Cleardocs Update - changes to SMSF, Discretionary Trust, Unit Trust and Hybrid Trust

As part of its regular review of Cleardocs products, Maddocks has recommended updates to the Cleardocs SMSF, Discretionary Trust, Unit Trust and Hybrid Trust products.

As a result, Cleardocs has updated:

• the SMSF trust deed to reflect changes to superannuation law which took effect on 1 July 2015; and
• the trust deeds for the Cleardocs Discretionary Trust, Unit Trust and Hybrid Trust to reinforce the trustee's discretion to determine income.

Changes to the Cleardocs SMSF trust deed

The Cleardocs SMSF trust deed has been updated to include a revised form of Product Disclosure Statement (PDS) with updated details on government co-contributions, contribution caps and other matters for the 2015-2016 financial year.

Why have the changes to the SMSF trust deed been made?

Maddocks has made the changes to ensure that the deed is up-to-date and that the PDS reflects current tax treatment of superannuation.

There is no issue in using a pre-1 July 2015 Cleardocs SMSF trust deed in the 2015-2016 financial year onwards, as the document refers to where current information can be located: however to the extent the PDS relies on hyperlinks, then some hyperlinks to ATO websites may no longer be functional. If you prefer to have the latest form of PDS, you can use the SMSF Update product to update your trust deed to the new version.

Changes to the trust deeds for the Discretionary Trust, Hybrid Trust and Unit Trust

Minor amendments have been made to the Cleardocs Discretionary Trust, Hybrid Trust and Unit Trust deeds to reinforce the trustee's unfettered discretion in relation to making determinations about a trust's income.

The changes expressly state that those provisions of the trust deed which confer powers on the trustee to exercise this discretion are 'unconfined and not merely administrative': this is relevant to provisions which relate to determining the definition of income and the allocation of income, capital and expenses.

Why have the changes to the Discretionary, Hybrid and Unit trust deeds been made?

Basically, the amendments have been made out of an abundance of caution. In short, it is important that the flexibility afforded to trustees, as confirmed by the Bamford decisions is available to them in all cases. For some time Maddocks has monitored court decisions which deal with income categorisation & streaming provisions in trust deeds, and the prevailing approaches and attitudes of tax practitioners.

Depending on the specific trust deed, a trustee may for a variety of reasons allocate certain income or capital of the trust to particular beneficiaries, or adopt a definition of 'income' which differs from the definition used in other income periods. This discretion is exercised prior to resolving to making distributions to beneficiaries, often by considering the individual beneficiaries' circumstances, any relevant tax benefits or discounts and income thresholds, and it is often important that the discretion cannot be read as confined in any way.

The Forrest case by way of example^[1]

The Forrest case was a tax case between the taxpayer beneficiary (Forrest) and the Federal Commissioner of Taxation, dealing with income streaming provisions in a hybrid trust deed.

Mr Forrest was a unit holder in a 'unitised hybrid' trust with a discretionary component. The trust had two components:

• units — which entitled the unit holders to the 'fixed income' of the trust (similar to a unit trust); and
• a 'discretionary component' — which allowed the trustee to distribute the 'discretionary component' to a range of beneficiaries listed in a schedule to the trust deed at the trustee's discretion (similar to a discretionary trust).

The 'fixed income' was all income of the trust, other than the 'discretionary component'. The 'discretionary component' was all capital gains derived from holding or realising any investment.

The trustee had a power 'at any time and from time to time determine whether' different amounts received by the trust were 'on capital or income account or partly on capital and partly on income account and in what proportions'. The power was expressed relatively broadly.

What were the facts?

Mr Forrest borrowed a sum of money to purchase units in the unitised hybrid trust. He subsequently claimed income tax deductions under the ITAA 1997^[2] for interest costs, being the costs of borrowing.

The dispute between the Commissioner and Mr Forrest related to whether the nexus was satisfied between interest costs on borrowing, and the production of assessable income.

• Forrest argued that there was a nexus between the borrowing costs — incurred to acquire the units — and the production of assessable income, being the income received on the units acquired with the borrowed money. That income was received on the units pursuant to the fixed entitlement to all income which was not realised or unrealised capital gains.
• The Commissioner disputed this. He acknowledged that the borrowing costs were incurred to acquire the units, but argued that the nature of the units, and the rights which attached to them, were such that they did not entitle Forrest as the unit holder to any fixed amount of income.

The Commissioner's view was that the trust deed gave the trustee an unfettered discretion to determine whether an amount received by the trust was income or capital. In other words, if a unit holder received income from their units it was pursuant to the trustee's discretion — not a fixed entitlement of the Unitholder.

The issue before the Court was:

• whether the trustee's powers under the deed allowed the trustee to determine what was received on income account and what was received on capital account; and
• by exercising that power, to thereby determine whether an amount received amounted to 'fixed income' under the deed, or a 'discretionary component'.

What was the outcome of the case?

The Court found in favour of Mr Forrest.

The Court's view was that the relevant clause in the trust deed — which granted the trustee a power to determine any amounts received as income or capital — was simply an administrative power to make an 'honest' administrative determination as to whether receipts were income or capital. The clause was to be read with the balance of the trust deed, and was 'not an unlimited power to be exercised in the trustee's unconfined discretion'.

Importantly, the definitions in the trust deed of 'fixed entitlement' and 'discretionary component' allowed the trustee no discretion. For instance, if the relevant amount received by the trust was 'realised or unrealised capital gains derived from the holding or realisation of any Investment', then is was a 'discretionary component'. The trust deed did not go further and say that the trustee could adopt a different definition of either 'fixed income' and 'discretionary component'.

As a result, the Court found that the unit component of the trust was fixed. The fixed portion provided a reliable source of income for the unit holders (or at least that portion which the trustee honestly determined was income) and the borrowing costs associated with buying those units was deductible.

What does the case mean?

A trustee's discretionary powers — especially about classifying receipts as income or capital, and determining what terms like 'income' mean - can be a really important source of flexibility. One needs to always monitor whether there is some way those powers could be read down by a Court.

The Forrest case was surprising in some respects as the relevant clause was a commonly drafted, discretionary power to determine amounts received as on income or capital account. However that discretion was not supported by further discretions: the result being that the taxpayer understood their trust correctly as conferring a fixed income entitlement on unit holders.

The prevalence of trustees and advisors relying on discretionary powers calls for a 'safety first' and proactive approach, hence these minor changes to the Cleardocs products.

Maddocks considers the changes to the Discretionary, Hybrid or Unit trust deeds are consistent with the trust deeds' existing provisions and are a sensible addition to the Cleardocs products, ultimately made out of an abundance of caution rather than in response to any issue with the existing trust deeds.

Existing Discretionary, Hybrid or Unit trust deeds

If you advise clients whose Discretionary Trust, Hybrid Trust or Unit Trust uses a previous version of the relevant Cleardocs trust deed, Maddocks does not consider it needs to be updated to incorporate this change.

Trustees and advisors simply need to continue to be proactive in administration of trusts, exercise caution when relying on provisions of trust deeds, and seek advice where there is any doubt.

More Cleardocs information on related topics

You can read earlier ClearLaw articles on a range of trust matters.

Order Cleardocs trust packages

• Discretionary (Family) Trust
• Unit Trust - fixed
• Unit Trust - non-fixed
• Hybrid Trust