Once upon a time…
In medieval England, there was no income tax, no capital gains tax, no complex tax code and regulations, and trusts could continue to operate indefinitely. However, this enabled wealthy families to hold property in their trusts indefinitely, or in perpetuity. Ultimately, that situation was judged to be against public policy and the law changed to force the winding up (or vesting) of trusts after a specified period (the perpetuity period).
In some of the older trust deeds, the perpetuity period was generally expressed to be 21 years after the death of the last living descendant of King George V (who was then King at the time these trusts were established). Others provide for the perpetuity period to end upon the death of the principal family member instrumental in setting up the trust. However, the vast majority of recent trust deeds provide for the trust to vest 80 years after their establishment date. This is supported by statute in all jurisdictions in Australia (often called the Perpetuities and Accumulations Act), other than in South Australia which has abolished the perpetuity period altogether.
What is a vesting?
Consistently with the law which requires trusts to end, rather than to exist in perpetuity, on the vesting date, the assets of the trust will no longer be under the control of the trustee but will vest in:-
- those beneficiaries determined by the trustee under a valid power, and in the proportions or the amounts determined by the trustee:- or
- where the trustee fails to make a determination, the assets of the trust will vest in those beneficiaries who are entitled to the assets according to the terms of the trust deed.
The interest of the beneficiaries is then fixed and, if the assets have not been distributed to the beneficiaries, the trustee is deemed to hold them, in fixed amounts, in trust for the beneficiaries.
What makes a trust vest?
The trust will vest (or terminate) either:-
- on the date specified in the trust deed as the vesting date; or
- on the date nominated by the trustee if the power to bring the vesting date forward has been conferred on, and exercised by, the trustee under the trust deed.
What happens when a trust vests?
If the trustee takes no action
This will depend entirely on the provisions of the trust deed. Some trusts provide for the trustee to hold trust property for specified beneficiaries after the vesting date. If that applies, the duties of the trustee will change. For example, the trustee will no longer have any discretionary powers to appoint income or capital after vesting. However, importantly, it is probable that CGT Event E1 will have occurred.
The vesting of the trust does not always end the trust or create a new trust. The most common outcome results in the ending of the trust and its assets becoming vested in those beneficiaries who are entitled to receive the assets. Those beneficiaries then hold a fixed interest in the capital and income of the trust and the trustee is duty bound to make distributions to those beneficiaries as soon as possible.
If the trustee is proactive
Subject to the powers conferred on the trustee by the trust deed, a proactive trustee will take control of the vesting of the trust and will, if permitted, decide which beneficiaries will receive the final distribution of income and capital. That decision may align with the default provisions of the trust deed, or may be somewhat different. However the trustee may only distribute the final distributions to persons and entities who are income and capital beneficiaries respectively.
What happens if the trustee decides to change the vesting date?
If the trustee exercises the power conferred on it by the trust deed to change the vesting date, and provided the vesting date is not later that the perpetuity date under statute, the change is effective and there are no CGT consequences.
If the trustee has no power under the trust deed to change the vesting date of the trust, a purported attempt to vest the trust on an earlier or later date will be ineffective. The only effective way of changing the vesting date under these circumstances is to obtain an order from the Supreme Court.
What happens if the vesting date has passed and no-one has noticed?
Continuing to administer the trust in the same manner as it was administered before the vesting will not extend the vesting date. It is too late to change the vesting date of a trust after it has passed. Depending on the exact provisions of the trust deed, it will be deemed that the trustee is holding the trust property in separate trusts for the beneficiaries in quantities implied or expressed in the trust deed. This may have CGT consequences.
Although the Supreme Court is not known for its flexibility in applications to extend the vesting date of a trust, there was a case in 2014 in Queensland (Re: Arthur Brady Family Trust  QSC 244) where the Court showed some leniency.
The case related to two discretionary trusts. One trust was formed in 1977 and had a vesting date of February 2017. The other trust was formed in 2008 with its vesting date being one day prior to the vesting date of the first trust. Neither trust deed permitted the trustee to change the vesting date but all potential beneficiaries had consented to the proposed amendment of the vesting dates.
At the time of the case, the two trusts held property valued in excess of $15 million and the disposal of that property to the beneficiaries would have caused the trusts to incur CGT of some $1.1 million and the beneficiaries to have a stamp duty liability of around $770,000. As the parties did not have access to funds to cover those transfer costs, the court made an order to amend the vesting date of the first trust to the eightieth anniversary of its formation date, and to amend the vesting date of the second trust to one day prior to the vesting date of the first trust.
What are the tax consequences on the vesting of a trust?
There may be income tax implications when the trust vests depending on the trust deed, including capital gains tax (CGT) consequences. The ATO’s views on the CGT consequences of a trust vesting are set out in Taxation Ruling TR 2018/6. Essentially, it states that:-
The provisions contained in the trust deed will dictate whether or not the vesting of the trust will give rise to a CGT liability.
CGT Event E1 – Creation of new trust
CGT Event E1 need not happen merely because a trust has vested and its property is settled into the new fixed trust for the benefit of the capital beneficiaries. However, if the parties enter into a deed to extend the vesting date of the previous trust (such as when the vesting date has passed but the trustee continues to make discretionary distributions of income and/or capital), CGT Event E1 will have occurred. This is because the ATO will deem that a new trust has been created, with the assets of the “previous” trust being transferred to the “new” trust at market rates. This may give rise to a liability for the trustee of the “previous” trust.
CGT Event E5 – Beneficiary becoming absolutely entitled
This is not likely to occur but is included in this article in the interest of completeness. Once a trust vests, the capital beneficiaries will have a fixed interest in the assets of the trust and are absolutely entitled to those assets as against the trustee. If there were a trust with a sole capital beneficiary, that person would have a fixed interest in all of the trust’s assets. Any act carried out by the trustee is treated as if it was carried out by the beneficiary. For example, if the trustee were to sell an asset, effectively the beneficiary’s interest in that asset has been sold and the CGT liability would attach to the beneficiary.
These provisions apply separately to each beneficiary and asset of the trust. They require absolute entitlement to the whole of a CGT asset of the trust.
CGT Event E7 – Disposal to beneficiary to end capital interest
CGT event E7 happens if the trustee of a trust disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary’s interest, or part of it, in the trust capital. This may occur after the trust vests, such as if CGT assets are actually distributed to beneficiaries, but only if the beneficiaries are not already absolutely entitled to the CGT assets as against the trustee.
Taxation of trust net income after the vesting date
Before the trust vests, the trustee is entitled to exercise its discretion and distribute income to such beneficiaries as the trustee determines. After the trust vests, the trustee is obliged to distribute income to each of the capital beneficiaries. This is usually distributed in the same proportions to their vested interests in the property of the trust.
It is important to note that after a trust vests, all of the net income of the trustee is assessable in the hands of the capital beneficiaries and none of it is assessable against the trustee.
Although many practitioners regard the vesting of a trust to be somewhat mechanical and requiring simple documentation, great care needs to be taken where:-
- a trustee wishes to extend the vesting date;
- clients wish to bring forward the vesting date;
- a distribution of pre-vesting and post-vesting income is to occur; and
- the trustee wishes to determine the recipients of the final distribution of capital on vesting.
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