Commissioner of Taxation v David Clark; Commissioner of Taxation v Helen Clark
Document type: Decision Impact Statement
Venue: Federal Court of Australia (QUD 1 of 2010; QUD 2 of 2010 (FC) / B10 2011 (HC))
Judgment date: 21 January 2011
Date published: 28 October 2013

Summary of decision:
Outlines the ATO view of this case which concerns whether for tax purposes capital gains made in the 2001 income year could be reduced by prior year capital losses, where a number of significant changes were made to the trust in the intervening period.

Overview of facts:
In working out whether the Carringbush Unit Trust (CUT), a closely held unit trust, had made a net capital gain in the 2001 income year in connection with the sale of properties acquired in 1997, an issue arose as to whether capital losses made by the CUT originating from the 1991, 1992 and 1993 income years could be applied against the gains made from those sales. | The relevant capital losses were made by the CUT whilst the CUT was under the control of the Denoon family and its units were held by members of the Denoon family and entities associated with that family (the Denoons). | In June 1993, various instruments were entered into that provided for control in the CUT to pass from the Denoon family to the Clark family, and entities associated with the Clark family received units in the CUT. Until then, as reflected in its most recent balance sheet, the CUT had a deficiency of liabilities over assets of approximately $3.9 million. | In particular, these instruments resulted in: • a change in the trustee of the CUT from a Denoon controlled entity to a Clark controlled entity; • the Denoon controlled trustee writing off all but $10 of the CUT's assets (i.e. loans owing to it from associates), securing the release of the liabilities it owed to associates and third parties, and purportedly waiving its right to indemnity from the trust fund in respect of liabilities properly incurred by it in discharging its powers and duties as trustee; • the Clark controlled trustee injecting $1.8 million into the CUT; • Denoon controlled entities transferring five of the 10 issued units in the CUT to Clark controlled entities on the understanding and provision that the remaining 5 units (still held by the Denoons) would receive no further benefits from the CUT unless and until the Denoons had made a matching contribution of $1.8 million to the CUT, and nonetheless would be transferred to Clark controlled entities if this contribution was not made within two years. | • a change in the trustee of the CUT from a Denoon controlled entity to a Clark controlled entity; • the Denoon controlled trustee writing off all but $10 of the CUT's assets (i.e. loans owing to it from associates), securing the release of the liabilities it owed to associates and third parties, and purportedly waiving its right to indemnity from the trust fund in respect of liabilities properly incurred by it in discharging its powers and duties as trustee; • the Clark controlled trustee injecting $1.8 million into the CUT; • Denoon controlled entities transferring five of the 10 issued units in the CUT to Clark controlled entities on the understanding and provision that the remaining 5 units (still held by the Denoons) would receive no further benefits from the CUT unless and until the Denoons had made a matching contribution of $1.8 million to the CUT, and nonetheless would be transferred to Clark controlled entities if this contribution was not made within two years. | The Denoons received a fee of $60,000 for passing control of the trust to the Clarks. | In the event, the Denoons did not make the matching contribution of $1.8 million to the CUT. As a result, in April 1996, the remaining 5 units in the CUT were transferred to the Clark controlled entities. | The CUT made capital gains in the 2001 income year from property development activities that were funded by capital contributions (including the $1.8 million) from the Clark controlled entities, namely from the sale of two properties. | The Commissioner proceeded on the basis that the capital losses made in respect of the earlier years of income were not available to be recouped against the gains made in the 2001 income year in calculating the net income of the trust for that year on the basis that the trust estate that made those capital losses was not, for tax purposes, the same trust estate that made the gains. In proceeding on this basis, the Commissioner looked to whether continuity of the trust estate had been maintained and in this context focussed on the three main indicia of continuity identified by the High Court in Federal Commissioner of Taxation v Commercial Nominees (2001) 75 ALJR 1172. These indicia are continuity of the constitution of the trusts under which the fund operated, of the trust property and of its membership. | Issues decided by the courts | Full Federal Court - majority decision in taxpayer's favour | Edmonds & Gordon JJ rejected the Commissioner's contention that there was a lack of continuity of the trust estate. | Their Honours acknowledged [at para 77] that a similar issue arose in Commercial Nominees in respect of the former taxing regime for superannuation funds, and quoted the High Court as finding in that case that: [t]he three main indicia of continuity [for the purposes the former taxing regime for superannuation funds] 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. [emphasis added by Edmonds and Gordon JJ] | However, their Honours were of the view [at paras 78 and 79] that the High Court had also endorsed the reasoning of the Full Federal Court in Commercial Nominees (1999) 167 ALR 147 that so long as any amendment to the trust obligations is made in accordance with a power conferred by the trust instrument creating the obligations, and continuity of the property that is the subject of the trust obligation is established, then there will be 'identity' of the taxpayer notwithstanding any amendment of the trust obligation and any change in the property itself. | Finally, their Honours concluded [at para 87] that: [w]hen the High Court in Commercial Nominees spoke about trust property and membership as providing two of the indicia for the continued existence of the ... trust estate, the Court was not suggesting that there had to be a strict or even partial identity of property for the first and objects for the second. It was speaking more generally: that there had to be a continuum of property and membership, which could be identified at any time, even if different from time to time; and without severance of one or both leading to the termination of the trust in question... | On this basis, their Honours rejected the Commissioner's contention that there was a 'substantial discontinuity' with respect to each of the three main indicia identified by the High Court in Commercial Nominees . Their Honours also made some specific observations in respect of each of the indicia. | Constitution of the trust | Their Honours observed [at para 76] that it was not without significance that all of the arrangements were effected without making any alteration to the terms of the [deed of the CUT]. In other words, there was no alteration to the terms of the trusts embodied in that document even if a beneficial interest in the trust fund was affected, even extinguished, by virtue of the arrangements ... | Their Honours then referred by way of example to the Denoon controlled trustee's waiver of its right to be indemnified out of the assets of the trust fund, later observing [at para 82] that this 'no more created a new trust than it terminated an existing one. At the most it may have extinguished a 'beneficial interest' in the trust assets .... but even that is not clear'. | Their Honours also found that the arrangements under which the Denoons agreed they would obtain no further benefits from the CUT unless and until they made a capital contribution to the trust equal to that made by the Clarks 'did not vary the trusts [of the CUT] let alone terminate them or bring a new trust into existence' [at para 83]. | Trust property and membership | Their Honours observed that it was significant in their view that the Commissioner had never contended that 'there was a cessation in the continuum of trust property such as to leave it open to find that the trust estate as originally constituted had come to an end', adding that at most 'it was put that only a money amount of $10, being the amount of the original settlement, remained', but it was not disputed that this amount continued to exist [at para 53]. | Their Honours also noted that under the terms of the CUT, it would be expected that trust property would change as units were subscribed for and redeemed, and its membership would change as new units were issued and existing units transferred or redeemed [at paras 85-86]. | Their Honours found [at para 87] that whilst the identity of the trust property and objects of the CUT changed over time, there had not been any severance in their continuum. | By way of final remark, their Honours stated [at para 88] that the approach they had taken was 'consistent with the position at general law in relation to the four essential indicia of the existence of a trust: the trustee, trust property, the beneficiary and an equitable obligation annexed to the trust property' and that: [i]n Commercial Nominees both the Full Court, at [49] of its reasons, and the High Court, at [35] of its reasons, pointed out that there was nothing in Pt IX [the then statutory taxation regime for superannuation funds], nor in the 1936 Act generally, which imposed some statutory requirement of continuity for determining when there is a sufficient identity of the trusts involved. With respect, the same applies in the case of Div 6 of Pt III of the 1936 Act. | Full Federal Court - dissent | Dowsett J dissented and found that the trust estate that made the capital gains was not the same trust estate as made the capital losses [at paras 44 and 45]. In so doing, his Honour commented [at para 44] that: it cannot seriously be contemplated that [the 2001 net capital gain] was the product of any part of the trust estate held prior to, or at 18 June 1993, nor can it sensibly be argued that any part of the capital gain was produced by the $10 settlement amount. It cannot be said that there was continuity of the trust estate from any time prior to 18 June 1993 until the date of acquisition [of the properties in 1997] or the date of their sale in the 2001 year of income. | Earlier his Honour had observed [at para 39] that by 18 June 1993, the CUT had 'in effect, been wound up ... as at 18 June 1993 the relevant trust estate was of only nominal value'. | His Honour concluded [at para 45] that while changes in the ownership of the units were clearly contemplated by the trust deed, and while changes in the terms of the trust were also contemplated, as was augmentation of the fund, 'where a trust has been effectively deprived of all assets and re-endowed, I see no way in which it can be said that the original trust estate has continued'. | Application for special leave to appeal to the High Court rejected | The Commissioner sought special leave to appeal against the decision of the Full Federal Court to the High Court. In support of his application, the Commissioner argued that in proceeding on the assumption that the Commissioner could only succeed if there was a complete absence of trust property with the result that the trust estate had come to an end, the Federal Court's approach was difficult to reconcile with that of the High Court in Commercial Nominees . The Commissioner argued that: - in Commercial Nominees the High Court had rejected the proposition that the test to be applied looks simply to whether there has been a resettlement of trust property at general law; - the High Court, contrary to the apparent approach of the Full Federal Court in Clark, expressly stated in Commercial Nominees [at para 36] that the test to be applied was instead one of continuity, a point also made by the Full Federal Court in that case [at para 55]; - the test of continuity set out by the High Court in Commercial Nominees has two limbs, namely, whether changes in one or more of the trust constitution, property and membership are such to: (a) terminate the existence of the trust, or (b) produce the result that it does not derive the income in question. Expressed in terms of the facts in Clark, the relevant enquiry is therefore not complete simply by asking whether changes in one or more of the constitution of the CUT, the trust property, and membership were such as to terminate the existence of the trust. Rather one must go further and also ask whether the changes were nonetheless such as to produce the result that the trust estate that made the earlier capital losses is not the trust estate that made the later capital gains from the sale of trust property acquired after the recapitalisation; - such a two limb approach to the test of continuity necessarily contemplates the existence of situations in which the existence of a trust was not terminated but changes to the constitution, trust property and / or membership nevertheless produce a situation in which the requirement of continuity is not satisfied. | - in Commercial Nominees the High Court had rejected the proposition that the test to be applied looks simply to whether there has been a resettlement of trust property at general law; - the High Court, contrary to the apparent approach of the Full Federal Court in Clark, expressly stated in Commercial Nominees [at para 36] that the test to be applied was instead one of continuity, a point also made by the Full Federal Court in that case [at para 55]; - the test of continuity set out by the High Court in Commercial Nominees has two limbs, namely, whether changes in one or more of the trust constitution, property and membership are such to: (a) terminate the existence of the trust, or (b) produce the result that it does not derive the income in question. Expressed in terms of the facts in Clark, the relevant enquiry is therefore not complete simply by asking whether changes in one or more of the constitution of the CUT, the trust property, and membership were such as to terminate the existence of the trust. Rather one must go further and also ask whether the changes were nonetheless such as to produce the result that the trust estate that made the earlier capital losses is not the trust estate that made the later capital gains from the sale of trust property acquired after the recapitalisation; - such a two limb approach to the test of continuity necessarily contemplates the existence of situations in which the existence of a trust was not terminated but changes to the constitution, trust property and / or membership nevertheless produce a situation in which the requirement of continuity is not satisfied. | (a) terminate the existence of the trust, or (b) produce the result that it does not derive the income in question. Expressed in terms of the facts in Clark, the relevant enquiry is therefore not complete simply by asking whether changes in one or more of the constitution of the CUT, the trust property, and membership were such as to terminate the existence of the trust. Rather one must go further and also ask whether the changes were nonetheless such as to produce the result that the trust estate that made the earlier capital losses is not the trust estate that made the later capital gains from the sale of trust property acquired after the recapitalisation; | In refusing the Commissioner's application for special leave, the High Court stated that the decision of the Full Federal Court 'involved characterisation and evaluation of the continuity of the trust estate' and it was not attended with sufficient doubt to warrant the grant of special leave.

Issues decided:
Full Federal Court - majority decision in taxpayer's favour: Edmonds & Gordon JJ rejected the Commissioner's contention that there was a lack of continuity of the trust estate. Their Honours acknowledged [at para 77] that a similar issue arose in Commercial Nominees in respect of the former taxing regime for superannuation funds, and quoted the High Court as finding in that case that: [t]he three main indicia of continuity [for the purposes the former taxing regime for superannuation funds] 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. [emphasis added by Edmonds and Gordon JJ] However, their Honours were of the view [at paras 78 and 79] that the High Court had also endorsed the reasoning of the Full Federal Court in Commercial Nominees (1999) 167 ALR 147 that so long as any amendment to the trust obligations is made in accordance with a power conferred by the trust instrument creating the obligations, and continuity of the property that is the subject of the trust obligation is established, then there will be 'identity' of the taxpayer notwithstanding any amendment of the trust obligation and any change in the property itself. Finally, their Honours concluded [at para 87] that: [w]hen the High Court in Commercial Nominees spoke about trust property and membership as providing two of the indicia for the continued existence of the ... trust estate, the Court was not suggesting that there had to be a strict or even partial identity of property for the first and objects for the second. It was speaking more generally: that there had to be a continuum of property and membership, which could be identified at any time, even if different from time to time; and without severance of one or both leading to the termination of the trust in question... On this basis, their Honours rejected the Commissioner's contention that there was a 'substantial discontinuity' with respect to each of the three main indicia identified by the High Court in Commercial Nominees . Their Honours also made some specific observations in respect of each of the indicia. Constitution of the trust Their Honours observed [at para 76] that it was not without significance that all of the arrangements were effected without making any alteration to the terms of the [deed of the CUT]. In other words, there was no alteration to the terms of the trusts embodied in that document even if a beneficial interest in the trust fund was affected, even extinguished, by virtue of the arrangements ... Their Honours then referred by way of example to the Denoon controlled trustee's waiver of its right to be indemnified out of the assets of the trust fund, later observing [at para 82] that this 'no more created a new trust than it terminated an existing one. At the most it may have extinguished a 'beneficial interest' in the trust assets .... but even that is not clear'. Their Honours also found that the arrangements under which the Denoons agreed they would obtain no further benefits from the CUT unless and until they made a capital contribution to the trust equal to that made by the Clarks 'did not vary the trusts [of the CUT] let alone terminate them or bring a new trust into existence' [at para 83]. Trust property and membership Their Honours observed that it was significant in their view that the Commissioner had never contended that 'there was a cessation in the continuum of trust property such as to leave it open to find that the trust estate as originally constituted had come to an end', adding that at most 'it was put that only a money amount of $10, being the amount of the original settlement, remained', but it was not disputed that this amount continued to exist [at para 53]. Their Honours also noted that under the terms of the CUT, it would be expected that trust property would change as units were subscribed for and redeemed, and its membership would change as new units were issued and existing units transferred or redeemed [at paras 85-86]. Their Honours found [at para 87] that whilst the identity of the trust property and objects of the CUT changed over time, there had not been any severance in their continuum. By way of final remark, their Honours stated [at para 88] that the approach they had taken was 'consistent with the position at general law in relation to the four essential indicia of the existence of a trust: the trustee, trust property, the beneficiary and an equitable obligation annexed to the trust property' and that: [i]n Commercial Nominees both the Full Court, at [49] of its reasons, and the High Court, at [35] of its reasons, pointed out that there was nothing in Pt IX [the then statutory taxation regime for superannuation funds], nor in the 1936 Act generally, which imposed some statutory requirement of continuity for determining when there is a sufficient identity of the trusts involved. With respect, the same applies in the case of Div 6 of Pt III of the 1936 Act. | Full Federal Court - dissent: Dowsett J dissented and found that the trust estate that made the capital gains was not the same trust estate as made the capital losses [at paras 44 and 45]. In so doing, his Honour commented [at para 44] that: it cannot seriously be contemplated that [the 2001 net capital gain] was the product of any part of the trust estate held prior to, or at 18 June 1993, nor can it sensibly be argued that any part of the capital gain was produced by the $10 settlement amount. It cannot be said that there was continuity of the trust estate from any time prior to 18 June 1993 until the date of acquisition [of the properties in 1997] or the date of their sale in the 2001 year of income. Earlier his Honour had observed [at para 39] that by 18 June 1993, the CUT had 'in effect, been wound up ... as at 18 June 1993 the relevant trust estate was of only nominal value'. His Honour concluded [at para 45] that while changes in the ownership of the units were clearly contemplated by the trust deed, and while changes in the terms of the trust were also contemplated, as was augmentation of the fund, 'where a trust has been effectively deprived of all assets and re-endowed, I see no way in which it can be said that the original trust estate has continued'. | Application for special leave to appeal to the High Court rejected: The Commissioner sought special leave to appeal against the decision of the Full Federal Court to the High Court. In support of his application, the Commissioner argued that in proceeding on the assumption that the Commissioner could only succeed if there was a complete absence of trust property with the result that the trust estate had come to an end, the Federal Court's approach was difficult to reconcile with that of the High Court in Commercial Nominees . The Commissioner argued that: - in Commercial Nominees the High Court had rejected the proposition that the test to be applied looks simply to whether there has been a resettlement of trust property at general law; - the High Court, contrary to the apparent approach of the Full Federal Court in Clark, expressly stated in Commercial Nominees [at para 36] that the test to be applied was instead one of continuity, a point also made by the Full Federal Court in that case [at para 55]; - the test of continuity set out by the High Court in Commercial Nominees has two limbs, namely, whether changes in one or more of the trust constitution, property and membership are such to: (a) terminate the existence of the trust, or (b) produce the result that it does not derive the income in question. Expressed in terms of the facts in Clark, the relevant enquiry is therefore not complete simply by asking whether changes in one or more of the constitution of the CUT, the trust property, and membership were such as to terminate the existence of the trust. Rather one must go further and also ask whether the changes were nonetheless such as to produce the result that the trust estate that made the earlier capital losses is not the trust estate that made the later capital gains from the sale of trust property acquired after the recapitalisation; - such a two limb approach to the test of continuity necessarily contemplates the existence of situations in which the existence of a trust was not terminated but changes to the constitution, trust property and / or membership nevertheless produce a situation in which the requirement of continuity is not satisfied. - in Commercial Nominees the High Court had rejected the proposition that the test to be applied looks simply to whether there has been a resettlement of trust property at general law; - the High Court, contrary to the apparent approach of the Full Federal Court in Clark, expressly stated in Commercial Nominees [at para 36] that the test to be applied was instead one of continuity, a point also made by the Full Federal Court in that case [at para 55]; - the test of continuity set out by the High Court in Commercial Nominees has two limbs, namely, whether changes in one or more of the trust constitution, property and membership are such to: (a) terminate the existence of the trust, or (b) produce the result that it does not derive the income in question. Expressed in terms of the facts in Clark, the relevant enquiry is therefore not complete simply by asking whether changes in one or more of the constitution of the CUT, the trust property, and membership were such as to terminate the existence of the trust. Rather one must go further and also ask whether the changes were nonetheless such as to produce the result that the trust estate that made the earlier capital losses is not the trust estate that made the later capital gains from the sale of trust property acquired after the recapitalisation; - such a two limb approach to the test of continuity necessarily contemplates the existence of situations in which the existence of a trust was not terminated but changes to the constitution, trust property and / or membership nevertheless produce a situation in which the requirement of continuity is not satisfied. (a) terminate the existence of the trust, or (b) produce the result that it does not derive the income in question. Expressed in terms of the facts in Clark, the relevant enquiry is therefore not complete simply by asking whether changes in one or more of the constitution of the CUT, the trust property, and membership were such as to terminate the existence of the trust. Rather one must go further and also ask whether the changes were nonetheless such as to produce the result that the trust estate that made the earlier capital losses is not the trust estate that made the later capital gains from the sale of trust property acquired after the recapitalisation; In refusing the Commissioner's application for special leave, the High Court stated that the decision of the Full Federal Court 'involved characterisation and evaluation of the continuity of the trust estate' and it was not attended with sufficient doubt to warrant the grant of special leave.

ATO view of decision:
The Commissioner considers that the decision of the Full Federal Court in Clark does not change the basic proposition that, based on the authority in Commercial Nominees , the relevant focus is on whether continuity of the trust estate has been maintained. That this is so is confirmed by the High Court's language in disposing of the Commissioner's application for special leave where the High Court noted that the decision of the Full Federal Court involved 'characterisation and evaluation of the continuity of the trust estate '. | The statute does not contain a statement of the applicable criteria against which continuity is to be assessed. As was recognised by the Full Federal Court in Commercial Nominees [at para 49], the consequence is that criteria must be established for these purposes. As decided by the High Court in Commercial Nominees , the Commissioner considers that 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. | To the extent that the High Court in Commercial Nominees left open the possibility that there might be a loss of continuity in circumstances short of the existence of the trust having come to an end, the Commissioner acknowledges that in Clark there were significant changes to the property, membership and operation of the CUT without any finding by the courts that there was a loss of continuity such as to deny the trust access to the losses being carried forward. Relevantly, in disposing of the Commissioner's special leave application, the High Court noted that the application raised the question: [w]hether a trustee of a unit trust could set-off, against capital gains, capital losses incurred some years before under a different trustee with different unit holders, with an intervening excess of liabilities over assets, subsequent recapitalisation of the trust and a waiver by the original trustee of its right to be indemnified from the assets of the trust. | Accordingly, following Clark, there will not be a loss of continuity sufficient to deny a trustee access to any capital losses being carried forward without a termination of the existence of the trust estate. | Not being central to the matter in dispute, the Commissioner does not view this case as deciding the issue of whether or not an attempt by a trustee to waive its right of indemnity may be effective at law.

Administrative treatment:
Even though this case considered whether changes in a continuing trust were sufficient to treat that trust as a different taxpayer for the purpose of applying a net capital loss, the ATO accepts the principles set out in this case have broader application. In particular, the case is relevant to the question of the circumstances in which CGT Event E1 may happen by reason of a new trust coming into existence consequent on changes being made to an existing trust. In that context the ATO accepts that the reasoning of the court has the effect that a valid amendment to a trust, not resulting in a termination of the trust will not of itself result in the happening of CGT event E1. On this basis the 'Creation of a new trust - Statement of Principles August 2001' was withdrawn on 20 April 2012. | Consequently the ATO has withdrawn Creation of a new trust - Statement of Principles August 2001 . The ATO view in relation to this matter is now set out in Taxation Determination TD 2012/21 which addresses the question: does CGT event E1 or E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 happen if the terms of a trust are changed pursuant to a valid exercise of a power contained within the trust's constituent document, or varied with the approval of a relevant court? | Implications on current Public Rulings & Determinations | None

Legislative references: Income Tax Assessment Act 1936 6(1) 95(1) 96 97 Income Tax Assessment Act 1997 6-5 6-10 102-5(1) 102-15
Case references: Australian Securities Investments Commission v Rich (2009) 75 ACSR 1 [2009] NSWSC 1229 Cajkusic v Federal Commissioner of Taxation (2006) 155 FCR 430 2006 ATC 4752 64 ATR 676 Chief Commissioner of Stamp Duties (NSW) v Buckle (1998) 192 CLR 226 98 ATC 4097 37 ATR 393 Commissioner of Taxation v Everett (1980) 143 CLR 440 10 ATR 608 80 ATC 4076 Federal Commissioner of Taxation v Bamford (2010) 240 CLR 481 2010 ATC 20-170 [2010] HCA 10 75 ATR 1 Federal Commissioner of Taxation v Commercial Nominees of Australia Ltd (2000) 43 ATR 42 [1999] FCA 1455 99 ATC 5115 Federal Commissioner of Taxation v Commercial Nominees of Australia Ltd (2001) 75 ALJR 1172 [2001] HCA 33 47 ATR 220 Howey v Federal Commissioner of Taxation (1930) 44 CLR 289 [1930] HCA 45 Octavo Investments Pty Ltd v Knight (1979) 144 CLR 360 Salt v Marquess of Northampton [1892] 2 AC 1 Stewart Dawson Holdings Pty Ltd v Commissioner of Taxation (1965) 39 ALJR 300
Subject references: Continuity of trust estate Net capital gain Net capital loss Net income in relation to a trust estate Share of the net income of a trust estate