Re-settlement of trusts – towards a definitive test

Until relatively recently, it was generally thought that amending a Trust Deed to add beneficiaries (for example) would amount to a Re-Settlement (Re-Settlement) of the trust and the creation of a new trust with consequential effects of capital gains tax (GST) and potential liability for state based transfer duty.  The case of Commissioner of Taxation v Clark [2011] FCAFC 5 (Clark) provides authority for the proposition that this is not necessarily the case. Clark and provides a basis for the development of a formulaic approach to the development of a set of broad tests which can be applied to ascertain whether a Re-Settlement may or may not occur.

What is a trust Re-Settlement?

A trust is re-settled when a trust estate as originally constituted had come to an end and has subsequently been ‘resettled’ or recreated.  Because the trust has been resettled the question then becomes whether there is liability for CGT or state based transfer duty (Stamp Duty) as the case may be.

What is the test to determine whether a trust has been resettled?

The Commissioner of Taxation has said in Taxation Determination 2012/21 Resettlement of Trusts at 15 that:

“…a new trust arises for these purposes where there was a ‘fundamental change’ to the trust relationship and that a change in the ‘essential nature and character’ of the trust relationship can result in the creation of a new trust”.

Put another way, it was said at 16 that:

“the question is whether a trust has sufficiently changed such that it might be concluded that there is not sufficient continuity between the trust as originally constituted and the trust in its current form”.

The Commissioner stated that test contained in Commercial Nominees^[1] at 19 was:

“the test to be applied looks to whether changes to one or more of the trust’s constituent documents, the trust property, and the identity of those with a beneficial interest in the trust property are such as to terminate the existence of the trust”.

What is the meaning of “continuity” of a trust estate

In Commercial Nominees^[2] it was said that the amendments to the Trust Deed did not “of itself” create new beneficial interests. That said it was determined by Gyles JJ at 57 that there had been continuity of the trust estate. The reasons for this can be summarised as:

• there had been continuity of the regulatory regime associated with the Trust fund;
• the amendments to the Trust Deed were in accordance with the power to amend the Trust Deed as contemplated by the Settlors in the original Deed;
• there had been continuity of trust property that was the subject of the Trust;
• the change of name did not interfere with the continuity of the Trust Fund; and
• the change of rules of membership of the Fund did not interfere with the continuity of the fund that was originally established.

Therefore, it was held that there was a continuity in the trust and as a result the losses incurred in the previous years were able to be carried forward for the purposes of calculating the taxable income for the fund.

In Commissioner of Taxation v Clark^[3], the essential question for determination was whether there was a continuity of trust estate and if the trust estate had effectively ceased, then the Trustee would be denied access to the losses carried forward.

The test provided by Dowsett, Edmonds and Gordon JJ at 34 in endorsing the decision of the High Court in Commercial Nominees^[4] it was noted to be in the absence of a statutory definition in Part IX of the Income Tax Assessment Act:

“The three main indicia of continuity for the purposes of Pt IX are the constitution of the trusts under which the fund (if a trust fund) operated, the trust property, and membership. Changes in one or more of those matters must be such as to terminate the existence of the eligible entity, or to produce the result that it does not derive the income in question, to destroy the necessary continuity”.

It was further said by their Honours at 55 that, interalia that in order to establish continuity of the fund, it will be necessary to:

•  establish some degree of continuity of trust property;
• establish continuity of the regime of trust obligations affecting the property in that any amendments must be in accordance with the terms of the original trust;

It was also said at 56 that:

“So long as any amendment of the trust obligations relating to such trust property is made in accordance with any power conferred by the instrument creating the obligations, and continuity of the property that is the subject of trust obligation is established, there will be identity of the “taxpayer” for the purposes of s 278 and ss 79E(3) and 80(2), notwithstanding any amendment of the trust obligation and any change in the property itself”.

Therefore it is considered that these reasons need to be considered in addition to the reasons provided by Gyles J at 57 in Commercial Nominees.

What are the effects of a Re-Settlement?

Sections 104-55 and 104-60 of the Income Tax Assessment Act 1997 (Cth) describe the circumstances which will result in a capital gains tax (CGT) event and also describe circumstances which will not result in a CGT Event.

If a Re-Settlement is deemed to have occurred, then it’s likely that the Trustee will be liable to pay capital gains tax.   Therefore it is imperative that in making amendments to a Trust Deed that author consider carefully whether the amendments maintain the continuity in the trust estate or whether they are likely to result in a Re-Settlement of the Trust.

Links and further references

Legislation

Income Tax Assessment Act 1997 (Cth)

Taxation determinations

TD 2012/21 – Resettlement of Trusts – the Commissioner’’s view on whether CGT Event E1 or E2 in sections 104-55 and 104-60 of the Income Tax Assessment Act 1997 (Cth) happen if the terms of a trust are changed pursuant to a valid exercise of a power contained within the trust’s constitute document

Decision Impact Statement on Commissioner of Taxation v. David Clark; Commissioner of Taxation v. Helen Clark [2011] FCAFC 5 – DIS QUD 1 of 2010

Cases

Commissioner of Taxation v Clark [2011] FCAFC 5 (21 January 2011)

Federal Commissioner of Taxation v Commercial Nominees of Australia Ltd [1999] FCA 1455

Commissioner of Taxation v Commercial Nominees of Australia Limited [2001] HCA 33

Davidson v Chirnside [1908] HCA 65

Further information

If you need further information regarding amending a Trust Deed, please contact us for an obligation free and confidential discussion.

Disclaimer

This article contains general commentary only. You should not rely on the commentary as legal advice. Specific legal advice should be obtained to ascertain how the law applies to your particular circumstance.

[1] Federal Commissioner of Taxation v. Commercial Nominees of Australia Ltd [1999] FCA 1455.

[2] Federal Commissioner of Taxation v. Commercial Nominees of Australia Ltd [1999] FCA 1455.

[3] Commissioner of Taxation v Clark [2011] FCAFC 5 (21 January 2011).

[4] Commissioner of Taxation v Commercial Nominees of Australia Limited [2001] HCA 33.

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