Private ruling: Potential capital gains tax and Division 7A implications
Date of advice: 28 August 2018
Published: October 2018
Ruling period: 1 July 20xx to 30 June 20xx
Date scheme commenced: 1 July 20xx

Ruling: Q1: Will the proposed amendments to the Trust Deed of the Apple Family Trust, appointment of an Additional Trustee and Additional Appointor in respect of a part of the Trust Fund result in a capital gains tax (CGT) E1 or E2 events happening pursuant to sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Will the contemplated changes impact the treatment of the unpaid present entitlements of Pear Pty Ltd that arose before 16 December 2009 pursuant to Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)? | A2: No

Relevant facts and circumstances: Apple Family Trust 1. Ben Apple is the current Appointer of the Apple Family Trust (Family Trust). 2. The Trustee of the Family Trust is Veggie Pty Ltd (Veggie). Ben and Lily Apple are the shareholders of the company. Together with their sons, Sam and Paul Apple, Ben and Lily are also the directors of Veggie. Relevant provisions of the Deed of Settlement, as amended. 3. The Specified Beneficiaries of the Family Trust are Ben and Lily Apple. Broadly, the other eligible beneficiaries include: a. the family members of Ben and Lily Apple b. any corporation in which shares are held by a beneficiary, or beneficially held, or by a trustee of a trust under which a beneficiary has an interest, and c. trustees of any trust nominated in writing as beneficiary by the trustee of the Family Trust. 4. The scope of beneficiaries has remained unaltered since the Family Trust was settled. 5. Sub-clause 1(5) of the Deed of Settlement defines ‘Trust Fund’ to mean the settlement fund and all moneys, investments and property paid or transferred to or accepted by the trustee as additions to the Trust Fund, and any accumulations of income and all accretions and additions to the Trust Fund from whatever source. 6. Clause 4 of the Deed of Settlement provides the Trustee with the absolute discretion to distribute or accumulate the whole or any part of the net income of the Trust Fund at any time prior to the expiration of the relevant Accounting Period. a. Sub-clause 1(9) defines Accounting Period to mean the 12 month period ending on 30 June each year. 7. Clause 5 of the Deed of Settlement provides that at Vesting Day the Trustee shall stand possessed of the Trust Fund and the income of the Trust for such of the beneficiaries and for such charitable purposes in such proportions as the Trustee may determine in writing. 8. Subject to any express provision to the contrary, clause 11 gives the Trustee the absolute and uncontrolled discretion to exercise any powers given to them. 9. The Appointor is entitled to: a. remove a Trustee and appoint any additional or new Trustee in accordance with sub-clause 16(1) of the Deed of Settlement, and b. appoint a new or additional Appointor by will, deed or notice in writing to the Trustee in accordance with sub-clause 16(7) of the Deed of Settlement. 10. Sub-clause 19(1) provides that the Trustee may, by deed, revoke, add or vary, all or part of the Deed on the condition that such variations are not in favour or to the benefit of the Settlor or Trustee. a. Sub-clause 19(2) further provides that the Trustee is not permitted to alter clause 19. 11. Clause 26 allows the Trustee to be indemnified out of the assets of the Trust Fund against liabilities incurred by the Trustee. Activities of the Family Trust 12. The main assets of the Family Trust are: a. Fruit and Veggie Pty Ltd, the family business b. real property c. shares in listed companies, and d. investments in private companies, cash and other. 13. Recently, Sam Apple was appointed as the managing director of Fruit and Veggie Pty Ltd. 14. Sam Apple is also actively involved in property investment. Given his role and experience, it is considered that Sam is best placed to guide decisions regarding the future of these investments. Proposed changes 15. Over recent years, Ben has gradually reduced his business activities with succession goals in respect of the businesses, family wealth management and charitable activities. 16. Ben and Lily Apple believe that now is an appropriate time for greater responsibility for the administration of the assets and liabilities of the Family Trust to be placed on their sons. To this end, they desire joint control of the Family Trust to be provided to Paul and Sam Apple to allow them to work together for the long-term benefit of the family. 17. To achieve the desired succession planning goal, it is proposed to: a. amend the trust terms to allow for the appointment of additional trustees in respect of part of the Trust Fund b. execute a Deed of Appointment appointing Potato Pty Ltd (Potato) as an additional trustee over specified assets of the Family Trust, and c. execute a Deed of Appointment appointing Sam Apple as an additional appointor over the part of the trust fund that Potato is the Trustee. Proposed key amendments to the Deed of Settlement 18. It is proposed that a Deed of Amendment for the Family Trust be executed to: a. insert clause 4A to provide that in making a determination about how to distribute the net income of the trust fund for a particular accounting period, each Trustee of any part/s of the trust fund must: i. take into account the losses incurred by the other part of the trust fund ii. ensure that the Trustee’s proportion of shared expenses of the whole trust fund are paid or accounted for, and iii. not distribute an amount that exceeds the total net income of the relevant part less losses incurred by each other part of the trust fund. b. make clause 9, which requires the Trustees, if more than one, to act jointly and delegate any power or discretion in writing, subject to new clause 9A c. insert clause 9A, which will state: While the Trust Fund will still exist as one fund, any Trustee appointed as trustee for a separate part of the Trust Fund may act severally for that part of the Trust Fund held on trust by the Trustee, provided that for: (a) any actions specified in the Second Schedule to this Trust Deed the prior written consent of all separate Trustees must be obtained; and (b) matters which one Trustee reasonably considers that the agreement of all Trustees is required, but not limited to: (i) selecting an accountant for preparation of the tax return for the Trust; (ii) incurring joint expenses of the Trust; (iii) amending this Deed; (iv) determining an earlier Vesting Date for the Trust, all separate Trustees must act together. d. insert clause 9B to require each Trustee to at all times act reasonably and use its best endeavours to do all things reasonably necessary to allow the other Trustee to fully act as Trustee for its relevant part of the trust fund e. insert clause 16(1)(d) to broadly enable the Appointor to appoint additional trustees to any part of parts of the Trust Fund f. delete and replace existing clause 16(7) with the following: Any Appointor: (a) may, subject to any conditions of the Appointor’s appointment, by writing in the form of a deed appoint one or more persons to be an additional Appointor; and (b) resigning or renouncing under clause 16(2) may be writing in the form of a deed appoint one or more persons to replace the Appointor as an appointor, subject to any conditions not inconsistent with this Trust Deed the Appointor deems prudent. g. insert clause 27, which states: If at any time Trustees are appointed to separate portions of the Trust Fund the funds to satisfy any right of indemnity the Trustee seeks to rely on must first be drawn from the portion of the Trust Fund controlled by the Trustee claiming the benefit of the right of indemnity. h. insert a Second Schedule which requires that the matters requiring Trustees’ consent are: i. incurring debt of over a specified, but as yet not identified, amount ii. granting security over any assets of the Trust, and iii. carrying on an active business. 19. You explain that new clause 4A is intended to allow each Trustee to deal with the net income of their respective asset pool but in doing so, must have regard to joint expenses of the trust and any losses. Proposed Deed of Appointment of Additional Trustee 20. The proposed Deed of Appointment of Additional Trustee appoints Potato as additional trustee and removes Veggie as trustee for following assets: a. all ordinary units currently held by Veggie in the Agriculture Investments Trust, and b. all 7,800 ordinary units held by Veggie in the Fruit and Veggie Trust. 21. Sam and Ben Apple are the directors and shareholders of Potato. 22. Clause 6 of the proposed Deed of Appointment of Additional Trustee provides as follows: The Additional Trustee undertakes that the Obligations will be paid: (a) firstly by the Additional Trustee with funds drawn from the portion of the Trust Fund controlled by the Additional Trustee; and (b) by the Current Trustee only to the extent that the portion of the Trust Fund controlled by the Additional Trustee is insufficient to satisfy the Obligations. 23. The Obligations are listed in the Schedule as follows: (a) Unpaid distributions owing to Pear Pty Ltd ABN XX XXX XXX XXX of $X that arose prior to 16 December 2009. Proposed Deed of Appointment of Additional Appointer 24. The proposed Deed of Appointment of Additional Appointer is executed by William Apple in his capacity of appointer of the Family trust. In this deed he appoints Sam Apple as an Additional Appointer in respect to the appointment of Potato (or any successor to Potato) and declares that he will only remain the appointer of the trust in respect of assets held by Veggie (or any successor to Veggie). Operation of the Family Trust after changes 25. You state that the proposed arrangement will only impact the administration of the Family Trust to ‘…facilitate orderly succession planning and future management by Sam and Paul for the continued benefit of the family as a whole.’ 26. You further state that there is no desire to limit the potential beneficiaries who could benefit from the income or capital of the Trust, nor is there any intention to amend the definition of beneficiary. 27. You state that subsequent to the amendments, it is intended that each Trustee will be the sole Trustee over their respective asset pool. You state that each Trustee will be empowered to exercise their rights and discretions in respect of their asset pool under the Deed of Settlement. However, you claim that as there is only one Trust, the Trustees will need to come together for particular purposes to allow for the proper administration of the Trust. Consistent with this, you state that one set of accounts will be kept for the trust and one joint tax return will be prepared for the single trust. You also confirmed that this means that the taxation of trust income will be calculated on the basis of their being the one trust. Unpaid present entitlement to Pear Pty Ltd 28. The primary obligation of the Family Trust is an unpaid present entitlement (UPE) of $X in favour of Pear Pty Ltd (Pear) which arose prior to 16 December 2009. a. Pear is currently controlled by Ben and Lily Apple. You state that they will retain this control under the proposed arrangement. 29. You state that the current market value of the family business exceeds the amount of the UPE. Furthermore, the additional trustee will have full recourse to the entire trust fund of the Family Trust to satisfy this UPE such that you state that this entitlement will not be compromised by the proposed arrangement. 30. You state that the UPE has been consistently recorded in the financial statements of the Family Trust and Pear as an UPE that arose prior to 16 December 2009. You explain that the UPE has not been treated as a loan for the purposes of Division 7A of the ITAA 1936 which is consistent with Taxation Ruling TR 2010/3 and PS LA 2010/4. 31. You confirm that subsequent to the implementation of the proposed arrangement, the UPE will continue to be recorded in the financial statements of both the Family Trust and Pear in the same manner as is currently done. 32. You state that the payment of the UPE is an important element of the family succession plan in that it will provide funding for Ben and Lily Apple’s retirement, as well as supporting their charitable activities.


Reasons for decision: Summary: Will the proposed amendments to the Trust Deed of the Apple Family Trust, appointment of an Additional Trustee and Additional Appointor in respect of a part of the Trust Fund result in a CGT E1 or E2 events happening pursuant to sections 104-55 or 104-60 of the ITAA 1997? 33. Subsection 104-55(1) of the ITAA 1997 provides that CGT event E1 happens when a trust is created over a CGT asset by declaration or settlement. Pursuant to subsection 104-55(2), the CGT event happens at the point in time the trust is created. Therefore, in order for CGT event E1 to occur, there needs to be both the creation of a trust and that this be done by way of declaration or settlement. 34. Guidance on the Commissioner’s preliminary view on whether a ‘trust split’ arrangement will result in CGT event E1 can be found in Draft Taxation Determination TD 2018/D3 Income Tax: Will a trust split arrangement of the type described in this Determination cause a new trust to be settled over some but not all assets of the original trust with the result that CGT event E1 in subsection 104-55(1) of the Income Tax Assessment Act 1997 happens? (TD 2018/D3). 35. TD 2018/D3 considers arrangements which have all or most of the following features: i. the original trustee of the trust estate is removed over some of the assets and a new trustee is appointed over these assets ii. control of the original trustee passes to a subset of the beneficiaries of the original trust, with the new trustee controlled by a different subset of beneficiaries of the original trust iii. different appointors are appointed over each trustee iv. the trustees’ rights of indemnity are segregated such that each trustee can only be indemnified from the assets held by that trustee v. the expectation that the new trustee will exercise its powers in respect of the assets it holds independently of the original trustee to benefit their subclass of beneficiaries to the exclusion of the others. Conversely, the original trustee is also expected to exercise its powers for the benefit of its subclass of beneficiaries to the exclusion of other vi. the rights, obligations and powers of the trustees and beneficiaries all remain to be governed under the same trust deed, and vii. the original and new trustee keep separate books of account. 36. Paragraphs 14 to 28 of TD 2018/D3 explain the Commissioner’s reasons for forming the preliminary view that the arrangement described in that draft Determination will cause CGT event E1 to happen in respect to the assets transferred to the new trustee. 37. There is no case law which deals directly with the tax implications of the appointment of different trustees in respect to different parts of a pre-existing trust fund. The decisions in FC of T v Commercial Nominees of Australia Ltd and FC of T v Clark considered whether alterations to the identity of a trustee, the terms of a trust instrument, or the trust property, pursuant to valid exercises of power to vary the terms of a trust can be such as to bring to an end the original trust and into being a new trust. 38. The question under consideration in this case is not whether the Family Trust will come to an end, but whether the assets transferred to Potato are settled on a new trust fund that is separate from the existing Family Trust. Consequently, these earlier case decisions are of minimal assistance. 39. It is the Commissioner’s view that the phrase “you create a trust over a CGT asset” is to be understood by reference to the general law of trusts. 40. Ford and Lee in Principles of the Law of Trusts define a trust as “an obligation enforceable in equity which rests on a person (the trustee) as the owner of some specific property (the trust property) to deal with that property for the benefit of a certain person (the beneficiary) or persons …”. 41. The authors of Jacobs’ Law of Trusts describe a trust as “a relation between the trustee and beneficiary in respect of certain property… which arises when the owner of a legal or equitable interest in property is bound by an obligation recognised by and enforced in equity to hold that interest for the benefit of others.” 42. In DKLR Holding Co (No 2) Pty Ltd v. Commissioner of Stamp Duties Hope JA quoted, with approval, a similar statement in an earlier edition of Jacobs and went on to describe the ‘very nature of a trust’ in terms of being a personal obligation of a trustee annexed to property to hold the property for the benefit of another. Hope JA emphasised that both elements were necessary for the existence of a trust. As such, a personal obligation not annexed to property is insufficient to constitute a trust and, conversely, a right annexed to property but without any concomitant personal obligation is likewise insufficient. 43. Therefore, to determine whether proposed changes to a trust fund result in the creation of a new trust it is necessary to determine whether new personal obligations and new rights annexed to property have been created. That is, consideration of the dual nature of a trust, being the personal obligations of the trustee and the concomitant rights of the beneficiaries annexed to the trust property, is required. 44. In relation to a mere change in a trustee of a trust, this will not create a new trust and cause CGT event E1 to happen. Nor will the transfer of assets to an established trust cause a new trust to be created. 45. In contrast, a trust splitting arrangement is often more than merely the appointment of a new trustee. It is an arrangement which generally involves the transfer of some of the assets of the original trust to a new trust fund that has been separated, or carved out of, the original trust fund. Further, a trust splitting arrangement is one which is directed at separating the functional operation of the trust. It is put into place with the intention of: a. separating those who control and can benefit from part of the trust corpus transferred to the new trustee from those who control and benefit from the remaining assets held by the original trustee b. removing the fiduciary obligations of the original trustee in relation to the assets transferred to the new trustee c. removing the entitlement of the original trustee to be indemnified out of the transferred assets for expenses incurred after the introduction of the new trustee, and d. ensuring that the new trustee will have no fiduciary obligations in respect of the assets retained by the original trustee and will have no right to be indemnified from those assets. 46. As a result of the trust splitting arrangement described in TD 2018/D3, paragraph 25 of that Taxation Determination explains that each trustee’s obligations and powers will relate to the particular assets they hold. Moreover, in relation to the assets it holds, each trustee will exercise its powers independently of the other and will be solely responsible for the manner in which those powers are exercised. Consequently, there will no longer be one trust fund over all of the assets of the fund but instead, two distinct trust funds that are administratively and legally separated. 47. Paragraph 28 of TD 2018/D3 further concludes that the trust powers and discretions vested in the original and new trustee have purposes distinct from each other despite the fact that these powers and discretions are identical and contained in the same trust deed. | Detailed Reasoning - By declaration or settlement: 48. Where assets have been settled on terms of a new trust, it is also necessary to establish that this new trust has been created by declaration or settlement in order for subsection 104-55(1) to be satisfied, thereby causing CGT event E1 to occur. 49. Paragraph 36 of TD 2018/D3 explains that a trust is created by declaration when it is created by words or conduct that is sufficient to demonstrate an intention to create an express trust over property. Further, paragraph 36 also explains that, consistent with the meaning found in subsection 104-55(1), where a trust split is implemented by execution of a deed of variation, or other similar document, the terms of the agreement will demonstrate an express intention to hold the transferred assets subject to the terms of the trust deed, which is sufficient to create a trust over those assets by declaration. 50. Further, a trust is created by settlement when property is vested in a trustee for the benefit of others. A trust split involves the vesting of existing trust property in a new trustee and will therefore be the creation of a trust by settlement. | Detailed Reasoning - Transferring a CGT asset to a trust: CGT event E2: 51. Section 104-60 provides that CGT event E2 will occur when a CGT asset is transferred to an existing trust. The note to subsection 104-60(1) makes it clear that CGT event E2 will not occur merely because there is a change in trustee of an existing asset. | Detailed Reasoning - Application to your circumstances: 52. You propose to implement an arrangement to enable Sam and Paul Apple to have greater responsibility and administration over the assets and liabilities of the Family Trust. You claim this is desired to achieve the succession planning needs of Ben and Lily Apple. 53. Your proposed arrangement will contain some of the features paragraph 16 of TD 2018/D3 explains are usually present in a trusting splitting arrangement, being that: a. Veggie will be removed as trustee over some of the assets and Potato will be appointed as the trustee over these assets b. different Appointors will be appointed over the trustees with the appointment of Sam Apple as Appointor over Potato, and c. the rights, obligations and powers of the trustees and beneficiaries will all continue to be governed under the Deed of Settlement of the Apple Family Trust. 54. These elements potentially lead to a conclusion that the assets to which Potato will be appointed as trustee will be settled on a new and distinct trust fund. However, your proposed arrangement contains the following features which may indicate that these assets are not being settled on a new and distinct trust: a. Although each trustee is empowered to make a determination in respect of income arising each year, this is subject to limitations set out in the proposed clause 4A which prevent distributions of income which exceed the net income across the whole trust fund; b. The trustees are required under the proposed clause 9A to seek consent or agreement of the other trustees for some decisions c. Under the proposed clause 27 the Trustees’ rights of indemnity will not be entirely segregated but instead each trustee will have recourse to all of the trust assets where the assets held by them is insufficient; and d. Although control of Potato will pass to Sam Apple, there is no indication that control of Veggie will be amended. 55. Considering these elements together with the other elements of the proposed arrangement, the Commissioner concludes that the proposed arrangement will not cause the assets transferred to Potato to be subjected to new personal obligations and new rights annexed to that property. Instead, the Commissioner concludes that the Family Trust will continue as one trust fund, albeit with split trustee responsibilities. Thus, the first element required by subsection 104-55(1) for a trust splitting arrangement will not be met. Given this, consideration of whether a new trust has been created by declaration or settlement is not necessary. 56. In conclusion, your proposed arrangement will not fall within subsection 104-55(1) and CGT event E1 will not occur. 57. Further, as your proposed arrangement does not include a transfer of assets to an existing trust, rather it involves in appointment of a new trustee over certain assets of the existing asset pool, section 104-60 will not be satisfied and CGT event E2 will not occur. | Detailed Reasoning - Question 2: Will the contemplated changes impact the treatment of the unpaid present entitlements of Pear Pty Ltd that arose before 16 December 2009 pursuant to Division 7A of the ITAA 1936? | Detailed Reasoning - DISTRIBUTIONS TO ENTITIES CONNECTED WITH A PRIVATE COMPANY – DEEMED DIVIDENDS: 58. Broadly, Division 7A of Part III of the ITAA 1936 (Division 7A) is an integrity measure aimed at ensuring that profits of a private company are not effectively received by its shareholders in non-dividend form. The general provisions of Division 7A apply to treat amounts paid, lent, or debts forgiven, by a private company to a shareholder of a private company, or an associate of such a shareholder, as unfranked dividends, unless they come within specified exclusions. 59. Subsection 109D(3) of the ITAA 1936 defines the term ‘loan’ to include: (a) an advance of money; and (b) a provision of credit or any other form of financial accommodation; and (c) a payment of an amount for, on account of, on behalf of or at the request of, an entity, if there is an express or implied obligation to repay the amount; and (d) a transaction (whatever its terms or form) which in substance effects a loan of money. 60. In relation to unpaid present entitlements (UPEs) of company beneficiaries of a trust, Taxation Ruling TR 2010/3 Income Tax: Division 7A loans: trust entitlements (TR 2010/3) provides that it is the Commissioner’s view that a private company will provide financial accommodation to the trustee in relation to the UPE if, under consensual agreement: a. the private company grants some form of pecuniary aid to the trust, and b. the principle sum is ultimately payable to the private company. 61. Paragraph 21 of TR 2010/3 explains that if a private company beneficiary allows the trustee’s continued use of funds representing the private company’s UPE for trust purposes by not calling for the payment of the UPE or the investment of the funds representing the UPE for the private company beneficiary’s sole benefit, then this will be considered as consensual agreement for the provision of pecuniary aid to the trustee. 62. TR 2010/3 further explains that the arrangement will be considered to be a loan of money from the private company to the trustee for the purposes of Division 7A for UPEs arising after 16 December 2009. 63. This is supported by Practice Statement Law Administration PS LA 2010/4 Division 7A: trust entitlements (PS LA 2010/4), which states that TR 2010/3 applies prospectively only and that the Commissioner will not apply Division 7A (other than Subdivision EA) to UPEs in existence before 16 December 2009. | Detailed Reasoning - Application to your circumstances: 64. As a result of the proposed arrangement, Potato will be appointed as Trustee over the family business investments of the Family Trust. According to the proposed Deed of Appointment of Additional Trustee, Potato will undertake the unpaid distribution of $X obligation owing to Pear, which arose prior to 16 December 2009. 65. You state that the current market value of the family business investments exceeds the amount of the UPE. You also state that Potato, as additional trustee, will have full recourse to the entire trust fund of the Family Trust to satisfy this UPE such that you state that this entitlement will not be compromised by the proposed arrangement. 66. As explained above, your proposed arrangement will not result in the creation of a new trust. Moreover, the proposed changes will not create any new rights or obligations in relation to the existing UPE other than transferring it between trustees of the same continuing trust. Consequently, these UPEs will continue to be ones which were created prior to 16 December 2009.