Tax Brief - High Court Obscures Trust Taxation

Every so often, the High Court issues a judgment with difficult and potentially far-reaching implications which, one fears, were not fully explored in the case.  The recent judgment in CPT Custodian Pty Ltd is one such case.

The issue in the case involved a narrow and quite precise land tax question – whether the holder of some or all of the units in a unit trust which holds land is the “owner” of the land for land tax purposes.  The High Court concluded that the answer was no – the unitholder was not the owner in either case.

However, in the course of reaching this unremarkable conclusion, the High Court made observations which cast doubt on some of the trust law and practice that underpins current views about the way a variety of other tax provisions operate in the presence of a trust.

The facts

The case involved a company which held units in unit trusts, the trustees of which owned land in Victoria.  In one case, the company was the sole unitholder in the trust; in another it held 50% of the issued units.

Land tax was payable by any person who was an “owner” of land.  The Victorian Commissioner of State Revenue took the view that the company as unitholder was the owner, and assessed the company to land tax as owner of the land in the first trust, and as owner of 50% of the land in the second trust. 

The Court of Appeal of the Supreme Court of Victoria had upheld the assessment for the first parcel of land but not the second.  The judges took the view that the holder of 50% of the issued units was not in the same position as a person who owned 100% of the issued units.

So far as one can tell from the reports of the case, the Trust Deeds in question contained standard kinds of clauses for this type of arrangement:

• The trust assets were vested in the trustee to be held upon trust for the unitholders.
• The beneficial interest in the trust assets was divided into units, and each unit conferred an equal interest in all trust property.
• No unit conferred an interest in any particular trust asset, and unitholders could not insist on the transfer to them of any particular trust property.
• The trustee had powers to sell existing investments, to appropriate the proceeds and other receipts to meet future and contingent liabilities and to purchase new investments.
• The trustee had powers to issue new units and to redeem existing units.
• Income was to be distributed to unitholders periodically. 
• The trust was to be wound up on the vesting day.
• The trustee and the manager were entitled to be paid fees out of the trust, and to reimbursement of their costs, charges and expenses.

The High Court began its judgment with the observation that the case turned on whether the terms of the trust upon which each parcel of land was held created interests which met the statutory definition of “owner.”  They noted that it would likely lead to error to apply the tax based on “a priori assumptions as to the nature of unit trusts under the general law and principles of equity …” They observed that, in “the absence of an applicable statutory definition, [the term “unit trust”] does not have a constant, fixed normative meaning which can dictate the application to particular facts of the definition in … the Act.”

Thus, the Court looked at the terms of the relevant Trust Deeds without giving any significance to the label unit trust. They said the terms above argued against the unitholder being the “owner” of the trust land, particularly the provisions with respect to the application of proceeds of selling trust assets, reinvesting proceeds and paying or providing for trust expenses, and the provisions dealing with the fees payable to the Trustee and Manager and their right to be indemnified out of the trust assets for their expenses.

The Court was not persuaded that the analysis was different if the company was the sole unitholder or one of several; in neither case was it the owner.

The implications

The principal concern about this case is just how far its implications extend – what impact does the judgment have for other taxes, and in circumstances where similar terms and concepts are used in other tax legislation?  Two lessons are clear.

Australia’s income and capital gains tax operate differently for trusts with different features.  It is common to classify trusts for tax purposes as discretionary trusts, fixed trusts other than unit trusts, unit trusts, superannuation funds, deceased estates and so on.  The first salutary lesson from CPT Custodian is that the labels will often be unhelpful – what matters in most instances, the High Court stresses, is the terms of the Trust Deed, not whether the terms create the kind of trust that would commonly be called a “unit trust.”

(However, one should not take this too far.  Although it is not mentioned in the judgment, there are some tax regimes where the fact that the Deed creates the kind of trust commonly called a “unit trust” will matter – tax effects are triggered for “unit trusts” that are not triggered for other kinds of trusts.  For example, the capital gains tax rules, the rules determining whether a trust is to be taxed as company, various provisions dealing with interest withholding tax and the Tax File Number rules contain special operative provisions that are triggered only when the trust in question is a unit trust.)

When one examines the provisions of the Trust Deed, the second lesson from the High Court is that there are often clauses in deeds (previously considered relatively innocuous) which can contradict the general impression created by the label “unit trust” – for example, the presumption that the beneficiaries of a unit trust have a fixed and ascertainable proprietary interest in each asset of the trust may be put in doubt by the terms of the Deed.  The High Court was particularly interested in the impact of the clauses in the Deed empowering the Trustee to manage the trust’s portfolio of assets and dealing with receipts, and those dealing with the Trustee and Manager’s right to fees and to be indemnified for expenses.

Beyond these two observations, there are several areas of tax law where, one can speculate, the judgment may have worrying implications.

First, there has been an ongoing debate between the Australian Taxation Office and the profession about whether a unit trust is by definition a “fixed trust” – that is, a trust in which the beneficiaries have fixed interests in the trust’s income and capital.  The term “fixed trust” is used for example in the tax laws dealing with the ability of trusts to carry forward losses and the ability of beneficiaries to claim access to franking credits on dividends paid to the trustee.  As a result of this case, the ATO’s position – that many unit trusts will not automatically be fixed trusts – may have more support, and, accordingly, the trust’s ability to utilise a carry forward loss or the ability of a beneficiary to claim the benefit of a franking credit may be less certain.

Similarly, if we look outside the unit trust context, there must be doubts about the operation of the tax law dealing with capital gains and losses.  The capital gains tax rules provide that a capital gain or loss made by a fixed trust that is not a unit trust, is made by the beneficiary and not the trustee if the beneficiary is “absolutely entitled” to the trust asset.  Again, it is almost an article of faith that where a single beneficiary owns all the interests in the trust, that beneficiary is “absolutely entitled” to the trust assets.  This was the logic underlying the position taken in the Supreme Court of Victoria in CPT Custodian which the High Court over-turned. It was also the view taken by the Commissioner of Taxation in his Draft Tax Ruling on the meaning of “absolute entitlement” discussed in our Tax Brief last year [http://www.gf.com.au/articles_335.htm].  Indeed, the Commissioner has gone even further in one of his determinations to argue that a trust is not longer a “unit trust” if all the units are held by a single entity.

The difference – whether the capital gain is made by the beneficiary directly or is made in the trust – has important ramifications if there are losses or where the character of the capital gain matters.  For example, if the asset is sold at a capital loss, the loss would be available to the beneficiary if the beneficiary is absolutely entitled, whereas it will be quarantined in the trust if the beneficiary is not.  As a result of this case, it is just a little harder to be entirely confident that a trust can just be disregarded for capital gains tax purposes where there is only one beneficiary.

The implications of the judgment may even flow into other areas where the question is not the taxation of the trustee or beneficiaries, but rather the tax treatment of another taxpayer owned or controlled via a trust.  For example, the rules which deny a company the ability to deduct tax losses are triggered where there is change to the identity of people who are the beneficial owners of the company.  One might have pause to wonder now just who is the beneficial owner of a company if the shares have been issued to the trustee of a unit trust.  Does anyone have a sufficient interest to satisfy the test where the Trust Deed contains the same clauses that troubled the High Court?

The judgment is difficult and the profession is still coming to grips with its implications.  There will certainly be much more speculation about its meaning and effect outside the land tax context.

For further information, please contact,
Andrew Mills
61 2 9225 5966

andrew.mills@gf.com.au