Australia: Trust split arrangements may give rise to capital gains tax

In brief - Trustees should consider tax implications of trust splitting in light of ATO's TD 2018/D3

The Australian Taxation Office (ATO) has issued draft determination TD 2018/D3 which says that trust split arrangements of the type described in it will cause CGT event E1 to arise. CGT event E1 happens when a trust is created over a CGT asset by declaration or settlement. Parties to a trust should be aware that when the draft determination is finalised, it will apply before and after the date of issue.

The trust split arrangements described in TD 2018/D3 are those where the parties to an existing trust functionally split the operation of the trust so that some assets are controlled by and held for the benefit of some of the beneficiaries, and other assets are controlled and held for the benefit of other beneficiaries. A trust split exhibits all or most of these features:

• the trustee of an existing trust is removed as trustee of some of the assets and a new trustee is appointed to hold those assets
• control of the original trustee is changed so that it passes to some of the beneficiaries and the new trustee is controlled by other beneficiaries
• different appointors are appointed for each trustee
• the rights of indemnity of the trustees are segregated so that each trustee can only be indemnified out of the assets held by that trustee
• the expectation is that each trustee will exercise its powers in respect of the assets it holds independently of the other trustee to benefit the relevant beneficiaries to the exclusion of the other beneficiaries, regardless of whether the beneficiaries that can benefit from particular assets is expressly limited
• the rights, obligations and powers of the trustees and beneficiaries remain governed by a single trust deed
• each trustee keeps separate books of account

Lack of clarity in TD 2018/D3 leaves taxpayers with more questions than answers

The view favoured by some tax practitioners prior to the issue of TD 2018/D3 was that many trust split arrangements did not give rise to capital gains tax. This view was based on Commissioner of Taxation v Commercial Nominees of Australia Ltd [1999] FCA 1455, Commissioner of Taxation v Clark [2011] FCAFC 5, TD 2012/21, and certain binding private rulings issued by the ATO.

It is now clear that it is no longer safe to proceed on that basis.

Unfortunately, TD 2018/D3 potentially creates more uncertainty than it resolves as it only applies to the trust split arrangements described in it. It is unclear whether the trust split has to exhibit all of the features described above or just some of them. If it's only some of them, which ones?

The reasoning in TD 2018/D3 is arguably flawed. It commences by saying that creation of a trust is to be understood by reference to trust law. It then describes the features and character of a trust but does not address in any detail how a trust is created as a matter of trust law. Instead, the reasoning is primarily based on the economic and practical effects of a trust split.

TD 2018/D3 then says the decisions in Commercial Nominees and Clark are of minimal assistance in considering the tax implications of a trust split. It adopts a very fine distinction that those cases concerned whether an existing trust had come to an end and the assets were then held on a different trust, rather than whether a new trust has been separated (or carved out of) the original trust. This is contrary to the ATO's position in TD 2012/21 that the principles in those cases had a broader application.

TD 2018/D3 relies on Commissioner of State Revenue v Lam & Kym Pty Ltd [2004] VSCA 204 and Oswal v Commissioner of Taxation [2013] FCA 745, but those decisions can be easily distinguished because they did not involve trust split arrangements. Also, Lam & Kym concerned a particular provision of the Victorian stamp duty legislation and was decided before Commercial Nominees and Clark.

TD 2018/D3 contains a very limited discussion on what constitutes a declaration or settlement. According to the ATO, a declaration is words or conduct which demonstrates an intention to create an express trust over property, while a settlement involves the vesting of property in a trustee for the benefit of others. These are difficult concepts which have been the subject of a substantial amount of litigation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.