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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.

This ruling applies for the following period

Year ending 30 June 2011

The scheme commenced on

16 December 1986

Relevant facts

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

The eligible beneficiaries include:

a) Person A and Person B

b) Children, grandchildren or great grandchildren of either Person A or Person B

c) Spouses (including former spouses), parents, parents-in law, bothers, sisters, brothers-in-law of the above named eligible beneficiaries

d) Companies and trusts which any eligible beneficiary of the trust is a director, shareholder or beneficiary.

Person B has the power to change the trustee of the Trust.

The Trustee has the power to amend the Trust Deed (clause 5(3)).

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 B can receive capital distributions from the Trust, unless:

a) Person A and B consent - while they are alive; or

b) If Person A and B are not alive - both of their children consent.

The Variation would introduce the following definitions:

"capital gain" has the same meaning as in section 995 of the Income Tax Assessment Act 1997

"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 A and person B.

The Deed of Variation would also add the following clauses:

3(6) The Trustee must not distribute any portion of a capital gain that is included in the income of the Trust Fund to any beneficiary who is not a Family Beneficiary unless the Parents consent or, if there is no surviving Parent, all surviving Family Principals consent.

4(8) Notwithstanding any other provision, the Trustee must not make any distribution under this clause 4 to a beneficiary who is not a Family Beneficiary unless the Parents consent or, if there is no surviving Parent, unless all surviving Family Principals consent.

Following the end of clause 5(3):

Provided that the Trustee must not amend this deed in a way that amends or changes the effect of clause 3(6), clause 3(1) or clause 4(8) unless the Parents consent or, if there are no surviving Parents, unless all surviving Family Principals consent.

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.

Relevant legislative provisions

Section 104-55 of the Income Tax Assessment Act 1997

Reasons for decision

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

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 Persons A and B 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 Persons A and B, 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 Persons A and B 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 clause 3(1) of the current trust deed:

The trustee shall hold the income for that year of the Trust fund UPON TRUST either:-

(a) to pay or apply the whole or any part of the same in the absolute and uncontrolled discretion of the Trustee to or for the benefit of any one or more of the Eligible Beneficiaries (whether to the exclusion of some or all of them or not) …

The Trustee had the power to appoint or remove any beneficiaries under clause 2, as well as the general power to amend the deed under clause 5(3).

In the exercise of the Trustee's powers the Deed states at clause 5(1):

a) Every discretion or power hereby conferred upon the Trustee shall be exercisable by the Trustee in his absolute and uncontrolled discretion …

Under the Deed of Variation, the Trustee's powers are limited in respect of the capital beneficiaries being the Family Beneficiaries. The proposed clause 3(6) would remove the Trustee's discretion in respect of the distribution of income where that income includes a capital gain. Furthermore, clause 4(8) 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 clause 5(1).

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 addition to clause 5(3) would limit the power to amend the deed by placing certain restrictions on the Trustee in respect of making amendments to clauses 3(6), 3(1) and 4(8).

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.