Edited version of your written advice

Authorisation Number: 1051466734997

Date of advice: 13 December 2018

Ruling

Subject: Present entitlement to income

Question 1

By virtue of the deed, when the trust derives income are the Unit Holders presently entitled to the income under Section 97(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Can the Beneficiaries be presently entitled to income for the purpose of Section 97(1) of the ITAA 1936?

Answer

Yes

This ruling applies for the following period:

1 July 2018 to 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

1. The Trust was established by deed of settlement (Trust Deed). The Trust was established for the benefit of the Subscribers and the Unit Holders and Beneficiaries.

2. The Trust was settled by X, who is the sole subscriber of a number of Ordinary Units and the sole trustee (Trustee). An Ordinary Unit is defined in the Trust Deed.

3. The entitlement of units and the Trustee’s ability to issue and modify units are defined in the Trust Deed.

4. The only units currently issued are the original Ordinary Units issued to X and no new Units including Special Units have been issued.

5. A Unit and a Unit Holder is defined in the Trust Deed.

6. The beneficiaries (Beneficiaries) are defined in the Trust Deed.

7. The Beneficiaries include those that are outlined in the Schedule and those deemed to be included as per the Trust Deed.

8. The Schedule of the Trust Deed has a wide list of beneficiaries.

9. The entitlement of a Unit Holder to income and capital of the Trust are stated in the Trust Deed.

10. The distribution of income is outlined in the Trust Deed.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1936 Section 97(1)

Reasons for decision

Anti-avoidance rules

Not considered

Reasons for decision

Issue 1

Question 1

By virtue of the deed, when the trust derives income are the Unit Holders presently entitled to the income under Section 97(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Summary

Unit Holders are not presently entitled to the income under Section 97(1) of the ITAA 1936 when the income is derived as the Trustee of the Trust has powers to otherwise retain, apply or set aside the income of the Trust and present entitlement to the balance of the income is conditional on being a solvent Unit Holder at midnight on the last day of the accounting period.

Detailed reasoning

Present entitlement is not defined in the ITAA 1936. The ordinary meaning of present entitlement has been determined over time by the courts. The definitive statement on the meaning of ‘presently entitled’ is to be found in Harmer v. Federal Commissioner of Taxation [1991] 173 CLR 264. In order for a beneficiary to be presently entitled to trust income, the following two conditions must be satisfied:

1. The beneficiary has an interest in the trust income which is both vested in interest and vested in possession. This means that the interest must not be contingent and that the beneficiary has the right to demand immediate payment (or would have had the right to demand payment had they not been under a legal disability).

2. The Beneficiary has a present legal right to demand and receive payment of the income. This means that the income must be legally available for distribution to the beneficiary whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.

How income is determined and how it is distributed is outlined in the Trust Deed. Under the Trust Deed the Trustee has the ability to determine if any amounts received by the Trust are to be treated as income or capital of the trust. Failing this determination for any accounting period, the income of the Trust is the total of the net income under section 95 of the ITAA 1936 (net income) and any income amounts not therein included that any provision of the Income Tax Assessment Act 1997 or the ITAA 1936 includes in the Unit Holders or Beneficiaries assessable income (other assessable income amounts).

Under the Trust Deed the amount of the income of the Trust is determined by the Trustee in each accounting period. The Trustee must determine if any of this income is to be applied and retained to recoup any prior year losses of the Trust Fund. The Trustee must also, from the income of the Trust, set aside any amounts it considers proper to be retained in the Trust Fund as reserves to meet contingencies and may accumulate amounts into an accumulated income account. Any ‘other assessable income amount’ is accumulated as part of the Trust capital unless the Trustee determines otherwise.

The income of the Trust, less the sums retained, applied or set aside (Income Available for Distribution), firstly that is ‘other assessable income amounts’ (if any) the Trustee can in its absolute discretion determine to be for the Beneficiaries. Secondly the balance of the income is allocated to Unit Holders in accordance to any special or preferential rights and then proportionally to the Unit Holders registered at midnight on the last day of the accounting period.

Unit Holders can be disentitled to Income Available for Distribution if they become insolvent. Income to which such Unit Holders would have been entitled shall be distributed by the Trustee between the Unit holders and/or Beneficiaries in proportion the Trustee determines. Failing such, proportionally to the Unitholders, or if no Unitholders, to the Primary Beneficiaries equally.

The Unit Holders are not presently entitled to the income of the Trust when the income is derived as the Income Available for Distribution for an accounting period is subject to the Trustee determining to retain, apply or set aside amounts from the income of the Trust for the purposes described. The fact that Unit Holders can be disentitled due to insolvency, is another means by which Unit Holders do not have an interest in the trust income which is both vested in interest and vested in possession when the income of the Trust is derived.

Moreover, under the Trust Deed the Trustee has the ability to issue new units and the discretion to attach to these new Units any special right, privileges, conditions or restrictions. The Trustee can also classify, re-classify and modify or vary the right attached already issued Units.

Notably, Unit Holders present entitlement to any income that is ‘other assessable income amounts’ is also conditional on it not being allocated to a Beneficiary. Furthermore, a Unit Holder’s present entitlement to the balance of the income is conditional upon being a solvent Unit Holder at midnight on the last day of the accounting period.

Question 2

Can the Beneficiaries be presently entitled to income for the purpose of Section 97(1) of the Income Tax Assessment Act 1936?

Summary

The Beneficiaries are able to be allocated income of the Trust under certain circumstances only, once these circumstances are met and the Trustee exercises their discretion to make a determination to allocate that income to a Beneficiary, the Beneficiary then becomes presently entitled to income under Section 97(1) of the ITAA 1936.

Detailed reasoning

The ordinary meaning of present entitlement is detailed in Question 1. In summary, for the Beneficiaries to be presently entitled for the purpose of section 97(1) of the ITAA 1936 it is necessary to have an interest in income of the Trust that is vested in interest and possession and to have a present legal right to demand and receive payment of The Trust’s income.

As stated in Question 1, under the Trust Deed the Trustee has the ability to determine if any amounts received by the Trust are to be treated as income or capital of the trust and the income of the Trust for any accounting period. If this determination is not made then the income of the Trust is the total of the net income under section 95 and ‘any other assessable income amounts’ (as described herein).

An example of the latter income amounts included is income which is not taxable income for the trust but which is assessable to the beneficiaries by a provision outside of Division 6 of Part III of the ITAA 1936.

A Beneficiary is only entitled to the income of the Trust in two ways and therefore can only have present entitlement in these two instances. The first instance is if the Trustee uses its discretionary power to distribute any ‘other assessable income amounts’ to the Beneficiaries. The second instance is if a Unit Holder is disentitled to income due to being insolvent and the Trustee exercises its discretion to distribute income otherwise theirs, to the Beneficiaries.

Where any amount is properly income under or in accordance the Trust Deed, regardless if it is an amount received in running a business or on sale of a capital asset, as income of the Trust amounts it may be distributed in accordance with the Trust Deed.

Once the Trustee has made a determination allocating the income to a Beneficiary in accordance with the Trust Deed the allocation is irrevocable. Therefore, the Beneficiary is presently entitled to Trust income as soon as the Trustee has allocated the income to the Beneficiary as provided under the Trust Deed.