Edited version of your private ruling

Authorisation Number: 1012548198754

Ruling

Subject: Capital gains tax

Question 1

Did the Deed of Revocation and Resettlement (Deed 2) cause a disposal of an asset by one person and the acquisition of an asset by another person for the purposes of section 160M of the Income Tax Assessment Act 1936 ("ITAA 1936")?

Answer

Yes

Question 2

Did the Deed of Revocation and Resettlement (Deed 3) cause a disposal of an asset by one person and the acquisition of an asset by another person for the purposes of section 160M of the ITAA 1936?

Answer

Yes

Question 3

Did the Deed of Revocation and Resettlement (Deed 4) cause a disposal of an asset by one person and the acquisition of an asset by another person for the purposes of section 160M of the ITAA 1936?

Answer

Yes

Question 4

Did the Deed of Variation (Deed5) cause CGT event E1 for the purposes of section 104-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 5

Did Deed 3 cause a change in the majority underlying interests in the property of the Trust to the extent that the assets acquired on or before 19 September 1985 are considered to be acquired after that date for the purposes of section 160ZZS of the ITAA 1936?

Answer

No

Question 6

Was CGT event K6 triggered upon the sale of shares in the company pursuant to the Agreement for the purposes of section 104-230 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

Income year ending 30 June 2012

The scheme commences on:

March 1971

Relevant facts and circumstances

The Trust was created in Month 19XX (Deed 1).

The terms of Deed 1 gave the Trustee power to revoke and make void all or any of the trusts powers and provisions provided that by the same instrument, new or other trusts powers and provisions are declared for the benefit of specified beneficiaries.

The property of the Trust included 50% of the issued shares in the Company.

The Trustee of the Trust acquired the shares prior to 20 September 1985.

In Month 19YY the Trustee of the Trust executed a Deed of Revocation and Resettlement (Deed 2).

The terms of Deed 2 gave the Trustee power to revoke the presents and the trusts powers and provisions in the trust instrument

Deed 2 vested in Month 20XX

In Month 19ZZ the Trustee of the Trust executed a Deed of Revocation and Resettlement (Deed 3).

The terms of Deed 3 changed the entitlement of the beneficiaries to share in the capital of the Trust.

The Terms of Deed 3 provide that all of the terms of Deed 2, as amended, are confirmed and are to be read in conjunction with the terms of Deed 3.

In Month 19XY the Trustee of the Trust executed a Deed of Revocation and Resettlement (Deed 4).

The terms of Deed 4 increased the number of beneficiaries entitled to share in the income of the Trust.

The Terms of Deed 4 provide that all of the terms of Deed 2, as amended, are confirmed and are to be read in conjunction with the terms of Deed 4.

In June 19XZ the Trustee of the Trust executed a Deed of variation (Deed 5).

The terms of Deed 5 expanded the powers of the Trustee to distribute income, and extended the vesting date of the Trust

The Terms of Deed 5 provide that all of the terms of Deed 2, as amended, are confirmed and are to be read in conjunction with the terms of Deed 5.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 160A,

Income Tax Assessment Act 1936 Section 160L,

Income Tax Assessment Act 1936 Section 160M,

Income Tax Assessment Act 1936 Section 160U,

Income Tax Assessment Act 1997 Section 104-55 and

Income Tax Assessment Act 1997 Section 104-230.

Reasons for decision

Question 1

Detailed reasoning

The Trust) was executed in Month 19XX (Deed 1). The property of the Trust included shares in the Company. Since its establishment, the Trustee of the Trust has executed several instruments that revoke and resettle, or vary, the terms on which the trust property is held. The relevant instruments include a deed of revocation and resettlement (Deed 2), a deed of revocation and resettlement (Deed 3), a deed of revocation and resettlement (Deed 4), and a deed of variation (Deed 5).

At the time that Deed 2 was executed, the legislation that governed capital gains and capital losses was set out in Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936).

Section 160L of the ITAA 1936 provided that Part IIIA applied:

… in respect of every disposal on or after 20 September 1985 of an asset, whether situated in Australia or elsewhere or not situated anywhere, that:

(a) immediately before the disposal took place, was owned by:

(i) a person (not being a person in the capacity of a trustee) who was a resident of Australia; or

(ii) a person in the capacity of a trustee of a resident trust estate or of a resident unit

(b) was acquired by that person on or after 20 September 1985.

'Asset' was defined in section 160A of the ITAA 1936 to mean 'any form of property'.

Section 160M set out rules on what constituted a disposal or acquisition. Sub-section 160M(1) provided that a disposal was deemed to have been effected where a change in the ownership of an asset had occurred:

...where a change has occurred in the ownership of an asset, the change shall be deemed, for the purposes of this Part, to have effected a disposal of the asset by the person who owned it immediately before the change and an acquisition of the asset by the person who owned it immediately after the change.

Sub-section 160M(2) provided the meaning of 'change in the ownership of an asset' for the purposes of 160M(1):

A reference in subsection (1) to a change in the ownership of an asset is a reference to a change that has occurred in any way, including any of the following ways:

(a) by the execution of an instrument;

(b) by the entering into of a transaction;

(c) by the transmission of the asset by operation of law;

(d) by the delivery of the asset;

(e) by the doing of any other act or thing;

(f) by the occurrence of any event.

In Commissioner of Taxation v Sara Lee Household & Body Care (Australia) Pty Ltd 201 CLR 520, Callinan J stated that sub-section 160M(2) of the ITAA 1936 '... evinces an intention to cover all conceivable means of effecting the change in the ownership of an asset' (at 547).

Sub-section 160U(4) of the ITAA36 provided that where an acquisition or disposition of an asset occurred other than by way of a contract, the time of that acquisition or disposition is taken to be the time of the change of ownership from one person to another.

Change in ownership by the execution of an instrument

As stated above, a change in the ownership of an asset can occur by way of the execution of an instrument.

An instrument is not defined in the tax law. The meaning of instrument was considered in Azevedo v Secretary, Department of Primary Industries and Energy (1992) 106 ALR 683. French J was considering the meaning of 'instrument' as used in section 46 of the Acts interpretation Act 1901:

The ordinary English meaning in this context is 'a formal legal document whereby a right is created or confirmed, or a fact recorded; a formal writing of any kind, as an agreement, deed, charter, or record, drawn up and executed in technical form... (at 699)

Deed 2 is an instrument for the purposes of sub-section 160M(2) of the ITAA 1936. Deed 2 was created pursuant to Deed 1 which gave power to the Trustee to revoke the trusts powers and provisions in Deed 1.

The Commissioner accepts that the Trustee had power to create Deed 2, and that Deed 2 was a validly executed instrument. What is at issue is whether the execution of Deed 2 has terminated the trust created by Deed 1 and caused a resettlement of trust property under a new trust (Deed 2). If the trust created by Deed 1 has terminated there will have been a disposal of the trust property by the trustee of Deed 1 and an acquisition of the trust property by the trustee of Deed 2.

A trust will not terminate if there is continuity of the trust. Whether there is continuity of the trust was considered by the High Court in Commissioner of Taxation v Commercial Nominees of Australia Limited [2001] HCA 33 (Commercial Nominees), in the context of part IX of the ITAA 1936. The court stated that:

As the Full Court, and the Administrative Appeals Tribunal held, the question is one of continuity … The three main indicia of continuity … are the constitution of the trusts under which the fund (if a trust) operated, the trust property, and membership. Changes in one or more of those matters must be such as to terminate the existence of the eligible entity …, to destroy the necessary continuity … (at 36)

In coming to its decision in Commercial Nominees the High Court cited with approval the reasoning of the Full Federal Court (Commissioner of Taxation v Commercial Nominees of Australia Ltd [1999] FCA 1455). Relevantly, paragraphs 55 and 56 of the Full Federal Court decision state:

55 … in order to determine whether losses of particular trust property are allowable as a deduction from income accruing to that trust property in a subsequent income year, it will be necessary to establish some degree of continuity of the trust property or corpus that earns the income from the income year of loss to the year of income. It will also be necessary to establish continuity of the regime of trust obligations affecting the property in the sense that, while amendment of those obligations might occur, any amendment must be in accordance with the terms of the original trust.

56 So long as any amendment of the trust obligations relating to such trust property is made in accordance with any power conferred by the instrument creating the obligations, and continuity of the property that is the subject of trust obligation is established, there will be identity of the "taxpayer" for the purposes of section 278 and sections 79E(3) and 80(2), notwithstanding any amendment of the trust obligation and any change in the property itself.

The decisions of the High Court and Full Federal Court in Commercial Nominees were followed in Commissioner of Taxation v Clark [2011] FCAFC 5. In that case the Full Federal Court had to determine whether changes to the property, membership and operation of the trust had caused a termination of the trust for the purposes of Division 6 of Part III of the ITAA 1936. In finding there was a continuity of the trust the court stated:

When the High Court in Commercial Nominees spoke of trust property and membership as providing two of the indicia for the continued existence of the eligible entity or trust estate, the Court was not suggesting that there had to be a strict or even partial identity of property for the first and objects for the second. It was speaking more generally: that there had to be a continuum of property and membership, which could be identified at any time, even if different from time to time; and without severance of one or both leading to the termination of the trust in question. In the present case, the Commissioner never contended, nor on the evidence could he, that there was a severance in the continuum of trust property and objects of the CU Trust. Their identity changed from time to time, but not their continuum (at 87).

The Commissioner's view on this issue is stated in Taxation Determination TD 2012/21 which considers whether CGT event E1 or E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 happens where 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. It states:

1. No. In these circumstances neither CGT event E1 nor CGT event E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 (ITAA 1997) happens unless:

· the change causes the existing trust to terminate and a new trust to arise for trust law purposes, or

· the effect of the change or court approved variation is such as to lead to a particular asset being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust.

…

20. It is clear following Clark that, at least in the context of recoupment of losses, continuity of a trust estate will be maintained so long as the trust is not terminated for trust law purposes. As such, in the absence of termination, tax losses being carried forward by a trustee will as a general rule remain available to be recouped against relevant trust income derived in future years of income.

21. Furthermore, as a general proposition, it would seem that the approach adopted by the Full Federal Court in Commercial Nominees , as explained by Edmonds and Gordon JJ in Clark , is authority for the proposition that assuming there is some continuity of property and membership of the trust, an amendment to the trust that is made in proper exercise of a power of amendment contained under the deed will not have the result of terminating the trust, irrespective of the extent of the amendments so made so long as the amendments are properly supported by the power…

Is there continuity of trust in Deed 1?

The meaning to be given to the terms of an instrument of trust (construction) was considered In Montevento Holdings Pty Ltd & Another v Scaffidi & Another [2012] HCA 48, where the Court had to consider whether the appointment of a trustee under a power of appointment was valid. In finding that the appointment was not valid the court stated that to determine the meaning of clauses in an instrument it is necessary to consider the ordinary and natural meaning of the clauses:

It is enough to say that cl 11.03 does not bear the meaning which the first respondent attributed to it. The ordinary and natural meaning of the clause is that any natural person who holds the office of appointor may not be appointed as trustee..., when cl 11.03 is read in the context of the whole document, which repeatedly distinguishes between an "individual" (in the sense of a natural person) and a corporation, the clause must be read in the manner indicated by Buss JA… (at paragraph 25)

Buss JA made the following dissenting comments in the full Federal court regarding the construction of an instrument (Scaffidi v Montevento Holdings Pty Ltd [2011] WASCA 146 at paragraphs 65 and 66):

65 The construction of an instrument involves ascertaining what a reasonable person would have understood the parties to the instrument to mean. Consideration should ordinarily be given not only to the language of the instrument, but also to the surrounding circumstances known to the parties when the instrument was executed, and the apparent purpose and object of any transaction created by or evidenced in the instrument. These propositions were enunciated in Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd [2004] HCA 52; (2004) 219 CLR 165 [40] (Gleeson CJ, Gummow, Hayne, Callinan & Heydon JJ) in the context of an instrument that was a contract. However, the propositions are applicable to instruments generally, subject to any particular rules of construction which have been developed in relation to a particular kind of provision or instrument.

66 If a clause in an instrument is to be construed, the words of the clause are to be given their natural and ordinary meaning in the context of the language of the instrument as a whole, and also the surrounding circumstances known to the parties when the instrument was executed, and the apparent purpose and object of any transaction created by or evidenced in the instrument. The words of the clause are to be given the most appropriate meaning which they can legitimately bear.

As discussed above, Deed 2 was executed pursuant to a power contained in Deed 1, which gave the Trustee power to revoke and make void all or any of the trusts powers and provisions provided that by the same instrument, new or other trusts powers and provisions are declared for the benefit of specified beneficiaries.

The words 'revoke' and 'void' are not defined in Deed 1. Accordingly, these words must take their ordinary meaning. 'Revoke' is defined by the Macquarie Dictionary Online to mean '...to take back or withdraw; annul, cancel, or reverse; rescind or repeal…' Void is defined by the Macquarie Dictionary Online to mean '… without legal force or effect; not legally binding or enforceable…'

The terms of Deed 2 provide that the trusts created by Deed 1 are revoked, and replaced by the trusts created by Deed 2

On an ordinary reading of the terms of Deed 2, Deed 1 has been terminated. The recitals to Deed 2 show that the Trustee intended that Deed 1 be revoked and the trust property resettled under Deed 2, and the operative provisions put into action that intention. As such, there was a disposal of the trust property by the Trustee of Deed 1 and an acquisition of the trust property by the Trustee of Deed 2 for the purposes of section 160M of the ITAA 1936. In accordance with section 160U of the ITAA 1936 the date of disposal and acquisition was the date ownership of the property changed from the Trustee of Deed 1 to the Trustee of Deed 2 (the date of execution of Deed 2).

From Month 19YY the Trust was subject to the terms of Deed 2.

Question 2

Detailed reasoning

As discussed in question 1, whether the property the subject of Deed 2 has been disposed of for the purpose section 160M will depend on whether there is continuity of trust in Deed 2, or a new trust is created under the terms of Deed 3.

Deed 3 is an instrument for the purposes of sub-section 160M(2) of the ITAA 1936. Deed 3 was created pursuant to Deed 2 which gave power to the Trustee to revoke the presents and the trusts powers and provisions in Deed 2.

The terms of Deed 3 revoked the definition of Capital Beneficiary and replaced it with a new definition of Capital Beneficiary. The terms of Deed 2 otherwise prohibited the Trustee from changing the definition of Capital Beneficiary.

Deed 2 prevents the Trustee from amending or varying the definition of Capital Beneficiary. By the terms of Deed 2 the Trustee could not change the definition, except by using the power of revocation and resettlement, which it did. On an ordinary reading of the terms of Deed 2, any change to the definition of Capital Beneficiary could not occur without a revocation of Deed 2 and a resettlement of the trust property under a new trust. The Trustee did not otherwise have the power to validly change the definition of Capital Beneficiary.

As such, there was a disposal of the trust property by the Trustee of Deed 2 and an acquisition of the trust property by the Trustee of Deed 3 for the purposes of section 160M of the ITAA 1936.

From Month 19ZZ the Trust was subject to the terms of Deed 3.

Question 3

Detailed reasoning

In the period between the execution of Deeds 3 and 4, section 160M of the ITAA 1936 was amended by the Tax Laws Amendment Act (No. 2) 1994, which introduced a new paragraph 160M(3)(a). The amendment applied from 12 January 1994. Paragraph 160M(3)(a) provided as follows:

160M(3) Without limiting the generality of subsection (2), a change shall be taken to have occurred in the ownership of an asset by:

(a) the creation of a trust, by declaration or settlement, over the asset, other than where either:

(i) all of the following sub-subparagraphs apply:

a. the person who owned the asset immediately before the creation of the trust is the sole beneficiary of the trust;

b. that person is absolutely entitled to the asset as against the trustee or would, but for a legal disability, be so entitled;

c. the trust is not a unit trust; or

(ii) all of the following sub-subparagraphs apply:

a. the trust is created by the transfer of an asset to a trust from another trust;

b. the beneficiaries of the trusts are identical;

c. the terms of the trusts, including the interest of each beneficiary in the income and corpus of the trusts, are identical;…

For the purposes of the current question, the above amendment does not change in a material way the enquiry to be made in determining whether a disposal of an asset has occurred for the purpose of section 160M of the ITAA 1936. It is necessary to determine whether there is continuity of Deed 3, or a new trust created under the terms of Deed 4.

By Deed 3 all of the terms of Deed 2 unaffected by Deed 3, were confirmed and are to be read in conjunction with the terms of Deed 3.

Deed 4 was created pursuant Deed 2 which gave power to the Trustee to revoke the presents and the trusts powers and provisions in the trust instrument.

The terms of Deed 4 revoked the definition of Income Beneficiary and replaced it with a new definition of Income Beneficiary. The terms of Deed 2 otherwise prohibited the Trustee from changing the trusts declared by the instrument and the definition of Income Beneficiary.

Deed 3 prevents the Trustee from amending the trusts declared in Deed 3 and the definition of Income Beneficiary. By the terms of Deed 2 the Trustee could not change the Trusts declared by Deed 3, or the definition of Income Beneficiary, except by using the power of revocation and resettlement, which was used to effect the change. On an ordinary reading of the terms of Deed 2, any change to the trusts declared in Deed 3 and the definition of Income Beneficiary could not occur without a revocation of Deed 3 and a resettlement of the trust property under a new trust. The Trustee did not otherwise have the power to validly amend the trusts declared by Deed 3 and the definition of Income Beneficiary.

As such, a new trust was created by settlement (deed 4) for the purposes of paragraph 160M(3)(a). However, there will be no disposal if the exceptions at sub-paragraphs 160M(3)(a)(i) and 160M(3)(a)(ii) apply. In the circumstances, the exceptions are not considered to apply. Sub-paragraph 160M(3)(a)(i) applies where the person that owned the asset before the creation of the trust is the sole beneficiary of the trust; the Trust is not a sole beneficiary trust. Sub-paragraph 160M(3)(a)(ii) applies where the beneficiaries are identical and the terms of the trust are identical; Deed 4 increases the number of Income Beneficiaries of the Trust.

The execution of Deed 4 caused a disposal of the trust property by the trustee of Deed 3 and an acquisition of the trust property by the trustee of Deed 4 for the purposes of section 160M of the ITAA 1936.

From Month 19XY the Trust was subject to the terms of Deed 4.

Question 4

Detailed reasoning

In the period between the execution of Deeds 4 and 5, section 160M of the ITAA 1936 was repealed and replaced by Division 104 of the ITAA 1997. Division 104 sets out the CGT events for which an entity can make a capital gain or loss, how to work out if an entity has made a gain or loss, and the time of the event.

Paragraph 160M(3)(a) of the ITAA 1936 was replaced by CGT event E1 in section 104-55 of the ITAA 1997. Sub-section104-55 (1) provides that:

CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement.

Whether or not an E1 event has occurred by the execution of Deed 5 will depend on whether there is continuity of the trust created by Deed 4, or a new trust created under the terms of Deed 5.

By Deed 4 all of the terms of Deed 2 and Deed 3, unaffected by Deed 4, were confirmed and are to be read in conjunction with the terms of Deed 4.

Deed 5 was created pursuant Deed 2 which gives power to the Trustee to vary, modify, repeal, add to, extend the scope of, or amend the powers, discretions or authorities contained in the trust instrument, subject to specified exceptions.

The terms of Deed 5 vary the Trustees powers with respect to the distribution of income, and vary the vesting date of the Trust.

The Commissioner accepts that the Trustee had power to amend its powers with respect to distribution of income. However, the Commissioner does not accept that the Trustee had power to change the vesting date. Deed 2 expressly prevents the Trustee from making changes to the definition of vesting date. The Trustee did not have power to amend the definition of vesting day.

Deed 4 is not terminated by Deed 5 and no new trust has been settled; there is continuity of the trust instrument, trust property, and membership. As such, the execution of Deed 5 did not cause CGT event E1 to happen with regard to the trust property of Deed 4.

Although the Trustee did not have power to amend the vesting date, the Trustee has continued to manage the trust property in accordance with the terms of Deed 4 after the vesting day passed. In effect, on the vesting date an implied trust was created over the trust property the object of the Trust. At the time the Trustee of the Trust sold the shares in the Company the Trust was subject to the terms of the implied trust.

Question 5

Detailed reasoning

Sub-section 160ZZS(1) of the ITAA 1936 provides the following:

For the purposes of the application of this Part in relation to a taxpayer, an asset acquired by the taxpayer on or before 19 September 1985 shall be deemed to have been acquired by the taxpayer after that date unless the Commissioner is satisfied, or considers it reasonable to assume, that, at all times after that date when the asset was held by the taxpayer, majority underlying interests in the asset were held by natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset.

As concluded in question 1, the assets acquired on or before 19 September 1985 (Pre-CGT) the object of Deed 1 were disposed of by the Trustee of Deed 1 and acquired by the Trustee of Deed 2 on the execution of Deed 2. The assets acquired by the Trustee of Deed 2 had lost their character as Pre-CGT assets, as they were acquired after 19 September 1985. The Trustee of Deed 2 did not hold any pre-CGT property at the time Deed 3 was executed. As such, section 160ZZS has no application.

Question 6

Detailed reasoning

Section 104-230 of the ITAA 1997 describes CGT event K6 as follows:

104-230(1) CGT event K6 happens if:

(a) you own shares in a company or an interest in a trust you acquired before 20 September 1985; and

(b) CGT event A1, C2, E1, E2, E3, E5, E6, E7, E8, J1 or K3 happens in relation to the shares or interest; and

(c) there is no roll-over for the other CGT event; and

(d) the applicable requirement in subsection (2) is satisfied.

104-230(2) Just before the other event happened:

(a) the market value of property of the company or trust (that is not its trading stock) that was acquired on or after 20 September 1985; or

(b) the market value of interests the company or trust owned through interposed companies or trusts in property (except trading stock) that was *acquired on or after 20 September 1985;

must be at least 75% of the net value of the company or trust.

As discussed in question 5, the pre-CGT character of the property held in the trust created by Deed 1 was lost when the property was disposed of by the Trustee of Deed 1 and acquired by the Trustee of Deed 2. As such, at the time that the Trustee of the Trust sold the shares in the Company (the trust property), the Trustee did not hold any property that was acquired on or before 19 September 1985. As such, CGT event K6 was not triggered when the Trustee for the Trust sold the shares in the Company.