By Andrew Henshaw and Rosalind Li, Velocity Legal
TRUST SPLITTING: THE ATO’S CONTROVERSIAL NEW DRAFT TAXATION DETERMINATION
By Andrew Henshaw and Rosalind Li, Velocity Legal
The Australian Taxation Office (ATO) issued Draft Taxation Determination TD 2018/D3 (Draft Determination) on 11 July 2018. The Draft Determination contains the ATO’s preliminary public views on the tax implications of trust splitting, and in particular, whether a trust split will trigger CGT event E1.
While the ATO have previously expressed their views on the tax issues regarding trust splitting via several private rulings, the Draft Determination represents the ATO’s first public view on the topic.
The Draft Determination concludes that a trust split will usually trigger CGT event E1. This will come as a surprise to many taxpayers, given the ATO’s previous private ruling decisions on the topic. Worse, the Draft Determination is supported by minimal case law, gives little weight to the closest relevant case law authorities, and is proposed to apply with retrospective effect.
This article addresses the following issues:
- the circumstances in which trust splitting usually arises;
- the ATO’s views on trust splitting in previous publications and in the current Draft Determination; and
- a number of issues and concerns raised by the Draft Determination in its current form.
What is trust splitting?
Trust splitting usually occurs where:
- there is a pre-existing discretionary trust;
- the trust has several trust fund assets, with significant value; and
- there are issues concerning the current or future management and administration of the trust, such that the controllers wish to ‘split’ or ‘segregate’ the trust fund assets so that different persons control different trust fund assets.
The intention of trust splitting is to generally produce a structure where certain persons have control of particular trust assets, and other persons have control of other trust assets. When a trust split occurs, typically the following will happen:
- a new trustee will be appointed as trustee of certain trust assets;
- the existing trustee (or separate new trustee) will remain the trustee in respect to the remaining trust assets;
- the controllers of the new trustee and the existing trustee will generally be different;
- the broad class of discretionary beneficiaries will remain the same;
- there may be a separate appointor established for each trustee; and
- each trustee’s right to seek recourse from the trust fund may be limited.
Trust splitting does not generally involve a change to the trustee powers or a change to the beneficiaries. In addition, it is important to note that (subject to the ATO’s views in the Draft Determination) there is technically still a single trust fund that continues to be held subject to the terms of the trust deed.
Why does trust splitting arise in the first place?
Trust splitting generally arises in the context of family estate planning or business succession matters. This is best illustrated with an example.
Example: Bill and Harry
John and Jane set up a discretionary trust. The discretionary trust owns a business and an investment property. John and Jane now wish to pass control of the discretionary trust to their two children, Bill and Harry. John and Jane’s intention is that Harry will control (and benefit from) the business, and that Bill will control (and benefit from) the investment property.
Bill and Harry each have their own families. Further, Bill and Harry do not see eye to eye. Therefore, a structure where Bill and Harry must make decisions unanimously for both the business and the investment property is not appropriate.
For Bill and Harry, a simple option would be to vest the trust, or transfer either the business or the investment property to a new trust (controlled by one brother), leaving the other brother to control the existing trust. However, either option may trigger CGT consequences and stamp duty.
An alternative option is to ‘split’ the trust, by appointing a new trustee to hold the investment property (for example). As explained above, splitting the trust would allow Harry to have a degree of autonomy over business, and allow Bill to have a degree of autonomy over the investment property.
The ATO’s view on trust splitting arrangements
Prior to the Draft Determination, the ATO had issued a number of private ruling decisions that a trust split could occur without CGT consequences. In particular, those private rulings concluded that a trust split would not give rise to CGT event E1. The ATO’s new view (under the Draft Determination) is that a trust split will usually give rise to CGT event E1.
CGT event E1 occurs when a new trust is created by declaration or ‘resettlement’. The ATO’s view regarding ‘resettlements’ has changed dramatically over time.
Prior to Clark – Statement of Principles and ATO ID 2009/86
For many years, the ATO’s views on the circumstances in which a trust resettlement may occur were set out in the ATO’s Creation of a new trust – Statement of Principles (Statement of Principles).
The Statement of Principles provided that a resettlement may occur where a variation of the terms of the trust deed causes a ‘fundamental change’ to the essential nature and character of the original trust relationship between the trustee and beneficiaries. The Statement of Principles led to many taxpayers adopting a cautious position when it came to varying an existing discretionary trust.
The Statement of Principles was also reflected in Interpretative Decision ATO ID 2009/86 (ATO ID 2009/86). In ATO ID 2009/86, a new trustee was appointed in respect of a part of the trust property. The appointment of the new trustee was part of a broader family restructure designed to split certain assets between the two families. The taxpayers argued that splitting the trust’s assets between different trustees did not trigger a CGT event because following the split there continued to be a single trust.
However, the ATO concluded that a new trust was created in respect of the CGT assets to which a new trustee is appointed, and thus that CGT event E1 occurred. This is because there has been a ‘substantial alteration of the trust relationship in respect of the transferred assets’ and ‘the assets held by the new trustee are to be held for the exclusive benefit’ of the new trustee’s family.
The ATO’s change of position – Clark’s case and TD 2012/21
Following the Full Federal Court’s decision in Commissioner of Taxation v Clark FCAFC 5 (Clark), the ATO withdrew the Statement of Principles and ATO ID 2009/86, and acknowledged that a valid amendment to a trust, not resulting in a termination of the trust will not of itself result in the happening of CGT event E1.
Following the withdrawal of Statement of Principles, the ATO’s new trust resettlement position is contained in Tax Determination TD 2012/21 (TD 2012/21). Of relevance, TD 2012/21 provides that:
- applying the principles stated in Clark, CGT event E1 (or CGT event E2) does notoccur where an amendment to the trust (e.g. addition of new entities to and exclusion of existing entities from class of objects) is made pursuant to a proper exercise of a power of amendment contained under the deed; unless
- the effect of the change is that a particular asset becomes subject to a separate charter of rights and obligations which means the asset has been settled on terms of a different trust.
These principles have been subsequently applied in a number of private ruling decisions regarding trust splitting.
In the years following the withdrawal of the Statement of Principles, the ATO issued a number of private ruling decisions that confirmed that a trust split would not give rise to CGT event E1, so long as the trust split occurs by way of amendment of a Trust Deed by a valid exercise of a power of amendment.
For example, see the ATO’s private ruling dated 3 December 2015 (Private Ruling). The Private Ruling provided that:
- the appointment of separate appointors for each of the trust assets will not cause a resettlement or declaration of trust pursuant to subsection 104-55(1) of the Income Tax Assessment Act 1997 (ITAA97) and will not trigger CGT Event E1; and
- varying a trust deed to restrict the trustee’s right of indemnity in respect of the relevant trust assets will not cause a CGT event to occur, provided the power of variation contained in the trust deed is sufficiently wide.
In reaching these conclusions, the Private Ruling applied Clark, which confirmed that a variation of a trust in accordance with an express power in the trust instrument generally will not result the establishment of a new trust. The Private Ruling relied on Clark as follows:
The case law has established that short of bringing the trust to an end for trust law purposes, amendment of a trust’s deeds through a valid exercise of a power of amendment will not result in the happening of CGT event E1 (see Commissioner of Taxation v Clark  FCAFC 5 discussed in Taxation Determination TD 2012/21)…The designation of separate appointors in relation to the trust assets, without more, does not lead to the conclusion that Asset 1 and Asset 2 have commenced to be held subject to a new charter of rights and obligations consistent with the assets being held on the terms of a new trust.
This Private Ruling has been widely publicised since it was issued in December 2015.
Draft Determination – What’s Changed?
Following the withdrawal of the Statement of Principles and ATO ID 2009/86, the decision in Clark and the subsequent release of the Private Ruling, it appeared that trust splitting was a viable option for family groups wishing to divide trust assets without triggering CGT.
However, under the Draft Determination, the ATO’s view is that a trust split ‘as described in this draft Determination’ will result in the creation of a trust by declaration or settlements, and will thereby trigger CGT Event E1. This is on the basis that a new trust has been created because the trustee has ‘new personal obligations and new rights have been annexed to property’.
Sound familiar? Such a view was already expressed in ATO ID 2009/86, which was withdrawn after Clark. How did the ATO reach this conclusion (again) despite Clark?
What trust splitting arrangements are included?
Unfortunately, the Draft Determination’s description of the arrangements covered by the determination is vague. The Draft Determination states that the type of trust splitting arrangements it intends to cover will exhibit ‘all or most of’ the following features:
- the trustee of an existing trust is removed as trustee of part/some of the trust assets and a new trustee is appointed to hold those assets;
- control of the original trustee is changed such that control passes to a subset of the beneficiaries of the original trust. The new trustee is controlled by a different subset of beneficiaries;
- different appointors are appointed for each trustee;
- the rights of indemnity of the trustee are segregated such that each trustee can only be indemnified out of the assets held by that trustee;
- the ‘expectation’ is that the new trustee will exercise its powers in respect of the assets it holds independently of the original trustee to benefit the subset to the exclusion of others. The original trustee will also exercise its powers in respect of the assets held by it independently of the new trustee to benefit a different subset again to the exclusion of others. This is so whether the range of beneficiaries that can benefit from particular assets is expressly limited;
- the rights, obligations and powers of the trustees and beneficiaries remain governed by the one deed; and
- the original trustee and new trustee keep separate books of account.
The Draft Determination’s reference that trust splitting arrangements will ‘exhibit all or most of’ the features above is unclear. Which of the seven features are mandatory features? Does having four features constitute having ‘most’ of the features? Will greater weight be placed on certain features compared to other features?
In addition, the Draft Determination refers to there being an ‘expectation’ that each trustee will exercise its powers to benefit one subset of beneficiaries to the exclusion of others. The concept of ‘expectation’ is ambiguous. If finalised, this test will essentially mean that the ATO could form the view that CGT event E1 occurs based on an ‘expectation’. How can an ‘expectation’ lead to a separate charter of rights and responsibilities?
Sole Example Provided in the Draft Determination
The Draft Determination provides one single example. The Draft Determination concludes that the arrangement put in place in the example ‘completely segregates the obligations, powers and rights of the trustees attached to the different assets they respectively hold’. As a result, the Draft Determination considers that each trustee has a ‘separately identifiable parcel of trust property to which their separate trust obligations (and rights, as trustee) attach comprising separate trust funds’ and the ‘separation of trust estates is expected to be borne out of the exercise of the respective trustee’s powers’. For this reason, a new trust is created by resettlement and CGT Event E1 occurs.
Unfortunately, the facts set out in the example provides limited guidance for taxpayers. In particular, the example includes a number of features that may be included in some trust splitting arrangements but will not be present in other arrangements. For instance, a trust splitting arrangement may not involve a change of appointors, or any change to each trustee’s rights of indemnity.
While we disagree with the Draft Determination, it would at least have more potential to assist if it provided more examples to demonstrate the types of trust splitting arrangements that will amount to trust resettlement (i.e. lead to CGT event E1) and those that may not.
How has the ATO (not) supported its conclusion?
The Draft Determination expressly acknowledges that there is no case law dealing directly with the CGT implications of trust splitting.
The Draft Determination cites DKLR Holdings Co (No 2) Pty Ltd v Commissioner of Stamp Duties  1 NSWLR 510 as supporting authority for the proposition that a trust is ‘created’ when there is a creation of personal obligations and rights annexed to the property.
Draft Determination goes on to briefly mention, and then dismiss, the more recent leading decisions of the High Court in FCT v Commercial Nominees of Australia(2001) 47 ATR 220 (Commercial Nominees) and the Full Federal Court in Clark. These decisions are described as of ‘minimal assistance in considering the tax implications of a trust split’. In the ATO’s view, this is because Commercial Nominees and Clark both consider the question of whether the original trust has been terminated rather than whether a new trust has been created (in addition to the original trust).
While neither Commercial Nominees or Clark considered whether a new trust was created (in addition to the original trust), we consider that this is a distinction without difference, and not a sufficient reason to conclude that the cases provide ‘minimal assistance’. Further, we consider that the cases of Commercial Nominees and Clarkare highly relevant to determining the CGT consequences of a trust split.
In Commercial Nominees, the High Court held that no new trust was created despite the changes that were made to the trust deed of a superannuation fund. This was on the basis that there was a continuing trust estate. The High Court rejected the Commissioner’s argument that ‘a new charter of future rights and obligations’ as follows:
So long as any amendment of the trust obligations relating to such trust property is made in accordance with any power conferred by the instrument creating the obligations, and continuity of the property that is the subject of trust obligation is established, there will be identity of the “taxpayer” for the purposes of section 278 and sections 79E(3) and 80(2), notwithstanding any amendment of the trust obligation and any change in the property itself.
In other words, the High Court emphasised that as long as there is continuity of the property and the amendment (e.g. change of trusteeship) was made pursuant to proper exercise of powers conferred by the trust deed, there is no trust resettlement.
In Clark, the Commissioner argued that the effect of the change to the trustee’s right of indemnity was the creation of a new trust. It was also contended that the change to the trust property and the changes in the ownership of units of beneficial entitlement to the trust property either ‘terminates the existence of the trust estate’ or ‘brings into existence a new trust estate’. These contentions were rejected by the court as follows:
We cannot accept the Commissioner’s contention. When the High Court in Commercial Nominees spoke of trust property and membership as providing two of the indicia for the continued existence of the eligible entity or trust estate, the Court was not suggesting that there had to be a strict or even partial identity of property for the first and objects for the second. It was speaking more generally: that there had to be a continuum of property and membership, which could be identified at any time, even if different from time to time; and without severance of one or both leading to the termination of the trust in question.
In addition, it was acknowledged that over the life of a trust, it is expected that there will be changes made to the trust. The Full Federal Clark agreed with this principle raised in Commercial Nominees as follows:
At  of its reasons in Commercial Nominees, the High Court observed that the nature of an eligible entity was such that changes in the incidents of the trust relationship established on its creation are not only possible, but in some respects probable… The same applies to a unit trust of the kind here under consideration.
Conclusion on Case law
The ATO acknowledge that there is no specific law on trust splitting. However, while the ATO relies on ‘trust resettlement’ principles to support the claim that trust splitting triggers CGT event E1, the Draft Determination almost entirely discounts the two most recent leading cases on this very concept of trust resettlements.
For the ATO to apply ‘trust resettlement’ principles, without appropriate consideration of Commercial Nominees and Clark, to form the view that a trust split will trigger CGT event E1 is unsatisfactory. This is heightened by the numerous changes in view that the ATO has had over time (i.e. the issue of ATO ID 2009/86, the withdrawal of ATO ID 2009/86, favourable private rulings, and now the Draft Determination).
It is proposed that the Draft Determination, when finalised, will apply both retrospectively and prospectively. Thus, taxpayers who have entered into trust splitting arrangements based on recent private ruling decisions (as well as the principles in Clarkand Commercial Nominees, and the withdrawal of ATO ID 2009/86) may be left exposed.
We consider that the Draft Determination should only apply prospectively. For example, as was the approach taken with Taxation Ruling TR 2010/3: Division 7A loans (TR 2010/3). Although TR 2010/3 was a change in interpretation regarding Division 7A, the ATO recognised that the ruling itself should not (and does not) apply to taxpayers in respect of all or part of any unpaid present entitlement that arose before 16 December 2009.
The Draft Determination draws some hardline conclusions regarding the CGT consequences of trust splitting. However, the Draft Determination fails to offer legally sound explanations or provide sufficient case law authority to support those conclusions. In addition, the position put forward in the Draft Determination represents another ‘change in interpretation’ by the ATO.
Taxpayers who are considering a trust splitting arrangement should carefully consider whether a trust split arrangement is the best way to achieve their desired objectives. Finally, because the Draft Determination is proposed to have retrospective effect, taxpayers who have implemented trust splitting arrangements, who have not obtained a favourable private ruling, should seek advice immediately.
 The application of stamp duty to trust splitting arrangements is beyond the scope of this article.
 ATO Decision Impact Statement on Commissioner of Taxation v Clark  FCAFC 5, 28 October 2013.
 Private Ruling Authorisation Number: 1012921290075, 3 December 2015.
 TD 2018/D3, bullet point 5 of paragraph 2.
 TD 2018/D3, paragraph 11.
 TD 2018/D3, paragraph 11.
 TD 2018/D3, paragraph 15.
 TD 2018/D3, paragraph 18.
 TD 2018/D3, paragraph 21.
 TD 2018/D3, paragraph 23.
 Commissioner of Taxation v Clark  FCAFC 5, paragraph 80.
 Commissioner of Taxation v Clark  FCAFC 5, paragraph 86.
 Commissioner of Taxation v Clark  FCAFC 5, paragraph 82 and 87.
 Commissioner of Taxation v Clark  FCAFC 5, paragraph 84.
 TD 2018/D3, paragraph 23.
 TR 2010/3, paragraph 16, 28 and 29