Edited version of private advice

Authorisation Number: 1012645677661

Ruling

Subject: Trusts - fixed trusts

Question

Is the trust a 'fixed trust' pursuant to section 272-65 of the Income Tax Assessment Act 1936 (ITAA 1936)

Answer

No

This ruling applies for the following periods

Year ending 30 June 2005

Year ending 30 June 2006

Year ending 30 June 2007

Year ending 30 June 2008

Year ending 30 June 2009

Year ending 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on

The scheme has commenced

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.

• Unit Trust Deed for the Trust

The trust) was created some years ago with the trustee being X.

The trust is a closely held trust because fewer than 20 individuals have between them fixed entitlements to a share of 75% or more of the income.

The principle activity of the trust is the property development.

The Trust has been affected by the recent property downturn and accumulated a significant trading loss.

The directors want to access these losses by continuing with development activities and want to ensure that they are able to do so in light of some changes to the unit holdings and possible directorship change.

There have been two directors from inception to present.

Other than the unitholders with a spousal relationship, the unitholders are not related.

One director is proposing to resign, leaving the remaining director as the sole director.

Beneficial interest of unit holders and units held in the Trust

Clause 6.1 of the Unit Trust Deed states that the beneficial interest in the Fund is divided into Units.

The unit holders and total issued units from inception in 200X to present are:

A and B - 50 units held jointly; and

C (now deceased) - 49 units

D - 1 unit

C's units are currently held by the estate with a plan to transfer them to D, resulting in unit ownership as follows:

A and B - 50 units held jointly; and

D - 50 units

Clause 6.1.3 of the Unit Trust Deed states that the Trustee may issue additional units.

Since the trust was established, has there only been one class of units on issue, no further units have been issued and no units have been redeemed.

Unit Price

The initial application price of the units was $x per unit.

A Clause of the Unit Trust Deed states that notwithstanding the Unit Price for which a Unit may have been issued, all Units are of equal value, to be determined by dividing the value of the Trust Fund by the number of units.

Distribution of Net Trust income and other (including capital) distributions

Certain clauses of the Unit Trust Deed outline the trustee's obligations with regards to the distribution of income.

Distributions of income must be made so that each unit holder is entitled to the same proportion of the distribution that the total number of units held by the unit holder bears to the total number of all units on issue.

A clause of the Unit Trust Deed deals with "Interim distributions" (including capital distributions). The persons entitled to receive an interim distribution of capital must be the registered holder of units as at the date of such distribution and any such distribution shall be made to each unit holder in the same proportion of the distribution that the total number of units held by the unit holder bears to the total number of all units on issue.

Variation of trust deed

One clause of the Unit Trust Deed states that the Trustee may from time to time by deed, oral declaration recorded in a minute or resolution of the Trustee or in writing add to, vary or amend the provisions of the Deed, provided at least 75% of the unit holders support the variation.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 267-30(2)

Income Tax Assessment Act 1936 section 267-35

Income Tax Assessment Act 1936 subsection 267-40(2)

Income Tax Assessment Act 1936 Subdivision 267-B

Income Tax Assessment Act 1936 section 95A(2)

Income Tax Assessment Act 1936 subsection 272-5(1)

Income Tax Assessment Act 1936 subsection 272-5(2)

Income Tax Assessment Act 1936 section 272-65

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

Reasons for decision

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

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

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 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;

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 a word that 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, 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 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 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 of 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'. The meaning of the term 'vested and indefeasible' (in the context of Schedule 2F to the ITAA 1936) also appears in subsection 95A(2) of the ITAA 1936 and has been considered in that context by the courts - refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4525; Walsh Bay Developments Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4378; Dwight v Commissioner of Taxation (1992) 92 ATC 4192; Harmer v FC of T (1991) 173 CLR 264; 91 ATC 5000.

Also relevant are MSP Nominees Pty Ltd v Commissioner of Stamps (SA) (1999) 198 CLR 494; 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54; Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490.

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 and 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 under which the trust is constituted. Neither the form of the trust nor the labels that are attached to it can determine this question.

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 assumptions 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]…'

For the purposes of the phrase "vested and indefeasible" in subsection 272-5(1) of Schedule 2F to the ITAA 1936, the fact that a power held by the trustee or manager has not yet been exercised is not relevant when determining if the power results in an interest being defeasible. The exercise of the power is relevant to determining whether an interest has in law been defeased, not to whether the interest is defeasible. The key question is whether the power, if exercised, would result in a defeasance of some or all of a unit holder's rights to the income and/or capital of the trust.

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the constitution consists of the trust deeds and supplementary deeds. The constitution provides that the beneficial interest in the Trust is divided into units. The unit holder's interest is not contingent upon any event. They have a present right to the future income and capital of the trust.

It is accepted that the constitution provides unit holders with a vested interest in the income and capital of the Trust.

However, the Trust Deed (the relevant trust instrument) contains certain clauses by which a unit holder's interest in a share of the income or capital of the Trust may be defeased.

One clause of the Unit Trust Deed states that the Trustee may from time to time by deed, declaration, resolution of the Trustee or in writing add to, vary or amend the provisions of the Deed, provided at least 75% of the unit holders support the variation.

An amendment effected by the Trustee to the trust instrument could permit the amendment of clauses to introduce defeasible powers which do not currently exist.

Another clause of the Unit Trust Deed provides for the creation of new units which could enable the trustee to stream income or capital to new unit holders at the expense of existing unit holders. This could also defease the rights of some of the unit holders to a share of the income or capital of the Trust.

Therefore, it is considered reasonable to conclude, in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936, that all unit holders do not have fixed entitlements to all of the income and capital of the Trust. The Trust is therefore categorised as a non-fixed trust.