House of Representatives

Explanatory Memorandum

Circulated By the Authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 1 - Removal of capital gains tax trust cloning exception and provision of limited fixed trust roll-over

Outline of chapter

1.1 Schedule 1 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to repeal the exception to capital gains tax (CGT) events E1 and E2 widely known as the 'trust cloning' exception. Schedule 1 also provides a limited CGT roll-over for the transfer of assets between trusts with the same beneficiaries each of which has the same interests in each trust. These amendments apply to CGT events that happen after 31 October 2008.

1.2 Schedule 1 clarifies that a mere change of the trustee of a trust does not change the entity that is the trustee for the purposes of the ITAA 1997 and the A New Tax System (Goods and Services Tax) Act 1999 (GST Act).

1.3 All references to legislative provisions in this chapter are references to the ITAA 1997 unless otherwise stated.

Context of amendments

1.4 The trust cloning exception allows the creation of a trust over a CGT asset or the transfer of a CGT asset to an existing trust without triggering a CGT taxing point, provided the beneficiaries and terms of both trusts are the same.

1.5 However, this can be used to change ownership of an asset without a CGT taxing point. It potentially allows taxpayers to eliminate tax liabilities on accrued capital gains, undermining equity and the integrity of the tax system.

1.6 The repeal of the trust cloning exception is consistent with the policy principle of taxing capital gains that arise where there is a change in ownership of an asset.

1.7 The CGT regime may provide a CGT roll-over where there is a change in legal ownership of a CGT asset but no change in its underlying ownership. Nevertheless, roll-over is not always provided where there is no change in underlying ownership. Other considerations are important, such as ensuring tax system integrity and the existence of alternatives in the income tax laws.

1.8 Providing a limited CGT roll-over for the transfer of assets between certain trusts with the same beneficiaries is consistent with that approach. This roll-over will ensure that CGT considerations are not an undue impediment to the restructure of those trusts, whilst ensuring that subsequent changes to the manner and extent to which beneficiaries can benefit from the trusts are subject to appropriate tax consequences.

Summary of new law

1.9 Part 1 of Schedule 1 amends the ITAA 1997 by repealing the CGT trust cloning exception.

1.10 Part 2 of Schedule 1 inserts Subdivision 126-G into the ITAA 1997 to provide a limited CGT roll-over for the transfer of assets between certain trusts. Broadly, the effect of the roll-over is to defer the making of any capital gain or capital loss in respect of the asset transfer. The cost base of beneficiaries' interests in the transferring trust is apportioned across their interests in both trusts.

1.11 To be eligible, both trusts must have the same beneficiaries with the same entitlements and no material discretionary elements. Further, the receiving trust must be an 'empty trust', meaning:

•

a newly created trust; or

•

a trust with no CGT assets other than a small amount of cash or debt.

1.12 Part 3 of Schedule 1 clarifies that a mere change of trustee of a trust does not change the entity that is the trustee for the purpose of the ITAA 1997 and the GST Act.

Comparison of key features of new law and current law

Detailed explanation of new law

Abolishing the trust cloning exception

1.13 The trust cloning exception provides an exception to CGT events E1 and E2.

•

CGT event E1 happens where a trust is created over a CGT asset by declaration or settlement.

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The trust cloning exception to CGT event E1 applies where the trust was created by transferring the asset from another trust and the beneficiaries and terms of both trusts are the same.

•

CGT event E2 happens where a CGT asset is transferred to an existing trust.

-

The trust cloning exception to CGT event E2 applies where the asset was transferred from another trust and the beneficiaries and terms of both trusts are the same.

1.14 Schedule 1 repeals the trust cloning exception to CGT events E1 and E2. The other exception to CGT events E1 and E2 (that may apply when an asset is transferred to a relevant trust by a sole beneficiary of the trust that is absolutely entitled to the asset) will be retained. [Schedule 1, item 1, subsection 104-55(5) and item 2, subsection 104-60(5)]

The 'trustee entity' provision

1.15 Subsection 960-100(2) states that the trustee of a trust is taken to be an 'entity' consisting of the person who is the trustee, or persons who are the trustees, at any given time. An identical definition exists in subsection 184-1(2) of the GST Act.

1.16 As part of the Tax Law Improvement Project, the Joint Committee of Public Accounts and Audit in An Advisory Report on the Tax Law Improvement Bill No. 2 1997 (Report 356 of 1998) stated that the interaction of the proposed subsection 104-10(2) with the 'entity' provision in subsection 960-100(2) was unclear - that it was possible that a mere change of trustee of a trust was technically a 'disposal' and thus a CGT taxing point. The Committee recommended 'clarification by way of amendment or the addition of guide material' to the proposed subsection 104-10(2). An amendment was subsequently provided in paragraph 104-10(2)(b).

1.17 In AXA Asia Pacific Holdings Limited v Commissioner of Taxation [2008] FCA 1834, Justice Lindgren, in interpreting subsection 184-1(2) of the GST Act, noted that '[t]his provision is concerned with continuity irrespective of changes that may occur in the identity of the trustee or trustees from time to time. Under the provisions, a change in the identity of a trustee of a trust does not mark a change in the entity, which is the 'trustee of [the] trust'.'

1.18 The amendments reflect Justice Lindgren's interpretation by adding a note to each of the 'entity' definitions that confirm that a mere change in the person who is the trustee does not mean there is a new trustee entity for tax purposes. That is, the trustee is still the same entity even if there is a change in the person who holds the office of trustee. [Schedule 1, items 14 and 15, subsection 184-1(2) of the GST Act; and items 19 and 20, subsection 960-100(2)]

1.19 Additional notes in CGT events A1, E1 and E2 explain that a mere change of trustee of a trust does not trigger a CGT event. This follows because the entity that is the trustee does not change for tax purposes and so does not give rise to any of these CGT events.

•

The definition of disposal for CGT event A1 in subsection 104-10(2) is updated to remove the unnecessary exclusion of a mere change of trustee.

[Schedule 1, item 16, subsection 104-10(2), item 17, subsection 104-55(1) and item 18, subsection 104-60(1)]

Example 1.1

Steven and Amanda are the joint trustees of a trust. Steven and Amanda retire and Lachlan is appointed as the replacement trustee. Subsequently, Mikayla Pty Ltd is appointed as an additional trustee to Lachlan. No other changes are made and the property continues to be held on the same trust.

Although there is a change in legal ownership of the trust assets from Steven and Amanda to Lachlan, and then to Lachlan and Mikayla Pty Ltd as joint owners, no CGT event happens in respect of either transaction because there is no change in the entity that is the trustee of the trust for tax purposes.

Limited CGT roll-over for certain trusts

1.20 Schedule 1 also provides an optional CGT roll-over that permits deferral of a capital gain or capital loss made on the transfer of an asset from one trust (the transferring trust) to another trust (the receiving trust).

1.21 The objective of this roll-over is to ensure that CGT considerations are not an undue impediment to the restructure of trusts, whilst ensuring that subsequent changes to the manner and extent to which beneficiaries can benefit from the trusts are subject to appropriate tax consequences. [Schedule 1, item 9, section 126-220]

1.22 If the CGT roll-over is chosen, there is also roll-over for any balancing adjustment that arises from the transfer of a depreciating asset (see paragraphs 1.81 to 1.84).

1.23 The CGT roll-over is available if these conditions are met:

•

both trusts are eligible (paragraphs 1.26 to 1.41);

•

the same beneficiaries have the same interests in both trusts (paragraphs 1.42 to 1.47); and

•

no exception applies (paragraphs 1.48 to 1.65).

[Schedule 1, item 9, subsection 126-225(1)]

1.24 These conditions aim to ensure that the asset transfer does not change the underlying ownership of the asset, that subsequent changes in ownership are subject to appropriate tax consequences, and that the roll-over cannot be used to undermine the integrity of the tax system.

1.25 This part of the explanatory memorandum discusses these conditions, as well as the consequences for the trustees and beneficiaries if the roll-over applies.

Conditions for roll-over

Trusts eligible for the roll-over

1.26 The trustee of the transferring trust and the trustee of the receiving trust must both choose the roll-over in order for it to apply. [Schedule 1, item 9, subsection 126-225(3)]

1.27 For the trustees to choose the roll-over, the beneficiaries' interests in each trust must satisfy a number of requirements. Trusts that satisfy these requirements are sometimes referred to as 'fixed trusts'.

•

However, the conditions for this roll-over do not employ the existing definition of 'fixed trust' in Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936).

•

Furthermore, unlike the trust cloning exception, the roll-over does not require the terms of the two trusts to be precisely the same. However, any differences in terms that result in a significant difference in the nature or extent of beneficiaries' interests will prevent the roll-over applying.

CGT event E4 capable of happening to interests

1.28 CGT event E4 must be capable of happening to all the units or interests in each of the trusts. [Schedule 1, item 9, subsection 126-230(2)]

1.29 This requirement ensures that so-called discretionary trusts cannot access the roll-over. This is because it is difficult to establish, with any degree of certainty, the real underlying ownership of the assets of a discretionary trust. Therefore, it is equally difficult to test whether that ownership has been maintained.

1.30 An example of a discretionary trust is one where the trustee has a power to appoint the income or capital of the trust to any one of the listed beneficiaries as the trustee sees fit.

Beneficiaries' entitlements not discretionary

1.31 The manner or extent to which each beneficiary of each trust can benefit from the trust must not be capable of being significantly affected by the exercise, or non-exercise, of a power. [Schedule 1, item 9, subsection 126-230(3)]

•

The requirement must be satisfied by each of the beneficiaries of each of the trusts in respect of each of their membership interests.

•

Each beneficiary of the trust must have an interest in the trust that is of a sufficiently definable quality and extent as to be capable of measurement without the exercise or non-exercise of a power (in the sense discussed in Gartside v Inland Revenue Commissioners [1968] 2 WLR 277).

•

The quality or extent of each beneficiary's interest should not be capable of being defeated or substantively altered by the exercise, or non-exercise, of a power.

•

The requirement has regard to the exercise, or non-exercise, of a power by any entity, and not just the trustee of the trust.

•

For these purposes, a power includes both trust powers (that is, powers that must be exercised but which allow discretion as to when or how they are exercised) and mere powers (that is, discretions), but does not include trustees' duties. A trustee duty is a thing a trustee must do as prescribed, or refrain from doing, to avoid being in breach of trust (refer discussion in Jacobs' Law of Trusts in Australia , 7th ed., Heydon and Leeming at [1606]).

1.32 In effect, beneficiaries' interests should be 'fixed'.

1.33 This requirement is consistent with the objective of ensuring that subsequent changes in 'effective ownership' are subject to appropriate tax consequences. These consequences could be a CGT taxing point (such as on the disposal of an interest) or cost base adjustments (for example, as a result of the value shifting rules applying).

1.34 The following are examples of powers that may, depending on their context, be capable of significantly affecting the manner and extent to which a beneficiary can benefit from a trust:

•

a power to appoint the beneficiary's interest in the income or capital to another beneficiary;

•

a power to characterise receipts or expenses as income or capital, or to accumulate trust income to capital (unless those otherwise entitled to the income have the same interests in the capital);

•

a power to add new beneficiaries (other than by issuing new units or interests in a way that does not significantly affect the value of existing interests);

•

a power to appoint any part of the trust property to a new trust with different beneficiaries;

•

a power to issue new interests with rights attached that significantly alter the rights or the value of the rights attached to existing interests; and

•

a power to amend the trust deed to include a power capable of materially altering a beneficiary's membership interest(s).

1.35 Powers such as the following that merely facilitate the administration of the trust are not regarded as significantly affecting the manner and extent to which a beneficiary can benefit:

•

a power to round distributions or other amounts to whole cents per unit or interest;

•

a power to alter the manner in which beneficiary entitlements are paid, for example, to determine that they be credited directly to beneficiaries' bank accounts; and

•

a power to pay beneficiary entitlements at any time within a prescribed period.

1.36 Similarly, a trustee's right to be reimbursed or exonerated out of the trust property in respect of liabilities and expenses properly incurred in the administration of the trust (see Chief Commissioner of Stamp Duties for New South Wales v Buckle (1998) 192 CLR 226) would not be viewed as a power to significantly affect the manner and extent to which beneficiaries can benefit from the trust. Such a right, supported by a lien over the trust assets, simply represents an interest in the trust assets that ranks ahead of the claims of beneficiaries.

Example 1.2

A trust has $1 billion in assets and has annual income of around $100 million.

Under the terms of the trust deed, the trustee has the power to issue new units - at an issue price, to persons, and with rights and obligations as determined by resolution. The power could be used, for example, to issue 'preference' units that entitle unitholders to the first $100 million of income of the trust.

This would significantly undermine the value of existing units. Therefore, the extent to which each beneficiary can benefit from the trust is capable of being significantly affected by the exercise, or non-exercise, of a power.

Disregard certain powers if their existence does not affect market value

1.37 A trust that is a managed investment trust (MIT) may be eligible for the roll-over notwithstanding that the manner or extent to which a beneficiary can benefit from the trust is capable of being significantly affected by the exercise, or non-exercise, of a power.

1.38 This 'saving clause' applies only if the transferring and receiving trusts are both MITs. The savings clause applies if the market value of all of the interests in the MIT would not be significantly different if it were hypothesised that the power did not exist. [Schedule 1, item 9, subsection 126-230(4)]

1.39 In other words, beneficiaries' interests are effectively 'fixed' if a hypothetical buyer, acting at arm's length in an open market and with reasonable knowledge of the facts, would not discount the value of the interests because of the existence of a discretionary power. In that case, the MIT may be eligible for the roll-over notwithstanding the existence of the power.

1.40 For example, the market value of interests in a MIT might not be significantly affected by the existence of a power that apparently could significantly change the value of the interest, where:

•

prudential or market forces effectively prevent the power from being used in a way that would significantly devalue any existing interests;

•

the power can only be exercised with the consent of all, or almost all, of the beneficiaries of the trust and there is no particular beneficiary (or group of associated beneficiaries) who control the voting power; and/or

•

more generally, there is little or no likelihood that the power will be exercised in a way that significantly reduces the value of each existing interest.

1.41 If the total market value of all of the interests in a MIT is substantially the same as the net value of the trust, this may suggest that the existence of 'discretionary' powers in the trust does not significantly affect the market value of interests in the MIT.

Example 1.3

Further to Example 1.2, the trust is a MIT that is listed on the Australian Securities Exchange. There has only ever been one class of units on issue.

Various prudential and regulatory forces prevent the trustee from exercising powers in a way that is detrimental to existing unitholders. Furthermore, the total market value of units in the trust is approximately equal to the net value of the trust.

The trust meets the roll-over condition in section 126-230 because the existence of the power does not significantly affect the market value of interests in the trust.

Additional requirements for receiving trust

1.42 The receiving trust must have no CGT assets, other than a small amount of cash or debt, just before the transfer time. [Schedule 1, item 9, paragraph 126-225(1)(b)]

•

If the transfer is part of a series of roll-overs under an arrangement (see paragraphs 1.66 to 1.72), this condition only applies to the first transfer time.

1.43 This 'empty trust' requirement is important to ensure that the roll-over cannot be used to marry gain and loss assets or else 'share' losses in a way that would not otherwise be permitted under the income tax laws.

1.44 If the receiving trust has any revenue or capital losses just after the (first) transfer time, they are effectively extinguished (that is, they cannot be used). This is an automatic consequence of choosing roll-over and is discussed in paragraphs 1.78 to 1.80.

1.45 This approach increases the flexibility of the roll-over by not requiring the receiving trust to be a newly created trust, whilst maintaining the integrity of the tax system. The same beneficiaries must have the same interests in both trusts

1.46 Both trusts must have the same 'direct' beneficiaries. In other words, the same entities, acting in the same capacities, must be beneficiaries of both trusts. It is not sufficient that the 'indirect' or ultimate beneficiaries of both trusts are the same. [Schedule 1, item 9, subparagraph 126-225(1)(c)(i)]

1.47 Further, both trusts must have the same classes of membership interests. [Schedule 1, item 9, subparagraph 126-225(1)(c)(ii)]

•

Membership interests constitute a class if they have the same, or substantially the same, rights. [Schedule 1, item 10, subsection 995-1(1)]

Beneficiaries must have the same interests - the market value test

1.48 The market value test determines whether beneficiaries have the same proportionate membership interests before and after the transfer.

1.49 Under this test, the total market value of each beneficiary's interests in the transferring trust of a particular class and their interests of the matching class in the receiving trust must be substantially the same just before and just after the transfer time. [Schedule 1, item 9, subparagraph 126-225(1)(c)(iii)]

Example 1.4

TrustOne is an eligible trust with two beneficiaries: Sheila and Peter. There are two classes of units in the trust:

•

Class A units entitle the holder to a share of the rental income from properties held by the trust; and

•

Class B units entitle the holder to a share of the capital value of the properties held by the trust.

TrustTwo is also an eligible trust with the same beneficiaries. TrustTwo has two classes of units labelled Class 1 and Class 2, which have the same rights as Classes A and B respectively.

For each beneficiary, the number and market value of units in TrustOne is shown in Table 1.1. Just before the transfer time, the market value of all units in TrustTwo is effectively zero.

Table 1.1: Number and value of units in TrustOne

Beneficiary / Unit	Number of units	Market value of each unit	Total market value
Sheila
Class A units	1,000	$100	$100,000	Class B units	1,000	$1,000	$1,000,000
Peter
Class A units	500	$100	$50,000	Class B units	Nil	Nil	Nil

The trustee of TrustOne transfers two of its properties to the trustee of TrustTwo for no consideration. As a result, the market values of Class A and Class B units fall and the market values of Class 1 and Class 2 units increase. The trustee of TrustOne incurs fees in the transfer of $2,000, and is reimbursed from the capital of TrustOne.

Table 1.2: Market value (MV) of units after the transfer

Beneficiary / Unit	MV of units in TrustOne	MV of units in TrustTwo	Total market value
Sheila				Class A / 1	$80,000	$20,000	$100,000
Class B / 2	$898,000	$100,000	$998,000
Peter
Class A / 1	$40,000	$10,000	$50,000
Class B / 2	Nil	Nil	Nil

Roll-over is available because the total market value of the interests within each pair of the matching classes of units is substantially the same before and after the transfer time.

Exceptions to roll-over

1.50 In certain situations, roll-over is not available.

Foreign trust and not taxable Australian property

1.51 Roll-over is not available if the receiving trust is a foreign trust for CGT purposes and the transferred asset is not taxable Australian property. Permitting roll-over in these circumstances would effectively allow a CGT exemption for any accrued capital gain, rather than a deferral. [Schedule 1, item 9, subsection 126-235(1)]

Trusts taxed like companies

1.52 Roll-over is not available if either trust is a corporate unit trust or a public trading trust at any time in the income year that the transfer occurs. Companies are not eligible to choose this roll-over and, on that basis, trusts that are taxed like companies also cannot choose the roll-over. [Schedule 1, item 9, subsection 126-235(2)]

•

In order to transfer assets between related companies without immediate CGT consequences, companies are able to form (and head) a consolidated group.

Trusts have not made the same tax choices

1.53 Roll-over is not available unless both trusts have the same tax choices (or elections) in force just after the transfer. This applies to any choice made under the tax laws where the absence of the same choice in the other trust would or could have an ongoing impact on the calculation of any entity's net income (worked out under sections 90 or 95 of the ITAA 1936) or taxable income. [Schedule 1, item 9, subsection 126-235(3)]

1.54 This requirement is important to ensure that trusts cannot use the roll-over to circumvent the conditions in the primary provisions that govern when, why and how the choice can be made, or unmade.

Example 1.5

Further to Example 1.4, the trustee of TrustOne has made a family trust election. The individual specified in the election is Sheila.

To be able to choose the roll-over, the trustee of TrustTwo must also make a family trust election with Sheila as the test individual.

1.55 It does not matter whether the presence of the original choice in one trust may have an ongoing impact on the calculation of that trust's net income (or any other entity's net income or taxable income). What matters is whether the absence of the mirror choice in the 'other trust' has an ongoing impact on any entity's net income or taxable income. [Schedule 1, item 9, paragraph 126-235(3)(c)]

Example 1.6

Further to Example 1.5, in a previous income year, the trustee of TrustOne chose a CGT roll-over (under Subdivision 124-B) when a property of the trust was destroyed. The trustee of TrustOne purchased a replacement property with an insurance payout.

The trustee of TrustTwo does not need to make a 'mirror choice' of the Subdivision 124-B roll-over. This is because the absence of such a choice will not affect the calculation of TrustTwo's net income (nor the net income or taxable income of any other entity).

That is, the Subdivision 124-B choice affects the tax position of TrustOne (because it determines the cost base of the replacement asset in the hands of the trustee of TrustOne). The impact of the choice is confined to TrustOne and its absence in TrustTwo has no bearing on TrustTwo's net income (or the net income or taxable income of any other entity).

This will be the case even if the replacement asset is one of the transferred assets in respect of which the trusts now seek to apply the limited fixed trust roll-over.

Timing of making a mirror choice

1.56 Generally, mirror choices (if required) must be in force just after the transfer time. However, the roll-over will still be available if:

•

the trustee makes the mirror choice before the first time the choice matters for tax purposes; or

•

it would not be reasonable to require the making of the mirror choice.

[Schedule 1, item 9, subsection 126-235(4)]

1.57 The purpose of this reasonableness test is to provide limited flexibility where a trustee cannot make the mirror choice, and the absence of the choice would or could have only an immaterial effect on any entity's net income or taxable income.

Example 1.7

MarketTrust is a MIT. The trustee of MarketTrust makes the deemed capital account election (proposed but not yet enacted).

In September of the following income year, the trustee of MarketTrust transfers a commercial property to a newly created trust, PropertyTrust. Both trusts are eligible for the roll-over, and have the same beneficiaries with the same proportionate membership interests.

The trustee of PropertyTrust buys and sells 10 commercial properties between September and June.

Before lodging an income tax return for that income year, the trustee of PropertyTrust makes the deemed capital account election.

As the lodgement of the tax return is the first time the election matters for tax purposes, both trusts can choose the roll-over.

However, if the trustee of PropertyTrust did not (or could not) make the capital account election, then roll-over is not available in respect of the property transferred from MarketTrust.

1.58 Where it is necessary for a trustee to make a mirror choice to be able to choose this roll-over, the trustee must still be able to make the choice under the primary provisions that govern when, why and how the choice can be made. Nothing in this roll-over (including the transitional provisions) allows a trustee to make a choice they could not otherwise have made.

1.59 If it is not possible to make the mirror choice, then the roll-over will not be available, unless it would be unreasonable to require that a mirror choice be made (see paragraph 1.56). Denial of the roll-over does not in itself make it unreasonable to require the making of the mirror choice.

Consequences of making a mirror choice

1.60 Any restrictions or conditions that apply to the original choice (or first choice) will apply in a corresponding way to the mirror choice. If, just after the transfer time, the trustee that made the first choice cannot revoke or vary that choice, a trustee that makes a mirror choice also cannot revoke or vary that choice. Alternatively, if the first choice can be revoked or varied, but there are tax consequences in doing so, then those consequences will apply if the mirror choice is revoked or varied. [Schedule 1, item 9, subsection 126-235(5)]

1.61 This will be the case regardless of whether the circumstances might otherwise have allowed the mirror choice to be revoked or varied; or have allowed it to be revoked or varied without attracting the tax consequences relevant to the first choice.

1.62 The restrictions or conditions to which this rule applies are those that apply to the first choice just after the transfer time. If either choice only becomes irrevocable or unchangeable because of events that occur after the transfer time, this has no effect on the other choice.

1.63 Alternatively, if tax consequences for revoking or varying either choice only arise because of events that occur after the transfer time, this has no effect on the other choice.

1.64 In other words, where the trustee revoking or varying the choice is the trustee that made the first choice, the consequences depend on the history of that trust before and after the transfer time.

1.65 However, where the trustee revoking or varying the choice is the trustee that made the mirror choice, the consequences depend on:

•

the history of that trust, after the time of the transfer; and

•

the history of the other trust, up until the time of the transfer.

Example 1.8

Further to Example 1.5, assume that the trustee of TrustOne cannot revoke the family trust election, because it has previously relied on the family trust election to carry forward and deduct tax losses.

As a result, the trustee of TrustTwo cannot revoke the family trust election, even if it has never used or relied upon the election.

Application of the roll-over to multiple assets

1.66 The roll-over applies on an asset-by-asset basis, which is consistent with the CGT provisions. However, there are special rules to ensure that the roll-over can apply to multiple assets transferred as part of an arrangement.

1.67 If assets were transferred at different times, then in the absence of these special rules, it would be effectively impossible to satisfy the 'empty trust' requirement (paragraphs 1.42 to 1.45) at the second and later transfer times. These special rules also avoid any uncertainty that assets transferred simultaneously - say in the sense of being transferred under a single transfer agreement - are, in effect, transferred sequentially and therefore at different times.

1.68 Therefore, the 'empty trust' requirement does not apply to the second and later transfer times, provided:

•

each asset is transferred from the same transferring trust to the same receiving trust under an arrangement (as defined in subsection 995-1(1));

•

the asset was an asset of the transferring trust at the start of the arrangement; and

•

the asset is transferred in the same income year of the transferring trust as the first transfer time.

[Schedule 1, item 9, subsection 126-225(2)]

1.69 If these conditions are met, the loss cancellation rules do not apply to the second and later transfer times (see paragraphs 1.78 to 1.80). [Schedule 1, item 9, subsection 126-240(3)]

1.70 The requirement that CGT event E4 must be capable of happening to all the membership interests of both trusts and that beneficiaries' entitlements cannot be discretionary must be met at all times during the period of the arrangement - that is, at all times from the first asset transfer to the last asset transfer. [Schedule 1, item 9, subsection 126-230(1)]

1.71 However, the requirements that each trust has the same beneficiaries with the same proportional interests need only be met at the transfer time of each asset under the arrangement. The exceptions also apply at each transfer time.

1.72 If the roll-over does not apply to one or more assets transferred under an arrangement, this does not invalidate previous successful roll-overs. It also does not necessarily prevent the roll-over from applying to future transfers under the arrangement, provided the conditions of the roll-over are satisfied at that time.

Example 1.9

Further to Example 1.4, assume that the trustees of TrustOne and TrustTwo made an arrangement to transfer a total of five properties. All of the properties were assets of TrustOne at the time. All of the events in this example occurred during the same income year in which the arrangement was made.

Two properties were rolled over at the first transfer time. The receiving trust satisfied the 'empty trust' requirement at that time.

The trustee of TrustOne transfers another property to TrustTwo. Although TrustTwo has significant CGT assets (two properties), the trustees can still choose the roll-over if all of the other conditions are met. (The losses of TrustTwo are not extinguished - see paragraph 1.80.)

Before the transfer of the fourth property, Peter sells his interest in TrustOne to Graeme. When the property is transferred, roll-over is not available because the beneficiaries of both trusts are not the same.

Peter sells his interest in TrustTwo to Graeme before the transfer of the fifth property. As the beneficiaries of both trusts are the same, the roll-over may be chosen for the fifth property if all the conditions (other than the 'empty trust' requirement) are met.

Suppose that the trustee of TrustOne sold one of the original five properties and purchased a replacement property. The roll-over cannot be chosen for that replacement property because it was not an asset of TrustOne when the arrangement was made.

Consequences of roll-over for the trustees

1.73 There are consequences for the trustee of the transferring trust (in respect of any capital gain or capital loss arising from the asset transfer). There are also consequences for the trustee of the receiving trust (in respect of tax attributes relevant to the transferred asset in its hands).

Capital gain or capital loss disregarded

1.74 If both trustees choose the roll-over, any capital gain or capital loss made by the trustee of the transferring trust in respect of the transferred asset is disregarded. [Schedule 1, item 9, subsection 126-240(1)]

Asset's cost base and reduced cost base

1.75 The first element of the cost base and reduced cost base of the asset in the hands of the trustee of the receiving trust is equal to the cost base and reduced cost base of the asset in the hands of the trustee of the transferring trust just before the transfer time. [Schedule 1, item 9, subsection 126-240(2)]

Asset's date of acquisition

1.76 If the trustee of the transferring trust acquired the asset before 20 September 1985, the trustee of the receiving trust is taken to have acquired the asset before that date. [Schedule 1, item 9, subsection 126-240(4)]

1.77 Otherwise, the general acquisition rules in Subdivision 109-A apply - that is, the receiving trust acquires the roll-over asset when the trust is created or the asset is transferred. However, for the purposes of the CGT discount, the ownership period of the transferred asset in the receiving trust includes the period of ownership by the trustee of the transferring trust (see paragraph 1.111).

Example 1.10

To return to Example 1.2, the trustees of both trusts choose the roll-over. The two properties transferred were called Beachside (acquired in 1991) and Bayside (acquired before 20 September 1985). The cost base and reduced cost base of Beachside in the hands of the trustee of TrustOne was $20,000.

The trustee of TrustOne disregards any capital gain or capital loss made on the transfer of Beachside and Bayside to the trustee of TrustTwo.

The first element of the cost base and reduced cost base of Beachside in the hands of the trustee of TrustTwo is $20,000. The trustee of TrustTwo is also taken to have acquired Bayside before 20 September 1985.

Losses extinguished

1.78 If the receiving trust has carried forward any net capital losses or tax losses made in an income year that ends before the transfer time, they cannot be used to reduce the trust's capital gains or its assessable income after the transfer. The losses are effectively extinguished. [Schedule 1, item 9, subsection 126-240(3)]

•

This ensures the roll-over cannot be used to marry gains and losses. For example, it cannot be used to transfer gain assets under cover of the roll-over to a trust with capital or revenue losses.

1.79 For the income year that includes the transfer time, the trustee of the receiving trust makes a notional calculation as to whether it would have had a net capital loss or a tax loss if the income year had ended just before the transfer time.

•

If there would have been a net capital loss, that amount is effectively extinguished by reducing the sum of capital losses at the end of the year by that amount (whether or not the trust is otherwise in a net capital gain or capital loss position).

•

If there would have been a tax loss, that amount is effectively extinguished by reducing the sum of deductions at the end of the year by that amount (whether or not the trust is otherwise in a taxable income or a tax loss position).

1.80 As noted earlier, if multiple assets are rolled over as part of an arrangement, the extinguishment of losses only applies at the first transfer time. [Schedule 1, item 9, subsection 126-240(3)]

Consequences of the roll-over for depreciating assets

1.81 The transfer of a depreciating asset from the transferring trust to the receiving trust will cause a balancing adjustment event (as defined by section 40-295).

1.82 Where there is a difference between the asset's termination value (the final sale price) and its adjustable value (the original cost less the decline in value while the taxpayer held it), a balancing adjustment may occur.

1.83 The trustee of the transferring trust will be eligible for roll-over under section 40-340 if three conditions are satisfied:

•

there is a balancing adjustment event caused by the disposal of a depreciating asset;

•

the disposal involves a CGT event; and

•

the limited fixed trust CGT roll-over is chosen.

[Schedule 1, item 4, subsection 40-340(1)]

1.84 As a result of the roll-over, the consequences of the balancing adjustment are deferred until a subsequent balancing adjustment event. The trustee of the receiving trust can continue to claim deductions for the depreciating asset in the same way as the trustee of the transferring trust could.

Consequences for beneficiaries

1.85 Beneficiaries are required to adjust the cost base and reduced cost base of their interests in both trusts.

•

Although there is no disposal of membership interests in the transferring trust, there may be a transfer of value from interests in the transferring trust to interests in the receiving trust.

•

Consistent with the approach for other CGT roll-overs and the 'empty trust' requirement, the acquisition date of beneficiaries' interests in the receiving trust will also change.

1.86 Cost base adjustments are done on an interest-by-interest basis. However, because adjustments are made on a reasonable basis, there may be an opportunity for beneficiaries to reduce their compliance costs by grouping relevant membership interests (for example, where they have common tax attributes). This is explained further in Example 1.11.

1.87 The general rule is that beneficiaries must make these adjustments in respect of each asset transfer (paragraphs 1.88 to 1.94). Alternatively, beneficiaries may be permitted to make a single adjustment covering multiple asset transfers (paragraphs 1.98 to 1.100). [Schedule 1, item 9, subsection 126-245(1)]

Adjusting cost bases and reduced cost bases

1.88 The first element of the cost base and reduced cost base of each membership interest in the transferring trust after the transfer time is a proportion of the cost base of that interest, just before the transfer time. [Schedule 1, item 9, subsections 126-245(2) and (4)]

•

The proportion is what is reasonable having regard to the market value of that interest (or a reasonable approximation of its market value), just before and just after the transfer time.

•

The effect of the adjustment is to reduce the other elements of the cost base and reduced cost base to zero. This ensures that elements of the cost base are not double-counted in this roll-over.

1.89 The following formula is a reasonable basis for calculating the first element of the cost base of each interest in the transferring trust:

1.90 The first element of the cost base and reduced cost base of each membership interest in the receiving trust is an amount such that the total cost base of that interest and the cost base of the corresponding interest(s) or proportion of interest in the transferring trust, just after the transfer time, reasonably approximates the total cost base of those interests just before the transfer time. [Schedule 1, item 9, subsections 126-245(3) and (4)]

•

In other words, the increase in cost bases of interests in the receiving trust matches the decrease in cost bases of corresponding interests in the transferring trust.

1.91 The following formula can be used to calculate a reasonable approximation of the first element of the cost base of each interest in the receiving trust (which is in bold):

where CB is the cost base; the interest(s) or proportion of interest in the transferring trust corresponds to the interest in the receiving trust; and, the time is just before and just after the transfer time.

1.92 One interest of a particular class in the receiving trust may correspond to more than, less than or exactly one interest of the matching class in the transferring trust.

•

For example, a beneficiary may have two Class A units in the receiving trust for each Class A interest in the transferring trust, as well as one Class B unit in the receiving trust for every five Class B units in the transferring trust.

•

However, the proportion of interests of a particular class that a beneficiary has in the receiving trust (for example, 10 per cent of all the Class A units on issue) will be the same proportion of the matching class of units in the transferring trust held by that beneficiary.

1.93 The trustee of the transferring trust must provide beneficiaries with sufficient information to make these calculations (see paragraphs 1.101 to 1.105).

1.94 If a beneficiary adjusts the cost base and reduced cost base of their interests in both trusts as a result of the roll-over, no other adjustments can be made under the ITAA 1997 or the ITAA 1936 because of something that happens in relation to the asset transfer from the transferring trust to the receiving trust. [Schedule 1, item 9, section 126-255]

Example 1.11

Further to Example 1.9, assume that Sheila's Class A units in TrustOne have different cost bases as a result of her purchasing them at two different prices. The cost bases of these units and the corresponding units in TrustTwo are shown in Table 1.3.

Table 1.3: Corresponding units for each original unit

Original units	Cost base	New units	Cost base
600 Class A units	$10 each	300 Class 1 units	$0
400 Class A units	$20 each	200 Class 1 units	$0
1,000 Class B units	$200 each	100 Class 2 units	$10 each

Sheila adjusts the cost base of her units in the transferring trust on a reasonable basis, having regard to the market value of the interests just before and just after the transfer time. Given the difference in cost base of the two groups of Class A units, it would not be reasonable for Sheila to adjust the units as a single group.

The market value of Class A units just before the transfer was $100 and just after the transfer was $80 (see Tables 1.1 and 1.2). The market value of Class B units before the transfer was $1,000 and after the transfer was $898. These are relevant in determining the first element of the cost base of each unit in the TrustOne (the first three rows of Table 1.4).

For example, the cost base of each of the 600 Class A units just before the transfer was $10. A reasonable proportion of that cost base is the market value after the transfer ($80) divided by the market value before the transfer ($100). Multiplying $10 by ($80 / $100) equals $8, the first element of the cost base of those interests after the transfer.

Using these cost bases, Sheila calculates the first element of the cost base of interests in TrustTwo, such that the sum of the cost bases of corresponding units in both trusts is the same before and after the transfer time (the last three rows of Table 1.4).

For example, just before the transfer, the total cost base of one Class 1 unit and the corresponding two Class A units was $20 (2 ? $10 + 0). Just after the transfer, the cost base of the two Class A units is $16 (2 ? $8). Therefore, the first element of the cost base of the Class 1 unit is $4 using the formula in paragraph 1.91.

Table 1.4: Calculating the cost base of each unit

Membership interest	Cost base
600 Class A units	$8 - $10 * (80 / 100)
400 Class A units	$16 - $20 * (80 / 100)
1,000 Class B units	$180 - $200 * (898 / 1,000) (approx)
300 Class 1 units	$4 - $4 + (2 * $8) = $0 + (2 * $10)
200 Class 1 units	$8 - $8 + (2 * $16) = $0 + (2 * $20)
100 Class 2 units	$210 - $210 + (10 * $180) = $10 + (10 * $200)

Assume that each unit had the same cost base and reduced cost base before the transfer. Therefore, the amount worked out above as the first element of the cost base of each unit will also become the first element of the reduced cost base of each unit.

Deemed acquisition date of interests in receiving trust

1.95 Beneficiaries are deemed to have acquired their interests in the receiving trust at the transfer time. This is consistent with the general approach for CGT roll-overs. It is also consistent with the 'empty trust' approach. Furthermore, it prevents the potential avoidance of tax, such as by receiving trusts with pre-CGT interests being loaded with post-CGT assets and the beneficiaries disposing of their pre-CGT interests (instead of the receiving trust disposing of its post-CGT assets). [Schedule 1, item 9, subsection 126-245(5)]

1.96 There is one exception. Interests in the receiving trust will be taken to have been acquired before 20 September 1985 if corresponding interests in the transferring trust were acquired before that date. [Schedule 1, item 9, subsection 126-245(6)]

1.97 For the purposes of the CGT discount, the ownership period of membership interests in the receiving trust includes the period of ownership of membership interests in the transferring trust (see paragraph 1.112)

Example 1.12

Further to Example 1.11, suppose that Sheila also has 1,000 Class A units that she acquired before 20 September 1985. She still has only 500 Class 1 units in the receiving trust. Taking this into account, the new allocation of units in TrustTwo is shown in Table 1.5.

Table 1.5: Corresponding units for each original parcel

Original units	Cost base	Corresponding units	Cost base
600 Class A units	$10 each	150 Class 1 units	$0
400 Class A units	$20 each	100 Class 1 units	$0
1,000 Class A units	Nil	250 Class 1 units	$0

Because half of Sheila's Class A units in TrustOne were acquired before 20 September 1985, she is deemed to have acquired half (250) of the corresponding Class 1 units in TrustTwo before that date.

The cost bases of the Class A units (before and after the adjustment) do not change from Example 1.11. However, a reasonable calculation of the cost base of each of the Class 1 units taken to have been acquired at the transfer time does change, because now one Class 1 unit in TrustTwo corresponds to four Class A units in TrustOne instead of two.

For example, just before the transfer, the total cost base of one Class 1 unit and the corresponding four Class A units was $40 (4 ? $10 + 0). Just after the transfer, the cost base of the four Class A units is $32 (4 ? $8). Therefore, the first element of the cost base of the Class 1 unit is $8.

Similarly, the first element of the cost base of the other 100 Class 1 units is $16. Using the formula explained in paragraph 1.91, the calculation is as follows: $16 + (4 ? $16) = $0 + (4 ? $20).

Other approach for making adjustments covering multiple transfers

1.98 If there is a series of roll-overs for assets transferred under an arrangement and a beneficiary continuously owns interests in the transferring trust over a period of time that covers multiple transfers, the beneficiary can choose to make the necessary cost base and acquisition date adjustments only once for those interests. [Schedule 1, item 9, section 126-250]

1.99 A beneficiary that chooses this approach adjusts the cost bases of interests in the transferring trust based on the market value (or a reasonable approximation of market value) of those interests just before the first transfer, and just after the last transfer.

•

Similarly, the beneficiary adjusts the cost bases of the corresponding interests in the receiving trust such that the total cost base of the corresponding interests in both trusts, just after the last transfer, reasonably approximates the total cost base just before the first transfer.

•

The acquisition date of those interests in the receiving trust is treated as having been acquired just after the transfer time of the last transfer in the chosen series.

•

Note that whilst the condition for applying this approach is couched in terms of continuing ownership of interests in the transferring trust, the beneficiary must also continuously own corresponding interests in the receiving trust for the roll-over to apply.

[Schedule 1, item 9, subsection 126-250(3)]

1.100 If a beneficiary disposes of their interests in either trust part way through an arrangement, they must adjust the cost bases and relevant acquisition dates of those interests based on the most recent transfer time before the disposal. This is because the beneficiary will not be able to choose the multiple-transfer approach for a subsequent roll-over in respect of those interests, or the corresponding interests in the 'other trust'.

Example 1.13

To return to Example 1.9, because Sheila continuously held her interests in both trusts throughout the period, she could choose to adjust the cost base and reduced cost base of her interests based on the market value of her interests just before the first transfer, and just after the transfer of the fifth property.

Because Peter sold his interest in the transferring trust after the second transfer time, he must adjust the cost base and reduced cost base of the interest based on the market value of the interest just after the second transfer time. He also adjusts the cost base, reduced cost base and acquisition date of his corresponding interest in the receiving trust. (Alternatively, Peter can choose to make the necessary adjustments at the first and second transfer time using the transfer-by-transfer approach.)

As Graeme is only involved in one successful roll-over, he adjusts the cost bases and acquisition dates of his interests using the transfer-by-transfer approach.

Trustee must give relevant information to beneficiaries

1.101 The trustee of the transferring trust must send written notice containing certain information to each of its beneficiaries (as at the transfer time) within three months of the end of the income year in which the transfer occurs. [Schedule 1, item 9, subsection 126-260(1)]

•

The trustee may send the notice by post to the beneficiary's most recently notified address, or by any other means chosen by the beneficiary for receiving correspondence.

•

Beneficiaries need this information to be able to comply with their obligations under the income tax laws - for example, to determine the consequences of the roll-over for their membership interests in the transferring and receiving trusts.

1.102 The following information must be included in the notice given to each beneficiary (other information may also be included):

•

the transfer time;

•

the market value of each of the beneficiary's membership interests in the transferring trust, both just before and just after the transfer time; and

•

sufficient information to allow beneficiaries to work out which interests in the receiving trust correspond to each of the beneficiary's interests in the transferring trust. This effectively requires the beneficiary to know:

-

the class of interests in the receiving trust that matches each class of interests in the transferring trust; and

-

for each matching class, the number of interests in the receiving trust that equals one matching interest in the transferring trust.

[Schedule 1, item 9, subsection 126-260(2)]

1.103 Failure to comply with this requirement is a strict liability offence, punishable by 30 penalty units. The purpose of this offence is to place trustees on notice against contravening the requirement to give beneficiaries the information they need to meet their obligations. [Schedule 1, item 9, subsections 126-260(3) and (4)]

1.104 If there are two or more trustees, each trustee is liable, although any trustee can discharge the obligation for all of the trustees. [Schedule 1, item 9, subsection 126-260(5)]

1.105 However, it is a defence if the trustee being prosecuted proves that the trustee did not in any way contribute to the failure to provide the necessary information to beneficiaries, by act or omission. The reversal of the burden of proof is necessary given that the offence is one of strict liability, and that beneficiaries need the information to meet their obligations. [Schedule 1, item 9, subsection 126-260(6)]

Roll-over consequences still apply for beneficiary if no notice given

1.106 The consequences for beneficiaries explained in paragraphs 1.85 to 1.100 still apply even if the trustee of the transferring trust fails to comply with the requirement to give notice. That is, the obligation on the trustee of the transferring trust does not relieve a beneficiary of its obligation to make cost base and other adjustments in respect of its membership interests. [Schedule 1, item 9, subsection 126-260(7)]

Application and transitional provisions

1.107 These amendments will apply to CGT events happening on or after 1 November 2008. [Schedule 1, items 3 and 11]

Additional time for trustees making tax choices

1.108 Trustees will have six months from the date of Royal Assent to make the mirror tax choices discussed in paragraph 1.53, notwithstanding that the absence of the election impacted on the assessment of the trust's or any other entity's income.

•

However, a mirror choice may only be made under this transitional rule if it otherwise meets the requirements of the relevant choice provision and is within the time permitted by that provision.

•

The Commissioner of Taxation can extend the six-month period.

[Schedule 1, item 12]

Transitional time for penalty provision

1.109 To avoid any retrospective penalties from the failure of a trustee to provide beneficiaries with relevant information for a roll-over that occurs in the 2008-09 income year, the trustee will have six months from the date of Royal Assent to comply with the requirement to give information. [Schedule 1, item 13]

Consequential amendments

1.110 Consequential amendments will be made to the guide material in Subdivision 112-B to direct readers to the modified cost base rules in Subdivision 126-G. Subdivision 112-B lists situations when the general cost base and reduced cost base rules may be modified. [Schedule 1, item 6, section 112-54A]

1.111 Consequential amendments will also be made to include the roll-over of the asset at the trust level in the table of same-asset roll-overs in Subdivision 112-D. This will ensure that, for the purposes of the CGT discount, the ownership period of the roll-over asset in the hands of the trustee of the receiving trust includes the period of ownership by the trustee of the transferring trust. [Schedule 1, item 7, section 112-150]

1.112 Consequential amendments will also be made to the table in subsection 115-30(1). This will ensure that, for the purposes of the CGT discount, the ownership period of membership interests in the receiving trust includes the period of ownership of the corresponding membership interests in the transferring trust. [Schedule 1, item 8, subsection 115-30(1)]

1.113 Amendments will be made to the guide material in Subdivision 109-B to direct readers to this modified acquisition rule in section 115-30. [Schedule 1, item 5, section 109-55]