Edited version of private advice

Authorisation Number: 1052266467223

Date of advice: 26 June 2024

Ruling

Subject: Commissioner's discretion - vested and indefeasible interest

Question 1

Will the unitholders of the Trust 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) of the Income Tax Assessment Act 1936 (ITAA 1936), once the Amended Deed is executed?

Answer

No.

Question 2

If the answer to question 1 is 'No', will the Commissioner exercise the discretion pursuant to former subsection 160APHL(14) of the ITAA 1936 to treat the unitholders of the Trust as having vested and indefeasible interests in so much of the corpus of the Trust as is comprised by the Trust holding?

Answer

Yes.

This ruling applies for the following periods:

XX/XX/XXXX to XX/XX/XXXX

The scheme commenced on:

XX/XX/XXXX

Relevant facts and circumstances

1.            The Trust is an Australian resident unit trust that was settled by deed.

2.            The Trustee of the Trust an Australian resident company.

3.            The Trust holds shares in a Company.

4.            The Company carried on a business and currently its only assets are cash and loans receivable.

5.            The Trust expects to receive a fully franked dividend from the Company for the next 2 income years. The Company did not pay any dividends to the Trust in the previous income year.

6.            All units in the Trust currently on issue are fully paid units.

7.            The units in the Trust are held by fewer than 20 entities (the unitholders). It is not anticipated that the Trust will have 20 or more unitholders at any time while it is in existence.

8.            None of the unitholders are related parties of the Trustee.

9.            None of the units in the Trust have been, nor anticipated to be, listed for quotation in the official list of an approved stock exchange.

10.          In accordance with the powers to amend the Deed, the Trustee proposes to amend the Deed as follows:

(a)          the definitions in relation to fixed interest and net asset value

(b)          a clause to render other clauses of the Deed to be inoperative to the extent it would cause the unitholder to cease to have fixed interests

(c)           the Trustee has the power to issue Units and the application price for new units or withdrawal price for forfeiture of units or redemption is determined pursuant to Net Asset Value in accordance with Australian accounting standards.

(d)          the Deed requires all unit on issue to have equal value and the same rank and entitlements to income and capital of the Trust.

(e)          the income of the Trust is equal to the net income as defined in subsection 95(1) of the ITAA 1936, including the discount portion of any capital gain derived or taken to be derived in a Financial Year, excluding notional amounts of income or credits in the nature of income (including without limitation, tax credits, or franking credits) from the calculation of income. The Trustee has no discretion in relation to treating particular receipts of the Trust as income or capital.

(f)            the Trustee has a right to be indemnified in full out of the assets of the Trust in respect of all expenses, liabilities, costs, claims and demands brought against the Trustee in its capacity as Trustee of the Trust.

(g)          the Trustee has the power to revoke, add to or vary the Deed with the consent of the unitholders. However, this power is limited in that the Trustee cannot revoke, add to or vary the Deed where the change would cause the unit holder to cease to have a fixed interest for the purposes of section 160APHL(11) of the ITAA 1936.

11.          At no point has the Trustee exercised its powers set out in clause 7 of the Deed to enforce the forfeiture or cancellation of partly paid units and has no intention of exercising these powers before the Amended Deed takes effect.

Assumptions

12.          Throughout the ruling period:

(a)           no partly paid units will be issued

(b)           the Trustee will not amend the Deed to either defeat or be capable of defeating a unitholder's interest in the income or capital of the Trust

(c)           the Trustee will not exercise a power to either defeat or be capable of defeating a unitholder's interest in the income or capital of the Trust

(d)           the Trust is not and will not be a Managed Investment Trust (MIT) pursuant to Division 275 of the Income Tax Assessment Act 1997 (ITAA 1997)

(e)           the Trustee will not make the choice for the Trust to be treated as a MIT

(f)            no arrangement has been or will be entered into which would result in:

                                  (i)          a 'related payment' under former section 160APHN of the ITAA 1936 being made

                                 (ii)          the unitholders will have no materially diminished risks of loss or opportunities for gain of less than 30% in respect of shares held by the trustee in its capacity as trustee for the Trust (refer to former section 160APHM of the ITAA 1936)

                                (iii)          the unitholders are not being sufficiently exposed to the risk of loss or opportunity for gain in respect of the units in the Trust

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

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

                                (vi)          fraud or evasion.

Relevant legislative provisions

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(12)

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

Income Tax Assessment Act 1936 Former paragraph 160APHL(13)(d)

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

Income Tax Assessment Act 1936 Former paragraph 160APHL(14)(a)

Income Tax Assessment Act 1936 Former paragraph 160APHL(14)(b)

Income Tax Assessment Act 1936 Former paragraph 160APHL(14)(c)

Income Tax Assessment Act 1936 Former section 160APHM

Income Tax Assessment Act 1936 Former section 160APHN

Income Tax Assessment Act 1997 Paragraph 207-150(1)(c)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(d)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(e)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(f)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(g)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(h)

Income Tax Assessment Act 1997 Division 275

Reasons for decision

All legislative references are to the ITAA 1936 unless otherwise stated.

Question 1

Will the unitholders of the Trust 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), once the Amended Deed is executed?

Summary

The unitholders do not a vested and indefeasible interest in the corpus of the Trust as is comprised by their unitholding for the purposes of former section 160APHL(11).

Detailed reasoning

1.            Former section 160APHL(11) provides:

For the purposes of subsection (10), the 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.

2.            Determining whether a beneficiary has 'a 'vested and indefeasible' interest in a trust requires an examination of the terms of the trust upon which the relevant trust property is held, including individual clauses, and whether a beneficiary's interest in a share of the capital is defeasible by virtue of any of the powers contained in the trust instrument (see CPT Custodian Pty Ltd v Commissioner of State Revenue; Commissioner of State Revenue v Karingal 2 Holdings Pty Ltd [2005] HCA 53 (CPT Custodian Case)).

3.            In Dwight v Commissioner of Taxation [1992] FCA 210, Hill J stated:

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 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 cannot. 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.

No vested and indefeasible interest

4.            Clause XX in the Amended Deed provides that each unit confers on the unitholder a beneficial interest in the assets corresponding to units. Further, clauses XX and XX in the Amended Deed provides the unitholder with a vested interest in the corpus of the Trust.

5.            Clauses XX and XX in the Amended Deed provides for the Trustee to be indemnified, to be paid, out of the assets of the Trust.

6.            It is our view that pursuant to the High Court judgement in CPT Custodian Case it is not possible for a beneficiary of the trust to have a fixed interest for the purposes of former subsection 160APHL(11) where a trustee's indemnity results in the trustee having an interest in the trust's property.

7.            There are also certain powers contained in the Amended Deed that may defease the interests that the unitholders have in the corpus of the Trust including:

(a)          under clause X the Trustee may amend the Deed with the consent of the unitholders. Any ability to amend the Deed, whether requiring unitholder approval or not, will constitute a power capable of defeating a beneficiary's interest in the income or capital of the Trust. As noted by Stone J in Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 at [106]:

it follows [from unit holders' ability to amend the Constitution] that the members could vote to terminate the present right to a share of income and capital.

An amendment could also permit the amendment of clauses which currently do not contain defeasible powers to do so.

(b)          the Trustee has the power to issue as a result of clause XX in the Amended Deed that each unit issued has to have to be the same value, rank equally and provided the unitholders with identical rights to income and capital of the Trust. Accordingly, the 'savings rule' in former paragraph 160APHL(13)(d) will apply which prevents the power to issue further units in the Trust being taken as defeasible power pursuant to former subsection 160APHL(12); and

(c)           the Trustee has a power to redeem under clause XX in the Amended Deed, however the Trustee has no discretion in relation to the withdrawal price paid per unit as this is required to be calculated based on the net value of the Trust according to Australian accounting principles. Accordingly, the 'saving rule' in former paragraph 160APHL(13)(d) applies which prevents the power to redeem units in the Trust being taken as defeasible pursuant to former subsection 160APHL(12).

8.            In view of the reasoning provided above, the unitholders of the Trust do not have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by their unit holding pursuant to former subsection 160APHL(11).

9.            The only way that a unitholder of the Trust can have such a vested and indefeasible interest is if the Commissioner exercises the discretion in former subsection 160APHL(14).

Question 2

If the answer to question 1 is 'No', will the Commissioner exercise the discretion pursuant to former subsection 160APHL(14) to treat the unitholders of the Trust as having vested and indefeasible interests in so much of the corpus of the Trust as is comprised by the Trust holding?

Summary

The Commissioner will 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 their unit holding during the ruling period.

Detailed reasoning

10.          Former subsection 160APHL(14) allows the Commissioner to determine an interest as being vested and indefeasible if its prescribed conditions are met.

Threshold condition

11.          Former paragraph 160APHL(14)(a) requires the relevant taxpayer to have an interest in the corpus of the Trust.

12.          This condition is met, as the unitholders in the Trust will have an interest in the corpus of the Trust as mentioned above under clause XX in the Amended Deed.

Not vested or indefeasible condition

13.          Former paragraph 160APHL(14)(b) requires that the interest in the corpus of the Trust is not vested or indefeasible.

14.          As per the answer to Question 1, this condition is met as the interests of the unitholder in the corpus of the Trust are defeasible.

Factors to have regards to

15.          Former paragraph 160APHL(14)(c) provides:

the Commissioner considers that the interest should be treated as being vested and indefeasible, having regard to:

                                     (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.

Circumstances in which defeasance can occur

1.            As per the answer to Question 1, the unitholder's interests in the Trust can be defeased as a result of the Trustee's indemnity and the Trustee's power to amend the Deed.

Likelihood of defeasance

16.          From the information provided and assumptions agreed to, the circumstances in which the interests in the Trust can be defeased will not occur during the ruling period.

Nature of the Trust

17.          The Trust is a unit trust with less than 20 members that is not listed for quotation on the official list of an approved stock exchange.

Other matters

18.          The discretion in former subsection 160APHL(14) relates 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.

19.          The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 2) 1999, which accompanied the introduction of former subsection 160APHL(14), outlined the purpose of those 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.

20.          In exercising the discretion, the Commissioner must ensure that the purpose of the integrity measures is not undermined.

21.          The unitholders are in substance the economic owners of the shares in the Company as a result of the interest their units provide in the Trust's assets and due to the assumptions forming part of this ruling their interests cannot be defeated and no arrangements have been entered into with a purpose of undermining the integrity of the imputation system.

Conclusion

22.          Taking into consideration the above relevant matters, it is appropriate for the Commissioner to exercise the discretion under former subsection 160APHL(14) to treat the unitholders as having a vested and indefeasible interests in so much of the corpus of the Trust as is comprised by their unit holding during the ruling period.

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