Edited version of private advice

Authorisation Number: 1051725594539

Date of advice: 28 July 2020

Ruling

Subject: Streaming a trust capital gain to a beneficiary

Question 1

Is the taxpayer permitted by the terms of the trust deed and Subdivision 115 of the Income Tax Assessment Act 1997 (ITAA 1997) to confer specific entitlement upon Individual A in respect of the capital gain referable to the sale of the Property?

Answer

Yes

Question 2

Does Individual A have a share of the amount of the capital gain to which they will be specifically entitled within paragraph 115-227(a) of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

1 July 20xx to 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Background

The taxpayer seeks a ruling on whether it would be permitted to stream the capital gain expected to be realised upon the sale of its interest in a property to Individual A during the 20xx income year under Sub-division 215 of the ITAA 1997.

Trustee for the trust

The taxpayer is a trust (Trust 1) established by a trust deed.

The trustee of the trust was Company A.

Company B was the subscriber of units (unit holder) upon the terms of the deed.

Company A is also the trustee of a second trust (Trust 2).

Company C was appointed as new trustee by deed. Company A was removed as trustee on the same time.

Company D was appointed as new trustee of Trust 1 by deed. Company C was removed as trustee on the same date.

Individual A was appointed sole director of Company D.

At all times, Company D engaged Individual A as an employee being a director and secretary for the company.

Company D made PAYG payments in respect of salary and wages paid to Individual A.

Company B voluntary deregistered.

Purchase of property

Company A executed a deed between itself in the capacity as trustee for Trust 2 of the one part and Trust 1 of the other part.

The two trusts agreed that Company A shall enter into a contract of sale to acquire the land and improvements known as the Property.

Company A then entered into the contract of sale for the Property between Company A as trustees for the two trusts as purchaser and Company E as the vendor.

Agreement 1 was entered into to facilitate funding for and development of the project. It outlines that:

·        Company A has entered in a contract of sale to purchase the Property as trustee for the two trusts.

·        A representative and authorised agent of Company F has agreed to loan an amount to Company A

·        Company A has undertaken to carry out the Project

·        Individual B agreed to be Project Manager of the Project and to provide the Guarantee for them self in favour of Company F.

Individual A is director of Company F. Individual A is the sole shareholder of Company F.

Agreement 2 was entered into to incorporate the earlier agreement and facilitate funding and development of the Project. It outlines that:

·        Company A in its capacity as trustee for Trust 2 requested Company F to lend Company A money for the purchase of the Property.

·        In consideration for Company F to lend money to Company A, Company A agreed to share with Company F the profit from the development from the Property.

·        The parties wish to record their agreement as to the terms upon which Company F has agreed to advance money to Company A.

At this time, essentially 2 parties drove this arrangement:

·        Individual A who controls Company F,

·        Individual B and their associates who controls the other entities (Company A and Company C).

However, Individual B and associated entities were not able to meet their obligations under the mortgages secured against the Property.

Individual A took steps to take over the Property from Individual B. This resulted in Agreement 3 which contained the following:

·        That this agreement shall prevail any previous agreements.

·        Company C as trustee for Trust 1 cede and hand over control and management of the Property to Company F.

·        Company A and Company C grant power of attorney to Company F and its authorised officers for the purpose of dealing with the Property.

·        Company C, Company A, Company B and Individual B agree from this date they have no entitlement to either any income or proceeds of sale of the Property.

Agreement 3 resulted in Individual A and their associated entity Company F indirectly controlling the Property held in Trust 1 by Company C, as the then trustee.

Trust deed clauses

The clauses of the trust deed determined who is beneficiary of Trust 1.

A class of beneficiary in the trust deed includes any person employed or previously employed by the Trustee.

The Trustee has general powers under the trust deed that extended to the Trustee having all the powers over and in respect to the Trust Fund and investments, dealing with real property and make determinations between capital and income.

The Trustee has the powers under the trust deed to determine, apply or otherwise deal with the income of the trust.

The Trust Deed does not specify the percentage entitlements of the classes of beneficiaries. The trustee is not bound by any specified percentages.

There are clauses in the trust deed that relates to the Trustee's power in respect to distributions of income generally.

As at the date of this application, there are no income unit holders, preference units or unit holders.

The Trust Deed allows the trustee for making of determinations (in its absolute discretion) which can include a payment or setting aside an amount for a beneficiary.

Pursuant to the trust deed, the beneficiary's entitlement to an amount of income is recorded in its character in the accounts/records of the trust.

The trustee has the right to remuneration for services.

The Trustee has unfettered power or discretion pursuant to the Trust Deed when the Trustee is entitled to exercise a power or discretion.

Proposed transaction

It is proposed that during the 20xx income year, the trustee for the Trust 1 will dispose of its interest in the Property by sale on the open market. The trustee will then distribute the capital gain to Individual A.

Relevant legislative provisions

Section 97 of the Income Tax Assessment Act 1936

Subsection 6-10(4) of the Income Tax Assessment Act 1997

Section 10-5 of the Income Tax Assessment Act 1997

Subsection 102-5(1) of the Income Tax Assessment Act 1997

Section 104-10 of the Income Tax Assessment Act 1997

Subsection 108-5(1) of the Income Tax Assessment Act 1997

Section 115-10 of the Income Tax Assessment Act 1997

Section 115-15 of the Income Tax Assessment Act 1997

Subsection 115-25(1) of the Income Tax Assessment Act 1997

Section 115-227 of the Income Tax Assessment Act 1997

Paragraph 115-227(a) of the Income Tax Assessment Act 1997

Section 115-228 of the Income Tax Assessment Act 1997

Section 115-215 of the Income Tax Assessment Act 1997

Paragraph 115-215(3)(b) of the Income Tax Assessment Act 1997

Section 115-225 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Summary

The taxpayer is permitted by the terms of the trust deed and Subdivision 115-C of the ITAA 1997 to confer specific entitlement upon Individual A in respect of the capital gain referable to the sale of the Property.

Company D, as the trustee, has the requisite powers in the trust deed to confer specific entitlement upon Individual A as a beneficiary. As Individual A is a beneficiary of the trust pursuant to the trust deed, Individual A would be specifically entitled under subsection 115-228(1) of the ITAA 1997 to an amount of a capital gain made by Trust 1 from the proposed sale of the property.

Detailed reasoning

To determine whether Individual A is a beneficiary of the trust and entitled to receive distributions of income and capital, the provisions of the trust deed must be considered.

The trustee is entitled to remuneration for services from the income or capital of the trust whether by way of periodical fee, salary or commission or otherwise pursuant to the trust deed.

The word beneficiary is defined in the trust deed to include any person employed or previously employed by the trustee.

In this case, Individual A has been employed by Company D as a director and derived salary and wages since the trustee was appointed as trustee for Trust 1.

Individual A is a beneficiary under the trust deed having been employed by the trustee and derived salary and wages since Company D was appointed trustee for Trust 1.

In addition, the trustee will exercise its powers to confirm Individual A's entitlement.

Subdivision 115-C of the ITAA 1997 sets out the rules for calculating a beneficiary's net capital gain if they are entitled to a distribution from a trust that includes a net capital gain. In this case, when the property is sold, the trustee for the trust will make a capital gain.

Section 115-228 of the ITAA 1997sets out the requirements for distributing or streaming a capital gain to a particular beneficiary. For streaming to be effective for tax purposes, the beneficiary must be specifically entitled to all or part of the capital gain.

A beneficiary is specifically entitled to a capital gain if the following two conditions are satisfied:

·        The first condition for a beneficiary to be specifically entitled to a capital gain is that the beneficiary receives, or is reasonably expected to receive, an amount equal to their share of the net financial benefit that is referable to the capital gain (paragraphs (a) and (b) of subsection 115-228(1) of the ITAA 1997). A beneficiary's entitlement can be expressed as a dollar amount, a share of the trust gain or distribution, or using a known formula provided it refers to the capital gain.

·        The second condition for a beneficiary to have a specific entitlement to a capital gain is that the beneficiary's entitlement to the amount is recorded in its character as referable to the capital gain (paragraph 115-228 (1)(c) of the ITAA 1997). This record must be contained in the accounts or records of the trust, such as the trust deed, trust accounts, resolutions and distribution statements, including schedules and notes attached to, or intended to be read with, these documents. A record for tax purposes only does not create specific entitlement.

A resolution to distribute a specified amount of trust income, a percentage of the trust income or the balance of the trust income does not create a specific entitlement if there is no reference to a capital gain. However, if the capital gain is clearly referred to in another document, such as the trust accounts, the recording requirement may be satisfied.

When a beneficiary is specifically entitled to a capital gain, the beneficiary is assessed on the capital gain, with all the associated tax consequences in respect of that distribution applying.

The trustee for the trust proposes to sell the property during the 20xx income year which will result in a capital gain being made as a result of the disposal. Clauses in the trust deed permits the trustee to distribute to Individual A as a beneficiary as determined in the trust deed as an employee of the trustee. In addition, the clauses in the trust deed gives the trustee powers to determine proportions and to exclude certain beneficiaries.

The trust deed does not specify the percentage entitlements of the classes of beneficiaries in the trust deed. As the trustee is not bound by any specified percentages, the trustee's discretion in the trust deed takes effect so that the trustee is given the power to distribute, apply or otherwise deal with the income of the trust under clause xx.xx in its absolute discretion.

It is proposed all of the proceeds which includes all of the capital gain made by the Trust, will be distributed to Individual A. Entitlement to the capital gain will be recorded in its character in the accounts of the Trust. It will be recorded by the trustee declaration within 2 months after the end of the income year. The trust declaration of distribution for the 20xx income year is a statement of resolution, and therefore will satisfactorily meet the requirement of being recorded in records of the trust.

Conclusion

As the two conditions in subsection 115-228(1) of the ITAA 1997 are satisfied, Individual A will be specifically entitled to the capital gain made by the trustee. Individual A will have to show the capital gain in their income tax return.

Company D, as the trustee, has the requisite powers in the trust deed to confer specific entitlement upon Individual A as a beneficiary. As Individual A is a beneficiary of the trust pursuant to the clauses in the trust deed, Individual A would be specifically entitled under subsection 115-228(1) of the ITAA 1997 to a xx % share of the capital gain made by the Trust from the proposed sale of the property.

Question 2

Summary

Individual A will have a xx% share of the amount of the capital gain to which they will be specifically entitled under paragraph 115-227(a) of the ITAA 1997.

Individual A will receive a distribution of the capital gain referable to the gain made on the sale of the Property. Because the gain is a discounted capital gain in the trust, then upon distribution of the discounted capital gain, Individual A will be treated as having made a capital gain equal to twice the amount as per paragraph 115-215(3)(b) of the ITAA 1997.

Detailed reasoning

Assessable income of a resident taxpayer includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.

Subsection 6-10(4) of the ITAA 1997 provides that for an Australian resident, your assessable income includes statutory income derived from all sources, whether in or out of Australia, during the income year.

Section 10-5 of the ITAA 1997 lists certain statutory amounts that form part of assessable income. Included in this list is income derived pursuant to section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) and section 102 of the ITAA 1997.

Section 97 of the ITAA 1936 includes in a person's assessable income distributions of income made by a trust to the person as a beneficiary.

Based on the information provided, the trust proposes to dispose of the property. The proceeds as a result of the proposed disposal will represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions.

Capital gains tax

Under subsection 102-5(1) of the ITAA 1997, your assessable income includes your net capital gain (if any) for the income year. A net capital gain is worked out in accordance with the method statement set out in subsection 102-5(1).

A capital gain or loss arises when a CGT event occurs. The most common CGT event is A1, disposal of a CGT asset, which is outlined in section 104-10 of the ITAA 1997.

Generally, the time of the event is when the contract for the disposal is entered into. If there is no contract, the event occurs when the change of ownership takes place (section 104-10 of the ITAA 1997).

The term 'CGT asset' is defined in subsection 108-5(1) of the ITAA 1997 as:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

Application to the sale

In this case, the property is a CGT asset. It is proposed that during the 20xx income year, the taxpayer will dispose of its interest in the Property by sale on the open market. The proposed disposal of the property by the trust will cause CGT event A1 to occur. The time of the CGT event is the date when the contract to end the ownership of the asset is entered into.

Discount capital gain

Section 115-10 of the ITAA 1997 provides that to be a discount capital gain the capital gain must be made by an, individual, a complying superannuation fund, a trust or a life insurance company in relation to a CGT event in respect of particular CGT assets. A capital gain made from CGT event A1 meets the requirements of a discount capital gain under section 115-10 of the ITAA 1997.

A capital gain is only a discount capital gain if it results from a CGT asset that was acquired at least 12 months before the CGT event that gave rise to the gain under subsection 115-25(1) of the ITAA 1997.

In this case, the facts indicate the asset was acquired more than 12 months before the proposed CGT event A1 happens to the asset.

Accordingly, the trustee of trust is eligible to claim the 50% discount capital gain under section 115-15 of the ITAA 1997.

You advise that you do not intend to claim the small business reduction concession in Subdivision 152-C of the ITAA 1997 and hence paragraph 115-215(3)(b) of the ITAA 1997 applies to include double the capital gain (discounted at the trust level) in the assessable income of the beneficiary.

Subdivision 115-C

The rules in Subdivision 115-C of the ITAA 1997 will apply to treat the beneficiary as having made a capital gain to the extent the capital gain otherwise forms part the Trust's net capital gain calculated under subsection 102-5(1) of the ITAA 1997 and the Trust has a positive net income, grossed up for any relevant CGT discount applied by the Trust at step three of the method statement in subsection 102-5(1) and for any of the small business CGT concessions applied by the Trust at step four of the method statement in subsection 102-5(1). The beneficiary will then be entitled to apply any relevant discounts and concessions as are available to them to the capital gain they are taken to have made.

The manner in which Subdivision 115-C of the ITAA 1997 allocates a trust capital gain depends on whether, and the extent to which, a beneficiary is 'specifically entitled' to that capital gain. A beneficiary of a trust which is made 'specifically entitled' to a capital gain will be assessed on it.

Section 115-228 of the 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 section 115-225 of the 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 of the ITAA 1997) multiplied by the trust's net capital gain. Under section 115-227, a beneficiary's 'share of the capital gain' is any amount of the capital gain to which they are specifically entitled (paragraph 115-227(a)) plus their 'Division 6 percentage' share of any amount of the capital gain to which no beneficiary is specifically entitled (paragraph 115-227(b)).

In this case, subject to the Trustee's resolution, the beneficiary will be made specifically entitled (for the purposes of section 115-228 of the ITAA 1997) to the entire amount of capital gain made by the trustee from CGT event A1. That amount will be the beneficiary's share of the capital gain under section 115-227 of the ITAA 1997.

The beneficiary is not simply treated as then having made their share of the capital gain for the purpose of working out their own net capital gain or loss. The way in which the Trustee has worked out its own net capital gain affects the way in which the beneficiary calculates their capital gain.

Firstly, the rules in section 115-225 of the ITAA 1997 are applied to work out that part of the trust capital gain remaining after the Trustee has applied any capital losses or net capital losses to the capital gain and after applying any CGT discounts - subsection 115-225(1). That means, if the Trustee has applied its own capital losses or net capital losses in working out its net capital gain, this will be reflected in (and will reduce) the capital gain the beneficiary is taken to have made.

The result obtained following the application of section 115-225 of the ITAA 1997 is then doubled if the Trustee applied the 50% CGT discount in working out its own net capital gain: subsection 115-215(3) of the ITAA 1997. That is the amount treated as a capital gain of the beneficiary which is then taken into account (along with the beneficiary's other capital gains and losses) in working out the beneficiary's net capital gain or loss under section 102-5 of the ITAA 1997. In doing so, the beneficiary can apply their own capital losses and net capital losses and any relevant CGT discount.

Individual A will have a xx% share of the proposed amount of the capital gain to which he will be specifically entitled within paragraph 115-227(a) of the ITAA 1997.

Individual A will receive a distribution of the capital gain referable to the gain made on the proposed sale of the Property. Because the gain is a discounted capital gain in the trust, then upon distribution of the discounted capital gain, Individual A will be treated as having made a capital gain equal to twice the amount, as per paragraph 115-215(3)(b) of the ITAA 1997.

Conclusion

Individual A will have a xx% share of the amount of the capital gain to which he will be specifically entitled under paragraph 115-227(a) of the ITAA 1997.

Individual A will receive a xx% distribution of the capital gain referable to the gain made on the sale of the Property. Because the gain is a discounted capital gain in the trust, then upon distribution of the discounted capital gain, Individual A will be treated as having made a capital gain equal to twice the amount as per paragraph 115-215(3)(b) of the ITAA 1997.

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