Alert

Who does this affect?

Anyone who currently or intends to manage, or be the beneficiary of, a trust seeking to be treated as an “absolute entitlement” trust for tax purposes.

What do you need to do?

Consider whether the decision impacts on the availability of “absolute entitlement” trust treatment and review the trust deeds for clauses which may impact the availability of “absolute entitlement” treatment.

John Edstein
Partner
T +61 2 9296 2129

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Andrew Clements
Partner
T +61 3 9643 4089

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Sydney
John Edstein
Karen Rooke

Melbourne
Andrew Clements

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Authors
Andrew Clements
John Edstein
Karen Rooke
Kai-Chen Chang

The Federal Court of Australia delivered its judgment in the case of Kafataris v Deputy Commissioner of Taxation [2008] FCA 1454 (Kafataris’ Case) on 24 September 2008.

The decision provides some guidance as to when a particular trust is likely to qualify to be treated as an “absolute entitlement” trust for tax purposes, particularly in the absence of any definitive or binding guidance from the ATO regarding this issue.

The decision

Kafataris’ Case considered two trusts established by a husband and wife. These trusts were established as self-managed superannuation funds for each of the husband and wife. Each of the husband and wife acted as trustee for their own trust, and each of the trusts were settled with a half share of property which had been held jointly. This property was sold shortly after the trusts were settled.

In order to establish that a capital gains tax event did not occur when the trusts were settled the taxpayers needed to show that they were each the sole beneficiary of their respective trust and that they were “absolutely entitled” to the assets of the trust as against the trustee.

The Court (Lindgren J) found that the taxpayers could not establish their case on the basis that:

• The trusts each had more than one “beneficiary”, as the trusts provided for other persons to become members of the trusts, and for benefits to be paid to relatives of the members in certain circumstances.

• Members of the trusts were not “absolutely entitled” to the assets of the trust, as the trust deed provided that a trustee “may” but was not required to distribute the trust assets in specie to a member even where the member’s consent had been obtained, and that the trustee could sell the assets of the trust.

Potential application of the decision

The trust deeds and factual scenario considered in Kafataris’ Case are significantly different to the absolute entitlement products commonly encountered in the funds management industry. The decision may therefore be of only limited relevance in these circumstances.

However, the Court’s reasoning in Kafataris’ Case suggests that the inclusion of certain provisions in a trust deed may prevent a beneficiary from being regarded as “absolutely entitled” to an asset as against the trustee, such as provisions which:

• allow other beneficiaries to be admitted to the trust

• allow entitlements to be paid to person who are not beneficiaries, even where they are related to the beneficiary in some way

• permit but do not require assets to be transferred in specie to a beneficiary where the beneficiary has given consent, and

• permit the trustee to sell or deal with trust assets as the trustee determines.

Following Kafataris’ Case, there may be some suggestion that the inclusion of such clauses in a trust deed may prevent the absolute entitlement concession from being available.

The Court also did not consider whether the trust asset was an undivided half share interest in real property prevented the beneficiary from being “absolutely entitled”. The Commissioner took the position, in the draft ruling on absolute entitlement TR 2004/D25, that a beneficiary could not be “absolutely entitled” to an undivided interest in a block of land. Accordingly, Kafataris’ Case may assist joint account holders of wrap products in establishing that they are “absolutely entitled”, and may cause the Commissioner to reconsider his position regarding this issue.