When a Unit Trust is Not a Fixed Trust

Acis, current as of: 17 February 2017.

It can be surprisingly easy to confuse unit trusts and fixed trusts, leading to potentially damaging and costly outcomes for you and your clients. We have previously written about some of the considerations around fixed trusts as we often see instances where assumptions are made that unit trusts and fixed trusts are one and the same thing.

Why does the distinction matter? 

  • There are different rules regulating a trust’s ability to carry forward losses – it is generally harder for a non-fixed trust to do so.
  • Unit holders may have difficulty claiming franking credits in a non-fixed trust if they receive dividends.
  • Unit holders may not be entitled to claim borrowing costs incurred in acquiring units in a non-fixed trust.

These are by no means exhaustive examples, but serve to highlight the potential outcomes if unit trusts are treated in the same way as fixed trusts.

Defining a fixed trust

Section 272-65 in ITAA 1936 defines a fixed trust as one in which: “persons have fixed entitlements to all of the income and capital of the trust”.

Section 272-5(1) in ITAA 1936 states that beneficiaries (unit holders) have a fixed entitlement to the income and capital if they have a vested and indefeasible interest in a share of income or capital of the trust. Where a unit holder does not have a fixed entitlement (e.g. because the trust is not “fixed”), the Commissioner has a discretion to treat the unit holders’ entitlement as fixed having regard to:

  • The circumstances in which the entitlement is capable of not vesting or the defeasance can happen;
  • The likelihood of the entitlement not vesting or the defeasance happening; and
  • The nature of the trust.

Unfortunately, many practitioners assume that a unit trust is a fixed trust simply because it is a unit trust. That’s not always the case and, unfortunately, it would be almost impossible for a modern unit trust to qualify as a “fixed” trust.

Very little certainty in the PCG

This issue was brought into focus by the Federal Court decision in Colonial First State Investments Ltd v Commissioner of Taxation which determined that the unit trust in that case would not qualify as a fixed trust because the trust deed contained a clause which allowed the deed to be amended. The court’s thinking was that the trust deed could be amended to remove a fixed entitlement to income/capital at any time, therefore the unit holders’ interests could not be vested and were indefeasible.

Since that case, trusts wanting to qualify as “fixed” have had to rely on the exercise of the Commissioner’s discretion. This has meant a great deal of uncertainty because section 272-5(3) provides very little guidance about what the Commissioner will take into account.

Now the Commissioner has issued Practical Compliance Guideline 2016(D16) (PCG) in an apparent effort to provide some certainty regarding the circumstances in which the discretion in section 272-5(3) will be exercised.

While the effort is to be applauded, there is still some way to go before it provides the certainty required by taxpayers. For example:

  • A Practical Compliance Guideline is non-binding (unlike a tax ruling), meaning the Commissioner in practice will apply a broad discretion depending on circumstances.
  • The PCG purports to deal only with the trust loss provisions in Schedule 2F of the ITAA 1936 but not any other circumstances in which the distinction between fixed and non-fixed trusts is critical.
  • The PCG contains uncertain language – it warns that there are many factors the Commissioner may consider in making a determination. A number of examples are given but the circumstances presented are then simply graded as “favourable”, “unfavourable” or “neutral”.

The Acis team is happy to take a look at your trust deeds if you have doubts about them. Otherwise, you might want to revisit our trust deed checklist as part of your regular trust reviews.