Edited version of private advice

Authorisation Number: 1052156157243

Date of advice: 28 August 2023

Ruling

Subject: Change to trust deed

Question 1

Will the execution of the Deed of Variation and the subsequent execution of the Deed of Appointment of Distributors cause CGT event E1 in section 104-55 of the Income Tax Assessment Act 1997 (ITAA 1997) to happen?

Answer

No

Question 2

Will CGT event E1 in section 104-55 of the ITAA 1997 happen at the time of the division of the Relevant Distributable Income and the Relevant Distributable Capital into shares and the appointment of the Distributors to each share?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

1.      The scheme that is the subject of this Private Ruling is identified and described in the following:

•         Discretionary Trust Deed for the XXXX Trust dated XX XXX XXXX (Trust)

•         Unexecuted Deed of Variation, XXXX Trust received 07 August 2023

•         Unexecuted Deed of Appointment of Distributors in relation to XXXX Trust received 07 August 2023.

2.      The Trust was established by deed (Trust Deed) on XX XXX XXXX.

3.      The current Appointor is the sole director and secretary of the Trustee and the 'named beneficiary' under the Trust Deed.

4.      Clause 2 of the Trust Deed gives the Trustee the power to pay, apply or set aside the income or the capital of the trust amongst the beneficiaries in such proportions and manner as the Trustee in the absolute discretion of the Trustee from time to time deems fit.

5.      Clause 5 of the Trust Deed gives the Trustee, with the consent of the Appointor, the power to revoke, add or vary all of the trusts, duties, obligations, terms, provisions of or under the Trust Deed.

Deed of Variation

6.      The Deed of Variation will:

a) revoke and replace clause 4 regarding the Appointor and insert a new definition of "Appointor" in clause 1.1; and

b) insert 'distributor provisions' in new clause 9 and associated definitions in clause 1.1.

7.      The effect of the new clause 4 is to change how the existing clause 4 applies in respect of (a) how the powers of the Appointors are exercised if there are more than one Appointor and (b) what happens if an Appointor dies.

8.      The 'distributor provisions' will give the Appointor the power, from time to time, to:

• direct the Trustee to divide the income of the Trust into 2 or more shares (which need not be equal);
• appoint a person to be the Distributor in respect of those shares for the purposes of giving the Trustees certain directions; and
• remove a Distributor from office.

9.      If at any time that the Trustee determines to distribute income of the Trust (the Relevant Distributable Income) and there is a Distributor in office, then the Trustee must:

•         divide the Relevant Distributable Income into shares in accordance with the latest direction of the Appointor;

•         distribute each share for any one or more beneficiaries of the Trust in such proportions as the relevant Distributor may direct (but if the Distributor does not give a direction to the Trustee, then the Trustee may deal with that share as if there was no Distributor in office).

10.   Corresponding provisions apply where the Trustee determines to distribute capital of the Trust (the Relevant Distributable Capital).

Deed of Appointment of Distributors

11.   Immediately after the execution of the Deed of Variation, the Appointor and the Trustee intend to execute the Deed of Appointment of Distributor, where effective from and contingent on the Appointor's death:

•         the Relevant Distributable Income and the Relevant Distributable Capital will be divided into shares; and

•         each of the Appointor's children will be appointed a Distributor of each share.

Assumption

12.   The Trustee has the power to amend the clauses of the Trust Deed under the Trust Deed; The Amending Deeds 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 Division 104

Income Tax Assessment Act 1997 section 104-55

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

Reasons for decision

Question 1 and 2

Summary

On the basis of the assumption that the amendments are valid, that is, that the proposed variations to the Trust Deed will amend the terms of the Trust Deed pursuant to a valid exercise of a power contained within the Trust Deed, the amendments will not cause the Trust to terminate and a new trust to arise for trust law purposes (it will not lead to any asset of the Trust 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).

In that case, CGT event E1 in section 104-55, of the ITAA 1997 will not happen in the circumstances as a result of making the proposed variations to the Trust Deed - noting that where a proposed change is beyond the power conferred by the terms of a trust, it will be of no effect and, therefore, cannot give rise to a resettlement of the trust, and would not result in CGT event E1 happening.

Further, the elements of subsection 104-55(1) will not be satisfied and CGT event E1 will not happen at the time of the division of the Relevant Distributable Income and the Relevant Distributable Capital into shares, and the appointment of the Distributors to each share.

Detailed reasoning

A trust resettlement will occur for income tax purposes 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 as a result of CGT event including E1.

Subsection 104-55(1) of the ITAA 1997 provides that CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement.

In the Full Federal Court case of Commissioner of Taxation v Clark [2011] FCAFC 5 (Clark), it was established that a trust will not be terminated provided that any amendment to the trust is made in accordance with a power conferred by the trust instrument and there is some continuity of property and membership of the trust.

Following Clark, the Commissioner issued 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 a power contained within the trust's constituent documents, or varied with the approval of a relevant court? (TD 2012/21).

In TD 2012/21 the Commissioner expresses the view that in the circumstances 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, neither CGT event E1 nor CGT event E2 in sections 104-55 or 104-60 of the 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.

For CGT event E1 to occur, it is required that there be both the creation of a trust and that this be done by way of declaration or settlement.

The phrase "you create a trust over a CGT asset" is to be understood by reference to the general law of trusts.

In DKLR Holding Co (No 2) Pty Ltd v Commissioner of Stamp Duties [1980] 1 NSWLR 510 at 518-519. Hope JA analysed the 'very nature of a trust' in terms of a personal obligation of a trustee annexed to property to hold the property for the benefit of another.

In order to 'create' a trust, there must be a creation of both elements of a trust; that is, a creation of personal obligations and a creation of rights annexed to property.

Notwithstanding that an existing trust estate may not have come to an end and the entirety of the trust fund settled on terms of a new trust, it is possible for assets to be settled on a new trust estate that has been separated from (or carved out of) the original trust fund. This may occur notwithstanding that the transactional documents executed to affect such a separation do not expressly speak of the asset having been settled on a new trust.

The decision of the Supreme Court of South Australia in Dyda P/L & Anor v Commissioner of State Taxation [2013] SASC 156 (Dyda), albeit concerned with a different legislative regime, is instructive in this context.

In Dyda the Supreme Court of South Australia considered whether a series of steps to transfer control of a real property to the Dyda group gave rise to a stamp duty liability. The land in question was held in a unit trust, the Woodville Property Trust. Units in this trust were held by two family trusts, the Meeuwissen Family Trust and the Young Family Trust.

The transfer of the control of the real property was affected through a series of steps. First Dyda Pty Ltd was appointed as trustee of the part of the trust assets of the Woodville Property Trust which comprised the real property. This part of the trust was to be known as the Burleigh Avenue Trust. The trust deed was amended to allow for a new type of units, funding units, which could receive income in priority to all existing units. Dyda Nominees was appointed as trustee to part of the Meeuwissen Family Trust comprising 1 ordinary unit in the Burleigh Avenue Trust. This was henceforth known as the Burleigh Avenue Trust No. 2. John Dyda was also made guardian and appointor of the Burleigh Avenue Trust No. 2. Similarly, Dyda Nominees was appointed as trustee to part of the Young Family Trust comprising 1 ordinary unit in the Burleigh Avenue Trust. This was henceforth known as the Burleigh Avenue Trust No. 3. John Dyda was also made guardian and appointor of the Burleigh Avenue Trust No. 3.

The appellants argued that upon appointment of the new trustee, no rights were conferred in relation to the trust property. The rights remained as they were because the same persons remained objects and beneficiaries of the discretionary trusts.

Stanley J rejected the arguments of the appellants. At paragraphs [143] - [144] he concluded as follows:

143. The appointment of Dyda Nominees as trustee of the Burleigh Avenue Trust No. 2 and No. 3, was in each case, effectively the resettlement of the units under a new trust rather than the appointment of a new trustee to existing trusts. The requisite continuity of the trust did not exist.

1.44 The continuity of trusts was broken because of the transfer of control of these two discretionary trusts to the Dyda group, which occurred on 8 March 2007. This was achieved by the appointment of Dyda Nominees as the trustee, and by the appointment of John Dyda as the appointor and guardian under the trusts. In his capacity as guardian, John Dyda could control the distributions of some income and of all of the capital of the trusts. A member of the class of potential beneficiaries of the trusts who was not a member of the Dyda group could not realistically expect ever again to receive any distributions under the trusts. This conclusion is reinforced by the granting of the indemnities. Accordingly, Dyda Nominees acquired an absolute interest in the ordinary units.

Dyda demonstrates that in particular circumstances the appointment of different trustees and appointors over specific trust assets can cause those assets to be settled on terms of a new trust.

The Commissioner's view on the potential capital gains tax implications of a 'trust split' is contained in Taxation Determination TD 2019/14 Income Tax: Will a trust split arrangement of the type described in this Determination cause a new trust to be settled over some but not all assets of the original trust with the result that CGT event E1 in subsection 104-55(1) of the Income Tax Assessment Act 1997 happens? (TD 2019/14). For this determination, a trust split is defined as an arrangement which generally involves the transfer of some of the assets of the original trust to a new trust fund that has been separated, or carved out of, the original trust fund. TD 2019/14 at paragraph 47 sets out that the purpose of such arrangements is directed to separating the functional operation of the trust. It is put into place with the intention of:

(a)  separating those who control and can benefit from part of the trust corpus transferred to the new trustee

(b)  from those who control and benefit from the remaining assets held by the original trustee

(c)   removing the fiduciary obligations of the original trustee in relation to the assets transferred to the new trustee

(d)  removing the entitlement of the original trustee to be indemnified out of the transferred assets for

expenses incurred after the introduction of the new trustee, and

(e)  ensuring that the new trustee will have no fiduciary obligations in respect of the assets retained by the original trustee and will have no right to be indemnified from those assets.

By declaration or settlement

The second element necessary for CGT event E1 to happen is that the creation of the trust is by declaration or settlement.

A trust is created by declaration within the meaning of subsection 104-55(1) when it is created by words or conduct sufficient to demonstrate an intention to create an express trust over property (Kafataris v. DC of T (2015) 243 FCR 291 at [26]) (Kafataris). Transactional documentation that evidences an express intention to hold the transferred assets subject to the terms of the trust deed, may suffice to create a trust over those assets by declaration.

A trust is created by settlement when property is vested in a trustee for the benefit of others (Taras Nominees Pty Ltd v. FC of T (2015) 228 FCR 418 at [5]; Kalantaris at [31]). A transfer of existing trust property to, and the vesting of this property in, a new trustee for the benefit of others can satisfy the description of the creation of a trust by settlement.

Application in these circumstances

This ruling is based on the assumption that the Trustee has the power to amend the Trust Deed in accordance with the proposed amendments.

In accordance with the assumption:

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

The proposed variations to the Trust Deed will amend the terms of the Trust Deed pursuant to a valid exercise of a power contained within the Trust Deed and therefore the amendments will not cause the Trust to terminate and a new trust to arise for trust law purposes (it will not lead to any asset of the Trust 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 words and conduct are not sufficient to demonstrate an intention to create an express trust over property. Further, the proposed arrangements are distinguishable from the circumstances in Dyda, and the trust splitting arrangements of the kind described in TD 2019/14 because of the following factors:

•         the Deed of Appointment of Distributors allows for the division of Relevant Distributable Income and Relevant Distributable Capital into two or more shares and appoints a Distributor in relation to each of those shares. The roles and responsibilities of the Trustee remain largely unchanged in all other respects of the Trust. The Trust fund continues to be governed by the terms originally set out in the Trust Deed and the range of beneficiaries does not change;

•         there is no transfer of Trust assets to the Distributor with the Trustee retaining legal ownership of the Trust fund until distribution;

•         the Trustee is entitled to be indemnified out of all of the assets of the Trust; and

•         the Trustee retains the power to determine under the Trust Deed to distribute income or capital. It is only once a decision to distribute has been made by the Trustee, that the Distributors role is able to direct the Trustee to distribute in such proportion and in such a manner as the Distributor decides.

Considering these factors together with the other elements of the proposed arrangement, it cannot be concluded that a new charter of personal obligations and rights has been created. Dividing the Relevant Distributable Income and Relevant Distributable Capital into shares, and appointing a Distributor for each of those shares for the purpose of giving the Trustee directions in relation to the proportions and manner of the distribution to the beneficiaries of the Relevant Distributable Income and Relevant Distributable Capital, has not resulted in the creation of a new trust.

We conclude that the Trust will continue as one trust. The proposed variations do not affect the composition of the trust property, or the obligations under which the assets comprising the trust property are held. There is continuity of property and membership of the Trust with the assets of the Trust to continue to be held for the benefit of the Trust beneficiaries.

Consequently, the elements of subsection 104-55(1) will not be satisfied and CGT event E1 will not happen.