Most trust deeds, including most unit trust deeds, will not satisfy the requirements to be a ‘fixed trust’. However, if a trust does not qualify as a fixed trust, the Commissioner has a discretion to still treat the trust as if it is a fixed trust. The Commissioner has released draft Practical Compliance Guideline 2016/D16, which is intended to give some guidance as to how the Commissioner might exercise this discretion.
Whether beneficiaries have ‘fixed entitlements’ in trusts is important for a number of tax provisions. For example, if beneficiaries/unitholders do not have ‘fixed entitlements’:
- the rules for carrying forward losses are more complex and may prevent prior year losses being available against income of later years;
- franking credits do not flow through to beneficiaries (unless the trust can make a family trust election – which may not be possible with a unit trust); and
- income from the trust will be non-arm’s length income of SMSFs that are unitholders and taxed in the SMSF at top tax rates.
The PCG discusses a number of particular ATO concerns with provisions in trust deeds that can mean a trust is not a ‘fixed trust’, including provisions giving the trustee power to:
- redeem units without the consent of the unitholder, or at a price the trustee determines in its discretion;
- amend the trust deed (without restrictions); and
- reclassify units or issue units of a different class.
In our view, there are a number of clauses that can be included in unit trust deeds to enhance the prospects of the ATO accepting the trust is a fixed trust, including providing that:
- the trust deed cannot be amended without the consent of all unitholders;
- the trustee cannot exercise any powers under the deed in a way that would result in unitholders not having ‘fixed entitlements’ to all income and capital;
- only fully paid ordinary units can be issued;
- units can only be issued or redeemed for market value based on a net asset approach (applying Australian accounting standards);
- all distributions of net income and capital must be allocated to unitholders in proportion to the number of units they hold on the distribution date;
- the trustee must not have the power to make gifts; and
- any net income not distributed for a year is held for the unitholders in proportion to the number of units they hold on 30 June.
The ATO state in the PCG that the guideline does not apply in determining whether SMSFs have a ‘fixed entitlement’ in a trust. In our view, it is still prudent to ensure SMSFs hold ‘fixed entitlements’ as discussed in the PCG as:
- the ATO have only provided limited and ambiguous guidance on what is required to give an SMSF a ‘fixed entitlement’ in this context – for example, in TR 2006/7 the ATO refer to an entitlement that ‘does not depend upon the exercise of the trustee’s or any other person’s discretion’; and
- some AAT decisions consider the loss trust definitions in deciding whether SMSFs have a ‘fixed entitlement’ in a trust.
PCG 2016/D16 highlights the importance of ensuring trust deeds provide ‘fixed entitlements’ and the issues that need to be considered if amending trust deeds so beneficiaries have ‘fixed entitlements’.