Edited version of your written advice

Authorisation Number: 1013121566479

Date of advice: 8 November 2016

Ruling

Subject: Capital gains tax - trust - net trust income

Question 1:

Will you as the trustee be entitled to apply the X0% capital gains tax (CGT) discount to the capital gain made on the sale of the X0% ownership interest in the property under Division 115 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

Question 2:

Will you as the trustee be assessable on the capital gain made on the sale of the X0% ownership interest in the property under section 98 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer:

No.

Question 3:

Will you as the trustee be assessable on the trust's capital gain made on the sale of the X0% ownership interest in the property under sections 115-220 and 115-222 of the ITAA 1936?

Answer:

No.

Question 4:

Will you as the trustee be assessable on the capital gain made on the sale of the X0% ownership interest in the property under subsection 12(9) of the Income Tax Rates Act 1986?

Answer:

No.

Question 5:

Will you be assessed on the capital gain made on the sale of the X0% ownership interest in the property if the beneficiaries are specifically entitled under section 115-228 of the ITAA 1997?

Answer:

No.

This ruling applies for the following period

Year ending 30 June 201X

The scheme commences on

1 July 201X

Relevant facts and circumstances

After 20 September 1985, settlement occurred on the purchase of the property (the Property) by Persons A and B as tenants in common.

After a number of years Person A (the deceased) passed away.

The deceased's Will appointed Person B and Person C as the Executors and Trustees of the deceased's estate:

Under the deceased's Will provided that:

● a trust would be created over both the deceased's X0% ownership interest in the Property

● Person B would be entitled to receive the rent from the Property during their lifetime; and

● when Person B passed away, the residue of the deceased's estate would be distributed to the beneficiaries in amounts as specified in the Will.

All of the residuary beneficiaries are Australian resident individuals, with none of them being under a legal disability.

Probate on the deceased's estate was granted a number of months after the deceased passed away.

The interest earned in relation to the deceased's X0% ownership interest in the Property was distributed to Person B during their lifetime.

Person B passed away a number of years after Person A had passed away.

A number of months after Person B had passed away, a contract of sale of the Property was entered into for the sale price of $XXX,000, with settlement occurring some time later in the following income year.

You have calculated that a capital gain of $XX,XXX was made on the sale of the Property.

You made a CGT streaming election under Subdivision 115-C of the Income Tax Assessment Act 1997 after settlement on the sale of the Property had occurred,

You have not made the choice under section 115-230 of the ITAA 1997 to be specifically entitled to the capital gain made on the sale of the X0% ownership interest in the Property.

On the same day that you had made the election under Subdivision 115-C of the ITAA 1997, you recorded that the in accordance with the deceased's Will, the beneficiaries were entitled to the residue of the deceased's estate, which included the X0% ownership interest in the Property.

A Statement of Liabilities of the deceased's estate for the income year ending 30 June 201X was prepared.

The beneficiaries of the deceased estate are entitled to the following in accordance with the deceased's Will in the income year ending 30 June 201X:

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6

Income Tax Assessment Act 1936 Division 6E

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 99A

Income Tax Assessment Act 1997 Subdivision 115-C

Income Tax Assessment Act 1997 Section 115-225

Income Tax Assessment Act 1997 Section 115-227

Income Tax Assessment Act 1997 Section 115-228

Income Tax Rates Act 1986 Subsection 12(9)

Reasons for decision

Eligibility to apply the X0% discount

For the purposes of Division 115 of the ITAA 1997 an individual and a trust may make a discount capital gain provided that the capital gain is not calculated using an indexed cost base.

The applicable discount rate is X0% for both entities. However, before a capital gain can be treated as a discount capital gain it is necessary for the asset to have been held by the taxpayer for at least 12 months before the CGT event.

There are special rules about the time of acquisition that apply to a legal personal representative (LPR) and beneficiary which are contained in section 115-30 of the ITAA 1997. These provisions deem the LPR and beneficiary to have acquired the asset when the deceased acquired it. This means that the LPR or beneficiary can dispose of the asset within 12 months of acquiring it and still be eligible to treat any capital gain as a discount capital gain.

Application to your situation

The Property was sold and it has been calculated that the capital gain made on the sale of your X0% ownership interest in the Property is $XX,XXX.

The capital gain will be a discount capital gain because you had held the X0% ownership interest in the Property for more than 12 months.

The net capital gain made on the sale of the X0% ownership interest in the Property will be included in your calculation of your taxable income (also described as your net income).

We will consider who is assessable on the capital gain made on the sale of the deceased's X0% ownership interest as follows:

Taxation of the net income of a trust

The liability to taxation on the net income of a trust is generally determined under the following sections:

● Section 97 of the ITAA 1936, which applies where a beneficiary is presently entitled to a share of the net income and is not under a legal disability

● Section 98 of the ITAA 1936, which applies where a beneficiary is presently entitled but is under a legal disability; and

● Sections 99 and 99A of the ITAA 1936, which apply where there is an absence of present entitlement of the beneficiary to all or some of the net income of the trust estate.

However, Division 6E of the ITAA 1936 refers the determination of the liability to tax on capital gains made by a trust to Subdivision 115-C of the ITAA 1997.

Streaming of a trust's capital gains to specifically entitled beneficiaries

Changes made by Tax Laws Amendment (2011 Measures No.5) Act 2011 apply to ensure that if permitted by the trust deed, the trust's capital gains and franked distributions can be effectively streamed to beneficiaries for tax purposes by making those beneficiaries specifically entitled to those amounts.

The new law amends the Income Tax Assessment Act 1997 (ITAA 1997), specifically Subdivision 115-C (which contains the rules for trusts with net capital gains) and Subdivision 207B (which includes rules for franked distributions received through a trust).

These new rules apply from the 2010-11 income year. That is, the streaming changes only affect trusts that make a capital gain or that are in receipt of a franked distribution for the 2010-11 or a later income year. In years in which the trust does not make a capital gain or receive a franked distribution, the streaming changes will not affect how tax law applies to the trust.

A beneficiary specifically entitled to a capital gain will generally be assessed on that gain, regardless of whether the benefit they receive or are expected to receive is income or capital of the trust. Therefore, unlike the situation that applied before the amendments, a beneficiary may be assessed based on a specific entitlement to a capital gain of the trust, even though they do not have a present entitlement to income of the trust estate.

The key change to Subdivision 115-C of the ITAA 1997 is that beneficiaries no longer need to have an assessable amount included under section 97, 98A or 100 of the ITAA 1936 to be treated as having an (assessable) extra capital gain under section 115-215 of the ITAA 1997. This ensures that a 'capital beneficiary' that is specifically entitled to an amount representing a capital gain of a trust is treated as having an extra capital gain in relation to that amount even if they are not presently entitled to a share of the income of the trust estate.

The concept of specific entitlement “overrides” the operation of the general trust rules in Division 6 of the ITAA 1936 (including the requirement that beneficiaries must be presently entitled to the income of a trust estate in order to be assessed on the trust's net income). Specifically entitled beneficiaries are not assessed under Division 6 in relation to the capital gains of a trust.

If capital gains are included in a beneficiary's assessable income under Division 115-C of ITAA 1997, new Division 6E of the ITAA 1936 excludes them from also being included in assessable income under sections 97 or 98 of the ITAA 1936. A similar outcome applies to the trustee who would otherwise be assessable under either sections 99 or 99A of the ITAA 1936.

A beneficiary is specifically entitled to a capital gain made by the trustee where:

● the beneficiary receives, or is reasonably expected to receive, an amount equal to the net financial benefit referable to the capital gain (ie the capital gain reduced by any losses consistent with the application of capital losses for tax purposes).

Taxation Determination TD 2012/11 outlines that it is not necessary that the gain itself be reasonably certain, merely that if a gain arises it is reasonably certain that a share of the gain will be received by the beneficiary. For example, if a trustee enters into a contract before the end of the income year for the disposal of an asset, a beneficiary may be reasonably certain to receive an amount referable to the gain, should it arise, even if the completion of the contract is not itself reasonably certain.

● no later than two months after year end, the beneficiary's entitlement is recorded (in its character as a capital gain) in the accounts or records of the trust, such as the trust deed or a resolution.

To be specifically entitled to an amount of capital gain made by the trust estate, the beneficiary must identify their relevant “share of the net financial benefit'. There are four steps to calculating the beneficiaries' extra capital gain as follows:

Step 1: Determine the share of a capital gain (Section 115-227 of the ITAA 1997).

A beneficiary or trustee's share of a capital gain of a trust is a dollar amount that comprises both:

● any part of the capital gain they are specifically entitled to; and

● a proportionate share of any part of the capital gain remaining after all specific entitlements to it have been determined.

The beneficiary or the trustee's proportionate share of any remaining capital gain is their adjusted Division 6 percentage of that gain.

A beneficiary's adjusted Division 6 percentage is the trust income to which they are entitled, expressed as a percentage (excluding any franked distributions or capital gains to which any entity is specifically entitled).

Step 2: The share as a percentage of the capital gain (Section 115-225 of the ITAA 1997)

To work out the percentage of the capital gain this share represents, divide the amount worked out at step 1 by the total amount of the capital gain and multiply by 100.

Step 3: Determine the attributable gain (Section 115-225 of the ITAA 1997)

Multiply the net income that relates to the capital gain by the percentage worked out at step 2. The result is the beneficiary or trustee's attributable gain.

Generally, the net income of the trust that relates to the capital gain is the taxable amount of the capital gain remaining after the trustee has applied any capital losses, including carried forward losses, and the CGT discount or small business concessions (if relevant).

This net income amount will equal the trust's net capital gain if the trust only has one capital gain.

The trustee can choose the order in which the capital losses and net capital losses are applied against individual capital gains of the trust. This may reduce the taxable amount for a particular capital gain to zero.

Step 4: Gross up the attributable gain (Subsection 115-215(3) of the ITAA 1997)

The beneficiary's attributable gain must be grossed up to adjust for any discounts the trustee has applied to that gain, so if:

● no discounts were applied, there is no gross up

● either (but not both) the general CGT discount or the small business X0% reduction was applied, the amount is doubled

● both discounts were applied, the amount is quadrupled.

The attributable gain (grossed up as appropriate) gives the beneficiary an extra capital gain. Beneficiaries treat extra capital gains the same way they would treat any capital gain. That is, they may reduce it by any current or prior year capital losses they have and apply any relevant discounts to work out their own net capital gain.

Application to your situation

The deceased passed away and Person B and Person C were appointed as the trustees of the deceased's estate in accordance with the Will.

In compliance with the deceased's will a trust was set up over the deceased's X0% ownership interest in the Property, with Person B receiving the rental income earned in relation to that ownership interest until they passed away, with the residue of the deceased's estate being distributed to the beneficiaries in the specified amounts.

A contract for the sale of the Property was entered into with settlement occurring a number of months later.

You have made the choice for the beneficiaries to be specifically entitled to the capital gain made on the sale of the ownership interest in the Property.

In this case, we are considering the application of Subdivision 115-C of the ITAA 1997 which is concerned with the rules for trusts with net capital gains.

The two conditions for the beneficiaries of the deceased's estate to be viewed as being specifically entitled have been met because:

● while the Property had been sold with a CGT event occurring in the 201X-1X income year, but with settlement occurring in the 201X-1X income year, it is reasonable to expect that the beneficiaries will receive a share of the capital gain arising as a result of the sale of the Property; and

● the percentage of the capital gain to be distributed to each of the beneficiaries has been recorded in the will and also in the letter of distribution of the capital gain made on the sale of the X0% ownership interest in the Property.

Therefore, the beneficiaries are viewed as being specifically entitled to the whole of the capital gain included in your net income. Consequently, you do not have a share of this capital gain under section 115-227 of the ITAA 1997, or an attributable capital gain under section 115-225 of the ITAA 1997 as trustee of the trust.

Therefore, there is no amount to be included in your assessable income under section 115-222 of the ITAA 1997.

Note: Fact sheet Streaming trust capital gains and franked distributions (QC 24534) which can be viewed on our web site www.ato.gov.au provides guidance and examples in relation to specific entitlement and how to calculate the extra capital gain.

Further issues for you to consider

The following information is provided as written guidance. A taxpayer who relies on guidance will remain liable for any tax shortfall if the guidance is incorrect or misleading and they make a mistake as a result (unless a time limit imposed by the law precludes the liability). However, they will be protected against the shortfall penalty and interest on the tax shortfall provided they relied on that guidance reasonably and in good faith.

The following information is provided to assist you with finalising the administration of the deceased's estate. The fact sheets can be viewed on our website www.ato.gov.au and can be found by searching for the Quick Code (QC) number:

● Fact sheet When a beneficiary is presently entitled (QC 40484) outlines when a beneficiary is presently entitled and also lists the information that the trustee of a deceased estate should be provide to beneficiaries so that they can prepare their own tax returns, such as “Statement of Distributions”

● Fact sheet TFN withholding for closely held trusts (QC 23140), link Who the rules apply to outlines that TFN withholding rules apply to most closely held trusts and their beneficiaries with some exclusions.

Trusts of a deceased estate are excluded from the TFN withholding rules up until the end of the income year in which the fifth anniversary of the individual's death occurred - after this the trustee will need to consider whether they will be subject to the TFN withholding rules.

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