Edited version of private advice

Authorisation Number: 1051934644308

Date of advice: 21 December 2021

Ruling

Subject: Conversion of a discretionary trust to a unit trust

Question

Will the proposed amendment to the trust deed converting the Trust from a discretionary trust to a fixed unit trust cause any of CGT events E1 to E3 of the Income Tax Assessment Act 1997 (ITAA 1997) happening?

Answer

No.

This ruling applies for the following:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The X Trust (Trust) is a discretionary trust established by trust deed (Deed) on XX/XX/XX with A Pty Ltd (Trustee) as trustee.

At the date of this Ruling:

(a) the Trustee is the current trustee of the Trust

(b) Y is the sole Appointor of the Trust; and

(c) Y and his spouse K are the Specified Persons of the Trust.

The Trust conducts a business under the business name 'Z' and holds assets relating to the conduct of that business (Trust Fund).

The beneficiaries of the Trust are the Specified Persons, plus a broader class of beneficiaries which includes the children, parents, grandparents, siblings, grandchildren and great-grandchildren of the Specified Persons and their spouses, in addition to any corporations or trusts in which any of the Specified Persons have an interest.

Clause XX of the Deed provides as follows:

The Trustee may at any time and from time to time with the written consent of the Appointor (if any) by deed revoke, re-settle, add to or vary any provision of this deed or any variation of it and may by the same or any other deed declare any new or other trusts, powers or discretions concerning the Trust Fund or any part of it but so that neither the law against perpetuities nor the law relating to accumulations is infringed and so that the new or other trusts, powers, discretions, alterations or variations:

XX.1 are not in favour of or for the benefit of the Settlor or result in any benefit to the Settlor;

XX.2 do not affect the beneficial entitlement to any amount already set aside for or vested in any Beneficiary;

XX.3 do not affect the powers of any person in whom the power of removing and appointing Trustees is vested under this Deed.

Clause X of the Deed generally requires the Trustee to hold the income of the Trust Fund on trust for the Beneficiaries then living or in existence and in such proportions as the Trustee in its absolute discretion thinks fit.

Clause X of the Deed generally requires the Trustee to hold the capital of the Trust Fund on trust for the Beneficiaries then living or in existence and in such proportions as the Trustee in its absolute discretion thinks fit.

The Trust is governed by the laws of X Australia.

Proposal

The Trustee, with the consent of Y in his capacity as the Appointor of the Trust, now wishes to amend the Deed to convert the Trust from a discretionary trust to a fixed unit trust (Unit Trust). The proposed amendments will be done by a Deed of Amendment (Amendment Deed) to the original Deed.

The purpose of the proposed amendment is to enable interests in the Trust to be disposed of in the future to potential investors or to key employees.

The proposed amendments would be effected as follows:

(a)          the Deed governing the Trust will be amended strictly in accordance with the terms of clause XX of the Deed so as to convert the Trust from a discretionary trust to a Unit Trust

(b)          the Amendment Deed will revoke the original Deed in its entirety and replace it with a new Replacement Deed

(c)           the net value of the assets of the Trust will be valued immediately prior to the proposed amendment

(d)          the Trustee will create the number of units in the Trust as is equivalent to the 'net value of the assets of the Trust' divided by $1.00 (e.g., If the net value of the assets of the Trust is $1 million, 1 million ordinary units in the Trust will be created and issued)

(e)          separately, a new discretionary trust will be created on identical terms and with identical beneficiaries to that of the Trust and will be known as the 'B No 2' (Trust No 2)

(f)            the Trustee will issue 100% of the units in the Unit Trust to Trust No 2.

Following the proposed amendment, the Trust will be a Unit Trust and Trust No 2 will hold 100% of the issued units in the Trust.

The Trust will retain the same assets, TFN and ABN as attributable to the Trust immediately prior to the proposed amendment.

Finally, no beneficiary of the Trust will be absolutely entitled to any CGT asset of the Trust as against the Trustee immediately prior to the proposed amendment.

Assumptions

This Ruling is based on the following assumptions:

(a)          The amendments as set out in the proposed Deed of Amendment constitute a valid exercise of the Trustee's power contained in Clause XX of the original trust Deed.

(b)          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

Income Tax Assessment Act 1997 Section 104-55

Income Tax Assessment Act 1997 Section 104-60

Income Tax Assessment Act 1997 Section 104-65

Reasons for decision

CGT event E1 and E2

CGT event E1[1] happens if a taxpayer creates a trust over a CGT asset by declaration or settlement. CGT event E2[2] happens when a taxpayer transfers a CGT asset to an existing trust.

In 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?) the Commissioner states that in circumstances where the terms of a trust are changed pursuant to a valid exercise of a power contained within the trust's constituent document, CGT event E1 or E2 will not happen unless:

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

(b)          the effect of the change 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.[3]

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.[4]

As detailed in the facts, the Trustee of the Trust proposes to use its power under Clause 21 of the original Trust Deed to vary the Trust from a discretionary trust to a unit trust. For the purposes of the ruling decision, it is assumed that the amendments set out in the Deed of Amendment constitute a valid exercise of the Trustee's amendment power.

Based on the assumptions, 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 converting the Trust to a unit trust.

CGT event E3

CGT event E3[5] happens if a trust over a CGT asset is converted into a unit trust and, just before the conversion, a beneficiary was absolutely entitled to the asset as against the trustee.

Paragraph 13 of 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 ITAA 1997) states that an object of a discretionary trust cannot be absolutely entitled to one or more trust's assets prior to an exercise of the trustee's discretion in their favour.

Based on the information provided, CGT event E3 will not happen when the Trust is converted into a unit trust, as no beneficiary of the Trust will be absolutely entitled to any asset, or assets of the Trust prior to the variation.

[1] Section 104-55 of the ITAA 1997.

[2] Section 104-60 of the ITAA 1997.

[3] Paragraph 1 of TD 2012/21.

[4] TD 2012/21, paragraph 21 & 26.

[5] Section 104-65 of the ITAA 1997.