Edited version of private advice

Authorisation Number: 1051872353826

Date of advice: 27 July 2021

Ruling

Subject: Will the proposed conversion of the Trust from a discretionary trust to a unit trust trigger CGT Event E1 or E3 or have consequences under CGT Event C2 Income Tax Assessment Act 1997 (ITAA 1997)?

Question 1

Will the proposed conversion of the Trust from a discretionary trust to a unit trust trigger CGT Event E1 pursuant to section 104-55 Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the proposed conversion of the Trust from a discretionary trust to a unit trust trigger CGT event E2 pursuant to section 104-60 of the ITAA1997?

Answer

No.

Question 3

Will the proposed conversion of the Trust from a discretionary trust to a unit trust result in a gain or loss under CGT Event C2 to happen to the Trust's beneficiaries pursuant to section 104-25 of the ITAA 1997.

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2022

Ongoing

The scheme commences on:

1 July 2021

Relevant facts and circumstances

The X Service Trust (Trust) is currently a discretionary trust and operates as a service entity for X Practice. At all times the directors of the Trustee have been YY and ZZ who are both practicing doctors at X Practice.

The Trustee proposes to amend the Trust Deed in accordance with the draft Deed of Amendment (Proposed Amendments). The Proposed Amendments are intended to remove the discretionary distribution powers of the Trustee in order to ensure that all future distributions of income and capital are fixed in accordance with the proportion of units held by each beneficiary. The proposed amendments will have the effect of converting the Trust from a discretionary (non-fixed) trust to a unit (fixed) trust. The Trust Deed has not previously been amended.

Under the Trust Deed, the named beneficiaries are 'XX and the spouse of XX' and 'YY and the spouse of YY'. Under the Proposed Amendments, it is intended that the family discretionary trusts of each of XX and YY are to be made the holders of the units in the Trust. The Proposed Amendments will not impact the continuity of the property or membership of the Trust and the beneficiaries of the Trust will, in substance, remain the same as the new holders of the units in the Trust.

The reason for the Proposed Amendments is to enable investment in the Trust through the issue or sale of new units.

Assumptions

1.     The Trustee has the power to amend the clauses of the Trust Deed under the Trust Deed;

2.     The Proposed Amendments are within the amendment powers of the Trust Deed and do not enliven any restrictions or limitations on the power of amendment under the Trust Deed;

Relevant legislative provisions

Section 104-55 ITAA 1997

Section 104-60 ITAA 1997

Section 104-25 ITAA 1997

Section116-30(2) ITAA 1997

Reasons for decision

Questions 1 and 2

Summary

In accordance with the assumptions, the Proposed Amendments to the terms of the Trust are made in proper exercise of a power of amendment and are properly supported by that power.

Consistent with the Commissioner's views in TD 2012/21, CGT Events E1 or E2 will not apply to the Proposed Amendments.

Detailed reasoning

The application of CGT Event E1 or E2 to amendment to a trust deed will generally turn on questions of trust law, concerning the scope of the variation power in the trust instrument.

In TD 2012/21 the Commissioner states that CGT event E1 or E2 will not 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 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.

The Commissioner accepts the general proposition that where there is some continuity of property and membership of the trust, changes to the terms of a trust that are made in proper exercise of a power of amendment will not terminate the trust where they are properly supported by that power. Accordingly, the scope of the amendment power and the validity of its exercise in a particular case will be critical.

Application to the X Service Trust Deed.

The facts of this ruling contain an assumption that the Trustee has the power to amend the Trust Deed in accordance with the Proposed Amendments.

In accordance with the assumption:

•                 The proposed amendments will not result in the termination of the Trust, provided that the amendments are validly made within the scope of the amendment power.

•                 the proposed amendments will not, if valid, result in any assets of the Trust being held on new and different trusts.

On the basis of the assumption that the proposed amendments are valid, and in accordance with the views expressed in TD 2012/21, neither CGT event E1 or E2 will happen by reason of the variation of the trust instrument.

Question 3

Summary

On the facts and circumstances, the proposed conversion of the discretionary interest to a fixed interest will not impact the continuity of the property or membership of the trust. The proposal is such that the beneficiaries of the Trust receiving replacement units for their discretionary beneficial interest will, in substance, remain the same as the new holders of the units in the Trust and will not have consequences from the proposed change under CGT event C2..

The proposed conversion will also have the outcome that CGT Event C2 will have no consequences for beneficiaries of the Trust that do not receive units, after the application of the market value substitution rules.

Detailed reasoning

Under section 104-25 ITAA 1997, CGT Event C2 happens if ownership of an intangible CGT asset ends by the asset:

a) being redeemed or cancelled;

b) being released, discharged, or satisfied;

c) expiring;

d) being abandoned, surrendered or forfeited;

e) if the asset is an option - being exercised; or

f) if the asset is a convertible note - being converted.

It is the ATO's view (TD 2001/26) that an interest in a discretionary trust is a CGT asset.

TD 2001/26 states that the cost base of a beneficiary's interest in the discretionary trust is likely to be nil, however:

Whether the default beneficiary's interest has any substantial value or not will need to be determined on a case by case basis depending in each case on the terms of the particular trust and its purpose, the past history of distributions made by the trustee in favour of the default beneficiary and all the other circumstances of the particular case

In addition, CGT Event C2 ITAA 1997 has a particular market value substitution rule outlined in s116-30(2)(b)(ii):

If you received no capital proceeds from a CGT event, you are taken to have received the market value of the CGT asset that is the subject of the event. (The market value is worked out as at the time of the event.)

Example: You give a CGT asset to another entity. You are taken to have received the market value of the CGT asset.

There are capital proceeds

(2) The capital proceeds from a *CGT event are replaced with the *market value of the *CGT asset that is the subject of the event if:

(a) some or all of those proceeds cannot be valued; or

(b) those capital proceeds are more or less than the market value of the asset and:

(i) you and the entity that *acquired the asset from you did not deal with each other at * arm's length in connection with the event; or

(ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings).

Application to the X Service Trust Deed.

As a result of the proposed conversion of the discretionary trust to a unit trust the interests of the beneficiaries that do not receive units will end. Under the proposal, where units are received the discretionary right will be converted to a fixed interest in the income and assets of the trust.

Under the proposed arrangement, the Proposed Amendments (in accordance with the assumptions):

1.               will not terminate the Trust;

2.               will not create a new Trust;

3.               will not impact the continuity of the property or membership of the trust in that the beneficiaries of the Trust will, in substance, remain the same as the new holders of the units in the Trust; and

Beneficiaries that do not receive units

In this case, as a result of the proposed "conversion" of the discretionary trust to a unit trust the interests of the beneficiaries that do not receive units will "end" (or otherwise be extinguished).

The CGT proceeds received for the ending of the units is nil, as no legal consideration is proposed to be received for these beneficiaries. Relying on TD 2001/26, the cost base of a beneficiary's discretionary interest is likely to be nil, and in the circumstances of this case and the proposed arrangement there is nothing in the scheme facts that would indicate the respective CGT cost base of the beneficiaries interest is not nil.

Given there were no capital proceeds, the "market value substitution rule" in Division 116 of the ITAA 1997 has application and there will be no consequences from the operation of CGT event C2.

Under Section 116-30(2), the capital proceeds are replaced with the market value of the asset that is the subject of the CGT event where the capital proceeds are more or less than the market value of the asset and the relevant CGT event is C2. In the facts and circumstances of this case it is reasonable to take the position that no capital gain or loss will arise and CGT event C2 will not have consequences for beneficiaries for which the beneficial interest is proposed to end.

Beneficiaries that do receive units

In the circumstances of this case, where units are received, the discretionary right will be converted to a fixed interest in the income and assets of the same trust.

The interest held previously as a discretionary interest will be converted to a fixed interest, such that there is still an interest in the same trust and CGT event C2 will not have any consequences upon the conversion of the interest. On the facts and circumstances in the current case, the conversion of the discretionary interest to a fixed interest will not impact the continuity of the property or membership of the trust such that the beneficiaries of the Trust will, in substance, remain the same as the new holders of the units in the Trust.