Trust Structure Analysis and Taxation Implications

It is a common transaction to want to subdivide property. Ideally this can be done with minimal tax consequences. Here is a breakdown of one way one might subdivide ‘Greyacre’ into its parts ‘Blackacre’ and ‘Whiteacre’.

Facts and Assumptions

Subdivision

The background facts are:

1. Greyacre will be purchased and subdivided into 2 Lots, and these will be held as follows:
   • (“Trustee 1”) as trustee for (“Trust 1”) will hold Blackacre;
   • (“Trustee 2”) as trustee for (“Trust 2”) will hold Whiteacre;

   (here after referred to as “the Trusts”)

2. To avoid confusion where I am referring to these companies in the trustee capacities set out above, I will refer to them as “Primary Trustee” if I describe them as acting as trustee of another trust I will refer to them as being a “Custodian Trustee”.

Affecting the Purchase

The following steps will take place in order to affect the split and subdivision:

Step One – Agreement to Act as Custodian Trustees

The Trustees will agree to act as Custodian Trustee if they are appointed to do so:

1. The Trustees will act as follows:
   • Trustee 1:
     • is trustee of the Trust 1; and
     • will be appointed to act as Custodian Trustee of Trust 2;
   • Trustee 2:
     • is trustee of the Trust 2; and
     • will be appointed to act as Custodian Trustee of Trust 1;

   (note that this will take place prior to settlement of the purchase)

Role of Custodian Trustee

• Each Trustee (in their role as Custodian Trustee) must follow the directions of the Trustee of each Trust;
• The Custodian Trustee will be indemnified out of the assets for which they are appointed as custodian only (and not from the remainder of the respective trust fund); and
• The Custodian Trustee must retire at the direction of the Trustee;

Step Two – Purchase of the Land

The Trusts will purchase the Land and hold it as joint tenants:

1. Ideally the contract for purchase of the Land should note:
   • each trustee of each trust will be the registered owner of the Land;
   • which of the Trusts is intending to purchaser which proposed lots;
   • which Trustee will be Custodian Trustee of each of the remaining Trusts;
2. If it is not possible to include these terms in the contract for purchase of the Land then the Trusts should document agreement on these terms;
3. However, at settlement the Trusts will all be registered as the owners of the Land;

Step Three – Subdivision of Land

The subdivision plans of Greyacre will be lodged with the Lands Titles Office:

1. 2 new certificates of title will be issued;
2. When the new Certificates of Title are issued they will be issued to Trustee 1 and Trustee 2 as joint tenants;
3. Each trust deed will note who is the Trustee and who are the Custodian Trustees;
4. In accordance with the resolution, the certificates of title will be registered as set out at Recital A.i above;

Step Four – Retirement of the Trustees

Each trustee will retire as Custodian Trustee, but not retire as Primary Trustee for their respective trusts:

1. A deed of retirement will be completed for each Custodian Trustee of each Trust;
2. This will take effect in trust law and but immediately on the new Certificates of Title; and
3. The trustees that have not been removed will remain registered on the new Certificates of Title as Custodian Trustees until legal effect is given to their removal;

Step Five – Transfers to Trustees

The Legal effect will be given to retirements by transferring each title so that the relevant trustees will be the sole Trustee of the individual Lots;

Contract Law Issues

In relation to the contract:

Generally, a contract for the sale of undivided property is unlawful, unless there is a clear intent for the purchaser to divide the land after purchase;¹

(1) A person must not grant, sell, transfer, convey, mortgage or encumber an estate or interest (except a right-of-way or other easement) in land (whether or not the land has been brought under the provisions of this Act) unless that land constitutes—

1. the whole of an allotment, or of a number of allotments; or
2. an allotment or allotments and a part allotment that is contiguous with that allotment or with one or more of those allotments and is comprised within the same certificate; or
3. an allotment or allotments and a series of 2 or more part allotments each of which is contiguous with the part allotment or part allotments next to it and at least 1 of which is also contiguous with 1 or more of those allotments and the allotment or allotments and part allotments are comprised within the same certificate.

(5) This section does not affect the validity of a contract to grant, sell, transfer, convey, mortgage or encumber an estate or interest in land if—

1. a division of land—
   1. under this Part; or
   2. by strata plan under the Strata Titles Act 1988 or by community plan under the Community Titles Act 1996, is contemplated by the parties to the contract; and
2. the contract could, if the land were divided as contemplated by the parties, be carried into effect in conformity with this section; and
3. the contract provides that the grant, transfer, conveyance, mortgage or encumbrance of estates or interests in land pursuant to the contract will not have effect until the plan of division, strata plan or community plan contemplated by the parties has been deposited in the Lands Titles Registration Office by the Registrar-General.

Accordingly, even though it is prohibited to have a contract to sell undivided part of the land, there is an exception to that the intention of the parties is to sub-divide that land;

There is a further applicable exception that the RPA that does not impose on equitable interests;²

(1) Nothing contained in this Act shall affect the jurisdiction of the Courts of law and equity in cases of actual fraud or over contracts or agreements for the sale or other disposition of land or over equities generally.

It follows that this contract and dealings are not prevented by the Real Property Act, even thought they may be in relation to undivided parts of the same land.

Capital Gains Tax and Trust Splitting

An interesting question is whether this constitutes a trust split, and hence triggers CGT, given that it is the splitting of property into multiple parts across different trusts.

ATO View

The ATO’s view is:³

‘trust split’ refers to an arrangement where the parties to an existing trust functionally split the operation of the trust so that some trust assets are controlled by and held for the benefit of a subset of beneficiaries, and other trust assets are controlled and held for the benefit of others.

The Commissioner goes on further to state that a trust split in this sense will exhibit all or most of the following features. Many of these other features are (in my view) irrelevant to a trust split and their presence or absence is of no assistance. However, I shall examine them in any event:⁴

Features and Analysis

1. “The trustee of an existing trust is removed as trustee of part/some of the trust assets and a new trustee is appointed to hold those assets.”

   In my view this is only partially undertaken:

   • there is a removal of a trustee over part of the Land at Step Four, but there is no appointment of a further or alternative trustee;
   • the critical part of a trust split (from the Commissioner’s view) is the appointment of a new trustee over some of the trust assets and the removal of the progenitor trustee from those same assets;

2. “Control of the original trustee is changed such that control passes to a subset of the beneficiaries of the original trust. The new trustee is controlled by a different subset of beneficiaries.”

   In respect of this matter:

   • there is no change in control of the trustees either in there capacity as Trustee or Custodian Trustee;
   • in my view, this is not a characteristic of a trust split, but merely of some certain trust splits which have the objective of separating assets;

• “A different appointor is appointed in respect of the part of the fund held by the new trustee, the control of the new appointor aligned with the control of the new trustee.”

  In respect of this matter:

  • there is no change of the appointor of the trusts;
  • in my view this is not a characteristic of a trust split, but merely of some certain trust splits with the objective to separating assets;

• “The rights of indemnity of the trustees are segregated such that each trustee can only be indemnified out of the assets held by that trustee.”

  A Trustee’s right of indemnity is one of the dominant factors the Commissioner will consider in his determination of a trust split:

  • in my view, it is also irrelevant, as the trustee’s right of indemnity is something that is held by the trustee and does not benefit the beneficiaries of the trust;
  • in this matter each trustee can only be indemnified out of the assets of the trust for which they are trustee of;
  • there is no reduction in the assets for which they are Custodian Trustee of;
  • they have a limited duty to transfer to the correct trustee once the Land has been partitioned;
  • it is also difficult to reconcile with a simple retirement of a trustee, whereby the retiring trustee will no longer have recourse to the assets of the trust that it has retired in respect of. Instead, once a trustee has retired it will have a right for damages against the new or remaining trustee;⁵
  • this also implies that there is a change, when instead there is not;

• “The expectation is that the new trustee will exercise its powers in respect of the assets it holds independently of the original trustee to benefit one subset of beneficiaries to the exclusion of others. The original trustee is also expected to exercise its powers in respect of the assets held by it independently of the new trustee to benefit instead a different subset again to the exclusion of others. This is so whether the range of beneficiaries that can benefit from particular assets is expressly limited.”

  In these circumstances:

  • there is no change in the expectation of which beneficiaries the trustees will exercise their discretion in favour of;
  • the trusts remain under the same control and will not change the set or subset of persons whom they exercise their discretion in favour of;
  • in my view this is not a characteristic of a trust split, but merely of some certain trust splits with the objective to separating assets;

• “The rights, obligations and powers of the trustees and beneficiaries remain governed by the one deed.”

  In these circumstances:

  • the rights, obligations and powers of the trustees and beneficiaries are each governed by the respective trust deeds, and not one deed. There is no change in this; and
  • to the extent that a Custodian Trustee retiring was originally governed by the primary trust deed, this simply ceases upon retirement;

• “The original trustee and new trustee keep separate books of account.”

  In these circumstances:

  • the applicable reference is in relation to a Custodian Trustee and the Primary Trustee;
  • there is one book of account, held by the Primary Trustee;
  • The Custodian Trustee is merely holding the Land for the benefit of/at the direction of the Primary Trustee;
  • there are however separate books of account held by each respective Primary Trustee, but that is a function of them being trustees of separate trusts;

Comments on Commissioner’s View

I make the following comments on the Commissioner’s view on trust splits:

• Under a trust split there is at first one tax law entity and then after the split there are two or more tax law entities. This in my view is the core of the Commissioner’s basis for the tax treatment of trust splitting;
• If an asset starts in one tax law entity and finishes in a different tax law entity, there must be a CGT event. In my view this is incorrect because the operation of the legislation presently drafted means the only way of arriving at that position is by way of the new trust view, which holds the view that every new trustee is the creation of a new trust and thus is an incidence for tax, unless a specific exemption applies;
• If there is no exemption upon new trustee for a trust split there is no exemption for change of trustees in the ordinary course;
• Notwithstanding these inherit problems with the Commissioner’s position, it seems that should there be no change in the number of tax law entities the Commissioner will not consider there to have been a CGT on the change of Trustees;
• Accordingly, we should expect that the ATO will not consider this to be a trust split

Capital Gains Tax

In respect of the CGT implications:

1. For the Trusts at Step One there is no CGT event however, the purchase price of the Land will be relevant for the cost base of each of the Lots when they are subsequently disposed;
2. The CGT implications at Step Two will be as a change of trustee is specifically excluded from being a CGT event;⁸
3. The CGT implications at Step Three will be Nil as there is no CGT event upon the dividing of a parcel of land into two or more separate titles if the original owner retains ownership of the subdivided blocks;
4. The CGT implications at Step Four will be Nil, as a change of trustee is specifically excluded from being a CGT event;

A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event A1 will not happen merely because of a change in the trustee.

The CGT implications at Step Five will be Nil as this is just giving effect to the change of trustee stated above.

In the Part 2 of this article I will consider Stamp Duty and Land Tax consequences.