Private ruling: Capital gains tax and proposed conversion of a discretionary trust to a unit trust
Date of advice: 10 January 2018
Published: May 2018
Ruling period: 1 July 2017 – 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Will the proposed conversion of the Trust from a discretionary trust to a unit trust trigger capital gains tax (CGT) event E1 under section 104-55 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Will the proposed conversion of the Trust from a discretionary trust to a unit trust trigger CGT event E2 under section 104-60 of the ITAA 1997? | A2: No | Q3: Will the proposed conversion of the Trust from a discretionary trust to a unit trust trigger CGT event E3 pursuant to section 104-65 of the ITAA 1997? | A3: No | Q4: Will the proposed conversion of the Trust from a discretionary trust to a unit trust trigger CGT event E5 pursuant to section 104-75 of the ITAA 1997? | A4: No | Q5: Will the proposed conversion of the Trust from a discretionary trust to a unit trust trigger any of CGT event E4 (section 104-70 of the ITAA 1997), CGT event E6 (section 108-80 of the ITAA 1997), CGT event E7 (section 104-85 of the ITAA 1997) or CGT event E8 (section 104-90 of the ITAA 1997)? | A5: No

Relevant facts and circumstances: A trust (Trust) was created by a trust deed (Trust Deed). A Pty Ltd is the trustee (Trustee). Individual X and their child Y are the Directors of the Trustee company. X is also the sole shareholder of the Trustee company. X and their family members belong to a class of beneficiaries defined in the Trust Deed. The Trust Deed provides that the income and capital of the Trust are available to be applied at the discretion of the Trustee to benefit all or any of the objects of the Trust. The Trust Deed further provides that, subject to certain restrictions, the Trustee ‘may at any time and from time to time….revoke, add to or vary all or any of the trusts contained in this Deed….and may by the same or any other resolution or deed declare any new or other trusts or powers concerning the Trust Fund or any part or parts thereof….’. The Proposal X wishes to pass the control of the family business conducted by the Trust to their family. To achieve this objective, the Trustee proposes to vary the Trust by deleting all the provisions of the Trust Deed and replacing them with a Deed of Variation (proposed Deed), the effect of which is to constitute the Trust as a unit trust. X and members of the family will each received a specified number of units in the unit trust. These units carry voting rights, income rights and capital rights proportionate to the unit holdings. The Trustee continues to be the Trustee of the unit trust. The existing assets of the Trust together with the settled sum continue to be held by the Trustee on trust in accordance with the terms of the proposed Deed. X’s control and shareholding in the Trustee company and their units in the unit trust will be transferred to their family in accordance with the terms of their Will. None of the restrictions to the Trustee’s powers of variation applies to the Proposal.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-55 | Income Tax Assessment Act 1997 Section 104-60 | Income Tax Assessment Act 1997 Section 104-65 | Income Tax Assessment Act 1997 Section 104-70 | Income Tax Assessment Act 1997 Section 104-75 | Income Tax Assessment Act 1997 Section 104-80 | Income Tax Assessment Act 1997 Section 104-85 | Income Tax Assessment Act 1997 Section 104-90

Reasons for decision: Detailed Reasoning - Question 1: CGT event E1: CGT event E1 happens if a trust is created over a CGT asset by declaration or settlement (subsection 104-55(1) of the ITAA 1997). CGT event E2 happens if a CGT asset is transferred to an existing trust (subsection 104-60(1) of the ITAA 1997). Taxation Determination TD 2012/21 Income tax: 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? (TD 2012/21) expresses the view that CGT event E1 or CGT event E2 does not happen if the terms of the 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 unless: ● the change causes the existing trust to terminate and a new trust to arise for trust law purposes; or ● the effect of the change or court approved variation is such as to lead to a particular asset being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust. TD 2012/21 explains (at paragraph 24) that: … the ATO accepts that a change in the terms of the trust pursuant to exercise of an existing power (including an amendment to the deed of a trust), or court approved variation, will not result in a termination of the trust and, therefore, subject to the observation in paragraph 27 below, will not result in CGT event E1 happening. Where an asset is instead transferred to an existing trust, CGT event E2 will be the relevant event – subsection 104-60(1). Paragraphs 26 and 27 further states that: 26. Whether a purported change to a trust in exercise of a power under the deed is properly supported by the power is to be determined in accordance with principles of trust law having regard to the scope of the power properly construed. Relevant to this question will be whether the deed itself explicitly specifies conditions (including procedural conditions) that need to be satisfied for the exercise of the power to be effective. 27. Even in instances where a pre-existing trust does not terminate, it may be the case that assets held originally as part of the trust property commence to be held under a separate charter of obligations as a result of a change to the terms of the trust - whether by exercise of a power under the deed (including a power to amend) or court approved variation - such as to lead to the conclusion that those assets are now held on terms of a distinct (that is, different) trust. In this case, the Trust Deed provides the Trustee with powers to vary, alter or add to any of the provisions of the Deed in the absolute discretion of the Trustee subject to certain restrictions, none of which applies to the Proposal. Therefore, as the amendments are within the Trustee’s powers contained in the trust instrument the proposed amendments to the terms of the Trust to convert the Trust to a unit trust will not trigger the happening of CGT event E1 or CGT event E2 in section 104-55 or section 104-60 of the ITAA 1997. | Detailed Reasoning - Question 2: CGT event E2: Refer to Question 1 | Detailed Reasoning - Question 3: CGT event E3: CGT event E3 happens if a trust (that is not a unit trust) over a CGT asset is converted to a unit trust and just before the conversion, a beneficiary was absolutely entitled to the asset as against the trustee despite any legal disability of the beneficiary (subsection 105-65(1) of the ITAA 1997). Paragraphs 90 to 93 of Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (TR 2004/D25) express the view that joint and multiple beneficiaries cannot be absolutely entitled to the asset of the trust (of which the trustee is the owner) unless it is a fungible asset, for example shares. Furthermore, paragraph 52 of TR 2004/D25 states that an interest in the trust, or in the trust property, may also be a CGT asset as that term is defined in section 108-5 of the ITAA 1997, but neither of them is a CGT asset to which the absolute entitlement provisions refer. Therefore, no beneficiary of the Trust can be said to be absolutely entitled to any CGT asset as against the Trustee and CGT event E3 under subsection 104-65(1) of the ITAA 1997 does not happen. | Detailed Reasoning - Question 4: CGT event E5: CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust as against the trustee despite any legal disability of the beneficiary (subsection 104-75(1) of the ITAA 1997). CGT event E5 does not happen if the trust is a unit trust. At the point of conversion, the Trust becomes a unit trust, hence the exception relating to unit trust applies. In addition, no beneficiary of the Trust can be said to be absolutely entitled to any assets of the Trust (of which the Trustee is the owner) as explained above. Therefore, CGT event E5 does not happen when the Trust is converted to a unit trust. | Detailed Reasoning - Question 5: CGT events E4, E6, E7 and E8: CGT event E4 in section 104-70 of the ITAA 1997 does not happen because the trustee did not make a payment to the beneficiary in respect of their interest in the trust. CGT event E6 (section 104-80), CGT event E7 (section 104-85) or CGT event E8 (section 104-90) is not relevant and does not happen because of the exception relating to unit trust as explained above.