Are a trustee's gains or losses from investments always on capital account?

Issue raised

ATO Response/Action taken

The preservation of the real value of the capital of a trust is a key factor for most (if not all) trustees. Therefore a presumption arises that the actions of a trustee which gives rise to income are caused by the trustee discharging their fiduciary obligations to maintain the capital. So there is an assumption that any gain made by a trustee will be on capital account.

Noted but not accepted. Case law establishes that each case will require an assessment of all relevant facts and circumstances to determine whether a gain or loss is on revenue or capital account.

In certain circumstances, although there may be factors that support the proposition that the investments are on capital account, the ATO may view that the gains or losses are on revenue account.

The Determination points out that:

• all relevant factors need to be considered and weighed together; and
• on balance a revenue characterization is usually more appropriate.

In Example 1 in the draft determination, a trust is established to invest in listed securities and the trustee's investment policy is to invest in securities which display above-average earnings growth potential and therefore support the proposition that the investments are on capital account.

The ATO however, view that these factors support the conclusion that the gains and losses on the disposal of securities are in fact on revenue account.

In the example:

• although the trustee downgrades its view of the growth prospects of some securities because of changes in financial markets (indicating the trustee still seeks to preserve the capital and not necessarily invest for profit);
• the average turnover of the securities (while varying from year to year) exceeds 10%; and
• under the trust deed the trustee has broad powers to vary investments and an unfettered discretion to distribute any part of the trust fund at any time.

The ATO's view that any gains realised on securities together with interest and dividend income are on revenue account.

The ATO clarifies that:

• the trust was established to ensure a substantial annual return for unitholders in respect of share investments; and
• the trustees need to consider why the variations have occurred and not simply focus on a generic turnover percentage.

Given that the trust was established to ensure a substantial annual return for unitholders in respect of share investments and the structure of the investments, a return of profits on share sales would have been contemplated.

The ATO considers that trustees need to consider why the variations have occurred and not simply focus on a generic turnover percentage. Recognising gains on securities at fair value is generally consistent with adopting appropriate accounting standards. Indeed, some unit trusts, particularly if they are managed investments, are required to do so.

In Example 4, a family trust is established by a husband and wife to have enough flexibility to provide for the family and ultimately for their retirement.

The trustee invested in securities which had a prospect of growing in value and over the years, the level of switching between stocks has generally been no more than 4 to 5% of the value of the trust's total portfolio. In the example, the ATO viewed that the nature of the trust and the trustee's duties do not point strongly to either a revenue or capital account characterisation.

During the consultation, comments were made that the following factors clearly pointed towards a capital account characterisation:

• the nature of the trust to assist the family and to provide for the retirement of the husband and wife; and
• the trustee's duties to preserve the real value of the capital of the trust.

The ATO clarified that each case involves an assessment of all relevant facts and circumstances.

One purpose in establishing the trust in this example was to provide for the needs of the family. This might be best achieved through the buying and selling of investments at a profit. The nature and extent of the trustee's trading activities would need to be considered when characterising any gain or loss.

The draft determination noted that if a trust deed authorises the trustee to engage in business or undertake some profit making activity with a view to generating profits from which distributions to investors can be made, then that fact would lend support to a conclusion that the profits are made on revenue account.

During the consultation, comments were made that most trust deeds are likely to authorise a trustee to engage in a business. (The Cleardocs Discretionary trust deed does so.) The fact that a trustee is authorised to do something does not necessarily support a conclusion that the profits or losses made by the trust are on revenue account. To argue that is akin to arguing that any gain/loss made by an individual will be on revenue account because an individual is allowed to be a share trader. The issue must always be whether the individual/trustee is actually trading on revenue account.

The ATO noted the comment and amended the Determination. Its focus is now on a situation where, having regard to the purposes of the trust, it is clear that the trust exists with a view to generating profits from which distributions to investors can be made.