Edited version of private advice

Authorisation Number: 1051821929236

Date of advice: 30 March 2021

Ruling

Subject: CGT trust vesting

Question 1

Will the Capital Beneficiaries be liable for any capital gains tax under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997) when the Trust Assets of the Trust are transferred to the Capital Beneficiaries?

Answer

No.

Question 2

Will the first element of the cost base of the Trust Assets to be transferred to the Capital Beneficiaries equal the market value of the Trust Assets as at the date of their transfer to the Capital Beneficiaries, pursuant to subsection 110-25(2) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Trust is a discretionary trust, established for estate planning and succession purposes.

The Trust is in the business of farming.

According to the Trust Deed of the Trust (the Trust Deed):

•         "Capital Beneficiaries" mean Mr A and Mrs B, their children and the children's spouses, and grandchildren and their grandchildren's spouses.

•         "Income Beneficiaries" includes, but is not limited to, the Capital Beneficiaries.

•         "Trust Fund" is defined to mean "the said settled sum all moneys investments and property paid or transferred to and accepted by the Trustees as additions to the Trust Fund the accumulations of income hereinafter directed or empowered to be made all accretions and additions to the Trust Fund from whatsoever source and the investments and property from time to time representing the said money investments property accumulations accretions and additions or any part or parts thereof respectively".

•         "the Vesting Day" means the first to occur of the following dates -

(a)  the day specified in the Schedule as the Vesting Day, or

(b)  such date being earlier than the day so specified as the Trustees may in their absolute discretion appoint.

•         The perpetuity period applicable to the dispositions effected by the Trust Deed under the Rule against Perpetuities shall be the period described in the Schedule, being eighty years.

•         The Trustees stand possessed of the Trust Fund and of the income thereof upon the Trusts, and with and subject to the powers and provisions expressed in the Trust Deed.

•         As from the Vesting Day the Trustees shall stand possessed of the Trust Fund and the income thereof as to several assets (the Trust Assets) listed in the Trust Deed. The Trust Assets include properties, farming plant and equipment and livestock, and any public company shares.

•         The Trustees may in their absolute discretion and before the Vesting Day transfer the whole or any part of the Trust Fund, or out of the capital of the Trust Fund, to any Capital Beneficiary, or lend any sum to any beneficiary.

•         The Trustees may in their absolute discretion and at any time pay, or apply to or for the benefit of, any beneficiary the whole or any part of the capital or income to which they are either absolutely or contingently entitled (notwithstanding that their interest is liable to be defeated by the exercise of any power of appointment or revocation or to be diminished by the increase of the class to which they belong) in such manner and subject to such terms and conditions as they think fit.

•         In relation to property, the Trustees have the power to hold, use, purchase, construct, demolish, maintain, repair, renovate, reconstruct, develop, improve, sell, transfer, convey, surrender or lease it.

•         The Trustees shall have power at their absolute discretion to sell, transfer, hire, lease or dispose of any real or personal property of the Trust Fund.

•         Subject to any express provision of the Trust Deed to the contrary, every discretion vested in the Trustees shall be absolute and uncontrolled, and every power vested in them shall be exercisable at their absolute and uncontrolled discretion.

•         The Trustees may at any time and from time to time by deed revoke, add to or vary all or any of the Trusts, or the Trusts provided by any variation, alteration or addition made, and may by the same or any other deeds declare any new or other Trusts, powers concerning the Trust Fund or any part thereof, so long as any law against perpetuities is not infringed. Further, any such new or other Trust powers, discretions, alterations or variations may relate to the management or control of the Trust Fund, or the investments, and may be for the benefit of all or any Capital Beneficiary but shall not result in any capital or income benefit passing to any person other than a Capital Beneficiary or Income Beneficiary respectively, and shall not affect the beneficial entitlement to any amount set aside for any beneficiary prior to the date of the variation, alteration or addition.

Several Deeds of Variation have been executed by the Trustees. Some have had the effect of varying the subclauses in clause X of the Trust Deed (i.e. the list of Trust Assets and the identity of the Capital Beneficiaries in respect of whom those Trust Assets are held in trust as from the Vesting Day). Under each of the variations clause X continued to read "[a]s from the Vesting Day the Trustee shall stand possessed of the Trust Fund and the income thereof -".

None of the variations to the Trust Deed resulted in a resettlement of the Trust.

According to the Trust Deed the Trust vests eighty years from the date of the Trust Deed or on any earlier day specified by the Trustees in their absolute discretion.

As from the Vesting Day the Trustees shall stand possessed of the Trust Fund in accordance with the terms of the Trust Deed and the Deed of Variation executed on XX XX XX (being the most recent variation).

The Trustees will then transfer the Trust Assets (which includes property) in accordance with clause X of the Trust Deed, as amended under the most recent variation, to the relevant Capital Beneficiaries, identified in the most recent variation as being the children of Mr A and Mrs B.

The Trustees have in their absolute discretion specified that the Vesting Day for the Trust will be 30 June 20XX (the vesting date) and the transfer of Trust Assets to the Capital Beneficiaries will be as at the vesting date, and not prior to the vesting date.

Assumption

None of the Capital Beneficiaries have or will acquire their interest in a Trust Asset for expenditure.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 section 104-75

Income Tax Assessment Act 1997 section 104-85

Income Tax Assessment Act 1997 subsection 104-85(2)

Income Tax Assessment Act 1997 subsection 104-85(3)

Income Tax Assessment Act 1997 subsection 104-85(5)

Income Tax Assessment Act 1997 paragraph 104-85(6)(a)

Income Tax Assessment Act 1997 section 106-50

Income Tax Assessment Act 1997 subsection 110-25(2)

Income Tax Assessment Act 1997 section 112-15

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 subsection 112-20(1)

Income Tax Assessment Act 1997 paragraph 112-20(1)(a)

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Division 128

Reasons for Decision

Question 1

Summary

Any capital gain the Capital Beneficiaries make upon the transfer of Trust Assets to them by the Trustee on the vesting date will be disregarded pursuant to paragraph 104-85(6)(a) of the ITAA 1997 because the Capital Beneficiaries will acquire their interest in those Trust Assets (representing capital of the Trust) for no expenditure.

Detailed reasoning

Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens. All CGT assets acquired since the CGT regime started on 20 September 1985 are subject to CGT unless specifically excluded. The Trust Assets and interests in the Trust are CGT assets.

Section 104-10 of the ITAA 1997 describes the most common CGT event, being CGT event A1. A CGT event A1 happens if there is a disposal of a CGT asset.

Under section 104-85 of the ITAA 1997 a CGT event E7 happens if the trustee of a trust (other than a unit trust or a trust to which Division 128 of the ITAA 1997 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest (or part of it) in the trust capital. The timing of the event is when the disposal occurs (subsection 104-85(2)).

Both CGT event A1 and CGT event E7 will happen if the transfer of legal ownership of the Trust Assets to the Capital Beneficiaries is treated as a disposal for CGT purposes. CGT event A1 is a general provision about disposals but CGT event E7 is a specific provision relating to a form of disposal from a trust to a beneficiary. CGT event E7 is more specific to this situation.

Subsection 104-10(2) defines a disposal as:

You dispose of a *CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

When considering the disposal of a CGT asset (or an interest therein) it must be determined who the legal and/or beneficial owner of the CGT asset is. It is possible for legal ownership to differ from beneficial ownership. In this case, the Trustees (as trustees for the Trust) are the legal owner of the Trust Assets.

Generally, where there is a transfer in the legal ownership of a CGT asset, a CGT event occurs. However, there is an exception to this outcome where the legal owner (being a trustee) is holding the asset on trust for a beneficiary who is absolutely entitled to the asset as against the trustee and the legal ownership of the asset is transferred to that beneficiary. The exception applies because the absolutely entitled beneficiary is already considered to be the owner of the asset for capital gains purposes by section 106-50 of the ITAA 1997.

Section 106-50 of the ITAA 1997 and CGT event E5 in section 104-75 of the ITAA 1997 are the main provisions to which the concept of absolute entitlement is relevant. These provisions apply if a beneficiary is (or becomes) absolutely entitled to a CGT asset of the trust as against the trustee (disregarding any legal disability).

These provisions apply separately to each beneficiary and asset of the trust. They require absolute entitlement to the whole of a CGT asset of the trust.

Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (Draft TR 2004/D25) discusses the concept of 'absolute entitlement' and states, at paragraph 10, that:

The core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction ...

Draft TR 2004/D25 also provides at paragraphs 23 to 25:

More than one beneficiary with interests in a trust asset

23. If there is more than one beneficiary with interests in the trust asset, then it will usually not be possible for any one beneficiary to call for the asset to be transferred to them or to be transferred at their direction. This is because their entitlement is not to the entire asset.

24. There is, however, a particular circumstance where such a beneficiary can be considered absolutely entitled to a specific number of the trust assets for CGT purposes. This circumstance is where:

•         the assets are fungible;

•         the beneficiary is entitled against the trustee to have their interest in those assets satisfied by a distribution or allocation in their favour of a specific number of them; and

•         there is a very clear understanding on the part of all the relevant parties that the beneficiary is entitled, to the exclusion of the other beneficiaries, to that specific number of the trust's assets.

25. Because the assets are fungible, it does not matter that the beneficiaries cannot point to particular assets as belonging to them. It is sufficient in these circumstances that they can point to a specific number of assets as belonging to them...

Land is rarely fungible because each parcel of land is unique (paragraph 94 of draft TR 2004/D25). Real estate is traded based on the actual sale price, not the sale price per unit. Unlike fungible commodities, parcels of real estate do not have equal value.

Taxation Ruling TR 2018/6: Income tax: trust vesting - consequences of a trust vesting (TR 2018/6) explains the Commissioner's views about the immediate income tax consequences of a trust vesting.

TR 2018/6 states at paragraphs 2 and 3:

2. While the trust deed may or may not specify how the trust is to be administered post vesting, when a trust vests, all of the interests in the trust as to income and capital become vested in interest and possession.

3. The income tax consequences that arise on, and after, the vesting of a trust depend on the terms of the deed. Vesting of itself may, but need not, cause a CGT event to happen.

Generally when a discretionary trust vests, the trustee no longer has any discretionary power to appoint the income or capital of the trust, but rather it holds the trust property for the absolute benefit of those beneficiaries specified as the takers on vesting (paragraph 12 of TR 2018/6).

However, whether or not a CGT event happens on vesting requires consideration of the trust deed, including consideration of the effect of vesting on the beneficial interests in the trust, and the nature of the property held on trust (paragraph 12 of TR 2018/6).

Application to your circumstances

As objects of a discretionary trust, the Capital Beneficiaries do not have an interest in any part of the Trust Fund (including the Trust Assets) and cannot be absolutely entitled to any of the Trust Assets prior to the exercise of a discretion in their favour by the Trustees.

The Trustees in their absolute discretion will determine the Vesting Day for the Trust to be

30 June 20XX, and on that vesting date the Trustees will transfer the Trust Assets (which form part of the Trust Fund) to particular Capital Beneficiaries in accordance with the terms of clause X of the Trust Deed, as amended under the most recent Deed of Variation.

The Capital Beneficiaries will not be considered absolutely entitled to any of the Trust Assets on the vesting date and prior to the transfer of those Trust Assets as the Trustees will continue to have discretionary power to appoint the income or capital of the Trust (as evidenced by a number of clauses of the Trust Deed), and will therefore not hold the Trust Assets for the absolute benefit of the Capital Beneficiaries (i.e. the interests of the Capital Beneficiaries will remain defeasible).

If the Trustees were to cease to have any discretionary power to appoint the income or capital of the Trust on the vesting date (not considered to be the case) then, outside of the limited circumstances contemplated by paragraph 24 of Draft TR 2004/D25, absolute entitlement to Trust assets would nevertheless not materialise in circumstances where more than one of the Capital Beneficiaries have an interest in a Trust Asset.

As the Capital Beneficiaries will not be absolutely entitled to the Trust Assets as against the Trustees on the vesting date and prior to their transfer, CGT event E7 will happen when the Trustees transfer the legal title of those Trust Assets to the Capital Beneficiaries in satisfaction of their respective interests in those assets.

As a consequence, the Trustee will make a capital gain if the market value of the Trust Asset (at the time of the disposal) is more than its cost base, or a capital loss if that market value is less than the asset's reduced cost base (subsection 104-85(3) of the ITAA 1997).

Each Capital Beneficiary will make a capital gain if the market value of the Trust Asset (at the time of the disposal) is more than the cost base of the interest, or the part of it, being satisfied, or a capital loss if that market value is less than the interest's reduced cost base (subsection 104-85(5) of the ITAA 1997).

However, any capital gain or capital loss made by a Capital Beneficiary under

subsection 104-85(5) will be disregarded pursuant to paragraph 104-85(6)(a) of the ITAA 1997 as the Capital Beneficiary acquired their interest in the Trust Asset for no expenditure.

Question 2

Summary

The market value substitution rule in section 112-20 of the ITAA 1997 will apply to determine the first element of the cost base of the Trust Assets immediately following their transfer to the Capital Beneficiaries.

Detailed reasoning

Under subsection 110-25(2) of the ITAA 1997, the first element of the cost base of a CGT asset is the total of the money a taxpayer paid, or is required to pay, in respect of acquiring the CGT asset, and the market value of property the taxpayer gave, or is required to give, in respect of acquiring it (worked out at the time of the acquisition).

However, under section 112-15 of the ITAA 1997, if a cost base modification replaces an element of the cost base of a CGT asset with an amount, Parts 3-1 and 3-3 of the ITAA 1997 apply as if the amount that had been paid for the asset was the substituted value.

Subsection 112-20(1) of the ITAA 1997 states:

The first element of your *cost base and *reduced cost base of a *CGT asset you *acquire from another entity is its *market value (at the time of acquisition) if:

(a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from:

(i) *CGT event D1 happening; or

(ii) another entity doing something that did not constitute a CGT event happening; or

(b) some or all of the expenditure you incurred to acquire it cannot be valued; or

(c) you did not deal at *arm's length with the other entity in connection with the acquisition.

The expenditure can include giving property: see section 103-5.

The acquisition time that a taxpayer acquires a CGT asset as a result of CGT event E7 happening is when the trustee disposes of a CGT asset to the beneficiary. This will be on the date the Trust Assets are transferred to the Capital Beneficiaries.

As the Capital Beneficiaries will not incur any expenditure to acquire the Trust Assets, the first element of the cost base (and reduced cost base) of those Trust Assets will be their market value at the time of acquisition by the Capital Beneficiaries (paragraph 112-20(1)(a) of the ITAA 1997).

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