Edited version of private advice

Authorisation Number: 1052056448358

Date of advice: 10 November 2022

Ruling

Subject: CGT - trusts - non-resident beneficiary

Question 1

Is the estate a fixed trust?

Answer

Yes. For the purposes of section 272-65 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) and section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997), the estate is a fixed trust.

Question 2

Can a capital gain, to which the non-resident remainder beneficiary is presently entitled, be disregarded if the gain is not on taxable Australian real property?

Answer

Yes, a capital gain that is not on taxable Australian real property can be disregarded by the non-resident remainder beneficiary.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The settlor established the trust in 19XX and appointed their child A and spouse R each with a 50% share of the trust income during their lifetime.

The settlor passed away in 19XX. R passed away in 19XX with their 50% share of income reverting to the surviving life tenant A, under the relevant clause of the trust deed.

A passed away in March 20XX, with probate in their estate granted in July 20XX.

Under the trust deed, clause X nominates the living children of A as residuary beneficiaries in equal shares on A's death, provided they reach 21 years of age.

A's four children - AA, AB, AC and AD - have all satisfied the 21 years of age requirement and are each presently entitled to one quarter of the income and corpus of the trust residue. This includes an E5 capital gain upon vesting date in March 20XX.

All of A's children are Australian residents for tax purposes with the exception of AC, who is a resident of a country other than Australia.

The assets of the trust consist of listed equities on the ASX, and unlisted managed funds.

The remainder beneficiaries have a fixed and vested interest in the income and capital of the trust estate. They each have a present right to future enjoyment of their equal share in the income and capital. There is no condition in the will by which any of the remainder beneficiaries could forfeit their interest in the estate.

The non-resident remainder beneficiary is presently entitled to capital gains after the death of the surviving life tenant.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1936 section 98A

Income Tax Assessment Act 1936 subsection 98(2A)

Income Tax Assessment Act 1936 section 98A

Income Tax Assessment Act 1997 section 104-75

Income Tax Assessment Act 1997 section 855-10

Income Tax Assessment Act 1997 section 855-15

Income Tax Assessment Act 1997 section 855-20

Income Tax Assessment Act 1997 section 855-40

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

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

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

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

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Fixed trusts

Section 272-65 of Schedule 2F to the 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. Section 995-1 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.

Vested and indefeasible interests

The term 'vested and indefeasible' is not defined in taxation legislation. However, Practical Compliance Guideline PCG 2016/16 Fixed entitlements and fixed trusts explains at paragraphs 13 and 15:

13. In terms of the concept of 'fixed entitlement', an interest is 'vested' if it is vested in interest or vested in possession. An interest is vested in possession when it gives its holder a right of present enjoyment, whereas an interest is vested in interest if it gives its holder a present right to future enjoyment.

15. An interest is defeasible if it can be defeated by the actions of one or more persons or by the occurrence of one or more subsequent events.

The Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 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 Income tax: Trust losses - fixed entitlement - beneficiaries of a deceased estate 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. ATO ID 2006/279 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 (and Codicil of the Will), by which any of the residuary beneficiaries could lose their interest in the estate.

Application to your circumstances

In relation to the income and capital of the estate:

•         The beneficiaries entitled are the children of the deceased life tenant

•         The beneficiaries are ready to take possession of their interest in possession after the death of the life tenant

•         No contingencies exist.

At the time the life tenant passed away, the residual beneficiaries had all attained the age of 21.

In this case, there are no conditions subsequent or any indication that anything external to the will that would have the effect of a condition subsequent in relation to the income and capital of the estate, by which the beneficiary could lose their interests in the estate.

Therefore, the remainder beneficiaries have a vested and indefeasible interest in the income and capital of the estate.

As the interest of the remainder beneficiaries in the income and capital of the estate is vested and indefeasible, fixed entitlement exists in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936. Therefore, the estate is a fixed trust under section 272-65 of Schedule 2F to the ITAA 1936 and section 995-1 of the ITAA 1997.

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.

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; and the gain is attributable to a CGT event happening to a CGT asset of a trust that is the fixed trust (paragraph 855-40(2)(a) and subparagraph 855-40(2)(b)(i) of the ITAA 1997); 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) of the ITAA 1997)

In this case, the relevant conditions in subsection 855-40(2) of the ITAA 1997 are satisfied in respect of the interests of the non-resident beneficiary in the estate. The non-resident beneficiary is a non-resident for tax purposes; the estate is a fixed trust at the time of the CGT event; and the assets of the estate are not taxable Australian property for the purposes of Division 855 of the ITAA 1997.

Therefore, the non-resident remainder beneficiary can disregard a capital gain that is not on taxable Australian real property.

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