Key points
- The Tribunal found that pre-CGT status of trust assets was maintained despite the addition of a new beneficiaries to the trust.
- Division 149 does not automatically remove pre-CGT status from discretionary trust assets simply because beneficial interests in trust assets can’t be quantified.
- The decision is significant for holders of pre-CGT assets in trusts, but further developments should be monitored.
The Administrative Review Tribunal (“the Tribunal”) handed down a decision concluding that shares acquired by a discretionary family trust before 20 September 1985 continued to be treated as pre-CGT assets up until their sale in the 2020 income year. The Commissioner argued that Division 149 of the Income Tax Assessment Act 1997 (“Division 149”) operated to end the pre-CGT status of the shares in 2011 when a new company was added to the trust’s class of beneficiaries. The Commissioner argued that this resulted in a change of majority underlying interests held in the asset compared to those held just before 20 September 1985. The Tribunal noted the difficulty in applying Division 149 to assets held in discretionary trusts but ultimately concluded in the taxpayer’s favour. Although only a Tribunal decision, it is the first case to consider how Division 149 applies to discretionary trusts and provides critical guidance to those who continue to maintain pre-CGT assets in such structures.
What were the facts of the case?
In XLZH v FCT[1] the taxpayer received a distribution of over $64 million from a family trust that was referable to a capital gain the trust made in the 2020 year from the sale of shares in a private company (referred to as “Alpha”) that conducted a business controlled by the taxpayer and her husband. It was common ground that the shares were acquired by the company before 20 September 1985[2] and held until their sale for $100 million in July 2019.
The discretionary trust that sold the Alpha shares was established in 1977. The primary beneficiaries of the trust included the taxpayer, her husband’s siblings and lineal descendants, the spouses of her husband’s children and a charitable trust. Critically, the taxpayer’s husband had the power to nominate additional beneficiaries but was himself excluded as a beneficiary (being the appointor or nominator of the trust).
The taxpayer’s husband exercised his power to add additional family members to the class of beneficiaries in 2009, 2010, 2011 and 2014. However, it was the addition of new a corporate beneficiary (referred to as “Beta”) in June 2011 to the class of beneficiaries that the Commissioner took issue with.
Beta was owned by a different trust, described as a hybrid trust, in which units were held by the taxpayer and her husband but where the trustee had a broad discretion to distribute income or capital to a wide class of beneficiaries including family members, corporations and other trusts. From 2011, some of the dividends paid by Alpha were distributed to Beta. Some of the dividends paid by Beta were distributed to the taxpayer’s husband. The effect of this addition saw the dividend income derived from Alpha shares start flowing, in part, to the taxpayer’s husband who was otherwise excluded as a beneficiary from the family trust.
While the taxpayer’s husband ultimately received the benefit of dividends paid by Alpha, it was noted that the husband received either 0% or between 15% and 39% of the distributed dividends from Alpha in any given year, and only 19% of the dividends across all the 2009 to 2019 income years.
What were the issues in dispute?
There was only one issue in dispute in the case, being whether the taxpayer could disregard the capital gain made by the trust from the sale of the Alpha shares (which it distributed to her) on the basis that the shares were pre-CGT assets.
The Commissioner argued that the addition of Beta to the class of beneficiaries triggered the application of Division 149, resulting in a change of majority underlying interests in the Alpha shares, and the loss of their pre-CGT status.[3] Broadly, Division 149 operates to remove the pre-CGT grandfathering of assets that are held by trusts and companies where there is a 50% or greater change in the ultimate owners who hold the underlying beneficial interests in the asset as compared to those who held those interests just before 20 September 1985.
What did the tribunal decide?
Deputy President Lazanas held in favour of the taxpayer and allowed the objection against her assessment
The tracing requirement
The Tribunal outlined that the application of Division 149 requires tracing the ‘beneficial interests’ in the asset and the income derived from it directly or indirectly through companies, trusts and partnerships to its ultimate owners that are individuals.[4]
The decision explained that the nature of beneficial interests held by beneficiaries of discretionary trusts are such that it is impossible to measure or otherwise predict which specific individuals would benefit from the asset at any time. Because these interests cannot be expressed in percentage terms, the comparison between those holding interests in the asset just before 20 September 1985 and any later time cannot ordinarily be performed (for example, using a mathematical comparison of interests held).
Reasonable to assume alternative
However, the Tribunal noted that the term ‘beneficial interest’ should be read more broadly in the context of Division 149 as the legislation should permit pre-CGT status of discretionary trust assets to be maintained. In particular, the Tribunal highlighted that subsection 149-30(2) allows the Commissioner, or the Tribunal standing in the shoes of the Commissioner, [5] to conclude that majority underlying interests in the asset were maintained if so satisfied or if reasonable to assume.
Subsection 149-30(2) was held to be a concessional provision to be construed beneficially and can displace the primary test which requires a mathematical comparison of the percentages of beneficial interests held. Importantly, subsection 149-30(2) can be applied where there are evidentiary gaps as well as where it is impossible to quantify interests held due the nature of a discretionary trust. It was noted that while Division 149 is an integrity provision, a tax avoidance purpose is not necessary to establish a change in majority underlying interests in a pre-CGT asset.
Income Tax Ruling IT 2340
The Tribunal also considered the application of IT 2340 issued in July 1986. These older rulings pre-date the current system of binding rulings, but the Tribunal nevertheless considered that it is arguably administratively binding on the Commissioner such that he should depart from the ruling only when there are good and substantial reasons to do so.
IT 2340 dealt with the predecessor provision to Division 149 which the Tribunal considered expressed the same ideas, such that the ruling remained relevant. The examples in IT 2340 that informed the Tribunal’s decision included one where it was ruled that there was in practical effect a change of 50% or more in the underlying interest in the assets of a family trust where an entirely new group of beneficiaries are substituted in place of a group of former beneficiaries.
Conclusion
Ultimately, the Tribunal was satisfied that at all times from 20 September 1985 to the date of disposal of the Alpha shares that the family trust always held the shares for the benefit of the same family group, being the taxpayer and her husband’s family (excluding the husband himself). While not prescribing a strict pattern of distributions test, the Tribunal reviewed the history of distributions and noted that the taxpayer’s husband did not indirectly receive more than 50% of the dividends from Alpha shares in the period from 2011 to 2020 or in any single year. The addition in 2011 of Beta (through which the husband could benefit) as a beneficiary of the trust did not cause a change in the majority underlying interests held in the Alpha shares.
What are the next steps?
This decision is likely to significantly influence taxpayers who have continued to hold pre-CGT assets through discretionary trusts, or subsidiaries of discretionary trusts. While it is unknown yet whether the Commissioner will seek to appeal the decision, he is likely to do so and may seek to issue a decision impact statement in the interim. Taxpayers with pre-CGT assets will need to closely monitor the outcomes of this case. In particular, it may be useful to conduct a “distribution” tracing exercise.
Please contact your Pitcher Partners representative if you would like to review your existing arrangements and determine what action may be required in light of the decision.
[1] [2025] ARTA 2154.
[2] Note that the company was incorporated in 1988. However, it appears that a transfer of pre-CGT business assets occurred from the trust to this wholly-owned subsidiary pursuant to a CGT roll-over that resulted in the shares issued for the transfer obtaining pre-CGT status.
[3] If this occurs, the asset is taken to be acquired for its market value at that time. Any capital gains or losses accrued up to that time should remain tax-free upon ultimate disposal of the asset.
[4] For completeness, ultimate owners can also include companies who are prevented from distributing money or property to its members.
[5] The ability for the Tribunal to make such decisions afresh may be a reason to a appeal to a Tribunal rather than the Federal Court.
