Fixed or not? Are unit trusts fixed trusts and the new ATO ‘safe harbours’ in PCG 2016/16

The ATO has confirmed in Practical Compliance Guideline PCG 2016/16 that, unless unitholders have a ‘fixed entitlement’ to all income and capital of the trust, a unit trust will not qualify as a ‘fixed trust’.

Most unit trusts (including some described as ‘fixed’ trusts) will not qualify as a ‘fixed trust’ because the unitholders do not have a ‘fixed entitlement’ to income and capital. For example, a unit trust may not qualify as a fixed trust if:

• the trust deed can be amended without the unanimous approval of unitholders;
• the trustee can issue new units or redeem existing units other than at market value;
• the trustee can make gifts;
• the deed allows for different classes of units;
• the trustee can transfer assets of the trust to another trust with similar beneficiaries (trust cloning power); and
• there are partly paid units.

Why is this important?

If a unit trust does not qualify as a fixed trust this can affect:

• the availability of prior year tax losses (under the trust loss provisions in Schedule 2F of the Income Tax Assessment Act 1936);
• the ability of a company with losses to satisfy the continuity of ownership test; and
• the passing on of franking credits to beneficiaries (as the unit trust will generally not be able to make a family trust election or interposed entity election).

Why is the PCG important?

Where a unit trust does not satisfy all conditions to be considered a ‘fixed trust’, the Commissioner has the discretion to deem entitlements to be fixed. The PCG:

• provides a list of relevant factors that ATO will look at when considering whether to exercise this discretion; and, importantly
• provides a number of safe harbours setting out scenarios where the ATO will accept that entitlements are deemed to be fixed – without the need to apply for the exercise of the discretion.

Will the safe harbours apply?

PCG 2016/16 outlines six safe harbours but only safe harbours 5 and 6 will apply to private unit trusts.

Safe harbour 5 only applies where the unitholders are individuals, listed trusts or managed investment schemes. Safe harbour 6 will have wider application and will be the relevant benchmark for most private unit trusts.

The main conditions that must be satisfied for safe harbour 6 to apply are that:

• all units on issue must have the same rights to income and capital;
• no discretionary units, which give the trustee the discretionary power to distribute income or capital, have been issued;
• the trustee does not have a discretion in relation to the distribution of income or capital between the unitholders; and
• the trustee has never exercised any:
  • discretion to distribute income or capital other than in proportion to the unitholdings;
  • power to gift any assets of the unit trust; or
  • power to hold the assets of the trust on the terms of another trust.

The fixed trust deeds supplied by Cooper Grace Ward and CGW Structures already qualify as fixed trusts. They will also satisfy the requirements for safe harbour 6.

You will need to carefully check the wording of your unit trust deed to determine whether the requirements of the safe harbours are satisfied (many existing trusts will not qualify) or whether amendments are required.

What does this mean for advisers?

The PCG is a timely reminder that most unit trust deeds do not give beneficiaries a fixed entitlement to income and capital but it also provides an opportunity to review and, where necessary, amend existing deeds to ensure certain outcomes for clients.

When amending trust deeds care must be taken to avoid triggering any unnecessary tax and duty consequences.

Please contact a member of the CGW team if you wish to establish a fixed unit trust, vary an existing unit trust so that it is fixed, or discuss this PCG and its implications further.