Turning Water into Wine? What Re EM McPherson Settlement Tells Us About Converting a Discretionary Trust into a Fixed Trust

In light of the Federal Government’s recent proposal to introduce a 30 per cent minimum tax on discretionary trusts from 1 July 2028, together with the prospect of rollover relief for trust restructures, taxpayers should be considering whether restructuring existing trust arrangements may be appropriate.

One possible response is to vary existing trust deeds from a discretionary trust to a fixed trust as suggested by the Treasury in its consultation paper. However, any such strategy raises a fundamental question: can a discretionary trust be transformed into a fixed trust without offending trust law principles?

While Treasury’s consultation paper addresses some of the potential tax consequences of restructuring and contemplates targeted relief measures, it offers little guidance on trust law issues, including the interests of beneficiaries and the trustee’s fiduciary obligations.

The decision of the Supreme Court of Victoria in Re EM McPherson Settlement (2024) 76 VR 360; [2024] VSC 744 (Re EM McPherson Settlement) provides useful guidance on how courts may approach tax-driven trust variations and the limits of permissible amendments.

Re EM McPherson Settlement

The Supreme Court of Victoria’s decision in Re EM McPherson Settlement (2024) 76 VR 360; [2024] VSC 744 (Re EM McPherson Settlement) provides detailed guidance on when a Court will approve amendments to a discretionary family trust under s 63A of the Trustee Act 1958 (Vic), particularly where the primary motivation is the achievement of taxation advantages.

The case confirms that tax planning is not, of itself, an improper purpose for varying a trust. At the same time, the Court emphasised that there are limits. In particular, it refused to approve a broad amendment power because it could not be satisfied that future, unspecified amendments would benefit minor and unborn beneficiaries.

Background

Re EM McPherson Settlement concerned a family discretionary trust known as the Ethel McPherson Settlement Trust, which was established in 1972 for the benefit of Barbara and David Hamer and their descendants. By 2024 the trust held assets worth approximately $20 million.

The trust had a vesting date of 30 June 2030 and the trust deed contained no general amendment power, meaning that changes could only be made through the Court’s approval under s 63A of the Trustee Act 1958 (Vic) (Trustee Act). As a result, the trustee sought approval under s 63A of the Trustee Act to amend the deed.

The proposed amendments included:

1. Extending the trust vesting date.
2. Replacing the common law perpetuity period with an 80-year statutory period.
3. Expanding the class of beneficiaries to include companies and trusts associated with existing beneficiaries.
4. Introducing powers for income streaming.
5. Allowing sub-trust arrangements.
6. Giving the trustee power to determine trust income and net income.
7. Introducing a broad future power of amendment.

The evidence established that the principal reasons for the amendments were taxation efficiency, succession planning and preservation of family wealth.

Can a trust be varied for tax advantages?

The critical question was whether the Court should approve variations where the dominant purpose was to avoid adverse tax consequences or achieve more favourable tax outcomes.

Section 63A allows the Court to approve a trust variation on behalf of minor, unborn or incapacitated beneficiaries provided that:

• the arrangement would be for their benefit; and
• the arrangement is fair and proper.

The Court therefore had to consider whether tax advantages constitute a sufficient “benefit” for these beneficiaries.

The Court in this case confirmed that the fact that achieving a taxation advantage was a significant purpose of a trust variation was not a reason for the Court to refuse approval if the variation was otherwise beneficial and appropriate, noting previous authorities recognising that reducing tax liabilities may amount to a financial benefit capable of satisfying variation of trust legislation.

Further, the Court rejected any suggestion that there must always be a separate non-tax purpose before the Court can approve a variation.

Extension of vesting date

Following from the above, the Court approved the extension of the vesting date and considered that:

• unborn beneficiaries would have a longer opportunity to benefit from the trust;
• the continuation of the trust would preserve family wealth;
• adverse tax consequences would be deferred; and
• the variation was fair and proper.

The judgment therefore reinforces a growing line of authority in Victoria approving vesting date extensions where the trust remains fundamentally the same trust.

Broadening the Beneficiary Class

Broadening of the beneficiary class to include companies and trusts associated with existing beneficiaries was also approved.

The Court accepted that:

• distributions to companies could utilise lower corporate tax rates;
• distributions could be directed to entities holding carry-forward losses;
• greater flexibility in tax planning would be achieved.

However, the Court was concerned that the proposed drafting was too broad. It ultimately approved a narrower version limited to private companies controlled by existing beneficiaries.

Importantly, while the Court accepted a broadening of the beneficiary class in this context, the decision should not be taken as authority that a court will readily approve amendments that narrow or remove existing beneficial interests.

Broad future power of amendment

Introduction of the general amendment power was, however, rejected.

The trustee argued that this would avoid future court applications and facilitate responses to changing taxation laws, but the Court refused this argument due to the following reasons:

• future amendments were unknown;
• their effect on minor and unborn beneficiaries could not be assessed;
• any supposed benefit was speculative; and
• the Court could not be satisfied that future exercises of the power would be beneficial.

This refusal demonstrates the Court’s insistence that benefits must be identifiable and not merely hypothetical.

Turning a discretionary trust to a fixed trust

The reasoning in Re EM McPherson Settlement raises important issues for taxpayers considering a conversion of a discretionary trust into a fixed trust in response to the proposed minimum tax regime.

Such a restructuring would likely require careful consideration of at least the following matters.

1. Trustee powers:

The trust deed must contain a sufficiently broad amendment power, or there must otherwise be a mechanism available to effect the proposed changes.

Absent a valid amendment power, court approval may be required.

2. Effect on Beneficiaries:

This is likely to be the most significant hurdle.

Unlike the amendments approved in Re EM McPherson Settlement, a conversion from a discretionary trust to a fixed trust would ordinarily:

• define ownership interests;
• fix income entitlements; and
• fix capital entitlements.

Such changes would alter the nature of beneficiaries’ interests fundamentally.

Beneficiaries who were previously mere objects of a discretion would instead acquire vested and potentially indefeasible rights.

This goes considerably further than the variations considered in Re EM McPherson Settlement and raises questions as to whether the trust remains fundamentally the same trust.

3. Minor and unborn beneficiaries:

Any proposed restructuring must also consider its impact on minor and unborn beneficiaries.

In Re EM McPherson Settlement, the Court refused to approve a broad amendment power because it was unable to assess its future impact on those beneficiaries. The Court concluded that any supposed benefit was too speculative to satisfy the requirements of s 63A.

A similar difficulty may arise where a discretionary trust is converted into a fixed trust. It may be challenging to demonstrate that fixing the interests of some beneficiaries is beneficial, or even neutral, from the perspective of minor or unborn beneficiaries whose future claims may be affected.

Challenges await

The proposed 30 per cent minimum tax on discretionary trusts remains a proposal and has not yet been enacted.

As a result, taxpayers may find it difficult to demonstrate a concrete and identifiable benefit from converting a discretionary trust into a fixed trust at present. The reasoning in Re EM McPherson Settlement suggests that courts will require more than hypothetical benefits when assessing whether a variation is beneficial and fair.

Further, how taxpayers would establish that fixing beneficial interests in favour of particular beneficiaries does not prejudice the interests of minor, contingent or unborn beneficiaries is yet to be seen.

For further information please contact Corporate & Commercial Senior Associate, Peter Azam on 03 5273 5273 or email info@coulterlegal.com.au.