Edited version of private ruling

Authorisation Number: 1011664960195

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Ruling

Subject: Capital gains tax (CGT) - transfer of CGT assets as a result of the death of an individual; and the effect of certain agreements made prior to death; and the effect of a deed of arrangement to settle a claim against the estate.

1. Does Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the proposed transfer of CGT assets from the separate estates of your parents to you, so as to disregard any capital gain or loss upon the transfer and to pass those assets to you at the relevant cost base prescribed under section 128-15 of the ITAA 1997?

Yes.

2. Do CGT events E5 to E8 in sections 104-75 to 104-100 of the ITAA 1997 apply to the proposed transfer of assets from the separate estates of your parents?

As it has been determined in response to question 1 that Division 128 applies to the trusts, it is not necessary to provide a response to this question.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Partnership assets

You were in partnership with your parents and one of your siblings. The partnership assets consisted of stock, plant and equipment only. Later the partnership purchased land.

The partnership deed sets out terms and conditions including the allocation of capital and reallocation upon the death of partners.

Your family entered an agreement to determine the terms and allocation of business assets.

You father died leaving instructions within his Will to create a testamentary trust for the resolution of distributing the residue of his estate.

Some of your father's property was pre-CGT and some was post-CGT, including the properties he held with his wife as joint tenant, however that property would devolve to his wife by right of survivorship.

Your mother died leaving testamentary instructions similar to that of your father. As her death was subsequent to your father's death, the residue of her estate included all property owned by her and that which devolved to her by the right of survivorship.

You and your siblings have been in dispute as to their respective entitlements under each Will of your parents.

Following negotiations between the legal representatives the parties have reached general agreement as to the manner in which the assets of the estate should be distributed. It is proposed that the parties will execute a deed of arrangement.

Relevant legislative provisions

Income tax Assessment Act 1997 Division 104

Income tax Assessment Act 1997 Section 104-75

Income tax Assessment Act 1997 Section 104-80

Income tax Assessment Act 1997 Section 104-85

Income tax Assessment Act 1997 Section 104-90

Income tax Assessment Act 1997 Section 104-95(2)

Income tax Assessment Act 1997 Section 104-100(2)

Income tax Assessment Act 1997 Division 128

Income tax Assessment Act 1997 Section 128-10

Income tax Assessment Act 1997 Section 128-15

Income tax Assessment Act 1997 Subsection 128-15(1)

Income tax Assessment Act 1997 Subsection 128-15(1)(b)

Income tax Assessment Act 1997 Subsection 128-15(3)

Income tax Assessment Act 1997 Subsection 128-15(4)

Income tax Assessment Act 1997 Section 128-20

Income tax Assessment Act 1997 Subsection 128-20(1)(d).

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

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

Question 1

Summary

Division 128 will apply to the proposed transfer of CGT assets from the separate estates of your parents to you, so as to disregard any capital gain or loss upon the transfer and to pass the assets to you at the relevant cost base prescribed under section 128-15.

Detailed reasoning

General discussion of the law

The administration of a deceased estate

Taxation Ruling IT 2622 sets out the Commissioner's view on the administration of deceased estates. Paragraph 6 illustrates the stages of administration of the estate of a deceased person as follows:

Period of Administration

Date of Death

Stages of Administration

1. Burial of deceased

2. Executor appointed

3. Probate applied for and granted by court.

4. Assets vest in executor who pays debts and testamentary expenses

· Initial stage - net income applied to reduce debts

· Intermediate stage - part income not required to pay debts may be paid to beneficiaries

· Final stage - debts paid or provided for in full and net income is available for distribution

Administration of estate is complete

In relation to a deceased estate, paragraph 7 of IT 2622 states that, whether a beneficiary is presently entitled to a share of the income of a trust estate for the purposes of Division 6 of Part III of the Income Tax Assessment Act 1936 depends on:

a. The stage reached in the administration of the deceased estate.

b. The terms of the deceased's will or codicil, trust law and principles enunciated and orders made by the Courts.

c. Whether any discretionary payments have been made to the beneficiary by the executor or trustee.

IT 2622 discusses that the leading case on present entitlement under a trust arising during the administration of an estate is the decision of the High Court in Federal Commissioner of Taxation v. Whiting (1943) 68 CLR 199; (1943) 7 ATD 179; (1943) 2 AITR 421 (Whiting's Case). The High Court held that a beneficiary of a deceased estate cannot be presently entitled to the income of the trust estate until the estate has been fully administered.

In Whiting's Case the High Court found that in order for a beneficiary to be 'presently entitled' to the income of a trust estate, the beneficiary must be able to demand immediate payment of such income from the trustee.

The High Court decided that the beneficiaries of a deceased estate have no right to demand payment of any part of the estate until such time as the estate has been fully administered. An estate will be fully administered when all of the assets and liabilities have been ascertained and payment or provision for payment of liabilities has been made. Until such time, the residue cannot be ascertained and there is no present entitlement to income.

Paragraph 13 of IT 2622 highlights the Commissioner's view that until such time as estate is fully administered, a residuary beneficiary has no interest in any specific investment that forms part of the estate, nor the income from that investment.

CGT and the effect of death

Division 128 provides special rules that apply when a taxpayer dies. Section 128-10 provides that a capital gain or capital loss from a CGT event that results for a CGT asset you owned just before dying is disregarded.

Subsection 128-15(1) sets out what happens if a CGT asset you owned just before dying:

(a) devolves to your legal personal representative, or

(b) passes to a beneficiary in your estate.

Subsection 128-15(3) provides special rules for legal personal representatives and states that any capital gain or capital loss the legal personal representative makes if the asset passes to a beneficiary in your estate is disregarded.

Subsection 128-15(4) provides modifications to the cost base of the CGT asset in the hands of the legal personal representative and the beneficiary.

Subsection 128-20(1) outlines when an asset passes to a beneficiary, in particular that a CGT asset passes to a beneficiary in your estate if the beneficiary becomes the owner of the asset:

(a) under your will, or that will as varied by a court order; or

(b) by operation of an intestacy law, or such a law as varied by a court order; or

(c) because it is appropriated to the beneficiary by your legal personal representative in satisfaction of a pecuniary legacy or some other interest or share in your estate; or

(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.

(It does not matter whether the asset is transmitted directly to the beneficiary or is transferred to the beneficiary by your *legal personal representative.)

Taxation ruling TR 2006/14 discusses that the Division 128 exception does not appear to apply to trusts. It contains rules about the passing of assets from the deceased individual's legal personal representative to a beneficiary of the estate, in particular as part of the administration of the estate. For example, if an asset owned by the deceased at the time of death is subject to a life interest under the deceased's Will, the asset passes to the remainderman as a beneficiary of the estate, Division 128 applies.

In contrast, where an asset is acquired by an executor subsequent to the deceased's death, and subject to a life interest, that asset is held by the trustee of a trust which is not a deceased estate, Division 128 does not apply.

Deed of arrangement to vary terms of deceased's Will

To illustrate the operation of paragraph 128-20(1)(d), paragraph 33 of TR 2006/14 states that beneficiaries in a deceased estate who have been granted life and remainder interests may be dissatisfied with the provision that the deceased person made for them under their will. The beneficiaries may enter into a deed of arrangement under which they agree to share the deceased's assets rather than their life and remainder interest.

Paragraph 34 of TR 2006/14 states that assets may pass to them as a beneficiary in the estate under paragraph 128-20(1)(d). If this occurs, there will be no consequences for the life and remainder interests as the intended owners of those interests are treated as if they had not been bequeathed them.

Further, paragraph 35 of TR 2006/14 sets out that a deed of arrangement will be effective for the purposes of paragraph 128-20(1)(d) provided that it is entered into:

· to settle a claim to participate in the estate, and

· any consideration given by the beneficiary consisted only of the variation or waiver of a claim to an asset or assets that formed part of the estate.

For the purposes of paragraph 128-20(1)(d) a deed of arrangement must be entered into prior to the administration of the estate being completed unless the beneficiary can demonstrate that a court would, at the time the deed was entered into, have entertained their application for family provision, or an extension of time in which to make such an application.

You do not need to commence legal proceedings in order to establish, for the purposes of paragraph 128-20(1)(d), you have a claim to participate in the distribution of the assets of the estate. A claim may be established by a potential beneficiary communicating to the trustee their dissatisfaction with the Will.

Application of the law

The Wills, and the operation of the partnership agreement in conjunction with those estates, has been in dispute at all times during the administration of those estates. The administration is not complete at present.

It is considered that, until such time as the deed of arrangement is entered into, the trustees of the respective estates could not ascertain the residual of the estate so as to fully administer the estate. Further, in considering IT 2622 and TR 2004/D25, no beneficiary can be presently entitled to income, nor is any beneficiary absolutely entitled to the assets, of the trust. Therefore the assets have not yet passed to the beneficiary under paragraph 128-15(1)(b).

You propose to enter into a deed of arrangement in respect of CGT assets of the respective deceased estates, to effect the transfer of those CGT assets among the beneficiaries.

The CGT assets to be transferred are assets that formed part of the respective estates of the deceased persons. Under the deed of arrangement you will vary or waiver your claim to those assets. Therefore the deed of arrangement is considered to be in accordance with paragraph 35 of TR 2006/14, so that upon entering the deed of arrangement, paragraph 128-20(1)(d) will operate to pass those CGT assets to you.

Therefore, Division 128 will apply to the proposed transfer of CGT assets from the estates of your parents to you, so as to disregard any capital gain or loss upon the transfer and to pass the assets to you at the relevant cost base prescribed under section 128-15.

Question 2

Detailed reasoning

In accordance with TR 2006/14, as it has been determined that Division 128 applies in respect of the assets described within the facts of this ruling, it is not necessary to consider whether any other CGT event has happened.

This question will not be considered further.