Edited version of private advice

Authorisation Number: 1051566582380

Date of advice: 14 August 2019

Ruling

Subject: Fixed trust

Question 1

Is the Trust a fixed trust within the meaning of section 272-65 in Schedule 1 of the Income Tax Assessment Act 1936?

Answer

No.

Question 2

Will the Commissioner exercise his discretion under section 272-5 in Schedule 1 of the ITAA 1936 to treat an interest in the income or capital of the Trust as being a fixed entitlement - such that the Trust is treated as a fixed trust for the purposes of the trust loss provisions?

Answer

Yes.

Question 3

Can any future trustees and/or unitholders of the Trust rely on this private binding ruling?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

Relevant facts and circumstances

The Trust is an Australian unit trust.

The corporate trustee is an Australian resident company - a wholly owned subsidiary of Company A. Company A holds the rights to certain works and has granted the corporate trustee of the Trust the licence to present the work. Prior to an internal reorganisation, the corporate trustee of the Trust was a wholly owned subsidiary of Company B and Company B held the aforementioned rights to the work and had granted the corporate trustee of the Trust the licence to present the work. As a result of that internal reorganisation Company A became the parent of Company B. Pursuant to the internal reorganisation, Company A acquired all the shares in the corporate trustee of the Trust) and Unit A of the Trust.

Company A is owned by 3 entities.

Following the internal reorganisation, ownership of Company A reflects the ownership of Company B prior to the reorganisation.

There are 2 classes of units:

·                    Unit A - the sole unit is held by Company A. Prior to the aforementioned internal reorganisation, Unit A was issued to Company B (i.e. the previous licensor and owner of the corporate trustee).

·                    Unit B - with a number of unit holders.

The beneficiaries' rights are vested against the Trustee pursuant to the rights to Distributable Income as set out in Clause X of the Trust Deed.

Clause X of the Trust Deed deals with the income of the trust fund - and relevantly, in broad terms, provides that:

·                    Unit B Holders are entitled to 50% of any Distributable Income which relates to certain revenue in proportion to the units held; and

·                    Unit A Holders are entitled to 50% of any Distributable Income which relates to certain revenue and any other Distributable Income in proportion to the units held.

The Distributable Income for the purposes of the Trust Deed reflects the treatment of Total Revenue for the purposes of the Investment Deed. The Investors have entered into an agreement to fund the production - by way of an initial limited recourse borrowing loan to the corporate trustee. The Investment Deed, that governs that funding arrangement, provides that the loan is to be repaid from the total revenue. Clause X of the Investment Deed sets out the manner in which the total revenue is to be dealt:

The total revenue shall be applied in the following manner for the following purposes and in the following order of priority:

·                    in payment of fees to the certain participants;

·                    in payment of the certain expenses;

·                    in payment of any other expenses and repayment of any loans or advances made to fund the other expenses together with any interest payable on any such loans or advances;

·                    in retaining (until released) any reserve or reserves for contingencies which the producer reasonably considers should be retained;

·                    in repaying in full the investor contributions to the relevant contributors up to an amount equal to their respective contributions to the capitalisation (including in the case of the investor, the investor contribution) according to the proportions that their respective contributions bear to the total investor contributions (and in the case of the investor, by reference to the investor contribution percentage);

·                    the balance of the total revenue then remaining after the deductions referred to items above, comprises the net profits of the production for the purposes of Investment Deed and will be the distributed subject to and in accordance with the Trust Deed.

Under the Trust Deed the corporate trustee has various discretions - including:

·                    Issue new units in the Trust- which is subject to requiring the Unit Holders' consent in particular, where there is an objection, it requires a Special Resolution being a resolution of a majority of no less than 75% of the votes cast by the unit holders present of the unit holders of each class, and market value (assuming that fair value means it will reflect market values).

·                    Classify receipts as being on income or capital account, and Unit A Holders and Unit B Holders have different rights to the income and capital of the Trust- which is subject to accounting principles and standards and noting that the unit holders are unrelated.

·                    Transfer all or any part of the Trust Fund to the trustee of any other trust - which is subject to market value (assuming that fair value means it will reflect market values).

·                    Appropriate all or part of the Trust Fund in satisfaction of the interest of any unit holder.

·                    Vary the Trust Deed- which is which is subject to requiring the Unit Holders' consent.

It is anticipated that no further units will be issued.

Thus far the Trustee has not exercised any powers to defeat the interest of any unit holder.

Until all of the losses that arose during this arrangement are utilised:

·                    Receipts will be classified as income or capital based on accepted accounting principles and standards.

·                    No powers will be exercised to defeat the interest of any unit holder.

·                    The trust deed will not be varied.

·                    There are restrictions on the right to transfer units.

·                    No new units will be issued.

Relevant legislative provisions

ITAA 1936 Section 272-5 in Schedule 2F

ITAA 1936 Section 272-65 in Schedule 2F

TAA 1953 Section 359-30 in Schedule 1

Reasons for decision

Issue 1

PCG 2016/16, explains that a trust is a fixed trust if the beneficiaries have fixed entitlements to all of the income and capital of the trust and confirms that a person will have a fixed entitlement to a share of income or capital of a trust if, under the trust instrument, that person has a vested and indefeasible interest in that share of income or capital. Relevantly, it explains when an interest is defeasible:

Indefeasible interests

15. An interest is defeasible if it can be defeated by the actions of one or more persons or by the occurrence of one or more subsequent events. An interest of a default beneficiary in the income or capital of the trust is an example of a defeasible interest.

16. Powers in modern trust instruments which cause a beneficiary's interests to be defeasible include:

·                    Broad powers to amend the trust instrument.

·                    Powers to issue new units after the trust is settled, or to redeem existing units.

·                    A power to reclassify existing units so that they do not all have equal rights to receive the income and capital of the trust.

·                    A power to classify receipts as being on income or capital account where the units that have been issued do not all have the same rights to receive the income and capital of the trust.

·                    A power to appoint a beneficiary's interest in the income or capital of the trust to another beneficiary.

·                    A power to settle or appoint any part of the corpus of the trust to a new trust with different beneficiaries.

·                    A power to enforce the forfeiture or cancellation of partly paid units due to the non-payment of a call except where such partly paid units would be void ab initio.

There are various clauses in the Trust Deed relating to the trustee's discretions that may cause a beneficiary's interests to be defeasible - including the power to:

·                    Issue new units in the Trust.

·                    Classify receipts as being on income or capital account, and Unit A Holders and Unit B Holders have different rights to the income and capital of the Trust.

·                    Vary the Trust Deed.

For these reasons, the Trust would not satisfy the definition of 'fixed trust' in section 272-65 of Schedule 2F of the ITAA 1936.

Issue 2

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) of Schedule 2F to the ITAA 1936.

In broad terms, there are 4 key matters that the Commissioner takes into account in deciding whether to exercise the discretion:

a)            the circumstances in which a beneficiary's interest is capable of being defeated or not vesting.

b)            the likelihood of the interest being defeated or not vesting;

c)            the nature of the trust; and

d)            whether the exercise of the discretion would enable a taxpayer to obtain a tax benefit from a trust with a tax loss in circumstances where the economic loss incurred was not borne by the taxpayer.

Paragraph 55 of PCG 2016/16 outlines factors favourable to the exercise of the Commissioner's discretion:

The Commissioner regards the following factors favourably when deciding whether to exercise the discretion:

·                    a trustee or manager has never exercised a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the trust

·                    commitments are made in unit holder agreements, Product Disclosure Statements or other documents with legal consequences that the trustee or manager will not exercise a power capable of defeating a beneficiary's interest at all, or in a way that is adverse to the rights of beneficiaries to receive the income and capital of the trust

·                    all beneficiaries have the same rights to receive the income and capital of the trust

·                    the trust instrument can only be amended with the unanimous (100%) approval of the beneficiaries

·                    although the trust instrument can be amended without the unanimous approval of beneficiaries, the approval percentage calculated on the current interest or unit holdings of beneficiaries effectively means that all beneficiaries must approve any amendment (for example, where the approval of 75% of unit holders is required to make the amendment and the smallest unit holding is more than 25% of the units)

·                    the trust instrument has been amended in accordance with section 601GC of the Corporations Act 2001 (so as to assist with the efficient administration of the trust) but no beneficial interests in the income and capital of the trust are adversely affected

·                    the beneficiaries whose rights to receive the income and capital of the trust have been adversely affected by the exercise of a power capable of defeating a beneficiary's interest have explicitly consented to that specific act (such as upon the redemption of the interests of an employee not covered by the savings rule upon the cessation of employment)

·                    the trustee or manager deals with the beneficiaries of the trust on an arm's length basis, and

·                    the trust would satisfy the basic and specific conditions (as applicable to the type of trust) for access to a safe harbour.

Factors adverse to the exercise of the Commissioner's discretion are listed in paragraph 56 of PCG 2016/16 and include:

The Commissioner regards the following factors unfavourably when deciding whether to exercise the discretion:

·                    a trustee or manager exercises a power to defeat beneficiaries' interests in the income or capital of the trust, however:

-                  the nature of the power that is exercised will be important, for example, compulsorily redeeming units where a unit holder's stake is less than a minimum specified in the trust instrument, and the unit holder receives the redemption price of those units, is unlikely to preclude the exercise of the discretion

-                  where external factors (such as those in the Global Financial Crisis) temporarily affect the ability of the trustee or manager to fund distributions or redemptions, this is unlikely to preclude the exercise of the discretion (for example, a temporary wholesale freezing or deferral of interests)

·                    there are significantly different beneficiaries of the trust in an income year for which an entity seeks to have a fixed entitlement, than the beneficiaries of the trust in the income year(s) in which the trust made a tax loss, or incurred a bad debt deduction or debt/equity swap deduction

·                    an arrangement has been entered into which would result in:

e)            section 272-35 having application

f)             the trafficking of the tax benefit of a tax loss, bad debt deduction or debt/equity swap deduction, or

g)            fraud or evasion.

Losses

The significant concern in this case is the utilisation of trust losses (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 intended to provide for special circumstances where there is a low likelihood of a beneficiary's vested interest being taken away or defeated and, having regard to the scheme of the trusts loss provisions to prevent the transfer of the tax benefit of losses and other deductions incurred by trusts, it would be unreasonable to treat the beneficiary's interest as not constituting a fixed entitlement.

This 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.

The beneficiaries of the Trust have a vested interest in the income and capital of the Trust. However, the beneficiaries do not have an indefeasible interest in the income and capital of the Trust.

The circumstances in which the defeasance of the interest can happen

The Commissioner accepts that the Trustee's undertaking in respect of their discretion to issue new units, deal with the classification of receipts, transfer or appropriate any part of the Trust Fund, or vary the trust deed mitigates the circumstances in which the beneficiaries' interests in the income and capital of the trust can be defeated.

The likelihood of the defeasance happening

The undertaking is that the powers contained in the following relevant clauses will not be exercised until the losses that arose during this arrangement are utilised:

·                    Defeat the interest of any unit holder - including transfer all or any part of the Trust Fund to the trustee of any other trust, and appropriate all or part of the Trust Fund in satisfaction of the interest of any unit holder.

·                    Vary the Trust Deed - which is subject to requiring the Unit Holders' consent.

·                    Grant the beneficiaries the right to transfer their units to an Australian entity.

·                    Issue new units in the Trust.

It is also noted that the Trustee will classify receipts as being on income or capital account with reference to accounting principles and standards.

The Commissioner accepts that consequently the likelihood of the beneficiaries' interests in the income and capital of the trust being defeated is low.

The nature of the trust

The Trust is a closely held investment trust, where the beneficiaries are unrelated parties.

Losses

No units will be transferred and no new units will be issued until the losses that arose during this arrangement are utilised.

As such, it is considered that, were the Commissioner to deem fixed entitlements to exist under subsection 272-5(3) of Schedule 2F to the ITAA 1936 this would not result in the integrity purpose of Schedule 2F to the ITAA 1936 being undermined.

Conclusion

It is accepted that based on the 'trust instrument' of the Trust that for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the beneficiaries of the Trust do not have fixed entitlements to any of the income and capital of the Trust.

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) of Schedule 2F to the ITAA 1936 and submissions from the applicant, it is considered that it is appropriate that the Unit Holders of the Trust should be treated as having fixed entitlements to all of the income and capital of the Trust for the relevant income years.

In summary, as:

·                    the trust instrument (being the Trust Deed) contains powers which have not been and will not be used to defease the interests of the beneficiaries in the income or capital of the Trust;

·                    the likelihood of defeasance is low; and

·                    there is little likelihood that a tax benefit of the Trust will be transferred

it is reasonable 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 Trust as having a fixed entitlement to their share of the income and capital of the Trust for the relevant income years.

Issue 3

Relevantly, section 359-30 in Schedule 1 of the TAA states that a private ruling given to or for the trustee of a trust and relating to the affairs of a trust also applies to the beneficiaries of the trust (unless it is an indirect or excise ruling) and another trustee who is appointed to replace the trustee:

359-30 Ruling for trustee of a trust

A *private ruling given to or for the trustee of a trust and relating to the affairs of the trust also applies to:

(a) if the ruling is not an *indirect tax or excise ruling - the beneficiaries of the trust; and

(b) in any case - another trustee who is appointed to replace a trustee.

Based on this, the ruling would apply to another trustee who steps into the shoes of the current trustee.

The Explanatory Memorandum to the Tax Laws Amendment (Improvements to Self Assessment) Bill (No. 2) 2005 explains the introduction of section 359-30 in Schedule 1 of the TAA:

Applying for a private ruling

3.67... Trustees may apply for private rulings about the affairs of the trust... However, a private ruling given to a trustee in respect of the tax affairs of a trust continues to apply where a new trustee is appointed and a ruling relating to the affairs of the trust also applies to the beneficiaries of the trust. In situations where the trustee is replaced, the private ruling continues to apply to the new trustee, or any trustee replacing the new trustee, provided the ruling would have applied to the former trustee.

The Commissioner confirms that a private ruling given to a trustee in respect of the tax affairs of a trust also applies to the beneficiaries of the trust and to any replacement trustee provided the ruling would have applied to the former trustee (which it would not have if, for example, the scheme in respect of which the private ruling is made is not materially the same as the scheme actually implemented). As such, the private binding ruling would not apply where future beneficiaries acting with the Trustee alter the nature of the scheme in respect of which the private ruling is made, that gives rise to a scheme that is materially different.

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