ATO Interpretative Decision
ATO ID 2014/10
Can the unit trust fulfil the qualification period in the section of 160APHO of the Income Tax Assessment Act 1936 (ITAA 1963) as a significant matter, to be considered by the Commissioner to exercise discretion to treat holders interest as vested and indefeasible under paragraph 160APHL(14)(c) of the ITAA 1936?
No. The unit trust beneficiary cannot fulfil the qualification period in section 160APHO of the ITAA 1936. The matter is not significant for the Commissioner to consider utilizing discretion to deal with the unit holder’s interest as vested and indefeasible under paragraph 160APHL (14) (c) of the ITAA 1936.
Through the operation of the unit trust, contributions are made by employer to an employee remuneration arrangement.
The unit trust trustee provides non-recourse interest free loan to employee. The loan attained is used by the employee to obtain units in a trust. There is no requirement to repay the loan until cancellation of the unit.
The unit holder is allowed to obtain a proportion of their unit holding, income distributions, including franked dividends received by the trustee on allocated shares.
A cancel entitlement is held by the unit holder when the units have been cancelled. The cancellation entitlement provides the unit holder the choice of obtaining a special distribution of shares or a payment of cash equal to the market value of the shares.
When the cancellation is claimed and there is insufficient amount to cover the outstanding loan, an acceptance of the cancellation entitlement in full and final satisfaction of the amount outstanding on the loan made by the trustee.
Further the employee holds no further interest to shares other than the beneficiary of the unit trust and does not have vested and indefeasible interest in the corpus of a trust. Therefore the unit holder is not qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 unless the discretion in former subsection 160APHL (14) of the ITAA 1936 is exercised in the unit holder’s favour.
Reason for Decision
A beneficiary of a trust is only permitted to the tax balance under section 207-45 of the Income Tax Assessment Act 1997 (ITAA 1997) if beneficiary is a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 (the Division) in relation to the distribution – paragraph 207-150(1) (a) of the ITAA 1997.
The Division intentions are to confirm that the true economic owner of a share will benefit of the franked distribution, which defines the entity that is exposed to risks of loss and the opportunities for gain associated with share ownership. The division aims to prevent taxpayers who have limited exposure to risk and opportunities from obtaining access to franking credits. In this regard paragraph 4.6 of the Explanatory Memorandum to the Tax Laws Amendment Bill (No. 2) 1999 (the EM) states:
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.
A trust that is not widely held, and the beneficiary is not vested and indefeasible in the corpus of a trust, arrangements to exercise the discretion in former subsection 160APHL (14) of the ITAA 1936 to treat the interest as being vested and indefeasible will be carried out by the Commissioner of Taxation.
Exercising this discretion, paragraph 160APHL (14) (c) of the ITAA 1936 sets out the matters to which the Commissioner of Taxation should have considered:
- the circumstances in which the interest is capable of not vesting or the defeasance can happen; and
- the likelihood of the interest not vesting or the defeasance happening; and
- the nature of a trust; and
- any other matter the Commissioner thinks relevant.
Exercising the discretion by the Commissioner subsection 160APHL(14) of the ITAA 1936, states the taxpayer will not otherwise be able to satisfy the qualification period in former section 160APHO of the ITAA 1936 is not a relevant matter under paragraph 160APHL(14)(c) of the ITAA 1936. The Commissioner’s discretion becomes relevant since the requirements of former section 160APHO of the ITAA 1936 have not been met but whether the discretion should be exercised depends on separate considerations.
In considering the factors set out in paragraph 160APHL (14) (c) of the ITAA 1936, the unit holder may not be exposed to the risk of loss or opportunity for gain in respect of their shares due to:
- The limited recourse nature of the loan (so that the unit holder is wholly protected from a fall in the market value of the shares);
- The loan not being interest bearing;
- The requirement for the unit holder to repay the loan from their own funds before being eligible to an in specie distribution;
- The arrangement being generally promoted or operated on the basis that a unit holder will, upon cancellation of the units, receive cash rather than an in specie distribution; and
- The various discretions of the trustee affecting the vesting of the shares.
Section 160APHL (14) ITAA 1936 states exercising discretion will not be permitted by the Commissioner, as the need to treat the interest as being vested and indefeasible where the employee is not adequately exposed to the risk of loss or opportunity for gain. Hence the employee will not be vested and indefeasible interest, and will not be a qualified person of Division 1A of former Part IIIAA of the ITAA 1936 (the Division) in relation to the distribution and under section 207-45 ITAA 1997 indicates they will not be entitled to a tax offset.