Edited version of your written advice

Authorisation Number: 1051241175081

Date of advice: 22 June 2017

Ruling

Subject: Income tax: unit trust: fixed entitlement

Question 1

Will the Commissioner treat a beneficiary’s interest in a share or income derived by, and of the capital of, the trust as being a vested and indefeasible interest, and therefore the beneficiary having a fixed entitlement to that share of the income or capital, pursuant to subsection 272-5(3) of Schedule 2F to the Income Tax Assessment Act 1936?

Answer

Yes

Question 2

Will the Commissioner determine that a beneficiary’s interest in so much of the corpus of the trust as is comprised by the trust holding is treated as being a vested and indefeasible interest pursuant to subsection 160APHL(14) in Division 1A of former Part IIIAA of the Income Tax Assessment Act 1936?

Answer

Yes

Question 3

Will the trust be a fixed trust within the meaning of subsection 995-1(1) of the Income Tax Assessment Act 1997?

Answer

Yes

Question 4

Will the Trustee for the trust be a qualified person in relation to the dividends pursuant to section 160APHO in Division 1A of former Part IIIAA of the Income Tax Assessment Act 1936?

Answer

Yes

Question 5

Will the Commissioner make a determination under paragraph 177EA(5)(b) of the Income Tax Assessment Act 1936 that no imputation benefit is to arise in respect of a distribution made, or that flows indirectly, to the Trustee for the trust or to beneficiaries of the trust?

Answer

No

Question 6

Will gains and losses made by the Trustee for the trust on swap arrangements be assessable and deductible respectively under section 230-15 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following periods:

Income tax years 1 July 2017 to 30 June 20XX

The scheme commences on:

1 July 2017

Relevant facts and circumstances

The Trustee, an Australian resident company, settled the trust with a constitution. The terms of the constitution may be amended by members resolution or deed executed by the trustee as prescribed by the Corporations Act 2001.

The Trustee holds an Australian Financial Services Licence authorising the Trustee to act as responsible entity of the trust.

The trust is an Australian resident trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

The trust is an unlisted “managed investment scheme” as defined in section 9 of the Corporations Act 2001. The trust is registered with retail membership under section 601EB of the Corporations Act 2001.

The trust is not and will not be a “trading trust” for the purposes of Division 6C of Part III of the ITAA 1936.

The trust is not a 'managed investment trust’ within the meaning in section 275-10 of the Income Tax Assessment Act 1997 (ITAA 1997).

The trust is a unit trust and the beneficiaries of the trust own units in the trust.

The trust offers a single class of units to beneficiaries which carry identical rights and rank equally across all beneficiaries.

The Trustee may issue units at any time it determines and may issue units at a discount to the issue price.

Issued units are subject to forfeiture upon a default or defect in the application for units.

Units in the trust are valued periodically (daily) based on their net asset value and can be acquired and redeemed periodically based on the net asset value.

The Trustee may redeem or transfer units in accordance with the constitution.

All beneficiaries of the trust are Australian residents.

The Trustee acquires and passively holds membership interests listed on the share market over the long term pursuant to an investment strategy.

The Trustee does not and will not actively trade in any particular membership interests.

The Trustee will receive franked (including any associated franking credits) and unfranked distributions from the membership interests it holds.

The Trustee will not claim franking credits in relation to dividends paid on shares where the holding period requirement in former section 160APHO of the ITAA 1936 has not been satisfied in relation to those shares.

The Trustee will not hold sufficient membership interests in any particular entity to have influence over the dividend policy of the entity.

The Trustee enters into swap arrangements with global investment banks as part of the investment strategy. Fees are payable on the swap arrangements.

The swap arrangements are governed by standard International Swap and Derivatives Association (ISDA) agreements.

The Trustee does not and will not enter into any one or more “short position” (as defined in former subsection 160APHJ(3) of the ITAA 1936) in relation to any share or other security which reduces its risk of loss or opportunities for gain by more than 70% (measured with a delta of minus 0.7).

The Trustee will at all times maintain a “net position” (as defined in former subsection 160APHJ(5) of the ITAA 1936) of at least 30% (measured with a delta of 0.3) in relation to the shares or other securities it holds.

The trust derives income comprising of a mix of dividends and swap returns (net of fees).

Pursuant to the constitution, the Trustee may distribute an amount of income or capital to the beneficiaries of the trust.

Distributions to beneficiaries will not be calculated by reference to any franking credits the Trustee may receive.

The Trustee earns management fees which are not calculated by reference to any franking credits derived by the trust or swap returns received.

The Trustee may deal with related parties in carrying out its duties and obligations under the constitution.

All parties to the scheme operate independently.

All transactions are conducted on arm’s length terms and at prevailing market prices.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 1A of former Part IIIA

Income Tax Assessment Act 1936 section 160APHD

Income Tax Assessment Act 1936 section 160APHE

Income Tax Assessment Act 1936 section 160APHJ

Income Tax Assessment Act 1936 subsection 160APHJ(5)

Income Tax Assessment Act 1936 section 160APHL

Income Tax Assessment Act 1936 subsection 160APHL(7)

Income Tax Assessment Act 1936 subsection 160APHL(13)

Income Tax Assessment Act 1936 subsection 160APHL(14)

Income Tax Assessment Act 1936 section 160APHM

Income Tax Assessment Act 1936 subsection 160APHM(2)

Income Tax Assessment Act 1936 section 160APHN

Income Tax Assessment Act 1936 section 160APHN(2)

Income Tax Assessment Act 1936 section 160APHO

Income Tax Assessment Act 1936 subsection 160APHO(1)

Income Tax Assessment Act 1936 subsection 160APHO(2)

Income Tax Assessment Act 1936 subsection 160APHO(3)

Income Tax Assessment Act 1936 section 160APHU

Income Tax Assessment Act 1936 subsection 160APHU(1)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 Division 272 of Schedule 2F

Income Tax Assessment Act 1936 section 272-5

Income Tax Assessment Act 1936 section 272-65

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 section 207-145

Income Tax Assessment Act 1997 subsection 207-150(1)

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 section 230-15

Income Tax Assessment Act 1997 section 230-45

Income Tax Assessment Act 1997 subsection 230-45(1)

Income Tax Assessment Act 1997 subsection 230-45(2)

Income Tax Assessment Act 1997 section 275-10

Income Tax Assessment Act 1997 section 960-130

Income Tax Assessment Act 1997 section 960-135

Income Tax Assessment Act 1997 section 995-1

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

Reasons for decision

Question 1

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

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.

Subsection 272-5(1) of Schedule 2F to the ITAA 1936 states a beneficiary has a fixed entitlement to a share of the income or capital of a trust:

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.

Having regard to the factors in paragraph 272-5(3)(b) of Schedule 2F to the ITAA 1936, the Commissioner will treat all of the beneficiaries of the trust as having a vested and indefeasible interest and therefore a fixed entitlement to a share of income the trust derives from time to time and of the capital of the trust pursuant to subsection 272-5(3) of Schedule 2F to the ITAA 1936.

Question 2

Former subsection 160APHL(14) of Division 1A of Part IIIAA of the ITAA 1936 states:

Commissioner may determine an interest to be vested and indefeasible

(14) If:

(a) the taxpayer has an interest in so much of the corpus of the trust as is comprised by the trust holding; and

(b) apart from this subsection, the interest would not be a vested or indefeasible interest; and

(c) the Commissioner considers that the interest should be treated as being vested and indefeasible, having regard to:

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

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

(iii) the nature of the trust; and

(iv) any other matter the Commissioner thinks relevant;

the Commissioner may determine that the interest is taken to be vested and indefeasible.

Having regard to the factors in former paragraph 160APHL(14)(c) of the ITAA 1936 and the relevant facts of the proposed scheme, the Commissioner will treat all of the beneficiaries of the trust as having a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding under former subsection 160APHL(14) of the ITAA 1936.

Question 3

Subsection 995-1(1) of the ITAA 1997 states:

a trust is a fixed trust if entities have *fixed entitlements to all of the income and capital of the trust

The term fixed entitlement is defined in subsection 995-1(1) of the ITAA 1997:

an entity has a fixed entitlement to a share of the income or capital of a company, partnership or trust if the entity has a fixed entitlement to that share within the meaning of Division 272 in Schedule 2F to the Income Tax Assessment Act 1936.

As the Commissioner will, pursuant to subsection 272-5(3) of Schedule 2F to the ITAA 1936, treat all of the beneficiaries of the trust as having fixed entitlements to all of the income and capital of the trust (see reasoning to Question 1), it will be a 'fixed trust’ within the meaning of subsection 995-1(1) of the ITAA 1997.

Question 4

Section 207-145 of the ITAA 1997 relevantly states:

(1) If a *franked distribution is made to an entity in one or more of the following circumstances:

(a) the entity is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIA of the Income Tax Assessment Act 1936; …

then for the purposes of this Act:

(e) the amount of the franking credit on the distribution is not included in the assessable income of the entity under section 207-20 or 207-35;

(f) the entity is not entitled to a *tax offset under this Division because of the distribution; and …

The main test of what constitutes a “qualified person”, commonly known as the holding period rule, is in former section 160APHO of the ITAA 1936, which states:

(1) A taxpayer who has held shares or an interest in shares on which a dividend has been paid is a qualified person in relation to the dividend if:

(a) where neither the taxpayer nor an associate of the taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend – the taxpayer has satisfied subsection (2) in relation to the primary qualification period in relation to the dividend; or

(b) where the taxpayer or an associate of the taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend – the taxpayer has satisfied subsection (2) in relation to the secondary qualification period in relation to the dividend.

(2) A taxpayer who has held shares or an interest in shares on which a dividend has been paid satisfies this subsection in relation to a qualification period in relation to the shares or interest if, during the period:

(a) where the taxpayer held the shares – the taxpayer held the shares for a continuous period (not counting the day on which the taxpayer acquired the shares or, if the taxpayer has disposed of the shares, the day on which the disposal occurred) of not less than:

(i) if the shares are not preference shares – 45 days; or

(ii) if the shares are preference shares – 90 days.

(b) where the taxpayer held the interest in the shares – the taxpayer held the interest for a continuous period (not counting the day on which the taxpayer acquired the interest or, if the taxpayer has disposed of the interest, the day on which the disposal occurred) of not less than:

(i) if the shares are not preference shares – 45 days; or

(ii) if the shares are preference shares – 90 days.

Related payment rule

In order to determine what the relevant qualification period for purposes of former subsection 160APHO(1) of the ITAA 1936, it is necessary to determine whether the Trustee for the trust has made, or is under an obligation to make, or is likely to make, a related payment in respect of any of the dividends they receive.

Former section 160APHN of the ITAA 1936 gives examples of, but does not limit, what constitutes the making of a related payment by the trustee in respect of a dividend paid in respect of shares, or in respect of a distribution made in respect of interests in shares, held by the trustee of the trust.

Former subsection 160APHN(2) of the ITAA 1936 states:

The taxpayer or associate is taken, for the purposes of this Division, to have made, to be under an obligation to make, or to be likely to make, a related payment in respect of the dividend or distribution if, under an arrangement, the taxpayer or associate has done, is under an obligation to do, or may reasonably be expected to do, as the case may be, anything having the effect of passing the benefit of the dividend or distribution to one or more other persons.

Former subsections 160APHN(3) and (4) of the ITAA 1936 elaborate upon this.

If the Trustee (as shareholder) is not taken to pass the benefit of the dividend to another person in the circumstances set out above, the Trustee will need to satisfy the holding period requirement in relation to the primary qualification period in relation to the dividend in order to be a “qualified person”.

However, if the Trustee is taken to pass the benefit of the dividend to another person in the circumstances set out above, the Trustee will need to satisfy the holding period requirement in relation to the secondary qualification period in relation to the dividend in order to be a “qualified person”.

On the facts, the Trustee will not have made, or be under an obligation to make or be likely to make, a related payment in respect of any dividends paid by entities in which the Trustee will hold membership interests.

Therefore, the relevant qualification period is the 'primary qualification period’ pursuant to former paragraph 160APHO(1)(a) of the ITAA 1936.

Former section 160APHD of the ITAA 1936 defines the 'primary qualification period' in relation to a taxpayer in relation to shares or an interest in shares, to mean:

the period beginning on the day after the day on which the taxpayer acquired the shares or interest and ending:

(a) if the shares are not preference shares - on the 45^th day after the day on which the shares or interest became ex dividend; or

(b) if the shares are preference shares - on the 90^th day after the day on which the shares or interest became ex dividend.

Former section 160APHE of the ITAA 1936 defines ex dividend to mean:

(1) A share in respect of which a dividend is to be paid, or an interest (other than an interest as a beneficiary of a widely held trust) in such a share, becomes ex dividend on the day after the last day on which the acquisition by a person of the shares will entitle the person to receive the dividend.

An interest as a beneficiary of a widely held trust in a share in respect of which a dividend is to be paid becomes ex dividend on the day after the last day on which the acquisition by a person of the interest will entitle the person to receive a distribution from the trust.

Holding period rule

If the shares held by the Trustee for the trust are not preference shares, then Trustee is required to hold the shares on which a dividend has been paid for a continuous period of at least 45 days during the primary qualification period (former subparagraph 160APHO(2)(a)(i) of the ITAA 1936).

If the shares held by the Trustee for the trust are preference shares, then the Trustee is required to hold the shares on which a dividend has been paid for a continuous period of at least 90 days during the primary qualification period (former subparagraph 160APHO(2)(a)(ii) of the ITAA 1936).

In determining whether the Trustee for the trust held the shares, or interest in shares, for at least 45 or 90 days in the primary qualification period, the Trustee does not count the day on which it acquired the shares or interest in shares. If the Trustee has disposed of the shares or interest in shares, it does not count the day on which the disposal occurred (former paragraph 160APHO(2)(a) of the ITAA 1936).

Furthermore, former paragraph 160APHO(3) of the ITAA 1936 states:

In calculating the number of days for which the taxpayer continuously held the shares or interest, any days on which the taxpayer has materially diminished risks of loss or opportunities for gain in respect of the shares or interest are to be excluded, but the exclusion of those days is not taken to break the continuity of the period for which the taxpayer held the shares or interest.

Former paragraph 160APHM(2) of the ITAA 1936 states:

A taxpayer is taken to have materially diminished risks of loss or opportunities for gain on a particular day in respect of shares held by the taxpayer, or in respect of an interest held by the taxpayer in shares, if the taxpayer’s net position on that day in relation to the shares or interest has less than 30% of those risks and opportunities.

Accordingly, provided that the Trustee for the trust has a net position of at least 30% in relation to the shares it owns and holds such a net position in respect of those shares for the requisite holding period, the Trustee for the trust will be a “qualified person” in relation to the dividends it will receive pursuant to former section 160APHO of the ITAA 1936.

Question 5

Section 177EA of the ITAA 1936 is a general anti-avoidance provision. Its object is to prevent abuse of the imputation system through schemes which circumvent the basic rules for the franking of dividends. If the section applies, subsection 177EA(5) of the ITAA 1936 empowers the Commissioner to make a determination to create a franking debit or cancel a franking credit.

Section 177EA of the ITAA 1936 applies if the five conditions in subsection 177EA(3) of the ITAA 1936 are satisfied. Subsection 177EA(3) states:

This section applies if:

(a) there is a scheme for a disposition of membership interests or an interest in membership interests, in a corporate tax entity; and

(b) either:

(i) a frankable distribution has been paid, or is payable or expected to be payable to a person in respect of the membership interests; or

(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

A 'membership interest’ is defined in section 960-135 of the ITAA 1997 to mean:

If you are *member of an entity:

(a) each interest, or set of interests, in the entity; or

(b) each right, or set of rights, in relation to the entity:

by virtue of which you are a member of the entity is a membership interest of yours in the entity.

Pursuant to section 960-130 of the ITAA 1997, a 'member’ means:

● in relation to a company – a member of the company or stockholder in the company

● in relation to a trust – a beneficiary, unitholder or object of the trust.

The meaning of 'interest in membership interests’ is defined in subsection 177EA(13) of the ITAA 1936 and relevantly states:

A person has an interest in membership interests if:

(a) the person has any legal or equitable interest in the membership interests; or

(b) …

(c) the person is a beneficiary of a trust (including a potential beneficiary of a discretionary trust) and:

(i) the membership interests form, or will form, part of the trust estate; or

(ii) the trust derives, or will derive, income indirectly through interposed companies, trusts or partnerships, from distributions made on the membership interests.

Subsection 177EA(14) relevantly provides that a scheme for disposition or membership interests or an interest in membership interests includes:

(a) issuing the membership interests or creating the interest in membership interests;

(b) entering into any contact, arrangement, transaction or dealing that changes or otherwise affects the legal or equitable ownership of the membership interests or interest in membership interests;

(c) …

On the facts, the conditions in paragraphs 177EA(3)(a) to (d) of the ITAA 1936 will be satisfied.

The remaining condition is whether, having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit: paragraph 177EA(3)(e) of the ITAA 1936 (“the requisite purpose”).

This is a test of objective purpose. Circumstances which are relevant in determining whether the trust or any other person has the requisite purpose include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936. The relevant circumstances listed encompass a range of circumstances which taken individually or collectively could indicate the requisite purpose and broadly include:

● extent and duration of the risks of ownership: paragraph 177EA(17)(a)

● the tax profiles of the parties to the scheme: paragraphs 177EA(17)(b), (c), (d) and (e)

● any consideration paid by or to the relevant taxpayer: paragraph 177EA(17)(f)

● associated deductions or losses: paragraphs 177EA(17)(g) and (ga)

● equivalence to interest: paragraph 177EA(17)(h)

● length of the period for which the membership interests are held: paragraph 177EA(17)(i)

● other factors regarding the manner, form and effect of the scheme and nature of any connection with other persons: paragraph 177EA(17)(j)

Subsection 177EA(4) of the ITAA 1936 recognises that the mere acquisition of membership interests by a person would not of itself support a conclusion as to the requisite purpose:

(4) It is not to be concluded for the purposes of paragraph (3)(e) that a person entered into or carried out a scheme for a purpose mentioned in that paragraph merely because the person acquired membership interests, or an interest in membership interests, in the entity.

Subsection 177EA(4) of the ITAA 1936 is only relevant in considering the purpose of the person acquiring the membership interests. It does not affect the conclusion that can be drawn about any purpose of other parties to the scheme. The requirements of subsection 177EA(3) of the ITAA 1936 would be satisfied if the consideration of all the relevant circumstances led to the conclusion that some other party had a sufficient purpose of enabling the acquirer of the interest to obtain an imputation benefit.

Having regard to the relevant circumstances in subsection 177EA(17) of the ITAA 1936, it cannot be concluded on the facts that the Trustee for the trust or any other person entered into or carried out the scheme did so for the purpose of enabling the relevant taxpayer to obtain an imputation benefit. Accordingly, the condition in paragraph 177EA(3)(e) of the ITAA 1936 is not satisfied and therefore the Commissioner will not make a determination under paragraph 177EA(5)(b) of the ITAA 1936.

Question 6

Section 230-15 of the ITAA 1997 relevantly states:

230-15 Gains are assessable and losses deductible

Gains

(1) Your assessable income includes a gain you make from a *financial arrangement.

Note: This Division does not apply to gains that are subject to exceptions under Subdivision 230-H.

Losses

(2) You can deduct a loss you make from a *financial arrangement, but only to the extent that:

(a) you make it in gaining or producing your assessable income; or

(b) you necessarily make it in carrying on a *business for the purpose of gaining or producing your assessable income.

Note: This Division does not apply to gains that are subject to exceptions under Subdivision 230-H.

“Financial arrangement” is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by sections 230-45 to 230-55 of the ITAA 1997.

Subsection 230-45(1) of the ITAA 1997 relevantly states:

You have a financial arrangement if you have, under an *arrangement:

(a) a *cash settlable legal or equitable right to receive a *financial benefit; or

(b) a cash settlable legal or equitable obligation to provide a financial benefit; or

(c) a combination of one or more such rights and/or one or more such obligations;

unless:

(d) you also have under the arrangement one or more legal or equitable rights to receive something and/or one or more legal or equitable obligations to provide something; and

(e) for one or more of the rights and/or obligations covered by paragraph (d):

(i) the thing that you have the right to receive, or the obligation to provide, is not a financial benefit; or

(ii) the right or obligation is not cash settlable; and

(f) the one or more rights and/or obligations covered by paragraph (e) are not insignificant in comparison with the right, obligation or combination covered by paragraph (a), (b) or (c).

The right, obligation or combination covered by paragraph (a), (b) or (c) constitutes the financial arrangement.

Subsection 230-45(2) of the ITAA 1997 states:

A right you have to receive, or an obligation you have to provide, a *financial benefit is cash settlable if, and only if:

(a) the benefit is money or a *money equivalent; or

(b) in the case of a right – you intend to satisfy or settle it by receiving money or a money equivalent or by starting to have, or ceasing to have, another *financial arrangement; or

(c) in the case of an obligation – you intend to satisfy or settle it by providing money or a money equivalent or by starting to have, or ceasing to have, another financial arrangement; …

On the facts, the swap arrangements are cash settlable pursuant to subsection 230-45(2) of the ITAA 1997. Accordingly, each of the swap arrangements will be a “financial arrangement”.

Therefore, gains and losses made by the Trustee for the trust on swap arrangements will be assessable and deductible respectively under section 230-15 of the ITAA 1997.

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