined to be a benefit. For example, if the scheme assessable income is derived by the trust as a result of the transfer, under an agreement, to the trustee of an interest from which assessable income will be derived, the person who transferred that interest to the trustee will have thereby provided a benefit to the trustee, even if the interest is not a benefit other than by reason of satisfying paragraph 270-20(e). [Section 270-20]

10.19 A benefit is intended to include all means whereby value is transferred between the relevant parties.

What is an outsider?

10.20 The income injection test will only ever apply where the person who has provided directly or indirectly a benefit to the trustee or beneficiary of the trust (or an associate), is an outsider to the trust. The meaning of outsider depends on whether or not the trust is a family trust.

Outsider to a family trust

10.21 An outsider to a family trust is any person other than those individuals and entities that can be described as being in the same family group as the family trust. It is by this means that the income injection test does not inhibit income injection schemes that take place wholly within a family group.

10.22 The persons who are not outsiders to a family trust are as set out in Table 10.1.

Table 10.1 Persons who are not outsiders to a family trust
Person who is not an outsider Comments
The trustee of the family trust The trustee must be acting in their capacity as trustee
A person with a fixed entitlement to a share of the income or capital of the trust
The individual specified in the trust's family trust election or a member of his or her family Note that the definition of family as contained in section 272-95 is effective from 7.30 pm (EST), 13 May 1997. Before that time the broader definition of family as contained in Item 25 (see paragraph 15.32).
A company, partnership or trust that has made an interposed entity election to be included in the family group of the individual specified in the trust's family trust election The interposed entity election must take effect before the scheme commenced. Note that an interposed entity election can take effect from a time before it is actually made in a tax return (see section 272-85). There is also a transitional provision that relates to this requirement (see item 24 discussed in paragraph 15.36).
A fixed trust, company or partnership if some or all of the following have fixed entitlements, directly or indirectly, and for their own benefit, to all the income and capital of the fixed trust:

·
the individual specified in the family trust election;
·
the family members of that individual; and
·
family trusts of the same individual.

The family members etc. must beneficially hold the fixed entitlements at all times during the carrying out of the scheme. This means the income injection test may operate if the family acquires the trust as part of the scheme.
Note that the trustee of a family trust is taken to hold a fixed entitlement as an individual for its own benefit (see subsection 272-30(2)).
[Subsection 270-25(1)]

Outsider to a non-family trust

10.23 In the case of any trust that is not a family trust, an outsider is a person other than the trustee of the trust acting in their capacity as such or a person with a fixed entitlement to income or capital of the trust. [Subsection 270-25(2)]

Examples of how the income injection test applies

10.24 The following examples illustrate the application of the income injection test. Each example contains a diagram to give an overview of the facts for that example. Also, the references in each example to a trust doing a thing is a reference to the trustee of the trust doing that thing.

Example 1

Example 1 - Application of the income injection test

10.25 The same group of natural persons (A, B and C) control and are capable of benefiting (as discretionary objects) from two discretionary trusts, neither of which is a family trust. One of the trusts (Loss Trust) has incurred a loss in a previous year under section 36-10 of the ITAA 1997. The other trust (Income Trust) is profitable and is expected to continue to derive trust income and net income under Division 6 of Part III of the ITAA 1936 in the future.

10.26 The Loss Trust is added to the class of persons who are capable of benefiting under the Income Trust. The trustee of the Income Trust exercises its discretion to allocate net income of the Income Trust to the Loss Trust equal in amount to the amount of the prior year loss incurred by the Loss Trust (sheltered income). The distributable income of the Income Trust which represents the net income allocated to the Loss Trust is not paid to the Loss Trust, but is converted into a loan from the Loss Trust to the Income Trust. The terms of the loan are not evidenced in writing. The terms of the loan are that interest is chargeable at a nominal 1% rate and that interest is payable and principal is repayable at the times to be agreed between the parties in the future.

10.27 The requirements of paragraph 270-10(1)(b) are met because, under a scheme:

·
the Loss Trust has derived assessable income (because of the allocation of net income by the Income Trust);
·
the Income Trust (the outsider) has provided a benefit to the Loss Trust by allocating net income to the Loss Trust (this has given a right to the Loss Trust and is also something that has resulted in the Loss Trust deriving assessable income); and
·
the Loss Trust has provided a benefit to the Income Trust by loaning back an amount equal to its income allocation.

10.28 The requirements of paragraph 270-10(1)(c) are satisfied on the basis that the net income allocation has been made to the Loss Trust so that income tax will not be payable on that net income. The Income Trust has retained use of the income through the low interest loan on terms that are not commercial. It is reasonable to conclude that the assessable income was derived by the Loss Trust, and the benefits provided by the two trusts to each other, wholly or partly because of the prior year loss deductions in the Loss Trust. The connection is more than merely incidental.

10.29 The income injection test operates to increase the net income of the Loss Trust to equal the amount of the net income allocation from the Income Trust.

10.30 Even if the loan back of the net income allocation was on commercial terms, the scheme could still be one that is subject to the income injection test if it is the case that the distribution has been made by the Income Trust to the Loss Trust wholly or partly, but not merely incidentally, because a deduction is allowable to the Loss Trust for the losses (e.g. so that income tax would not be payable on the income of the Income Trust).

Example 1A

10.31 The facts are the same as in Example 1 except that the allocation of net income to the Loss Trust is actually paid to the Loss Trust and is used to fund a distribution of income to A, B and C by the Loss Trust. This scheme is also one that is subject to the income injection test. Although a benefit has not been provided directly to the outsider (the Income Trust), a benefit has been provided to associates of the Income Trust (A, B and C). It is reasonable to conclude that the assessable income has been derived, and the benefits provided, wholly or partly, but not just incidentally, because the Loss Trust has prior year losses available for deduction. The scheme is effectively a means of distributing the income of the Income Trust to its beneficiaries in a tax free form by passing that income through the Loss Trust.

10.32 If the income from the Income Trust had not been distributed by the Loss Trust to A, B and C but had instead been accumulated in the Loss Trust, the income injection test would not apply. This is because there would be no benefit given to the outsider or an associate of the outsider (including any takers in default of appointment in relation to the Loss Trust). However, if a benefit did subsequently flow out of the Loss Trust under the same scheme, the income injection test may apply. This would occur, for example, if A, B and C are takers in default of appointment in relation to the Loss Trust and they accessed that income. Also, if a beneficiary of the Loss Trust had a fixed entitlement in the Loss Trust, there could be said to be a benefit provided to that beneficiary because of the increase in value of the beneficiary's interest in the trust.

Example 1B

10.33 The facts are the same as in Example 1 except that:

·
the Loss Trust is a family trust which has specified A as the individual; and
·
the Income Trust has made an interposed entity election to be included in the family group of A.

10.34 The income injection test does not apply in this case. This is because the Income Trust is not an outsider to the Loss Trust.

Example 2

Example 2 - The income injection test does not apply in this case

10.35 Trust A is a discretionary trust (i.e. a non-fixed trust for the purpose of the Bill) in which no person has a fixed entitlement to income or capital of the trust. The trust incurred a $1M loss in a prior year. Under a scheme involving the trust and B (who did not have a fixed entitlement to income or capital of the trust prior to entry into the scheme), the following things occur:

·
B leases an income producing property to the trust; and
·
B is made a discretionary object of the trust.

10.36 Distributions from Trust A to B are intended as a substitute for lease payments for the lease of the property. These distributions could be income according to ordinary concepts in the hands of B and thus assessable to B under section 6-5 of the ITAA 1997. This is because the distribution represents a return on the property owned by B under a profit making scheme. The analysis below shows the consequences under the income injection test on the assumption that the distribution is not income according to ordinary concepts in the hands of B.

10.37 Disregarding the operation of the income injection test, the net income of Trust A does not reflect the assessable income derived by the trust from the holding of the property because it is offset by the deduction allowable for the whole or part of the $1M prior year loss in the income year(s) in which the assessable income is derived. The trustee of Trust A exercises its discretion to distribute income of the trust to B in successive years in accordance with the scheme until such time as all of the $1M prior year loss is deducted by the trust in calculating its net income under Division 6 of Part III of the ITAA 1936.

10.38 In each income year in which income is distributed to B, B is not presently entitled to any net income of the trust under Division 6 of Part III, since the assessable income derived by the trust from the holding of the property is sheltered from tax by the deduction to the trust of the whole or part of the prior year loss. The distributions are less than the market rent for the property because they will not bear tax in the hands of B. Trust A retains the difference between the income it receives from the property and the distributions made to B, effectively as a fee for the use of its losses. In some cases, such a fee could take another form, e.g. deductions allowable to Trust A in connection with holding the property.

10.39 The requirements of paragraph 270-10(1)(b) are met because, under a scheme:

·
Trust A has derived assessable income from the holding of the property;
·
B (the outsider) has provided a benefit to Trust A by leasing the property to the trust; and
·
Trust A has provided a benefit to B by distributing income of the trust to B.

10.40 The requirements of paragraph 270-10(1)(c) are satisfied on the basis that either or both of the following is the case.

·
The scheme was entered into so that B could derive income from the property in a tax free form by leasing that property to Trust A. In this case, it would be reasonable to conclude that the assessable income was derived by Trust A, and the benefits between Trust A and B were provided, because of the prior year loss deductions in Trust A.
·
The lease by B of the income producing property to Trust A was for a price (i.e. the distributions) which was calculated with reference to the availability of the deduction to the trust of the prior year loss. That is, the amount of the distribution to B is lower than the market rent of the property because the distribution will not bear tax in the hands of B. There was, therefore, a benefit provided to B wholly or partly because the deduction for the prior year loss was allowable to the trust.

10.41 In neither of the above cases could it be said that the connection between the deduction and the assessable income and benefits was merely incidental.

10.42 The income injection test operates to increase the net income of Trust A to equal the amount of the assessable income derived by the trust from the holding of the property. Also, any deductions of Trust A in connection with the derivation of income from the leased property are not allowable to Trust A in calculating its net income or tax loss for that year.

Example 3

Example 3 - The income injection test operates to increase the net income of Trust A to equal the amount of the assessable income derived by the trust from the holding of the property.

10.43 A discretionary trust has prior year losses. It also has surplus cash from trading profits which it invests in units in a widely held property trust by subscribing to those units. The units in the property trust can be subscribed for by the public at the price paid by the discretionary trust for the units. The discretionary trust subsequently receives distributions of income in respect of its units. All unit holders in the property trust receive the same distribution per unit.

10.44 Although it could be said that there is a scheme under which the discretionary trust derives assessable income and benefits are provided between that trust and the property trust (an outsider), this is a case that is not affected by the income injection test.

10.45 It is not reasonable to conclude that the benefit provided by the discretionary trust to the property trust (the subscription price of the units) is provided wholly or partly because the discretionary trust has losses. This is because the price paid by the discretionary trust for the units is what would be paid by a person who did not have any prior year loss or any other allowable deduction. The investment was made in the units because the discretionary trust has available funds to invest. The fact that the after tax return to the discretionary trust on the investment will be greater because of the prior year losses in the discretionary trust does not alter this conclusion.

10.46 The benefits provided by the property trust to the discretionary trust (the units and the distributions of income) are given without any regard to the losses of the discretionary trust. This is because the value of the units and the income distributed in respect of the units would be the same if the units had been held by a person who did not have any allowable deduction in the income year for which the distribution was made by the property trust. It cannot, therefore, be reasonably concluded that the benefits are given, or that the assessable income is derived, wholly or partly because of the losses in the discretionary trust. The connection between the deduction and the assessable income and benefits is merely incidental.

Example 4

Example 4 - The benefits provided by the property trust to the discretionary trust (the units and the distributions of income) are given without any regard to the losses of the discretionary trust.

10.47 Trust A, a discretionary trust which is not a family trust, has a net income under Division 6 of Part III of the ITAA 1936. It is issued with a small number of units in a unit trust (Loss Trust) which has incurred a loss in a previous year under section 79E, or a tax loss under section 36-10 of the ITAA 1997. The other units of the Loss Trust are held by Trust B which is also a discretionary trust. The only income Trust B has derived is distributions it has previously received from the Loss Trust.

10.48 The Loss Trust is added to the class of persons who are capable of benefiting under Trust A. The trustee of Trust A exercises its discretion to allocate an amount of net income to the Loss Trust equal to (or less than) the amount of the prior year losses incurred by the Loss Trust. This income is sheltered from tax using the losses. The trustee of the Loss Trust distributes some of the sheltered income back to Trust A and the rest is transferred back to Trust A through a non-arm's length transaction. The trustee of the Loss Trust distributes the rest of the sheltered income to Trust B (this represents a fee paid for the use of the losses in the Loss Trust).

10.49 Under subsection 270-25(2) an outsider to a non-family trust does not include a person with a fixed entitlement to a share of the income or capital of the trust. Assuming that Trust A has a fixed entitlement to a share of the income or capital of the Loss Trust it would normally not be an outsider to the Loss Trust. However, because of subsection 270-10(2) the income injection test will operate in this case.

10.50 The requirements of subsection 270-10(2) are met because:

·
the acquisition by Trust A of units in the Loss Trust is part of a scheme;
·
before the scheme was entered into, Trust A was an outsider to the Loss Trust;
·
after the scheme was entered into, Trust A was no longer an outsider to the Loss Trust because it had a fixed entitlement in the Loss Trust;
·
if Trust A had not ceased to be an outsider, the requirements of subsection 270-10(1) would have been met in relation to the scheme.

10.51 An explanation of the requirements of subsection 270-10(1) is found in paragraphs 10.6 to 10.12.

10.52 The income injection test operates to increase the net income of the Loss Trust to equal the amount of the net income allocation from Trust A.

Example 5

10.53 At the start of the year, Trust 1 carries on a retail business on a leased premises. The opportunity to purchase the premises arises and this is done through the establishment of a second trust (Trust 2). This trust is a discretionary trust and has X, Y and Z as discretionary objects. Trust 2 borrows the purchase price of the property ($1M) from A Bank at 10% (market interest). The loan is secured by a mortgage over the premises. The other costs to Trust 2 for the year are $20,000 of maintenance and administration costs. Trust 2 leases the property to Trust 1 for $80,000 per annum (market rent).

10.54 Trust 2 has assessable income of $80,000 and allowable deductions of $120,000 creating a $40,000 loss for the year under section 36-10 of the ITAA 1997. It also has a cash shortfall of $40,000 which is catered for through a loan (an overdraft facility) from B Bank at 15% (market interest). This overdraft is secured by personal guarantees by the directors of the corporate trustee of Trust 2, X and Y, and a second mortgage over the premises. The interest on the overdraft is incurred in the following year.

10.55 The income injection test does not apply to Trust 2 in relation to its deductions for interest or other costs. While it is possible to say that there is a scheme (the purchase of the property by Trust 2 and its lease to Trust 1) under which assessable income is derived (rent paid by Trust 1), and that there are benefits flowing between Trust 2 and various outsiders, it is not possible to say that the requirements of paragraph 270-10(1)(c) are satisfied.

10.56 If Trust 1 is treated as the outsider, it could not be said that either the lease of the property to Trust 1 or the payment of rent to Trust 2 are made wholly or partly because Trust 2 has allowable deductions for interest and other amounts. On the assumption that the property is leased on market terms that are not calculated with reference to the deductions of Trust 2, the benefits are provided between Trust 1 and Trust 2 without any regard to the deductions of Trust 2. In fact, the deductions are allowable to Trust 2 because the interest and other costs are incurred by Trust 2 in deriving the rental income from the property. For these reasons also, the assessable income derived by Trust 2 (the rent) is not derived wholly or partly because the trust has the deductions.

10.57 Applying the income injection test to A Bank as the outsider, it is not possible to conclude that the $1M loan or the interest payments on that loan are provided wholly or partly because the deductions for interest or other amounts are allowable to Trust 2. Assuming the loan is on market terms, the loan is made in order to fund the purchase of the property and not because of any allowable deductions Trust 2 may have in the future.

10.58 Applying the income injection test to B Bank as the outsider, it is also not possible to conclude that the $40,000 loan or interest payments are provided wholly or partly because the deductions for interest or other amounts are allowable. Assuming the overdraft is on market terms, the overdraft facility is used in order to cover a cash shortfall resulting from the liability of Trust 2 to pay the interest and other costs. It is not used because the interest and other costs are tax deductible.

Example 5

Example 5 - Applying the income injection test to B Bank as the outsider, it is also not possible to conclude that the $40,000 loan or interest payments are provided wholly or partly because the deductions for interest or other amounts are allowable.

10.59 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 for a term of ten years. In the first three years of the term of the lease, the taxable income of the partnership is nil as deductions of the partnership exceed assessable income derived by the partnership (e.g. because of depreciation expenses) in those years. However, in the last seven years of the term of the lease, the assessable income derived by the partnership under the leveraged leasing arrangement will exceed any allowable deductions.

10.60 Under a scheme, just prior to the end of the third year of the lease, the company (Assignor) assigns all of its 99% interest as a partner in the leveraged leasing partnership to a unit trust (Conduit Trust) by way of an Everett assignment in exchange for a lump sum. Under the scheme, units in the Conduit Trust are sold to other trusts (Loss Trusts) which incurred losses in previous years. The lump sum paid to the Assignor by the Conduit Trust for the leveraged lease is funded by the amounts paid by the Loss Trusts for the units. The price paid by the Loss Trusts for the units in the Conduit Trust are greater than would otherwise be expected because any income derived by the Loss Trusts from their unit holdings will be offset by the prior year losses they have. The Loss Trusts are effectively paid a fee for absorbing the assessable income of the Conduit Trust, the fee being the profit from the income they receive from holding units in the Conduit Trust.

10.61 The Assignor is not a trustee of any of the Loss Trusts and does not have a fixed entitlement to income or capital of any of the Loss Trusts. In a year or years of income (recoupment years) ending after the assignment, the Loss Trusts derive assessable income under Division 6 of Part III of the ITAA 1936 to the extent of any share of the net income of the Conduit Trust to which each of the Loss Trusts are presently entitled in accordance with their respective interests in the Conduit Trust. Disregarding the operation of the income injection test, the whole or part of the prior year losses incurred by the Loss Trusts constitute an allowable deduction to the Loss Trusts in the recoupment years with the result that they offset the assessable income so that it is not reflected in the net income of the Loss Trusts. The question is whether the income injection test applies to each Loss Trust in respect of their prior year loss deductions.

Treating the Assignor as the outsider

10.62 If the Assignor is treated as the outsider, the requirements of paragraph 270-10(1)(b) are met because, under a scheme:

·
each Loss Trust has derived assessable income from the holding of units in the Conduit Trust;
·
the Assignor (the outsider) has provided a benefit to the Conduit Trust (an associate of each Loss Trust) by assigning its interest in the leveraged leasing partnership to the Conduit Trust (it could also be said that the Assignor has indirectly provided a benefit to each Loss Trust by this means); and
·
the Conduit Trust (an associate of each Loss Trust) has provided a benefit to the Assignor by making the lump sum payment to the Assignor (it could also be said that each Loss Trust has indirectly provided a benefit to the Assignor since the lump sum is funded by the purchase price of units in the Conduit Trust).

10.63 Paragraph 270-10(1)(c) is satisfied on the basis that the scheme was entered into so that the interest of the Assignor in the leveraged leasing partnership could be sold, via the Conduit Trust, to trusts with losses. This was because the Loss Trusts could pay, indirectly, a higher price for the partnership interest because any income they received from the partnership interest could, in the absence of the income injection test, be sheltered by their losses. In this case, it would be reasonable to conclude that the assessable income was derived by each Loss Trust, and the benefits between the parties were provided, wholly or partly because the prior year loss deductions were allowable in each Loss Trust. The connection is not merely incidental.

10.64 The conclusion above would be the same if the benefit provided directly or indirectly by the Loss Trusts (or an associate of the trusts) to the Assignor (or an associate of the Assignor) was a benefit other than the lump sum paid for the assignment, for example, a management fee or the release of a debt owed by the Assignor (or an associate of the Assignor).

Treating the Conduit Trust as the outsider

10.65 If the Conduit Trust is also treated as the outsider, the requirements of paragraph 270-10(1)(b) are met because, under a scheme:

·
each Loss Trust has derived assessable income from the holding of units in the Conduit Trust;
·
the Conduit Trust (the outsider) has provided a benefit to each Loss Trust by issuing units and distributing income to each of those trusts; and
·
each Loss Trust has provided a benefit to the Conduit Trust by paying the purchase price for the units.

10.66 Paragraph 270-10(1)(c) is satisfied on a similar basis as discussed in paragraph 10.63 above. In particular, the benefit provided to the Conduit Trust by each Loss Trust (i.e. the purchase price of the units) was higher than it otherwise would have been because the income derived from the Conduit Trust could be offset by the losses. It is therefore reasonable to conclude that this benefit was provided wholly or partly because of the prior year loss deductions in each Loss Trust.

10.67 The income injection test operates to increase the net income of each Loss Trust to equal the amount of the assessable income (i.e. the net income allocations) derived by each trust from the Conduit Trust.

Chapter 11 - Family trust distribution tax

Overview of family trust distribution tax

11.1 Division 271 imposes a special tax in the circumstances where:

·
a trustee of a trust has made a family trust election under section 272-80; or
·
the partners in a partnership, a company or the trustee of a trust have made an interposed entity election under section 272-85 to be included in a family group in relation to a family trust;

and the trust, partnership or company distributes income or capital other than to the test individual or members of the test individual's family group [section 271-5] . The terms 'family trust election', 'interposed entity election', 'test individual' and 'family group' are explained in Chapter 5.

11.2 This tax need not ever be paid by any trust or interposed entity and in that sense is optional. The tax only becomes payable if a trust or interposed entity makes a distribution or confers a present entitlement that is inconsistent with its election to be treated as a family trust or member of the family group of a family trust.

When will the family trust distribution tax be payable?

11.3 The proposed legislation will impose a liability for tax under the proposed Family Trust Distribution Tax (Primary Liability) Act 1997 on certain conferrals of present entitlements to, or distributions of, income or capital made by the trustee of a family trust or an interposed entity that has made an interposed entity election in relation to a family trust (such a trust or entity is called an 'electing entity' below). The tax is called the family trust distribution tax.[F13] [Section 271-10]

11.4 The tax will be payable where a distribution is made by an electing entity to another person who is neither the individual specified in the family trust election nor a member of the individual's family group in relation to the distribution, as defined in section 272-90. The tax will also be payable where an electing entity confers on any of these persons a present entitlement to a distribution of income or capital of the entity. The tax will be payable at the top marginal rate of tax applying to individuals plus Medicare levy (currently 48.5%) on the amount or value of any such distributions or conferrals made by an electing entity at any time after the election made by the entity becomes effective. [Sections 271-15, 271-20, 271-25 and 271-30]

What is a distribution of income or capital?

11.5 The term 'distribution of income or capital' has been defined broadly - see definitions in Subdivision 272-B discussed in paragraphs 13.51 to 13.61.

When is a person presently entitled to income or capital?

11.6 The term present entitlement has its ordinary meaning. A person is presently entitled to a distribution when the person has a present legal right to demand and receive the distribution. For example, in the case of a partnership, a partner would be presently entitled to a distribution of income or capital when the profits of the partnership are divided among the partners or when the partner becomes entitled to withdraw capital from the partnership. Also, an electing entity can confer a present entitlement without there necessarily being a decision to that effect. For example, where a person becomes presently entitled to a distribution under the terms of a trust deed, the trust confers a present entitlement on that person even though the trustee has not made any decision.

What if a distribution is made in satisfaction of a present entitlement?

11.7 Where an electing entity has been subject to the family trust distribution tax because it has conferred a present entitlement to a distribution of income or capital, family trust distributiontax will not be payable on the income or capital when it is actually distributed. [Section 271-35]

What if the individual or family member is a trustee or a trust

11.8 A conferral or distribution to the specified individual or a member of the family group could attract the tax if the distribution is made to the individual or member in their capacity as a trustee or where the member is a trust. However, the liability for the tax will not arise where the individual or member of the individual's family group gets the conferral or distribution in a capacity as trustee or as a trust that is a member of the test individual's family group. This would be the case, for example, where the individual or member, as trustee, has made an interposed entity election under section 272-85 or is trustee of a fund that is in the family group under subsection 272-90(6) because it is listed in the gift deductibility provisions of the income tax law.

Who is liable to pay the family trust distribution tax?

11.9 The liability for tax falls on the persons set out in Table 11.1.

Table 11.1 Persons liable to pay family trust distribution tax
Electing entity Who has the liability for the tax?
Trust If the trustee is an individual - the trustee
If trustee is company - the trustee together with the directors of the company (jointly and severally liable)
Partnership The partners
If a partner is company - the directors of the company
(All jointly and severally liable)
Company The company and directors of the company
(jointly and severally liable)
[Sections 271-15, 271-20, 271-25 and 271-30]

Exclusion of directors from liability to pay tax

11.10 Section 271-40 applies to excuse a director of a company from the liability to pay the family trust distribution tax in circumstances where it would be unreasonable that the director be liable for the tax. The provision applies to a director who would otherwise be one of those persons who would be jointly and severally liable to pay the family trust distribution tax. [Subsection 271-40(1)]

11.11 A director will be not be included in those persons who are jointly and severally liable to pay the tax if:

·
the director did not take part in any way in any decision to make the conferral or distribution; and
·
if the director was aware of the proposal to make a decision or knew that it had been made, he or she had taken reasonable steps to prevent the making of the decision or its implementation. [Subsection 271-40(2)]

11.12 This provision ensures that a director will not be liable for the tax where the director was unaware of a decision to make the conferral or distribution. If the director had no knowledge of the proposed resolution or had no reason to suspect that a resolution would be passed that would authorise the distribution then this section would apply to excuse the director from the liability for the tax. Note that the provision will not apply where there was no decision , e.g. where a present entitlement is conferred by the terms of a trust deed.

11.13 A director will also not be liable for the tax if the director voted against or otherwise disagreed with a decision to make the conferral or distribution and took reasonable steps to prevent the distribution being made. [Subsection 271-40(3)]

Payment of family trust distribution tax

11.14 The date on which the family trust distribution tax is due and payable depends on when the conferral or distribution was made:

·
if the conferral or distribution was made before the day on which the election was made, the tax is due and payable at the end of 21 days after the day on which the election was made;
·
if the conferral or distribution was made at any other time, i.e. on the day the election was made or after that date, the tax is due and payable at the end of 21 days after that date. [Subsection 271-75(1)]

11.15 If there are special circumstances why a taxpayer cannot pay the tax within the specified time the Commissioner may allow an extension for payment as would be reasonable. [Subsection 271-75(1)]

11.16 A discretionary trust receives a distribution from a trust that has made a family trust election under section 272-80. The trustee of the discretionary trust lodges an interposed entity election under section 272-85 in order to become a member of the family group in relation to the family trust. The election is lodged with its return of income for the 1997-98 year of income on 31 October 1998. The election specifies that it is to take effect from 1 January 1998. The discretionary trust distributes income outside the family group on 31 July 1998. The trustee of the discretionary trust will be liable for the family trust distribution tax on the amount of the distribution at the end of 21 days after lodging its return of income (the day the election is made), i.e. the end of 21 November 1998. If the discretionary trust makes any further distributions outside the family group after 31 October 1998 the tax is to be paid at the end of 21 days after the making of the distribution.

Additional tax for late payment

11.17 The Bill imposes additional tax which is a penalty tax on overdue amounts of family trust distribution tax. If any amount of tax is outstanding at the end of 60 days after the due date for payment, additional tax will be imposed at the rate of 16% per annum on the unpaid amount. The interest will be calculated as from the end of the 60 day period. [Subsection 271-80(1)]

11.18 The Commissioner has the discretion to remit the additional tax, in whole or in part under certain circumstances. These circumstances are as follows:

·
where the circumstances that contributed to the delay in payment were not due to or caused by an act or omission of the person or persons liable to pay the tax and the persons have taken reasonable steps to mitigate the effects of the circumstances; or
·
where the Commissioner considers it fair and reasonable to remit in circumstances where the delay in payment was due to or caused by an act or omission and a person or persons liable for the tax have taken reasonable steps to mitigate the effect of those circumstances; or
·
where there are special circumstances and the Commissioner considers it fair and reasonable to remit. [Subsections 271-80(2), (3), (4) and (5)]

11.19 The effect of subsection 271-80(6) is to ensure that additional tax continues to accrue in respect of the unpaid tax notwithstanding that judgment for payment of the unpaid tax has been given by, or entered in, a court. Where, in such a case, the judgment debt itself carries interest, the additional tax otherwise payable is to be reduced by the amount of interest that relates to the unpaid family trust distribution tax.

Recovery of tax

11.20 The Commissioner can sue for any unpaid family trust distribution tax or unpaid additional tax payable under section 271-80 in a court of competent jurisdiction. [Section 271-85]

Notice of liability

11.21 The Commissioner is authorised to serve a notice on a person or persons, by post or otherwise, that specifies that they are liable to pay an amount of family trust distribution tax as has been ascertained by the Commissioner and also the day on which the tax is due and payable. [Subsection 271-90(1)]

11.22 A person's liability to the family trust distribution tax and the due date for payment are not dependent on or affected by the serving of a notice in respect of an amount. This will mean, for example, that a liability for the tax will exist on the amount or value of a distribution made to a person or persons regardless of whether the person making the distribution has received the notice. [Subsection 271-90(3)]

11.23 The Commissioner is authorised to amend a notice at any time. An amended notice is a notice for the purposes of this section. If more than one notice has been issued then the later notice prevails over an earlier notice where there is an inconsistency. [Subsections 271-90(4) and (5)]

Request for notice

11.24 Any person or persons may write to the Commissioner requesting that they be served with a notice in respect of circumstances under which the family trust distribution tax may become payable. This request must be made only in respect of circumstances that have actually occurred rather than hypothetical circumstances that may occur. [Subsection 271-95(1)]

11.25 The Commissioner must comply with the request if it is lodged within the 21 day period specified under subsection 271-75(1), i.e. before the date when the tax becomes due and payable. The Commissioner may, in circumstances where it would be fair and reasonable to do so, extend this period. However, the Bill provides a mechanism for the Commissioner to get further information to allow the notice to be given. If the information is not provided, the Commissioner does not need to issue the notice. [Subsection 271-95(2), (4) and (5)]

Review of notice

11.26 The notice system provides a mechanism through which a taxpayer may object or appeal against a decision of the Commissioner that family trust distribution tax is payable [subsection 271-90(6)] . For example, a trustee could think that the tax may be payable on a distribution but may seek the Commissioner's opinion on that matter by asking the Commissioner to issue a notice. If the trustee does not agree with the Commissioner's opinion, they could object against it in the normal manner for objecting against taxation decisions.

Evidentiary effect of notice

11.27 A notice served under section 271-90 or another document that is signed by the Commissioner and appears to be a copy of a notice of this kind is conclusive evidence that the notice was duly served and that the amount of family trust distribution tax as shown in the notice became due and payable by the person or persons on whom it was served on the date specified in the notice. [Subsection 271-100(1)]

11.28 This section does not apply in proceedings under Part IVC of the Taxation Administration Act 1953 on a review or appeal relating to the review. [Subsection 271-100(2)]

Income tax exemption for taxed distributions

11.29 An entity that makes a conferral or distribution subject to family trust distribution tax under the Family Trust Distribution Tax (Primary Liability) Act 1997, and the person receiving the distribution, are not required to include the relevant part of the conferral or distribution in their assessable income. The amount not included in the assessable income will depend on the extent to which the tax is paid. [Section 271-105]

11.30 A consequence of this approach is that any losses or outgoings incurred in deriving the distribution that will be exempted from tax will not be deductible to the person to whom the distribution is made.

How is the exempt amount calculated?

11.31 A formula is used to determine the amount which is not included in assessable income, as follows:

(Tax payment amount / Tax payable) * Original assessable amount

The tax payment amount is the amount of a particular payment of the tax, or the amount by which the tax payable is reduced under the Family Trust Distribution Tax (Secondary Liability) Act 1997.[F14]

The tax payable is the amount of family trust distribution tax payable under the Family Trust Distribution Tax (Primary Liability) Act 1997.

The original assessable amount is the amount of the distribution that is included in assessable income.

Example

11.32 The trustee of a trust becomes liable to $487 family trust distribution tax when a person (Jill), who is not a member of the family group, becomes presently entitled to $1,000 net income of the trust. Under section 97, the $1,000 is included in Jill's assessable income. The trustee pays the tax in two instalments, $200 on day 1 and $287 on day 2.

11.33 On day 1, the amount that needs to be included in Jill's assessable income is reduced by $410.68 (i.e. ($200 (tax payment amount) divided by $487 (tax payable)) multiplied by $1,000 (original assessable amount)). On day 2, when the second instalment is paid, the amount that needs to be included in Jill's assessable income is reduced by a further $589.32 (i.e. ($287 (tax payment amount) divided by $487 (tax payable)) multiplied by $1,000 (original assessable amount)).

What if an exempt distribution is a dividend?

11.34 If the distribution not included in assessable income is a dividend from a company, the grossed-up amount of the dividend is not included in the assessable income of the person to whom the distribution was made and any franking credits associated with the dividend do not, therefore, flow to the recipient of the dividend.

Consequential amendments to other provisions

11.35 A number of consequential amendments are made to other provisions in the income tax law and other Acts to deal with the effect of family trust distribution tax. These are discussed in Chapter 14.

What is the Family Trust Distribution Tax (Primary Liability) Act 1997?

11.36 The Family Trust Distribution Tax (Primary Liability) Act 1997 mentioned in this Chapter and Chapter 12 will be the imposition Act that imposes family trust distribution tax [clause 3 of the Family Trust Distribution Tax (Primary Liability) Bill 1997] . The tax will be imposed at the highest marginal rate applying to individuals plus Medicare levy, on an amount or value of income or capital (currently 48.5%) [clause 4 of the Family Trust Distribution Tax (Primary Liability) Bill 1997] . The circumstances in which this tax would be imposed are discussed in the preceding paragraphs of this Chapter and in Chapter 12.

Chapter 12 - Provisions relating to non-resident entities

Overview

12.1 Provisions are included in the Bill to ensure that the trust loss measures cannot be avoided where non-resident entities are concerned. These provisions do not need to be considered by resident taxpayers who are not connected to a non-resident entity. The provisions discussed in this Chapter are sections 266-55, 266-60, 266-175 to 266-185, 267-80 to 267-90, 271-45 to 271-70 and subsections 271-75(2) and (3), 271-90(2) and 271-95(3).

12.2 The Bill contains information gathering powers of an anti-avoidance nature to enable the collection of information about certain non-resident entities. These powers will allow the following to be administered by the Commissioner:

·
the proposed condition in section 266-45 (i.e. the alternative condition for ordinary fixed trusts that fail the 50% stake test because they are held 50% or more by non-fixed trusts) - see paragraphs 6.18 to 6.24;
·
the family trust tracing rule in subsection 272-30(2) (i.e. the rule that treats the trustee of a family trust as an individual holding a fixed entitlement for its own benefit) - see paragraph 13.42; and
·
the payment of family trust distribution tax in relation to non-resident family trusts or non-resident entities that have made an interposed entity election.

12.3 The Bill also includes rules so that, under specified conditions, the Commissioner can recover from resident persons unpaid family trust distribution tax that should have been paid by non-resident persons.

What is a non-resident entity?

12. 4 For the purposes of the explanation in this Chapter, the term non-resident entity means:

·
a non-resident company;
·
a partnership where a partner is a non-resident; and
·
a trust where either a trustee is a non-resident or the central management and control of the trust is outside Australia.

Information-gathering powers

Why are information-gathering powers necessary?

12.5 Information-gathering powers are needed to ensure that the trust loss measures are being complied with where a non-resident entity is taking advantage of the family trust rules or is required to meet certain tests.

12.6 In the case of the application of the alternative condition for ordinary fixed trusts (section 266-45), the Commissioner will need to know whether any non-resident non-fixed trust that holds a direct or indirect fixed entitlement in the fixed trust is complying with the tests that need to be met under subsection 266-45(5).

12.7 In a case where a non-resident trust elects to be a family trust, the Commissioner will need to know whether the trust is meeting the distribution requirements for family trusts (i.e. that any distributions or conferrals of present entitlement other than to members of the family group are taxed). This is important to the application of the concessional tracing rules for family trusts which may apply where a non-resident family trust holds a direct or indirect fixed entitlement in a resident trust.

12.8 For the administration of the family trust distribution tax system, the Commissioner may require information about conferrals of present entitlements to, or distributions of, income or capital by a non-resident family trust or a non-resident entity that has made an interposed entity election in relation to a family trust. This is because the Commissioner will need to know whether any family trust distribution tax is payable by the non-resident family trust or non-resident entity that has made the interposed entity election.

Information notice - fixed trusts held by non-fixed trusts

12.9 The trustee of a fixed trust may need to provide certain information to the Commissioner where the fixed trust has satisfied the alternative condition (set out in section 266-45) that applies to ordinary fixed trusts held 50% or more by non-fixed trusts. If the fixed trust does not provide the information requested by the Commissioner, it will be taken never to have met the condition. [Sections 266-55 and 266-60]

12.10 This information is needed for the purposes of determining whether the requirements of subsection 266-45(5) are satisfied in relation to any non-fixed trust that holds a direct or indirect fixed entitlement in the fixed trust. Under subsection 266-45(5) every non-fixed trust (that is not a family trust or other excepted trust) that holds a fixed entitlement, directly or indirectly, in the fixed trust is required to satisfy the relevant tests that apply to non-fixed trusts if they stood in place of the loss trust.

When can a notice be given?

12.11 The Commissioner can give a notice under the above sections if, in an income year, a fixed trust is:

·
able to deduct a tax loss or debt deduction; or
·
not required to work out its net income and tax loss under Division 268;

only because it met the conditions set out in subsections 266-45(2) to (5). Also, the non-fixed trust must be non-resident at the time the Commissioner gives the notice. [Subsections 266-55(2) to (4)] .

12.12 The Commissioner must give the notice to the trustee of the fixed trust before the later of:

·
5 years after the income year in which the fixed trust deducted the tax loss or debt deduction or did not work out its net income and tax loss under Division 268; and
·
the end of the period in which the trustee of the fixed trust is required to keep records under section 262A in relation to the income year mentioned above. [Subsection 266-55(5)]

What information can be requested?

12.13 The notice must set out information that the Commissioner requires. This information need not be within the knowledge of the trustee of the fixed trust at the time the notice is given. [Subsections 266-60(1) and (2)]

12.14Under the notice the Commissioner would seek information on transactions or acts and other matters that would enable him or her to determine whether a non-fixed trust has satisfied the conditions set out in subsection 266-45(5). These are the conditions that need to be satisfied by a non-fixed trust before a prior or current year loss or debt deduction can be deducted. This would include information on distributions of income or capital made by the non-fixed trust, any changes in control of the non-fixed trust and also whether there has been any changes in individuals who hold fixed entitlements in the non-fixed trust. As part of this information-gathering process the Commissioner may request a copy of the trust deed of the non-fixed trust or other relevant documents relating to the non-fixed trust.

12.15 The notice must specify a time within which the trustee is to provide the Commissioner with the information. The Commissioner must allow a period of at least 21 days commencing on the date the notice was given [subsection 266-60(3)] . The Commissioner can extend the time for compliance with the notice.

What are the consequences of not giving the information?

12.16 If the trustee does not comply with the request mentioned in paragraph 12.13, the fixed trust will be taken not to have satisfied the conditions set out in section 266-45 and thus:

·
a deduction for the tax loss or debt deduction will not be allowable to the trust in relation to that year of income; or
·
the trust will be required to work out its net income and tax loss for the income year under Division 268. [Subsection 266-60(4)]

12.17 If the trust is required to work out its net income and tax loss under Division 268, the income year is split up into such periods as would result in the highest possible net income for the income year [subsection 266-60(5)] For this purpose a period could have a minimum length of one day.

No offences or penalties

12.18 The mere fact that a trustee of a fixed trust fails to provide the Commissioner with the required information so that the consequences of section 266-60 apply, does not mean that the trustee will be taken to have committed an offence or be liable to any penalty under Part VII for claiming a tax loss or debt deduction or for not working out the trust's net income and tax loss under Division 268 on lodging the return. Whether the provisions of Part VII apply would require a separate finding by the Commissioner. [Subsection 266-60(6)]

Information notice - family trust holding a fixed entitlement, directly or indirectly, in a trust

12.19 A trust in which individuals hold fixed entitlements may be able to pass the 50% stake test contained in Divisions 266 or 267 because of interests held by a non-resident family trust (under subsection 272-30(2) a family trust is treated as an individual holding fixed entitlements for its own benefit). The Commissioner may require the trust to give information about conferrals of present entitlements to, or distributions of, income or capital by the non-resident family trust. If this information is not given the trust will be taken not to have satisfied the 50% stake requirements. [Sections 266-175 to 266-185 and 267-80 to 267-90]

12.20 The information will allow the Commissioner to determine whether any family trust distribution tax is payable in respect of conferrals of present entitlement or distributions made by the non-resident family trust.

When can a notice be given?

12.21 The Commissioner can give a notice under the above sections if, in an income year, a resident trust has satisfied the condition in sections 266-40, 266-45, 266-90, 266-125, 266-165, 267-40 or 267-70. These conditions must have been met only because a non-resident family trust that holds a fixed entitlement, directly or indirectly, in the trust is treated, under subsection 272-30(2), as an individual holding the fixed entitlement for its own benefit. [Subsections 266-180(2) and (3) and 267-85(2) and (3)]

12.22 The Commissioner must give the notice to the trustee of the resident trust before the later of:

·
5 years after the income year in which the trust deducted the tax loss or debt deduction or did not work out its net income and tax loss under Division 268; and
·
the end of the period in which the trustee of the trust is required to keep records under section 262A in relation to the income year mentioned above. [Subsections 266-180(5) and 267-85(5)]

What information can be requested?

12.23 Under the notice the Commissioner can require the trustee to provide information in respect of conferrals of present entitlements to, or distributions of, income or capital by the non-resident family trust. These must be conferrals or distributions made since the start of the test period mentioned in the sections discussed in paragraph 12.21. This information need not be within the knowledge of the trustee at the time the notice is given. [Subsections 266-185(1) and (2) and 267-90(1) and (2)]

12.24 The notice must specify a time within which the trustee is to provide the Commissioner with the information. The Commissioner must allow a period of at least 21 days commencing on the date that the notice was given [subsections 266-185(3) and 267-90(3)] . The Commissioner can extend the time for compliance with the notice.

What are the consequences of not giving the information?

12.25 If the trustee does not comply with the request mentioned in paragraph 12.23, the trust will be taken not to have satisfied the conditions in sections 266-40, 266-45, 266-90, 266-125, 266-165, 267-40 or 267-70 and thus:

·
the deduction for the tax loss or debt deduction is not allowable to the trust in relation to that year of income; or
·
the trust is required to work out its net income and tax loss for the income year under Division 268. [Subsections 266-185(4) and 267-90(4)]

12.26 Where the trust is required to work out its net income and tax loss under Division 268, the income year is split up into such periods as would result in the highest possible net income for the income year. [Subsections 266-185(5) and 267-90(5)]

Example

12.27 The fixed entitlements to income and capital in a resident fixed trust with a prior year loss are held, throughout a test period, as follows:

·
30% by Jill (a natural person);
·
25% by a non-resident discretionary trust that has elected to be a family trust; and
·
45% by a resident discretionary trust that has not elected to be a family trust.

12.28 The fixed trust passes the 50% stake test and is able to deduct the loss because 55% of the fixed entitlements in the trust are held, throughout the test period, by Jill and the trustee of the non-resident family trust. Under subsection 272-30(2), the trustee is treated as an individual holding the fixed entitlements for its own benefit. The fixed trust is able to deduct its loss only because of the interest held by the non-resident family trust. This is because, if the trustee of the non-resident family trust was not treated as an individual under subsection 272-30(2), the fixed trust would have failed the 50% stake test.

12.29 In this case, the Commissioner can use his or her information-gathering power to request information about the non-resident family trust from the trustee of the fixed trust. The information requested would include data about the distributions made by the non-resident family trust. This would be used to determine whether any family trust distribution tax was payable in respect of distributions made by the non-resident family trust.

No offences or penalties

12.30 Sections 266-185(6) and 267-90(6) operate in the same way as section 266-60(6) (see paragraph 12.18 above).

Information notice - information about non-resident family trusts or entities that have made an interposed entity election

12.31 Family trust distribution tax imposed by the Family Trust Distribution Tax (Primary Liability) Act 1997 may be payable in certain circumstances by a resident entity (i.e. resident family trust or resident entity that has made an interposed entity election). This would be where the entity has conferred a present entitlement to, or made distributions of, income or capital to a non-resident entity (including a family trust) that is in the same family group. The liability for the tax will arise where the resident entity fails to provide certain information about conferrals of present entitlements or distributions made by the non-resident entity. [Sections 271-45 to 271-55]

12.32 The information will allow the Commissioner to determine what family trust distribution tax is payable by the non-resident entities that are part of a family group.

When can a notice be given?

12.33 The Commissioner may give a notice to:

·
a resident family trust that has conferred a present entitlement to, or made a distribution of, income or capital to a non-resident entity that has made an interposed entity election in relation to the individual specified in the family trust election [subsections 271-45(2) and (3)] ;
·
a resident entity that has made an interposed entity election in relation to a family trust and has conferred a present entitlement to, or made a distribution of, income or capital to a non-resident entity that is either:

-
a non-resident family trust in relation to which the resident entity has made the interposed entity election; or
-
a non-resident entity that has made an interposed entity election and so is part of the same family group as the resident entity. [Subsections 271-50(2) and (3)]

12.34 The Commissioner must give the notice to the resident entity (i.e. trustee, partners or company) before the later of:

·
5 years after the income year in which the present entitlement was conferred or distribution made by the resident entity; and
·
the end of the period in which the trustee, partners or company is required to keep records under section 262A in relation to the income year mentioned above. [Subsections 271-45(4) and 271-50(4)]

What information can be requested?

12.35 Under the notice the Commissioner can require the resident entity(trust, partnership or company) to provide information in respect of certain conferrals of present entitlements or distributions since the time the resident entity conferred the present entitlement or made the distribution to the non-resident entity. These are conferrals or distributions made by:

·
the non-resident entity; or
·
any other non-resident entity which has made a family trust or interposed entity election in respect of the family group of the individual specified in the family trust election. [Subsections 271-55(1) and (2)]

12.36 This information need not be within the knowledge of the resident entity at the time the notice is given. [Subsection 271-55(3)] This means that the trustee, partners or company may need to take steps to obtain the information requested in the notice.

12.37 The notice must specify a time within which the entity is to provide the Commissioner with the information. The Commissioner must allow a period of at least 21 days commencing on the date that the notice was given [subsection 271-55(4)] . The Commissioner can extend the time for compliance with the notice.

What are the consequences of not giving the information?

12.38 If the trustee does not comply with the notice mentioned in paragraph 12.35, family trust distribution tax is payable by the resident entity in respect of its conferrals of present entitlements or distributions to the non-resident entity. The persons on whom the liability for the tax falls depends on whether the resident entity is a trust, partnership or company. Those persons are the same as those in the table at paragraph 11.9 depending on whether the entity is a trust, partnership or company. [Subsections 271-55(5) to (7)]

12.39 The tax is due and payable at the end of 21 days after the period specified in the notice or the later time that the Commissioner allows for compliance with the notice. [Subsection 271-75(2)]

Example

12.40 Company A is a resident that has made an interposed entity election in respect of a non-resident family trust of which Bill is the specified individual. Company B is a non-resident company that is part of the same family group. In the income year Company A has paid dividends to the family trust. The Commissioner gives Company A a notice under section 271-50 to obtain information to be supplied by the company on conferrals of present entitlements or distributions of income or capital by Bill's family trust and also dividends paid by Company B. This information will allow the Commissioner to determine whether any family trust distribution tax is payable by the family trust and Company B.

12.41 If Company A does not respond to the notice within the time specified on the notice or such later time as the Commissioner allows, the company and its directors at the time the dividend was paid to the family trust will be jointly and severally liable to pay family trust distribution tax on the net amount of the dividend paid by Company A to the trust.

Recoupment of family trust distribution tax payable by non-resident entities

Why are recoupment provisions required?

12.42 Special rules have been included to provide that family trust distribution tax imposed by the Family Trust Distribution Tax (Secondary Liability) Act 1997 is payable in specified circumstances. The circumstances arise where a non-resident entity becomes liable for family trust distribution tax under the Family Trust Distribution Tax (Primary Liability) Act 1997 and the Commissioner is unable to recover the tax because of territorial limitations. [Sections 271-60 and 271-65]

When tax consequences may result

12.43 A resident entity (and relevant company directors) is liable to pay family trust distribution tax when the following conditions are met:

·
a non-resident entity has made a family trust election or an interposed entity election;
·
the non-resident entity has conferred a present entitlement to, or made a distribution of, income or capital;
·
family trust distribution tax has become payable on the amount or value of the conferral or distribution;
·
the tax remains unpaid after the tax has become due and payable by the non-resident entity - as specified under section 271-75 the tax generally becomes due and payable at the end of 21 days after the conferral or distribution was made;
·
the Commissioner has made a determination in writing that the whole or part of the tax that has become due and payable by the non-resident entityis unlikely to be paid.

[Subsections 271-60(1) and 271-65(1) and (2)]

Tax consequences

12.44 The liability for the family trust distribution tax will fall on a resident trust, partnership or company as follows:

·
any trust that has satisfied the conditions in sections 266-40, 266-45, 266-90, 266-125, 266-165, 267-40 or 267-70 only because the non-resident entity is a family trust that holds a fixed entitlement, directly or indirectly, in the trust and is treated, under subsection 272-30(2), as an individual holding the fixed entitlement for its own benefit [subsections 271-60(4)] ;
·
any trust, partnership or company that has:

-
made a family trust or interposed entity election that relates to the same specified individual as the election made by the non-resident entity; and
-
conferred a present entitlement to, or made a distribution of, income or capital to the non-resident entity or any other non-resident entity that is part of the same family group when the conferral or distribution took place. [Subsections 271-65(5) and (6)]

Persons on whom tax consequences may fall

12.45 The person or persons on whom liability for the tax falls depends on whether the resident entity is a trust, partnership or company. Those persons are the same as those in the table at paragraph 11.9 depending on whether the entity is a trust, partnership or company. [Subsections 271-60(2) and (3) and 271-65(3) and (4)]

12.46 The Commissioner must give a notice to the persons liable to pay tax under the Family Trust Distribution Tax (Secondary Liability) Act 1997 [subsection 271-90(2)] . The tax becomes payable at the end of 21 days after the day on which the notice is given [subsection 271-75(3)] . Also, a person may request that such a notice be given to them by the Commissioner. [Subsections 271-95(1) and (3)]

Example

12.47Company A is a non-resident that has made an interposed entity election in respect of a resident family trust of which Jill is the specified individual. The family trust has made distributions of income to Company A. During the income year Company A has paid dividends to individuals who are outside the family group and thus there is a liability to pay family trust distribution tax imposed by the Family Trust Distribution Tax (Primary Liability) Act 1997. Thisinformation was obtained by the Commissioner from the trustee under section 271-55.

12.48 Under section 271-75 the tax is due and payable at the end of 21 days after the dividends were paid. The due date has passed and the tax has not been paid. Given the circumstances surrounding the non-payment of the tax the Commissioner makes a determination that the tax is unlikely to be paid. Under section 271-65 the trustee of Jill's family trust will be liable for the family trust distribution tax imposed by the Family Trust Distribution Tax (Secondary Liability) Act 1997. The trustee of the family trust and, if the trustee is a company, the directors of the company, will be jointly and severally liable to pay the tax.

12.49 If resident entities that had made an interposed entity election in respect of the family trust had also made distributions etc to Company A, the liability for the family trust distribution tax would also fall on those entities. The person (or persons) liable for the tax are those specified in subsections 271-65(3) and (4)).

Reduction of liability where tax paid

12.50 The liability for family trust distribution tax will be reduced as follows:

·
if the non-resident entity later pays the tax (i.e. the primary tax ) the tax payable by the connected resident entity (the secondary tax ) at the time the payment is made is reduced by the amount of the primary tax paid;
·
if the resident entity pays the tax (the secondary tax ) the liability to the tax payable by the non-resident entity (the primary tax ) is similarly reduced. [Section 271-70]

What is the Family Trust Distribution Tax (Secondary Liability) Act 1997?

12.51 The Family Trust Distribution Tax (Secondary Liability) Act 1997 mentioned in this Chapter will be the imposition Act that imposes family trust distribution tax under sections 271-60 and 271-65 [clause 3 of the Family Trust Distribution Tax (Secondary Liability) Bill 1997] . The tax will equal the full amount of unpaid family trust distribution tax imposed under the Family Trust Distribution Tax (Primary Liability) Act 1997 [clause 4 of the Family Trust Distribution Tax (Secondary Liability) Bill 1997] . The circumstances in which this tax would be imposed are discussed in the preceding paragraphs of this Chapter.

Chapter 13 - Interpretation of terms used in the provisions

What is a fixed entitlement to income or capital?

13. 1 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.

13.2 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 mainly used in the legislation to trace whether a person has an indirect fixed entitlement to the income or capital of a trust. Fixed entitlements are also used to determine whether a family trust can revoke a family trust election and whether entities are in a family group.

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

13.3 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 272-5(1)] . 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.

What is a vested interest?

13.4 A person has a vested interest in something if the person has a present right relating to the thing. Stated simply, a vested interest is one that is bound to take effect in possession at some point in time. A vested interest is to be contrasted with a 'contingent' interest which may never fall into possession. 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 since such an interest is instead 'contingent' upon the event occurring.

13.5 In traditional legal analysis, a person can be said to be either 'vested in possession' or 'vested in interest'. A present interest, i.e. one that is being enjoyed, is said to be 'vested in possession'; a future interest, i.e. one which gives its holder a present right to future enjoyment, is said to be 'vested in interest'. A person is vested in possession where the person has a right to immediate possession or enjoyment of the thing in question. In the definition of fixed entitlement, 'vested' includes both vested in possession and vested in interest.

13.6 Because vested interests include future interests, a person can have a vested interest in a thing even though the person's actual possession and enjoyment of the thing is delayed until some time in the future.

When is a vested interest indefeasible?

13.7 A vested interest is indefeasible where, in effect, it is not able to be lost. 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 taken away by the exercise of a power by the trustee or any other person, the interest will not be a fixed entitlement.

13.8 Where the trustee exercises a power to accumulate income or capital of the trust in accordance with the trust deed, the accumulation does not result in a beneficiary's interest being taken away or defeased as long as the beneficiary nevertheless remains entitled at some future time to enjoy his or her share of the income or capital which has been accumulated.

Example

13.9 A unit trust has 100 units. All of the units carry equal rights to income and capital of the trust. The trustee has no discretion to allocate income or capital of the trust to unit holders other than in accordance with the share of income and capital represented by their units. The trustee has the power to accumulate income of the trust if the majority of the unit holders agree to such accumulation. However, each unit holder retains their interest in the share of accumulated income represented by their units. All of the income and capital of the unit trust is subject to fixed entitlements. The mere fact that the income of the trust is accumulated in the trust in accordance with the terms of the trust deed does not prevent the beneficiaries of the trust from being treated as having a vested and indefeasible interest in the income or capital of the trust.

The mere fact that units can be issued or redeemed at market value does not mean an interest is defeasible

13.10 The Bill includes a provision to clarify that the interest of a unit holder in a unit trust will not taken to be defeasible only because units in a unit trust can be issued or redeemed. However, for this clarifying provision to operate, the issue or redemption of the units must be at full value. This means that additional units could be issued or units redeemed only for market value or for a price that represents the net asset value of the trust. For listed unit trusts, market value of the units would be the listed price. For other unit trusts, the units need to be issued or redeemed at a value representing the net asset value of the trust. [Subsection 272-5(2)]

13.11 Subsection 272-5(2) is not intended to disturb the ordinary meaning of 'vested and indefeasible interest' in any way except in accordance with its terms. Thus, if an interest is vested and indefeasible ignoring subsection 272-5(2), it will be a fixed entitlement.

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

13.12 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 become vested or would be defeased;
·
the likelihood of the interest not vesting or not being defeased; and
·
the nature and type of the trust. [Subsection 272-5(3)]

13.13 This provision is intended to provide for special circumstances where there is a low likelihood of a beneficiary's vested interest being taken away or defeated and, having regard to the scheme of the trust loss provisions to prevent the transfer of the tax benefit of losses and other deductions incurred by trusts, it would be unreasonable to treat the beneficiary's interest as not constituting a fixed entitlement

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

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

13.15 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 a right to receive dividends that might be paid by the company. A company declares dividends out of the profits of the company. The extent of a shareholder's entitlement is expressed as a percentage of the total dividends declared by the company that the shareholder has a right to receive. [Subsection 272-10(1)]

13.16 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 a right to receive any return of capital in the company (e.g. in the event of a winding-up or a capital reduction of the company). The extent of the entitlement is expressed as a percentage of the capital returns by the company to shareholders which the particular shareholder has the right to receive. [Subsection 272-10(2)]

What is a fixed entitlement in a partnership?

13.17 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 person 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 272-15(1)]

13.18 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 272-15(2)]

When is a fixed entitlement held indirectly?

13.19 The concept of a fixed entitlement being held indirectly through one or more interposed companies, partnerships or trusts (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 9.22 to 9.33);
·
an individual is deemed to have been distributed any part of a test year distribution for the purposes of the pattern of distributions test applying to non-fixed trusts (see paragraphs 9.48 to 9.52);
·
an individual is taken to hold units in a unit trust for the purposes of the widely held unit trust definition (see paragraph 13.76);
·
a family trust can revoke a family trust election because it is wholly owned by an individual, members of his or her family and family trusts where the individual is specified (see paragraphs 5.13 to 5.16);
·
a company, trust or partnership is a member of a family group because it is wholly owned by an individual, members of his or her family and family trusts where the individual is specified (see paragraphs 5.34 and 10.22)

Tracing through fixed entitlements in companies, partnerships and trusts

13.20 A person will be taken to have a fixed entitlement in the income or capital of a company, partnership or trust (an entity) if the person is indirectly entitled to the income or capital through fixed entitlements in a chain of one or more interposed entities [section 272-20] . 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.

13.21 When tracing fixed entitlements to income of an entity, the fixed entitlements to income of the interposed entities are taken into account. When tracing fixed entitlements to the capital of an entity, the fixed entitlements to capital of the interposed entities are taken into account.

13.22 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).

13.23 For example, when tracing fixed entitlements in a loss trust, 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

13.24 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.

13.25 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 of Company B.

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

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

A more complex example of how fixed entitlements are traced

13.27 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

13.28 If a fixed entitlement to income or capital of an entity (the head entity) 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 entity 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 entity to which the trustee of the interposed non-fixed trust has a fixed entitlement.

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

Special tracing rules where fixed entitlements have be traced through certain types of interposed entities

13.30 The Bill contains special rules that apply to modify the general principles, discussed above, as to how fixed entitlements in a loss trust (or an interposed trust, company or partnership where relevant) are traced through some kinds of interposed entities. This is to overcome difficulties caused by the nature of the interests individuals hold in certain interposed entities or because of the practical difficulties in tracing through certain entities.

13.31 The sections containing these rules (sections 272-25 and 272-30) operate only where provisions of the Bill talk about a fixed entitlement being held 'directly' or 'indirectly' or both. If a provision simply refers to a person holding a fixed entitlement in a trust, that refers to a situation where the person directly holds those entitlements (see for example the definition of 'fixed trust' in section 272-65).

What if a superannuation fund, government body or special company holds fixed entitlements directly or indirectly?

13.32 There are several kinds of company (special companies) in which members do not have fixed entitlements meaning that fixed entitlements in an entity cannot be traced through those companies. For example, members of mutual companies, including life policy holders of mutual insurance companies, generally only have a right to vote, rather than a right to participate in the profits or capital of the company. There are other special companies in a similar position. The term 'special company' is defined in section 272-140 (see paragraph 13.108).

13.33 In addition, it may be difficult and costly for a superannuation fund or an approved deposit fund to determine the exact quantum of the fixed entitlements to income and capital held by each of the members in the fund. This is because the quantum of an individual member's interest in the fund will depend upon a range of facts and matters, for example, the superannuation contributions made by and on behalf of the member and the benefit scheme which operates for the member.

13.34 Problems also arise with a government body because individuals could not be said to beneficially own the income and capital of those bodies in the appropriate sense. The term 'government body' is defined in section 272-140 (see paragraph 13.102).

13.35 Special tracing provisions are included in the Bill to overcome the problems discussed above.

Interposed fund or special company with more than 50 members or interposed government body

13.36 In some cases an interposed complying superannuation fund, complying approved deposit fund, foreign superannuation fund[F15] or special company is taken to hold the fixed entitlements in the trust (or interposed entity where relevant), whether directly or indirectly, as an individual for its own benefit. This is where the fund or special company has more than 50 members. Fixed entitlements held by government bodies are treated in the same way [subsection 272-25(4)] .[F16] To avoid doubt, the members who may actually have the fixed entitlements indirectly through the interposed fund or special company are taken not to have those entitlements for the purposes of this concession. The exception is where the rule on 50 or fewer members deems those members to hold the fixed entitlements.

Interposed fund or special company with 50 or less members

13.37 In the case where the interposed fund or special company has 50 or less members, each of the members will be taken to have an equal share of the fixed entitlements that the fund or special company holds in the trust (or interposed entity where relevant). [Subsection 272-25(5)]

13.38 The following example illustrates the application of subsection 272-25(5). A complying superannuation fund holds 20% of the fixed entitlements in a loss trust and has 10 members. Each member is taken to hold, indirectly, 2% of the fixed entitlements in the loss trust.

What if a fund or special company's membership fluctuates during the times at which a 50% stake has to be maintained?

13.39 A provision is included in the Bill to cater for the situation where a fund or special company's membership fluctuates above or below 50 members during a period, or at times, when a 50% stake has to be maintained in a trust. In this case, the rule on 50 or less members applies (i.e. subsection 272-25(5)).

What if a special company loses its status as such?

13.40 A provision has been inserted in the Bill to cover the situation where a special company loses its status as such (e.g. a mutual insurance company de-mutualises and becomes a company limited by shares). The Commissioner has a discretion in these cases to treat the members (e.g. shareholders) of the company after it loses its status as having held the fixed entitlements held by the company at all times when the company was a special company [subsections 272-25(7) and (8)] . In exercising this discretion, the Commissioner is to have regard to a number of matters as set out in subsection 272-25(8).

13.41 The following example illustrates the application of subsections 272-25(7) and (8). A mutual insurance company holds a fixed entitlement in a trust. The trust incurred losses in Year 1 and seeks to recoup those losses in Year 2. At the end of Year 1 (part of the test period for determining continuity of ownership of the trust), the mutual insurance company de-mutualises and becomes a company limited by shares. The shareholders of the company after the de-mutualisation may, if appropriate, be treated by the Commissioner as holding, during the whole of Year 1, the fixed entitlements in the loss trust, indirectly, in the same proportions that they hold fixed entitlements in the de-mutualised insurance company.

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

13.42 A special rule will apply to circumstances where a fixed entitlement to the income or capital of an entity is held, directly or indirectly, by a family trust at a particular time. The trustee of the family trust will be taken to have that fixed entitlement to the income or capital of the entity as an individual for its own benefit [subsection272-30(2)] . However, this rule does not apply for the purposes of the application of the pattern of distributions test to non-fixed trusts.

Listed public companies and widely held unit trusts

13.43 There are considerable practical difficulties in tracing interests in or through listed public companies, because of the large number of shareholders and the likelihood that individuals will not hold shares in the listed public company directly. Similar problems arise for widely held unit trusts. The main problem is that it may be difficult, in particular cases, to identify all the direct and indirect holders of fixed entitlements in those entities. The term 'listed public company' is defined in section 272-135 (see paragraphs 13.95 and 13.96).

13.44 A provision has been included in the Bill to assist in overcoming difficulties in appropriate cases. This provision will allow the Commissioner to treat all or part of the fixed entitlements in a trust (or interposed entity where relevant) held, directly or indirectly, by a listed public company or widely held unit trust as being held by that company or trust as an individual for its own benefit. [Subsections 272-30(3) and (4)]

13.45 The Commissioner will be able to exercise his or her discretion to do this where he or she considers it fair and reasonable to do so having regard to a number of factors set out in subsection 272-30(4). These factors relate to:

·
the practicability of identifying individuals who have fixed entitlements;
·
any changes in individuals holding fixed entitlements; and
·
any other relevant matters (e.g. whether there has been any abnormal dealing in a listed public company's shares).

Example

13.46 A listed public company holds all the fixed entitlements in a loss trust. It is only possible for the trust to determine the individuals who, directly and indirectly, hold 90% of the fixed entitlements in the company. This means the trust can determine the individuals who indirectly hold 90% of the fixed entitlements in the trust itself. If appropriate, the Commissioner could treat the remaining 10% (or part thereof) of the fixed entitlements in the loss trust as being held by the company as an individual for its own benefit.

Fixed entitlements - avoidance arrangements

13.47 The Bill contains a provision to deal with avoidance arrangements designed to ensure that individuals have a direct or indirect fixed entitlement in a trust, company or partnership of a certain level. A fixed entitlement held by a person is treated as not having been held by the person if certain conditions are met.

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

·
the arrangement is in some way related to, affected or depended 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 fixed entitlement that would be treated as not being held by a person; and
·
the purpose, or one of the purposes, of the arrangement was to ensure that individuals would have a fixed entitlement for one or more of the purposes set out in paragraph 13.19 - this makes it clear that the arrangement has been entered into to ensure a person has a fixed entitlement for one or more of those purposes. [Section 272-35]

13.49 Section 272-35 performs a similar role to subsections 80B(5), (6) and (7) of the ITAA 1936 or sections 165-180 to 165-190 of the ITAA 1997. These provisions apply to companies. For example, section 272-35 can apply in circumstances where a person who holds a fixed entitlement in a trust enters into an arrangement before the end of the test period for the purposes of the 50% stake test to transfer their fixed entitlement to another person. The transfer is delayed until after the end of the test period to enable the tax benefit from the losses to be transferred to the person who has acquired the fixed entitlement. The person who held the fixed entitlement during the test period would be treated as not having held it in that period.

What happens if a beneficial owner of an entitlement dies?

13. 50 The Bill makes special provision for the situation where an individual who directly or indirectly holds a fixed entitlement in a trust dies. This is necessary to prevent a trust failing the 50% stake (continuity of ownership) test, the widely held unit trust definition or other relevant provisions 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 as a beneficiary of the dead person's estate. [Section 272-40]

What is a distribution of income or capital?

13.51 This Bill sets out the circumstances in which a distribution of income or capital by a trust, company or partnership will be taken to have occurred for the purposes of the trust loss measures. The distribution concept is mainly used in:

·
the pattern of distributions condition contained in section 267-30 and Subdivision 269-D (this is applied to determine changes in who benefits from a non-fixed trust); and
·
sections 271-15, 271-20, 271-25 and 271-30 which impose a liability to family trust distribution tax when distributions are made outside a family group.

13.52 The term distribution of income or capital is defined to include distributions of income and capital as generally understood. However, it is also given an extended meaning that includes loans, distributions in specie as well as other benefits that are provided to a person by a trust, company or partnership. The extended meaning given to the term ensures that regard is to be had to benefits of whatever nature or form that have accrued to a person.

Normal meaning of distribution

13.53 Sections 272-45, 272-50 and 272-55 set out when distributions of income or capital as generally understood are considered to be made. Table 13.1 summarises when a distribution is made under these sections.

Table 13.1 Normal meaning of distribution of income or capital
Entity Income Capital
Trust The income is paid or credited to a person as money or is transferred as property The income is reinvested or dealt with on behalf of the person or as the person directs The income is otherwise applied for the benefit of a person The income distribution must be made to the person in their capacity as a beneficiary of the trust The capital is paid or credited to a person as money or is transferred as property The capital is reinvested or dealt with on behalf of the person or as the person directs The capital is otherwise applied for the benefit of a person The capital distribution must be made to the person in their capacity as a beneficiary of the trust
Company A payment of a dividend within the meaning of the ITAA 1936 to a person.[F17] This would include formal and informal distributions made upon winding up of a company (subsections 47(1) and (2A)) as well as deemed dividends (e.g. sections 108 or 109). A payment or crediting of money or the transfer of property to a person that is not a dividend and represents (i) a repayment of money paid up on a share or (ii) results in a debit entry to a share premium account of the company.
Partnership The income is paid or credited to a person as money or is transferred as property The income is reinvested or dealt with on behalf of the person or as the person directs The income is otherwise applied for the benefit of a person The income distribution must be made to the person in their capacity as a partner in the partnership The capital is paid or credited to a person as money or is transferred as property The capital is reinvested or dealt with on behalf of the person or as the person directs The capital is otherwise applied for the benefit of a person The capital distribution must be made to the person in their capacity as a partner in the partnership

Extended meaning of distribution

13.54 In addition to the above, distribution is given an extended meaning so that it includes the following:

·
the payment (including by way of a loan) or crediting of money of the entity to a person or the reinvesting of such money for that person; or
·
the transfer of property of the entity to a person or allowing the use of such property by a person; or
·
the application of money or property of the entity for the benefit of a person including where the money or property is dealt with for or on behalf of the person or as the person directs (e.g. where the entity pays-off a debt owed by the person to a third party); or
·
the extinguishment, forgiveness, release or waiver of a debt or other liability owed by a person to the entity. [Subsection 272-60(1)]

13.55 However, one of the above things will only be a distribution under the extended meaning if it is not a distribution in the normal meaning (i.e. under sections 272-45, 272-50 and 272-55).

13.56 As indicated, a distribution may not always be in the form of money or money equivalent. If the distribution takes the form of property or some other benefit, it will be necessary to obtain a monetary equivalent of the property or other benefit provided. The valuation should be made by reference to all relevant matters affecting the value of the property or benefit, for example, its market price (if any).

13.57 Because of the broad meaning given to the term 'distribution of income or capital' in subsection 272-60(1), in the absence of special provision, it could include all of any payment or benefit provided to a person even though that person has given valuable consideration in return for that payment or benefit. To overcome this, the definition of the term will be limited so that the things discussed in paragraph 13.54 above are only included as a distribution to the extent that the amount or value of the thing exceeds the consideration given in return. [Subsection 272-60(2)]

13.58 If the consideration is given after the time the distribution is made it may be necessary to calculate the value of the distribution by reference to the present value of the consideration to be given. The present value of the consideration must be determined at the time the distribution is made and must take into account any amounts owed or things to be given under contract by the beneficiary to the trust (or third party) in return for the distribution.

13.59 If consideration that was to be given at the time of a distribution is not subsequently given, it will be necessary to treat the distribution as a distribution for the purposes of these measures.

Example

13.60 A trustee provides an interest free loan to a beneficiary of $1,000 which is repayable in 5 years time. To obtain a comparable loan from a financial institution the beneficiary would have to repay the principal of the loan in equal instalments over a 5 year period and incur an interest rate of 10%. If the annual interest rate on a comparable loan is 10% the present value of $1,000 repayable in 5 years time is $620. The benefit provided to the beneficiary is $1,000-$620, i.e. $380. For the purposes of this provision $380 will be taken to be a distribution of income.

Income v capital

13.61 Any distribution made by an entity that is taken to be a distribution because of subsection 272-60(1) will be taken to be a distribution of income unless it is clear that the distribution has been made out of the capital of the entity. [Subsection 272-60(3)]

When is income or capital distributed indirectly?

13.62 The concept of a distribution being made indirectly is used in the pattern of distributions test (see section 269-60 discussed in Chapter 9).

13.63 A trust is taken to distribute all or part of a test year distribution to an individual indirectly if an amount or property attributable to the test year distribution is successively distributed by each interposed entity in a chain of one or more interposed entities to the individual. The amount of a 'test year distribution' of income or capital distributed to a person through interposed entities is determined by ascertaining what is fair and reasonable having regard to the actual distributions made by each successive entity. [Section 272-63]

13.64 The definitions of 'distribution of income or capital' in sections 272-45 to 272-60 will also apply to distributions made by interposed entities in the distribution chain.

Examples which show whether a distribution has been made indirectly

Example 1

13.65 In an income year Trust A makes a distribution of income indirectly through a chain of entities to Bill. The amount of distributions of all the distributing entities is shown in the diagram below.

Example 1 - Whether a distribution has been made indirectly

13.66 It would be fair and reasonable in the circumstances to take Trust A as having indirectly distributed $60 of the distribution to Bill as Trust B only distributed to Company C $60 of the $100 distributed from Trust A. Only half of the profits distributed by Company C can be traced back to Trust A.

Example 2

13.67 As shown in the diagram below, in the income year Trust A makes a distribution of income of $100 to Trust B. Under the trust deed of Trust B, the trustee has a discretion to distribute only interest derived by the trust from accumulated income of the trust to discretionary beneficiaries. The trustee exercises the discretion to pay the amount of interest income derived by the trust for the income year in favour of Bill.

Example 2 - Whether a distribution has been made indirectly

13.68 It would not be fair and reasonable in the circumstances to take Trust A as having indirectly distributed $100 to Bill as the income that has been distributed to Bill is sourced from the interest income derived by Trust B.

What is a fixed trust?

13.69 A fixed trust is a trust where all of the income and capital of the trust is the subject of fixed entitlements held by persons [section 272-65] . Paragraph 6.7 discusses the nature of a fixed trust in more detail.

What is a non-fixed trust?

13.70 A non-fixed trust is any trust which is not a 'fixed trust' [section 272-70] . Paragraph 7.5 above discusses the nature of a non-fixed trust in more detail.

What is an excepted trust?

13.71 There are six kinds of trusts that are excepted trusts . They are:

·
family trusts (discussed in Chapter 5);
·
complying superannuation funds, complying approved deposit funds and pooled superannuation trusts;
·
fixed unit trusts if all of the direct and indirect fixed entitlements to income and capital of the trust are held by bodies exempt from tax under section 23 of the ITAA 1936 or Division 50 of the ITAA 1997; and
·
deceased estates within a reasonable administration period. [Section 272-100]

13.72 The definitions of a complying superannuation fund, a complying approved deposit fund and a pooled superannuation trust are in section 272-140.

13.73 The term 'deceased estate' has its ordinary meaning. It is the trust which arises upon the death of a person for the administration of the deceased's estate by his or her personal representative in accordance with the will or codicil of the deceased or the intestacy laws of the relevant jurisdiction. It does not, however, include a testamentary trust (i.e. a trust, other than the deceased estate itself, established under the terms of a will or codicil).

13.74 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 272-100(c)] . This will give the trustee of the deceased estate the opportunity to complete the administration of the estate.

What is a widely held unit trust?

13.75 Unlisted widely held trusts, listed widely held trusts, unlisted very widely held trusts and wholesale widely held trusts are all widely held unit trusts with particular characteristics.

13.76 A fixed trust is a widely held unit trust if it is a unit trust and is not closely held [subsection 272-105(1)] . A trust is closely held if 20 or less individuals between them hold, directly or indirectly, and for their own benefit, 75% or more of the fixed entitlements to income or capital of the trust (the 20/75 rule) [subsection 272-105(2)] .

13.77 For the purposes of the definition of a widely held unit trust an individual 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 272-105(3)]

13.78 The rule that 20 or fewer individuals must not hold 75% or more of the interests in income or capital of the trust is affected by an anti-avoidance provision which is similar to those contained in section 102G of the ITAA 1936. 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 20 or less individuals would, directly or indirectly, hold fixed entitlements to 75% or more of the trust's income or capital, the trust will not be a widely held unit trust. [Subsection272-105(4)]

What is an unlisted widely held trust?

13.79 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 ITAA 1936. However, the characterisation of such a trust may be affected by the rule that defines some trusts to be of the same kind as their parent trust (see Subdivision 272-J discussed at paragraphs 13.91 and 13.92). [Section 272-110]

What is a listed widely held trust?

13.80 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 ITAA 1936. [Section 272-115]

What is an unlisted very widely held trust?

13.81 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, if the units are redeemable, 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 272-120(1)]

13.82 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 272-120(2)]

13.83 The characterisation of a trust meeting the requirements of section 272-120 may be affected by the rule that defines some trusts to be of the same kind as their parent trust (see Subdivision 272-J discussed at paragraphs 13.91 and 13.92).

Start-up period of an unlisted very widely held trust

13.84 Because it is often the case that trusts in which units are offered to the public take a while to grow, a trust that becomes an unlisted very widely held trust will be deemed to be such during its start-up period even if it does not strictly meet the necessary criteria. Accordingly, a trust will be taken to be an unlisted very widely held trust at all times from the time the units of the trust were first issued until the end of a start-up period if certain conditions are met. These are:

·
the trust became an unlisted very widely held trust at a time within 2 years of first issuing units;
·
there was no abnormal trading in the trust's units, within the meaning of subsections 269-15(1) or section 269-20, in the start-up period; and
·
at all times in the start-up period, other than the first 90 days of that period, the trust was a widely held unit trust. [Subsection 272-120(3)]

13.85 The start-up period is essentially the period from when the trust first issued units until the earlier of the end of 2 years after that first issue or when the trust becomes an unlisted very widely held trust. If the trust does not become an unlisted very widely held trust within 2 years, it will not benefit from the start-up rules.

13.86 As noted above, a condition that must be satisfied is that there has been no abnormal trading in the trust during this period within the meaning of subsection 269-15(1) or section 269-20. Subsection 269-15(1) sets out factors that have to be considered in determining whether there has been abnormal trading and section 269-20 provides that abnormal trading will have occurred if a trustee knows or reasonably suspects that an acquisition or merger is taking place.

What is a wholesale widely held trust?

13.87 It is normal industry practice for unlisted very widely held and listed widely held trusts (retail trusts) as well as other pooled investment vehicles to invest their funds in wholesale trusts. Wholesale trusts are a means by which the funds of retail trusts and other investment bodies can be pooled and invested in particular types of investments (e.g. Australian shares, property, etc.).

13.88 A wholesale widely held trust is a trust that meets the following conditions:

·
the trust is an unlisted widely held trust but not an unlisted very widely held trust;
·
75% or more of the units in the trust are held by any one or more of a listed widely held trust, an unlisted very widely held trust, a complying superannuation fund, a complying approved deposit fund, a pooled superannuation trust, a life assurance company (within the meaning of section 110 of the ITAA 1936) or a registered organisation (within the meaning of section 116E of the ITAA 1936) - these are all called qualifying holders in the Bill;
·
all of the units in the trust carry the same rights;
·
if the units in the trust are redeemable, they are redeemable for a price determined on the basis of the trust's net asset value, according to Australian accounting principles;
·
the minimum initial subscription amount for units in the trust by each person is at least $500,000;

13.89 In addition the trust can only engage in certain activities. These are the same as those discussed at paragraph 13.82. [Section 272-125]

13.90 The characterisation of a trust meeting the requirements of section 272-125 may be affected by the rule that defines some trusts to be of the same kind as their parent trust (see Subdivision 272-J discussed at paragraphs 13.91 to 13.92).

How is the classification of a trust affected when it is wholly owned by a higher level trust?

13.91 The characterisation of a trust may be affected by whether it is wholly owned, directly or indirectly, by another trust. An unlisted widely held trust, unlisted very widely held trust or wholesale widely held trust whose fixed entitlements to income and capital are all held, directly or indirectly, by another trust of a higher level will instead be a trust of the same kind as that higher level trust. The parent trust must be of a higher level so that the subsidiary trust will not be worse off. The level of trust is determined in the following order (from lowest to highest):

·
unlisted widely held trust;
·
unlisted very widely held trust;
·
wholesale widely held trust;
·
listed widely held trust. [Section 272-127]

Example

Example - How is the classification of a trusted affected when it is wholly owned by higher level trust?

13.92 In the above ownership structure, the classification of the B Unit Trust remains as listed widely held since its parent (the A Unit Trust) is not of a higher level. The C Unit Trust and D Unit Trust are re-classified as unlisted very widely held trusts because they are each wholly owned by the A Unit Trust which is of a higher level. The classification of the D Unit Trust is unaffected by the classifications of the B Unit Trust and C Unit Trust since neither of them owns 100% of it.

What if a trust begins or ceases to exist in a period?

13.93 A provision has been included to clarify how the provisions work when a trust begins or ceases to exist during a period for which it is required to meet a condition. Where a trust does not exist during a part of a period for which a condition needs to be met, the period is taken not to include the period when the trust does not exist. [Section 272-130]

Example

13.94 A fixed trust is created by settlement on 1 April 1998 and incurs a loss during the 1997-98 income year. The test period for the purposes of applying the 50% stake test to the trust does not include the time from the beginning of the 1997-98 income year to 1 April 1998.

What is a listed public company?

13.95 A company is a listed public company if its shares are quoted on an approved stock exchange (as defined in section 470 of the ITAA 1936) and the company satisfies what is generally known as the 20/75 rule. [Section 272-135] .

13.96 The 20/75 rule requires that 20 or less individuals must not hold, between them, and directly or indirectly, 75% or more of the relevant ownership rights in the company.

Other definitions not previously dealt with [section 272-140]

What is an approved stock exchange?

13.97 An approved stock exchange has the same meaning as in section 470 of the ITAA 1936. Section 470, together with regulations made for the purposes of that section, list a number of stock exchanges around the world as approved stock exchanges.

What is an arrangement?

13.98 The term 'arrangement' is used in anti-avoidance provisions (e.g. section 269-85 and 272-35). An arrangement means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

What is an associate?

13.9 The term associate has the same meaning as in section 318 of the ITAA 1936. This kind of definition is commonly used in the income tax law to define who an associate of another person is.

What is a breakdown in the marriage?

13.100 There is a breakdown in the marriage of an individual if the individual is living with another individual on a genuine domestic basis as husband or wife (whether legally married or not) and ceases to do so. Thus, there could be a breakdown in the marriage of a legally married couple even if they have not been formally divorced.

What is a complying superannuation fund, complying approved deposit fund and pooled superannuation trust?

13.101 The definition of these entities is taken from sections 45, 47 and 48 of the Superannuation Industry (Supervision) Act 1993, respectively.

What is a government body?

13.102 Special tracing rules apply where fixed entitlements are held, directly or indirectly, by a government body. A government body is the Commonwealth, a State or Territory, a municipal corporation or other local governing body or a foreign state.

What is an income year?

13.103 The term income year is used throughout the provisions dealing with trust losses. In the case of the ITAA 1936 it is the 'year of income' (defined in subsection 6(1) of that Act). In the case of the ITAA 1997, the relevant term is already the income year (see the definition in subsection 995-1(1)).

What is a loss year?

13. 104 A loss year is a year of income in which a tax loss was incurred.

Who is a member of a company?

13.105 A member of a company is a shareholder or stockholder and, in the case of a mutual insurance company, includes a person who holds a life insurance policy of the company.

What is a scheme?

13.106 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 ITAA 1936. Part IVA is the general anti-avoidance provision in the income tax law.

13.107 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 special company?

13.108 A special company benefits from concessional tracing rules where it is interposed between an entity and individuals. A special company means:

·
a mutual affiliate company (within the meaning of section 121AC of the ITAA 1936);
·
a mutual insurance company (within the meaning of section 121AB of the ITAA 1936);
·
a company that is, by the terms of the company's constituent document, prohibited from making any distribution of income and capital (within the meaning of subsection 272-50) to its members (e.g. non-profit sporting clubs or trade unions);
·
a credit union, within the meaning of section 3 of the Financial Institutions Codes of the States and Territories (these are defined in section 111AZC of the Corporations Law), whose constituent documents prevent it from paying dividends to its members;
·
any company prescribed by the regulations.

What is a tax loss?

13.109 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 ITAA 1936 which deal with the deductibility of losses. A tax loss also includes a loss worked out under section 36-10 of the ITAA 1997. In general terms, a tax loss arises when a taxpayer's non-loss allowable deductions exceed assessable income and net exempt income.

Chapter 14 - Related and consequential amendments

Overview

14.1 A number of related and consequential amendments are made to the following Acts:

·
the ITAA 1936;
·
the ITAA 1997;
·
the Fringe Benefits Tax Assessment Act 1986;
·
the Superannuation Contributions Tax (Assessment and Collection) Act 1997;
·
the Medicare Levy Act 1986.

Integration of loss rules into the ITAA 1936 and ITAA 1997

14.2 The Bill also makes a number of amendments to the ITAA 1936 and ITAA 1997 consequential on the insertion of Schedule 2F. The consequential amendments integrate Schedule 2F into the ITAA 1936 and ITAA 1997.

Amendments to the ITAA 1936

14.3 Amendments are made to sections 79E and 79F of the ITAA 1936. These amendments make it clear that, if a trust has a loss calculated under the current year loss rules (Division 268) for an income year, that is the relevant loss for that year for the purposes of sections 79E and 79F. [Item 3, subsection 79E(2A); item 4, subsection 79F(5A)]

14.4 An amendment is also made to section 95 of the ITAA 1936. 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 and tax loss in a special way if the relevant rules in the Bill are triggered. A similar amendment is also being made to sections 102D and 102M which deal with the calculation of the net income of corporate unit trusts and public trading trusts. These amendments integrate the proposed current year loss rules for trusts into the ITAA 1936. [Items 5, 6 and 7]

Amendments to the ITAA 1997

14.5 Section 25-35 of the ITAA 1997 contains the general provision for deductibility of bad debts and contains a table that points readers to provisions in the income tax law that may affect the deductibility of losses. The Bill inserts items into the table to direct readers to the debt deduction provisions that may affect the deductibility of bad debts of trusts. [Item 26]

14.6 Section 36-10 of the ITAA 1997 contains the general provision for calculation of a tax loss for an income year and section 36-25 contains tables that point readers to provisions in the income tax law that may affect the deductibility of losses. The Bill inserts a table to direct readers to the prior and current year loss rules and income injection test that may affect the deductibility of trust losses. [Item 27]

14.7 Subsection 995-1(1) of the ITAA 1997 contains a definition of film component of a tax loss. The Bill inserts a note in this definition to make it clear that the film component of a tax loss of a trust may need to be calculated under the current year loss rules applying to trusts (see section 268-65 discussed in paragraph 8.46). [Item 28]

14.8 In similar fashion, a note is added at the end of the definition of tax loss in subsection 995-1(1) to indicate that a tax loss of a trust may need to be calculated under the current year loss rules applying to trusts (see section 268-60 discussed in paragraph 8.46). [Item 29]

Debt deductions

14.9 The Bill inserts a provision into the ITAA 1936 to provide that a deduction for a bad debt or deduction under section 63E in respect of an extinguished debt is not allowable to a trust in certain circumstances. This is where the debt is incurred and written off as bad or extinguished on the last day of an income year. This provision is an anti-avoidance measure and is intended to bring the deductibility of the relevant amounts by trusts into line with the provisions that apply to companies under subsection 63A(11) of the ITAA 1936. [Item 2, section 63G]

Foreign loss deductions

14.10 Amendments are being made to section 160AFD of the ITAA 1936 in order to prevent the transfer of the tax benefit of quarantined foreign losses of trusts to those who did not suffer them. Broadly, section 160AFD quarantines certain classes of overall foreign losses and allows them to be deducted only against assessable foreign income of the same class. Section 160AFD limits the use of quarantined foreign losses of companies by saying that the company must meet the relevant loss deductibility tests in relation to the overall foreign loss. A similar amendment is being made for overall foreign losses of trusts.

14.11 The Bill provides that a trust may not use an overall foreign loss if, on the assumption that the overall foreign loss was a tax loss, Divisions 266 and 267 of Schedule 2F would prevent its deduction. Divisions 266 and 267 deal with changes in ownership and control of trusts. [Item 9, subsection 160AFD(6A)]

14.12 The Bill also provides that a trust may not use a foreign loss if the income injection test (Division 270 of Schedule 2F) would apply on the assumption that:

·
the overall foreign loss was a deduction allowable in the particular year of income; and
·
the assessable foreign income of the same class as the foreign loss is the scheme assessable income. [Item 9, subsection 160AFD(6B)]

Amendment of assessments

14.13 Section 170 of the ITAA 1936 provides rules dealing with how assessments can be amended by the Commissioner. An assessment can normally only be amended within 4 years. However, in the case of many anti-avoidance rules, the amendment period is longer.

14.14 An amendment has been made to subsection 170(10) so that section 170 does not prevent the amendment of an assessment for the purposes of giving effect to section 271-105 which operates to exempt a person from income tax on amounts subject to family trust distribution tax (see paragraphs 11.29 to 11.34). The amendment is necessary because a trustee may pay tax, under section 99A, on an amount of net income and more than 4 years later may distribute that income to a non-family member. If the assessment could not be amended double taxation would be caused as a result of the trustee's liability to pay family trust distribution tax on the amount distributed. [Item 10]

14.15 Subsection 170(13) has also been amended in order to allow for a trust's assessment to be amended for the purpose of the income inject test if the amendment is made within 6 years after the date upon which the tax became due and payable under the assessment. Subsection 170(13) already applies in this way to the income injection test applying to companies. [Item11]

Consequential amendments relating to family trust distribution tax

14.16 Family trust distribution tax may be payable by a family trust or by an entity that has made an interposed entity election. This will be where the trust or entity has made a distribution of income or capital outside the family group (see Chapter 11). A number of consequential amendments are being made to ensure that:

·
double taxation will not arise where the tax is paid; and
·
the income tax exemption for amounts on which family trust distribution tax has been paid cannot be used as a tax planning tool to avoid the superannuation contributions tax and Medicare levy.

14.17 Section 271-105 provides an exemption from income tax for amounts on which family trust distribution tax has been paid (see paragraphs 11.29 to 11.34).

Prevention of double taxation

14.18 Subsection 128B(3) of the ITAA 1936 is being amended so that a liability to non-resident withholding tax does not arise on an amount of income or capital that is exempt from income tax under section 271-105. [Item 8]

14.19 Section 136 of the Fringe Benefits Tax Assessment Act 1986 is being amended so that an exempt fringe benefit includes any fringe benefit that is a distribution of income or capital on which family trust distribution tax has been paid. [Item 30]

Prevention of avoidance of Medicare levy and superannuation contributions tax

14.20 The exemption from income tax for amounts that have been subject to family trust distribution tax is intended to ensure that there is no double taxation of income. It is not intended to be a means for avoidance of the superannuation contributions tax or increased Medicare levy for those high income earners without private health insurance. In the absence of any special provision, tax planning opportunities could arise under which distributions are deliberately made subject to family trust distribution tax in order to reduce the taxable income of an individual to a level where the superannuation contributions tax and Medicare levy could be avoided. Accordingly, amendments are being made to the Superannuation Contributions Tax (Assessment and Collection) Act 1997 and the Medicare Levy Act 1986.

Superannuation contributions tax

14.21 An amendment is made to the definition of 'adjusted taxable income' in section 43 of the Superannuation Contributions Tax (Assessment and Collection) Act 1997 so that this amount will also include amounts that would have been in the taxable income of a person if it were not for the operation of section 271-105. [Item 32]

Medicare levy

14.22 An amendment is also made to the Medicare Levy Act 1986 so that, for the purposes of sections 8B to 8G, taxable income will include an amount that has been exempted from income tax under section 271-105. Sections 8B to 8G are the sections of the Medicare Levy Act that deal with the private health insurance incentives. [Item 1 of Schedule 1 of the Medicare Levy Consequential Amendment (Trust Loss) Bill 1997]

Distributions through interposed trusts or partnerships

14.23 The amendments to the superannuation contributions tax and Medicare levy legislation will ignore section 271-105 for all purposes in calculating the taxable income of a person for the purposes of that legislation. This includes the case where an amount that has been subject to family trust distribution tax is distributed to a person through interposed trusts or partnerships.

Chapter 15 - Application of the measures and transitional provisions

Overview

15.1 Division 3 of Part 1 of the Bill deals with application and transitional matters. The amendments are of two kinds:

·
application arrangements; and
·
transitional arrangements.

Application arrangements

15.2 In general terms, the provisions dealing with trust losses (Schedule 2F) proposed to be inserted in the ITAA 1936 will apply to all transfers of losses after 1995 Budget time. 1995 Budget time means 7.30 pm, by legal time in the Australian Capital Territory (i.e. Eastern Standard Time (EST)), on 9May 1995. In some cases the 1996 Budget time or the 1997 Budget time is a relevant date. 1996 Budget time means 7.30 pm, by legal time in the Australian Capital Territory (i.e. EST), on 20 August 1996. 1997 Budget time means 7.30 pm, by legal time in the Australian Capital Territory (i.e. EST), on 13 May 1997. [Item 12]

Application of prior year loss rules

General

15.3 The earlier year loss provisions (defined in item 12 ) apply from the 1994-95 income year [subitem 13(1)] . However, the Bill ensures that the proposed prior year loss measures will apply only from 1995 Budget time for the 1994-95 and later income years by saying that if a test period would begin before 1995 Budget time, it is taken instead to begin at 1995 Budget time [subitem 13(2)] . This will be the case where the loss was incurred in the 1994-95 income year or an earlier income year.

15.4 The 'test period' is the period used in determining whether certain events that will prevent the deduction of a prior year loss have occurred. Subitem 13(2) also has the effect that the test period begins at the 1995 Budget time for the purposes of the provisions saying that a trust must be of a particular kind at all times, or certain times, during the test period.

Application of pattern of distributions test

15.5 There is also a provision to ensure that the pattern of distributions test that applies for non-fixed trusts (see paragraphs 7.12 to 7.13) will, in effect, only apply from the date of introduction of the 1995 Bill (see paragraph 3.3) into the Parliament. The application of this test is different because the details of the test, as they were presented in the 1995 Bill, were not effectively announced until 28 September 1995. This special application provision will ensure no retrospective operation of the test. It does this by saying that:

·
the pattern of distributions test does not apply where the income (i.e. recoupment) year is the 1994-95 income year; and
·
for the 1995-96 income year, at least part of a test year distribution that has to be taken into account in applying the pattern of distributions test must occur after 28 September 1995. [Subitem13(3)]

15.6 The Bill also modifies the pattern of distributions test to alleviate the impact of the trust loss measures in the transitional stages. Where distributions made prior to the 1995 Budget time have to be taken into account in applying the pattern of distributions test, all portions of all test year distributions received by members of the same family prior to and after the 1995 Budget time will be treated as having been received by the same individual. The family is determined by reference to a particular individual to whom part of a test year distribution has been made and the members of that individual's family (see section 272-95). [Subitem13(4)]

15.7 In the 1995 Bill, the period for which a test year distribution was determined for the pattern of distributions test was the income year only. This was changed in the exposure draft of the trust loss measures released on 10 February 1997 to the period to the end of two months after the end of the income year. This reflects the fact that, for administrative reasons, trust distributions may frequently not be able to be made in the income year. To prevent retrospectivity, if the income year is the 1995-96 or 1996-97 income year, the relevant period will be the income year.[F18] For the 1997-98 and later income years the period includes the two months after the end of the income year. [Subitem 13(5)]

Application of current year loss provisions

15.8 The current year loss provisions (defined in item 12 ) apply from the 1994-95 income year. However, various provisions ensure that they have no application prior to the 1995 Budget time.

15.9 A trust with a substituted accounting period for the 1994-95 income year that ends before the 1995 Budget time will not be required to apply the current year loss provisions for that year. [Subitem 13(6)]

15.10 The Bill also ensures that the current year loss rules operate only from the 1995 Budget time by saying the following about the events that may lead to a trust having to calculate its net income and tax loss in a special way:

·
no abnormal trading in a trust's units 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 1995 Budget time; and
·
a trust is taken to be of the same kind from the commencement of the 1994-95 year of income until the 1995 Budget time as it was at the 1995 Budget time. [Subitem 13(7)]

Application of debt deduction rules

15.11 For the debt deduction provisions (defined in item 12 ),[F19] similar rules to those applicable for prior year loss purposes apply, except that the 1996 Budget time is the relevant application date. [Item 14]

Application of income injection test

15.12 The income injection test in Division 270 applies for the 1994-95 and later income years. However, it will only apply where the following happens:

·
the assessable income derived under an income injection scheme is derived after 1995 Budget time; and
·
the benefit provided to the trust, beneficiary or associates under the scheme is provided after 1995 Budget time. [Item15]

Application of expanded definition of distribution

15.13 An expanded definition of distribution (see section 272-60) was included in the exposure draft on the trust loss measures released on 10February 1997. Since this change had not previously been announced, the wider definition will only apply after the date of introduction of the Bill into the Parliament. [Item 16]

Application of new section 63G

15.14 New section 63G of the ITAA 1936 as inserted by Item 2 will apply to assessments for the 1996-97 income year and later income years. This provision relates to debts written off as bad on the last day of an income year (see paragraph 14.9). The application of this provision has been set at the 1996-97 income year because the debt deduction provisions commence from the 1996 Budget time. [Item 17]

Application of foreign loss provisions

15.15 For the foreign loss rules contained in new subsection 160AFD(6A), similar rules to those applicable for prior year loss and debt deduction purposes apply, except that the date of introduction of the Bill into the Parliament is the relevant application date. [Item 18]

15.16 The provision applying the income injection test to foreign losses (see 160AFD(6B)) is the same as the general application provision for that test, except that the date of introduction of the Bill into the Parliament is the relevant application date. [Item 19]

Application of amendments of subsections 170(10) and 170(13)

15.17 Amendments to subsections 170(10) and 170(13) made by items 10 and 11 apply to assessments made either before or after the commencement of those items. These provisions deal with the amendment of assessments (see paragraphs 14.13 to 14.15. Because these amendments relate to the operation of the trust loss measures, they will not have any application before the commencement of those measures. [Item 20]

Application of consequential amendment to Fringe Benefits Tax Assessment Act 1986

15.18 The consequential amendment to section 136 of the Fringe Benefits Tax assessment Act 1986 (see paragraph 14.19) applies to benefits conferred either before or after Royal Assent. However, because this amendment relates to the operation of the trust loss measures, it will not have any application before the commencement of those measures. [Item 31]

Application of consequential amendment to Superannuation Contributions Tax (Assessment and Collection) Act 1997

15.19 The consequential amendment to section 43 of the Superannuation Contributions Tax (Assessment and Collection) Act 1997 (see paragraph 14.21) applies to the calculation of adjusted taxable income for the financial year that began on 1 July 1996 or a later financial year. This is the application date of the superannuation contributions tax measures. [Item 33]

Application of consequential amendment to Medicare Levy Act 1986

15.20 The consequential amendment to section 3 of the Medicare Levy Act 1986 (see paragraph 14.22) applies for the 1997-98 income year and all later income years. This is the application date of the measures that impose an increased Medicare levy on some taxpayers who do not have private health insurance. [Item 2 of Schedule 1 of the Medicare Levy Consequential Amendment (Trust Loss) Bill 1997]

Transitional arrangements

Family trusts

15.21 A trust can elect to be a family trust from the commencement of the proposed trust loss measures. However, family trust distribution tax will not be payable on any distributions outside the family group where certain transitional conditions are met. This effectively allows a trust to be treated as a family trust at all times from the commencement of the measures if it first becomes a family trust, fully subject to the family trust distribution tax rules, from 1 July 1997.

Family trust elections

15.22 In general terms, a family trust election can be made to be effective from the 1997-98 or any later years of income [subitem 21(1)] . However, a trust can become a family trust from the start of the 1994-95, 1995-96 or 1996-97 income year by electing, generally in its 1997-98 return, to be a family trust from the start of that earlier income year. However, this can only be done if the family trust passes the family control test at all times from the beginning of the earlier income year to the end of the 1997-98 income year [subitem 21(2)] . The family control test is contained in section 272-87 and is discussed in paragraphs 5.28 to 5.30.

15.23 It is not necessary for the trust to lodge a family trust election until the due date for the return of income for the 1997-98 income year. If a trust is not required to lodge a return, the election must normally be lodged within 2 months of the end of the 1997-98 income year in accordance with paragraph 272-80(2)(b).

15.24 The election may need to be made from the start of the 1994-95 income year because of the way the application provisions for current year losses are drafted (see paragraph 15.10). However, those provisions, and the prior year loss provisions, have no impact before the 1995 Budget time.

15.25 If an election is made as discussed in paragraph 15.22, family trust distribution tax will be payable on any conferrals of present entitlement or distributions by the trust outside the family group at any time from when the election becomes effective. However, no tax is payable on any conferrals or distributions made before the 1995 Budget time [paragraph 21(3)(a)] . This ensures that there is no retrospectivity in the application of that tax.

15.26 Also, no family trust distribution tax is payable in any income year before the 1997-98 income year if the family trust meets a requirement. This is that the trust satisfies, in the income year, the ordinary tests for deductibility of prior or current year losses or debt deductions that will apply to trusts that are not family trusts (i.e. the trust is not prevented under the trust loss measures from deducting a tax loss or an amount in respect of a debt, or is not required to calculate its net income and tax loss under Division 268). [Paragraph 21(3)(b)]

Interposed entity elections

15.27 In general terms, an interposed entity election for a trust, company or partnership (entity) to be included in the family group of an individual specified in a family trust election can be made to be effective from a day after the start of the 1997-98 income year. [Subitem 22(1)]

15.28 However, an entity can make an interposed entity election to start from an earlier day (not before the 1995 Budget time) by making the election in its 1997-98 return. The election can only be made from a day in an earlier year of income if the entity passes the family control test[F20] from that day. This does not mean that the election can only be made from the day from which the family controls the entity: it can be made from a later day. Also, the entity cannot be treated as the member of the family group of an individual before the family trust election relating to that individual has been made [subitem 22(2)] . Family trust distribution tax would be payable on any conferrals of present entitlement or distributions outside the family group by the entity from the day the election becomes effective.

Jointly held trusts

15.29 Where two parties jointly operate a business through a fixed trust in which each party owns a 50% share, and one sells its share to the other or to a third party then, in the absence of a special provision, any deduction that is available for prior orcurrent year losses or debt deductions of the trust will be lost. This is because the party that remains in the trust does not maintain fixed entitlements to a greater than 50% share of the income and capital of the trust. This being the case the fixed trust would not be able to satisfy the 50% stake test that applies to fixed trusts to test continuity of ownership. The parties could be two individuals or family trusts or an individual or family trust and a non-fixed trust (not being a family trust).

15.30 The Bill includes transitional provisions that will apply to ensure that the trust loss measures do not prevent the deductibility of prior or current year losses or debt deductions in two sets of circumstances. Effectively, these transitional provisions will treat the 50% stake test as having been satisfied where certain conditions are met.

First circumstance - test period commencing before 1996 Budget time

15.31 The first circumstance is where a joint vehicle fixed trust existed as such at some time from the 1995 Budget time to the 1996 Budget time and the relevant test period commences before the 1996 Budget time. This provision will treat the 50% stake test as having been passed if:

·
the 50% stake test cannot otherwise be passed by the fixed trust for the test period;
·
the test period commences at the start of, or during, the 1994-95, 1995-96 or 1996-97 income years but not after the 1996 Budget time;
·
at the start of the qualifying period, two individuals or an individual and a non-fixed trust each held, directly or indirectly, and for their own benefit, fixed entitlements to 50% of the income and to 50% of the capital of the trust; and
·
throughout the qualifying period, one of those individuals or, in the case where an individual and a non-fixed trust each hold 50% of the fixed entitlements, the individual directly or indirectly held, for his or her own benefit, fixed entitlements to at least 50% of the income and 50% of the capital of the trust. [Subitem 23(2)] .

15.32 The qualifying period is the test period for which the 50% stake test has to be applied. For current year loss purposes, the qualifying period does not include any period before the 1995 Budget time. Also, for the purpose of this provision, the family trust tracing rule in subsection 272-30(2) applies so that the trustee of a family trust (as defined) is treated as an individual holding a fixed entitlement for its own benefit.

Example

15.33 A fixed trust has a prior year loss incurred in the 1993-94 income year. At the 1995 Budget time, Family Trust A and Family Trust B each held a 50% share of the fixed entitlements to both income and capital of the fixed trust. Both Family Trust A and Family Trust B have elected to be family trusts from the start of the 1994-95 income year. On 31 July 1996, Family Trust B sold 25% of its fixed entitlements to income and capital of the fixed trust to Family Trust A with the remaining 25% being sold to Josephine. The fixed trust seeks to recoup its 1993-94 loss in the 1996-97 income year.

15.34 The fixed trust fails the 50% stake test because there is only continuity of ownership of 50% of the fixed entitlements (by Family Trust A) throughout the test period (i.e. the period from the 1995 Budget time to the end of the 1996-97 income year). However, the fixed trust satisfies the transitional provision in subitem 23(2) because:

·
Family Trust A has held, throughout the test period fixed entitlements to at least 50% of the income and 50% of the capital of the fixed trust; and
·
at the start of the test period, Family Trust A and only one other individual (Family Trust B) each held fixed entitlements to 50% of the income and 50% of the capital of the fixed trust.

Second circumstance - test period commencing after 1996 Budget time

15.35 The second circumstance is where a joint vehicle fixed trust exists at the 1996 Budget time and the relevant test period commences after the 1996 Budget time. This provision says that the 50% stake test is taken to be satisfied if:

·
the 50% stake test cannot otherwise be passed by the fixed trust for the test period;
·
at the 1996 Budget time, two individuals, or an individual and a non-fixed trust, each held, directly or indirectly, and for their own benefit, fixed entitlements to 50% of the income and 50% of the capital of the trust;
·
between the 1996 Budget time and the start of the test period, the two individuals, or the individual and the non-fixed trust, each continued to hold that same stake in the same way; and
·
throughout the test period, one of those individuals or, in the case where an individual and a non-fixed trust each hold 50% of the fixed entitlements, the individual directly or indirectly held, for his or her own benefit, fixed entitlements to at least 50% of the income and 50% of the capital of the trust. [Subitem 23(3)]

Income injection test - family trusts

15.36 A transitional provision has been inserted into the Bill to ensure that an entity that makes an interposed entity election effective from the 1995 Budget time will not be an outsider to the relevant family trust at any time before the 1995 Budget time. In the absence of this provision, the income injection test may have applied because the entity making the interposed entity election would otherwise have been an outsider in relation to benefits covered by subparagraph 270-10(1)(b)(iii) provided to it before the 1995 Budget time. [Item 24]

Definition of family

15.37 The definition of family in section 272-95 was narrowed with effect from the 1997 Budget time so that it would be appropriate in the light of modifications made to the income injection test in relation to family trusts. Between the 1995 Budget time and the 1997 Budget time members of the family of a test individual include the following:

·
the test individual's spouse or former spouse;
·
a parent, brother, sister, child, nephew or niece of:

-
the test individual; or
-
the test individual's spouse; or
-
a former spouse of the test individual;

·
a child of any individual mentioned above who, under the trust, is capable of benefiting on the death of the test individual;
·
a grandparent, great-grandparent, aunt or uncle of the test individual;
·
a child of a child of the test individual;
·
the spouse or a former spouse of any individual mentioned above. [Item 25]

Appendix - Tables summarising the main provisions

Tables summarising the main provisions

Table 1 Definitions of trusts
Type of trust Description
Fixed trust Persons have fixed entitlements to all the income and capital of the trust
Widely held unit trust A fixed trust that is a unit trust
20 or less individuals between them do not beneficially hold, directly or indirectly, 75% or more of the fixed entitlements to income or capital of the trust
Unlisted widely held trust(1) A widely held unit trust
The units are not listed on an approved stock exchange
Listed widely held trust A widely held unit trust
The units are listed on an approved stock exchange
Unlisted very widely held trust(1) An unlisted widely held trust with at least 1,000 unit holders
Compliance with other conditions as specified in section 272-120
Wholesale widely held trust(1) An unlisted widely held trust where 75% or more of the units in the trust are held by certain bodies and the initial amount subscribed for units in the trust by each particular unit holder in the trust is at least $500,000
Compliance with other conditions as specified in section 272-125
Non-fixed trust A trust that is not a fixed trust
Family trust A trust that has made the election to be a family trust for the purposes of the trust loss measures
Excepted trust A family trust
A complying superannuation fund, complying approved deposit fund or pooled superannuation trust
A unit trust where tax exempt bodies have fixed entitlements, directly or indirectly, to all the income and capital of the trust
Certain deceased estates
(1) Note that the classification of a trust that meets the definition of unlisted widely held trust, unlisted very widely held trust or wholesale widely held trust may be affected by the nature of its parent (see section 272-127 discussed in paragraphs 13.91 and 13.92)

Table 2 Prior and current year losses and debt deductions - tests that apply to each type of trust for it to be able to deduct a loss or debt
Type of trust 50% stake test Same business test Pattern of distribution test Control test Income injection test
Fixed trust other than a widely held unit trust *(1) *
Unlisted widely held trust * *
Listed widely held trust * *(2) *
Unlisted very widely held trust * *
Wholesale widely held trust * *
Non-fixed trust * *(3) * *
Family trust *(4)
Excepted trust (other than a family trust)
(1) An alternate test is also available in certain cases where non-fixed trusts directly or indirectly hold fixed entitlements in the fixed trust
(2) This test can be applied if the 50% stake test is failed by a listed widely held trust
(3) This test does not apply for current year loss purposes
(4) The income injection test does not apply where entities and individuals within a family group inject income into a family trust with losses

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
Failure of alternate condition
Unlisted widely held trust Failure of 50% stake test
(50% stake tested on abnormal trading)
Listed widely held trust Failure of 50% stake test (unless the same business test is satisfied)
(50% stake tested on abnormal trading)
Unlisted very widely held trust Failure of 50% stake test
(50% stake tested on abnormal trading)
Wholesale widely held trust Failure of 50% stake test
(50% stake tested on abnormal trading)
Non-fixed trust Failure of 50% stake test
Failure of continuity of control test
(1) A period will always end at the end of the year of income

Table 4 Tests that apply to limit deductibility of losses and debt deductions[F21]
What is the 50% stake test for fixed trusts? Applies to all fixed trusts other than excepted trusts The same individuals have fixed entitlements, directly or indirectly, to more than 50% of the income of the trust at the relevant times (1)
and
The same individuals (not necessarily the same as those that holdfixed entitlements to income) have fixed entitlements, directly indirectly, to more than 50% of the capital of the trust at the relevant times (1).
What is the 50% stake test for non-fixed trusts? Applies to non-fixed trusts other than excepted trusts If individuals have fixed entitlements to more than 50% of the income of the trust at any time in the test period, then at all times in the period from that time, the same individuals must hold more than a 50% stake in the income of the trust(2)
and
If individuals have fixed entitlements to more than 50% of the capital of the trust at any time in the test period, then at all times in the period from that time, the same individuals (not necessarily the same as those that hold fixed entitlements to income) must hold more than a 50% stake in the capital of the trust(2)
What is the alternate test for fixed trusts? Applies to fixed trusts (other than excepted trusts) that are not widely held unit trusts if:

·
at all times in the test period, 50% or more of the fixed entitlements to income or capital of the trust or a holding entity of the trust are directly held by a non-fixed trust(s) (other than a family trust)(3); and
·
individuals do not have more than a 50% stake in the income or capital of the trust at the start of the test period

There is no change in the persons directly holding fixed entitlements to shares of the income or capital of the trust or holding entity nor the percentage of their shares
and
Every non-fixed trust (that is not a family trust or other excepted trust) that holds fixed entitlements in the fixed trust, directly or indirectly, would satisfy the relevant tests that apply to non-fixed trusts if they stood in place of the loss trust
What is the same business test? Applies to listed widely held trusts other than excepted trusts All the following are met:

·
the trust carried on the same business as it carried on before a particular time(4);
·
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(4); or
-
a transaction of a kind that it did not enter into in the course of its business operations before a particular time(4);

·
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(4). The things are:

-
start to carry on a business of a kind it did not carry on before the particular time; or
-
enter into a transaction of a kind that it had not entered into in the course of its business operations before the particular time;

·
the trust does not incur expenditure in carrying on a business of a kind that it did not carry on before a particular time(4)(5);
·
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(4)(5)

What is the pattern of distributions test? Applies to non-fixed trusts other than excepted trusts More than 50% of the relevant distributions of the relevant income years (as specified in Subdivision 269-D) are distributed (directly or indirectly) to the same individuals(6)(7)
What is the control test? Applies to non-fixed trusts other than excepted trusts A group must not begin to control the trust, directly or indirectly, during the test period(8)
What is the income injection test? Applies to all fixed trusts (including widely held unit trusts) and non-fixed trusts Does not apply to excepted trusts other than family trusts The trust has a prior year loss deduction or a current year deduction and:

·
under a scheme, assessable income is derived by the trust, an outsider provides the trustee or a beneficiary (or an associate) with a benefit and the trustee, a beneficiary (or an associate) provide a benefit to the outsider or an associate of the outsider(9); and
·
the assessable income has been derived, or any of the benefits have been provided, wholly or partly, but not merely incidentally, because of the loss or other deduction in the trust

(1) If a trust is a widely held unit trust it is taken to pass the 50% stake test if it is reasonable for the Commissioner to assume that the test is passed
(2) Under subsections 267-40(3) and 267-70(3) the Commissioner may treat this test as not having been failed if he or she considers it fair and reasonable to do so having regard to certain matters
(3) A 'holding entity' is a trust or company that holds all of the fixed entitlements to income and capital of the trust (whether directly or indirectly)
(4) A particular time is a reference to the time immediately before the first abnormal trading in units of the trust and on testing at that time the trust fails the 50% stake test
(5) This test applies for current year loss purposes only
(6) The smallest percentage of any distribution to an individual is taken into account in determining whether this test has been satisfied. The combined smallest percentages for all beneficiaries must be greater than 50%
(7) This test only applies for prior year loss purposes
(8) The terms 'control' and 'group' are defined in section 269-95
(9) An associate of an outsider effectively does not include a member of the family group where the trust is a family trust (see subparagraph 270-10(1)(b)(iii))


These are deductions for bad debts and certain debt/equity swap deductions.


That is, deductions for bad debts under section 51 or 63, or sections 8-1 or 25-35 of the ITAA 1997, or debt/equity swap deductions under section 63E.


See Chapter 15 for an explanation of the transitional rules that apply if the year specified is prior to the 1997-98 income year.


Note that the trustee of a family trust is taken to beneficially hold a fixed entitlement as an individual (see subsection 272-30(2)).


The definition of family as contained in section 272-95 is effective from 7.30 pm (EST), 13 May 1997. Before that time a broader definition of family as contained in Item 25 of the Schedule applies (see Chapter 15).


But see paragraph 13.8.


This two month rule is affected by application provisions in subitems 13(5), 14(5) and 18(5) - see paragraph 15.7.


This two month rule is affected by application provisions in subitems 13(5), 14(5) and 18(5) - see paragraph 15.7.


This two month rule is affected by application provisions in subitems 13(5), 14(5) and 18(5) - see paragraph 15.7.


This two month rule is affected by application provisions in subitems 13(5), 14(5) and 18(5) - see paragraph 15.7.


The term 'breakdown in the marriage'' is defined in section 272-40 (see paragraph 13.100).


The term 'breakdown in the marriage'' is defined in section 272-40 (see paragraph 13.100).


Family trust distribution tax may also become payable under certain provisions relating to non-resident entities (see Chapter 12).


Tax under the Family Trust Distribution Tax (Secondary Liability) Act 1997 may become payable in some cases where non-resident entities are involved (see Chapter 12).


The term 'foreign superannuation fund' is defined in subsection 6(1) of the ITAA 1936.


If fixed entitlements are being traced for the purposes of determining whether a trust is a widely held unit trust, the fixed entitlement held by the fund or special company with more than fifty members or a government body is treated as though it is held by more than 20 individuals for their own benefit.


Payment of a dividend includes the crediting or distribution of the dividend (see the definition of 'paid' in subsection 6(1) of the Act).


For subitem 13(5) to apply to the 1996-97 income year, that year must end before the date of introduction of the Bill into the Parliament. For most trusts this will be the case. Only those trusts with a substituted accounting period ending after the date of introduction will not apply subitem 13(5) for the 1996-97 income year.


These relate to bad debt (including certain debt/equity swap) deductions.


The family control test is contained in section 272-87 and is discussed in paragraphs 5.28 to 5.32.


See Table 2 above.


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