Taxation alert: Trust cloning CGT exemption abolished

The capital gains tax (CGT) exemptions for trust cloning are to be abolished from 1 November 2008 (retrospectively). This resolves a longstanding controversy around trust cloning. Paul Ellis and Michael Taylor-Sands

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The legislation to abolish the capital gains tax (CGT) exemptions for trust cloning has not yet been prepared. When it is passed, it will be effective retrospectively from 1 November 2008 — the day after the change was announced by Assistant Treasurer, Chris Bowen MP.

Why were trusts cloned?

Trust cloning became a popular tax planning strategy because it enabled assets pregnant with capital gains to be transferred from one trust to a new trust without triggering a CGT event. Circumstances in which trust cloning could be used included:

• when a trustee wished to rearrange the holding of business assets held in the one trust to more properly align different business assets with different business activities; or
• when the trustee of a trust holding business and non-business assets wanted to protect the non-business assets from future risk by transferring them into a separate trust.

A trust was 'cloned' when the deed establishing the trust was replicated in exactly the same form (terms, beneficiaries, vesting date) through a new trust settlement. The old and the new trust existed side-by-side with or without the same trustee.

How did the tax advantage arise?

The tax advantage of the cloning arose under exemptions that apply to CGT events E1 and E2 in the Income Tax Assessment Act 1997:

• event E1 applies when a trust is created over a CGT asset.
• event E2 applies when a CGT asset is transferred to a trust.

In either of those 2 events, a capital gain arises if the proceeds from the creation of the trust or the transfer is greater than the cost base of the CGT assets.

The general capital gains tax rule would have meant that the capital gain had to be included in a taxpayer's assessable income (subject to the 50% discount if that applies). However, exceptions to that general rule apply:

• if the trust is created (event E1) by transferring the asset from another trust, and the beneficiaries and the terms of both trusts are the same; and
• if the asset is transferred (event E2) from another trust and the beneficiaries and terms of both trusts are the same.

More information

To read more about the Federal Government's proposal, click here.

If you have any questions about this article, contact Maddocks on (03) 9288 0555 and ask for the Cleardocs Help Desk: they will put you through to the relevant member of our Commercial Team.