Creation of a new trust - Statement of Principles August 2001

5. Application of principles in some specific scenarios

This document is no longer current. For more information refer to the Overview and the Decision Impact Statement for Commissioner of Taxation v Clark [2011] FCAFC 5

It must be stressed that this statement only addresses the termination and creation of trusts. Even in situations where there is a continuing trust estate the changes may cause other tax consequences for trustees, beneficiaries or others which are not dealt with in this statement. For the purposes of this statement we also assume that the changes are legally effective. If, for example, an act by a trustee was beyond its power and did not achieve its purported effect, then different tax issues could arise which are beyond the scope of this statement.

5.1 Addition or removal of beneficiaries

The identity of those for whose benefit the trust exists is an essential element of the trust obligation and hence the trust relationship. Therefore, changes amounting to a redefinition of the membership class or classes would terminate the original trust. By contrast, changes in the membership of a continuing class are consistent with a continuing trust. In some situations the correct characterisation is unclear but the following examples may assist.

Example 5.1.1

A discretionary trust has as its beneficiaries 'the children and grandchildren of X'. One of the children dies and two new grandchildren are born.

These changes do not terminate the trust. They represent changes in the membership of a continuing beneficiary class.

Example 5.1.2

Another discretionary trust has as beneficiaries 'the children of Y', and anyone else named in the deed as a beneficiary at a particular time. The trustee has a power to nominate beneficiaries, but only if they are parents or grandchildren of Y or their spouses. The trustee nominates Y's mother as a beneficiary.

In this case, the beneficiary group could be characterised as the children of Y and those members of the wider group nominated from time to time. Under this approach there is a mere change of membership and no new trust.

Ordinarily, the ATO will accept that there has been only a change in the membership of a continuing class when:

• an already existing power to nominate new beneficiaries is only exercisable under the terms of the trust in favour of a clearly defined group which it could be reasonably inferred that the trust was intended to benefit
• it can be shown from the deed and surrounding circumstances that the actual objective purpose or theme of the trust was to benefit that wider group.

In circumstances where the power to nominate or remove has the broad effect of a power of appointment among a group that the trust is clearly designed to benefit, it is more likely that group can be reasonably characterised as the beneficiary class. In these situations the trustee may benefit the 'inner group' members (those already named in the deed, for instance Y's daughter), by an appointment in their favour. When deciding to benefit the 'wider group' members (such as Y's mother) the trustee first exercises the power of nomination and then, if it so decides, the power of appointment.

In other situations it will be more difficult to characterise all those who may be nominated as beneficiaries as being merely members of a wider beneficiary group. If so, the effect of nominations and removals may be to vary the trust by redefining the group of beneficiaries so that a new trust is created.

Example 5.1.3

A family discretionary trust (which may or not have made a family trust election) has as its beneficiaries members of the X family. The trustee has a power in the deed to nominate new beneficiaries. It may not be exercised in favour of certain persons such as the settlor, but is not restricted to members of the family group and their associates. The power is exercised to nominate members of the Y family as beneficiaries.

In this situation we would conclude that the power of nomination has been exercised to redefine the group of beneficiaries, and thus, to create a new trust.

Example 5.1.4

A 'standard' investment unit trust regularly redeems from, and issues to, investors, units of the same class, or a number of existing classes, on arms' length terms.

The beneficiary class could generally be defined as those who from time to time hold the units under the terms of the trust. This class has an intrinsically changing membership and the issues and redemptions are consistent with a continuing trust estate.

Example 5.1.5

A piece of real estate is owned by the trustee of a 'standard' investment unit trust. X owns all the units and all the shares in the corporate trustee. Both the shares and units are transferred to B. The transfer of units could be direct, or by way of redemption and reissue.

In the ATO's view the transfer of units, in itself, is consistent with a continuing trust estate for the reasons given in Example 5.1.4 above. In respect of the shares, a change in control of the trustee in these circumstances would be a normal incident in the continuing operation of a trust estate of this type.

This situation can be contrasted with the change in the family discretionary trust in Example 5.1.3. The purpose and essential nature of that trust was to benefit the members of the X family, and a new purpose or theme arose on the change of beneficiaries. By contrast, the unit trust in Example 5.1.5 is for the benefit of those who have subscribed for units and their assignees, and here, no change in that purpose has occurred.

The above comments only apply where the changes in question are not accompanied by other indicia of a new trust. While these features considered in isolation would generally not lead to a new trust, they may form part of an arrangement which does.

Example 5.1.6

A 'standard' investment unit trust is varied to create and issue a new class of units.

Such variations may not only create a new beneficiary group (the holders of the new class) but also may lead to an express or effective change in the rights attaching to the pre-existing class or classes, for instance through introducing a competing claim on the proceeds of the trust fund. The overall result may be a redefinition of the trustee's obligations to the beneficiaries and hence the trust relationship, resulting in the creation of a new trust estate. As noted at the beginning of this statement, tax consequences then arise at both the trustee and beneficiary level.

5.2 Extending the term (duration) of the trust

The trusts under consideration will be established for a defined period, either because of rules against remoteness of vesting or the wishes of the settlor. This statement only covers valid changes to the term of a trust, and not situations where it may purport to continue (perhaps through an oversight) after the date for its termination.

When the term of a trust is extended (say, by exercise of a trustee's discretion or through agreement of the beneficiaries), the ATO needs to consider whether a new trust arises and if so, whether it commences when the variation takes effect or alternatively on the previous termination date. The uncertainty of the law here and the scope for conflicting views is illustrated by the discussion by members of the House of Lords in Re Holmden's Settlement Trusts [1968] 1 All ER 148.

Given this absence of clear judicial guidance, the ATO will accept that in most circumstances the mere extension of the term of a trust is consistent with a continuing trust estate. The ATO will reach this conclusion when:

• the trust deed confers an express power to alter the termination date
• the deed and the surrounding circumstances do not indicate that a particular trust period was a fundamental feature of the particular trust relationship
• other accompanying circumstances do not indicate a fundamental change to the trust.

In some trusts, the specified term may be an essential feature whose variation could be a factor pointing towards the creation of a new trust. In these situations the subject matter of the trust can be most accurately described as the income and other benefits arising from the trust property over a particular period.

Example 5.2.1

A trustee holds Blackacre under a trust set up for a ten year term. The beneficiaries of the trust are entitled to the rents of Blackacre over that period. On consideration of the overall circumstances it is clear that it was those ten years' rents, and not just the rents in general or Blackacre itself, that the trust was established to deal with.

Example 5.2.2

A trust is set up specifically as a vehicle for a particular project or to hold an asset of intrinsically limited duration.

If the trusts referred to in Examples 5.2.1 and 5.2.2 were extended, particularly if there were other changes such as the introduction of new investments or activities, it is likely that a new trust would be formed in respect of the new subject matter.

When extending the term of a trust, even in situations when no new trust estate arises, it will be essential to consider the tax consequences for the parties whose interests would have vested in possession on the now varied termination date. The extension of the term could amount to a disposal of these reversionary interests. Furthermore, and particularly in situations where the extension is at the behest of the beneficiaries, consideration will need to be given to the potential application of section 160ZX of the 1936 Act and CGT event E5 under the Income Tax Assessment Act 1997 .

5.3 Changes in trust property

In many trusts the property is whatever investments the trustee holds from time to time under its terms. In these situations changes in investments are generally consistent with a continuing trust estate.

Some trusts by contrast may have highly specific subject matter, for instance a trust established for the express purpose of holding a particular asset. In these situations replacing the trust property with other assets may indicate the creation of a new trust.

The relevant principle here is similar to that which we will apply to changes to the termination date: the more specific the subject matter of the trust, the stronger the likelihood that changes to that subject matter result in a new trust estate. Both the terms of the trust and purposes inferred from the surrounding circumstances will be taken into account.

The creation of a trust through a nominal settlement and the later addition of the bulk of the trust property is a long standing practice. In Truesdale v. FCT 70 ATC 4056 it was held that a contribution of this type to an existing trust fund did not amount to the creation of a new trust in respect of that contribution for the purposes of section 102 of the Income Tax Assessment Act 1936 . In comparable circumstances a new trust estate will not arise under Division 6.

The situation is less clear when a later injection of assets takes place which is difficult to reconcile with the original trust purpose. One instance is the acquisition of new and different property in asset-specific trusts of the type referred to earlier. Another is when inactive trusts with negligible assets are 'revived' with new property. In these situations it may be that the injection amounts to a new trust estate incorporating the terms of the previous trust.

The ATO accepts that this will not always be the case. For instance, a general purpose trust vehicle controlled by a particular group or family may be dormant for a period and then reactivated for a new activity which, in the overall circumstances, would not amount to a new purpose or theme. On the other hand, when control and/or 'ownership' of a trust without significant assets passes to new parties who then establish a new trust fund, it may be that a new trust estate is created.

As a general principle, the ATO will usually not treat the mere addition of new property to an existing trust fund as giving rise to a new trust estate. However, such additions will be taken into account when accompanied by other potential indicia of a new trust.

An important point is that there can be no trust without trust property, so exhaustion of the trust fund will bring a trust estate to an end.

5.4 Changes of trustee

A change of trustee does not in itself result in a termination of the trust. If there is merely a change of trustee, the trust property with the accompanying equitable duties are assumed by the new trustee and the trust estate continues unchanged. On the other hand, a change in the trustee or control of the trustee may be an element in arrangements which in their entirety amount to the creation of a new trust.

5.5 Changes to the terms of the trust

It is important to distinguish between changes which are merely procedural and those which fundamentally redefine the relationship between the trustee and beneficiaries in respect of the trust property. It is generally only changes of the latter type which will give rise to a new trust. However:

• it is sometimes unclear whether a variation of terms is fundamental or merely procedural
• extensive procedural changes may be taken into account along with other changes in considering whether there is a new trust
• in some circumstances new trusts have been held to arise even though their terms have been very similar to a prior arrangement (eg Davidson v. Chirnside ).

The application of the general principle can be seen in the following examples.

Conversion of a trust to a unit trust

Example 5.5.1

The deed of a fixed trust is converted to substitute interests in the trust property for units and to allow the trustee to issue and redeem units.

In our view, the conversion of a non-unitised fixed trust to a unit trust may involve a fundamental change in the trust relationship. It may also be indicative of a new trust purpose, involving the creation of an actual or potential joint investment vehicle. The ATO would generally regard such a conversion as the creation of a new trust.

Conversion of a fixed trust to a 'hybrid' discretionary trust

Example 5.5.2

The deed of a fixed trust (unitised or otherwise) is amended to give the trustee a discretionary power of appointment over the income of the trust.

Although the new discretionary beneficiaries may not have a proprietary interest in the trust fund, the rights of the holders of previously fixed interests are radically changed. Previously, they would be presently entitled to, and accordingly had a right to demand, payment of all income. Now, assuming a mere power, any rights would only be in respect of the unappointed residue, if any. In this situation the essential nature and character of the trust relationship changes and a new trust estate comes into being.

Conferring a power to accumulate income

Example 5.5.3

A trustee is given the discretion to accumulate income to which beneficiaries previously would have been presently entitled.

The new discretion involves a material change in beneficiaries' rights. However, in the ATO's view this change will not usually be sufficient in itself to alter the essential nature and character of the trust relationship, and thus result in a new trust. Whether it does or not will depend on the essential nature of the change and its effects.

The ATO will accept that creating a power to accumulate is in itself consistent with a continuing trust where the retained income will accumulate solely for the benefit of those same beneficiaries who would have been presently entitled before the change.

Example 5.5.4

The beneficiaries of a unit trust are presently entitled to each year's income in proportion to their unit holdings. The deed is varied to give the trustee the discretion to accumulate some, or all, of the income. The beneficiaries' beneficial interests in the accumulated income are unaltered, and they are entitled to share in any distribution of income in proportion to their unit holdings.

Here, the accumulation power can be seen as enabling the trustee to decide from time to time whether the interests of the beneficiaries are best served by retaining or distributing income. Where any accumulations can only be for the benefit of those otherwise entitled to the income, the ATO accepts that conferring the power, in itself, alters the management of the trust's undertaking rather than the essential nature of the trust relationship itself. In the absence of other factors pointing to a new trust, the ATO accepts that no new trust estate arises.

Example 5.5.5

A discretionary trust deed ensures that beneficiaries are presently entitled to all income. It is varied to confer on the trustee a power to accumulate.

Provided that accumulations can only be appointed among the same class of beneficiaries as would otherwise have been presently entitled, the ATO view this situation in the same way as Example 5.5.4. In the absence of other factors, the variation goes to the management of the trust's undertaking rather than the essential nature of the trust relationship.

Example 5.5.6

A unit trust has X units with present entitlement to all income and Y units with rights to capital. The trustee is given a new discretion to accumulate income and add it to capital.

In contrast to the previous examples, here the effect of the change is to redefine the nature of the equitable interests in the trust fund. There is a fundamental change in the essential nature and character of the trust relationship, and this will bring about a new trust estate.

Definition of trust income

The insertion or variation of any 'income' definition in a trust deed potentially alters the substantive rights of beneficiaries. For example, if a deed defined 'income' as net income for the purposes of section 95 of the Income Tax Assessment Act 1936 the respective rights of capital and income beneficiaries could be significantly different than if the term was undefined and ordinary trust law concepts applied. See, for example, the effect of the definition considered in FCT v. Australian and New Zealand Savings Bank Limited 98 ATC 4850.

Although inserting or varying an income definition may materially change the rights of beneficiaries, it may not in itself alter the essential nature and character of the trust relationship so as to result in a new trust estate. The ATO will accept that no new trust estate arises where, in the absence of other factors:

• it can be reasonably concluded that the purpose and effect of the new definition is to clarify rather than significantly redefine entitlements to income and capital
• where there is a significant change in respective entitlements, it is between the rights of a single beneficiary or class of beneficiary, rather than between different beneficiaries or classes of beneficiaries.

The second criterion reflects the principle which the ATO will apply to powers of accumulation. The changes under this heading are those which may affect a beneficiary's access to distributions at a particular time but not the essential nature of his/her interest in the trust.

Example 5.5.7

The property of a unit trust consists of an annuity with a substantial purchase price. The deed is amended to define 'income' as net income for the purposes of section 95 of the Income Tax Assessment Act 1936 . There was no previous definition.

If the trust resembled Example 5.5.4, where income and capital rights accrue to the same units, the ATO would accept in the absence of other factors that there was no fundamental change in the trust relationship and no new trust estate. The change affects distribution of funds rather than the essential character of beneficiaries' interests. By contrast, if the trust resembled Example 5.5.6 the change would significantly alter entitlements between the two classes of units and be a strong indicator of a new trust relationship.

Given the uncertainty of the law and lack of clear judicial and ATO guidance in the past, the ATO will give less weight to changes or insertions of income definitions as indicia of a new trust when considering alterations made before the release of this statement. This will be so even if the effect of the change is such that it meets neither of the above criteria.

For instance, in response to the introduction of capital gains tax, deeds without an income definition may have been amended to define 'income' as tax law 'net income'. Where the variations took place before the release of this statement the ATO will not treat these changes as having in themselves terminated the previous trust. As with other factors which may not in themselves be determinative, they will be taken into account if accompanied by other features indicative of the creation of a new trust. For future arrangements, the principles outlined above will be applied.

Procedural changes

Changes which are merely procedural or administrative generally will not in themselves amount to the creation of a new trust. These could include:

• changes in the person acting as trustee or manager
• changes which merely affect administrative and 'housekeeping' procedures without substantially altering the rights of the beneficiaries in respect of the trust property.

It should be noted that changes may substantially alter beneficiaries' rights even though their interests are not adversely affected. What is important is the extent and nature of the change to the bundle of rights making up the beneficiaries' respective interests.

Once again, administrative and procedural changes will be taken into account when accompanied by other features pointing towards the creation of a new trust.

ATO references:
NO 4913