Edited version of your written advice

Authorisation Number: 1051404882638

Date of advice: 30 July 2018

Ruling

Subject: Fixed trust - fixed entitlement

Question 1

Will the Beneficiaries 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 Income Tax Assessment Act 1936 (ITAA 1936)?

Answer:

Yes

Question 2

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 of the income and capital of the Trust?

Answer:

Not applicable

This ruling applies for the following period:

From the date of execution of the Proposed Amendments to the Trust Deed to 30 June 2022

The scheme commenced on:

1 July 2017

Relevant facts and circumstances

Background of the Trust

The Trust was established in 1990s with a settled sum of $X and a number of units were issued at that time to the Initial Unit Holders of the Trust.

There is only one class of units on issue which carry equal rights to income and capital.

All Unit Holders in the Trust are income and capital beneficiaries of the Trust.

One of the Initial Unit Holders of the Trust redeemed their units a number of years ago.

Additional units were issued a few years ago to the remaining Initial Unit Holders.

Other relevant information

The Trustee does not have any carried forward losses.

The Trustee does not forecast any tax losses to occur.

The Trust carries on a business activity.

Proposed amendments to the Trust Deed

It is proposed to amend the Trust Deed via the execution of the ‘XXXX’ and ‘YYYY’ Draft Deed of Variation to, broadly:

● Remove absolute discretion by the Trustee to vest the Trust;

● Require the Trustee to issue and redeem Units at market value determined in accordance with Australian Accounting Standards to satisfy the ‘saving rule’;

● Prevent the Trustee from classifying and reclassifying units at its discretion;

● Make the Trust a fixed trust for the purpose of section 3A(3B) of the Land Tax Management Act 1956 (NSW);

● Remove discretion by the Trustee to postpone the sale and conversion of investments and property of the Trust;

● Remove discretion by the Trustee to distribute any trust assets in specie in satisfaction of the Unit Holder’s entitlement on termination of the Trust;

● Remove the Trustee’s absolute discretion to determine drawings on account of income or profit distributions;

● Amend clause AA.A to prevent any amendments to the Trust Deed in the future in relation to the above dot points; and.

The purpose of the ‘XXXX’ Variation is to make the Trust a fixed trust for the purposes of section 3A(3B) of the Land Tax Management Act 1956 (NSW).

Relevant legislative provisions

Income Tax Assessment Act 1936

Subsection 95A(2)

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 272-65 of Schedule 2F

Income Tax Assessment Act 1997

Section 995-1

Subsection 995-1(1)

Other legislative references

The Land Tax Management Act 1956 (NSW).

Section 3A(3B)

The Corporations Act 2001

Chapter 5C

Section 601GC

Reasons for decision

Question 1

Fixed trust

The term ‘fixed trust’ is defined in subsection 995-1(1) of the ITAA 1997 and section 272-65 of Schedule 2F to the ITAA 1936 to mean a trust in which entities or persons (respectively):

… have fixed entitlements to all of the income and capital of the trust.

The definition of the term ‘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 as follows:

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) 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 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 Schedule 2F to 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 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 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 Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 does discuss its ordinary meaning at some length, at paragraphs 13.4 to 13.9.

The meaning of the term ‘vested and indefeasible’ (in the context of Schedule 2F to the ITAA 1936) has not been judicially considered, other than a discussion in Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 in the limited context of amending the constitution of a registered managed investment scheme under section 601GC of the Corporations Act 2001. However, the term ‘vested and indefeasible’ does appear in subsection 95A(2) of the ITAA 1936 and has been considered in that context by the courts – 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.

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.

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 first step in determining whether a beneficiary has a vested and indefeasible interest in a share of the income or capital of a trust is to ascertain the terms of the trust upon which the relevant trust property is held. As the High Court recently stated in CPT Custodians Pty Ltd v Commissioner of State Revenue (Vic); Commissioner of State Revenue (Vic) v Karingal 2 Holdings Pty Ltd (2005) 224 CLR 98 at [15], in taking this step:

‘…a priori assumptions as to the nature of unit trusts under the general law and principles of equity [will] not assist and would be apt to mislead. All depends, as Tamberlin and Hely JJ put it in Kent v SS “Maria Luisa” (No 2), upon the terms of the particular trust. The term “unit trust” is the subject of much exegesis by commentators. However, “unit trust”, like “discretionary trust”, in the absence of an applicable statutory definition, does not have a constant, fixed normative meaning which dictate the application to particular facts of the [relevant statutory definition]…’

There will be some circumstances in which a trust instrument must be read subject to the operation of a particular legal rule, whether by common law, statute or statutes. See, for example, the provisions of Chapter 5C of the Corporations Act 2001 which, if inconsistent with the constitution of a registered managed investment scheme, can have the effect of altering or modifying the scheme’s constitution. It is possible for a constitution to be altered or modified by operation of law irrespective of whether the trust instrument itself expressly recognises the relevant common law rule or statute, and the entitlements of a beneficiary under the trust instrument are those as so altered or modified by operation of law.

Vested interests

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, in this case the trust instrument consists of the Trust Deed as to be amended by the ‘XXXX’ and ‘YYYY’ Draft Deed of Variations.

It is accepted that the Trust Deed (after the Proposed Amendments are executed) provides the Beneficiaries with a vested interest in the income and capital of the Trust.

Defeasible power in the Trust Deed overcome by the savings rule in subsection 272-5(2)

Under subsection 272-5(1) in Schedule 2F to the ITAA 1936 a person will be taken to have a fixed entitlement to a share of the income or capital of a trust if they have a vested and indefeasible interest under the trust instrument.

After the Proposed Amendments, under the Trust Deed, the Beneficiaries 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 defeasible powers in a number of subclauses where the Trustee is allowed to create and issue additional Units or to redeem Units.

However, Units will be issued and redeemed based on the Trust’s net asset backed value according to Australian accounting principles set for each financial year as calculated and agreed by the Unit Holders. It’s also stipulated, after the Proposed Amendments, in the Trust Deed that a formal valuation of the Trust’s assets will be obtained at least every few financial years. This formal valuation must be reflected in the Trust’s financial statements after the Proposed Amendments. As such, the requirements of the savings rule in subsection 272-5(2) of Schedule 2F to the ITAA 1936 will be satisfied such that the ability to issue or redeem Units under the Trust Deed will not constitute a defeasible power.

Power to amend not a defeasible power

In the case of Colonial First State Investments Ltd v Commissioner of Taxation ([2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235) it was found that a power to amend in a trust deed will constitute a defeasible power where insufficient restrictions as to the exercise of that power are included.

In the present case, the Proposed Amendments include a restriction of the power to amend in clause AA.A such that an amendment may not cause a fixed entitlement in section 272-5 of Schedule 2F to the ITAA 1936 to end. As such the power to amend in clause AA.A will not constitute a defeasible power.

Conclusion

Therefore, the Beneficiaries of the Trust have a fixed entitlement to a share of the income and capital of the Trust for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936 following the execution of the Proposed Amendments.

Question 2

In view of the conclusion above that the Beneficiaries of the Trust have vested and indefeasible interests, pursuant to subsection 272-5(1) of Schedule 2F to the ITAA 1936, it is not necessary to consider subsection 272-5(3) of Schedule 2F to the ITAA 1936.