Edited version of private advice

Authorisation Number: 1052189465690

Date of advice: 3 November 2023

Ruling

Subject: CGT - redeeming units in a unit trust

Question 1

Does the redemption of Y fully paid Units pursuant to CGT event A1 under section 104-10, or alternatively, CGT event C2 under section 104-25, for an amount of $Y (which is equal to the amount paid for such Units at the date of subscription) result in a nil capital gain?

Answer

Yes.

Question 2

Does the amendment of the terms of the Unit Trust Deed to create and permit the issue of special income units (Special Units) having a right at the discretion of the Trustee to distributions of income, changed pursuant to a valid exercise of the power of amendment included within the Deed of Trust, or varied with the approval of a relevant court, and the subscription for the acquisition of Special Units, cause CGT event E1 or E2 in sections 104-55 or 104-60 to happen, where such change doesn't cause the existing trust to terminate or lead to a particular asset or assets being subject to a separate charter of rights and obligations so as to give rise to a conclusion that an asset has been settled on the terms of a different trust?

Answer

No.

This ruling applies for the following period:

1 July YYYY to 30 June XXXX

The scheme commenced on:

1 July YYYY

Relevant facts and circumstances

1.            XYZ Group Pty Ltd is a parent company for some wholly owned and some partly owned subsidiaries. We'll describe the parent and subsidiaries as the XYZ Group. It isn't an income tax consolidated group.

2.            <Paragraph removed for privacy reasons.>

3.            The XYZ Service Trust was settled by the unitholders (XYZ Group Pty Ltd, and Entity A as trustee for the ABC Discretionary Trust) and the trustee (Entity B in its capacity as trustee for the XYZ Service Trust).

4.            The trust deed of the XYZ Service Trust defines a 'unit' as an undivided part or share of the trust fund created under the deed, which entitles the unit holder to income and capital distributions (fixed in proportion to the number of units held), capital on termination of the trust (fixed in proportion to the number of units held), and votes on the trust's administration.

5.            Clause X of the trust deed says that the trustee:

•                     through the deed, has constituted a unit trust known as the XYZ Service Trust

•                     declares that it holds the trust fund and any income on trust for the unit holders

•                     acknowledges having received the initial sum which entitles the initial unit holders to be registered.

6.            The XYZ Service Trust has two unitholders holding a total of Z fully-paid units at $1 each. Item 2 of the Reference Schedule describes the initial unit holders.

1: Unitholdings in the XYZ Service Trust

7.            The XYZ Service Trust has only one class of units, but the trust deed permits other classes of units to be created with the unanimous resolution of unitholders.

8.            Since there is only one class of units, if the XYZ Service Trust has distributable income, the trustee must make income distributions to each unit holder in proportions established by the issued unitholdings.

9.            The XYZ Group is considering amending the XYZ Service Trust's deed to convert it to a hybrid trust.

10.         The proposed amendments will involve:

•                     the ABC Discretionary Trust redeeming its unitholding and being removed as a unitholder

•                     introduce discretionary income units (special income units) to permit the distribution of income at the trustee's discretion, with the XYZ Group's prior approval.

11.         The applicants supported their application with the original trust deed, which we'll treat as being incorporated in these facts.

12.         The Trustee may, on the request of a unitholder, redeem all or any of its units at the unit price. The unit price is determined by the net asset value at the valuation date.

13.         The XYZ Group and the ABC Discretionary Trust consider the unit price for redemption would be the amount the ABC Discretionary Trust paid at subscription, being $Y to acquire Y fully paid units.

14.         The XYZ Service Trust proposes to redeem the units at $1 per unit.

15.         Ownership and voting control and the right to receive dividends from XYZ group won't change through the proposed arrangements.

Assumptions

A.            The proposed variations to the XYZ Service Trust's deed will be supported by the variation power in clause X of that deed.

B.            The market value of the ABC Discretionary Trust's units in the XYZ Service Trust (at redemption) would be $Y, that is, equal to the initial sum paid at the establishment of the XYZ Service Trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 104-55

Income Tax Assessment Act 1997 section 104-60

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 section 116-20

Reasons for decision

Question 1

Does the redemption of Y fully paid Units pursuant to CGT event A1 under section 104-10, or alternatively, CGT event C2 under section 104-25, for an amount of $Y (which is equal to the amount paid for such Units at the date of subscription) result in a nil capital gain?

Answer

Yes.

Summary

16.         The ABC Discretionary Trust won't have a capital gain or loss when it redeems its units because its capital proceeds and cost base will be equal.

Explanation

Regardless of whether CGT event A1 or C2 happens, there's no capital gain or loss because any capital proceeds and cost base would be equal.

17.         Broadly, the CGT rules calculate capital gains and capital losses from CGT events, net them off against each other, apply relevant discounts, and include any resulting net capital gain in your assessable income. See the guide in Division 100 and the method statement in section 102-5.

18.         CGT event A1 is about disposals of CGT assets. Subsection 104-10(1) says that CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(2) says that you dispose of a CGT asset if a change of ownership occurs from you to another entity. However, a change of ownership doesn't occur if you stop being the legal owner but continue to be the beneficial owner.

19.         CGT event C2 happens if your ownership of an intangible CGT asset ends in any of a list of circumstances including 'being redeemed or cancelled': subsection 104-25(1).

20.         We don't need to determine whether CGT event A1 or C2 happens on redemption for reasons we explain in the following paragraphs.

21.         Capital gains and losses are calculated the same way for both CGT events. For CGT event A1, subsection 104-10(4) says you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. For CGT event C2, subsection 104-25(3) says you make a capital gain if the capital proceeds from the ending are more than the asset's cost base. For both CGT events, you make a capital loss if those capital proceeds are less than the asset's reduced cost base.

22.         Capital proceeds are generally money received and market value of property received in respect of the event happening: section 116-20.

23.         However, there's a market value substitution rule. Subparagraph 116-30(2)(b)(ii) says the capital proceeds from a CGT event are replaced with the market value of the CGT asset that's the subject of the event if the capital proceeds are more or less than the asset's market value, and the CGT event is CGT event C2.

24.         First element of cost base is generally the money paid and market value of property given in respect of acquiring the asset: subsection 110-25(2).

25.         There's a market value substitution rule which applies if you didn't deal at arm's length with the other entity in connection with the acquisition: see paragraph 112-20(1)(c).

26.         That market value substitution rule doesn't apply where you acquired a unit in a unit trust issued to you by the trustee and you didn't pay anything for it: Item 6 in the table in subsection 112-20(3).

27.         Here, the ABC Discretionary Trust won't have a capital gain or loss from any CGT event. If either CGT event A1 or C2 happens, the first element of cost base would be the $Y it paid to acquire its units in the XYZ Service Trust at $1 each. Its capital proceeds from any CGT event would be the $Y it receives from the XYZ Service Trust when it redeems its units at $1 each. We've assumed that the subscription price reflects the market value of the units, so the market substitution rules won't apply. It follows that, if either CGT event happens, there would be no capital gain or loss because the capital proceeds ($Y) and cost base (also $Y) would be equal.

Question 2

Does the amendment (pursuant to a valid exercise of the power of amendment included within the Deed of Trust, or with the approval of a relevant court) of the Unit Trust Deed to permit the creation and the issue of special income units (Special Units), having a right at the discretion of the Trustee to distributions of income, and the subscription for the acquisition of Special Units, cause CGT event E1 or E2 in sections 104-55 or 104-60 to happen, where such change doesn't cause the existing trust to terminate or lead to a particular asset or assets being subject to a separate charter of rights and obligations so as to give rise to a conclusion that an asset has been settled on the terms of a different trust?

Answer

No.

Summary

28.         The proposed variation won't trigger CGT events E1 or E2. The ATO view in TD 2012/21 is that an amendment to a trust deed supported by a variation power, which doesn't cause an existing trust to terminate under trust law principles, and doesn't set aside trust funds under a separate trust, won't cause CGT events E1 or E2 to happen. The question presumes that none of those provisos apply here. It follows that CGT events E1 and E2 won't happen.

Explanation

Following the ATO view in TD 2012/21, on the premises that the variation is within power and won't create a new trust, the proposed variation won't cause CGT events E1 or E2 to happen.

29.         Subsection 104-55(1) says CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement.

30.         Subsection 104-60(1) says CGT event E2 happens if you transfer a CGT asset to an existing trust.

31.         Broadly, the ATO view is that CGT events E1 and E2 don't happen where a variation to a trust deed is supported by the variation power. TD 2012/21[1] asks whether CGT event E1 or E2 happens if there's a change to a trust deed which is supported by a variation power within that deed. It answers that those CGT events won't happen unless the change either:

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

•                     the change has the effect of settling a particular asset on the terms of a different trust (under a separate charter of rights and obligations).

TD 2012/21 at paragraphs 21 through 23 discusses Commercial Nominees[2] and Clark.[3] It concludes that they are authority for the proposition that a trust will continue after an amendment so long as it preserves some continuity of trust property and beneficiaries. At paragraph 24, it says these principles are also relevant to determining whether CGT events E1 and E2 happen.

32.         Whether a variation to a trust deed is supported by a power depends on the terms of the trust deed, considered as a whole. TD 2012/21, at paragraph 26, says that whether a purported change to a trust is properly supported by a variation power is determined in accordance with principles of trust law including properly construing the scope of the power. It's also possible that some purported changes to a trust deed might exceed the scope of the variation power if they change the trust's purpose or 'substratum'.[4]

33.         CGT events E1 and E2 won't happen given our assumptions. The question presupposes - and we've assumed - that the deed is changed under a valid exercise of an amendment power in the deed or varied with approval of a relevant court. The question also presupposes that the change doesn't cause the existing trust to terminate, or cause trust assets to be subject to a separate charter. On those assumptions, following the approach in TD 2012/21, CGT events E1 and E2 won't happen.

[1] 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?

[2] Federal Commissioner of Taxation v Commercial Nominees of Australia Limited [2001] HCA 33 (2001) 47 ATR 220.

[3] Federal Commissioner of Taxation v Clark [2011] FCAFC 5 (2011) 190 FCR 206.

[4] See comments in TD 2012/21 at footnote 4, In Re Ball's Settlement Trust [1968] 1 WLR 899 at p.905 (per Megarry J), and In re Dyer; Dyer v. The Trustees, Executors, and Agency Co. Ltd [1935] VLR 273 at pp. 290-291 (per Martin J).