Edited version of private advice

Authorisation Number: 1051556053938

Date of advice: 26 July 2019

Ruling

Subject: Fixed interests

Question

Will the Commissioner exercise the discretion pursuant to former subsection 160APHL(14) of the Income Tax Assessment Act 1936 (ITAA 1936) to treat the Unitholders as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding?

Answer

Yes

This ruling applies for the following period:

1 July 2018 to 30 June 2020

The scheme commences on:

1 July 2018

Relevant facts and circumstances:

In relation to the Trust:

·        It was established by deed of settlement in July 201X.

·        It is an Australian resident unit trust.

·        It has XYZ Units on issue.

·        Only Units of a single class have ever been on issue.

·        It has had one Unitholder throughout its existence.

·        The Trustee will not exercise a power in the foreseeable future that is capable of defeating a beneficiary's interest in respect of income or capital of the Trust.

·        All beneficial interests in the income and capital of the trust are vested.

·        All beneficial interests have the same rights to receive income and capital of the trust.

·        All beneficial interests in the income and capital of the trust can be expressed as a percentage of the total income of the capital of the trust.

Assumptions:

Throughout the Ruling Period:

·        Only a single class of Units will remain on issue.

·        No fully or partly paid Units will be issued.

·        No Units will be repurchased.

·        No Units will be transferred.

·        No Units will be reclassified.

·        No streaming of income or capital will occur.

·        The Trustee will not exercise a power capable of defeating the Unitholder's interest to defeat the Unitholder's interest in the income or capital of the Trust.

An arrangement has not been entered into which would result in:

˗   a 'related payment' under former section 160APHN of the ITAA 1936;

˗   a Beneficiary of the Trust having materially diminished risks of loss or opportunities for gain of less than 30% in respect of shares held by the Trustee (refer to former section 160APHM of the ITAA 1936);

˗   a Beneficiary not being sufficiently exposed to the risk of loss or opportunity for gain in respect of the shares in the Trust as explained by ATO Interpretative Decision ATO ID 2014/10;

˗   the Commissioner making a determination under paragraph 177EA(5)(b) of the ITAA 1936;

˗   any of paragraphs 207-150(1)(c) to (h) of the ITAA 1997 (inclusive) applying; or

˗   fraud or evasion.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 177EA(5)

Income Tax Assessment Act 1936 former section 160APHD

Income Tax Assessment Act 1936 former section 160APHL

Income Tax Assessment Act 1936 former subsection 160APHL(11)

Income Tax Assessment Act 1936 former subsection 160APHL(13)

Income Tax Assessment Act 1936 former subsection 160APHL(14)

Income Tax Assessment Act 1936 former section 160APHM

Income Tax Assessment Act 1936 former section 160APHN

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

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise stated.

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 Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11). However, the Commissioner considers that it is reasonable to exercise the discretion in former subsection 160APHL(14) to treat the Unitholders, as 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.

Detailed reasoning

A "fixed interest" in the trust holding is defined in former subsection 160APHL(11) 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

The Trust Deed of the Trust contains powers which may defease the interest of a Unitholder in the corpus of the Trust.

(Note: The terms 'corpus' and 'capital' are considered to be synonymous for current purposes.)

As the beneficiaries do not have a vested and indefeasible interest in so much of the corpus (capital) of the Trust as is comprised by the trust holding pursuant to former subsection 160APHL(11), 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).

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

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 paragraph 160APHL(14)(a) contains a 'threshold' condition that the taxpayer has an interest in the corpus of the trust.

An interest for these purposes is considered to be a 'vested interest' and not a 'contingent' interest. An example of a contingent interest is one that relies upon the exercise, or the non-exercise, of a trustee's discretion in relation to the income or capital of a trust.

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 (as defined below), 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.

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.

Vested interests in the Trust Deed

Certain clauses of the Trust Deed effectively provide that the beneficial interest in the Trust Fund shall be vested in the Unitholders and that distributions thereof shall be to the Unitholders on a proportional basis.

Further, interests of the Unitholders are not contingent. That is, the trust is not a discretionary trust or a trust with default capital beneficiaries - such that, 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 Unitholder's interest in the corpus (Trust Fund) of the Trust is vested, the Trust Deed contains certain clauses by which a Unitholder's interest in a share of the corpus 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.

Clauses in the Trust Deed which contain powers which cause a beneficiary's interest in the income or capital of the Trust to be defeasible

The meaning of the term 'vested and indefeasible' (in the context of former section 16APHL) has been judicially considered in Re Soubra and Federal Commissioner of Taxation - (8 October 2009) - [2009] AATA 775; 2009 ATC 10-113; (2009) 77 ATR 946. In that case the Tribunal referred to the meaning of the term 'vested and indefeasible' as follows (at 3154 and 3155):

32. Section 160APHL(11) provides that for the purposes of subsection (10), a taxpayer's interest in the trust holding is a fixed interest to the extent that the interest is constituted by a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding.

33. As Hill J explained in

Dwight v Commissioner of Taxation 92 ATC 4192; (1992) 37 FCR 178, the words vested and indefeasible in the context of trust law are technical legal words of limitation, which have a well understood meaning to property conveyancers. He said, at 192:

"... Estates may be vested in interest or vested in possession, the difference being between a present fixed right of future enjoyment where the estate is said to be

2009 ATC 3155

vested in interest and a present right of present enjoyment of the right, where the estate is said to be vested in possession:

Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490 at 496 per Griffith CJ, at 501 per Isaacs J. A person with an 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 can not...."

34. As Mr Sest submitted, the use of the conjunctive phrase vested and indefeasible indicates the right must be absolute: see

Saunders v Vautier (1841) 49 ER 282. Mr Sest submitted an interest is defeasible where it is subject to a condition subsequent. He cited the following examples where this may occur:

(a) where that is the effect of the trust deed;

(b) where a beneficiary interest is disposed of by the trustee in the course of administration of the trust prior to vesting day;

(c) where there exists a contingency that the person may not be a beneficiary as at the vesting date; and

(d) where the beneficiary's vested interest is able to be divested by the exercise of a power by the trustee (or any other person).

In Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 the Federal Court considered the term in the limited context of amending the constitution of a registered managed investment scheme under section 601GC of the Corporations Act 2001.

The term 'vested and indefeasible' also appears 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

In terms of former subparagraph 160APHL(14)(c)(i)

Circumstances exist in which the defeasance of the interest can happen (in respect of the particular clauses of the Trust Deed).

In terms of former subparagraph 160APHL(14)(c)(ii)

In relation to the likelihood of the defeasance happening (in respect of the particular clauses of the Trust Deed discussed above) the Assumptions that will apply throughout the Ruling Period include that:

˗   The Trustee will not exercise a power capable of defeating the Unitholder's interest to defeat the Unitholder's interest in the income or capital of the Trust.

Also, throughout the Ruling Period the Trust will have only one Unitholder.

As such, the likelihood of a beneficiary's interest being defeated due to the existence of the amendment clause is considered to be low.

In terms of former subparagraph 160APHL(14)(c)(iii)

The nature of the trust:

·        The Trust is a closely-held trust that holds ownership interests in a bona fide business venture conducted between arm's length parties.

In terms of former subparagraph 160APHL(14)(c)(iv)

Any other matter the Commissioner thinks relevant:

·        The discretion in former subsection 160APHL(14) pertains to the utilisation of a tax offset for a share of the franking credit on a franked distribution. It was introduced as a part of integrity measures aimed at defeating franking credit trading schemes.

·        The EM which accompanied the introduction of former subsection 160APHL(14) outlined the purpose of the integrity measures:

4.6 One of the underlying principles of the imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves: a degree of wastage of franking credits is an intended feature of the imputation system.

4.7 In substance, the owner of shares is the person who is exposed to the risks of loss and opportunities for gain in respect of the shares. However, franking credit trading schemes allow persons who are not exposed, or have only a small exposure, to the risks and opportunities of share ownership to obtain access to the full value of franking credits, which often, but for the scheme, would not have been used at all, or would not have been fully used. Some of these schemes may operate over extended periods, and typically involve a payment related to the dividend which has the effect of passing its benefit in economic terms to a counterparty. The schemes therefore undermine an underlying principle of imputation.

·        As such, when considering the exercise of the discretion in former subsection 160APHL(14) the Commissioner must be mindful not to undermine the intended effect of the integrity measures themselves.

·        It is noted that certain assumptions have been included which will prevent the purpose of the integrity measures from being undermined, namely:

·        An arrangement has not been entered into which would result in:

˗   a 'related payment' under former section 160APHN;

˗   a Beneficiary of the Trust having materially diminished risks of loss or opportunities for gain of less than 30% in respect of shares held by the Trustee (refer to former section 160APHM);

˗   a Beneficiary not being sufficiently exposed to the risk of loss or opportunity for gain in respect of the shares in the Trust as explained by ATO Interpretative Decision ATO ID 2014/10;

˗   the Commissioner making a determination under paragraph 177EA(5)(b);

˗   any of paragraphs 207-150(1)(c) to (h) of the ITAA 1997 (inclusive) applying; or

˗   fraud or evasion.

Conclusion

The beneficiaries 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, for the purposes of former subsection 160APHL(11).

However, pursuant to the requirements of former subparagraphs 160APHL(14)(c)(i), (ii) and (iii) it is considered appropriate that the Unitholders should be treated as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding.

In summary, as:

·        the Trust Deed contains only minor provisions that may constitute defeasible powers (that have not been used to defeat Unitholder's interest in the Corpus of the Trust);

·        the Trustee will not exercise a power capable of defeating a Unitholder's interest to defeat a Unitholder's interest in the income or capital of the trust;

·        the likelihood of defeasance is low; and

·        there is little likelihood that a franking credit trading scheme will ensue;

there is a reasonable case for the Commissioner to exercise the discretion under former subsection 160APHL(14) to treat the Unitholders as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding throughout the Ruling Period.

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).