Tuesday, July 25, 2017

Another way to convert water into wine - trust to company rollovers

The vast majority of rollovers available under the Tax Act relate to transactions between companies.

There is however a series of transactions that effectively allows one form of structure to be converted into another.

Following last week’s post, I was reminded of one of the very few rollovers that allows the iteration from one legal structure to another. In particular, the tax rollover available for a discretionary trust that allows a trust to transfer all of its assets into a company, so long as the shares in the company are owned by that same discretionary trust. This form of rollover is available under Subdivision 122A of the 1997 Tax Act.

Obviously, there are stamp duty considerations in many states still that often need to be taken into account, however the rollover can be a very useful one in a wide range of circumstances to ensure no tax is triggered.

We have particularly seen it used proactively as part of a succession plan – it is often seen as easier to facilitate the transfer of shares in a company, as opposed to managing the control of a discretionary trust.

For those interested, our book ‘The Seven Foundations of Business Succession’ explores each of the key company and trust rollover concessions used in estate and succession planning see - http://viewlegal.com.au/product/the-seven-foundations-of-business-succession/

Image courtesy of Shutterstock

Tuesday, July 18, 2017

Converting water into wine (or family trusts into fixed trusts)

Recent posts have considered various aspects of fixed trusts, see - Unit trusts and fixed trusts.

For a myriad of structuring issues, one issue that appears to be raised more regularly is whether it is possible to convert a family discretionary trust into a fixed trust.

This issue was considered by the Tax Office in Private Ruling Authorisation Number: 1012991136582. As usual, if you would like a copy of the ruling please let me know.

Broadly the factual matrix was as follows -
  1. a 'standard' family trust held an asset; 
  2. the trust had a widely crafted power of variation; 
  3. the trustee resolved to make a capital distribution of the balance in the unrealised capital profits account to certain beneficiaries, with this amount left unpaid (ie meaning it was a debt owed by the trust to the beneficiaries); 
  4. by agreement there was then a conversion of the debts (and some other outstanding loans) to equity such that each of the relevant beneficiaries had a certain percentage of ‘equity’ in the trust; 
  5. relying on the power to vary, the trustee then amended the terms of the trust deed to convert it into a fixed unit trust. 
After analysing the provisions of its Tax Determination in relation to resettlements (namely TD2012/21, see our previous post that explores this - ATO releases draft determination on trust resettlements) the Tax Office confirms that so long as the amendments are within the powers of the trust deed, the continuity of the trust will be maintained for trust law purposes.

This is because the ultimate beneficiaries of the trust after the proposed amendments would be the individuals who were the objects of the trust before the variation. The fact that the extent of the interests of the beneficiaries in the trust change as a result of the variation was seen as irrelevant.

Therefore, the amendments to the terms of the trust did not trigger capital gains tax (CGT) event E1 or CGT event E2, being the 'resettlement' CGT events.

CGT event E1 happens if a trust is created over a CGT asset by declaration or settlement.

CGT event E2 happens if a CGT asset is transferred to an existing trust.

The Tax Office further confirmed that CGT event E5 was not triggered by the conversion of a family trust to a fixed trust.

CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust as against the trustee despite any legal disability of the beneficiary.

CGT event E5 does not however happen if the trust is a unit trust and thus this exemption was held to apply here.

The Tax Office also confirmed that there are no other CGT events that happened when the family trust was converted into a unit trust. This is because the amendments were within the trustee's powers contained in the trust instrument. This means that the continuity of the trust was maintained for trust law purposes.

The above post is based on an article originally published in the Weekly Tax Bulletin.

Turning comments into wine and books

All those who interact with the post this week with any comments or likes on LinkedIn will go into the draw to win a bottle of View wine (which we are excited to confirm is now drinkable) or a paperback copy of our workbook ‘40 Forms of Trusts’.

Image courtesy of Shutterstock

Tuesday, July 11, 2017

Fixed trusts – what exactly are they?

A recent post explored some threshold issues around the distinctions between unit trusts and fixed trusts (see - Unit trusts and fixed trusts).

Whether a unit trust is in fact a fixed trust is an area that has been the subject of significant uncertainty.

In 2016, the Tax Office did release Practice Compliance Guidelines on its view of what is a fixed trust. Unfortunately, the release by the Tax Office is problematic for at least three reasons, namely:
  1. it only considered the meaning of ‘fixed trust’ for the purpose of the trust loss provisions under the Tax Act; 
  2. the drafting approach of the Tax Office is non-definitive; in other words the Tax Office confirms it will retain the discretion to deem a trust not to be fixed despite what it sets out in the guidelines; 
  3. furthermore, the guidelines are not themselves binding on the Tax Office. 
Subject to the above comments, broadly it seems to be accepted that the following factors will be relevant to supporting that a trust is a fixed trust: 
  1.  the trustee cannot create different rights or different classes of units; 
  2. all units on issue must have the same rights to receive income and capital of the trust; 
  3. units must be allotted for market value; 
  4. all income and capital of the trust must be distributed in proportion to the unitholdings, i.e. there is no discretion held by the trustee; 
  5. partly paid units cannot be issued; 
  6. the trust deed requires all unitholders to agree on the redemption of units and any redemption must be at market value; 
  7. all valuations of the trust fund, and in turn the determination of unit values, must be conducted by a valuer in accordance with ‘applicable Australian accounting principles’; 
  8. the trustee cannot make gifts;
  9. the unanimous consent of all unitholders is required to vary the trust deed and the variation power should prohibit amendments to any of the above provisions.
The above post is based on an article originally published in the Weekly Tax Bulletin.

Image courtesy of Shutterstock

Tuesday, July 4, 2017

Tyre pumping, timesheets and The Force

Last week’s shout out to #oldlaw (or #BigLaw as the case may be) and #burningtimesheets caused a significant amount of discussion.

Some will recall our long held view (no pun intended) that if you are not part of the solution, you are part of the problem* – particularly in relation to sustainable business models for professional service firms.

Creating a #timeless solution was a key foundation for the launch of View 3 years ago this week.

The #starwars inspired 90 second video we created to explain our vision can be viewed (again no pun intended) here – https://youtu.be/g965Sz8n9uc

Best wishes for the new financial year ahead, particularly if you have suddenly been asked to be somewhere between 5% and 23.6% (depending on your firms definition of current CPI rates**) more valuable to your customers …

* For trainspotters this is the Eldridge Cleaver (of Black Panther Party fame) quote

** For trainspotters the actual CPI in Australia over the last year is somewhere around 1%-2%

Tuesday, June 27, 2017

Unit trusts and fixed trusts

One area that seems to be receiving an increasing amount of interest from the Tax Office in recent times concerns the distinction between a unit trust and a fixed trust.

Often, the differences between these two types of trusts can be quite subtle and the interpretation of the trust deed can be critical in this regard.

As has been mentioned in numerous previous posts, the starting point in any trust related matter is to read the trust deed.

Where a trust deed is reviewed and the instrument does not reflect the intention of the parties, it is generally possible to convert what would otherwise be a unit trust into a fixed trust for tax purposes (and vice versa) without any adverse tax or stamp duty consequences.

Obviously, care does always need to be taken in this regard, and due to the potentially significant tax differences between the ownership structures, particularly in relation to issues such as trust losses, capital gains tax events and valuation requirements. It is therefore generally recommended that the trustee obtains specific written advice before implementing any intended change.

Image courtesy of Shutterstock

Tuesday, June 20, 2017

Taxpayer 2 v Commissioner 1 – the continuing story of streaming franking credits via trusts

For those that do not otherwise have access to the Weekly Tax Bulletin, a further recent article is extracted below.

The recent case of Thomas & Anor v FCT [2017] FCAFC 57 (as usual, if you would like a copy of the decision please contact me), contains some particularly interesting comments in relation to the distribution of franking credits by the trustee of a discretionary trust, including the ability to stream franking credits as a separate class of income.

It follows the well-publicised decision of the Queensland Supreme Court in Thomas Nominees Pty Ltd ACN 010 049 788 v Thomas & Anor [2010] QSC 417. That decision held that franking credits could form part of the income of a trust estate for trust law purposes and be streamed to particular beneficiaries.

There then followed the Commissioner's subsequent (successful) application in Thomas v FCT [2015] FCA 968 (see the following post - http://blog.viewlegal.com.au/2015/09/at-last-some-clarity-with-streaming-of.html), which concluded that franking credits were not net income of the trust and therefore could not be "streamed" independently from the net income.

Facts and original decision

In brief, the trustee of Thomas Investment Trust purported to distribute the trust's income in several consecutive financial years as follows:
  • Around 90% of the franking credits and foreign income and 1% of the remaining net income to an individual beneficiary. 
  • The balance of the net income to a corporate beneficiary. 
In the original decision, the taxpayer successfully obtained a declaration from the Supreme Court of Queensland in relation to the proper construction of the trust resolutions distributing the income in the manner summarised above.

In particular, the taxpayer commenced proceedings seeking directions under s 96 of the Trusts Act 1973 (Qld) as to the manner in which the trust deed and trust distribution resolutions should be interpreted.

The Commissioner was notified of the application but informed the taxpayer's solicitor that it did not consider it appropriate for the Commissioner to be a party to the proceedings.

The Court granted the orders requested by the taxpayer, largely on the terms requested, which included that the proper construction of the trust deed and resolutions resulted in the majority of the franking credits passing to an individual, notwithstanding that the balance of the net income went to the corporate beneficiary.

Commissioner's appeal

Following the decision above, the Commissioner challenged the effect of the distributions and in essence, argued that the franking credits could not be distributed to a beneficiary independently of the franked dividend to which those franking credits related.

The judgment issued by the Federal Court rejected the earlier conclusion of the Queensland Supreme Court and provided significant guidance in relation to the streaming of franked dividends and franking credits.

In particular, it confirmed that Div 207 recognises and permits a trustee to stream some or all of a franked dividend to one or more beneficiaries to the exclusion of others, subject to the requisite powers under the trust deed.

However, the Court held that, while franking credits will generally have a clear commercial value to a beneficiary (as a result of the beneficiary's ability to claim a tax offset from the credit), a franking credit is not "income" for trust law purposes.

Consequently, although franking credits constitute statutory income for the purposes of the gross-up provisions, they are a notional, statutory creation in this regard and do not constitute "ordinary income" under trust law principles.

As a result, the Court held the operation of Div 207 makes it clear that franking credits can only "attach" to the franked dividend and cannot be streamed as a separate class of income, notwithstanding any other provision that may indicate to the contrary within the trust instrument and found in favour of the Commissioner.

Taxpayer's subsequent appeal

The taxpayer's appeal Thomas & Anor v FCT [2017] FCAFC 57 essentially hinged on the nature of the original decision issued by Applegarth J in Thomas Nominees Pty Ltd ACN 010 049 788 v Thomas & Anor [2010] QSC 417.

The taxpayer argued that the nature of the orders issued by Applegarth J regulated the rights of the beneficiaries and the trustee and had conclusively determined each beneficiary's share of the trust's net income.

In particular, the Full Federal Court noted:

"The application before his Honour [(ie Applegarth J)] required the Court to make sense of what may, perhaps not unfairly, be described as confused resolutions. The resolutions purported to do something and an ultimate intention could fairly be discerned however ineptly the two resolutions may have been drawn.

However the rights of the beneficiaries flowing as against the Commissioner from Div 207 of the 1997 Act depended wholly upon the effect of the rights created as between the trustee and the beneficiary by whatever the resolutions may have achieved.

The rights to be created by the trustee as against the Commissioner were a matter wholly within the control of the trustee and it was in the jurisdiction of the Supreme Court to make declarations concerning the proper construction of what the trustee had done pursuant to a domestic trust."

The Court went on to say:

"The Commissioner was not obliged to participate in that proceeding, and may not be bound by the construction of Div 207, but the Commissioner is bound by a declaration concerning the effect of the resolutions if the declaration conclusively determines that a beneficiary has a share of the trust's net income for a year of income that is covered by s 97(1)(a) of the 1936 Act."

Consequently, the Court found in favour of the taxpayer for the income years in which the original orders had been granted (2005-2008) and, "reluctantly", also for the 2009 resolutions, which had not been expressly considered by Applegarth J.

Although the taxpayer was successful, the Court appeared unimpressed by the reasoning of Applegarth J in his original decision on a number of occasions.

For instance, Pagone J commented:

"Applegarth J's declaration in 1(b)(iii) is, perhaps surprisingly, that the resolutions which the trustee had made in the years ended 30 June 2005 to 30 June 2008 had conferred upon each of the beneficiaries a vested and indefeasible interest in the distributable income consistent with the intended flow of franking credits."

More bluntly, Pagone J said:

"It is difficult to embrace the conclusions of Applegarth J ... The franking credit distribution resolution is explicable only by a fundamental confusion in the mind of the person drafting the resolution … Applegarth J, however, was persuaded …"

Perram J also noted:

"Like Pagone J, I am, with respect, sceptical about the construction of the resolutions adopted by Applegarth J, but that scepticism simply does not matter whilst the declaration remains on foot. It is what it is. That it might be attended by reasoning which may be erroneous is irrelevant whilst it exists."

It seems clear from the decision that the taxpayer has enjoyed an extremely fortunate outcome, essentially leveraging the interplay of a number of technicalities to engineer an unlikely win.

Indeed, it can also arguably be assumed that, with the aid of hindsight, the Commissioner would be regretting his decision not to be included as a party to the original application to the Queensland Supreme Court.

Position in relation to streaming franking credits

While the case is at face value a victory for the taxpayer, it far from authority for the conclusion that franking credits can be streamed as a separate class of income from the dividends giving rise to those credits.

Indeed, in the absence of construction orders like those granted here by Applegarth J in the Queensland Supreme Court, the correct interpretation of Div 207 is that outlined by Greenwood J in Thomas v FCT [2015] FCA 968.

That is that while franking credits constitute statutory income for the purposes of the gross-up provisions, they are a notional, statutory creation in this regard and do not constitute "ordinary income" under trust law principles.

Pagone J makes this abundantly clear by stating that the trust resolutions here, and in turn Applegarth J's analysis:

"…proceeded upon the same misunderstanding of the proper operation of Div 207; that is, upon the misunderstanding that franking credits could be distributed separately."


Ultimately, as explained in our previous post (see - http://blog.viewlegal.com.au/2015/09/at-last-some-clarity-with-streaming-of.html), there are a number of lessons that can be taken from these decisions.

Certainly, as a starting point, there is the need for the Government to prioritise the long awaited re-write of the legislation governing the taxation of trusts in order to simplify what continues to be an unnecessarily complex area of the taxation law.

As set out previously, the other key lessons include the following:
  • As regularly highlighted in this Bulletin, it is critical to "read the deed" before purporting to exercise trust powers, particularly in relation to trust distributions. 
  • While reading the trust deed (including all valid variations) is necessary, it will not be sufficient by itself. There are a myriad of related issues that need to be considered that may impact on the intended distribution, aside from whatever powers are set out in the trust instrument. Examples include renunciations and disclaimers by beneficiaries, purported changes that are not permitted under the relevant trust instrument and the effective narrowing (for tax purposes) of permissible beneficiaries due to the impact of family trust and interposed entity elections. 
  • The wording of the distribution minute or resolution will be critical for determining the consequences of the distribution. Terms like "income" and "net income" will be defined differently depending on the trust instrument (even deeds that have been sourced from the same provider) and failing to understand those distinctions can result in inadvertent adverse outcomes for the trustee and beneficiaries. 
  • Distribution resolutions must also be crafted with reference to the trust instrument, trust law principles, the ITAA 1936 and the ITAA 1997. For example, with increasing regularity, we are seeing trust deeds that require distributions take place before they are otherwise needed under the ITAA. 
  • Trustees should act with significant care when dealing with "notional" amounts such as franking credits, to ensure the intended tax and commercial objectives are achieved. 
  • Trustees have a duty to ensure they are aware of their rights and responsibilities under the trust deed and the limitations under the ITAA 1936 and the ITAA 1997. A failure to discharge this duty can mean a trustee is personally liable. 
Finally, many of the themes in this post were featured in our recent Estate Planning Roadshow.

Download the brochure to purchase a full recording of the event here - https://viewlegal.com.au/product/recorded-webinar-package/

Tuesday, June 13, 2017

How soon is now ** (or ‘as soon as practicable’)?

Last week’s post considered the phrase ‘as soon as practicable’ in light of the 2017 superannuation changes (see - Estate planning and the 2017 super reforms – the six post death strategies you must be aware of).

Regulation 6.21 of the Superannuation Industry (Supervision) Regulations 1994 (Cth) requires death benefits to be cashed ‘as soon as practicable’ following the death of a member.

Unfortunately, ‘as soon as practicable’ is not defined in the Regulations and has not been otherwise defined.

Generally in our experience the Tax Office has historically expected death benefits to be paid within 6 months of a person's death, or earlier if possible.

While perhaps not directly relevant, part of the reason for this approach is likely to be because under section 17A(4) of the Superannuation Industry (Supervision) Act 1993 (Cth), any replacement trustee (or replacement director of a corporate trustee) must resign within 6 months of the death benefits commencing to be paid. In other words, 6 months is legislated in a manner that is arguably analogous to the concept of ‘as soon as practicable’.

This said, if there are objectively reasonable circumstances preventing payment for more than 6 months, this is unlikely to cause a breach of the rules, so long as the payment occurs as soon as practicable once the relevant circumstances have been resolved.

Some examples of where a payment after 6 months may still meet the ‘as soon as practicable’ test include -
  1. it may be that probate of a member's estate is seen as required before paying a death benefit, and generally probate will take longer than 6 months; 
  2. if there is a risk that an estate may be challenged or the potential recipients of a death benefit challenging the trustee's decision, confirming that the risk has passed will generally take longer than 6 months; 
  3. similarly, if there is an actual challenge to a deceased estate this may warrant delaying paying of a death benefit; 
  4.  if there is uncertainty about the validity of any purported binding death benefit nomination this may take longer than 6 months to resolve; 
  5. the nature of the assets in a fund may make distributions within 6 months impossible, for example illiquid assets such as real estate or investments in platforms that have large penalties for early withdrawal; 
  6. it may also be that the values of assets that are will form part of the cashing take an extended period to value; 
  7. surrounding circumstances, such as poor health of a surviving fund member may also justify a payment commencing later than 6 months. 
Interestingly, the 2017 superannuation reform legislation permits a reversionary beneficiary 12 months to decide if they wish to cash their benefit before it is automatically credited to their transfer balance. This allowance may (again by analogy) support the argument that a death benefits payment within 12 months will meet the ‘as soon as practicable’ test, even without other explanatory reasons.

** for the trainspotters – check out iconic 1980s new wave band The Smiths perform ‘How soon is now?’ here - https://www.youtube.com/watch?v=hnpILIIo9ek

Finally, many of the themes in this post were featured in our recent Estate Planning Roadshow.

Download the brochure to purchase a full recording of the event here - https://viewlegal.com.au/product/recorded-webinar-package/