Edited version of private advice

Authorisation Number: 1052220751099

Date of advice: 16 August 2024

Ruling

Subject: Employee share schemes

Question 1

Will the proposed Employee Share Trust (the Trust) be an employee share trust pursuant to subsection 130-85(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the Trust be a 'fixed trust' pursuant to section 272-65 of Schedule 2F to the ITAA 1936?

Answer

No.

Question 3

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

Answer

Yes.

This advice applies for the following periods:

Year ended 30 June xx to 30 June yy

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

The Company

1.         The Company is an Australian company that is the holding company for the relevant group of companies (the Group).

2.         The Company currently has xx shareholders. All of the shareholders currently work for, or have previously worked for, the Group in the capacity as employees.

3.         The Company's Board is seeking to:

(a)           Facilitate the orderly and timely disposal of shares by some of the existing shareholders in the Company;

(b)           Maintain and develop share trading liquidity in the Company;

(c)           Incentivise current and future rising stars and encourage genuine employee engagement by way of enabling equity participation for employees;

(d)           Put in place an equity participation model for the growth of the business and shareholder values and returns.

4.         To achieve the objectives listed above, the Company will operate an employee incentive plan (Plan) in the form of an employee share trust.

5.         The following documents have been provided, the relevant parts of which are to be read with the Relevant facts and circumstances:

a.         the draft Trust deed

b.         the draft Loan Agreement

c.         the draft Amended and Restated Shareholder's Agreement (Shareholder's Agreement).

6.         It will remain possible for existing shareholders to sell shares outside of the employee share trust subject to the terms of the Shareholder's Agreement.

The Employee Share Trust (the Trust)

7.         The Company proposes to establish the Employee Share Trust (the Trust).

8.         The trustee of the Trust (Trustee)will be a corporate entity and will not be the trustee of any other trust. The Board of the Trustee will mirror that of the Company with the possibility that an additional director will be appointed as the participants' representative. The Company will have the power to appoint and remove the Trustee.

9.         The Trustee is not the holder of an Australian Financial Services licence and is not subject to any regulation by the Australian Prudential Regulation Authority (APRA) or any other Australian Federal Government authority.

10.      Eligible employees who choose to participate in the Plan (Plan Participants) will pay to acquire units in the Trust (Units). These funds will be used by the Trust to acquire shares in the Company. Loan funding will be made available by the Company to assist some Plan Participants to acquire Units (Loans).

Proposed trust deed:

11.      The proposed trust deed (proposed Trust Deed) of the Employee Share Trust explains that:

a.         the Share Plan is to be established to assist in attracting, retaining and motivating key employees of the Group

b.         the Trust is established to facilitate the Share Plan, and

c.         the Trustee will hold the Trust Fund for the benefit of the Plan Participants subject to the terms of the Trust Deed.

12.      The proposed Trust Deed provides:

a.         Clause 1.1 defines Unit Distribution Entitlement as follows:

a)         Unit Distribution Entitlement means, in respect of an Accounting Period, a sum equal to the income received or gains realised by the Trustee during that Accounting Period in Allocated shares referrable to Units held by a Unit Holder, including:

(a)           dividends; and

(b)           the amount received under clause 10,

in respect of which the Trustee declares a present and absolute entitlement after deducting:

(a)           all expenses and outgoings incurred by the Trustee in respect of the Allocated Shares during the Accounting Period;

(b)           such amount as, in the opinion of the Trustee (acting reasonably), is oar will be required to meet any Tax payable by the Trustee in respect of the income or gain; and

(c)           any amount that must be paid to the Holding Company under clause 9.

b.         Clause 4 provides that the beneficial interest in the Trust Fund is to be divided into units and that the Trustee may amend the number of Units on issue in accordance with the manner set out by the clause.

c.         Clause 5(a)(i) provides that a Unit entitles the holder of the Unit (Unit Holder) to receive a distribution in respect of each accounting period equal to the Unit Distribution Entitlement.

d.         Clause 5(a)(ii) provides that a Unit entitles the Unit Holder to direct the Trustee how the voting rights attached to the Allocated Shares referable to the Unit Holder's Units will be exercised.

e.         Clause 7 provides that:

                       i.             The Trustee may from time to time cause Units to be created and may increase the number of Units on issue by accepting in whole or in part applications for Units...'

                      ii.             The Company (and subsidiaries of the Company that are employers) nominate eligible employees and notify the Trustee of those nominations.

                     iii.             The Trustee then invites those eligible employees to apply for a specified number of Units (the number being determined by the Company).

                     iv.             Eligible employees that choose to become Plan Participants must complete an application form and pay an application fee. According to the definitions in Clause 1.1 the application fee (Application Money in the Trust Deed) is calculated by reference to the Issue Price where the Issue Price is the greater of the market value of the Unit or A$0.50.

                      v.             The Trustee will then issue Units so that the Plan Participant becomes a Unit Holder and use the application fee as payment for the Units and to pay the costs of acquisition of shares in the Company.

                     vi.             Share(s) will be allocated to the Units and become Allocated Shares.

                    vii.             Units cannot be transferred.

f.          Clause 8(c) of the Trust Deed states 'The Unit Holders will be presently and absolutely entitled to the net income of the Trust Fund derived during an Accounting Period to the extent of the Unit Distribution Entitlement for that Accounting period attaching to their Units...'.

g.         Clause 9 provides that if a Unit Holder is a party to a Loan, and there is an outstanding balance in relation to this Loan, the Trustee will apply 50% of any dividends received from Allocated Shares purchased using Loan funds to pay in the following order and manner:

(a)           firstly, payment of interest on the Loan;

(b)           secondly, repayment of the outstanding balance of the Loan; and

(c)           thirdly, repayment of all other amounts owing under the Loan agreement between the parties.

h.         Clause 10 of the Trust Deed provides that upon termination of their employment with the Company, or a subsidiary of the Company, Unit Holders are required to dispose of their Units in the manner described in the clause.

i.           Clause 11, in conjunction with clause 10, provides for the consequences of a 'Default Event'. If a Default Event occurs, the defaulting Unit Holder is taken to have ceased employment for the purposes of Clause 10, with the result that the Units are required to be disposed of in the way described by Clause 10. Default Events include:

                       i.             the Unit Holder breaches a material term of the Trust Deed, Shareholders' Agreement or their Employment Agreement and is not able to, or does not, remedy the breach as required

                      ii.             the Unit Holder is persistently and materially in breach of the Trust Deed or Shareholders' Agreement

                     iii.             the Unit Holder becomes insolvent

                     iv.             the Unit Holder commits a criminal office affecting the Company, its subsidiary, another Unit Holder or a shareholder in the Company.

j.           As provided in clause 12.3, the Trustee has the following powers:

(a)           to enter into and execute all contracts, deeds and documents and do all acts, matters or things which it may deem expedient for the purpose of giving effect to and carrying out the trusts, authorities, powers and discretions conferred upon the Trustee by the Trust Deed;

(b)           to purchase or otherwise acquire and to sell or otherwise dispose of property, rights or privileges on such terms and conditions as it thinks fit;

(c)           to appoint and, at its discretion, remove or suspend custodian trustees, agents, servants and other delegates, to determine the powers and duties to be delegated to them and to pay such remuneration to them as it may think fit;

(d)           to institute, conduct, defend, compound or abandon any legal proceeding concerning the affairs of the EST and also to compound and allow time for payment or satisfaction of any debts due and of any claims or demands by or against the EST;

(e)           to settle or compromise any claim or demand by or against the EST, and to refer any claim or demand by or against the EST to arbitration and observe and carry out awards;

(f)             to make and give receipts, releases and other discharges for money payable to the EST and for the claims and demands of the EST;

(g)           to open bank accounts and to retain on current or deposit account at any bank such moneys as it considers proper and to make regulations for the operation of such bank accounts, including the signing and endorsing of cheques in connection with such accounts;

(h)           to maintain proper written financial records in respect to the activities of the EST and cause those records to be audited annually and to be made available for inspection by Unit Holders at an office of the EST during normal business hours or such other times as is agreed with beneficiaries;

(i)             to determine who will be entitled to sign on the EST's behalf receipts, acceptances, endorsements, releases, contracts and documents; and

(j)             to receive money from the Company and deal with it in accordance with this Deed.

k.         Clause 16(c)(ii) provides that on the termination of the EST:

The Trustee will as soon as practicable distribute in specie the Trust Fund amongst the Unit Holders registered on the date of termination having regard to the Allocated Shares referable to the Units of which they were then respectively registered as the holders upon the execution by such Unit Holders in favour of the Trustee of such release as may be reasonably required by the Trustee and the delivery for cancellation to the Trustee (or such person as it appoints) of the certificates for Units held by such Unit Holders respectively.

l.           Clause 17(a) allows the Trustee to amend, by deed or resolution, any provision of the Deed.

m.        Clause 17(b) states:

No amendment to the provisions of this Deed may be made if, in the opinion of the Trustee, it would adversely affect in a material way the rights of Unit Holders at the time of such amendment without the prior consent of all Unit Holders whose rights are so affected, other than an amendment introduced primarily:

(i)         for the purpose of complying with the state of\r Commonwealth legislation governing or regulating the maintenance or operation of the Share Plan;

(ii)        to change the definition of Trust Period;

(iii)       to correct any manifest error or mistake;

(iv)       to introduce any change or amendment which is of a technical or administrative nature only.

n.         Clause 18.2 provides that, other than as otherwise specified in the Deed, no amount payable under the Trust can be alienated, transferred or assigned.

13.      The Issue Price for Units will be determined by reference to independent valuations that provide a market value.

14.      There are no vesting or performance conditions attached to Units.

Loan Agreements

15.      Loans may be made available by the Company to Plan Participants to assist Participants with raising the necessary funding to acquire Units.

16.      The Company may offer to fund part of the purchase price of Units in the Trust by way of a Loan. The Loan will be between the Company and the Plan Participant.

17.      The relevant terms of the proposed Loan Agreements include:

a.         The term of the Loan is the shorter of 5 years or when the borrower ceases to be a Unit Holder in the EST (Clause 3).

b.         Interest accrues on the Loan at the rate that is 50% of the Medium Business Interest Rate (Clause 4).

c.         The borrower agrees that 50% of any ordinary dividends declared and payable to the borrower on Allocated Shares in the EST will be used to repay the Loan (Clause 5).

d.         The Loan is limited recourse (Clause 6).

e.         If the borrower defaults, the lender 'may sell of otherwise realise the value of the Units acquired pursuant to the Loan, at such price and on such terms and conditions as the Lender may decide...' (Clause 7).

18.      At the time that Loans are made to Plan Participants, the Plan Participants will not be shareholders of the Company.

Shareholder's Agreement

19.      The Company's Shareholder's Agreement (Shareholder's Agreement) is to be amended to permit the establishment of the Trust.

Assumptions:

20.      All entities are Australian residents for income tax purposes.

21.      There are no associations between any entity engaged to perform valuation services and the Trustee and Unit Holders.

22.      There are no associations between the Unit Holders (other than as colleagues).

23.      All transactions between all entities are conducted at arm's length.

24.      There are no expected current year tax losses.

25.      There are no expected bad debts or debt/equity swap losses.

26.      Except as set out in paragraphs 12(h) (Clause 10 of the Trust Deed) and 12(i) (Clause 11 of the Trust Deed), and paragraph 16(e) (Clause 7 of the Loan Agreement) above, throughout the Ruling Period, no powers have been or will be exercised to defeat the interest of any Unit Holder, with respect to their units including:

a.    there will only be one class of units and no units of different classes will be issued.

b.    no units will be reclassified. The rights attached to units already in existence will not be modified, and

c.     Units will only be transferred or redeemed at the request of a Unit Holder.

27.      Units will be issued, redeemed, transferred or transmitted for a price determined on a basis that satisfies subsection 272-5(2) of Schedule 2F to the ITAA 1936. That is, Units will only be issued, redeemed, transferred or transmitted on the basis of the Trust's net asset value, according to Australian accounting principles, at the time of the issue or redemption having regard to paragraph 19 of the PCG 2016/16.

28.      No units will be issued or redeemed at a discount.

29.      The Trustee will ensure that units will only be transferred or transmitted for market value.

30.      No partly paid units will be issued.

31.      The Trustee will not seek to amend or vary the Trust Deed to defeat the interest or change the fixed entitlements of Unitholders to the income and capital of the Trust.

32.      All Unitholders will be entitled to the income and capital of the trust in proportion to their unit holding. To the extent permitted by clause 16(c)(i), if requested by a unit holder, the Trustee will transfer assets rather than pay cash in satisfaction of amounts owing, including as part of winding up the trust, to that particular unit holder. The Trustee will only transfer to that particular unit holder assets of the Trust to the extent that the market value of the assets equivalent to their proportion of unit holding. No other streaming of income or capital will occur.

33.      Throughout the Ruling Period, no arrangement has been or will be entered into 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 272-65 of Schedule 2F

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

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Subsection 130-85(4)

Income Tax Assessment Act 1997 Paragraph 130-85(4)(a)

Income Tax Assessment Act 1997 Paragraph 130-85(4)(b)

Income Tax Assessment Act 1997 Paragraph 130-85(4)(c)

Income Tax Assessment Act 1997 Subsection 130-90(1)

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 Subsection 207-5(3)

Income Tax Assessment Act 1997 Subdivision 207-A

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Question 1:

Will the proposed Trust be an employee share trust pursuant to subsection 130-85(4) of the ITAA 1997?

Summary:

The Trust satisfies the requirements in subsection 130-85(4) of the ITAA 1997 and is an employee share trust.

Detailed reasoning:

EXPLANATION OF THE LAW

Employee Share Schemes (ESS):

1.         Broadly, employee share schemes (ESS) are arrangements which allow employees to obtain benefits, such as shares or the opportunity to buy shares or rights (including options) in their employer company.

2.         The term 'employee share scheme' is defined in subsection 83A-10(2) of the ITAA 1997 as:

... a *scheme under which *ESS [employee share scheme] interests in a company are provided to employees, or *associates of employees, (including past or prospective employees) of:

(a) the company; or

(b) *subsidiaries of the company;

in relation to the employees ' employment.

Note: See section 83A-325 for relationships similar to employment.

3.         Subsection 83A-10(1) of the ITAA 1997 defines an 'ESS interest' in a company as:

(a)          a beneficial interest in a share in the company, or

(b)          a beneficial interest in a right to acquire a beneficial interest in a share in the company.

Employee Share Trusts:

4.         Subsection 130-85(4) of the ITAA 1997 defines the term 'employee share trust' for an ESS as a trust whose sole activities are:

(a)          obtaining *shares or rights in a company; and

(b)          ensuring that *ESS interests in the company that are beneficial interests in those shares or rights are provided under the employee share scheme to employees, or to *associates of employees, of:

(i)         the company; or

(ii)        a *subsidiary of the company; and

(c)           other activities that are merely incidental to the activities mentioned in paragraphs (a) and (b).

5.         Taxation Determination TD 2019/13 Income tax: what is an 'employee share trust'? (TD 2019/13) provides the Commissioner's views on the application of subsection 130-85(4) of the ITAA 1997. Paragraph 6 of TD 2019/13 explains that to determine whether the trustee of a trust satisfies subsection 130-85(4), and is an employee share trust, it is necessary to consider the actual activities of the trustee. Therefore, although the relevant trust documents may provide the trustee with broad reaching powers, the mere existence of these powers in the trust documents do not of themselves mean that the trustee has acted outside of the requirements for an ESS. Rather, as explained in paragraph 4, the trustee's activities must be limited to those described in paragraphs 130-85(4)(a), (b) and (c).

6.         Paragraph 130-85(4)(c) of the ITAA 1997 permits the trustee to undertake activities that are merely incidental to the activities outlined in paragraphs 130-85(4)(a) and (b). Paragraph 9 of TD 2019/13 explains that the term 'merely incidental' takes on its ordinary meaning and, per the definitions in the Macquarie Dictionary, the term:

... 'merely' to mean 'only as specified, and nothing more'. 'Incidental' is defined as 'happening or likely to happen in fortuitous or subordinate conjunction with something else'.

7.         Furthermore, paragraph 11 of TD 2019/13 states that:

Activities are merely incidental under paragraph 130-85(4)(c) if they are a natural incident or consequence¹² of the trust obtaining, holding and providing shares or rights under an ESS. If the activities undertaken by the trustee are not a natural incident or consequence of obtaining, holding and providing shares or rights under an ESS, or if the activity is undertaken for or follows from some other purpose, such activities are not merely incidental.

8.         Examples of the activities which ordinarily would be considered to be merely incidental for the purposes of paragraph 130-85(4)(c) are provided in paragraph 12 of TD 2019/13 and include:

a.         opening and operating bank accounts

b.         bookkeeping, preparing financial, tax and regulatory statements and other record-keeping and administrative functions necessary to operate the trust

c.         receiving, and distribution of, dividends in relation to the shares held on behalf of the participating employees

d.         borrowing funds on arm's lengths terms to allow for the acquisition of shares or rights in the employer company

e.         dealing with forfeited shares in the scheme, and

f.          transfer of shares to participating employees.

9.         Additionally, paragraph 13 of TD 2019/13 provides examples of activities which would not be considered to be merely incidental for the purposes of paragraph 130-85(4)(c) and includes, but is not limited to:

•               providing financial assistance, such as providing a loan to an employee to purchase shares or interests in the employer company

•               payment of income or accrued capital from unallocated shares to any beneficiaries (or to employees who do not hold a beneficial interest in the employer company under the trust)

•               waiving or relinquishing certain entitlements, such as waiving the right to be paid or credited dividends pursuant to a dividend waiver clause contained in the governing trust documents

•               exercising a general discretion to make distributions of income or capital to pay a class of participating employees or other beneficiaries of the trust amounts unrelated to their ESS interest or entitlements under the ESS rules

•               borrowing money

o   for a purpose other than purchasing shares or rights in the employer company, or

o   with security provided over any of the trust's assets for the loan, or

o   where the interest payable on the loan is more than arm's length commercial rates

•               investing in assets other than shares or rights to shares in the employer company

•               engaging in trading activities in relation to shares in the employer company, other than purchasing and selling shares to satisfy obligations under the ESS

•               distributing mainly cash payments to participating employees rather than shares or ESS interests under the ESS

•               providing additional benefits to participants and/or employees, over and above the delivery of the ESS interests or resulting shares and any dividend equivalent payment that accrues directly from the employee's ESS interest.

10.      Where a trust fails to satisfy subsection 130-85(4) such that it is not, or ceases to be, an employee share trust, it can never gain or regain that status. This is because the trust's sole activities will not be as outlined in paragraphs 130-85(4)(a) to (c).[1]

Application to your circumstances:

11.      The Company proposes to establish the Share Plan for the purposes of attracting, retaining and motivating key employees of the Group. To allow for this objective to be met, the Trust will be established and the Trustee will hold the Trust Fund for the benefit of the Plan Participants, subject to the terms of the Trust Deed.

12.      The proposed Trust Deed sets out the powers and obligations of the Trustee, with the key terms of the Deed being as summarised in paragraph 12, Notice of Administratively Binding Advice (above). Those powers and obligations of the Trustee pursuant to the proposed Trust Deed relate to:

a.         obtaining shares or rights in the Company, in accordance with paragraph 130-85(4)(a)

b.         ensuring the ESS interests in the Company are beneficial interests to employees, in accordance with paragraph 130-85(4)(b), and

c.         other activities that are merely incidental to subparagraphs 12.a and 12.b above, in accordance with paragraph 130-85(4)(c).

13.      Moreover, it is not anticipated that the Trustee will conduct any activities that are not merely incidental to those outlined in paragraphs 130-85(4)(a) and (b) of the ITAA 1997.

14.      Consequently, the proposed arrangement will satisfy all the conditions in subsection 130-85(4) of the ITAA 1997, the Trust will be an employee share trust.

Question 2:

Will the Trust be a 'fixed trust' pursuant to section 272-65 of Schedule 2F to the ITAA 1936?

Summary

The Trust will not be a fixed trust as the Unit Holders will not have fixed entitlements to all of the income and capital of the trust.

Detailed reasoning

EXPLANATION OF THE LEGISLATION

15.      Schedule 2F of the ITAA 1997 contains provisions dealing with trust losses and other deductions.

Fixed Trust:

16.      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:

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

Fixed Entitlement:

17.      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.

18.      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.

19.      The term 'vested and indefeasible' is not defined in the taxation legislation. Guidance on its intended meaning for the purposes of Schedule 2F can be found in the Explanatory Memorandum to Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 (EM) which introduced the provisions. In particular, the EM states that:

13.4 A person has a vested interest in something if the person has a present right relating to the thing. Stated simply, a vested interest is one that is bound to take effect in possession at some point in time. A vested interest is to be contrasted with a 'contingent' interest which may never fall into possession. If an interest of a beneficiary in income or capital is the subject of a condition precedent, so that an event must occur before the interest becomes vested, the beneficiary does not have a vested interest to the income or capital since such an interest is instead 'contingent' upon the event occurring.

13.5 In traditional legal analysis, a person can be said to be either 'vested in possession' or 'vested in interest'. A present interest, i.e. one that is being enjoyed, is said to be 'vested in possession'; a future interest, i.e. one which gives its holder a present right to future enjoyment, is said to be 'vested in interest'. A person is vested in possession where the person has a right to immediate possession or enjoyment of the thing in question. In the definition of fixed entitlement, 'vested' includes both vested in possession and vested in interest.

13.6 Because vested interests include future interests, a person can have a vested interest in a thing even though the person's actual possession and enjoyment of the thing is delayed until some time in the future.

20.      A vested interest is indefeasible where it cannot be defeated or lost. This means that where an interest is contingent on some other event occurring or condition being met, the interest can be lost and would be defeated. Consequently, a fixed entitlement is one where an interest is not defeasible. This is supported by paragraph 13.7 of the EM, which states:

...A condition subsequent is an event that could occur after the interest is vested that would result in the entitlement being defeated, for example, on the occurrence of an event or the exercise of a power. For example, where a beneficiary's vested interest is able to be taken away by the exercise of a power by the trustee or any other person, the interest will not be a fixed entitlement.

21.      The courts have also considered whether an interest to income of a trust is defeasible, such as in Colonial First State Investments Ltd v FCT [2011] (Colonial)[2], Kent v The Vessel 'Maria Luisa' [2003][3] and Dwight v FCT (1992).[4]

22.      Guidance on the Commissioner's view of when an interest would be defeasible can be found in the Decision Impact Statement issued in relation to The Trustee for the MH Ghali Superannuation Fund v FC of T (2012)[5], which states:

In Colonial First State Investments Ltd v FCT [2011] FCA 16, Stone J considered whether there was a fixed entitlement to a share of the income and capital of a trust for the purposes of Schedule 2F. Her Honour concluded (at [106]) that the fact members could vote to terminate the present right to a share of income or capital meant that the relevant rights were defeasible.

In Dwight v FCT (1992) 23 ATR 236, Hill J said:

An interest is said to be defeasible where it can be brought to an end and indefeasible where it can not. Thus, a beneficiary with an interest which is not contingent but which interest may be brought to an end by the exercise of a power of appointment, would be said to have a vested but defeasible interest...

Accordingly, where a trustee has a discretion to distribute income amongst unitholders in whatever proportion the trustee may in its absolute discretion determine, the Commissioner does not consider that the interest of a default beneficiary in income could be described as 'indefeasible': whatever interest in the income of the trust a default beneficiary would have is liable to be defeated by the trustee exercising its discretion to appoint the income to others.

Case where interest not defeasible

23.      Relevant to the circumstances in the current case, subsection 272-5(2) of Schedule 2F of the ITAA 1997 provides that if:

a.         a person holds units in a unit trust,

b.         the units are redeemable or further units are able to be issued, and

c.         where the units are not listed on an official stock exchange, the units will be redeemed, or further units will be issued, for a price determined on the basis of the net asset value (in accordance with Australian accounting principles) of the units at time of issue or redemption

the mere fact that the units are redeemable, or new units can be issued, will not result in the person's interests in the capital or income of the trust being defeasible.

Application to your circumstances:

24.      In order to establish whether the Trust will be a fixed trust pursuant to section 272-65 of Schedule 2F to the ITAA 1936, consideration of the proposed Trust Deed is necessary to determine whether the Unit Holders interests in the income or capital of the Trust that are vested and indefeasible.

Vested interest:

25.      Pursuant to the terms of the proposed Trust Deed, the Unit Holders will have an interest in the income and capital of the Trust Fund that is vested. That is, the Unit Holders will have a right to the enjoyment to a specified share in the income or capital of the Trust.

Defeasible interest:

26.      Based on the following assumptions, that:

a.         the Issue Price for Units will be determined by reference to independent valuations that provide a market value, and

b.         Units will be issued, redeemed, transferred or transmitted for a price determined in accordance with the Trust's net asset value, according to Australian accounting principles, at the time of the issue or redemption

the requirements in subsection 272-5(2) will be satisfied and these factors will not, of themselves, result in the Unit Holder's interests being defeasible.

27.      However, clause 17 of the proposed Trust Deed provides that the Trustee will have the power to amend any clause of the Trust Deed. Although this power is limited in some circumstances by clause 17(b), the Trustee will nevertheless be able to amend the Deed in a manner that could defeat a Unit Holder's interest in the capital or income of the trust fund. Consequently, the Unit Holders will not have fixed entitlements and the Trust will not be a fixed trust in accordance with section 272-65 of Schedule 2F of the ITAA 1936.

Question 3

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

Summary

The Commissioner will deem the Unit Holders as having fixed entitlements to all the income and capital of the Trust, pursuant to subsection 272-5(3) of Schedule 2F to the ITAA 1936.

Detailed reasoning

EXPLANATION OF THE LEGISLATION:

Deemed fixed entitlement:

28.      Subsection 272-5(3) of Schedule 2F of the ITAA 1936 provides that where a beneficiary does not have a fixed entitlement to a share of the income and capital of the trust, the Commissioner may treat that beneficiary as having 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...

29.      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.

30.      The EM 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.

31.      This passage indicates that in considering the discretion, the Commissioner should always have regard to whether the absence of a fixed entitlement could result in the trafficking (or transfer) of the tax benefit of any tax losses.

Application to your circumstances:

32.      The proposed Trust Deed also provides that the following provisions will cause the Unit Holder's interests not vesting or being defeated:

a.         clauses 7 and 10 which allow for the issue of new, or cancellation of, Units in accordance with clauses 7 and 10, and

b.         clause 17, which provides the Trustee with the power to amend any provision of the Trust Deed.

33.      However, as stated in paragraph 23, in accordance with subsection 272-5(2) of Schedule 2F of the ITAA 1997, the mere fact that the Units are redeemable and that additional Units may be issued will not, of itself, result in the Unit Holders' interests in the income or capital of the Trust being defeasible.

34.      With respect to the Trustee's power to amend the Trust Deed, as provide in clause 17, it is noted that this power is restricted by clause 17(b). Broadly, clause 17(b) requires the Trustee to obtain prior consent from the Unit Holders where a proposed amendment to the Trust Deed would adversely result in a material change to their rights. Given this, it is considered highly unlikely that Unit Holders would agree to an amendment to the Deed which would result in their interests to income or capital of the Trust being defeated or lost.

35.      The proposed Trust will be established to allow for:

a.         the facilitation of the disposal of the Company's shares by some of the existing shareholders

b.         the maintenance and development of the Company's share trading liquidity

c.         incentives for the Company's current and future well performing staff

d.         equity participation of the Company's employees for the growth of the business and shareholder returns.

36.      Moreover, as the Trust will be newly established, it will not have any tax losses upon creation. Further, the Trust does not expect any deductions will be claimed in the future for bad debts or debt/equity swap losses.

37.      It is noted that the assumptions included for the purposes of this ruling include that not arrangement has been or will be entered into which would result in section 272-35 of Schedule 2F to the ITAA 1936 applying, or in fraud or evasion.

38.      Based on the factors outlined above and without the existence of any other events which would impact the interests of the Unit Holders to the income and capital of the Trust, the Commissioner will deem the Unit Holders as having fixed entitlements in accordance with subsection 272-5(3) of Schedule F of the ITAA 1936.

Question 4:

Will capital gains tax (CGT) event E5 happen when the Plan Participants acquire Units in the Trust in accordance with section 104-75 of the ITAA 1997?

BENEFICIARY BECOMING ENTITLED TO A TRUST ASSET: CGT EVENT E5

39.      Subsection 104-75(1) of the ITAA 1997 provides that CGT event E5 will occur if a beneficiary of a trust estate becomes absolutely entitled to a CGT asset of a trust as against the trustee.

40.      Broadly, a beneficiary will have an absolute entitlement to a CGT asset where the beneficiary has a vested and indefeasible interest in the entire trust asset, to call for the assets to be transferred to them or to be transferred at their direction.[6]

41.      Guidance on the Commissioner's view on what is the relevant asset for unit holders is found in Taxation Determination TD 2000/32 Income Tax: capital gains: for capital gains purposes is the unit held by a unit holder in a unit trust the relevant CGT asset (TD 2000/32). TD 2000/32 explains that where the beneficiary of the trust is a unit holder in a unit trust, the relevant asset for capital gains purposes is the unit in the trust.

Application to your circumstances:

42.      The Proposed Trust Deed does not provide the Plan Participants with a vested and indefeasible interest in the trust assets, being the shares in the Company. Consistent with TD 2000/32, the relevant assets for capital gains purposes are the units in the Trust. As such, the Plan Participants will not have absolute entitlement to the CGT assets of the Trust as against the Trustee and subsection 104-75(1) will not be satisfied.

[1] Paragraph 14 of TD 2019/13.

[2] FCA 16, see paragraph 106.

[3] FCAFC 93, see paragraph 71.

[4] 23 ATR 236

[5] 2012 ATC 10-266.

[6] See for instance, paragraph 10 of Draft Taxation Ruling TR 2004/D25 Income Tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997. However, it should be noted that this ruling does not apply to unit holders of a unit trust.

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