Capital Gains Tax: trust split - appointing a new trustee - CGT event E1

Does capital gains tax (CGT) event E1 in section 104-55 of the Income Tax Assessment Act 1997 (ITAA 1997) happen if, in the circumstances outlined in the facts below, a new trustee is appointed to CGT assets forming part of the property of a trust and those assets are transferred to the new trustee?

Yes. CGT event E1 in section 104-55 of the ITAA 1997 happens because, in the circumstances outlined in the facts below, a new trust is created (by settlement) in respect of the CGT assets to which the new trustee is appointed. The event happens in respect of each CGT asset when it is transferred to the new trutee.

A family discretionary trust was settled for the primary purpose of benefiting members of the X family. It was called the X Family Trust.

However, the class of persons entitled to benefit under the trust was widely-drawn, such that the trustee also had the power to appoint income and capital to members of the Y family (who are relatives of the X family).

In June 2008, pursuant to a power contained in the trust deed, the appointor of the X Family Trust appointed a new trustee to CGT assets forming part of the trust property (namely 100 units in a unit trust). These assets were to be held on the same terms as contained in the original settlement in respect of the X Family Trust.

The trust deed governing the X Family Trust also provided that, on the appointment of a new trustee, the original trustee was obliged to convey relevant assets to the new trustee and to take all steps necessary to enable that to happen. It also made provision for the trust in respect of the assets transferred to the new trustee to have a different appointor from those assets retained by the original trustee.

The new trustee was a company controlled by the Y family. The objective was that the Y family should obtain exclusive benefit of the property to which the new trustee was appointed.

The remainder of the trust's property continued to be held by the original trustee.

The new trustee was appointed by a deed entered into by the appointor, the original trustee and the new trustee. The deed provided that: • Upon appointment of the new trustee in respect of some of the trust's assets, the original trustee undertook to transfer those assets to the new trustee. • The original trustee released the new trustee from any rights the original trustee may have to be indemnified (in respect of expenses incurred by the original trustee in the proper administration of the trust) out of assets now held by the new trustee. • The new trustee released the original trustee from any rights the new trustee may have to be indemnified (in respect of expenses incurred by the new trustee in the proper administration of the trust) out of assets that continue to be held by the original trustee. • The fiduciary or other obligations owed by each trustee to the beneficiaries shall be only in respect of the assets they hold following the appointment of the new trustee. • Each trustee is obliged to keep separate accounts in respect of the property held by it.

On the same day as the appointment of the new trustee, the original trustee transferred the 100 units to the new trustee by executing a 'Unit Transfer Form'.

Immediately following the appointment of the new trustee and the transfer of relevant assets to it, the trust deed of the X Family Trust was amended to change its name (to the Units Family Trust) insofar as it related to the assets held by the new trustee.

The appointment of the new trustee was part of a broader family restructure designed to split certain assets between the X and Y families. The broader arrangement was supported by a family agreement. Under that agreement the X family undertook to hold on a bare trust for the Y family any distributions received by the X family in respect of the assets to which the new trustee was appointed (as such assets were intended to benefit the Y family). Note: Because the new trustee holds its assets on the terms set out in the deed for the X Family Trust, it is conceivable that the X family could continue to benefit in respect of those assets (even though the Y family are intended to have the exclusive benefit of them); for example, in default of the new trustee making a determination to distribute them on the vesting of the trust. Thus the presumed need for the family agreement.

The appointment of a new trustee to a part of the trust property is sometimes referred to as 'trust splitting'. The relevant parties in this case argued that splitting the trust's assets between different trustees in the manner outlined above did not trigger a CGT event because, following the split, there continued to be a single trust.

CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement (subsection 104-55(1) of the ITAA 1997). The time of the event is when the trust over the asset is created (subsection 104-55(2) of the ITAA 1997).

However, CGT event E1 does not happen if the trust is created by transferring the asset from another trust and the beneficiaries and terms of both trusts are the same (paragraph 104-55(5)(b) of the ITAA 1997).

It is considered that a new trust is created in respect of those CGT assets of the X Family Trust to which a new trustee is appointed and which are transferred to the new trustee.

There has been a substantial alteration of the trust relationship in respect of the transferred assets. The trustees' rights will be altered in that the assets to which the new trustee is appointed will be excluded from the class of assets from which the original trustee is entitled to be indemnified for expenses properly incurred.

The rights of beneficiaries have been altered in that the class of persons who can benefit from the transferred assets has essentially been narrowed. That is, it is clear that the assets held by the new trustee are to be held for the exclusive benefit of the Y family (see particularly the family agreement whereby the X family agree to hold on a bare trust for the Y family any distributions received by the X family in respect of the assets to which the new trustee was appointed). See also Creation of a new trust - Statement of Principles, August 2001 (withdrawn on 20 April 2012).

Upon appointment of the new trustee in respect of particular assets of the X Family Trust, the original trustee is obliged (under the trust deed) and undertakes (under the deed of appointment of new trustee) to convey title in those assets to the new trustee and to execute relevant documentation to enable that to happen. In fulfilling its obligation to transfer the assets to the new trustee, the original trustee settles those assets on a new trust.

It is the actions of the original trustee in transferring the assets to the new trustee that cements the new trust relationship in respect of them, and it is those actions that cause CGT event E1 to happen.

Further, the conditions for the same trust exception in paragraph 104-55(5)(b) of the ITAA 1997 are not met in this case. The test of sameness is a strict one and even minor differences may prevent the exception applying (see Taxation Ruling TR 2006/4).

In this case, differences which prevent the application of the exception include the prospect that the two trusts may have different appointors, and the fact that the two trusts have widely-drawn beneficiary clauses (such that the trustee of the (new) Units Family Trust is a beneficiary of the (original) X Family Trust and vice versa, but neither is a beneficiary of itself).

Therefore, CGT event E1 happens in respect of each CGT asset of the X Family Trust when it is transferred to the new trustee. The original trustee will make a capital gain in respect of a transferred asset if its capital proceeds from the creation of the new trust over the asset are more than the asset's cost base. It will make a capital loss if its capital proceeds are less than the asset's reduced cost base (see subsection 104-55(2) and subsection 104-55(3) of the ITAA 1997). Note: The 'same trust' exception in paragraph 104-55(5)(b) of the ITAA 1997 has been repealed by Tax Laws Amendment (2009 Measures No. 6) Act 2010 and does not apply to CGT events happening on or after 1 November 2008.