Beware of trusts ending when time runs out
The aim of this article is to alert the reader that there are different reasons why a trust may come to an end (i.e. it vests). This vesting of a trust leads to further tax consequences and obligations for the trustee. Nexia Australia national taxation director Roelof van der Merwe outlines these issues.
A trust may end for a variety of legitimate business reasons (e.g. the business activities of the trust may have come to an end or the business owners may no longer want to use a trust structure to run their business but rather convert to a corporate structure). Alternatively, the trust may end by a court order, a resettlement or when the term of the trust expires (because trusts generally have a limited life-span up to a maximum statutory period of 80 years).
Although this vesting date is specified in the trust deed (usually in a vesting clause), it can easily be overlooked. Many people operating through trust structures are unaware of when their trust’s vesting date is.
Just imagine that after reading this article, you go and examine when the vesting date for your trust is. To your alarm you discover either that:
- the vesting date is within the next year (i.e. it may be a trust settled in the late 1980s with a lifespan of 30 years); or
- the trust has actually vested five years ago, yet you are still carrying on business through this trust (that vested five years ago).
What would you do in such situations?
Most probably the following three questions will be popping up in your head:
- What are the consequences (tax and non-tax) when a trust vests?
- Can you extend the vesting date to avoid the trust from vesting (and thereby avoid or defer any potential tax consequences)?
- What if you were unaware that the trust has already vested, yet you continued operating through such a trust without knowing that such a trust has already vested?
This article provides answers to these pertinent questions.
Consequences when a trust vests
When a trust vests, the interests of the beneficiaries in the trust property becomes fixed at law. This means that a trustee of a discretionary trusts will no longer have a discretionary power to decide which beneficiaries will be entitled to the income or capital of the trust. After vesting, trustees will hold the trust property for the absolute benefit of those beneficiaries specified as takers on vesting (as set out in the vesting clause).
In short, the vesting process is typically as follows:
- Trustee resolves to allocate assets to beneficiaries
- Vesting documentation
- Transfer of legal title of assets
- Trustee finalises accounts and tax return
Also, trust vesting may give rise to various tax (e.g. income tax, CGT, GST and stamp duty) and non-tax issues (e.g. trustee has different fiduciary duties when a trust ends).
1a. Tax issues
The tax consequences arising when a trust vests depends on a variety of factors (e.g. the type of trust, the residence of the trust, the type of beneficiaries, the type of assets and the type of distributions).
Broadly, for income tax purposes there will be a final distribution of trust income. It is therefore important to ensure that valid trust resolutions are in place before the vesting date to ensure there is no trustee assessment of undistributed income. Also, any unutilised trust losses will become unusable/lost.
The mere vesting of a trust will not necessarily give rise to CGT consequences. For example, if a trustee continues to hold trust assets for takers on vesting, the trust assets will be held on the same trust that existed pre-vesting – only the nature of the trust relationship changes on vesting.
A capital gain/loss will only arise if there is a disposal or transfer of legal title of the trust assets. On such a transfer the beneficiary will usually receive an uplift of the cost base to the market value of the asset received, depending on the type of trust and how the assets are disposed of. However, there may be significant capital gains on such transfers.
The most important post vesting events that may lead to CGT consequences are:
- When a new trust is created by declaration or settlement over the trust assets (i.e. CGT event E1);
- When the takers on vesting become absolutely entitled to CGT assets of the trust (i.e. CGT event E5); or
- Once CGT assets are actually distributed to beneficiaries (i.e. CGT event E7).
There are also GST issues (whether a cash distribution or an in specie distribution of assets is a taxable supply), which usually turns on whether the recipient is registered for GST. Stamp duty issues (whether dutiable property is transferred) also arise when a trust comes to an end. Depending on the state/territory, exemptions are available, provided the movement of assets is structured correctly.
1b. Non-tax issues
The trustee also has certain obligations to perform in order to pay the trust debts and distribute trust income and property (whether in cash or in specie) to beneficiaries – the steps that the trustee must follow are usually set out in the vesting clause of a trust deed.
Once this has been done, the trustee must generally complete all financial records, inform the beneficiaries in writing of the distributions and lodge final tax returns.
A word of caution for trustees: to avoid a potential liability, it is very important for the trustee to distribute trust property correctly when a trust ends.
2. Extending the vesting date to avoid the trust from vesting
The vesting date of a trust can be extended prior to vesting without triggering a resettlement or creating a new trust, provided:
- the trust deed or a court order allows such an extension of the vesting date; and
- there is continuity of the trust estate (i.e. the property and the membership of the trust is maintained after such a change).
3. What if the vesting date of the trust has been overlooked?
In such a case (i.e. where the trust is continued to be administered inconsistent with the vesting terms), there will be no automatic extension of the vesting date. Instead, a new trust would have been created because the nature of the trust has changed.
Because a new trust has been created:
- this will give rise to a capital gain/loss (because of CGT event E1) because a new trust has been created; and
- trust income derived before and after vesting date may be distributed to different beneficiaries (e.g. income appointed after the vesting date has passed should have gone to the takers on vesting – which may be different to the discretionary beneficiaries as was the case before the trust had vested).
Check your trust deed for vesting date;
Determine trustee’s obligations on vesting; and
Determine the consequences if vesting date has passed.
This article briefly touched upon some consequences when the term of a trust expires and the trust relationship comes to an end.
It also stressed the importance of being aware of when a trust’s vesting date is, and taking appropriate strategies to extend the vesting date before the trust vests.
As with most things in life, it is a good idea to plan ahead so that you have systems and strategies in place to ensure you have the best chances of identifying the vesting date of a trust and to ensure the trustee fulfills its obligations when a trust ends.
It is important to speak to a tax adviser that has the necessary expertise and experience to assist you in setting up your systems and strategies to help you manage your different trust risks.
Furthermore, because different states and territories in Australia have different rules about the basic powers and responsibilities of trustees, we would recommend that you speak to a tax adviser in your particular state so that the tax adviser can help identify and deal with any issues to help you strengthen your business.
Roelof van der Merwe, national tax director, Nexia Australia