5.5 Changes to the terms of the trust
It is important to distinguish between changes which are merely procedural and those which fundamentally redefine the relationship between the trustee and beneficiaries in respect of the trust property. It is generally only changes of the latter type which will give rise to a new trust. However:
- it is sometimes unclear whether a variation of terms is fundamental or merely procedural
- extensive procedural changes may be taken into account along with other changes in considering whether there is a new trust
- in some circumstances new trusts have been held to arise even though their terms have been very similar to a prior arrangement (eg Davidson v. Chirnside).
The application of the general principle can be seen in the following examples.
Conversion of a trust to a unit trust
The deed of a fixed trust is converted to substitute interests in the trust property for units and to allow the trustee to issue and redeem units.
In our view, the conversion of a non-unitised fixed trust to a unit trust may involve a fundamental change in the trust relationship. It may also be indicative of a new trust purpose, involving the creation of an actual or potential joint investment vehicle. The ATO would generally regard such a conversion as the creation of a new trust.
Conversion of a fixed trust to a 'hybrid' discretionary trust
The deed of a fixed trust (unitised or otherwise) is amended to give the trustee a discretionary power of appointment over the income of the trust.
Although the new discretionary beneficiaries may not have a proprietary interest in the trust fund, the rights of the holders of previously fixed interests are radically changed. Previously, they would be presently entitled to, and accordingly had a right to demand, payment of all income. Now, assuming a mere power, any rights would only be in respect of the unappointed residue, if any. In this situation the essential nature and character of the trust relationship changes and a new trust estate comes into being.
Conferring a power to accumulate income
A trustee is given the discretion to accumulate income to which beneficiaries previously would have been presently entitled.
The new discretion involves a material change in beneficiaries' rights. However, in the ATO's view this change will not usually be sufficient in itself to alter the essential nature and character of the trust relationship, and thus result in a new trust. Whether it does or not will depend on the essential nature of the change and its effects.
The ATO will accept that creating a power to accumulate is in itself consistent with a continuing trust where the retained income will accumulate solely for the benefit of those same beneficiaries who would have been presently entitled before the change.
The beneficiaries of a unit trust are presently entitled to each year's income in proportion to their unit holdings. The deed is varied to give the trustee the discretion to accumulate some, or all, of the income. The beneficiaries' beneficial interests in the accumulated income are unaltered, and they are entitled to share in any distribution of income in proportion to their unit holdings.
Here, the accumulation power can be seen as enabling the trustee to decide from time to time whether the interests of the beneficiaries are best served by retaining or distributing income. Where any accumulations can only be for the benefit of those otherwise entitled to the income, the ATO accepts that conferring the power, in itself, alters the management of the trust's undertaking rather than the essential nature of the trust relationship itself. In the absence of other factors pointing to a new trust, the ATO accepts that no new trust estate arises.
A discretionary trust deed ensures that beneficiaries are presently entitled to all income. It is varied to confer on the trustee a power to accumulate.
Provided that accumulations can only be appointed among the same class of beneficiaries as would otherwise have been presently entitled, the ATO view this situation in the same way as Example 5.5.4. In the absence of other factors, the variation goes to the management of the trust's undertaking rather than the essential nature of the trust relationship.
A unit trust has X units with present entitlement to all income and Y units with rights to capital. The trustee is given a new discretion to accumulate income and add it to capital.
In contrast to the previous examples, here the effect of the change is to redefine the nature of the equitable interests in the trust fund. There is a fundamental change in the essential nature and character of the trust relationship, and this will bring about a new trust estate.
Definition of trust income
The insertion or variation of any 'income' definition in a trust deed potentially alters the substantive rights of beneficiaries. For example, if a deed defined 'income' as net income for the purposes of section 95 of the Income Tax Assessment Act 1936 the respective rights of capital and income beneficiaries could be significantly different than if the term was undefined and ordinary trust law concepts applied. See, for example, the effect of the definition considered in FCT v. Australian and New Zealand Savings Bank Limited 98 ATC 4850.
Although inserting or varying an income definition may materially change the rights of beneficiaries, it may not in itself alter the essential nature and character of the trust relationship so as to result in a new trust estate. The ATO will accept that no new trust estate arises where, in the absence of other factors:
- it can be reasonably concluded that the purpose and effect of the new definition is to clarify rather than significantly redefine entitlements to income and capital
- where there is a significant change in respective entitlements, it is between the rights of a single beneficiary or class of beneficiary, rather than between different beneficiaries or classes of beneficiaries.
The second criterion reflects the principle which the ATO will apply to powers of accumulation. The changes under this heading are those which may affect a beneficiary's access to distributions at a particular time but not the essential nature of his/her interest in the trust.
The property of a unit trust consists of an annuity with a substantial purchase price. The deed is amended to define 'income' as net income for the purposes of section 95 of the Income Tax Assessment Act 1936. There was no previous definition.
If the trust resembled Example 5.5.4, where income and capital rights accrue to the same units, the ATO would accept in the absence of other factors that there was no fundamental change in the trust relationship and no new trust estate. The change affects distribution of funds rather than the essential character of beneficiaries' interests. By contrast, if the trust resembled Example 5.5.6 the change would significantly alter entitlements between the two classes of units and be a strong indicator of a new trust relationship.
Given the uncertainty of the law and lack of clear judicial and ATO guidance in the past, the ATO will give less weight to changes or insertions of income definitions as indicia of a new trust when considering alterations made before the release of this statement. This will be so even if the effect of the change is such that it meets neither of the above criteria.
For instance, in response to the introduction of capital gains tax, deeds without an income definition may have been amended to define 'income' as tax law 'net income'. Where the variations took place before the release of this statement the ATO will not treat these changes as having in themselves terminated the previous trust. As with other factors which may not in themselves be determinative, they will be taken into account if accompanied by other features indicative of the creation of a new trust. For future arrangements, the principles outlined above will be applied.
Changes which are merely procedural or administrative generally will not in themselves amount to the creation of a new trust. These could include:
- changes in the person acting as trustee or manager
- changes which merely affect administrative and 'housekeeping' procedures without substantially altering the rights of the beneficiaries in respect of the trust property.
It should be noted that changes may substantially alter beneficiaries' rights even though their interests are not adversely affected. What is important is the extent and nature of the change to the bundle of rights making up the beneficiaries' respective interests.
Once again, administrative and procedural changes will be taken into account when accompanied by other features pointing towards the creation of a new trust.