Issue 2 : Trust cloning

Issue 2

2008-09 Budget and CGT CGT 30 June planning Consolidation regime 2008-09 improvement threshold What is income? Amendment of assessments for CGT Trust cloning CGT market value substitution rule Amounts misappropriated by employee or agent Default by borrower on unsecured note – no CGT event McNeil’s case amendments Wash sales Deferred purchase agreement warrants CGT STATUS REPORT

A paper entitled “Some CGT Aspects of ‘Trust Cloning’ – an ATO Perspective” was delivered by Glen Davies on 29 April 2008 at a Taxation Institute seminar.  The paper  considers some significant aspects of issues associated with “trust cloning” when seeking to take advantage of the exemption from the happening of CGT events E1 and E2 where the two trusts have the same beneficiaries and terms. 

The paper states that “failsafe” clauses have been suggested. The ATO’s understanding is that a failsafe clause is a clause inserted into the trust deed for the new trust to the effect that the new trust has the same terms with the same meaning and effect as the original trust, and any clause that would have a different meaning and effect is struck down. Whatever the effectiveness of this type of drafting technique, it presumably can only be effective to the extent that it is in fact possible to make all of the beneficiaries and terms the same.

Possible solutions to widely drawn beneficiary clauses

The paper notes that a number of approaches have been suggested to “get around” the difficulty posed by widely drawn beneficiary clauses. One involves amending the deed for the original trust to exclude the new trust, and not including the original trust as a beneficiary of the new trust. The argument is that the amendment to the original trust will not cause a resettlement (as it only narrows the objects that the trustee has to consider).

Another approach (which avoids the need to amend the deed of the original trust) involves a disclaimer by the trustee of the new trust of its interest in the original trust, and again not including the original trust as a beneficiary of the new trust. (There are issues as to whether the disclaimer should be effected in the deed of the new trust or outside it, and whether, if it is included in the deed of the new trust, the new trust then has a term that the first trust does not have.)

Another possible approach involves the deed for the new trust providing that the term “beneficiary” has the same meaning as it has in the deed for the original trust. The deed for the new trust also makes it clear that no person can benefit under its terms unless that person is a beneficiary under the terms of the original trust, and the deed says it is intended that beneficiaries of the new trust shall be the same as the beneficiaries of the original trust so that the trusts may satisfy the requirements of sec 104-60(5)(b) ITAA 1997.This seems to ensure that the original trust is not a beneficiary of the new trust (because the original trust cannot be a beneficiary of itself and therefore cannot be a beneficiary of the new trust).   However, it is not clear to the ATO how this approach actually prevents the new trust from being a beneficiary of the original trust.

The general anti-avoidance provisions (Part IVA ITAA 1936) may be a relevant consideration when looking at the steps taken to remove or eliminate so-called “cross-holdings” between the two trusts. In this regard, the ATO would say that, in substance, a disclaimer (or implied disclaimer) by the new trust is no different from an amendment to the original trust excluding the new trust from benefiting. That is, regardless of which technique is used – disclaimer or amendment – the end result is that the new trust cannot benefit under the original trust.

Also, issues may arise as to the source of the power of the trustee of the original trust to transfer the asset to the new trust for less than market value consideration if the new trust’s beneficial interest in the original trust is removed – depending on whether other terms may be relied on, whether a power can be inferred or whether consents of the beneficiaries may be required.

Some further points

Other points made in the paper are:

• the exception will not applyif both trusts have the same settlors but different persons (called “notional settlors”) have contributed to the trust after the initial settlement (of, say, $10) and both trusts have a clause excluding notional settlors from benefiting.  In that case, any person who has made a subsequent contribution to the original trust is excluded from benefiting under the original trust, but not the new trust. And any person who has made a subsequent contribution to the new trust is excluded from benefiting under the new trust, but not the original trust.  It may be that the “original trust” is a notional settlor in respect of the new trust to the extent that they have transferred the assets to the new trust for less than market value consideration. Also, the original trust cannot, of course, be a beneficiary of itself. Together, those two factors would mean that, in this example, the original trust is a beneficiary of neither trust. The ATO is considering whether any other ramifications flow from the original trust being a notional settlor of the new trust. It may depend on the terms of the trusts;

• the exception will not apply if both trustees have the power to appoint additional beneficiaries and the trustee of the original trust has exercised that power, but the beneficiaries so appointed to the original trust are not included as beneficiaries of the new trust; 

• the exception will not apply if the trusts have different settlors and both trustees have a power to invest the trust fund in any loan to any person (other than the settlor or a person who has made an addition to the settlement); 

• the exception will not apply if the trusts have different establishment dates and both have a clause that includes in the class of general beneficiaries any person who has donated more than $5,000 to a named charity after the trust’s establishment;  and

• the exception may not apply if the trustee of the original trust has the power to treat income accumulated to capital before 30 June 2000 as income available for distribution to beneficiaries and the new trust is established in June 2008.  Assuming that, at the date of the asset transfer, the trustee of the original trust retains such capital, it could then be said that the trustee of the original trust has a power that the trustee of the new trust does not. While the new trust may contain the same clause, it could be argued that it does not amount to a power in respect of the trustee of the new trust because there is no possibility (given the establishment date of the new trust) of the new trustee obtaining such property.

Other examples are given in the paper.  It seems that not all of the problems identified are insuperable.

For binding rulings issued by the Commissioner on the same beneficiary’s exemption, see TD 2004/14 and TR 2006/4.

For the text of the paper, click here.

Disclaimer
The material contained in this publication is of a general nature and is not advice. No representation or warranty is made as to its correctness. Readers must obtain their own professional advice before making any decisions as to their own or their clients’ affairs.

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