Senate

Supplementary Explanatory Memorandum

Amendments, requests for amendments and new item to be moved on behalf of the Government(Circulated by authority of the Treasurer,the Hon Ralph Willis, MP)

Trust losses

Amendments 25 to 38

Explanation of the amendments

3.1 A number of amendments are being made to the trust loss measures set out in Schedule 7 of the Bill.

Amendments 25, 26 and 34 - unlisted very widely held unit trusts - start-up period

3.2 Under the Bill an unlisted very widely held unit trust cannot deduct prior year or current year losses if it fails the 50% stake test. The 50% stake test is used in determining whether there has been a change in ownership of a fixed trust. It looks at fixed entitlements to income and capital of the trust held directly or indirectly by individuals.

3.3 An unlisted very widely held trust is an unlisted widely held unit trust with at least 1,000 unit holders. There are also a number of other conditions that have to be satisfied such as the units must carry the same rights and the trust must engage only in investment or business activities that are set out in the trust instrument or deed and prospectus of the trust. Because the trust is a widely held unit trust some of the units in the trust must be prescribed interests which have been offered for subscription or purchase to the public within the meaning of Part 7.12 of the Corporations Law.

3.4 A special rule applies to test the change of ownership of unlisted very widely held unit trusts. This rule is that continuity of ownership (ie the 50% stake test) only has to be met when there is abnormal trading in the trust's units. Subdivision 269-B sets out when abnormal trading is taken to have occurred and takes into account general factors such as the timing of trading and the number of units traded, or more specific factors such as the number of units traded in a single transaction or whether the trustee knows or reasonably suspects that an acquisition or merger is taking place.

3.5 In the period commencing when the first units are issued and ending at the time when the trust first reaches 1,000 unit holders, an unlisted very widely held unit trust may fail the 50% stake test because the number of unit holders have increased rapidly due to issue to new investors. It is often the case that trusts in which units are offered to the public take a while to grow.

3.6 Accordingly, the definition of 'unlisted very widely held trust' in section 271-70 is being amended so that a trust will be taken to be an unlisted very widely held trust at all times from the formation of the trust until the end of a start-up period if certain conditions are met. These are:

•

the trust became an unlisted very widely held trust at a time within 2 years of first issuing units;

•

there was no abnormal trading in the trust's units, within the meaning of subsections 269-15(1) or section 269-30, in the start-up period; and

•

at all times in the start-up period, other than the first 90 days of that period, the trust was a widely held unit trust.

3.7 The start-up period is essentially the period from when the trust first issued units until the earlier of the end of 2 years after that first issue or when the trust becomes an unlisted very widely held trust. If the trust does not become an unlisted very widely held trust within 2 years, it will not benefit from the start-up rules.

3.8 As noted above, a condition that must be satisfied is that there has been no abnormal trading in the trust during this period within the meaning of subsection 269-15(1) or section 269-30. Subsection 269-15(1) sets out factors that have to be considered in determining whether there has been abnormal trading and section 269-30 provides that abnormal trading will have occurred if a trustee knows or reasonably suspects that an acquisition or merger is taking place.

3.9 Sections 266-115 and 266-120, which set out the rules for the deductibility of current and prior year losses for unlisted very widely held trusts, will also be amended so that the start-up period will be excluded from the test period where the conditions set out in amended section 271-70 are satisfied.

Amendment 27 - pattern of distributions test

3.10 Under the Bill the pattern of distributions test for non-fixed trusts examines the pattern of distributions of income and capital of the trust over a period to determine whether there has been an effective change in those who benefit under the trust. It compares the distributions made by a trust in the year of recoupment and the relevant years in the 6 years prior to this year. The pattern of distributions test does not apply to family trusts as defined in the Bill.

3.11 The pattern of distributions test may be failed by non-fixed trusts that are not family trusts as defined where the potential beneficiaries of the trust have included natural persons who have died or who no longer benefit under the trust because of a divorce. If a person who received a distribution in an earlier year which is tested under the pattern of distributions test has died before another distribution is made it may mean that the test cannot be passed.

3.12 Subsections 267-25(3A)-(3C) will be inserted into the Bill to apply where distributions have been made from the trust in the past to a person who is no longer able to receive distributions because that person has died or has been a party to a divorce (subsection 3A). The amendment will apply so that the distributions which had been received by the deceased or divorced person will be ignored in applying the pattern of distributions test to the trust (subsection 3B). Also, where a deceased person had a direct or indirect fixed entitlement in the trust and that entitlement is passed on to the person's estate or an heir, the distributions flowing from the fixed entitlements will also be ignored in appyling the pattern of distributions test (subsection 3C).

Amendments 28, 31 and 35 - tracing through certain superannuation funds and approved deposit funds

3.13 A complying superannuation fund or a complying approved deposit fund ('ADF') may invest in another trust. It may be necessary to trace through to the ultimate beneficial owners of these funds to determine whether a trust in which one of those funds has invested and which has incurred losses ('loss trust') has satisfied the 50% stake test. For example, if a complying superannuation fund has an interest in a loss trust it would be necessary to trace through to the fixed entitlements held by each individual member in the fund to determine the individuals who hold a stake in the income or capital of the loss trust when applying the 50% stake test to the loss trust.

3.14 However, it may be difficult and costly for a superannuation fund or an ADF to determine the exact quantum of the fixed entitlements to income and capital held by each of its members in the fund. This is because the quantum of an individual members interest in the fund will depend upon a range of facts and matters, for example, the superannuation contributions made by and on behalf of the member and the benefit scheme which operates in relation to the member.

3.15 To overcome this problem the Bill will insert new subsection 271-5(3) which provides that each of the members of the complying superannuation fund or an ADF will be deemed to have an equal fixed entitlement to the income and capital of the fund.

3.16 The Bill will also provide a definition for 'complying superannuation or deposit fund' in section 271-75 of the Bill. The inclusion of this definition has required a further amendment to the definition of 'excepted trust' contained in section 271-50 which includes the terms complying superannuation or deposit fund. This change to section 271-50 in no way alters the effect of that section.

Amendments 29 and 36 - holdings of mutual companies in fixed trusts - 50% stake test

3.17 Under the Bill, a fixed trust cannot deduct a prior year loss if there has not been sufficient continuity of ownership of the trust. As outlined in paragraph 3.2 above, the 50% stake test applies to fixed trusts to test whether there has been a change of ownership.

3.18 The interests of a member in a mutual company are usually characterised as a right to vote at meetings and, in some cases, to participate in any surplus of the company on winding up. Thus, members of mutual companies do not usually have fixed entitlements to income and capital of the trust. The effect is that if a mutual trust has a fixed entitlement to income or capital of a trust that interest will be excluded in determining whether the trust has satisfied the 50% stake test.

3.19 New subsection 271-10(3) will be inserted into the Bill with the effect that members and life policy holders who are not also members of a mutual company or a mutual affiliate companywill be treatedas holding an equal fixed entitlement to the capital and income of the company. A mutual insurance company will be as defined in subsection 121AB(1) of the Act and a mutual affiliate company will be as defined in section 121AC. These sections are proposed to be inserted in the Act by Schedule 3 of the Bill.

Amendment 30 - change to definition of 'family trusts'

3.20 A family trust is defined in section 271-45 of the Bill as a trust in which an individual and his or her family are the only persons who are able, directly or indirectly, to receive distributions of income or capital of the trust for their own benefit. Also, special provision is made to ensure a family trust retains its status as such where certain bodies, such as charitable institutions, can benefit under the trust on the death of family members.

3.21 Some non-fixed trusts of a predominantly family nature are able to make distributions during the life of the trust to a fund, authority or institution in Australia which is listed under the gift tax provisions of section 78 of the Income Tax Assessment Act 1936 (the Act). A trust which includes such a fund, authority or institution as a beneficiary will not currently satisfy the definition of 'family trust'.

3.22 The definition of 'family trust' contained in section 271-45 of the Bill is being amended so that a trust will be a family trust where a fund, authority or institution in Australia that is mentioned in any of the tables in subsection 78(4) or that is covered by paragraph 78(5)(a) of the Act is able to receive a distribution from the trust. However, the distribution must be, or be capable of being, fully deductible under section 78A of the Act on the assumption that the distribution was a deductible gift within the meaning of section 78.

Amendment 32 - trusts with only tax exempt bodies as beneficiaries

3.23 Some unit trusts only have units held, directly or indirectly, by tax exempt bodies. Before these trusts can deduct prior year losses they will have to satisfy the 50% stake test as described above. This test depends on being able to identify an individual's fixed entitlement in a trust. Where a tax exempt body holds the units, directly or indirectly, in the trust it will generally not be possible to identify an individual's fixed entitlement in the trust.

3.24 The definition of 'excepted trust' contained in section 271-50 is therefore being amended so that it will include a unit trust all of the direct and indirect fixed entitlements to income and capital of which are held by bodies exempt from tax under section 23 of the Act. No advantage from the losses can arise to these trusts because of their tax exempt status. 'Excepted trusts' are trusts which have been exempted from the trust loss measures.

Amendment 33 - unlisted very widely held trusts - conditions that units must be redeemable

3.25 In the Bill, special rules apply in the testing of ownership of unlisted very widely held trusts. One of the conditions that must be satisfied before a trust qualifies as an unlisted very widely held trust is that the units of the trust must be redeemable 'at any time' for a price determined on the basis of its net asset value.

3.26 It may not be possible for these trusts to redeem units at any time because of various requirements in trust deeds or the Corporations Law, ie it may be necessary for a given period of time to elapse before redemptions may be made. For instance, some trust deeds allow the trustee up to 30 days in which to redeem, and Division 5A of Part 7.12 of the Corporations Law allows unlisted property trusts to restrict redemptions in circumstances where, by redeeming on request, the trust will become illiquid.

3.27 Paragraph 271-70(1)(d) is being amended to provide that, whenever a redemption occurs, the redemption price must be determined on the basis of the fund's net asset value. This amendment will remove the need for units to be redeemable at any time.

Amendment 37 - transitional arrangements for family trusts

3.28 Under the trust loss measures family trusts receive concessional treatment with the result that they are not required to satisfy any of the tests for deductibility of prior or current year losses other than the income injection test. As outlined in paragraph 3.20 above, a family trust is defined in the Bill as a trust where an individual and his or family are the only persons who are able, directly or indirectly, to receive distributions of income or capital of the trust for their own benefit.

3.29 Under the transitional arrangements for family trusts, a trust that is predominantly, although not technically, a family trust which became a family trust as defined within a transitional period will be treated as though it satisfied the definition of family trust from the time of the 1995 Budget. The transitional period is the time from the 1995 Budget until the earlier of 30 June 1996 or the time the trust becomes a family trust. A trust will be predominantly a family trust where 50% or more of the individuals who are able, directly or indirectly, to receive distributions from the trust are family members.

3.30 A trust that is predominantly a family trust may not be able to satisfy the requirements of this transitional provision. This is because at the Budget time, the beneficiaries of the trust may include any company or trust in which a family member has an interest. Thus, if a family member holds an interest in a large public company or widely held trust, there will be a very large number of non-family members who are able to indirectly benefit from the trust with the result that the existing transitional provision cannot be satisfied. However, the trust may have made distributions only to members of the family.

3.31 To overcome this problem, paragraph (2)(a) of item 7 of Schedule 7 will be replaced with paragraphs (2)(a) and (aa).

3.32 Paragraph (2)(a) will allow the transitional provision to apply where the majority of both the income and capital distributions made by the trust in the six years prior to the test time were received, directly or indirectly, by family members. The test time refers to the time before 1 July 1996 when the trust became a family trust.

3.33 Paragraph (2)(aa) will apply where the trust did not distribute income or capital in the period of six years prior to the test time. In this case, the trust will be able to satisfy the conditions of the transitional provision if the Commissioner considers it reasonable to treat the trust as a family trust. The Commissioner is to have regard to the individuals who during that six year period were capable of receiving, directly or indirectly, and for their own benefit, income or capital of the trust.

Amendment 38 - transitional provision for fixed trusts where fixed entitlements are held by non-fixed trusts where no individuals have more than a 50% stake

3.34 In the Bill, the 50% stake test which applies to test the continuity of ownership of fixed trusts is the only test, other than the income injection test, that needs to be satisfied by fixed trusts. In contrast, in addition to the income injection test, a non-fixed trust has to satisfy a control test. It may also have to satisfy a 50% stake test (if individuals have fixed entitlement to more than 50% of the income or capital of the trust at any time during the relevant test period) and a pattern of distributions test.

3.35 The 50% stake test which applies to fixed trusts operates in the same manner as the continuity of beneficial ownership test that applies to companies under the existing company loss provisions in section 80A of the Act. For the purposes of applying section 80A, where shares in a company are held by a non-fixed trust in which there are no fixed entitlements, no natural person can be treated as beneficially owning those shares.

3.36 Similarly, where a fixed entitlement in a fixed trust is held by a non-fixed trust in which there are no fixed entitlements, no natural person will have any fixed entitlement to the income and capital of the fixed trust. This is because a person who is merely a potential beneficiary under a non-fixed trust does not have an entitlement to receive anything and thus does not own anything which is capable of being taken into account in applying the 50% stake test (and correspondingly, which is capable of economically suffering the loss).

3.37 Thus, for example, where the majority of the fixed entitlements in a fixed trust are held by a non-fixed trust in which there are no fixed entitlements, the 50% stake test cannot be satisfied by the fixed trust.

3.38 The effect of these provisions is that a fixed trust (which is not a family trust) which has losses incurred before the Budget date may lose those losses solely because majority interests in the trust are held by a non-fixed trust with no or insufficient fixed entitlements. The difficulty does not arise if the non-fixed trust is a family trust or could become a family trust. This is because of the special rule in subsection 271-20(2) of the Bill, for calculating fixed entitlements held by a family trust.

3.39 A new transitional provision will be inserted into Part 3 of Schedule 7 which will apply where individuals do not, directly or indirectly, hold more than 50% of the fixed entitlements in a fixed trust because some or all of the fixed entitlements in that trust are held directly or indirectly by a non-fixed trust.

3.40 The transitional provision will only apply if the following conditions are satisfied:

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the trust was a fixed trust at all times during the period from the 1995 Budget to the end of the income year and had incurred a loss for the 1994-95 or an earlier income year;

•

there is no change in the persons holding, directly or indirectly, fixed entitlements in the trust or the percentage of their fixed entitlements; and

•

every non-fixed trust (that is not a family trust) that holds entitlements in the fixed trust would satisfy the continuity of ownership, control and pattern of distribution tests if they stood in place of the loss trust.

3.41 Where these conditions are satisfied, the relevant loss of the 1994-95 or earlier income years can be carried forward for offset against later income of the trust.