Yeah right** - because before Rinehart, there was Murdoch

While the Rinehart decision received significant attention in relation to many issues, including the tax consequences of ending a trust, the tax principles of another famous case are worth remembering, namely the decision in Murdoch v Commissioner of Taxation [2008] FCAFC 86.

Broadly the situation was as follows –

1. Dame Elisabeth Murdoch (Dame) had a life interest in the income of several family trusts settled by her husband in the 1930s.
2. The remainder interest was held by one or more of the Dame’s children or grandchildren.
3. For many years, the trustee of the relevant trusts was effectively the Dame, her son Rupert Murdoch and a third party.
4. It was however noted that the Dame was likely influenced in her role to accept the investment decisions due to the very strong personality of her son Rupert.
5. A Reorganisation Agreement under which Dame surrendered her life interests under each of the Trusts were entered into, with the consideration a lump sum payment of more than $85m.
6. The payment was couched as releasing the trustees from potential claims for breaches of trustee duties.
7. In particular, the investment policy that had been adopted (apparently at Rupert’s strong recommendation) was overwhelming weighted to shares in Murdoch family companies that produced capital growth, but comparatively small dividend income. This investment approach essentially benefited the remainder beneficiaries, at the expense of the Dame as life tenant.
8. The payment was said to be to help avoid the need for litigation amongst the family.
9. Around 65% of the $85m was then gifted by the Dame to Rupert and charities she was associated with.
10. The payment was funded by the sale of pre capital gains tax shares and was essentially received tax free by the Dame.

In confirming the extremely onerous fiduciary duties of a trustee (see the post from last week) the court confirmed that Rupert had breached his obligations, even though there was no lack of good faith or particular damage to the Dame.

The court relied particularly on the principles of the case Phipps v Boardman [1967] 2 AC 26, which held that this style of claim was not for a reimbursement of the income shortfall.

The payment was therefore on capital, not income, account as a claim against the profit made by Rupert and in essence a constructive trust over assets of the trust.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Dinosaur Jnr song ‘Yeah, right’.

Listen here:

Taxation consequences of testamentary trust distributions - Part II

Again for those that do not otherwise have easy access to the Weekly Tax Bulletin, Part II of the article by fellow View Legal Director Patrick Ellwood and I is extracted below.

Part I of this article (at 2014 WTB 19 [658]) considered a number of specific aspects of the transfer of assets under a deceased estate testamentary trust. Part II of the article now considers:

• distributions from testamentary trusts to beneficiaries;
• the proposed changes to CGT event K3; and
• the proposed changes where an intended beneficiary dies.

Distributions from testamentary trusts

In 2003, the ATO released PS LA 2003/12, which states that its purpose is to inform ATO staff that the Commissioner will not depart from the long-standing administrative practice of treating the trustee of a testamentary trust in the same way as a legal personal representative (LPR) is treated for the purposes of Div 128 of the ITAA 1997.

In the 2011-12 and 2012-13 Federal Budgets, it was proposed that the current ATO practice set out in PS LA 2003/12 of allowing a testamentary trust to distribute an asset of a deceased person without a capital gains tax (CGT) taxing point occurring would be codified.

While draft legislation to effect the change was prepared, the Federal Government announced that it was reviewing the progress of a large number of unenacted legislative announcements and ultimately confirmed on 14 December 2013 that the amendments would not be implemented - see 2013 WTB 53 [2270] and also 2014 WTB 12 [399].

As set out at 2014 WTB 16 [561], the ATO recently republished PS LA 2003/12 confirming that it intends to continue to consider itself bound by it. Despite the ATO apparently acknowledging that the Government will not proceed with any legislative changes, some amount of confusion has been caused by the ATO stating in updates on its website that it will "accept tax returns as lodged during the period up until the proposed law change is passed by Parliament". Those comments are contained in the ATO update entitled "Refinements to the income tax law in relation to deceased estates" (dated 22 April 2014). It is assumed these comments are simply an oversight by the ATO and that PS LA 2003/12 (as amended) will continue to be applied indefinitely into the future.

The position therefore appears to remain that there is exemption roll-over from CGT covering the "transfer" of assets from the LPR to the trustee of the testamentary trust in the first instance and the subsequent transfer by the trustee to an eventual beneficiary of the testamentary trust. The subsequent transfer may either involve a capital distribution being made by the trustee of the trust to a beneficiary during the lifetime of the trust, or a payment of capital upon vesting of the trust.

The result of PS LA 2003/12 is that, on the subsequent disposal of a CGT asset from a testamentary trust trustee to a beneficiary of the testamentary trust:

• any capital gain or loss that the testamentary trust trustee makes is disregarded under s 128-15(3); and
• the beneficiary will be taken to have acquired the CGT assets of the deceased at the date of the deceased's death (rather than on the date they were distributed by the LPR) and the first element of the cost base and reduced cost base for the beneficiary will be:
• for pre-CGT assets in the hands of the deceased - the market value of the asset on the day the deceased died; and
• for post-CGT assets in the hands of the deceased - the deceased's cost base (or reduced cost base) at the date of their death.

Ultimately under PS LA 2003/12, Div 128 (in particular ss 128(2), (3) and (4)) effectively applies twice:

• initially, when the LPR is the "LPR" for the purposes of Div 128 and the testamentary trust trustee is the "beneficiary"; and
• subsequently, when the testamentary trust trustee is treated as an "LPR" for the purposes of Div 128 and the beneficiaries of the testamentary trust are treated as the "beneficiaries".

CGT event K3

The ATO has indicated that the position in PS LA 2003/12 is subject to CGT event K3, which covers assets passing to tax-advantaged entities.

CGT event K3 operates to ensure that, where assets pass to concessionally taxed entities from a deceased estate, a capital gain or loss is recognised in the deceased's final tax return. This prevents assets with embedded capital gains from avoiding capital gains when they are later disposed of by the concessionally taxed entity. CGT event K3 has, in the past, been avoided by ensuring an asset does not pass to a concessionally taxed entity until after the deceased's standard amendment period (generally 4 years after the assessment) has expired.

As part of the 2011-12 Budget measures, it was announced that amendments would be made to ensure that where CGT event K3 happened outside of the deceased's standard amendment period, a CGT liability still arose in the deceased's tax return. It was proposed this could be achieved by excluding CGT event K3 from the standard amendment period.

In particular, the CGT event would have been deemed to happen to the relevant entity that passed the asset to the concessionally taxed entity (rather than with the beneficiary), avoiding the need to amend the deceased's tax return. This change would have allowed the entity to which CGT event K3 applied to be able to utilise its realised capital losses against CGT event K3, instead of the deceased utilising their capital losses against their capital gain from CGT event K3.

The change would have been consistent with how Div 128 operates under PS LA 2003/12 where an LPR or testamentary trust trustee sells an asset to a third party, rather than passing the asset to the intended beneficiary of the estate.

However, as with other proposed changes mentioned below, the announced changes to CGT event K3 were abandoned in late 2013.

Where an intended beneficiary dies before administration is completed

The Federal Government released a proposal paper "Minor amendments to the capital gains tax law" in June 2012 which specifically addressed the circumstance where an intended beneficiary dies before administration of an estate is completed. Generally, in that situation, s 128-15 provides a CGT roll-over provided that the asset passes from the first deceased's LPR to the beneficiary's LPR.

However, no CGT roll-over exists where the asset passes (ultimately) from the first deceased's LPR via the second deceased's LPR to the trustee of a testamentary trust or a beneficiary of the intended beneficiary's (ie the second deceased) estate because the asset was not one which the intended beneficiary owned when they died.

The former Labor Federal Government proposed to introduce measures to allow the intended beneficiary's LPR to access the roll-over where the intended beneficiary died before an asset that the first deceased owned passed to them, regardless of whether it passed first to a testamentary trust trustee. Again, however, the Coalition Government confirmed the amendments would not be implemented.

Arguably, PS LA 2003/12 can be relied on to provide relief in this type of situation.

Image credit: Alan Cleaver cc

Buy sell deeds, family trusts and the deemed market value substitution rule

Click here for an overview of buy-sell arrangements

With thanks to co View Legal director Tara Lucke, today’s post considers an issue that has been raised with us by an adviser recently.

It is generally accepted that where a business succession plan is structured with self owned insurance policies and a buy sell deed using put and call options, the deemed market value substitution rules apply for taxation purposes.  This outcome occurs notwithstanding that the transfer has been funded (either wholly or partly) by insurance.

Given the recent changes to the rules relating to the taxation of trusts, some uncertainty has arisen in relation to the ability to effectively manage the taxation consequences of a deemed capital gain arising from a transfer under a buy sell deed.

Under the ‘interim’ taxation rules relating to trusts, there can be particular problems relating to distributions of capital gains arising under the deemed market value substitution rule.  In particular, it is generally not possible to create specific entitlement to a deemed capital gain, notwithstanding that there may be a streaming power in the trust deed. 

However, where $1 of consideration has been received (which is how we generally recommend buy sell deeds be crafted), provided a beneficiary is made specifically entitled to the $1 of consideration, the deemed gain should be distributed to that same trust beneficiary.

It will therefore be important in each case to consider the specific terms of the trust deed and the other income of the trust, and to craft the distribution minute correctly to ensure the gain can ultimately be distributed to individuals who can access the general 50% capital gains tax discount. 

Until next week.

What are some of the issues with a professional partnership ‘rolling over’ into a company structure?

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘What are some of the issues with a professional partnership ‘rolling over’ into a company structure?’at the following link - http://youtu.be/pIwVOyEAeBA



As usual, a transcript of the presentation for those that cannot (or choose not) to view the presentation is below –

The rollover at face value is always the easiest way to go, because it removes one seriously significant transaction cost being the capital gains tax implications. The problem though is that when you dig a little bit deeper, that is a little illusionary at times, particularly for a group of individual partners rolling over to a company. The attraction of taking that style of rollover can be diminished by the fact that they will still individually own the shares in the company.

So if it's a standard rollover, for example a partnership to a company under Division 122B of the Tax Act, ultimately, the individuals would still actually own the shares in the company. What they will have done is taken away 100 cents in the dollar, if that’s the right way to say it, of income that they’ve historically been enjoying and replaced that with 70 cents in the dollar and an imputation credit or franking credit.

This can lead to a situation where people, having done a rollover are then looking to restructure again anyway. So effectively it's a double restructure because they'll want to divest themselves individually of shares and make those shares be owned via some sort of discretionary trust arrangement.

It can also lead into a range of other potential restructures, dividend access shares and these types of arrangements that certainly get away from the overall goal in the first place, which was to simplify arrangements and get true limited liability.

The other areas (and some of these touched on in other parts of today's program) that obviously need to be taken into account include that while there is no stamp duty on unlisted shares, there is certainly stamp duty in every state moving from an individual or partnership arrangement into a company arrangement. That's a significant transaction cost that cannot be avoided in any way, shape or form currently and needs to be paid upfront effectively to get yourself into the new structure. The other ancillary costs that go around an incorporation include issues such as payroll tax, which is inevitably a lot more expensive if you've moved into a company structure as opposed to remaining in a partnership structure.

Until next week.

Company owned insurance policies for business succession

We recently had an adviser seeking more detailed comments about company owned business succession insurance policies.

In particular, feedback was requested about the specific reservations with insurance policies for business succession being owned by a company. In summary, and with thanks to co View Legal director Tara Lucke, we provided the following reasons:

1   while capital gains tax (CGT) should not be payable on receipt of life insurance proceeds, it will be payable on any total and permanent disablement or trauma proceeds that are paid to a company. In contrast, no CGT should be payable on receipt of the insurance proceeds where the policies are self owned;

2   there can also be significant practical difficulties in extracting insurance proceeds from a company to the appropriate recipient. This is particularly important when the main purpose of the policy is for an equity payment, as opposed to debt cover. Again, where the policy is self owned, the exiting principal or their estate will receive the proceeds directly and none of these practical issues will arise, as long as an appropriate agreement is implemented;

3   where insurance proceeds need to be accessed by the exiting principal (or their estate) this is generally only achievable via a share buy-back or dividend. A dividend will likely be tax inefficient and generally a buy back will also have an inefficient tax outcome for the following reasons:

(a) the consideration will be split between an assessable capital gain and a dividend, which restricts access to the full benefit of the CGT 50% discount and small business CGT concessions;

(b) while a company may be able to pay the proceeds to the exiting shareholder/s as a partially or fully franked dividend, this will use franking credits that would otherwise have been available for distributing profits; and

(c) the surviving owner/s will own 100% of a company after a share buy-back, however their cost base in the shares will not have increased;

4   insurance proceeds will be under the control of the remaining director/s of a company, in contrast with a self owned or superannuation owned policy where the estate directly receives the benefit of the proceeds; and

5   finally, the legal documentation required for company ownership is comparatively complex to all other policy ownership approaches.

Until next week.

Deed updates by exception post Bamford

During our recent master class seminars on trusts, one specific issue that was addressed related to updating family trusts after the Bamford decision and related legislation.

The post today is the 3rd instalment of 4 in this series of posts via the following video link under the heading ‘Deed updates by exception post Bamford’. If you would like a link to the video please let me know.

As with other video posts, for those that do not have easy access to the streaming or would otherwise prefer to read the transcript, this is set out below -

The second approach is ‘by exception’, that is you do something. So on the basis that even if you do nothing, you've got to do something; which is you've got to have someone read the deed.

The by exception approach is if it's a particularly nasty deed, or there is as particularly big capital gain this year we’re going to invest in this and we're going to look at it and we're possibly going to amend it, because of the particular circumstances.

We're going to do that, because even doing nothing, we've actually sat down and looked at the document and we understand it.

The trigger for a lot of people on that, if you're looking for a date, but don’t quote me because again not all deed providers were diligent in doing this, but by and large, any deed after 1993, from any even remotely reputable provider, will have streaming.

So if you're looking for a date to say I would hope to be basically right, you can use 1993 as the date, because that’s when streaming ruling came out or whatever it was and most deed providers across the board went through and did it. Indeed, a lot of them went and did actual updates in 1993. So even your pre-’85 trusts had gone and had that amendment in 1993.

The next post will look at the third main approach we are seeing in this area.

Until next week.

‘Deriving’ trust income

This week’s post looks at a recent case from the Federal Court and is of interest for those following the ongoing debate about trust income.

The name of the case was SCCASP Holdings as trustee for the H&R Superfund v FCT (a link to the full copy of the decision is as follows – http://www.austlii.edu.au/cgi-bin/sinodisp/au/cases/cth/FCA/2012/1052.html?stem=0&synonyms=0&query=SCCASP%20Holdings%20\).

In summary, the core factual background was as follows:

1    A family trust that had made a capital gain of $14 million sought to have this received by a related self managed superannuation fund (SMSF).

2    The ATO was seeking to argue that in the hands of the SMSF, the income was 'special income' and therefore taxed at 47%, as opposed to the taxpayer who argued that it was only subject to tax at the standard income tax rate for SMSFs (namely 15%).

3    The particular 'technical' argument that the taxpayer sought to rely on was that because the trustee of the family trust had not made a decision to pay or apply any amount of the capital gain, then for the purposes of the tax rules, it could not be said that the SMSF 'derived' the income.

Ultimately, the Court agreed with the Tax Office and held that the word 'derived' extended to effectively capture anything that was ultimately received by the SMSF, and in particular, extended to the concepts such as money being 'attributed' or ‘imputed’ to the SMSF.

Until next week.

Insurance premiums & FBT

As many regular readers would be aware, one particular innovation in recent times in relation to insurance funded business succession arrangements is the so-called 'debt reduction' strategy.

One aspect of the arrangement that is often raised concerns the fringe benefits tax (FBT) implications of the premium payments.

Broadly, there are a number of reasons as to why FBT will normally not apply to the payment of insurance policy premiums.

Generally the accountant for the business will always be best placed to give the guidance, however some of the reasons FBT will not apply can include –

1.    the arrangements not having anything to do with employment;

2.    in some instances, the otherwise deductible rule; or

3.    while for administrative ease the premiums might be paid by the business, the actual tax position is that the amount is included as part of other payments made (for example, a dividend).

It is important to remember that aside from FBT, there are a number of other tax issues that may also be relevant (for example division 7A or capital gains tax) so it is also best to ensure the exact circumstances are considered by the accountant for the particular client.

Until next week.

ATO reminder – read the deed

Following on from the recent posts about the ATO draft determination on resettlements (TD2012/D4), today's post is in effect a further reminder of an earlier post that focused on the catch phrase 'Read the Deed', again with thanks to co View Legal director Tara Lucke.

One of the key themes in the recent ATO determination is that a trust variation must be made within the scope of the variation power in the trust deed.

If a purported variation is made outside the scope of the particular variation power, the ATO has provided guidance that this may result in the termination of a trust (i.e. a resettlement for CGT purposes).

We are constantly encountering deeds that have significant limitations on the variation power, particularly with the regular amendments we are doing for clients of accounting firms to ensure that trust deeds are up-to-date for all recent changes in law.

Next week’s post will focus on some of the common variation prohibitions we come across.

Until next week.

More comments on ATO resettlements determination

As mentioned in the last post, the ATO has released a draft determination, TD2012/D4, in relation to resettlements.

With particular thanks to View Legal director Tara Lucke, today’s post focuses on the interplay of the draft determination with the ATO’s previous published position on resettlements – the Statement of Principles.

In summary, according to the determination:

1.        The ATO has withdrawn its Statement of Principles as of April 2012.

2.        The ATO accepts that although the Clark and Commercial Nominee cases were decided in perhaps slightly different contexts to many of the issues dealt with in the Statement of Principles, the conclusions reached in each of those two cases do have a broader application.

3.        Provided an amendment to a trust is valid at trust law and is in accordance with the terms of the trust instrument, CGT event E1 should not be triggered.

4.       The ATO will expect any deed of variation to be made in accordance with trust law principles and the particular requirements of the trust instrument in order for the amendment to be effective.

Until next week.

ATO releases draft determination on trust resettlements

Posts from last year looked at the Clark decision.  In that case, the court held that significant changes to a trust instrument would not of themselves cause a resettlement of the trust for tax purposes.

As mentioned in last week’s post, the Tax Office has now released draft determination TD2012/D4 which provides some further clarity around when the Tax Office will deem changes to a trust to amount to a capital gains tax event under CGT events E1 and E2 (i.e. a resettlement).

In broad terms, the Tax Office states that unless variations cause a trust to terminate, then there will be no resettlement for tax purposes.

A number of examples are provided, which give some guidance around issues such as changes of beneficiaries and update to address distribution of trust income.

Unfortunately, the examples provided are not particularly comprehensive and issues such as changing appointors and multiple changes (for example, changing beneficiaries, the trustee and the appointor as part of an estate planning exercise) are not specifically addressed.

This said, the draft determination should provide a level of confidence that relatively significant changes to trust instruments can be made without adverse tax consequences, although it remains necessary to also consider the separate stamp duty and trust law implications of any such change.

A full copy of the draft determination is at the following link – http://law.ato.gov.au/atolaw/view.htm?docid=%22DXT%2FTD2012D4%2FNAT%2FATO%2F00001%22

Until next week.

Valuations for the small business CGT concessions

There have been a number of court decisions in recent times focused on the way in which valuations are conducted for the purposes of satisfying (what is currently) the ‘$6M net asset test’ for the small business capital gains tax concessions.

The Tax Office has recently released a Decision Impact Statement following one of the cases from last year (for a full copy of the statement, please email me).

In the statement the Tax Office has confirmed that its publication ‘market valuation for tax purposes’ provides the guidance that it believes should be followed in order to establish a market value for tax purposes.

In particular, the Tax Office states that it believes market value should be determined with reference to the ‘highest and best use’ of each asset being assessed.

While generally the sale price of an asset will be its market value, the Tax Office believes that each situation must be considered on a case by case basis to determine the most appropriate methodology for determining market value.

Often this will lead to reference to the long standing concept of ‘what a desirous buyer would have paid as a fair price to a willing vendor who was not necessarily desirous (or over anxious) to sell’.

Until next week.

What are the tax consequences of assets passing via a testamentary trust

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘what are the tax consequences of assets passing via a testamentary trust ?’ at the following link - http://youtu.be/pqngu0EddtQ

As usual, a transcript of the presentation for those that cannot (or choose not) to view the presentation is below -

The reality has been that ever since the Practice Statement was released in around 2003, there has been a really implicit acceptance across the industry, and one would hope from the Tax Office as well, that the interpretation of Division 128 that allowed the transfer of assets, not only from a legal personal representative down into a testamentary trust, but then from that testamentary trust to another testamentary trust under some form of cascading arrangement, would be free from capital gains tax.

More importantly, any ultimate transfer out of the testamentary trust, whether it be the initial trust or a subsequent trust, would also be free of capital gains tax.

What that Practice Statement did was effectively give that approval from the Tax Office that that approach, that really had been the approach across the industry for many, many years, was not going to be challenged by the Tax Office.

What we've seen in very recent times, particularly with the 2011 federal budget, is that even though that approval seemed to be there from the Tax Office, the level of uncertainty that was created when you read that back with Division 128, meant that legislative reform was required.

We're seeing that coming through the system now with the announcement in the 2011 federal budget, which effectively looks to replicate the position under the Practice Statement from 2003.

Until next week.

Do ‘cascading’ testamentary trusts cause a tax problem

With thanks to the Television Education Network, there will be a series of posts over the next period of time where excerpts from a recent video presentation I have provided will be the basis of the post.

Each week, I will also include a transcript of the presentation for those that cannot (or choose not) to view the presentation.

The first excerpt posted today is under the title ‘Do ‘cascading’ testamentary trusts cause a tax problem’ at the following link - http://youtu.be/YaMouN6Pox0

As explained at the above link -

Under Division 128 of the 1997 Tax Act, the concept of an asset passing from a will maker or the executor into the estate is absolutely certain that that transfer of wealth is not subject to any capital gains tax.

Where some confusion arises, particularly in relation to cascading trusts or master trusts, is that the language under Division 128 is a little bit obscure or a little bit uncertain as to exactly what is going to happen once the assets have passed into the estate. So in other words, the transfer from the will maker to the legal personal representative, absolutely no capital gains tax.

The transfer from the legal personal representative or the executor down into an initial testamentary trust, again absolutely no capital gains tax.

The confusion then arises that is it the case that from the testamentary trust to a beneficiary, particularly if that beneficiary happens to be another testamentary trust, will that transfer be without capital gains tax?

On a plain reading of Division 128, there is little question that that transfer of subsequent assets, even if it is to another trust, will be free of capital gains tax. But there has been, I guess for many years now, a level of uncertainty about that, simply because of the language used under that particular division.

Until next week.

De facto death duty confirmation

As many will have seen, the lead article in Friday’s Financial Review confirmed that, as far as the Tax Office is concerned, payments made by a super fund, following the death of a member, will be subject to (at least) a 10% capital gains tax bill.

Tax is payable in these circumstances on the difference between the market value of the underlying assets of the fund and the cost base.

While some advisers have tried to adopt approaches to get around what is effectively a death duty, the conservative view as to the likely ATO approach has now been confirmed beyond doubt.

Depending on the exact circumstances of a client, there are still mechanisms to significantly reduce and/or eliminate the capital gains tax liability that might otherwise be triggered on the death of a fund member, however the announcement by the Tax Office further underlines the importance of ensuring a comprehensive, integrated and up-to-date estate plan.

For those interested in reading the full draft ruling, a link is set out below.

Until next week.

http://law.ato.gov.au/atolaw/view.htm?DocID=DTR/TR2011D3/NAT/ATO/00001&PiT=99991231235958

Lineal descendant trusts post Bamford

As touched on in a recent post, often 'lineal descendant trusts' will adopt a 'hybrid' approach whereby:

1) The capital is protected for lineal descendants.

2) The income may be distributed to a wide range of potential beneficiaries (including non lineal descendants).

We have seen a number of instances lately where trusts that were originally prepared along the lines outlined above where, following Bamford on the recent Government legislation concerning streaming, the client was wanting to redefine income and in particular allow capital gains to form part of the net income of the trust. While (as is the case in many of these areas) there are a number of competing arguments, there is a real risk that this kind of amendment to a 'hybrid' lineal descendant trust would amount to a resettlement for tax purposes.

For regular readers, you will recall that an earlier posting specifically mentions the Tax Office’s Statement of Principles and provides a link to that document.

Until next week.

ATO gives some relief in lead up to 30 June for trust distribution resolutions

Extracted below is the announcement the ATO has made this morning confirming the transitional arrangements that will apply for 30 June 2011 in relation to trust distributions.

The comments in relation to IT 328 are particularly interesting.


Other administrative arrangements

The Commissioner recognises that the passage of this legislation so close to the end of the income year to which it will first apply gives trustees and practitioners little time to familiarise themselves with its content and to determine how it might affect the circumstances of a particular trust for that income year (that is, the 2010-11 income year).

Therefore, following representations from practitioners, and in recognition of the practical difficulties faced by them and by trustees as a result of the timing of the new law, the Commissioner will put in place the following administrative arrangements in respect of the application of the new law to the 2010-11 income year.

Specific entitlement to franked distributions

As regards the timing of recording such an entitlement for the 2010-11 income year, the Commissioner has agreed to adopt a similar approach to that set out in Income Tax Rulings IT 328 and 329 in respect of ‘present entitlement’ to trust income.

That is, for trusts with a 30 June balance date the Commissioner will accept that a relevant record made in respect of a franked distribution by 31 August 2011 meets the requirements of the new law for the 2010-11 income year in any case where ITs 328 and 329 would permit the trustee to take steps within that same period to make beneficiaries presently entitled to trust income for the purpose of Division 6.

For trusts that balance earlier than 30 June 2011 (or later than 30 June 2011 but before 31 August 2011) the Commissioner will likewise accept a relevant record made by 31 August 2011.

As the new law (if enacted as passed) will permit relevant records to be made in respect of capital gains no later than two months after the end of the relevant income year, there is no need for this arrangement to be extended to a beneficiary’s specific entitlement to capital gains.

It should be noted that the arrangement outlined above concerning a beneficiary’s specific entitlement to franked distributions will apply only for the 2010-11 income year.

Further, the Commissioner intends withdrawing ITs 328 and 329 for the 2011-12 and later income years.

Compliance action

Staff will also be instructed not to select cases for review or audit in respect of the 2010-11 income year for the sole purpose of determining whether the purported streaming of capital gains or franked distributions by a trustee is effective.

This instruction will not apply where there has been a deliberate attempt to exploit weaknesses or deficiencies in the law. In those cases we will apply the law as we understand it to operate.

We will also apply the law as we understand it to operate in any case that has been selected for review or audit for other reasons, and in preparing rulings or objections, and in arguing cases before the Tribunal or the courts.


At this stage the next post will be Monday week.

2011 Federal Budget and deceased estates

Three relatively obscure changes announced in the budget recently have important implications for those in the estate planning space, namely –

1. Legislating the current Tax Office practice (see Practice Statement LA 2003/12) of allowing a testamentary trust to distribute an asset of a deceased person without a capital gains tax (CGT) taxing point occurring.

This is an important clarification and provides confirmation that there are effectively three CGT rollovers in deceased estates; that is -

(a) will maker to legal personal representative (LPR);

(b) LPR to testamentary trust; and

(c) testamentary trust to a beneficiary.

Unfortunately the stamp duty position is not so clear in relation to this 'third' rollover from a testamentary trust to a beneficiary.

It should be noted that it will be necessary to continue to rely on PS LA 2003/12 for the immediate future as the changes will only apply to CGT events happening on or after the day the legislation receives Royal Assent.

2. The Commissioner will be given a discretion to extend the two-year ownership period in which the trustee of a deceased estate (or beneficiary) must dispose of their interest in the deceased's dwelling to access a CGT main residence exemption.

This is also important as the two-year ownership period is currently the only CGT event where it is the date of completion (as opposed to the date of contract) that is the relevant date for CGT purposes.

3. Finally, as most will have seen, the relatively minor tax planning opportunity in relation to unearned income derived by minors through family trusts (via the low income tax offset) has been removed with effect from 1 July 2011. The indications seem to be that there will be no change however to the excepted trust income rules for minors receiving distributions via testamentary trusts.

Until next week.

'Colonial' decision released

Earlier in the month the long awaited 'Colonial' decision was released by the Federal Court.

Although, unlike other tax cases last year (such as Bamford and Thomas), the taxpayer was largely unsuccessful, the Colonial decision again reinforces that the provisions of the trust deed are critical.

For those interested the full title of the case is 'Colonial First State Investments Limited v Commissioner of Taxation [2011] FCA 16' (Federal Court of Australia, Stone J, 18 January 2011).

In brief terms, the key aspects of the decision were as follows:

1. The main interest in the decision will be for the Australian funds management industry as it focussed on the tax effect of provisions in a unit trust that sought to allocate part of the taxable income to a unitholder redeeming units.

2. The tests that must be satisfied to meet the definition of a 'fixed trust' for tax purposes will be difficult for many unit trusts. Here the unit trust was held not to constitute a fixed trust, primarily due to the wide amendment power that allowed changes to be made to unitholders' entitlements. The ability to satisfy the Tax Act definition of fixed trust is important in a number of areas including -

(a) to carry forward tax losses;
(b) passing through franking credits to unit holders; and
(c) where superannuation funds are unitholders, avoiding application of the ‘non-arm’s length income’ rules (note that prior to 1 July 2007, these rules were called ‘special income’).

3. The attempt by way of variation to provide the trustee the discretion to allocate discounted and non-discounted capital gains to unitholders on redemption was ineffective.

As set out in the post on 17 December 2010, it has been confirmed that there will be a full review of the way in which trusts are taxed.

The Colonial decision further highlights the need for a comprehensive review of the existing rules and Stone J mentions the need for legislative change in this regard.

A number of commentators also believe the proposed managed investment trust attribution regime (due to take effect on 1 July 2011) may address many of the concerns raised in Colonial.
Until next week.

ATO ruling on insurance trusts

Last week the ATO released a Product Ruling (PR2010/18) in relation to the capital gains tax consequences for the beneficiary of an insurance trust deed.

In many respects the ruling reflects what most specialists in this area (including View Legal) have been saying for many years. That is that a properly crafted insurance trust deed should provide appropriate protection for the principals of a business without any significant tax detriment, notwithstanding that there may be other commercial issues to consider regarding the structure.

Unfortunately the positive aspects of the ruling are largely undermined by the fact that the outcomes are based on the assumption that the insurance trust deed will create absolute entitlement for each beneficiary in the relevant insurance policy. As many advisers who work in this area will know, the expressed views of the ATO concerning absolute entitlement are somewhat contentious and the ATO continues to refer to a draft ruling that has never been finalised - despite being issued in 2004.

One practical issue is that the ruling released last week confirms that in order to ensure absolute entitlement the relevant beneficiary must be able to call for the asset at any time. This largely undermines one of the main reasons advisers had historically recommended insurance trusts - that is that the trustee will have the ability to ultimately control the payment of any insurance proceeds received.

A further practical issue, given the way in which many providers have traditionally structured trust arrangements is that the product ruling only relates to insurance trust deeds where the company acting as trustee is an entity owned and controlled by the principals involved in the business entity and the relevant insurer is not be a party to the arrangements.

For those interested in reading a full copy of the ruling please email me.

Until next week.