Edited version of your written advice

Authorisation Number: 1051251657094

Date of advice: 10 August 2017

Ruling

Subject: Deceased estate and present entitlement of beneficiaries to the income of the estate

Question 1

Are the residual beneficiaries presently entitled to all of the income of the estate?

Answer

No.

Question 2

Does the share of the boarding house that the deceased acquired on the death of their spouse qualify for the active asset reduction and the retirement exemption?

Answer

Yes.

Question 3

Does the share of the boarding house that the deceased acquired on the death of their spouse qualify for the 15 year exemption?

Answer

No.

Question 4

Does the share of the boarding house that the deceased acquired prior to 20 September 1985 qualify for the active asset reduction?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

M (the deceased) died on XX March 20XX.

Probate was granted to B and C (the executors) on XX July 20XX.

The net value of assets in the estate at the time of lodging probate was $X.

The deceased and their spouse purchased a property (the property) as joint tenants before 20 September 1985, which they used to conduct a business.

The deceased’s spouse died on XX June 20XX and their interest in the property passed to the deceased by survivorship.

The deceased continued to run the business until they entered an aged care facility in 20XX, at which time they arranged for a family member (F) to carry on the business as their agent.

The arrangement between F and the deceased consisted of the following:

- F retained $XX per week from the business as a management fee for services performed.

- All expenses relating to the business were paid by the deceased from the business bank account.

The deceased was a small business entity.

Upon the deceased’s death, the executors continued the arrangement with F on the same terms as agreed to with the deceased.

The arrangement continued between the executors and F until XX October 20XX, at which time an agent was appointed to manage the business and the sale of the property and business. The agent continued to manage the property on behalf of the executors until completion of the sale of the property and business on XX February 20XX.

The property and business was sold on XX November 20XX as a going concern.

A capital gain was made on the disposal of the property.

As at the 30 June 20XX:

- all estate assets have been realised and converted into cash,

- all debts of the deceased had been paid,

- All legacies had been paid; and

- Each of the charities comprising the residuary beneficiaries had received a distribution of $X paid as follows:

XX September 20XX	$X
XX December 20XX	$X
XX March 20XX	$X

- Remaining liabilities of the estate were accountant’s fees, legal costs, liability for executor’s commission (if granted) and income tax (if liable).

- Executors held the sum of $X in estate accounts:

By the 30 June 20XX, the sum of $X had been distributed to the beneficiaries.

After the last distribution on XX March 20XX, the estate received income in the form of interest on bank accounts to the sum of $X.

The boarding house:

A lodger was provided with a serviced room in return for a service fee.

A lodger was entitled to the following:

- Use of a serviced room designated from time to time

- Linen

- The use of all facilities being the bathroom, toilets and laundry including the washing machine

- The use of a key to whichever room was designated to the lodger from time to time

- The proprietor to provide all gas and electricity.

The rights of the proprietor:

- Retention of a key to the room designated

- A right of entry into the room without notice at reasonable times for reasonable purposes

- A right to designate another room from time to time

- As right to terminate upon reasonable written notice

- A right to evict without first obtaining a Court order

The proprietor exercised a high level of control over conduct within the boarding house by means of the house rules which lodgers accepted as a condition of their continuing occupancy, including:

- Noise control

- Visitors

- No attachments permitted to the walls and furniture of a bedroom

- Bedrooms to be kept clean and tidy

- Cooking areas to be cleaned after use

- No additional furniture permitted

- No smoking in bedrooms or common areas

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 95(1)

Income Tax Assessment Act 1936 section 97

Income Tax Assessment Act 1936 section 99

Income Tax Assessment Act 1936 section 99A

Income Tax Assessment Act 1997 section 115-215

Reasons for decision

Present entitlement of residual beneficiaries

Summary

The beneficiaries will be presently entitled to the income of the estate only to the extent of any amount actually paid to them. The trustee will be assessed on any income that has not been distributed.

Detailed reasoning

Where a resident beneficiary of a trust estate who is not under a legal disability is presently entitled to a share of the income of the trust estate, section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) operates to include in the assessable income of the beneficiary, their share of the net income of the trust. This income must be included as assessable income, by the beneficiary, in the year of income in which it was received or entitled to be received.

Where no beneficiary is presently entitled, sections 99 and 99A of the ITAA 1936 will apply to assess the trustee on the net income of the trust.

Net income is defined in subsection 95(1) of the ITAA 1936 as the total assessable income of the trust derived during the income year, calculated as if the trustee were a resident taxpayer, less allowable deductions. Where an asset is sold by the trust any capital gain is included in the net income of the trust.

The term 'present entitlement' is not defined in the ITAA 1936. It is therefore necessary to rely on the meaning which has been given to the term by the Courts.

Present entitlement is discussed at length in the Federal Court cases FC of T v. Whiting (1943) 68 CLR 199; 7 ATD 179 and Taylor Trust, Trustees of v. FC of T (1970) 119 CLR 444; 70 ATC 4026. The Courts in these cases held that in order for a beneficiary to be presently entitled to trust income, the following two conditions must be satisfied:

● The beneficiary must have an indefeasible, absolute vested, beneficial interest in possession in the trust income. That is, the interest must not be contingent. This 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).

● The income must be legally available for distribution to the beneficiary. In the case of a deceased estate, the beneficiaries will not be presently entitled to income until it is possible to ascertain the residue with certainty (after provision for debts, legacies, and so on).

Taxation Ruling IT 2622 provides the Commissioner's view on present entitlement during the stages of administration of deceased estates.

The net income of the deceased estate and whether any beneficiary is presently entitled is determined on the last day of each income year (30 June). This means that, on the last day of the income year, a beneficiary who is presently entitled will be assessed on their share of the net income for the whole of the income year.

IT 2622 explains that beneficiaries cannot enjoy present entitlement to income derived by a deceased estate during the administration of the estate. However, it also explains where the administration of a deceased estate is completed during the course of an income year, the beneficiaries (who are not under any legal disability) will be presently entitled during that income year and should bear tax on their shares of the net income of the trust estate for that income year.

Taxation Ruling IT 2622 defines when a deceased estate has been fully administered, as follows:

"....an estate has been fully administered by payment or provision for the payment of funeral and testamentary expenses, death duties, debts, annuities and legacies and the amount of the residue thereby ascertained….”

Paragraph 14 of IT 2622 provides that if during the administration of a deceased estate, the point may be reached where it is apparent to the executor that part of the net income of the estate will not be required to either pay or provide debts, etc. The executor in this situation might exercise the discretion, to pay some of the income to, or on behalf of the beneficiaries. The beneficiaries in this situation will be presently entitled to the income to the extent of the amounts actually paid to them or actually paid on their behalf. The fact that the estate has not been fully administered does not prevent the beneficiaries in this situation from being presently entitled to the income actually paid to, or on behalf of, the beneficiaries.

Paragraph 16 of IT 2622 states that the administration of a trust estate does not have to reach the stage where the estate is wound up for beneficiaries to enjoy present entitlement to the income of the estate. Once the executor has provided for all debts incurred by the deceased before his or her death and for debts incurred in administering the estate and provided for distribution of specific assets or legacies, it will be possible to ascertain the residue with certainty, even though the executor may not have actually made all the transfers necessary to satisfy these demands on the estate.

In this case, the liabilities of the estate at 30 June 20XX were for income tax (if liable), accountant’s fees, legal costs and a potential liability for executor’s commission, if granted, in the discretion of the court. In this case, it cannot be said that the residue of the estate can be ascertained with certainty because there are potential liabilities that are yet to be determined.

Accordingly, as per paragraph 14 of IT 2622, the residual beneficiaries can only be presently entitled to the income of the estate that has actually been paid to them or on their behalf. The trustee of the estate will be assessed on any remaining income that has not been paid out to the beneficiaries.

CGT small business concessions

Summary

The trustee is eligible to apply the active asset reduction and retirement exemption to the share of the boarding house that the deceased acquired from their spouse as it was disposed of within two years of the deceased’s death. The 15 year exemption cannot be applied to this share as the deceased did not own the share for 15 years.

As the estate continued to run the boarding house after the deceased’s death, the boarding house continued to be an active asset and consequently the trustee is entitled to the active asset reduction in relation to the share of the boarding house acquired by the deceased prior to 20 September 1985.

Detailed reasoning

Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year.

(b) the event would have resulted in the gain

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

To be eligible to apply the small business CGT concessions you must satisfy all four of the basic conditions above.

Active asset test

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

● you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period of ownership, or

● you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 and a half years.

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset’. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with’ you, in the course of carrying on a business.

Importantly, subsection 152-40(4) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset.

Taxation Determination TD 2006/78 discusses whether there are circumstances in which a premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the ITAA 1997, notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997. The taxation determination explains that whether an asset’s main use is to derive rent will depend on the particular circumstances of each case.

A key factor in determining whether an occupant of premises is a lessee is whether the occupier has a right to exclusive possession (Radaich v Smith (1959) 101 CLR 209; Tingari Village North Pty Ltd v Commissioner of Taxation [2010] AATA 233 at paragraphs 44-66, 2010 ATC 10-131, 78 ATR 693 and associated Decision Impact Statement 2008/4646 & 2008/4647).

If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are unlikely to be rent.

Ultimately, these are questions of fact depending on all the circumstances involved. Relevant factors to consider in determining these questions (in addition to whether the occupier has the right to exclusive possession) include the degree of control retained by the owner and the extent of any services provided by the owner such as room cleaning, provision of meals, supply of linen and shared amenities (Allen v Aller (1966) 1 NSWR 572), Appah v Parncliffe Investments Ltd [1964] 1 All ER 838 and Merchant v Charters [1977] 3 All ER 918).

Death and the CGT small business concessions

Under section 152-80 of the ITAA 1997 the legal personal representative (LPR) or beneficiary of the deceased estate will be eligible for the small business CGT concessions where:

● the asset is disposed of within two years of the date of death; and

● the asset would have qualified for the small business concessions if the deceased had disposed of the asset immediately before her death.

The LPR is taken to have acquired the assets on the date of death. Generally the cost base of the asset is transferred to the assets in the hands of the LPR. However market value is used if the deceased acquired the asset before 20 September 1985.

Retirement exemption

As noted above, for the purposes of the retirement concession, under section 152-80 of the ITAA 1997 the LPR or beneficiary of a deceased estate is eligible for the retirement exemption to the same extent that the deceased would have been just prior to their death, except that there is no requirement for the deceased to contribute an amount to a complying superannuation fund or a retirement savings account.

Application to this case

In this case, the deceased had two separate ownership interests in the boarding house property. One interest was a pre-CGT interest and the other, acquired upon the death of her spouse was a post-CGT interest.

Deceased’s post-CGT interest in the boarding house

At the time of the deceased’s death, the deceased would have satisfied the basic conditions for eligibility to apply the CGT small business concessions for their post-CGT interest in the property had they disposed of the property immediately before their death as:

● we accept the disposal would have resulted in a gain

● the deceased was a small business entity; and

● the property would have satisfied the active asset test as discussed below.

The occupants of the rooms at the boarding house are allowed to enter and use the premises for certain purposes. There was a high degree of control retained by the deceased and as well as services provided including cleaning and the supply of linen as part of the provision of the room. It is considered that the payments involved would be unlikely to be rent and the boarding house would be considered an active asset.

The property was used in a business carried on by the deceased for the entire period of ownership; and will accordingly have met the active asset test for the deceased.

The deceased would have been entitled to apply the 50% discount as they held the asset for longer than 12 months, the 50% active asset reduction and the retirement exemption to their post-CGT interest in the property.

Subsection 152-80(2) of the ITAA 1997 operates to remove certain requirements for an executor to apply the 15 year exemption; however the provision only allows an executor to apply the concession to the extent the deceased would have been able to just prior to their death. There is no provision that extends the relevant ownership period past the death of the deceased. Accordingly, as the deceased did not hold their post-CGT interest in the property for 15 years or more, they would not be entitled to the 15 year exemption.

As the asset was disposed of within two years of the deceased’s death, the trustee is able to apply the 50% active asset reduction and the retirement exemption (up to the amount available under the deceased’s CGT retirement exemption limit – see below note) to the post-CGT interest in accordance with section 152-80 of the ITAA 1997.

Note: The choice to apply the retirement exemption must be made in writing. An amount disregarded under the retirement exemption must also not exceed an individual’s lifetime CGT retirement exemption limit of $500,000. The trustee should consider whether the deceased had accessed the retirement exemption previously when determining the amount that can be disregarded under the retirement exemption. (Sections 152-315 and 152-320 of the ITAA 1997).

Deceased’s pre-CGT interest in the boarding house

The deceased, would not have satisfied the basic conditions in relation to their pre-CGT interest in the property as the CGT event would not result in a gain as it was a pre-CGT asset. Accordingly the estate cannot access the small business concessions under section 152-80 of the ITAA 1997.

The trustee of the estate is taken to have acquired the assets of the deceased on the date of their death. In relation to the deceased’s pre-CGT interest in the property, the first element of cost base will be the market value as at the date of death, as the deceased acquired their pre-CGT interest in the property before 20 September 1985.

The trustee continued to run the boarding house business that the deceased operated prior to their death. The boarding house property continued to be an active asset in the business for the executor.

The trustee meets the basic conditions for the CGT small business concessions as a CGT event occurred which resulted in a gain. The executor would be considered a small business entity as they continued to carry on the boarding house business from the date of the deceased’s death until the sale of the boarding house and the boarding house satisfies the active asset test.

The trustee would only be entitled to apply the 50% active asset reduction as they do not meet the additional conditions required to apply the other concessions as the boarding house was held by the executor for less than 12 months and the estate does not satisfy the significant individual test.

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