Edited version of private advice

Authorisation Number: 1052080456846

Date of advice: 31 January 2023

Ruling

Subject: CGT events E1 to E9 - trusts

Question 1

Will amending the trust deed of Trust A (the Trust) to remove two classes of General Beneficiaries (the Proposed Amendments) constitute a change so fundamental as to result in the termination of the Trust and the resettlement of the Trust property?

Answer

No.

Question 2

Will the Proposed Amendments cause CGT event E1 or E2 in section 104-55 or section 104-60 of the Income Tax Assessment Act 1997 (ITAA 1997) to happen?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Overview of the Trust and A Family

The Trust is an Australian resident discretionary trust. Settlement of the Trust occurred in 20XX.

The Trust was initially established for the benefit of A and B and their family, including their 3 children - X, Y and Z (collectively, the Family).

The Trust owns a factory out of which the Family's manufacturing business operates.

A valid family trust election has been in place for the Trust.

Trust Deed of the Trust

Pursuant to the Deed of Settlement for the Trust (Trust Deed):

(a)  A Pty Ltd is the trustee for the Trust (Trustee). The Trustee has shares on issue which are equally held by A and B;

(b)  C is the Settlor of the Trust; and

(c)   A is the Guardian of the Trust.

Power to amend the Trust Deed

Under the terms of the Trust Deed, the Trustee has very broad powers to vary or amend the Trust Deed with the consent of the Guardian. The Trust Deed was amended in 20XX and again in 20XX, pursuant to the terms of the Trust Deed.

The latest amendment amended the Schedule to the Trust Deed by replacing the provisions relating to the Guardian to reflect Z's appointment as Guardian of the Trust upon the passing of both of his parents.

Beneficiaries of the Trust

The beneficiaries of the Trust pursuant to the Trust Deed are the General Beneficiaries which is defined to include the following:

(a)  the Primary Beneficiaries, being A and B;

(b)  The Class A Beneficiaries, being X, together with prescribed members of their family and various related/controlled entities (as defined under the relevant clause);

(c)   The Class B Beneficiaries, being Y, together with prescribed members of their family and various related/controlled entities (as defined under the relevant clause); and

(d)  The Class C Beneficiaries, being Z, together with prescribed members of their family and various related/controlled entities (as defined under the relevant clause).

Proposed Amendments

The Family is undertaking succession and estate planning for the purposes of ensuring wealth preservation and the continuation of the Family business.

The Family is united in their intention for Z to assume control and continue to run the Family business without the involvement of their siblings or of the broader Family, upon A and B's retirement or passing.

Under such an arrangement, Z would start to control the family business, including assets and entities associated with the business, and have sole discretion over the distribution of business profits.

To this end, the Family wishes to amend the Trust Deed to remove X and Y, together with prescribed members of their families and certain related/controlled entities, as General Beneficiaries of the Trust (Proposed Amendments).

The Proposed Amendments will be carried out in exercise of the power under the Trust Deed by the Trustee executing a deed of amendment or variation with the consent of the Guardian to amend the Trust Deed.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-55

Income Tax Assessment Act 1997 subsection 104-55(1)

Income Tax Assessment Act 1997 section 104-60

Income Tax Assessment Act 1997 subsection 104-60(1)

Reasons for decision

All subsequent legislative references are to the ITAA 1997.

Question 1

Summary

No. On the basis that there is continuity in the membership and property of the Trust and the Proposed Amendments will be made in the proper exercise of the power of amendment contained in the Trust Deed, the Proposed Amendments will not cause the Trust to terminate or the property of the Trust to be settled on terms of a different trust.

Detailed reasoning

A trust resettlement is a trust law concept and occurs where one trust estate has ended and another has replaced it. The effect of such a resettlement is that a disposal of the trust assets is deemed to occur. In consequence, capital gains could accrue to beneficiaries as a result of various capital gains tax (CGT) events.

When a trust deed is varied or amended, there is a risk that this may cause a resettlement of the trust. However, taxation legislation does not contain a test for determining when a resettlement has occurred. As a result, we must look to the established cases.

Commercial Nominees

The High Court in Federal Commissioner of Taxation v. Commercial Nominees of Australia Ltd [2001] HCA 33; (2001) 75 ALJR 1172; ATR 220; ATC 4336 (Commercial Nominees) considered whether a superannuation fund was entitled to utilise prior year losses following amendments to its trust deed (including the appointment of a new trustee, the fund adopting a new set of rules and a change in the nature of benefits from defined to accumulations). The High Court addressed the issue of whether the changes to the deed resulted in a resettlement of the trust.

The High Court confirmed that the question is one of continuity and that [at paragraph 36]:

..The three main indicia of continuity [for the purposes of the former taxing regime for superannuation funds] are the constitution of the trusts under which the fund (if a trust fund) 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, or to produce the result that it does not derive the income in question, to destroy the necessary continuity.

(emphasis added)

The High Court held that resettlement did not arise because:

•         the trusts under which the fund operated were constituted by the original trust deed as varied;

•         the amendments were authorised by the trust deed;

•         the trust property and the fund members did not change; and

•         the fund before and after the amendment was administered as a single fund.

Clark

The High Court's decision in Commercial Nominees was followed in Commissioner of Taxation v. David Clark; Commissioner of Taxation v. Helen Clark [2011] FCAFC 5; 2011 ATC 20-236; (2011) 79 ATR 550 (Clark).

Clark considered whether a unit trust was able to utilise carry forward capital losses where the trust deed had undergone significant changes between incurring those losses and seeking to apply them.

Edmonds and Gordon JJ in the Full Federal Court held that there was continuity and no resettlement of the trust. Their Honours were of the view [at paragraphs 78 and 79] that the High Court in Commercial Nominees had endorsed the Full Federal Court's reasoning in Commercial Nominees (1999) 167 ALR 147 that so long as any amendments to the trust obligations are made in accordance with a power conferred by the trust instrument creating the obligations, and continuity of the property that is the subject of the trust obligations is established, then there will be identity of the taxpayer notwithstanding any amendment of the trust obligation and any change in the property itself.

Their Honours concluded [at paragraph 87] that:

...When the High Court in Commercial Nominees spoke about trust property and membership as providing two of the indicia for the continued existence of the... 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...

Following the decision in Clark, the ATO published its view of the decision in a Decision Impact Statement (DIS). In the DIS, the Commissioner considers that:

•         Clark does not change the basic proposition that, based on the authority in Commercial Nominees, the relevant focus is on whether continuity of the trust estate has been maintained.

•         As decided by Commercial Nominees, the test to be applied looks to whether changes to one or more of the trust's constituent documents, the trust property, and the identity of those with a beneficial interest in the trust property are such as to terminate the existence of the trust.

•         The principles set out in Clark have broader application. In particular, the case is relevant to the question of the circumstances in which CGT event E1 may happen by reason of a new trust coming into existence consequent on changes being made to an existing trust. In that context the ATO accepts that the reasoning of the court has the effect that a valid amendment to a trust, not resulting in a termination of the trust will not of itself result in the happening of CGT event E1.

TD 2012/21

The ATO's approach to this matter is now set out 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 the trust are changed pursuant to a valid exercise of power contained within the trust's constituent document, or varied with the approval of a relevant court? (TD 2012/21).

Paragraph 21 of TD 2012/21 explains that:

....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...

(emphasis added)

Further, paragraph 24 of TD 2012/21 provides that:

Even though Clark and Commercial Nominees were decided in the context of whether changes in a continuing trust were sufficient to treat that trust as a different taxpayer for the purpose of applying relevant losses, the ATO accepts the principles set out in these cases have broader application. Relevantly, the principles established by those cases are also relevant to the question of the circumstances in which CGT event E1 or E2 may happen as a result of changes being made to the terms of an existing trust pursuant to a valid exercise of a power in the deed (including a power to amend). In light of those principles, the ATO accepts that a change in the terms of the trust pursuant to exercise of an existing power (including an amendment to the deed of a trust), or court approved variation, will not result in a termination of the trust and, therefore, subject to the observation in paragraph 27 below, will not result in CGT event E1 happening.

(emphasis added)

Paragraph 26 of TD 2012/21 explains that:

Whether a purported change to a trust in exercise of a power under the deed is properly supported by the power is to be determined in accordance with principles of trust law having regard to the scope of the power properly construed. Relevant to this question will be whether the deed itself explicitly specifies conditions (including procedural conditions) that need to be satisfied for the exercise of the power to be effective.

Paragraph 27 of TD 2012/21 cautions that:

Even in instances where a pre-existing trust does not terminate, it may be the case that assets held originally as part of the trust property commence to be held under a separate charter of obligations as a result of a change to the terms of the trust - whether by exercise of a power under the deed (including a power to amend) or court approved variation - such as to lead to the conclusion that those assets are now held on terms of a distinct (that is, different) trust.

TD 2012/21 provides a number of examples. Of relevance to the current circumstances is Example 1 which is reproduced below:

Example 1: addition of new entities to, and exclusion of existing entities from, class of objects

2. The Acorn Trust is a family discretionary trust that was settled to benefit the members of the Squirrel Family. Under the terms of the trust deed the trustee (a private company of which Mr and Mrs Squirrel are directors) has the power at its absolute discretion to appoint income to any one or more of the General Beneficiaries. The General Beneficiaries are defined under the terms of the trust deed to be Mr Squirrel, his wife, their children, their grandchildren, and Oak Pty Ltd, a private company through which the family runs a business of growing flowers to supply local florists.

3. Having decided to get out of the flower industry, the Squirrel Family dispose of their interests in Oak Pty Ltd to an unrelated third party.

4. The trust deed for the Acorn Trust provides for a procedure for the trust to be amended, namely by trustee resolution recorded in writing. Pursuant to this procedure the trustee resolves in writing to amend the deed to specifically remove Oak Pty Ltd by name from the class of General Beneficiaries. The trustee further resolves to add to the class of General Beneficiaries:

•         the respective spouses of the children;

•         trusts and companies in which the family has a majority controlling interest; and

•         a philanthropic charity unrelated to the Squirrel Family.

5. The making of these resolutions, being a valid exercise of a power of amendment contained within the deed, does not give rise to the happening of a CGT event.

(emphasis added)

Application to your circumstances

The underlying principles encapsulated in paragraphs 21 and 24 of TD 2012/21 provide that, assuming there is some continuity of property and membership of a trust, an amendment to the trust that is made in a proper exercise of a power of amendment contained under the trust deed will not result in a termination of the trust - regardless of the extent of the amendments, so long as the amendments are properly supported by the power.

The Proposed Amendments do not materially alter the constitution or deed of the Trust under which it operates.

The changes proposed are limited to those required to effect the removal of X and Y as beneficiaries of the Trust (as well as prescribed members of their respective families and related/controlled entities of theirs). The Proposed Amendments do not involve any change to the Trust property.

The Proposed Amendments are comparable to the situation in Example 1 of TD 2012/21, which involved the removal of a particular beneficiary under the trust by way of trustee resolution and which was held to be a valid exercise of power of amendment contained within the deed.

The Proposed Amendments are considered to fall within the scope of the Trustee's power of amendment provided for in the Trust Deed. The execution of a deed of amendment or variation with the consent of the Guardian to amend the Trust Deed would constitute a valid exercise of power of amendment.

As the Proposed Amendments are within the Trustee's powers contained in the Trust Deed, the Commissioner considers that - following the execution of the deed to amend the Trust Deed to effect the proposed changes - there will be continuity:

•         of the Trust property;

•         in the membership of the Trust, apart from the removal of the particular beneficiaries of the Trust; and

•         in the operation of the Trust.

On this basis, as continuity in the membership, operation and property of the Trust would be maintained following the execution of the Proposed Amendments to the Trust Deed pursuant to a valid exercise of the amendment power in the Trust Deed, such amendments would not result in a termination of the Trust. This is consistent with the decisions in both the Commercial Nominees and Clark cases.

Having regard to paragraph 27 of TD 2012/21, the Commissioner is also satisfied that the Proposed Amendments would not result in an asset of the Trust being subject to a separate charter of rights and obligations such as to give rise to the conclusion that an asset of the Trust would be settled on the terms of a different trust.

Therefore, the Proposed Amendments to the Trust Deed would not result in a termination of the Trust or resettlement of the Trust property.

Question 2

Summary

No. As concluded in answer to Question 1, the Proposed Amendments to the Trust Deed would be amendments pursuant to a valid exercise of a power under the terms of the Trust Deed and will not cause a termination of the Trust or resettlement of the Trust property. Therefore, the Proposed Amendments would not give rise to CGT events E1 or E2.

Detailed reasoning

Under subsection 104-55(1), CGT event E1 happens if a trust is created over a CGT asset by declaration or settlement. Under subsection 104-60(1), CGT event E2 happens if you transfer a CGT asset to an existing trust.

Paragraph 1 of TD 2012/21 provides that CGT events E1 and E2 do not happen if the terms of a trust are changed pursuant to a valid exercise of power contained within the trust's constituent documents 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.

As concluded in answer to Question 1:

•         the Proposed Amendments to the Trust Deed would be amendments pursuant to a valid exercise of a power under the Trust Deed and will not cause a termination of the Trust or resettlement of the Trust property; and

•         the Commissioner is satisfied that the Proposed Amendments would not result in an asset of the Trust being subject to a separate charter of rights and obligations such as to give rise to the conclusion that an asset of the Trust would be settled on the terms of a different trust.

Therefore, the Proposed Amendments would not give rise to CGT events E1 or E2.