Avoiding trust resettlement — further insight gained from the decision in Commissioner of Taxation v Clark

A recent case confirms that there are circumstances under which a trust may significantly change its trust membership and property without causing a 'resettlement' or the creation of a new 'trust estate'. (The case maybe appealed to the High Court.)

The full Federal Court handed down its decision in Commissioner of Taxation v Clark[1] on 21 January 2011. It was an appeal by the Commissioner of Taxation against a decision of the Federal Court of Australia.

The Court found that as long as continuity of trust property, membership and trust obligations can be established along a continuum, then various changes made overtime to a trust's characteristics, membership and property, will not necessarily create a new trust — particularly if the trust deed contemplates these changes.

The facts

• A unit trust was established by deed in July 1984. The trust fund contained the settled sum of $10.00 which represented the initial beneficial interest of the fund separated into 10 units valued at $1.00 each.
• The original units were redeemed and a further 10 units were issued in March 1987.
• The trust was restructured in 1993 to facilitate a property development joint venture.
• In the income year ending 30 June 2001, the trustee at the time, Carringbush Pty Ltd, sold two properties in Gladstone, Queensland, realising a net capital gain of approximately $1.9 million.
• The trustee claimed that the trust incurred net capital losses in the 1991-1993 income years which could be applied to reduce net capital gain arising from disposal of the Gladstone properties to nil.
• The net capital losses were attributable to a disposal of two share parcels in Rothwells Limited which took place as result of:
  • the trustee writing off a loan to a company called Relsun Pty Limited;
  • the liquidation of a company called Carringbush Kumagai Limited; and
  • a write down of the trust's investment in shares in Carringbush Kumagai Limited as irrecoverable.
• An income tax assessment was conducted by the Commissioner.
• Between June 1993 and 30 June 2001, various characteristics of the trust changed including:
  • a change in trustee;
  • changes in unitholders;
  • extinguishment of liabilities of the trust;
  • extinguishment of a former trustee's right of indemnity out of the trust assets; and
  • changing trust activity from a dormant trust to an active trust.

The question

The Court considered whether prior trust losses were available to the trustee of the unit trust even though there had been substantial changes to the key characteristics of the trust over time, namely: the trustee, the trust property and ownership of the beneficial interest in the trust property.

Further, did those changes result in a re-settlement of the trust i.e. the creation of a new trust, at any stage?

The Commissioner's argument

The Commissioner:

• questioned whether the trust had incurred the losses claimed; and
• submitted that, even if it could be established that the losses were incurred, the continuity of the trust had been interrupted by a variety of material changes which collectively created a new 'trust estate' for income tax purposes.

The Clarks' argument

The Clarks' argued that the losses were correctly incurred and the trust was not resettled at any stage.

What did the Court decide?

By a majority of 2 to 1, the Court found in favour of the Clarks' against the amended assessments issued by the Commissioner.

The Court concluded that the Commissioner had not been able to show that there was break in the continuity of the trust property such as to leave it open to find that the trust estate as originally constituted had come to an end and had been 'resettled'. The $10 settled sum always remained property of the trust fund. Changes in the terms of the trust and its unitholders were clearly contemplated by the trust deed.

As a result, the capital losses were available to the trustee to offset the capital gain in 2001.

The majority judges made the following comments:

1. They said it was not without significance to the issue of trust estate continuity that all of the various changes referred to in the judgment were effected without the need to amend the trust deed;

2. The trust deed specifically contemplated that the identity of the unit holders in the trust would change over time; and

3. It was to be expected of the unit trust that the trust property would constantly change as subscriptions for units are made and redemptions of units occurred.

Implications

This case led to an extension of the reasoning in of the High Court in the Commercial Nominees case[2], which dealt with a superannuation fund that underwent significant changes to its classes of membership and a change to the nature of the benefits provided to members of the fund. This reasoning can now be applied in the context of unit trusts.

Concerning the extension of the Commercial Nominees case to the facts of the present case, the majority judges said:

When the High Court in Commercial Nominees spoke of trust property and membership as providing two of the indicia for the continued existence of the eligible entity or trust estate, the Court was not suggesting that there had to be a strict or even partial identity of property for the first and objects of the second. It was speaking more generally: that there has to be a continuity of property and membership, which could be identified at any time, even if different from time to time: and without severance of one or both leading to the termination of the trust in question. In the present case, the Commissioner never contended, nor on the evidence could he, that there was a severance in the continuum of trust property and objects of the CU Trust. Their identify changed from time to time, but not their continuum.

It must also be noted that the relevant tax regime in Commercial Nominees was contained in Pt IX of Income Tax Assessment Act 1936 (1936 Act), which related specifically to superannuation funds, rather than Div 6 of the 1936 Act, which deals with trusts. Even so, the Court commented that Pt IX operated in a manner similar to Div 6 by imposing a tax liability "upon a person, or persons, or a corporation in a representative capacity".

Appeal to the High Court

On 18 February 2011, the Commissioner sought special leave to appeal to the High Court. In light of this it would be prudent to monitor whether leave is granted and any further developments arising out of this decision.

Useful tips: about the risks of resettling a trust

Trust resettlement can have significant tax implications for the trustee and beneficiaries of a trust. A resettlement occurs when a new 'trust estate' is created 'out of an old trust'. When that happens, the trustee will be considered to have disposed of the assets of the 'old' trust and in turn, there is a variation in the interests of the trust's beneficiaries. As a new trust is deemed to be created, any accumulated losses or gains from the previous trust, cannot be carried forward into the new trust.

Individuals involved in trust structures should seek advice before making significant changes to a trust. Depending on the assets of the trust, there may be stamp duty, CGT and income tax implications associated with the proposed changes which may not have been originally contemplated.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask for a member of the Maddocks Superannuation Team.

More Cleardocs information on related topics

For more information:

• about the Cleardocs:
  • Discretionary Trust, see here. You can order a trust online from that page;
  • Unit Trusts (fixed or non-fixed), see here. You can order a trust online from that page;
  • Hybrid Trust, see here. You can order a trust online from that page;
• see a Guide by Maddocks dealing with:
  • a comparison table of key benefits and things to be wary of in each type of trust, here; and
  • a comparison table of the key features of each type of trust here.
• about Bamford's case, see here

[1] [2011] FCAFC 5

[2] Federal Commissioner of Taxation v Commercial Nominees of Australia Limited 2001, 75ALGR 1172