Edited version of your written advice

Authorisation Number: 1012995263228

Date of advice: 13 April 2016

Ruling

Subject : Vested and Indefeasible Interest

Issue

Will the interests of the Unitholders of the Trust in the trust holding be fixed interests under former subsection 160APHL(10) of the Income Tax Assessment Act 1936?

Question 1

Will the Unitholders of the Trust have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936?

Answer

No

Question 2

Will the Commissioner exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat the Unitholders of the Trust as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding?

Answer

Yes

This ruling applies for the following periods:

1 July 2014 to 30 June 2019

The scheme commences on:

1 July 2014.

Relevant facts and circumstances

The trust was established by deed (the trust deed) as a unit trust (the trust).

The trust has several beneficiaries, all of which are Australian residents.

The trust was established for the purpose of certain non-related sophisticated and wholesale investors making investments and purchasing shares.

Initial unit subscriptions were $2 million.

The trust has held shares in the company on capital account and it will continue to do so.

The trust deed may be amended by the trustee with the unanimous approval of the unitholders.

The trust deed will not be amended throughout the ruling period.

Only a single class of units is on issue.

Unit issues and redemptions can only occur at the net asset backed value of the units.

The valuation must be based on Australian accounting principles.

The trust deed provides the unitholders with a vested interest in the capital of the trust.

The Trustee does not have any carried forward 'tax losses'.

The Trustee does not forecast a 'tax loss' to occur during the Ruling Period.

The nature of the investments are such that it would reasonably be expected that the Trustee derives a recurring 'income' stream such that this income exceeds its expenses for tax purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997

paragraph207-145(1)(a)

Income Tax Assessment Act 1936

former section 160APA

former section 160APHD

former section 160APHL

former subsection 160APHL(7)

former subsection 160APHL(10)

former subsection 160APHL(11)

former subsection 160APHL(12)

former subsection 160APHL(13)

former subsection 160APHL(14)

Reasons for decision

Question 1

Summary

The terms of the trust instrument do not provide the unitholders with a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936.

Detailed reasoning

A taxpayer must be a "qualified person" to be entitled to a franking credit in respect of a dividend. To be a qualified person, a taxpayer must satisfy the 45-day holding period rule. Although the related payments rule is applied by reference to the repealed provisions of the ITAA 1936, the Tax Office stated in Determination TD 2007/11 that the ITAA 1936 rules have ongoing application as a result of being "imported" into the ITAA 1997 regime via the anti-manipulation rule in s 207-145(1)(a) of the ITAA 1997.

In the case of a trust distribution consisting wholly or partly of dividend income, generally the trustee must be a qualified person and, in addition, the beneficiary must be at risk for a prescribed period during the qualification period in respect of the taxpayer's interest in the membership interest from which the dividend income is derived (former section 160APHL of the ITAA 1936).

The effect of deemed long and short positions under former sections 160APHL(7) and (10) relating to shares held is that unless a beneficiary has a fixed interest constituted by a vested and indefeasible interest in the corpus of the trust or an exception applies, a beneficiary in a non-widely held trust will typically have a net position of zero, i.e., not be sufficiently at risk, meaning that franking credits will not pass through the trust (eg see ATO ID 2002/122 ).

Practice Statement PS LA 2002/11: 'Issues concerning fixed entitlements to a share of the income or capital of a trust' has application to former sections 160APA and 160APHD of the ITAA 1936 but not directly to former section 160APHL (only indirectly via the definition of 'widely held trust' which, in part, relies upon the definition of 'fixed trust' in Schedule 2F to the ITAA 1936).

For the purposes of former section 160APHL of the ITAA 1936 the Trust is in the category of 'all other non-widely held trusts' apart from family trusts, deceased estates and employee share scheme trusts.

A "fixed interest" in the trust holding is defined in former subsection 160APHL(11) of the ITAA 1936 as "a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding." [emphasis added]

Is there an 'interest in so much of the corpus of the trust as is comprised by the trust holding'?

Former section 160APHL provides that in calculating the extent of a beneficiaries interest, it is necessary to distinguish between the interest of a beneficiary in shares held by a widely-held trust (as defined below), and the interest of a beneficiary in shares held by other trusts.

The Trust is not a 'widely held trust' for the purposes of former section 160APHD of the ITAA 1936.

This necessitates that a 'look through' approach will be required to determine the interest that a Member has in each of the underlying shares in the Trust [refer to paragraphs 4.26, 4.77 and 4.88 of the EM with accompanied the Taxation Laws Amendment Bill (No. 2) 1999.]

Although the method of calculating the interest that a Member has in the trust holding differs as between widely-held trusts and trusts other than widely-held trusts, the beneficiaries of both types of trusts do have an interest in the trust holding.

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 602-603 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 (Vic) (2005) 224 CLR 98). 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 former section 160APHL of the ITAA 1936, 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 capital of the trust that is susceptible to measurement. To adopt the words of Lord Wilberforce in Gartside v Inland Revenue Commissioners, the right must have 'the necessary quality of definable extent'.

The term 'vested and indefeasible' is also not defined in the taxation legislation and to date there is no 'ATO view' which defines or clarifies the term.

The meaning of the term 'vested and indefeasible' has been considered by the courts in relation to subsection 95A(2) of the ITAA 1936 and in the context of Schedule 2F to the ITAA 1936) - 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; Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235.

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; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490.

Vested interests

For the purposes of former subsection 160APHL(11) of the ITAA 1936, it is accepted that the trust deed provides the unitholders with a vested interest in the capital of the trust.

Defeasible power in the trust deed

Power of variation

Under the trust deed, the unitholders in the trust may not be considered to have a vested and indefeasible interest in all of the income and capital of the trust as the trust deed provides a power for the trustee to amend the trust deed which constitutes a defeasible power.

It is noted that a unanimous resolution of unitholders is required in relation to a variation concerning certain matters.

However, the mere existence of a power to amend the trust deed constitutes a defeasible power [Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 at [106]].

Where unanimous agreement of the unitholders is required prior to an amendment this will only be relevant to the considerations of the Commissioner for the purposes of determining the likelihood of a defeasance occurring for the purposes of former subparagraph 160APHL(14)(c)(ii) of the ITAA 1936.

Issue and redemption price of Units

Former subsection 160APHL(12) effectively provides that the ability of a trustee to redeem or issue units will be taken to be defeasible powers in certain circumstances (i.e., where a unit is redeemed for less than its value or where the issue of units materially reduces the value of units already issued.

The terms of the trust deed require that units be issued and redeemed on a net asset backed value basis which would satisfy the requirements of former paragraph 160APHL(13)(d) in any case.

Therefore, the ability of the trustee to issue or redeem units does not constitute a defeasible power under the trust deed.

Conclusion

Therefore, although the unitholders of the trust do have a vested interest in a share of the capital of the trust they do not have an indefeasible interest in a share of the capital of the trust, i.e. an interest in a share (or proportion) of all of the capital of the trust. (Note: The terms 'corpus' and 'capital' are considered to be synonymous for current purposes.)

As such, the unitholders of the trust do not have a vested and indefeasible interest in so much of the corpus (capital) of the trust as is comprised by the trust holding.

Question 2

Summary

The Commissioner considers that it is reasonable to exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat the unitholders of the trust as having a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding.

Detailed reasoning

In view of the conclusion above that the unitholders of the trust do not have a vested and indefeasible interest in so much of the corpus (capital) of the trust as is comprised by the trust holding (being the trustee's ownership of shares) pursuant to former subsection 160APHL(11) of the ITAA 1936, the only way that the unitholders can have such a vested and indefeasible interest is if the Commissioner exercises the discretion in former subsection 160APHL(14).

Former subsection 160APHL(14) of the ITAA 1936 contains a discretion, whereby in cases where beneficiaries do not have a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding, the Commissioner may determine that the interest is to be taken to be vested and indefeasible.

The requirements to be satisfied in respect of the discretion are contained in former subsections 160APHL(14)(a), (b) and (c) of the ITAA 1936.

In terms of former paragraph 160APHL(14)(a) -

The taxpayer has an interest in so much of the corpus of the trust as is comprised by the trust holding:

As discussed above, the unitholders in the trust will have an interest in so much of the corpus of the trust as is comprised by the trust holding.

In terms of former paragraph 160APHL(14)(b) -

Apart from this subsection, the interest would not be a vested or indefeasible interest:

As discussed above, although a unitholder's interest in the capital of the trust is vested, the trust deed contains certain clauses by which a unitholder's interest in a share of the capital of the trust may be defeased.

In terms of former paragraph 160APHL(14)(c) -

Having regard to the factors prescribed in former paragraph 160APHL(14)(c):

These factors are:

(i) the circumstances in which the interest is capable of not vesting or the defeasance can happen; and

(ii) the likelihood of the interest not vesting or the defeasance happening; and

(iii) the nature of the trust; and

(iv) any other matter the Commissioner thinks relevant.

Former subparagraph 160APHL(14)(c)(i) of the ITAA 1936:

In relation to the circumstances in which the entitlement is capable of not vesting or the defeasance happening, the following comments are made:

• The trust deed may be varied with the unanimous approval of the unitholders.

Former subparagraph 160APHL(14)(c)(ii) of the ITAA 1936:

In relation to the likelihood of the entitlement not vesting, or the defeasance happening, the following comments are made:

• The trustee's behaviour as the trustee of the trust from the settlement of the trust is relevant. In respect of past events the defeasible powers contained in the trust deed have not been exercised to defease any of the requisite interests of the unitholders;

• In respect of the ruling period no amendments will be made to the trust deed.

Therefore, it is considered that the likelihood of defeasance happening is low.

Former subparagraph 160APHL(14)(c)(iii) of the ITAA 1936:

In relation to the nature of the trust the following comments are made:

• The trust is a unitised trust;

• The trust was established for the purpose of investing amongst non-related parties. The unitholdings of the trust consist of wholesale investors and sophisticated investors. The unitholders include the trustees of a superannuation fund;

• The capital of the trust exceeds $2 million;

• The main activity of the trust is to make investments and purchase shares.

Former subparagraph 160APHL(14)(c)(iv) of the ITAA 1936:

In relation to other relevant matters it is noted that there will be no tax losses in existence during the ruling period such that tax loss trafficking or value shifting cannot occur.

Recommendation

As per former paragraph 160APHL(14)(c) of the ITAA 1936 it is considered that the unitholders in the trust may be treated as having vested and indefeasible interests in so much of the corpus of the trust as is comprised by the trust holding.

This treatment is considered to be appropriate after having regard to the requirements of former subparagraphs 160APHL(14)(c) (i), (ii) and (iii) as discussed above.

In summary, it is submitted that as:

• the circumstances in which the interest is capable of not vesting or a defeasance happening are limited;

• the likelihood of the interest not vesting or a defeasance happening are remote; and

• the "nature of the trust" is of one involved in investment by wholesale or sophisticated investors;

there is a reasonable case for the Commissioner to exercise the discretion pursuant to former paragraph 160APHL(14)(c) to treat the interests of Unitholders in the corpus of the Trust as vested and indefeasible.