Edited version of private advice

Authorisation Number: 1052051300788

Date of advice: 18 November 2022

Ruling

Subject: Commissioner's discretion - fixed interests

Question 1

Will the Unitholders of the Trust have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936?

Answer

No.

Question 2

Will the Commissioner exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat the Unitholders of the Trust as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding?

Answer

Yes.

This determination applies for the following period

1 July 20XX to 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

The Trust is an Australian resident unit trust.

The Trust is not a Managed Investment Scheme (MIS) under Chapter 5C of the Corporations Act 2001(Cth) (the Corporations Act) and is not a widely held unit trust.

The Trustee is not a holder of an Australian Financial Services License for the purposes of Part 7.6 of the Corporations Act.

The Trust is not a family trust within the meaning of Schedule 2F to the ITAA 1936.

The Trustee has not carried out (and will not carry out) any non-arm's length transactions which may have served to defeat or dilute the interests of the unit holders in the income and capital of the Trust.

The Trust deed will not be amended during the Ruling Period.

The initial unitholders of the Trust (the Unitholders) are:

•         Company A and

•         Company B.

The Unitholders of the Trust have not changed since establishment of the Trust.

Both Unitholders are family trusts within the meaning of Schedule 2F to the ITAA 1936.

The Unitholders have each held X% of the units in the Trust at all times since establishment of the Trust.

The units in the Trust are not listed on any stock exchange and there is no expectation that they will be listed on any stock exchange in the foreseeable future.

The Trust carries on investment activities and holds X% shares in Company X.

The Unitholders' interest in the shares of Company X is not an employee share scheme security.

The Trust made a loss of $Z for the financial year ended 30 June 20XX, which has been fully utilised.

The Trust has no carry forward tax losses.

The Trust received dividend income in the financial year ended 30 June 20XX which had franking credits attached. These franking credits were distributed to the Unitholders of the Trust in accordance with their fixed unitholding.

For the financial year ended 30 June 20XX, the Trust received total dividend income of $Z, which had franking credits attached. These franking credits flowed to the Unitholders of the Trust in accordance with their fixed unitholding.

Exercise of the Trustee's powers

The Trustee has never exercised a power capable of diluting or defeating a unitholder's interest in the income or capital of the Trust.

The Trustee will not, at any time during the Ruling Period, exercise a power capable of diluting or defeating a unitholder's interest in the income or capital of the Trust.

Further, the trustee has not created or issued any units to date and, if units are redeemed, the redemption price of the units is determined in accordance with the terms of the Trust Deed.

Details of the Trustee's powers are provided in the Trust Deed.

Further facts and Assumptions

There are no trust losses forecasted for the prospective years of the Ruling Period.

The Trustee will not have any debt deductions throughout the Ruling Period.

The Trustee has never used and will not use its power and discretion to set a price for units for the purpose of diluting or defeating the interests of any registered unitholder in the income and capital of the Trust.

There will only be one class of units on issue throughout the Ruling Period.

In respect of the period of this ruling, the Trustee or Unitholders have not entered and will not enter into an arrangement that would result in:

•         a 'related payment' under former section 160APHN of the ITAA 1936;

•         a Unitholder having materially diminished risks of loss or opportunities for gain of less than 30% in respect of shares held by the Trustee (refer to former section 160APHM of the ITAA 1936);

•         a Unitholder not being sufficiently exposed to the risk of loss or opportunity for gain in respect of the shares in the Trust as explained by ATO Interpretative Decision ATO ID 2014/10;

•         the Commissioner making a determination under paragraph 177EA(5)(b) of the ITAA 1936;

•         any of paragraphs 207-150(1)(c) to (h) of the ITAA 1997 (inclusive) applying; or

•         fraud or evasion.

Relevant legislative provisions

Income Tax Assessment Act 1936

Schedule 2F

Paragraph 177EA(5)(b)

Former subsection 160APHL(7)

Former subsection 160APHL(10)

Former subsection 160APHL(11)

Former subsection 160APHL(12)

Former subsection 160APHL(13)

Former subsection 160APHL(14)

Former subparagraphs 160APHL(14)(c)(i), (iii), (iii) and (iv)

Former section 160APHM

Former section 160APHN

Former section 160APHO

Income Tax Assessment Act 1997

Division 207

Subdivisions 207-A and 207-B

Subsection 207-35(3)

Section 207-45

Section 207-150

Subsection 207-150(1)

Paragraphs 207-150(1)(c) to (h)

Corporations Act 2001

Chapter 5C

Part 7.6

Reasons for decision

Question 1

Will the Unitholders of the Trust have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936?

Summary

No. The Unitholders of the Trust will not have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936. The Unitholders' interest in the Trust are defeasible.

Detailed reasoning

As background to this ruling, the Trust expects to receive franked dividends from Company X. The Trustee would seek to on-distribute the franked dividends to their Unitholders (ultimately being distributed to their beneficiaries).

Division 207 of the ITAA 1997 sets out the consequences of an entity receiving directly or indirectly a franked distribution from a corporate tax entity. Generally, an entity receiving a franked distribution will be entitled to gross up their assessable income for the franking credit and obtain a tax offset equal to the franking credit received (Subdivisions 207-A and 207-B of the ITAA 1997).

Broadly, a taxpayer must be a 'qualified person' to be entitled to a franking credit in respect of a franked distribution. A taxpayer is a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 if, generally speaking, they satisfy the holding period rule and/or the related payments rule (see former section 160APHO of the ITAA 1936).

Section 207-150 of the ITAA 1997 applies where a franked distribution flows indirectly to an entity. Under subsection 207-150(1) of the ITAA 1997, if an entity to whom a franked distribution is made is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936, the amount of franking credit received on the distribution is not included in their assessable income, nor can they claim a tax offset equal to the franking credit; and if the distribution flows indirectly through the entity to another entity - subsection 207-35(3) and section 207-45 of the ITAA 1997 (gross-up of assessable dividends and tax offset entitlement, respectively) do not apply to that other entity. Although Division 1A of former Part IIIAA of the ITAA 1936 was repealed with effect from 1 July 2002, it is necessary to have regard to the rules contained in the repealed provisions in determining whether an entity is a qualified person for the purposes of section 207-150 in respect of a franked distribution (see Taxation Determination TD 2007/11).

The effect of deemed long and short positions under former subsections 160APHL(7) and (10) of the ITAA 1936 relating to shares held is that unless a beneficiary has a fixed interest constituted by a vested and indefeasible interest in the corpus of the trust or an exception applies, a beneficiary in a non-widely held trust will typically have a net position of zero, i.e., not be sufficiently at risk, meaning that franking credits will not pass through the trust, as explained in ATO Interpretative Decision ATO ID 2002/122.

A 'fixed interest' in the trust holding is defined in former subsection 160APHL(11) of the ITAA 1936 as "a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding".

Former subsection 160APHL(12) of the ITAA 1936 (certain interests in trust holding taken to be defeasible) states:

"Subject to subsection (13), if the taxpayer has an interest in the trust holding and either:

(a) the interest may be redeemed under the terms of the trust for less than its value; or

(b) the value of the interest may be materially reduced by:

(i) if the trust is a unit trust - the issue of further units; or

(ii) otherwise - the creation of other interests under the trust;

the interest is taken to be defeasible."

Former subsection 160APHL(13) of the ITAA 1936 provides a 'savings rule' in relation to defeasible interest:

"if:

(a) the trust is a unit trust and the taxpayer holds units in the unit trust; and

(b) the units are redeemable or further units are able to be issued; and

(c) where units in the unit trust are listed for quotation in the official list of an approved stock exchange (within the meaning of section 470) - the units held by the taxpayer 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) where the units are not listed as mentioned in paragraph (c) - the units held by the taxpayer will be redeemed, or any further units will be issued, for a price determined on the basis of the unit trust's net asset value, according to Australian accounting principles, 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 taxpayer's interest, as a unit holder, in so much of the corpus of the trust as is comprised by the trust holding is defeasible."

Vested and indefeasible interest

The expression 'vested and indefeasible' is not defined in the taxation legislation. However, the Explanatory Memorandum to A New Tax System (Closely Held Trusts) Act 1999 provides:

"What is a vested interest?

1.20 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.

...

When is a vested interest indefeasible?

1.23 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.

1.24 Where the trustee exercises a power to accumulate income or capital of the trust in accordance with the trust deed, the accumulation does not result in a beneficiary's interest being taken away or defeased as long as the beneficiary nevertheless remains entitled at some future time to enjoy his or her share of the income or capital which has been accumulated."

The Commissioner accepts that the Trust Deed provides the Unitholders with a vested interest in the income and capital of the Trust.

However, the vested interest is not indefeasible. While the power to issue and redeem units may satisfy the savings rule in former subsection 160APHL(13) of the ITAA 1936, there are other various clauses in the Trust Deed which may, or would, cause a beneficiary's interest to be defeasible.

It is noted in this regard that the Trust Deed provides the Trustee with the power to reclassify income and capital of the Trust and to allocate income or capital of a category.

It is, however, the breadth of the powers afforded to the Trustee under the Trust Deed in relation to the Trustee's power to vary the Trust Deed that renders the Unitholders' interests defeasible.

For the above reasons, the Unitholders do not have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936.

Question 2

Will the Commissioner exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat the Unitholders of the Trust as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding?

Summary

Yes. The Commissioner will exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat the Unitholders of the Trust as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding.

Detailed reasoning

Former subsection 160APHL(14) of the ITAA 1936 contains a discretion whereby, in cases where beneficiaries do not have a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding, the Commissioner may determine that the interest is to be taken to be vested and indefeasible, where it is reasonable to do so based upon the factors prescribed in former paragraph 160APHL(14)(c) of the ITAA 1936.

Former paragraph 160APHL(14)(c) of the ITAA 1936 provides that:

"(c) the Commissioner considers that the interest should be treated as being vested and indefeasible, having regard to:

(i) the circumstances in which the interest is capable of not vesting or the defeasance can happen; and

(i)            the likelihood of the interest not vesting or the defeasance happening; and

(ii)           the nature of the trust; and

(iii)          any other matter the Commissioner thinks relevant;

the Commissioner may determine that the interest is to be taken to be vested and indefeasible.

Former subparagraph 160APHL(14)(c)(i) of the ITAA 1936

In respect of the circumstances in which the interest is capable of not vesting or the defeasance can happen, it is noted earlier that there are several clauses in the Trust Deed that give rise to circumstances of potential defeasance.

However, the Commissioner also takes into consideration the following factors:

In respect of the issue and redemption of units:

•         there can only be one class of units;

•         the Trustee may only redeem units with the unanimous consent of the unitholders;

•         the restrictions contained in several clauses of the Trust Deed with respect to the issue and redemption of units cannot be removed;

In this regard, the savings rule in former subsection 160APHL(13) of the ITAA 1936 is satisfied in respect of the issue and redemption of units

•         Further restrictions are placed on the Trustee's powers as outlined in Clauses X and Y.

•         The Trustee has made regular distributions of income to the Unitholders in proportion to their respective unit holdings and these distributions have always been to the same unitholders.

Former subparagraph 160APHL(14)(c)(ii) of the ITAA 1936

Despite the Trustee's powers to cause potential defeasance, the Commissioner considers that the probability of the defeasance happening is low.

It is a material fact in this regard that the Trustee has never exercised a power capable of defeating a beneficiary's interest.

It is also a material consideration that, in respect of the future exercise of the Trustee's powers, the Trustee will not exercise a power capable of diluting or defeating a unitholder's interest in the income or capital of Trust during the Ruling Period.

In this regard, the Commissioner also takes into account the various restrictions on the exercise of the Trustee's powers as imposed by the Trust Deed

The Trustee will not amend the Trust Deed during the Ruling Period.

Former subparagraph 160APHL(14)(c)(iii) of the ITAA 1936

In considering the natureof the trust, with regard to the general characteristics of the Trust, it is noted that:

•         The Trust carries on investment activities. It holds 100% of the shares in Company X.

•         The Trust is a unitised trust. However, the units are not publicly listed on an approved stock exchange and the Trust is not a registered MIS under Chapter 5C of the Corporations Act.

•         In considering the nature of the trust, the Commissioner also has regard to the various restrictions on the exercise of the Trustee's powers as imposed by the Trust Deed as outlined in the facts and circumstances with respect to this ruling.

Former subparagraph 160APHL(14)(c)(iv) of the ITAA 1936

In regard to any other matter the Commissioner thinks relevant:

The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 2) 1999, which accompanied the introduction of former subsection 160APHL(14) of the ITAA 1936, outlines the purpose of the integrity measures:

"4.6 One of the underlying principles of the imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves: a degree of wastage of franking credits is an intended feature of the imputation system.

4.7 In substance, the owner of shares is the person who is exposed to the risks of loss and opportunities for gain in respect of the shares. However, franking credit trading schemes allow persons who are not exposed, or have only a small exposure, to the risks and opportunities of share ownership to obtain access to the full value of franking credits, which often, but for the scheme, would not have been used at all, or would not have been fully used. Some of these schemes may operate over extended periods, and typically involve a payment related to the dividend which has the effect of passing its benefit in economic terms to a counterparty. The schemes therefore undermine an underlying principle of imputation."

As such, when considering the exercise of the discretion in former subsection 160APHL(14) of the ITAA 1936, the Commissioner must bear in mind the intended effect of the integrity measures.

In relation to the likelihood of the intended effect of the integrity measures being undermined, the following factors are relevant:

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

•         In respect of the period of this ruling, the Trustee or Unitholders have not entered and will not enter into an arrangement that would result in:

o   a 'related payment' under former section 160APHN of the ITAA 1936;

o   a Unitholder having materially diminished risks of loss or opportunities for gain of less than 30% in respect of shares held by the Trustee (refer to former section 160APHM of the ITAA 1936);

o   ­a Unitholder not being sufficiently exposed to the risk of loss or opportunity for gain in respect of the shares in the Trust as explained by ATO Interpretative Decision ATO ID 2014/10;

o   the Commissioner making a determination under paragraph 177EA(5)(b) of the ITAA 1936;

o   any of paragraphs 207-150(1)(c) to (h) of the ITAA 1997 (inclusive) applying; or

o   fraud or evasion.

Consequently, the Commissioner would accept that the likelihood of the integrity measures being undermined would be low.

Conclusion

The Unitholders do not have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936.

However, after considering former subparagraphs 160APHL(14)(c)(i), (ii), (iii) and (iv), the Commissioner will exercise the discretion under former subsection 160APHL(14) of the ITAA 1936 to treat the Unitholders as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding during the Ruling Period.