Edited version of private advice

Authorisation Number: 1051939836986

Date of advice: 20 January 2022

Ruling

Subject: Fixed trust and fixed entitlements

Question 1

Is the Trust a fixed trust for the purposes of section 272-65 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

If the Trust is not a fixed trust for the purposes of section 272-65 of Schedule 2F to the ITAA 1936, will the Commissioner exercise the discretion under in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the Unit Holders 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 ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trust

•         The Trust is a unit trust that was established pursuant to the Constitution dated X XX 20XX.

•         The Trust is a resident trust estate for the purposes of section 95(2) of the ITAA 1936.

•         The main activity of the Trust is commercial transactions and investments.

•         The Trust is not registered as a managed investment scheme (MIS) for the purposes of the Corporations Act 2001 and it does not expect to become an MIS.

The Trustee

•         The Trustee of the Trust is XXX, a proprietary company limited by shares.

•         The Trustee:

­        is an Australian tax resident;

­        is a trustee company only - it does not conduct any business, hold investments or receive income in its own name;

­        is not the trustee of any other trust;

­        does not hold an Australian Financial Services Licence (AFSL) for the purposes of Part 7.6 of the Corporations Act 2001; and

­        is not subject to any regulation by the Australia Prudential Regulation Authority.

•         The Trustee is not prevented from owning units in the Trust for its own benefit. However, it does not currently hold any units in the Trust.

Unit Holders and Units in the Trust

•         The sole unit holder of the Trust from the time it was established to the date of this ruling application is XXX, which holds XX Units originally issued at $1.00 per unit.

•         There is only one class of Units on issue.

•         Units in the Trust are not listed on any stock exchange.

The terms of the Trust based on the Constitution

•         Only one class of Units may be issued.

•         All Units are of equal value and have the same rights.

•         Units issued against uncleared funds which do not subsequently clear are voidable.

•         The Trustee must only issue fully paid Units.

•         Units may only be issued or redeemed/withdrawn for a price determined on the basis of the net asset value (according to Australian accounting principles) of the Trust at the time of issue or redemption/withdrawal.

•         The Unit Holders will be entitled to the income and capital of the Trust in proportion to their unitholding.

•         The Trustee may amend the Constitution (including the amendment clause) by deed with the consent of all the Unit Holders.

•         The Trustee has discretion to terminate the Trust.

Other relevant information

•         No amendments to the Constitution have been made and no Units have been redeemed since the Trust was established.

•         The Trust has invested in an overseas based entity.

•         The Trust has prior year tax losses of $XXX as at 30 June 20XX.

•         During the Ruling Period of 1 July 20XX to 30 June 20XX:

­        Any proposal to deduct carried forward losses will depend on the return of the underlying investment. The source of the assessable income of the Trust that will be offset against the tax losses is an investment in an overseas based company.

­        No streaming of income or capital to different unit holders will occur.

­        No Units will be issued and/or redeemed at a discount.

­        No Units of different classes will be issued.

­        No proposals to amend the Trust's Constitution.

­        The Trust will not be registered as a managed investment scheme.

­        Units will not be listed on the stock exchange.

•         The Trustee of the Trust wishes to determine whether the Trust is a fixed trust for the purposes of section 272-65 of Schedule 2F to the ITAA 1936. The Trustee is seeking to reduce compliance costs and to allow for any tax losses to be carried forward (subject to the trust loss provisions in Schedule 2F of the ITAA 1936).

Assumptions

Throughout the Ruling Period:

•         No amendments will be made to the Constitution.

•         Additional Units will be issued and Units will be redeemed on a basis that will satisfy subsection 272-5(2) of Schedule 2F to the ITAA 1936.

•         Only a single class of Units will remain on issue.

•         The Trust will not become an Attribution Managed Investment Trust (AMIT).

•         The Trustee will not exercise a power capable of defeating a Unitholder's interest in the income or capital of the Trust.

•         An arrangement will not be entered into which would result in:

­        section 272-35 of Schedule 2F to the ITAA 1936 having application;

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

­        fraud or evasion.

Relevant legislative provisions

Income Tax Assessment Act 1936

Schedule 2F

Section 272-5

Subsection 272-5(1)

Subsection 272-5(2)

Subsection 272-5(3)

Section 272-65

Income Tax Assessment Act 1997

Subsection 995-1(1)

Reasons for decision

Question 1

Summary

As the Unit Holders of the Trust do not have fixed entitlements to all of the income and capital of Trust in accordance with subsection 995-1(1) of the ITAA 1997 and subsection 272-5(1) of Schedule 2F to the ITAA 1936, the Trust is not a fixed trust for the purposes of section 272-65 of Schedule 2F to the ITAA 1936.

Detailed reasoning

A '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 'fixed entitlement' in subsection 995-1(1) of the ITAA 1997 provides:

...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.

The word 'interest' 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, 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 not defined in the taxation legislation. The Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997explains its ordinary meaning at some length, at paragraphs 13.4 to 13.9.

Practical Compliance Guideline 2016/16 (PCG 2016/16) explains the meaning of the terms 'vested' and 'indefeasible' in the context of section 272-5 of Schedule 2F to the ITAA 1936 at paragraphs 13 and 15:

In terms of the concept of 'fixed entitlement', an interest is 'vested' if it is vested in interest or vested in possession. An interest is vested in possession when it gives its holder a right of present enjoyment, whereas an interest is vested in interest if it gives its holder a present right to future enjoyment.

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.

In Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16 Stone J stated at [97] that in the absence of a definition, and subject to qualification in subsection 272-5(2) of Schedule 2F, the term 'indefeasible' bears its ordinary meaning when applied to an interest, that is that 'the interest cannot be terminated, invalidated or annulled'.

In a case where a beneficiary has a vested interest which may be 'terminated, invalidated or cancelled' the beneficiary will have a defeasible interest. For example, where that interest is brought to an end by the exercise of a power of appointment in favour of someone else - see Dwight v Commissioner of Taxation (1992) 107 ALR 407; 92 ATC 4192; 23 ATR 236.

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'.

Determining whether a beneficiary has a 'vested and indefeasible' interest in a trust requires an examination of the terms of the trust upon which the relevant trust property is held, including individual clauses, and whether a beneficiary's interest in a share of the income or capital is defeasible by virtue of any of the powers contained in the trust instrument (see CPT Custodian Pty Ltd v Commissioner of State Revenue; Commissioner of State Revenue v Karingal 2 Holdings Pty Ltd [2005] HCA 53).

For example, the existence of a power in a trustee to issue new units of the same class will render the interests of all unit holders in that class defeasible if the issuing of the units has the potential to cause a contraction of the proportionate interest that each of the existing unit holders has.

Similarly, a power under a trust instrument to redeem, revoke or cancel units is a power that would render a unit holder's interest defeasible, even if the power is one that can only be exercised with the unit holder's consent.

However, the saving rule in subsection 272-5(2) of Schedule 2F to the ITAA 1936 provides that the interest of a unit holder in a unit trust will not be taken to be defeasible only because the units can be issued or redeemed. This is provided the units are redeemable or further units are able to be issued only for market value or for a price that represents the net asset value of the trust. Subsection 272-5(2) states:

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.

Application to your circumstances

Vested interests

For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the trust instrument consists of the Constitution of the Trust.

It is accepted that the Constitution of the Trust provides the Unit Holders with a vested interest in the income and capital of the Trust.

Defeasible powers in the Constitution

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.

The Constitution of the Trust contains certain clauses by which a Unit Holder's interest in a share of the income or capital of the Trust may be defeased.

One of those clauses permits the Trustee to amend the Constitution without any specified restriction other than the need for approval of all the Unit Holders. It states:

'Subject to the Law, the Trustee may amend this Constitution (including this clause) by deed with the consent of all the Unit holders.'

Despite the amendments require unanimous approval by all of the Unit Holders, the mere existence of a power to amend the trust instrument constitutes a defeasible power (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]).

Where unanimous approval by all Unit Holders is required before amendments are made, this will only be relevant to the considerations of the Commissioner for the purposes of determining the likelihood of a defeasance occurring for the purposes of subparagraph 272-5(3)(b)(ii) of Schedule 2F to the ITAA 1936.

As the Constitution of the Trust contains clause(s) by which a Unit Holder's interest in a share of the income or capital of the Trust may be defeased, in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936, the Unit Holders of the Trust do not have a fixed entitlement to all of the income and capital of the Trust. As a result, the Trust is not a fixed trust for the purposes of purposes of section 272-65 of Schedule 2F to the ITAA 1936.

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 Unit Holders 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, 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) 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.

According to the Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 (at paragraph 13.13), the discretion 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 trust 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.

Subparagraph 272-5(3)(b)(i) - the circumstances in which the entitlement is capable of not vesting or the defeasance can happen

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

•         Issue of Units: the Trustee is allowed to issue additional Units for a price determined on the basis of the net asset value (according to Australian accounting principles) of the Trust at the time of issue or transfer.

•         Redemption (Withdrawal) of Units: any Unit Holder may request that their Units be redeemed. If the Trustee accepts the request, the redemption price is determined on the basis of the net asset value (according to Australian accounting principles) of the Trust at the time of redemption.

As stated earlier, under subsection 272-5(2) of Schedule 2F to the ITAA 1936, the interests of a unit holder in a unit trust will not be taken to be defeasible only because units in the trust can be issued or redeemed. For this provision to operate, the issue or redemption of the units must be at full value. That is, additional units can be issued or units redeemed only for market value (if the units in the trust are listed) or for a price that represents the net asset value of the trust (if the units in the trust are not listed).

The Units in the Trust can only be issued or redeemed at a price determined on the basis of the net asset value of the Trust at the relevant time, according to Australian accounting principles.

Therefore, the saving provision in subsection 272-5(2) of Schedule 2F to the ITAA 1936 will apply such that the Trustee's powers conferred under the Trust's Constitution will not cause a Unit Holder's interest in the income or capital of the Trust to be defeasible for the purposes of subsection 272-5(1).

•         Amendments to the Constitution: the Trustee may amend the Constitution (including the amendment clause) by deed with the consent of all the Unit Holders.

Even though 100% unanimous agreement of Unit Holders is required to amend the Trust's Constitution, such a power, nevertheless, constitutes a defeasible power. Such a power can be so exercised to introduce into the terms of the Trust further powers which could dilute the interest of existing Unit Holders such that would regard the interest as defeasible.

However, as at the date of this ruling application, the Trustee hasn't made any amendments or variations to the Constitution since the establishment of the Trust. The Trustee has also advised that it is not proposed to amend the Constitution during the Ruling Period.

Therefore, the Commissioner accepts that the circumstances in which the Unit Holders' entitlement is capable of not vesting or a defeasance happening are limited.

Subparagraph 272-5(3)(b)(ii) - the likelihood of the entitlement not vesting or the defeasance happening

In relation to the ability of the Trustee to vary the terms of the Trust Constitution:

•         Any variation to the Trust Constitution requires the approval of all the Unit Holders;

•         There have been no amendments to the Trust's Constitution; and

•         There are no proposals to amend the Trust's Constitution during the Ruling Period.

In relation to the use of the powers available under the Trust's Constitution by the Trustee:

•         The Trust is a unit trust with only one class of Unit on issue;

•         All Units are of equal value and have the same rights;

•         The Trustee must only issue fully paid Units;

•         Only fully paid Units have been issued;

•         No Units have been compulsorily sold or redeemed;

•         No Units have been issued at a discount by the Trustee;

•         The Trustee has discretion to terminate the Trust. However, the Unit Holders will be entitled to the income and capital of the Trust in proportion to their unitholding.

In respect of the Trust, for the Ruling Period of 1 July 20XX to 30 June 20XX:

•         No streaming of income or capital to different unit holders will occur;

•         No Units will be issued and/or redeemed at a discount;

•         No Units of different classes will be issued; and

•         No proposals to amend the Trust's Constitution.

Therefore, it is considered that the likelihood of the entitlement not vesting or defeasance happening is low.

Subparagraph 272-5(3)(b)(iii) - the nature of the trust

•         The Trust is a unitised trust, however, the Units are not publicly listed on an approved security exchange and the Trust is not a managed investment scheme. As such the circumstances and likelihood in which each Unit Holder's/Beneficiary's entitlement is capable of not vesting or the defeasance happening are reduced in this Trust.

•         At the date of the ruling application, the Trust has only one Unit Holder.

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. 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 trust loss measures 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 to provide for special circumstances where there is a low likelihood of a beneficiary's vested interest being taken away or defeased and, having regard to the scheme of the trusts loss provisions to prevent the transfer of the tax benefit of the 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 regard should always be had to whether a fixed entitlement in these circumstances could result in the transfer of the benefit of the tax loss.

The relevant facts and circumstances:

•         The Trust has carried forward tax losses of $XXX as at 30 June 20XX. The tax losses may be recouped to the extent that there is assessable income derived by Trust from its underlying investment.

•         As at the date of the ruling application there is only one Unit Holder in the Trust.

•         The Unit Holder(s) will benefit from the use of the tax losses incurred by the Trust and not a third party.

•         While there may be Units 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.

•         No streaming of income or capital will happen and no Units will be reclassified.

•         It is not proposed that the Trustee will amend the Constitution during the Ruling Period.

These facts indicate that there is a low risk of trust tax loss trafficking occurring in relation to the Trust's carried forward tax losses.

Conclusion

After having regard to the factors in subparagraphs 272-5(3)(b)(i), (ii) and (iii) of Schedule 2F to the ITAA 1936 and the submissions of the applicant, it is considered that the facts warrant the exercising of the Commissioner's discretion to deem the Unit Holders to have fixed entitlements to the income and capital of the Trust.