Australia: Taxation Ruling TR 2018/6 – Income Tax: consequences of a trust vesting

Introduction

Taxation Ruling TR 2018/6 provides guidance on the income tax and capital gains tax (CGT) taxation consequences of a trust vesting. The Ruling has been in effect from 15 August 2018 and builds upon the Draft Taxation Ruling TR 2017/D10.

CGT Events

The effect of CGT on income tax liability is best described as follows:

'CGT affects your income tax liability because your assessable income includes your net capital gain for the income year. Your net capital gain is the total of your capital gains for the income year, reduced by certain capital losses you have made.'1

A capital gain or loss occurs only if a CGT event occurs.2

Most CGT events involve CGT assets such as:3

  • land and buildings, for example, a weekender;
  • shares;
  • units in a unit trust;
  • collectables which cost over $500, for example, jewellery or an artwork; or
  • personal use assets which cost over $10,000, for example, a boat.

Ruling

The following is a summary of each issue:

  1. Amending a Trust's Vesting Date

The Commissioner notes in the Ruling that amending a trust's vesting date must be:

  1. prior to a trust's vesting, which requires careful consideration of the terms of the trust deed; and
  2. pursuant to a proper exercise of a valid power under the deed or following an application to a court.

If these conditions are satisfied no new CGT liability will arise by virtue of the fact that no new trust will be deemed to be created over the assets pursuant to CGT event E1.

The Commissioner clarified that once the vesting date has past the trust has vested and accordingly it is no longer possible for the trustee to change the vesting date as the interests in the trust property become fixed at law, irrespective of the circumstances. It is also said to be 'unlikely' that a court would extend the vesting date once the interests of the beneficiaries in the trust have vested.

  1. Trust law consequences of trust vesting

The vesting date is really the vesting of the beneficial interests in a trust. Even if the vesting date is described as a 'Termination Date', it will not ordinarily cause the trust to come to an end, nor cause a new trust to arise. Where the terms of a trust deed dictate that a trustee continues to hold property for takers on vesting, the property will be held on the same trust as prior to the vesting date, albeit with an altered trust relationship.

In the case of a discretionary trust, the practical effect is that the trustee no longer has any discretionary power to appoint the income or capital of the trust but rather holds the trust property for those beneficiaries specified in the trust deed as takers on vesting.

  1. CGT consequences of trust vesting

Determining whether or not a CGT event happens on vesting (or post-vesting) requires a close consideration of the trust deed, specifically:

  1. the effect of vesting on the beneficial interests in the trust; and
  2. the nature of the property held on trust.

The relevant CGT events that may occur are:

  1. CGT Event E1 – creation of a new trust.
  2. This may occur if the parties to a trust relationship act in a matter which results in a new trust being created by declaration or settlement.

    An example provided by the Commissioner would be where the vesting date passes and all of the takers on vesting agree that the trust assets should continue to be held on a new trust on the same terms as the original trust.

    The effect of CGT Event E1 occurring is that:

    1. a new trust is created over the assets;
    2. the new trust is taken to acquire each asset when the trust is created; and
    3. the first element of each asset's cost base is its market value.
  1. CGT Event E5 – beneficiary becoming absolutely entitled.
  2. If the takers on vesting become absolutely entitled as against the trustee to the CGT assets of the trust then CGT Event E5 will apply, although this is dependent on the particular interests of the takers on vesting.

  1. CGT Event E7 – disposal to beneficiary to end capital interest.

This may occur post vesting, such as if CGT assets are actually distributed to beneficiaries, but only if the beneficiaries are not already absolutely entitled to the CGT assets as against the trustee.

  1. Income tax consequences of trust vesting

If the vesting date is part way through the tax year, there are two relevant periods that need to be considered:

  1. Income of the trust estate derived before the vesting date ('pre-vesting income').
  2. Pre-vesting income will be distributed pursuant to the powers of the trustee under the trust deed. In a discretionary trust, the trustee may exercise their discretion to appoint pre-vesting income among beneficiaries.

    The pre-vesting trust income will be taxed at the personal tax rate of the beneficiary who is 'presently entitled' to the trust income.4 If not, the trust income will be taxed in the hands of the trustee at the penalty rate.5

  1. Income of the trust estate derived after the vesting date on the vested property ('post vesting income').
  2. Post-vesting income will be held by the takers on vesting, usually in proportion to their vested interests in the property of the trust.

    The post-vesting trust income will be taxed in the hands of the beneficiary according to their entitlement and therefore none of the trust income will be taxed in the hands of the trustee.

If the vesting date occurs during a tax year, the Commissioner will accept an allocation of income of the trust estate into pre-vesting and post-vesting income provided that it is done 'on a fair and reasonable basis having regard to all of the relevant circumstances.'6

In subsequent income years, the takers on vesting will usually have a fixed entitlement to the income of the trust estate and will be assessed on their proportionate share of the net income of the trust.

Conclusion

Taxation Ruling TR 2018/6 provides clarification on the ATO view on the income tax consequences of a trust vesting. When considering the consequences of a trust vesting, it is important to have careful regard to the terms of the trust deed. Once the trust deed has been reviewed, practical examples 1 to 6 provided by the Commissioner in Ruling TR 2018/6 provide a useful starting point for determining the effect of purported trust amendments and the applicable tax liabilities of the trust both pre and post-vesting.

Footnotes

1Income Tax Assessment Act 1997 s 100-10.

2 Ibid s 100-20.

3 Ibid s 100-25.

4 Income Tax Assessment Act 1936 (Cth) s 97.

5 Ibid s 99A.

6 Taxation Ruling TR 2018/6.

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.

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