Edited version of your written advice

Authorisation Number: 1013015773359

Date of advice: 18 April 2016

Ruling

Subject: Whether a trust is a fixed trust

Question 1

Is the Trust a 'fixed trust' under section 272-65 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) and subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No

Question 2

Will the beneficiaries of the Trust have fixed entitlements to all the income and capital of the Trust as defined in subsection 272-5(1) of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997?

Answer:

No

Question 3

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 to all the income and capital of the trust?

Answer:

No

Question 4

Does subsection 855-10(1) of the ITAA 1997 allow the beneficiary to disregard a capital gain made as a foreign resident beneficiary of the Trust?

Answer:

No

This ruling applies for the following periods:

Year ended 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

The scheme commenced on:

1 July 2014

Relevant facts and circumstances

The beneficiary is a family member of the Settlor of the Trust.

The beneficiary hold shares in an entity A.

The beneficiary is a resident of a foreign country for tax purposes.

The Trust is a resident trust for Australian tax purposes.

Entity A sold all its assets and loaned the entire proceeds equally and interest free to entities B and C.

The only assets of entity A in their balance sheet are the loans.

The directors of entity A are considering winding up the entity by placing it into voluntary liquidation.

When entity A is wound up the liquidator will make a distribution to in satisfaction of the beneficiary interest as an individual shareholder in entity A.

The liquidator will also make a distribution to the Trust in satisfaction of the Trust's interest as a shareholder in entity A.

The interests held in Entity A are not taxable Australian property for the purposes of section 855-15 of the ITAA 1997 because the only assets of entity A are the loans to a number of entities.

The Trust was established on XXXX between the Settlor and the Trustee.

The Trust

The applicant provided a copy of the Deed for the Trust (the Deed) and the Deed provides the following clauses:

Clause 1(c) provides that 'the vesting day' means the day on which shall expire the period of 80 years after the execution of the trust deed. However after the expiration of the period of one month from the date of execution of the deed, the trustee may by deed appoint an earlier date to be the vesting day subject always to the approval by the appointors specified under Clause 8.

• Clause 2(a) states:

Until the vesting day the trustee shall stand possessed of the Trust Fund UPON TRUST as to the income thereof as follows:

(i) during the life of the First Beneficiary, for the First Beneficiary absolutely; and

(ii) thereafter, for the Other Beneficiaries or any one or more of them exclusive of the other or others in such shares and proportions as the trustee in its absolute discretion may from year to year determine.

• Clause 4 states:

The Trustee shall stand possessed of the Trust Fund on the vesting day in trust as to income and capital as follows:

(i) for the 'First Beneficiary' absolutely;

(ii) if the first beneficiary shall die before the vesting day, for such of the 'Other Beneficiaries' as are then living or in existence or any one or more of them exclusive of the other or others in such shares and proportions as the trustee in its absolute discretion may determine and in default of any such determination, shall stand possess of the Trust Fund for such of the relatives (as defined in Clause 6(a) of the Schedule) as shall then living and if more than one as tenants in common in equal shares.

• Clause 6 provides that the trustee shall until the vesting day and during such further period if any that the law may allow have additional powers in the administration of the trust, for example, in paragraph (t) where it states:

power in its absolute discretion, and notwithstanding any rule of law or equity to the contrary, to determine whether any receipt, profit or gain or any payment, loss or outgoing or any sum of money or investment is or is not to be treated as being on income or capital account and, if the trustee so chooses, to distinguish between income of any one type or character and income of another type or character, and to deal with one type or character of income in one manner and any other type of character or income in a different manner.

• Clause 8 states:

The power of appointing a new trustee in place of a trustee or in addition to any existing trustee and also the power to remove any trustee shall be vested:

(a) in the Settlor and XXXX jointly during their joint lifetime and on the death of one of them then in the survivor during his lifetime;

(b) on and from the death of the survivor of the settlor and XXXX.

PROVIDED ALWAYS that notwithstanding anything to the contrary herein contained the settlor or any beneficiary shall not at any time be eligible for appointment as a trustee hereof.

• Clause 11 states:

At any time following the death of the First Beneficiary (the beneficiary) and prior to the termination of the trust hereby declared the trustee may from time to time in its absolute discretion notwithstanding anything to the contrary hereinbefore contained by deed vary the trusts or provisions hereof in any manner whatsoever provided that any variation of the objects shall be in favour of all or any one or more of the following, namely:

• any relatives by blood or adoption by the First Beneficiary (other than XXXXX); or of

• any spouse by the First Beneficiary

SUBJECT ALWAYS to no share or benefit from or interest in or under the Trust Fund at any time anyway acquired by or passing to the settlor his executors, or administrators consequent upon or pursuant to any such variation aforesaid and PROVIDED THAT any such variation of the objects shall be subject to a restriction to the intent that no part of the income or capital of the Trust Fund shall be paid or be capable of being paid by the trustee to any person or institution which might involve non-compliance with the rule against perpetuities.

The Schedule to the Deed provides the following clauses:

• Clause 5 of the Schedule defines the 'First Beneficiary' to mean the beneficiary who is the subject of this private ruling.

• Clause 6(a) of the Schedule defines the 'Other Beneficiaries' to mean:

any descendant of Settlor and XXXXX born before the vesting day (excluding XXXX), or any adopted child of any such descendant, or the lawful spouse, widow or widower of any such descendant or adopted child born before the vesting day (hereinafter called 'Relatives').

Relevant legislative provisions

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 Section 272-5

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

Income Tax Assessment Act 1936 Subsection 272-5(3)

Income Tax Assessment Act 1936 Paragraph 272-5(3)(a)

Income Tax Assessment Act 1936 Paragraph 272-5(3)(b)

Income Tax Assessment Act1936 Subparagraph 272-5(3)(b)(i)

Income Tax Assessment Act1936 Subparagraph 272-5(3)(b)(ii)

Income Tax Assessment Act 1936 Subparagraph 272-5(3)(b)(iii)

Income Tax Assessment Act 1936 Section 272-65

Income Tax Assessment Act 1997 Section 115-215

Income Tax Assessment Act 1997 Subsection 115-215(3)

Income Tax Assessment Act 1997 Subsection 115-215(4A)

Income Tax Assessment Act 1997 Subsection 855-10(1)

Income Tax Assessment Act 1997 Section 855-40

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

Reasons for decision

Fixed trust

The term 'fixed trust' is defined in section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997 to mean a trust in which persons or entities (respectively) have fixed entitlements to all of the income and capital of the trust.

Fixed entitlement is determined with reference to section 272-5(1) of Schedule 2F to the ITAA 1936 where it provides:

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.

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

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, 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 infeasible' (in the context of Schedule 2F) has not been judicially considered. However, the term appears in Division 6 subsection 95A(2) of the ITAA 1936 and in the context of that subsection, the term has been considered by the courts; for example, refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4,525; 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) 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; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490.

Determining whether a beneficiary has a 'vested and indefeasible' interest in a trust, requires an extensive review of the relevant trust instrument(s) including individual clauses to determine, based on the principles established in the above cases, the existence of defeasible powers.

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 or 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.

The important question is whether the vested and indefeasible interests represent 100% of the income and 100% of the capital of the trust. The fact that a power held by the Trustee has not yet been exercised is not relevant when determining if the power results in an interest being defeasible. The exercise of the trustee's power goes to whether an interest has in law been defeased, not to whether it is defeasible, and the real question is whether the power, if exercised would result in a defeasance of some or all of the beneficiary's rights to the income and/or capital of the trust.

Do vested and indefeasible interests exist in the income and capital of the Trust?

A review of the Deed of the Trust shows that the beneficiaries have an 'interest' in the income and capital of the Trust.

Entitlement to income

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the terms of the Trust under the Deed provides that a vested and indefeasible interest in the income of the Trust exists. The First Beneficiary of the Trust does have a vested and indefeasible interest in all of the income of the trust. According to the terms of the Deed the First Beneficiary's entitlement to all of the income of the trust is absolute for life.

Hence there is fixed entitlement to the income of the trust but only during the life time of the First Beneficiary (life tenant) - Clause 2(a)(i) of the Deed.

After the death of the First Beneficiary, there is no vested and indefeasible interest by the Other Beneficiaries (remainder owners) because the Trustee has absolute discretion to determine the allocation of income amongst the remainder owners. The Trustee has the power to allocate income to any one or more of them exclusive of the other or others in such shares and proportions as the trustee may determine. As such, there is no fixed entitlement to the income of the trust after the death of the First Beneficiary - Clause 2(a)(ii) of the Deed.

Entitlement to capital
For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the terms of the Trust Deed provide that a vested and indefeasible interest in the capital of the trust does not exist. The First Beneficiary does not have a vested and indefeasible interest in all of the capital of the trust.

By the terms of the Deed, the First Beneficiary does not have any entitlement to all of the capital of the Trust.as when the First Beneficiary dies, the capital of the Trust does not go to the First Beneficiary's estate. Instead the capital is passed over to the Other Beneficiaries (remainder owners) subject to the Trustee's absolute discretion. As such the beneficiaries in the trust do not have fixed entitlement to all of the capital of the Trust - Clause 4(ii) of the trust Deed.

If a beneficiary has an interest in the asset that is vested in possession and is indefeasible, the beneficiary is able to terminate the trust in respect of the asset by demanding that the asset be transferred to them or at their direction. This is known as the rule in Saunders v. Vautier (1841) Cr & Ph 240; 49 ER 282.

In the present case, there are no provisions in the Deed where the First Beneficiary is given the power to terminate the Trust and demand payment from the Trust fund prior to vesting day.

The First Beneficiary has a life interest only - see Clause 2(a) and Clause 4 of the Deed of the Trust.

Taxation Ruling TR 2006/14 explains (at paragraph 184):

A life interest is generally measured by the life of the life interest owner although it can be measured by the life of another individual. The life interest ends on the death of the individual who is the measuring life. Except in the limited case where the life interest owner dies before the individual who is the measuring life, the life interest does not form part of the estate of the life interest owner.

TR 2006/14 further explains (at paragraph 185):

The remainder owner is entitled to an interest which vests in possession only when the prior life interest ends. Unlike a life interest, the remainder forms part of the remainder owner's estate for distribution in accordance with their will, or upon intestacy.

Section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997 require that a trust is a 'fixed trust' if persons or entities (respectively) have fixed entitlements to all of the income and capital of the trust.

Although a fixed entitlement exists to the income of the Trust under subsection 272-5(1) of Schedule 2F to the ITAA 1936 while the First Beneficiary is alive, no fixed entitlement exists to the capital of the Trust pursuant to that subsection. As such the requirements of a 'fixed trust' are not sufficiently satisfied.

Therefore, the Trust is not a 'fixed trust' for the purposes of section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997.

Commissioner's discretion - Consideration of the factors in subsection 272-5(3) of the ITAA 1936

Subsection 272-5(3) of Schedule 2F to the ITAA 1936 contains a discretion, whereby in cases where beneficiaries with an interest in the income and capital of the trust do not have a fixed entitlement, the Commissioner may, for the purposes of the ITAA 1936, treat such cases as having fixed entitlement.

In terms of paragraph 272-5(3)(a) of the ITAA 1936:

As discussed above, in this case, the beneficiaries of the Trust do not have a vested and indefeasible interest in the capital of the Trust. As such the Commissioner is unable to consider the discretion under paragraph 272-5(3)(a) of Schedule 2F to the ITAA 1936.

In terms of paragraph 272-5(3)(b) of the ITAA 1936:

Paragraph 272-5(3)(b) of Schedule 2F to the ITAA 1936 stipulates that the Commissioner may treat a beneficiary as having fixed entitlement (in cases where in fact beneficiaries do not have fixed entitlements) 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.

In this case, the Commissioner is also unable to consider the discretion under paragraph 272-5(b) of Schedule 2F to the ITAA 1936 as the Trust is a discretionary trust which is subject to the Trustee's absolute discretion under Clause 11 of the Deed. As such the interest and/or entitlement of the beneficiaries can be defeated by the exercise of the Trustee's absolute discretionary powers - subparagraphs 272-5(3)(b)(i) and (ii) of Schedule 2F to the ITAA 1936.

As to the nature of the Trust, apart from being discretionary trusts, the Trust is also a private trust. As such the Trustee is not subject to any fiduciary controls, for example the application of Chapter 5C of the Corporations Act 2001, above those which apply generally to trustees - subparagraph 272-5(3)(b)(iii) of Schedule 2F to the ITAA 1936.

Conclusion

As explained above, the requirements of a 'fixed trust' are not sufficiently satisfied. Therefore, the Trust is not a fixed trust for the purposes of section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997.

Given the beneficiaries do not have a vested and indefeasible interest in the capital of the trust, the Commissioner is unable to consider the discretion under paragraph 272-5(3)(a) of Schedule 2F to the ITAA 1936.

Having regard to the factors in paragraph 272-5(3)(b), it is considered that the facts of this case do not warrant the exercise of the Commissioner's discretion to deem fixed entitlements.

On the basis that the Trust is not a 'fixed trust' and as the First Beneficiary is a non-resident for tax purposes the beneficiary is not eligible for the exemption in section 855-40 of the ITAA 1997.

Question 4

Shares in a company (or membership interest in a company) are CGT assets for the purposes of section 108-5 of the ITAA 1997.

Subsection 855-10(1) of the ITAA 1997 provides that a capital gain or capital loss from a CGT event is disregarded if:

(a) You are a foreign resident just before the CGT event happens; and

(b) The CGT event happens in relation to a CGT asset that is not taxable Australian property.

Interest as beneficiary of the Trust

CGT event C2 in section 104-25 of the ITAA 1997 happens to the Trust when the Trust's interest as a shareholder of entity A ends. The liquidator will make a distribution to the Trust in satisfaction of the ending of their interest in entity A.

The liquidator's distribution will form part of the capital proceeds from CGT event C2. The Trust will make a capital gain if the capital proceeds from the event are more than the asset's cost base and the Trust will make a capital loss if the capital proceeds are less than the asset's cost base - subsection 104-25(3) of the ITAA 1997.

Subdivision 115-C of the ITAA 1997 contains rules that apply if the net income of a trust (worked out in accordance with subsection 95(1) of the ITAA 1936) includes a net capital gain. These rules treat parts of net income attributable to the trust's capital gains as capital gains made by the beneficiaries assessed on those parts. This lets the beneficiaries reduce those parts by their own capital losses. The beneficiaries are also taken to have made extra capital gains - subsections 115-215(1) and (3). The rules in subsection 115-215(4A) make it clear that the beneficiaries are taken to have made these capital gains even though no CGT event happened to the beneficiaries.

In this case, the First Beneficiary who is foreign resident for tax purposes is presently entitled to all of the income of trust.

In the private ruling application, the tax agent stated that the Trust is an Australian resident for tax purposes. Given the tax agent's statement the ATO considers that the Trust is a resident trust for CGT purposes. Accordingly, if the trust's net income includes a net capital gain, the rules in Subdivision 115-C of the ITAA 1997 will apply.

Accordingly, the issue arises as to whether the 'capital gains' made by the foreign resident beneficiary because of the operation of section 115-215 of the ITAA 1997 can be disregarded under subsection 855-10(1) of the ITAA 1997.

Subsection 855-10(1) of the ITAA 1997 provides that a foreign resident can disregard a capital gain or capital loss from a CGT event if the CGT event happens in relation to a CGT asset that is not taxable Australian property.

The tax agent has confirmed that the interest in Entity A is not taxable Australian property for the purposes of section 855-15 of the ITAA 1997. Hence the second condition in subsection 855-10(1) of the ITAA 1997 is satisfied.

However, in this case, the 'capital gains' and the 'extra capital gains' that the First Beneficiary is taken to have made as a foreign resident beneficiary of the trust is not from the happening of a CGT event. Rather the 'capital gains' arise from the operation of section 115-215 of the ITAA 1997.

Accordingly, the requirements of subsection 855-10(1) of the ITAA 1997 are not sufficiently satisfied. As such the First Beneficiary in their capacity as foreign resident beneficiary of the trust is not eligible for the CGT exemption set out in subsection 855-10(1) of the ITAA 1997.

The decision is supported by the ATO view expressed in ATO ID 2007/60.

Conclusion

Interest as beneficiary of the Trust

The First Beneficiary in their capacity as foreign resident beneficiary of the Trust is not eligible for the CGT exemption in subsection 855-10(1) of the ITAA 1997. In this case, any 'capital gains' the First Beneficiary makes are not capital gains from the happening of a CGT event. Instead the 'capital gains' arise because of the operation of the rules in section 115-215 of the ITAA 1997. As such the beneficiary cannot disregard those 'capital gains' under subsection 855-10(1) of the ITAA