Federal Court case supports ATO’s position on trust splitting. So what are my other options?

We previously reported on the draft taxation determination 2018/D3 released by the ATO. That draft set out the view of the ATO that a ‘trust split’ may trigger CGT consequences. Click here for that publication.

Although the ATO has admitted there is no case law dealing directly with the implications of a trust split, the comments made by the full Federal Court in its recent decision in the Aussiegolfa DomaCom case could provide an indication as to how the courts may treat trust splitting.

Aussiegolfa & the ATO’s view on trust splitting

That case involved two self-managed superannuation funds and another related investor making an investment in a large investment trust operated by an AFSL holder. The investment in the larger trust was subsequently allocated to a smaller sub-trust utilising terms contained within the constitution of the trustee for the larger trust.

The Court was required to determine whether the specific rights, obligations and restrictions associated with the allocation of the investment to the sub-trust resulted in the creation of a separate trust.

Interestingly, the Court confirmed a separate trust existed for the following reasons:

1. The distributable income derived from the assets of the sub-fund were to only be distributed to the beneficiaries of the sub-trust and not the beneficiaries of the larger trust.
2. The beneficiaries of the sub-trust had the ability to choose the assets in which the sub-trust invested.
3. The beneficiaries of the sub-trust had the ability to terminate the sub-trust and call for a capital distribution from the sub-trust without any intervention from the beneficiaries of the larger trust.
4. The assets of the sub-trust were not available to satisfy the liabilities in another sub-trust.
5. The trustee was not entitled to be indemnified out of the assets of the sub-trust in relation to liabilities of another sub-trust.

These factors relied on by the Court are similar to the factors outlined by the ATO in its recent draft determination 2018/D3.

This case supports that, where existing trust relationships are further characterised or restricted, or assets set aside on specific terms, there is a risk that a new trust may be created.

While this case provides an indication of the Court’s approach to the creation of new rights within an existing trust, each case will inevitably fall on its own facts and specific circumstances.

How do I deal with the succession of my discretionary trust now?

Holding assets in a discretionary trust is a common and often highly effective structuring option.

However, passing the benefit of the assets in discretionary trusts to the next generation is not so straightforward as no beneficiary of a discretionary trust has a defined entitlement. Trust splitting was one way of addressing this issue.

As trust splitting will now likely give rise to adverse tax consequences given the ATO’s position, it is necessary to consider the other options, including:

• trust cloning – where the assets of the trust are moved to a new ‘cloned’ trust; or
• adding generational transfer provisions to the trust deed – these allow designated beneficiaries to take out a share of the trust assets after the death of the parents.