Edited version of private advice

Authorisation Number: 1052223996610

Date of advice: 20 February 2024

Ruling

Subject:CGT - legal vs beneficial ownership

Question

Do the capital gains tax provisions contained in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the Trustee when the asset was sold?

Answer

No.

This ruling applies for the following period:

1 July 20xx to 30 June 20xx

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

The Trustee held legal title to the asset.

The Beneficiary contributed part of the funds to acquire the asset.

The Beneficiary was unable to obtain finance to fund the balance of the acquisition price.

The Trustee provided the balance of the funds for the beneficiary.

There was an agreement between the parties that although the Trustee held legal title to the asset and provided finance for the balance of the purchase price, the Beneficiary had full and unrestricted use of the asset and was entitled to the full proceeds when it was disposed of.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-55

Income Tax Assessment Act 1997 section 106-50

Income Tax Assessment Act 1997 section 108-5

Property Law Act 1958 (Vic) section 53

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless stated otherwise.

Summary

The capital gains tax provisions contained in Parts 3-1 and 3-3 do not apply to the Trustee when the asset was sold.

Detailed reasoning

Capital gains tax

Section 102-20 states that a capital gain or a capital loss is made only if a capital gains tax (CGT) event happens to a CGT asset.

A property is a CGT asset under section 108-5.

Under section 104-10 CGT event A1 happens if you dispose of a CGT asset.

An individual can be a legal owner but have no beneficial ownership in an asset. It is the beneficial owner that will have a CGT event upon sale of a CGT asset. In some cases, an entity may hold a legal ownership interest in property for another individual in trust.

When considering the disposal of your interest in a CGT asset, the most important element in the application of the CGT provisions is ownership. It must be determined who is the legal and/or beneficial owner of the property. It is possible for legal ownership to differ from beneficial ownership.

The CGT provisions do not apply to the legal owner of an asset if the legal owner held it on trust for another person and that other person was absolutely entitled to that asset as against the trustee.

In such a case, the transfer of the asset from the other person to the legal owner on trust for the other person is not a transfer of ownership for CGT purposes and no capital gain or capital loss will result. This is because the CGT provisions consider the beneficiary to be the asset's owner, not the legal owner.

Legal verses beneficial ownership

Legal interest in a property is determined by the legal title to the property under the property law legislation in the state or territory in which the property is situated.

In Australia, the principle of indefeasibility operates which is a process of title of real property by registration, by which a person holds title against the world. 'Indefeasible title' is subject to some exceptions, such as equitable rights against the person who holds such a title.

In certain situations, legal ownership of an asset may differ from beneficial ownership of an asset.

The legal term 'beneficial ownership' means the right to deal with property as one's own, free of any contractual obligation in respect of it. The person who enjoys the property or who is entitled to the benefit of the property would be considered to be the beneficial owner.

Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners contains guidance on the issues involved where the equitable interest in a property may not follow the legal title.

As stated in paragraph 41 of TR 93/32, the Commissioner considers that there are extremely limited circumstances where the equitable interests are not the same and that there is sufficient evidence to establish that equitable interest is different from the legal title. We will assume where taxpayers are related, for example, husband and wife, that the equitable right is the same as the legal title.

To prove that a different equitable interest exists, there must be evidence that a trust has been established, such that one party is taken merely to hold their interest in the property for the benefit of the other.

Establishment of a trust

A trust is created by declaration when it is created by the holder of the undivided legal interest in property using words or actions that sufficiently evidence an intention to create a trust over that property (Korda v Australian Executor Trustees (SA) Limited [2015] HCA 6; 317 ALR 225;). This will often be done through the execution of a trust deed, but may occur nevertheless without a trust deed being prepared or executed.

A trust is created by settlement by vesting property subject to a trust for the benefit of others (Taras Nominees Pty Ltd as Trustee for the Burnley Street Trust v Commissioner of Taxation of the Commonwealth of Australia [2014] FCA 131). Again, this will often be done by execution of a trust deed, but may occur without a trust deed being executed.

A declaration and a settlement are not mutually exclusive, and there are many situations where both will occur during the settlement of a trust. For example, the holder of an unencumbered parcel of land may first declare that they hold the land on trust for a particular beneficiary and then settle the property on a trustee.

An implied trust arises when a person holds legal ownership of an asset but is considered to hold it on behalf of someone else. This situation often occurs when property is registered in another person's name, even though the original owner did not intend for that person to become the sole beneficial owner.

The circumstances where an implied trust may exist are often similar to those where a resulting trust arises. An implied trust can emerge without any express statement from a person. Its existence is determined by the specific facts of each case.

An implied trust arises where an individual can establish that in spite of being the legal owner of an asset, that they only hold this asset on behalf of someone else.

Most trusts created under English law are done so deliberately and are formed involving three parties:

(a)          the settlor, who creates the trust

(b)          the trustee, who holds the legal interest in the trust property and who administers the trust, and

(c)           the beneficiary, who holds the equitable interest in the trust property, who enjoys the trust but who also acts as an 'enforcer' of the trust, ensuring that the trustee honours the terms of the trust.

Most trusts that are formed deliberately, or expressly, do not have to comply with any requirements as to form. This means they can, for the most part, be created entirely orally. For example, a settlor can simply instruct a trustee to hold property for a beneficiary's benefit. The hallmark of such express trusts is that they are created by the settlor's intention.

A major exception to this principle exists, however, for trusts which have land as their subject matter. All trusts which are expressly created and have land as all, or part, of their subject matter are caught by a statutory provision which means that they must be evidenced in writing. There is no option for settlors to circumvent this requirement, for the wording of paragraph 53(1)(b) of the Property Law Act 1958 (Vic) currently in force in the State of Victoria provides:

... a declaration of trust respecting any land or any interest therein must be manifested and proved by some writing signed by some person who is able to declare such trust or by his will.

For most legal rules there are exceptions and the provision in subsection 53(2) of the Property Law Act 1958 follows that tradition, which provides that 'This section does not affect the creation or operation of resulting, implied or constructive trusts'.

Subsection 53(2) of the Property Law Act 1958 consequently permits implied trusts to be created orally, even where their subject matter is land. Implied trusts can, therefore, be created by the parties quite informally and flexibly. However, the courts have restricted the growth of what appears to be, at first glance, a highly malleable form of trust.

In this case, the parities agreement and conduct prior, during and after the asset was acquired established who the beneficial owner of the asset was.

CGT Event E1

CGT event E1 happens if a taxpayer creates a trust over a CGT asset by declaration or settlement (subsection 104-55(1)). The CGT event happens if the trust was created between living persons or under the Will of a deceased person.

However, there are some situations in which CGT event E1 does not happen. CGT event E1 does not happen if a bare trust is created. That is, where the taxpayer creating the trust is the sole beneficiary of the trust and is absolutely entitled to the asset against the trustee (disregarding any legal disability) (paragraph 104-55(5)(a)).

If CGT event E1 does not happen because of this exception and the taxpayer is absolutely entitled to the asset as against the trustee (disregarding any legal disability), the CGT provisions apply to an act done by the trustee in relation to the asset as if it were done by the taxpayer (section 106-50). This means, for CGT purposes, the asset effectively continues to be owned by the taxpayer and not the trustee of the trust. For example, if the asset is sold by the trustee, any capital gain or loss from CGT event A1 (disposal of a CGT asset - section 104-10) arises in the hands of the beneficiary/taxpayer and not in the hands of the trustee.

In this case, the Trustee was the legal owner that held the asset on behalf of the Beneficiary.

Absolute entitlement - bare trusts

A trust is a bare trust where the trustee has no interest in the trust assets other than that existing by reason of the office of trustee and the holding of the legal title to the assets, and the trustee did not have active duties to perform or has ceased to have those duties so that in either case the property is merely awaiting transfer to the beneficiary or to another party at the direction of the beneficiary (Herdegen, H.K. v. Commissioner of Taxation [1988] FCA 699; 88 ATC 4995; 84 ALR 271).

If a beneficiary is absolutely entitled to a CGT asset as against the trustee of a trust, the CGT provisions apply to an act done by the trustee, as if it were an act done by the beneficiary.

Meaning of 'absolutely entitled'

To be 'absolutely entitled' to an asset as against the trustee of a trust, a beneficiary must have both a vested and an indefeasible interest in an asset, and to be able to demand transfer of the asset by the trustee. It is not sufficient if the beneficiary merely has a right or entitlement under the deed to be paid a benefit. The beneficiary must have an immediate entitlement to demand transfer of the particular asset in circumstances where that entitlement cannot be defeated.

Meaning of 'absolutely entitled' - Commissioner's views

The Commissioner's views on the meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in the CGT provisions are set out in Draft Taxation RulingTR 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.

TR 2004/D25 explains the circumstances in which a beneficiary of a trust is considered to be absolutely entitled to a CGT asset of the trust as against the trustee. In such circumstances, the beneficiary (rather than the trustee) is treated as the relevant taxpayer in respect of the asset for the purposes of the CGT provisions and especially section 106-50.

The core principle underpinning the concept of absolute entitlement 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. See the rule, as handed down by the Court of Chancery, in Saunders v Vautier [1841] 4 BEAV 115; 49 ER 282.

The most straightforward application of the core principle is one where a single beneficiary has all the interests in the trust asset. Generally, a beneficiary will not be absolutely entitled to a trust asset if one or more other beneficiaries also have an interest in it.

A single beneficiary who has all the interests in a trust asset will be absolutely entitled to that asset as against the trustee for the purposes of the CGT provisions if the beneficiary can (ignoring any legal disability) direct the trustee to transfer the asset to them or to transfer it at their direction.

In this case, trust asset was held by the Trustee solely for the unrestricted use and benefit of the Beneficiary. The Beneficiary was therefore absolutely entitled to the asset as against the Trustee for the purposes of the CGT provisions.

CGT event happens to a trust asset to which a beneficiary is absolutely entitled

Section 106-50 provides that, immediately after a beneficiary becomes absolutely entitled to a CGT asset as against the trustee (disregarding and legal disability):

(a)          the asset is treated as the beneficiary's asset (and not the asset of the trust); and

(b)          an act done in relation to the asset by the trustee is treated as if it had been done by the beneficiary (and not by the trustee).

Conclusion

The Beneficiary was the sole beneficiary of the bare trust. The Beneficiary had an indefeasible interest in the trust asset and is therefore absolutely entitled to asset as against the Trustee for the purposes of the CGT provisions.

In this case, the capital gains tax provisions contained in Parts 3-1 and 3-3 do not apply to the Trustee, when the asset was sold.

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