CGT: declaration over part of corpus of discretionary trust triggers CGT event E1 - Oswal v FCT

The Federal Court has held that the legal effect of the decision of a trustee of a discretionary trust to exercise a special power of "appointment" to make 2 beneficiaries of the trust absolutely entitled to part of the corpus of the trust was to trigger CGT event E1 (creation of trust over assets). This was despite the fact that the taxpayer argued that the effect of the declaration was "merely" to establish a "separate fund of assets under the umbrella of the trust": Oswal v FCT^[1].

Background

The taxpayer was the trustee of a discretionary trust whose corpus was comprised of some 1,148 shares in a private company. On 13 March 2007, the trustee resolved "to appoint for the absolute benefit of the named beneficiaries [namely, him and his wife] a part of the corpus [being 574 shares each]" and that "henceforth the corpus so appointed and income or accretion of capital there from shall be held on separate trust and for the absolute benefit of the named beneficiaries in their own individual capacities".

The Commissioner argued that the effect of the "appointment":

• was to create a new trust over the assets pursuant to CGT event E1; or
• in the alternative, created a "resettlement", which triggered CGT event A1 (disposal) or triggered CGT event E5 (beneficiary becoming absolutely entitled to trust asset).

As a result, the Commissioner issued relevant amended assessments to the trustee taxpayer and beneficiaries which are currently subject to appeal.

In these ex-parte proceedings, the taxpayer asked the Court to determine whether CGT event E5 applied in the circumstances, while the Commissioner asked the Court to determine whether CGT event E1 or CGT event A1 applied in the circumstances. In support of its claim, the taxpayer argued that "the effect of the appointment made by the 13 March 2007 resolution was to establish a separate fund of assets under the 'umbrella' of the ...Trust, but that the appointment did not create a new trust" in respect of the shares.

Decision

The Court found that the legal effect of the appointment was to create a separate trust over that part of the corpus for the absolute benefit of the 2 beneficiaries and that therefore, CGT event E1 applied to the transaction.

In particular, the Court found that even though there was no express declaration of trust and no transfer of property, and even though the terms "declaration" or "settlement" are not defined under CGT event E1, nevertheless the resolution of 13 March 2007 was a "declaration" of trust as ordinarily understood and that as a result, it created a trust over the relevant assets and not merely "a separate fund" of them.

In arriving at this conclusion, the Federal Court noted the following:

• it is not always easy to draw a line between the establishment of a separate fund on the one hand and the creation of a new trust on the other;
• the taxpayer was not only making the appointment but resolving (declaring) that he would hold that part of the corpus on separate trust for the absolute benefit of himself and of his wife;
• the methods of creating a trust by declaration and creating a trust by exercise of a power of appointment are not mutually exclusive; and
• the fact that the trustee who made the resolution was also a beneficiary was not relevant.

At the same time, the Court found that the "appointment" would have amounted to a "settlement" in any event – albeit, noting that it "is notoriously difficult to define a settlement, but that does not mean that it is difficult to recognise one" and notwithstanding that the "settlement" in this case created no succession of interests and that it provided for the beneficiaries to "take absolutely".

In view of these findings, the Court found it unnecessary to consider whether CGT event A1 or CGT event E5 applied but in view of the extensive arguments raised about CGT event E5, it did address the issue and, particularly, the relevance and meaning of "absolutely entitled" for these purposes. In this regard, it first noted that the expression "'absolutely entitled to the asset as against the trustee' ... is intended to describe a situation in which the beneficiary of a trust has a vested, indefeasible and absolute entitlement in trust property and is entitled to require the trustee to deal with the trust properly as the beneficiary directs".

However, after further analysis of the issue, it then found that CGT event E5 would not have applied because the beneficiaries did not become "absolutely entitled" to the assets because of the trustee's lien in respect of his right of indemnity that continued to attach to the shares after the making of the resolution in view of the trust's existing liabilities (apparently in excess of $300 million).

Appeals update

The taxpayers have lodged a notice of appeal against the decision to the Full Federal Court.

Source: This article was first published in Thomson Reuters' Weekly Tax Bulletin. To subscribe to Weekly Tax Bulletin, or for more information, please:

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