Australia: A More Workable Approach For Fixed Trusts: Discussion Paper

Last Updated: 26 September 2012
Article by Allan Mortel

We welcome the opportunity to make a submission to the Australian Treasury on the discussion paper titled "A more workable approach for fixed trusts" ("the Discussion Paper").

Moore Stephens commends the Federal Government on their initiative to resolve the uncertainty that currently exists around the tests that determine whether a trust is a 'fixed trust'. We believe that this initiative, along with the balance of announced reforms relating to the taxation of trusts are important elements for the Australian managed funds industry.


Under section 272-65 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936), a trust is a fixed trust if persons have fixed entitlements to all of the income and capital of the trust.

Whether an interest in a trust is 'vested' and 'indefeasible' is generally determined by examining the terms of the trust instrument. For example, if a deed gives a beneficiary (the default beneficiary) an interest in income which may be defeated by the trustee appointing income in favour of a different beneficiary, the default beneficiary's interest is vested but defeasible. As shown in the Colonial First State case, a statutory power can also cause an interest in the trust to be defeasible.

The focus of the current test is not whether the interest has been defeated but rather whether it is capable of being defeated. This causes the current fixed trust test to be an extraordinarily difficult test to apply as the certain powers that exist in many modern trust deeds irrespective of how likely or unlikely they will be exercised can cause a trust to fail the fixed trust definition.

In a widely held trust context, the main issue causing trusts to fail the fixed trust test is that the powers in the trust deed may cause an interest in the trust to be defeasible even though the interest in the trust is vested.

The Discussion Paper notes that in practice very few trusts can actually satisfy the fixed trust definition without the exercise of the Commissioner's discretion. This is clearly an unsatisfactory outcome for an industry such as the funds industry in Australia that utilises trusts as the main form of investment vehicle.

Question 5:

Could a 'clearly defined rights test' be used to determine whether a trust is a fixed trust? If so, should additional safeguards be introduced, particularly in relation to trusts that are not publicly listed or widely held, and what should they be?

The 'clearly defined rights test' was an option canvassed in the consultation process for Managed Investment Trust (MIT) reforms (refer report Review of the Tax Arrangements Applying to Managed Investment Trusts).

The Board of Taxation (Board) has recommended that MITs with 'clearly defined rights' be deemed to be a 'fixed trust' for income tax law purposes as this would provide an appropriate balance between integrity and access to the relevant tax treatment.

The Discussion Paper noted that it may be appropriate to adopt this approach, or a similar approach, in relation to trusts more generally. The discussion paper, Implementation of a New Tax System for Managed Investment Trusts considered options for implementing the 'clearly defined rights' requirement. In particular, the paper considered using a 'no material discretionary elements' approach based on Subdivision 126-G of the Income Tax Assessment Act 1997 (ITAA 1997).

Our understanding of the operation this test is to look at whether the exercise or non-exercise of a power can significantly affect the manner or extent to which each beneficiary of a trust can benefit from the trust. Therefore, the existence of powers in the trust deed that cannot significantly affect the market value of the units can be disregarded. In this sense, the test allows a degree of flexibility without compromising the fixed trust status.

The problems we foresee with this test includes the following:

  • This test would ultimately require consensus on what powers are considered to be material. Although the Discussion Paper distinguishes between powers that are either 'trust powers', 'powers of the appointor' and 'mere powers', sometimes it is not the existence of the power but rather whether the power is exercised that is appropriate in determining fixed trust status. This issue is better dealt with in the 'vested and not defeated' test (refer below);
  • The clauses shown on page 8 of the Discussion Paper highlights some unacceptable clauses as these are standard clauses or common clauses in trust deeds.

The examples of such powers that are considered in the Discussion Paper as being capable of significantly affecting the manner and extent to which a beneficiary can benefit and thus should not be appropriate for a fixed trust are as follows:

  • a power to appoint the beneficiary's interest in the income or capital to another beneficiary;
  • a power to characterise receipts or expenses as being on income or capital account, or to accumulate trust income to capital (unless those otherwise entitled to the income have the same interests in the capital);
  • a power to add new beneficiaries (other than by issuing new units or interests in a way that does not significantly affect the value of existing interests);
  • a power to appoint any part of the trust property to a new trust with different beneficiaries or giving different interests among existing beneficiaries;
  • a power to issue new interests with rights attached that significantly alter the rights or the value of the rights attached to existing interests (for example, a right to a preferential distribution of income); and
  • a power to amend the trust deed to include a power capable of materially altering a beneficiary's membership interest(s).

As mentioned above, some of these powers, are a consistent feature in many unit trust deeds that would have been originally included for the purpose of providing flexibility to the trustee to ensure that distributions amongst a group of beneficiaries remain fair in various circumstances (e.g. similar to the facts in Colonial).

In the MIT and other widely held trust context, we consider that, commercial forces would generally dictate that interests are, in a commercial sense, fixed as between investors of the same class as unfair treatment between different investors would cause an exodus of investors and cause reputational damage to the managers. Furthermore, MITs are widely held vehicles that are subject to various regulatory oversight mechanisms that add an additional layer of integrity such that they should be treated as fixed trusts. Notwithstanding this, we would support the use of certain saving provisions, e.g. special rules that allow fixed trust treatment provided the trust deed exhibited certain features, for example, where the trust deed can only be amended in a way such that every member's rights will not be adversely affected.

As the proposed MIT regime is in its infancy and has not yet been tested in the real world in this regard it is difficult to assess the appropriateness of introducing a clearly defined rights test for fixed trust that are not MIT's.

Question 7:

Is it appropriate to allow fixed trust treatment where rights are vested but are not indefeasible? If so, in which cases is it inappropriate?

The Colonial decision confirms the generally held view that in practice very few trusts satisfy the definition of 'fixed trust' in section 272-65 of Schedule 2F and would be required to rely on the Commissioner's discretion to be treated as a fixed trust. The reason why most trusts fail to satisfy the definition is because the beneficiary's interest is capable of being defeated by the exercise of a power in the deed or through a statutory power.

We consider that it is appropriate to install a test of 'fixed trust' status that does not rely on the interests of the beneficiaries being indefeasible.

The option canvassed in the Discussion Paper involves the removal of the requirement that an interest be 'indefeasible' to qualify as a 'fixed entitlement' and replace it with a requirement that the interest has not been defeated at the relevant time or over the relevant period being considered. Under this option, an interest would be a 'fixed entitlement' if it is vested and has not been defeated.

We consider that in practice, subject to appropriate safeguards that this is workable as it means that the powers of the trustee that are included merely for fairness and flexibility purposes do not cause the trust to lose its fixed trust status merely by their existence, as oppose to their exercise.

As noted in the Discussion Paper, the difficulty with this approach is the means to be adopted to measure whether an interest has been defeated. The suggestion is that provided there is no 'significant diminution' in the value of the rights attaching to the units during a specified period the interest is not considered to be defeated. (i.e. provided that the quantum of the entitlements do not significantly diminish over a relevant period).

Whilst this test is potentially workable, the problems we foresee with measuring value are as follows:

  • What is the appropriate period of time during which the value of the interest is measured;
  • What is considered to be 'significant;
  • What valuation methods are acceptable and are formal valuations required.

We consider the suggestion in the Discussion Paper to import the value shifting rules to determine the diminution of rights is not workable. The value shifting rules are quite complex, not easily adaptable to the current context in the sense that the value shifting rules have quite a number of preconditions, and ultimately does not provide a mechanism for measuring value. We therefore recommend that a different set of rules be developed to measure the diminution of rights attaching to units.

Although there are difficulties measuring the value of a unit in order to determine whether there is significant diminution in value and hence whether an interest has been defeated, we nevertheless consider this test to be potentially workable. Furthermore, it will give a higher level of comfort and certainty and does not rely on the Commissioner's exercise of discretion.

The Colonial case may have been decided differently under this test.

Our preference is that a trust should be considered a fixed trust unless it has exercised discretionary powers from one year to the next (e.g. different proportional income distributions or capital distributions).

Administrative Note

We consider it appropriate that if a new definition of fixed trust is to be introduced or if the existing definition is to be 'tightened' then transitional rules should be put in place to enable existing trusts that are being treated as fixed trusts but would no longer qualify as a fixed trust under a new definition, to be able to amend their deed in order to fit within the new definition without risk of resettlement.

Thank you for considering our submission. If you have any questions regarding the above, please do not hesitate to contact:

  • Stephen O'Flynn (03) 8635 1986;
  • Andrew Lam (02) 8236 7774;
  • Emma Crowley (02) 8236 7717; or
  • Me (02) 8236 7725.

This publication is issued by Moore Stephens Australia Pty Limited ACN 062 181 846 (Moore Stephens Australia) exclusively for the general information of clients and staff of Moore Stephens Australia and the clients and staff of all affiliated independent accounting firms (and their related service entities) licensed to operate under the name Moore Stephens within Australia (Australian Member). The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Moore Stephens Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication. Copyright © 2011 Moore Stephens Australia Pty Limited. All rights reserved.

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