Edited version of your written advice

Authorisation Number: 1051474148761

Date of advice: 16 January 2019

Ruling

Subject: Trust net income

Question 1

Is the net income (as that term is defined in subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936)) of the Trustee of the Trust assessable under section 99A of the ITAA 1936?

Answer

Yes

This ruling applies for the following period:

1 July 2017 to 30 June 2018

The scheme commences on:

1 July 2017

Relevant facts and circumstances

Trust Deed (relevantly) provides that:

1. (c)

(iii) “Beneficiaries” – the lessees under the Leases…

(xiii) “Trust Fund” – all the moneys and assets of the Trust from time to time

(xv) “Unit Entitlement” – the Unit Entitlement in respect of a Unit shown in Schedule “A”

4 Surplus

Whenever the Trustee is of the opinion that the funds held by it exceed the amount required for the purpose of this Trust, the Trustee may pursuant to a unanimous resolution of the Advisory Committee, distribute the surplus to or grant credits for the benefit of the Beneficiaries in proportion to the Unit Entitlement of their respective Units.

16 Determination by the Trustee

Any determination or resolution of the Trustee under any of the provisions of the Deed shall be recorded in a written minute and such minute shall be signed by the Trustee and kept with the accounts and records of the Trust Fund. A decision or resolution by a Trustee which is a corporation may be made or passed by a meeting of directors duly constituted pursuant to the articles of association of such company.

There is no income distribution clause contained within the Trust Deed.

In respect of the year of income ended 30 June 2018 and clause 4 of the Trust Deed:

● The Trustee did not form an opinion that that the funds held by it exceed the amount required for the purpose of the Trust;

● A unanimous resolution of the Advisory Committee was not made.

The Trustee accumulates any net income each year and uses it as working capital.

No cash is actually distributed to Beneficiaries - it is all kept in the Trust Fund.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1936 Subsection 95(1)

Income Tax Assessment Act 1936 Section 97

Income Tax Assessment Act 1936 Subsection 97(1)

Income Tax Assessment Act 1936 Section 98

Income Tax Assessment Act 1936 Section 99

Income Tax Assessment Act 1936 Section 99A

Income Tax Assessment Act 1936 Subsection 99A(4)

Income Tax Assessment Act 1936 Division 6

Income Tax Assessment Act 1936 Division 6E

Income Tax Assessment Act 1997 Subdivision 115-C

Reasons for decision

Summary

As the Unitholders are not assessable on a share of the net income of the Trust under subsection 97(1) of the ITAA 1936 the Trustee is assessable on the net income of the Trust under subsection 99A(4) of the ITAA 1936.

It is problematic as to whether clause 4 of the Trust Deed provides the Trustee with a power to distribute trust income.

However, even upon proceeding on the assumption that such a power does exist the Unitholders in the Trust did not have a present entitlement to the income of the Trust as the terms of clause 4 of the Trust Deed:

● are not ‘self-executing’ such that the Unitholders of the Trust do not automatically become presently entitled to the income of the Trust;

require:

● an opinion to be formed that that the funds held by it exceed the amount required for the purpose of the Trust; and

● a unanimous resolution of the Advisory Committee to be made.

And these requirements were not satisfied.

The Unitholders do not have vested and indefeasible interests in the income of the Trust for the purposes of clause 4 of the Trust Deed or any other of its terms.

Detailed reasoning

Taxation of the net income of a trust generally

The net income of a trust estate for a particular year is calculated in accordance with section 95 of the ITAA 1936. Broadly, it is the amount that would have been the trustee's taxable income if it were assumed that the trustee was a resident taxpayer. The net income is assessed to the trustee or to beneficiaries of the trust in accordance with the rules set out in Division 6 of Part III of the ITAA 1936.

Section 97 of the ITAA 1936 provides (subject to certain exceptions not relevant in this case) that a beneficiary who is presently entitled to a share of the income of a trust estate must include in their assessable income that share of the net income of the trust estate.

A trust beneficiary is presently entitled to a share of the income of the trust estate if (and only if) the beneficiary has an interest in the income which is both vested in interest and vested in possession, and the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.

The liability to taxation on the net income of a trust is generally determined under the following sections:

● Section 97 of the ITAA 1936, which applies where a beneficiary is presently entitled to a share of the net income and is not under a legal disability

● Section 98 of the ITAA 1936, which applies where a beneficiary is presently entitled but is under a legal disability; and

● Sections 99 and 99A of the ITAA 1936, which apply where there is an absence of present entitlement of the beneficiary to all or some of the net income of the trust estate.

However, Division 6E of the ITAA 1936 refers the determination of the liability to tax on capital gains made by a trust to Subdivision 115-C of the ITAA 1997.

Where the whole or some part of the net income of a trust estate for a year of income is not assessable under section 97 or 98 of the ITAA 1936, the net income or that part is assessable to the trustee in accordance with section 99 or 99A of the ITAA 1936.

Taxation of the net income of the Trust

In the present case, the abovementioned rules apply such that if subsection 97(1) of the ITAA 1936 does not apply to assess the Beneficiaries in respect of a share of the net income of the Trust then the Trustee will be assessed under subsection 99A(4).

Present entitlement under a unitised trust

A beneficiary can become presently entitled to an amount from a trust pursuant to a direct term of the relevant trust deed, or as a result of the trustee of the trust exercising a power under a trust deed to make the beneficiary so entitled (usually by resolution) [TD 2012/74].

The terms of the Trust Deed are paramount in this regard. There is no term contained within the Trust Deed that creates an automatic present entitlement to the income of the Trust.

If clause 4 is viewed as containing a power of the Trustee to distribute the income of the Trust then any interests that may arise from it are contingent upon the Trustee forming the requisite opinion and then for the unanimous resolution to be passed by the Advisory Committee.

Under the terms of the Trust Deed, can a Beneficiary of the Trust be presently entitled to a share of the Division 6 Distributable Trust Income for the purposes of subsection 97(1) of the ITAA 1936?

Paragraph 12 of TR 2012/D1 provides that the income of the trust estate for section 97 of the ITAA 1936 purposes is the ‘distributable income’:

Amount beneficiary can be made presently entitled to

12. In the context of Division 6, the 'income of the trust estate', is not a reference to the gross income of a trust estate, but rather a reference to the net amount of income to which a beneficiary could be made presently entitled or accumulated. That is, it is a reference to the income available for distribution to beneficiaries or accumulation by the trustee, commonly referred to as 'distributable income'.

A beneficiary is only presently entitled to income if they have:

(a) an interest in the income which is both vested in interest and vested in possession; and

(b) a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment. [FCT v. Bamford [2010] HCA 10 at [37]; 75 ATR 1; 2010 ATC 20-170; Harmer v. FCT (1991) 173 CLR 264 at [271]; 22 ATR 726; 91 ATC 5000.] (paragraph 13 of TD 2018/9)

(a) an interest in the income which is both vested in interest and vested in possession

The particular terms of the Trust Deed are paramount in determining whether the requirements for present entitlement have been satisfied.

It is asserted that the Trust is a ‘fixed unit trust’ and that, as a result, each Beneficiary has a vested and indefeasible interest in the income of the Trust. It is implied that that no Trustee resolution is required as a result (due to vested and indefeasible interests already existing under the terms of the Trust Deed).

The term ‘fixed unit trust’ is not defined but it is assumed that it is a reference to a trust in which the interests of the beneficiaries in the income (and capital) are vested and indefeasible (Harmer & Ors v FC of T 91 ATC 5000).

It is asserted that there are a number of Unitholders that are fixed and that, therefore, the Trust is a ‘fixed unit trust’.

However, it is insufficient that there be a fixed number of Unitholders without there also being the accompanying terms in the Trust Deed to create the vested interests in the income of the Trust.

Clause 4 of the Trust deed

This clause provides that:

4 Surplus

Whenever the Trustee is of the opinion that the funds held by it exceed the amount required for the purpose of this Trust, the Trustee may pursuant to a unanimous resolution of the Advisory Committee, distribute the surplus to or grant credits for the benefit of the Beneficiaries in proportion to the Unit Entitlement of their respective Units.

It is noted that clause 4 does not refer to the income of the Trust specifically but only to funds (that are ‘surplus’).

The term ‘funds’ is not defined in the Trust Deed. The term ‘Trust Fund’ is defined and means ‘… all the moneys and assets of the Trust from time to time…’

In relation to the term ‘income of a trust, paragraph 64 of TR 2012/D1 provides that:

It is clear then that the determination of the income of a trust is grounded in trust law and generally involves a focus on the receipts and outgoings for an income year. The reference to trust law in this context encompasses various factors, including the general law, statutory law, trust accounting principles, the trust deed, the actions taken by the trustee in accordance with the deed (including a resolution to appoint income or capital to particular beneficiaries) and the settlor's intention.

There is considerable doubt as to whether a ‘surplus of funds’ as per clause 4 of the Trust Deed can be assimilated with the term ‘income of the Trust’ for the purposes of section 97 of the ITAA 1936. Therefore, there is also considerable doubt that clause 4 is capable of conferring a present entitlement to, or distributing, the income of the Trust.

In any case it is apparent that any interest that the Unitholders may have in the income of the Trust can only be created under Clause 4 of the Trust Deed after certain events happen. That is, such interests are contingent upon (i) the Trustee forming an opinion that a surplus exists; and (ii) a unanimous resolution of the Advisory Committee happening.

As such, any interest in the income of the Trust that may be created under clause 4 of the Trust Deed is a ‘contingent interest’ and, as such, cannot be a ‘vested interest’.

Interest is defeasible

It is noted that clause 11 of the Trust Deed provides a power to vary the Trust Deed.

The Federal Court has held that a power of the trustee or manager to amend the constitution of the trust results in the beneficiaries' interests being defeasible and, consequently (see Colonial First State Investments Ltd v. Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 at [94] - [106].)

As such, not only are the interests of the beneficiaries in the income of the Trust contingent but they are also defeasible.

Note: The above conclusion also precludes subsection 95A(2) of the ITAA 1936 from applying to the income of the Trust. As stated by Hill J in in Trustees of the Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4525: ‘…an interest in income will be vested where the holder has an immediate fixed right of present or future enjoyment. A contingent interest would not suffice. An interest will be indefeasible where it is not subject to any condition…’ [at 4541]

(b) a present legal right to demand and receive payment of the income

No particular Unitholder has a present legal right to demand and receive a payment of the income.

The objects, as stated in clause 2 of the Trust Deed, require that expenditure be made in a wide range of circumstances that concern the operational matters to the ultimate benefit of the Unitholders. Under the Trust Deed the Trustee may accumulate any income of the Trust (net income for the purposes of subsection 95(1) of the ITAA 1936) each year and use it as working capital in the pursuit of the objects of the Trust. The actions of the Trustee support a conclusion that the income of the Trust was derived and retained by the Trustee for use as working capital of the Trust with no rights created that would enable a Unitholder to demand and receive a proportionate share of that income.

Relevant case law

A conclusion that no Unitholder is presently entitled to the income of the Trust is consistent with the decisions made in the cases of:

Pearson v FCT (2006) 64 ATR 109: In that case the unitholder in a unit trust was not presently entitled because its trust deed required the trustee to resolve that income be distributed (and no such resolution had been passed). Under the terms of the unit trust deed, in the absence of a trustee resolution, the income automatically formed a part of the unit trust fund (corpus).

Trustees Executors & Agency Co Ltd v Acting FC of T [(1918) 23 CLR 576; sub nom In the Will of McGregor, Trustees, etc v FC of T, (1918) R & McG 9] where surplus income of the trust was held to be income which no one was presently entitled.

Overall conclusion as to whether there is a present entitlement for the purposes of subsection 97(1) of the ITAA 1936

The requirements for the existence of a present entitlement to the income of the Trust do not exist as:

(a) an interest in the income which is both vested in interest and vested in possession does not exist – any interest in the income under clause 4 of the Trust Deed (or any other clause) is a contingent one; and

(b) a present legal right to demand and receive payment of the income does not exist.

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