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Subject: Capital gains tax - E5 event - transfer to beneficiaries - absolutely entitled

Question:

Does subsection 104-75(1) of the Income Tax Assessment Act 1997 apply to the transfer of shares held by Company A as trustee for a Trust to the shareholders who are beneficiaries of the Trust?

Answer:

No.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts

Company A is a mining technology services company and is listed on the Australian Stock Exchange (ASX)

Legal proceedings were filed in another country against a subsidiary of Company A.

The existence of this lawsuit was perceived to be a major obstacle in the successful initial public offering (IPO) of company A on the ASX.

To protect incoming shareholders from any exposure to the lawsuit, it was resolved that the existing shareholders would fund up to a cap any payments made in respect of the loss or settlement of the lawsuit.

The legal mechanism to facilitate this agreement was for new bonus shares in Company A to be issued and held in escrow on behalf of shareholders.

Dividend income received during the escrow period was paid to Company A shareholders in accordance with their shareholdings.

An explanation of this arrangement was provided in the prospectus issued by Company A.

A legal liability did not arise and company A shares came out of escrow and were returned to shareholders.

You have supplied a number of documents which form part of and should be read in conjunction with this private ruling:

We have determined from these documents that a trust allotment schedule was in existence prior to the trustee distributing the shares which accurately reflects the beneficiaries' interest in a specific number of shares.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 Section 106-50

Income Tax Assessment Act 1997 Subsection 104-75(1)

Income Tax Assessment Act 1997 Subsection 104-75(2).

Reasons for decision:

Capital gains taxation event E5 in section 104-75 of the Income Tax Assessment Act 1997 (ITAA 1997) happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 of the ITAA 1997 applies) as against the trustee (disregarding any legal disability the beneficiary is under). If CGT event E5 happens, there may be CGT consequences for both the trustee and the beneficiary.

In Draft Taxation Ruling TR 2004/D25, the Commissioner stated his view that the core principle underlying the concept of absolute entitlement in the CGT rules is the ability of a beneficiary who has a vested and indefeasible interest in the entire trust asset to call for the asset to be transferred to them or as they so direct. The main CGT provisions (section 106-50 and 104-75 of the ITAA 1997) to which the concept of absolute entitlement is relevant apply separately to each beneficiary and asset of the trust. They also require absolute entitlement to the whole of a CGT asset of the trust.

Asset treated as belonging to absolutely entitled beneficiary

Once a beneficiary of a trust becomes absolutely entitled to an asset as against the trustee, the CGT provisions apply as if the asset were vested in the beneficiary, and as if any acts of the trustee were acts of the beneficiary (section 106-50 of the ITAA 1997). This means, for example, that the subsequent distribution of the asset to the beneficiary would not have any CGT consequences and a sale of the asset by the trustee to a third party would be treated as a sale by the beneficiary.

Absolute entitlement

TR 2004/D25 sets out the Commissioners views on the concept of absolute entitlement to trust assets. The position where more than one person may have an interest in those assets is outlined in the following paragraphs:

84. A beneficiary with a vested and indefeasible interest in trust assets where one or more others also have an interest in those assets will nonetheless be considered absolutely entitled to a specific number of the trust's assets if the three factors listed below are also present.

85. First, the assets must be fungible, at least to the extent to which a person would reasonably be expected to be indifferent to the replacement of any one asset with another.

86. Secondly, it must be the case that equity would permit the beneficiary to have their interest in all those assets satisfied by a distribution or allocation in their favour of a specific number of them.

87. Thirdly, there must be a very clear understanding on the part of all the relevant parties that the beneficiary is entitled, to the exclusion of the other beneficiaries, to a specific number of the trust's assets.

88. If these factors are present, then the beneficiary will be considered absolutely entitled to that specific number of the trust's assets for CGT purposes. Because the assets are fungible it does not matter that the beneficiaries cannot point to particular assets as belonging to them. It is sufficient that they can point to a specific number of assets as belonging to them, even though it is impossible to say exactly which ones.

In this case as the shares are considered to be fungible assets and the first and second factors mentioned above are satisfied it depends on the timing of the third factor.

Therefore, as the trust allotment schedule provides for a specific number of shares that were to be held on trust for the beneficiaries CGT event E5 never occurs as the beneficiaries are considered to be absolutely entitled to the specific amount of shares as opposed to shared interests from the day the trust was settled.

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