Edited version of private advice

Authorisation Number: 1051935395822

Date of advice: 21 December 2021

Ruling

Subject: Fixed trust

Question 1

Will CGT event E1 or CGT event E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 (ITAA 1997) happen as a result of making the proposed variations to the Trust Deed for the Trust?

Answer

No

Question 2

Will the proposed amendments to the trust deed result in CGT event E4 in section 104-70 of the ITAA 1997?

Answer

No

Question 3

Following the implementation of the proposed amendments to the Trust Deed, will the Unitholders of the Trust have fixed entitlements to all of the income and capital of the Trust as defined in subsection 995-1 of the Income Tax Assessment Act 1997 Act (ITAA 1997) and subsection 272-5(1) of Schedule 2F to the Income Assessment Act 1936 (ITAA 1936) such that the Trust will be a 'fixed trust' under section 272-65 of Schedule 2F to the ITAA 1936 and section 995-1 of the ITAA 1997?

Answer

No

Question 4

If the answer to Question 1 is 'no', following the implementation of the proposed amendments to the Trust Deed, will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem the Unitholders 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 period: XXXX

Relevant facts and circumstances

The Trust was established pursuant to the terms of the trust deed dated XXXX (Trust Deed).

The Trustee is not a trustee of any other trust.

The Trustee is not a holder of an Australian Financial Services Licence and is not subject to any regulation by the Australian Prudential Regulation Authority (APRA) or any other Australian Federal Government authority.

The Trustee was the first trustee of the Trust and continues to be sole trustee of the Trust.

There are two Unitholders.

All entities are Australian residents for income tax purposes.

Regulation of the Trust

The Trustee has not engaged another entity to perform investment management services in relation to the Trust.

Amendments to the Trust Deed

Since the establishment of the Trust, no amendments have been made to the Trust Deed.

Proposed amendments to the Trust Deed

Relevantly, the proposed amendments to the Trust Deed will:

Change the beneficiaries of the Trust by removing Discretionary Beneficiaries, who were individuals and entities associated with the Unitholders, as described in the Second Schedule of the deed and making consequential amendments relating to this revocation - in particular:

•         Removing references to 'Discretionary Beneficiary' and 'Unitholders' Class of Discretionary Beneficiaries'.

•         Excising the Second Schedule.

Reflect that previous rights and obligations will now be curtailed to ensure that they relate to the Unitholders' interests in proportion to their respective unitholdings - in particular:

Clause X will be amended to provide that the beneficial interest in the Trust Fund as originally constituted and as existing from time to time shall be vested in the Unitholders (in proportion to their respective holdings of such units).

Clauses X and X will be amended to remove the Trustee's discretion as it relates to distributions of income (i.e. net income that is not accumulated) or capital by providing that income and capital distributions will be in proportion to the respective unitholdings.

Remove the Trustee's power to issue different classes of units by limiting the units in the Trust to type of unit described in the First Schedule, i.e. Ordinary Unit, and making consequential amendments relating to this change - in particular:

Amending Clause X to provide that all units will comprise one class and of equal value.

Removing the Third Schedule relating to the power to issue Income Units and Equity Units and the rights etc. attached to such units.

The proposed amended Trust Deed will clarify that:

Under Clause X fully paid units are void and cancelled if the funds do not clear within 2 weeks.

Units are issued and redeemed with reference to 'Unit Value' in Clause X (relevantly to mean the net asset value of the Trust, determined in accordance with Australian accounting principles, divided by the number of Units on issue) and making consequential amendments relating to this clarification - in particular Clauses X, X and X.

The value of in specie distributions plus all cash received for redeemed units must be equal to the unit value of the units - Clause X

The payment referred to in Clause X does not encompass a distribution of income - and consequently it cannot operate to defease a Unitholder's interest in the income of the Trust - Clause X relates to the issue of additional units, except in the circumstances of Clause X, which sets out the conditions under which the trustee may issue additional units to satisfy any payment due to unit holders based on 'unit value.

Associations

For the purposes of section 318 of the ITAA 1936:

There are no associations between the controllers of the Trust and the Unitholders other than Unitholders being recipients of trust distributions.

There are no associations between any entity engaged to perform valuation services and the Trustee and Unitholders.

There are no associations between the Unitholders.

The relationships and transactions between all entities are conducted at arm's length.

Trust Distributions

In practice the distribution of income/capital to discretionary objects was advised to the Trustee by each of the two Unitholders.

The Unit Holders' Class of Discretionary Beneficiaries are mutually exclusive between the Unitholders.

Losses

There are no carried forward tax losses and no expected current year tax losses.

There are no expected bad debts or debt/equity swap losses.

Assumptions

The proposed amendments to the Trust Deed are valid.

Throughout the Ruling Period, no powers will be exercised to defeat the interest of any Unitholder, with respect to their units (Ordinary Units) including:

There will only be one class of units - i.e. no units of different classes will be issued.

No units will be reclassified. The rights attached to units already in existence will not be modified.

Units will only be transferred or redeemed at the request of a Unitholder.

Units will be issued or redeemed for a price determined on a basis that satisfies the 'savings rule' in subsection 272-5(2) of Schedule 2F to the ITAA 1936 - i.e. on the basis of the Trust's net asset value, according to Australian accounting principles, at the time of the issue or redemption having regard to paragraph 19 of the PCG 2016/16.

No units will be issued or redeemed at a discount.

The Trustee will ensure that units will only be transferred for market value.

No partly paid units will be issued.

No streaming of income or capital will occur.

The Trustee will not seek to amend or vary the Trust Deed to defeat the interest or change the fixed entitlements of Unitholders to the income and capital of the Trust.

All Unitholders will be entitled to the income and capital of the trust in proportion to their unitholding - if requested by a unitholder, the Trustee will transfer assets rather than pay cash in satisfaction of amounts owing, including as part of winding up the trust, to that particular unitholder. The Trustee will only transfer to that particular unitholder assets of the Trust to the extent that the market value of the assets is less than or equivalent to their proportion unitholding.

Throughout the Ruling Period, no arrangement has been or will be entered into which would result in section 272-35 in Schedule 2F of the ITAA 1936 having application, in the trafficking of the tax benefit of a tax loss, bad debt deduction or debt/equity swap deduction, or in fraud or evasion.

Relevant legislative provisions

ITAA 1936 subsection 272-5(1) of Schedule 2F

ITAA 1936 subsection 272-5(3) of Schedule 2F

ITAA 1936 section 272-65 of Schedule 2F

ITAA 1997 section 104-55

ITAA 1997 section 104-60

ITAA 1997 section 104-70

ITAA 1997 section 995-1

Reasons for decision

Question 1

Summary

On the basis of the assumption that the amendments are valid, i.e. that the proposed variations to the Trust Deed will amend the terms of the Trust Deed pursuant to a valid exercise of a power contained within the Trust Deed, the amendments will not cause the Trust to terminate and a new trust to arise for trust law purposes (it will not lead to any asset of the Trust being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust).

In that case, neither CGT event E1 nor CGT event E2 will happen as a result of making the proposed variations to the Trust Deed for the Trust to remove Discretionary Beneficiaries or the limit the units one class of units - noting that where a proposed change is beyond the power conferred by the terms of a trust, it will be of no effect and, therefore, cannot give rise to a resettlement of the trust, and would not result in CGT event E1 or E2 happening.

Detailed reasoning

Subsection 104-55(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement.

Subsection 104-60(2) of the ITAA 1997 provides that CGT event E2 happens if you transfer a CGT asset to an existing trust.

In the Full Federal Court case of Commissioner of Taxation v Clark [2011] FCAFC 5 ('Clark's case'), it was established that a trust will not be terminated provided that any amendment to the trust is made in accordance with a power conferred by the trust instrument and there is some continuity of property and membership of the trust.

Following Clark's case, the Commissioner issued Taxation Determination TD 2012/21 Income tax: does CGT event E1 or E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 happen if the terms of the trust are changed pursuant to a valid exercise of a power contained within the trust's constituent documents, or varied with the approval of a relevant court? (TD 2012/21).

In TD 2012/21 the Commissioner expresses the view that in the circumstances where the terms of a trust are changed pursuant to a valid exercise of a power contained within the trust's constituent document, or varied with the approval of a relevant court, neither CGT event E1 nor CGT event E2 in sections 104-55 or 104-60 of the ITAA 1997 happens unless:

•         the change causes the existing trust to terminate and a new trust to arise for trust law purposes, or

•         the effect of the change or court approved variation is such as to lead to a particular asset being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust.

Paragraph 24 of TD 2012/21 explains that the Commissioner accepts that a change in the terms of a trust pursuant to an existing power (including an amendment to the deed of a trust) will not result in the termination of the trust.

Paragraph 27 of TD 2012/21 states that even in instances where a pre-existing trust does not terminate, it may be the case that assets held originally as part of the trust property commence to be held under a separate charter of obligations as a result of a change to the terms of the trust - whether by exercise of a power under the deed (including a power to amend) or court approved variation - such as to lead to the conclusion that those assets are now held on terms of a distinct (that is, different) trust.

In this case, the Trust was established by the Trust Deed which constitutes the Trust's constituent document.

Relevantly, the Trustee proposes to vary the Trust Deed by a deed of variation to:

a)    Change the beneficiaries of the Trust - by removing Discretionary Beneficiaries (i.e. only Unitholders will remain Beneficiaries of the Trust).

b)    Remove the Trustee's discretion as it relates to the distribution of income or capital - by providing that net income (that is not accumulated with the consent of Unitholders) and capital are to distributed proportionately with unitholdings.

c)    Remove the Trustee's power to issue different classes of units - by limiting the units in the Trust to one type of units, being Ordinary Units.

Clause 13 of the Trust Deed contains the Trustee's powers to vary the Trust and the Trust Deed. Amongst other things, it provides that any revocation, addition, amendment or variation:

•         must not affect the rights of Unitholders to participate in the income or capital of the Trust in accordance with this Deed; and

•         must not affect the rights of a Unitholder to income of the Trust previously set aside or held for the benefit of the Unitholder prior to the variation.

The changes to the beneficiary and class of units will not affect the rights of Unitholders (distinct from Discretionary Beneficiaries) to participate in the income or capital of the Trust. Nor will it affect Unitholders' rights to the income of Trust that has been set aside or held for their benefit.

The proposed variations do not affect the composition of the trust property, or the obligations under which the assets comprising the trust property are held.

The proposed variations to the Trust Deed will amend the terms of the Trust Deed pursuant to a valid exercise of a power contained within the Trust Deed - the amendments will not cause the Trust to terminate and a new trust to arise for trust law purposes (it will not lead to any asset of the Trust being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust). Consequently, neither CGT event E1 nor CGT event E2 will happen as a result of making the proposed variations to the Trust Deed for the Trust to remove Discretionary Beneficiaries or the limit the units one class of units.

That is, on the basis of the assumption that the amendments are valid, and in accordance with the views expressed in TD 2012/21, neither CGT event E1 or E2 will happen by reason of the variation of the trust instrument.

It should be noted that where a proposed change is beyond the power conferred by the terms of a trust, it will be of no effect. Therefore, it cannot give rise to a resettlement of the trust, and would not result in CGT event E1 or E2 happening.

Question 2

Summary

CGT event E4 has no application with respect to the proposed amendments to the Trust Deed itself: however, the changes will mean a trust in the nature of a unit trust, where the unitholders have acquired their units for consideration, such that section 104-70 of the ITAA 1997 is capable of applying where the Trustee makes a non-assessable distribution to the Unitholders in respect of their unitholdings.

Detailed reasoning

In broad terms, CGT event E4 (section 104-70 of the ITAA 1997) happens where the trustee of a trust makes a payment to a taxpayer in respect of their unit or interest in the trust acquired after 20 September 1985 (except for CGT event A1, C2, E1, E2, E6, or E7 happening in relation to it), and some or all of the payment is not included in the taxpayer 's assessable income, described as a non-assessable part (non-assessable distribution), which may be reduced by exclusions and adjustments under section 104-71.

The Revised Explanatory Memorandum to the New Business Tax System (Miscellaneous) Act (No. 2) 2000 explains the operation of the provision as follows:

10.8 Section 104-70 of ITAA 1997 reduces the cost base of a unit or fixed interest in a trust where the trustee pays a non-assessable amount to the beneficiary. If the payment is more than the beneficiary's cost base, a capital gain is made.

This means that, where the trustee makes such a payment, the beneficiary will need to make an adjustment to the cost base of their trust asset or unit. This adjustment will affect the calculation of any capital gain or capital loss on the sale of the trust asset or unit. However, if the amount of the payment exceeds the cost base of the trust interest or unit, the excess is treated as a capital gain in the year it is paid to the beneficiary (see Taxation Determination TD 93/170 Income tax: capital gains: how is the adjusted payment calculated pursuant to subsection 160ZM(3A) of the Income Tax Assessment Act 1936 where there is a non assessable distribution from a unit trust and when is the adjusted payment used for the purposes of calculating a capital gain or loss under section 160ZM? and Taxation Determination TD 93/171 Income tax: capital gains: what are the consequences where a taxpayer receives a non assessable distribution in respect of units in a unit trust and the distribution exceeds the indexed cost base of the units?).

In Taxation Determination TD 2003/28 Income tax: capital gains: does CGT event E4 in section 104-70 of the Income Tax Assessment Act 1997 happen if the trustee of a discretionary trust makes a non-assessable payment to (a) a mere object; or (b) a default beneficiary?, the Commissioner confirm that that CGT event E4 applies in respect of an interest in a trust that acquired for consideration or by way of assignment:

In its context in section 104-70, the interest in the trust is one that is coloured by the nature of a unit in a unit trust, that is, the interest in the trust is one that is akin to the interest that a Unitholder has in a unit trust. The interest that is contemplated is one in which a taxpayer invests.

CGT event E4 has no application with respect to the proposed variations itself: however, the changes will mean a trust in the nature of a unit trust, where the unitholders have acquired their units for consideration, such that section 104-70 of the ITAA 1997 is capable of applying where the Trustee makes a non-assessable distribution to the Unitholders in respect of their unitholdings.

Question 3

Summary

The Unitholders as beneficiaries of the Trust do not have fixed entitlements to all of the income and capital of Trust as defined in subsection 995-1(1) of the ITAA 1997 and subsection 272-5(1) of Schedule 2F to the ITAA 1936.

Detailed reasoning

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:

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 Unitholder, in the income or capital of the unit trust is defeasible.

PCG 2016/16: Fixed entitlements and fixed trusts, explains that a trust is a fixed trust if the beneficiaries have fixed entitlements to all of the income and capital of the trust and confirms that a person will have a fixed entitlement to a share of income or capital of a trust if, under the trust instrument, that person has a vested and indefeasible interest in that share of income or capital. Relevantly, it explains when an interest is defeasible - paragraphs 15 and 16 of PCG 2016/16 define indefeasible interests:

15. An interest is defeasible if it can be defeated by the actions of one or more persons or by the occurrence of one or more subsequent events. An interest of a default beneficiary in the income or capital of the trust is an example of a defeasible interest.

16. Powers in modern trust instruments which cause a beneficiary's interests to be defeasible include:

•         Broad powers to amend the trust instrument.

•         Powers to issue new units after the trust is settled, or to redeem existing units.

•         A power to reclassify existing units so that they do not all have equal rights to receive the income and capital of the trust.

•         A power to classify receipts as being on income or capital account where the units that have been issued do not all have the same rights to receive the income and capital of the trust.

•         A power to appoint a beneficiary's interest in the income or capital of the trust to another beneficiary.

•         A power to settle or appoint any part of the corpus of the trust to a new trust with different beneficiaries.

•         A power to enforce the forfeiture or cancellation of partly paid units due to the non-payment of a call except where such partly paid units would be void ab initio.

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the trust instrument consists of the Trust Deed and proposed variations (collectively, the proposed Amended Trust Deed for the purposes of this discussion).

It is accepted that the proposed Amended Trust Deed provides the Unitholders with a vested interest in the income and capital of the Trust. Relevantly, Clauses 7 and 8 provide that Unitholders will be entitled to income and capital distributions based on their pro rata share of units held in the Trust.

However, there are various clauses in the proposed Amended Trust Deed relating to the Trustee's discretions that may cause a beneficiary's interests to be defeasible - including the power to:

• Issue new units - (Clause 3).
• Vary the Constitution (Clause 13).

Therefore, the Unitholders as beneficiaries of the Trust do not have a fixed entitlement to a share of the income or capital of the Trust for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936.

Question 4

If the answer to Question 1 is 'no' will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem the Unitholders of the Trust as having fixed entitlements to all of the income and capital of the Trust?

Summary

As the Unitholders in the Trust do not have vested and indefeasible interests, pursuant to subsection 272-5(1) of Schedule 2F to the ITAA 1936, subsection 272-5(3) of Schedule 2F to the ITAA 1936 may be considered. 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 Unitholders as beneficiaries of the Trust as having fixed entitlements to all of the income and capital of the Trust.

Detailed reasoning

Where all of the beneficiaries' interests in the capital of the trust are not fixed interests, the trustee may request that the Commissioner exercise the discretion to treat beneficiaries' interests as being vested and indefeasible.

A trust can both rely on the savings rule in relation to some trustee powers (the power to issue or redeem units), and request that the Commissioner exercise the discretion in the context of other powers that may defeat a beneficiary's interest (such as in relation to a power to amend).

Savings rule

The 'savings rule' in subsection 272-5(2) of Schedule 2F to the ITAA 1936 provides that the mere fact that a trustee has power to redeem units in a unit trust, or issue further units for the following value does not mean that Unitholders' interests in the corpus of the unit trust are defeasible:

•         where the units are listed for quotation in the official list of an approved stock exchange - the same price as other units are offered for sale on that exchange at the time of the redemption or issue, or

•         where the units are not so listed - a price determined on the basis of the net asset value of the unit trust at the time of the redemption or issue according to Australian accounting principles.

The Commissioner considers that the savings rule is satisfied where further units may be issued or existing units redeemed in any of the following situations (paragraphs 18 and 19 Practical Compliance Guideline PCG 2016/16 Fixed entitlements and fixed trusts):

•         for a price based on a market value of the assets and liabilities of the trust which has been determined by a licensed valuer

•         for a price based on a market value of the assets and liabilities of the trust which has not been determined by a licensed valuer, but which nevertheless is accurate

•         for a price determined by reference to a value of the trust which is sufficiently close to its net asset value (allowing an adjustment for transaction costs)

•         for a price determined by reference to a value of the trust which is sufficiently close to its net asset value (allowing an adjustment for transaction costs), including where accrued distributions are excluded from the net asset value based on a 'unit day's pricing model'

•         for a price based on the volume weighted average price (VWAP) of the units, or

•         in accordance with ASIC Corporations (Managed investment product consideration) Instrument 2015/847, ASIC Class Order [CO 13/655] and ASIC Class Order [CO 13/657] (if relevant), or any other ASIC guidance or relief on the same subject.

Discretion

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, for the purposes of the Act, treat such beneficiaries as having a fixed entitlement where it is reasonable to do so based upon the factors prescribed in paragraph 272-5(3)(b).

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

In broad terms, there are four key matters that the Commissioner takes into account in deciding whether to exercise the discretion:

a)    the circumstances in which a beneficiary's interest is capable of being defeated or not vesting.

b)    the likelihood of the interest being defeated or not vesting;

c)    the nature of the trust; and

d)    whether the exercise of the discretion would enable a taxpayer to obtain a tax benefit from a trust with a tax loss in circumstances where the economic loss incurred was not borne by the taxpayer.

Paragraph 55 of PCG 2016/16 outlines factors favourable to the exercise of the Commissioner's discretion:

The Commissioner regards the following factors favourably when deciding whether to exercise the discretion:

• a trustee or manager 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
• commitments are made in Unitholder agreements, Product Disclosure Statements or other documents with legal consequences that the trustee or manager will not exercise a power capable of defeating a beneficiary's interest at all, or in a way that is adverse to the rights of beneficiaries to receive the income and capital of the trust
• all beneficiaries have the same rights to receive the income and capital of the trust
• the trust instrument can only be amended with the unanimous (100%) approval of all the beneficiaries
• although the trust instrument can be amended without the unanimous approval of beneficiaries, the approval percentage calculated on the current interest or unit holdings of beneficiaries effectively means that all beneficiaries must approve any amendment (for example, where the approval of 75% of Unitholders is required to make the amendment and the smallest unit holding is more than 25% of the units)
• the trust instrument has been amended in accordance with section 601GC of the Corporations Act 2001 (so as to assist with the efficient administration of the trust) but no beneficial interests in the income and capital of the trust are adversely affected
• the beneficiaries whose rights to receive the income and capital of the trust have been adversely affected by the exercise of a power capable of defeating a beneficiary's interest have explicitly consented to that specific act (such as upon the redemption of the interests of an employee not covered by the savings rule upon the cessation of employment)
• the trustee or manager deals with the beneficiaries of the trust on an arm's length basis
• the trust is governed by a foreign law that is similar to Chapter 5C of the Corporations Act 2001, and
• the trust would satisfy the basic and specific conditions (as applicable to the type of trust) for access to a safe harbour.

Factors adverse to the exercise of the Commissioner's discretion are listed in paragraph 56 of PCG 2016/16 and include:

The Commissioner regards the following factors unfavourably when deciding whether to exercise the discretion:

• a trustee or manager exercises a power to defeat beneficiaries' interests in the income or capital of the trust, however:

-          the nature of the power that is exercised will be important, for example, compulsorily redeeming units where a Unitholder's stake is less than a minimum specified in the trust instrument, and the Unitholder receives the redemption price of those units, is unlikely to preclude the exercise of the discretion

-          where external factors (such as those in the Global Financial Crisis) temporarily affect the ability of the trustee or manager to fund distributions or redemptions, this is unlikely to preclude the exercise of the discretion (for example, a temporary wholesale freezing or deferral of interests)

• there are significantly different beneficiaries of the trust in an income year for which an entity seeks to have a fixed entitlement, than the beneficiaries of the trust in the income year(s) in which the trust made a tax loss, or incurred a bad debt deduction or debt/equity swap deduction
• an arrangement has been entered into which would result in:

o   section 272-35 having application

o   the trafficking of the tax benefit of a tax loss, bad debt deduction or debt/equity swap deduction, or

o   fraud or evasion.

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 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.

Paragraph 272-5(3)(a) of Schedule 2F to the ITAA 1936:

The proposed Amended Trust Deed provides the Unitholders with vested interests in a share of the income that the Trust derives from time to time and a share of the capital of the Trust.

Each Unitholder of the Trust does not, however, have a fixed entitlement to the share of income and capital in the Trust.

As a result, paragraph 272-5(3)(a) of Schedule 2F to the ITAA 1936 is satisfied.

Subparagraph 272-5(3)(b)(i) of Schedule 2F to the ITAA 1936:

When examining the circumstances in which a beneficiary's interest is capable of not vesting or being defeated, the Commissioner will have regard to any factor that may affect the defeasance of any beneficiary's interest, including:

•         the number of circumstances of potential defeasance, and

•         the significance of those circumstances.

This includes having regard to:

•         any person who is capable of altering the beneficiary's interest

•         the nature of their relationship to the beneficiary, and

•         any limitation on their capability to so alter that interest.

In relation to the circumstances in which the entitlement is capable of not vesting or the defeasance happening, the following factors are relevant:

•         Issue of units: The Trustee may issue one class of units (Clause 3). Units issued against uncleared funds which do not subsequently clear are void (Clause 3.9.10). During the Ruling period, only one class of unit has been or will be issued and the units have been or will only be issued for a price determined on the basis of the Net Fund Value or Net Asset Value (according to Australian accounting principles - having regard to the meaning of 'unit value) of the Trust at the time of issue. As such the saving rule in paragraph 272-5(2)(d) would be satisfied.

•         Redemption of units: Units may only be redeemed upon the retirement of a Unitholder (Clause 7). The redemption price has been or will be determined on the basis of the Net Fund Value or Net Asset Value (according to Australian accounting principles - having regard to the meaning of 'unit value) of the Trust at the time of redemption. As such, the saving rule in paragraph 272-5(2)(d) of Schedule 2F to the ITAA 1936 would be satisfied.

•         Amendment of the Trust Deed: The Trustee may amend the Trust Deed with the consent of the unitholders or on Trustee's own accord where they consider the change will not materially adversely affect the rights of the Unitholders. With the exception of the proposed amendments, no amendments have been made to the Trust Deed.

The Commissioner accepts that the assumptions mitigate the circumstances in which the beneficiaries' interests in the income and capital of the Trust can be defeated.

Subparagraph 272-5(3)(b)(ii) of Schedule 2F to the ITAA 1936:

When considering the likelihood of the interest not vesting or being defeated, the Commissioner must form a view as to the probability that the contingency or defeasance will happen. Where the likelihood of the contingency happening is high or the action or event of defeasance occurring is low, this will weigh towards a favourable exercise of the discretion.

Where the trustee or manager of the trust has a particular power to defeat a beneficiary's interest, it is relevant to consider how often, if at all, they have exercised that power over a relevant period.

Any preconditions or caveats that affect the likelihood of a beneficiary's interest not vesting or being defeated are also relevant.

In relation to the likelihood of the entitlement not vesting, or the defeasance happening, the following factors are relevant:

•         The Trustee's behaviour from the time the Trust was settled to the date of this ruling application is relevant. It is noted that defeasible powers contained in the Trust Deed have not been exercised to defease any of the requisite interests of the Unitholders.

•         In respect of the Ruling period ending DD MMM 20XX, having regard to the assumptions, the Trustee has exercised or may exercise its powers under the Constitution such that:

• There will only be one class of units will be issued.
• No units will be reclassified. The rights attached to units already in existence will not be modified.
• Units will only be transferred or redeemed at the request of a Unitholder.
• Units will be issued or redeemed for a price determined on a basis that satisfies the 'savings rule' in subsection 272-5(2) of Schedule 2F to the ITAA 1936 - i.e. on the basis of the Trust's net asset value, according to Australian accounting principles, at the time of the issue or redemption having regard to paragraph 19 of the PCG 2016/16.
• No units will be issued or redeemed at a discount.
• No partly paid units will be issued.
• No streaming of income or capital will occur.
• The Trustee will not seek to amend or vary the Trust's Constitution to defeat the interest or change the fixed entitlements of Unitholders to the income and capital of the Trust.
• In the event the Trust is terminated, all Unitholders will be entitled to the income and capital of the trust in proportion to their unitholding - the Trustee will not transfer assets rather than pay cash in satisfaction of amounts owing, as part of winding up the trust, to any particular unitholder.

The Trustee has never exercised its powers under the Deed in a way that the above assumptions would not be applicable and will not to do so for the Ruling period, to defeat a Unitholder's interest in the income or capital of the Trust. Consequently, the Commissioner would accept that the likelihood of the beneficiaries' interests in the income and capital of the Trust being defeated would be low.

Subparagraph 272-5(3)(b)(iii) of Schedule 2F to the ITAA 1936:

The nature of the trust refers to its basic legal characteristics and its economic function, both actual and intended. The ability of the trustee or manager of the trust to adversely affect the interests of beneficiaries could be limited where:

•           additional responsibilities are placed on the trustee by legislation, most commonly as a registered managed investment scheme under Chapter 5C of the Corporations Act 2001;

•           contractual restrictions limit the trust manager's access to trust assets;

•           the trust is subject to industry regulations, licensing or registration requirements, which are legally enforceable, such as the Australian Securities Exchange (ASX) Listing Rules which are enforceable against listed entities and their associates (sections 793C and 1101B of the Corporations Act 2001);

•           commitments are made in a product disclosure statement, investment memorandum or other document to exercise powers in a particular (restrictive and/or non-adverse) way;

•           the trust deed restricts the ability of the trustee to issue and redeem units at anything other than market value or other values approximating net asset value, or

•           the unanimous (100%) approval of the beneficiaries is required prior to the exercise of a power capable of defeating a beneficiary's interest by the trustee or manager.

In relation to the nature of the trust the following factors are relevant:

•         The Trust is a unitised trust; however, the Units are not publicly listed on an approved stock exchange and the Trust is not a managed investment scheme. Therefore, the circumstances and likelihood in which each Unitholder's entitlement is capable of not vesting or the defeasance happening is not reduced in this Trust.

•         The purpose of establishing the Trust is to allow the Unitholders to derive income/profits from the investments made by the Trust. At the date of the ruling application, the Trust has two unrelated Unitholders.

•         The Trustee is not required to hold an Australian Financial Services Licence in order to act as Trustee of this Trust and therefore not subject to Australian financial services regulations.

•         The parties are dealing on an arm's length basis.

The Commissioner accepts that in these circumstances the ability of the Trustee to adversely affect the interests of beneficiaries is limited - the parties are unrelated parties dealing on an arm's length basis.

Schedule 2F to the ITAA 1936 and tax losses

In relation to the circumstances pertaining to the existence of a tax loss it is noted that:

• At the date of the ruling application, the Trustee does not forecast a tax loss for the Trust.
• No arrangements have been or will be entered into that would result in section 272-35 in Schedule 2F of the ITAA 1936 having application, in the trafficking of the tax benefit of a tax loss, bad debt deduction or debt/equity swap deduction, or in fraud or evasion.
• If there are further units to be issued and/or redeemed, the Trustee will do so satisfying the saving rule in paragraph 272-5(2)(b) of Schedule 2F to the ITAA 1936.

Conclusion

It is accepted that 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 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 considered that it would be appropriate that the Unitholders 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 and proposed variations) contains powers which will not be used to defease the interests of the beneficiaries in the income or capital of the Trust - i.e. the circumstances in which the entitlement is capable of not vesting or a defeasance happening are limited having regard to the Assumptions included;

•         the "nature of the trust" is a unit trust established for the purposes of carrying out investment;

•         the likelihood of the entitlement not vesting or a defeasance is low; and

•         there is little likelihood that a tax benefit of the Trust will be transferred (the opportunity to traffic any tax loss appears to be limited)

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