Edited version of your written advice

Authorisation Number: 1051386419266

Date of advice: 18 June 2018

Ruling

Subject: Fixed entitlements

Question 1

Will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the beneficiaries of the Fund as having fixed entitlements to all of the income and capital of Fund?

Answer

Yes

Question 2

Will the Commissioner exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat the beneficiaries of the Fund as having a vested and indefeasible interest in so much of the corpus of the Fund as is comprised by the trust holding?

Answer

Yes

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

The scheme commences on:

The date the fund was established

Relevant facts and circumstances

This description of facts is based on the following documents. The documents form part of and are to be read with this description. The relevant documents are:

● The Private Ruling Application (and attachments);

● The information request from the ATO; and

● The email to the ATO from the tax representative.

In relation to the Fund:

● it is a registered managed investment scheme (MIS) under Chapter 5C of the Corporations Act 2001 (Corporations Act).

● it is intended that the Fund will remain a MIS at least until the end of the ruling period.

● the Responsible Entity (RE) holds an Australian Financial Services License (AFSL).

● it is intended that only one class of Units will be issued in the Fund.

● the RE has never exercised a power capable of defeating a beneficiary's interest.

● the Fund does not meet the definition of an Attribution Managed Investment Trust (AMIT) and is therefore unable to elect into the AMIT regime.

● The Fund has a single class of units on issue. The class is a wholesale class of units.

● The Fund does not currently have any carried forward tax losses.

● At present, there is no expectation that the Fund will make a tax loss during any of the income years during the Ruling Period, but it is possible that a tax loss may be made depending on the performance of the market.

● The Fund seeks to make monthly cash distributions while having these distributions and the invested capital keep pace with inflation over time. In particular units pay out distributions at a specified fixed percentage rate applicable to all units.

● The Fund’s investment and distribution strategy is designed to provide investors regular stable cash flow from their investments in the Fund. The assets of the Fund are allocated across a broadly diversified selection of asset classes - including shares, bonds, cash, commodities and selected other investments.

● The RE has a diversified investment focus across a range of asset classes.

● The RE is seeking this ruling in order to obtain certainty around the tax treatment of the Fund while it continues to not satisfy the requirements to be a “managed investment trust” such that it is unable to elect to apply the AMIT regime.

● If, however, circumstances change and the Fund qualifies at a “managed investment trust”, the RE intends to elect for the AMIT regime to apply to the Fund.

Assumptions

Throughout the Ruling Period:

1. The Fund will remain a registered MIS.

2. The RE will hold an AFSL.

3. The beneficiaries of the Fund do not have fixed entitlements to all of the income and capital of Fund as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) and subsection 272-5(1) of Schedule 2F to the ITAA 1936.

4. The beneficiaries of the Fund do not have a vested and indefeasible interest in so much of the corpus of the Fund as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936?

5. The application and redemption price of Units in the Fund will be determined on the basis of the valuation of the assets and liabilities of the Fund in accordance with Australian accounting principles.

6. The Fund will not be an AMIT for the purposes of the ITAA 1997.

7. The Fund will have a single class of Units on issue.

8. The RE will not exercise a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the trust.

Relevant legislative provisions

Income Tax Assessment Act 1936

Section 272-5 of Schedule 2F

Subsection 272-5(1) of Schedule 2F

Subsection 272-5(2) of Schedule 2F

Subsection 272-5(3) of Schedule 2F

Section 272-35 of Schedule 2F

Section 272-65 of Schedule 2F

former section 160APHL

former subsection 160APHL(11)

former subsection 160APHL(14)

Income Tax Assessment Act 1997

Subsection 995-1(1)

Reasons for decision

Question 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 the Fund. However, the Commissioner considers that it is reasonable to exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the beneficiaries of the Fund as having fixed entitlements to all of the income and capital of the Fund.

Detailed reasoning

Generally

A ‘fixed trust’ is defined in subsection 995-1(1) of the ITAA 1997, and section 272-65 of Schedule 2F to the ITAA 1936. That definition provides that:

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

The definition of ‘fixed entitlement’ in subsection 995-1(1) of the ITAA 1997 provides that ‘an entity has a fixed entitlement to a share of the income or capital of a 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.’

Specifically

Subsection 272-5(3) of Schedule 2F to the ITAA 1936 contains a discretion, whereby in cases where beneficiaries do not have a fixed entitlement, the Commissioner may, for the purposes of the Act, treat such beneficiaries as having a fixed entitlement where it is reasonable to do so based upon the factors prescribed in paragraph 272-5(3)(b). Paragraph 272-5(3)(b) stipulates that the Commissioner may treat a beneficiary as having a fixed entitlement (in cases where in fact beneficiaries do not have a 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.

Therefore, it is a pre-condition of the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 that a beneficiary does not have a requisite fixed entitlement under subsection 272-5(1).

Although the PBR applicant does not argue that subsection 272-5(1) of Schedule 2F to the ITAA 1936 is satisfied in respect of the Constitution, for the purposes of the matters that the Commissioner is required to consider in deciding whether to exercise the discretion in subsection 272-5(3) it is necessary to identify powers which may defease a vested interest in the income or capital of the Fund.

The term ‘vested and indefeasible’ is not defined in the taxation legislation.

PCG 2016/16 does discuss the meaning of the terms ‘vested’ and ‘indefeasible’ in the context of section 272-5 of Schedule 2F to the ITAA 1936.

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.

The meaning of the term ‘vested and indefeasible’ (in the context of Schedule 2F to the ITAA 1936) has not been judicially considered, other than a discussion in Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 in the limited context of amending the constitution of a registered managed investment scheme under section 601GC of the Corporations Act.

However, the term ‘vested and indefeasible’ does appear 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) 198 CLR 494; 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490.

It is an essential element of subsection 272-5(1) of Schedule 2F to the ITAA 1936 that in order to have a fixed entitlement to a share of income or capital there must be a vested or indefeasible interest ’under a trust instrument’. In all cases, the determining factor in deciding if fixed entitlements exist will be the terms of the trust instrument under which the trust is constituted. Neither the form of the trust nor the labels that are attached to it can determine this question.

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the trust instrument is the Consolidated Constitution dated XX. It is accepted that the Constitution provides members with a vested interest in the income and capital of the Fund.

As per paragraph 16 of PCG 2016/16, the Constitution contains certain clauses by which a Unit Holder’s interest in a share of the income or capital of the Fund may be defeased. Therefore, it can be concluded, in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936, that all beneficiaries (Unit Holders of the Fund) do not have fixed entitlements to all of the income and capital of the Fund.

Clauses in the Constitution which contain powers which cause a beneficiary’s interest in the income or capital of the Fund to be defeasible

Clause A Issue of Units of different classes

Clause B Re-classification of Units

Clause C Classification of receipts

Clause D Application price for Units

Clause E Redemption of Units

Clause F Amendments to the Constitution

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

Subsection 272-5(3) of Schedule 2F to the ITAA 1936 contains a discretion, whereby in cases where beneficiaries do not have a fixed entitlement, the Commissioner may treat such beneficiaries as having a fixed entitlement, having regard to the factors prescribed in paragraph 272-5(3)(b).

In view of the conclusion above that the beneficiaries (Unit Holders) of the Fund do not have a vested and indefeasible interest in the income and capital of the Fund, and hence do not have a fixed entitlement pursuant to subsection 272-5(1) of Schedule 2F to the ITAA 1936, the only way that the beneficiaries can have a fixed entitlement is if the Commissioner exercises the discretion in subsection 272-5(3).

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

The beneficiaries (Unit Holders) of the Fund have a vested interest in the income and capital of the Fund, as detailed above.

Further, as per paragraph 25 of PCG 2016/16 the trust is not a discretionary trust or a trust with default income or capital beneficiaries - that is, no beneficial interest in the income or capital of the trust is capable of being defeated, partly or wholly, by the exercise of a power of appointment of income or capital by the trustee or other donee.

However, the beneficiaries (Unit Holders) do not have an indefeasible interest in the income and capital of the Fund.

In terms of subparagraph 272-5(3)(b)(i) –

The circumstances in which the defeasance of the interest can happen (in respect of the particular clauses of the Fund Constitution) have been discussed above.

In terms of subparagraph 272-5(3)(b)(ii) –

The likelihood of the defeasance happening (in respect of the particular clauses of the Fund Constitution discussed above):

It is considered unlikely that a defeasance of Unit Holder's interests will occur as the result of the existence of the powers contained within this clause of the Constitution.

In terms of subparagraph 272-5(3)(b)(iii) –

The nature of the trust:

● The Fund is a registered managed investment scheme under the Corporations Act, and thus subject to the controls contained in Chapter 5C;

● The RE of the Fund has certain fiduciary duties under Chapter 5C of the Corporations Act, and in particular the duties specified under subsection 601FC(1):

In exercising its powers and carrying out its duties, the responsible entity of a registered scheme must:

(a) act honestly; and

(b) exercise the degree of care and diligence that a reasonable person would exercise if they were in the responsible entity's position; and

(c) act in the best interests of the members and, if there is a conflict between the members' interests and its own interests, give priority to the members' interests; and

(d) treat the members who hold interests of the same class equally and members who hold interests of different classes fairly; and

(e) not make use of information acquired through being the responsible entity in order to:

(i) gain an improper advantage for itself or another person; or

(ii) cause detriment to the members of the scheme; and

(f) ensure that the scheme's constitution meets the requirements of sections 601GA and 601GB; and

(g) ensure that the scheme's compliance plan meets the requirements of section 601HA; and

(h) comply with the scheme's compliance plan; and

(i) ensure that scheme property is:

(i) clearly identified as scheme property; and

(ii) held separately from property of the responsible entity and property of any other scheme; and

(j) ensure that the scheme property is valued at regular intervals appropriate to the nature of the property; and

(k) ensure that all payments out of the scheme property are made in accordance with the scheme's constitution and this Act; and

(l) report to ASIC any breach of this Act that:

(i) relates to the scheme; and

(ii) has had, or is likely to have, a materially adverse effect on the interests of members;

as soon as practicable after it becomes aware of the breach; and

(m) carry out or comply with any other duty, not inconsistent with this Act, that is conferred on the responsible entity by the scheme's constitution.

● The RE of the Fund holds an Australian financial services licence (AFSL) authorising it to operate a managed investment scheme under section 601FA of the Corporations Act. As such it is required to meet the AFSL conditions as set out in ASIC Pro Forma 209, as well as the prescribed conditions under Regulation 7.6.04 of the Corporation Regulations.

● The RE of the Fund must comply with the terms of any ASIC Class Orders.

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 (in the absence of any express provision or explanatory guidance that indicates a different context is relevant). 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 Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 states (at paragraph 13.13) in respect of the Commissioner’s power in subsection 272-5(3) of Schedule 2F to the ITAA 1936 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 indicates that when looking at the facts of a case, in the context of the criteria listed in subsection 272-5(3) of Schedule 2F to the ITAA 1936, unless the context of the provision for which fixed entitlement is required provides otherwise, the Commissioner should always have regard to whether the absence of a fixed entitlement, in these circumstances, could result in the trafficking (or transfer) of the tax benefit of any tax losses.

It is noted that:

● The Fund does not currently have any carried forward tax losses.

● At present, there is no expectation that the Fund will make a tax loss during any of the income years during the Ruling Period, but it is possible that a tax loss may be made depending on the performance of the market.

● The RE currently does not forecast any deductions to be claimed for bad debts or debt/equity swap losses. The activities of the Fund and the portfolio in which it invests is unlikely to generate deductions of this kind.

On balance, it is reasonable to conclude that the transfer of the tax benefit of the tax loss deductions does not constitute a material risk.

Recommendation

As stated above, it is reasonable to conclude, based on the “trust instrument” of the Fund, that for the purposes of subsection 272-5(1), the beneficiaries (Unit Holders) of the Fund do not have fixed entitlements to any of the income and capital of the Fund.

However, pursuant to paragraph 272-5(3)(b) of Schedule 2F to the ITAA 1936, and after having regard to the requirements of subparagraphs 272-5(3)(b)(i), (ii) and (iii) and submissions from the applicant, it is submitted that it is appropriate that the Unit Holders of the Fund should be treated as having fixed entitlements to all of the income and capital of the Fund for the relevant income years.

In summary, as:

● the trust instrument (being the Constitution of the Fund) contains only minor provisions that may constitute defeasible powers;

● the Fund is a registered managed investment regime that is subject to Chapter 5C of the Corporations Act;

● The RE has an AFSL;

● the likelihood of defeasance is low; and

● there is little likelihood that a tax benefit of the Fund will be transferred,

there is a reasonable case for the Commissioner to exercise the discretion under subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat all of the Unit Holders of the Fund as having a fixed entitlement to their share of the income and capital of the Fund for the relevant income years.

Issue 2

Question 2

Summary

The terms of the trust instrument do not provide the beneficiaries with a vested and indefeasible interest in so much of the corpus of the Fund as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936. However, the Commissioner considers that it is reasonable to exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat the beneficiaries of the Fund as having a vested and indefeasible interest in so much of the corpus of the Fund as is comprised by the trust holding.

Detailed reasoning

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." [emphasis added]

No vested and indefeasible interest

It has already been determined, in relation to question 1, that the Unit Holders of the Fund do have a vested interest in a share of the capital of the Fund but not an indefeasible interest in a share of the capital of the trust, i.e. an interest in a share (or proportion) of all of the capital of the trust. (Note: The terms 'corpus' and 'capital' are considered to be synonymous for current purposes.)

Therefore, it follows that the Unit Holders of the Fund do not have a vested and indefeasible interest in so much of the corpus (capital) of the Fund as is comprised by the trust holding.

In view of the conclusion above that the beneficiaries (Unit Holders) of the Fund do not have a vested and indefeasible interest in so much of the corpus (capital) of the Fund 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 beneficiaries can have such a vested and indefeasible interest is if the Commissioner exercises the discretion in former subsection 160APHL(14).

Former subsection 160APHL(14) of the 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 subsections 160APHL(14)(a), (b) and (c) of the ITAA 1936.

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:

Former section 160APHL provides that in calculating the extent of a beneficiary’s interest, it is necessary to distinguish between the interest of a beneficiary in shares held by a widely-held trust (as defined below), and the interest of a beneficiary in shares held by other trusts.

The Fund 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 beneficiary has in each of the underlying shares in the fund [refer to paragraphs 4.26, 4.77 and 4.88 of the EM which accompanied the Taxation Laws Amendment Bill (No. 2) 1999.]

Although the method of calculating the interest that a beneficiary 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 are capable of having an interest in the trust holding.

The undivided equitable interest in the Trust Property that Unit Holders have constitute the requisite interest in the corpus of the trust as is comprised by the trust holding for current purposes.

Further, the trust is not a discretionary trust or a trust with default capital beneficiaries - that is, no beneficial interest in the capital of the trust is capable of being defeated, partly or wholly, by the exercise of a power of appointment of capital by the trustee or other donee.

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

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

As discussed above, although a Unit Holder's interest in the capital of the Fund is vested, the Constitution of the Fund contains certain clauses by which a Unit Holder’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; 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.

It has already been determined, above, that the Commissioner should exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 so that the Unit Holders of the Fund will be treated as having a fixed entitlement to (being a vested and indefeasible interest in) all of the capital of the Fund.

The factors in former paragraph 160APHL(14)(c) are identical, mutatis mutandis, to the factors in paragraph 272-5(3)(b) of Schedule 2F to the ITAA 1936, except for an additional factor in subparagraph (iv) of former paragraph 160APHL(14)(c).

The saving rule in former subsection 160APHL(13) of the ITAA 1936 is identical, mutatis mutandis, to the saving rule in subsection 272-5(2) of Schedule 2F to the ITAA 1936.

Also, the assumptions made in relation to this ruling application include that, ‘The RE will not exercise a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the trust.’

Therefore, for the reasons given in relation to Issue 1, the Commissioner will exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat the Unit Holders of the Fund as having a vested and indefeasible interest in so much of the corpus (capital) of the Fund as is comprised by the trust holding.

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