In a recent case, the Federal Court had to consider whether past net capital losses of a trust were available to offset against capital gains made by the trust, where there had been changes in the trust between when the capital losses were incurred and when of the capital gains were derived.
The decision is important because it extends the precedential value of an earlier High Court decision concerning superannuation funds to trust estates generally, a position that the Commissioner has not, to date, accepted. It is also an important decision because arguably the decision may have application to the question of whether there has been a trust resettlement in similar circumstances.
In this case, the Court held that, although there had been a change in the underlying unit holders, this did not constitute a change in the entity which was the notional taxpayer for CGT purposes because the rights of the holders of those units had not changed i.e. it was the rights attaching to the units which mattered and not the entity holding those units. The case may further limit the Commissioner’s ability to argue a trust resettlement even where there has been a substantial restructure.
The Commissioner argued that in order for the net capital losses to be available the same taxpayer had to incur the capital losses as the taxpayer which derived the capital gains. This is not a controversial position. It is a question of what this statement of principle means.
According to the Commissioner, the following restructure of the trust which occurred between the two events meant that a different taxpayer derived the capital gains from the taxpayer which incurred the capital losses:
- a change of the trustee and a consequent extinguishment of the former trustee’s right of indemnity, the existence of which meant, the liabilities of the trust fund substantially exceeded its assets which meant it was insolvent
- a mutual waiver and release of all liabilities as between the trust and a major creditor who indemnified the incoming trustee resulting in the net assets of the trust fund now consisting of the original settlement sum of $10.00 which then enabled a capital contribution of $1.8m to be made to the trust fund
- five of the 10 issued units were transferred to a new unit holder who had contributed the $1.8m under an arrangement that if the existing unit holder did not also contribute $1.8m, the existing unit holder had to transfer its remaining 5 units to the new unit holder for $5.00 with its rights remaining in suspension under the trust deed until the matching $1.8m contribution was made and ultimately some time later the matching $1.8m contribution was not made and the remaining 5 units were transferred to the new unit holder in a later income year.
The Court observed that there was nothing in the Tax Acts which specifically required a continuity in the trust estate, a continuity in the structure of the trust or a continuity in the rights, duties and obligations arising under the trust instrument.
However the Court also observed that the statutory provisions of the Tax Acts, insofar as they apply to the determination of a net capital gain in an income year by the application of previously unapplied net capital losses from previous years, contemplate a notional taxpayer as an entity who is the trustee of a trust estate which is made up of an aggregation of assets. Therefore the trust estate that suffered the capital loss in the earlier year must be the same trust estate that made the capital gain in the relevant income year. It was only in this sense that there must be continuity or sufficient identity between the trust that incurred the loss and the trust which generated the capital gain.
The Court relied upon the earlier High Court decision of FCT v Commercial Nominees of Australia Ltd. This case involved a superannuation fund. However the Court found that this High Court decision was equally applicable to determining whether there was a continuity of the trust estate for the current purposes. This is interesting because, notwithstanding that decision, the Commissioner’s view has been that that case had no precedential value for trust estates other than superannuation entities.
The Court said that there are three requirements arising out of the decision of Commercial Nominees which are relevant to determining the continuity of a trust estate. These are as follows:
- continuity in the Trust Fund
- continuity in the Trustee’s interest in the trust estate
- continuity in the interests of the beneficiaries.
In relation to the first requirement, the Commissioner argued that the above arrangements brought about a fundamental change to the state of the trust fund effecting a restructure of the trust fund. However the Court held that the arrangements did not fundamentally alter the trust property but this was merely a condition of the appointment of a new trustee which in turn facilitated the capital contribution to the trust fund in association or joint venture with another company as contemplated by the terms of the Trust Deed and which provided the basis on which the trustee of the trust could acquire the development properties in accordance with the powers of management of the trust estate conferred upon it by the Trust Deed.
In relation to the second requirement, the Commissioner argued that the discharge of the trustee’s right of indemnity altered the trustee’s interest in the trust estate and therefore broke the required continuity. However the Court held that this discharge of the trustee’s indemnity was an element of enabling further contributions to be made to the trust fund to enable it to continue to embark upon property development projects as it had historically done up until the time that it was unable to continue to do so as a result of the accumulated losses and an inability to raise capital or debt.
In relation to the third requirement, the Commissioner argued that the change in the interests of the unitholders in the trust fund broke the continuity. The Court held that a change in control in the exercise of relevant trust powers, is not inconsistent with the continuity of the trust or trust estate. In this case a comparison of the trust estate in the income year of the capital loss with the trust estate in the income year of the capital gain showed that the although the ownership of the units in the trust had changed by transfer under the Trust Deed, the interests of the holders of the issued units in the 1993 income year were the same. The two year suspension pending a capital contribution by the then existing unit holder did not destroy the continuity of interests at the relevant dates attaching to the units such that the suspension period brought about a termination of the existence of the Trust of made the Trust which incurred the capital los a different trust to the one which derived the capital gain.
Therefore there was the required continuity of the trust estate and the capital losses were available to offset against the capital gains in a later income year. The decision is also of import in that it does show that substantial changes to a trust may not cause a resettlement of the trust.