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



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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’.

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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.

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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.

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