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Ruling

Subject: Deed of Variation - Trust Resettlement

Question

Will the proposed amendments to the Trust give rise to Capital Gains Tax (CGT) event E1 under section 104-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Relevant facts

The Trust was established by trust deed and was varied by Deed of Variation.

The primary beneficiaries are Person A, Person B, Person C, Person D and their spouses.

Secondary beneficiaries include grandparents, parents, brothers, sisters, children and grandchildren of the primary beneficiaries, and any religious, charitable or public educational institution.

Tertiary beneficiaries are companies and trusts of which any beneficiary of the Trust is a director, shareholder or beneficiary.

Person C is the Appointer of Trust.

The Appointer has the power to appoint and remove beneficiaries and to appoint and remove the Trustee.

The Trustee has the power to amend the Trust Deed.

The assets of the Trust include real estate and other assets acquired subsequent to 20 September 1985 and the current market value of these assets (as a whole) would exceed the cost base of those assets.

The Trustee proposes to vary the Trust Deed so that only lineal descendants of Person A and C (the Parents) can receive capital distributions from the Trust, unless:

a) the Parents consent - while they are alive; or

b) If the Parents are not alive - both of Persons B and D consent.

The Variation would introduce the following definitions:

"Family Beneficiary" means each Parent and the lineal descendants of each Parent

"Family Principal" means each child of the Parent or, if the child of the Parent has died and is survived by children, the legal personal representatives

"Family Members" in respect of a person means the Spouse, grandparents, parents, siblings, children and other direct descendants of that person

"Parents" means Person C and Person A

The Deed of Variation would also add other relevant clauses.

If the Variation proceeds the Trustee will not receive any capital proceeds in respect of any of the CGT assets of the Trust as a consequence of the Variation.

The cost base of some of the CGT assets of the Trust will be less than their market value.

A capital gain or loss is made only if a CGT event happens. The CGT event at issue is CGT event E1.

Reasons for decision

Section 104-55 of the ITAA 1997 provides that CGT Event E1 happens if you create a trust over a CGT asset by declaration or settlement.

CGT Event E1 will happen where changes made to a trust alter the nature and character of the trust relationship such that the original trust ceases to exist and a new trust is created.

The Creation of a New Trust Statement of Principles August 2001 (Statement of Principles) outlines when the Commissioner will treat changes to a trust as giving rise to a new trust.

The Statement of Principles makes it clear that a change to the essential nature and character of the original trust relationship creates a new trust. Part 4 of the Statement of Principles considers a number of changes, which alone or together, may result in a creation of a new trust, including:

§ any change in beneficial interests in trust property;

§ a new class of beneficial interest (whether introduced or altered);

§ a possible redefinition of the beneficiary class;

§ changes in the terms of the trust or the rights or obligations of the trustee;

§ depletion of the trust property;

§ a change to the trust that is not contemplated by the terms of the original trust;

§ a change in the essential nature and purpose of the trust

Depending on their nature and extent, and their combination with other indicia, these changes may amount to a mere variation of a continuing trust, or alternatively, to a fundamental change in the essential nature and character of the trust relationship. In this second case, the original trust is brought to an end and/or a new trust is created.

The Statement of Principles highlights that creating a new trust will depend on the terms of the original trust, and on the powers of the trustee. In addition, the original intentions of the settlor must be considered in determining whether a new trust has been created.

In his decision in Kearn v. Hill (1990) 21 NSWLR 107, Meagher JA at 110-111, referred to Re Dyer (1935) VLR 273, where:

It was held that the power of variation contained in a particular trust deed did not extend to varying the trust in a way which would destroy its substratum.

New class of beneficial interest and a possible redefinition of the beneficiary class

Under the existing Trust Deed all beneficiaries are eligible to be considered for distribution of both the income and the capital of the Trust. Although it is the Trustee's absolute discretion as to who receives a distribution, at all times the beneficiaries remain in a pool of potential beneficiaries.

The Deed of Variation seeks to include a new definition being that of Family Beneficiaries which limits the distribution of capital to only those beneficiaries who are classed as Family Beneficiaries being the Parents and their lineal descendants.

It is noted that the intention of the Trust Deed does appear to be for the benefit of the family group defined by reference to the Parents, however there is no indication that the intention was to limit that defined group to the lineal members of the family group.

The effect of this variation is to preclude any member of the class of potential beneficiaries of the trust, who is not a Family Beneficiary, from being able to be considered by the Trustee for distribution of capital from the Trust. Although capital may be distributed outside of the Family Beneficiaries with the consent of the Parents or Family Principals, there is still a change in the relationship as the discretion of the Trustee to distribute income and capital as they see fit is removed.

By inserting the definition of Family Beneficiary the effect is twofold. Firstly, there is the introduction of a new class of beneficiaries being capital beneficiaries limited to lineal descendants of the Parents and secondly, a redefinition of the broader class of beneficiaries effectively giving rise to a class of income only beneficiaries.

Previously the Trustee had the discretion with regards to the distribution of income and capital. At all times they could choose to limit who received distributions of income and capital. The Trustee could choose to limit any capital distribution to certain beneficiaries if that was the intention.

Changes in the terms of the trust or the rights or obligations of the trustee

Under a clause of the current trust deed:

The Trustee may in its absolute discretion at any time and from time to time up to and including the perpetuity date:

Distribute all or part of the net income to or for all the beneficiaries or to one or more of them to the exclusion of the others and in such shares as the Trustee may decided.

The Trustee had the power to appoint or remove any beneficiaries under a clause, as well as the general power to amend the deed.

In the exercise of the Trustee's powers the Deed states at a relevant clause:

In exercising any power or discretion, the Trustee:-

§ is free from the control or interference of any beneficiary or other person;

§ is not required to provide any reasons for its decisions;

§ may do all things which the Trustee could do if the discretion or power was vested in the Trustee personally;

§ …

Under the Deed of Variation, the Trustee's powers are limited in respect of the capital beneficiaries being the Family Beneficiaries. The proposed clause 5.09 would remove the Trustee's discretion in respect of the distribution of income where that income includes a capital gain. Furthermore, a clause would restrict the Trustee's power to use his discretion to distribute capital unless the consent of the Family Beneficiaries was sought, which limits the powers provided under another clause.

Therefore the Trustee is no longer at liberty to exercise their discretion in relation to a class of income as well as the class of beneficiary that is to receive the distribution of income.

Furthermore, under the current deed the Trustee has the discretion to amend any or all of the Trust Deed. However, the introduction of a relevant clause would limit the power to amend the deed by placing certain restrictions on the Trustee in respect of making amendments to other clauses.

Conclusion

By varying the Trust Deed to introduce the definition of Family Beneficiaries as well as limit the Trustee's powers in relation to the Family Beneficiaries and the distribution of capital to those outside of the Family Beneficiary definition the nature and character of the trust relationship has been altered so that a new trust is created and CGT event E1 will happen.