Australia: Tax effective trust deeds - part 2

3. STREAMING PROVISIONS

Why the trust deed must include streaming provisions

The explanatory memorandum that accompanied the legislation that introduced the streaming measures made it clear that trusts could only stream capital gains and franked dividends if the trust deed contained express provisions allowing this. In particular, paragraph 2.35 of the EM contained the following statement.

What is required to have an effective streaming provision?

Neither the legislation nor the EM provide any guidance as to what is required for an effective attribution clause but some guidance can be obtained from Taxation Ruling TR 1992/13. This ruling was withdrawn following the decisions in Bamford and Greenhatch but the following comments on what is required for an effective attribution clause are still relevant.

The ATO view in that ruling can be summarised as follows.

• The trust deed should contain a clause that expressly empowers a trustee to selectively allocate particular types of income to beneficiaries.
• The accounting records of the trust must be maintained in such a way that each class of income derived by the trustee can be identified and traced... into a share of the income of the trust distributed to the beneficiary.

Taxpayers are unlikely to have any issues in applying the statutory streaming provisions if there is an express clause in the deed along the following lines:

In determining the net income or making any determination to distribute or accumulate net income, the Trustee may:

1. identify an amount by reference to its character or description in the Tax Acts;
2. account separately for that amount; and
3. make a determination to pay, apply, transfer or set aside or accumulate in respect of the whole or part of that amount.

Importance of trust distribution minutes when streaming capital gains or dividends

In addition to having an effective attribution clause in the trust deed, trustees need to take care in drafting distribution minutes if they want to stream capital gains or franked dividends to particular beneficiaries given the statement of the ATO in TR 1992/13 that 'each class of income derived by the trustee can be identified and traced, less expenses, into a share of the income of the trust distributed to the beneficiary'.

The approach we recommend is as follows:

• The distribution resolution should record whether the trust deed has a definition of income and whether the trustee has a discretion to apply that definition or adopt some other concept of income.
• If the trustee has a discretion, the resolution should state what concept of income is being adopted for the year in question.
• The resolution should identify the capital gains or franked dividends and the 'net financial benefit' from those gains or dividends (or how the net financial benefit will be calculated);
• There should be separate resolutions in relation to capital gains and franked dividends if the trustee wants to stream these to specific beneficiaries.

Is it possible to stream classes of income other than capital gains and franked dividends?

Primary production income

When the CGT and dividend streaming measures were introduced in 2011 the 1997 Act was also amended to allow a limited concept of streaming where a trust derives primary production income. The measures (to the extent they are relevant to this paper) provide as follows

The effect of these provisions is that, if a discretionary trust carries on a primary production business, all beneficiaries who are presently entitled to at least $1,040 of the trust income will be deemed to also be carrying on a primary production business.

Other income

Prior to the decision in Bamford, the ATO view was that it was possible to stream different types of income to particular beneficiaries provided the deed had an adequate attribution clause²⁹.

However, as a result of the decision in FCT v Greenhatch,³⁰ it is now clear that, apart from the statutory exceptions, income derived by a trust does not retain its character when distributed to beneficiaries.

4. AMENDING TRUST DEEDS – HOW FAR CAN YOU GO?

A discretionary trust deed should provide flexibility for the clients to vary the deed to deal with changes in their circumstances or in legislation effecting the trust.

Therefore, unless there are specific reasons to limit the scope of the variation power, the amendment clause should be as wide as possible.

It is also imperative when amending a trust deed to carefully read the deed to ensure that the powers are wide enough and that any procedures in the deed are followed. For example, advisers need to check the provisions of the deed to ascertain:

• whether the power of variation allows amendments of all provisions in the deed (including schedules) or only limited provisions;
• who has the power to make the change (e.g. the trustee or appointor);
• the procedures for variation (e.g. by deed, minute or notice in writing);
• whether it is necessary to obtain the consent of any party such as the appointor or guardian; and
• whether there are any specific restrictions on the power of variation (e.g. prohibiting amendment of certain clauses).

A failure to comply with procedural requirements may result in a purported variation being ineffective as illustrated by the decisions in Re Cavill Hotels Pty Ltd. ³¹ and Idlecroft v Commissioner of Taxation.³²

In Cavill the trust deed empowered the trustee to vary the provisions of the second schedule to the deed 'by adding the name of any person' and also 'by deleting the name of any Capital Beneficiary'. The trustee purported to vary the deed by deleting various categories of beneficiaries (e.g. a group described as 'Family Beneficiaries').

The court held that the variation was invalid because, to effectively remove a beneficiary, the deed of variation had to refer to the beneficiary by name not by reference to a class of eligible beneficiaries. Willams J had this to say:

Is the proposed amendment within the scope of the power of variation

There are many varieties of trust deed in circulation, and the wording of the common variation powers can be significantly (or subtly) different. Some examples of common wording for variation clauses in trust deed are as follows:

Example 1

Example 2

The first example was the variation clause in the deed considered in Jenkins v Ellett³⁴ where the facts were as follows.

• The original Principal was George Jenkins who was also a trustee along with Luciano Menniti.
• Part 9 of the schedule to the deed provided that, on George's death, his executor became the Principal.
• In 1999, George used his power as Principal to remove Luciano as trustee, and replaced him with Joyce Ellett.
• Then, he and Joyce (as trustees) purported to amend the deed to appoint Joyce as Principal in place of George.

The question was whether the 1999 deed appointing Joyce Ellett as Principal was valid. Douglas J held that the variation power did not authorise an amendment to the definition of 'Principal' in the schedule to the deed for a number of reasons.

• Although, the deed defined the term 'this Trust' to mean 'the trust constituted by and comprised in this Deed and the Schedule', the variation clause, when specifying what could be varied, did not refer to 'this Trust' but instead referred to 'the Trusts declared'.
• His Honour held that the purported change of Principal was not a variation of 'the Trusts declared' and was invalid.

A similar outcome occurred in Mecanti v Mercanti³⁵. The deed in that case permitted the trustee to 'revoke add or vary all or any of the trusts hereinbefore provided...'. The court held that the identity of the Appointor was not 'any of the trusts hereinbefore provided' and therefore a variation deed purporting to change the appointor was not valid.

The clause in the second example is slightly different to that in the deed for Jenkins v Ellett but the differences are material, in particular because of the further words that 'define' the expression 'trust or powers' as including all of the provisions of the deed.

Many deeds that have a variation clause similar to this also contain a further interpretive provision that stipulates the 'deed' includes the schedules attached to the deed – which is desirable.

Our view is that an amendment clause that is similar to example 3 below is to be preferred as it makes it clear that the trustee can vary all provisions of the deed, including the schedules.

Example 3

How far can you go without triggering a resettlement?

When varying a trust deed it is important to consider the broader duty and tax implications and particularly whether the proposed variation might trigger a resettlement.

However, the risk of a variation of trust or change in beneficiaries triggering a resettlement is substantially reduced as a consequence of the decision in Commissioner of Taxation v Clark³⁶ and the subsequent release of Taxation Determination TD 2012/21.

Prior to these developments there was a good deal of confusion about what constituted a resettlement – or at least what the ATO considered was a resettlement. In Buzza v Controller of Stamps (Vic)³⁷ Dixon J unhelpfully said, "it is notoriously difficult to define a settlement, but that does not mean that it is difficult to recognise one." ³⁸

The High Court decision in FCT v Commercial Nominees of Australia Ltd ³⁹ should have clarified the position but it concerned changes to the deed for a superannuation fund and the ATO initially refused to accept that the principles outlined in Commercial Nominees applied to other trusts.

In Commercial Nominees the High Court considered that, notwithstanding the quite dramatic changes that were made to the trust deed and the structure of the superannuation fund, the original fund "did not come to an end" but that continued as the same entity.

The fact that the original trust deed provided the trustee with the power to make the changes was a significant factor in the Federal Court decision which was appealed to the High Court.⁴⁰

In Clark, the Federal Court (both at first instance⁴¹ and on appeal) indicated that the principles enunciated in Commercial Nominees are not confined to superannuation funds and are equally applicable to other trusts. Importantly, all members of the Full Court followed the approach of the High Court in Commercial Nominees.

Dowsett J cited the following passage from the High Court decision in Commercial Nominees as summarising the correct approach in determining whether there is a resettlement: ⁴²

The ATO subsequently issued Taxation Determination TD 2012/21 which can be summarised as follows:

• The previous approach of the ATO 'is not sustainable'.
• The principles in Commercial Nominees are relevant in determining whether there is a resettlement of an existing trust.
• An amendment will not trigger a resettlement unless the variation of the trust 'causes the existing trust to terminate and a new trust to arise for trust law purposes'.
• Clark 'is authority for the proposition that, assuming there is some continuity of property and membership of the trust, an amendment of the trust that is made in proper exercise of a power of amendment contained under the deed will not have the result of terminating the trust, irrespective of the extent of the amendments so made so long as the amendments are properly supported by the power'.⁴³
• However there may be some instances where, although a variation to a trust deed does not result in a resettlement, the change may result in some assets being held on a different trust. Commissioner of State Revenue v Lam and Kym Pty Ltd⁴⁴ and Oswal v Commissioner of Taxation⁴⁵ illustrate how this might occur.

Therefore, provided that a proposed amendment is within the powers under the deed and there is continuity of at least some of the three essential elements of the trust (as specified in Commercial Nominees) it is unlikely that a variation will trigger a resettlement for tax purposes.

Can you amend a troublesome variation clause?

A question that often arises where there is a restriction in the power of variation, is whether the deed can be amended to remove that restriction. While the answer to this question will often depend upon exactly what is the nature of the restriction that is imposed and the scope of the power of variation, the general principle appears to be that a power of variation will not generally allow an amendment removing a restriction on the exercise of that variation power.⁴⁶

One argument as to why such a restriction should not be capable of amendment is that the trustee has a primary obligation to adhere to the terms of the trust deed.⁴⁷

The scope of powers of amendment in trust deeds is discussed in Thomas on Powers. ⁴⁸ In that text the author makes the following comments:

There are also a number of authorities involving amendments to superannuation and pension deeds which suggest that the power of variation cannot be used to remove restrictions on that power.

For example, in UEB Industries Ltd v Brabant⁵⁰ Cook P (with whom the majority agreed) held that the power of amendment in the deed did not extend to removing a restriction on the exercise of that power. These superannuation cases need to be considered in the context that superannuation and pension deeds are a special class of trust which are different from traditional trusts because they are based on a contract between the employer, trustee and employees.⁵¹

There is also a general principle that it is not permissible to do indirectly what is prohibited directly because this might constitute a 'fraud on the power'.⁵²

For example, if a trust deed prohibits distributions to a particular person, a variation that allowed the trustee to distribute to another trust of which that person is a beneficiary might be held to be void as being a fraud on the power.

A power given to a trustee under a deed can only be exercised for the purpose for which it is given and not an ulterior purpose. If the trustee attempts to exercise that power for an ulterior purpose, this may constitute a fraud on the power which means the variation would be void. This is a long-standing principle of trust law and is outlined in the House of Lords decision in Duke of Portland v Topham:⁵³

In determining the purpose of the exercise of a power, the court will have regard not just to the terms of the power in the deed but also the surrounding the circumstances and practical effect of the exercise of the power.⁵⁴

5. PERPETUITY PERIOD ISSUES

The rule against perpetuities or rule against remoteness of vesting, prevents the creation of trusts over property which are to vest at too remote a time. Under the general law this required that a trust must vest within 21 years of the date of death of a person alive at the date the trust was created (perpetuity period).

The common law rule was summarised by the Privy Council in Air Jamaica Limited v Charlton⁵⁵:

A significant risk factor with the general law rule was that, if when the trust was established there was any possibility the trust might vest outside the perpetuity period, it was void from inception.

These general law principles have been relaxed somewhat by statutory provisions in most states which allow the trust deed to stipulate a fixed perpetuity period that does not exceed 80 years.⁵⁷ These provisions also adopt a 'wait and see rule' so that a trust that might vest outside the perpetuity period is not void from inception. If the trust actually vests before the end of the perpetuity period it will still be valid⁵⁸.

The position is different in South Australia, where the rule against perpetuities has been abolished by legislation.⁵⁹

The 'disconnect' between the approach adopted in South Australia and most of the other Australian states raises the question of whether a trust established in another state can avoid the rule against perpetuities by nominating the law of South Australia as the proper law of the trust.

A similar issue was considered by the High Court in Augustus v Permanent Trustee Co Ltd. ⁶⁰ In that case, a trust that was actually established in the ACT contained a provision which gave the trustee 'all or any powers, authorities and discretions conferred on trustees by the law of New South Wales'. The issue was whether the trust was valid because, under the law of the ACT it would have breached the rule against perpetuities whereas this was not the case under the New South Wales legislation at the time.

The court determined that the provision purporting to make the trust subject to the laws of New South Wales was enforceable and therefore the relevant gift under the trust that was in dispute was valid. The judgment was delivered by Walsh J who made the following comments:

Therefore, it seems certainly arguable that clients establishing trusts with the objective that they should not vest within any set period may be able to nominate that the trust will be subject to and administered in accordance with the laws of South Australia.

However, some caution may be required in adopting this approach as subjecting the trust to the laws applicable in another state may have unforeseen consequences. Specific instructions would generally be required before adopting that approach.

In circumstances where the preferred approach is to subject the trust to the laws in the state in which the trust property is located, some flexibility can still be achieved if the perpetuity period clause is drafted to provide that the trust will not be subject to any perpetuity period if the law in that state is amended to abolish the rule against perpetuities.

6. UTILISING THE TRUST FOR RISK MANAGEMENT

Accumulating assets in a discretionary trust can be an effective risk management and asset protection strategy because none of the beneficiaries has a defined interest in the trust assets but merely a right to have the trust administered in accordance with its terms.⁶².

Therefore, if a beneficiary becomes bankrupt, the assets in the trust will be protected to some extent from claims by a trustee in bankruptcy.

The position is different if a beneficiary is involved in a matrimonial property dispute because the focus under the Family Law Act is more on who controls the assets.⁶³ However, even in a family law context, assets held in a discretionary trust may be protected to some extent if the relevant beneficiary does not control the trust.

The decisions in ASIC: In the matter of Richstar Enterprises Pty Ltd v Carey No 6⁶⁴ and Kennon v Spry65 raised significant questions as to the extent to which assets held in discretionary trusts are protected against claims in the event of insolvency or in matrimonial property disputes.

In my view, while both cases are significant, the potential negative impact of the decisions has been overstated. In this paper I will not consider these decisions in detail but will focus more on subsequent decisions that support the view that properly structured trust deeds may still provide protection against claims by creditors or in a property dispute under the Family Law Act.

Richstar decision

The case involved an application by the ASIC to freeze assets held by trustees of discretionary trusts which the ASIC alleged were controlled by officers of the failed Westpoint group.

Section 1323 of the Corporations Act provides that the court can make orders effectively freezing assets of a person under investigation by the ASIC and "money, financial products and other property" held by a third party "on behalf of" the person under investigation.

French J considered that, where the trustee of a discretionary trust is "effectively the alter ego of a beneficiary", then that beneficiary had a least a contingent interest in the assets of the trust⁶⁶ and he extended the freeze orders to several discretionary trusts in circumstances where there were varying levels of involvement and control.

There have been several cases decided since Richstar, where the courts have "watered down" the notion that a beneficiary of a discretionary trust has an interest that should be characterised as "property".

In Lygon Nominees Pty Ltd v Commissioner of Stamp Duties (Vic)⁶⁷, Redlich JA held that:

Also, in Kawaski (Australia) Pty Ltd v ARC Strang Pty Ltd⁶⁹, the Federal Court made the following comment in relation to the Richstar decision:

In Public Trustee v Smith⁷¹ the Court made the following observations in relation to the Richstar decision⁷²:

• In Richstar "French J did not say that it followed from the defendants position as beneficiaries of discretionary trusts and their control of the trustees that this amounted to actual ownership as distinct from 'effective ownership".
• Richstar did not "establish that because a beneficiary of a discretionary trust controls the appointment or removal of the trustee, or controls the exercise of the trustees' powers and can appoint trust property to himself or herself, that the holder of such a power is the beneficial owner of the trust property irrespective of the terms of the trust deed".

Kennon v Spry

The first point which should be made in relation to the potential impact of this decision is that it related to a family law dispute with somewhat unusual facts.

Prior to this decision there were numerous instances of the Family Court making orders in respect of assets held in discretionary trusts where a party to the marriage had a degree of control over the trust and the assets⁷³ and therefore the result in Kennon v Spry is not that surprising.

The position of the High Court can I think be summarised by the conclusion of French CJ where he said that:

Importantly, His Honour acknowledged that

There have been a number of family court decisions since Kennon v Spry where the Family Court has relied on the High Court decision to make orders in respect of assets held in a discretionary trust structure.⁷⁵ However, there have also been some decisions which have distinguished Kennon v Spry.

In Leader & Martin the court considered that the principles in Kennon v Spry would not be applicable where a wife was merely an eligible beneficiary of a trust established by her parents and the trust was controlled by other family members.⁷⁶

In Harris & Harris⁷⁷ the court similarly found that a husband did not control a trust of which he was a beneficiary and therefore, the assets of the trust were not included in the matrimonial pool. The following extract from the judgement is relevant.

In Morton & Morton⁷⁸, the husband and his brother jointly controlled a discretionary trust but the wife argued that the husband had de facto control of the trust and that the trust assets should be regarded as assets of the husband. Bell J determined that:

The 'take away message' that emerges from these decisions is that it is still possible to protect assets held in discretionary trusts from claims by third parties (including in the context of family law proceedings). Clients who want to establish or vary a trust to secure asset protection advantages need to consider a range of issues.

Should the "at risk" client have any role at all in relation to the trust (for example, as director, trustee, appointor or beneficiary)?

If the client does want to have a role as director or appointor etc it is important that they are not the sole holder of that office and anyone else who acts in that role is not seen to always act in accordance with their wishes or directions.

In some cases, it may be desirable to appoint an independent third party as the appointor.

Footnotes

¹ [2010] HCA 10
² [2010] NSWCA 144
³ TR 2012/D1 at paragraph 15
⁴ [2010] QSC 417
⁵ [2015] FCA 968
⁶ At [493]
⁷ section 207-50 - 1997 Act.
⁸ Harmer at page 5004.
⁹ Taxation Ruling TR 92/13 at paragraph 17
¹⁰ 119 CLR 177.
¹¹ At paragraph 13
¹² paragraphs 52 and 53
¹³ sections 115-228 and 207-58
¹⁴ Section 99B(2) of the 1936 Act and Taxation Determination TD 2003/28
¹⁵ [2016] HCA 11
¹⁶ s 51 Trusts Act 1973 (Qld)
¹⁷ Schedule 2F of the 1936 Act
¹⁸ Section 271-105 of Schedule 2F
¹⁹ Item 28 in table in section170(10) of 1936 Act
²⁰ Subdivision 152-B
²¹ Subdivision 152-D
²² Taxation Rulings IT 328 and 329
²³ [2011] FCA 16
²⁴ 2001 ATC 4111
²⁵ Section 54, Duties Act 1997 (NSW)
²⁶ Section 167(3), Duties Act 2001 (Qld
²⁷ [1970] 120 CLR 353 at 362
²⁹ Taxation Ruling TR 92/13 – paragraph 4
³⁰ [2012] FCAFC 84
³¹ [1998] 1 Qd R 396.
³² 2004 ATC 4845
³³ At 402
³⁴ [2007] QSC 154
³⁵ [2015] WASC 297
³⁶ [2011] FCAFC 5
³⁷ [1951] 83 CLR 286
³⁸ Ibid at 300
³⁹ 2001 ATC 4336
⁴⁰ 99 ATC 5115 at 5124
⁴¹ [2009] FCA 1401
⁴² [2011] FCAFC 5 at paragraph 34
⁴³ Paragraph 21
⁴⁴ [2004] VSCA 204
⁴⁵ [2013] FCA 745
⁴⁶ Equity and Trust in Australia, GE Dal Pont and DRC Chalmers, 4^th Edition, 2007 at p641
⁴⁷ O'Brien, Moore and Papadopolous, Varying trusts after Clark, Tax Institute, Victorian Division, 13 March 2013 at 14
⁴⁸ 1^st Edition, 1998
⁴⁹ at 585 to 586
⁵⁰ (1995) 1 NZSC 40, 341
⁵¹ Lock v Westpac Banking Corporation (1991) 25 NSWLR 593
⁵² A H Slater QC Amendment of Trust Instruments. STEP on-line publication, November 2009
⁵³ (1864) 11 HL CAS 32 at 54; 11 ER 1242 at 1251
⁵⁴ Re Burton [1955] CH 82
⁵⁵ [1999] 1 WLR 1399
^56
57 Perpetuities Act 1984 (NSW), Property Law Act 1974 (QLD), Perpetuities and Accumulations Act 1992 (TAS), Perpetuities and Accumulations Act 1968 (VIC) and Property Law Act 1969 (WA)
⁵⁸ Refer to Nemesis Australia Pty Ltd v FCT 2005 ATC 4881
⁵⁹ Law of Property Act 1936
⁶⁰ [1971] HCA 25
⁶¹ At 23.
⁶² Gartside v Inland Revenue Commissioners [1968] AC 553, Kennon v Spry [2008] HCA 56 (paragraph 77)
⁶³ Ashton and Ashton (1986) 11 Fam LR 457; Goodwin and Goodwin (1991) FLC 92-192; Kelly and Kelly (No. 2) (1981) FLC 91-108
⁶⁴ [2006] FCA 814
⁶⁵ [2008] HCA 56
⁶⁶ Ibid at 14
⁶⁷ 2007 ATC 4,643
⁶⁸ Ibid at 4,644
⁶⁹ [2008] FCA 461
⁷⁰ Ibid at paragraphs 74 and 75
⁷¹ [2008] NSWSC 397
⁷² Ibid at paragraph 138
⁷³ E.g. Ashton and Ashton (1986) 11 Fam LR 457, Goodwin and Goodwin (1990) 101 FLR 386 and In the Marriage of Davidson (No 2) (1990) 101 FLR 373
⁷⁴ paragraph 81
⁷⁵ Simmons v Simmons [2008] FamCA 1088; Allan v Allan [2009] FamCA 553
⁷⁶ Leader v Martin Leader (No 2) [2009] FamCA 979
⁷⁷ [2011] FamCAFC 245
⁷⁸ [2012] FamCA 30
⁷⁹ Paragraph 38

Link to part 1

Tax effective trust deeds - part 1

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.