Edited version of private advice

Authorisation Number: 1012619252969

Ruling

Subject: Closely held trust

Question 1

Do the unit holders (beneficiaries) of the Trust have fixed entitlements to all the income and capital of the Trust for the purposes of subsections 272-5(1) and 272-5(2) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

The unit holders in the Trust do not have fixed entitlements to all of the income and capital of the Trust for the purposes of subsection 272-5(1) and 272-5(2) of Schedule 2F to the ITAA 1936.

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 the Trust as having fixed entitlements?

Answer

The Commissioner will exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem the beneficiaries of the Trust to have fixed entitlements to the income and capital of the Trust?

Question 3

Is the Trust a closely held trust for the purposes of subsection 102UC(1) of the ITAA 1936?

Answer

The Trust is not a closely held trust for the purpose of subsection 102UC(1) of the ITAA 1936.

This ruling applies for the following periods:

1 July 2012 to 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

The Trust was established on 1 July 20XX.

The Trustee is the holder of Australian Financial Services Licence.

X unrelated individual unitholders each own X% of the units in the Trust.

The Trust is a special purpose collective investment vehicle without concentration of ownership. The Trust is a unit trust with only the same class of units on issue for investors. The Trust deed is drafted with the intent for investors to have proportionate entitlements to income and capital of the Trust by reference to their subscription capital.

The Trustee was not required to register the Trust as a managed investment scheme because subsection 601ED(2) of the Corporations Act 2001 applies. Subsection 601ED(2) states that a managed investment scheme does not have to be registered if all the issues of interests in the scheme would not have required the giving of a product disclosure statement under Division 2 of Part 7.9 if the scheme had been registered when the issues were made. In simple terms, the scheme does not have to be registered because all of the investors are wholesale clients, sophisticated investors and other investors in respect of whom it is not necessary to provide a product disclosure statement.

The Trust deed can be modified, repealed or replaced;

n Units can be issued or redeemed; and

n Units can be issued at a discount.

No partly paid units have been issued.

No partly paid units are proposed to be issued prior to the end of the ruling period.

No partly paid units have been forfeited due to non-payment of any instalment.

No units have been compulsorily sold or redeemed.

No units have been issued at a discount by the Trustee.

The trust deed has not been amended.

The trust does not have any prior year tax losses. The relevant tax return, being its first return, will show net income.

The trust loss recoupment rules of Schedule 2F to the ITAA 1936 are not applicable.

If it is confirmed that the trust is not a closely held trust, it may disregard the completion of the following labels in the relevant income tax return and future years' tax returns where the factual circumstances of the trust remain unchanged:

• Trustee beneficiary statement information - labels 54P and 54Q

• Annual trustee payment report - labels 54S and 54T.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6D

Income Tax Assessment Act 1936 Section 102UC

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 section 272-5

Income Tax Assessment Act 1936 section 272-10

Income Tax Assessment Act 1936 section 272-15

Income Tax Assessment Act 1936 section 272-40

Income Tax Assessment Act 1936 section 272-65

Reasons for decision

Question 1

Fixed entitlement

A 'fixed trust' is defined in section 272-65 of Schedule 2F to the ITAA 1936:

A trust is a fixed trust if persons have fixed entitlements to all of the income and capital of the trust.

The term 'fixed entitlement' is defined in subsection 272-5(1) of Schedule 2F to the ITAA 1936 which states that:

'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.'

The expression 'vested and indefeasible interest' is not defined in the ITAA 1936 or the ITAA 1997. However in ATO ID 2002/676 the Commissioner explains the broad meaning of vested and indefeasible interest. The same view is also contained in the Explanatory Memorandum to A New Tax System (Closely Held Trusts) Bill 1999:

Fixed entitlement to a share of income or capital is defined in subdivision 272-A of Schedule 2F to the Income Tax Assessment Act 1936 (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.

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.

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 sometime in the future.

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.

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.

In Colonial First State Investments Ltd v FCT (2011) 192 FCR 298; 201 ATC 20-235 at 97, the Federal Court defined an indefeasible interest under subsection 272-5(1) of Schedule 2F to the ITAA 1936 as having "its ordinary meaning when applied to an interest, that is that the interest cannot be terminated, invalidated or annulled."

In a case where a beneficiary has a vested interest which may be 'terminated, invalidated or cancelled' the beneficiary will have a defeasible interest. For example, where that interest is brought to an end by the exercise of a power of appointment in favour of someone else - see Dwight v Commissioner of Taxation (1992) 107 ALR 407; 92 ATC 4192; 23 ATR 236. In Dwight's case Hill J made the following observations about the meaning of 'vested and indefeasible':

The words vested and indefeasible in the context of trust law are technical words of limitation, which have a well understood meaning to property conveyancers. Estates may be vested in interest or vested in possession, the difference being between a present fixed right to future enjoyment where the estate is said to be vested in interest and a present right of present enjoyment of the right, where the estate is said to be vested in possession: Glenn & Ors v Federal Commissioner of Land Tax (1915) 20 CLR 490 at 496 per Griffith CJ, at 501 per Isaacs J. A person with interest in remainder, subject to a pre-existing life interest, has an interest which is vested in interest, but being a future interest is not yet vested in possession. That person's interest will vest in possession on the death of the life tenant. In the present context the word "vested" is used in contradistinction to contingent.

An interest is said to be defeasible where it can be brought to an end and indefeasible where it cannot. Thus, a beneficiary with an interest which is not contingent but which interest may be brought to an end by the exercise of a power of appointment, would be said to have a vested but defeasible interest: cf Queensland Trustees Limited & Ors v Commissioner of Stamp Duties (1952) 88 CLR 54 at 63, and Re Kilpatrick's Policies Trusts [1966] Ch 730.

Trust Instrument

The fact that a beneficiary may have an interest in a trust that is described as a 'unit trust' does not answer the question: "does the beneficiary have a fixed entitlement in a share of the income or of the capital of that trust?"

The determining factor in deciding if a fixed entitlement exists under subsection 272-5(1) of Schedule 2F to the ITAA 1936 will be the terms of the trust instrument under which the trust is constituted.

In the context of subsection 272-5(1) determining whether a beneficiary has a 'vested and indefeasible' interest in a trust, requires examination of the terms of the trusts upon which the relevant trust property is held, including individual clauses, and whether a beneficiary's interest in a share of the income or capital is defeasible by virtue of any of the powers contained in the trust instrument (see CPT Custodian Pty Ltd v Commissioner of State Revenue; Commissioner of State Revenue v Karingal 2 Holdings Pty Ltd [2005] HCA 53).

For example, the existence of a power in a trustee to issue new units of the same class will render the interests of all unit holders in that class defeasible if the issuing of the units has the potential to cause a contraction of the proportionate interest that each of the existing unit holders has.

Similarly, a power under a trust instrument to redeem, revoke or cancel units is a power that would render a unit holder's interest defeasible, even if the power is one that can only be exercised with the unit holder's consent.

However subsection 272-5(2) of Schedule 2F to the ITAA 1936 (the 'savings provision') states that the interest of a unit holder in a unit trust will not be taken to be defeasible only because the units can be issued or redeemed. This is provided the units are redeemable or further units are able to be issued only for market value or for a price that represents the net asset value of the trust.

Application of the law

Under subsection 272-5(1) in Schedule 2F to the ITAA 1936 a person will be taken to have a fixed entitlement to a share of the income or capital of a trust if they have a vested and indefeasible interest under the trust instrument.

Under the Trust deed, the unit may not be considered to have a vested and indefeasible interest in all of the income and capital of the fund as the Trust deed provides for the following:

• The Trustee may issue or redeem units; and

• The Trust deed can be modified, repealed or replaced.

The power of the trustee to issue new units of the same class will render the interests of all unit holders in that class defeasible if the issuing of the units has the potential to cause a contraction of the proportionate interest that each of the existing unit holders has in the trust.

The power under the Trust instrument to redeem, revoke or cancel units is a power that would render the unit holders' interests defeasible, even if the power is one that can only be exercised with the unit holder's consent.

Under subsection 272-5(2) of Schedule 2F to the ITAA 1936 the interests 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 the units must be at full value. That is, additional units can be issued or units for a price that represents the net asset value of the trust (if the units in the trust are not listed).

However as the Trustee has a discretion to issue new units in the Trust at a value of the Trustee's choosing and has the power to redeem units at a value which may or may not represent 'full value', it is considered that the savings provision will not apply.

Conclusion

Given that the unit holders' (beneficiaries) interests can be defeased, the unit holders do not have fixed entitlements to all of the income and capital of the trust.

Question 2

The Commissioner's discretion

Under subsection 272-5(3) of Schedule 2F to the ITAA 1936 the Commissioner has the discretion to deem certain beneficiaries to have fixed entitlement to the income or capital of a trust:

272-5(3) Deemed fixed entitlement

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.

According to the Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 (at paragraph 13.13), the discretion 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.

The EM points out that in exercising the discretion regard must be had to the 'scheme of the trust loss provisions' in Schedule 2F to the ITAA 1936.

The exercise of the Commissioner's discretion to deem the trust to be a fixed trust is being sought for the purposes of Division 6D of the ITAA 1936 (the trustee beneficiary reporting rules). If the trust is deemed to be a fixed trust it will not be a closely held trust and therefore will not be required to provide the following information in the trust's income tax return:

• Trustee beneficiary statement information - labels 54P and 54Q

• Annual trustee payment report - labels 54S and 54T.

Subparagraph 272-5(3)(b)(i) - the circumstances in which the entitlement is capable of not vesting or the defeasance can happen

Under certain clauses of the Trust deed the entitlement of the unit holders may be considered not to vest or be defeased.

The Trustee may issue or redeem units:

Under subsection 272-5(2) of Schedule 2F to the ITAA 1936 the interests 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 the units must be at full value. That is, additional units can be issued or units redeemed only for market value (if the units in the trust are listed) or for a price that represents the net asset value of the trust (if the units in the trust are not listed).

The Trust deed gives the Trustee the right to acquire a unit holder's interest at a price equal to 80% of the current market value of those units in the event of a default event by a unit holder.

A power under the trust instrument to redeem, revoke or cancel units is a power that would render a unit holder's interest defeasible. Subsection 272-5(2) of Schedule 2F to the ITAA 1936 will not apply to the interests of the unit holders as the redemption price of the units is equal to 80% of the current market value of those units. This may or may not represent the net asset value of the trust at the time of redemption.

The Trust deed can be modified, repealed or replaced:

This power is a defeasible power, as noted by Stone J in Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; 2011 ATC 20-235 at [106]:

it follows [from unit holders' ability to amend the Constitution under paragraph 601GC(1)(a) of the Corporations Act 2001 by special resolution, i.e. less than unanimous unit holder approval] that the members could vote to terminate the present right to a share of income and capital.

Subparagraph 272-5(3(b(ii) - the likelihood of the entitlement not vesting or the defeasance happening

In relation to the issue, redemption or cancellation of units the trustee has advised:

• The trust is a unit trust with only one class of unit on issue;

• No partly paid units have been issued;

• No partly paid units are proposed to be issued prior to the end of the ruling period;

• No partly paid units have been forfeited due to non-payment of any instalment;

• No units have been compulsorily sold or redeemed;

• No units have been issued at a discount by the trustee; and

• The trust deed has not been amended.

Subparagraph 272-5(3(b(iii) - the nature of the trust

The Trustee is the holder of Australian Financial Services Licence.

The Trust is a special purpose collective investment vehicle without concentration of ownership. The Trust is a unit trust with only the same class of units on issue for investors. The Trust deed is drafted with the intent for investors to have proportionate entitlements to income and capital of the Trust by reference to their subscription capital.

The Trustee is not required to register as a Managed Investment Scheme, for the purposes of Chapter 5C of the Corporations Act 2001, because subsection 601ED(2) applies. Subsection 601ED(2) states that a managed investment scheme does not have to be registered if all the issues of interests in the scheme would not have required the giving of a product disclosure statement under Division 2 of Part 7.9 if the scheme had been registered when the issues were made.

In simple terms, the scheme does not have to be registered because all of the investors are wholesale clients, sophisticated investors and other investors in respect of whom it is not necessary

Conclusion

After having regard to the factors in subparagraphs 272-5(3)(b)(i), (ii) and (iii) of Schedule 2F to the ITAA 1936 and the submissions of the applicant, it is considered that the facts warrant the exercising of the Commissioner's discretion to deem the unit holders to have fixed entitlements to the income and capital of the Trust.

Question 3

The legislation

The ultimate beneficiary rules in Division 6D of Part III of the ITAA 1936 were introduced in 1999 as an integrity measure aimed at preventing complex chains of trusts to avoid or indefinitely defer tax. These measures ensured that the necessary information was made available to allow the Commissioner to check whether the assessable income of ultimate beneficiaries correctly included any required share of net income and that the net assets of the ultimate beneficiaries reflected the receipt of tax-preferred amounts.

Division 6D was subsequently amended by the Tax Laws Amendment (2007 Measures No. 4) Act 2007 to reduce the costs of complying with the ultimate beneficiary rules by requiring trustees of closely held trusts to only report to the Commissioner details of trustee beneficiaries, rather than trace amounts through to ultimate beneficiaries.

A trustee of a closely held trust must make a correct trustee beneficiary statement to the Commissioner in respect of each trustee beneficiary who has a share of the trust's net income or is presently entitled to tax-preferred amounts.

A 'closely held trust' is defined in subsection 102UC(1) of the ITAA 1936 as:

a) a trust where an individual has, or up to 20 individuals have between them, directly or indirectly, and for their own benefit, fixed entitlements to a 75% or greater share of the income, or a 75% or greater share of the capital, of the trust; or

(b) a discretionary trust;

except where the trust is an excluded trust.

A discretionary trust is defined in subsection 102UC(4) of the ITAA 1936 as a trust that is not a fixed trust within the meaning of section 272-65 in Schedule 2F to the ITAA 1936. Under section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997), a trust will be a fixed trust if entities have fixed entitlements to all of the income and capital of the trust.

Is the Trust a 'closely held trust'?

The definition of 'closely held trust' in paragraph 102UC(1)(a) of the ITAA 1936 requires an individual , or up to 20 individuals, to have between them, directly or indirectly, and for their own benefit, fixed entitlements to a 75% or greater share of the income, or a 75% or greater share of the capital, of the trust.

The X unrelated individual unitholders each own X% of the units in the Trust.

As 20 'individuals' own 50% of the share to the income and capital of the trust then up to 20 individuals, do not have between them, directly or indirectly, and for their own benefit, fixed entitlements to a 75% or greater share of the income, or a 75% or greater share of the capital, of the trust.

Therefore the Trust cannot be regarded as a 'closely held trust' as defined in paragraph 102UC(1)(a) of the ITAA 1936.

Discretionary Trust

A trust will also be considered to be a 'closely held trust' if the trust is a discretionary trust. A discretionary trust is defined in subsection 102UC(4) of the ITAA 1936 as "a trust that is not a fixed trust within the meaning of section 272-65 in Schedule 2F of Schedule 2F to the ITAA 1936 ".

It has been established that the unit holders do have fixed entitlements to all of the income and capital of the Trust - see response to Question 1. Therefore, as the Trust is a fixed trust, it cannot be regarded as a discretionary trust for the purposes of subsection 102UC(4) of the ITAA 1936.

Conclusion

The Trust does not meet the definition of 'closely held trust' as:

n An individual, or up to 20 individuals do not have between them, directly or indirectly, and for their own benefit, fixed entitlements to a 75% or greater share of the income, or a 75% or greater share of the capital, of the trust (102UC(1)(a) of the ITAA 1936); and

n The Trust is not a discretionary trust (102UC(1)(b) of the ITAA 1936).

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