Edited version of private advice

Authorisation Number: 1052182921431

Date of advice: 6 November 2023

Ruling

Subject: Trust - vested and indefeasible interest

Question 1

Will the Unit Holder 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 Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

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

Answer

Yes.

This ruling applies for the following period:

XX XX XXXX

The scheme commenced on:

XX/XX/XX

Relevant facts and circumstances

1.            The Trust was established for the purpose of owning shares in Company B.

2.            The trustee of the Trust, Company C (the Trustee), has no other activities other than operating as trustee.

3.            The Trust acquired shares in the Company in 20XX.

4.            The Trust has not undertaken any other activity apart from holding the abovementioned shareholdings.

5.            The Company was incorporated in XX XXXX and all shares have been owned by the Trustee of the Trust since incorporation.

6.            The Company holds shares in Company D, a wholly owned subsidiary. Other than this, the Company has no other assets. Company D previously held shares in ASX Company which was listed on the ASX before being acquired by the Company in XX XXXX. Company E as trustee for the X Trust is the sole unit holder (the Unit Holder) of the Trust.

7.            The Company is contemplating the payment of a fully franked dividend during the year ending XX/XX/XX. The Trustee of the Trust would seek to pass on the franking credits to the Unit Holder if such a dividend is received from the Company.

8.            The maximum amount of franked dividend is $X. The ultimate source of these dividends relates to profits made from the disposal of shares in the ASX Company as well as fully franked dividends received from the ASX Company by Company D.

9.            The source of the retained profits and franking credits did not exist prior to the Trust acquiring the shares in the Company.

10.          The Unit Holder has always been the sole unit holder holding the same X ordinary units of the Trust since the Trust's establishment.

11.          The Trustee is an Australian resident for tax purposes.

12.          The directors of the Trustee are Australian residents for tax purposes.

13.          No trust distributions have been made by the Trust since its inception.

14.          The Trust has no losses carried forward.

Additional relevant information

15.          No partly paid units have ever been issued.

16.          No partly paid units have been forfeited due to non-payment of any instalment.

17.          No units have been compulsorily sold or redeemed.

18.          No units of different classes have ever been issued by the Trustee.

Assumptions

19.          Throughout the ruling period:

(a)          there will be only one class of units on issue in the Trust

(b)          no partly paid units will be issued

(c)           the Trust Deed will not be amended

(d)          the Trustee will not exercise a power capable of defeating a Unit Holder's interest to defeat a Unit Holder's interest in the income or capital of the Trust

(e)          any further Units in the Trust will be issued, or any redemption of Units will happen, in accordance with the 'savings rule' in former subsection 160APHL(13) of the ITAA 1936

(f)            the Trustee will not exercise a power capable of defeating a Unit Holder's interest to defeat a Unit Holder's interest in the income or capital of the Trust

(g)          no arrangement has been or will be entered into which would result in:

                                  (i)          a 'related payment' under former section 160APHN of the ITAA 1936 being made

                                 (ii)          the Unit Holder having materially diminished risks of loss or opportunities for gain of less than 30% in respect of shares held by the trustee in its capacity as trustee for the Trust (refer to former section 160APHM of the ITAA 1936)

                                (iii)          the Unit Holder not being sufficiently exposed to the risk of loss or opportunity for gain in respect of the units in the Trust

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

                                 (v)          any of paragraphs 207-150(1)(c) to (h) of the Income Tax Assessment Act 1997 (inclusive) applying

                                (vi)          fraud or evasion.

Relevant legislative provisions

Income Tax Assessment Act 1936 Former subsection 160APHL(11)

Income Tax Assessment Act 1936 Former subsection 160APHL(13)

Income Tax Assessment Act 1936 Former paragraph 160APHL(13)(d)

Income Tax Assessment Act 1936 Former subsection 160APHL(14)

Income Tax Assessment Act 1936 Former paragraph 160APHL(14)(a)

Income Tax Assessment Act 1936 Former paragraph 160APHL(14)(b)

Income Tax Assessment Act 1936 Former paragraph 160APHL(14)(c)

Income Tax Assessment Act 1936 Former section 160APHM

Income Tax Assessment Act 1936 Former section 160APHN

Income Tax Assessment Act 1936 Paragraph 177EA(5)(b)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(c)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(d)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(e)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(f)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(g)

Income Tax Assessment Act 1997 Paragraph 207-150(1)(h)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1936 unless otherwise stated.

Question 1

Will the Unit Holder 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)?

Summary

The Unit Holder of the Trust does 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).

Detailed reasoning

20.         Former section 160APHL(11) provides:

For the purposes of subsection (10), the taxpayer's interest in the trust holding is a fixed interest to the extent that the interest is constituted by a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding.

21.         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 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 (CPT Custodian Case)).

22.         In Dwight v Commissioner of Taxation [1992] FCA 210, Hill J stated:

Estates may be vested in interest or vested in possession, the difference being between a present fixed right of future enjoyment where the estate is said to be vested in interest and a present right of present enjoyment of the right, where the estate is said to be vested in possession:

Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490 at 496 per Griffith CJ, at 501 per Isaacs J. A person with an interest in remainder, subject to a pre-existing life interest, has an interest which is vested in interest, but being a future interest is not yet vested in possession. That person's interest will vest in possession on the death of the life tenant. In the present context the word 'vested' is used in contradistinction to contingent.

An interest is said to be defeasible where it can be brought to an end and indefeasible where it cannot. Thus, a beneficiary with an interest which is not contingent but which interest may be brought to an end by the exercise of a power of appointment, would be said to have a vested but defeasible interest.

No vested and indefeasible interest

23.          The Unit Holder has a vested interest in the corpus of the Trust under clauses X and X of the Trust Deed.

24.          Clause X and X of the Trust Deed provides for trustee indemnity to be paid out of the Trust Fund and the ability to withhold from amounts payable to the Unit holders amounts payable to the trustee by way of indemnity.

25.         We consider the effect of the High Court's judgement in CPT Custodian case is that it is not possible for a beneficiary of the trust to have a fixed interest for the purposes of former subsection 160APHL(11) where a trustee's indemnity results in the trustee having an interest in the trust's property.

26.         There also certain powers contained in the Trust Deed that contain powers that may defease the interests that the Unit Holders have in the corpus of the Trust including:

(a)          the power to issue new units on any terms with rights, restrictions and obligations as the Trustee thinks fit in its absolute discretion (clause X and X of the Trust Deed). This will not satisfy the requirements of the 'savings rule' in former paragraph 160APHL(13)(d).

(b)          the power to classify or reclassify or designate the Units in any manner which the Trustee thinks fit, including into classes or into a different class (clause X and X of the Trust Deed). The Trustee may, in its absolute discretion, determine whether any receipt, profit, gain (whether realised or unrealised), payment, loss, outgoing, provision or reserve or any sum of money or investment is be treated as being on income or capital account (clause X). Where different classes of Units are on issue these clauses may cause a Unitholder's interest in the Trust's capital to be defeased.

(c)           Clause X contains a power to redeem units at a price that is not determined on the basis of the net asset value of the trust according to Australian accounting principles. This will not satisfy the requirements of the 'savings rule' in former paragraph 160APHL(13)(d) such that the ability to redeem Units by the trustee will constitute a defeasible power.

(d)          Under clause X the trustee may amend the trust deed with the consent of Unit Holders by Ordinary Resolution. Any ability to amend the Trust Deed, whether requiring Unit Holder approval or not, will constitute a power capable of defeating a beneficiary's interest in the income or capital of the Trust. As noted by Stone J in 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]:

it follows [from unit holders' ability to amend the Constitution] that the members could vote to terminate the present right to a share of income and capital.

An amendment could also permit the amendment of clauses which currently do not contain defeasible powers to do so.

27.         In view of the conclusion above that the beneficiaries (the Unit Holder) of the Trust does not have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding pursuant to former subsection 160APHL(11).

28.         The only way that the Unit Holders can have such a vested and indefeasible interest is if the Commissioner exercises the discretion in former subsection 160APHL(14).

Question 2

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

Summary

The Commissioner will exercise the discretion under former subsection 160APHL(14) to treat the Unit Holder 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.

Detailed reasoning

29.         Former subsection 160APHL(14) allows the Commissioner to determine an interest as being vested and indefeasible if its prescribed conditions are met.

Threshold condition

30.         Former paragraph 160APHL(14)(a) requires the relevant taxpayer to have an interest in the corpus of the Trust.

31.         This condition is met, as the Unit Holder in the Trust will have an interest in the corpus of the Trust as mentioned above under clauses X and X of the Trust Deed.

Not vested or indefeasible condition

32.         Former paragraph 160APHL(14)(b) requires that the interest in the corpus of the Trust is not vested or indefeasible.

33.         As per the answer to Question 1, this condition is met as the interests of the Unit Holder in the corpus of the Trust are defeasible.

Factors to have regards to

34.         Former paragraph 160APHL(14)(c) provides:

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.

Circumstances in which defeasance can occur

35.         As per the answer to Question 1, the Unit Holders' interests in the Trust can be defeased in the circumstances stated in paragraphs 24 and 26.

Likelihood of defeasance

36.         The circumstances in which the interests in the Trust can be defeased will not occur during the Ruling Period in accordance with the facts and assumptions forming part of this Ruling.

Nature of the Trust

37.         The Trust is a unit trust with one unit holder. The Unit Holder has always been the sole unit holder holding the same 100 ordinary units of the Trust since the Trust's establishment.

Other matters

38.         The discretion in former subsection 160APHL(14) relates to the utilisation of a tax offset for a share of the franking credit on a franked distribution. It was introduced as a part of integrity measures aimed at defeating franking credit trading schemes.

39.         The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 2) 1999, which accompanied the introduction of former subsection 160APHL(14), outlined the purpose of those 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.

40.         In exercising the discretion, the Commissioner must ensure that the purpose of the integrity measures is not undermined.

41.         The purpose of the integrity measures will not be undermined due to the facts and assumptions forming part of this Ruling.

Conclusion

42.          Taking into consideration the above relevant matters, it is appropriate for the Commissioner to exercise the discretion under former subsection 160APHL(14) to treat the Unit Holders 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.