Why do you need to be careful when adding or removing a beneficiary in your discretionary trust?

When adding or removing a named beneficiary of a discretionary trust, it is important to know the risks associated with amending trust deeds. If the changes are of a fundamental nature, there is a risk that a new trust will be created (a 'resettlement'), potentially triggering duty and other tax consequences.

This article outlines what a trust resettlement is, the consequences of resettling your trust and the key considerations to be aware of when amending your trust deed, focusing on amendments that alter the named beneficiaries of a trust. The article also considers what other considerations trustees should bear in mind when adding or removing a beneficiary, as well as tips on how to draft your trust deed to minimise resettlement risk.

What is resettlement risk?

Amending a trust deed carries a risk of 'resettlement'. The High Court of Australia has expressed that a trust is 'resettled'; when an amendment to the trust is so substantial that the trust is fundamentally changed. In FCT v Commercial Nominees (2001) and FCT v Clark (2011), the Court considered that a trust is resettled when an amendment causes a lack of 'continuum' of the trust, especially in respect of:

• the constitution of the trust;
• the property of the trust; and
• the membership of the trust.

The Commissioner of Taxation's view in Taxation Determination TD 2012/21 is that an amendment to a trust deed will only trigger a resettlement when:

• the change causes the existing trust to terminate and a new trust to arise for trust law purposes; or
• certain property of the trust is declared to be held on trust for particular beneficiaries, giving rise to a new trust despite the old trust not terminating.

You should always consider resettlement risk when adding or removing a beneficiary from a trust, and whether that change is so substantial that it causes a lack of continuity in the trust. According to Commercial Nominees and Clark, if an amendment is within the scope of a power of variation, there may be no resettlement as the change is within the contemplation of the deed. Furthermore, if a change to beneficial entitlements is consistent with the nature or purpose of the trust, a resettlement is less likely to be triggered.
The law around resettlement is complicated and highly dependent on the particular circumstances and the nature of the trust, the trust deed, the trust property the proposed amendment. If you are concerned about resettlement risk, you should seek legal advice.

What are the consequences?

If a trust is found to be ‘resettled’ by a court or a taxing authority (for example, a state revenue office or the ATO), then it may result in:
stamp duty being payable;

• income tax consequences (such as capital gains tax or the generation of income according to ordinary concepts); or
• the forfeiture of any carried forward tax benefits, such as tax losses or capital losses, as well as any franking credits

When should I be careful about adding or removing beneficiaries?

When adding or removing a beneficiary from a trust, resettlement risk should be closely evaluated, especially in circumstances where:

• the amendment is a change not previously contemplated by the trust deed, for example, there is no apparent power of amendment in the deed to add or remove beneficiaries;
• the addition or removal of beneficiaries significantly changes the mandated, default or customary distribution of beneficial entitlements under the trust;
• the addition or removal of a beneficiary is accompanied by other changes, such as amendments to the property or constitution of the trust; and
• the amendment alters the nature or purpose of the trust, for example, if an amendment alters the purpose of the trust from providing for a family to a trust aimed at other purposes.

What other requirements are there?

When adding or removing a beneficiary, as when considering any deed amendment or proposed trustee action, the trust deed should be read closely. Requirements may typically include one or more of the following:

• a formal amendment deed, such as a deed of variation, entered into by the trustee (and any other required party);
• compliance with a restriction on an amendment power, for example where the deed prohibits the addition of beneficiaries who are not direct lineal descendants of the existing named beneficiaries or the addition of beneficiaries who are foreign persons;
• a trustee resolution; and/or
• the written consent of an ‘Appointor’ or ‘Guardian’ or other specified participant.

An important point on stamp duty

State and territory governments are increasingly changing their tax and revenue laws in ways which specifically impact trusts and the beneficiaries of trusts. They do so, on occasion, in ways which 'deem' trusts such as discretionary trusts to confer rights on beneficiaries which their deeds do not.

For instance, in Western Australia, if a beneficiary who is a taker in default ‘surrenders’ their interest in a trust that owns dutiable property (directly or indirectly), there is a deemed disposal of a proportional interest in the underlying property. For example, if a trust owns underlying dutiable property and has two named beneficiaries, and one beneficiary is removed from the trust, then this amounts to a deemed disposal of a 50% interest in the trust’s underlying dutiable property. This increases the interest in the underlying dutiable property held by the remaining named beneficiary by 50%. Duty may then be payable by the remaining beneficiary on the 50% interest that they acquire in the underlying property.

Accordingly, changes to named beneficiaries who receive distributions ‘by default’ (that is, if the trustee does not exercise discretion by a particular deadline, for example 30 June) must be very carefully considered in some jurisdictions. The change may not amount to a ‘resettlement’, but may nonetheless be deemed to be a dutiable transaction.

Should I change how I draft my trust deed?

To minimise resettlement risk, you should consider drafting your trust deed with a broad variation power that contemplates any expected changes to the trust.
A ‘letter of wishes’, from the settlor of the trust to the trustee upon the settlement of the trust, may also be useful. The letter may convey that the trust is to be flexible and may be varied as necessary (under a power of amendment) to achieve an expressed purpose.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Commercial team.

More Cleardocs information on related topics

• Trust Resettlements And TD 2012/21: Some Comfort But Uncertainties Remain 
• Resettlement' And Continuity Of 'Trust Estate' — Update On The ATO's View After Commissioner Of Taxation v Clark
• Avoiding Trust Resettlement — Further Insight Gained From The Decision In Commissioner Of Taxation v Clark

Related document packages

• Discretionary (Family) Trust
• Family Trust Trustee Bundle
• Unit Trust – fixed
• Hybrid Trust
• Stamp Duty – Trusts VIC