Note on Splitting of Trust, Demerger of Section 8 Company and Division of Co-operative Societies.
- Splitting of Trust.
1.1. Trust Split Overview
Trust splitting has been an important tool in effective estate planning (refer case study 2). The appointment of a trustee to part of the trust fund enables that part of the trust property to be dealt with separately from the remaining fund and therefore provide greater surety to the existing beneficiaries as to who will benefit from that part of the trust fund.
It is arguable that undertaking a trust split such as that shown in case study 2should be exempt from capital gains tax as the measure is aimed at providing the trustee with greater legal protection as opposed to altering (deliberately or inadvertently) beneficiary entitlements. However, it is our opinion that any form of trust split carries considerable tax risk and should only be undertaken if a trustee is willing to accept the potential tax burden.
- The trust split proposed in case study 2 involves:
- The creation of sub-trusts under the main trust.
- The trustees of the main trust should be appointed as trustees of the sub trust.
- The sub trusts will hold the property that the trustee has been appointed to.
- The main trust will be entitled to all income and capital of the sub trusts (and
hence there will be no change in the beneficiaries’ entitlements and
therefore, no CGT event).
- The trustees of the sub trust (which may not continue to be the same as the
original trustee) will hold the assets of the sub trust for the benefit of
the beneficiary. The indemnity of the sub trusts should be limited to the assets held within the sub trust. Accordingly, the risks pertaining to each sub trust will be limited to the value of property that the trustee of that sub trust is responsible for.
- No risk assets should remain in the main trust as any claim against the main trust may expose the sub trusts to the same claim.
- The main trust will have a future entitlement to any distributions made by the
sub trusts and an equal liability in respect of its appointment of that
distributions to the beneficiaries of the trust.
Under this structure the sub trusts would be forever tied to the main trust such that, whilst the trust property may be held separately by various trustees (or by the same trustee) on behalf the beneficiaries of the main and sub trusts, the distribution of any income or capital from a sub trust toa beneficiary would need to be via the main trust. This will create complexities, some of which will be addressed in this paper. The primary benefit of a sub trust split is the ability to shield part of the trust fund under separate trustees which minimizes the risk of these assets forming part of the pool of assets available to persons seeking compensation from the trust fund.
It should be noted that the reduction in the indemnity of the trustees will only be in respect of future liabilities of the trust.
However, in an estate planning exercise, it is often the desire to set up this structure well in advance of its need and accordingly it may be the case that the current trustees will continue their position until the statute of limitation has expired.
A sub trust split may also provide beneficiaries with a greater sense of entitlement in regard to the assets of the trust fund that the original trustees consider they are entitled to. Whilst a beneficiary is not specifically entitled to any property or income of a trust, having those beneficiaries appointed as trustees or co-trustees of a sub trust containing the property that they are expected to benefit from may ensure the family members feel more involved in the process. This is at the cost of several practical difficulties which are discussed further in the paper.
1.2 Splitting the Trust
The purpose behind a trust split is generally to ensure the various assets of the trust fund are allocated to a particular beneficiary. Undertaking a traditional trust split (i.e., before the abolishment of the exception) establishes new trust relationships between a trustee and a particular class of beneficiaries in respect of certain trust property. Such a trust split enables the trustee to protect investment assets from risk assets. Further different trustees were generally appointed to manage different classes of trust property. Undertaking such a traditional trust split at present is likely to result in the Commissioner considering that CGT Event E1 has occurred (though whether this is correct will require judicial oversight).
As the Commissioner has set the precedent for the creation of a sub trust, it is perhaps arguable that a sub trust, trust split is viable. A trustee of a sub trust will hold the assets of the trust for the benefit of the beneficiaries but should have no power of appointment or only have the power to appoint income and capital of the trust fund to the main trust. The main trust will continue to appoint the income it is entitled to from the sub trusts to the beneficiaries of the trust fund. Under this structure, we are of the view that CGT Event E1 would not apply. However, the benefits of trust splitting are also somewhat limited in this approach.
1.3 Factors to Consider
When undertaking a trust split the key issue is understanding the issues within the family. Too often, advisors can be focused on the tax outcomes or the legal issues which while important, are generally not the driver for the family undertaking such a complex exercise.
Often a trust split is performed as part of a succession plan. As a result, determining which assets of a trust are to be held separately for particular beneficiaries is a discussion that is often best held between an advisor, the trustees of the trust and all beneficiaries so that it is clear what everyone’s expectations and intentions are, and so all potential beneficiaries understand what they may be entitled to.
Identifying which part of the trust fund will be held for each beneficiary is critical. Personal interests, risk profile and experiences of the respective beneficiaries will play a pivotal role in such a decision.
1.4 Appointment of Trustees
Under a sub trust, trust split, the trustees of the sub trust will hold the assets in the sub trust for the benefit of the beneficiaries and hence be liable for the protection and administration of the trust fund. However, there should be no power to appoint income directly to any beneficiary. Instead, all appointments of income and capital will be directed to the main trust or in fact the main trust automatically derives all income and capital of the trust fund,
Assuming the original trustees have retired, we would consider that each trustees of the sub trust be a beneficiary of the assets that the sub trusts holds on their behalf in addition to being a joint trustee of the main trust (the benefits of which are discussed further in this paper).
In the case where a beneficiary does not have the necessary skills or acumen to act as trustee, it may be important to appoint an advisor in that capacity. This may be necessary to ensure their interest in the trust fund is properly administered and protected.
1.5 Practical Issues
- Distribution of Income
A sub trust split has a number of issues to be addressed. One of the key issues is the allocation of trust income and capital. In a sub trust split structure, each sub trust will generate its own income and capital which will be required to be distributed to the main trust before being appointed to the beneficiaries of the trust. If each sub trust has a separate trustee, how does that trustee ensure the income generated from the assets of the sub trust be appointed by the main trust in favour of the beneficiaries for which it wishes to appoint the income to.
There is no simple answer here. Whilst the original trustee(s) remain as trustees of the main trust, a sub trust trustee may be able to rely on the original trustee’s discretion to appoint the income and capital to a desirable beneficiary. However, a trust split generally is done on the basis that the original trustee role will be taken by a replacement trustee and the replacement trustee may not act in the same manner as the original trustee envisaged.
Therefore, under a sub trust split it will most likely be necessary to amend the trust deed to require that all trustees are to act unanimously when resolving to appoint the income and capital of the trust. Accordingly, it would be expected that all trustees of the sub trusts are joint trustees of the main trust and that the sub trust trustees come together to appoint the income in a manner that is fair in relation to trust assets held on behalf of the beneficiaries.
- Trust Losses
A trustee can only make a valid distribution if there is net income derived by the trust. In this case of a sub trust arrangement, it is possible to end up with an arrangement whereby one sub trust incurs a tax loss and is therefore forced to retain that loss whilst another sub trust has net income which it appoints to the main trust. Without the sub trust structure in place, the main trust would have been able to offset the losses in sub trust 1 against the income derived in sub trust 2 however in this case, the main trust will only receive the net income from sub trust 2 and hence the beneficiaries will be required to pay tax on the net income of the main trust without the benefit of offsetting the losses that were incurred in sub trust 1.
- Existing Debt in the Main Trust
The split of the trust property amongst the sub trusts includes all liabilities pertaining to the trust fund. One of the more challenging liabilities will be the existence of interest-bearing debt. Ignoring the need to allocate the net assets of the trust fairly between the sub trusts (a conversation that we noted should occur between the family members) the future deductibility of any interest-bearing debt must be considered especially if an asset for which borrowings were incurred is split toa sub trust separate to the original debt.
One such solution to this issue would be the creation of a loan between the two sub trusts to charge interest in relation to borrowings to acquire that particular asset. However, we would strongly recommend discussions with your advisor.
- Tax Returns
The question arises as to whether a separate tax return is required for a sub trust. The Commissioner’s position in TR 2010/3 and PS LA 2010/4suggests that a separate tax return is required when the sub trust stands possessed of a specific asset that was transferred from the main trust.
Aside from the Commissioner’s position above, the legislation states that every person (which includes a person in the capacity of trustee of a trust estate) must, if required by the Commissioner, give to the Commissioner a return for a year of income.
Further, the act states that a person (again including a person acting incapacity of a trustee of a trust estate) may apply to the Commissioner for the issue of a tax file number.
Accordingly, it would appear that the sub trust is entitled to a tax file number. And since the primary benefit of a trust split is to protect the assets of the sub trust from claim of the other sub trusts it would be best to demonstrate that the sub trust is as independent from the other trusts as possible.
- Demerger Section 8 Company.
- Whether a Section 8 Company can demerge any of its division? If yes, if it is necessary that such demerged entity shall also be a Section 8 Company?
Yes, there is no restriction in demerger of any division of a Section 8 Company. However, considering the restrictions placed under section 8(10) and in Form INC 16 (license issued by the Central Government) in terms of rule 20 of the Companies (Incorporation) Rules, 2014, only with another company registered under section 8 of the Act and having similar objects, an analogy can be drawn that such demerged entity shall also be a Company registered under Section 8 of the Companies Act, 2013.
- Demerger meaning:
A demerger under Companies Act 2013, can be defined as corporate restructuring in which a business breaks into components. These components can operate as a separate unit or can be sold or can be liquidated. It allows a large company to split into various business units.
- Demerger Under Companies Act 2013:
Demerger of a company can be defined as a division or split of a company in a number of small companies. The new company may not necessarily be a subsidiary of the parent company after the split.
In other words, demerger is a corporate partition of a company into smaller undertakings, where one separated undertaking is retained by the parent company while others are either acquired by other, work independently, liquidated, or are sold.
- Types of Demergers of a Company:
Spin-off Split-up Split-off Equity carve-Out Divestment Divestiture
This type of demerger means creating a subsidiary of the firm with some proportion of its shares. The holding of the spin-off subsidiary and the main company is in the same proportion. This demerger is generally carried to give freedom to the subsidiary to take its own decision and devise its own strategy for a specific product. The subsidiary gains control of the business related to that product.
In this type of demerger, a single holding company and some of its subsidiaries are created from one parent company. The holding company has only financial assets and doesn’t operate physically. It only has the holdings of all the shares of its subsidiaries. Its shareholding pattern could vary among subsidiaries.
This type of demerger is done for companies with diversified businesses where single central management can’t manage all the different areas. Thus, separate subsidiaries are created with different management with the power of taking decisions for their sectors. There is no interference from one subsidiary to the other in business decisions and each can operate independently.
- Split off
In this way of demerger, a business vertical of the main company sold off to a different company. It is simply a business transfer done by the company. The vertical is first separated into a different company and sold off to the other company. It is done when a firm wants to move out of production or services related to a certain market, product, or area.
- Equity carve-out
In this procedure, the parent company reduces its holding in one of its subsidiaries by a small fraction. It earns huge income from this and thus, it is also termed as an investment. If a company wants to reduce its workload of maintaining compliance for a subsidiary due to its large shareholding, it takes this way of the demerger. Although this independence from meeting compliance norms comes at the financial cost of losing shareholding in the subsidiary.
This type of demerger is carried out by the government. It reduces its holdings in a Public Sector Undertaking (PSU) by releasing a tender to sell its stakes. This generally happens when the government wants to exit a certain business sector or wants to raise funds to lower down its fiscal deficit.
The process is similar to divestment. However, it can be carried out for any public or private limited company. The process is carried out purely for financial reasons (to raise money). This is generally carried out when an organization wants to change its investment strategy and move to a different sector or company.
- What Causes a Company to Go for A Demerger?
Companies opt for demergers mainly due to the following reasons:
- When the company aims for restructuring of its corporate position to adjust to the changing political and economic environment of the country.
- Corporate restructuring helps to exploit opportunities effectively to optimize the use of resources when the parent company is not able to do so.
- If the company got engaged in a business without any expertise or experience and has thus not been able to earn profits.
- When a company is planning for an acquisition but is short of finances, they go for a demerger to generate resources.
- To realize capitals gains out of the assets those are underperforming.
- To develop more profitable opportunities by restructuring the financial and managerial resources available.
- Demerger of a company helps in selling unwanted, surplus, or unconnected parts of the business. This way you get rid of the sick part of your company.
- Division of Co-operative Societies as per Co-operative Societies Act, 2011.
- As per section 154 (Division of co-operative society) of the Co-operative Societies Act, 2011-
- A co-operative society may, by preliminary resolution passed by three-fourths of the members present and voting at a special general meeting called for the purpose, resolve to divide itself into two or more co-operative societies.
- In this section “preliminary resolution” means a resolution that— (a) contains proposals for the division of the assets and liabilities of the co-operative society among the new co-operative societies into which it is proposed to divide the co-operative society; and (b) specifies the area of operation of, and the members who will constitute, each of the new co-operative societies.
- A copy of the preliminary resolution shall be sent to the Registrar and all members and creditors of the cooperative society that is being divided.
- At least 10 days’ notice of the preliminary resolution shall be given to any person whose interest will be affected by the division of the co-operative society by publishing a notice in the Gazette and— (a) not less than two issues of a newspaper published and circulated in Montserrat; or (b) in a place or through a medium of communication that is stipulated in the bye-laws and is in the opinion of the Board, prominent and accessible to members.
- A member of a co-operative society may, notwithstanding any byelaw to the contrary, by notice given to the co-operative society within a period of 3 months from his receipt of the preliminary resolution, state his intention not to become a member of any of the new co-operative societies.
- A creditor of the co-operative society may, notwithstanding any agreement to the contrary, by notice given to the co-operative society within a period of 3 months from his receipt of the preliminary resolution, state his intention to demand the payment of moneys due him.
- Any person, other than a member or creditor, whose interest may be affected by the division of a co-operative society may, by notice given to the co-operative society, object to the division unless his claim is satisfied.
- After the expiry of 3 months from the receipt of the preliminary resolution sent to all the members and creditors of the co-operative society and of the notice to other persons given under subsection (4), another special general meeting of the co-operative society, of which at least 15 days’ notice shall be given to its members, shall be convened for the consideration of the preliminary resolution.
- If at the special general meeting referred to in subsection (8) the preliminary resolution is confirmed by a special resolution either without changes or with such changes as in the opinion of the Registrar are not material, the Registrar may, subject to subsection (11) and section 16, register the new co-operative societies; and upon registration, the original co-operative society shall be taken to be dissolved and its registration cancelled.
- The decision of the Registrar as to whether any changes made in the preliminary resolution are material shall be final and not subject to any appeal.
- At the special general meeting referred to in subsections (8) and (9) provision shall be made by another resolution for—
(a) repayment of the share capital of all the members who have given notice under subsection (5);
(b) satisfaction of the claims of all the creditors who have given notice under subsection (6); and
(c) satisfaction of the claims of such of the other persons, who have given notice under subsection (7), but no member or creditor or other person shall be entitled to such repayment or satisfaction until the preliminary resolution is confirmed in accordance with subsection (9).
(12) If within such time as the Registrar considers reasonable—
(a) the share capital of the members referred to in subsection (11)(a) is not repaid;
(b) the claims of the creditors referred to in that subsection are not satisfied; or
(c) the claims of the other persons referred to in subsection (11)(c) are not satisfied or secured, the Registrar may refuse to register the new co-operative societies.
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