Edited version of private ruling

Authorisation Number: 1011813414337

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Ruling

Subject: Fixed Trust and Capital Gains Tax

Issue

Whether unit holders (beneficiaries) of Trust X have fixed entitlements to all the income and capital of the trust as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 and pursuant to subsections 272-5(1) and 272-5(3) of Schedule 2F to the Income Tax Assessment Act 1936.

Question 1

Is Trust X a fixed trust for the purposes of section 272-65 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer: No.

Question 2

Will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem the beneficiaries of Trust X as having fixed entitlements?

Answer: No.

Question 3

Will subsection 855-40(2) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to allow the capital gain made by the unit holders in respect of their interest in Trust X to be disregarded?

Answer: No.

Question 4

Will subsection 855-40(3) of the ITAA 1997 result in the trustee of Trust X not being liable for tax in relation to the capital gain exemption by virtue of subsection 855-40(2) of the ITAA 1997?

Answer: No.

This ruling applies for the following period

At the time the CGT event occurred.

The scheme commenced on

The scheme has commenced.

Relevant facts

Trust X is an Australian resident trust for tax purposes. The trustee of the trust is an Australian resident company. The unit holder was the original and sole unit holder of the trust. Under the trust deed for Trust X, there are a few additional unit holders, however only the current Unit Holder subscribed for the units.

The Unit Holder passed away in 2006 and the units in the Trust X were transferred to Trust Y in accordance to the Unit Holder's will.

Trust Y is a US resident trust and it is still the sole unit holder of Trust X.

The directors of the trustee company are and were not related to the Unit Holder or Trust Y and all dealings are at arms length. Trust Y is controlled by the personal legal representatives of the estate of the Unit Holder.

The main assets held by the Trust X are shares in an Australian resident public company. The sole purpose of Trust X was to hold the investment in the public company on behalf of the unit holder.

The applicant claims that there has never been any intention for other parties to subscribe to units in this trust or acquire units from the existing Unit Holder

Trust X owned 2.5% of the public company's share capital. None of the other shareholders of the public company are associated with Trust Y.

The shares owned by Trust X in the public company were sold in 2009, resulting in a gross capital gain.

In accordance with the trust deed, all of the income of Trust X, including the capital gain, was distributed by the trustee to the sole unit holder in 2010.

The trustee has stated that it will vest Trust X once all proceeds relating to the capital gain are received. No further activities or investments will be undertaken by the trust in the meantime.

Trust Deed

The trust deed provides the following:

· that the beneficial interest in the Trust Fund as originally constituted and as existing from time to time shall be held by the Unit Holders for the time being in proportions to the Units registered in their respective names and all units shall at any given time be of equal value.

· that each unit shall entitle the registered holder thereof equally with the registered holders of all other units to the beneficial interest in the Trust Fund as an entirety but subject thereto shall not entitle the Unit Holder to any particular security or investment comprised in the Trust Fund or any part thereof and (save as hereinafter expressly provided in this Deed) no Unit Holder shall be entitled to the transfer to him of any property comprised in the Trust Fund.

· That the trustee may create and issue additional units from time to time on such terms and with such rights as it sees fit (including without limitation non-voting units) with power to classify or designate the same, or to re-classify units which are already issued, in such manner as the Trustee thinks fit.

Redemption of Units

The trust deed provides that the trustee may redeem any units with the consent of the unit holder for the price that the trustee and unit holder agree is the market value of the unit at the date of redemption or which is determined by a valuer where agreement is not reached.

Distribution of Income

The Deed requires the trustee each year to set aside the whole of the net income of the trust for the benefit of the unit holders in such proportions (which may include a zero proportion in respect of any units) as the trustee may determine from time to time provided that if no determination is made as at the end of such Accounting Period then in proportion to the number of units registered in their respective names as at the end of such Accounting Period.

Variation of Trust

The trustee may with the consent of the unit holders to vary any provisions of the deed or revoke add to or vary all or any of the trusts declared in this deed or the trusts declared by any variation or addition made thereto.

Consent of Unit Holders

For the purposes of the deed the 'consent' of the unit holders is not less than 51% of the issued units or a majority of not less than 51% of the votes of those present in person or by proxy at a meeting of unit holders.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 272-5 of Schedule 2F

Income Tax Assessment Act 1936 Subsection 272-5(1) of Schedule 2F

Income Tax Assessment Act 1936 Subsection 272-5(2) of Schedule 2F

Income Tax Assessment Act 1936 Subsection 272-5(3) of Schedule 2F

Income Tax Assessment Act 1936 Section 272-65 of Schedule 2F

Income Tax Assessment Act 1997 Section 855-40

Income Tax Assessment Act 1997 Subsection 995-1(1)

Corporations Act 2001 Part 5C

Corporations Act 2001 Section 601FA

Corporations Act 2001 Subsection 601FC(1)

Corporations Act 2001 Paragraph 601GC(1)(a)

Reasons for decision

Issue

Questions 1

Summary

The terms of the trust instrument do not provide the beneficiaries with vested and indefeasible interests in all of the income and capital of Trust X.

Detailed reasoning

For purposes of section 855-40 ITAA 1997 a trust will be a fixed trust if entities have fixed entitlements to all the income and capital of the trust: section 995-1 ITAA 1997. Fixed entitlement is determined with reference to section 272-5(1) of Schedule 2F ITAA 1936:

If, under a trust instrument, a beneficiary has a vested and indefeasible interest in a share of income of the trust that the trust derives from time to time, or of the capital of the trust, the beneficiary has a fixed entitlement to that share of the income or capital.

Also, subsection 272-5(2) states that:

If:

(a) a person holds units in a unit trust; and

(b) the units are redeemable or further units are able to be issued; and

(c) if units in the unit trust are listed for quotation in the official list of an approved stock exchange - the units held by the person will be redeemed, or any further units will be issued, for the price at which other units of the same kind in the unit trust are offered for sale on the approved stock exchange at the time of the redemption or issue; and

(d) if the units are not listed as mentioned in paragraph (c) - the units held by the person will be redeemed, or any further units will be issued, for a price determined on the basis of the net asset value, according to Australian accounting principles, of the unit trust at the time of the redemption or issue;

then the mere fact that the units are redeemable, or that the further units are able to be issued, does not mean that the person's interest, as a unit holder, in the income or capital of the unit trust is defeasible.

The word 'interest' is a word that is capable of many meanings. In the absence of a definition one must infer its meaning from the context in which it is found (see Gartside v Inland Revenue Commissioner [1968] AC 553 at 602-602 and 617-618 Commissioner of Stamp Duties (Queensland) v Livingston (1964) 112 CLR 12 at 28-29; and CPT Custodian Pty Ltd v Commissioner of State Revenue 2005 HCA 53).

There may be circumstances in which the word 'interest' could be interpreted broadly to include any right or advantage that a person might be able to claim with respect to the income or capital of the trust and/ or in respect of the trustee, whether present or future, ascertained or potential. In the context of Schedule 2F, however, it is clear that for an interest to be recognised as a fixed interest it must be a right with respect to a share of the income or of the capital of the trust that is susceptible to measurement. To adopt the words of Lord Wilberforce in Gartside v Inland Revenue the right must have 'the necessary quality of definable extent'.

The term 'vested and indefeasible' is also not defined in the taxation legislation and to date there is no precedential 'ATO view' which defines or clarifies the term. The Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 does discuss its ordinary meaning at some length, at paragraphs 13.4 to 13.9.

In Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16 Stone J stated at [97] that in the absence of a definition, and subject to qualification in subsection 272-5(2) of Schedule 2F, the term 'indefeasible' bears its ordinary meaning when applied to an interest, that is that 'the interest cannot be terminated, invalidated or annulled'. The meaning of the term 'vested and indefeasible' (in the context of Schedule 2F to the ITAA 1936) also appears in subsection 95A(2) of the ITAA 1936 and has been considered in that context by the courts - refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4525; Walsh Bay Developments Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4378; Dwight v Commissioner of Taxation (1992) 92 ATC 4192; Harmer v FC of T (1991) 173 CLR 264; 91 ATC 5000.

Also relevant are; MSP Nominees Pty Ltd v Commissioner of Stamps (SA) (1999) 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54; and Glenn v Federal Commissioner of Land Tax (1915) 21 ALR 465.

Determining whether a beneficiary has a 'vested and indefeasible' interest in a trust, requires an extensive review of the relevant trust instrument(s) including individual clauses to determine, based on the principles established in the above cases, the existence of defeasible powers.

There will be some circumstances in which a trust instrument must be read subject to the operation of a particular legal rule, whether by general law or statute. See, for example, the provisions of Chapter 5C of the Corporations Act 2001 which, if inconsistent with the constitution of a registered managed investment scheme, can have the effect of altering or modifying the scheme's constitution. It is possible for a constitution to be altered or modified by operation of law irrespective of whether the trust instrument itself expressly recognises the relevant general law rule or statute, and the entitlements of a beneficiary under the trust instrument are those as so altered or modified by operation of law.

The important question is whether the vested and indefeasible interests represent 100% of the income and a 100% of the capital of the trust. The fact that a power held by the trustee or manager has not yet been exercised is not relevant when determining if the power results in an interest being defeasible. The exercise of the power goes to whether an interest has in law been defeased, not to whether it is defeasible, and the real question is whether the power, if exercised would result in a defeasance of some or all of the unitholder's rights to the income and/or capital of the trust.

Subsection 272-5(3) contains a discretion, whereby in cases where beneficiaries with an interest in the income and capital of the trust do not have a fixed entitlement, the Commissioner may, for the purposes of the Act, treat such cases as having fixed entitlement.

Subsection 272-5(3)(b) stipulates that the Commissioner may treat a beneficiary as having fixed entitlement (in cases where in fact beneficiaries do not have fixed entitlements) having regard to:

(i) the circumstances in which the entitlement is capable of not vesting or the defeasance can happen; and

(ii) the likelihood of the entitlement not vesting or the defeasance happening; and

(iii) the nature of the trust.

An examination of the relevant trust instrument, in this case the Deed of Trust for Trust X discloses certain clauses by which the beneficiary's interest in the income and capital of the trust may be regarded as defeasible. Therefore, it is considered reasonable to conclude, in accordance with subsection 272-5(1) of schedule 2F of the ITAA 1936, that the unit holder in Trust X does not have a fixed entitlement to all the income and capital of the Trust.

It is accepted that the trust deed provides unit holders with an 'interest' in the income and capital of Trust X; Clauses of the trust deed provide that the Trust Fund and the income will be held on trust for the Unit Holders and the beneficial interests of the trust will be divided into units.

The clauses in the Trust X instrument which may contain defeasible power are as follows:

· The trustee may create and issue additional units from time to time on such terms and with such rights as it sees fit. Hence the trust does not constitute a closed class. Furthermore subsection 272-5(2) of Schedule 2F of the ITAA 1936 is not met as further units can be issued at values other than net asset value as prescribed by paragraph 272-5(2)(d);

· The trustee may redeem any units with the consent of the unit holder for the price that the trustee and unit holder agree is the market value of the unit at the date of redemption or which is determined by a valuer where agreement is not reached. This does not accord with paragraph 272-5(2)(d) which requires that redemptions must be at a price determined on the basis of "net asset value according to Australian accounting principles";

· The trustee is required each year to set aside the whole of the net income of the trust for the benefit of the unit holders in such proportions (which may include a zero proportion in respect of any units) as the trustee may determine from time to time provided that if no determination is made as at the end of such Accounting Period then in proportion to the number of units registered in their respective names as at the end of such accounting Period;

· The trustee for the time being may with the consent of the unit holders at any time and from time to time by supplemental deed or by oral resolution or by instrument in writing …or by resolution of the board or directors of the trustee vary any provisions of this deed or revoke add to or vary all or any of the trusts declared in this deed or the trusts declared by any variation or addition made there to from time to time….


· The 'consent' of the unit holders is not less than 51% of the issued units or a majority of not less than 51% of the votes of those present in person or by proxy at a meeting of unit holders.

Considering these clauses above, the trustee has various powers, which if exercised, may defease the Unit Holders interest in a share of the income of the trust. As such a Unit Holder does not have a fixed entitlement to a share of the income or capital of the trust.

Question 2

Summary

It is considered that the facts of the current case do not warrant the exercising of the Commissioner's discretion to deem fixed entitlements.

Detailed reasoning

Commissioner's discretion

As the Unit holders in Trust X does not have a fixed entitlement pursuant to subsection 272-5(1) of Schedule 2F to the ITAA 1936, subsection 272-5(3) may be applied where, among other things, 'a beneficiary with an interest in a share of income that the trust derives from time to time, or of the capital of a trust, does not have a fixed entitlement to the share.'

Subsection 272-5(3) of Schedule 2F to the ITAA 1936 provides that:

If:

(a) a beneficiary with an interest in a share of income that the trust derives from time to time, or of the capital of a trust, does not have a fixed entitlement to the share; and

(b) the Commissioner considers that the beneficiary should be treated as having the fixed entitlement, having regard to:

(i) the circumstances in which the entitlement is capable of not vesting or the defeasance can happen; and

(ii) the likelihood of the entitlement not vesting or the defeasance happening; and

(iii) the nature of the trust;

the beneficiary has the fixed entitlement.

The interpretation of section 272-5 of Schedule 2F to the ITAA 1936 (the meaning of vested and indefeasible) was raised at the March 2006 meeting of the National Tax Liaison Group (NTLG), and referred to the newly formed Trust Consultation Sub-group for discussion; at their meeting on 28 November 2006, the ATO advised that:

'In applying the discretion, the ATO would have regard to what the Office understands was the policy that underlay the provisions at the time they were enacted. The Commissioner would also have to apply the statutory tests having regard to the terms of the particular trust deeds and all the surrounding circumstances.'

(see section 30.15 of the Minutes of NTLG meeting - 7 Dec 2006)

In the absence of any precedential guidelines, taxpayers seeking access to the Commissioner's discretion will be dealt with according to the relevant facts; on a case by case basis. In the case of trusts which are managed investment schemes, it is also appropriate that consideration is given to any potential impacts that the Corporations Act 2001 (as noted above), the regulatory powers of the Australian Securities and Investments Commission (ASIC), and the actions of the ASX may have on the administration of the trust and the entitlements of beneficiaries.

In view of the conclusion above that unit holders in Trust X do not have vested and indefeasible interests, pursuant to subsection 272-5(1) of Schedule 2F to the ITAA 1936, subsection 272-5(3) may be considered.

Consideration of the factors in subsection 272-5(3) of Schedule 2F ITAA 1936

In terms of paragraph 272-5(3)(a):

The trust deed provides the unit holders of Trust X with vested interests in:

· A share of the income that the Trust derives from time to time, and

· In a share of the capital of the Trust.

As per subparagraph 272-5(3)(b)(i):

The following comments are made in relation to the circumstances in which the entitlement is considered unlikely to vest or be defeased (as outlined in the above discussion on particular clauses in the Trust deed).

A clause of the trust deed provides that:

The trustee may create and issue additional units from time to time on such terms and with such rights as it sees fit (including without limitation non-voting units) with power to classify or designate the same, or to re-classify units which are already issued, in such manner as the Trustee thinks fit.

Section 272-5(2) states the interest of a unit holder in a unit trust will not be taken to be defeasible only because units in the trust can be issued or redeemed. However, for this provision to operate, the issue or redemption of units must be at full value. That is additional units can be issued or units could be redeemed only for market value or for a price that represents the net asset value of the trust.

Under the trust deed the trustee can issue units on 'such terms and with such rights as it sees fit.' There is no special requirement that any additional units should be issued at a price that represents the net asset value of the trust in accordance with Australian Accounting Principles (therefore s272-5(2) does not apply).

A clause of the trust deed provides that the trustee shall in each Accounting Period until the vesting day pay apply or set aside the whole of the net income of the Trust Fund … to or for the benefit of the unit holders in such proportions (which may include a zero proportion in respect of any units) as the trustee may determine from time to time provided that if no determination is made as at the end of such Accounting period then in proportion to the number of units registered in their respective names as at the end of such Accounting Periods.

If the trustee does not make any special determination, then the unit holder will receive all of the income of the trust in that accounting period, as he is the sole unit holder. However should the trustee decide to exercise its power, and issue additional units of a different class, then the trustee will be able to make a special determination where it could stream trust income to different classes of units.

A clause of the trust deed enables the trustee, with the consent of the unit holders to vary any provisions of this deed or revoke add to or vary all or any of the trusts declared in this deed or the trusts declared by any variation or addition made thereto.

Considering there is only one unit holder, and the trustee needs a majority vote from the unit holders before the trustee can make any changes to the deed, it would seem unlikely that the unit holder would agree to any changes in the deed that will defease his entitlements to income or capital.

However, as the trustee also has the power to issue additional units, the trustee may still be able to make what changes to the deed if it issued additional units and then obtained approval from the majority of the additional unit holders. According to a clause of the trust deed only a 51 percent majority is needed, therefore any minority unit holder(s) may have their entitlements defeased.

As per subparagraph 272-5(3)(b)(ii):

Although there are several circumstances where the trustee could exercise a power under the trust deed which would defease the unit holder's entitlement to income in the trust, we also need to consider the likelihood of this happening as per subparagraph 272-5(3)(b)(iii).

Although the trustee has the power in the clauses of the trust deed to create/issue or redeem units (which may not reflect the value of the trust), there was one initial unit holder from the date of the creation of the trust until that unit holder passed away in 2006, and the units passed to his deceased estate. The trustee has not issued any additional units.

The applicant claims that there is no intention for any other units to be issued. The assets of the trust (shares) have been sold and no further activities or investments will be undertaken. The trust will be vested once all consideration for the assets has been received.

A clause of the trust deed enables the trustee to make what is largely an unfettered (special) determination on how to distribute the income of the trust between classes on units should there be more than one class on offer. Whilst there is only one unit holder and one class of unit currently issued it seems unlikely that trustee will have a need for a special determination however there is nothing to prevent the trustee issuing further units at a price which does not accord with subsection 272-5(2).

As per subparagraph 272-5(3)(b)(iii):

Trust X is a unitised trust, however, its units are not publicly listed on an approved stock exchange nor is it a MIS. The trust is prima facie a private 'closely held' trust, and therefore the trustee is not subject to any fiduciary controls e.g. Chapter 5C of the Corporations Act 2001, above those which apply generally to trustees.

Schedule 2F to the ITAA 1936 and tax losses

The concept of a 'fixed entitlement' was originally introduced in the context of the trust loss measures and should primarily be interpreted in that context. The trust loss measures are an important integrity measure, removing a structural flaw in the tax system. The concept of a 'fixed entitlement' is fundamental to the structure and effectiveness of the trust loss measures.

The EM to the trust loss measures states (at paragraph 13.13) in respect of the Commissioner's power in subsection 272-5(3) that:

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

This passage seems to indicate that when looking at the facts of a case in the context of the criteria listed in subsection 272-5(3) regard should always be had to whether the absence of a fixed entitlement in these circumstances could result in the transfer of the benefit of the tax loss.

In the current case there is a relatively small tax loss in the 2009 year. The trust had income in the 2007 and 2008 years and a nil income in 2006. However, and notwithstanding the relatively small tax loss in existence, on balance, the likelihood of any tax benefit of any future tax loss being transferred is not mitigated substantially by the factors identified above. In essence the trust is a unit trust where a unit holder does not have vested and indefeasible interest in a share of the income and capital - and there are no special circumstances to conclude that it is reasonable for the Commissioner to exercise the discretion in subsection 272-5(3).

Conclusion

As stated in above, for the purposes of subsection 272-5(1), the unit holder Trust X does not have a fixed entitlement to a share of the income and capital of the trust.

Further, after having regard to the factors in subparagraphs 272-5(3)(b)(i), (ii) and (iii) and the submissions of the Applicant, it is considered that the facts of the current case do not warrant the exercising of the Commissioner's discretion to deem fixed entitlements.

In summary, it is considered that as:

· The trust deed contains several powers that may defease the unit holder's interest in a share of the income or capital, and

· Trust X is regarded as a private 'closely held' trust which is not subject to any fiduciary controls above those that apply generally to a trustee,

on balance, the Applicant has been unable to establish a reasonable case that special circumstances exist for the Commissioner to exercise the discretion pursuant to subsection 272-5(3) to treat the interests of unit holder in the income and capital of Trust X as fixed entitlements.

Question 3

Section 855-40 of the ITAA exempts a capital gain that a foreign resident beneficiary in a fixed trust is taken to have made as a result of a capital gains tax (CGT) event happening to a CGT asset of a trust if, at the time of the event, the asset was not taxable Australian property of the trust and the trust is a fixed trust.

On the basis that Trust X is not a fixed trust at the time the CGT event occurred, the unit holders will not be eligible for the exemption under section 855-40 of the ITAA 1997.

Question 4

Subsection 855-40(3) of the ITAA 1997 provides that a trustee of a fixed trust in which a foreign resident beneficiary holds an interest will not be assessed in respect of any amount which is disregarded under subsection 855-40(2).

As the unit holders of Trust X which is not a fixed trust will not be eligible for the exemption under subsection 855-40(2) of the ITAA 1997, subsection 855-40(3) of the ITAA 1997 does not apply to the trustee of Trust X

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