Edited version of your written advice

Authorisation Number: 1012896084007

Date of advice: 23 October 2015

Ruling

Subject: Trust Losses

Question 1

Can The Unit Trust deduct its current year losses and prior year losses against a discretionary trust distribution?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2015

The scheme commences on

1 July 2014

Relevant facts and circumstances

The unit trust has two equal unit holders which are unrelated entities, The A Trust and B.

The structure of the unit trust has remained the same since the losses were first incurred.

The unit holders have remained the same since the losses were incurred.

B is a beneficiary of The C Trust.

The trustee of the unit trust is D who controls the A Trust.

The unit holders have the ability to reappoint a new trustee.

The unit trust is a potential beneficiary of both the A Trust and the C Trust.

The unit trust is considered to be a non-fixed unit trust.

The unit trust owns property which has had some period of vacancy which has resulted in the trust incurring a loss.

Both the A Trust and the C Trust loaned money to the unit trust.

The A Trust and the C Trust will distribute income to the unit trust to utilise the losses.

These distributions will be treated as a repayment of the existing debt that exists between the parties.

The unit trust has not distributed income in the past.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 267-30(1) of Schedule 2F

Income Tax Assessment Act 1936 Subsection 267-40(2) of Schedule 2F

Income Tax Assessment Act 1936 Subsection 267-45 of Schedule 2F

Income Tax Assessment Act 1936 Subsection 269-95(5) of Schedule 2F

Income Tax Assessment Act 1936 Subsection 269-95(1) of Schedule 2F

Income Tax Assessment Act 1936 Section 270-15 of Schedule 2F

Income Tax Assessment Act 1936 Subsections 270-10(1) of Schedule 2F

Income Tax Assessment Act 1936 Section 267-20 of Schedule 2F

Income Tax Assessment Act 1936 Section 270-20 of Schedule 2F

Income Tax Assessment Act 1936 Section 272-100 of Schedule 2F

Reasons for decision

The trust loss legislation applies different tests and rules to each of the following categories of trust:

• fixed trust

• non-fixed trusts, and

• excepted trusts.

In this case, the trust is a non-fixed unit trust and as such needs to pass the 50% stake test, the pattern of distribution test, the control test and the income injection test in order to deduct tax losses.

As per subsection 267-30(1) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) the pattern of distribution test applies if the trust distributed income in the income year or within 2 months after its end; and in at least one of the 6 earlier income years.

In this case, the unit trust has not distributed income in the past and therefore this test is not applicable.

The 50% stake test applies if individuals have fixed entitlements to more than 50% of the income or the capital of the trust at any time during the test period.

In this case, the unit holders do not have more than a 50% fixed entitlement in the income or capital of the trust and therefore the test is not applicable.

Under section 267-45 of Schedule 2F of the ITAA 1936, a group must not begin to control the trust directly or indirectly during the test period.

A group is defined in subsection 269-95(5) of Schedule 2F of the ITAA 1936 as a person; or a person and one or more associates; or 2 or more associates of a person.

Under subsection 269-95(1) of Schedule 2F of the ITAA 1936, a group controls a non-fixed trust if:

(a)    the group has power, by means of the exercise of a power of appointment or revocation or otherwise, to obtain beneficial enjoyment (directly or indirectly) of the capital or income of the trust; or

(b)   the group is able (directly or indirectly) to control the application of the capital or income of the trust;

(c)    the group is capable, under a scheme, of gaining the beneficial enjoyment in paragraph (a) or the control in Paragraph (b);

(d)   the trustee is accustomed, under an obligation or might reasonably be expected to act in accordance with the directions, instructions or wishes of the group;

(e)    the group is able to remove or appoint the trustee; or

(f)     the group acquires more than a 50% stake in the income or capital of the trust.

In this case, the unit holders have remained the same since the losses were incurred. Therefore, a group has not started to control the trust during the test period.

Under section 270-15 of Schedule 2F of the ITAA 1936, a trust may be denied a deduction for a tax loss or other deductions if there is an income injection scheme designed to take advantage of the deductions.

Under subsections 270-10(1) of Schedule 2F of the ITAA 1936, the income injection test applies where:

(a) a deduction is allowable to the trust in the income year (including a prior year loss);

(b)   there is a scheme under which:

(i)    the trust derives assessable income (the scheme assessable income); and

(ii)   an outsider to the trust, directly or indirectly, provides a benefit to the trustee or a beneficiary or an associate of the trustee or of a beneficiary; and

(iii)  a return benefit is provided to the outsider; and

(c)    it is reasonable to conclude that the trust derived the assessable income or the benefits have been provided, wholly or partly (but not merely incidentally) because the deduction is allowable; and

(d)   the trust is not an excepted trust under paragraph 272-100(b),(c), or (d) of Schedule 2F of the ITAA 1936.

In this case, the unit trust can claim a deduction for prior year tax losses and is not denied any part of this deduction under section 267-20 of Schedule 2F, therefore meeting paragraph 270-10(1)(a) of Schedule 2F of the ITAA 1997. The unit trust will derive assessable income for the 2015 financial year, being the distributions from the A Trust and the C Trust.

The definition of an outsider to the trust will depend on whether or not the trust is a family trust. As the unit trust is not a family trust, an 'outsider to the trust' is a person other than:

• a person with fixed entitlement to income or capital of the trust, or

• the trustee of the trust.

As the trust is a non-fixed unit trust there is no person with a fixed entitlement to the income or capital of the trust for the purposes of the income injection test. Therefore the A Trust and the C Trust are both outsiders to the unit trust.

Section 270-20 of Schedule 2F of the ITAA 1936 covers what is considered to be a benefit under the division. Section 270-20 of the ITAA 1936 provides:

A benefit is:

(a) money, a dividend or property (whether tangible or intangible); or

(b) a right or entitlement (whether or not property); or

(c) services; or

(d) the extinguishment, forgiveness, release or waiver of a debt or other liability; or

(e) the doing of anything that results in the derivation of assessable income; or

(f) anything that, disregarding the preceding paragraphs, is a benefit or advantage

The definition of benefit in section 270-20 of the ITAA 1936 is very wide. The Explanatory Memorandum to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 describes "benefit" in the following terms:

10.17 The term benefit is broadly defined and will include any benefit or advantage within the ordinary meaning of those expressions. However, it is defined to specifically include money or other property (whether tangible or intangible), rights or entitlements (whether proprietary or not), services and the extinguishment, forgiveness, release or waiver of a debt or other liability.

10.18 The doing of anything that results in the derivation of assessable income by the trust is also specifically defined to be a benefit. For example, if the scheme assessable income is derived by the trust as a result of the transfer, under an agreement, to the trustee of an interest from which assessable income will be derived, the person who transferred that interest to the trustee will have thereby provided a benefit to the trustee, even if the interest is not a benefit other than by reason of satisfying paragraph 270-20(e) of the ITAA 1936.

10.19 A benefit is intended to include all means whereby value is transferred between the relevant parties.

It is not strictly necessary to refer to the Explanatory Memorandum as paragraph (f) of the definition of benefit in section 270-20 of the ITAA 1936 defines it as "anything that, disregarding the preceding paragraphs, is a benefit or advantage." It is clear that it is intended to be all encompassing. 

Advantage is not defined so it takes on its ordinary meaning. The Macquarie Dictionary describes it as:

1. any state, circumstance, opportunity, or means specially favourable to success, interest, or any desired end:

2. Benefit; gain; profit:

In short it means a person who has gained a benefit is placed in a better financial position than previously as a result of dealing with the trust. 

In this case, the unit trust will be the beneficiary of the A Trust and the C Trust for the relevant year and is entitled to income appointed to it which is a benefit.

The A Trust and the C Trust are outsiders to the unit trust and must also receive a benefit for the income injection test to apply. As a result of the distribution from the two family trusts the unit trust is able to repay the loans previously received from the family trusts. The immediate repayment of the loans is considered to be a benefit to the A Trust and the C Trust.

In this case, it is reasonable to assume that the income has been derived, or the benefits have been provided, wholly or partly, (but not merely incidentally) because the deduction was available. It is unlikely the benefit provided to the unit trust, being an entitlement to receive income, would have been made if it did not have losses available to deduct against that income. Additionally, the unit trust is not an excepted trust under paragraph 272-100(b), (c), or (d) of Schedule 2F of the ITAA 1936.

The unit trust is therefore denied a deduction, in the 2014-15 income year, for prior year tax losses under the provisions in section 270-15 of Schedule 2F as it has failed the income injection test, notwithstanding that is has satisfied the conditions of subsection 267-20(2) of Schedule 2F.