Private ruling: Fixed Entitlement
Published: July 2012
Ruling period: 1 July 2012 to 30 June 2013.
Date scheme commenced: 1 July 2012.

Ruling: Q3: Whether unit holders of the Trust have fixed entitlements to all the income and capital of the trust as defined in section 995-1 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 | Q4: Will the Commissioner exercise the discretion in subsection 272-5(3) of Schedule 2F to the ITAA 1936 to deem the beneficiaries of the trust as having fixed entitlements? | A2: Yes

Relevant facts and circumstances: The Trust carries on a business The applicant advised that the Trust is not a 'public trading trusts for the purposes of Division 6C of Part III of the Income Tax Assessment Act. The Trust currently has a majority of common unit holders (holding approximately 62% of the units in each trust). Of these, a publicly listed company holds 50% of the units in the trust. The Trust has two classes of units, being Capital Units and Income Units. Holders of Capital Units have a beneficial entitlement to a fraction of the income and capital of the respective trust, based on the proportional. Capital Unit holders have the right to vote at unit holder meetings. Holders of Income Units are entitled to share in of the income of their respective trusts, pari passu with the Capital Unit holders. Income Unit holders do not have the right to vote at unit holder meetings. The number of Capital Units and shares in the trustee company on issue are required to be the same. Also, any issue of capital units must be accompanied by a corresponding issue of shares in the respective trustee company. The applicant has advised that all unit holders in the Trusts are Australian residents for tax purposes.

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


Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Summary: The terms of the trust instrument do not provide the unit holders with vested and indefeasible interests in the income and capital of the trust. | 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) 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 term 'vested and indefeasible' is 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. | Although the meaning of the term 'vested and infeasible' (in the context of Schedule 2F to the ITAA 1936) has not been judicially considered, the term does appear in subsection 95A(2) of the ITAA 1936 and has been considered in that context by the courts - refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4525; Walsh Bay Developments Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4378; Dwight v Commissioner of Taxation (1992) 92 ATC 4192; Harmer v FC of T (1991) 173 CLR 264; 91 ATC 5000. | Also relevant are MSP Nominees Pty Ltd v Commissioner of Stamps (SA) (1999) 198 CLR 494; 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54; Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490. | 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 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); Commissioner of State Revenue (Vic) v Karingal 2 Holdings Pty Ltd (2005) 224 CLR 98 at [15], in taking this step: | '… a priori assumptions 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 by common law, statute or statutes. See, for example, the provisions of Chapter 5C of the Corporations Act 2001 which, if inconsistent with the constitution of a registered managed investment scheme, 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 common 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. | · a vested interest if the unit holder has a present right relating to the income and/or capital of the trust; i.e. a vested interest is one that is bound to take effect in possession at some point in time, in contrast to a contingent interest which may never fall into possession: ATOID 2002/676. | · an indefeasible (vested) interest where, in effect, it is not able to be lost; i.e. it is not subject to a condition subsequent that may lead to the entitlement being divested: ATOID 2002/676 | For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, in this case the trust instrument consists of the Trust Deed consolidated to incorporate amendments. It is accepted that the Deed provides capital unit holders with a vested interest in the capital of the Unit Trust. It is accepted that the Deed provides income unit holders with a vested interest in the income of the trust. | However, the Deed 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 addition, some clauses could enable the Trustee to stream income or capital to favoured unit holders, so that other unit holders would not receive income or capital to which they would otherwise be entitled. This may constitute a defeasible power. | Therefore, it is considered reasonable to conclude, in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936, that all unit holders (or beneficiaries) do not have fixed entitlements to all of the income and capital. | Summary: The terms of the Deed do not provide the unit holders with vested and indefeasible interests in the income and capital of the trust. | However, in the circumstances of this case, the Commissioner considers that it is reasonable to exercise his discretion to treat the beneficiaries as having fixed entitlements to a share of the income and capital of the trust. | 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 based upon the factors prescribed in paragraph 272-5(3)(b). Paragraph 272-5(3)(b) 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. | The interpretation of section 272-5 of Schedule 2F to the ITAA 1936 (the meaning of vested and indefeasible) was raised at the March 2006 meeting of the NTLG, and referred to the newly formed Trust Consultation Sub-group for discussion; at their meeting on 28 November 2006, the ATO advised that: | In applying the discretion, the ATO would have regard to what the Office understands was the policy that underlay the provisions at the time they were enacted. The Commissioner would also have to apply the statutory tests having regard to the terms of the particular trust deeds and all the surrounding circumstances. | (See Minutes of NTLG meeting - 7 Dec 2006) | In the absence of any precedential guidelines, taxpayers seeking access to the Commissioner's discretion will be dealt with according to the relevant facts on a case by case basis. In the case of trusts which are managed investment schemes, it is also appropriate that consideration is given to any potential impacts that the Corporations Act 2001 (as noted above), the regulatory powers of the Australian Securities and Investments Commission (ASIC), and the actions of the Australian Securities Exchange (ASX) may have on the administration of the trust and the entitlements of beneficiaries. | In view of the conclusion above that unit holders do not have vested and indefeasible interests pursuant to subsection 272-5(1) of Schedule 2F to the ITAA 1936, subsection 272-5(3) may be considered. | Circumstances in which the entitlement is capable of not vesting or the defeasance can happen: subparagraph 272-5(3)(b)(i) | Variation to the Deed: The practical effect of the variation powers in the Deed is that they can only be exercised for the purposes specified. This power is further constrained by the requirement that such variations only take effect if ratified by a unanimous resolution of all the capital unit holders. | The applicant acknowledges in relation to the trustee's power of variation that the trustee owes a fiduciary duty to all unit holders and is required to act in their best interests. The applicant states that it is highly unlikely that the trustee would amend the Deed in a manner that would prejudice the interests of unit holders. | Income streaming: Any capacity to stream income or capital to particular unit holders is unlikely to be exercised to adversely affect unit holders' entitlements: | · Likelihood of the entitlement not vesting or the defeasance happening: subparagraph 272-5(3)(b)(ii) | · On balance, the likelihood of the entitlement not vesting or the defeasance happening is relatively low. | · The nature of the trust: subparagraph 272-5(3)(iii) | The trust is a Unit Trust. The trust is not a public trading trust for the purposes of Division 6C of Part III of the ITAA. | All unit holders are Australian residents for tax purposes. | Recommendation: The Trust is not a fixed trust but, after considering all the relevant factors set out in the subparagraphs of subsection 272-5(3) discussed earlier, it is reasonable for the Commissioner to exercise his discretion to treat the unit holders as having fixed entitlements to both income and capital. | Therefore the trust will be a fixed trust as defined in section 272-65 of Schedule 2F.