Edited version of private advice

Authorisation Number: 1052330488914

Date of advice: 13 November 2024

Ruling

Subject: CGT - trust resettlement

Question 1

Will CGT event E1 or CGT event E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 (ITAA 1997) happen as a result of making the amendments to the Trust Deed of the Trust?

Answer

No.

Question 2

Will CGT event E3 in section 104-65 of the ITAA 1997 happen as a result of making the amendments to the Trust Deed of the Trust?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

The Trust is a discretionary trust.

Individuals A and B are the Trustees. A is also named as Principal in the trust deed.

The Trust is engaged in leasing, management and maintenance of two residential properties.

The named beneficiaries were the minor children of A and B.

No distributions had been made to the beneficiaries.

In 20XX, a deed of variation was executed by the Trustees removing the original named beneficiaries and appointing A and B as beneficiaries.

In 20XX, a second deed of variation of discretionary trust was executed by the Trustees:

• declaring the removal of original beneficiaries
• appointing A and B as beneficiaries; and
• converting the Trust from a Discretionary Trust to a Unit Trust.

The Trustee's deed of variation is in accordance with the Trustee's powers in clause X of the Trust Deed, in effect to convert the Trust from a discretionary trust to a fixed unit trust.

The Trust will retain the same assets. No beneficiary of the Trust will be absolutely entitled to any CGT asset of the Trust as against the Trustee prior to the amendment.

Relevant clauses in the Deed

The power of appointing a new trustee is vested in the Principal. The Principal, may at any time without the consent of any person by deed or instrument in writing remove any Trustee or appoint a new Trustee.

Amendment of Deed

The Trustee may be deed or resolution at any time revoke, add to, release, delete or vary all or any of the trusts or powers declared in this Deed provided that:

• the Rule against perpetuities is not infringed;
• it will not be in favour of the Settlor or the Settlor's estate or any Corporation or trust in which the Settlor or the Settlor's estate has any actual or contingent beneficial interest;
• it will not affect the beneficial entitlement of any Beneficiary to any amount to which the Beneficiary became entitled under the Deed prior to the date the revocation, addition, release deletion or variation is effected; and
• the variation does not purport to remove or replace the Principal or to add another person or persons as Principal without the consent inwriting of the Principal first being obtained.

Trust fund income and capital

• The Trustee may classify the income or capital of the Trust into one or more classes, whether by reference to source nature or otherwise in its absolute discretion.
• The Trustee may at any time prior to the expiration of any Accounting Period, distribute all or any parts of the Income to one or more of the Beneficiaries living or in existence at the time or the determination and accumulate the same or any part.
• Until the vesting day, the Trustee in its absolute discretion will have the power to distribute part or parts of the capital of the Trust fund.

Relevant clauses in the unit trust deed

Under the unit trust deed, A and B are the trustees and unit holders holding equal number of units each.

The relevant clauses in the unit trust deed are as follows:

The Trust Fund

• The Trustee will hold the Trust Fund on trust for the Unitholders in proportion to each Unitholder's Proportion.
• All units will be of equal value.
• All Units must be issued and redeemed at Market Value.
• The Trustee may issue additional Units, from time to time in such manner as the Trustee thinks fit subject to the Units being issued at Market Value
• the Unitholders have a vested and indefeasible interest in a share of the income and capital of the Trust in accordance with their Unitholder's Proportion. The Trustee must not exercise any power that is capable of defeating a Unitholder's interest in the income or capital of the Trust and any attempt to exercise such power is void.

Unitholders Approval for the purpose of the variation of trust deed is carried if all Unitholders unanimously are in favour of the resolution.

Income of the Trust

• Until the Vesting Date the Trustee must before the expiration of each Accounting Period determine to Pay or accumulate all or any part of the Net Income for each Accounting Period
• If the Trustee determines to Pay any or all of the Net Income, the Trustee must Pay that income to the Unitholders in accordance with their respective Unitholder's Proportions at the time of such Determination.
• The Trustee's discretion to make a Determination is absolute and the Trustee will not be bound to give any reason for its Determination.
• The Trustee will hold so much of the Net Income for each Accounting Period which is not the subject of a Determination under this Deed on trust for the Unitholders in accordance with each Unitholder's Proportions on the last day of such Accounting Period.

Change of Trustee

• Any Trustee may retire upon giving one month's notice in writing to the Unitholders of that Trustee's desire to do so.
• Subject to Unitholders Approval, the Unitholders may remove the Trustee as a trustee of the Trust by written notice to that Trustee signed by those Unitholders in favour of the removal.
• Subject to Unitholders Approval, the Trustee may by deed appoint a person or corporation to be the trustee of the Trust whether in addition to or in replacement of a trustee.

Variation of Trust Deed

• Subject to Unitholders Approval, the Trustee may add to, alter, vary, modify, delete or otherwise amend any provision of the trust deed and/or declare any new or other trusts, powers or discretions concerning the Trust Fund or any part of it. The power to vary the trust deed should not infringe against the rule of perpetuities or affect the beneficial entitlement to any amount already Set Aside for or vested in any Unitholder unless that Unitholder consents in writing.

Assumptions

• 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 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 proposed amendments to the Trust Deed are valid and effective in accordance with the law of the relevant state.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 section 104-55

Income Tax Assessment Act 1997 section 104-60

Income Tax Assessment Act 1997 section 104-65

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1

Will CGT event E1 or CGT event E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 (ITAA 1997) happen as a result of making the amendments to the Trust Deed of the Trust?

Summary

As the amendments are within the Trustees' powers contained in the trust deed, the Commissioner considers there will be continuity of the Trust property, membership of the Trust and operation of the Trust. The amendments to the trust deed 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, neither CGT event E1 or CGT event E2 will happen in accordance with sections 104-55 or 104-60 of the ITAA 1997.

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 a taxpayer creates a trust over a CGT asset by declaration or settlement. CGT event E2 happens when a taxpayer transfers a CGT asset to an existing trust.

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 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? (TD 2012/21).

In TD 2012/12 the Commissioner expresses the view 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, or varied with the approval of a relevant court, neither CGT event E1 or E2 of 104-55 or 104-60 of the ITAA 1997 will not happen unless:

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

•         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.[1]

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.

144 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 from those who control and benefit from the remaining assets held by the original trustee

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

(c)   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

(d)  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.

In TD 2012/21, the Commissioner accepts that "continuity of a trust is a function of whether the trust continues in existence under trust law in contradistinction to having terminated". The determination states that CGT event E1 and CGT event E2 will not generally happen if the terms of a trust are changed pursuant to a valid exercise of a power contained in the trust's constituent document or are varied with a court's approval. However, a CGT event will occur if the change:

• causes the existing trust to terminate and a new trust to arise for trust law purposes; or
• results in a particular asset being subject to a separate charter of rights and obligations such as to give rise to the conclusion that asset has been settled on terms of a different trust.[2]

Application to your circumstances

This ruling is based on the assumption that the Trustees have the power to amend the trust instrument in accordance with the proposed amendments.

The current Deed provides the Trustees with broad powers to revoke, alter to or vary all of any of the provisions of the trust instrument at any time.

The changes to the Deed are also considered to fall within the scope of the Trustee's power of amendment provided for in the Deed. In this regard, it is noted that the amendments are not considered to fall within the specific restrictions.

The Commissioner is satisfied that the factors regarding possible trust splitting will not occur in your case. The trustees of the unit trust are the same trustees in the original Deed. The assets of the trust remain the same. The change in the beneficiaries was within the Trustees' power to amend or vary the Deed. Further the change in the named beneficiaries was made prior to the execution of the unit trust deed.

Therefore, the amendments to the Deed did not result in the creation of a new trust by declaration or settlement as the Trustee does not have new personal obligations and new rights have not been annexed to the assets held by the Trust. Therefore, CGT Events E1 and E2 will not happen.

As the amendments are within the Trustee's powers contained in the trust instrument, the Commissioner considers that, following the execution of the deed of variation to amend the terms of the trust instrument, there will be continuity:

• of the Trust property;
• in the membership of the Trust; and
• in the operation of the Trust.

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.

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 instrument pursuant to a valid exercise of the amendment power in the trust instrument, such amendments would not result in a termination of the Trust.

Having regard to paragraph 27 of TD 2012/21, the Commissioner is satisfied that the 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, in accordance with paragraph 1 of TD 2012/21, executing the Deed of Amendment to amend the current Trust Deed pursuant to a valid exercise of the amendment power contained in clause X of the current Trust Deed, would not cause either CGT event E1 or CGT event E2 of the ITAA 1997 to happen.

Question 2

Will CGT event E3 in section 104-65 of the ITAA 1997 happen as a result of making the amendments to the Trust Deed of the Trust?

Summary

No beneficiary was absolutely entitled to any CGT asset of the Trust just before the conversion of the Trust to a Unit Trust and as such CGT event E3 will not happen with respect to the amendments.

Detailed reasoning

Subsection 104-65(1) of the ITAA 1997 provides that CGT event E3 happens if a trust over a CGT asset is converted to a unit trust and just before the conversion, a beneficiary was absolutely entitled to the asset as against the trustee.

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 Income Tax Assessment Act 1997 (TR 2004/D25)sets out the Commissioner's view on when a beneficiary may become absolutely entitled to an asset.

Paragraphs 10 and 11 of TR 2004/D25 provide:

10. The core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction. This derives from the rule in Saunders v Vautier applied in the context of the CGT provisions (see Explanation paragraphs 41 to 50). The relevant test of absolute entitlement is not whether the trust is a bare trust (see Explanation paragraphs 33 to 40).

11. Under the rule in Saunders v Vautier, the courts do not regard as effective a direction from the settlor of the trust that purports to delay the beneficiary's full enjoyment of an asset. However, if there is some basis upon which a trustee can legitimately resist the beneficiary's call for an asset, then the beneficiary will not be absolutely entitled as against the trustee to it.

Beneficiaries of a discretionary trust do not have any interest, either individually or collectively, in the property or income of a trust estate. Where there is a discretionary trust deed, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital: it is for the trustee to determine, firstly, whether such beneficiaries will benefit at all under the terms of the trust and, secondly, to what extent the beneficiaries will benefit. Such beneficiaries have no more than a right to have the trust duly administered. (See Gartside and Another v. Inland Revenue Commissioners [1968] 1 All ER 121 and Re Weir's Settlement MacPherson and Another v. Inland Revenue Commissioners [1970] 1 All ER 297).

Application to your circumstances

Prior to the amendments, the Trustee has the discretion to pay the whole or any part of the income or capital of the Trust to any one or more of the eligible beneficiaries to the exclusion of the others in such proportions as the Trustee may determine. Consequently, no beneficiary was absolutely entitled to any CGT assets of the Trust.

Therefore, CGT event E3 will not happen with respect to the amendments.

[1] TD 2012/21 paragraph 1.

[2] TD 2012/21 paragraphs 21 and 26.