Edited version of your private ruling

Authorisation Number: 1051812191788

Date of advice: 23 March 2021

Ruling

Subject: Fixed trust entitlements - discretion

Question 1

Will the beneficiaries of the Trust have fixed entitlements to all of the income and capital of Trust 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 Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

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

Answer

Yes

This ruling applies for the following period:

1 July 20xx to 30 June 2024

The scheme commences on:

September 20xx

Relevant facts and circumstances

The Trust was established by the Deed as an Australian resident unit trust and had two original unit holders, both of which are trustees of self-managed superannuation funds (SMSFs 1 and 2). On establishment of the Trust, the unit holders both held a 50% beneficial interest in the Trust respectively.

A member from each of SMSF 1 and SMSF 2 is a director of the corporate trustee of the Trust.

The Trust was established in September 20xx by issuing of units as follows:

SMSF 1: 50% of total units at $1 each

SMSF 2: 50% of total units at $1 each.

Additional units were issued in April 2019 as follows:

B Pty Ltd: units at $x.x0 each

SMSF 2: units at $x.x0 each.

An external valuation exercise was undertaken at the time these units were issued to ensure that the units were issued at market value.

The units in the Trust are not listed on any stock exchange and are not anticipated to be listed in the foreseeable future.

In accordance with the requirements of the Deed, a Deed of Variation was executed in July 20xx to remove certain clauses/powers which, although provided flexibility, were never used and were considered by the Trustee and the unitholders to be unnecessary in the circumstances.

The Trust is not a Managed Investment Scheme (MIS) under Chapter 5C of the Corporations Act 2001 (Cth) (Corporations Act) and is not a widely-held unit trust.

The Trust is not the holder of an Australian Financial Services License for the purpose of Part 7.6 of the Corporations Act.

The Unit Holders made their investments by subscribing for units in the Trust.

The Trust is currently owned as follows:

•         xx.xxx% by SMSF 1

•         x.xxx% by B Pty Ltd

•         50% by SMSF 2

SMSF 1 and B Pty Ltd are associates of each other and together hold 50.0% of the units in the Trust.

SMSF 1 and SMSF 2 are not 'associates' or 'connected entities' of each other for tax purposes (having regard to section 318 of the ITAA 1936).

The Trust holds development properties. The Trust has three unitholders who have respectively invested into the Trust for commercial reasons (i.e. to derive prospective returns from the development of the underlying properties).

The Trustee considers that the Trust meets the requirements to fall within the safe harbour set out in Practical Compliance Guideline PCG 2016/16: Fixed entitlements and fixed trusts. However, the Trustee has requested the exercise of the Commissioner's discretion to ensure that the Trustee has certainty in relation to whether the Trust is a fixed trust.

Deed

The pertinent terms of the Deed are as follows:

General entitlement of Unitholders: The Unitholders are entitled to the benefit of the Trust Fund in the proportion in which they are registered as holding Units from time to time, but an individual Unitholder is not entitled to any particular asset, Security or investment comprised in the Trust Fund or to the transfer to that Unitholder of any property or assets comprised in the Trust fund except in accordance with the provisions of this deed.

Additional Units: The Trustee may, with the consent of the Unitholders, create and issue additional units.....

Redemption of Units: (a) With the consent of the Unitholders, the Trustee may reduce the Trust Fund by the redemption of any Units in the Trust.....

Payments from distribution account:

a)    Subject to clause on interim distributions, as soon as practicable after the end of each Financial Year the Trustee must distribute to the Unitholders the amount (if any) standing to the credit of the distribution account, in the proportion in which they were registered as holding Units on the last day of the Financial Year to which the distribution relates.

b)    Subject to the above paragraph, the Unitholders as at the end of the Financial Year will be presently entitled to the Income standing to the credit of the distribution account in the proportion in which they were registered as holding Units on the last day of that Financial Year.

Amendment of Deed: The Trustee may with the consent of the Unitholders by deed amend or add to this deed and, on the execution of any supplemental deed, this deed has effect as amended or added to by the supplemental deed.

Deed variation

In July 20xx the Deed was varied to delete the following clauses in their entirety:

Unit classes and special rights: With the consent of the Unitholders, the Trustee may issue units of different classes with such preferred, deferred or other special rights or such restrictions whether in regard to Income, capital, voting rights or otherwise as the Trustee determines.

Party paid Units: With the consent of Unitholders, the Trustee may issue units on the basis of part payment of the addition to the Trust Fund required by paragraph 3.3(a) (Additional Units) and payment of the balance on terms approved by the Trustee.

Throughout the ruling period

No powers will be exercised to defeat the interest of any unitholder, including:

•         There will only be one class of units - i.e. no units of different classes will be issued.

•         No units will be reclassified. The rights attached to units already in existence will not be modified.

•         Units will only be redeemed at the request of a unitholder.

•         Units will be issued or redeemed for a price determined on a basis that satisfies the 'savings rule' in subsection 272-5(2) of Schedule 2F to the ITAA 1936 - i.e. on the basis of the unit trust's net asset value, according to Australian accounting principles, at the time of the issue or redemption  having regard to paragraph 19 of PCG 2016/16 .

•         No partly paid units will be issued.

•         No units will be transferred.

•         No streaming of income or capital will occur.

•         The trust deed will not be amended, varied etc, where the effect of such amendment or variation would be to defease a unitholders interest in the income or capital of the Trust.

•         In the event the trust is terminated, all unitholders will be entitled to the income and capital of the trust in proportion to their unitholding - the trustee will not transfer assets rather than pay cash in satisfaction of amounts owing a part of winding up the trust to any particular unitholder.

•         Trustee has not and will not redeem units of unit holders on a basis different the proportional holdings of the unitholders, with or without consent of the unitholders.

The Trustee and Unit Holders have not and will not enter into an arrangement during the Ruling period which would result in section 272-35 in Schedule 2F of the ITAA 1936 having application, in the trafficking of the tax benefit of a tax loss, bad debt deduction or debt/equity swap deduction, or in fraud or evasion.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 272-5 of Schedule 2F

Income Tax Assessment Act 1936 section 272-35 of Schedule 2F

Income Tax Assessment Act 1936 section 272-65 of Schedule 2F

Other relevant documents

PCG 2016/16: Fixed entitlements and fixed trusts

Does the meaning of Non-arm's length income apply to this ruling?

Non-arm's length income (NALI) is defined in section 295-550 of the ITAA 1997 and applies where income has been derived by a complying superannuation fund. It covers private company dividends, including income derived indirectly from a dividend and non-share dividends, income from a non-arm's length transaction, income received from a trust in the capacity of beneficiary other than by virtue of holding a fixed entitlement, non-arm's length income received from a trust in the capacity of beneficiary with a fixed entitlement and from 1 July 2018, where the fund incurred expenses in deriving the income that are less than, including nil expenses, those which the fund would otherwise have been expected to incur if the parties were dealing on an arm's-length basis.

If the factors set out in section 295-550 apply to the income of the Trust or the income of the unitholders, the income will be taxed at the highest marginal rate.

We have not considered the application of section 295-550 of the ITAA 1997 to the arrangement, or to an associated or wider arrangement of which that arrangement is part.

Reasons for Decision

Question 1

Summary

The Unit Holders as beneficiaries of the Trust do not have fixed entitlements to all of the income and capital of Trust as defined in subsection 995-1(1) of the ITAA 1997 and subsection 272-5(1) of Schedule 2F to the ITAA 1936.

Detailed reasoning

The term 'fixed trust' is defined in subsection 995-1(1) of the ITAA 1997 and section 272-65 of Schedule 2F to the ITAA 1936 to mean a trust in which entities or persons (respectively):

... have fixed entitlements to all of the income and capital of the trust.

The definition of the term '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.'

Subsection 272-5(1) of Schedule 2F to the ITAA 1936 defines a 'fixed entitlement' in a trust:

If, under a trust instrument, a beneficiary has a vested and indefeasible interest in a share of income of the trust that the trust derives from time to time, or of the capital of the trust, the beneficiary has a fixed entitlement to that share of the income or capital.

In addition, subsection 272-5(2) states that:

If:

(a) a person holds units in a unit trust; and

(b) the units are redeemable or further units are able to be issued; and

(c) if units in the unit trust are listed for quotation in the official list of an approved stock exchange - the units held by the person will be redeemed, or any further units will be issued, for the price at which other units of the same kind in the unit trust are offered for sale on the approved stock exchange at the time of the redemption or issue; and

(d) if the units are not listed as mentioned in paragraph (c) - the units held by the person will be redeemed, or any further units will be issued, for a price determined on the basis of the net asset value, according to Australian accounting principles, of the unit trust at the time of the redemption or issue;

then the mere fact that the units are redeemable, or that the further units are able to be issued, does not mean that the person's interest, as a unit holder, in the income or capital of the unit trust is defeasible.

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:

Paragraphs 15 and 16 of PCG 2016/16 define 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.

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the trust instrument consists of the Deed (as amended). It is accepted that the Deed provides the unitholders with a vested interest in the income and capital of the Trust.

However, 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 - including different classes of units.

•         Classify receipts as being on income or capital account.

•         Vary the Deed.

Therefore, the Unit Holders as beneficiaries of the Trust do not have a fixed entitlement to a share of the income or capital of the Trust for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936.

Question 2

Summary

As the Unit Holders in the Trust do not have vested and indefeasible interests, pursuant to subsection 272-5(1) of Schedule 2F to the ITAA 1936, subsection 272-5(3) of Schedule 2F may be considered. The Commissioner considers that it is reasonable to exercise the discretion in subsection 272-5(3) of Schedule 2F to treat the Unit Holders as beneficiaries of the Trust as having fixed entitlements to all of the income and capital of the Trust.

Detailed reasoning

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) of Schedule 2F to the ITAA 1936 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).

In broad terms, there are four 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 all 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
• the trust is governed by a foreign law that is similar to Chapter 5C of the Corporations Act 2001, 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:

a)    section 272-35 having application

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

c)     fraud or evasion.

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.

Paragraph 272-5(3)(a) of Schedule 2F to the ITAA 1936:

The Deed provides the Unit Holders with vested interests in a share of the income that the Trust derives from time to time and a share of the capital of the Trust. Each unitholder of the Trust does not, however, have a fixed entitlement to the share of income and capital in the trust. As a result, paragraph 272-5(3)(a) of Schedule 2F to the ITAA 1936 is satisfied.

Subparagraph 272-5(3)(b)(i) of Schedule 2F to the ITAA 1936:

In relation to the circumstances in which the entitlement is capable of not vesting or the defeasance happening, the following factors are relevant:

Issue of units: The Trustee may issue only one class of Units. The Trustee must only issue fully paid units. If units are issued during the Ruling period, the units will only be issued for a price determined on the basis of the Net Fund Value or Net Asset Value (according to Australian accounting principles) of the Trust at the time of issue. As such the savings rule in paragraph 272-5(2)(d) would be satisfied.

Redemption of units: The Trustee may redeem units with the consent of the unitholders. The redemption price is determined on the basis of the Net Fund Value or Net Asset Value (according to Australian accounting principles) of the Trust at the time of redemption. As such, the savings rule in paragraph 272-5(2)(d) of Schedule 2F to the ITAA 1936 would be satisfied.

Amendment of the Trust Deed: The Trustee may amend the Deed with the consent of the unitholders or by the execution of any supplemental deed. As at the date of this ruling application, amongst other things, the Trustee has amended the Deed to delete the following clauses in their entirety:

•       Classes and special rights

With the consent of the Unitholders, the Trustee may issue units of different classes with such preferred, deferred or other special rights or such restrictions whether in regard to Income, capital, voting rights or otherwise as the Trustee determines.

•       Party paid Units

With the consent of Unitholders, the Trustee may issue units on the basis of part payment of the addition to the Trust Fund required by paragraph 3.3(a) (Additional Units) and payment of the balance on terms approved by the Trustee.....

The Trustee will not seek to further amend or vary the Deed during the Ruling period.

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 Commissioner accepts that the undertakings by the Trustee mitigate the circumstances in which the beneficiaries' interests in the income and capital of the trust can be defeated.

Subparagraph 272-5(3)(b)(ii) of Schedule 2F to the ITAA 1936:

In relation to the likelihood of the entitlement not vesting, or the defeasance happening, the following factors are relevant:

The Trustee's behaviour from the time the Trust was settled to the date of this ruling application is relevant. It is noted that the Trustee's private ruling application is dated 4 July 2019 while the Trust was settled on 25 September 2015. The defeasible powers contained in the Deed have not been exercised to defease any of the requisite interests of the Unit holders.

In respect of the Ruling period ending 30 June 2024, the Trustee may exercise its powers under the Deed such that:

•         There will only be one class of units - i.e. no units of different classes will be issued.

•         No units will be reclassified. The rights attached to units already in existence will not be modified.

•         Units will only be redeemed at the request of a unitholder.

•         Units will be issued or redeemed for a price determined on a basis that satisfies the 'savings rule' in subsection 272-5(2) of Schedule 2F to the ITAA 1936 - i.e. on the basis of the unit trust's net asset value, according to Australian accounting principles, at the time of the issue or redemption  having regard to paragraph 19 of PCG 2016/16.

•         No partly paid units will be issued.

•         No units will be transferred.

•         No streaming of income or capital will occur.

•         The trust deed will not be amended, varied etc, where the effect of such amendment or variation would be to defease a unitholders interest in the income or capital of the Trust.

•         In the event the trust is terminated, all unitholders will be entitled to the income and capital of the trust in proportion to their unitholding - the trustee will not transfer assets rather than pay cash in satisfaction of amounts owing a part of winding up the trust to any particular unitholder.

•         Trustee has not and will not redeem units of unit holders on a basis different to the proportional holdings of the unitholders, with or without consent of the unitholders.

The Trustee has not, and has given an undertaking not to do so for the Ruling period, exercised their powers under the Deed to defeat a Unit Holder's interest in the income or capital of the Trust.

The Commissioner would accept that consequently the likelihood of the beneficiaries' interests in the income and capital of the trust being defeated would be low.

Subparagraph 272-5(3)(b)(iii) of Schedule 2F to the ITAA 1936:

In relation to the nature of the trust the following factors are relevant:

•         The Trust is a unitised trust; however, the Units are not publicly listed on an approved stock exchange and the Trust is not a managed investment scheme. Therefore, the circumstances and likelihood in which each Unit Holder's entitlement is capable of not vesting or the defeasance happening is not reduced in this Trust.

•         The purpose of establishing the Trust is to allow the Unit Holders to derive income/profits from the development of the properties held by the Trust. At the date of the ruling application, the Trust has three Unit Holders.

•         In your ruling application you advised that on self-assessment the Trust has met the safe harbour conditions in paragraph 54 of PCG 2016/16.

Schedule 2F to the ITAA 1936 and tax losses

In relation to the circumstances pertaining to the existence of a tax loss it is noted that:

•         At the date of the ruling application, the Trustee does not forecast a tax loss for the Trust.

•         The Trustee and Unit Holders have given undertaking that no arrangements will be entered into that would give or can give any benefits of tax losses to any of the beneficiaries. It is noted that as at the date of the ruling application there are only three Unit Holders in the Trust.

•         If there are further units to be issued and/ or redeemed, the Trustee will do so satisfying the savings rule in paragraph 272-5(2)(b) of Schedule 2F to the ITAA 1936.

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 and submissions from the applicant, it is considered that it would be 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 as amended) 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 - i.e. the circumstances in which the entitlement is capable of not vesting or a defeasance happening are limited;

•         the "nature of the trust" is a unit trust established for the purposes of carrying out the business of property development;

•         the likelihood of the entitlement not vesting or a defeasance is low; and

•         there is little likelihood that a tax benefit of the Trust will be transferred (the opportunity to traffic any tax loss appears to be limited)

It would be 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.

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