Private ruling: Deed of amendment implications
Published: June 2015
Ruling period: Year ending 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the proposed Deed of Amendment in respect of the Trust, give the unit holders fixed entitlement to the income of the Trust for the purposes of subsection 295-550(4) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Will the proposed Deed of Amendment in respect of the Trust, trigger the happening of CGT events E1, E2 or E3 in sections 104-55, 104-60 or 104-65 of the ITAA 1997 respectively? | A2: No

Relevant facts and circumstances: The Trust is a unit trust. Since the establishment of the Trust, there have been several changes in the unit holdings of the Trust. There are only ordinary units on issue which entitle the unit holders to equal voting, income and capital rights in proportion to their unit holding. None of the unit holders are in a position, together with associates within the meaning of Part 8 of the Superannuation Industry (Supervisions) Act 1993 (SISA), to have a controlling interest in the Trust. A number of unit holders are contemplating redeeming their units during the course of the financial year ended 30 June 2015. To ensure the Trust continues to hold sufficient capital to enable it to maintain its investments, the trustee is proposing to accept applications for the issue of new units from trustees of self-managed superannuation funds (SMSF) during that same year. Prospective SMSF trustee unit holders have sought assurance for the trustee of the Trust that their proposed investment would be in a trust that meets the requirements of Part 8 of the SISA as an unrelated trust and would not cause the SMSF trustee to receive non-arm's length income under subsection 295-550(4) of the ITAA 1997. Should the SMSF trustees acquire the units, the trustee of the Trust shall ensure that none of the unit holders, including the existing unit holders and the new unit holders, would hold a controlling interest in the Trust.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 295-545 | Income Tax Assessment Act 1997 Section 295-550 | Income Tax Assessment Act 1997 Section 104-55 | Income Tax Assessment Act 1997 Section 104-60 | Income Tax Assessment Act 1997 Section 104-65

Reasons for decision: Detailed Reasoning - Fixed entitlement for the purposes of subsection 295-550(4) of ITAA 1997: Subsection 295-545(1) of the ITAA 1997 provides relevantly that the income of a complying superannuation fund is split into a non-arm's length component and a low tax component. Subsection 295-545(2) of the ITAA 1997 provides that the non-arm's length component for an income year is the entity's non-arm's length income for that year less any deductions to the extent that they are attributable to that income. Non-arm's length income does not attract a concessional rate of tax and is taxed at the entity's highest marginal rate. Section 295-550 of the ITAA 1997 provides the meaning of 'non-arm's length income'. There are various subsections in the provision under which amounts of ordinary income or statutory income of a complying superannuation fund are non-arm's length income of the fund. Subsections 295-550(4) and (5) of the ITAA 1997 specifically apply to such amounts derived as a beneficiary of a trust. In the present case this means income derived by the trustees of the SMSFs as a result of purchasing units in the Trust. Under subsection 295-550(4) of the ITAA 1997 income is not non-arm's length income if it is derived by an entity as a beneficiary of a trust because of holding a fixed entitlement to the income. The proposed amendments to the trust deed have the object of ensuring that the trustees of SMSFs that purchase units in the Trust will hold a fixed entitlement to the income of the Trust and that the income will not be non-arm's length income by the application of subsection 295-550(4). However, under subsection 295-550(5) of the ITAA 1997, income derived by an entity as a beneficiary of a trust through holding a fixed entitlement to the income will be non-arm's length income of the entity if the fixed entitlement to the income was acquired, or the income itself was derived, under a scheme the parties to which were not dealing with each other at arm's length and the amount of income is greater than might have been expected to have been derived if the parties had been dealing at arm's length. Based on the facts presented, this ruling deals only with the question of whether the proposed amendments to the trust deed for the Trust will result in the proposed SMSF trustee unit holders holding a fixed entitlement to the income of the Trust for the purposes of subsection 295-550(4) of the ITAA 1997. Fixed entitlement to income derived as a beneficiary of a trust under the current terms of the Trust Deed A clause provides the Trustee with the flexibility to distribute income to one or more of the beneficiaries. Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, complying approved deposit fund or pooled superannuation trust in relation to a year of income expresses the view (at paragraph 102) that a complying superannuation fund has a fixed entitlement to a trust distribution 'if the entity's entitlement to the distribution does not depend upon the exercise of the trustee's or any other person's discretion'. Although TR 2006/7 is primarily concerned with section 273 of the ITAA 1936, it is also taken to be a ruling about section 295-550 of the ITAA 1997. Section 295-550 refers to the income covered by it as 'non arm's length income'. To the extent that the ruling addresses issues in section 295-550 that are the same as were in section 273 the references to 'special income' should be read as 'non arm's length income' (paragraphs 1A and 1C of the ruling). Subsections 273(6) and 273(7) of the ITAA 1936 were rewritten as subsections 295-550(4) and 295-550(5) of the ITAA 1997 respectively. Section 357-85 in Schedule 1 to the Taxation Administration Act 1953 provides that a ruling about a relevant provision (the 'old' provision) that is re-enacted or remade (the 'new' provision) is taken also to be a ruling about the new provision in so far as the new provision expresses the same ideas as the old provision. In this case, the clauses of the Trust Deed are clearly not consistent with the view expressed in TR 2006/7 because the entitlement of the beneficiaries depends upon the exercise of the Trustee's discretion. Accordingly, under the current terms of the Trust Deed, the beneficiaries, which include the unit holders do not hold fixed entitlements to the income of the trust for the purposes of subsection 295-550(4) of the ITAA 1997 based on the ATO view of the meaning of 'fixed entitlement' expressed in TR 2006/7. Fixed entitlement to income derived as a beneficiary of a trust under the proposed changes to the Trust Deed A proposed new clause will have the effect that the default distribution provision will operate to deem trust income as having been distributed to those unit holders, whose units entitle them to voting rights, in proportion to their unit holding. The trustee will no longer have an absolute discretion to distribute income. A proposed new subclause will limit the trustee's powers to only issue ordinary units at a time when any unit holder is a trustee of a complying superannuation fund. Ordinary units entitle the holder to voting rights. It is therefore considered that after the proposed amendments to the Trust Deed trustees of SMSFs that purchase ordinary units in the Trust will hold a fixed entitlement to the income of the Trust for the purposes of subsection 295-550(4) of the ITAA 1997 based on the ATO view of the meaning of 'fixed entitlement' expressed in TR 2006/7. Other matters This ruling does not consider whether the other subsections in section 295-550 will apply to an amount of income (ordinary or statutory) derived by a complying superannuation fund in the capacity of a beneficiary of a trust. TR 2006/7 explains (at paragraph 103 onwards) when trust distributions arising from a fixed entitlement will be non-arm's length income under section 295-550. Whether the conditions mentioned at paragraph 103 of the ruling, which are relevant to subsection 295-550(5), are satisfied will be a question of fact. It is noted that the trustee of a complying superannuation fund is not the applicant for this PBR. It is a matter for the trustee of the SMSFs to ensure they meet all of the requirements in Part 8 of the SIS Act. | Detailed Reasoning - CGT events E1 and E2: CGT event E1 in section 104-55 of the ITAA 1997 happens if a trust is created over a CGT asset by declaration or settlement (subsection 104-55(1)). The time of the event is when the trust over the asset is created (subsection 104-55(2)). Subsection 104-55(5) of the ITAA 1997 contains the exceptions for CGT event E1 where it provides that the event does not happen if you are the sole beneficiary of the trust and you are absolutely entitled to the asset as against the trustee (disregarding any legal disability); and the trust is not a unit trust. In this case, the exceptions in subsection 104-55(5) do not apply. CGT event E2 in section 104-60 of the ITAA 1997 happens if you transfer a CGT asset to an existing trust (subsection 104-60(1)). The time of the event is when the asset is transferred (subsection 104-60(2)). The exceptions in subsection 104-60(5) provide that the event does not happen if you are absolutely entitled to the asset as against the trustee (disregarding any legal disability); and the trust is not a unit trust. In this case, the exceptions in subsection 104-60(5) of the ITAA 1997 also do not apply. Taxation Determination TD 2012/21 expresses the view that, if the terms of a trust are changed pursuant to a valid exercise of a power in the deed, or court approved variation, neither CGT event E1 nor CGT event E2 happens unless: • the change causes the existing trust to terminate and a new trust to arise for trust law purposes, or • the effect of the change or court approved variation is such as to lead to a particular asset being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust. Based on the decision in Commissioner of Taxation v. David Clark; Commissioner of Taxation v. Helen Clark [2011] FCAFC 5; 2011 ATC 20-236; (2011) 79 ATR 550 ( Clark ), it is clear at least in the context of recoupment of losses, continuity of a trust estate will be maintained so long as the trust is not terminated for trust law purposes (TD 2012/21 at paragraph 20). Also, as a general proposition, it would seem the approach adopted by the Full Federal Court in Federal Commissioner of Taxation v. Commercial Nominees of Australia Ltd [1999] FCA 1455; 99 ATC 5115; (1999) 43 ATR 42 ( Commercial Nominees) , as explained by Edmonds and Gordon JJ in Clark , is authority for the proposition that assuming there is some continuity of property and membership of the trust, an amendment to the trust that is made in proper exercise of a power of amendment contained under the deed will not have the result of terminating the trust. It's irrespective of the extent of the amendments so made provided the amendments are properly supported by the power in the deed (TD 2012/21 at paragraph 21). TD 2012/21 further explains (at paragraph 24) that the principles established in Clark and Commercial Nominees are also relevant to the question of the circumstances in which CGT event E1 or E2 may happen as a result of changes being made to the terms of an existing trust pursuant to a valid power in the deed (including a power to amend). In light of those principles, the ATO accepts that a change in the terms of the trust pursuant to exercise of an existing power (including an amendment to the deed of a trust), or court approved variation, will not result in a termination of the trust. Therefore, the change in the terms of the trust will not result in CGT event E1 happening subject to the observation explained in paragraph 27 of TD 2012/21. In this case, a clause of the Trust Deed allows the Trustee to amend the Deed provided a 75% majority must pass a resolution agreeing to the amendment which must be in writing and executed by the Trustee, and the amendment must not adversely affect any vested entitlement of a unit holder. Therefore, based on the view expressed in TD 2012/21, the proposed Deed of Amendment in respect of the Trust, if executed, will not trigger the happening of CGT event E1 or E2 as the amendments are permitted under a clause of the Trust Deed subject to conditions set out in that clause. | Detailed Reasoning - CGT event E3: CGT event E3 in section 104-65 of the ITAA 1997 happens if a trust (that is not a unit trust) over a CGT asset is converted to a unit trust, and just before the conversion, a beneficiary under the trust was absolutely entitled to the asset as against the trustee (disregarding any legal disability the beneficiary is under) (subsection 104-65(1)). The time of the event is when the trust is converted. In this case, CGT event E3 does not apply because the Trust is already a unit trust. This is evidenced by the number of entities holding units in the Trust. As such, the Trust cannot be converted into a unit trust. Furthermore, Draft Taxation Ruling TR 2004/D25, explains that the concept of absolute entitlement is not relevant to the holder of a unit in a unit trust in respect of the assets of the trust. It states at paragraph 134: Even though a unit holder in a unit trust may, depending on the terms of the trust, have an interest in the property of the trust (see Charles v. FCT (1954) 90 CLR 598) they are not subject to the treatment that otherwise applies to a person who is absolutely entitled to any asset of the trust for CGT purposes. This is because the scheme of the CGT provisions is to treat the units in the trust as the relevant asset rather than any interest the unit holder might have in the underlying property of the trust (see Taxation Determination TD 2000/32). Therefore, the concept of absolute entitlement is not relevant to the holder of a unit in a unit trust in respect of the assets of the trust. It is for this reason that this Ruling does not apply to them. The draft ruling further explains the alternative view at paragraph 135: The alternative view is that a unit holder can be absolutely entitled - provisions such as subparagraphs 104-55(5)(a)(ii) and 104-60(5)(a)(ii) seem to recognise that possibility - and so should be afforded the associated treatment. However, such an outcome would be contrary to the general scheme of the CGT provisions as it could result in a beneficiary holding two assets for CGT purposes (the units and the underlying trust asset) which represent the one thing. The statutory scheme is to treat that interest as being represented by the units on the basis that the units are also assets and, importantly, assets that are traded and that are treated as discrete investment vehicles. It is noted that section 108-5 of the ITAA 1997 specifically identifies units in a unit trust as examples of CGT assets. Therefore, in this case the proposed Deed of Amendment in respect of the Trust, if executed, will not trigger the happening of CGT event E3 as the event is not relevant to the Trust being a unit trust.

Current clauses of the Trust Deed subject to the proposed amendment: The terms of the Trust Deed in its current form (subject to the proposed amendments) provide the following: | (a) A clause allows the Trustee (in addition to the initial units) to issue units of 4 different classes: | • ordinary units - that give the holder an entitlement to the capital of the fund and to vote in relation to the administration of the Trust, fixed in proportion to the number of units held; | • non-voting units - that give the holder an entitlement to the capital of the fund fixed in proportion to the number of units held, but give no entitlement to vote; | • voting only units - that give the holder an entitlement to vote in relation to the administration of the trust, but give no entitlement to net income or capital of the fund; and | • non-voting income only units - that give the holder an entitlement to net income of the fund, but no entitlement to capital of the fund or to vote. | (b) A clause allows the Trustee to create and issue further classes of units and define the terms, conditions, rights and entitlement that such units give the holder, in accordance with the terms of the Trust Deed, and so long as such further classes of units are issued at market value. | (c) A clause provides that the Trustee may elect to temporarily or permanently exclude a beneficiary, refrain from distributing or providing income, capital or other benefits to a beneficiary subject to any family trust election that may be made. A subclause defines the broad beneficiary class. | (d) A clause allows the trustee to accumulate net income of the trust and hold such amounts as an accretion to the capital of the fund for the benefit of the capital unit holders in proportion to the number of units held. | (e) A clause provides the Trustee with an absolute discretion to distribute income to or for any one or more of the beneficiaries, which include unit holders, as defined in a subclause of the Trust Deed. | (f) A clause provides that in default of any determination by the Trustee at the end of the relevant financial year, income is deemed to be distributed to each unit holder of units which grant voting rights in proportion to their unit holding in the Trust. | (g) A clause provides that the trustee is able to distribute capital prior to the vesting date to the capital unit holders in proportion to their unit holding in the Trust. | (h) A clause provides that the Trustee must distribute the remaining capital of the Trust (after payment of any liabilities) on the vesting date to the capital unit holders in proportion to their unit holding. | (i) A clause provides that the Trustee may amend the Trust Deed subject to the following: | • The amendment must be in writing and executed by the Trustee; and | The Trustee proposes to execute a Deed of Amendment in respect of the administration of the Trust. In particular, the Deed of Amendment seeks to: | a) Ensure that a unanimous vote by 100% of the unit holders is required prior to the Trustee exercising certain powers, including: | • The issuing of further units of the same or different class at market value; | • The transfer of units between unit holders or to new or prospective unit holders; | • The buying back and redemption of units at market value; | • The reclassifying of any units that have already been issued; | • The appointment and removal of Trustee; | • Bringing forward the vesting of the Trust; and | • Making amendments to the Trust Deed. | It's proposed that a reference to "a seventy-five per cent (75%) majority" throughout the Trust Deed shall be deleted and replaced with "one-hundred per cent (100%) of the unit holders by unanimous vote". | b) Suspend the Trustee's absolute discretion to make discretionary distributions of income amongst the unit holders (and related discretionary beneficiaries) for as long as any unit holder is a trustee of a complying superannuation fund. Accordingly, the default distribution provisions would operate to have trust income distributed amongst the unit holders in proportion to their unit holding. | c) Suspend the Trustee's power to issue units other than ordinary units for as long as any unit holder of the Trust is a trustee of a complying superannuation fund. | d) Suspend the amendment power of the Trustee to prevent the removal or modification of the prospective amendments or issuing of units other than ordinary units whilst any unit holder includes trustees of complying superannuation funds.