Most trusts, and all private discretionary trusts, have what is known as a vesting date which is described differently in different trust deeds e.g. Vesting Date, Perpetuity Date, Termination Date, Vesting Day. The question often asked is what happens when that day is reached? This issue is considered by the ATO in Taxation Ruling TR 2018/6 Income tax: trust vesting – consequences of a trust vesting.
Many practitioners believe that on reaching that day the trust comes to an end and essentially requires a winding up process: realise such of the assets as are necessary to pay out liabilities, pay liabilities, and transfer the surplus assets are those that are entitled. In private discretionary trusts, the trustee will have a discretion to nominate which of the beneficiaries are entitled to surplus.
Clearly this is an issue for many practitioners, resulting in the ATO issuing a public ruling.
The concern is that the sale of assets and transfer of surplus assets to beneficiaries will trigger liabilities for capital gains tax and stamp duty, based on the market value of the assets at the time of the transfer. Bearing in mind the perpetuity period is often 80 years, these liabilities can be significant.
This belief arises because it is generally understood that the life of a trust is limited by a perpetuity period (often set as a period of 80 years prescribed by statute), and at the end of that period the trust must come to an end.
The concept of a perpetuity period is founded in what is described as the ‘rule against perpetuities’. That rule is described in Jacobs’ Law of Trusts in Australia 8th edition in the following way:
In its modern formulation, as stated in Cadell v Palmer, it provided that an interest in property if not vested at the time of its creation, must vest [within the perpetuity period]; if there was merely a possibility that this might not occur, the disposition was void. It will be observed that the rule is not strictly a rule against perpetuities, but against remoteness of vesting.
The writer has always taken the view that the rule requires that the interests in the trust become fixed, with proper processes the trust does not come to an end, and a trust may exist in perpetuity provided it vests (with fixed interests in nominated beneficiaries) within the perpetuity period. The result is that with proper processes capital gains tax and stamp duty liabilities can be avoided on the vesting date.
Capital Gains Tax – relevant CGT events for consideration are CGT events A1, E1, E5 and E7. By adopting the proper process, there is no transfer of assets, beneficiaries do not become absolutely entitled to the assets, and the other CGT events will not apply.
Transfer (Stamp) Duty – this applies if there is a transfer of dutiable property or a change of trust interests. By adopting the proper process there will be no transfer or such a change.
In Taxation Ruling TR 2018/6, the ATO considers the income tax consequences of reaching the vesting date. Consistent with our view above, the ATO states in paragraph 13:
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, or 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).
Upon the vesting of a discretionary trust, the interests of entitled beneficiaries become fixed, and the trust converts from a discretionary trust to a fixed trust. Various restructures of either the trust assets or the vested interests may be considered which do not trigger liabilities for capital gains tax and/or stamp duty.
When considering these issues it is prudent to use advisers that are fully aware of the legal ramifications, and do not need to wait for ATO guidance.