Edited version of your written advice

Authorisation Number: 1012921736456

Date of advice: 14 December 2015

Ruling

Subject: Trust Losses

Question 1

Can the Trust make a retrospective family trust election (FTE)?

Answer

No

Question 2

Can the Trust claim a deduction for its prior year tax losses?

Answer

No

This ruling applies for the following periods

Year ended 30 June 2006

Year ended 30 June 2007

Year ended 30 June 2008

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

The scheme commences on

1 July 2005

Relevant facts and circumstances

The Trust was created under a deed on XXXX.

The trustee company went into voluntary administration.

The company has been wound up.

The business which was operated under the Trust structure was closed and all Trust assets were sold.

Under the Deed, the company ceased to be the Trustee when it went into liquidation.

A and B are both named in the Deed as Guardians with power to appoint a new Trustee.

A and B were both unable to do so because they were both declared bankrupt in XXXX.

A and B were both discharged from bankruptcy in XXXX.

In XXXX, A as Guardian varied the Trust Deed and appointed themselves and B as joint Trustees for the Trust (replacement Trustee).

A new retail business has been operated under the Trust structure.

A is the director and public officer of the company (former Trustee).

A is the 'primary individual' to be specified in the FTE.

Relevant legislative provisions

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 Subdivision 267-B

Income Tax Assessment Act 1936 Subdivision 269 -E

Income Tax Assessment Act 1936 Subdivision 272-D

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

Reasons for decision

All legislative references are to Schedule 2F of the ITAA 1936, unless stated otherwise.

The trust loss measures in Schedule 2F to the ITAA 1936 do not prevent a family trust from deducting prior year losses if it is a family trust at all times in the relevant test period: Subdivision 272-D.

A trust is a family trust if a family trust election (FTE) is in force: section 272-75.

The making of an FTE is governed by section 272-80, which provides in part:

• a trust's trustee may make a written election that the trust is a family trust at all times after the beginning of a specified income year: subsections 272-80(1) and (2).

• the trustee must not make that election, if the trust does not pass the 'family control test' in section 272-87 at the end of the specified income year: subsection 272-80(4).

• the specified income year may be a year before the one in which the election is made, if the requirements of subsection 272-80(4A) are met.

Therefore, to make a retrospective FTE in this matter, subsection 272-80(4A) requires:

• the Trust must pass the family control test in section 272-87 from XXXX through to XXXX: paragraph 272-80(4A)(a); and

• any conferral of present entitlement to, or any actual distributions of, the Trust's income or capital made by the Trustee during that period was made to A (being the primary individual as referred to in paragraph 272-87(1)(a)), and to A's family group: paragraph 272-80(4A(b).

The application of the family control test to this matter is explored below.

Family control test

The family control test in subsection 272-87(1) must be passed at all times from XXXX to XXXX. This includes a requirement to satisfy a paragraph in subsection 272-87(2).

For the XXXX income years, the Trust passes the family control test on the understanding that A and B were able to remove or appoint the Trust's Trustee throughout these years.

It is understood that in the last month of the XXXX income year, the Trust's corporate Trustee went into voluntary administration and was ultimately wound up. During this process, all the Trust's assets were sold and the Trust effectively became dormant for a period. Further, in XXXX, the Trust's Appointors (namely A and B) were declared bankrupt. As a consequence of these events, the corporate Trustee in the XXXX income year and the Appointors in the XXXX income year vacated their office and ceased to act as such.

It is assumed that at some time between XXXX (when A and B were discharged from bankruptcy) and XXXX, A was re-appointed as the Trust's Appointor based on the Trust Deed. This enabled A and B's appointment in XXXX as joint Trustees of the Trust.

If the assumptions immediately above are correct, then:

a) for the XXXX income year, paragraph 272-87(2)(e) is satisfied. This is because A and B in their capacity as the Trust's Appointors were able under the terms of the Trust to appoint a new Trustee (following the corporate Trustee's automatic removal in June 20XX). Consequently, it can be accepted that the family control test is passed in that income year.

b) for the XXXX income years, paragraph 272-87(2)(e) is not satisfied. As such, the family control test cannot be passed on the basis of paragraph 272-87(2)(e). This is because A and B were automatically removed from acting as the Trust's Appointors upon their bankruptcy. It is considered that the terms of the Trust precluded A and B being Appointors throughout their bankruptcy. Consequently, A was not able to appoint a new Trustee at all times during these income years.

Subsection 272-87(2) applied to Trust's terms in the 2009 income year

c) for the XXXX income year:

i) paragraph 272-87(2)(a) is not satisfied. This is because A did not have power throughout this income year to obtain beneficial enjoyment of the Trust's capital or income by exercising a power to revoke or appoint.

ii) paragraph 272-87(2)(b) is not satisfied. This is because application of the Trust's capital or income is controlled through exercise of the Trustee's discretion according to the terms of the trust. Upon bankruptcy, A was not able to directly or indirectly control such exercise. As such, A had no power to ensure the Trust's capital or income was applied in the family's favour.

iii) paragraph 272-87(2)(c) is not satisfied. This is because upon the corporate Trustee's winding up and the bankruptcy, the terms of the trust revoked and precluded A from occupying any position from which to have immediate power or control to ensure the Trust's capital or income was applied in A's family's favour. Therefore, A and the relevant members of A's family had no instant capacity under the terms of the Trust to make agreements or engage in conduct to gain the requisite influence.

It is noted that the potential for a scheme to exist would arise for example if another family member (who does not suffer an incapacity) was appointed as Trustee following the corporate Trustee's removal and the facts indicated an agreement or course of conduct between them resulting in the Trust's capital or income being applied to A's family's favour. At this preliminary stage, there is no such evidence of any scheme outside the terms of the trust having been agreed or embarked upon to direct the Trust's funds to A's family's benefit.

Indeed, beyond the terms of the trust, in the situation of winding-up and bankruptcy, it is assumed the application and enjoyment of the Trust's income and capital was affected by unrelated parties. This further diminishes the possibility of a requisite scheme.

iv) paragraph 272-87(2)(d) is not satisfied. This is because the corporate Trustee is assumed to have been automatically removed under the terms of the Trust in the previous income year and is not the Trustee in the XXXX income year. A and B are contended not to have been eligible under the terms of the Trust to be appointed as Trustees whilst bankrupt. Therefore, if there was no Trustee following the removal of the corporate Trustee, the liquidator had the default power of appointing the Trust's Trustee. It is assumed that any such Trustee so appointed, would not become accustomed, be under an obligation or be reasonably expected to act in accordance with A's directions, instructions or wishes.

v) paragraph 272-87(2)(f) is not satisfied. This is because, for instance, the Trustee has the discretion to distribute income and capital to charitable bodies or persons. As such, A's family does not have more than a 50% stake in the Trust's income or capital.

vi) paragraph 272-87(2)(g) is not satisfied. As set out immediately above, A and A's family are not the only persons who, under the terms of the Trust, can obtain the beneficial enjoyment of the Trust's income and capital.

The above analysis focuses on the terms of the trust. Under those terms, the corporate Trustee's winding up and the Appointors' bankruptcy disrupted the control (direct and indirect) A and A's family previously enjoyed in respect of the Trust's income and capital. In particular, it disrupted the power to control the Trust's capital or income by exercising the power to appoint or revoke the Trustee, which A and B had controlled before A's intervening bankruptcy. The bankruptcy and the making of the winding-up order and consequential operation of company legislation similarly disrupted A and A's families' capability to control the application of the Trust's capital or income.

Conclusion

In conclusion, the Trust does not pass the family control test in the XXXX income year.

Consequently, none of the paragraphs in subsection 272-87(2) were met in the XXXX income year. As such, the requirements in paragraph 272-80(4A)(a) are not satisfied since the Trust does not pass the family control test at all times from XXXX to XXXX.

Accordingly, the Trust cannot make a retrospective FTE.

Deducting tax losses from earlier years

A non-fixed trust that is not a family trust may still be allowed to deduct prior year tax losses if the trust satisfies certain tests. To obtain a deduction for a prior year tax loss, the trust must pass up to three separate tests: subsection 267-20(2). The three tests are:

• control test; and

• 50% stake test (if applicable); and

• pattern of distribution test (if applicable).

If a particular test is to be satisfied, it must generally be satisfied during the relevant test period. To deduct prior year losses, the relevant test period extends from the beginning of the income year in which the loss was incurred, the income year in which the loss is claimed as a deduction (the recoupment year) and all the intervening income years: subsection 267-20(1).

In the present case, the 50% stake test is not applicable because the Trust (being a discretionary trust), individual beneficiaries are unlikely to have held (directly or indirectly) fixed entitlements to more than 50% of the income or capital of the Trust at any time during the test period.

As to the pattern of distribution test, there's no evidence provided that certain distributions have been made by the Trustee of the Trust for the purposes of section 267-30. As such, this test may not necessarily be applicable in the present case.

Applying the control test

There must be continuity of control of the Trust by the original group during the relevant test period for the Trust to be able to deduct prior tax losses. The control test in section 267-45 applies to all non-fixed trusts. That section provides that no group must begin to control the trust (directly or indirectly) during the relevant test period.

Subsection 269-95(1) provides the meaning of when a group controls a non-fixed trust. The reference is to a 'new group' beginning to control the trust. The Trust will fail the control test when a paragraph in that subsection is satisfied.

A group is a person; or a person and one or more associates; or two or more associates of a person (subsection 269-95(5)). A person is not limited to a natural person, for example, subsection 995-1(1) of the ITAA 1997 provides that a person includes a company.

The term 'liquidator' is not defined in the Tax Act. The Macquarie Dictionary defines the term as a 'person' appointed to carry out the winding up of a company. Therefore, a liquidator falls under the meaning of a 'group' for the purposes of section 269-95.

Broadly, on the appointment of a liquidator, the powers of the directors of the company cease: subsection 499(4) of the Corporations Act 2001. Under the Corporations Act, the liquidator's powers include all of the powers that vested in the directors of the company, and among other things, the power to sell the assets or any business of the company.

In the present case, when the corporate Trustee went into liquidation, A's power as the director and public officer of the trustee company defaulted to the liquidator. A ceased to have any authority in the company. The control of all assets and the conduct of any financial affairs of the company were effectively transferred to the liquidator. As such the corporate Trustee ceased to control the Trust as A no longer had any power as to that Trustee.

In addition, A and B were declared bankrupt. Under the Trust's term A's power as Guardians and Appointors ceased. Hence, A was not able to appoint a new trustee.

When a liquidator is appointed in respect of a company that is a trustee, the liquidator is invested with the trustee's power to administer the trust. This power comes from paragraph 477(2)(m) or section 499 of the Corporations Act 2001.

As such, in the present case, the liquidator is considered a 'new group' beginning to control the trust for the purposes of subsection 269-95(1) during the period of insolvency by the corporate trustee. Having that power, effectively:

• the liquidator is able (directly or indirectly) to control the application of the capital or income of the Trust: paragraph 269-95(1)(b); or

• the liquidator is capable, under a scheme, of gaining the control in paragraph (b): paragraph 269-95(1)(c )

Therefore, as the definition of control in said paragraphs of subsection 269-95(1) is satisfied, the Trust does not pass the control test in section 267-45.

Special circumstances in which control will not be taken to have changed

Subsection 269-95(2) contains a concessionary treatment where it deems no change of control in the trust. It applies to certain circumstances where a member of the controlling group (original group) ceases to control the trust because of death, incapacitation or breakdown in the marriage or relationship of the individual in that original group (subsection 269-95(3) and paragraph 269-95(2)(a)). The requirements for this concession (which must be all satisfied) are:

• the group that begins to control the trust (the replacement group) must consist of only members of the family of the affected controller and all other members of the original controlling group (who do not suffer incapacitation or marriage/ relationship breakdown) - paragraph 269-95(2)(c); and

• the replacement group must begin to control the trust within one year from the death, incapacity or marriage/ relationship breakdown unless the Commissioner determines a longer period - paragraph 269-95(2)(b); and

• the replacement group must have only took control of the trust because of the death, incapacity or marriage/ relationship breakdown of the affected controller - paragraph 269-95(2)(d); and

• disregarding any deceased, incapacitated or separated individuals and the new controllers, there are no changes to the beneficiaries - paragraph 269-95(2)(e).

In the present case, the requirement in paragraph 269-95(2)(c) is not satisfied because the liquidator (considered as replacement group) that began to control the trust is not a member of A and B's family for the purposes of section 272-95.

The Explanatory Memorandum to Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997, which introduced the trust loss measures in Schedule 2F to the ITAA 1936, explains the meaning of an incapacitated person. It states (at item 9.64):

A member of the family of a person is defined in section 272-95. An incapacitated person is one who is mentally or physically disabled such that they can no longer control the trust.

This implies that the meaning of the term 'incapacitation' as used in subsection 269-95(2) refers only to an individual member of the family of a person in the context of section 272-95. It does not relate to insolvency. Therefore the concession provided in subsection 269-95(2) does not apply to A's circumstances.

Conclusion

In conclusion, the control test in section 267-45, as defined in subsection 269-95(1), is not satisfied during the period of insolvency by the corporate Trustee. This is because A's power as to the corporate Trustee (being the original controller) ceased and that power defaulted to the liquidator.

In addition, A's and B's power to appoint or revoke a trustee (being Guardians and Appointors) also ceased under the Trust's terms when they were both declared bankrupt. Hence, A was not able to appoint a new trustee.

As such the liquidator is considered a 'new group' beginning to control the Trust for the purposes of subsection 269-95(1) during the period of insolvency by the corporate trustee. Having that power, effectively the liquidator is able (directly or indirectly) to control the application of the capital or income of the Trust; or the liquidator is capable, under a scheme, of gaining that control as defined in paragraphs 269-95(1)(b) and 269-95(1)(c).

Consequently, as the definition of control provided in paragraphs 269-95(1)(b) and 269-95(1)(c) is satisfied, the Trust does not pass the control test in section 267-45.

Accordingly, the Trust cannot claim a deduction for its prior year tax losses accumulated before the former Trustee's winding up and the Appointors' bankruptcy.