Edited version of private ruling

Authorisation Number: 1011504327009

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Income Tax: Capital Gains Tax: Trust -Vesting of property

Issue 1

Question 1

Will the vesting of the property from the trustee of W Family trust to the beneficiaries Y and Z give rise to a capital gain or loss pursuant to Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes

Question 2

If a capital gain arises on the vesting of the property from the trustee of the W Family trust to the beneficiaries Y and Z will the trustee be entitled to claim the 50% discount in accordance with sub-paragraph 115-100(a)(ii) of the Income Tax Assessment Act 1997?

Answer: Yes

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Issue 2

Question 1

Is the vesting of the property from the trustee of the W Family trust to the beneficiaries Y and Z attributable to an unrealised gain pursuant to subsection 109XA(1) of the Income Tax Assessment Act 1936 (ITAA 1936) ?

Answer: No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

The trustee of the W Family trust currently owns the property which was acquired after 19 September 1985. Y and Z are the beneficiaries of the trust.

The W Family trust has unpaid present entitlements at 30 June 2009 owing to Y and Z of and X Pty Ltd. The entitlement is recorded as unpaid present entitlement in the balance sheet. The unpaid present entitlements were created when the trustee made unpaid distributions from time to time.

Vesting the property to Y and Z will not reduce or discharge the unpaid present entitlement of the beneficiaries.

The shareholders of X Pty Ltd are Y and Z who each own 1 share, that is each hold 50% of X Pty Ltd.

Y and Z are general beneficiaries as per the trust deed. Accordingly, X Pty Ltd is also one of the beneficiaries of W Family trust as per the trust deed.

These unpaid entitlements did not arise from amounts attributable to unrealised gains accrued in the trust.

Proposed Transaction

The trustee of the trust is seriously contemplating vesting the property in specie from the trust to Y and Z as tenants in common for nil monetary consideration.

The Trustee has not re-valued the property since acquisition.

To the extent that a taxable realised capital gain arises the Trustee proposes to confer a present entitlement to Y and Z to the extent of the taxable gain with any remaining amount being attributed to the corpus of the trust i.e.: the original historical cost of the asset.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subdivision EA

Income Tax Assessment Act 1936 subsection 109XA(1)

Income Tax Assessment Act 1936 Paragraph 109XA(1)(b)

Income Tax Assessment Act 1936 subsection 109XA(7)

Income Tax Assessment Act 1936 section 109XB

Income Tax Assessment Act 1997 section 104-75

Income Tax Assessment Act 1997 subsection 112-20(1)

Income Tax Assessment Act 1997 section 115-10

Income Tax Assessment Act 1997 subsection 115-25(1)

Income Tax Assessment Act 1997 subsection 115-210(1)

Income Tax Assessment Act 1997 subsection 115-215(3)

Income Tax Assessment Act 1997 subsection 115-215(6)

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Issue 1

Question 1

Summary

CGT Event E5 under section 104-75 of the ITAA 1997 happens when the beneficiary becomes absolutely entitled to the trust asset against the trustee.

The trustee will make a capital gain or capital loss from the CGT event E5 under section 104-75(3) of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

The proposed vesting of the trust's property will mean that the respective beneficiary becomes absolutely entitled to a CGT asset of the trust as against the trustee, causing CGT event E5 to happen under section 104-75 of the ITAA 1997.

The time of the CGT event E5 is when the beneficiary becomes absolutely entitled to the asset under subsection 104-75(2) of the ITAA 1997. The trustee makes a capital gain if the market value of the asset at the time of the event is more than the cost base of the asset, and makes a capital loss if the market value is less than the reduced cost base of the asset under subsection 104-75(3) of the ITAA 1997.

When a beneficiary becomes absolutely entitled to a CGT asset of the trust as against the trustee, the beneficiary makes a capital gain if the market value of the asset at that time is more than the cost base of the beneficiary's interest in the trust capital to the extent it relates to the asset. A capital loss will arise if that market value is less than the reduced cost base of that beneficiary's interest in the trust capital to the extent it relates to the asset, subsection 104-75(5) of the ITAA 1997.

The cost base of the beneficiary's interest, if the beneficiary did not incur expenditure to acquire it, would be subject to the market value substitution rule set out in subsection 112-20(1) of the ITAA 1997, which would make the first element of the cost base of the interest its market value at the time the beneficiary acquired the interest. That time would be when the beneficiary became absolutely entitled to the asset constituted by the interest, as the beneficiary would not have any interest in the trust capital prior to becoming absolutely entitled to the trust asset.

As the market value of the asset at the time the beneficiary becomes absolutely entitled to them, and the cost base of the beneficiary's interest in the trust capital to the extent it relates to the asset are the same, there will be no CGT consequences for the beneficiary upon becoming absolutely entitled to the asset.

Issue 1

Question 2

Summary

A discount capital gain must be made under section 115-10 of the ITAA 1997. In this case the trustee is eligible for 50% CGT discount from the capital gain made from CGT event E5 for the calculation of net capital gain of the trust under subsection 115-210(1) of the ITAA 1997.

A beneficiary who is not under a legal disability and who is presently entitled to a share of the income of a trust must include in their assessable income their share of the net income of the trust estate under section 97 of the ITAA 1936.

Detailed reasoning

Section 115-10 of the ITAA 1997 provides that to be a discount capital gain the capital gain must be made by an, individual, a complying superannuation fund, a trust or a life insurance company in relation to a CGT event in respect of particular CGT assets. A capital gain made from CGT event E5 meets the requirements of a discount capital gain under section 115-10 of the ITAA 1997.

A capital gain is only a discount capital gain if it results from a CGT asset that was acquired at least 12 months before the CGT event that gave rise to the gain under subsection 115-25(1) of the ITAA 1997.

In this case the facts indicate the asset was acquired after 19 September 1985. It is assumed that the trustee acquired the asset more than 12 months before the CGT event E5 happens to the asset.

Accordingly, the trustee is eligible to claim the 50% discount capital gain under section 115-15 of the ITAA 1997.

Subdivision 115-C of the ITAA 1997 sets out the rules for dealing with the net income of the trust that has a capital gain. The rules treat that part of the net income attributable to the trust's net capital gain as a capital gain made by a beneficiary who is presently entitled to a share of the trust net income.

Subsection 115-210(1) of the ITAA 1997 states that this Subdivision applies where a net capital gain is taken into account in calculating the trust's net income for the year. This subsection adopts the definition of 'net income' contained at subsection 95(1) of the ITAA 1936.

A beneficiary who is not under a legal disability and who is presently entitled to a share of the income of a trust must include in their assessable income their share of the net income of the trust estate under section 97 of the ITAA 1936.

Section 115-215 of the ITAA 1997 treats a beneficiary as having capital gains in addition to those they have from a CGT event happening. For each part of a trust capital gain that was reduced by the CGT discount and which is included in the beneficiary's income under section 97 of the ITAA 1936, the beneficiary is treated as having made a capital gain equal to twice that amount under paragraph 115-215(3)(b) of the ITAA 1997.

Subsection 115-215(6) of the ITAA 1997 provides a beneficiary with a deduction to the extent that a capital gain has been included in assessable income under section 97 of the ITAA 1936. This deduction ensures that the beneficiary is not taxed twice on the trust capital gain.

Issue 2

Question 1

Summary

For a trustee payment to be included in assessable income under section 109XB of the ITAA 1936, it must meet the requirements of subsection 109XA(1) of the ITAA 1936.

A present entitlement will be attributable to an amount that is an 'unrealised gain', within the meaning of paragraph 109XA(1)(b) of the ITAA 1936, where the trust deed empowers the trustee to declare present entitlement to an amount representing the 'unrealised gain', and the trustee has declared present entitlement to that amount.

However, not all unrealised gains attract the operation of these rules. Unrealised gains that have or will be included in the assessable income of the trust in an income year prior to the year when the actual payment was made; or an income year in which the actual payment was made; or the income year following that in which the actual payment was made, are excluded.

The realised gain will not reduce the unpaid present entitlements from the company as well as the beneficiaries. Accordingly, Subdivision EA of the ITAA 1936 will not apply to the distribution of capital from CGT event E5 under section 104-75 of the ITAA 1997.

Detailed reasoning

Subdivision EA of the ITAA 1936 deems certain payments, loans or forgiven debts (made on or after 12 December 2002) by a trustee of a trust estate to a shareholder (or associate) of a private company, to be included in their assessable income as if it were a dividend, where the private company is presently entitled to an amount from the net income of the trust estate, and that amount has not been fully paid out before the 'lodgement day'.

The 'lodgement day' is the earlier of the due date for lodgement and date of lodgement of the trust's tax return for the income year in which the payment, loan or debt forgiveness occurs.

For a trustee payment to be included in assessable income under section109XB of the ITAA 1936, it must meet the requirements of subsection 109XA(1) of the ITAA 1936 which provides as follows:

Section 109XB applies if:

a) a trustee makes a payment to a shareholder or an associate of a shareholder of a private company (except a shareholder or associate that is a company) (the actual transaction ); and the payment is a discharge of or a reduction in a present entitlement of the shareholder or associate that is wholly or partly attributable to an amount that is an unrealised gain; and

.....

[emphasis added]

The word 'attributable' is not defined for the purposes of subsection 109XA(1) of the ITAA 1936 and therefore adopts its ordinary meaning. The New Shorter Oxford English Dictionary, ( 1993, 4th edn, The Clarendon Press, Oxford) defines 'attributable' as:

attributable (a) . able to be attributed to , owing to

Similarly, in Hartley v. Hartley [1986] 2 NZLR 64 at 75 Somers J held 'attributable' to mean:

owing to or produced by

A present entitlement will be attributable to an amount that is an 'unrealised gain', within the meaning of paragraph 109XA(1)(b) of the ITAA 1936, where the trust deed empowers the trustee to declare present entitlement to an amount representing the 'unrealised gain', and the trustee has declared present entitlement to that amount.

For the purposes of paragraph 109XA(1)(b) of the ITAA 1936 'unrealised gain' is defined in subsection 109XA(7) of the ITAA 1936 as:

In this section:

unrealised gain, in relation to a trust estate and an actual payment, means any unrealised gain, whether of a capital or income nature, but does not include an unrealised gain to the extent that it has been or would be included in assessable income of the trust, apart from this Division, for:

a) a year of income before the year in which the actual payment was made; or

b) the year in which the actual payment was made; or

c) the year of income following the year in which the actual payment was made.

Subsection 109XA(7) of the ITAA 1936 carves out certain payments which are otherwise included in assessable income (within certain timeframes) and clarifies that both capital and income 'unrealised gains' are included.

Apart from these matters, the phrase 'unrealised gain' is not defined for the purposes of Subdivision EA of the ITAA 1936 and adopts its ordinary meaning.

The Macquarie Dictionary (3rd edition, 2001, The Macquarie Library, Australia) defines the words 'realise' and 'gain' in the relevant context as follows:

realise ...

6. to bring as proceeds, as from a sale: the goods realised $1000

gain

8. profit; advantage.

The ordinary meaning of the phrase 'realised gain' is therefore to have a profit or advantage that has materialised in the form of proceeds from a sale.

The High Court in Read v. Commonwealth (1988) 167 CLR 57 at 66 expressed a similar meaning in distinguishing between a realised and unrealised gain of a capital nature where it was said:

A capital gain is realised when an item of capital which has increased in value is ventured, either in whole or in part, in a transaction which returns that increase in value.

The 'cash' and 'accrual' methods of accounting, however, recognise proceeds of sale at different times. The cash method recognises the proceeds when physical payment is received (Brent v. FC of T (1971) 125 CLR 418 at 429; 71 ATC 4195 at 4200; (1971) 2 ATR 563 at 571) whereas the accruals method recognises the proceeds when it constitutes a recoverable debt ( Henderson v. FC of T (1970) 119 CLR 612; 70 ATC 4016; (1970) 1 ATR 596 and Barratt & ors v. FC of T (1992) 23 ATR 339 at 344; 92 ATC 4275 at 4280).

The Explanatory Memorandum to the Tax Laws Amendment (2004 Measures No. 1) Bill 2004 (the EM) provides at paragraph 8.13:

For the purposes of these rules, realisation will be taken to have occurred when a gain converts into a recoverable debt.

Further, paragraph 8.14 of the EM states that:

8.14 However, not all unrealised gains attract the operation of these rules. Unrealised gains that have or will be included in the assessable income of the trust in:

· an income year prior to the year when the actual payment was made; or

· an income year in which the actual payment was made; or

· the income year following that in which the actual payment was made,

are excluded. These rules ensure that unrealised gains that have already been assessed, or will be assessed in the near future, are not inappropriately caught by the amendments. A typical example would be an entitlement of a beneficiary generated from a transaction involving trading stock.

In this case the facts indicate that the unpaid present entitlement is not from unrealised gain and the capital gain from CGT event E5 from the vesting of property to the beneficiaries will be included in the net income of the trust and distributed to the beneficiaries. The realised gain will not reduce the unpaid present entitlements from the company as well as the beneficiaries.

Accordingly, Subdivision EA of the ITAA 1936 will not apply to the distribution of capital from CGT event E5 under section 104-75 of the ITAA 1997.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).