Edited version of your written advice

Authorisation Number: 1051252367484

Date of advice: 17 July 2017

Ruling

Subject: Determination - Vested and Indefeasible Interest

Question and Answer

Will the Commissioner, for the 2013, 2015 and 2016 income years, make a determination under former subsection 160APHL(14) of the ITAA 1936 that The Trust has a vested and indefeasible interest in the corpus of the Unit Trust, and is therefore a qualified person within the meaning of Division 1A of former Part IIIAA of the ITAA 1936 in respect of any franked income derived by and flowing from the Unit Trust?

Yes

This ruling applies for the following periods

1 July 2012 to 30 June 2013

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

The scheme commences on

1 July 2012

Relevant facts and circumstances

Liquidators (the “liquidators”) of the Trustee Company were appointed.

The Trustee Company is the trustee of the Trust (“The Trust”).

Units in the Unit Trust

At the time of appointment of the liquidators the primary asset held by the Trustee as trustee of the Trust was 6 ordinary units (comprising a 1/3rd interest) in a unit trust, (“The Unit Trust”).

The UNIT TRUST was established under deed with 18 ordinary units issued.

The Trust acquired its 6 ordinary units in the Unit Trust on establishment of the trust

The other 12 ordinary units in the Unit Trust were originally owned by 3 other parties unrelated to the Trust (2 holdings of 3 units and one holding of 6 units). The other unitholder holding the original 6 units subsequently acquired the 2 holdings of 3 units. As a result, at the time the Liquidators were appointed the Trust held 6 units (1/3rd) and another unrelated party owned 12 units (2/3rd).

The unitholders of the Unit Trust also own all the ordinary shares in the trustee company.

There were no capital or income distributions from the Unit Trust prior to the 2013 income tax year. The Unit Trust has made distributions to unitholders in the 2013 and subsequent income years based on the units held (i.e. The Trust has received its 1/3 share).

The Unit Trust is currently being wound up and the Trust expects to receive its final 1/3 share in the return of any income and capital of the Unit Trust.

The Unit Trust has not made a family trust election.

Key provisions of the trust deed are:

a. Beneficial interest – the beneficial interest in the Trust Fund is vested in the unit holders (clause 7.1). Where units are fully paid, a unit holder is entitled to the income and capital of the trust in proportion to their unit holding (clauses 24.1 and 25.1)

b. Issue of Units – the trustee may issue units in such manner and at such price as the trustee shall think fit provided that the issue of units is in accordance with the Deed (requiring they be offered to existing unitholders) or is otherwise approved by a special resolution (clause 8.6). A special resolution requires a majority of not less than 75% of unit holders (clause 1.1).

c. Redemption – the trustee can only redeem units at fair value (clause 16.1).

d. Variation of Trust – the trustee can only vary the trust deed by a unanimous resolution of all unit holders (clause 61).

Receipt of franked distributions indirectly

During the years ending 30 June 2013, 2015 and 2016, the Trust received distributions from the Unit Trust and was presently entitled to a share of the taxable income of Unit Trust which included franked dividends and franking credits as follows:

Present entitlement to income of trust

For each of the relevant years (2013, 2015 and 2016), it has been determined that no beneficiary is “presently entitled” to income of the Trust.

As no beneficiary is “presently entitled” to income of the trust, the trustee is assessed to tax on the taxable income of the trust under section 99A of the ITAA 1936.

The Trust has lodged income tax returns for the 2013, 2015 and 2016 income years on this basis.

Qualified person and entitlement to franking credit tax offset

The income tax returns have also been lodged on the basis that the Trust is not entitled to a franking credit tax offset on the basis it is not a “qualified person” in relation to the distribution from the Unit Trust for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1936

former section 160APHD

former section 160APHL

former sections 160APHL(7)

former sections 160APHL(10)

former subsection 160APHL(11)

former subsection 160APHL(12)

former subsection 160APHL(13)

former subsection 160APHL(14)

former paragraph 160APHL(14)(a)

former paragraph 160APHL(14)(b)

former paragraph 160APHL(14)(c)

former subparagraph 160APHL(14)(c)(i)

former subparagraph 160APHL(14)(c)(ii)

former subparagraph 160APHL(14)(c)(iii)

former subparagraph 160APHL(14)(c)(iv)

Reasons for decision

Former subsection 160APHL(14) of the Income Tax Assessment Act 1936 (ITAA 1936) contains a discretion, whereby in cases where beneficiaries do not have a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding, the Commissioner may determine that the interest is to be taken to be vested and indefeasible.

The requirements to be satisfied in respect of the discretion are contained in former paragraphs 160APHL(14)(a), (b) and (c) of the ITAA 1936.

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 of the interest not vesting or the defeasance happening; and

iii. the nature of the trust; and

iv. any other matter the Commissioner thinks relevant.

A taxpayer must be a "qualified person" to be entitled to a franking credit in respect of a dividend. To be a qualified person, a taxpayer must satisfy the 45-day holding period rule. In the case of a trust distribution consisting wholly or partly of dividend income, generally the trustee must be a qualified person and, in addition, the beneficiary must be at risk for a prescribed period during the qualification period in respect of the taxpayer's interest in the membership interest from which the dividend income is derived (former section 160APHL of the ITAA 1936).

The Unit Trust (being a non-widely held unit trust that has not made a family trust election) has held the relevant shares at risk for more than 45 days and a distribution attributable to franked dividend income was made to the unitholders (including The Trust). Further, no other positions in respect of the shares or the interest in the shares are held nor are there any other related payment obligations in respect of the dividends.

The effect of deemed long and short positions under former sections 160APHL(7) and (10) relating to shares held is that unless a beneficiary has a fixed interest constituted by a vested and indefeasible interest in the corpus of the trust or an exception applies, a beneficiary in a non-widely held trust will typically have a net position of zero, i.e., not be sufficiently at risk, meaning that franking credits will not pass through the trust.

For the purposes of former section 160APHL of the ITAA 1936 the Trust is in the category of 'all other non-widely held trusts’ apart from family trusts, deceased estates and employee share scheme trusts.

A "fixed interest" in the trust holding is defined in former subsection 160APHL(11) of the ITAA 1936 as "a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding."

Is there an 'interest in so much of the corpus of the trust as is comprised by the trust holding'?

Former section 160APHL provides that in calculating the extent of a beneficiaries interest, it is necessary to distinguish between the interest of a beneficiary in shares held by a widely-held trust, and the interest of a beneficiary in shares held by other trusts.

The Trust is not a 'widely held trust' for the purposes of former section 160APHD of the ITAA 1936.

This necessitates that a 'look through' approach will be required to determine the interest that a Member has in each of the underlying shares in the Trust.

Although the method of calculating the interest that a Member has in the trust holding differs as between widely-held trusts and trusts other than widely-held trusts, the beneficiaries of both types of trusts do have an interest in the trust holding.

No vested and indefeasible interest

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 the existence of defeasible powers.

The Members are provided with a vested interest in the income and capital of the Trust. Under the Trust Deed, the Members in the Trust may not be considered to have a vested and indefeasible interest in all of the income and capital of the Trust as the Trust Deed provides defeasible powers.

The trustee of the Unit Trust may issue new units at a price to be determined by the trustee provided the issue is made in accordance with provisions in the Trust Deed (offering to existing unit holders) or approved by a special resolution. This means that the Trust’s interest in the Unit Trust will under subsection 160APHL(12) of the ITAA 1936 be taken to be defeasible if the issue of new units has the effect of materially reducing the value of the relevant interest.

Where the issue is conducted in accordance with subsection 160APHL(13) of the ITAA 1936, no material reduction in the value of the interest will be taken to have occurred and the interest will not be taken to be defeasible. However, as the trustee is at liberty to determine the issue price of any new units that may be issued, subsection 160APHL(13) of the ITAA 1936 will not apply.

In view of the conclusion above that the Members of the Trust do not have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding (being the Trustee's ownership of shares) pursuant to former subsection 160APHL(11) of the ITAA 1936, the only way that the Members can have such a vested and indefeasible interest is if the Commissioner exercises the discretion in former subsection 160APHL(14).

In terms of former paragraph 160APHL(14)(a) –

The taxpayer has an interest in so much of the corpus of the trust as is comprised by the trust holding:

The Members in the Trust will have an interest in so much of the corpus of the trust as is comprised by the trust holding.

In terms of former paragraph 160APHL(14)(b) –

Apart from this subsection, the interest would not be a vested or indefeasible interest:

Although a Member’s interest in the capital of the Trust is vested, the Constitution of the Trust contains certain clauses by which a Member’s interest in a share of the capital of the Trust may be defeased.

In terms of former paragraph 160APHL(14)(c) –

Having regard to the factors prescribed in former paragraph 160APHL(14)(c):

These factors are:

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

ii. the likelihood of the interest not vesting or the defeasance happening; and

iii. the nature of the trust; and

iv. any other matter the Commissioner thinks relevant.

160APHL(14)(c)(i)

The first factor is the circumstances in which the unit holdings of the Trust are capable of not vesting or a defeasance.

When examining the circumstances in which a beneficiary's interest is capable of not vesting or being defeated, the Commissioner will have regard to any factor that may affect the defeasance of any beneficiary's interest, including:

● the number of circumstances of potential defeasance

● the significance of those circumstances, and

● whether any preconditions or caveats affect those circumstances such that defeasance is unlikely.

This includes having regard to:

● any person who is capable of altering the beneficiary's interest

● the nature of their relationship to the beneficiary, and

● any limitation on their capability to so alter that interest.

In relation to the Unit Trust, the trust is a unit trust in which a unitholder's entitlement to income and capital is in proportion to their unit holding. However, the trust deed includes the power to issue units at a price the trustee sees fit, to redeem units at fair value and to vary the trust deed.

However, each of these circumstances of potential defeasance has preconditions or caveats affecting them such that defeasance is unlikely. In particular:

a. The issue of new units must be offered to existing unitholders or must otherwise be approved by a special resolution (clause 8.6). A special resolution requires a majority of not less than 75% of unit holders (clause 1.1).

As a result, Unit Trust is unable to favour one of the existing unitholders (or a third party) in relation to the issue of any new units at an undervalue. This is because both existing unitholders would either first need to be offered those units at that price or they would otherwise need to approve the unit issue (given the Trust owns 1/3 of units). Therefore, the issue of new units other than at market value would be unlikely.

b. The trustee can only redeem units at fair value (clause 16.1).

c. The trustee can only vary the trust deed by a unanimous resolution of all unit holders (clause 61). The Unit Trust could not amend the trust deed in order to defeat a unitholders interest because such an amendment requires the unanimous approval of the unitholders.

Other relevant circumstances in determining whether to treat a trust as a fixed trust are:

160APHL(14)(c)(ii)

This factor requires consideration of the likelihood of the interest not vesting or the defeasance happening.

When considering the likelihood of the interest not vesting or being defeated, the Commissioner must form a view as to the probability that the contingency or defeasance will happen. Where the likelihood of the contingency or event of defeasance occurring is low, this will weigh towards a favourable exercise of the discretion.

Where the trustee or trust manager has a particular power to defeat a beneficiary's interest, it is relevant to consider how often, if at all, they have exercised that power over a relevant period.

No further units have ever been issued in addition to the initial 18 units, no new classes of units have been created and no units have been redeemed (and there is no intention or proposal to do so) and the trust deed for the Unit Trust has not been varied or amended.

160APHL(14)(c)(iii)

This factor requires consideration of the nature of the trust.

The nature of the trust refers to its basic legal characteristics and its economic function, both actual and intended. The ability of a trustee or manager of the trust to adversely affect the interests of beneficiaries could be limited where:

● fiduciary responsibilities are placed on the trustee via legislation, most commonly as a registered managed investment scheme (MIS) in Chapter 5C of the Corporations Act 2001

● contractual restrictions limit the trust manager's access to trust assets

● the trust is subject to industry regulations, licensing or registration requirements, which are legally enforceable, such as the Australian Securities Exchange (ASX) Listing Rules which are enforceable against listed entities and their associates

● commitments are made in Product Disclosure Statements to exercise powers in a particular (restrictive and/or non-adverse) way, or

● the trust deed restricts the ability of the trustee to issue and redeem units at anything other than market value or other values approximating net asset value.

While the Trust is a closely held trust the trust deed provides restrictions around issuing, redeeming units and varying the trust deed as noted above.

160APHL(14)(c)(iv)

This factor requires consideration of any other matters the Commissioner considers relevant.

The Commissioner will also consider other relevant factors including the purpose for which the discretion is being considered.

The Trust invested in the Unit Trust on its inception and indirectly via the Unit Trust invested in shares in certain private companies (that ultimately paid franked dividends). Effectively, the Trust has had a fixed interest in the trust fund and has had an indirect interest in the private companies (at risk) such that the determination would be consistent with the purpose of the franking credit holding period rules.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).