Edited version of private advice

Authorisation Number: 1051697008824

Date of advice: 18 June 2020

Ruling

Subject: Discretionary trust distribution to a non-resident beneficiary

Question 1

Will the Commissioner treat the trustees of the W Trust as "legal personal representatives" (LPR's) for the purposes of Division 128, in particular section 128-15(3) of the Income Tax Assessment Act 1997 (ITAA 1997), in accordance with PS LA 2003/12?

Answer

Yes

Question 2

Will the Y Shares and the X Shares constitute trading stock?

Answer

No

Question 3

If a portion of the Y Shares and the X Shares held by the W Trust are distributed to Z's Trust will Division 128 apply to cause any capital gain made on that distribution to be disregarded or indeed prevent the relevant CGT event from happening (on the basis the W Trust is a trust to which Division 128 applies)?

Answer

Yes

Question 4

Following Question 3, will CGT event K6 happen on that distribution?

Answer

No

Question 5

Following Question 3, will Z's Trust obtain a cost base in the Y Shares distributed to it equivalent to the market value of those Y Shares at the date of the Deceased's death?

Answer

Yes

Question 6

If Z's Trust sells the X Shares and distributes the proceeds from the same to the non-resident beneficiary and/or another Country U resident for tax purposes, will the Country U DTA prevent the distribution from being subject to tax in Australia?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The deceased died on XX XXXX 20XX. Probate was granted to the Executors on XX XXXX 20XX.

The deceased had 3 children.

2 of the children reside in Australia (and are Australian residents for tax purposes)

One of the children has resided in the Country U for a large number of years (and is not an Australian resident for tax purposes)

The will was executed on XX XXXX 20XX.

The will gives the whole of the Estate to the Executors upon trust to establish the W Trust.

The W Trust is therefore established under the Will.

The Will provides that the Executors can distribute the capital and net income of the W Trust to certain listed beneficiaries as they think fit.

Those beneficiaries include the children mentioned above, their children and any spouse of the aforementioned persons.

The Will provides that any reference to the aforementioned beneficiaries shall be deemed to be a reference to them personally or any inter vivos discretionary trust of which they are a beneficiary at the option of the beneficiary.

The Will also provides that the Executors can pay and transfer both the capital and any unexpended net income of the W Trust to any one or more of the listed beneficiaries.

It is broadly understood between the Executors and Deceased's children, that the assets held by the W Trust will be split on a per stirpes basis between the three children, either by way of being transferred to them (or their children) directly, or to a discretionary trust they will benefit from.

The will empowers the Executors to sell, appropriate, invest or otherwise deal with any assets of the W Trust as they think fit.

Y and X Shares

Relevantly for the purposes of the Application, the Estate's assets include the following assets:

a)    The X shares; and

b)    The Y shares:

Company Y & Y Shares

Company Y is a family owned investment company that passively invests in Australian listed securities.

At date of death, nearly all of Company Y's assets consisted of shares that were acquired by Company Y after the CGT date. Only a small proportion of the shares were purchased prior to the CGT Date.

Company Y's aim has been that of passive investment.

The Deceased acquired the Y Shares prior to the CGT Date.

Company Y does not hold 10% or more of the shares in any of the companies in which it invests, and therefore does not hold 10% or more the voting rights and rights to distributions of profit or capital in those entities.

X Shares

The Deceased held these shares for long periods of time, with some being Pre-CGT shares.

Historically the Deceased had a relatively low share transaction activity.

The Deceased acquired shares as long term investments and only sold shares on the advice of financial planners on the longer term merits of owning a particular share and with the aim of maintaining a balanced portfolio.

The total combined holdings of the relevant holders of the shares does not exceed 10% of the issued shares in any one of those companies

Non-resident child

The non-resident child has resided in Country U for a significant period of time and plans to do so for the foreseeable future.

Z's Trust

Z's Trust will be a discretionary trust, established and governed under State X law, of which the non-resident child will be the primary beneficiary.

The trustee of Z's Trust will be a company incorporated in Australia.

As the non-resident child will be a beneficiary of Z's Trust (in fact the "primary beneficiary") when it is established, the non-resident child will acquire their interest in Z's Trust for no consideration.

Proposed Distributions of Y and X Shares

Under the Terms of the Will, the Estate is to be held by the Executors as trustees for the W Trust.

The Executors can distribute the capital of the W Trust to the beneficiaries as they think fit.

With the agreement of the children, the Executors, in their capacity as trustees of the W Trust, intend to make in specie distributions of the Y Shares and the X Shares between the beneficiaries

Following the receipt of the aforementioned in specie distribution, the trustee of the Z's Trust intends to sell the X Shares received from the W Trust, and then remit the cash proceeds to the non-resident child and/or other Country U residents for tax purposes.

The non-resident child will be made specifically entitled to the capital gains by the Trustee of Z's Trust.

Assumptions

The Shares will be held on capital account during the relevant transactions

The Shares are not being sold as part of a business operation

Z's Trust will be an Australian resident trust for tax purposes

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 95(1)

Income Tax Assessment Act 1936 section 98

Income Tax Assessment Act 1997 subsection 70-10(1)

Income Tax Assessment Act 1997 section 104-215

Income Tax Assessment Act 1997 section 104-230

Income Tax Assessment Act 1997 subsection 104-230(1)

Income Tax Assessment Act 1997 subsection 104-230(2)

Income Tax Assessment Act 1997 section 115-215

Income Tax Assessment Act 1997 subsection 115-215(3)

Income Tax Assessment Act 1997 subsection 115-225(1)

Income Tax Assessment Act 1997 subsection 115-225(2)

Income Tax Assessment Act 1997 subsection 115-225(3)

Income Tax Assessment Act 1997 section 115-227

Income Tax Assessment Act 1997 subsection 115-227(a)

Income Tax Assessment Act 1997 subsection 115-227(b)

Income Tax Assessment Act 1997 section 115-228

Income Tax Assessment Act 1997section 128-15

Income Tax Assessment Act 1997 subsection 128-15(3)

Income Tax Assessment Act 1997 subsection 128-15(4)

Income Tax Assessment Act 1997 section 128-20

Income Tax Assessment Act 1997 paragraph 128-20(1)(a)

Income Tax Assessment Act 1997 subsection 128-20(2)

Income Tax Assessment Act 1997 section 855-10

Income Tax Assessment Act 1997 subsection 855-10(1)

Income Tax Assessment Act 1997 section 855-15

Income Tax Assessment Act 1997 section 855-25

Income Tax Assessment Act 1997 section 855-30

Income Tax Assessment Act 1997 subsection 855-30(1)

Income Tax Assessment Act 1997 subsection 855-30(2)

Income Tax Assessment Act 1997 subsection 855-30(3)

Income Tax Assessment Act 1997 subsection 855-30(4)

Income Tax Assessment Act 1997 section 855-40

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997) deals with the CGT consequences when the owner of a CGT asset dies.

Generally, any capital gain or capital loss from a CGT event that results for an asset owned by a person just before their death is disregarded (section 128-10 ITAA 1997).

Section 128-15 ITAA 1997 sets out the CGT consequences for a CGT asset owned by a deceased person just before dying that:

(a)  devolves to a legal personal representative; or

(b)  passes to a beneficiary of that person's estate.

The term 'legal personal representative' is defined in subsection 995-1(1) ITAA 1997 and relevantly includes, 'an executor or administrator of an estate of an individual who has died...'

Section 128-20 ITAA 1997 defines when a 'CGT asset passes to a beneficiary' in a person's estate. This will relevantly happen if the person becomes the owner under the deceased's will (paragraph 128-20(1)(a) ITAA 1997).

Subsection 128-20(2) ITAA 1997 provides that a CGT asset does not pass to a beneficiary in your estate if the beneficiary becomes the owner of the asset because your legal personal representative transfers it under a power of sale.

Subsection 128-15(3) ITAA 1997 provides that any capital gain or capital loss the legal personal representative makes if the asset 'passes to a beneficiary in your estate' (as defined in section 128-20 ITAA 1997) is disregarded.

Effect of Practice Statement PS LA 2003/12

Law Administration Practice Statement PS LA 2003/12 Capital gains tax treatment of the trustee of a testamentary trust confirms that:

...the Commissioner will not depart from the ATO's long-standing administrative practice of treating the trustee of a testamentary trust in the same way that a legal personal representative is treated for the purposes of Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997), in particular subsection 128-15(3). (Paragraph 2)

For PS LA 2003/12 to apply, the trust in question must be a testamentary trust.

In the present case, the trust is a testamentary trust as it was created under the terms of the Will. Therefore the testamentary trust will be able to utilise the Commissioner's administrative practice in PS LA 2003/12 and treat the trustee of the testamentary trust in the same way as a legal personal representative is treated for the purposes of Division 128 of the ITAA 1997.

Question 2

Subsection 70-10(1) ITAA 1997 states:

Trading stock includes:

a)    anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of business; and

b)    live stock.

Therefore whether the Estate holds the items as trading stock depends on whether they are running a business of share trading. The shares in the circumstances are being held for passive investment. This is evident from the long periods of time the deceased held the property and the low transaction activity that occurred during that time. The deceased always treated the assets as being held on the capital account. The Estate has retained these characteristics in their holding of the Shares. Their intention is to distribute the shares as per the terms of the Will. Accordingly there is no intention to sell the shares in a business.

The Estate is not running a business of share trading and the shares will not be trading stock.

Question 3

PS LA 2003/12 confirms the Commissioner's longstanding administrative practice of not recognising any taxing point in relation to assets owned by a deceased person until they cease to be owned by the beneficiaries named in the will (unless there is an earlier disposal by the legal personal representative or testamentary trustee to a third party or CGT event K3 applies).

The trustees of the Estate will be treated as legal personal representatives as per the answer to Question 1. There has been no earlier disposal to a third party and the beneficiary in this instance is not an exempt entity, the trustee of a complying superannuation fund or a foreign resident. Matthew's Trust is also mentioned as a beneficiary in the Will. Therefore any capital gain made on distribution from the trustees of the Estate to Matthew's Trust will be disregarded.

Question 4

CGT event K6 is an anti-avoidance measure designed to prevent the possible avoidance of CGT where the owners of interests in a company or trust, acquired prior to 20 September 1985 (Pre-CGT Interest), dispose of these interests, rather than actual property of the company or trust acquired after 20 September 1985 (Post-CGT Property).

Specifically under subsection 104-230(1) of the ITAA 1997, CGT event K6 happens when:

·         you own shares in a company or an interest in a trust you acquired before 20 September 1985,

·         CGT event A1, C2, E1, E2, E3, E5, E6, E7, E8, J1 or K3 (the Other CGT Event) happens in relation to the shares or interest in the trust,

·         there is no roll-over for the Other CGT Event, and

·         the 75% test in subsection 104-230(2) of the ITAA 1997 is satisfied.

The 75% test in subsection 104-230(2) of the ITAA 1997 is satisfied when just before the Other CGT Event happened:

·         the market value of property of the company or trust (that is not trading stock) that was acquired on or after 20 September 1985, or

·         the market value of interests in the company or trust owned through interposed companies or trusts in property (except trading stock) that was acquired on or after 20 September 1985,

must be at least 75% of the net value of the company or trust.

In your case, a rollover would occur under Division 128. This means CGT event K6 would not occur.

Question 5

Section 128-15 ITAA 1997 sets out what happens to CGT assets that devolve to a legal personal representative or pass to a beneficiary of an estate. Relevant to your situation is item 4 in the table contained in subsection 128-15(4) ITAA 1997 which states the following:

The Y shares were pre-CGT shares of the deceased. Accordingly Z's Trust's first element cost base will be taken to be the market value of the Y shares on the day the deceased died.

Question 6

The capital gains and losses of a resident trust are determined without regard to whether they arise from Taxable Australian Property (TAP), or whether the trust has non-resident beneficiaries. Any net capital gain is included in the trust's net income for the income year, calculated in accordance with subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

Broadly, the rules in Subdivision 115-C operate to ensure, among other things, that a beneficiary of a trust which is made 'specifically entitled' to a capital gain will be assessed on it.

Section 115-228 ITAA 1997 sets out when a beneficiary will be regarded as specifically entitled to a trust's capital gain.

The amount of the trust's capital gain that is assessed to a beneficiary is worked out by reference to their attributable gain which is calculated in accordance with subsection 115-225(1) ITAA 1997. A beneficiary's attributable gain is calculated on a gain by gain basis.

Generally, a beneficiary's attributable gain is their 'share of the capital gain' (see section 115-227 ITAA 1997) multiplied by the trust's net capital gain.

Under section 115-227 ITAA 1997, a beneficiary's 'share of the capital gain' is any amount of the capital gain to which they are specifically entitled (subsection 115-227(a) ITAA 1997) plus their 'Division 6 percentage' share of any amount of the capital gain to which no beneficiary is specifically entitled (subsection 115-227(b) ITAA 1997).

However, note the calculation of attributable gain amount is subject to the modification in subsections 115-225(2) and (3) ITAA 1997. These provisions rateably reduce the taxable amount of the capital gain to ensure that beneficiaries are not assessed on more than the trust's net income. The reduction applies if the sum of the trust's net capital gains and franked distributions (less directly relevant deductions) exceeds the trust's net income (excluding franking credits).

In the present circumstances, the trustee's of Z's trust will sell the X Shares and distribute to the non-resident child or another non-resident beneficiary who will be made specifically entitled to a capital gain within the terms of section 115-228 ITAA 1997.

Extra Capital Gains- Subdivision 115-C

Where a beneficiary makes an attributable gain, section 115-215 ITAA 1997 requires that the attributable gain be 'grossed-up' with 'extra capital gains'. A beneficiary will be deemed to have made extra capital gains depending on whether the gain was subject to the CGT discount percentage and/or small business 50% reduction at the trust level.

Subsection 115-215(3) ITAA 1997 states the following:

"If you are a beneficiary of the trust estate, for each capital gain of the trust estate, Division 102 applies to you as if you had:

(a) if the capital gain was not reduced under either step 3 of the method statement in subsection 102-5(1) (discount capital gains) or Subdivision 152-C (small business 50% reduction) - a capital gain equal to the amount mentioned in subsection 115-225(1); and

(b) if the capital gain was reduced under either step 3 of the method statement or Subdivision 152-C but not both (even if it was further reduced by the other small business concessions) - a capital gain equal to twice the amount mentioned in subsection 115-225(1); and

(c) the capital gain was reduced under both step 3 of the method statement and Subdivision 152-C (even if it was further reduced by the other small business concessions) - a capital gain equal to 4 times the amount mentioned in subsection 115-225(1)."....

The term "capital gain" is defined in section 995-1 ITAA 1997 as follows:

'capital gain: for each CGT event a capital gain is worked out in the way described in that event.'

The capital gain in question is the gain made by Matthew's Trust from CGT event A1.

The amount referred to in the expression 'amount mentioned in subsection 115-225(1)' in paragraphs (a) to (c) of subsection 115-215(3) ITAA 1997 is the amount of a beneficiary's attributable gain.

Paragraph (b) of subsection 115-215(3) ITAA 1997 is relevant to the present circumstances. Under paragraph (b) where a capital gain is reduced at the trust level by the CGT discount percentage (step 3 of the method statement) but not the small business 50% reduction in Subdivision 152-C ITAA 1997, the capital gain will effectively double. The beneficiary will obtain a capital gain equal to twice the amount mentioned in subsection 115-225(1) ITAA 1997 which calculates the attributable gain.

The result in the currently scenario is that the non-resident beneficiary will be assessed on extra capital gains under subsection 115-215(3) of the ITAA 1997.

General foreign resident exemption: section 855-10

Subsection 855-10(1) ITAA 1997 provides that a foreign resident can disregard a capital gain or capital loss from a CGT event if the event happens in relation to a CGT asset that is not TAP.

It has been suggested that this 'general' exemption provision disregards a capital gain or capital loss which a foreign resident beneficiary of a trust is taken to have made as a result of a CGT event happening to non-TAP assets of the trust.

The X Shares will both not be considered taxable Australian property as the holdings do not constitute an indirect real property interest.

However, a capital gain that a foreign resident beneficiary makes because of the operation of subsection 115-215(3) ITAA 1997 is not a capital gain from a CGT event that happens to the beneficiary. Rather, such an event happens to the trustee. While subsection 855-10(1) ITAA 1997 does not expressly provide that the relevant CGT event must happen 'to' the foreign resident, this is an inference which may be drawn from the statutory context.

In particular, the presence of a specific rule in section 855-40 ITAA 1997 enabling beneficiaries of fixed trusts to disregard certain trust capital gains is a strong indicator that beneficiaries of non-fixed trusts are not catered for by section 855-10 ITAA 1997.

If subsection 855-10(1) ITAA 1997 could disregard trust capital gains attributed to foreign resident beneficiaries, it would on its terms do so without regard to whether the trust was a fixed trust or a non-fixed trust, rendering that aspect of section 855-40 ITAA 1997 redundant. The statutory context strongly suggests that the intention is for foreign resident beneficiaries of fixed trusts to have capital gains or losses disregarded in appropriate cases, but not foreign resident beneficiaries of non-fixed trusts.

Application to your circumstances

Section 115-220 ITAA 1997 will assess the trustee under section 98 ITAA 1936 on the trust's capital gain attributed to the non-resident beneficiary. The non-resident beneficiary is being made specifically entitled to the capital gains and under subsection 115-215(3) ITAA 1997, the gains should be taken into account in calculating the non-resident beneficiary's net capital gain/loss.

As Z's Trust is a discretionary trust, section 855-40 ITAA 1997 will not apply to disregard each capital gain made by the non-resident beneficiary under subsection 115-215(3) ITAA 1997 in relation to a capital gain made by the trustee of Z's Trust from the sale of the X Shares.

Further, for the reasons outlined above, each capital gain made by the non-resident beneficiary under subsection 115-215(3) ITAA 1997 in relation to a capital gain made by the trustee of Z's Trust from the sale of the X Shares will not be disregarded under section 855-10 ITAA 1997.

Application of the Convention between Australia and Country U (Country U DTA)

In determining liability to Australian tax on capital gains received by a non-resident, it is necessary to consider not only Australian income tax laws but any applicable double tax agreement (DTA).

The relevant Articles of the Country U DTA allow Australia to tax the capital gain under its domestic law. Therefore the DTA will not prevent the distribution from being taxed in Australia.

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