Edited version of private advice

Authorisation Number: 1052077248394

Date of advice: 12 January 2023

Ruling

Subject:CGT events - deed of amendment

Question 1

Will executing the proposed Deed of Amendment give rise to CGT event E1 or E2?

Answer

No

Question 2

Will executing the proposed Deed of Amendment give rise to CGT event E3?

Answer

No

Question 3

Will executing the proposed Deed of Amendment give rise to CGT event E5?

Answer

No

Question 4

Will executing the proposed Deed of Amendment give rise to CGT event E8?

Answer

No

Question 5

Will executing the proposed Deed of Amendment result in any other CGT event occurring?

Answer

Yes

This ruling applies for the following period:

XXXX and XXXY income years

The scheme commences on:

XXXX

Relevant facts and circumstances

1.         The applicant applied for a private ruling about whether a proposed amendment to Trust A's deed will trigger any CGT event. They gave us copies of the original trust deed and the proposed amendment deed as supporting documents.

2.         Trust A was settled under a deed executed in XXXX. (We'll just call Trust A 'the trust' for convenience.)

3.         The trust's deed hasn't been amended yet.

4.         Broadly, the original trust deed established Trust A as a discretionary trust. The trustee has rights to allocate income and capital to beneficiaries in any proportions at their discretion. The trustee also may resolve to accumulate (and not distribute) all or any trust income, so that it becomes trust capital. If there's no resolution, the trustee is deemed to hold unallocated income for listed beneficiaries under a separate trust. But if the listed beneficiaries no longer exist, then the unallocated income will be accumulated as capital. See Table 2 for a summary of what we see as the key terms in Trust Deed, annotated to show the proposed amendments.

5.         The trust currently has 3 classes of beneficiaries: primary, secondary, and tertiary. We loosely describe the beneficiary classes in Table 1.

Table 1: beneficiaries for the trust

6.         The trust assets comprise real property.

7.         The original trust deed has a variation power, with restrictions. The trustee can (by deed) alter, vary, revoke, or add to any trust power or provision. However, another clause restricts the variation power. Variations are ineffective if they:

•                weren't approved by the appointor in writing

•                happen or take effect after the trust terminates

•                divert or modify beneficiary entitlements which have already vested, or to which beneficiaries are absolutely entitled

•                infringe the rule against perpetuities

•                result in a void provision

•                result in a permanently excluded beneficiary acquiring a beneficial interest in the trust fund or any part of it.

8.         The trustee proposes to amend the trust deed to convert the trust from a discretionary trust into a unit trust by executing a deed of amendment. It includes an execution page for the trustee and each appointor to sign. We describe the draft amendment deed in Table 2. We'll call it the amendment deed. Broadly synthesising, the amendment deed amends the original deed by:

•                removing existing beneficiaries

•                establishing the trustee for Trust D as the initial subscriber and sole unitholder

•                limiting the trustee's discretion, and requiring the trustee to distribute income and capital to beneficiaries in proportion to unit holdings

•                adding a schedule into the trust deed which, very broadly, set up rules for issuing and subscribing for new units, transferring units, paying distributions, and meetings of unit holders

•                adding a clause in that schedule that allows the trustee to create new classes of units.

9.         The (draft) amendment deed includes clauses confirming:

•                the appointors consent to the trustee varying the trust deed in accordance with the amendment power and the trust deed

•                the trustee 'acknowledges and confirms' that the amendment deed doesn't infringe any restrictions on the amendment power in the trust deed.

10.      The applicant will treat Trust D as having paid a nominal price for the units.

11.      We'll describe the ownership structure for Trust D.

•                Trust D was established with 2 classes of units: income units, and capital growth units. X units were issued in each class, with a nominal subscription price. Trust D doesn't hold any assets.

•                Company E holds all income units.

•                Trust F holds all the shares in Company E.

•                Trust G holds all capital growth units.

12.      The applicant has confirmed that immediately before the proposed amendments:

•                Trust A's trustee won't have any unsatisfied obligations to pay or distribute trust income or capital to existing beneficiaries

•                no beneficiary will be entitled to demand the trustee transfer trust assets to it

•                the trustee won't be prohibited from distributing capital to Trust D

•                Trust D won't be an excluded beneficiary under the (original) trust deed.

13.      Both Trust F and Trust G can be broadly described as discretionary trusts. The trustees have discretions to distribute (or accumulate) income and capital to any beneficiary in any proportion. They have broad classes of beneficiaries which are very similar to Trust A's original trust deed (before the amendment). Person B and Person C (and their spouses) are named as primary beneficiaries. Describing them very broadly, beneficiaries include:

•                Person B and Person C

•                Person B and Person C's relatives

•                spouses of Person B, Person C, or their relatives

•                trusts or companies in which of the individuals already covered as beneficiaries have an interest.

14.      The applicant explained their reasons for proposing the arrangement in this way. The amendment is intended to:

•                remove the trustee's discretionary powers

•                ensure that all future income and capital distributions flow to Trust D

•                allow Trust D to invest its funds by equity investments in or loans to other trusts in the family group to give it the capital to expand and operate

•                require Trust D to split income and capital distributions so that there's a clear structure and division of assets across entities in the family group which have been established for different purposes.

15.      We illustrate the current structure and proposed structure in Diagrams 1 and 2.

Diagram 1: current structure

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Diagram 2: proposed structure after the amendment

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Table 2 Summary of original trust deed, and amendments

Note: italics text is inserted by the proposed amendment. Strikethrough refers to text removed by the proposed amendment.

Table 3 Summary of Trust D's deed

Table 4 Summary of other discretionary trust deeds

Assumption

The proposed amendment is supported by the amendment power in the current trust deed.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 4-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-25

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-20

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Section 104-55

Income Tax Assessment Act 1997 Section 104-60

Income Tax Assessment Act 1997 Section 104-65

Income Tax Assessment Act 1997 Section 104-70

Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 Section 104-80

Income Tax Assessment Act 1997 Section 104-85

Income Tax Assessment Act 1997 Section 104-90

Income Tax Assessment Act 1997 Section 104-105

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 112-20

Income Tax Assessment Act 1997 Section 116-20

Income Tax Assessment Act 1997 Section 960-100

Reasons for decision

In these reasons, references to legislative provisions are in the Income Tax Assessment Act 1997, except for 'Part IVA' which means the general anti-avoidance rules in Part IVA of the Income Tax Assessment Act 1936.

General remarks about edited versions of private advice: they're not binding, and they're not guidance to other taxpayers

16.      The applicant has referred to ATO edited versions of private rulings to support their submission that converting a discretionary trust into a unit trust won't cause CGT events E1 or E2 to happen.

17.      Edited versions of private rulings issued by the ATO aren't binding and aren't intended to be public guidance. They are published for integrity reasons as a public historical record. PS LA 2008/4[1] at paragraph 2 explains that EVs

•                aren't binding (the original ruling binds the relevant taxpayer, not the EV)

•                aren't intended to provide other taxpayers with advice or guidance

•                aren't a publication approved in writing by the Commissioner

•                don't set out a general administrative practice.

18.      For those reasons:

•                we won't discuss other edited versions

•                other taxpayers shouldn't rely on this edited version (or any other) to determine how tax laws might apply to their circumstances.

This ruling doesn't address Part IVA.

19.      Very broadly, Part IVA includes a general anti-avoidance rule which disallows tax benefits where relevant parties entered a scheme for the sole or dominant purpose of obtaining them.

20.      We haven't addressed whether Part IVA could apply in this ruling.

21.      We think it's possible that Part IVA could apply where a taxpayer converted a discretionary trust into a unit trust:

•                in circumstances which achieved a tax benefit,

•                were part of a wider scheme directed at achieving tax benefits, (including where the unit trust structure makes possible a choice or election that defers taxation, such as a rollover), or

•                the cost base of the units doesn't reflect the cost base of the discretionary interests just before the conversion.

CGT background relevant to all questions: you include net capital gains from CGT events in your assessable income; some CGT events are about trusts.

22.      Very broadly, capital gains provisions assess capital gains when CGT events happen to CGT assets.

•                Section 102-5 says you include net capital gains from CGT events in your assessable income.

•                Broadly 'you' means entities recognised by tax laws generally - which include individuals, companies, and trusts. See sections 4-5 and 960-100.

•                CGT events are listed in Division 104; each CGT event prescribes specific conditions about when they happen.

•                Most (but not all) CGT events happen to CGT assets.

•                CGT assets include property, and legal and equitable rights that aren't property. See section 108-5. A note to that section says examples of CGT assets include land, buildings, and units in unit trusts.

•                If CGT events happen, you may make a net capital gain or loss from the event. Generally, you make a capital gain when the capital proceeds exceed the cost base. You make a capital loss when the reduced cost base exceeds the capital gain. Broadly, capital proceeds include the money and market value of property you receive (or are entitled to receive) when an event happens. See section 116-20. Cost base includes the money and market value of property you provide (or are required to provide) to acquire a CGT asset, and some other costs. See section 110-25.

•                Some CGT events are specific to trusts. These are the 'E' events - CGT events E1 through E9. (Ignoring CGT event E10, just relevant to attribution managed investment trusts.)

Discretionary trusts and unit trusts are shorthand terms which describe both the trustee's powers and the nature of beneficial interests in the trust income and capital.

23.      Trusts are a legal relationship between a trustee and a beneficiary, in respect of certain property. According to Jacob's Law of Trusts, the elements of that relationship are that a trustee holds property (usually legal title, but occasionally equitable title), under an obligation to deal with that property, for the benefit of others (or some purpose permitted by law).[2]

24.      The words 'discretionary trust' and 'unit trust' are shorthand terms used to describe trusts which meet certain characteristics. In Chief Commissioner of Stamp Duties v Buckle,[3] the High Court of Australia commented that the term has no fixed meaning and is used to describe features of certain express trusts. The same court made similar comments about unit trusts in CPT Custodian Pty Ltd[4]. Jacob's Law of Trusts says that 'discretionary trust' generally refers to express trusts where the trustees have powers to distribute property to beneficiaries within nominated classes, and beneficiaries don't have definite or ascertainable interests to income or capital.[5] Beneficiaries merely have standing to compel the proper administration of the trust.[6] In contrast, unit trusts divide trust property into units.[7]

Question 1

Will executing the proposed Deed of Amendment give rise to CGT event E1 or E2?

Summary

25.      No. The amendment won't cause CGT events E1 or E2 to happen. We've chosen not to characterise this amendment as terminating the trust and creating a new trust. The same trust will hold the same CGT asset after the amendment. It follows that the amendment won't create a trust over the asset by declaration or settlement, and won't transfer a CGT asset to another existing trust.

Explanation

CGT event E1: creating a trust over a CGT asset by declaration or settlement.

26.      Broadly, CGT event E1 happens when you create trusts over CGT assets, except where you're absolutely entitled. Subsection 104-55(1) says CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement. This is qualified by subsection 104-55(5). CGT event E1 doesn't happen if:

•                if you are the sole beneficiary of the trust

•                you are absolutely entitled to the asset as against the trustee, disregarding any legal disability, and

•                the trust isn't a unit trust.

27.      We'll address the elements of CGT event E1 in turn.

•                Has a relevant person created a trust over a CGT asset?

•                If yes, is that trust created by declaration or settlement?

•                Does the exception in subsection 104-55(5) apply?

First condition for CGT Event E1: will the amendment cause an entity to create a trust over a CGT asset? No. Applying TD 2012/21, we've decided that the trust will still be treated as the same trust for CGT purposes.

28.      In passing, the trust's asset is a CGT asset. The note to section 108-5 says real property (land and buildings) is a CGT asset. The trust holds a real property, so that's a CGT asset.

29.      We need to determine if the amendment will create a trust over that CGT asset.

Relevant law: exercising a valid amendment power in a trust deed usually won't terminate and resettle a trust.

30.      Broadly, the ATO view is that changes to a trust won't create a new trust for CGT purposes if they're permitted by an amendment power. TD 2012/21[8] explains this view. It says that changing the terms of a trust won't cause CGT event E1 or E2 to happen where three conditions are met.

•                The change is either a valid exercise of a power under the trust deed, or a court approved variation.

•                The change doesn't cause the existing trust to terminate and create a new trust for trust law purposes.

•                The effect of the change won't mean a particular asset has been settled under a different trust subject to a separate charter of rights and obligations.

31.      While TD 2012/21 doesn't expressly say so, presumably an amendment which subjected all trust assets to a new charter of rights and obligations (rather than just a single asset) would fail the second condition. Establishing a new charter of rights and obligations over all trust assets would usually terminate the existing trust and create another in its place. (We don't need to settle a view about whether an amendment which did create a new charter of rights would necessarily terminate and resettle a trust. On these facts, we've decided not to characterise this amendment as an entirely new charter of rights and obligations. See paragraphs 41 to 43.)

32.      The ATO view is that determining whether a variation creates a new trust for trust law purposes is about assessing continuity of the trust instrument, membership, and property.

•                The ATO's decision impact statement[9] on the Full Federal Court decision in Clark[10] confirms that determining whether a trust has been resettled is about whether the change maintains trust continuity.

•                The statement cites a continuity test from Commercial Nominees[11]. Are changes to constituent documents, trust property, and beneficiaries enough to terminate the trust?

•                TD 2012/21 applies Clark to suggest that an amendment won't terminate the trust so long as two conditions are met. First, there's some continuity of property and membership. Second, the amendment is supported by an amendment power in the trust deed. [paragraph 21]

•                While Clark and Commercial Nominees were about losses, the ATO accepts the same principles apply when determining whether trust amendments trigger CGT event E1 or E2. See TD 2012/21. [paragraph 24]

•                TD 2012/21 suggests that whether an amendment is supported by the trust deed is determined by trust law principles. The scope of the power and whether the deed explicitly specifies conditions about exercising the power are relevant questions. [paragraph 26]

33.      But determining whether an amendment deed will maintain trust continuity under trust law principles is broader than simply looking at express limitations on the amendment power. Footnote 6 of TD 2012/21 says that determining the scope of the amendment power requires construing the words of the trust deed, the surrounding context, and any relevant admissible evidence. There are also some judicial comments suggesting a purported variation which alters the trust's 'substratum' or is inconsistent with the trust's purpose would be a resettlement producing a new trust.[12]

34.      Also, TD 2012/21 adds a provison about separate trusts. It explains that some variations might create a new trust where particular assets begin to be held under a separate charter of obligations:

27. Even in instances where a pre-existing trust does not terminate, it may be the case that assets held originally as part of the trust property commence to be held under a separate charter of obligations as a result of a change to the terms of the trust - whether by exercise of a power under the deed (including a power to amend) or court approved variation - such as to lead to the conclusion that those assets are now held on terms of a distinct (that is, different) trust.

35.      TD 2012/21 cites a Victorian stamp duty case when elaborating this point. In Lam & Kym,[13]a discretionary trust had two classes of beneficiaries. The deed was amended to allow the trustee to transfer all or part of the fund to benefit any beneficiary within one of those classes. The trustee then executed an instrument declaring that it held some trust property separately in trust for named beneficiaries within the relevant class. The Court of Appeal of the Supreme Court of Victoria held that the instrument was a declaration that the real estate was held under a separate trust.[14] At paragraph 29, TD 2012/21 concludes that in similar circumstances, assets may have been settled under a different trust to the remaining trust assets.

36.      To briefly summarise, following TD 2012/21, a trust deed amendment won't create a new trust if three conditions are met. The amendment must:

•                be supported by an amendment power in the original trust deed

•                not cause the trust to terminate and resettle under general trust law principles (applying the continuity test from Commercial Nominees); in other words - set up a new charter of rights and obligations over all the trust assets

•                not cause some of the trust assets to be carved out and held under a separate charter of rights and obligations (eg, a separate trust or sub-trust).

Applying these principles: applying TD 2012/21, we've decided that the proposed amendment won't create a new trust.

37.      Here, Trust A proposes to amend its trust deed.

•                The trust deed has a broad amendment power.

•                The taxpayer describes the effect of the amendment as converting the trust from a discretionary trust into a unit trust.

•                The trustee currently has broad discretions to distribute trust income or capital within broad beneficiary classes. Tertiary beneficiaries include the trustee of another trust, in which any beneficiary (under Trust A) has an interest under that other trust.

•                After the amendment, one trust in the family group will own the sole unit in the trust, which will entitle it to all the trust's income if distributed, and any capital on winding up.

•                However, the trustee will retain some discretions. The trustee will have a discretion to accumulate income (rather than distribute it). It also will have a discretion to distribute capital before termination, in proportion to units. (The amendment doesn't appear to give beneficiaries the right to demand capital distributions before termination or to terminate the trust.) The amended deed will also allow the trustee to issue new units to subscribers and attach special rights to units.

38.      Will the amendment trigger CGT event E1? To answer this question, we'll apply the three conditions in TD 2012/21.

First condition in TD 2012/21: is the amendment supported by an amendment power? Yes. The trust deed contains a broad amendment power, and we've assumed that the amendment is supported by that power under general law.

39.      While we won't determine this issue, the amendment may be supported by an amendment power. The deed has a clause which allows the trustee (by deed) to amend any trust power or provision. Another clause restricts the variation power: variations will be ineffective in prescribed circumstances. They don't seem relevant here: see our brief discussion in Table 5. However, the proper construction of the trust deed and the effectiveness of this amendment is for a court to determine applying legal interpretation and equitable principles. We're also conscious that a court might find implied limitations from the purpose or context of the amendment power and the rest of the deed. We don't think it's appropriate to determine general law issues in this private ruling.

40.      We've assumed that the proposed amendment is supported by the amendment power in the trust deed, so the first condition is met.

Table 5: prohibited variations

Second condition in TD 2012/21: would the amendment create a new trust for trust law purposes? No. We've decided not to characterise this amendment as creating a new trust, applying the continuity test from Commercial Nominees.

41.      Applying the continuity test from Commercial Nominees, we've decided not to characterise this amendment as creating a new trust.

•                In form, the trust will retain the same deed, despite substantial amendments.

•                We don't think these amendments should be characterised as creating a new charter of rights and obligations, as we explain in paragraph 43.

•                The amendment won't change the trust property. The sole asset will be a single item of real property before and after the amendment.

•                There's arguably some continuity of membership. The proposed initial unitholder is a beneficiary under the current trust deed. While the nature of that beneficiary's interest will be different after the new trust, we've chosen to characterise the amendment as preserving membership continuity as we explain in paragraph 43.

•                Trust B is covered as an existing beneficiary, and won't be an excluded beneficiary. Its unitholders are 1) a company, in which a discretionary trust (Trust F) holds all the shares, and 2) another discretionary trust (Trust G). Both discretionary trusts have similar classes of beneficiaries to Trust A's original trust deed.

42.      We can see an argument that the proposed amendments are so extensive that they destroy membership continuity by establishing a new charter of rights and obligations.

•                A discretionary trust has a mere right of due administration. They have a right to compel the trustee to exercise their discretion and consider them as a potential beneficiary, but no right to compel the trustee to distribute income or capital to them.[15]

•                That description applies to the current trust deed. The beneficiaries - including the prospective unitholder - have no definite right to any income or capital. They merely have a hope or chance that the trustee will exercise the discretion in their favour.

•                After the amendment, the unitholder will have a right to a definite percentage of income or capital if they remain the sole unitholder. Trust B will receive 100% of any income (if distributed) and 100% of any capital (if the trust is wound up).

•                Arguably, replacing discretionary rights with fixed rights doesn't preserve continuity because they're different rights. All discretionary rights to income and capital end, and one beneficiary receives fixed rights in their place. The change can't be fairly described as a mere modification of rights.

43.      Nevertheless, on these facts, we think the proposed amendments can be characterised as preserving enough continuity (and substratum) to remain the same trust for four reasons.

•                First, the initial unitholder (Trust B) is a potential beneficiary under the current trust deed.

•                Second, the initial unitholder is established as a beneficiary by the amendment, so there's no period where the trust will lack beneficiaries. (If the unitholder had to separately subscribe after the amendment, the trust would temporarily have no beneficiaries. That might terminate the trust and create a new trust in its place.)

•                Third, we don't think the amendments will significantly change ultimate beneficial interests in the underlying asset. Taking a flow-through approach, the same broad classes of family beneficiaries will enjoy similar potential, discretionary rights to any income and capital. The unitholder is effectively owned by two discretionary trusts with similar beneficiaries to those which initially had interests under Trust A.

•                Fourth, after the amendments, the trustee will retain some discretions. Those discretions mean the unitholder won't receive income if the trustee decides to retain income. Also, the capital distributions (either before winding up, or on winding up) are at the trustee's discretion. Also, the trustee may decide to issue new classes of units with special rights to other beneficiaries. If exercised, those powers might cause the trust to retain some features of a discretionary trust, and limit the unitholders' certainty to income and capital.

44.      Nevertheless, we think it's possible that in some situations, amendments which have the effect of changing a discretionary trust into a unit trust could be characterised as a resettlement (or a new charter of rights and obligations). For example, we may have concerns if the new structure had the substantive effect of distributing income or capital to entities who were not beneficiaries under the original trust deed.[16] In some cases, the surrounding context and consequences may be relevant to determining whether an amendment was a resettlement, or a change in substratum producing that effect.

45.      Our decision in this private ruling wouldn't necessarily apply more generally to other taxpayers with similar facts. In every case, whether the variation constituted a resettlement would depend on the trust deed, the legal and practical effect of the amendments, and the surrounding circumstances.

Third condition in TD 2012/21: will the amendment establish a new charter of rights and obligations over particular trust assets? No. The amendment doesn't carve out any property from the rest of the trust fund.

46.      The next question is whether the amendments subject particular trust assets to a new charter of rights and obligations.

47.      We've decided those amendments won't have that effect here. All trust property will be held under a single trust. There's only one trust asset, and it will be held for the sole unitholder. It can't be characterised as carving off some trust property under a separate trust or sub-trust arrangement while retaining the residual property under the original trust.

Conclusion on the three conditions in TD 2012/21: the proposed amendment won't create a new trust.

48.      This amendment won't create a new trust because it meets the three conditions set out in TD 2012/21. First, we've assumed that the amendment is supported by an amendment power. Second, we've chosen not to characterise the proposed amendment as terminating the existing trust and creating a new trust over the same asset. Third, the amendment won't have the effect of carving any trust property out and subjecting it to a different trust. Therefore, an entity hasn't created a trust over a CGT asset for CGT purposes.

Second condition for CGT Event E1: is the trust created by declaration or settlement?

49.      We don't need to determine this issue because we've concluded this amendment won't have the effect of creating a new trust, but we'll address it briefly for completeness.

50.      The phrase 'declaration or settlement' is broad, covering many arrangements which create trusts. TD 2019/14[17] at paragraph 57 says that a trust is created by declaration when it is created by words or conduct demonstrating an intention to create an express trust over property. At paragraph 58, it says a trust is created by settlement when property is vested in a trustee for the benefit of others.

51.      Applying TD 2019/14, we think an amending deed would be a declaration, and if it did create a trust, would usually be a settlement.

Third condition for CGT Event E1: does the exception in subsection 104-55(5) apply?

52.      We don't need to determine this issue because we've concluded this amendment won't have the effect of creating a new trust, but it seems unlikely this exception could apply here.

53.      The exception in subsection 104-55(5) has three elements. To restate, CGT event E1 doesn't happen where:

•                there's a sole beneficiary

•                who's absolutely entitled to the asset against the trustee, and

•                the trust isn't a unit trust.

54.      The first element is met: the amendment will establish Trust B as the sole unitholder, and sole beneficiary.

55.      The second element - about absolute entitlement - won't be met. See our discussion about absolute entitlement in Question 2 at paragraphs 72 to 73.

56.      The third element won't be met either because we think the amendment will have the effect of converting the trust into a unit trust apply. See Question 2 at paragraphs 66 to 70 for our explanation.

Conclusion on CGT event E1

57.      CGT event E1 won't happen, we've concluded that the trust will still be treated as the same trust for CGT purposes.

CGT event E2: transferring a CGT asset to an existing trust

58.      CGT event E2 happens when you transfer a CGT asset to an existing trust: see section 104-60. (That's qualified by subsection 104-60(5), which sets out the same absolutely entitled beneficiary exception as for CGT event E1.)

59.      CGT event E2 can't happen. The trust won't transfer assets to another trust. It holds a single CGT asset, and will continue to hold the same asset after the amendment. Even if we characterised this amendment as ending the trust and creating a new trust, it wouldn't have the effect of transferring assets to an existing trust. (We characterised the amendment as not creating a new trust, but preserving the trust, as we explained in Question 1 at paragraphs 30 to 45.)

60.      For completeness, the exception for absolutely entitled beneficiaries is unlikely to apply - see our discussion about absolute entitlement in Question 2 at paragraphs 72 to 73.

Conclusion on Question 1:

61.      The amendment won't cause CGT events E1 or E2 to happen. We've chosen not to characterise the amendment as terminating and creating a new trust. The same trust will hold the same CGT asset after the amendment. It follows that the amendment won't create a trust over the asset by declaration or settlement, and won't transfer a CGT asset to another existing trust.

Question 2

Will executing the proposed Deed of Amendment give rise to CGT event E3?

Summary

62.      No. CGT event E3 happens when a trust with an absolutely entitled beneficiary converts into a unit trust. While the proposed amendment will convert a discretionary trust into a unit trust, no beneficiary will be absolutely entitled to trust assets just before the conversion.

Explanation

63.      CGT event E3 happens where a trust with an absolutely entitled beneficiary converts into a unit trust. Section 104-65 says it happens where:

•                a trust (that isn't a unit trust) over a CGT asset is converted to a unit trust, and

•                just before the conversion, a beneficiary under the trust was absolutely entitled to the asset as against the trustee, disregarding any legal disability.

64.      As noted at paragraph 28, the trust's assets are CGT assets.

65.      We need to determine if:

•                the amendment will convert that trust into a unit trust, and

•                any beneficiary will be absolutely entitled to the CGT assets just before the amendment.

First condition: will the amendment convert the trust into a unit trust? Yes. We think the amendment will have that effect because it divides trust capital into units.

Relevant law: unit trust doesn't have a fixed meaning, but generally means trusts which divide the trust capital into 'units,' and beneficiary rights to income and capital are determined by their unit holdings.

66.      Unit trust isn't defined, so we'll look to other guidance to explain its meaning.

67.      Dictionaries suggest unit trusts divide interests in their property into fractions which are sold to the public.

•                The Macquarie Dictionary[18]: a unit trust is a trust which purchases shares and divides its portfolio into equal units for sale to the public.

•                The Australian Oxford Dictionary[19]: an investment company investing contributions from many people into securities, and paying them dividends in proportion to their holdings.

•                The Encyclopaedic Australian Legal Dictionary[20]: a trust in which the beneficial interest in trust property is divided into fractions which are typically offered to the public. This is an express, fixed trust because all beneficiaries are ascertainable.

•                A Dictionary of Law[21]: a trust enabling small investors to buy interests in companies and other investments. The managers sell units to investors, who acquire an interest in the fund proportionate to their investment.

68.      There are two High Court (of Australia) authorities suggesting the term 'unit trust' has no fixed meaning but depends on both statutory context and the trust deed. In CPT Custodian Pty Ltd[22] the High Court said:

unit trust...does not have a constant, fixed normative meaning which can dictate the application to particular facts...

These comments were approved in ElecNet (Aust) Pty Ltd.[23] In that case, the trust was created by an employer to give certain benefits to its workers. Their rights weren't described as units and depended partly on the employer's discretion. The High Court held that the taxpayer wasn't a public trading trust for Division 6C purposes. The High Court agreed with the Commissioner that the taxpayer wasn't a unit trust. It didn't try to define the phrase beyond approving previous comments in CPT Custodian Pty Ltd.

69.      There's also comments from a stamp duty case describing a unit trust. The facts and issues aren't relevant here, so we'll just say that Softcorp Holdings Pty Ltd[24] was an appeal to the Full Court of the Supreme Court of South Australia about whether an amendment to a trust deed attracted stamp duty. O'Loughlin J described a typical unit trust as where unitholders have interests in the trust fund in proportion to the number of units they hold:

In a conventional unit trust (in the absence of special or unusual powers) the holders of units in the unit trust have an undivided interest in the whole of the trust fund in direct proportion to the number of units held by them. But this statement of the law may not necessarily hold good in the face of specific, and contrary, provisions of a unit trust deed, or in the face of some decision or action on the part of a trustee in pursuance of powers reposed by the deed in the trustee.

Applying these principles: the amendment will convert the trust into a unit trust, because entitlements to income and capital will be determined by unit holdings.

70.      Here, the first condition will be met. The applicant describes the effect of the amendment as converting a discretionary trust into a unit trust. Unit trust doesn't have a fixed meaning. We don't see anything from the context to suggest it should be limited to public unit trusts (offered to the public). Here, the beneficiaries' interests in the trust, after the amendment, are described as units. Unitholders' entitlements to income and capital are determined by their proportion of units. While the trustee has a discretion to create new classes of units, the facts don't suggest it's about to exercise that power. Even if it did, it's possible that a trust with multiple classes of units, each with different entitlements, could still be described as a unit trust. We think the trust currently can be described as a discretionary trust, and after the amendment, could be fairly described as a unit trust.

Second condition: will the beneficiary be absolutely entitled to a trust asset just before the amendment? No, because none of the beneficiaries will be able to direct the trustee to transfer it to them.

71.      We'll discuss the second condition about absolute entitlement.

72.      Broadly, the ATO view is that a beneficiary is absolutely entitled to an asset when it can direct the trustee to give it to them. TR 2004/D25[25] is about what it means to be absolutely entitled to an asset as against a trustee. We'll paraphrase some propositions it makes.

•                Absolute entitlement means a beneficiary can call for the asset to be transferred to them. [10]

•                A beneficiary is absolutely entitled where no other beneficiaries have an interest in the asset, and they can terminate the trust over the asset by directing the trustee to transfer it to them - this may happen where they have a vested and indefeasible interest. [21-22, and 41]

•                Beneficiaries are unlikely to be absolutely entitled if multiple beneficiaries have interests in trust assets. [23]

•                Nevertheless, where there are multiple beneficiaries, one beneficiary might be absolutely entitled if they can direct the trustee to give them a specific number of fungible assets. [24-25]

•                Beneficiaries under unit trusts can't be absolutely entitled to trust assets for CGT purposes; the CGT rules treat their units as being the relevant CGT assets. [5, 134, 135]

73.      No beneficiary is absolutely entitled before the proposed amendment. The current trust deed gives the trustee the discretion to distribute trust capital or trust assets to any beneficiaries at their discretion. However, beneficiaries aren't entitled to any trust assets unless and until the trustee exercises that discretion in their favour. The facts say that the trustee won't have unsatisfied obligations to pay or distribute income, capital, or assets to any beneficiary immediately before the amendment.

Conclusion on Question 2

74.      CGT event E3 won't happen. While the amendment will have the effect of converting a discretionary trust into a unit trust, no beneficiary will be absolutely entitled to a trust asset immediately before the amendment.

Question 3

Will executing the proposed Deed of Amendment give rise to CGT event E5?

Explanation

75.      Broadly, CGT event E5 happens when a beneficiary becomes absolutely entitled to a CGT asset. It doesn't apply to unit trusts or trusts covered by Division 128 (which is broadly about trusts created on death - ie, deceased estates). See section 104-75.

76.      We don't think CGT event E5 will happen here for two reasons.

77.      First, we think that the amendment will have the effect of converting the trust into a unit trust. We explained in Question 2 at paragraphs 66 to 70.

78.      Second, even if it doesn't create a unit trust, there's still some doubt about whether the sole unitholder will be absolutely entitled after the conversion. The trustee has the discretion to distribute trust capital before termination, or to wind up the trust before the vesting date. But we don't see that the unitholder has the power to compel the trustee to do either of those things at its direction. The trustee might issue new units to subscribers before the trust terminates, so the sole beneficiary mightn't have vested and indefeasible interests to the trust assets. Applying TR 2004/D25, the beneficiary mightn't be absolutely entitled.

Question 4

Will executing the proposed Deed of Amendment give rise to CGT event E8?

Summary

79.      No. One of the conditions for CGT event E8 is that a beneficiary disposes of its interest in the trust. That won't happen here because no beneficiaries will transfer their interests in the discretionary trust to other entities. Rather, the conversion will bring all those interests to an end.

Explanation

80.      CGT event E8 happens when 3 conditions are met. Section 104-90 says it happens if:

•                you are the beneficiary under a trust (except a unit trust or a trust to which Division 128 applies)

•                you didn't give money or property to acquire (the CGT asset that's) your interest in the trust capital (and you didn't acquire it by assignment)

•                you dispose of the interest or part of it (but not to the trustee).

81.      The ATO has guidance on CGT event E8. TD 2009/19[26] was about whether a taker in default could have an interest in the trust capital for CGT event E8 purposes. It said that only vested and indefeasible interests in trust capital fall within the scope of CGT event E8. Takers in default have defeasible interests so CGT event E8 doesn't happen.

82.      A couple of other provisions are relevant to interpreting CGT event E8. Subsection 104-10(2) says you dispose of a CGT asset when a change of ownership occurs from you to another entity. Section 108-5 says CGT assets are property, and legal or equitable rights which aren't property. We don't see any reason to think the terms 'disposal' and 'CGT asset' would have a different meaning in this context. Also, TD 2001/26[27] suggests that an interest in a discretionary trust is a CGT asset.

83.      CGT event E8 won't happen when the trust deed is amended because the third condition won't be met. Disposal requires a change of ownership in a CGT asset. Before the amendment, beneficiaries enjoy discretionary rights to income or capital. The beneficiary's rights are CGT assets because they're equitable rights, and that's consistent with TD 2001/26. But those beneficial interests won't change ownership; they'll end when the trust deed is amended, and no beneficiary will enjoy similar rights afterwards. It follows that no beneficiary will dispose of their interest in the trust.

84.      For completeness, the first two conditions would be met. For the first condition, the trust has beneficiaries, and before the amendment, the trust couldn't be described as a unit trust. (We discussed what 'unit trust' means in Question 2 at paragraphs 66 to 70.) The trustee has a discretion to allocate income or capital to any beneficiaries in any amounts at their discretion. Beneficiary interests aren't described as units. Further, they couldn't be fairly described as units because no beneficiary has a percentage interest in income or capital. For the second condition, we don't have any reason to think any beneficiary gave money or property for their interest in the trust or acquired their interest through an assignment. Rather, the trust deed creates classes of beneficiaries within a family group.

Question 5

Will executing the proposed Deed of Amendment result in any other CGT event occurring?

Summary

85.      Yes, but there may be no practical consequences. CGT event C1 and possibly CGT event C2 will happen when the deed is amended, because it will destroy existing rights in the trust assets. But the relevant entities are unlikely to have capital gains or losses from the amendment: the capital proceeds and cost base will both be nil.

Explanation

86.      We've identified a few possible CGT events in Table 6. We think CGT event C1 (and possibly CGT event C2) will happen as discussed in rows 2 and 3 that table.

87.      However, there will be no capital gains or losses arising from those CGT events because the capital proceeds and cost base will both be nil. See paragraphs 88 through 96.

Table 6: list of possible CGT events

Capital gains and losses from CGT events C1 and C2.

88.      Broadly, capital gains and losses are determined by comparing capital proceeds and cost base for CGT events. For CGT event C1 and C2, there's a capital gain if the capital proceeds from the loss, or destruction, or ending are more than the asset's cost base. There's a capital loss if the capital proceeds are less than the asset's reduced cost base. See subsection 104-20(3) for CGT event C1, and subsection 104-25(3) for CGT event C2.

89.      Capital proceeds and cost base are determined by rules in Divisions 116, 110, and 112.

•                Capital proceeds include money and market value of property you received (or were entitled to receive) in respect of the event happening: section 116-20.

•                Under a market value substitution rule, if you received no capital proceeds from a CGT event, you are taken to have received the CGT asset's market value, worked out as at the time of the event: section 116-30.

•                Cost base includes money paid and market value of property given (or required to be paid or given): section 110-25.

•                There's also a market value substitution rule for cost base in section 112-20. First element of cost base for an asset you acquire from another entity is its market value. However, it doesn't apply where you didn't incur expenditure to acquire it, except where your acquisition resulted from CGT event D1 or another entity doing something which didn't trigger a CGT event.

90.      Market value generally means the price that parties acting at arms' length would agree to buy or sell the asset. The phrase isn't defined; subdivision 960-S adjusts the market value but doesn't change its core meaning. But TD 2007/1[35] (about consolidation) cites cases and a textbook to the effect that market value means the price that would be negotiated between knowledgeable, willing but not anxious buyers and sellers acting at arm's length. See paragraphs 12 through 14.

91.      For completeness, we expect there would be no capital gains or losses if CGT event C1 or C2 happens. Capital proceeds and cost base will most likely both be nil for the reasons we explain in the following paragraphs.

92.      Capital proceeds and cost base would both be nil under the standard rules. Money or property wouldn't change hands on creating or ending the relevant trust interests. The facts don't suggest that beneficiaries will be compensated for losing their interests (in the discretionary trust) when the deed is amended. Discretionary beneficiaries wouldn't normally pay for their rights either: they are beneficiaries because they fit within broad classes established by the trust deed.

93.      We don't think the market value substitution rules will modify the capital proceeds or cost base here.

94.      For the capital proceeds, market value for the interests in the trust just before the CGT event would be nil. Beneficiaries under a discretionary trust have a mere right to be considered as potential beneficiaries. They have no right to receive any amount or proportion of trust income or capital unless and until the trustee exercises a discretion in their favour.[36] An arm's length buyer would be unlikely to pay for the right to be a potential beneficiary under a discretionary trust (assuming no separate influence over the trustee) because there's no guarantee the trustee would exercise any discretion in their favour. If they did, the amount is also at their discretion. Giving discretionary trust interests nil market value seems even more appropriate here because the proposed amendment will bring those rights to an end when the CGT event happens. A fully informed purchaser wouldn't buy them.

95.      For cost base, the market value rule won't apply. While the relevant beneficiaries didn't incur expenditure for their interests, they would have acquired their rights through CGT event D1 happening. CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. Beneficiaries have equitable rights (albeit mere rights of due administration) under a discretionary trust. The settlor would have created those rights in the beneficiaries when settling the trust deed. (For completeness, market value may be nil anyway for the reasons discussed in paragraph 94.)

96.      It follows that there will be no capital gains or losses if CGT events C1 or C2 happen because the capital proceeds and cost base will both be nil.

Conclusion on Question 5

97.      CGT event C1 and possibly CGT event C2 will happen when the trust deed is amended, but there will be no capital gain or loss because the capital proceeds and cost base will be nil.

[1] Practice Statement Law Administration PS LA 2008/4 Publication of edited versions of written binding advice.

[2] Heydon, JD and Leeming, MJ (2016) Jacob's Law of Trusts in Australia, 8^th edn, LexisNexis Butterworths Australia [1.01, 1.04]. Accessed at https://advance.lexis.com on 30 November 2022.

[3] Chief Commissioner of Stamp Duties (NSW) v Buckle (1998) 192 CLR 226 at 234, [1998] HCA 4 at [8] per Brennan CJ, Toohey, Gaudron, McHugh, and Gummow JJ.

[4] CPT Custodian Pty Ltd v Commissioner of State Revenue (VIC); Commissioner of State Revenue (VIC) v Karingal Holdings Pty Ltd [2005] HCA 53; (2005) 224 CLR 98 at [15] pp. 109-110 per Gleeson CJ, McHugh, Gummow, Callinan, and Heydon JJ.

[5] Heydon, JD and Leeming, MJ (2016) Jacob's Law of Trusts in Australia, 8^th edn, LexisNexis Butterworths Australia [3.14]. Accessed at https://advance.lexis.com on 30 November 2022. See also how Lord Reid from the (UK) Judicial Committee of the House of Lords described the interest of beneficiaries under a discretionary trust in Gartside v Inland Revenue Commissioners [1967] AC 553 at pp.605-606: "you cannot tell what any one of the beneficiaries will receive until the trustees have exercised their discretion."

[6] Heydon, JD and Leeming, MJ (2016) Jacob's Law of Trusts in Australia, 8^th edn, LexisNexis Butterworths Australia [3.14]. Accessed at https://advance.lexis.com on 30 November 2022. See also how Lord Wilberforce from the Judicial Committee of the House of Lords described the interest of beneficiaries under a discretionary trust in Gartside v Inland Revenue Commissioners [1967] AC 553 at pp.617-618.

[7] Heydon, JD and Leeming, MJ (2016) Jacob's Law of Trusts in Australia, 8^th edn, LexisNexis Butterworths Australia [3.10].

[8] Taxation Determination TD 2012/21 Income tax: does CGT event E1 or E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 happen if the terms of a trust are changed pursuant to a valid exercise of a power contained within the trust's constituent document, or varied with the approval of a relevant court?

[9] ATO Decision impact statement on Commissioner of Taxation v Clark [2011] FCAFC 5.

[10] Federal Commissioner of Taxation v Clark [2011] FCAFC 5 (2011) 190 FCR 206.

[11] Federal Commissioner of Taxation v Commercial Nominees of Australia Limited [2001] HCA 33 (2001) 47 ATR 220.

[12] To take three examples of cases where this issue was discussed, see Re Dyer; Dyer v Trustees, Executors & Agency Co Ltd [1935] VLR 273 (Supreme Court of Victoria - Full Court) at p. 287 per Gavan Duffy J and at p. 290-291 per Martin J (both approving first instance decision of Macfarlan J reported at pp. 277-288); Re Ball's Settlement [1968] 1 WLR 899 [1968] 2 All ER 438 (UK High Court of Justice - Chancery Division) at pp. 903-906 per Megarry J; Kearns v Hill (1990) 21 NSWLR 107 (Supreme Court of New South Wales - Court of Appeal) at pp. 110-111 per Meagher JA (Mahoney and Clarke JA agreeing).

[13] Commissioner of State Revenue v Lam & Kym Pty Ltd [2004] VSCA 204; (2004) 58 ATR 60 (Supreme Court of Victoria - Court of Appeal).

[14] Commissioner of State Revenue v Lam & Kym Pty Ltd [2004] VSCA 204; (2004) 58 ATR 60 at [47] p. 73, per Nettle JA (Vincent JA and Hansen AJA agreeing).

[15] See generally Heydon, JD and Leeming, MJ (2016) Jacob's Law of Trusts in Australia, 8^th edn, LexisNexis Butterworths Australia [3.14]. Accessed at https://advance.lexis.com on 30 November 2022. See also comments by the (UK) Judicial Committee of the House of Lords in Gartside v Inland Revenue Commissioners [1967] AC 553 at pp.605-606 per Lord Reid and at pp. 617-618 per Lord Wilberforce.

[16] We would also need to consider whether the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 applied to arrangements that produced a potential tax benefit.

[17] Taxation Determination TD 2019/14 Income tax: will a trust split arrangement of the type described in this Determination cause a new trust to be settled over some but not all assets of the original trust with the result that CGT event E1 in subsection 104-55(1) of the Income Tax Assessment Act 1997 happens?

[18] Macquarie Dictionary Publishers (2022) The Macquarie Dictionary online, (entry for 'unit trust') accessed at https://www.macquariedictionary.com.au on 1 December 2022.

[19] Oxford University Press (2004) Australian Oxford Dictionary, 2^nd edition, (entry for 'unit') accessed at https://www.oxfordreference.com on 1 December 2022.

[20] LexisNexis Australia (2022) Encyclopaedic Australian Legal Dictionary, (entry for 'unit trust') accessed at https://advance.lexis.com on 1 December 2022.

[21] Law J (ed.) (2022) A Dictionary of Law, 10^th edition, Oxford University Press (entry for 'unit trust') accessed at https://www.oxfordreference.com on 1 December 2022.

[22] CPT Custodian Pty Ltd v Commissioner of State Revenue (VIC); Commissioner of State Revenue (VIC) v Karingal Holdings Pty Ltd [2005] HCA 53; (2005) 60 ATR 371 (2005) CLR 98 at pp.109-110 [15] per Gleeson CJ, McHugh, Gummow, Callinan, and Heydon JJ.

[23] Elecnet (Aust) Pty Ltd v Commissioner of Taxation [2016] HCA 51 (2016) 259 CLR 73 at [48] p.87 per Kiefel, Gageler, Keane, and Gordon JJ.

[24] Commissioner of Stamps (SA) v Softcorp Holdings Pty Ltd (1987) 47 SASR 382 at p.386; (1987) 19 ATR 1718; at p.386 of the SASR per O'Loughlin J (Jacobs ACJ and Prior J agreeing).

[25] Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997.

[26] Taxation Determination TD 2009/19 Income tax: does a taker in default of trust capital have an 'interest in the trust capital' for the purposes of CGT event E8 in section 104-90 of the Income Tax Assessment Act 1997?

[27] Taxation Determination TD 2001/26 Income tax: capital gains: what are the capital gains tax consequences for a beneficiary of a discretionary trust who renounces their interest in the trust?

[28] Taxation Determination TD 1999/79 Income tax: capital gains: does the expression 'lost or destroyed' for the purposes of CGT event C1 in subsection 104-20(1) of the Income Tax Assessment Act 1997 apply to a) a voluntary 'loss' or 'destruction' or b) intangible assets?

[29] Macquarie Dictionary Publishers (2022) The Macquarie Dictionary online, (entry for 'lose') accessed at https://www.macquariedictionary.com.au on 28 November 2022.

[30] Macquarie Dictionary Publishers (2022) The Macquarie Dictionary online, (entries for 'cancel', 'release', 'discharge', and 'satisfy') accessed at https://www.macquariedictionary.com.au on 28 November 2022.

[31] Macquarie Dictionary Publishers (2022) The Macquarie Dictionary online, (entry for 'intangible') accessed at https://www.macquariedictionary.com.au on 28 November 2022.

[32] ATO Interpretative Decision ATO ID 2003/638 Income Tax: CGT: Capital proceeds payable by instalments - not all received - application of CGT event C2.

[33] Macquarie Dictionary Publishers (2022) The Macquarie Dictionary online, (entry for 'issue') accessed at https://www.macquariedictionary.com.au on 28 November 2022

[34] Taxation Determination TD 2003/28 Income tax: capital gains: does CGT event E4 in section 104-70 of the Income Tax Assessment Act 1997 happen if the trustee of a discretionary trust makes a non-assessable payment to a) a mere object, or b) a default beneficiary?

[35] Taxation Determination TD 2007/1 Income tax: consolidation: in working out the market value of the goodwill of each business of an entity that becomes a subsidiary member of a consolidated group, should the value of related party transactions of each business of the entity be recognised on an arm's length basis?

[36] Heydon, JD and Leeming, MJ (2016) Jacob's Law of Trusts in Australia, 8^th edn, LexisNexis Butterworths Australia [3.14]. Accessed at https://advance.lexis.com on 30 November 2022. See also how Lord Reid from the (UK) Judicial Committee of the House of Lords described the interest of beneficiaries under a discretionary trust in Gartside v Inland Revenue Commissioners [1967] AC 553 at pp.605-606: "you cannot tell what any one of the beneficiaries will receive until the trustees have exercised their discretion."

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