On 13 December 2017, the ATO issued a Draft Ruling on trust vesting: Draft TR 2017/D10. This sets out the Commissioner’s preliminary views about the vesting of a trust, changing the trust’s vesting date and the income tax consequences of vesting.
Amending a Trust’s Vesting Date
A trust deed will nearly always specify a date on which the interests in the trust vest and contain a clause which specifies the consequence of that date being reached (for example, that the property is to be held from that date for the takers on vesting in equal shares absolutely). This is to ensure that the rule against perpetuities (or ‘indestructible trusts’ or ‘remoteness of vesting’) is not breached. The date is commonly labelled in the deed as the ‘Vesting Date’ or ‘Termination Date’.
The ATO notes that vesting does not, of itself, ordinarily cause the trust to come to an end or cause a new trust to arise (see CGT event E1 below). In particular, the underlying trust relationship will continue while the trustee holds property for the takers on vesting.
The key points made in Draft TR 2017/D10 are that:
- prior to a trust’s vesting, it may be possible to extend the vesting date (by applying to a court or by the trustee exercising a power to nominate a new vesting date);
- it is too late to change the vesting date once it has passed; and
- continuing to administer the trust in a way that is inconsistent with the vesting terms might be invalid (just because it is not authorised by the trust deed) or conceivably might result in a new trust being declared or settled (eg potentially CGT event E1).
The draft ruling, studiously, says nothing about, what has been the burning issue with regard to amending trust deeds (which includes extending the vesting date) – except by implication. The issue is whether the amendment has ‘created a new trust’ and triggered CGT E1, for the entire trust estate. The case law now confirms that the exercise of a pre-existing amendment power does not create a new trust. This draft ruling doesn’t mention any of that case law, and doesn’t quite deal with the issue of whether extending the vesting date is an E1 event. But it does deal with extending the a trusts vesting date, without mentioning such a big impact as this. Also, it does expressly confirm that the vesting of a trust does not create a new trust. So the ruling would provide some additional comfort on this issue.
CGT consequences of trust vesting
Draft TR 2017/D10 considers whether various CGT events may occur on vesting or post-vesting, noting that the terms of the trust deed are particularly relevant.
The ATO says that:
- CGT event E1 (creation of a new trust) “need not happen merely because a trust has vested”, as vesting does not, of itself, cause the trust to come to an end and settle property on the terms of a new trust. However, E1 may occur if the parties to a trust relationship subsequently act in a manner that results in a new trust being created by declaration or settlement;
- CGT event E5 (beneficiary becoming absolutely entitled) may occur if the vesting results in the takers becoming absolutely entitled as against the trustee to CGT assets of the trust; and
- CGT event E7 (disposal to a beneficiary to end a capital interest) may happen on actual distribution of CGT assets to beneficiaries, but it will not occur to the extent that the beneficiaries are already absolutely entitled to the CGT assets as against the trustee.
At paragraph 11, the draft ruling states as follows.
11. In itself, the vesting of beneficial interests in a trust, even if described as a ‘Termination Date’, does not ordinarily cause the trust to come to an end, nor cause a new trust to arise. Vesting does not mean trust property must be transferred to the takers on vesting on the vesting date, nor that the trust must be wound up either immediately or within a reasonable period (although the deed may require these events to occur after vesting).
The ruling also squibs another important matter, which is whether beneficiaries are ‘absolutely entitled’ to the trust’s assets, when it vests. Again, this is one of the principal concerns for people facing an imminent vesting with a significant latent capital gain in the trust’s assets. When a beneficiary is ‘absolutely entitled’ as against the trustee (the trigger for an E5 event) is difficult law and not yet clearly established. The better view is, that this cannot arise until a beneficiary (probably alone, not jointly) is absolutely entitled to a particular trust asset – so that merely converting to fixed interests in a multi asset estate does not realise a latent capital gain in the whole estate. There is another tricky issue in that the trustee, probably, needs to have no indemnity against the fund for liabilities it has incurred. This is because the trustee has a non-specific charge over the entire estate, to allow it to be reimbursed. A beneficiary could not be ‘absolutely entitled’ to an asset, unless the trustee freed this asset from its indemnity/charge.
This is barely dealt with in Example 7, which is as follows.
Example 7 – absolute entitlement
41. The trust deed for the Ho Family Trust provided that the trust would vest on 1 August 2014. It further provided that unless the trustee resolved to distribute the trust capital to particular beneficiaries, before the vesting date, the trustee would hold the trust property absolutely and solely for Lu.
42. On 1 August 2014 (the vesting date), Lu has a vested and indefeasible interest in the trust property. In addition, he has become absolutely entitled to the trust assets as against the trustee causing CGT event E5 to happen.
Note that the example has been drawn with only one (not multiple) takers on vesting. And note, it says nothing about whether the trustee has a charge over the trust assets to secure its indemnity.
Taxation of trust net income after the vesting date
Draft TR 2017/D10 notes that, in the income year of vesting, different beneficiaries may be presently entitled to trust income derived before and after the vesting date. For example, the trustee of a discretionary trust may, prior to vesting, exercise a discretion to appoint pre-vesting income among those entitled to benefit under the trust. By contrast, the takers on vesting will be presently entitled to post-vesting income (usually in proportion to their vested interests in the trust property). In this situation, the Commissioner will accept a “fair and reasonable” allocation of trust income into pre-vesting and post-vesting trust income.
The Draft includes 7 examples, covering effective and ineffective extensions of the vesting date, the consequences of ignoring the vesting date and the various entitlements of beneficiaries.
PROPOSED DATE OF EFFECT: When the final Ruling is issued, it is proposed to apply both before and after 13 December 2017.
[ATO website – TR 2017/D10; FJM; LTN 239, 13/12/17; Tax Month Dec 2017]