Trustee choice to be assessed on capital gains
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Commencing for the 2010-11 income year the trustee of a resident trust may choose (if permitted by the trust deed) to be assessed on a capital gain of the trust. This is allowed provided no beneficiary has received any amount referable to the gain during the income year or within two months of the end of the income year. The choice must be made in respect of the whole capital gain.
This is similar to (and will replace) the choice available to the trustee of a testamentary trust under the law prior to the 2010-11 amendments, but is not limited to those trustees. Under the previous law (that applied from the 2005-06 income year) the trustee of a resident testamentary trust could choose to be assessed on the capital gains for an income year which would otherwise be assessed to an income beneficiary (or the trustee on their behalf).
The trustee will be able to make the choice if, for example, under the terms of the trust the income beneficiary cannot benefit from the capital gains. It is only the trustee that can make this choice.
If the trustee makes a choice in respect of a capital gain then:
- the trustee will be assessed on the capital gain under section 99 or 99A, as appropriate
- the capital gain is not taken into account in working out any beneficiary's net capital gain for an income year.
Example 108: Trustee choice to be assessed
Marcia is entitled to all the income of a resident trust for the duration of her life. Under the terms of the trust deed, the trust would be wound up on her death and the corpus distributed to Trevor.
While Marcia is alive, the trustee disposes of some shares in the trust and makes a capital gain. Marcia is not entitled under the terms of the trust to receive the proceeds from the disposal of the shares as Trevor is the capital beneficiary.
As the capital gain is included in the net income of the trust for tax purposes, Marcia may be assessed on her share of the capital gain even though she is not entitled to benefit from the gain. The trustee can make a choice to be assessed on the share of the capital gain that would otherwise be assessed to Marcia.
Earnout arrangements are often employed as a way of structuring the sale of a business to deal with uncertainty about its value. In an earnout arrangement, the proceeds for the sale of the business (or assets of the business) generally include a lump sum payment. However, the terms of the sale contract require either the buyer or the seller to make further payments that are contingent on the performance of the business. The right to receive further payments is called an 'earnout right'.
There are two types of earnout arrangement:
- a standard earnout arrangement, in which the seller holds the earnout right and may receive additional payments
- a reverse earnout arrangement, in which the buyer holds the earnout right and may receive additional payments.
Draft Taxation Ruling TR 2007/D10 sets out the ATO view on the application of the CGT provisions to earnout arrangements. The view taken in the draft ruling is that dealings in earnout rights have CGT consequences that are independent from those that arise from the sale of the business.
Government announcement: Look-through treatment for earnout arrangements
On 12 May 2010, as part of the 2010 Budget, the Government announced 'Look-through' treatment for earnout arrangements to simplify sale of business assets.
Under this measure:
- additional payments made under a 'standard' earnout arrangement will be treated as relating to the original asset for the seller and will be added to the cost base for the buyer
- payments made under a 'reverse' earnout arrangement will be treated effectively as a repayment of part of the capital proceeds.
This change will apply to earnout arrangements any taxpayer enters into on or after Royal Assent of the amending legislation. It also applies, where a taxpayer makes a choice for the changes to apply from either 12 May 2010 or, in limited situations, 17 October 2007.
Information on earnout arrangements are shown at Part O of the CGT schedule.
Last modified: 08 Jul 2013QC 25657