ATO Interpretative Decision

ATO ID 2008/138

Income Tax

• This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

Issue

For the purpose of working out the 'control percentage' in subsection 328-125(4) of the Income Tax Assessment Act 1997 (ITAA 1997), can the characterisation of amounts paid or applied by the trustee be determined by reference to the trust deed or by exercise of a power conferred upon the trustee under the trust deed?

Decision

No. For the purpose of subsection 328-125(4) of the ITAA 1997, the character of an amount paid or applied by the trustee is to be determined having regard to its character in the hands of the trustee.

Facts

The trustee of a discretionary trust made a capital gain on the disposal of a CGT asset during the income year ended 30 June 2008.

The trustee sought to apply one of the CGT small business concessions in respect of the capital gain.

The trust deed contained a clause defining the trust's income for an income year as equal to the trust's net income for the income year as calculated under section 95 of the Income Tax Assessment Act 1936 (ITAA 1936).

During the 2005-06 income year, the trustee paid an amount to a beneficiary that equalled more than 40% of the trust's net income - where net income is calculated under subsection 95(1) of the ITAA 1936.

But the amount so paid was less than 40% of the trust's income for the 2005-06 income year - where the trust's income is determined having regard to the character of amounts in the hands of the trustee and ignoring the clause in the deed.

The beneficiary did not receive any other distributions from the trustee for any of the 2003-04, 2004-05, 2005-06 or 2006-07 income years. Also, the trustee did not pay or apply an amount in respect of an affiliate of the beneficiary for any of those income years.

The issue is whether the distribution received by the beneficiary in the 2005-06 income year means the beneficiary is 'connected with' the discretionary trust for the purpose of determining whether the various conditions for accessing the CGT small business concessions are satisfied.

Reasons for Decision

An entity can use the CGT small business concessions only if it satisfies various tests, including the maximum net asset value test in section 152-15 of the ITAA 1997.

An entity satisfies the maximum net asset value test if, just before the CGT event that gave rise to the capital gain, the net value of its CGT assets (and those of entities connected with it and of its affiliates) do not total more than $6 million.

Therefore, if the beneficiary is connected with the discretionary trust, then the value of the beneficiary's assets will be counted in determining whether the discretionary trust meets the test.

An entity is connected with another entity if either entity controls the other entity in one of the ways specified (paragraph 328-125(1)(a) of the ITAA 1997).

One of the ways in which an entity controls a discretionary trust is if the entity (and/or its affiliates) receives 40% or more of the trust's income or capital distributions for any of the four income years preceding the income year in which the capital gain was made. See further subsection 328-125(4) of the ITAA 1997 which says.

328-125(4) An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a)

the trustee of the trust paid to, or applied for the benefit of:

(i)

the first entity; or

(ii)

any of the first entity's *affiliates; or

(iii)

the first entity and any of its affiliates

any of the income or capital of the trust; and

(b)

the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

In determining the control percentage the character of amounts paid or applied by the trustee is to be determined having regard to the character of those amounts in the hands of the trustee.

That is, the 'income......paid or applied' by the trustee means that which is received by the trustee in the relevant income year and which, retaining that character, is paid or applied by the trustee for that income year for the benefit of an entity (and/or the entity's affiliates). This will be the case notwithstanding that the trust deed (or the trustee acting under authority of the deed) determines that for trust purposes 'income' is to have a different meaning (see Federal Commissioner of Taxation v. Totledge Pty Ltd (1982) 12 ATR 830; 82 ATC 4168, Commissioner of Taxation v. ANZ Savings Bank Ltd (1998) 194 CLR 328; 98 ATC 4850; 39 ATR 419).

Therefore, in this case, the beneficiary does not control the discretionary trust in the manner described in subsection 328-125(4) of the ITAA 1997.

Year of income:  Year ended 30 June 2008

Legislative References:
Income Tax Assessment Act 1997
   Subdivision 152-A
   paragraph 328-125(1)(a)
   subsection 328-125(4)

Case References:
Commissioner of Taxation v. ANZ Savings Bank Ltd
   (1998) 194 CLR 328
   98 ATC 4850
   39 ATR 419

Keywords
Basic conditions for relief
Capital gains
Capital gains tax
CGT small business relief
Connected entity
Income
Maximum net asset value test

Business Line:  Losses and Capital Gains Tax Centre of Expertise

Date of publication:  24 October 2008

ISSN: 1445-2782