Edited version of your private ruling

Authorisation Number: 1012587564847

Ruling

Subject: Transferred Shares: Liquidators liability and absolute entitlement

Question 1

Are the former Entity's clients (Former Clients) absolutely entitled to the shares for the purposes of section 106-50 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Does section 254 of the Income Tax Assessment Act 1936 (ITAA 1936) apply to make the Rulees liable to tax on the income or gains relating to the shares (in their capacity as liquidators) in relation to Former Clients where they are Australian Residents, during the relevant income years?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

1 July 2009

Relevant facts and circumstances

The Entity had administrators appointed who subsequently become the Liquidators (Rulees) of the Entity. This ruling was lodged by the Applicant on behalf of the Rulees.

Prior to going into administration the Entity had provided a service to investors. The Entity had a trust like relationship with its investors' (Former Clients) trust entitlement arising at the time of their payment to the Entity.

The Rulees sought a Court order in relation to a variety of matters. Their submission included a request for the confirmation from the Court to approve the transfer of particular shares to certain Former Clients of the Entity. These shares had been held by the Entity in a trust like relationship for the Former Clients and were now being held by the Rulees in their role of Liquidators of the Entity. The Rulees also sought a ruling providing them with the right of recourse to the shares and the share proceeds, to cover the remuneration and expenses they incurred. The order provided by the Court included directions ordering the transfer of the shares to the beneficial owners being the Former Clients. The Judge also ordered that the Rulees should have recourse to the Former Clients' shares and their proceeds to cover the remuneration and expenses they have incurred (but only to the extent that the remuneration and expenses relate to dealing with claims of Former Clients claiming an in specie entitlement to the shares).

The Entity's Former Clients were all Australian residents and no clients were under a legal disability.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6

Income Tax Assessment Act 1936 Section 95AAA

Income Tax Assessment Act 1936 Section 97

Income Tax Assessment Act 1936 Section 98

Income Tax Assessment Act 1936 Section 99

Income Tax Assessment Act 1936 Section 99

Income Tax Assessment Act 1936 Section 254

Income Tax Assessment Act 1997 Subsection 102-5

Income Tax Assessment Act 1997 Subsection 106-50

Corporations Act 2001 Section 511

Corporations Act 2001 Section 544

Trustee Act 1958

Reasons for decision

Issue 1

Question 1

Are the Former Clients absolutely entitled to the shares for the purposes of section 106-50 of the ITAA 1997?

Summary

The Judge confirmed the right of the Rulees to remuneration and expenses to the extent that they relate to dealing with claims of an in specie entitlement to those shares, whether the shares were held as a bare or other trustee by the Rulees. The shares themselves were affirmed by the Judge to be the property of the Former Clients and the order provided they were to be returned to them. As stated in TR 2004/D25 the existence of a trustees right to be indemnified does not prevent a beneficiary from being absolutely entitled to the asset. It just means the beneficiaries can only exercise their rights subject to the rights of a trustee to be indemnified.

Accordingly the Former Clients are considered to be absolutely entitled to the shares at all times over the relevant period.

Detailed reasoning

If the Former Clients are absolutely entitled to the shares then Rulees as trustees can apply section 106-50 of the ITAA 1997 which states that:

If you are absolutely entitled to a CGT asset as against the trustee of a trust (disregarding any legal disability), this part and Part 3-3 apply to an act done by the trustee in relation to the asset as if you had done it.

Broadly, an absolutely entitled beneficiary (rather than the trustee) is treated as the relevant taxpayer in respect of the asset for the purposes of the capital gains tax (CGT) provisions.

Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in parts 3-1 and 3-3 of the Income Tax Assessment Act 1997, explains the circumstances in which a beneficiary of a trust is considered to be absolutely entitled to a CGT asset of the trust as against its trustee stating:

Core principle

10. The core principle underpinning the concept of absolute entitlement in the CGT provisions 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 to be transferred at their direction. This derives from the rule in Saunders v. Vautier applied in the context of the CGT provisions

As against the trustee

60. The CGT provisions require the beneficiary to be absolutely entitled to the asset as against the trustee and not as against the whole world.

The Judge confirmed in the Court case that the Former Clients were beneficially entitled to the shares and made an order for the Rulees to deliver the shares to the Former Clients

In considering the interests of the Rulees in the shares the Judge stated that the shares should be charged with a fair share of the Liquidators' Remuneration and Expenses to the extent that they relate to dealing with claims of an in specie entitlement to those shares. The order included that the recourse should extend to the power to sell a sufficient number of the shares to cover the relevant portion of the Liquidators' remuneration and expenses.

Therefore, in line with the Judge's statements, whether the shares were being held as either as bare or other trustee the Rulees had an 'equitable lein' or 'right for indemnify' over these shares. TR 2004/D25 provides guidance on whether such a situation would prevent the Former Clients from having absolute entitlement of the shares stating:

A trustee's lien does not prevent absolute entitlement

64. The existence of a trustee's lien to enforce a right of indemnity against a trust asset will also not prevent a beneficiary being absolutely entitled to that asset. The rights of beneficiaries are always subject to the rights of the trustee to be indemnified for outgoings. However, the existence of a trustee's right to be indemnified should not be viewed as diluting or erasing any rights held by the beneficiaries. It just means that the beneficiaries can only exercise their rights subject to the rights of a trustee to be indemnified.

The judgment confirmed the right of the Rulees to remuneration and expenses to the extent that they relate to dealing with claims of an in specie entitlement to those shares, whether the shares were held as a bare or other trustee by the Rulees. The shares themselves were affirmed in the judgment to be the property of the Former Clients and the order provided they were to be returned to them. As stated in TR 2004/D25 the existence of a trustees right to be indemnified does not prevent a beneficiary from being absolutely entitled to the asset. It just means the beneficiaries can only exercise their rights subject to the rights of a trustee to be indemnified.

Accordingly the Former Clients are considered to be absolutely entitled to the shares at all times over the relevant period.

Question 2

Does section 254 of the ITAA 1936 apply to make the Rulees liable to tax on the income or gains relating to the shares (in their capacity as liquidators) in relation to Clients where they are Australian Residents, during the relevant income years?

Summary

The Former Clients had a pre-existing interest in the income from the shares, the Court case merely ascertained the right of the Rulees to indemnify themselves in regards to the work done as liquidators in relation to the shares and the Entity. It therefore follows that the Former Clients were presently entitled to the income, profits or gains derived from the shares and liable for tax on these amounts over the relevant period. Accordingly the Rulees are not liable to tax on the income or gains relating to the shares (in their capacity as liquidators of the Entity) during the relevant period.

Detailed reasoning

As the appointed administrators then liquidators of the Entity the Rulees stand as the trustees of its assets and income.

The income and gains from the shares, which themselves form part of the Entity's assets, albeit held on trust for the Former Clients, accordingly form part of the income of the trust estate.

Pt III of Division 6 sets out the basic income tax treatment of the net income of a trust estate with section 95AAA providing that generally:

a) it has the result of assessing beneficiaries on a share of the net income of the trust estate based on their present entitlement to a share of the income of the trust estate; and

b) it has the result of assessing the trustee directly on any residual net income; and

c) as a collection mechanism, it has the result of assessing the trustee in respect of some beneficiaries, such as non-residents or those under a legal disability.

Taxation Ruling IT 2680 Income tax: withholding tax liability of non-resident beneficiaries of Australian trusts provides the ATO view on the meaning of present entitlement to trust income stating:

Present entitlement to trust income

24. The requirement of present entitlement to a share of the income of the trust estate refers 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 the trustee's hands, is legally available to be distributed to those entitled to it as beneficiaries under the trusts.

The Rulees filed an application with a court of Australia seeking directions on a number of matters. No income or assets of the Entity were distributed to Former Clients pending the judgement and orders of the court case.

In the court case the Rulees were not contesting the ownership of the shares by the Former Clients rather it was common ground that these shares were not the subject of the application. The Rulees only sought an order from the Court that they could be indemnified by the Former Clients for expenses incurred in relation to the shares, which the Judge provided. As determined in the Reasons for decision in question 1 above, it is the Commissioner's view that the Former Clients are absolutely entitled to the shares over the relevant period. Of issue then is whether the Former Clients were presently entitled to the income, gains and profit associated with the transferred shares prior to the court case orders or whether present entitlement waited upon the court's recognition of their entitlement.

In considering present entitlement in such scenarios the Judges in Harmer & Ors v Federal Commissioner of Taxation 91 ATC 5000 (Harmer) stated :

The fact that orders were subsequently made for payment of the interest earned in the tax years to one or other of the claimants does not assist the appellants unless those orders represented a judicial recognition of a present or relevantly vested beneficial entitlement to the interest which existed at the time when the interest was derived, that is to say, which existed independently of the actual order.

…

There are many circumstances in which trust money can be paid into court by a trustee either pursuant to an order made on the application of a beneficiary or pursuant to an application made by the trustee himself or herself. In such a case, the funds paid into court remain subject to any pre-existing trust notwithstanding the payment in. If some person or persons were presently entitled to the corpus or income before payment in, the fact of payment in to await the orders of the court will not, of itself, displace that present entitlement. If entitlement is disputed, the function of the Court will be to identify existing interests in the money paid into court rather than to create new ones. If the interest of a beneficiary in the moneys is vested and the beneficiary has a right to demand and receive payment of income, the fact that the interest and the right are disputed and await vindication by the order of the Court will not make the interest contingent or negate the existence of the right. That being so, if a beneficiary is found by the Court to have had a pre-existing interest in the income, the fact that the interest was not admitted or its extent was not ascertained at the time of payment in or until the making of the relevant order does not mean that the beneficiary was not presently entitled to it both at that time and during the period pending the Court's determination.

The Former Clients had a pre-existing interest in the income from the shares, the court case merely ascertained the right of the Rulees to indemnify themselves in regards to the work done as liquidators in relation to the shares and the Entity. It therefore follows that the Former Clients were presently entitled to the income, profits or gains derived from the shares and liable for tax on these amounts over the relevant period. Accordingly the Rulees are not liable to tax on the income or gains relating to the shares (in their capacity as liquidators of the Entity) during the relevant period.

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