Edited version of private ruling

Authorisation Number: 1011481642672

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Ruling

Subject: Capital gains tax - deceased estate - court order - constructive trust

Question 1:

Will the first element of the constructive trust's cost base be the market value of the 50% interest in the dwelling on the date of the deceased's death?

Answer: Yes.

Question 2:

Can any expenses incurred by the constructive trust in relation to the 50% interest in the dwelling be included in the trust's cost base?

Answer: Yes.

Question 3:

Can any court and litigation costs incurred by the constructive trust in relation to the 50% interest in the dwelling be included in the trust's cost base?

Answer: Yes.

Question 4:

Will the Commissioner exercise his discretion to allow the constructive trust to be taxed at a concessional marginal tax rate?

Answer: No.

This ruling applies for the following period:

Year ended 30 June 2005

The scheme commences on:

1 July 2004

Relevant facts and circumstances

You and your late spouse purchased a dwelling as joint tenants before 20 September 1985.

The dwelling became the main residence of you, your late spouse and your child.

Your late spouse was involved in an accident and as a consequence became disabled. As a consequence of your late spouse's condition, the spouse was transferred to a nursing home and never returned to the dwelling.

Your late spouse prepared a will which bequeathed their entire estate to you and appointed you as executor, but if you predeceased them, their entire estate was bequeathed to your child, who was to be executor.

You and your child moved out of the dwelling after a number of years.

Around that time you and your late spouse agreed to divorce and obtain orders from the Family Court to give effect to a property settlement.

The divorce was granted and the consent orders made by the Family Court included the following:

· the dwelling be sold, and after each party being responsible for a share of the associated costs in proportion to their ownership interest in the dwelling, the residue to be divided equally between the parties.

· pending the sale of the property, you were responsible for all outgoings in relation to the dwelling.

You and your late spouse agreed not to sell the dwelling until some vital repairs had been made to the property so that a better sale price may be obtained.

Your late spouse died.

At that time, the dwelling had not been sold, and was still registered in the names of both you and your late spouse as joint tenants.

As a result of your late spouse's death, full title to the dwelling vested in you as the surviving joint tenant.

As you and your late spouse were divorced at the time of their death, pursuant to section 15A of the Wills, Probate and Administration Act 1898, the whole of your late spouse's estate passed to your child as if you had predeceased your late spouse.

Your child, as executor of your late spouse's estate, was granted Letters of Administration.

You and your child became involved in a legal dispute over the dwelling.

You claimed that the gift of the dwelling to you was intended by your late spouse, despite the fact that you were divorced. You also contended that if the gift was invalid, you were entitled to provision from the estate.

Your child claimed that, by virtue of the Family Court orders, you held the property on trust for the estate, and that your child was entitled to orders from the Family Court to sever the joint tenancy and have one half of the dwelling transferred to them as executor of the deceased's estate.

Your child also claimed that should you be successful in your claim, your child was entitled to provision from the estate.

You attempted to sell the dwelling, but your child filed a caveat on the title to protect their alleged interest.

You then commenced proceedings in the Supreme Court of NSW.

The dwelling had been vacant during this period and as you had continued to incur expenses in relation to the dwelling, you had filed a notice of death and an application to lapse your child's caveat.

The dwelling was transferred to you so that it could be sold. Your child did not agree to this, however it was agreed that the property be sold on condition that proceeds of the sale attributable to your late spouse's share in the dwelling be held in trust in an account controlled by your child's solicitors, pending the outcome of the litigation.

The dwelling was sold.

You and your child agreed to settle your differences on the basis of a draft deed of settlement. The main points are:

· you and your child will be equally liable for any capital gains tax from the sale of the dwelling; and

· after certain payments are made to your child, not being a transfer of proceeds of the sale, all parties are released from any further claims.

The Supreme Court issued consent orders in this matter. The Court ordered that you held your late spouse's interest in the dwelling on trust for their estate from date of death, and that the proceeds held in trust pending the outcome of litigation are an asset of that estate.

You incurred a number of expenses in relation to the dwelling and have not claimed any deduction in relation to those expenses.

The constructive trust has not lodged its 2004-05 income tax return.

Reasons for decision

Creation of a constructive trust

A constructive trust is a trust imposed by operation of law, whenever equity considers it unconscionable for the party holding title to the property in question to deny the interest claimed by another. The existence of a constructive trust is dependent upon the order of the court, even though that order may operate retrospectively by dating the origin of the trust from some earlier wrongful act.

As a result of a court order, a constructive trust was created from the date of your late spouse's death. The constructive trust was created in relation to the interest in the dwelling which belonged to your late spouse's estate. This interest is viewed as being a post-CGT asset as your late spouse died after 20 September 1985. The court ordered that you held your late spouse's interest on trust for the deceased's estate from the date of the deceased's death, and that the proceeds from the disposal of the interest will be held in trust as an asset of the estate pending the outcome of litigation.

The creation of the trust over the interest in the dwelling is viewed as a CGT event E1. The time of the CGT event was the date of the deceased's death, when the constructive trust was created.

Cost base

The cost base of a CGT asset is made up of five elements.

The first element

The first element is the money you paid, or are required to pay, to acquire the asset and the market value given, or required to be given, to acquire the asset

When CGT event E1 occurs, it is considered that the trust acquires the CGT asset at market value. In this situation, the first element of the constructive trust's cost base will be the market value of the deceased's interest in the dwelling on the date the constructive trust was created, the deceased's date of death.

The third element

The costs of owning an asset can be included in the third element when:

· the asset was acquired after 21 August 1991

· no deduction has been claimed in relation to the expense; and

· you can still claim a deduction for the expense because the period for amending the relevant income tax assessment has not expired.

In this case, a number of expenses have been incurred in relation to the dwelling. As all of the above mentioned conditions for an expenses to be included in the third element have been met. Therefore, the expenses listed above can be included in the third element of the constructive trust's cost base to the extent that they were incurred by you as trustee of the constructive trust.

Note: The third element of the cost base is not included in the reduced cost base of an asset that has been sold.

The fifth element

The fifth element included any capital costs incurred in preserving or defending your rights to an asset. In this case, there has been court action and litigation concerning the deceased's will. The legal costs can be included in the fifth element of the constructive trust's cost base to the extent that they have been incurred by you as trustee of the constructive trust.

Taxation of the trust

When trustees make a capital gain and beneficiaries are presently entitled to the net income of the trust on the last day of the financial year, the capital gain flows through to the beneficiaries to whom the trustees distribute the capital gain. The liability to pay tax falls on those beneficiaries.

However, in this situation, due to the conditions outlined in the court order, your child, the beneficiary, was not presently entitled to the net income of the trust at the end of the income year in which the dwelling was disposed of. Therefore, any capital gain that has been made on the disposal of the interest in the dwelling will be assessable to you as trustee of the constructive trust.

Sections 99 and 99A of the Income Tax Assessment Act 1936 (ITAA 1936) apply to assess the trustee on income to which no beneficiary is presently entitled, which is retained or accumulated by the trustee.

Subsection 99A(2) of the ITAA 1936 outlines the circumstances when the Commissioner may apply his discretion for Section 99A of the ITAA 1936 not to apply. If the discretion under Subsection 99A(2) is exercised, the trust's income is taxed under Section 99 of the ITAA 1936 at a concessional rate of tax.

When the Commissioner does not apply his discretion for Section 99A of the ITAA 1936, the income of a trust where no beneficiary is presently entitled will be taxed at the top marginal rate of tax.

Subsection 99A(2) of the ITAA 1936 gives the Commissioner discretion to assess the trustee pursuant to section 99, rather than section 99A, where the following kinds of trust estates are involved:

· a will, such as a testamentary trust

· a trust estate consisting of the property of a bankrupt

· child maintenance trusts; and

· trusts established to provide for persons suffering from personal injury.

A trustee who is assessable under section 99A of the ITAA 1936 in respect of net income to which no beneficiary is presently entitled will be taxed a rate of tax that is set at the prevailing highest marginal rate for that income year.

In this case, a court order made by the Supreme Court which provided that you hold your late spouse's interest in the dwelling on trust for the estate from the date of their death. The constructive trust is not a trust that has been created as a result of a will, such as a testamentary trust, but has been created independently to the will.

As you have not been appointed the trustee of the deceased's estate, but have been appointed the trustee of the constructive trust under a court order, the Commissioner does not have any discretion to disregard the application of section 99A of the ITAA 1936 to the constructive trust. You, as trustee of the trust are assessable under section 99A of the ITAA 1936 on the trust's net income to which no beneficiary is presently entitled. Therefore, the trust will be taxed at the highest marginal rate for the 2004-05 income year, 47%.

Note: Section 115-225 of the Income Tax Assessment Act 1997 (ITAA 1997) states that the trustee who has their net trust income assessed under section 99A of the ITAA 1936 will not be entitled to use the discount method when calculating their net capital gain.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 99.

Income Tax Assessment Act 1936 Section 99A.

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 Subsection 110-25.

Income Tax Assessment Act 1997 Subsection 110-25(2).

Income Tax Assessment Act 1997 Subsection 110-25(4).

Income Tax Assessment Act 1997 Subsection 110-25(6).

Income Tax Assessment Act 1997 Section 115-225

Taxation Administration Act 1953 Subsection Sch1-359-35(2)(a).

Income Tax Rates Act 1986 Subsection 12(9)