ATO Interpretative Decision

ATO ID 2006/34

Income Tax

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

Issue

Can a capital gain or capital loss made by a testamentary trust on the transfer of an interest in a dwelling by the trustee to an individual beneficiary be disregarded under item 2(c) in the table in subsection 118-195(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision

No. Item 2(c) in the table in subsection 118-195(1) of the ITAA 1997 can apply only if a relevant CGT event happens to an individual beneficiary to whom an ownership interest in a dwelling has passed.

Facts

A taxpayer acquired a dwelling which was their main residence throughout the period they owned it.

The taxpayer died in the 1998-99 income year.

Under the taxpayer's will, the dwelling was to be held on trust for five individuals. The individuals were not the deceased's spouse nor were they granted a right to occupy the dwelling under the will.

Immediately after the deceased died, one of the beneficiaries (with the consent of the other beneficiaries) started to occupy the dwelling as their main residence.

In the 2005-06 income year, the beneficiaries and the trustee agreed to transfer ownership of the dwelling to the beneficiary who had been residing there.

In order to achieve this, the trustee transferred a 1/5th interest in the dwelling directly to that beneficiary consistent with their entitlement in the trust.

The trustee sold the remaining 4/5th interest to that same beneficiary in accordance with the trustee's power of sale.

The trustee wishes to know whether the capital gain they made on the sale of the 4/5th interest to the beneficiary can be disregarded.

Reasons for Decision

CGT event A1 in section 104-10 of the ITAA 1997 happened when the trustee of the testamentary trust disposed of the 4/5th interest in the dwelling to the beneficiary under the trustee's power of sale.

The capital gain from this CGT event happening is not disregarded under Division 128 of the ITAA 1997 as this interest in the dwelling did not pass to the beneficiary under the deceased's will in the ways set out in section 128-20 of the ITAA 1997. Subsection 128-20(2) of the ITAA 1997 provides that an asset does not pass to a beneficiary in your estate if it is transferred to them under a power of sale.

Section 118-195 of the ITAA 1997 sets out the circumstances in which a full main residence exemption (in the sense that a capital gain or capital loss is fully disregarded) is available to an individual beneficiary or a trustee of a deceased estate. In determining whether the trustee's capital gain qualifies for the exemption in section 118-195, there are two issues that need to be considered - the meaning of 'trustee of a deceased estate' for the purposes of that provision and whether the requirements set out in column 3 of the table in subsection 118-195(1) of the ITAA 1997 are satisfied.

Meaning of 'trustee of a deceased estate'

We take the view that the words 'trustee of a deceased estate' as used in section 118-195 of the ITAA 1997 are not limited to a legal personal representative but include the trustee of a testamentary trust.

This view is supported by comments made in the Explanatory Memorandum to the Taxation Laws Amendment Bill 1990 which introduced changes to section 160ZZQ of the Income Tax Assessment Act 1936 (ITAA 1936) to provide an exemption for the period a dwelling was occupied by an individual under the terms of the deceased's will. The Explanatory Memorandum provided:

The amendments are being made to allow the sole or principal residence exemption to apply to the dwelling of a deceased person for any period since the date of the deceased person's death during which the dwelling had been the sole or principal residence of the spouse of the deceased person or of a person who had the right to occupy the dwelling (life tenant) under the terms of the deceased person's will. At present no account is taken of the time during which a dwelling owned by a trustee of a deceased person's estate was the sole or principal residence of a life tenant.

As a life tenancy would only arise after administration of an estate has been completed, the phrase 'trustee of a deceased estate' in section 118-195 of the ITAA 1997 must be interpreted as including the trustee of a testamentary trust to give effect to the intended policy.

Main residence requirements in the table in subsection 118-195(1) of the ITAA 1997

Subsection 118-195(1) of the ITAA 1997 provides that an exemption is available in respect of certain dwellings owned by a deceased person if:

Item 1 - the ownership interest ends within two years of the deceased's death, or

Item 2 - the dwelling was from the deceased's death until the ownership interest ends, the main residence of one or more of:

(a)

the spouse of the deceased immediately before the death (except a spouse who was living permanently separately and apart from the deceased); or

(b)

an individual who had a right to occupy the dwelling under the deceased's will; or

(c)

if the CGT event was brought about by the individual to whom the ownership interest passed as a beneficiary - that individual.

In this case, the trustee's ownership interest did not end within two years of the deceased's death. Further, the dwelling was not from the time of the deceased's death the main residence of the deceased's spouse or an individual who had a right to occupy the dwelling under the deceased's will. The fact that the individual was a beneficiary of the trust does not mean that they had a right to reside in the dwelling under the will. Therefore the requirements in items 1 and 2(a) and 2(b) in the table in subsection 118-195(1) of the ITAA 1997 are not satisfied in this case. The issue is therefore the proper construction of item 2(c).

In rewriting section 160ZZQ of the ITAA 1936, section 118-195 of the ITAA 1997 combined exemptions for beneficiaries and trustees that had previously been dealt with in separate provisions.

In particular, section 118-195 of the ITAA 1997 rewrote subsection 160ZZQ(15) of the ITAA 1936 which provided an exemption for the disposal of a dwelling by a trustee where, among other things, the disposal took place within two years of the deceased's date of death or the dwelling had been, from the time of death to the time of the disposal, the sole or principal residence of the deceased's spouse or a person with a right to occupy the dwelling under the deceased's will. No exemption was provided under subsection 160ZZQ(15) of the ITAA 1936 for a trustee in respect of a period that the dwelling was the sole or principal residence of a beneficiary.

While the rewrite of the ITAA 1936 provisions also introduced changes to the main residence requirements in the table in subsection 118-195(1) of the ITAA 1997, it is clear from the wording of the legislation that the changes were only intended in the context of determining the beneficiary's eligibility for the main residence exemption.

In our view, in its particular context and having regard to section 1-3 of the ITAA 1997, item 2(c) in the table in subsection 118-195(1) of the ITAA 1997 is properly construed as capable of applying only to a CGT event which happens to an individual to whom the ownership interest 'passed' as a beneficiary, within the meaning of section 128-20 of the ITAA 1997. For example, if the beneficiary brings about the sale of the interest in the dwelling which has passed to them. A trustee would have no need to apply item 2(c) to a capital gain or loss that arises in respect of an ownership interest which passes to a beneficiary because it would be disregarded under Division 128 of the ITAA 1997, irrespective of who occupied the dwelling as their main residence from the date of the deceased's death.

In any case, if item 2(c) were thought on its literal terms to have potential application to a trust capital gain, the relevant ownership interest at issue on the facts of this case (the 4/5th interest) did not 'pass' to the individual as a beneficiary for the reasons already discussed. Rather, it was transferred to them as a purchaser. The transfer of this interest was also not 'brought about' by that individual, but rather by the trustee and the other beneficiaries by agreement.

For all these reasons, the capital gain made by the trustee on the sale of the 4/5th interest in the dwelling to the beneficiary is not disregarded.

Year of income:  Year ended 30 June 2006

Legislative References:
Income Tax Assessment Act 1936
   section 160ZZQ
   subsection 160ZZQ(15)

Keywords
Capital gains tax
CGT deceased estates
CGT events
CGT main residence exemption
Wills

Siebel/TDMS Reference Number:  5031649

Business Line:  Private Groups and High Wealth Individuals

Date of publication:  10 February 2006

ISSN: 1445-2782