House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 13 - Interpretation of terms used in the provisions

What is a fixed entitlement to income or capital?

13. 1 The concept of a fixed entitlement is central to the operation of the trust loss measures. A fixed entitlement to income or capital is defined for each of the following:

•

trusts;

•

companies; and

•

partnerships.

13.2 Fixed entitlements in trusts are used to determine whether a trust is a fixed trust or a widely held unit trust, whether a trust has continuity of ownership and control and for tracing indirect entitlements in other trusts. Fixed entitlements in companies and partnerships are mainly used in the legislation to trace whether a person has an indirect fixed entitlement to the income or capital of a trust. Fixed entitlements are also used to determine whether a family trust can revoke a family trust election and whether entities are in a family group.

What is a fixed entitlement to income or capital of a trust?

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.

What is a vested interest?

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.

When is a vested interest indefeasible?

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.

Example

13.9 A unit trust has 100 units. All of the units carry equal rights to income and capital of the trust. The trustee has no discretion to allocate income or capital of the trust to unit holders other than in accordance with the share of income and capital represented by their units. The trustee has the power to accumulate income of the trust if the majority of the unit holders agree to such accumulation. However, each unit holder retains their interest in the share of accumulated income represented by their units. All of the income and capital of the unit trust is subject to fixed entitlements. The mere fact that the income of the trust is accumulated in the trust in accordance with the terms of the trust deed does not prevent the beneficiaries of the trust from being treated as having a vested and indefeasible interest in the income or capital of the trust.

The mere fact that units can be issued or redeemed at market value does not mean an interest is defeasible

13.10 The Bill includes a provision to clarify that the interest of a unit holder in a unit trust will not taken to be defeasible only because units in a unit trust can be issued or redeemed. However, for this clarifying provision to operate, the issue or redemption of the units must be at full value. This means that additional units could be issued or units redeemed only for market value or for a price that represents the net asset value of the trust. For listed unit trusts, market value of the units would be the listed price. For other unit trusts, the units need to be issued or redeemed at a value representing the net asset value of the trust. [Subsection 272-5(2)]

13.11 Subsection 272-5(2) is not intended to disturb the ordinary meaning of 'vested and indefeasible interest' in any way except in accordance with its terms. Thus, if an interest is vested and indefeasible ignoring subsection 272-5(2), it will be a fixed entitlement.

Commissioner's discretion to treat an entitlement as not being able to be varied

13.12 The Bill gives the Commissioner a discretion to determine that an interest of a beneficiary to income or capital that is not vested and indefeasible can be treated as vested and indefeasible. This in turn would mean the interest could be treated as a fixed entitlement. The Commissioner could exercise this power having regard to:

•

the circumstances in which the beneficiary's interest would not become vested or would be defeased;

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the likelihood of the interest not vesting or not being defeased; and

•

the nature and type of the trust. [Subsection 272-5(3)]

13.13 This provision is intended to provide for special circumstances where there is a low likelihood of a beneficiary's vested interest being taken away or defeated and, having regard to the scheme of the trust loss provisions to prevent the transfer of the tax benefit of losses and other deductions incurred by trusts, it would be unreasonable to treat the beneficiary's interest as not constituting a fixed entitlement

What is a fixed entitlement to income or capital of a company?

13.14 A fixed entitlement in a company is defined for both income and capital.

13.15 A person has a fixed entitlement to income of a company if the person is the beneficial owner of shares in the company that carry a right to receive dividends that might be paid by the company. A company declares dividends out of the profits of the company. The extent of a shareholder's entitlement is expressed as a percentage of the total dividends declared by the company that the shareholder has a right to receive. [Subsection 272-10(1)]

13.16 A person has a fixed entitlement to capital of a company if the person is the beneficial owner of shares in the company that carry a right to receive any return of capital in the company (e.g. in the event of a winding-up or a capital reduction of the company). The extent of the entitlement is expressed as a percentage of the capital returns by the company to shareholders which the particular shareholder has the right to receive. [Subsection 272-10(2)]

What is a fixed entitlement in a partnership?

13.17 A person will have a fixed entitlement to either income or capital of a partnership (whichever is applicable) where the following conditions are met:

•

the person is entitled to a share of the income of the partnership that the partnership derives from time to time (i.e. current and future income), or a share of capital of the partnership; and

•

the share is not able to be varied. [Subsection 272-15(1)]

13.18 As with trusts, the Commissioner will have a discretion to treat an entitlement to income or capital of a partnership as a fixed entitlement in special circumstances notwithstanding that the partner's share is able to be varied. [Subsection 272-15(2)]

When is a fixed entitlement held indirectly?

13.19 The concept of a fixed entitlement being held indirectly through one or more interposed companies, partnerships or trusts (all called entities for this purpose) is used in determining whether:

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individuals have more than a 50% stake in the income or capital of a trust (see paragraph 9.22 to 9.33);

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an individual is deemed to have been distributed any part of a test year distribution for the purposes of the pattern of distributions test applying to non-fixed trusts (see paragraphs 9.48 to 9.52);

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an individual is taken to hold units in a unit trust for the purposes of the widely held unit trust definition (see paragraph 13.76);

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a family trust can revoke a family trust election because it is wholly owned by an individual, members of his or her family and family trusts where the individual is specified (see paragraphs 5.13 to 5.16);

•

a company, trust or partnership is a member of a family group because it is wholly owned by an individual, members of his or her family and family trusts where the individual is specified (see paragraphs 5.34 and 10.22)

Tracing through fixed entitlements in companies, partnerships and trusts

13.20 A person will be taken to have a fixed entitlement in the income or capital of a company, partnership or trust (an entity) if the person is indirectly entitled to the income or capital through fixed entitlements in a chain of one or more interposed entities [section 272-20] . The income or capital that a person is entitled to through interposed entities is determined by multiplying the entitlements of the person in each successive entity.

13.21 When tracing fixed entitlements to income of an entity, the fixed entitlements to income of the interposed entities are taken into account. When tracing fixed entitlements to the capital of an entity, the fixed entitlements to capital of the interposed entities are taken into account.

13.22 All relevant fixed entitlements of one entity in another are expressed as a percentage of the total fixed entitlements to income or capital of the entity concerned (whichever is applicable).

13.23 For example, when tracing fixed entitlements in a loss trust, to determine one entity's fixed entitlement in an entity immediately above it, the entitlement of the lower entity in the higher entity is multiplied by the entitlement of the higher entity in the loss trust. If the higher entity is the loss trust being considered, the entitlement of the lower entity is multiplied by its fixed entitlement in the loss trust.

Example 1: A simple example of how fixed entitlements are traced

13.24 Trust A has prior year losses. Company B has a 40% fixed entitlement to the income of the trust and a 40% fixed entitlement to capital. Jack holds 60% of the shares in Company B, all of which are of the same class.

13.25 Jack's fixed entitlement to the income of Trust A is 60% (his fixed entitlement to income (dividends) of Company B) multiplied by 40% (Company A's fixed entitlement in the income of Trust A). This gives Jack a 24% fixed entitlement in the income of Trust A for the purposes of the 50% stake test. Jack's fixed entitlement to capital of Trust A is worked out in the same way (also 24%) except that it is traced through Jack's fixed entitlement to capital of Company B.

Example 2: A more complex example of how fixed entitlements are traced

13.26 Jill holds an indirect fixed entitlement to the income of Trust A through the structure set out in the following diagram.

13.27 The following steps are taken in working out Jill's fixed entitlement in Trust A.

Step 1: Partnership B's fixed entitlement to the income of Trust A is ascertained. This is 60%.

Step 2: Company C's fixed entitlement to the income of Partnership B (50%) is multiplied by Partnership B's fixed entitlement to the income of Trust A (60%). This equals 30%.

Step 3: Trust D's fixed entitlement to income (dividends) of Company C (100%) is multiplied by Company C's indirect fixed entitlement to the income of Trust A (30%). This equals 30%.

Step 4: Jill's fixed entitlement to the income of Trust D (50%) is multiplied by Trust D's indirect fixed entitlement to the income of Trust A (30%). This equals 15%.

The result is that Jill is taken to have a fixed entitlement to 15% of the income of Trust A.

Tracing through non-fixed interests in trusts

13.28 If a fixed entitlement to income or capital of an entity (the head entity) is held by a non-fixed trust in which no persons have a fixed entitlement to income or capital, there will not be individuals who have a fixed entitlement to any of the income or capital of the head entity to which the trustee of the interposed non-fixed trust has a fixed entitlement. This is because it is only possible to trace through fixed entitlements in a non-fixed trust in order to determine if an individual has a fixed entitlement to the whole or part of the income or capital of the head entity to which the trustee of the interposed non-fixed trust has a fixed entitlement.

13.29 However, where there are persons who have fixed entitlements to income or capital of a non-fixed trust which is interposed between the head entity and an individual, a fixed entitlement to income or capital of the head entity will be able to be traced through the interposed non-fixed trust to the extent of the fixed entitlement.

Special tracing rules where fixed entitlements have be traced through certain types of interposed entities

13.30 The Bill contains special rules that apply to modify the general principles, discussed above, as to how fixed entitlements in a loss trust (or an interposed trust, company or partnership where relevant) are traced through some kinds of interposed entities. This is to overcome difficulties caused by the nature of the interests individuals hold in certain interposed entities or because of the practical difficulties in tracing through certain entities.

13.31 The sections containing these rules (sections 272-25 and 272-30) operate only where provisions of the Bill talk about a fixed entitlement being held 'directly' or 'indirectly' or both. If a provision simply refers to a person holding a fixed entitlement in a trust, that refers to a situation where the person directly holds those entitlements (see for example the definition of 'fixed trust' in section 272-65).

What if a superannuation fund, government body or special company holds fixed entitlements directly or indirectly?

13.32 There are several kinds of company (special companies) in which members do not have fixed entitlements meaning that fixed entitlements in an entity cannot be traced through those companies. For example, members of mutual companies, including life policy holders of mutual insurance companies, generally only have a right to vote, rather than a right to participate in the profits or capital of the company. There are other special companies in a similar position. The term 'special company' is defined in section 272-140 (see paragraph 13.108).

13.33 In addition, it may be difficult and costly for a superannuation fund or an approved deposit fund to determine the exact quantum of the fixed entitlements to income and capital held by each of the members in the fund. This is because the quantum of an individual member's 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 for the member.

13.34 Problems also arise with a government body because individuals could not be said to beneficially own the income and capital of those bodies in the appropriate sense. The term 'government body' is defined in section 272-140 (see paragraph 13.102).

13.35 Special tracing provisions are included in the Bill to overcome the problems discussed above.

Interposed fund or special company with more than 50 members or interposed government body

13.36 In some cases an interposed complying superannuation fund, complying approved deposit fund, foreign superannuation fund ^[F15] or special company is taken to hold the fixed entitlements in the trust (or interposed entity where relevant), whether directly or indirectly, as an individual for its own benefit. This is where the fund or special company has more than 50 members. Fixed entitlements held by government bodies are treated in the same way [subsection 272-25(4)] . ^[F16] To avoid doubt, the members who may actually have the fixed entitlements indirectly through the interposed fund or special company are taken not to have those entitlements for the purposes of this concession. The exception is where the rule on 50 or fewer members deems those members to hold the fixed entitlements.

Interposed fund or special company with 50 or less members

13.37 In the case where the interposed fund or special company has 50 or less members, each of the members will be taken to have an equal share of the fixed entitlements that the fund or special company holds in the trust (or interposed entity where relevant). [Subsection 272-25(5)]

13.38 The following example illustrates the application of subsection 272-25(5). A complying superannuation fund holds 20% of the fixed entitlements in a loss trust and has 10 members. Each member is taken to hold, indirectly, 2% of the fixed entitlements in the loss trust.

What if a fund or special company's membership fluctuates during the times at which a 50% stake has to be maintained?

13.39 A provision is included in the Bill to cater for the situation where a fund or special company's membership fluctuates above or below 50 members during a period, or at times, when a 50% stake has to be maintained in a trust. In this case, the rule on 50 or less members applies (i.e. subsection 272-25(5)).

What if a special company loses its status as such?

13.40 A provision has been inserted in the Bill to cover the situation where a special company loses its status as such (e.g. a mutual insurance company de-mutualises and becomes a company limited by shares). The Commissioner has a discretion in these cases to treat the members (e.g. shareholders) of the company after it loses its status as having held the fixed entitlements held by the company at all times when the company was a special company [subsections 272-25(7) and (8)] . In exercising this discretion, the Commissioner is to have regard to a number of matters as set out in subsection 272-25(8).

13.41 The following example illustrates the application of subsections 272-25(7) and (8). A mutual insurance company holds a fixed entitlement in a trust. The trust incurred losses in Year 1 and seeks to recoup those losses in Year 2. At the end of Year 1 (part of the test period for determining continuity of ownership of the trust), the mutual insurance company de-mutualises and becomes a company limited by shares. The shareholders of the company after the de-mutualisation may, if appropriate, be treated by the Commissioner as holding, during the whole of Year 1, the fixed entitlements in the loss trust, indirectly, in the same proportions that they hold fixed entitlements in the de-mutualised insurance company.

What if a fixed entitlement is held through a family trust?

13.42 A special rule will apply to circumstances where a fixed entitlement to the income or capital of an entity is held, directly or indirectly, by a family trust at a particular time. The trustee of the family trust will be taken to have that fixed entitlement to the income or capital of the entity as an individual for its own benefit [subsection272-30(2)] . However, this rule does not apply for the purposes of the application of the pattern of distributions test to non-fixed trusts.

Listed public companies and widely held unit trusts

13.43 There are considerable practical difficulties in tracing interests in or through listed public companies, because of the large number of shareholders and the likelihood that individuals will not hold shares in the listed public company directly. Similar problems arise for widely held unit trusts. The main problem is that it may be difficult, in particular cases, to identify all the direct and indirect holders of fixed entitlements in those entities. The term 'listed public company' is defined in section 272-135 (see paragraphs 13.95 and 13.96).

13.44 A provision has been included in the Bill to assist in overcoming difficulties in appropriate cases. This provision will allow the Commissioner to treat all or part of the fixed entitlements in a trust (or interposed entity where relevant) held, directly or indirectly, by a listed public company or widely held unit trust as being held by that company or trust as an individual for its own benefit. [Subsections 272-30(3) and (4)]

13.45 The Commissioner will be able to exercise his or her discretion to do this where he or she considers it fair and reasonable to do so having regard to a number of factors set out in subsection 272-30(4). These factors relate to:

•

the practicability of identifying individuals who have fixed entitlements;

•

any changes in individuals holding fixed entitlements; and

•

any other relevant matters (e.g. whether there has been any abnormal dealing in a listed public company's shares).

Example

13.46 A listed public company holds all the fixed entitlements in a loss trust. It is only possible for the trust to determine the individuals who, directly and indirectly, hold 90% of the fixed entitlements in the company. This means the trust can determine the individuals who indirectly hold 90% of the fixed entitlements in the trust itself. If appropriate, the Commissioner could treat the remaining 10% (or part thereof) of the fixed entitlements in the loss trust as being held by the company as an individual for its own benefit.

Fixed entitlements - avoidance arrangements

13.47 The Bill contains a provision to deal with avoidance arrangements designed to ensure that individuals have a direct or indirect fixed entitlement in a trust, company or partnership of a certain level. A fixed entitlement held by a person is treated as not having been held by the person if certain conditions are met.

13.48 The conditions are that an arrangement must have been entered into and:

•

the arrangement is in some way related to, affected or depended for its operation, whether directly or indirectly, on the fixed entitlement or the value of the fixed entitlement - this condition makes the necessary link to the fixed entitlement that would be treated as not being held by a person; and

•

the purpose, or one of the purposes, of the arrangement was to ensure that individuals would have a fixed entitlement for one or more of the purposes set out in paragraph 13.19 - this makes it clear that the arrangement has been entered into to ensure a person has a fixed entitlement for one or more of those purposes. [Section 272-35]

13.49 Section 272-35 performs a similar role to subsections 80B(5), (6) and (7) of the ITAA 1936 or sections 165-180 to 165-190 of the ITAA 1997. These provisions apply to companies. For example, section 272-35 can apply in circumstances where a person who holds a fixed entitlement in a trust enters into an arrangement before the end of the test period for the purposes of the 50% stake test to transfer their fixed entitlement to another person. The transfer is delayed until after the end of the test period to enable the tax benefit from the losses to be transferred to the person who has acquired the fixed entitlement. The person who held the fixed entitlement during the test period would be treated as not having held it in that period.

What happens if a beneficial owner of an entitlement dies?

13. 50 The Bill makes special provision for the situation where an individual who directly or indirectly holds a fixed entitlement in a trust dies. This is necessary to prevent a trust failing the 50% stake (continuity of ownership) test, the widely held unit trust definition or other relevant provisions merely because a stakeholder in the trust dies. Where the individual dies, the fixed entitlement is taken to continue to be owned by the individual as long as:

•

the entitlement is held by the trustee of the dead person's estate; or

•

the entitlement is held by a person as a beneficiary of the dead person's estate. [Section 272-40]

What is a distribution of income or capital?

13.51 This Bill sets out the circumstances in which a distribution of income or capital by a trust, company or partnership will be taken to have occurred for the purposes of the trust loss measures. The distribution concept is mainly used in:

•

the pattern of distributions condition contained in section 267-30 and Subdivision 269-D (this is applied to determine changes in who benefits from a non-fixed trust); and

•

sections 271-15, 271-20, 271-25 and 271-30 which impose a liability to family trust distribution tax when distributions are made outside a family group.

13.52 The term distribution of income or capital is defined to include distributions of income and capital as generally understood. However, it is also given an extended meaning that includes loans, distributions in specie as well as other benefits that are provided to a person by a trust, company or partnership. The extended meaning given to the term ensures that regard is to be had to benefits of whatever nature or form that have accrued to a person.

Normal meaning of distribution

13.53 Sections 272-45, 272-50 and 272-55 set out when distributions of income or capital as generally understood are considered to be made. Table 13.1 summarises when a distribution is made under these sections.

Extended meaning of distribution

13.54 In addition to the above, distribution is given an extended meaning so that it includes the following:

•

the payment (including by way of a loan) or crediting of money of the entity to a person or the reinvesting of such money for that person; or

•

the transfer of property of the entity to a person or allowing the use of such property by a person; or

•

the application of money or property of the entity for the benefit of a person including where the money or property is dealt with for or on behalf of the person or as the person directs (e.g. where the entity pays-off a debt owed by the person to a third party); or

•

the extinguishment, forgiveness, release or waiver of a debt or other liability owed by a person to the entity. [Subsection 272-60(1)]

13.55 However, one of the above things will only be a distribution under the extended meaning if it is not a distribution in the normal meaning (i.e. under sections 272-45, 272-50 and 272-55).

13.56 As indicated, a distribution may not always be in the form of money or money equivalent. If the distribution takes the form of property or some other benefit, it will be necessary to obtain a monetary equivalent of the property or other benefit provided. The valuation should be made by reference to all relevant matters affecting the value of the property or benefit, for example, its market price (if any).

13.57 Because of the broad meaning given to the term 'distribution of income or capital' in subsection 272-60(1), in the absence of special provision, it could include all of any payment or benefit provided to a person even though that person has given valuable consideration in return for that payment or benefit. To overcome this, the definition of the term will be limited so that the things discussed in paragraph 13.54 above are only included as a distribution to the extent that the amount or value of the thing exceeds the consideration given in return. [Subsection 272-60(2)]

13.58 If the consideration is given after the time the distribution is made it may be necessary to calculate the value of the distribution by reference to the present value of the consideration to be given. The present value of the consideration must be determined at the time the distribution is made and must take into account any amounts owed or things to be given under contract by the beneficiary to the trust (or third party) in return for the distribution.

13.59 If consideration that was to be given at the time of a distribution is not subsequently given, it will be necessary to treat the distribution as a distribution for the purposes of these measures.

Example

13.60 A trustee provides an interest free loan to a beneficiary of $1,000 which is repayable in 5 years time. To obtain a comparable loan from a financial institution the beneficiary would have to repay the principal of the loan in equal instalments over a 5 year period and incur an interest rate of 10%. If the annual interest rate on a comparable loan is 10% the present value of $1,000 repayable in 5 years time is $620. The benefit provided to the beneficiary is $1,000-$620, i.e. $380. For the purposes of this provision $380 will be taken to be a distribution of income.

Income v capital

13.61 Any distribution made by an entity that is taken to be a distribution because of subsection 272-60(1) will be taken to be a distribution of income unless it is clear that the distribution has been made out of the capital of the entity. [Subsection 272-60(3)]

When is income or capital distributed indirectly?

13.62 The concept of a distribution being made indirectly is used in the pattern of distributions test (see section 269-60 discussed in Chapter 9).

13.63 A trust is taken to distribute all or part of a test year distribution to an individual indirectly if an amount or property attributable to the test year distribution is successively distributed by each interposed entity in a chain of one or more interposed entities to the individual. The amount of a 'test year distribution' of income or capital distributed to a person through interposed entities is determined by ascertaining what is fair and reasonable having regard to the actual distributions made by each successive entity. [Section 272-63]

13.64 The definitions of 'distribution of income or capital' in sections 272-45 to 272-60 will also apply to distributions made by interposed entities in the distribution chain.

Examples which show whether a distribution has been made indirectly

Example 1

13.65 In an income year Trust A makes a distribution of income indirectly through a chain of entities to Bill. The amount of distributions of all the distributing entities is shown in the diagram below.

13.66 It would be fair and reasonable in the circumstances to take Trust A as having indirectly distributed $60 of the distribution to Bill as Trust B only distributed to Company C $60 of the $100 distributed from Trust A. Only half of the profits distributed by Company C can be traced back to Trust A.

Example 2

13.67 As shown in the diagram below, in the income year Trust A makes a distribution of income of $100 to Trust B. Under the trust deed of Trust B, the trustee has a discretion to distribute only interest derived by the trust from accumulated income of the trust to discretionary beneficiaries. The trustee exercises the discretion to pay the amount of interest income derived by the trust for the income year in favour of Bill.

13.68 It would not be fair and reasonable in the circumstances to take Trust A as having indirectly distributed $100 to Bill as the income that has been distributed to Bill is sourced from the interest income derived by Trust B.

What is a fixed trust?

13.69 A fixed trust is a trust where all of the income and capital of the trust is the subject of fixed entitlements held by persons [section 272-65] . Paragraph 6.7 discusses the nature of a fixed trust in more detail.

What is a non-fixed trust?

13.70 A non-fixed trust is any trust which is not a 'fixed trust' [section 272-70] . Paragraph 7.5 above discusses the nature of a non-fixed trust in more detail.

What is an excepted trust?

13.71 There are six kinds of trusts that are excepted trusts . They are:

•

family trusts (discussed in Chapter 5);

•

complying superannuation funds, complying approved deposit funds and pooled superannuation trusts;

•

fixed unit trusts if all of the direct and indirect fixed entitlements to income and capital of the trust are held by bodies exempt from tax under section 23 of the ITAA 1936 or Division 50 of the ITAA 1997; and

•

deceased estates within a reasonable administration period. [Section 272-100]

13.72 The definitions of a complying superannuation fund, a complying approved deposit fund and a pooled superannuation trust are in section 272-140.

13.73 The term 'deceased estate' has its ordinary meaning. It is the trust which arises upon the death of a person for the administration of the deceased's estate by his or her personal representative in accordance with the will or codicil of the deceased or the intestacy laws of the relevant jurisdiction. It does not, however, include a testamentary trust (i.e. a trust, other than the deceased estate itself, established under the terms of a will or codicil).

13.74 For the purposes of the legislation, a deceased estate will only be treated as an excepted trust during a reasonable administration period. This period is the part of the income year from the date of death of the person and the next five full income years [paragraph 272-100(c)] . This will give the trustee of the deceased estate the opportunity to complete the administration of the estate.

What is a widely held unit trust?

13.75 Unlisted widely held trusts, listed widely held trusts, unlisted very widely held trusts and wholesale widely held trusts are all widely held unit trusts with particular characteristics.

13.76 A fixed trust is a widely held unit trust if it is a unit trust and is not closely held [subsection 272-105(1)] . A trust is closely held if 20 or less individuals between them hold, directly or indirectly, and for their own benefit, 75% or more of the fixed entitlements to income or capital of the trust (the 20/75 rule) [subsection 272-105(2)] .

13.77 For the purposes of the definition of a widely held unit trust an individual and his or her relatives and nominees are treated as being one individual. This will prevent an individual circumventing the intent of the 20/75 rule by having family members or nominees holding units on his or her behalf. [Subsection 272-105(3)]

13.78 The rule that 20 or fewer individuals must not hold 75% or more of the interests in income or capital of the trust is affected by an anti-avoidance provision which is similar to those contained in section 102G of the ITAA 1936. This provision looks to the rights attached to units and at any arrangement, contract, etc. that would affect those rights in a way that would circumvent the 20/75 rule. If the rights attaching to units are capable of being varied or abrogated in such a way that 20 or less individuals would, directly or indirectly, hold fixed entitlements to 75% or more of the trust's income or capital, the trust will not be a widely held unit trust. [Subsection272-105(4)]

What is an unlisted widely held trust?

13.79 An unlisted widely held trust is a widely held unit trust whose units are not listed for quotation in the official list of an approved stock exchange within the meaning of section 470 of the ITAA 1936. However, the characterisation of such a trust may be affected by the rule that defines some trusts to be of the same kind as their parent trust (see Subdivision 272-J discussed at paragraphs 13.91 and 13.92). [Section 272-110]

What is a listed widely held trust?

13.80 A listed widely held trust is a widely held unit trust whose units are listed for quotation in the official list of an approved stock exchange within the meaning of section 470 of the ITAA 1936. [Section 272-115]

What is an unlisted very widely held trust?

13.81 An unlisted very widely held trust is an unlisted widely held unit trust with at least 1,000 unit holders. All of the units in the trust must carry the same rights and, if the units are redeemable, the redemption price must be a true reflection of the trust's market value, i.e. based on its net asset value according to Australian accounting principles. [Subsection 272-120(1)]

13.82 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. All these activities must be carried out at arm's length. Thus, if any of the activities are not at arm's length, the trust will not be an unlisted very widely held trust. [Subsection 272-120(2)]

13.83 The characterisation of a trust meeting the requirements of section 272-120 may be affected by the rule that defines some trusts to be of the same kind as their parent trust (see Subdivision 272-J discussed at paragraphs 13.91 and 13.92).

Start-up period of an unlisted very widely held trust

13.84 Because it is often the case that trusts in which units are offered to the public take a while to grow, a trust that becomes an unlisted very widely held trust will be deemed to be such during its start-up period even if it does not strictly meet the necessary criteria. Accordingly, a trust will be taken to be an unlisted very widely held trust at all times from the time the units of the trust were first issued 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 269-20, 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. [Subsection 272-120(3)]

13.85 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.

13.86 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 269-20. Subsection 269-15(1) sets out factors that have to be considered in determining whether there has been abnormal trading and section 269-20 provides that abnormal trading will have occurred if a trustee knows or reasonably suspects that an acquisition or merger is taking place.

What is a wholesale widely held trust?

13.87 It is normal industry practice for unlisted very widely held and listed widely held trusts (retail trusts) as well as other pooled investment vehicles to invest their funds in wholesale trusts. Wholesale trusts are a means by which the funds of retail trusts and other investment bodies can be pooled and invested in particular types of investments (e.g. Australian shares, property, etc.).

13.88 A wholesale widely held trust is a trust that meets the following conditions:

•

the trust is an unlisted widely held trust but not an unlisted very widely held trust;

•

75% or more of the units in the trust are held by any one or more of a listed widely held trust, an unlisted very widely held trust, a complying superannuation fund, a complying approved deposit fund, a pooled superannuation trust, a life assurance company (within the meaning of section 110 of the ITAA 1936) or a registered organisation (within the meaning of section 116E of the ITAA 1936) - these are all called qualifying holders in the Bill;

•

all of the units in the trust carry the same rights;

•

if the units in the trust are redeemable, they are redeemable for a price determined on the basis of the trust's net asset value, according to Australian accounting principles;

•

the minimum initial subscription amount for units in the trust by each person is at least $500,000;

13.89 In addition the trust can only engage in certain activities. These are the same as those discussed at paragraph 13.82. [Section 272-125]

13.90 The characterisation of a trust meeting the requirements of section 272-125 may be affected by the rule that defines some trusts to be of the same kind as their parent trust (see Subdivision 272-J discussed at paragraphs 13.91 to 13.92).

How is the classification of a trust affected when it is wholly owned by a higher level trust?

13.91 The characterisation of a trust may be affected by whether it is wholly owned, directly or indirectly, by another trust. An unlisted widely held trust, unlisted very widely held trust or wholesale widely held trust whose fixed entitlements to income and capital are all held, directly or indirectly, by another trust of a higher level will instead be a trust of the same kind as that higher level trust. The parent trust must be of a higher level so that the subsidiary trust will not be worse off. The level of trust is determined in the following order (from lowest to highest):

•

unlisted widely held trust;

•

unlisted very widely held trust;

•

wholesale widely held trust;

•

listed widely held trust. [Section 272-127]

Example

13.92 In the above ownership structure, the classification of the B Unit Trust remains as listed widely held since its parent (the A Unit Trust) is not of a higher level. The C Unit Trust and D Unit Trust are re-classified as unlisted very widely held trusts because they are each wholly owned by the A Unit Trust which is of a higher level. The classification of the D Unit Trust is unaffected by the classifications of the B Unit Trust and C Unit Trust since neither of them owns 100% of it.

What if a trust begins or ceases to exist in a period?

13.93 A provision has been included to clarify how the provisions work when a trust begins or ceases to exist during a period for which it is required to meet a condition. Where a trust does not exist during a part of a period for which a condition needs to be met, the period is taken not to include the period when the trust does not exist. [Section 272-130]

Example

13.94 A fixed trust is created by settlement on 1 April 1998 and incurs a loss during the 1997-98 income year. The test period for the purposes of applying the 50% stake test to the trust does not include the time from the beginning of the 1997-98 income year to 1 April 1998.

What is a listed public company?

13.95 A company is a listed public company if its shares are quoted on an approved stock exchange (as defined in section 470 of the ITAA 1936) and the company satisfies what is generally known as the 20/75 rule. [Section 272-135] .

13.96 The 20/75 rule requires that 20 or less individuals must not hold, between them, and directly or indirectly, 75% or more of the relevant ownership rights in the company.

Other definitions not previously dealt with [section 272-140]

What is an approved stock exchange?

13.97 An approved stock exchange has the same meaning as in section 470 of the ITAA 1936. Section 470, together with regulations made for the purposes of that section, list a number of stock exchanges around the world as approved stock exchanges.

What is an arrangement?

13.98 The term 'arrangement' is used in anti-avoidance provisions (e.g. section 269-85 and 272-35). An arrangement means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

What is an associate?

13.9 The term associate has the same meaning as in section 318 of the ITAA 1936. This kind of definition is commonly used in the income tax law to define who an associate of another person is.

What is a breakdown in the marriage?

13.100 There is a breakdown in the marriage of an individual if the individual is living with another individual on a genuine domestic basis as husband or wife (whether legally married or not) and ceases to do so. Thus, there could be a breakdown in the marriage of a legally married couple even if they have not been formally divorced.

What is a complying superannuation fund, complying approved deposit fund and pooled superannuation trust?

13.101 The definition of these entities is taken from sections 45, 47 and 48 of the Superannuation Industry (Supervision) Act 1993 , respectively.

What is a government body?

13.102 Special tracing rules apply where fixed entitlements are held, directly or indirectly, by a government body. A government body is the Commonwealth, a State or Territory, a municipal corporation or other local governing body or a foreign state.

What is an income year?

13.103 The term income year is used throughout the provisions dealing with trust losses. In the case of the ITAA 1936 it is the 'year of income' (defined in subsection 6(1) of that Act). In the case of the ITAA 1997, the relevant term is already the income year (see the definition in subsection 995-1(1)).

What is a loss year?

13. 104 A loss year is a year of income in which a tax loss was incurred.

Who is a member of a company?

13.105 A member of a company is a shareholder or stockholder and, in the case of a mutual insurance company, includes a person who holds a life insurance policy of the company.

What is a scheme?

13.106 The term 'scheme' is used mainly in the income injection test. It has the same meaning as that term has in Part IVA of the ITAA 1936. Part IVA is the general anti-avoidance provision in the income tax law.

13.107 In Part IVA a scheme is defined as:

'(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.'

What is a special company?

13.108 A special company benefits from concessional tracing rules where it is interposed between an entity and individuals. A special company means:

•

a mutual affiliate company (within the meaning of section 121AC of the ITAA 1936);

•

a mutual insurance company (within the meaning of section 121AB of the ITAA 1936);

•

a company that is, by the terms of the company's constituent document, prohibited from making any distribution of income and capital (within the meaning of subsection 272-50) to its members (e.g. non-profit sporting clubs or trade unions);

•

a credit union, within the meaning of section 3 of the Financial Institutions Codes of the States and Territories (these are defined in section 111AZC of the Corporations Law), whose constituent documents prevent it from paying dividends to its members;

•

any company prescribed by the regulations.

What is a tax loss?

13.109 A tax loss is defined as a loss within the meaning of sections 79E, 80 or 80AA or a film loss within the meaning of sections 79F or 80AAA. Those sections are the provisions of the ITAA 1936 which deal with the deductibility of losses. A tax loss also includes a loss worked out under section 36-10 of the ITAA 1997. In general terms, a tax loss arises when a taxpayer's non-loss allowable deductions exceed assessable income and net exempt income.