Private ruling: Fixed Entitlement for Unit Trust

Ruling: Q2: Will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem the beneficiaries of Trust X as having fixed entitlements? Answer: Yes


Relevant legislative provisions: Income Tax Assessment Act 1936 Section 272-5 of Schedule 2F | Income Tax Assessment Act 1936 Subsection 272-5(1) of Schedule 2F | Income Tax Assessment Act 1936 Subsection 272-5(2) of Schedule 2F | Income Tax Assessment Act 1936 Subsection 272-5(3) of Schedule 2F | Income Tax Assessment Act 1936 Section 272-65 of Schedule 2F | Income Tax Assessment Act 1997 Subsection 995-1(1) | Corporations Act 2001 Part 5C | Corporations Act 2001 Section 601FA | Corporations Act 2001 Subsection 601FC(1) | Corporations Act 2001 Paragraph 601GC(1)(a)

Reasons for decision: Summary: The terms of the trust instrument do not provide the beneficiaries with vested and indefeasible interests in a share of the income and capital of Trust X. | Detailed Reasoning - 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; that definition provides that: A trust is a fixed trust if persons 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 that '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. In addition, subsection 272-5(2) of Schedule 2F to the ITAA 1936 states that: 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. 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 602-602 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 2005 HCA 53). 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, it is clear that 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 the right must have 'the necessary quality of definable extent'. The term 'vested and indefeasible' is also not defined in the taxation legislation. However, the Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 does discuss its ordinary meaning at some length, at paragraphs 13.4 to 13.9. In particular, paragraph 13.7 of the EM provides: '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'. 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 of the ITAA 1936, the term 'indefeasible' bears its ordinary meaning when applied to an interest, that is that 'the interest cannot be terminated, invalidated or annulled'. 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'. In all cases, the determining factor in deciding if fixed entitlements exist will be the terms of the trust instrument (in this case the Constitution of Trust X) under which the trust is constituted. Neither the form of the trust nor the labels that are attached to it can determine this question. The first step in determining whether a beneficiary has a vested and indefeasible interest in a share of the income or capital of a trust is to ascertain the terms of the trust upon which the relevant trust property is held. As the High Court recently stated in CPT Custodians Pty Ltd v Commissioner of State Revenue (Vic) and Commissioner of State Revenue (Vic) v Karingal 2 Holdings Pty Ltd (2005) 224 CLR 98 at [15], in taking this step: '… a priori assumption as to the nature of unit trusts under the general law and principles of equity [will] not assist and would be apt to mislead. All depends, as Tamberlin and Hely JJ put it in Kent v SS "Maria Luisa" (No 2) , upon the terms of the particular trust. The term "unit trust" is the subject of much exegesis by commentators. However, "unit trust", like "discretionary trust", in the absence of an applicable statutory definition, does not have a constant, fixed normative meaning which dictate the application to particular facts of the [relevant statutory definition]…' There will be some circumstances in which a trust instrument must be read subject to the operation of a particular legal rule, whether under the general law, or statute. For example, the provisions of Chapter 5C of the Corporations Act 2001 which, if inconsistent with the constitution (being the trust instrument) of a registered MIS, can have the effect of altering or modifying the scheme's constitution. It is possible for a constitution to be altered or modified by operation of law irrespective of whether the trust instrument itself expressly recognises the relevant general law rule or statute, and the entitlements of a beneficiary under the trust instrument are those as so altered or modified by operation of law. | Detailed Reasoning - Vested and Indefeasible Interests: For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the trust instrument in this case consists of the consolidated Constitution of Trust X. It is accepted that the Constitution provides unit holders with an 'interest' in the income and capital of Trust X. Relevantly the Constitution provides that the beneficial interest of the Trust will be divided into units. However, the Constitution of Trust X contains certain clauses by which a unit holder's interest in a share of the income or capital of the trust may be defeased. In this regard it is noted: · partly paid units may be issued in certain circumstances; · units of different classes may be issued from time to time; · the RE is able to determine whether receipts of the trust are treated as income or capital; · subject to the Corporations Act 2001 , the RE shall be entitled by supplemental deed to alter, modify, add to or delete any provision of the Deed; · paragraph 601GC(1)(a) of the Corporations Act 2001 permits a MIS to modify, replace or repeal its constitution by special resolution; and · an amendment, whether approved by unit holders or effected by the Trustee's own act, could also permit the introduction of powers that could later result in the defeasance of a unit holder's interest. Therefore, it is concluded, in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936, that the unit holders (beneficiaries) do not have fixed entitlements to all of the income and capital of Trust X. | Summary: The Commissioner considers that it is reasonable to exercise the discretion to treat the beneficiaries as having fixed entitlements to a share of the income and capital of Trust X. | Detailed Reasoning - 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, taking into account 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. In the case of trusts which are MIS', it is appropriate that consideration is also given to any potential impacts that the Corporations Act 2001 (as noted above) and the regulatory powers of the Australian Securities and Investments Commission (ASIC) may have on the administration of the trust and the entitlements of beneficiaries. While it is considered that the unit holders in Trust X do not have vested and indefeasible interests, the Commissioner may apply his discretion having regard to the relevant factors prescribed in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat the unit holders as having a fixed entitlement if it is reasonable to do so. | Detailed Reasoning - Paragraph 272-5(3)(a) of Schedule 2F to the ITAA 1936: In terms of paragraph 272-5(3)(a), the Constitution of Trust X provides the unit holders with vested interests in: · a share of the income that the Trust derives from time to time; and · a share of the capital of the Trust. | Detailed Reasoning - Subparagraph 272-5(3)(b)(i) of Schedule 2F to the ITAA 1936: In relation to subparagraph 272-5(3)(b)(i) it is noted that: · Trust X is a registered MIS for the purposes of the Corporations Act 2001 ; · The Constitution of Trust X is comparable and commensurate to the trust instruments of similar MIS'; and · No clause includes an express or implied power which would enable the RE of Trust X to redeem units without valuable consideration passing to the affected unit holder. | Detailed Reasoning - Subparagraph 272-5(3)(b)(ii) of Schedule 2F to the ITAA 1936: As per subparagraph 272-5(3)(b)(ii), the likelihood of the entitlement not vesting or the defeasance happening in respect of the clauses in the Trust Deed (outlined above) are considered as follows: · Units in Trust X have been issued under a DRP for which the price was based on the proposed distribution for the year and a yield; · In relation to the Distribution Reinvestments, as per the Constitution, any discount can not exceed 10%. In this case this is seen as an acceptable departure from the requirements of paragraph 272-5(2)(c) of Schedule 2F to the ITAA 1936 for purposes of this subparagraph; · There is no proposal for Trust X to issue partly paid units; · Although it could be possible for the RE of Trust X to stream income or capital, only one class of units have been issued in Trust X, there is no provision in the Constitution of Trust X to re-classify units of a particular class to a different class; · The RE has been consistent with the way it determines the distributable income of Trust X and no streaming of income or capital has occurred. Unit holders' entitlements to amounts of income and capital are determined by the provisions prescribed in the Constitution; and · The vested interests of unit holders in a share of the income and capital of Trust X could be defeated by the unit holders exercising the powers granted to them under paragraph 601GC(1)(a) of the Corporations Act 2001 to modify, replace or repeal the constitution by special resolution. The Constitution of Trust X has been amended a number of times since the Trust was created. Whilst the Constitution has been amended in the past, these were minor amendments. However the following is relevant: · The RE owes fiduciary duties to all the unit holders under the general law to act in their best interests, and not to discriminate against minority unit holders. This would affect its exercise of the power to amend the Constitution; · When unit holders approve amendments with less than 100% approval, this is not a defeasance of unit holders' entitlements, but an agreed alteration to the rights attached to their units; and · The RE is bound by paragraph 601FC(1)(c) of the Corporations Act 2001 to act in the best interests of the members, and by paragraph 601FC(1)(d) to treat the members who hold interests of the same class equally and members who hold interests of different classes fairly. | Detailed Reasoning - Subparagraph 272-5(3)(b)(iii) of Schedule 2F to the ITAA 1936: In accordance with subparagraph 272-5(3)(b)(iii), regard must also be had to the nature of the trust. As Trust X is a MIS and thus subject to the provisions contained in Chapter 5C of the Corporations Act 2001 , the RE is subject to additional fiduciary obligations imposed in subsection 601FC(1). The RE of Trust X must be a public company that holds an AFSL authorising it to operate a MIS as per section 601FA of the Corporations Act 2001 . As such, the RE is required to meet certain conditions, as well as the prescribed conditions under Regulation 7.6.04 of the Corporation Regulations. In addition, the RE does not have any discretion in relation to the unit holders' rights to income or capital, as these are governed by the formulae in the Constitution. | Detailed Reasoning - 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 (in the absence of any express provision or explanatory guidance that indicates a different context is relevant). 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 passage 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, unless within the context of the provisions for which fixed entitlement is required they provide otherwise (in this case Division 266 of Schedule 2F to the ITAA 1936) regard should always be had to whether the absence of a fixed entitlement, in these circumstances, could result in the trafficking or transfer of the tax benefit of any tax losses. The Applicant advised that Trust X intends to utilise tax losses incurred in the previous income year against income earned in the current income year. There are no tax losses forecast for any future income years that are subject to this Ruling. | Detailed Reasoning - Commissioner's Discretion: As per paragraph 272-5(3)(b) of Schedule 2F to the ITAA 1936 it is considered that the unit holders in Trust X may be treated as having fixed entitlements to a share of the income and capital of Trust X for the period covered by the Ruling. This treatment is considered to be reasonable after having regard to the requirements of subparagraphs 272-5(3)(b)(i), (ii) and (iii) as discussed above. In summary, it is submitted that as: · Trust X is subject to the managed investment regime in the Corporations Act 2001 ; and · there is only one class of unit on issue; and · the RE acts in a similar capacity in relation to other trusts and can be considered a 'professional trustee' which acts at arm's length and undertakes its fiduciary role accordingly; and · unit holders' entitlements to Distributable Amounts are prescribed within the terms of the Constitution; it is reasonable for the Commissioner to exercise the discretion pursuant to subsection 272-5(3) of Schedule 2F to the ITAA 1936 to treat 100% of the interests of unit holders in the income and capital of Trust X as fixed entitlements for the relevant period of the scheme of the Ruling. | Detailed Reasoning - Does Part IVA, or any other anti-avoidance provision, apply to this ruling?: Part IVA is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns. | Question 1: Do the unit holders (beneficiaries) of Trust X have fixed entitlements to all the income and capital of the trust as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) and subsection 272-5(1) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936)? | Relevant facts: As per the Applicant's submission: | · Trust X is a managed investment scheme (MIS) and has a number of unit holders; | · Trust X intends to utilise prior year tax losses; | · It is intended that Trust X will remain a MIS for the purposes of the Corporations Act 2001 until the end of the Ruling period; | · It is intended that Trust X will remain listed on the ASX until the end of the Ruling period; | · Company A is a holder of an Australian Financial Services Licence (AFSL) for the purposes of Part 7.6 of the Corporations Act 2001 ; | · Pursuant to the Constitution of Trust X, Company A is permitted to hold units in Trust X; | · No units in Trust X have been issued at a discount rate; | · Units were issued under a distribution reinvestment plan (DRP), the price was based on the proposed distribution for the year and a yield; | · Trust X has not issued any options or rights and there is no proposal to do so; | · Trust X has not issued any partly paid units and there is no proposal to do so; | · The Constitution of Trust X does not permit compulsory redemption of units; | · No small holdings have been sold or redeemed; | · Pursuant to the Constitution of Trust X, the RE has the ability to determine whether receipts of the Trust are treated as income or capital. The RE has been consistent with the way it determines the distributable income of Trust X; and