Tag Archives: trust deeds

Changing the trustee of a trust – some elements for success

It is sometimes wrongly assumed that a minute of the current trustee is sufficient to change the trustee of:

  • a family discretionary trust (FDT); or
  • a self managed superannuation fund (SMSF) (which must be a trust with a trustee too – see sub-section 19(2) of the Superannuation Industry (Superannuation) Act (C’th) 1993 (SIS Act));

and that a change of trustee will have no serious tax consequences. The second proposition is more likely to be true, but not always.

FDTs and SMSFs invariably commence with a deed which contains the terms (the trust terms or governing rules – TTOGRs) on which the trust commences. That, in itself, is a reason why I contended in 2009 in Redoing the deed that an instrument or resolution less than a deed to change the trustee is prone to be ineffective even where change by less than or other than a deed is stated to be permitted by the TTOGRs in the trust deed.

Changing trustee relying on ability to change in the trust deed

It is thus to the trust deed that one needs to look to find:

  1. whether there is a power in the TTOGRs to appoint a new trustee or to otherwise change the trustee; and
  2. if, so, what the procedure or formalities are for doing so.

Changing trustee relying on the Trustee Acts

If ability to change trustee is not present, or is derelict, in the TTOGRs then the Trustee Acts in states (and territories) provide options for appointing a new or additional trustee which vary state to state.

Trustee Act – New South Wales

In New South Wales: section 6 of the Trustee Act (NSW) 1925 allows a person nominated for the purpose of appointing trustees in the TTOGRs, a surviving trustee or a continuing trustee to appoint a new trustee in certain specified situations such as where a trustee:

  • has died;
  • is incapable of acting as trustee; or
  • is absent for a specified period out of the state.

However an appointment of a new trustee in these situations must be effected by registered deed: sub-section 6(1) That is the deed of appointment must be registered with the general registry kept by the NSW Registrar-General, which is publicly searchable, and the applicable fee to so register the deed must be paid to NSW Land Registry Services for the appointment to take effect.

It is apparent from sub-section 6(13) that registration of a deed of appointment is not required where ability to appoint a new trustee is in the TTOGRs where the TTOGRs express a contrary intention; that is: where the TTOGRs expressly and effectively allow an appointment to be effected without a registered deed.

Trustee Act – Victoria

In Victoria there is a comparable capability for a person nominated for the purpose of appointing trustees in the TTOGRs, a surviving trustee or a continuing trustee to appoint a new trustee in writing in certain specified situations such as where a trustee:

  • has died;
  • is incapable of acting as trustee; or
  • is absent for a specified period out of the state;

under section 41 of the Trustee Act (Vic.) 1958. However this Victorian law does not impose any requirement that the required instrument of appointment in writing must be registered.

Changing trustee by obtaining a court order

The supreme courts of the states and territories are also given a residual statutory capability to appoint trustees under the respective Trustee Acts. However applying to a supreme court for an order to change a trustee of a FDT or a SMSF with sufficient supporting grounds is an option of last resort given likely significant costs and uncertainties of obtaining the order.

Changing trustee by deed

The TTOGRs in a trust deed of a FDT or a SMSF will frequently require that an appointment of a new trustee may or must be effected by a deed. It is desirable that it should do so to ensure the appointment of a new trustee does not become of a matter of uncertainty and difficulty for the reasons I have described in Redoing the deed.

Tax consequences of a change of trustee

As a change of trustee without more generally does not change beneficial entitlements under a trust, the tax consequences are usually benign:

For capital gains tax (CGT), assurance that changing trustee does not give rise to a CGT event for all of the CGT assets held in a trust is diffuse under the Income Tax Assessment Act (C’th) (ITAA) 1997:

Sub-section 104-10(2) concerning CGT event A1 states:

(2) You dispose of a * CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event A1 will not happen merely because of a change in the trustee.

Sub-section 960-100(2) with the Notes below it in fact say:

(2) The trustee of a trust, of a superannuation fund or of an approved deposit fund is taken to be an entity consisting of the person who is the trustee, or the persons who are the trustees, at any given time.

Note 1: This is because a right or obligation cannot be conferred or imposed on an entity that is not a legal person.

Note 2: The entity that is the trustee of a trust or fund does not change merely because of a change in the person who is the trustee of the trust or fund, or persons who are the trustees of the trust or fund.

Similarly sections 104-55 and 104-60 of the ITAA 1997 which concern:

• Creating a trust over a CGT asset: CGT event E1

• Transferring a CGT asset to a trust: CGT event E2

each restate the above Note: viz.

Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event E… will not happen merely because of a change in the trustee.

Stamp duty

A change of trustee can have stamp duty consequences where the trust holds dutiable property such as real estate.

Duty – NSW

Concessional stamp duty on the transfer of the dutiable property of the trust to the new trustee can be denied in NSW to a FDT unless the trust deed of the trust limits who can be a beneficiary, for anti-avoidance reasons: see sub-section 54(3) of the Duties Act (NSW) 1997.

Indeed Revenue NSW withholds the requisite satisfaction in sub-section 54(3) unless the TTOGRs provide or have been varied in such a way so that an appointed new trustee or a continuing trustee irrevocably cannot participate as a beneficiary of the trust. Contentiously satisfaction is withheld by Revenue NSW unless a variation to a FDT to so limit the beneficiaries is “irrevocable“ : see paragraph 6 of Revenue Ruling DUT 037, even though that variation may not be plausible or permissible under the TTOGRs of the FDT.

This hard line is taken by Revenue NSW to defeat schemes where someone, who might otherwise be a purchaser of dutiable property who would pay full duty on purchase of the property from the trust, becomes both a trustee and beneficiary able to control and beneficially own the property who is thus able to contrive liability only for concessional duty and avoid full duty,

Duty – Victoria

Although the Duties Act (Vic.) 2000 contains anti-avoidance provisions addressed at this kind of anti-avoidance arrangement, there is no comparable hard line to that in NSW in sub-section 33(3) of the Duties Act (Vic.) 2000 so that the transfer of dutiable property, including real estate, on changing trustee is more readily exempt from stamp duty.

Other requirements

A prominent requirement on changing trustee of a SMSF is notification to the Australian Taxation Office, as the regulator of SMSFs, within twenty-eight days of the change: see Changes to your SMSF at the ATO website.

Where changing trustee involves a corporate trustee then there may also be an obligation to inform the Australian Securities and Investments Commission of changes to details of directors of the corporate trustee, if any. There may be further matters to be addressed if any new or continuing directors are or will become non-residents of Australia and, with SMSFs, the general requirement in section 17A of the SIS Act that the parity between members of the fund on the one hand and trustees, or directors of the corporate trustee on the other, needs to borne in mind and, if need be, addressed.

Full Federal Court pinpoints year end trust resolutions that fail

failContractual principles apply to construe trust resolutions

The Full Court of the Federal Court in Lewski v. Commissioner of Taxation [2017] FCAFC 145 has given us a roadmap to construing trust resolutions in line with principles for the construction of contracts, from Byrnes v Kendle [2011] HCA 26, and has applied two of those principles of contractual construction to pinpoint invalid trust resolutions as follows:

  • an invalid trust resolution can be severed from another valid resolution or resolutions so that those resolutions can stand, but only if those resolutions are not interdependent with the invalid resolution and it is not artificial for them to stand severed from the invalid resolution; and
  • if there are two open constructions of a trust resolution, one of which results in validity and one of which results in invalidity, the construction that preserves validity is to be preferred.

Trust resolutions to confer a present entitlement to discretionary trust income

An Australian tax resident beneficiary must be presently entitled to the income of a discretionary trust in the income year in which income has earned by the trust before the relevant share of that income can be included in the assessable income of the beneficiary: sub-section 97(1) of the Income Tax Assessment Act (ITAA) 1936. If it cannot be shown that:

"the beneficiary has an interest in the income which is both vested in interest and vested in possession; and (b) the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment."  

High Court in Harmer v. Commissioner of Taxation (1991) 173 CLR 264 at p. 271

then the beneficiary is not presently entitled to the relevant share of income with section 99A of the ITAA 1936 applying to tax the trustee on the income to which no beneficiary is presently entitled at the highest individual marginal income tax rate.

Ownership and present right to demand payment

“Vested in interest” and “vested in possession” are technical concepts which broadly equate to ownership, and the extent of ownership required for present entitlement is ownership of the share of income sufficient to bestow a present legal right to demand payment of the income. The legal right to demand and receive payment of an ascertainable entitlement to a share of income must be present and fully defined in the income year even if the entitlement cannot be numerically ascertained due to accounts not having been taken by the end of the relevant income year. In a discretionary trust the trustee is generally reliant on a valid year end trust resolution to distribute income of the trust to confer a sufficient present entitlement to the income of a discretionary trust on a beneficiary so that section 99A will not be attracted.

After Bamford

We have known, especially since 2011, when the Commissioner of Taxation came to take a harder and more sophisticated line on year end trust resolutions following the High Court decision in Commissioner of Taxation v Bamford [2010] HCA 10 and the Tax Laws Amendment (2011 Measures No. 5) Act 2011 introduced in response to the Bamford decision; that the form of the year end trust income distribution resolution is vital to the taxation of discretionary distributions to beneficiaries.

Construing the Lewski trust resolutions

In Lewski discretionary trust resolutions to distribute income were stress tested for present entitlement, meaning and validity to determine where liabilities to tax lay.

The Commissioner, in amended assessments issued to Ms. Lewski, and the Administrative Appeals Tribunal (“AAT”) at first instance, disallowed carry forward tax losses to discretionary trusts and assessed trust income of $10,108,621 and $3,143,199 to Ms. Lewski as a presently entitled beneficiary of each trust under sub-section 97(1). Ms. Lewski sought to reduce or deflect the tax liability on this income by claiming that, alternatively:

  • the carry forward trust losses should have been allowed as deductible to the trusts;
  • her entitlements to the income of the trusts had been disclaimed;
  • the trust distributions were ineffective as they were made in a manner beyond the power of the trustees; and
  • Ms. Lewski was not presently entitled to the trust distributions;

which the Commissioner disputed.

The strategy of Ms. Lewski was to reduce the liability to tax or to deflect liability to tax under the amended assessments elsewhere, whether to the trustees of the trusts on income to which no beneficiary was presently entitled under section 99A or to default beneficiaries of the trusts, companies ACUPL and AISPL respectively (abbreviated), claimed to be entitled to the adjusted income of the trusts under the amended assessments instead of Ms. Lewski. It is supposed that, in both income years, less tax was recoverable by the Commissioner in those cases than if Ms. Lewski was presently entitled as a beneficiary of the trusts to the adjusted income.

Ms. Lewski wins

Before the Full Court of the Federal Court Ms. Lewski successfully challenged the disallowance of the tax losses and thus won her appeal against the imposition of the tax liabilities.

Resolutions under scrutiny

The applicable year end trust resolution documents distributed the income of the trusts:

2006 year:

100% to Ms. Lewski

2007 year:

the first $3.5 million to AISPL and the balance to Ms. Lewski.

In each resolution document, there was also a ‘variation of income’ resolution to the effect that, should the Commissioner disallow any amount claimed as a deduction or include any amount of the deduction in the assessable income of the trust, there would be a “deemed” distribution to the default beneficiaries (in the 2006 year, 100% to ACUPL; in the 2007 year, 100% to AISPL).

The “variation of income” resolutions made the 2006 year and 2007 year distributions contingent on events that could occur after the end of those years of income respectively. The Commissioner contended that the variation of income resolutions, which were of doubtful validity, could be severed from the valid resolutions in the resolution documents distributing the income of the trusts. Applying the principles and authorities relating to the severance of provisions in contracts the court did not accept this approach. The distribution resolutions and the variation of income resolutions where found to be interdependent and so the variation of income resolutions could not be “severed” from the distribution resolutions with the effect that either:

  • each purported income distribution was subject to a live contingency in the variation of income resolutions after the end of the applicable income year – the court’s preferred view; or
  • the distributions failed as the interdependent variation of income resolution was invalid in each case – the court’s alternative view;

defeating the present entitlement of Ms. Lewski to the income of the trusts at the end of the year of income of each trust in either case.

The trust deeds of each of the trusts contained notably complicated clauses for the ascertainment and distribution of the income of the trusts. Ms. Lewski contended that the distribution of “income” in the trust resolutions, rather than “net income”, was beyond the power of the trustees and so failed as resolutions beyond the power of the trustees given in the trust deeds. The court rejected this contention after applying the contractual principle that where there are two open constructions of a provision, the construction of the provision that preserves validity is to be preferred. From that perspective “income” in the trust resolutions could be treated as meaning “net income”.

Construing income equalisation clauses

Two aspects of the Full Federal Court decision in Lewski are useful in construing income equalisation clauses in discretionary trust deeds.

Generally an income equalisation clause sets the net income of the trust to which sub-section 97(1) applies, being “trust income” or “distributable income” identified in Bamford, equal to the net income of the trust under section 95 of the ITAA 1936. Understanding that the Commissioner can amend the net income of the trust under section 95 by an amended assessment well after the end of the income year, can this contingency affect the “trust income” or “distributable income” by which the shares and proportions of income distributed to beneficiaries are ascertained?

The preferred construction, if available, of an income equalisation clause is that “trust income” is set to the net income of the trust under section 95 of the ITAA 1936 based on understandings that are ascertainable at the end of the year of income when the income distribution is made. In other words the taxable income of the trust that is ascertainable. That follows from Lewski where the court found, in the context of distributions asserted by Ms. Lewski to be beyond the power of the trustees, that where there are two open constructions of a trust distribution resolution, the construction which results in validity is to be preferred to the construction which results in invalidity.

“Trust income” needs to be closed at year end

To sustain a valid construction an income equalisation, effectuated by an income equalisation clause in a discretionary trust deed, needs to be a closed parameter at the end of a year of income. If the parameter is open, that is, if “trust income” or “distributable income” identified in Bamford is not fully ascertainable by the end of the applicable income year using the income equalisation mechanism in a trust deed, then a distribution based on trust income reliant on that mechanism will not confer a present entitlement and section 99A can apply to the income purportedly distributed as income to which no beneficiary is presently entitled.