1. There is a certain type of sub-trust over income that many trust deeds purport to create, and which the Federal Commissioner purports to allow. This is where a trust is established over the income distributed from another trust. This is problematic for the reasons that follow.
  1. The Commissioner’s guidance in PCG 2017/13 purports to allow the types of sub-trust arrangements in the circumstances set out in the PCG and related rulings. This does not have any force of law. Importantly, the Commissioner cannot remedy the fundamental trust law failures of this view, which have the result that no sub-trust over income exists;
  1. In PSLA 2010/4 “Option 1” and “Option 2” each concern an arrangement whereby a trustee, in its capacity as trustee of a the “main trust” and the “sub-trust” “places funds representing the UPE” on a loan from the sub trust to the main trust for a period of 7 or 10 years respectively;
  1. The difficulty is that neither the sub-trust nor the funds representing the UPE exist, and so the arrangement must fail;
  1. Unless the trustee expressly identifies a discrete parcel of trust property and thereupon vests that property in the beneficiary, then the trust will fail at once for lack of certainty of subject matter;[1]
  1. In Paragraph 71 of TD 2022/11 where the Commissioner correctly points to Corporate Initiatives[2] which determined that “where a beneficiary has a UPE, the beneficiary does not have a proprietary right in any assets of the trust and the trustee would be free to deal with the trust assets for trust purposes”;
  1. A sub-trust could be created in relation to a particular asset. This occurred in Oswal[3] where shares in Burrup Holdings Pty Ltd were held on a separate trust for the absolute benefit of those beneficiaries. Because there was a particular asset the subject of the sub-trust, then the sub-trust had some subject matter. The sub-trust was hence properly created, giving rise to the occurrence of CGT Event E1;
  1. The trust deeds in both Corporate Initiatives and Oswal contained a clause stating UPEs are to be held on a separate trust for the beneficiaries until the time that that income is paid to the beneficiary. This clause purports to create a sub-trust of the kind envisaged in the Option 1 and Option 2. However, in neither case did the Court consider, nor was it necessary to consider, whether such a trust existed:
    • Corporate Initiatives was concerned with the effects of the distributions of income to a loss entity;[4]
    • The “Sub-Trust” definition in the trust deed in Corporate Initiatives merely concerned a trust that was a beneficiary of a further trust, in order to determine eligible beneficiaries; and
    • Oswal was concerned with a distribution of an asset, and not income;
  1. It is, of course, never strictly correct to identify any underlying property interest in an entitlement to income, for the concept of income comprises no more than the difference between the increase in net assets between one period and the next: see FCT v Slater Holdings (No. 2) Pty Ltd.[5]  Hence, a beneficiary could never, strictly speaking, be entitled to income or profits.  Instead, it is treated as a compendious way of saying that the beneficiaries are entitled to property of the trust equal in an amount or magnitude to the trust property changes. In this, the expression is taken to mean that the beneficiary is entitled to assets and property (indeed, if there be any) of the trust equal in amount to the income derived during the period of which they are said to be presently entitled;
  1. Even this description does not suffice for there may be no trust property at all. Instead, the income may be manifested by a reduction in liabilities where there were no assets at the commencement of the accounting period; 
  1. Income is no more than the measurement of a change in net assets over an accounting period. See for example re Spanish Prospecting Company, Limited [1911] 1 Ch. 92, 98 where Fletcher Moulton LJ stated: “‘profits’ implies a comparison between the states of business at two specific dates usually separated by an interval of a year.  The fundamental meaning is the amount of gain made by the business during the year.  This can only be ascertained by comparison of the assets of the business at the two dates.
  1. It is not necessary to identify a separate fund of assets to be allocated to a beneficiary to effect an appointment of an amount of income, thereby constituting a trust of discrete assets, before the beneficiary can rightly claim that she or he is entitled to demand it. A bare claim to “income” does not create a separate trust, since “income” is not itself property;
  1. Even in the exceptional case where the trust fund consists only of cash,[6] it might be thought that little difficulty would arise in identifying the property that would entitle the beneficiary to demand immediate payment. But since cash is usually no more than a chose in action in the form of a contract between banker and customer, there is nothing in a part of the balance owing under that contract that could constitute the subject of a discrete trust – since one cannot identify with certainty any subject matter of the trust;
  1. If a trustee applied property in satisfaction of a present entitlement then the present entitlement would be satisfied. A sub-trust in the form of that in Oswal would be created over that property. This is quite different to the arrangement considered in Option 1 or Option 2. No trust would be created over the “income”;
  1. Given that no trust can be created over income, you should never attempt to create a sub-trust of the type set out in PCG 2017/13 even in reliance of the Commissioner’s published views, as they are from time to time. The Commissioner’s opinion cannot alter the fundamental requirement of a trust to have some subject matter. Any taxpayer who has attempted to create a sub-trust of the type described in Option 1 or Option 2 has failed in their creation;

16. The problems with attempting to create sub-trusts over income was correctly observed by the Tribunal in the recent case of Bendel[7] where it rejected the argument that income could be held on a separate trust:

“75. In circumstances where an ‘entitlement to some part of a fund of property that is held on trust [is] not … reflected in an absolute beneficial entitlement to the whole or some part of any specific asset within that fund’, as is the case presently, the beneficiary’s interest in the income of the trust is thus ‘an equitable obligation’ on and of the trustee. That equitable obligation reflecting the beneficiary’s interest in the income of the trust is not property the trustee owns or controls. Income is not property. At times income is a character given to a receipt, entitlement, or profit. And, at other times it is a measure of performance, of a fund divisible among a class, or of an entitlement. Cash or money, receivables, trading stock or some other blend of assets that represents the income are property. If any property is created by the resolution to distribute or vest entitlements to income, it is the property of the beneficiary, namely the right to be paid. Such a resolution does not create property held by the trustee. The trustee has an obligation, with corresponding rights of indemnity or exoneration. […]

79. In the present circumstances, where it is not possible to identify any asset or property held on any separate trust as conventionally understood, notwithstanding the acceptance of the parties that a separate trust was created, what was created upon passing resolutions to distribute Gleewin’s income was a right or entitlement for the beneficiary coupled with the corresponding obligation of the trustee of a nature contemplated by what Gageler J said in Fischer v Nemeske.
80. Accordingly, the Tribunal does not accept contentions that a separate trust in fact arose in any conventional sense that had the effect of discharging or replacing the obligation to pay entitlements to income. Those entitlements to be paid shares of Gleewin’s income continued to exist.
81. Each party’s contentions that were based on the concept of a separate trust having the effect that the entitlements to income were discharged or paid are not accepted.  ” [underlining added]

17. The Commissioner should consider withdrawing any rulings that purport to encourage the erroneous creation of a trust over the accounting and tax law concept of income; and

18. If your trust deed purports to allow sub-trusts over income then you should most likely want to have that problematic clause removed.

[1] Knight v Knight (1840) 3 Beav 148

[2] Corporate Initiatives Pty Ltd v Commissioner Of Taxation [2005] FCAFC 62

[3] Oswal v Commissioner of Taxation [2013] FCA 745

[4] Criticisms of the case are in any event set out in the article by A H Slater QC, ‘Unit trusts: Law and Lore’ (2006) 35 Australian Tax Review 185, 196

[5] 84 ATC 4883.

[6] That is, cash that is not simply physical legal tender, I,e, the notes and coins issued under the authority of Australian statute, principally, the Reserve Bank of Australia Act 1956 (which prints notes) and the Currency Act 1965 (that deals with coins).

[7] Bendel and Commissioner of Taxation (Taxation) [2023] AATA 3074