Edited version of private advice

Authorisation Number: 1052127494311

Date of advice: 16 October 2023

Ruling

Subject: Fixed trust - qualified persons

Question 1

Will the Unitholders be 'qualified persons' for the purposes of paragraph 207-150(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

If not, will the Commissioner exercise the discretion in former subsection 160APHL(14) of the Income Tax Assessment Act 1936 (ITAA 1936) to treat the Unitholders of the Trust as having a vested and indefeasible interest?

Answer

Yes.

This ruling applies for the following periods:

year ending 30 June 2023

year ending 30 June 2024

year ending 30 June 2025

year ending 30 June 2026

year ending 30 June 2027

The scheme commenced on:

1 July 2020

Relevant facts and circumstances

The trustee for the Unit Trust (The Trust) is owned by non-associated discretionary trusts.

The Unit Trust holds shares in a number of companies and expects to commence receiving franked dividend income from these shareholdings. It is expected that franked dividends will be paid on these shareholdings in the relevant period and beyond.

The discretionary trust Unitholders have, or will have, made family trust elections such that they will each be classified as a 'family trust' for the purposes of Schedule 2F of the ITAA 1936.

There will be no related payments made during the relevant period.

The taxpayer has not and will not have a family trust election in place.

The trustee has not and does not intend to exercise a power capable of defeating a Unitholders interest in the income or capital of the trust during the relevant period.

The Trustee has been and will be the Trustee of the taxpayer at all relevant times during the relevant period.

The only class of units on issue in the Unit Trust during the relevant period will be ordinary units. The ordinary units carry equal rights to the income and capital of the trust fund. No streaming of the distributable income or capital of the trust may happen in any way that is not directly proportionate to each Unitholder's respective interest in the Trust.

The current Unitholders were also the initial Unitholders and to date no new units have been issued.

Any distributions and related franking credits will be made proportionate to the number of units held by the Unitholders.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 subsection 207-35(3)

Income Tax Assessment Act 1997 section 207-45

Income Tax Assessment Act 1997 subsection 207-50(3)

Income Tax Assessment Act 1997 section 207-145

Income Tax Assessment Act 1997 section 207-150

Income Tax Assessment Act 1997 subsection 207-150(1)

Income Tax Assessment Act 1997 paragraph 207-150(1)(a)

Income Tax Assessment Act 1997 subsection 207-150(3)

Income Tax Assessment Act 1936 section 160APHD

Income Tax Assessment Act 1936 subsection 160APHG(3)

Income Tax Assessment Act 1936 subsection 160APHL(7)

Income Tax Assessment Act 1936 subsection 160APHL(10)

Income Tax Assessment Act 1936 subsection 160APHL(11)

Income Tax Assessment Act 1936 subsection 160APHL(12)

Income Tax Assessment Act 1936 subsection 160APHL(13)

Income Tax Assessment Act 1936 subsection 160APHL(14)

Income Tax Assessment Act 1936 subsection 160APHM(2)

Income Tax Assessment Act 1936 subsection 160APHM(3)

Income Tax Assessment Act 1936 section 160APHO

Income Tax Assessment Act 1936 subsection 160APHU(1)

Reasons for decision

Question 1

Qualified person and shares

A beneficiary of a trust can deduct an amount that is equal to the least of its share of the distribution under subsection 207-50(3) of the ITAA 1997 and its share of the franking credit on the distribution if the franked distribution flows directly to it (subsection 207-150(3) of the ITAA 1997).

Subject to the operation of section 207-150 of the ITAA 1997, section 207-45 of the ITAA 1997 provides that an entity to which a franked distribution flows indirectly in an income year is entitled to a tax offset for that income year equal to its share of the franking credit on the distribution.

A franked distribution is taken to flow indirectly to a beneficiary of a trust estate for the purposes of section 207-45 of the ITAA 1997 where the three requirements of paragraphs 207-50(3)(a)-(c) of the ITAA 1997 are satisfied:

• First, during that income year the distribution must be made to the trustee of the trust;

• Second, the beneficiary must have a share of the trust's net income for that income year in the relevant sense;

• Third, the beneficiary's share of the distribution as identified in accordance with section 207-55 of the ITAA 1997 must be a positive amount.

Even where the indirect flow through rules are satisfied, a beneficiary of a trust to whom a franked distribution flows indirectly is only entitled to the tax offset under 207-45 of the ITAA 1997 if they are a 'qualified person' for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 in relation to the distribution (paragraph 207-150(1)(a) of the ITAA 1997).

By virtue of sections 207-145 and 207-150 of the ITAA 1997 as well as Taxation Determination TD 2007/11

Income tax: imputation: franked distributions: qualified persons: does an entity have to be a qualified person within the meaning of Division 1A of former Part IIIAA of the Income Tax Assessment Act 1936 to avoid the application of paragraphs 207-145(1)(a) and 207-150(1)(a) of the Income Tax Assessment Act 1997 in respect of a franked distribution made directly or indirectly to the entity on or after 1 July 2002?, it is clear that regard must be had to the rules in Division 1A of former Part IIIAA of the ITAA 1936 in determining whether a person is a qualified person and hence able to derive the benefit of franking credits attached to distributions made directly or indirectly to the entity. The purpose of the Division is to ensure that the benefits of the franking credits on distributions paid on shares are only available to the true economic owners of the shares, that is, those persons who are sufficiently exposed to the risks of loss and opportunities for gain associated with ownership of the shares (paragraphs 4.6 and 4.7 of the Explanatory Memorandum that accompanied Taxation Law Amendment Act (No. 2) of 1999 which introduced the Division).

Importantly, irrespective of whether or not a trust is a widely held trust as defined, a beneficiary of the trust cannot be a qualified person in relation to a franked distribution which has indirectly flowed to them through the trust unless the trustee of the trust is themselves a qualified person in relation to the distribution (former subsection 160APHU(1) of the ITAA 1936).

As such, unitholders cannot be qualified persons in relation to franked distributions flowing indirectly to them as beneficiary of the Trust unless the Trustee is also a qualified person in relation to the distributions, that is the Trustee satisfies the holding period rules and, where relevant, related payment rules of former section 160APHO of the ITAA 1936 in respect of the franked distributions.

By reason of former paragraph 160APHO(1)(a) and former subparagraph 160APHO(2)(b)(i) of the ITAA 1936, where a taxpayer who holds an interest in shares (not being preference shares) on which a dividend has been paid, and neither the taxpayer nor the associate of the taxpayer has made, is under an obligation to make or is likely to make a related payment in respect to the dividend, the taxpayer will be a qualified person in respect of the dividend if, during the primary qualification period, they held their interest in the shares for a continuous period of not less than 45 days.

Under former subsection 160APHG(3) of the ITAA 1936, the beneficiaries of a trust that is not a widely held trust are deemed to have acquired, held or disposed of an interest in shares when the trustee acquires, holds or disposes of those shares.

The 'primary qualification period' in relation to an interest in a share (not being a preference share) is defined in former section 160APHD of the ITAA 1936 as the period beginning on the day after the day the taxpayer acquired their interest and ends on the 45^th day after the day on which the interest became ex-dividend. In relation to a beneficiary of a non-widely held trust, under former subsection 160APHE(1) of the ITAA 1936 an interest in a share becomes ex-dividend on the day after the last day on which the acquisition by a person of the share will entitle the person to receive the dividend.

Practice Statement Law Administration PS LA 2002/11: Issues concerning fixed entitlements to a share of the income or capital of a trust has application to former sections 160APA and 160APHD of the ITAA 1936 but not directly to former section 160APHL (only indirectly via the definition of 'widely held trust' which, in part, relies upon the definition of 'fixed trust' in Schedule 2F to the ITAA 1936). For the purposes of former section 160APHL of the ITAA 1936, the Trust is in the category of 'all other non-widely held trust' apart from family trusts, deceased estates, and employee share scheme trusts.

In accordance with former subsection 160APHO(3) of the ITAA 1936, in calculating the number of days for which unit holders continuously held an interest in a share held by the Trust, any days on which unit holders had 'materially diminished risks of loss or opportunities for gain in respect of the shares or interest are to be excluded' (although this exclusion is not taken to break the continuity of the period for which the interest was held).

Former subsection 160APHM(2) provides that 'a taxpayer is taken to have materially diminished risks of loss or opportunities for gain on a particular day in respect of' an interest held by the taxpayer in a share if their net position on that day in relation to the interest has less than 30% of those risks and opportunities. Former subsection 160APHM(3) of the ITAA 1936 states that a taxpayer's net position for this purpose 'is worked out using the financial concept of delta'.

Former section 160APHL of the ITAA 1936 will apply as the shares were acquired after 31 December 1997. Former subsection 160APHL(7) of the ITAA 1936 attributes a delta of +1 to the interest in the shares held by a beneficiary of a non-widely held trust as determined under former subsection 160APHL(5) of the ITAA 1936.

Unless there is a family trust election in place (or exceptions relating to deceased estates or employee share schemes are satisfied), former subsection 160APHL(10) of the ITAA 1936 attributes additional positions to the beneficiary. It gives rise to a short position equal to the beneficiary's long position determined under former subsection 160APHL(7) of the ITAA 1936 and a long position equal to so much of the taxpayer's interest in the trust holding as is a fixed interest. For the purposes of former subsection 160APHL(10), the beneficiary's interest in the trust holding will be taken to be a fixed interest to the extent that the interest represents a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding.

A 'unitholder in a unit trust whose deed permits the issue of new units at the trustee's discretion and at a price determined by the trustee' is not a qualified person for the purposes of paragraph 207-150(1)(a) of the ITAA 1997 in relation to dividends where the trustee has held the shares at risk for more than 45 days if there is no family trust election (ATO Interpretative Decision ATO ID 2005/172).

In this case, the Unitholders will have a long position with a delta of +1 under former subsection 160APHL(7) of the ITAA 1936 and a short position with a delta of -1 under former subsection 160APHL(10) of the ITAA 1936. In the absence of any other long positions, this will leave the Unitholder with a net position of zero and a materially diminished risk of loss or opportunity for gain in accordance with former subsection 160APHM(2) of the ITAA 1936. However, a long position will arise in respect of the Unitholder's interest in the Trust Holding as it is a fixed interest to the extent that the interest is constituted by an indefeasible vested 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.

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.

In the present circumstances where the Trustee may, with the consent of the Unitholders, issue further units at the Unit Value, the interest will under former subsection 160APHL(12) of the ITAA 1936 be taken to be defeasible if the issue of new units has the effect of materially reducing the value of the relevant interest. However, where the issue is conducted in accordance with former subsection 160APHL(13) of the ITAA 1936, no material reduction in the value of the interest will be taken to have occurred and the interest will not be taken to be defeasible. However, as the Trustee is at liberty to determine the issue price of any new units that may be issued, former subsection 160APHL(13) of the ITAA 1936 will not apply should the trustee determine the issue price of the units in contravention of the requirements of former subsection 160APHL(13) of the ITAA 1936. Consequently, the Unitholder will have no additional long position and will not be a qualified person in relation to any dividend paid on the shares.

Question 2

If not, 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?

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 1, 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':

Former paragraph 160APHL(14)(a) of the ITAA 1936 contains a 'threshold' condition that the taxpayer has an interest in the corpus of the Trust. An interest for these purposes is considered to be a 'vested interest' and not a 'contingent' interest (an interest that does not take effect until certain conditions are met).

In this case, a clause of the Deed effectively provides that the Trustee determine whether any payments in connection with any property shall be credited or debited to capital or to income. There is no contingency that exists.

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.

Other matters the Commissioner may consider relevant are found in Practical Compliance Guidelines PCG 2016/16 Fixed entitlements and fixed trusts at paragraphs 34 and 35.

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 Unit Trust is closely-held and was established for the purpose of undertaking commercial transactions and investments to derive income/profits for the benefit of its unitholders.
• The Trustee wishes to pass on dividends, if received, to the Unitholders. At the date of the ruling application, the Trust has two Unitholders.
• Since its inception, the unit holding proportions has not changed, the current Unitholders were the initial Unitholders.
• The interests of the Unitholders are not contingent, it is not a discretionary trust, the trust does not have default capital beneficiaries.
• The Trustee will only redeem Units at Unit 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 does not intend to exercise its amendment power to affect the law against perpetuities, or confer a benefit on any person other than the Unitholders.

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:

•         only one class of Units has been issued (and no other classes of units may be issued) and each Unit is of equal value and has the same rights

•         no streaming of the distributable income or capital of the trust may happen in any way that is not directly proportionate to each Unitholder's respective interest in the Trust.

The Trustee has said it is not proposed to make amendments to the Trust Deed during the Ruling period.

Conclusion

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).