Edited version of your private ruling

Authorisation Number: 1012461745395

Ruling

Subject: Fixed Trust

Question 1

Do the beneficiaries (Unit Holders) of the Trust have fixed entitlements to all of the income and capital of the Trust under subsection 272-5(1) of Schedule 2F to the ITAA 1936?

Answer

No

Question 2

If the answer to Question 1 is no, will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat all Unit Holders of the Trust as having fixed entitlements?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

12 August 2008

Relevant facts and circumstances

· The trustee is and has always been the same.

· The trust is an Australian unit trust and resident for Australian taxation purposes.

· The trust has X units on issue.

· The unit holders since settlement of the trust have always been the same entities

· All unit holders are unrelated parties.

· None of the units are quoted on the official list of any stock exchange.

· The trust is not registered as a managed investment scheme.

· The trust instrument contains certain clauses by which a beneficiary's interest in a share of the income or capital of the trust may be defeased.

Relevant legislative provisions

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

Income Tax Assessment Act 1936 Subsection 272-5(1) of Schedule 2F

Income Tax Assessment Act 1936 Subsection 272-5(2) of Schedule 2F

Income Tax Assessment Act 1936 Subsection 272-5(3) of Schedule 2F

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

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

Reasons for decision

Question 1

Do the beneficiaries (Unit Holders) of the Trust have fixed entitlements to all of the income and capital of the Trust under subsection 272-5(1) of Schedule 2F to the ITAA 1936?

Answer

No

Detailed reasoning

A 'fixed trust' is defined in section 272-65 of Schedule 2F to the ITAA 1936. Section 272-65 of the ITAA 1936 provides that:

A trust is a fixed trust if persons have fixed entitlements to all of the income and capital of the trust.

The definition of '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) of Schedule 2F to the ITAA 1936 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;

1. 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.

The word 'interest' is capable of many meanings. In the absence of a definition one must infer its meaning from the context in which it is found (see Gartside v Inland Revenue Commissioner [1968] AC 553 at 602-602 and 617-618; Commissioner of Stamp Duties (Queensland) v Livingston (1964) 112 CLR 12 at 28-29; and CPT Custodian Pty Ltd v Commissioner of State Revenue 2005 HCA 53).

There may be circumstances in which the word 'interest' could be interpreted broadly to include any right or advantage that a person might be able to claim with respect to the income or capital of the trust and/or in respect of the trustee, whether present or future, ascertained or potential.

In the context of Schedule 2F to the ITAA 1936, however, it is clear that for an interest to be recognised as a fixed interest it must be a right with respect to a share of the income or of the capital of the trust that is susceptible to measurement. To adopt the words of Lord Wilberforce in Gartside v Inland Revenue the right must have 'the necessary quality of definable extent'.

The term 'vested and indefeasible' is also not defined in the taxation legislation. However the Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 does discuss its ordinary meaning at some length at paragraphs 13.4 to 13.9.

In particular, paragraph 13.7 of the EM provides:

'A vested interest is indefeasible where, in effect, it is not able to be lost. A vested interest is defeasible where it is subject to a condition subsequent that may lead to the entitlement being divested. 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'.

In Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16 Stone J stated at [97] that in the absence of a definition, and subject to qualification in subsection 272-5(2) of Schedule 2F to the ITAA 1936, the term 'indefeasible' bears its ordinary meaning when applied to an interest, that is that 'the interest cannot be terminated, invalidated or annulled'.

It is an essential element of subsection 272-5(1) of Schedule 2F to the ITAA 1936 that in order to have a fixed entitlement to a share of income or capital there must be a vested or indefeasible interest 'under a trust instrument'.

In all cases, the determining factor in deciding if fixed entitlements exist will be the terms of the trust instrument (in this case the Trust Deed) under which the Trust is constituted. Neither the form of the Trust nor the labels that are attached to it can determine this question.

The first step in determining whether a beneficiary has a vested and indefeasible interest in a share of the income or capital of a trust is to ascertain the terms of the trust upon which the relevant trust property is held.

As the High Court recently stated in CPT Custodians Pty Ltd v Commissioner of State Revenue (Vic); Commissioner of State Revenue (Vic) v Karingal 2 Holdings Pty Ltd (2005) 224 CLR 98 at [15], in taking this step:

'…a priori assumption as to the nature of unit trusts under the general law and principles of equity [will] not assist and would be apt to mislead. All depends, as Tamberlin and Hely JJ put it in Kent v SS "Maria Luisa" (No 2), upon the terms of the particular trust. The term "unit trust" is the subject of much exegesis by commentators. However, "unit trust", like "discretionary trust", in the absence of an applicable statutory definition, does not have a constant, fixed normative meaning which dictate the application to particular facts of the [relevant statutory definition]…'

There will be some circumstances in which a trust instrument must be read subject to the operation of a particular legal rule, whether under the general law, or statute. For example, the provisions of Chapter 5C of the Corporations Act 2001 which, if inconsistent with the constitution (being the trust instrument) of a registered MIS, can have the effect of altering or modifying the scheme's constitution. It is possible for a constitution to be altered or modified by operation of law irrespective of whether the trust instrument itself expressly recognises the relevant general law rule or statute, and the entitlements of a beneficiary under the trust instrument are those as so altered or modified by operation of law.

Vested and Indefeasible Interests

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the trust instrument consists of the Trust Deed.

It is accepted that the Trust Deed provides Unit Holders with an 'interest' in the income and capital of the Trust.

Relevantly the Trust Deed provides that the beneficial interest of the Trust will be divided into Units.

However, the Trust Deed contains certain clauses by which a Unit Holder's interest in a share of the income or capital of the Trust may be defeased by the actions of the Trustee.

Therefore, given that the Trustee has powers and rights, as conferred to it by the Trust Deed and, as against the Unit Holders, it is concluded, in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936, that the Unit Holders do not have fixed entitlements to all of the income and capital of the Trust.

Question 2

If the answer to Question 1 is no, will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat all Unit Holders of the Trust as having fixed entitlements?

Answer

Yes

Detailed reasoning

Subsection 272-5(3) of Schedule 2F to the ITAA 1936 states:

Deemed fixed entitlement

272-5(3) If:

a) A beneficiary with an interest in a share of income that the trust derives from time to time, or of the capital of a trust, does not have a fixed entitlement to the share; and

b) the Commissioner considers that the beneficiary should be treated as having the 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;

the beneficiary has the fixed entitlement.

In summary, 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 taking into account the factors prescribed in paragraph 272-5(3)(b).

In the present case, while it is considered that the Unit Holders in the Trust do not have vested and indefeasible interests (Question 1), the Commissioner may apply his discretion having regard to the relevant factors prescribed in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the Unit Holders as having a fixed entitlement if it is reasonable to do so. These factors are considered below.

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

In terms of paragraph 272-5(3)(a), clause 3 of the Trust Deed provides the Unit Holders of the Trust 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.

In addition, it has been determined under question 1 that the Unit Holders do not have a fixed entitlement to the share of income and capital to the Trust.

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

In relation to subparagraph 272-5(3)(b)(i) it is noted that:

· Clauses of the Trust Deed provide the Trustee with express or implied powers which would enable the Trustee to redeem Units without valuable consideration passing to the affected Unit Holder. However, the numerous provisions of the Trust Deed provide the Unit Holders with sufficient protection such that their Unit Holdings are protected from the operations of those clauses in the Trust Deed.

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

In relation to subparagraph 272-5(3)(b)(ii), the likelihood of the entitlement not vesting or the defeasance happening in respect of the clauses in the Trust Deed is considered as follows:

· Although it could be possible for the Trustee of the Trust to stream income or capital, only one class of Units have been issued in the Trust, there is no provision in the Trust Deed of the Trust to re-classify Units of a particular class to a different class

· The Trustee has not exercised any of the broad discretionary powers provided in clause of the Trust Deed in the past to the detriment of Unit Holders.

· As trustees have fiduciary obligations to all unit holders under general law to act in their best interests, and not to discriminate against minority unit holders, the Trustee is unlikely to exercise the broad discretionary powers without the consent of all Unit Holders.

· No clause in of the Trust Deed includes an express or implied power which would enable the Trustee to redeem Units without valuable consideration passing to the affected Unit Holder.

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

In accordance with subparagraph 272-5(3)(b)(iii), regard must also be had to the nature of the trust.

Since coming into existence following matters in relation to the Trust have remain unchanged to date of this Ruling:

· there is only one class of Unit on issue;

· the Trustee, Unit Holders and their respective Unit Holdings have remained the same;

· the Unit Holders are unrelated parties;

· the Trustee has not exercised any of the broad discretionary powers provided in the Trust Deed in the past to the detriment of Unit Holders

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 trust loss measures 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'.

This passage 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 within the context of the provisions for which fixed entitlement is required they provide otherwise (in this case Division 266 of Schedule 2F to the ITAA 1936) regard should always be had 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.

Commissioner's Discretion

As per paragraph 272-5(3)(b) of Schedule 2F to the ITAA 1936 it is considered that the Unit Holders in the Trust may be treated as having fixed entitlements to a share of the income and capital of the Trust for the period of the Ruling.

This treatment is considered to be reasonable after having regard to the requirements of subparagraphs 272-5(3)(b)(i), (ii) and (iii) above.

In this case the factors have been considered and it is reasonable for the Commissioner to exercise the discretion pursuant to subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat 100% of the interests of Unit Holders in the income and capital of the Trust as fixed entitlements for the relevant period of the scheme of the Ruling.