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Ruling

Subject: Sale of property by statutory trustees

Issue 1

Capital Gains Tax effects on the appointment of statutory trustees and the subsequent sale of the property by the trustees

Question 1

Did the Statutory Trustees acquire The Property for CGT purposes when they were appointed by the Court Order?

Answer

Yes

Question 1.1

If the answer to Q1 is yes, did the Statutory Trustees acquire The Property as a result of a CGT event A1 under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 1.1.1

If the answer to Q 1.1 is yes, did this CGT event occur on 30 June 2010?

Answer

Yes

Question 1.2

If the answer to Q 1.1 is no, does any other CGT event in the ITAA 1997 occur when the Statutory Trustees were appointed by the Court Order?

Answer

Not necessary to answer.

Question 2

Did CGT event A1 happen when the Statutory Trustees sold The Property in their capacity as statutory trustees?

Answer

Yes

Question 3

If a CGT event A1 occurred when the Statutory Trustees were appointed, is the first element of the cost base of The Property the net sale proceeds received from the sale that took place on the certain date 2010?

Answer

Yes

Question 3.1

If the first element of the cost base is not the net sale proceeds, is the first element of the cost base the market value of The Property as at 30 June 2010?

Answer

Not necessary to answer.

Question 4

Does the net capital gain arising from the sale of The Property form part of the net income of the statutory trust for the purposes of Division 6 of Part III of the ITAA 1936?

Answer

No.

Question 4.1

If the answer to Q 4 is yes, is the capital gain assessable in the hands of the co-owners as beneficiaries under the statutory trust, pursuant to section 97 of the ITAA 1936?

Answer

Not necessary to answer

Question 4.2

Is any capital gain arising from the sale of The Property assessable in the hands of the statutory trustees under section 99 ITAA 1936?

Answer

No.

Issue 2

Tax implications for rent income received by the statutory trustees

Question 5

Does the net rental income from The Property for the period from 30 June 2010 to the date the sale was completed form part of the net income of the Statutory Trust for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1997 (ITAA 1936)?

Answer

Yes.

Question 5.1

If the answer to Q 5 is yes is the net rental income from The Property from 30 June 2010 to the date the sale was completed assessable in the hands of the co-owners as beneficiaries of the statutory trust under section 97 ITAA 1936?

Answer

Yes.

Question 5.2

If the answer to Q 5.1 is no, is the net rental income from The Property from 30 June 2010 to the date the sale was completed assessable in the hands of the Statutory Trustees under section 99 of the ITAA 1936?

Answer

Not necessary to answer.

This ruling applies for the following period:

1 July 2009 to 30 June 2011

The scheme commences on:

30 June 2010

Relevant facts and circumstances

A partnership of 4 individuals owned real estate which was held by them as tenants in common in equal shares, that is 25% share per person.

The individuals who formed this partnership are:

A, B, C and D.

A dispute had arisen between these individuals concerning the property leading to A & B seeking a court order for the sale of the property.

The Supreme Court of NSW made an order which appointed E and F as trustees for the sale of the property pursuant to section 66G of the Conveyancing Act 1919 (NSW) (the Conveyancing Act).

The terms of the order were:

· The property vest in the trustees subject to any encumbrances affecting the entirety of the said property but free from encumbrances, if any, affecting any undivided share or shares therein, to be held by the trustees upon the statutory trusts for sale under Division 6 Part IV of the Conveyancing Act.

· The net proceeds of the sale be distributed to the co-owners in the proportions of their respective interests.

· The cost of the proceedings to obtain the order be paid out of proceeds of the sale of the property.

The trustees subsequently took possession of the property and the trustees shortly after obtained a valuation from a real estate agent which valued the property at $X.

Contracts were exchanged for the sale of the property three months later. The sale price was $Y which was settled in February 2011.

The trustees received rental income from the property for the duration of the trust because the property was tenanted prior to and after they had been appointed.

The trustees have incurred various legal, accounting and other expenses in connection with the sale of the property.

Reasons for decision

Issue 1

Summary

The sale of the property by the trustees results in no capital gain being assessed to the trustees

Detailed Reasoning

Capital Gains Tax effects on the appointment and the subsequent sale of the property by the statutory trustees

Where the disposal of a CGT asset does not occur under a contract, CGT event A1 happens when the change of ownership occurs, per subsection 104-10(3) of the Income Tax Assessment Act 1997 (ITAA 1997). The effect of the Court Order made in respect of the subject property was to vest the property in the trustees appointed under that order. Paragraph 66G(3)(b) of the Conveyancing Act provides that when trustees for sale are appointed, the subject property vests in the trustees.

Paragraph 66G(7)(b) of the Conveyancing Act states that where land becomes subject to a statutory trust for sale it shall be deemed to be 'converted' upon the appointment of trustees for sale unless the court otherwise directs.

In equity, conversion is the notional change of land into money (or money into land). Its effect is to turn realty into personalty (or personalty into realty). The principle is that land directed to be sold and turned into money (or money directed to be employed in the purchase of land) is considered to be that species of property into which it is directed to be converted. Refer Meagher, Gummow and Lehane, Equitable Doctrines & Remedies , Fourth edition (Meagher, Lehane and Leeming) Butterworths, Lexis Nexis, 2002 at [38-005] and [38-010]; Fletcher v. Ashburner (1779) 1 Bro CC 497; 28ER 1259.

On the making of the court order the whole of the co-owners' interests in the property vested in the accountants appointed as trustees for the sale of the property. The co-owners' interests were converted into personalty, that is, into a right to compel due performance of the trust and to share in the proceeds of sale in accordance with their interests.

In these circumstances it is considered that the making of the court order effects a disposal of the property from the co-owners to the trustees for sale by operation of law. Therefore, CGT event A1 happens at the time of the making of the Court Order.

As the trustees were the legal owners of the subject property when they ultimately sold it another CGT event A1 happened at that time.

The cost base of the property to the trustees is governed by subsection 110-25(2) of the ITAA 1997 which sets out the first element of the cost base of a CGT asset:

The first element is the total of:

(a) the money you paid, or are required to pay, in respect of *acquiring it; and

(b) the *market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition).

At the time of the Court Order the trustees did not pay anything and they did not give any other property for the acquisition of the property. They had a responsibility to sell the property and pay the net proceeds of that sale to the co-owners. The first element of the cost base is what the trustees are required by the Court Order to pay to the co-owners from the sale of the property which is the net proceeds of the sale. This amount will not be known until such time as the trustees have sold the property. Costs of sale will also form part of the cost base.

The result is that the trustees have neither made a capital gain or a capital loss from the sale of the property which means that no proceeds of the sale forms part of the net income of the trust.

Issue 2

Summary

The co-owners of the property are presently entitled to the entirety of the net rental income from the property derived by the trustees.

Detailed reasoning

Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) governs the tax treatment of the income of a trust, including trustees and beneficiaries of a trust.

Under section 95 of the ITAA 1936 the expression "net income", in relation to a trust estate, means the total assessable income of the trust estate calculated under the Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions (except certain defined deductions).

Net income of a trust is also referred to as "section 95" income or the taxable income of the trust. However, it is important to appreciate the distinction between income according to trust law and income according to tax law.

Distributable income of a trust depends on the income of the trust according to trust law rather than income according to tax law.

Section 97 of the ITAA 1936 states that where a beneficiary is presently entitled to a share of the income of a trust estate, the assessable income of the beneficiary includes the beneficiary's share of the net income of the trust estate. (This is the proportionate approach, where after first establishing that the beneficiary is presently entitled to the trust distribution, the entire share of the net income of the trust to which the beneficiary is entitled is assessed to the beneficiary.)

There is no definition of the term 'presently entitled' in the ITAA 1936 or the ITAA 1997. It is therefore necessary to establish the meaning which has been given to the term by the courts. The principal cases on the concept of present entitlement are the High Court decisions in FC of T v. Whiting (1943) 68 CLR 99 (Whiting) and Taylor v. FC of T (1970) 119 CLR 444 (Taylor). The principles in Taylor's case are also dealt with in Income Tax Ruling IT 319.

In Whiting's case at page 215: a beneficiary is presently entitled only when he is entitled to immediate payment of a share of the income of a trust estate.

In Taylor's case, Kitto J set down 3 tests in respect of present entitlement:

· It was legally available for distribution;

· As to the whole of it, the beneficiary had an absolute vested beneficial interest in possession; and

· But for the legal disability from giving a discharge he would have succeeded in an action to recover it from the trustee.

The main principles emerging from Whiting's and Taylor's case are:

· ·The income must be legally available for distribution to the beneficiary. It does not matter whether the amount of income has not been exactly ascertained. Therefore, the fact that you are not in a position to know exactly what is available to distribute to a beneficiary does not alter the fact that in a legal sense, a beneficiary can still demand payment and be presently entitled;  

· The beneficiary must have an indefeasible, absolutely vested, beneficial interest in possession in the trust income. That is, the interest must not be contingent which means that the beneficiary must have the right to demand immediate payment (or would have had the right to demand payment had they not been under a legal disability). An interest is said to be defeasible where it can be brought to an end and indefeasible where it cannot.

Further, the principles concerning the meaning of present entitlement from Whiting and Taylor were applied by the Full High Court in FC of T v Totledge Pty Ltd 82 ATC 4168, when it said:

... the preferable construction of sec. 97(1) is to treat the requirement of present entitlement to a share of the income of the trust estate as not being concerned with distinctions between gross income as derived and 'surplus income' after payment of costs, expenses and outgoings but as referring to a present vested right to demand and receive payment of the whole or part of what has been received by the trustee as income and, retaining that character in his hands, is legally available to be distributed to those entitled to it as beneficiaries under the trusts to the relevant trust estate.  Such a right to demand and receive payment represents a present entitlement to receive a share of what retains its character as income of the trust estate regardless of whether upon closer analysis, it can be seen to reflect a beneficial interest in gross income as derived or whether it represents no more than, for example, the right of an annuitant to be paid a particular amount from surplus or net income.  Examination of the decided cases in which reference has been made to sec. 97(1) supports this approach.

At the heart of the concept of present entitlement lies the immediate present right of a beneficiary to demand and receive payment of the income of the trust estate or a share of it. The leading High Court authority, Harmer & Ors v FC of T 91 (Harmer), expressed the tests as follows at ATC 5004:

The parties are agreed that the cases establish that a beneficiary is ``presently entitled'' to a share of the income of a trust estate if, but only if:

(a)     the beneficiary has an interest in the income which is both vested in interest and vested in possession; and

(b)     the beneficiary has a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment.'

Paragraph 1(b) of the Court Order over the property refers to the property being held by the trustees upon the statutory trusts for sale under the Conveyancing Act. Paragraph 66F(2)(a) of the Conveyancing Act states:

(2)  

(a)  Property held upon the "statutory trust for sale" shall be held upon trust to sell the same and to stand possessed of the net proceeds of sale, after payment of costs and expenses, and of the net income until sale after payment of costs, expenses, and outgoings, and in the case of land of rates, taxes, costs of insurance, repairs properly payable out of income, and other outgoings upon such trusts, and subject to such powers and provisions as may be requisite for giving effect to the rights of the co-owners,

Under this provision, the trustees appointed for a statutory trust for sale are required to hold both the proceeds of the sale of the property and any income that may be generated from that property net of costs and expenses, outgoings, rates taxes insurance costs on trust for giving effect to the rights of the co-owners.

Under the terms of the trust as provided by the Conveyancing Act, the co-owners have a vested and indefeasible right to the net income derived by the trustees during the period from the date of the court order until the date the sale of the property was completed and are therefore presently entitled to that income.

As the co-owners are presently entitled to all of the net income of the trust there is no amount that is assessable to the trustees.

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