Edited version of private advice

Authorisation Number: 1051972233178

Date of advice: 24 June 2022

Ruling

Subject: CGT - implications for trustees on vesting of a testamentary trust

Question 1

Given the facts described in this case, does section 118-210 of the Income Tax Assessment Act (ITAA 1997) apply such that the trustees did not make a capital gain from CGT event A1, or from another CGT event?

Answer

No.

Question 2

If section 118-210 of the ITAA 1997 does not apply to the trustees, are the trustees and beneficiaries subject to capital gains tax?

Answer

Yes.

Question 3

If section 118-210(3) of the ITAA 1997 applies to the trustees in the present case, upon the distribution of the proceeds of the trust to the beneficiaries, are the beneficiaries liable to capital gains tax in respect of that distribution made to them by the trustees, and if so, to what extent?

Answer

No.

Question 4

If Section 118-210 of the ITAA 1997 does not apply to the trustees in this case, is it the case that the trustees are taken to have acquired the property as remainder owners whilst the life tenant acquired an ownership interest in the property from the time of its purchase until her death, in accordance with Section 118-130 ITAA 1997?

Answer

No.

Question 5

If CGT event A1 applies to the trustees upon the sale of the property and they held the legal title as remainder owners concurrently with the life tenant holding the equitable title, do the trustees have two cost bases, namely of the reversionary interest at the date of their purchase of the property as trustees under the management trust deed, and of the full legal and equitable interest on the date of the death of the life tenant?

Answer

No.

Question 6

Section 128-20(1)(d) does not apply to the trustees in this case, having entered into the management trust deed on XX November 1995.

Answer

No.

This ruling applies for the following period:

30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

ABC died on XX May 19XX.

In accordance with the terms of his will, one quarter of the residue of his estate was held in trust for his niece, XYZ ("ABC Trust").

By late 1995 all the individual trustees of the ABC Trust died or retired leaving DEF Ltd as sole trustee.

By deed dated XX November 19XX, the sole remaining trustee of the ABC Trust retired, appointing 2 individuals as trustees of the trust ("retirement deed").

The retirement deed describes, in Recital H, that the only active asset remaining in respect of the Estate of the deceased ABC is one quarter of the net residue, namely $XX,000 invested in a mortgage fund and $XX,000 in a cash management fund (see Schedule of the retirement deed).

On the same day, following their appointment as trustees, Mr AA and Mr BB entered into a deed ("management trust deed") with XYZ, therein described as The Life Tenant, and her four children, therein described as The Beneficiaries.

In accordance with the provisions of the management trust deed, the trustees purchased the residential property using all the remaining ABC Trust funds.

As the Life Tenant, XYZ paid all the rates and taxes levied on the property, as well as all repairs and maintenance costs in relation to the property.

XYZ resided in the property, as her principal residence until her death on XX March 20XX. One of her children resided in the property, with her mother XYZ, until the sale of the property was effected by the trustees.

The trust vested on the date of XYZ's death being XX March 20XX.

The trustees sold the property by a contract dated XX December 202X, the sale price being $XXX,000.

Relevant legislative provisions

Section 118-210 Income Tax Assessment Act 1997 (ITAA97)

Section 118-130 ITAA97

Section 128-80(1)(d) ITAA97

Section 128-20(1)(d) ITAA97

Reasons for decision

All legislation refers to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise cited.

Question 1

Summary

Given the facts described in the case, Section 118-210 does not apply to the capital gain from CGT event A1 (or any other CGT event).

Detailed reasoning

Section 118-210 is a provision that relates to when a trustee is considered to have acquired a dwelling under a will. This section applies if you are the trustee of a deceased estate and, under the deceased's will, you acquire an ownership interest in a dwelling for occupation by an individual.

We consider that you have not satisfied this provision because the dwelling was not acquired specifically 'under the terms of the will'. The new trustees have made the decision to buy the property and make XYZ the life tenant. The terms of ABC's will were not considered to be in accord with the decision of the new trustees to purchase the property. In your case, the purchase by the trustee happened some XX years after the original will was written. ATO Interpretative Decision 2003/109 gives guidance on this point, that is, we cannot speculate or guess after the intention set out in the will.

It says,

'An individual would be considered to occupy a dwelling under the deceased's will if it was in accordance with the terms of the will. This would also be the case if it was in pursuance of the will or under the authority of the will (see Evans v. Friemann (1981) 53 FLR 229 at 238).

In this case, the beneficiary had no right under the will to reside in the house. The beneficiary resided in the house because the executors and other beneficiaries so agreed.

This outcome is consistent with the general rule of construction that the intent of the deceased must be ascertained from the words of the will and that one cannot speculate or guess after that intention. (see Certoma, GL 1987, The Law of Succession in New South Wales, The Law Book Company, Sydney, p. 117.)'

[emphasis added]

The Commissioner does not consider that the trustees have acquired the dwelling in question under the will.

Question 2

Summary

Section 118-210 does not apply to the trustees and the trustees are subject to capital gains tax.

Detailed reasoning

As outlined in the previous question, the Commissioner does not consider that the trustees have acquired the dwelling under the will and Section 118-210 does not apply. CGT event A1 in section 104-10 happened when the trustee of the testamentary trust disposed of the interest in the dwelling in favour of the residual beneficiaries under the trustee's power of sale.

Section 118-195 sets out the circumstances in which a full main residence exemption is available to an individual beneficiary or a trustee of a deceased estate. To determine if the trustee's capital gain qualifies for the exemption in section 118-195, both the meaning of 'trustee of a deceased estate' and the requirements set out in item 2(c) of the table in subsection 118-195(1) must be considered.

Meaning of 'trustee of a deceased estate'

The words 'trustee of a deceased estate' as used in section 118-195 are not limited to a legal personal representative but include the trustee of a testamentary trust.

This view is supported by comments made in the Explanatory Memorandum to the Taxation Laws Amendment Bill 1990 which introduced changes to section 160ZZQ of the Income Tax Assessment Act 1936 (ITAA 1936) to provide an exemption for the period a dwelling was occupied by an individual under the terms of the deceased's will. The Explanatory Memorandum provided:

The amendments are being made to allow the sole or principal residence exemption to apply to the dwelling of a deceased person for any period since the date of the deceased person's death during which the dwelling had been the sole or principal residence of the spouse of the deceased person or of a person who had the right to occupy the dwelling (life tenant) under the terms of the deceased person's will. At present no account is taken of the time during which a dwelling owned by a trustee of a deceased person's estate was the sole or principal residence of a life tenant.

As a life tenancy would only arise after administration of an estate has been completed, the phrase 'trustee of a deceased estate' in section 118-195 of the ITAA 1997 must be interpreted as including the trustee of a testamentary trust to give effect to the intended policy.

Main residence requirements in the table in subsection 118-195(1) of the ITAA 1997

Item 2 in the table in subsection 118-195(1) provides that where the deceased owned the interest before 20 September 1985 an exemption is available if the dwelling was from the deceased's death until the ownership interest ends, the main residence of one or more of:

Item 1 - the ownership interest ends within two years of the deceased's death, or within a longer period allowed by the Commissioner, or

Item 2 - the dwelling was from the deceased's death until the ownership interest ends, the main residence of one or more of:

(a) the spouse of the deceased immediately before the death (except a spouse who was living permanently separately and apart from the deceased); or

(b) an individual who had a right to occupy the dwelling under the deceased's will; or

(c) if the CGT event was brought about by the individual to whom the ownership interest passed as a beneficiary - that individual.

In this case, the issue is the proper construction of item 2(c).

In rewriting the former section 160ZZQ of the ITAA 1936, section 118-195 of the ITAA 1997 combined exemptions for beneficiaries and trustees that had previously been dealt with in separate provisions. In particular, section 118-195 of the ITAA 1997 rewrote subsection 160ZZQ(15) and introduced item 2 (c) in the table. No exemption previously existed for a trustee in respect of a period that the dwelling was the sole or principal residence of a beneficiary. It is clear from the wording of the legislation that the changes were only intended to determine the beneficiary's eligibility for the main residence exemption.

In this context and having regard to section 1-3 of the ITAA 1997, item 2(c) in the table in subsection 118-195(1) of the ITAA 1997 only applies to a CGT event which happens to an individual to whom the ownership interest 'passed' as a beneficiary, within the meaning of section 128-20. For example, if the beneficiary brings about the sale of the interest in the dwelling which has passed to them. A trustee would have no need to apply item 2(c) to a capital gain or loss that arises in respect of an ownership interest which passes to a beneficiary because it would be disregarded under Division 128 of the ITAA 1997, irrespective of who occupied the dwelling as their main residence from the date of the deceased's death.

In any case, item 2(c) cannot apply to a trust capital gain, where the relevant ownership interest did not 'pass' to the individual as a beneficiary, but as a purchaser (see 128-20(2)). The transfer of this interest was also not 'brought about' by that individual, but rather by the trustee and the other beneficiaries by agreement.

For these reasons, the capital gain made by the trustee on the sale of the interest in the dwelling to the beneficiary is not disregarded.

Question 3

Summary

As Section 118-210(3) does not apply to the trustees in the present case, upon the distribution of the proceeds of the trust to the beneficiaries, the beneficiaries are liable to capital gains tax in respect of that distribution made to them by the trustees.

Detailed reasoning

As stated above, we do not consider that the dwelling was acquired under the will of ELA. Section 118-210(3) does not apply. The trustee is required to calculate and pay the capital gains tax on the sale of the property in the relevant tax year. They will be required to report this in the trust tax return in the prescribed way. Generally, the net income of a trust is taxed in the hands of the Australian resident beneficiaries (or the trustee on their behalf) based on their share of the trust's income (that is, the share they are 'presently entitled' to). The beneficiaries of the proceeds will report their distributions in their personal income tax returns.

Question 4

Summary

Section 118-210 does not apply to the trustees in this case and the trustees are not taken to have acquired the property as remainder owners whilst the life tenant acquired an ownership interest in the property from the time of its purchase until her death, in accordance with Section 118-130.

Detailed reasoning

Section 118-210 does not apply to the trustees in this case. We do not consider that XYZ acquired an ownership interest in the property from the time of its purchase until her death in accordance with Section 118-130 ITAA 1997.

In Taxation Ruling TR2005/D14 Income tax: capital gains tax: consequences of creating, and dealing in, life and remainder interests in property at paragraph 28, it relevantly states,

Mere right of occupancy

A right to reside in property for life (or a term of years) is not equivalent to a legal or equitable life interest. CGT event D1 in section 104-35 of the ITAA 1997 happens when such a right is granted.

In the Management Trust Deed executed by all parties 27 November 19XX at item 8, it is acknowledged that XYZ will no longer receive funds from the trust but will occupy the property in lieu of interest income from the trust. We consider that the interest that XYZ had in the property was in the nature of the right to occupy only. She did not have an ownership interest in the property and as such, the main residence exemption is not able to be applied to the sale of the property. That is, there is a capital gains tax liability on the sale.

There would also likely have been a D1 and C2 on the granting and cancellation of the right, however as there were no funds exchanged there should not be any implications in this regard.

Question 5

Summary

Event A1 applies to the trustees upon the sale of the property and they did not hold the legal title as remainder owners concurrently with the life tenant holding the equitable title. The trustees do not have two cost bases, namely of the reversionary interest at the date of their purchase of the property as trustees under the management trust deed, and of the full legal and equitable interest on the date of the death of the life tenant.

Detailed reasoning

We do not consider (for the reasons outlined above), that the property was held concurrently with XYZ and the trustees. XYZ only had a right to occupy the property and not an ownership interest. Under normal CGT rules, there will be only one cost base for the A1 CGT event, which is the original purchase price of the property in November 19XX. Capital proceeds will be the amount you received when you sold the property in 20XX.

Section 100-45 ITAA 97 sets out how to calculate the capital gain or loss for most CGT events.

Question 6

Summary

Does Section 128-20(1)(d) apply to the trustees in this case, having entered into the management trust deed on XX November 199X?

Detailed reasoning

Section 128-20(1)(d) sets out when an asset passes to a beneficiary, in particular when the asset passes under a Deed of Arrangement. It states,

'(1) A * CGT asset passesto a beneficiary in your estate if the beneficiary becomes the owner of the asset:

...

(d) under a deed of arrangement if:

(i) the beneficiary entered into the deed to settle a claim to participate in the distribution of your estate; and

(ii) any consideration given by the beneficiary for the asset consisted only of the variation or waiver of a claim to one or more other • CGT assets that formed part of your estate. ...'

In Taxation Determination TD 2004/3, it states at paragraph 1 that 'an asset will 'pass' to the beneficiary of a deceased estate when the beneficiary becomes absolutely entitled to the asset as against the estate's trustee.' MEW's entitlement under the Evelyn Trust was income/ revenue and not capital in nature. That is, she was not entitled to the capital of the trust before or after the Deed of Arrangement. The trust vested on her death and the asset of the trust (the Katoomba property) was sold and the proceeds will be distributed to her children under the terms of the will.

The capital gain from the CGT event happening is not disregarded under Division 128 of the ITAA 1997 as the asset in question (the XXXX property) did not pass to the beneficiary under the deceased's will in the ways set out in Section 128-20. The Deed of Arrangement signed in November 19XX also does not confer any rights to capital of the estate to MEW. The right to occupy the XXXX property was taken in lieu of any interest income on the corpus of the estate that she was entitled to.

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