1051408759178 | Legal database

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Edited version of your written advice

Authorisation Number: 1051408759178

Date of advice: 31 July 2018

Ruling

Subject: Fixed entitlements

Question 1

Will the Commissioner exercise the discretion pursuant to former subsection 160APHL(14) of the ITAA 1936 to treat the Beneficiary of the Trust, as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding?

Answer

Yes

This ruling applies for the following period:

1 July 2014 to 1 July 2019

The scheme commences on:

1 July 2014

Relevant facts and circumstances

In relation to the Trust:

it is an Australian unit trust

there has only ever been one class of units on issue and there have been no transfers or redemptions of units

the Trustee of the Trust does not intend to issue new units or redeem units in the foreseeable future

the Trust Deed has not been amended

at all relevant times:

● the Trustee deals with the beneficiaries of the trust on an arm’s length basis

● the Trust has had a trust instrument

● all beneficial interests in the income and capital of the Trust have been vested

● all beneficial interests have had the same rights to receive the income and capital of the Trust

● all beneficial interests in the income and capital of the Trust could be expressed as a percentage of the total income and capital of the Trust

● the Trust is not a discretionary trust or a trust with default income or capital beneficiaries

● a trustee or manager has never exercised a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the Trust

● it is not intended that the ownership or control of the Trustee will change during the prospective part of the Ruling Period.

● the Trustee does not intend to issue new Units of a separate class in the foreseeable future and has no intention to redeem Units in the foreseeable future.

Assumptions

Throughout the Ruling Period:

● The beneficiaries of the Trust do not have a vested and indefeasible interest in so much of the corpus as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936.

● The application and redemption price of Units in the Trust will be determined on the basis of the valuation of the assets and liabilities of the Trust in accordance with Australian accounting principles.

● The Trust will have a single class of Units on issue.

● The Trustee will not exercise a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the Trust.

The Unitholders will be sufficiently exposed to the risk of loss or opportunity for gain in respect of the shares in the Trust as explained by ATO Interpretative Decision ATO ID 2014/10.

● An arrangement will not be entered into which would result in:

● any of Taxpayer Alerts TA 2015/1, TA 2015/2 or TA 2018/1 applying

● a ‘related payment’ under former section 160APHN of the ITAA 1936

● a beneficiary of the trust having materially diminished risks of loss or opportunities for gain of less than 30% in respect of shares held by the trustee (refer to former section 160APHM of the ITAA 1936)

● the Commissioner making a determination under paragraph 177EA(5)(b) of the ITAA 1936

● any of paragraphs 207-150(1)(c) to (h) of the ITAA 1997 (inclusive) applying or

● fraud or evasion.

Relevant legislative provisions

Income Tax Assessment Act 1936

Subsection 177EA(5)

former section 160APHD

former section 160APHL

former subsection 160APHL(11)

former subsection 160APHL(13)

former subsection 160APHL(14)

former section 160APHM

former section 160APHN

Income Tax Assessment Act 1997

Subsection 207-150(1)

Reasons for decision

Summary

The terms of the trust instrument do not provide the beneficiaries with a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936. However, the Commissioner considers that it is reasonable to exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat the beneficiary of the Trust, as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding.

Detailed reasoning

A "fixed interest" in the trust holding is defined in former subsection 160APHL(11) of the ITAA 1936 as "a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding." [emphasis added]

No vested and indefeasible interest

As the beneficiary (Unitholder) of the Trust does not have a vested and indefeasible interest in so much of the corpus (capital) of the Trust as is comprised by the trust holding (being the Trustee's ownership of shares) pursuant to former subsection 160APHL(11) of the ITAA 1936, the only way that the beneficiaries can have such a vested and indefeasible interest is if the Commissioner exercises the discretion in former subsection 160APHL(14).

The requirements to be satisfied in respect of the discretion are contained in former subsections 160APHL(14)(a), (b) and (c) of the ITAA 1936.

In terms of former paragraph 160APHL(14)(a) –

The taxpayer has an interest in so much of the corpus of the trust as is comprised by the trust holding:

Former paragraph 160APHL(14)(a) of the ITAA 1936 contains a ‘threshold’ condition that the taxpayer has an interest in the corpus of the trust.

An interest for these purposes is considered to be a ‘vested interest’ and not a ‘contingent’ interest. An example of a contingent interest is one that relies upon the exercise, or the non-exercise, of a trustee’s discretion in relation to the income or capital of a trust.

Former section 160APHL of the ITAA 1936 provides that in calculating the extent of a beneficiaries interest, it is necessary to distinguish between the interest of a beneficiary in shares held by a widely-held trust (as defined below), and the interest of a beneficiary in shares held by other trusts.

The Trust is not a 'widely held trust' for the purposes of former section 160APHD of the ITAA 1936.

This necessitates that a 'look through' approach will be required to determine the interest that a beneficiary has in each of the underlying shares in the fund [refer to paragraphs 4.26, 4.77 and 4.88 of the EM which accompanied the Taxation Laws Amendment Bill (No. 2) 1999.]

Although the method of calculating the interest that a beneficiary has in the trust holding differs as between widely-held trusts and trusts other than widely-held trusts, the beneficiaries of both types of trusts are capable of having an interest in the trust holding.

Vested interests in the Trust Deed

Various clauses of the Trust Deed provide that:

● the Beneficiaries shall be entitled to the Trust Fund in proportion to their unitholding.

● upon termination of the Trust, the cash of the Trust Fund shall be distributed proportionately to Unitholders according to their Unitholding.

● the Trustee may, from time Trust to time, pay the capital of the Trust Fund (including as an in specie distribution of assets) to the beneficiaries proportionately.

● the term ‘Trust Fund’ is defined as including ‘investments and property’. As such, any shares held by the Trustee of the Trust would constitute form a part of the capital of the Trust which equates to the 'corpus' of the trust for current purposes.

The undivided equitable interest in the Trust Fund that a Unitholder has constitutes the requisite interest in the corpus of the trust as is comprised by the trust holding for current purposes.

Further, interests of the Unitholders are not contingent. That is, the trust is not a discretionary trust or a trust with default capital beneficiaries – such that, no beneficial interest in the capital of the trust is capable of being defeated, partly or wholly, by the exercise of a power of appointment of capital by the trustee or other donee.

In terms of former paragraph 160APHL(14)(b) –

Apart from this subsection, the interest would not be a vested or indefeasible interest:

As discussed above, although a Unit Holder's interest in the corpus (Trust Fund) of the Trust is vested, the Trust Deed of the Trust contains certain clauses by which a Unitholder’s interest in a share of the corpus of the Trust may be defeased.

In terms of former paragraph 160APHL(14)(c) –

Having regard to the factors prescribed in former paragraph 160APHL(14)(c):

These factors are:

(i) the circumstances in which the interest is capable of not vesting or the defeasance can happen; and

(ii) the likelihood of the interest not vesting or the defeasance happening; and

(iii) the nature of the trust; and

(iv) any other matter the Commissioner thinks relevant.

Clauses in the Trust Deed which contain powers which cause a beneficiary’s interest in the income or capital of the Trust to be defeasible

The meaning of the term ‘vested and indefeasible’ (in the context of former section 16APHL of the ITAA 1936) has been judicially considered in Re Soubra and Federal Commissioner of Taxation - (8 October 2009) - [2009] AATA 775; 2009 ATC 10-113; (2009) 77 ATR 946. In that case the Tribunal referred to the meaning of the term ‘vested and indefeasible’ as follows (at 3154 and 3155):

32. Section 160APHL(11) provides that for the purposes of subsection (10), a taxpayer's interest in the trust holding is a fixed interest to the extent that the interest is constituted by a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding.

33. As Hill J explained in

Dwight v Commissioner of Taxation 92 ATC 4192; (1992) 37 FCR 178, the words vested and indefeasible in the context of trust law are technical legal words of limitation, which have a well understood meaning to property conveyancers. He said, at 192:

"... Estates may be vested in interest or vested in possession, the difference being between a present fixed right of future enjoyment where the estate is said to be

2009 ATC 3155

vested in interest and a present right of present enjoyment of the right, where the estate is said to be vested in possession:

Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490 at 496 per Griffith CJ, at 501 per Isaacs J. A person with an interest in remainder, subject to a pre-existing life interest, has an interest which is vested in interest, but being a future interest is not yet vested in possession. That person's interest will vest in possession on the death of the life tenant. In the present context the word 'vested' is used in contradistinction to contingent.

An interest is said to be defeasible where it can be brought to an end and indefeasible where it can not...."

34. As Mr Sest submitted, the use of the conjunctive phrase vested and indefeasible indicates the right must be absolute: see

Saunders v Vautier (1841) 49 ER 282. Mr Sest submitted an interest is defeasible where it is subject to a condition subsequent. He cited the following examples where this may occur:

(a) where that is the effect of the trust deed;

(b) where a beneficiary interest is disposed of by the trustee in the course of administration of the trust prior to vesting day;

(d) where the beneficiary's vested interest is able to be divested by the exercise of a power by the trustee (or any other person).

In Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 the Federal Court considered the term in the limited context of amending the constitution of a registered managed investment scheme under section 601GC of the Corporations Act 2001.

The term ‘vested and indefeasible’ also appears 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; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490.

In terms of former subparagraph 160APHL(14)(c)(i)

The circumstances in which the defeasance of the interest can happen (in respect of the particular clauses of the Trust Deed) are:

Open class of beneficiaries

● Additional Units may be issued at such price as the Trustee thinks reasonable.

● As the price of further Units issued will not be determined on the basis of the net asset value of the Trust according to Australian accounting principles, the saving rule in former subsection 160APHL(13) of the ITAA 1936 will not be satisfied by Units whose Issue Price is determined under clause 7. As such, this power constitutes a defeasible power.

Trust Deed may be amended

● The Trustee may amend the Trust Deed with the support of a resolution of 75% of Unitholders.

● Any ability to amend the Trust Deed, whether requiring unanimous approval or not, will constitute a power capable of defeating a beneficiary’s interest in the income or capital of the Trust. As noted by Stone J in Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 at [106]:

it follows [from unit holders’ ability to amend the Constitution] that the members could vote to terminate the present right to a share of income and capital.

An amendment, whether approved by Unit Holders or effected by the Trustee's own act, could also permit the amendment of clauses which currently do not contain defeasible powers to do so.

In terms of former subparagraph 160APHL(14)(c)(ii)

The likelihood of the defeasance happening (in respect of the particular clauses of the Trust Deed discussed above):

Open class of beneficiaries

● It is noted that:

● There is a stated intention to maintain the single unitholding and to not issue further Units in the Trust.

● The Assumptions that will apply throughout the Ruling Period include that:

● The Trustee will not exercise a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the Trust.

● This will cause the savings rule in former subsection 160APHL(13) of the ITAA 1936 to be satisfied in respect of the issue of Units.

Trust Deed may be amended

● It is noted that:

● The Trustee requires at least 75% Unitholder approval to amend the Trust Deed. Currently there is a single Unitholder. This effectively means that 100% Unitholder agreement is required.

● The Assumptions that will apply throughout the Ruling Period include that:

● The Trustee will not exercise a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the Trust.

● As such, the likelihood of a beneficiary’s interest being defeated due to the existence of the amendment clause is considered to be low.

In terms of former subparagraph 160APHL(14)(c)(iii)

The nature of the trust:

● The Trust is a closely-held trust. However, it has had a single Unitholder, being the trustee of a family superannuation fund throughout its existence.

In terms of former subparagraph 160APHL(14)(c)(iv)

Any other matter the Commissioner thinks relevant:

● The discretion in former subsection 160APHLof the ITAA 1936 (14) pertains to the utilisation of a tax offset for a share of the franking credit on a franked distribution. It was introduced as a part of integrity measures aimed at defeating franking credit trading schemes.

● The EM which accompanied the introduction of former subsection 160APHL(14) outlined the purpose of the integrity measures:

4.6 One of the underlying principles of the imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves: a degree of wastage of franking credits is an intended feature of the imputation system.

4.7 In substance, the owner of shares is the person who is exposed to the risks of loss and opportunities for gain in respect of the shares. However, franking credit trading schemes allow persons who are not exposed, or have only a small exposure, to the risks and opportunities of share ownership to obtain access to the full value of franking credits, which often, but for the scheme, would not have been used at all, or would not have been fully used. Some of these schemes may operate over extended periods, and typically involve a payment related to the dividend which has the effect of passing its benefit in economic terms to a counterparty. The schemes therefore undermine an underlying principle of imputation.

As such, when considering the exercise of the discretion in former subsection 160APHL(14) the Commissioner must be mindful not to undermine the intended effect of the integrity measures themselves.

It is noted that certain assumptions have been included which will prevent the purpose of the integrity measures from being undermined, namely:

● The Unitholders will be sufficiently exposed to the risk of loss or opportunity for gain in respect of the shares in the Trust as explained by ATO Interpretative Decision ATO ID 2014/10.

● An arrangement will not be entered into which would result in:

● any of Taxpayer Alerts TA 2015/1, TA 2015/2 or TA 2018/1 applying

● a ‘related payment’ under former section 160APHN of the ITAA 1936

● the Commissioner making a determination under paragraph 177EA(5)(b) of the ITAA 1936

● any of paragraphs 207-150(1)(c) to (h) of the ITAA 1997 (inclusive) applying or fraud or evasion.

Recommendation

The beneficiaries of the Trust do not have a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936.

However, pursuant to the requirements of former subparagraphs 160APHL(14)(c)(i), (ii) and (iii) it is considered appropriate that the Unitholder should be treated as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding.

In summary, as:

● the Trust Deed contains only minor provisions that may constitute defeasible powers;

● the Trustee will not exercise a power capable of defeating a Unitholder’s interest to defeat a Unitholder’s interest in the income or capital of the trust;

● the likelihood of defeasance is low; and

● there is little likelihood that a franking credit trading scheme will ensue;

there is a reasonable case for the Commissioner to exercise the discretion under former subsection 160APHL(14) of the ITAA 1936 to treat the Beneficiary of the Trust as having a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding throughout the Ruling Period.

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