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III. Settled Property

24.A25. Under Australian law, it is possible to settle property on trusts lasting for many years. There are rules against lengthy accumulations and perpetuities; but generally there is no difficulty in creating a trust extending over two generations of a family, and sometimes a trust can be effectively extended into the third generation. While such a trust continues, the rights of the beneficiaries to income or to capital can be stated in precise terms (for example, to A for life, then to his children B and C for life and then to such of the children of B and C as live to attain 21 years) or can be left to be determined during the life of the trust under discretionary powers conferred upon the trustees or other persons. A trust can be created to last for upwards of 80 years under which the income is directed to be accumulated, or distributed among a specific class, such as the descendants of A, at the discretion of the trustee. Until the trust comes to an end, no beneficiary has any right, as a rule, to an identifiable part of the trust property, although he may receive some of the income or may expect to receive some of the capital. Clearly, such a device lends itself to tax avoidance.

24.A26. Generally, the creation of a trust, whether by settlement or will or otherwise, gives rise to no difficulties. (One exception is a settlement where the settlor retains an interest; this case is dealt with later in this appendix.) If the trust is created by will, the property subject to the trust will form part of the estate of the deceased; if created during the taxpayer's life, the property will be caught by the gift duty provisions. Thereafter, however, there is no easy solution to the problem of taxing property held in trust.




  ― 460 ―

Life Estates

24.A27. The Committee has come to the conclusion that, in determining the tax base, property the taxpayer did not own but whose yield of income he had the right to enjoy ought to be included. In the case of a life estate, this means that the corpus supporting the life estate should be taxed as part of the estate of the life tenant on his death. It can be argued that such a principle is too wide, that it is unfair to tax the corpus in the hands of the life tenant since he did not have the right to dispose of the corpus during his life and he was never the owner of it. A fairer solution, in the case of a life estate, might be to tax the life tenant on his death on part of the corpus, such part being the actuarial interest of the life tenant in the corpus when he first became entitled to the life estate. However, this solution would permit part only of the wealth subject to successive life estates held by members of successive generations to be taxed. If the life tenant is taxed on part only of the trust estate on his death, there is unlikely to be anyone else to whom the balance may be appropriately attributed. One cannot tax the persons ultimately entitled to the corpus, as they may not be known. To tax the trustee on the balance, the whole of the estate will be brought to charge but the aggregate of duty payable will usually differ from what would have been payable had the whole estate been taxed in the hands of the life tenant. The actual difference will depend on the rates. Unless a special rate is imposed on trustees, there will be a tax advantage in creating a life estate or a number of life estates. In the Committee's opinion, an estate bequeathed by X to his son for life and then to the son's children, should bear broadly the same duty as the estate would have borne had it been bequeathed by X to his son and had the son then bequeathed it to his children. The Committee recommends that, on the death of a life tenant, the assets supporting his life estate should form part of his dutiable estate and the duty on it should be paid out of those assets.

24.A28. A life tenant may bring his life estate to an end while he is alive by a surrender or a partition or by some other means. It would hardly be fair to tax assets subject to a life estate on the death of a life tenant but not to tax assets where a life tenant has surrendered his interest immediately before his death. In the Committee's opinion, where a life estate is teminated other than by disclaimer the life tenant should be taxed as if he had disposed of the whole of the assets subject to the life estate for a consideration equal to the consideration in fact received by him. The difference between the value of the assets and the consideration should be taxed as a gift.

24.A29. Where a life interest (whether vested or contingent) is disclaimed, there should be no such deemed disposal. A disclaimer is a rejection of an interest by a beneficiary before he takes any benefits to which he may be entitled by virtue of the interest. The Committee considers that this treatment of a disclaimed interest should be extended to a surrender by a beneficiary of an interest where the surrender is made within six months of the date on which the beneficiary receives the first benefits to which he was entitled under the interest. This treatment should only be available if all benefits received by virtue of the interest are repaid to the trustee to be held by the trustee as if the interest had been disclaimed.

24.A30. It seems arbitrary to treat an assignment differently to a surrender or a partition. An assignment, other than by charge, should be treated on the same basis as a surrender or partition; that is to say, the life tenant should be deemed to have disposed of the assets supporting his life estate for a sum equal to the consideration, if any, received by him from the assignee. The difference between the value of the assets and the consideration should be taxed as a gift.




  ― 461 ―

24.A31. The foregoing principles need to be supported by other rules:

  • (a) If there is a merger of the life estate by reason of the life tenant acquiring the remainder, the transaction should not attract any duty (unless the consideration paid is greater or less than the value of the remainder). Provided the assets comprising the corpus are still owned by the life tenant on his death, the whole will then be taxed.
  • (b) Sometimes a life estate is not in the whole of the assets held subject to the trust, but in part only of those assets. Where the part is a fraction of the whole, for example an interest in half the income from the estate for the life of X, the same fraction can be used to determine the extent of any liability for duty when the life tenant dies or deals with his interest in some way. Thus, if X is entitled to half the income from Blackacre during his life, half the value of Blackacre will be taxed on X's death. Sometimes the entitlement is fixed in money terms. For example, a settlor may direct that the first $5,000 of the income derived by the estate each year be paid to his daughter for her life, that half the balance be paid to his son for his life and that the remainder of the income be accumulated. The income from the estate may vary and, in a particular year, be less than $5,000. Where the entitlement is fixed in this way, the fraction A ÷ B should be employed to determine the interest in the corpus of the life tenant on his death or at some earlier point of time, where A is the total income that the life tenant became entitled to receive from the trust over the previous N years (or, if the entitlement has been for a lesser period, then that lesser period) and B is the total income derived by the estate during this period. The period of N years should be reasonably long—say ten years—to enable a clear picture to emerge. In applying the fraction, the income of the trust estate should be determined by principles of trust law rather than income tax law.
  • (c) For the purpose of applying the foregoing rules, distributions out of corpus should be disregarded unless there is undistributed income in the trust. Where there is undistributed income, applications from corpus should be deemed to be distributions of income to the extent of the amount of the undistributed income.

24.A32. If the assignment or surrender relates to a contingent life interest, that is to say, if a person assigns or surrenders his life interest before the interest vests, the transaction ought not to attract duty under the provisions recommended in paragraphs 24.A28 and 24.A30. If the consideration received on the assignment or surrender is greater or less than the value of the contingent interest at that time, there will be a gift of the difference.

24.A33. Once a life interest has been taxed, no further tax should be payable in relation to any subsequent dealings with the life interest for full consideration or on the death of the life concerned.

24.A34. The recovery of duty from the trustee of an estate in which a life interest is held is considered in paragraphs 24.64–24.65. Where the life tenant has died, it will be necessary to calculate what part of the estate duty is referable to the settled estate. In the Committee's view, the duty applicable to the settled estate should be the average rate of tax charged on the whole of the property owned or deemed to be owned or to have been disposed of by the deceased life tenant on his death. Where the person entitled to the estate next following that of the life tenant is a person in respect of whom an exemption is available, then so much of the exemption as is not absorbed by


  ― 462 ―
the actual estate of the deceased life tenant should be available against the duty charged on the corpus of the settlement.

Estates for a Term of Years or for the Life of Another Person

24.A35. Regard must be paid also to estates for a term of years and estates for the life of another person. If the legislation fails to deal with these kinds of interest, avenues of avoidance of the life estate provisions will be opened up. For example, instead of settling assets on his daughter (aged 30) for life, a settlor may provide her with an estate for a term of 60 years. Other illustrations are mentioned in the following paragraphs.

24.A36. One approach would be to treat the estate generally in a similar manner to a life estate, that is to say, to deem the relevant assets to have been disposed of by the holder of the estate on the expiration of the term or on an earlier assignment or surrender, but to bring to charge a fraction only of the assets. The fraction would be the ratio of the term of the interest to the life expectancy of the original holder of the interest at the time the interest was created, such fraction not to exceed one. An alternative approach would be to bring to tax the whole of the assets. This the Committee considers too drastic. It prefers that the former approach be adopted. There should be a provision, however, that if successive terms are created which have the effect of giving the holder of the terms a life estate, the whole of the assets will be taxed on the expiration, assignment or surrender of the last such term or on the death of the holder, credit being allowed for any tax paid on the expiration of the earlier terms. The rules mentioned in paragraphs 24.A28–24.A34 in relation to life estates should be applied to interests for terms of years and interests for the life of another.

Discretionary Trusts

24.A37. Discretionary trusts require further consideration. (‘Discretionary trust’ refers to a trust under which the trustee or some other person has a discretion as to how the trust income is to be distributed among persons entitled to be considered.) If

  • (a) a person is entitled to be considered in the exercise by another person of a discretion in relation to the distribution of income of a trust estate, and
  • (b) that entitlement ceases for any reason whatsoever (for example, the expiration of a term of years, the assignment of any future entitlement, the exercise of a discretion in relation to corpus or the death of the person entitled), and
  • (c) the person so entitled has received income as a result of the exercise of the discretion during a specified period of years (N years) preceding the date on which the entitlement ceases,

he should be deemed to have disposed of a fraction of the assets of the discretionary trust, such fraction being: (income received by that person over the N years) ÷ (total income of the discretionary trust during this period). The choice of an appropriate figure for N poses some difficulties. On the one hand, if N is small, say 5, one may expect that elderly beneficiaries will be phased out of income distributions as they advance in years, thus significantly reducing the fraction. But if the figure for N is large, there will be other problems. For example, if N is set at 50 and one person has received all the income from the estate during the last 20 years but little or nothing during the earlier 30 years, then only two-fifths of the assets would be brought to tax on the cessation or assignment of the interest. Conversely, it would seem somewhat unfair to tax the person who received the income during the earlier 30 years on a basis that would bring three-fifths of the value of the assets to tax at a date 20 years after he received the last benefit from the estate. In addition, a large figure for N will create


  ― 463 ―
administrative difficulties for the trustee and the Revenue. On balance, a smaller figure for N seems preferable, though it has to be recognised that this may encourage the establishment of discretionary trusts. The Committee suggests that a period of ten years be adopted; if the trust subsists for a lesser number of years, N should be equal to that number. For the purpose of determining the total income of the discretionary trust, concepts of trust law rather than income tax law should be employed and any applications from corpus should be deemed to be income to the extent that there is accumulated undistributed income in the trust.

Accumulating Income

24.A38. The foregoing rules do not deal with the case where income is accumulated. There are limitations in most jurisdictions on the extent to which income can be accumulated but some tax-haven countries have deliberately removed such limitations. To the extent that accumulation is permitted, the policy of levying duty at least once each generation is open to defeat since all the recommendations above depend on income being distributed.

24.A39. An estate may include non-income-producing assets such as works of art and land suitable for residential development purposes, or the gross income produced by or derived from an asset may be exactly set off by interest on borrowings or other outgoings. The concepts of income and outgoings can be defined by the relevant trust instrument in such a way that, though there is income for income tax purposes, there is no income for trust law purposes. A trust may have been established by a settlor with a view to deriving gains of a capital rather than of an income nature. The capital gains could be distributed to beneficiaries by means of distributions from time to time out of corpus. If the estate is wholly comprised of such assets, the rules suggested in paragraphs 24.A27–24.A37 will not be effective in relation to that estate.

24.A40. The Committee recommends that where during a relevant period (defined later) the trust has derived income and the income has not been wholly distributed during that period, the assets of the trust, or an appropriate part, should be brought to tax at the end of the relevant period. The fraction will be that part of the estate which is not brought to tax during the relevant period. Assume, for example, that a trustee has a discretion to accumulate the income or to make distributions to A or B during A's life and the trustee has, at all times, distributed one-third of the income to A and accumulated the balance. If A dies during the relevant period, one-third of the estate will be brought to tax on the death of A under the rule in paragraph 24.A37 and, at the end of the relevant period, the remaining two-thirds will be taxed. Alternatively, if A dies after the end of the relevant period, the whole estate will be brought to tax on the expiration of the relevant period. One-third will again be taxed on A's death, but here quick-succession relief will be available.

24.A41. In the case of a trust which, at any time during a relevant period, has held assets belonging to the class of assets described in the first sentence of paragraph 24.A39, the following rules should be applied:

  • (a) If a beneficiary who is a life tenant or who has an interest for the life of another has had the use or benefit of the asset during the term of his interest, the asset should be taxed on the expiry of his interest, or on a prior dealing, in the same way that it would have been taxed had the beneficiary received income from the asset.



  •   ― 464 ―
    (b) In any other case, the whole or part of the asset should be brought to tax at the end of the relevant period. Tax should be levied on that part of the asset not brought to tax during the relevant period.

A beneficiary should be regarded as having the use and benefit of an asset if the asset is dealt with or used in accordance with the beneficiary's directions.

24.A42. In the case of trusts existing when any legislation giving effect to these recommendations comes into force, the first relevant period referred to in paragraphs 24.A40–24.A41 should be twenty-five years from date on which the legislation comes into force. In the case of trusts arising after any such legislation comes into force, the first relevant period should be twenty-five years from the date on which the trust comes into existence. The second relevant period would commence on the day following the last day of the first period and so on, each relevant period being twenty-five years. If the trust comes to an end and all the assets are distributed during any such period of twenty-five years, then the relevant period should end on that day. However, the deemed disposal should be part only of the fraction mentioned above, such part being: (number of years and fractions thereof in the relevant period) divided by 25.

24.A43. Rate of duty on assets brought to tax by virtue of the provisions recommended in paragraph 24.A40 and under (b) in paragraph 24.A41 should be set sufficiently high to discourage the use of trusts as a means of avoiding tax.

Special Cases

24.A44. Three cases that would be caught by the foregoing rules require special consideration.

24.A45. The first case relates to the situation where a taxpayer settles property on himself for life with the remainder to other persons. Where the life interest is in the whole of the settled property, the property will be taxed on the death of the settlor or on an earlier dealing by him with the life estate and no tax need be imposed when the settlement is created. If the life interest is not in the whole of the settled property, then the value of that part to which the interest does not relate should be taxed as a gift at the time of the settlement.

24.A46. The second case is where an existing interest is enlarged. For example, assume that A, B and C are each entitled to a third of the income from Blackacre during the life of C and that A and B are entitled to half of Blackacre on the death of C. Under the Committee's recommended rules, the whole or a fraction (greater than a third) of the value of Blackacre would be brought to tax on the death of C, half on the death of A and half on the death of B. The Committee recommends that where

  • (a) an interest (whether for life, for a term of years or for the life of another or as a potential beneficiary under a discretionary trust) is determined, and
  • (b) the whole or any part of the corpus is taxed to the person who was the holder of that interest, and
  • (c) that person is absolutely entitled to the whole or a fraction of the corpus,

the amount of the corpus brought to tax should be limited to the amount by which the corpus deemed to have been disposed of by that person exceeds the amount of corpus to which that person is actually entitled. Under this exception, in the example given above, a third only of Blackacre will be brought to tax on the death of C, and a half on


  ― 465 ―
each of the deaths of A and B. The exemption ought not to be available if the entitlement to corpus is contingent or can be defeated by some means.

24.A47. The third case is the protective trust. Such trusts are established for the benefit of a beneficiary (herein called the ‘protected beneficiary’) who is unable to manage his affairs properly or may be unduly influenced to his own disadvantage. Generally the trustee has a discretion as to distribution of income. If, on the death of a protected beneficiary who has had a life estate, three-quarters of the income derived during the life of the protected beneficiary has been distributed, three-quarters of the corpus will come to be taxed under the provisions recommended in paragraphs 24.A27 and 24.A31. In the meantime, the accumulated income will have resulted in tax being imposed by virtue of the provisions recommended in paragraph 24.A40. Such treatment, in the Committee's view, is inappropriate. In the case of a protective trust, the whole of the assets subject to the trust should be taxed on the occasion when the interest of the protected beneficiary is taxed under the provisions recommended in paragraph 24.A27. No tax should be imposed prior to this occasion by virtue of the provisions recommended in paragraph 24.A40.

24.A48. In this discussion of limited interests it has been assumed that the holder acquired the interest in circumstances that did not involve his giving any consideration for the interest: he may have acquired the interest under a will or in an inter vivos settlement. If purchased interests are excluded from the proposed provisions, opportunities for tax avoidance will be created. Assume, for example, that a grandfather is near death and is giving instructions in regard to his will. If, by his will, he leaves a life estate in property to his son with remainder to the grandson, estate duty will be paid on the full value of the property on the death of the grandfather and again on the death of the son. If, instead, the son acquires, by purchase, a life estate in the property from the grandfather, and the grandfather leaves a legacy to the son of the amount paid for the life estate and the remainder interest to the grandson, estate duty will be paid on the full value of the property (the value of the remainder plus the amount paid by the son for the life interest) on the death of the grandfather but no estate duty will be paid on the value of the property on the death of the son. In the Committee's view the treatment should not be varied merely because consideration was in fact given.

24.A49. Where a life estate or an estate for the life of another or an interest in a discretionary trust is assigned, the estate or interest will be taxed at that point. No further tax need be charged on the expiry of the estate or interest or on any further dealing with it for adequate consideration.

24.A50. The notion of limited interest is very wide and will include interests, for example that of a lessee of property, which arise in ordinary commercial transactions. It will be necessary to exclude from the operation of the proposed provisions interests that have been acquired by persons dealing with each other at arm's length in ordinary commercial transactions.

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