Edited version of your written advice

Authorisation Number: 1051321153558

Date of advice: 20 December 2017

Ruling

Subject: Fixed entitlements

Issue

Are there fixed entitlements in the income and capital of the Trust for the purposes of section 269-50 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936)?

Question 1

Will the beneficiaries (“the Unit Holders”) of the Trust have fixed entitlements to all of the income and capital of the Trust as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) and subsection 272-5(1) of Schedule 2F to the ITAA 1936?

Answer

No

Question 2

Will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the beneficiaries of the Trust as having fixed entitlements to all of the income and capital of the Trust?

Answer

Yes

This ruling applies for the following periods

Year ended 30 June 2016

Year ended 30 June 2017

The scheme commenced on

1 July 2015

Relevant facts and circumstances

In relation to the Trust:

● The Trust is a unit trust;

● The Trust Deed is dated DDMMYY;

● It is not listed on the Australian Securities Exchange;

● It is not a registered managed investment scheme (MIS) under Chapter 5C of the Corporations Act 2001 (Corporations Act);

● The Trustee has incurred income tax losses;

● The Trustee intends to utilise all of the carried forward tax losses in the income year ended 30 June 2017;

● The Trust is not a trust for which a Family Trust Election (FTE) has been made;

● The units in the Trust (Units) are all of the same class with no special rights attached to any Units;

● The Unit Holders of the Trust had not changed;

● The 50% stake test as applicable to ordinary, closely-held fixed trusts, is relevant to the Trust (per sections 266-25; 266-40; 269-50 and 269-55 of Schedule 2F to the ITAA 1936);

● For the entirety of the existence of the Trust, the requirements of safe harbour 6 for ‘other trusts’ in PCG 2016/16 have been satisfied;

● The Trustee has never exercised a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the Trust.

Relevant legislative provisions

Income Tax Assessment Act 1936

Section 266-25 of Schedule 2F

Section 266-40 of Schedule 2F

Section 269-50 of Schedule 2F

Section 269-55 of Schedule 2F

Section 272-5 of Schedule 2F

Subsection 272-5(1) of Schedule 2F

Subsection 272-5(2) of Schedule 2F

Subsection 272-5(3) of Schedule 2F

Section 272-35 of Schedule 2F

Section 272-65 of Schedule 2F

Income Tax Assessment Act 1997

Subsection 995-1(1)

Reasons for decision

Question 1

Summary

The terms of the trust instrument do not provide the beneficiaries with vested and indefeasible interests in all of the income and capital of the Trust.

Detailed reasoning

Generally

The 50% stake test in section 269-55 of Schedule 2F to the ITAA 1936 relies upon the concept of having ‘more than a 50% stake’ in the income or capital of a trust (refer to section 269-50 of Schedule 2F to the ITAA 1936).

In respect of the income or capital of a trust ‘more than a 50% stake’ is taken to exist where there are individuals who have (between them), directly or indirectly, and for their own benefit, fixed entitlements to a greater than 50% share of the income or capital of the trust.

The definition of ‘fixed entitlement’ in subsection 995-1(1) of the ITAA 1997 provides that ‘an entity has a fixed entitlement to a share of the income or capital of a trust if the entity has a fixed entitlement to that share within the meaning of Division 272 in Schedule 2F to the Income Tax Assessment Act 1936.’

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 Schedule 2F to 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 term ‘vested and indefeasible’ is not defined in the taxation legislation.

PCG 2016/16 does discuss the meaning of the terms ‘vested’ and ‘indefeasible’ in the context of section 272-5 of Schedule 2F to the ITAA 1936.

Specifically

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the trust instrument consists of the Trust Deed, dated DDMMYY. It is accepted that the Trust Deed provides members with a vested interest in the income and capital of the Trust.

As per paragraph 16 of PCG 2016/16, the Trust Deed contains certain clauses by which a Unit Holder’s interest in a share of the income or capital of the Trust may be defeasance. Therefore, it can be concluded, in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936, that all beneficiaries (Unit Holders of the Trust) do not have fixed entitlements to all of the income and capital of the Trust.

Clauses in the Trust Deed which contain powers which cause a beneficiary’s interest in the income or capital of the Trust to be defeasible

Clause relating to Appointment by Trustee

Under this Clause the Trustee may appoint the whole or any part of the Trust Fund to other persons.

Clause relating to Amendment of the Trust Deed

This clause provides that with the consent of the Unit Holders the Trustee may revoke, add to or vary all or any one of the trusts terms or conditions among other things.

It is noted that less than 100% approval is permitted to amend the Trust Deed. As noted by Stone J in 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]:

it follows [from unit holders’ ability to amend the Constitution] that the members could vote to terminate the present right to a share of income and capital.

An amendment, approved by Unit Holders could permit the amendment of clauses which currently do not contain defeasible powers to do so.

Question 2

Summary

The Commissioner considers that it is reasonable to exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the beneficiaries of the Trust as having fixed entitlements to all of the income and capital of the Trust.

Detailed reasoning

Subsection 272-5(3) of Schedule 2F to the ITAA 1936 contains a discretion, whereby in cases where beneficiaries do not have a fixed entitlement, the Commissioner may treat such beneficiaries as having a fixed entitlement, having regard to the factors prescribed in paragraph 272-5(3)(b) of Schedule 2F to the ITAA 1936.

These factors are:

(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 view of the conclusion above that the beneficiaries (Unit Holders) of the Trust do not have a vested and indefeasible interest, pursuant to subsection 272-5(1) of Schedule 2F to the ITAA 1936, subsection 272-5(3) of Schedule 2F to the ITAA 1936 needs to be considered.

In terms of paragraph 272-5(3)(a) of Schedule 2F to the ITAA 1936 -

The beneficiaries (Unit Holders) of the Trust have a vested interest in the income and capital of the Trust, as detailed above.

However, the beneficiaries (Unit Holders) do not have an indefeasible interest in the income and capital of the Trust.

In terms of subparagraph 272-5(3)(b)(i) of Schedule 2F to the ITAA 1936 -

The circumstances in which the defeasance of the interest can happen (in respect of the particular clauses of the Trust Deed discussed above):

● It is noted that the Ruling Period is entirely retrospective (i.e., 1 July 2015 to 30 June 2017) and none of the circumstances in which a defeasance of an interest can happen have occurred.

In terms of subparagraph 272-5(3)(b)(ii) of Schedule 2F to the ITAA 1936 -

The likelihood of the defeasance happening (in respect of the particular clauses of the Trust Deed discussed above):

● Clause relating to Appointment by Trustee

– It is noted that the power contained in this clause was not used during the Ruling Period.

● Clause relating to Amendment of the Trust Deed

– It is noted that the power contained in this clause was not used during the Ruling Period.

● It is also noted that the Ruling Period is entirely retrospective so there is no likelihood of a defeasance now occurring.

In terms of subparagraph 272-5(3)(b)(iii) of Schedule 2F to the ITAA 1936 -

The nature of the trust:

● The Trust is a closely held investment trust.

Schedule 2F to the ITAA 1936 and tax losses

The concept of a 'fixed entitlement' was originally introduced in the context of the trust loss measures and should primarily be interpreted in that context (in the absence of any express provision or explanatory guidance that indicates a different context is relevant). The trust loss measures are an important integrity measure, removing a structural flaw in the tax system. The concept of a 'fixed entitlement' is fundamental to the structure and effectiveness of the trust loss measures.

The EM to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 states (at paragraph 13.13) in respect of the Commissioner’s power in subsection 272-5(3) of Schedule 2F to the ITAA 1936 that:

This provision is intended to provide for special circumstances where there is a low likelihood of a beneficiary's vested interest being taken away or defeated and, having regard to the scheme of the trusts loss provisions to prevent the transfer of the tax benefit of losses and other deductions incurred by trusts, it would be unreasonable to treat the beneficiary's interest as not constituting a fixed entitlement.

This passage indicates that when looking at the facts of a case, in the context of the criteria listed in subsection 272-5(3) of Schedule 2F to the ITAA 1936, unless the context of the provision for which fixed entitlement is required provides otherwise, the Commissioner should always have regard to whether the absence of a fixed entitlement, in these circumstances, could result in the trafficking (or transfer) of the tax benefit of any tax losses.

You state that an arrangement has not been entered into which would result in:

(a) section 272-35 having application

(b) the trafficking of the tax benefit of a tax loss, bad debt deduction or debt/equity swap deduction, or

(c) fraud or evasion.

You also state that:

● If fixed entitlements are deemed, the 50% stake test in section 269-55 of Schedule 2F to the ITAA 1936 will be passed; and

● The income injection test in Division 270 of Schedule 2F to the ITAA 1936 will not be failed.

As such, it is considered that, were the Commissioner to deem fixed entitlements to exist under subsection 272-5(3) of Schedule 2F to the ITAA 1936 this would not result in the integrity purpose of Schedule 2F to the ITAA 1936 being undermined.

Recommendation

As stated above, it is reasonable to conclude, based on the “trust instrument” of the Trust, that for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the beneficiaries (Unit Holders) of the Trust do not have fixed entitlements to any of the income and capital of the Trust.

However, pursuant to paragraph 272-5(3)(b) of Schedule 2F to the ITAA 1936, and after having regard to the requirements of subparagraphs 272-5(3)(b)(i), (ii) and (iii) of Schedule 2F to the ITAA 1936 and submissions from the applicant, it is submitted that it is appropriate that the Unit Holders of the Trust should be treated as having fixed entitlements to all of the income and capital of the Trust for the relevant income years.

In summary, as:

● the trust instrument (being the Trust Deed) contains powers which have not been used to defeasance the interests of the beneficiaries in the income or capital of the Trust;

● the likelihood of defeasance is low due to the Ruling Period being entirely retrospective;

● the requirements of safe harbour 6 in paragraph 54 of PCG 2016/16 are satisfied for the entire Ruling Period; and

● there is little likelihood that a tax benefit of the Trust will be transferred,

there is a reasonable case for the Commissioner to exercise the discretion under subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat all of the Unit Holders of the Trust as having a fixed entitlement to their share of the income and capital of the Trust for the relevant income years.