Overview
It is common to vary a trust constitution to improve trust administration, accommodate asset protection and succession planning and improve the tax effectiveness of distributions.
Common variations include changes of:
- powers (e.g. trustee distribution powers and discretions);
- trusts (e.g. vesting date and inclusion/exclusion of beneficiaries); and
- terms (e.g. appointor and guardian administration, powers and discretions).
Legislative references are to the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) and the Duties Act 2000 (Vic) (DA 2000).
Introduction
A variation which creates a new trust may have adverse income tax consequences, including loss of carried forward losses and tax deductions and a liability to pay capital gains tax (CGT) on the value of any CGT assets of the trust (FCT v Clark [2011] FCAFC 5; [2011] HCA Trans 236).
A variation which is a declaration of trust or a change in beneficial ownership may have adverse stamp duty consequences, including a liability to pay duty on the value of any dutiable property (such as land) of the trust (CSR (Vic) v Lam & Kym P/L [2004] VSCA 204).
Recent court decisions have lessened, but not eradicated, the tax risks of trust variations.
Income Tax
A variation to a trust will not constitute the creation of a new trust with adverse income tax consequences, unless there is a lack of continuity of the trust constitution, the trust property or the beneficiaries of the trust (FCT v Clark).
The FCT accepts that certain changes to the trust constitution pursuant to a valid amendment power do not create a new trust. However, a sufficient amendment to the trust constitution will terminate the old trust and create a new trust or subject particular trust property to a different trust (TD 2012/21).
The FCT accepts that a new trust is not generally created by:
- the addition of new entities to, and exclusion of existing entities from a class of beneficiaries (TD 2012/21 example 1);
- the expansion of power to invest (TD 2012/21 example 2);
- the addition of a definition of income, power to stream or extension of vesting date (TD 2012/21 example 3);
- a change of name (TR 2006/4(W) at [184]); o
- a change of trustee (TD 2001/26 at [14]; sec. 104-10 ITAA 1997 Note).
The same fiduciary principles regarding the change of trustee and trustee powers apply to a change of appointor/guardian or appointor/guardian powers (In re The A Trust [2012] JRC 169A (Jersey Royal Court)).
In Oswal v FCT [2013] FCA 745, the trustee of the Burrup Trust appointed ‘for the absolute benefit of the named beneficiaries…[Mr Oswal and Mrs Oswal, 574 shares each in Burrup Holdings P/L], a part of the corpus of the trust. Henceforth the corpus so appointed…shall be held on separate trust and for the absolute benefit of the named beneficiaries in their own individual capacities’ (at [14]).
At issue was whether the resolution in respect of the shares created a sub-trust subject to the trust constitution or a separate new and independent trust (refer to distinction in Bond (Inspector of Taxes) v Pickford [1983] STC 517).
The Federal Court held that, although the resolution was not expressed in terms of a ‘declaration’, it was a ‘declaration’ of trust and a ‘settlement’ for the purposes of CGT event E1 (creation of a trust over a CGT asset) so created a new trust over the assets the subject of the declaration.
On 4 August 2014, Oswal v FCT [2014] FCA 812 held that the decision of the primary judge did not attend sufficient doubt as to warrant leave to appeal and the issue should be dealt with at the main hearing of the matter. The Federal Court confirmed that the proper construction of the resolution was to create a new and independent bare trust in respect of the shares outside the decision of Bond (Inspector of Taxes) v Pickford (at [41]).
The Federal Court also considered the submission by the FCT that even a sub-trust would nonetheless constitute a separate trust had much force (at [50]). This reflects the continued uncertainty regarding the taxation of sub-trusts.
The Federal Court commented that it was probably not necessary for Mr Oswal as trustee to go through the formality of recording that he consented to the resolution in his capacity as Guardian (at [37]). This would seem to be contrary to the strict compliance requirements of exercising powers (Idlecroft v FCT [2004 FCA 1087 at [47] and [49]).
Unfortunately, the application for leave to appeal did not provide any guidance on the creation of a new trust.
Victorian stamp duty
A transfer of dutiable property and a declaration of trust over dutiable property (such as land) is a dutiable transaction (sec. 7 DA 2000). A ‘transfer’ includes a change of beneficial ownership arising from a change of equitable interests in dutiable property.
A variation or exercise of a power of appointment that subjects trust property to a different class of beneficiaries will constitute a dutiable declaration of trust (CSR (Vic) v Lam & Kym P/L [2004] VSCA 204 at [15], [27], [29], [30] & [45]).
A variation to hold the trust fund on the vesting date for certain beneficiaries did not vest the trust fund in the beneficiaries, but vested an interest of a lesser nature which had nominal value and only a minimal amount of stamp duty was exigible (CSR (NSW) v Buckle [1998] HCA 4 at [23], [37], [39] & [41]).
An income or capital beneficiary or a default beneficiary of a discretionary trust has no legal or beneficial entitlement or interest in the trust assets (Lygon Nominees P/L v CSR (Vic) (2007) VSCA 140; Pearson v IRC [1981] AC 753).
There is an alternate view that a default beneficiary has a proprietary interest in the trust fund (Queensland Trustees v CSD (Qld) (1952) 88 CLR 54, at 63) so a variation to the default beneficiary may have duty consequences.
The NSW OSR considers that there will not be any duty liability for a variation to the discretionary beneficiary, the default beneficiaries or the rights between beneficiaries (Ruling DUT 17 at [13] & [14]).
This interpretation by the NSW OSR should be applied by the VSRO and the other State and Territory revenue offices.
Since Oswal v FCT relied upon CSR (Vic) v Lam & Kym P/L, the main hearing of the matter may provide further guidance on the scope of the duty provisions.