Edited version of private advice

Authorisation Number: 1012641362276

Ruling

Subject: Fixed Entitlements

Question 1

Do the unit holders (beneficiaries) of the Trust have fixed entitlements to all the income and capital of the Trust for the purposes of subsections 272-5(1) and 272-5(2) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

The unit holders in the Trust do not have fixed entitlements to all of the income and capital of the Trust for the purposes of subsection 272-5(1) and 272-5(2) of Schedule 2F to the ITAA 1936.

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 the Trust as having fixed entitlements?

Answer

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

Question 3

Will the Unit Holders of the Trust be outsiders to the Trust for the purposes of subsection 270-25(2) of Schedule 2F to the ITAA 1936?

Answer

The Unit Holders of the Trust will not be outsiders to the Trust for the purposes of subsection 270-25(2) of Schedule 2F to the ITAA 1936.

This ruling applies for the following periods:

1 July 2013 to 30 June 2014

The scheme commences on:

1 July 2013

Relevant facts and circumstances

The Trust was established by trust deed (Trust Deed) on 1 July 2013.

The Trust is an Australian resident unit trust.

The Trust is not a family trust for the purposes of section 272-75 of Schedule 2F to the ITAA 1936.

All of the Units on issue are of the same class.

No streaming of income or capital to the Unit Holders has occurred.

In respect of the Trust, for the year ended 30 June 2014:

• No amount of deductions are forecast to be claimed (or provisions made) for bad debts or debt/equity swap losses;

• No further Units in the Trust will be issued;

• No Units in the Trust be will redeemed;

• No Units will be transferred;

• The Trust Deed will not be amended;

• The Trustee of the Trust will remain the same;

• No Units will be reclassified;

• No amounts of income or capital will be streamed;

Relevant legislative provisions

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 section 272-5

Income Tax Assessment Act 1936 section 272-10

Income Tax Assessment Act 1936 section 272-15

Income Tax Assessment Act 1936 section 270-25

Income Tax Assessment Act 1936 section 272-40

Income Tax Assessment Act 1936 section 272-65

Reasons for decision

Fixed entitlement

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

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

The term 'fixed entitlement' is defined in subsection 272-5(1) of Schedule 2F to the ITAA 1936 which states that:

'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 Colonial First State Investments Ltd v FCT (2011) 192 FCR 298; 201 ATC 20-235 at 97, the Federal Court defined an indefeasible interest under subsection 272-5(1) of Schedule 2F to the ITAA 1936 as having "its ordinary meaning when applied to an interest, that is that the interest cannot be terminated, invalidated or annulled."

In a case where a beneficiary has a vested interest which may be 'terminated, invalidated or cancelled' the beneficiary will have a defeasible interest. For example, where that interest is brought to an end by the exercise of a power of appointment in favour of someone else - see Dwight v Commissioner of Taxation (1992) 107 ALR 407; 92 ATC 4192; 23 ATR 236. In Dwight's case Hill J made the following observations about the meaning of 'vested and indefeasible':

The words vested and indefeasible in the context of trust law are technical words of limitation, which have a well understood meaning to property conveyancers. Estates may be vested in interest or vested in possession, the difference being between a present fixed right to 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 & Ors v Federal Commissioner of Land Tax (1915) 20 CLR 490 at 496 per Griffith CJ, at 501 per Isaacs J. A person with 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: cf Queensland Trustees Limited & Ors v Commissioner of Stamp Duties (1952) 88 CLR 54 at 63, and Re Kilpatrick's Policies Trusts [1966] Ch 730.

Trust Instrument

The fact that a beneficiary may have an interest in a trust that is described as a 'unit trust' does not answer the question: "does the beneficiary have a fixed entitlement in a share of the income or of the capital of that trust?"

The determining factor in deciding if a fixed entitlement exists under subsection 272-5(1) of Schedule 2F to the ITAA 1936 will be the terms of the trust instrument under which the trust is constituted.

In the context of subsection 272-5(1) of Schedule 2F to the ITAA 1936 determining whether a beneficiary has a 'vested and indefeasible' interest in a trust, requires examination of the terms of the trusts upon which the relevant trust property is held, including individual clauses, and whether a beneficiary's interest in a share of the income or 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).

For example, the existence of a power in a trustee to issue new units of the same class will render the interests of all unit holders in that class defeasible if the issuing of the units has the potential to cause a contraction of the proportionate interest that each of the existing unit holders has.

Similarly, a power under a trust instrument to redeem, revoke or cancel units is a power that would render a unit holder's interest defeasible, even if the power is one that can only be exercised with the unit holder's consent.

However subsection 272-5(2) of Schedule 2F to the ITAA 1936 (the 'savings provision') states that the interest of a unit holder in a unit trust will not be taken to be defeasible only because the units can be issued or redeemed. This is provided the units are redeemable or further units are able to be issued only for market value or for a price that represents the net asset value of the trust.

Application of the law

Under subsection 272-5(1) in Schedule 2F to the ITAA 1936 a person will be taken to have a fixed entitlement to a share of the income or capital of a trust if they have a vested and indefeasible interest under the trust instrument.

Under the Trust deed, the unit holders may not be considered to have a vested and indefeasible interest in all of the income and capital of the fund as the Trust deed provides for the following:

• The Trust deed can be modified, repealed or replaced.

Conclusion

Given that the unit holders' (beneficiaries) interests can be defeased, the unit holders do not have fixed entitlements to all of the income and capital of the trust.

Question 2

The Commissioner's discretion

Under subsection 272-5(3) of Schedule 2F to the ITAA 1936 the Commissioner has the discretion to deem certain beneficiaries to have fixed entitlement to the income or capital of a trust:

272-5(3) Deemed fixed entitlement

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.

According to the Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 (at paragraph 13.13), the discretion 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 trust 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.

The EM points out that in exercising the discretion regard must be had to the 'scheme of the trust loss provisions' in Schedule 2F to the ITAA 1936.

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

Under a clause of the Trust Deed the entitlement of the unit holders may be considered not to vest or be defeased. The Trust deed can be modified, repealed or replaced.

Subparagraph 272-5(3(b(ii) - the likelihood of the entitlement not vesting or the defeasance happening

The applicant has advised that:

n No amount of deductions are forecast to be claimed (or provisions made) for bad debts or debt/equity swap losses;

n No further Units in the Trust will be issued;

n No Units in the Trust be will redeemed;

n No Units will be transferred;

n The Trust Deed will not be amended;

n The Trustee of the Trust will remain the same;

n No Units will be reclassified;

n No amounts of income or capital will be streamed.

Therefore, the likelihood of a defeasance occurring is considered to be low.

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

The Trust is a closely held unit trust with an open class of Beneficiaries (with accompanying assurances that the class of Beneficiaries will be closed during the ruling period).

Conclusion

After having regard to the factors in subparagraphs 272-5(3)(b)(i), (ii) and (iii) of Schedule 2F to the ITAA 1936 and the submissions of the applicant, it is considered that the facts warrant the exercising of the Commissioner's discretion to deem the unit holders to have fixed entitlements to the income and capital of the Trust.

Question 3

Subsection 272-25(2) of Schedule 2F to the ITAA 1936 provides that:

If the trust mentioned in paragraph 270-10(1)(a) is not a family trust, an outsider to the trust is a person other than:

(a) the trustee of the trust; or

(b) a person with a fixed entitlement to a share of the income or capital of the trust.

The outcome of Question 2, above, to deem the Unit Holders of the Trust to have fixed entitlements to the income and capital of the Trust effectively means that those Unit Holders satisfy paragraph 272-25(2)(b) of Schedule 2F to the ITAA 1936. Therefore, the Unit Holders of the Trust are not outsiders the Trust for the purposes of subsection 272-25(2).