Tuesday, March 29, 2016

Trust Splitting – some clarity at last

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

The recent Tax Office Private Binding Ruling Authorisation number 1012921290075 (Ruling), considers a number of key issues relating to the concept of trust splitting.

While trust cloning is generally seen as preferable to trust splitting, there are a range of reasons cloning may be commercially inappropriate including –
  • an inability to access any of the small business CGT rollovers;
  • assets that do not lend themselves to complete separation;
  • no stamp duty relief (which is the case in most Australian states).
The Ruling is a timely reminder of the need to ensure care is taken with any intended rearrangement of an existing trust.

Overview of questions answered

The Ruling confirms the following key conclusions -
  • the insertion of powers into a trust instrument to provide a trustee the ability to create a split trust will not be a resettlement if the power of variation is sufficiently wide;
  • a change of trusteeship in relation to certain trust assets will not cause any tax consequences, again subject to the trust deed providing the requisite powers;
  • a change to the person nominated as principal or appointor of a split trust will not cause any tax consequences, again subject to the trust deed providing the requisite powers; 
  • varying a trust deed to limit each trustee’s right of indemnity such that each trustee is only permitted to be identified from the assets of the split trust they act as trustee for will not cause a resettlement; 
  • narrowing by deed amendment the class of beneficiaries of each split trust to focus around the family unit intended to control that trust will cause a resettlement. 
Arguably, since the decision in FCT v Clark [2011] FCAFC 5 (Clark) and the ATO’s response in Tax Determination 2012/21, none of the above conclusions are controversial, other than in relation to the narrowing of beneficiaries causing a resettlement. It is important to note however that the ability to limit the right of indemnity does change the previously adopted ATO position.

It might be recalled that in Clark, a majority of the Full Federal Court held that changes to a trust (primarily a change in the ownership of units of beneficial entitlement to the trust property and changes to the trust property itself) did not result in a break in continuity of the trust. As a result, capital losses incurred by the trustee before those changes occurred could be offset in calculating net capital gains arising after the changes occurred.

Each of these issues are explored in more detail below.

Narrowing of right of indemnity

One of the fundamental concerns with trust splitting, as compared with trust cloning, was the asset protection issues with trust splitting, if the trustee of each split trust remained able to be indemnified from assets held by other trustees of assets in a different split trust.

Prior to this Ruling, ATO guidance has historically indicated that limiting a trustee’s right of indemnity as part of a trust splitting arrangement could cause CGT event E1 to happen.

In particular, in ATO Interpretative Decision 2009/86, it was decided that a trust split did trigger CGT event E1 on the basis that there was a 'fundamental change to the rights and obligations attaching to the trust assets’. A key aspect raised by the ATO was that the trustee's rights of the ‘original’ trust had been altered by excluding the transferred assets from its right of indemnity.

In the Ruling, a desire to limit the right of indemnity was based on achieving the asset protection objectives and to align with the estate plans of the shareholders and directors of the trustee of the orignal trust.

However the ATO confirms in the Ruling that, following Clark, this type of change does not result in the trust estate as originally constituted coming to an end.

Furthermore the altering of the indemnity does not cause any of the assets of a trust to be subject to a new charter of rights or obligations separate to those on which the property was originally settled.

Rather, the restriction of the respective trustee’s rights to be indemnified is in fact consistent with the appointment of separate trustees over different assets of a trust. Ultimately then the changes, without more, did not alter the rights of the beneficiaries to be able to benefit from all of the assets of the trust.

Narrowing the class of beneficiaries

Again due to the objectives under the estate plans of the shareholders and directors of the trustee of the orignal trust, there was a desire to narrow the class of potential beneficiaries.

In the Ruling the ATO states that any such change will amount to a situation where assets are commenced to be held on trusts different to the original trust. In other words, that CGT event E1 would happen by reason of the changes.

In reaching this conclusion the ATO relies heavily on the decision in Commissioner of State Revenue v. Lam & Kym Pty Ltd (2004) 58 ATR 60 (Lam & Kym).

Whether the position adopted by the ATO on this point is correct would need to be considered in light of the following –
  • Lam & Kym involved an express declaration of trust over specific assets, which does not appear to be the case in the factual scenario considered in the Ruling.
  • In any event, Lam & Kym was a Victorian Supreme Court case which has been largely superseded by the High Court in Clark.
  • Clark confirmed, as acknowledged in TD 2012/21, that a variation of a trust by the trustee in accordance with an express power in the trust instrument will generally not result in the establishment of a new trust. 
  • The narrowing of a beneficiary class is analogous to Clark and TD 2012/21, which confirm that no resettlement arises from a variation of beneficiaries where the variation is permitted by the trust deed and there is continuity of the trust estate. 

The Ruling provides useful clarity around the scope of changes that can be implemented as part of a trust splitting arrangement. While the ATO’s position in relation to narrowing beneficiary classes is disappointing, there remains significant scope for helping trustees achieve succession planning objectives via trust splitting.

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