Senate

Explanatory Memorandum

(Circulated by the authority of the Treasurer the Hon Ralph Willis, M.P.)

Chapter 6 - Capital Gains Tax - Change in ownership of assets - Subdivision B of Division 3 (Part 3) of the Bill

Overview

6.1 The amendments deal with the operation of the CGT provisions as they apply to declarations of trust over assets, transfers of assets to trusts and certain conversions of trusts to unit trusts. The amendments are intended to ensure that certain transfers of assets to a trust are treated as changes in the ownership of the assets so that a capital gain may arise on the transfer.

Summary of amendments

Purpose of amendments

6.2 The amendments make clear the circumstances in which subsection 160M(1A) of the Act will have the effect that a change in the legal ownership of an asset is not to be treated as a change of ownership of an asset for CGT purposes. They will also provide that a declaration of trust over an asset owned by a person or the transfer of an asset to a trust will be a change of ownership of the asset unless the previous owner is absolutely entitled to the asset as against the trustee and the trust is not a unit trust. There will be no change of ownership if there is a mere change of trustee without any change at all in the trust arrangements including the interest of each beneficiary in the trust income and assets [Clause 29].

Date of effect

6.3 The amendments will apply to declarations of trusts, or transfers of property to trusts, made after 12:00 midday Eastern Summer Time on 12 January 1994 [Clause 32].

Background to the legislation

6.4 The capital gains tax (CGT) provisions of the Act apply where there is a disposal of an asset. Subsection 160M(1) of the Act deems a disposal whenever a change has occurred in the ownership of an asset.

Changes in beneficial ownership

6.5 Subsection 160M(1A) of the Act provides that a change in legal ownership of an asset, without a corresponding change in beneficial ownership, does not constitute a change in ownership and hence a disposal within the meaning of the CGT provisions. The explanatory memorandum to the Taxation Laws Amendment Bill 1990 which inserted subsection 160M(1A) identifies two situations where there will be a change in legal ownership but no change in beneficial ownership:

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first, where there is a change of trustee of a trust under which the beneficiary is absolutely entitled to the trust property (or would be but for a legal disability); and

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secondly, where a trust is established over property previously owned by a person and that person, as beneficiary of the trust, remains absolutely entitled to it (or would remain so but for a legal disability).

6.6 The existence of subsection 160M(1A) has given rise to possible opportunities for avoidance of CGT in cases where it is arguable that no change in beneficial ownership of an asset has occurred. An example is where a person transfers an asset to a unit trust in which he or she holds all the units, and then disposes of those units for an amount equal to their cost base (the market value of the asset).

Declaration of trust

6.7 Paragraph 160M(3)(a) of the Act provides that a declaration of trust over an asset constitutes a change in ownership (and therefore a disposal) of the asset to the beneficiary if the beneficiary is absolutely entitled to the asset as against the trustee.

6.8 If there is no beneficiary absolutely entitled to the asset there is no disposal to the beneficiary. However, if a person (the settlor) appoints another person (the trustee) to hold an asset for beneficiaries who are not absolutely entitled to the asset, there is a disposal by the settlor to the trustee since there has been a change in legal and beneficial ownership of the asset.

6.9 It has been argued that the current law is unclear as to whether there is a disposal from the settlor to the trustee if they are the same person (ie. if the settlor declares himself or herself to be trustee of the asset). In the case of a fixed trust there would be a disposal by reason of a change in beneficial ownership of the asset.

6.10 It has been argued that, in the case of a discretionary trust, the law is uncertain in its application where the settlor is also the trustee. This is because it is not completely clear what has happened to (and therefore whether there has been a change in) the beneficial ownership of the asset previously held by the settlor. Some have argued that paragraph 160M(3)(a) leads to a conclusion that there is no disposal of an asset when the beneficiary of the trust is not absolutely entitled to the asset as against the trustee.

6.11 In policy terms, there should be no difference between, on the one hand, the situation where a person appoints another to be trustee, and, on the other hand, where the person declares himself or herself to be trustee. This is because it is the position of trustee rather than the identity of the trustee which is important. Therefore, since a transfer to another person as trustee is a disposal for CGT purposes, the same should apply when the transferor is also the trustee.

Explanation of the amendments

6.12 The Bill will amend the Act to ensure that subsection 160M(1A) does not apply to transfers to a unit trust. The effect of the amendment is that any transfer of an asset to a unit trust will be a change in ownership of the asset. [Clause 30 - new paragraphs 160M(3)(a)].

6.13 The amendments will also have the effect that, subject to certain exceptions, the creation of a trust by declaration or settlement over an asset, or the transfer of an asset to a trust, will constitute a change in ownership. [Clause 30 - new paragraph 160M(3)(a), new subsection 160M(3A)] One exception applies where:

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there is a creation of a trust over an asset by declaration or settlement, or a transfer of an asset to a trust; and

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all of the following conditions are satisfied in relation to the creation or transfer:

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first, the person who owned the asset before the creation of the trust, or the transfer of the asset, is the sole beneficiary of the trust;

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secondly, the person is absolutely entitled to the asset as against the trustee or would, but for a legal disability, be so entitled; and

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thirdly, the trust is not a unit trust.

[Clause 30 - new subparagraph 160M(3)(a)(i)]

6.14 A further exception applies where there is a settlement of an asset to a trustee to hold on terms of an existing trust where the only change that occurs is a change of trustee. The effect of this exception is that where property is transferred from one trustee to another to be held under the same trust arrangements without any change at all in the trust arrangements including the interest of each beneficiary in the trust income and assets, there will be no change of ownership for CGT purposes [Clause 30 - new subparagraph 160M(3)(a)(ii)].

6.15 The amendments will also provide that the conversion of a trust to a unit trust will be a change in ownership of the assets of the trust if a person was absolutely entitled to the asset as against the trustee of the first trust or would, but for a legal disability, have been so entitled [Clause 30 - new paragraph 160M(3)(aa)].

6.16 The amendments provide a cost base to the trustee of the asset equal to the market value of the asset at the time of the change of ownership where:

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there is a creation of a trust over an asset by declaration or settlement, or a transfer of an asset to a trust and any of the following conditions are satisfied in relation to the creation or transfer:

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the person who owned the asset before the creation of the trust, or the transfer of the asset, is not the sole beneficiary of the trust;

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the person is not absolutely entitled to the asset as against the trustee or would, but for a legal disability, be so entitled; or

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the trust is a unit trust.

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the person who owned the asset before the creation of the trust is also the trustee of the trust; and

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on creation of the trust, no beneficiary is absolutely entitled to the asset as against the trustee. [Clause 30 - new subsections 160M(4A) and (4B)]

This market value will be the same amount as the disposal consideration that was taken into account in computing the capital gain or loss on the change of ownership.

6.17 The amendments will also provide that nothing in section 160V(1) will displace the change of ownership that occurs under paragraphs 160M(3)(a) and 160M(3)(aa) [Clause 31 - new subsection 160V(1B)].

6.18 The table that follows explains the effect of the amendments on declarations of trusts or transfers of property to trusts.

Interpretation

6.19 The Bill provides that the amendments are to be disregarded in determining the meaning that the CGT provisions had before the amendments [Clause 33].