Edited version of private advice

Authorisation Number: 1052091807348

Date of advice: 6 June 2023

Ruling

Subject: Commissioner's discretion - 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 in subsection 272-5(3) of Schedule 2F to the 1936 to treat the Unitholders of the Trust as having a fixed entitlement to all of the income and capital of the Trust?

Answer

Yes.

Question 3

Do 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 4

If the answer to Question 3 is No, 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 Unitholding?

Answer

Yes.

This ruling applies for the following periods:

year ended 30 June 2020

year ended 30 June 2021

year ended 30 June 2022

year ended 30 June 2023

The scheme commenced on:

1 July 2019

Relevant facts and circumstances

The applicant is a fixed unit trust (the Trust). The Trustee of the Trust is F Pty Ltd. The directors and shareholders are siblings. No other shares have been issued or officers appointed.

The Trust represents the transfer of wealth from one generation to the next and is controlled by the siblings.

The main activity of the Trust is investment operations.

Units and Unitholders

The Trust issued ordinary units (issued price of $x per unit) on formation to discretionary trusts, each is controlled by each of the siblings noted above. All issued units in the Trust are ordinary units and rank equally in terms of voting and entitlement to income and capital of the Trust. Under the terms of the Trust Deed, unitholders are referred to as Members. In forming the Trust, it was the intention of the Members to form a fixed trust and at all times they have operated on the basis that the Trust is a fixed trust.

Since its inception, each current Unitholder in the Trust has held the same respective unit holding proportions.

The Trust Deed

The Trust Deed states:

•         all units are of equal value.

•         all units must be issued, redeemed or forfeited at market value.

•         the Trustee may issue additional units at market value. The additional units will be offered first to existing Members in writing. Any new Member may be required to sign an application for units.

•         subject to Member's approval, the Trustee may redeem and cancel units at the written request of the departing Member, at market value.

•         notes that the power of the Trustee to make calls on the Members is inoperative where Annexure A is endorsed as Not Applicable. (This endorsement has been made on the deed at Annexure A).

•         until the vesting date the Trustee may before the end of each accounting period determine to pay or accumulate all or any part of the net income of the Trust.

•         the amount of any accumulation will be dealt with as an accretion to the Trust fund but the Trustee may at any time pay the whole or any part of any accumulation as if it was net income.

•         resolutions for the purposes of appointment of Trustee and variation of Trust Deed are carried if seventy-five percent (75%) of the votes cast on the resolution are in favour of the resolution

•         subject to Member's approval, the Members may remove the Trustee as a Trustee of the Trust.

•         the Trustee has the power to vary the Trust deed at any time subject to the law against perpetuities and any restrictions on power and Members Approval.

•         amendments to the deed cannot affect the beneficial entitlement set aside or already vested in any Member unless that Member consents in writing.

Other relevant information

The Trustee has never exercised a power capable of defeating a Member's interest.

The Unitholders Agreement was executed on X date. This agreement takes priority over the Unit Trust Deed and the Company Constitution if there are inconsistency between the documents and can only be varied by unanimous written agreement. The Unitholders Agreement sets out additional terms that govern how each Unitholder will interact with the Trust and each other to avoid future disputes that may disrupt family relations. It sets out such items as that the directors will meet monthly and the Trust will make equal monthly distributions of income to each Unitholder. The calculation of the amount of each distribution will be made at the beginning of each financial year and will be decided by a majority vote of the Directors. An increase to the amount of the distributions will require a majority vote of the Directors, a decrease will require a unanimous vote of the Directors. Distributions of capital may be made to the Unitholders in equal shares to each Unitholder.

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

Former subsection 160APHL(11)

Former subsection 160APHL(14)

Income Tax Assessment Act 1997

Subsection 995-1(1)

Reasons for decision

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)?

Summary

The terms of the Trust instrument do not provide the Unitholders with vested and indefeasible interests in all of the income and capital of the Trust. As a result, 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.

Vested and indefeasible interest

Vested interest

The term 'vested' is not defined in the tax legislation and takes on its ordinary meaning.

Practical Compliance Guidelines PCG 2016/16: Fixed entitlements and fixed trusts (the PCG) explains the meaning of the terms 'vested' in the context of section 272-5 of Schedule 2F to the ITAA 1936. Paragraphs 13 and 14 of the PCG relevantly state:

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.

The mere object of a discretionary trust does not have a vested interest in, and therefore does not have a fixed entitlement to, either the income or capital of the trust.

Indefeasible interest

The term 'indefeasible' is not defined in the tax legislation, however, broadly speaking, an interest is generally indefeasible where it 'cannot be terminated, invalidated or annulled' (see Colonial First State Investments Limited v Commissioner of Taxation [2011] FCA 16, paragraph 97).

Paragraph 15 of PCG 2016/16 provides that:

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.

The PCG at paragraph 16 also identifies powers in modern trust instruments which cause a beneficiary's interest to be defeasible. Such powers 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.

Application to your circumstances

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 of a trust there must be a vested and indefeasible interest 'under a trust instrument'. In all cases, the determining factor in deciding if 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 trust instrument consists of the Trust Deed including any amendments and associated agreements.

To that end, whilst it is accepted that the Trust Deed provides Unitholders with a vested interest in the income and capital of the Trust, this interest is not indefeasible.

In particular, is noted that the Trust Deed contains several clauses, in accordance with paragraph 16 of PCG 2016/16, that may cause the Unitholder's interest to be defeasible, namely:

• Issuing of new Units

Clause X gives the Trustee powers to issue additional units, as they think fit, at a price equal to its Market Value.

• Variation of Trust

Clause Y gives the Trustee the power to vary at any time by deed vary any provision of the Trust Deed. A variation could also result in the declaration of a new or other trusts, powers or discretions concerning the Trust Fund. Clause Y also provides that the Trustee may not vary the deed or exercise powers to infringe the law against perpetuities, or the law relating to accumulations, or affect the beneficial entitlement to any amount already set aside or vested in any Member.

• Classification of Receipts

Clause Z allows the Trustee to determine if a receipt is income or capital, or part thereof, and the proportions; and

• Redemption of Units

Clause XX that effectively provides for the redemption of Units by the Trustee, at Market Value.

Conclusion

Subsection 272-5(1) of Schedule 2F to the ITAA 1936 stipulates that in order to have a fixed entitlement to a share of income or capital there must be a vested or indefeasible interest. As previously noted, there are certain clauses of the Trust Deed that may cause the Unitholders' interests to be defeasible.

Given the clauses outlined above and their potential to cause defeasance, the Unitholders of the Trust, do not have a fixed entitlement to a share of the income or capital of the Trust in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936. As a result, the Trust is not a fixed trust for the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936.

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 in subsection 272-5(3) of Schedule 2F to the 1936 to treat the Unitholders of the Trust as having a fixed entitlement to all of the income and capital of the Trust?

Summary

Based on the facts provided, it would be reasonable for the Commissioner to exercise his discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the Unitholders as having fixed entitlements to a share of the income and capital of the Trust.

Detailed reasoning

Commissioner's discretion

The Commissioner's discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 is intended to provide for circumstances where, despite the Trust not technically meeting the requirements of a 'fixed trust', the likelihood of the beneficiary's vested interest being defeated is low, and it would be unreasonable in the context of the statutory scheme to treat the beneficiary's interest as not constituting a 'fixed entitlement'.

Subsection 272-5(3) states:

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; then

the beneficiary has the fixed entitlement.

The PCG 2016/16 provides guidance on what factors the Commissioner will need to consider when making his decision on exercising the discretion (see paragraphs 25 to 41 and Appendix C).

In each case the Commissioner will weigh up all factors (favourable and unfavourable) of the case.

Some of the factors which the Commissioner will consider include:

Factors favourable to the exercising of discretion

Paragraph 55 of the PCG 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 unit holder 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 averse 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 unit holders 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 that are not favourable to the exercising of discretion

Factors adverse to the exercise of the Commissioner's discretion are listed in paragraph 56 of the PCG, which states:

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 unit holder's stake is less than a minimum specified in the trust instrument, and the unit holder 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:

a) section 272-35 having application

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

c) fraud or evasion.

Application to your circumstances

Paragraph 272-5(3)(a)

As stated above, the Trust Deed provides the Unitholders with vested interests in a share of the income and capital of the Trust. However, each Unitholder of the Trust does not have a fixed entitlement to the share of income and capital in the Trust, in line with the analysis in Question 1. As a result, paragraph 272-5(3)(a) of Schedule 2F to the ITAA 1936 is satisfied.

Paragraph 272-5(3)(b)

Circumstances in which the entitlement is capable of not vesting or the defeasance can happen

There are clauses in the Trust Deed which give rise to circumstances of potential defeasance (see Question 1 for further details).

Likelihood of the interest not vesting or being defeated

Despite the Trustee's powers to cause potential defeasance (as mentioned above), the Commissioner considers, based on the facts provided, the probability of defeasance happening is low. It is a material fact in this regard that the Trustee has not exercised a power capable of defeating a Unitholder's interest, in particular:

•         The Trust has not issued any units with a discretionary entitlement to income or capital.

•         The power that the Trustee has to amend the deed is restricted to the extent that making changes will affect the beneficial entitlement to any amount already set aside for or vested in any Member.

•         The Annexure has been completed in a way that the provisions allowing the Trustee to make a call for capital are inoperative.

•         The Trustee is only ever able to cancel units by redeeming them for market value.

•         The Trustee has never exercised a power capable of defeating a Member's interest.

•         The amendment made by the Trustee to correct an error did not serve to defeat or infringe on the Unitholders' vested interests.

•         The commitments made in the Unitholders' agreement were that the Trustee will not act in a way that damages the interest of a Unitholder.

•         All Unitholders, by virtue of there being only ordinary units on issue, have the same rights to receive income and capital.

•         The Trust Deed can only be amended with the approval of 75% of the Unitholders. The smallest holding is greater than 25%. As each holding in the Trust is greater than 25%, achieving the approval of 75% of the Unitholders is not possible without also achieving a 100% approval, so it is the same as unanimous approval.

•         The Trustee is unable to amend the terms of the Trust in a way that will affect the beneficial entitlement already set aside for or vested in any Member.

The nature of the Trust

Taking into account the factors mentioned in paragraph 34 of PCG 2016/16, it is noted that, based on the statements provided:

•         The Trust is closely held and was established for the purpose of undertaking investment activities for the benefit of its Unitholders. The Unitholders are from the same family group. There is no indication that any other member of the family group will become a Unitholder.

•         The purpose of establishing the Trust is to allow the Unitholders to derive income/profits from investment activities undertaken by the Trust. At the date of the ruling application, the Trust has X Unitholders.

•         Since its inception, each current Unitholder in the Trust has held the same respective unit holding proportions.

•         The Trustee will only redeem units at market value.

•         The Trustee has the power to amend the provisions of the Trust Deed, but this is only possible with the unanimous consent of all Unitholders.

•         The Trustee will not exercise its amendment power to affect the beneficial entitlement to any amount already set aside for or vested in any Member.

It is considered, in this instance, that the circumstances and likelihood in which each Unitholder's entitlement is capable of not vesting or the defeasance happening are reduced in this Trust.

Other considerations

As per paragraph 35 of PCG 2016/16, the Commissioner must consider:

whether the exercise of the discretion would allow a person to obtain a tax benefit from a trust claiming a deduction for a tax loss, bad debt deduction or debt/equity swap deduction when the person did not bear the economic loss incurred by the trust

when exercising the discretion. It states at paragraph 37 of the PCG that these factors are still relevant 'even when the reason for requesting that the Commissioner exercise the discretion is related to one of the other legislative provisions listed in Attachment A'.

In relation to the circumstances which pertain to the existence, or lack thereof, of a tax benefit, it is noted that:

•         The Trust does not have any tax losses.

•         There are no deductions forecast to be claimed for bad debts or debt/equity swap losses.

•         There appears to be no arrangements to date that would give or can give any benefits of tax losses to any of the Unitholders.

•         Throughout the Ruling period the Trustee has stated no different classes of Units will be issued and that no streaming of income or capital has occurred.

•         The Trustee has said it will not make further amendments to the Trust Deed during the Ruling period.

As such, it is considered that, if the Commissioner were to exercise his discretion to deem fixed entitlements under subsection 272-5(3) of Schedule 2F to the ITAA 1936 this would not result in undermining the integrity purpose of Schedule 2F to the ITAA 1936 and would not give rise to a tax benefit.

Conclusion

Applying the guidance in PCG 2016/16, it is considered that it is reasonable for the Commissioner to exercise his discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem the Unitholders to have fixed entitlements to the income and capital of the Trust.

Question 3

Do 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

The terms of the Trust instrument do not provide the Unitholders with '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.

Detailed reasoning

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'.

Application to your circumstances

As noted above in Question 1, whilst it is accepted that the Trust Deed provides Unitholders with a vested interest, this interest is not indefeasible; the Trust Deed contains several clauses that contain a power that may defease the interest of a Unitholder in the capital of the Trust. (Note: the terms 'corpus' and 'capital' are considered to be synonymous for current purposes).

For the same reasons explained in Question 1, the Unitholders do not have a vested and indefeasible interest in so much of the corpus (capital) of the Trust as is comprised by the Trust holding (being the Trustee's ownership of shares) pursuant to former subsection 160APHL(11) of the ITAA 1936.

Question 4

If the answer to Question 3 is No, 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 Unitholding?

Summary

Based on the facts provided, it would be reasonable for the Commissioner to consider exercising his 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

As noted above in Question 3, the Unitholders do not have a vested and indefeasible interest in so much of the corpus of the Trust under former subsection 160APHL(11) of the ITAA 1936.

In accordance with former subsection 160APHL(14) of the ITAA 1936, in cases where beneficiaries do not have such an interest, the Commissioner may, for the purposes of the Act, treat such beneficiaries as having a fixed interest where it is reasonable to do so based upon the factors prescribed in subsection 160APHL(14) of the ITAA 1936, which state:

(14) If:

(a) the taxpayer has an interest in so much of the corpus of the trust as is comprised by the trust holding; and

(b) apart from this subsection, the interest would not be a vested or indefeasible interest; and

(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

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

(iii) the nature of the trust; and

(iv) any other matter the Commissioner thinks relevant;

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

Application to your circumstances

Former paragraph 160APHL(14)(a)

The taxpayer has an interest in so much of the corpus of the Trust as is comprised by the Trust holding:

As discussed above, the Unitholders of the Trust do have an interest in so much of the corpus of the Trust as is comprised by the trust holding.

Former paragraph 160APHL(14)(b) -

Apart from this subsection, the interest would not be a vested or indefeasible interest:

As discussed above in Question 1, although a Unitholder's interest in the corpus of the Trust is vested, the Trust Deed contains certain clauses by which a Unitholder's interest in a share of the corpus of the Trust may be defeased.

Former paragraph 160APHL(14)(c) -

The factors the Commissioner must consider are:

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

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

(iii)  the nature of the trust; and

(iv)  any other matter the Commissioner thinks relevant.

The factors in former paragraph 160APHL(14)(c) of the ITAA 1936 are identical, to the factors in paragraph 272-5(3)(b) of Schedule 2F to the ITAA 1936, except for an additional factor in subparagraph (iv) of former paragraph 160APHL(14)(c).

Other matters the Commissioner may consider relevant are found in PCG 2016/16 at paragraphs 34 and 35. These were considered in Question 2.

Since it has already been determined, in relation to Question 2, that the Commissioner will exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 so that the Unitholders of the Trust will be treated as having fixed entitlements to (being a vested and indefeasible interest in) all of the capital of the Trust, then a similar conclusion would result when considering the Commissioner's discretion under former subsection 160APHL(14) of the ITAA 1936.

Conclusion

For the reasons given in relation to Question 2, the Commissioner will exercise his discretion under 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 (capital) of the Trust as is comprised by the Trust holding (being the Trustee's ownership of shares).