Private ruling: Fixed entitlements
Date of advice: 26 July 2023
Published: 11 September 2023
Ruling period: 11 July 2019 to 30 June 2022
Date scheme commenced: 11 July 2019

Ruling: Q1: Do the Unitholders of the Trust have fixed entitlements to 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)? | A1: No. | Q2: If the answer to Question 1 is no, will the Commissioner exercise his discretion in accordance with subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem the Unitholders of the Trust as having fixed entitlements to all of the income and capital of the Trust? | A2: Yes.

Relevant facts and circumstances: The Trust derives assessable income from the operation of the Business. The Trustee has no other activities other than operating as trustee of the Trust. The Trustee is an Australian resident for tax purposes. The directors of the Trustee are Australian residents for tax purposes. All the unitholders are Australian tax residents The Trustee is also not a trustee of any other trust. Apart from the variation to change the name of the trust, there has been no other amendment to the Trust Deed during the ruling period . The beneficial interest in the Trust Fund is vested in the unitholders. The subscription price of each unit in the Trust was $1. Units may be reclassified with the unanimous approval of all unitholders. The trustee may issue additional units at such price the Trustee thinks fit, with the unanimous vote of all unitholders. No units have been reclassified by the Trustee. No units have been issued at a discount by the Trustee. No partly paid units have been issued. No partly paid units have been issued prior to the end of the ruling period. No partly paid units have been forfeited due to non-payment of any instalment. Unitholders have specified entitlements to the income and capital of the Trust. The trustee is not entitled to the differentiate between unitholders regarding the method of distribution of the income of the Trust. The Trust made income distributions in accordance with the terms of the unit holding in the A, B, C, D and E income years. The Trustee may repurchase units on certain conditions. The Trustee may only repurchase units for a price determined on the basis of the net value of the Trust at the time of the repurchase A unit holder may transfer their units. Since the establishment of the Trust no units have been compulsorily sold or redeemed . The Trust Deed can be modified, or additions can be made, to any of the provisions of the deed if authorised by Special Resolution of the unit holders. No deductions are forecast to be claimed (or provisions made) for bad debts or debt/equity swap losses in respect of X year. A franking offset has not been claimed on any distributions the Trust has made. 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 period of this determination, exercise a power capable of diluting or defeating a unitholder's interest in the income or capital of the Trust.

Relevant legislative provisions: Section 995-1(1) of the ITAA 1997 | Section 272-5(1) of Schedule 2F to the ITAA 1936 | Section 272-5(2) of Schedule 2F to the ITAA 1936 | Section 272-5(3) of Schedule 2F to the ITAA 1936

Reasons for decision: Summary: Question 1 | Detailed Reasoning - Subsection 272-5(1) of the ITAA 1936: Subsection 272-5(1) sets out the meaning of ' fixed entitlement '. Subsection 272-5(1) states the following: "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." | Detailed Reasoning - Fixed Entitlement: ATO ID 2002/676 and the explanatory memorandum to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 sets out the meaning of a fixed entitlement to income or capital of a trust, as follows: "13.3 A person (the beneficiary) will have a fixed entitlement to either income or capital of a trust (whichever is applicable) where the beneficiary has a vested and indefeasible interest in a share of the income of the trust that the trust derives from time to time (i.e. current and future income), or a share of capital of the trust [subsection 272-5(1)]. The share that the person has an interest in is expressed as a percentage of the total income or capital (whichever is applicable) of the trust." PCG 2016/16 states the following: "Fixed entitlements under subsection 272-5(1) 8. The concept of a 'fixed entitlement' is central to the trust loss provisions. It is used to determine whether a trust is a fixed trust, whether a trust's beneficiaries have maintained the requisite proportion of ownership, and for tracing direct and indirect entitlements. 9. A beneficiary will have a fixed entitlement to a share of the income or capital of the trust if, under a trust instrument, their interest in the income or capital is vested and indefeasible. 10. A trust is a fixed trust if the beneficiaries have fixed entitlements to all of the income and capital of the trust. Under a trust instrument 11. For these purposes, the Commissioner accepts that a 'trust instrument' includes a deed or constitution as supported by documentation such as a Product Disclosure Statement, Investment Memorandum or other document that modifies or supplements the terms of the trust set out in the deed or constitution. 12. The beneficiaries of a trust that does not have a 'trust instrument' are not capable of having fixed entitlements in the absence of the exercise of the Commissioner's discretion. Trustees of such trusts cannot rely on the safe harbour compliance approach in managing the trust's tax affairs. | Detailed Reasoning - Vested interest: ATO ID 2022/676 discusses vested interests at the following paragraphs: "13.4 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. 13.5 In traditional legal analysis, a person can be said to be either 'vested in possession' or 'vested in interest'. A present interest, i.e. one that is being enjoyed, is said to be 'vested in possession'; a future interest, i.e. one which gives its holder a present right to future enjoyment, is said to be 'vested in interest'. A person is vested in possession where the person has a right to immediate possession or enjoyment of the thing in question. In the definition of fixed entitlement, 'vested' includes both vested in possession and vested in interest. 13.6 Because vested interests include future interests, a person can have a vested interest in a thing even though the person's actual possession and enjoyment of the thing is delayed until some time in the future." PCG 2016/16 states the following: "Vested interests 13. 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. 14. 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." The unitholders of the Trust have a vested interest in the Trust by way of a beneficial interest in the Trust Fund. | Detailed Reasoning - Indefeasibility: In Colonial First State Investments v FC of T 2011 ATC 20-235, Stone J stated: "97. It was not contended by either party that the applicant's interest in a share of the income and capital of the trust was not vested. Both parties concentrated on the requirement that the interest be indefeasible. The Act does not define 'indefeasible' and therefore, subject to the qualification in s 272-5(2), it bears its ordinary meaning when applied to an interest, that is that the interest cannot be terminated, invalidated or annulled. Certainly this is the meaning to which the qualification in s 272-5(2) is directed." ATO ID 2022/676 discusses indefeasible interests at paragraph 13.7 and 13.8: 13.7 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. 13.8 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." PCG 2016/16 sets out the following regarding indefeasibility: "15. 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. 16. Powers in modern trust instruments which cause a beneficiary's interests to be defeasible 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." " It is considered in light of the terms of the Trust Deed that the Trustee is given a number of powers in the Trust Deed that cause the unitholders' interests to be defeasible. | Detailed Reasoning - Detailed reasoning: Paragraphs 55 and 56 of PCG 2016/16 outline various factors that the Commissioner takes into account when making a determination as to the exercise of his discretion in a particular case: "55. 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 adverse 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. | Detailed Reasoning - Factors adverse to the exercise of the Commissioner's discretion: 56. 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: o 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 o 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..." In reaching the decision to exercise the discretion favourably in this case, the Commissioner has taken into account the factors outlined in the context of the facts in this case. The Commissioner will exercise his discretion in accordance with subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem the unitholders of the Trust as having fixed entitlements to all of the income and capital of the Trust.