Edited version of private advice

Authorisation Number: 1051679116718

Date of advice: 21 May 2020

Ruling

Subject: Capital gains tax and deceased estate

Question 1

Is the estate of the deceased (A), a fixed trust?

Answer

Yes.

Question 2

Will the trustee of a fixed trust be liable to pay tax in respect of an amount to the extent that the amount gives rise to a capital gain that is disregarded for a non-resident beneficiary under subsection 855-40(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

The deceased A passed away in 19XX and left a Will.

A trustee and executor were appointed.

The trustee, in accordance with the terms of the Will, divided the residual estate of the deceased A into two testamentary trusts in equal shares to two family members (Trust J & Trust K) for their life of both the capital and income. Upon either J or K's death, then their 50% share is to be equally divided between their respective children that survived either J or K (respectively).

Family member J was a resident of Australia for taxation purposes and had several children. One child predeceased J.

J passed away in 20XX and at that time J's interest in the 50% share of the deceased's (A) Trust vested and ended.

The remaining children who survived J have attained the age of 25 years.

The remaining trust for the 50% share of the residual estate of the deceased's Trust (A) is still operating and paying the income to Trust K for the remainder of their life. On K's death, the trust fund will be distributed to the children of J that survive J.

The assets in deceased's estate Trust (A) consist of listed equities in the Australian Stock Exchange and unlisted managed funds which are non-taxable Australian property.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 95A(2)

Income Tax Assessment Act 1936 section 272-5 of Schedule 2F

Income Tax Assessment Act 1936 subsection 272-5(1) of Schedule 2F

Income Tax Assessment Act 1936 subsection 272-5(3) of Schedule 2F

Income Tax Assessment Act 1936 section 272-65 of Schedule 2F

Income Tax Assessment Act 1997 section 855-15

Income Tax Assessment Act 1997 section 855-20

Income Tax Assessment Act 1997 section 855-25

Income Tax Assessment Act 1997 section 855-40

Income Tax Assessment Act 1997 subsection 855-40(2)

Income Tax Assessment Act 1997 subsection 855-40(2)(a)

Income Tax Assessment Act 1997 subsection 855-40(2)(b)(i)

Income Tax Assessment Act 1997 subsection 855-40(2)(c)(i)

Income Tax Assessment Act 1997 subsection 955-1(1)

Reasons for decision

Question 1

Section 272-65 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) provides that a trust is a 'fixed trust' if persons have fixed entitlements to all of the income and capital of the trust. Subsection 995-1(1) of the ITAA 1997 provides that a trust is a fixed trust if entities have fixed entitlements to all of the income and capital of the trust.

Subsection 272-5(1) of Schedule 2F to the ITAA 1936 provides that, in relation to the meaning of the term fixed entitlement:

If, under a trust instrument, a beneficiary has a vested and indefeasible interest in a share of income of the trust that the trust derives from time to time, or of the capital of the trust, the beneficiary has a fixed entitlement to that share of the income or capital.

It is an essential element of subsection 272-5(1) of Schedule 2F to the ITAA 1936 that in order to have a fixed entitlement to a share of income or capital there must be a vested or indefeasible interest 'under a trust instrument'. In all cases, the determining factor in deciding if fixed entitlements exist will be the terms of the trust instrument under which the trust is constituted.

The meaning of the term 'vested and infeasible' (in the context of the Schedule 2F) has not been judicially considered. However, the term appears in Division 6 in subsection 95A(2) of the ITAA 1936 and in the context of that subsection, the term has been considered by the courts; for example, refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4, 525; Walsh Bay Developments Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4378; Dwight v Commissioner of Taxation (1992) 92 ATC 4192; Harmer v FC of T (1991) 91 ATC 5000.

Also relevant are MSP Nominees Pty Ltd v Commissioner of Stamps (SA) (1999) 198 CLR 494; 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490.

The term 'vested and indefeasible' is not defined in the taxation legislation and to date there is no 'ATO view' which defines or clarifies the term.

The Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 which introduced the trust loss measures gives an explanation in relation to the meaning of 'vested and indefeasible' interest (see paragraphs 13.3 to 13.9).

What is a vested interest?

The EM states:

13.4 A person has a vested interest in something if the person has a present right relating to the thing. Stated simply, a vested interest is one that is bound to take effect in possession at some point in time. A vested interest is to be contrasted with a 'contingent' interest which may never fall into possession. If an interest of a beneficiary in income or capital is the subject of a condition precedent so that an event must occur before the interest becomes vested, the beneficiary does not have a vested interest to the income or capital since such an interest is instead 'contingent' upon the event occurring.

13.5 In traditional legal analysis, a person can be said to be either 'vested in possession' or 'vested in interest'. A present interest, i.e. one that is being enjoyed, is said to be 'vested in possession'; a future interest, i.e. one which gives its holder a present right to future enjoyment, is said to be 'vested in interest'. A person is vested in possession where the person has a right to immediate possession or enjoyment of the thing in question. In the definition of fixed entitlement, 'vested' includes both vested in possession and vested in interest.

13.6 Because vested interests include future interests, a person can have a vested interest in a thing even though the person's actual possession and enjoyment of the thing is delayed until sometime in the future.

When is a vested interest indefeasible?

The EM states:

13.7 A vested interest is indefeasible where, in effect, it is not able to be lost. A vested interest is defeasible where it is subject to a condition subsequent that may lead to the entitlement being divested. A condition subsequent is an event that could occur after the interest is vested that would result in the entitlement being defeated, for example, on the occurrence of an event or the exercise of a power. For example, where a beneficiary's vested interest is able to be taken away by the exercise of a power by the trustee or any other person, the interest will not be a fixed entitlement.

13.8 Where the trustee exercises a power to accumulate income or capital of the trust in accordance with the trust deed, the accumulation does not result in a beneficiary's interest being taken away or defeased as long as the beneficiary nevertheless remains entitled at some future time to enjoy his or her share of the income or capital which has been accumulated.

Vested and indefeasible interests and a deceased estate

ATO Interpretative Decision ATO ID 2006/279 expresses the view that the terms of the Will governing the disposition of the property in the deceased estate confer fixed entitlements to all of the income and capital of the estate upon the residuary beneficiaries. The ATO ID explains that the interest of the residuary beneficiaries in the income and capital of the estate is indefeasible. There is no condition in the trust instrument, the Will, by which any of the residuary beneficiaries could lose their interest in the estate.

In relation to vesting, it is considered that for any interest to be 'vested in interest', the following conditions are present (Evans, M Equity & Trusts, Sydney: Butterworths 2003 at 354):

a.    The person or persons entitled to the interest must be ascertained;

b.    The interest must be ready to take effect in possession immediately upon termination of the prior interest;

c.     The gift must not be subject to any contingency; and

d.    Where the gift is in favour of a class, every member of the class must be ascertained (that is, identified), and the exact share of the each must also be ascertained.

Defeasible v indefeasible

With reference to the certainty of their duration, interests are divided into defeasible interests and indefeasible or absolute interests (Fearne, C An Essay on the Learning of Contingent Remainders and Executory Devises, (Colorado: Rothman, 10th ed 1980), Vol. 2, at 30).

A defeasible interest is an interest that is subject to be defeated by the operation of a subsequent or mixed condition;

An indefeasible interest, or an absolute interest as opposed to a defeasible interest, is one that is not subject to any condition.

In relation to the term 'defeasance' Fearne provides that (at 9):

Defeasances are provisos of the same import and efficacy as proper conditions subsequent, but are contained in a distinct deed, either delivered at the same time with the deed to which the condition relates, or, except in the case of things executory or chattels, delivered after the deed to which the condition relates.

Do vested and indefeasible interests exist in the income and capital of the Trust?

In relation to the income and capital of Trust J in this case:

a)    The beneficiaries entitled are the grandchildren of the deceased A.

The grandchildren were all identified and ascertained.

b)    The grandchildren are ready to take possession of their interest in possession after the death of family member J (life tenant).

The residual beneficiaries are able to take possession of their interests in the income and capital of the Trust J after the death of family member J as provided in the Will.

c)    No contingencies exist.

By the time family member J died, the residual beneficiaries had all attained the age of 25 years and all are living.

d)    Each of the beneficiaries is entitled to equal shares of the deceased's Trust A based on the terms of the Will.

In this case, each of the residuary beneficiaries has a present right to enjoyment of their equal share of the income and capital. There is no condition in the Will by which any of them could lose their interest in the estate. As all of the residuary beneficiaries have a vested and indefeasible interest in a share of the income and capital of the estate, they all have a fixed entitlement to a share of the income and capital of the estate.

Conclusion

Given the interests of the residual beneficiaries in the income and capital of the deceased's Trust A are vested and indefeasible, then fixed entitlements exist in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936. As such the deceased's Trust A is a fixed trust in accordance with section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997 following the death of family member J.

This conclusion is consistent with the view expressed in ATO ID 2006/279.

Question 2

Section 855-40 of the ITAA 1997 provides a CGT exemption for foreign residents making a capital gain in respect of their interest in a fixed trust (including a managed fund).

Relevantly, subsection 855-40(2) of the ITAA 1997 provides that a capital gain you make in respect of your interest in a fixed trust is disregarded if:

·         you are a foreign resident when you make the gain: paragraph 855-40(2)(a); and

·         the gain is attributable to a CGT event happening to a CGT asset of a trust (the CGT event trust) that is the fixed trust: subparagraph 855-40(2)(b)(i); and

·         the asset is not taxable Australian property for the CGT event trust at the time of the CGT event: subparagraph 855-40(2)(c)(i).

Subsection 855-40(3) of the ITAA 1997 provides that a trustee is not liable to pay tax in respect of an amount to the extent that the amount gives rise to a capital gain that is disregarded for a beneficiary under subsection 855-40(2).

Conclusion

The non-resident beneficiary satisfies the conditions for CGT exemption in subsection 855-40(2) of the ITAA 1997 and can disregard the capital gain made in respect of their interest in The Estate of deceased A for family member J. To the extent that the amount relates to the capital gain that is disregarded by the non-resident beneficiary, the trustee is not liable to pay tax in respect of that amount (subsection 855-40(3) of the ITAA 1997).

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