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What you need to know before making changes to a trust deed

If you’re a trustee, you’re most likely aware of your responsibilities for managing the trust’s tax affairs, which includes registering the trust in the tax system, lodging trust tax returns and paying some tax liabilities.

However, what you may not be aware of is that some changes to a trust deed can result in the creation of a new trust estate for income tax purposes.  

When does a change to a trust deed create a new trust estate?

Any variation to a trust deed requires consideration as to whether the change creates a new trust estate for income tax purposes. This falls under the ATO’s regulations regarding capital gains tax (CGT) – the difference between what it costs to acquire an asset and what you receive when you dispose of it.

Certain events – in this case, a CGT Event E1 (i.e. section 104-55 of ITAA 1997, which deals with creating a trust over a CGT asset by declaration or settlement) – can result in a capital gain or loss, which will have tax implications for your trust deed.  

What happens when a CGT Event occurs?

The effect of CGT Event E1 occurring is a deemed disposal of all CGT assets by the trustee to itself as trustee of a new trust. This could cause a freshening up of pre-CGT acquired assets held within the Trust, making them subject to CGT on a future disposal.

Alternatively, it could result in post-CGT acquired assets to be deemed to have been sold to the trustee in their capacity as trustee of the new trust, which could cause a tax liability.

The most recent case in this area is Commissioner of Taxation v. David Clark & Helen Clark (2011) FCAFC 5. In this Full Federal Court case, the Commissioner argued that changes made to a unit trust were so extensive that losses incurred before the changes were made couldn’t be recouped against gains made after the changes.

The changes involved new unit holders from an unrelated family coming into a unit trust, the control of the corporate trustee changing from one family to another, the trustee agreeing to waive their right to be indemnified, the original family being paid a fee to pass control of the trust, some of the original family’s units having their income rights suspended and their other units automatically being transferred if the original family didn’t make a matching capital contribution to the trust.

However, the Full Federal Court held that because the trust didn’t terminate and because trust obligations, trust property and beneficiaries continued to exist throughout the period, the losses were recoupable as a new trust had not been created through the extensive changes.

In other words, the original trust continued to exist throughout the loss and gain years. Leave to appeal to the High Court by the Commissioner of Taxation was rejected.

When does a CGT Event E1 occur?

After Clark’s case, the Commissioner issued Taxation Determination TD 2012/21, which sets out the Commissioner’s latest views on the application of CGT Event E1.

This can be summarised as:

Changes made to a trust deed, even if extensive, provided they’re validly exercised under a variation power in the trust deed will not cause CGT Event E1 to happen unless either:

(i)             the change causes the existing trust to terminate and a new trust to arise under trust law; or

(ii)           the effect of the change is to lead to a particular asset being subject to a separate charter of rights and obligations such as to give rise to a conclusion that the asset has been settled on the terms of a different (new) trust.

The Commissioner gives a range of examples in TD 2012/21, most of which do not cause CGT Event E1 to apply. These include matters such as altering the vesting date, expanding investment powers, adding new definitions, adding and removing people from the general beneficiary class as beneficiaries and changes in the identity of the trustee and appointor.

Given that Clark’s case has significantly widened the scope of trust deed changes that the courts consider don’t cause a new trust to arise, it appears that from a tax perspective alone, changes which are specifically allowed by the trust deed will generally not cause a new trust to arise.

However, given the potentially disastrous consequences that could occur, we recommend that a tax and trusts lawyer review any proposed changes to your trust deeds and advise whether the change is likely to withstand scrutiny from the ATO.

If you would like advice on making changes to a trust deed, then get in touch with CCASA. We’d be happy to help.