Edited version of your private ruling

Authorisation Number: 1012459249833

Ruling

Subject: Qualified persons - franking credits

Question

Will the Commissioner exercise his discretion in former subsection 160APHL(14) of the ITAA 1936 to deem the beneficiaries of the trust as having fixed interests in the corpus of the trust?

Answer

No

This ruling applies for the following period

Year ended 30 June 2011
Year ended 30 June 2012
Year ended 30 June 2013
Year ended 30 June 2014

The scheme commenced on

1 July 2010.

Relevant facts

The trust was established by deed as a unit holder of A unit trust (the unit trust).

Pre-CGT units in the unit trust were exchanged for shares in a company (the company), under a subdivision 124-H rollover.

The trust has several beneficiaries, all of which are Australian residents except for one Australian resident trust.

All the named beneficiaries form part of one extended family group but are not directly related such as to form a 'family group' for the purposes of the family trust election rules in section 272-90 of Schedule 2F of the Income Tax Assessment Act 1936.

The trust has always been effectively controlled by the same extended family group for the benefit of only their family members.

In the year ended 30 June 2011 the trust received one fully franked distribution from ordinary shares it owns in an Australian resident company ('the company').

The trust has no other franked dividend from the company in the prior five income years.

The trust acquired after 19 September 1985, what are taken to be pre-CGT shares in the company under a subdivision 124-H rollover. However, those shares are taken to be acquired after 31 December 1997 i.e. on their actual acquisition date, for imputation credit purposes.

The trust was established for the sole purpose of holding the units in the unit trust, and it subsequently held the shares in the company for the sole benefit of the extended family beneficiaries, to derive dividend income.

The trust has held shares in the company on capital account and it will continue to do so.

The trust deed was not amended in the income years where the trust owned the shares in the company.

The names of the original trust beneficiaries are provided.

The trustee of the trust is a company that has always been controlled by past and current directors all of which are members of the extended family group.

The appointer of the trust was its namesake but the position of Appointer lapsed upon her death.

The trustee can accumulate or distribute income to the named beneficiaries if they are living, or if they are dead, by deed appoint that it will be held on trust for such of those parties or their spouses, widows, widowers, children or grandchildren in such shares or proportions and generally in such manner the trustee thinks fit.

Upon vesting, the trustee must distribute the corpus to the beneficiaries who are living, or if they are dead, the amount that they would have received, to their legal personal representative on trust for the deceased's residuary beneficiaries, or by deed appoint that it be held on trust for beneficiaries or their spouses, widows, widowers, children or grandchildren or one or more as the trustee thinks fit.

The trustee may make capital advances to named beneficiaries. The deed does not specifically restrict capital distributions to the beneficiaries to being in equal shares in the Trust Fund notwithstanding that, in your view, over the life of the trust that should be implied.

The trust fund can be held on trust consistent with the above for the beneficiaries, their spouses or brothers, sisters, nephews or nieces of any of them, but not while a beneficiary is alive. Consistent with the above, this allows funds to continue to be held on trust for the benefit of the close family of the beneficiaries, rather than passing to the estate of the beneficiary and perhaps their creditors.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 207-45

Income Tax Assessment Act 1997 Section 207-50

Income Tax Assessment Act 1997 Section 207-55

Income Tax Assessment Act 1997 Section 207-145

Income Tax Assessment Act 1997 Section 207-150

Income Tax Assessment Act 1997 Section 160APHD

Income Tax Assessment Act 1997 Section 160APHE

Income Tax Assessment Act 1997 Section 160APHL

Income Tax Assessment Act 1997 Section 160APHM

Income Tax Assessment Act 1997 Section 160APHO

Income Tax Assessment Act 1997 Section 160APHU

Reasons for decision

Summary

Having considered the relevant circumstances, the Commissioner will not exercise the discretion available to him pursuant to subsection 160APHL(14) to treat the interests of the beneficiaries as a vested and indefeasible interest. Consequently, the beneficiaries will not be qualified persons and therefore will not be entitled to a tax offset under Division 207 of the ITAA 1997 in respect of any franked income derived by the trust.

Detailed reasons for decision

By virtue of sections 207-145 and 207-150 of the ITAA 1997 as well as Taxation Determination TD 2007/11, it is clear that regard must be had to the rules in Division 1A of former Part IIIAA of the ITAA 1936 in determining whether a person is a qualified person and hence able to derive the benefit of franking credits attached to distribution made directly or indirectly to the entity. The purpose of the Division is to ensure that the benefits of the franking credits on distributions paid on shares are only available to the true economic owners of the shares, that is, those persons who are sufficiently exposed to the risks of loss and opportunities for gain associated with ownership of the shares (see paragraphs 4.6 and 4.7 of the Explanatory Memorandum that accompanied Taxation Law Amendment Act (No. 2) of 1999 which introduced the Division).

Importantly, irrespective of whether or not a trust is a widely held trust as defined, a beneficiary of a trust cannot be a qualified person in relation to a franked distribution which has indirectly flowed to them through the trust unless the trustee of the trust is also a qualified person in relation to the distribution (subsection 160APHU(1) of the ITAA 1936). That is, the trustee must satisfy the holding period rules and, where relevant, related payment rules of section 160APHO of the ITAA 1936 in respect of the franked distributions.

As the trust does not satisfy any of the criteria under the definition of widely held trust in section 160APHD of the ITAA 1936, it is not a widely held trust for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

By reason of paragraph 160APHO(1)(a) and subparagraph 160APHO(2)(b)(i) of the ITAA 1936, where a taxpayer who holds an interest in shares (not being preference shares) on which a dividend has been paid, and neither the taxpayer nor the associate of the taxpayer has made, is under an obligation to make or is likely to make a related payment in respect to the dividend, the taxpayer will be a qualified person in respect of the dividend if, during the primary qualification period, the interest in the shares was held for a continuous period of not less than 45 days.

Under subsection 160APHG(3) of the ITAA 1936, the beneficiaries of a trust that is not a widely held trust are deemed to have acquired, held or disposed of an interest in shares when the trustee acquires, holds or disposes of those shares.

The primary qualification period in relation to an interest in a share (not being a preference share) is defined in section 160APHD of the ITAA 1936 as the period beginning on the day after the day the taxpayer acquired their interest and ends on the 45^th day after the day on which the interest became ex-dividend. In relation to a beneficiary of a non-widely held trust, under subsection 160APHE(1) of the ITAA 1936 an interest in a share becomes ex-dividend on the day after the last day on which the acquisition by a person of the share will entitle the person to receive the dividend.

In accordance with subsection 160APHO(3) of the ITAA 1936, in calculating the number of days for which beneficiaries continuously held an interest in a share held by the Trust, any days on which beneficiaries had 'materially diminished' risks of loss or opportunities for gain in respect of the interest are to be excluded (although this exclusion is not taken to break the continuity of the period for which the interest was held).

Subsection 160APHM(2) provides that a taxpayer is taken to have "materially diminished" risks of loss or opportunities for gain on a particular day in respect of an interest held by the taxpayer in a share if their net position on that day in relation to the interest has less than 30% of those risks and opportunities. Subsection 160APHM(3) of the ITAA 1936 states that a taxpayer's net position for this purpose is worked out using the financial concept of delta.

Section 160APHL of the ITAA 1936 will apply as the shares were acquired after 31 December 1997. Subsection 160APHL(7) of the ITAA 1936 attributes a delta of +1 to the interest in the shares held by a beneficiary of a non-widely held trust as determined under subsection 160APHL(5) of the ITAA 1936.

Unless there is a family trust election in place (or exceptions relating to deceased estates or employee share schemes are satisfied), subsection 160APHL(10) of the ITAA 1936 attributes additional positions to the beneficiary. It gives rise to a short position equal to the beneficiary's long position determined under subsection 160APHL(7) of the ITAA 1936 and a long position equal to so much of the taxpayer's interest in the trust holding as is a fixed interest. For the purposes of subsection 160APHL(10), the beneficiary's interest in the trust holding will be taken to be a fixed interest to the extent that the interest represents a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding.

In this case, the unit holder will have a long position with a delta of +1 under subsection 160APHL(7) of the ITAA 1936 and a short position with a delta of -1 under subsection 160APHL(10) of the ITAA 1936. In the absence of any other long positions, this will leave the unit holder with a net position of zero and a materially diminished risk of loss or opportunity for gain in accordance with subsection 160APHM(2) of the ITAA 1936. However, a long position will arise in respect of the beneficiary's interest in the trust holding to the extent that it has a 'fixed interest' in the trust (subsection 160APHL(10)). For the purposes of subsection (10), a fixed interest will only arise where there is a vested and indefeasible interest in the corpus of the trust: 160APHL(11) of the ITAA 1936.

Application to your circumstances

It is your view that the beneficiaries have a vested and indefeasible interest in the trust corpus because the trustee is unable to exercise its administrative power in an unfettered manner described in the Supplemental Trust Deed due to its fiduciary duty.

However, even if the trustee has never managed the trust in such a way as to deprive any beneficiary of his or her entitlement; the power does exist. Therefore a fixed interest does not exist.

Exercise of Commissioner's discretion under section 160APHL(14)

Subsection 160APHL(14) of the ITAA 1936 contains a discretion whereby, in cases where beneficiaries do not have a fixed interest, the Commissioner may, for the purposes of the Act, treat such beneficiaries as having a fixed interest where it is reasonable to do so based upon the factors prescribed in paragraph 160APHL(14)(c) of the ITAA 1936.

The Commissioner may treat a beneficiary as having a fixed interest (in cases where in fact beneficiaries do not have a fixed interest) 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; and

(iv) any other matter the Commissioner thinks relevant.

The first three factors are the same as those applying in the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem a fixed entitlement to the income and capital of a trust.

Under The Taxation Laws Amendment (Trust loss and Other Deductions) Act 1988 the Explanatory Memorandum, Chapter 13, Interpretation of terms used in the provisions at point 13.13 it states;

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 in the trusts, it would be unreasonable to treat the beneficiary's interest as not constituting a fixed entitlement

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

The Trustee has the power to enhance an individual's benefit where he or she thinks fit and, possibly, resulting in a beneficiary losing their entitlement. Therefore, the entitlement is not vested.

Further, you refer to the flexibility given by a clause of the deed (as amended by a new clause in the Supplemental Trust Deed dated 7 July 1988), in that the legal personal representative is able to hold corpus for the benefit of close family members and so the corpus amount is protected from creditors.

The Legal Personal Representative position is explained in Taxation Ruling IT 2622, Present Entitlement during the Stages of Administration of Deceased Estates, paragraph 2, which states;

…..When probate has been granted, the executor is free to call up the deceased's assets and liabilities and pay the debts, funeral and testamentary expenses. After these matters have been attended to, the executor distributes the property of the deceased to the beneficiaries of the estate.

Therefore, a creditor of the deceased has a legal claim against the estate; consequently, this clause of the trust deed (as amended by the new clause in the Supplemental Trust Deed) does not provide protection against claims from creditors.

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

The defeasance of the unit holders interest in the trust is unlikely but for a clause of the trust deed (as amended by a new clause in the Supplemental Trust Deed However, as stated previously, even if the trustee has never managed the trust in such a way as to deprive any beneficiary of his or her entitlement, the power does exist.

(iii) The nature of the trust

The trust is a closely held trust.

(iv) Any other matter the Commissioner thinks relevant

The Explanatory Memorandum which accompanied the introduction of section 160APHL of the ITAA 1936 provides the following as an example of when the exercise of the Commissioner's discretion under subsection 160APHL(14) of the ITAA 1936 may be appropriate:

4.82 Even if an interest is not fixed and indefeasible, the Commissioner may, in appropriate circumstances, deem it to be so. For example, it may be appropriate to exercise this discretion, if necessary, in relation to beneficiaries of certain hardship trusts (eg. trusts established under workers compensation legislation).

[Item 8, new subsections 160APHL(14 and (15)]

Using this example as a basis for the exercise of this discretion, the circumstances in this case are not the type of circumstances envisaged by the introduction of the discretion under subsection 160APHL(14) of the ITAA 1936.

It is considered that the ultimate owners of the unit trust's interests in any given year, with the subject trust being a discretionary trust, are not sufficiently certain and identifiable in any given year to satisfy the prerequisite requirements of Division 1A of former Part IIIAA of the ITAA 1936.

Having considered the above factors it is considered that defeasance of the interest in the trust is possible by virtue of the Trust Deed and Supplemental Trust Deed and whilst this may be unlikely, the circumstances of this case are not of the type for which the exercise of this discretion was intended to be applied.

There are no external controls or supervision that would restrict the Trustee from exercising his or her power as set out in the trust deed.

Having considered the relevant circumstances, the Commissioner will not exercise the discretion available to him pursuant to subsection 160APHL(14) of the ITAA 1936 to deem the beneficiaries of the trust as having fixed interests in the corpus of the trust. Consequently, the beneficiaries will not be qualified persons and therefore will not be entitled to a tax offset under Division 207 of the ITAA 1997 in respect of any franked income derived by the trust.

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