On 6 September 2011, the High Court refused the Commissioner's application for special leave to appeal the majority decision of the Full Federal Court in FCT v Clark [2011] FCAFC 5 (Clark).

The Commissioner argued that there was insufficient continuity in the trust to allow losses to be offset against capital gains in later years due to changes in the trustee, the trust property, the control of the trust and the membership of the trust. This argument was rejected by the High Court, with French CJ stating that:

"The Full Court of the Federal Court held, contrary to the Commissioner's contentions, that there was an identity between the trust estate in the year in which the assessable capital gain was made and the trust in the years in which the capital losses were incurred so as to allow the latter to be offset against the former. In our opinion, the decision of the Full Court involved characterisation and evaluation of the continuity of the trust in the trust estate. It is not attended with sufficient doubt to warrant the grant of special leave. Special leave will be refused with costs."

Recap on the decision of the Full Federal Court

The keys facts of Clark were that the unit trust, when controlled by the initial unitholders (the Denoon family), incurred substantial losses between 1991 and 1993. In June 1993, the Denoon family entered into a series of arrangements with the Clark family, which involved among other things a change in trustee, the Clark family receiving half of the units in the trust, the Clark family injecting capital into the trust, a waiver of the former trustee's right of indemnity against trust assets, and a suspension of the Denoon family's right to income from its units until they contribute funds into the trust.  By 1996, it was clear the Denoon family could not contribute the required funds, and their remaining units were transferred to the Clark family.  In 2001, the trust realised a capital gain which it sought to offset against losses incurred between 1991 and 1993.

The majority judgement of Edmonds and Gordon JJ (Dowsett J in dissent) held that Commissioner of Taxation v Commercial Nominees of Australia Ltd [2001] HCA 33 (Commercial Nominees) did not stand for the proposition that there had to be strict or even partial identity of trust property and membership, otherwise there would be a new trust.  The majority held there had to be a continuum of property and membership that could be identified at any time, even if it differed from time to time.

The majority noted that the trust deed contemplated changes in trust property, trustees and control of the trust, identity of beneficiaries, and ownership of units. The majority also noted that the waiver of the existing trustee's right of indemnity, and the variation of the Denoon interests' rights, did not result in any variation to the trust deed, and did not vary the trusts of the trust. As a result, there was continuity and the capital gains could be offset by the earlier losses.

ATO Statement of Principles

In its 'Creation of a new trust - Statement of Principles August 2001', the Commissioner restricted the decision in Commercial Nominees to superannuation entities, and took the view that the Statement of Principles would apply to other entities. 

In Clark, both the trial judge of the Federal Court and the appeal judges of the Full Federal Court applied the indicia set out in Commercial Nominees to the unit trust in question. It is clear from their application of Commercial Nominees, that the Commisioner's position restricting Commercial Nominees to superannuation entities is incorrect, and the indicia in Commercial Nominees can be applied to a other types of trusts.

Where to from here?

The decision in Clark suggests that significant changes can be made to trust property, trustees and membership without causing a resettlement of a unit trust, provided those factors are identifiable at all times.

The decision also underlines the importance of reviewing the terms of a trust deed before any changes are made, as the judges in both Clark and Commercial Nominees emphasised the importance of the nature of the trust when assessing if any changes caused a resettlement.

We expect the Commissioner will finally revisit the Statement of Principles to reflect Commercial Nominees and Clark.  And don't be surprised if there is a legislative move with an integrity measure specifically covering carry forward losses.