Edited version of private advice

Authorisation Number: 1051880977221

Date of advice: 5 August 2021

Ruling

Subject: Income tax - consolidated groups - modified market value - fixed entitlements

Question 1

Did Company A have fixed entitlements to all of the income and capital of Unit Trust A under subsection 272-5(1) to Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936) at the time Company A became a member of the Consolidated Group?

Answer

No

Question 2

Will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat Company A as having fixed entitlements to all of the income and capital of Unit Trust A at the time Company A became a member of the Consolidated Group?

Answer

Yes

Question 3

For the purposes of section 707-325 of the Income Tax Assessment Act 1997 (ITAA 1997), at the time Company A a member of the Consolidated Group, is there no limit on the amount of Company A's market value which is attributable to the Unit Trust A?

Answer

Yes

Question 4

Did Company A have fixed entitlements to all of the income and capital of Unit Trust 2 under subsection 272-5(1) to Schedule 2F of the ITAA 1936 at the time Company A became a member of the Consolidated Group?

Answer

No

Question 5

Will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat Company A as having fixed entitlements to all of the income and capital of Unit Trust B at the time Company A became a member of the Consolidated Group?

Answer

Yes

Question 6

For the purposes of section 707-325 of the ITAA 1997, at the time Company A became a member of the Consolidated Group, is there no limit on the amount of Company A's market value which is attributable to the Unit Trust B?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

X Month 20XX

Relevant facts and circumstances

The Unit Trusts are currently wholly owned by Company A and are part of a Consolidated Group. Company A is in turn wholly owned by Company B, a company incorporated overseas.

Company B acquired all the units in the Unit Trusts from unrelated third parties progressively.

Pursuant to the Share and Unit Sale and Purchase Deed, Company A acquired all of the issued units in the Unit Trusts. This interposed Company A between the Unit Trusts and Company B.

Company A then elected to form a tax consolidated group.

As Company A was, and is, wholly owned by Company B there was no change to the ultimate ownership of the Unit Trusts.

The transfer of units in Unit Trust A and B to Company B was an arm's length transaction between unrelated third parties there has been no value shifted from the transfer of units.

Relevant legislative provisions

Corporations Act 2001 Chapter 5

Corporations Act 2001 section 601GC

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 section 272-5 of Schedule 2F

Income Tax Assessment Act 1936 subsection 272-5(1) of Schedule 2F

Income Tax Assessment Act 1936 subsection 272-5(2) of Schedule 2F

Income Tax Assessment Act 1936 subsection 272-5(3) of Schedule 2F

Income Tax Assessment Act 1936 subsection 272-35 of Schedule 2F

Income Tax Assessment Act 1936 section 272-75 of Schedule 2F

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

Income Tax Assessment Act 1997 Division 707

Income Tax Assessment Act 1997 Subdivision 707-C

Income Tax Assessment Act 1997 subsection 707-325

Income Tax Assessment Act 1997 paragraph 207-325(1)(d)

Reasons for decision

Question 1

Did Company A have fixed entitlements to all of the income and capital of Unit Trust A under subsection 272-5(1) to Schedule 2F of the ITAA 1936 at the time Company A became a member of the Consolidated Group?

Summary

No. The terms of Unit Trust A trust deed did not provide the unitholders of the Unit Trust A with vested and indefeasible interests in all of the income and capital of the Unit Trust A.

Detailed reasoning

Relevance of fixed entitlements to the income and capital of Unit Trust A

Division 707 of the ITAA 1997 permits the transfer of losses from members of the tax consolidate group (the Transferor) incurred before its joins the group to be transferred to the head company of the group (Transferred Losses).

However, Subdivision 707-C of the ITAA 1997 restricts the utilisation of losses transferred to the head company to reflect the amount of the loss that the Transferor could have utilised for the income year if the Transferor of the loss had not become a member of the consolidated group.

This principle is brought into effect by the requirement to calculate an "Available Fraction" which sets a rate at which Transferred Losses can be used by the head company. A component of the Available Fraction calculation involves working out the Transferor's "Modified Market Value" under section 707-325 of the ITAA 1997.

In working out the Modified Market Value of an entity, the value attributable to the entity's interest in any trusts only includes value attributable to the entity's fixed entitlements to income or capital. According to the Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No 1) 2002 (EM), "the inclusion of this value recognises that outside consolidation the trust's income is sheltered from income tax by the joining entity's losses" (para 8.79). The EM provides an example where the Modified Market Value of a loss company includes the value attributed to its interest in a fixed trust (see example 8.9).

In working out the Modified Market Value of Company A, the contribution to Company A's market value made by Unit Trust A is limited to the amount attributable to Company A's fixed entitlements in Unit Trust A.

Accordingly, if the interests in Unit Trust A are treated as fixed entitlements there will be no reduction to Company A's Modified Market Value for the purposes of working out the Available Fraction of losses transferred by Company A to the consolidated group.

Under section 707-325 of the ITAA 1997, Company A's Modified Market Value is worked out at the time Company A becomes a member of the tax consolidated group.

Fixed entitlements

A 'fixed trust' is defined in section 272-65 of Schedule 2F to the ITAA 1936:

A trust is a fixed trust if persons have fixed entitlements to all of the income and capital of the trust.

A 'fixed entitlement' is defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997):

[A]n entity has a fixed entitlement to a share of the income or capital of a company, partnership or trust if the entity has a fixed entitlement to that share within the meaning of Division 272 in Schedule 2F of the Income Tax Assessment Act 1936.

Subsection 272-5(1) of Schedule 2F to the ITAA 1936 provides that:

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. [emphasis added]

Subsection 272-5(2) of Schedule 2F to the ITAA 1936 further provides 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.

Meaning of the word 'interest'

'Interest' has a range of meanings. In the absence of a definition, its meaning must be inferred from the context in which the word is found: as highlighted in 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 when 'interest' can be interpreted broadly to include any right or advantage that a person may 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.

For the purposes of Schedule 2F to the ITAA 1936, in order for an interest to be recognised as a fixed interest, it must be a right with respect to a share of the income or capital of the trust that is susceptible to measurement (ie the right must have 'the necessary quality of definable extent': Gartside v. Inland Revenue Commissioner [1968] AC 553).

Meaning of the words 'vested and indefeasible'

The terms 'vested and indefeasible' are not defined in the ITAA 1936 or ITAA 1997.

The Explanatory Memorandum to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 (EM) discusses the nature of a 'vested interest':

13.4 A person has a vested interest in something if the person has a present right relating to the thing. Stated simply, a vested interest is one that is bound to take effect in possession at some point in time. A vested interest is to be contrasted with a 'contingent' interest which may never fall into possession. If an interest of a beneficiary in income or capital is the subject of a condition precedent, so that an event must occur before the interest becomes vested, the beneficiary does not have a vested interest to the income or capital since such an interest is instead 'contingent' upon the event occurring.

13.5 In traditional legal analysis, a person can be said to be either 'vested in possession' or 'vested in interest'. A present interest, i.e. one that is being enjoyed, is said to be 'vested in possession'; a future interest, i.e. one which gives its holder a present right to a future enjoyment, is said to be a 'vested interest'. A person is vested in possession where the person has a right to immediate possession or enjoyment of the thing in question. In the definition of fixed entitlement, 'vested' includes both vested in possession and vested in interest.

13.6 Because vested interests include future interests, a person can have a vested interest in a thing even though the person's actual possession and enjoyment of the thing is delayed until some time in the future.

This is reflected in paragraph 13 of the Practical Compliance Guideline PCG 2016/16 Fixed entitlements and fixed trusts (PCG 2016/16).

The EM also addresses when a vested interest is indefeasible:

13.7 A vested interest is indefeasible where, in effect, it is not able to be lost. A vested interest is defeasible where it is subject to a condition subsequent that may lead to the entitlement being divested. A condition subsequent is an event that could occur after the interest is vested that would result in the entitlement being defeated, for example, on the occurrence of an event or the exercise of a power. For example, where a beneficiary's vested interest is able to be taken away by the exercise of a power by the trustee or any other person, the interest will not be a fixed entitlement.

'Vested and indefeasible', for the purposes of Schedule 2F to the ITAA 1936, has not been judicially considered, other than in the limited context of amending the constitution of a registered MIS under section 601GC of the Corporations Act: see Colonial First State Investments Ltd v. Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; ATC 20-235.

'Trust instrument'

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'.

The determining factor in deciding whether 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.

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the Commissioner accepts that a 'trust instrument' includes:

...a deed or constitution as supported by documentation such as a Product Disclosure Statement, Investment Memorandum or other document that modifies or supplements the terms of the trust set out in the deed or constitution.

Applying the law to your circumstances

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

As a result, the unitholders of the Trust do not have fixed entitlements to all of the income and capital of the Trust for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936.

Question 2

Will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat Company A as having fixed entitlements to all of the income and capital of Unit Trust A at the time Company A became a member of the Consolidated Group?

Summary

Yes. The Commissioner will exercise his discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the beneficiaries of Unit Trust A as having fixed entitlements to all of the income and capital of Unit Trust A.

Detailed reasoning

As highlighted in the answer to Question 1, the terms of the 'trust instrument' do not provide the unitholder of Unit Trust A with vested and indefeasible interests in all of the income and capital of the trust.

As a result, the unitholder of Unit Trust A does not have fixed entitlements to all of the income and capital of Unit Trust A for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936.

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) to (iii) and submissions from the taxpayer, the Commissioner considers it appropriate that the unitholder of Unit Trust A should be treated as having fixed entitlements to all of the income and capital of the Trust for the Ruling Period.

In summary, as:

-              The Unit Trust A Trustee did not exercise a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the trust;

-              The likelihood of defeasance is low;

-              There is no likelihood of the tax benefit of Unit Trust A being transferred;

the Commissioner will exercise his discretion under subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat all unitholder of Unit Trust A as having fixed entitlements to its share of the income and capital of Unit Trust A for the Ruling Period.

Question 3

For the purposes of section 707-325 of the Income Tax Assessment Act 1997 (ITAA 1997), at the time Company A became a member of the Consolidated Group, is there no limit on the amount of Company A's market value which is attributable to Unit Trust A?

Summary

Yes. Company A is considered to have had fixed entitlements to the income and capital of Unit Trust A and the market value of Company A will include the market value of Unit Trust A as at the date Company A became a member of the Consolidated Group.

Detailed reasoning

In the answer to Question 2, above, the Commissioner exercised the discretion in subsection 272-5(3) to deem fixed entitlements in the income and capital of Unit Trust A for the Ruling Period.

As such, Company A is considered to have had fixed entitlements to the income and capital of Unit Trust A and the market value of Company A will include the market value of Unit Trust A as at that date they became a member of the Consolidated Group.

Question 4

Did Company A have fixed entitlements to all of the income and capital of Unit Trust B under subsection 272-5(1) to Schedule 2F of the ITAA 1936 at the time Company A became a member of the Consolidated Group?

Summary

No. The terms of the Unit Trust B trust deed did not provide the unitholders of Unit Trust B with vested and indefeasible interests in all of the income and capital of Unit Trust B.

Detailed reasoning

Relevance of fixed entitlements to the income and capital of Unit Trust B

For the reasons already discussed above, in Question 1, the concept of fixed entitlements to the income and capital of Unit Trust B relates to the calculation of the Modified Market Value under section 707-325 of the ITAA 1997.

In working out the Modified Market Value of Company A, the contribution to Company A's market value made by Unit Trust B is limited to the amount attributable to Company A's fixed entitlements in Unit Trust B.

Accordingly, if the interests in Unit Trust B are treated as fixed entitlements there will be no reduction to Company A's Modified Market Value for the purposes of working out the Available Fraction of losses transferred by Company A to the consolidated group.

Under section 707-325 of the ITAA 1997, Company A's Modified Market Value is worked out at the time Company A becomes a member of the tax consolidated group.

Fixed entitlements

The concept of fixed entitlements is discussed above in Question1 and also applies here.

'Trust instrument'

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'.

The determining factor in deciding whether 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.

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the Commissioner accepts that a 'trust instrument' includes:

...a deed or constitution as supported by documentation such as a Product Disclosure Statement, Investment Memorandum or other document that modifies or supplements the terms of the trust set out in the deed or constitution.

Applying the law to your circumstances

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

As a result, the unitholders of the Trust do not have fixed entitlements to all of the income and capital of the Trust for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936.

Question 5

Will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat Company A as having fixed entitlements to all of the income and capital of Unit Trust B at the time Company A became a member of the Consolidated Group?

Summary

Yes. The Commissioner will exercise his discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the beneficiaries of Unit Trust B as having fixed entitlements to all of the income and capital of Unit Trust B.

Detailed reasoning

Commissioner's discretion

As highlighted above, the beneficiaries of Unit Trust B do not have a fixed entitlement in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936. This is because the beneficiaries do not have a vested and indefeasible interest in all of the income and capital of Unit Trust B.

As a result, Unit Trust B's Trustee may request that the Commissioner exercise his discretion under subsection 272-5(3) of Schedule 2F for the ITAA 1936 to deem the beneficiaries' interests as being vested and indefeasible: pursuant to paragraphs 25 and 26 of PCG 2016/16.

Subsection 272-5(3) of Schedule 2F to the ITAA 1936 provides:

If:

(a)          a beneficiary with an interest in a share of income that the trust derives from time to time, or of the capital of a trust, does not have a fixed entitlement to the share; and

(b)          the Commissioner considers that the beneficiary should be treated as having the fixed entitlement, 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;

the beneficiary has the fixed entitlement.

Conclusion

As highlighted in the answer to Question 4, the terms of the 'trust instrument' do not provide the unitholder of Unit Trust B with vested and indefeasible interests in all of the income and capital of the trust.

As a result, the unitholder of Unit Trust B does not have fixed entitlements to all of the income and capital of Unit Trust B for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936.

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) to (iii) and submissions from the taxpayer, the Commissioner considers it appropriate that the unitholder of Unit Trust B should be treated as having fixed entitlements to all of the income and capital of the Trust for the Ruling Period.

In summary, as:

-              The Unit Trust B Trustee did not exercise a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the trust;

-              The likelihood of defeasance is low;

-              There is no likelihood of the tax benefit of Unit Trust B being transferred;

the Commissioner will exercise his discretion under subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat all unitholder of Unit Trust B as having fixed entitlements to its share of the income and capital of Unit Trust B for the Ruling Period.

Question 6

For the purposes of section 707-325 of the ITAA 1997, at the time Company A became a member of the Consolidated Group, is there no limit on the amount of Company A's market value which is attributable to Unit Trust B?

Summary

Yes. Company A is considered to have had fixed entitlements to the income and capital of Unit Trust B as at the time they became a member of the Consolidated Group and the market value of Company A will include the market value of Unit Trust B as at that date.

Detailed reasoning

The contribution to Company A's market value by Unit Trust B is determined as at the date they became a member of the Consolidated Group for the purposes of paragraph 207-325(1)(d) of the ITAA 1997.

Whether a contribution to Company A's market value can be made is determined by whether Company A had fixed entitlements to the income and capital of Unit Trust B as at the date Company A became a member of the Consolidated Group.

In the answer to Question 5, above, the Commissioner exercised the discretion in subsection 272-5(3) to deem fixed entitlements in the income and capital of Unit Trust B for the Ruling Period.

As such, Company A is considered to have had fixed entitlements to the income and capital of Unit Trust B as at the date Company A joined the Consolidated Group and the market value of Company A will include the market value of Unit Trust B as at that date.