DW Fox Tucker Lawyers’ Director John Tucker discusses and explains the concepts of Trust Splitting and its predecessor, Trust Cloning.
Tax lawyers have a propensity for applying slickly phrased euphemisms for sets of procedures known commonly among them.
In this category are “Trust Splitting” and the previously popular “Trust Cloning”.
Both procedures have been employed to achieve a common primary outcome; in summary, to divide the control of assets held under an existing trust among a selected group of existing beneficiaries thereby removing the assets from the control of other persons all without causing a CGT Event to happen nor triggering a liability for ad valorem stamp duty.
The relevant CGT Events of concern, from which the procedures sought exemption, are those known as CGT Events E1 and E2.
At the time when Trust Cloning achieved popularity, CGT Event E2 contained an exemption applicable where a transfer occurred between trusts with the same beneficiaries. This exemption was removed on the introduction of the current Section 104-60[i]. The exemption was formally contained in Section 104‑60(5)(b).
The exemption required that the transfer be between trusts the beneficiaries and terms of which were both the same. Tension steadily built between the Commissioner of Taxation and taxpayers over the application of this section. From an accepting interpretation in Taxation Determination TD2004/14 the Commissioner progressively found circumstances where the exception would not apply.
Trust Cloning was particularly popular in some of the Eastern States for stamp duty reasons. In those States an exemption existed for conveyances where there was no change in beneficial interest in the property conveyed. The technique was to establish a trust in identical terms to an existing trust but with a different trustee. Assets would then be transferred from the trustee of the original trust to the trustee of its clone. Progressively the Australian Taxation Office pointed to provisions between the original trust and its clone which it said prevented exclusion even though the terms of each trust were, on their face, identical.
For example, if the original trust deed excluded, or included, its trustee as a beneficiary the Commissioner argued that the existence of different trustees in the original and cloned trusts meant that the two trusts did not have identical beneficiaries. Arguments were also raised in relation to the interests of the trustee of the original trust under its rights of indemnity and it was even argued that the existence of a Family Trust Election made with respect to the original trust and not applicable to the cloned trust would mean that the terms of the original and cloned trusts were not the same.
While the Trust Cloning exemption has been removed that is not to say that Trust Cloning is a redundant strategy, particularly in the Eastern States where the Stamp Duty exemption exists. There can be circumstances where causing CGT Event E2 to happen may be of no concern. For example, there may be no gains in value of the assets to be transferred, or losses in the original trust which will shelter any gains or gains that will be made will be eligible for some form of tax shelter. Indeed, triggering eligibility for tax shelter may be an advantage, for example, if the gains are such that their individual recipient will be entitled to the small business CGT concessions[ii] at the time but potentially ineligible in the future. Causing a CGT Event to happen may provide significant taxation advantages. Here, causing a CGT event to happen can be done more simply though than by Trust Cloning.
Trust Cloning did not enjoy the popularity in South Australia that it did in the Eastern States. This was because here the exemption for stamp duty that once existed for transfers where there was no change in beneficial interest had long been abolished. In its place Section 71(3) of the Stamp Duties Act 1936 deems an instrument effecting or acknowledging, evidencing or recording a transfer of property to a person who takes as trustee to be a conveyance operating as a voluntary disposition inter vivos and consequently liable to ad valorem duty.
Section 71(5)(d), however, deems a transfer of property for the purpose of effectuating the retirement of a trustee or the appointment of a new trustee not to be such a conveyance subject to the Commissioner being satisfied that it is not part of a scheme for conferring a benefit, in relation to the trust property, upon the new trustee or any other person, whether it is a beneficiary or otherwise, to the detriment of the beneficial interest of any person.
This difference in Stamp Duty exemptions attracted use of the Trust Splitting procedures in South Australia in preference to Trust Cloning.
A difference exists in the Cloning and Splitting procedures and this has consequences with respect to capital gains tax. While the Cloning process relied on the former exemption for a CGT Event E2 Splitting looked to that exemption and provisions applicable to CGT event E1.
CGT Event E1 happens under Section 104-50 of ITAA 97 where a new trust is created by declaration or settlement. The note to Section 104-55(1) however states that a change in the trustee of a trust does not cause the Event to happen. The note in its current form refers to a change in the trustee of a trust not constituting a change in the Entity that is the trustee of the trust, meaning that CGT Event E1 will not happen merely because of a change in the trustee. The current reference to Entity is because in Section 960-100(2) the trustee of a trust is taken to be an Entity consisting of the person who is the trustee or persons who are the trustees at any given time.
Aside from the specific exemptions relating to the appointment of a new trustee, Trust Splitting raises the question whether the assets transferred to the new trustee, to be held on the trusts of the original trust deed, comprise a separate trust estate to that upon which the assets that haven’t been transferred and remain under the control of the original trustee comprise. Is there a new trust with respect to the split assets?
The possibility for argument that there are different beneficiaries by reason of the exclusion or inclusion of the trustee for the time being among the eligible beneficiaries of the two trusts remains. Further, it is generally the case that for the split to achieve its objectives some amendment to the trust deed as it is to apply to the split assets is likely. Most notably if the trust deed contains provisions for an appointor with various controlling powers it is likely that the identity of the appointor, as it applies to the split assets, will be the subject of change. Also, in the process of splitting, if there are liabilities that will attach to the split assets the rights of the original trustee in respect of these assets may be sought to be modified.
Until recently the Commissioner of Taxation appeared to accept that on a simple trust split, involving the appointment of a new trustee to certain assets, including where the original trustee’s rights to directly access the split assets to exonerate or indemnity itself against liabilities were modified, and the identity of an appointor changed, CGT Event E1 would not happen.
This acceptance has not however been manifested in any particular Ruling or Determination by the Commissioner. Interpretative Decision 2009/86 provided an individual response that a new trust had not been created in the circumstances that it considered but that decision has since been withdrawn. Nevertheless the Commissioner has not been seen to be active in attacking trust splits, though that position may not continue.
Historically the Commissioner has, in somewhat similar circumstances, sought to assert the creation of a new trust. On 9 June 1999 the Commissioner issued a ‘Statement of Principles’ in which he set out principles he claimed should guide trustees as to when changes to a trust cause the trust to end and be replaced, by way of resettlement of the existing trust, into a new trust thereby causing CGT Event E1 to happen.
The Commissioner sought to have these principles judicially endorsed through litigating two leading cases. The first of these was FCT v Commercial Nominees of Australia Ltd [2001] HCA 33 where in the High Court the Commissioner unsuccessfully argued that changes affecting superannuation fund beneficiaries had the effect of creating a new trust. The second was FCT v Clark [2011] FCA] 1455 where in the Full Federal Court the Commissioner unsuccessfully argued that changes to a trust deed made within the scope of a power of amendment denied the continuity of a trust.
As a consequence of these decisions the Commissioner issued Taxation Determination 2012/21 in which he accepted that amendments to a trust made in proper exercise of a power of amendment contained under the deed will not prevent continuity of a trust irrespective of the extent of the amendments made so long as the amendments are properly supported by the power.
In the same determination the Commissioner nevertheless asserted 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 commenced 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 those assets are now held on terms of a distinct (that is, different) trust’.[iii]
In support of this claim the Commissioner draws on a decision of Commissioner of State Revenue the Lam & Kym Pty Ltd [2004] VSCA 204, a decision in the Supreme Court of Victoria in relation to Stamp Duty. This case involved a deed poll amending a trust to give the trustee power to transfer funds for the advancement of any of the discretionary beneficiaries. Pursuant to this power the trustee executed an instrument declaring it ‘hereafter held separately in trust’ property for certain beneficiaries. That exercise of the power of appointment was held to result in the property being held on a separate trust.
The case is cited by the Commissioner to illustrate the proposition that a distinct trust may arise, though he does so without further explanation.
Behind the Commissioner’s withdrawn Statement of Principles lies a significant body of judicial authority supporting the concept of a new trust arising on the creation of a charter of new rights and obligations applicable to a trustee or new trustee. These authorities seem not to have left the Commissioner’s mind. Recently he has warned that he has concerns about the use of Trust Splitting. In consequence the Commissioner has embarked on a course of confidential consultation with representatives of professional bodies apparently contemplating the issue of new Guidance expanding on his views in TD 2012/21. In South Australia the Commissioner for State Taxes has in practice generally accepted and argued that for both Stamp Duty and Land Tax purposes a trust split will not give rise to a new trust. Accordingly he has allowed exemption under Section 71(5)(d) for a simple trust split where assets are transferred to a new trust deed to be held upon the same terms as held by the transferring trustee under the original trust deed.
Similarly the Commissioner for State Taxes has argued that a trust split does not create a separate trust such as would deny operation of the aggregation principle under section 13 of the Land Tax Act 1936.
A somewhat different view was taken, at the urging of Counsel for the Commissioner, by Stanley J in Dyda v Commissioner of State Taxes [2013] SASC156. He applied the reasoning of the High Court decision in FCT v Commercial Nominees of Australia Ltd to hold that ‘by parity of reasoning it was apparent from the Court’s analysis that for the continued existence of a trust there must be a continuity in the constitution of the trust under which the trust fund operates, the trust property and the membership of the trust. Changes in one or more of those matters breaks continuity and thereby terminates the trust. This was seen consistent with the position in relation to the four essential indicia of the existence of the trust; the trust deed, the trust property, the beneficiary and an equitable obligation annexed to the trust property.[iv]
Elsewhere however the judgement refers to a “material change in the rights and obligations attaching to the trust property which is inconsistent with the continuity of the trust estate”. This is an obviously less harsh requirement than the contemplation that a change in trustee alone would breach continuity. Further, the decision clearly rested, not on the sole, but on a combination of the changes that were discussed. While the existence of a different trust deed was pointed to as one variation indicating a new trust others were also identified.
It is not only the potential happening of CGT Event E1 that attracts attention in respect of a trust split. Reporting for both income tax and the preparation of financial statements raises the issue whether the original trust and the trust administered by the separate trustee can be reported upon separately. For income tax the Commissioner has been prepared to issue a separate Tax File Number to the new trustee in respect of the assets under its administration. This may however be more a recognition of the trustee as a separate Entity in relation to its trust.[v] A similarly pragmatic view has been accepted by accountants.
A trust split can, as alluded to, be a very effective way of dealing with assets held under a trust deed so as to pass their control to a different group of beneficiaries than those controlling other assets. Commonly this will be a selected number of existing members of a later generation of family members to those controlling the original assets of the trust. Rarely however will the split not require amendments to the trust deed, as applicable to the transferred assets, such as a change of Appointor and, collaterally, attention to the rights of the original trustee with respect to the liabilities attached to the transferred assets.
The processes associated with the evolution of the Commissioner of Taxation’s views concerning lack of continuity of a trust, the creation of a new trust, his unsuccessful litigation and eventual reconsideration of Trust Splitting, up to the issue of Taxation Determination 2012/21, have been trying for taxpayers and tax practitioners alike. It is to be hoped that the Commissioner is not about to embark on a similar course in relation to trust splits which he has accepted up until now as not causing CGT Event E1 to happen. On the decisions that have considered comparable arrangements so far there appears no compelling authority to support his doing so. Presumably there will be circumstances where trust splits have been used in a particularly enterprising way to manage potential taxation liabilities and it is to be hoped that it is only these circumstances that are attracting a possible modification of the Commissioner’s position through his current processes.
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DW Fox Tucker Lawyers’ Director John Tucker leads the Tax team. He is widely regarded as a pre-eminent specialist in this field as evidenced by his recognition as Adelaide’s Tax Law Lawyer of the Year (2015) in Best Lawyers Australia. With experience spanning over four decades, John is regularly sought out to act in the most difficult of tax-related matters. His expertise includes advising on tax-effective business structures, acquisitions and disposals, restructures, mergers, demergers, buy-backs and share cancellations, structured finance packaging and superannuation fund advice. John also represents clients in taxation disputes through negotiation, documentation of submissions, objections and appeals, litigation and mediation. John is a life member and Chartered Tax Adviser of The Tax Institute and has served as its National President. Contact John at john.tucker@dwfoxtucker.com.au or connect via LinkedIn.
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[i] of Income Tax Assessment Act 1997 (ITAA 97)
[ii] in Division 152 ITAA 1997
[iii] In paragraph 27
[iv] Referring to class case [2001] FC5 at [88]
[v] Pursuant to section 960-100(2) ITAA 97