practical issues with trusts: important updates · 2016-05-25 · ken schurgott practical issues...

{/01394593:1}© Ken Schurgott, Brown Wright Stein Lawyers 2016

Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.

NSW 9th Annual Tax Forum

Practical Issues with Trusts:

Important Updates

Written and

presented by:

Ken Schurgott

Special Counsel

Brown Wright Stein

Lawyers

NSW Division

2-3 June 2016

Sofitel Wentworth, Sydney

Ken Schurgott Practical Issues with Trusts: Important Updates

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1 Introduction

This paper is directed at topical practical matters concerning the taxation of trusts.

Reforming the way in which trusts and their beneficiaries are subjected to tax is practical, topical

and important. However, since the Division 6 re-write project announced in November 2011

fizzled out and the Treasury White Paper on Tax paid scant attention to the taxation of trusts

simplification-minded practitioners have lost heart. There appears presently to be considerable

inertia about the topic, aided no doubt by the present political environment. For this writer, well-

versed in the complexities of the system, it is a profitable experience. However, for those

practitioners who focus on compliance it is a nightmare; one that many choose to ignore. The

Australian Taxation Office ("ATO") appears to take a pragmatic view of compliance. However,

much of this paper reflects the writer's experience dealing with issues raised in audits.


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2 Ordinary Trust Distributions

(a) Read that Trust Deed

It is, after all this time, alarming to be told by an accountant that he has never had a copy

of the Trust Deed for a particular trust of a client. It has always been assumed that the

accounting software income was the appropriate basis for determining the "distributable

income". In fact the Trust Deed provided that the net income is an amount equal to the

amount calculated in accordance with subsection 95(1) of the Income Tax Assessment

Act 1936 ("the 1997 Act") unless prior to the end of the accounting period the Trustee

has determined that net income is to be calculated in accordance with any other generally

accepted accounting method.

In this case the total tax law net income was $1,200,000 and accounting income

$1,000,000.

The resolution provided:

"15% of the net income to Dr Young

50% of the net income to Young Services Pty Ltd as trustee of the Young Services

Trust

balance of the net income to Young Consultants Pty Ltd."

The Young Services Trust has tax losses of $500,000 and the default beneficiary is

Dr Young. Dr Young has assessable income of $30,000 from other sources and no

deductions. The effect of the resolution is:

Tax law net income Accounting packaging

income

Dr Young $180,000 $150,000

Young Services Trust $600,000 $500,000

Young Consultants $420,000 $350,000

$1,200,000 $1,000,000

Dr Young will be subject to tax on $310,000. The objective had been to hit the point just

below the maximum marginal rate.

If the resolution had been expressed in the following way, there would have been no

problem:

(i) To Dr Young an amount of $150,000;

(ii) To Young Services Pty Ltd as trustee of the Young Services Trust, $500,000;

then

(iii) the balance of the net income to Young Consultants Pt Ltd.


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The effect of the resolution is:

Tax law net income Accounting packaging

income

Dr Young $150,000 $150,000

Young Services Trust $500,000 $500,000

Young Consultants $650,000 $350,000

$1,200,000 $1,000,000

Dr Young is assessed on $180,000. Cascading resolutions are acceptable to the

Commissioner. See generally TD 2012/22.

(b) Tax adjustments

Paragraph 64 in TD 2012/22 provides:

"64. However, some trustees instead attempt to deal with the assessment of an

increase in what they had understood to be the trust's net income by resolving that

any income which it represents is taken to have been distributed at year end to a

particular beneficiary. Resolutions of this type are not effective in creating a present

entitlement to income by 30 June; at best the beneficiary might be regarded as

having a contingent entitlement at that time (see Example 7). There may also be

cases where such resolutions are wholly ineffective in creating any entitlement,

contingent or otherwise, because all of the income has already been dealt with by

other resolutions (see Example 6). The Commissioner will disregard these resolutions

in determining step 1 percentages."

Such a resolution might be "$100,000 to each of Mum and Dad and if the Commissioner

of Taxation makes an adjustment to the net income of the Trust that amount to MD Pty

Ltd".

Resolutions to this effect are still seen from time to time.

A "balance beneficiary" resolution achieves the described outcome (provided the trust

income is determined in accordance with subsection 95(1) of the 1936 Act) without any

element of contingency. A default beneficiary clause would also direct the now

recognized trust income away from Mum and Dad (provided neither of them is the default

beneficiary).

(c) Hitting the Target

"The Trustee resolves to:

(1) pay to Dr Young an amount of the net income of the Trust equal to "T" in the

following formula:


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T = $180,000 – (O – D)

where

O = other amounts of assessable income assessable to Dr Young during

the income year (including franking credit gross up under Division

207)

D = allowable deductions to Dr Young incurred in the income year.

(2) the balance of the net income to Young Consultants Pty Ltd".

The only consideration the Commissioner has given to formulaic resolutions is in the

meeting of the NTLG Trust sub-group of 18 September 2012. The draft minutes of that

meeting record two examples as follows:

"an amount of trust income (to the maximum extent it is available) that would ensure

that Harry's share of the net income of the trust as determined under section 97(1)

of the ITAA 1936 does not exceed $30,000."

"an amount of trust income (to the maximum extent it is available) that would ensure

that Zac's total taxable income for the 2012 income year does not exceed $80,000."

The Commissioner's response was of the half-pregnant variety:

"Where the calculation of the net income depends on the exercise of a choice by the

trustee, the Commissioner's approach, unless there is evidence to the contrary, will

be to assume that the trustee had determined how it would be made prior to 30 June,

and that the calculation of the net income of the trust does not vary as between

different beneficiaries. In that way, beneficiaries will be treated as having a vested

and indefeasible interest in the trust income by 30 June wherever possible. On this

basis formulaic resolutions of the first type (set out above) would generally be

effective to create the purported entitlements. However, the Commissioner is not

inclined to include such resolutions as examples in the final Determination due to

their ostensible purpose of ensuring certain tax outcomes as opposed to particular

trust entitlements.

Resolutions of the second type are less certain and the Commissioner would not

generally accept such a resolution as being effective to create a present entitlement

to the income of the trust by 30 June. There are many matters which may happen

after 30 June which could affect the calculation of the beneficiary's taxable income –

each may have various choices to make under the tax law.

It is also difficult to see how a resolution of this second type would operate in respect

of an entity that is a beneficiary of two trusts where the trustees of both trusts had

made similar resolutions.


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Whilst members would have liked to see an example of the formulaic resolution in the

first issue included in the final Determination, they did not in the main disagree with

these views.

The thinking behind this resistance is more general than it first appears. The Commissioner

has a not yet fully resolved view that the assessable income of a taxpayer is not fully settled

as at 30 June as things can happen after that date which change the arithmetic outcome. For

example, the taxpayer may choose the small business CGT rollover or the small business

retirement exemption may depend on contributing an amount to a superannuation fund after

30 June. To the writer's mind this consideration is not relevant. The issue is about the

entitlement to an amount of income. Put another way what is the amount that a beneficiary

can demand from the trustee. A court would have no difficulty giving effect to the resolution

albeit with a retrospective eye.

The writer's view is that the formulaic resolution expressed in the manner at the outset of this

part of the paper should be given effect to.

For those of a braver mindset, what about the following:

"The Trustee resolves to:

(1) pay to the Trustee of the Young Services Trust an amount of the net income

of the Trust equal to the aggregate of the amounts which are allowable as tax

deductions in the income year under sections 8-1 and 8-5 of the Income Tax

Assessment Act 1997;

(2) the balance (if any) of the net income to Young Consultants Pty Ltd."

This resolution is designed to use brought forward tax losses of the Young Services Trust and

has the "purpose of securing" certain tax outcomes.

Again, the writer believes the resolution should be given effect to (again it requires the trust

accounting basis to equate to subsection 95(1) tax law net income).

(d) Timing of Resolutions

Distributions of trust income made after 30 June have no tax effect. If there is any part of the

trust income to which no beneficiary is presently entitled section 99A will apply with its 47%

tax rate (the budget repair levy will apply if the trustee is assessed on an amount exceeding

$180,000).

The Commissioner conducted a fairly half-hearted review of trust resolutions in July 2012

following up its education campaign that trust entitlements must be validly created prior to 1

July. The review did not consider whether the resolutions were effective in the context of the

Deed's requirements.


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The writer has, in the course of his professional practice, noted some slippage in complying

with the resolution timing requirements.

It is also noted that during the course of consultation regarding the Division 6 rewrite Treasury

were quite steadfast about not relaxing this time limitation.


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3 Streaming of capital gain and franked

distributions

As all readers will be aware the streaming measures were introduced in a rush in very late June

2011 to take effect from 1 July 2010.1 The Government made it clear that these were interim

measures driven by the urgent need to deal with the adverse interpretation placed on the

decision of the High Court in Bamford.2 The then Assistant Treasurer, Mr Shorten, admitted

potential shortcomings and "unintended consequences" which would be remedied promptly.

(See later comments in relating to capital gains distributed to non-residents).

The odd thing about the streaming rules is that they seem to be operating without controversy.

In the writer's opinion this is largely because the Commissioner is not policing them. Anyone

familiar with the extreme complications of the legislation will understand how hard it is to comply

with exactitude. The inter-relation of trust law, tax law general principles and the streaming

provisions is very demanding.

(a) The Easy Example

It is trite to say, that the Trust Deed will determine what is required to be undertaken in

order to create a specific entitlement in a beneficiary to a capital gain made by the Trustee.

The specific entitlement is created by directing the financial benefit of the capital gain to

the desired beneficiary. The following table shows what is required in order to do so in

respect of a discount capital gain:

Trust accounting basis What to do? By when?

No definition (ordinary

income)

Distribute entire amount

as capital according to

capital distribution clauses 31 August

Subsection 95(1)

definition

Distribute:

(a) half as income

(b) half as capital

30 June

31 August

Include as income (rare) Distribute as income 30 June

Occasionally deeds will have some other basis for dealing with capital gains but they are

uncommon.

Obstacles include:

1 Tax Laws Amendment (2011 Measures No. 5) Act 2011 2 FC of T v Bamford [2010] HCA 10


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the Trust Deed prohibits interim capital distributions;

capital distributions are limited to particular beneficiaries or classes of beneficiaries.

(b) A more difficult issue

The Trustee of the Young Services Trust has revenue losses brought forward from 2015

into the 2016 income year of $300,000. It contracted to sell a real property it acquired in

2005 for $500,000. The sale consideration is $1,500,000. The capital gain is $1,000,000.

The revenue losses and purchase price of the property are reflected in a beneficiary loan

of $800,000 with the effect that the net assets of the Trust amount to $700,000. The

question is what amount is to be appropriated to the beneficiary to ensure that the

beneficiary has become specifically entitled to the capital gain.

The capital gain is $1,000,000. The net assets available for distribution are $700,000 only.

The "net financial benefit" is defined in subsection 115-228(1) of the 1997 Act as:

"an amount equal to the financial benefit that is referrable to the capital gain

(after any application by the trustee of losses to the extent that the application is

consistent with the application, of capital losses against the capital gain in

accordance with the method statement is subsection 102-5(1)"

The term "financial benefit" is defined in subsection 974-160(1) and for present purposes

means anything of economic value. The "share of net financial benefit" is also defined in

subsection 115-228(1) as follows:

"an amount equal to the financial benefit that, in accordance with the terms of the

trust:

(a) the beneficiary has received or can be reasonably expected to

receive; and

(b) is referrable to the capital gain (after application by the trustee of any

losses, to the extent that the application is consistent with the

application of capital losses against the capital gain in accordance

with the method statement in subsection 102-5(1)); and

(c) is recorded, in its character as referrable to the capital gain, in the

accounts or records of the trust no later than 2 months after the end

of the income year."

The requirement is to apply "losses consistently with the way that capital losses are

applied in the method statement in subsection 102-5(1). Notably the word "losses" is used

rather than "capital losses". But, why the reference to consistency with capital losses?

Moreover, it could not be expected that the trustee would be required to create an

entitlement in a beneficiary exceeding the amount it has available to meet that entitlement


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(here $700,000 only). Practical reasoning suggests that the amount to which the

beneficiary is to become specifically entitled is limited to $700,000.

There is no useful guidance in the Explanatory Memorandum nor, as far as the writer is

aware, any guidance provided by the Commissioner.

But, what if this is an incorrect interpretation and the requirement is to make the

beneficiary specifically entitled the capital gain of $1,000,000 (and there is no default

beneficiary or there is no income to take the capital gain to a default beneficiary)? In these

circumstances no beneficiary would have been made entitled to 30% of the capital gain.

In that event the trustee would be assessed and the 50% general discount lost to that

extent.


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4 Capital gains and non-residents

This issue focuses on an Australian resident trust deriving capital gains in respect of a CGT asset

that has no connection with Australia (apart from it being owned by the Australian resident trust)

where the capital gain is appropriated to a non-resident.

One might reasonably think that Australia can expect to have no taxing rights in respect to such a

gain. If the gain was income there would be no Australian tax payable by the non-resident

beneficiary or the trustee.

The Commissioner has worked up an argument that a different result arises where the gain is a

capital gain.

The starting point is subsection 6-10(5) of the 1997 Act:

"If you are a foreign resident, your assessable income includes:

(a) your statutory income from all Australian sources;

(b) other statutory income that a provision includes in your assessable income on some

basis other than having an Australian source".

The term Australian source is defined in this way:

"ordinary income or statutory income has an Australian source if, and only if, it is derived from

a source in Australia for the purposes of the Income Tax Assessment Act 1936".

The statutory mechanism concerning income of a trust directed to a non-resident beneficiary is

found in subsections 97(1) and 98(3) of the 1936 Act.

Subparagraph 97(1)(a)(ii) includes in the assessable income of a non-resident beneficiary the

share of the net income of the trust attributable to sources in Australia. Note the different

language used, "derived from an Australian source" compared with "attributable to sources in

Australia". Although one might expect consistent language nothing appears to turn on the

difference.

Subsection 98(3) imposes the tax liability on the trustee but only in respect of the Australian

sourced income attributable to the non-resident.

The argument pressed by the Commissioner is that a capital gain since the 2011 amendments is

stripped out of subsection 97(1) by operation of Division 6E. It is replaced by a neutered amount

included by virtue of section 115-215 of the 1997 Act and in conjunction, it would appear, with

subsection 115-220(2) to impose tax on the trustee. It follows that this neutered amount (included

in both the beneficiary and trustee's assessment) has no source attributable to it and therefore it


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is "other statutory income that a provision includes in your assessable income on some basis

other than having an Australian source" caught by subsection 6-10(5).

It is somewhat surprising that a gain on a CGT asset which has nothing to do with Australia apart

from passing through an Australian resident trust is assessable to a non-resident when the same

gain falling on to income account is not. This would appear to be a strange policy outcome. The

Commissioner reasons that it is consistent with the operation of Division 855 of the 1997 Act

which exempts from tax otherwise taxable capital gains of a fixed trust distributed to a non-

resident beneficiary but not the capital gains appropriated by the trustee of a non-fixed trust to a

non-resident. However, it is plain that Division 855 is directed at relieving non-residents from

Australian tax on what would otherwise be Australian sourced capital gains other than taxable

Australian property and cannot be used to support the Commissioner's position.

The 2011 amendments to the tax laws were directed at overcoming an obstacle to the proper

functioning of the capital gains and franked dividend provisions to allow the tax attributes of the

entitlements to be enjoyed by beneficiaries. It was never intended that the amendments would

cause non-Australian source related capital gains appropriated to non-residents to be assessed.

Such an outcome would be contrary to the proper policy intent of the legislation taken as a whole

that non-residents are taxed on gains with an Australian source or where the legislation makes it

clear that the non-resident should be taxed where there is no attributable source. If the

Commissioner's position turned out to be a correct strict law interpretation of subsection 6-10(5),

to use Mr Shorten's words, it would be an unintended consequence which deserves retrospective

amendment.


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5 Small business restructure roll-over

The small business restructure roll-over is to take effect from 1 July 20163 albeit what is to be

regarded as a small business entity for these purposes awaits the coming election (presently it is the

$2,000,000 aggregate turnover test)

The focus here is on the restructuring issues for trusts. The roll-over will relieve the tax consequences

of the transfer of CGT assets, trading stock, revenue assets and depreciating assets provided they

are active assets. When coupled with stamp duty relief on business asset transfers after 30 June

20164 this roll-over is a powerful tool to optimize structures although it is limited to active assets as

that term is understood in a small business CGT concession context. The rules are tight and limited to

'genuine restructures', being a bona fide commercial arrangement undertaken to enhance business

efficiency and not artificial or unduly tax driven.

The provision works on the basis that transaction must satisfy the genuine restructure requirements of

subsection 328-430. The term "genuine restructure" is not defined. It is observed in the Explanatory

Memorandum that it is a question of fact determined having regard to all of the facts and

circumstances surrounding the restructure.

Paragraph 1.22 goes on to give examples of some relevant factors:

it is undertaken to enhance business efficiency.

the business continues to operate through a different entity structure but under the same

ultimate economic ownership.

the transferred assets continue to be used in the business.

the restructure results in a structure likely to have been adopted had the business owners

obtained appropriate professional advice when setting up the business.

the restructure is not artificial or unduly tax driven.

it is not a divestment or preliminary step to facilitate the economic realisation of assets.

These factors are expanded on and illustrated by examples in LCG 2016/D35.

In the trust context the important feature of the roll-over requirements is that the transaction must not

have the effect of changing the ultimate economic ownership of transferred assets in a material way.

Paragraph 328-430(1)(c) provides:

"the transaction does not have the effect of materially changing:

(i) which individual has, or which individuals have, the ultimate economic ownership of the asset; and

(ii) if there is more than one such individual – each such individual's share of that ultimate economic ownership"

All roll-over transactions face these tests but there is a safe harbour provision which allows the

3 introduced by Tax Laws Amendment (Small Business Restructure Roll-over) Act 2016 4 see section 37 Duties Act 1997 (NSW) 5 see draft Law Companion Guidelines LCG 2016/D3 for the ATO's views on what constitutes "genuine restructure of an

ongoing business


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ultimate economic ownership requirement to be avoided and is particularly pertinent to discretionary

trusts.

Section 328-440 provides:

"For the purposes of paragraph 328-430(1)(c), a transaction does not have the effect of changing

the ultimate economic ownership of an asset, or any individual's share of that ultimate economic

ownership, if:

(a) either or both of the following applies: (i) just before the transaction took effect, the asset was included in the property of a non-

fixed trust that was a family trust; (ii) just after the transaction takes effect, the asset is included in the property of a non-

fixed trust that is a family trust; and (b) every individual who, just before the transfer took effect, had the ultimate economic ownership

of the asset was a member of the family group (within the meaning of Schedule 2F to the Income Tax Assessment Act 1936) relating to the trust or trusts referred to in paragraph (a);and

(c) every individual who, just after the transfer takes effect, has the ultimate economic ownership of the asset is a member of the family group."

On the face of the legislation a transfer to a discretionary trust which has made a family trust election

with one of the original economic owners as the primary individual will allow the transfer to qualify for

the roll-over.

But is it that simple?

Some illustrations:

(a) Example 1.3 in the Explanatory Memorandum

This example is drawn from the Explanatory Memorandum and is exceedingly simple.

C and V are husband and wife and own all of the shares in Puppy Co. The premises are to be

transferred to the Fluffy Trust which has made a family trust election with V as the primary

individual. V and C are both members of V's family group.

There is no change in the ultimate economic ownership of the premises in this case because

just after the transaction the asset is held by a non-fixed trust which has made a family trust

election where one of the individuals who, just prior to the transaction taking effect, had

ultimate economic ownership and the other individuals who had ultimate economic ownership

were members of that person's family group. In other words, the requirements of section 328-

440 are plainly satisfied and there is no need to show that the transfer is a genuine

restructure.

(b) Trust to trust transfer

The Young Manufacturing Trust owns the IP of the business and wishes to transfer it to the

Young IP Trust for asset protection purposes. Both are non-fixed trust which satisfy the small

business turnover test and the IP is an active asset. Both trusts have made family trust

elections with Dr Young as the primary individual.

Paragraph 328-440(a) appears to contemplate that the asset can be originally held by a

discretionary trust and be transferred to another discretionary trust (the reference in (a) is to


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"either or both") The remainder of section 328-440 requires that any individual who had

ultimate economic ownership before and after the transaction is a member of the primary

individual's family group.

Is it sufficient that paragraph (a) is satisfied when the two trusts have made family trust

elections in respect of the same primary individual and paragraphs (b) and (c) are otiose in

those circumstances?

Looking to the non-safe harbour genuine restructure requirements it appears to be

contemplated that non-fixed trusts will have ultimate economic owners.

In paragraph 1.30 of the Explanatory memorandum it is observed that:

"Ultimate economic ownership of an asset can only be held by natural persons. therefore,

where a company, partnership or trust owns an asset it will be the natural person owners of

the interests in the interposed entities that will ultimately benefit economically from that asset"

In paragraph 1.29 it is noted that "the ultimate economic owners of an asset are the

individuals who, indirectly, beneficially own an asset."

In regard to non-fixed trusts it is observed:

"1.33 Identifying those individuals who will benefit economically from the assets of a

company, partnership or fixed trust is relatively straight forward, although the ultimate

economic ownership of an asset will be a question of fact to be ascertained based on

the circumstances of the particular case.

1.34 In some cases, non-fixed (discretionary) trusts may be able to meet the

requirements for ultimate economic ownership on their facts. For example, a trust

may be non-fixed for the purposes of the income tax law but, because there is no

practical change in which individuals economically benefit from the assets before and

after the roll-over, there will not have been a change in ultimate economic ownership

on the facts.

1.35 However, in other cases the nature of a non-fixed trust may mean that it is not

possible to determine proportionate ultimate economic ownership of the assets of the

trust. Therefore if a non-fixed trust seeking to use the roll-over (either as transferor or

transferee) is a family trust they may instead meet an alternative economic ownership

test."

Paragraph 1.34 is particularly cryptic. It is difficult to understand what the draftsman had in

mind. Does it contemplate a unit trust which fails the fixed trust test for some reason apart

from individuals having a prima facie fixed interest in the trust or is it directed at a more

general history of distribution of income and capital to the same group of individuals?

The more usual case would be that described in paragraph 1.35. Most discretionary trusts will

have no ultimate beneficial owners.

If that is correct then it could support a conclusion that where there is a trust to trust transfer it

is only necessary to have both trusts make a family trust election with the same primary

individual as paragraphs (b) and (c) have no operation.

If it is not correct then it would not be possible to use the restructure roll-over as between the

two trusts. This would be an unexpected outcome.


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In LCG 2016/D3 the Commissioner offers Example 2 where "Adrian carries on a business with

his two siblings in a discretionary family trust". Adrian is the primary individual in the family

trust election. Assets are transferred from the trust to a company owned by Adrian and his two

siblings. Later shares are issued to key employees and the question addressed is whether the

transaction was a genuine restructure. The safe harbour issue is not in question (albeit it may

have been initially used but failed when the shares were issued to the employees within the 3

year period). The Commissioner must have concluded that ultimate economic ownership

rested with Adrian and his siblings through the discretionary trust. The example appears to be

at odds with the conclusion that a discretionary trust will have no ultimate economic owners.

The position is ultimately confusing. It is not clear to the writer why the family trust election

exclusion is only set out in the safe harbour and arguably is quite limited in its function to

transfers in one dimensional, from a non-fixed trust to an entity in which there are individuals

who have ultimate economic ownership or the other way around.

(c) Company owned by non-fixed trust to company owned by individuals

This transaction will only qualify for the roll-over if there are economic owners of the non-fixed

trust as the safe harbour rule does not assist as it requires that the trust be the transferor not the

company.


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6 Fischer v. Nemeske Pty Ltd

Any decision of the High Court on the operation of trusts is significant for trust tragics. However, the

true interest for present purposes is what is its relevance to the taxation of trusts.

The matter was another succession case stemming from fertile disputes between beneficiaries.

Mr and Mrs Nemes controlled a discretionary trust of which Nemeske Pty Ltd was the trustee. The

most significant asset held by the trustee was shares in a private company. In 1994 the shares were

revalued and an amount of $3,904,300 was credited to an asset revaluation reserve. Soon afterwards

the trustee resolved to make a distribution “out of the asset revaluation reserve… and that it be paid

or credited to… the following beneficiaries in the following manner and order… the entire reserve, if

any, to be distributed to… Mr and Mrs Nemes as joint tenants.” The debt said to arise pursuant to the

distribution became subject of a charge in favour of Mr and Mrs Nemes.

Parts of the family came to control the trust and others the residuary estate (which included the

secured debt). The controllers of the trustee (the Fischers) sought to invalidate the secured debt by

arguing that the purported distribution was ineffective.

The judge at first instance6 rather generously gave effect to the clumsy attempt to distribute the asset

revaluation reserve by treating it as creating an obligation on the trustee to distribute an amount of

$3,904,300 to the beneficiaries and did not purport to create an interest in the shares held by the

trustee. The Court of Appeal upheld this decision.7

The High Court by a majority 3 to 2 found the distribution to be effective. The minority (Kiefel and

Gordon JJ) concluded that the distribution was ineffective as it did not purport to affect trust property.

Every decision stressed that the matter turned on the contents of the Trust Deed and how the trustee

purported to exercise its powers in accordance with the terms of the Deed.

What relevance does this decision have for trust taxation issues?

The first is obvious, the stress placed on the importance of the Deed and applying those terms

properly and appropriately to give rise to tax outcomes.

The second is more technical and trudges back to a consideration of streaming capital gains. A

specific entitlement requires the creation of a financial benefit in the beneficiary referable to the capital

gain. Some (few) will recall that the Explanatory Memorandum to the 2011 amendments has an

example (at para. 2.55) that involved distribution of a revaluation reserve as income.8

The thrust of the example is that the distribution of the asset revaluation reserve as income is that it

effects an appropriation of the economic value of the underlying CGT asset with the result that that

element of the capital gain can no longer be directed to a beneficiary.

6 Fischer v Nemeske Pty Ltd [2014] NSWSC 203 per Stevenson J. 7 Fischer v Nemeske Pty Ltd [2015] NSWSCA 6; in particular paras 51 to 64. 8 Cf Clark v Inglis [2010] NSWCA 144.


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The position has always been curious as there is no legal connection between the asset revaluation

reserve and the asset. The trustee is not prevented from raising further funds and paying out the

entire capital gain to a beneficiary who did not benefit from the asset revaluation reserve “distribution”.

The decision of the High Court in Fischer v Nemeske Pty Ltd stands for the proposition that an

entitlement to a money amount has been created but no interest in the underlying asset or the

proceeds of the sale.

It is true that in that case there was one asset of substance only and a charge over that asset, and

that in practice the economic value would pass to the beneficiary enjoying the appropriation of any

amount represented by the asset revaluation reserve balance. We will have to wait and see.


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7 Managed Investment Trust regime

The managed investment industry in Australia largely operates through the use of unit trusts and the

industry has laboured for a very long time under the uncertainties arising from the application of the

general trust assessing provisions in Division 6 of the 1936 Act (and also the public unit trust rules in

Division 6B). The Board of Taxation carried out a review of the taxation of Managed Investment Trusts

(“MITs”) and made 48 recommendations to the Government9. The Government accepted 38 of the

recommendations and proposed to introduce amending legislation with effect from 1 July 2011. One

of these recommendations was that character and source flow through should be a legislative

requirement.

A bill was ultimately introduced in to Parliament on 3 December 2015 to give effect to the

Government's decision10. Trusts falling into this regime can broadly be regarded as widely held and

private unit trusts will not qualify11. The proposed legislation broadly works on the basis that a trust will

be an "attribution MIT" (an “AMIT”) if the interests of members in the trust are “clearly defined”12.

Apart from specifying that a trust registered under section 601EB of the Corporations Act 2001 or a

trust in which the rights to income and capital for each membership interest in the trust are the same,

there is no definition of “clearly defined” and the term is to take its meaning from its ordinary use.13

The terms of the trust set out in the constituent document provide the gauge of clearly defined rights.

The Exposure Draft Bill had much more descriptive requirements but these have been omitted from

the legislation introduced to Parliament. The Explanatory Memorandum accompanying the Bill

observes that:

There must be an objective benchmark for the attribution of the tax consequences of the activities

of the trust to its members;

Trusts which provide the trustee with significant discretionary powers will not qualify.

If there are separate classes of members' interests the trustee may choose to treat each class, for the

purposes of the attribution rules, as a separate attribution MIT14. However, there is an overall

requirement that tax characterized amounts must be allocated as between classes on a fair and

reasonable basis. In effect the trust cannot have any significant discretionary attributes either overall

or internally in a class to qualify as an attribution MIT (or attribution MITs where there are separate

classes of members).

Once the trust has satisfied the definition of an attribution MIT it is treated for taxation purposes as a

fixed trust15. This is a mechanism introduced to deal with uncertainties arising under the trust loss

provisions and the 45 day rule.

9 Board of Taxation Report "Tax Arrangements Applying to Managed Investments Trusts". 10 Tax Laws Amendment (New Tax System for Managed Investment Trusts Bill 2015). 11 See definition of MITs in section 275-10. 12 Section 276-10. 13 Section 276-15. 14 Section 276-20. 15 The members are treated as having a fixed and indefeasible interest in the income and capital of the AMIT, proposed draft

276-55.


{/01394593:1}© Ken Schurgott 2016 20

These measures are designed to allow tax characteristics of amounts received by the trustee to be

attributed to the members. It is only the tax characteristics that are attributable and that

characterisation depends on the definition of amounts set out in the tax legislation and not their trust

law character.

The draft legislation requires the trustee to dissect its income into components relating to:

(a) assessable income;

(b) exempt income;

(c) non-assessable non-exempt income (“nane income”);

(d) tax offsets.16

A regime dealing with “unders and overs” adjustments made for inaccuracies in determining allocable

income in previous income years, is in effect a separate category.

The four components described in the Bill are called “trust components”. Their net amount is worked

out after applying expenses which directly relate to the categories and then allocating indirect

expenses on a reasonable basis.17

The trustee is required to advise the unit holders in an annual statement about the trust components

(called “determined trust components”).18

The ultimate outcome is to treat unit holders as having received amounts categorised as assessable

income, exempt income and nane income as follows:

“as having derived, received or made the amount reflected in the determined member component:

(a) in the member’s own right (rather than as a member of a trust); and

(b) in the same circumstances as the AMIT derived, received or made the amount to the extent that those

circumstances gave rise to the particular character of that component”.19

The intended effect is that the three components, together with capital gains and capital losses will be

applied to the unit holder as if the unit holder had directly generated the component. Tax offsets, that

is franking credits, Tax File Number withheld amounts etc., will be dealt with in the same way.20

Discount capital gains and franking credits are subject to the same gross up provisions as those set

out in the regular legislation.21

The regime as it applies to withholding tax separates non-resident treatment as between those

dealing with the dividend, interest and royalty withholding (which are subject to the withholding tax

rules in Division 11A of the 1936 Act) and the rules which require the trustee to withhold tax from

other types of income, notably ordinary income and capital gains pursuant to section 98 of the 1936

16 Section 276-260. 17 Sections 276-265 and 276-270. 18 Sections 267-450 and 267-455. The document is an “AMIT member annual statement” (AMMA statement). 19 Subsection 276-80. 20 Subsections 276-80(4) to (6). 21 Capital gains are doubled, Subdivision 115-C of the 1997 Act and an amount equal to the franking credit is included in the

assessable income of a recipient, Division 207 1997 Act.


{/01394593:1}© Ken Schurgott 2016 21

Act. These are very complicated rules required because the international withholding tax regime

operates on the basis of payment of amounts to non-residents whereas the new attribution rules

deem amounts to have been attributed.

Is the AMIT regime an appropriate model for private trust streaming rules?

No! It is exceedingly complex and possesses not a single characteristic of simplicity (apart perhaps

from treating the AMIT as a fixed trust, but this, of course, is directed at a very limited issue). The MIT

industry will be able to cope with its complications as the professionals dealing with the issues are

single mindedly focused on the specific issues which concern them. The industry input to the design

of the regime has been very substantial. In the private trust sector the trustees are generally

controlled by individuals or groups of individuals with once a year input to the allocation decisions

from tax professionals. They simply could not cope with such a complicated regime.


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8 ATO Activity

The ATO Trust Taskforce established in May 2013 with a specific four year grant of $67.9 million has

been working away under the radar focusing on higher risk trust issues not everyday “tax planning

associated with genuine business or family dealings”. The targets generally are found in the ‘naughty

side’ of trust use, for example, the situation described in Taxpayer Alert 2013/1.

In that case a conventional non-streamed distribution of income (which does not include the capital

gain) takes the tax liability on a capital gain to a company. A capital distribution of the capital gain is

made in the following income year (after 31 August) to individuals. The company is then liquidated.

However, the non-resident capital gains issue discussed earlier in this paper also emanates out of the

Trust Taskforce.

At the 2016 Barossa Convention, Fiona Dillion from the ATO mentioned only one area of activity

which appeared to be a new focus (at least to this writer) and that is compliance with PSLA 2010/4 so

far as sub-trust arrangements are concerned. To this writer sub-trusts have always been an artifice

invented by the ATO to avoid criticism of their stance on unpaid present entitlements. Compliance

with the ‘rules’ over many years (6 now) is extremely difficult and accountants will have struggled to

maintain the record keeping.


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9 Trust issues and the forthcoming election

Almost no mention at all about the taxation of trusts in the election campaign so far. The one

exception is the proposal aired in Labor's policy document "Multinational Tax Transparency" that

a "publicly accessible central registry of the beneficial ownership of companies, trusts and other

corporate structures" will be established to ensure that Australia "cannot be used as a destination

for money-laundering, tax evasion, terrorism financing or other criminal behaviour".

It is not at all clear whether such a register will be limited to offshore beneficial ownership or

extend to domestic trusts. The practical problem of identifying who is the beneficial owner of

discretionary trust property is obvious. It would be better to require disclosure of the appointor or

controller of the trust as this would be more meaningful and is not something presently publicly

available (compared to the directors and shareholders of a corporate trustee). How the scheme

would play out in an international context is problematic as beneficial ownership can change in an

instant and be remote from the apparent controllers. Experienced practitioners understand that

the ASIC corporate register is often quite out of date or the ownership details are inaccurate and

whether or not the shares are beneficially owned is quite often uncertain. The cost of failing to

correct or update the record is minimal. On balance the register of beneficial ownership is

probably not a workable idea.

It will be interesting to see if either party forming government has the "ticker" to address the mess

that is the taxation of trusts.

practical issues with trusts: important updates · 2016-05-25 · ken schurgott practical issues...

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