Edited version of private advice

Authorisation Number: 1012618717032

Ruling

Subject: Trust - fixed entitlement

Question

Will the Commissioner exercise the discretion in former section 272-5(3) of Schedule 2F to the ITAA 1936 to treat the unitholders of the Trust as having fixed entitlements to all the income and capital of the trust?

Answer

Yes

This ruling applies for the following periods

Years of income ending 30 June 2010, 2011, 2012 and 2013

The scheme commenced on

1 July 2009

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

• Your private ruling application.

• Constitution of the Trust

• Your emails to the ATO.

The Trust is a widely held unit trust registered as a Managed Investment Scheme ('MIS') with fiduciary obligations under section 601GC of the Corporations Act 2001.

The Trust is also a managed investment trust (MIT).

A Limited is the Responsible Entity (RE) and Trustee of the Trust, holding investments on trust for the unitholders.

A Limited as trustee for the Trust holds a Financial Services Licence.

The Trust's constitution has not been amended since the trust was established.

The Trust was established some years ago with the following two unitholders:

• B Limited as trustee for X Trust - X%

• C Limited as Trustee for Y Trust - X%.

Apart from the issue of units to the initial two unitholders, no further units have been issued in the trust and no units have been redeemed.

During the 20XX income year, D Pty Ltd as trustee for the Z Trust acquired all the units from C Ltd and currently holds X% of the units in the Trust.

The principle activity of the trust was the development of a property.

The developer and builder were engaged by the RE on normal commercial terms and conditions.

The Property has become an investment property, generating returns for the unitholders and the Trust will continue to hold its investment in the property.

The investment in the trust was not widely marketed to investors and there was no prospectus issued.

Z Trust and X Trust as unitholders of the Trust, deal with the RE on an arm's length basis and are not related parties.

D Pty Ltd deals with Z Trust on a cost recovery basis. There are no management or performance fees paid.

B Limited deals with X Trust on an arm's length basis.

Z Trust is a MIT and an unregistered MIS.

X Trust is not a MIS or a MIT, however X% of X Trust's units are held by a MIT.

Both Z Trust and X Trust have a single class of units on issue.

There has been no change in the RE of the Trust since the inception of the Trust.

Z Trust will receive no benefit from tax losses incurred during the year ended 30 June 20XX. The losses incurred during these income years cannot be carried forward due to failure of the X% stake test when B Ltd sold its unitholding to Z Trust in the 30 June 20XX income year.

Since its establishment, the Trust has only issued one class of unit.

Assumptions

You have requested that we rule on the assumption that A Limited as trustee for the Trust (the Trust) is not a fixed trust pursuant to sections 272-65 and 272-5(1) of Schedule 2F to the ITAA 1936 as a clause of the Constitution of the Trust may render unitholders' interests in a share of income, or of the capital, of the trust indefeasible.

This ruling is based on the above assumption.

Relevant legislative provisions

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

Reasons for decision

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) of the ITAA 1936.

Taxpayers seeking access to the Commissioner's discretion will be dealt with according to the relevant facts on a case by case basis. In the case of trusts which are managed investment schemes, it is also appropriate that consideration is given to any potential impacts that the Corporations Act 2001 (as noted above), the regulatory powers of the Australian Securities and Investments Commission (ASIC) and the actions of the Australian Securities Exchange (ASX) may have on the administration of the trust and the entitlements of beneficiaries.

In view of the assumption that 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 the ITAA 1936 may be considered.

Paragraph 272-5(3)(b) of 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) 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.

For the purposes of the consideration of the exercise of the discretion in subsection 272-5(3) the Commissioner is required to have regard to each defeasible power in the 163 PT Constitution.

Subparagraph 272-5(3)(b)(i) of the ITAA 1936:The circumstances in which the entitlement is capable of not vesting or the defeasance can happen.

These circumstances are considered to be as follows:

• Streaming: The Trustee may issue units of different classes. The Trustee may also determine the classification of any item as being on income or capital account;

• Amendments: Clause 26 of the Constitution provides that the Constitution may be amended by resolution (75%) or by deed executed by the Trustee.

• 'Open class' of beneficiaries: The Trust has an 'open class' of beneficiaries. However, the 'savings rule' in paragraph 272-5(2)(d) will be satisfied in respect of unit issues and redemptions as they are required to occur for a price determined on the basis of the net asset value of the assets of the trust (Clause for unit issues and Clause for unit redemptions).

The trust is a registered managed investment scheme for the purposes of the Corporations Act 2001.

Subparagraph 272-5(3)(b)(ii) of the ITAA 1936:

The likelihood of the entitlement not vesting or the defeasance happening

The likelihood of unit holder entitlements not vesting or a defeasance happening is considered extremely low having regard to the following:

• Streaming: There has only been one class of units on issue since the establishment of the trust.

• Amendments: The Trust's constitution has not been amended since the establishment of the trust.

• A Clause provides that, despite any other provision of the Constitution, a person cannot be defeased of any share of the Distributable Income to which the person is entitled under another clause.

It is accepted that it is unlikely that the unit holders would pass a resolution that would cause entitlements to be defeased. The trust is a registered managed investment scheme subject to Chapter 5C of the Corporations Act 2001 with two unrelated unitholders who are themselves unit trusts. One of these unitholders is a MIT. The other unitholder is not a MIT, however 100% of its units are held by a MIT.

The likelihood in which the entitlement is capable of not vesting or the defeasance can happen is considered below:

• In respect of the unitholders amending the Constitution by a special resolution, the required majority under subsection 601GC(1)(a) of the Corporations Act 2001 is 75%. As the trust has only two unitholders with a 50/50 interest, the practical effect of this is that unanimous agreement by both unitholders is required for an amendment of the Constitution;

• It is also noted that if unitholders amend the Constitution, this is not a defeasance of their rights but an agreed alteration to the rights attached to their units;

• The exercise of the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 is being considered in the context of the consideration of the RE's behaviour in relation to the trust from its establishment to June 20XX. In respect of past events the defeasible powers contained in the constitution have not been exercised to defease any of the requisite interests of the Unit Holders.

As such, it is unlikely that there will be circumstances where the deed will be amended in a way that causes the members' interests to be defeased.

Subparagraph 272-5(3)(b)(iii) of the ITAA 1936 - the nature of the trust:

The trust is a unitised trust but its units are not publicly listed on an approved stock exchange. It is a registered managed investment scheme and is subject to fiduciary controls under Chapter 5C of the Corporations Act 2001, above those which apply generally to trustees. The trust is allowed to change the Constitution only if it reasonably considers the change will not adversely affect unitholders' rights. This restricts the circumstances of which the Trustee is able to exercise its powers under the relevant clause of its Constitution.

Schedule 2F of 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. 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) that:

The 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 trust 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 having a fixed entitlement.

This passage seems to indicate that when looking at the facts of a case in the context of the criteria listed in subsection 272-5(3) regard should always be had to whether the absence of a fixed entitlement in these circumstances could result in the transfer of the benefit of the tax loss.

In this regard the RE has incurred losses in respect of each of the years that are the subject of the private ruling.

In this regard, the applicant has stated that Z Trust will receive no benefit from tax losses incurred during the years ended 30 June 20XX and 30 June 20XX.

Application to your circumstances

Having regard to the requirements of subparagraphs 272-5(3)(b)(i), (ii) and (iii) of Schedule 2F to the ITAA 1936 there is a reasonable case for the Commissioner to exercise the discretion pursuant to subsection 272-5(3) to treat the interests of the unitholders in the income and capital of the Fund as fixed entitlements.