High Court Clarifies What is a Unit Trust
The recent High Court decision in ElecNet (Aust) Pty Ltd v Commissioner of Taxation  HCA 51 provides useful guidance as to what constitutes a unit trust under the Income Tax Assessment Act 1936 (Cth) (ITAA).
The Key Facts
- ElecNet (Aust) Pty Ltd (ElecNet) was the trustee of the Electrical Industry Severance Scheme (EISS).
- The EISS was created in 1997 by deed (Trust Deed).
- Employers in the electrical industry can join the EISS. Employers can make payments to ElecNet with respect to an employee. That payment is credited by ElecNet to the name of the employee. If that employee’s employment is terminated, ElecNet makes a severance or redundancy payment to the employee.
- ElecNet sought a tax ruling that the EISS was a public trading trust. If EISS was a public trading trust, it would pay the lower corporate tax rate of 30% instead of the general rate applicable to trusts of 45%.
- The Commissioner ruled that the EISS is not a public trading trust.
- ElecNet appealed the Commissioner’s ruling and was successful at first instance in the Federal Court.
- The Commissioner succeeded on appeal to the Full Federal Court.
The High Court
- The issue before the High Court was whether EISS was a unit trust for the purpose of Division 6C of Part III the ITAA.
- Section 102M of the ITAA contains the following definitions:
(a) unit, in relation to a prescribed trust estate, includes a beneficial interest, however described, in any of the income or property of the trust estate.
(b) prescribed trust estatemeans a trust estate that is, or has been, a public trading trust in relation to any year of income;
- The expression “unit trust” is undefined in the ITAA.
- ElecNet argued that:
(a) each dollar paid by an employer to ElecNet and credited in respect of an employee is a “unit” as defined (being an employee’s beneficial interest
in the EISS trust estate), and the EISS is a unit trust;
(b) what constitutes a “unit”, as defined, should not constrained by pre-conceived assumptions of what the nature of a unit trust is; and
(c) the EISS belonged to an undefined category of “unit trust” which fell between a “discretionary trust” and a “fixed trust” under the ITAA.
This is because the beneficiaries of the EISS had entitlements capable of being calculated numerically or proportionately (“units”) which were contingent on a specified event occurring, but those entitlements could be defeated by an event, circumstance or authorised act of a trustee.
- The Commissioner argued that:
(a) the expression “unit trust” in Division 6C, and in common usage, refers to the recognised trust relationship developed, as an alternative to a company,
as a structure for investors to group resources for investing or trading;
(b) many aspects of the EISS are not analogous to that of a unit trust including:
(i)the beneficial interest in the EISS is not divided into units (however a unit is described);
(ii) the employees’ rights and entitlements are dependent on ElecNet exercising its discretion and on matters
peculiar to specific employees (such as amounts paid by employers to ElecNet on their behalf); and
(iii) ElecNet could distribute trust funds other than by payment to an employee.
The High Court’s decision
- The High Court held that the EISS was not a unit trust for the purpose of Division 6C, and therefore not a public trading trust.
- There were several key findings behind the leading judgment.
(a) ElecNet can broadly determine at its discretion which employees would be paid under the EISS and the amount of the payment.
This is indicative of the employees’ not having a beneficial interest in any of the income or property of the EISS.
(b) The extent of an employee’s entitlement is not measureable as a percentage of the EISS trust estate by reference to the terms of the Trust Deed.
The entitlement depends on the contributions paid on behalf of that employee by the employer to ElecNet and the employee’s other circumstances.
(c) The beneficial interest of each employee is not divided into units under the Trust Deed. There are no discrete parcels of rights which can be separately
dealt with. The employees were not issued, and did not hold, units merely through the crediting of payments to their name by ElecNet.
(d) The inclusive definition of “unit” in section 102M of the ITAA does not expand the meaning of “unit trust” for the purpose of Division 6C.
(e) The context of Division 6C requires the expression “unit trust” to be given its common usage meaning. There is no precedent, anywhere in
the world, for the term “unit trust” to apply in circumstances other than where under the applicable trust deed:
(i) the beneficial interest in the trust fund is divided into units; and
(ii) the units when created or issued are held by persons for whom the trustee maintains and administers the estate.
(f) The legislative purpose behind Division 6C is to treat unit trusts in a similar way to companies for tax purposes. The relationship established by the Trust Deed
between ElecNet and an employee is not analogous to the relationship between a shareholder and company:
(i) the entitlement of employees under the EISS is not divided into units in the way that a shareholder’s entitlement in a company is divided into shares;
(ii) a payment by an employer to ElecNet that is credited to an employee is not analogous to a person subscribing to the capital of a company
and obtaining rights to a proportion of its profits in return; and
(iii) a payment to an employee by ElecNet is not analogous to a dividend paid to a shareholder in a company, because the payment
is at the discretion of ElecNet and the quantum of payment differs from employee to employee.
The High Court decision helpfully identifies some of the key indicators of a unit trust. In establishing a trust, it is crucial to choose a structure and trust terms that suits the circumstances.