Edited version of private ruling

Authorisation Number: 1011762202358

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Ruling

Subject: Isolated transaction - partition of property - pre-CGT or Post-CGT interest - subdivision and bare trust

Issue 1

Question 1

Is the profit from the disposal of its interest in land known as Lot A, ordinary income of the Executors of the Estate of Landholder (deceased) (the deceased estate)?

Answer

No.

Question 2

Is the profit from the disposal of its interest in a specified area of land within Lot A (Sub lot) ordinary income of the Family Trust?

Answer

No.

Issue 2

Question 1

When did the Family Trust acquire Sub lot?

Answer

The Family Trust acquired Sub lot before 20 September 1985.

Question 2

Can the Family Trust disregard the capital gain it made on the disposal of Sub lot?

Answer

Yes.

Question 3

How is the capital gain from the disposal of Lot A to be apportioned between the Family Trust and the deceased estate?

Answer

It is the responsibility of the executors of the deceased estate and the Trustee for the Family Trust to determine the correct apportionment of the cost base and capital proceeds. They must follow the rule at subsection 116-40(1) of the Income Tax Assessment Act 1997.

Issue 3

Question 1

Are the Beneficiaries' shares of the deceased estate's capital gain, from its interest in Lot A assessable to the Beneficiaries?

Answer

Yes.

Question 2

Can the Beneficiaries disregard their shares of the Family Trust's capital gain from Sub lot?

Answer

Yes.

This ruling applies for the following period:

Financial year ended 30 June 2010

Relevant facts and circumstances

At a time before 20 September 1985 (pre-CGT) Landholder became the owner of a property (Original Property).

Original Property included a residence where Landholder resided until their death after 19 September 1985 (post-CGT).

By a pre-CGT contract of sale Landholder disposed of an undivided interest in Original Property to the Family Trust.

This undivided interest was an interest greater than 50%, and we will call it Majority Undivided Interest.

The beneficiaries of the Family trust were relatives of Landholder.

Title in Original Property was not changed at the time of contract and remained unchanged for many years, until a time after the first subdivision described below.

On a post-CGT date Original Property was subdivided into two lots (Lot 1 and Lot 2) for the purpose of selling Lot 2. The two lots remained registered in the name of Landholder. Lot 1 contained the area we are calling Sub lot, to which part of this ruling applies.

A short time later the title to Lot 2 was registered in the name of the trustee for the Family Trust, and then the Family Trust disposed of Lot 2 to an unrelated entity.

The present trustee of the Family Trust and the executors of the deceased estate of Landholder (the deceased estate) believe that the proceeds from the sale of Lot 2 were divided among the beneficiaries of the Family Trust and Landholder (who was not a beneficiary of the Family Trust).

No records can be found showing how the Family Trust or Landholder dealt with their shares of the proceeds.

Some years later Landholder subdivided Lot 1 into two blocks (Lot 1a and Lot 1b). The area called Sub lot was now part of Lot 1a.

Before this subdivision, Lot 1 had remained registered in the name of Landholder, and after it, both Lot 1a and Lot 1b remained registered in their name and retained the zoning which formerly applied to Lot 1.

Landholder's dwelling was contained in Lot 1b, to which development restrictions applied.

Landholder had never been a trustee of the Family Trust, but the Family Trust's deed required the trustee to consult with them on all or most decisions.

Some years later Landholder died. After their death the executors of their deceased estate and the trustee of the Family Trust (the executors/trustee) attempted to obtain evidence and old records from former accountants and the bank, to better understand the history and legal status of Lot 1a, Lot 1b and the Family Trust. None of them had been trustees of the Family Trust when earlier events occurred. Their attempts were not successful.

For some years after the death of Landholder the executors/trustee used the property to earn rent.

Meanwhile, a few months after Landholder's death the executors/trustee engaged a consultant to make a town planning application for Lot 1a. They proposed that part of Lot 1a be sold for commercial use.

The local council rejected this application. A few months later the executors/trustee appealed against that decision.

The Court decided in favour of the executors/trustee and council permission was granted for the requested commercial use. The commercial area was to be on only part of Lot 1a and rezoning was not necessary in the circumstances.

The executors/trustee did not place Lot 1a and Lot 1b on the market immediately, because they were involved in discussions with the council regarding zoning issues that would affect the sale of Lot 1b.

During the ensuing years the council proposed a number of planning changes which affected Lot 1a. In particular these affected the planned use of the area called Sub lot, which was now contained within Lot 1a. The council now considered the above mentioned plan for Lot 1a (including Sub lot) to be sufficient to meet future needs in the district.

Negotiations with council and changes to plans occurred from time to time

The landholder's will allow the executors to delay the sale of the property for some years after their death, in order to obtain a better price. All the beneficiaries of the deceased estate agreed to extend that time until the real estate market improved and the council finally resolved planning matters.

The executors/trustee did not intend to develop Lot 1a or Lot 1b.

Later the council approved a subdivision of the property into two different lots. These most recent subdivisions are:

· Lot A which consists of much of former Lot 1a, including Sub lot and the area approved for commercial use; and

· Lot B, comprising mostly the area previously called Lot 1b.

The council required the executors/trustee to carry out some earthworks and also required an open space land contribution to the council.

No other major subdivision or construction work was required by the council. Therefore the executors/trustee did not carry out any subdivision works apart from the bare minimum required by the council.

Lot B was sold in one parcel in a financial year prior to the financial year ended 30 June 2010.

A real estate firm handled the sale using advertising boards, newspaper and internet advertising. Lot B was sold with permits in place for subdivision. No other consultants were involved in the direct sale process.

Proceeds from the sale were deemed by the executors/trustee to belong wholly to the deceased estate. The executors of the deceased estate distributed the net proceeds to the beneficiaries of the deceased estate and advised them that they were assessable on their shares of the capital gain.

After further planning changes by the council requiring new plans by the executors/trustee all the beneficiaries against waiting any longer, and Lot A was sold in the financial year ended 30 June 2010.

You provided us with copies of the trust deed for the Family Trust and the will of Landholder.

Your provided information about the accounts of the deceased estate in the financial year ended 30 June 2010.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1
Income Tax Assessment Act 1997 Subdivision 108-D
Income Tax Assessment Act 1997 Subdivision 115-C
Income Tax Assessment Act 1997 section 104-10
Income Tax Assessment Act 1997 section 104-75
Income Tax Assessment Act 1997 section 106-50
Income Tax Assessment Act 1997 subsection 116-40(1)
Income Tax Assessment Act 1936 Division 6 of Part III
Income Tax Assessment Act 1936 subsection 95(1)
Income Tax Assessment Act 1936 subparagraph 97(1)(a)(i)

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.

Issue 1 Questions 1 and 2

Summary

1) Is the profit from the disposal of its interest in land known as Lot A, ordinary income of the Executors of the Estate of Landholder (deceased) (the deceased estate)?

2) Is the profit from the disposal of its interest in a specified area of land within Lot A (Sub lot) ordinary income of the Family Trust?

The profits are not assessable as ordinary income. The executors of the deceased estate and the trustee of the Family Trust (the executors/trustee) were not dealing with Lot A or Sub lot in the course of carrying on a business. Nor were they carrying out any profit making undertakings or schemes. The profits arose partly from the disposal of an asset in the course of administering a deceased estate. They were also partly from the mere realisation of an investment asset. The executors/trustee were carrying out the subdivision and sale of Lot A (including Sub lot) in an enterprising way. However their activities did not display the characteristics of a business or of a profit making undertaking or scheme.

Detailed reasoning

In your arguments you correctly refer to the Commissioner's view expressed in Taxation Ruling TR 92/3 regarding profits on isolated transactions. You state in part of your statement that:

The Commissioner has considered the issue as to whether profits from isolated transactions are income, at great length in his Taxation Ruling TR 92/3. In paragraph 6 of his ruling, he states that a profit from an isolated transaction is generally income when both of the following elements are present:

1. the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and
2. the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

You also correctly observes that; 'The Commissioner regards intention or purpose as being determined from an objective consideration of the facts and circumstances of the case.'

We have considered the circumstances and facts relating to the subdivision which created Lot A and Lot B. And we have considered the circumstances of the disposal of Lot A in the financial year ended 30 June 2010, and the disposal of Lot B in an earlier financial year. The executors of the deceased estate and the trustee of the Family trust were responsible for dealing with both lots (including Sub lot). The facts you have provided demonstrate that neither the deceased estate nor the Family Trust carried on a business of land development. The activities of the executors/trustee when dealing with council planning issues and subdivision concerning both lots, did not amount to the carrying on of a business.

The executors/trustee intended to improve these lots in order to dispose of them for increased prices. Their activities were spread over many years. However we consider their activities were not conducted in the sustained business-like and commercial manner which amounted to the carrying out of a profit making undertaking or scheme, as that term is understood by the Commissioner in TR 92/3. The executors/trustee were merely improving their assets so as to obtain the best prices on their disposal. Paragraph 36 of TR 92/3 refers to such a situation when it states in part that:

The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression 'mere realisation' is used to contradistinguish a business operation or a commercial transaction carrying out a profit-making scheme (Myer at 163 CLR 213; 87 ATC 4368-4369; 18 ATR 699-700).

Therefore the profits on the two disposals are not assessable as ordinary income. They are capital in nature, and their treatment for taxation has to be determined under the capital gains provisions in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

Issue 2 Question 1

Summary

When did the Family Trust acquire Sub lot which was later included within Lot A?

On the balance of evidence, it is reasonable to conclude that the Family Trust acquired Sub lot before 20 September 1985 (pre-CGT). We have decided that Landholder and the original Trustee for the Family Trust had agreed pre-CGT that the Family Trust was to own Sub lot. Therefore for CGT purposes, a contract was made pre-CGT and the Family Trust acquired its 100% interest in Sub lot as a result of that pre-CGT contract.

We do not believe that Landholder was holding Sub lot as a trustee on behalf of the Family Trust as beneficiary. Rather the disposal contract had a very long settlement period and title to Sub lot could not be transferred until settlement.

Detailed reasoning

The area we describe as 'Sub lot' was part of Lot 1 when that lot was created by the first subdivision. It became part of the parcel of land we are calling 'Lot 1a' which came into existence when Lot 1 was later subdivided.

Prior to the sale of Lot 2, the title to Lot 2 was transferred into the name of the Trustee for the Family Trust (the Family Trust). However title to Lot 1 remained in the name of Landholder, and continued to do so after Lot 1 was later subdivided into the lots designated as Lot 1a and Lot 1b. Titles remained thus until the death of Landholder. Therefore, in the absence of evidence to the contrary, the ownership of Lot 1 and of the later subdivisions of Lot 1, remained as it was just before each subdivision. This is the Commissioner's considered view of the capital gains tax (CGT) outcome when joint owners of land subdivide that land into smaller blocks, prior to any change of title. This view is set out in Taxation Determination TD 92/148. Paragraphs one and two use the example of joint owners each holding a 50% individual interest to explain that:

1. Upon initial acquisition and before the subdivision of the land by the former joint owners, each acquired a 50% individual interest in the whole land.

2. After the subdivision, both owners have a 50% interest in each of the subdivided blocks. As there has been no change in ownership of the subdivided land, there is no acquisition or disposal for CGT purposes (see CGT Determination No. 7).

Applying this to the land under consideration, it appears that from the date of the pre-CGT contract disposing of the Majority Undivided Interest in Original Property to it, the Family Trust held the Majority Undivided Interest first in the whole of Original Property and then in Lot 1 and Lot 2. Later the size of its undivided interest in Lot 1 changed, but the Family Trust continued to hold an undivided interest in Lot 1 then in Lot 1a and Lot 1b.

Using similar reasoning, from the date of the pre-CGT contract, Landholder held an undivided interest, in turn in each of the whole of Original Property, Lot 1 and Lot 2. Later, they continued to hold their original undivided interest percentage in Lot 1 and acquired a further undivided interest in Lot 1. When Lot 1 was divided into Lot 1a and Lot 1b, they continued to hold their original undivided interest percentage and the further undivided interest in each of these new lots, until their death.

The legal transfer of title in Lot 2 at a time post-CGT should mean that from the time of that legal transfer the Family Trust continued to hold its Majority Undivided Interest in Lot 2 and received the interest in Lot 2 transferred from Landholder. This is the Commissioner's view as expressed in paragraph three of TD 92/148:

3. However, as a result of the transaction whereby each now has sole ownership of an individual block, each owner is taken to have disposed of his or her 50% interest in the subdivided block which is now owned by the other. There have been corresponding acquisitions by each owner from the other of that interest in land now owned by each of them which was previously owned by the other.

We agree that no such change for Lot 1 happened when the first subdivision and the change of title to Lot 2 occurred. There are no written records to show what changes, if any, apart from registration of the subdivision, were made to the pre-existing interests in Lot 1 around that time, or at the time of the next subdivision of Lot 1 into Lots 1a and 1b. Whilst the name of the legal owner of Original Property was not changed, the pre-CGT contract of sale confirms the existence of the respective undivided ownership interests held by the Family Trust and Landholder, prior to the first subdivision and transfer of title in Lot 2. For CGT purposes, the time of acquisition of the Majority Undivided Interest by the Family Trust in both Original Property and in Lot 1 is the date of that contract. That was pre-CGT. Similarly, Landholder acquired their sole interest in Original Property, continued to hold their undivided interest in Original Property, then their undivided interest in Lot 1, all pre-CGT.

You have argued that any doubt regarding the correct treatment of ownership interests in both Lot 1 and Lot 2 from the time of the first subdivision may have two solutions. Your objection presents one alternative as the 'First Outcome' which proposes that Landholder did not partition Lot 2 when they transferred it to the Family Trust. In the absence of a written partition agreement, Landholder may have transferred their and the Family Trust's undivided interests in Lot 2 to the Trust, and retained an undivided interest in Lot 1 on behalf of them self and the Trust (as bare trustee), in the already existing proportions. You also argue that if such an arrangement occurred, no change in beneficial ownership happened as a result of the Family Trust's registration on the title to Lot 2.

Your possible 'Second Outcome' proposes that Landholder did partition Lot 2 to the Family trust and then held Sub lot on behalf of the Trust as part of Lot 1 as Bare Trustee. No partition agreement was found in the former solicitor's files or amongst the Landholder's records. Similarly, there is no mention in the Contract that the Deceased held the right to partition and transfer any parcel, although such rights would exist under general property law. We accept that facts exist to support one or the other outcome and that due to missing records it is difficult to make a judgement. You state that you and the executors/trustee believe that the Second Outcome is the most likely one. You further argue that the bare trust holding Sub lot came into existence at a time pre-CGT. As a consequence you argue that the Family Trust's interest in Sub lot was acquired by it pre-CGT.

The Commissioner recognises the complexities involved in the partition of land, and accepts that a straightforward change of ownership will not always occur. Goods and Services Tax Ruling GSTR 2009/2 sets out, among other matters, how he views land partitions and notes that different arrangements occur. It deals with a Goods and services tax question, however part of the discussion is relevant to your issues. Paragraphs 30 and 31 of GSTR 2009/2 state that:

30. After partition, the proportions of land received by each co-owner may not correspond with the entitlements or interests in the land of the co-owners prior to its division. Even if the portions received by the co-owners are equal in size they may not be precisely equal in value. In these cases, the co-owner(s) in receipt of the greater portion of land or with the greater value may pay compensation (usually a sum of money, called 'owelty' or 'equality' money) to the other co-owner(s) to take account of any differences in the value of the portions of the land they receive.

31. Alternatively, under a partition, one or more co-owners may not take part of the land in which they held an interest prior to its division. In these cases, each co-owner receiving a part of the land may pay monetary consideration ('owelty' money) to the other co-owner(s) for giving up their interests in the land without receiving an interest in any other land in return.

We agree that the partition which occurred soon after the first subdivision gave all of Lot 2 to the Family Trust. But no records show what Landholder and the Family Trust intended for Lot 1. They did not partition Lot 1 to either entity, nor any portion of it. We therefore have to examine your argument about a bare trust holding all or part of Lot 1.

For CGT purposes, the resolution of the problem will not depend on the existence of a bare trust. This is not the deciding factor for CGT matters, when determining the nature of an entity's interests in property held on trust, and the times at which the entity acquires the various types of interest as opposed to a trustee. Rather it is the concept of 'absolute entitlement' that determines these issues. Draft Taxation Ruling TR 2004/D25 sets out the Commissioner's considered view regarding the 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 ITAA 1997. The Commissioner explains that this phrase is used in some CGT provisions and is the relevant test; the concept of a bare trust is not considered in the CGT provisions and cannot be used here to determine ownership matters for CGT purposes. Whether your proposed bare trust assists or does not assist, to establish ownership at general law, is of no help because no records exist of bare trust arrangements or the intentions of the parties regarding such an arrangement. Further, the contract disposing of the Majority Undivided Interest to the Family trust had not been completed when the first subdivision into Lots 1 and 2, and the transfer of ownership of Lot 2 to the Family trust, happened. That contract was only partly completed by the transfer of Lot 2. It was not cancelled, so the obligations and rights under it remained in force for both parties, with respect to the remaining property interests.

The issue then is to decide whether any of the provisions in Part 3-1 of the ITAA 1997, which refer to absolute entitlement to a CGT asset, as between a beneficiary and a trustee, happened and if so did they determine when the Family Trust and Landholder acquired or disposed of interests in Sub lot or any other lots? The Commissioner states at paragraph eight of TR 2004/D25 that; 'The main CGT provisions to which the concept of absolute entitlement is relevant apply if a beneficiary is (or becomes) absolutely entitled to a CGT asset of the trust as against the trustee (disregarding any legal disability): see section 106-50 and CGT event E5 in section 104-75.' CGT event E5 may have occurred at some time for the Family Trust and could determine the time at which it acquired Sub lot for CGT purposes. Alternatively, if section 106-50 of the ITAA 1997 applied to the Family Trust's interests in the land at a time, the Family Trust may have been the owner of the interest for CGT purposes at that time, as opposed to a trustee of a bare trust, preventing a capital gain or change of ownership interest happening to the Family Trust as beneficiary. The Commissioner also states at paragraph 33 of TR 2004/D25:

33. It is considered that the test of absolute entitlement is based on whether the beneficiary can direct the trustee to transfer the trust property to them or at their direction. While the existence of a bare trust may be a good indicator that a beneficiary of the trust is absolutely entitled, it is not necessary to establish that the trust is a bare trust in order to establish absolute entitlement. Likewise, the existence of a bare trust does not lead automatically to the conclusion that a beneficiary of the trust is absolutely entitled.

To be absolutely entitled as against the trustee a beneficiary must have the same power to direct the trustee as in the case of Saunders v. Vautier. TR 2004/D25 explains this:

41. The principle invoked in the case of Saunders v. Vautier was that if a sole beneficiary's interest in the trust property is vested and indefeasible and they are of age then they can put an end to the trust by directing the trustees to transfer the trust property to them or at their direction, even though the trust deed contains a contrary intention. The basis of the principle is that a beneficiary is entitled now to that which will be theirs eventually anyway: Saunders v. Vautier (1841) 4 BEAV 115; 49 ER 282. …

If Landholder did hold anything on trust for the Family Trust, in the absence of records, it is difficult to determine what type of trust existed, and the rights of Family Trust as a the beneficiary and the duties and powers of Landholder as the trustee. If the Family Trust as beneficiary, had the right to direct Landholder as trustee to transfer trust property to it, or at its direction, the preceding discussion indicates that such trust property was merely a continuing undivided interest in Lot 1. It appears from your argument that you are not proposing the existence of other beneficiaries in this bare trust to interfere with any absolute entitlement of the Family Trust to the undivided interest in the bare trust's property. However a discussion of absolute entitlement appears irrelevant when one considers that the alleged bare trustee, Landholder, had influence over the Family Trust itself during Landholder's lifetime. Landholder as an individual had to be consulted by the trustee of the Family Trust prior to any decision by the trustee, as evidenced by some clauses of the trust deed of the Family Trust. The trust deed gave the trustees wide discretionary powers but they always needed the written agreement of Landholder (who was not a trustee) as shown in some clauses of the deed. The Trustees would:

… stand possessed of the Trust Fund and the income thereof in Trust for all or such one or more exclusively of the others or other of the Beneficiaries … in such shares and with such trusts and powers for their respective benefit … as the Trustees during the lifetime of Landholder and with the consent of Landholder in writing shall by any deed or deeds … appoint …

Notwithstanding the trusts powers and provisions therein declared and contained the Trustees may at any time or times during the lifetime of Landholder and with the consent of Landholder in writing if they shall in their absolute discretion think fit transfer the whole or any part or parts of the Trust Fund or the income thereof into the names or under the legal control of the trustees or trustee of and for the purposes of any Settlement … .

We believe the discussion of a bare trust or absolute entitlement will not resolve any CGT matter. Additionally, as just mentioned, the terms of the pre-CGT contract of might have placed restrictions on any subsequent arrangements. The contract of sale prevented the Family Trust from being entitled to ownership of any part of Original Property or Lot 1, at the time of the first subdivision and transfer of title to Lot 2. The settlement date of the pre-CGT contract was set some years after the first subdivision and transfer of title to Lot 2 occurred. The contract allowed Landholder the power to demand payment of the balance owing to them at any time before the settlement date. The pre-CGT contract stipulated that, prior to full payment the Family Trust could not have title and a full ownership interest. By mutual agreement, Landholder transferred Lot 2 into the name of the Family Trust just after the first subdivision. The records are silent on any transactions changing ownership of Lot 1 or Sub lot.

Furthermore your objection points out the great difficulty in determining the actual sequence of events. As it appears impossible to establish whether a bare trust existed and if or when the Family Trust could have a sole right to Lot 1 or Sub lot, we decided to look at other possibilities.

You included a copy of a letter from Landholder's solicitor at the time, written to Landholder soon after the disposal of Lot 2 by the Family Trust to an unrelated buyer. This suggests that by the time of the first subdivision Landholder and the then Trustee for the Family Trust were already in the process of completing the pre-CGT contract. The letter stated that the sale of Lot 2 to the unrelated party left a specified area of Family Trust land remaining on Landholder's current title (Lot 1). It speaks of the pre-CGT sale of the Majority Undivided Interest to the Family trust as if that interest were a certain area of the property rather than an undivided interest. The contents of the letter are summarised here:

Sale of X acres of Original Property to the Trustee for the Family Trust.

We confirm that following the sale of Y acres to the Unrelated buyer the remaining (X-Y) acres sold to the Trust remains on your Title.

We further confirm that the Trust owes you the balance of purchase money under the pre-CGT Contract of Sale.

Any monies currently in the Trust can be used to satisfy the debt in part or in whole, and if there is not adequate the balance can be paid from the eventual sale of the Trust's (X-Y) acres remaining on your Title.

We believe the solicitor would have known what type of ownership interests existed in Lot 1 and would have known the intentions of Landholder and the trustee of the Family Trust at the time of the first subdivision. The heading of the above mentioned letter suggests a sale of a specified number of acres was made to the Family Trust. It indicates that the solicitor was not talking about an undivided interest in Original Property. He states that the remaining '(X-Y)' acres sold to the Family Trust remains on Landholder's title. He said they could sell the '(X-Y)' acres belonging to the Family Trust at a future time.

This suggests that prior to the sale of Lot 2 to an unrelated party, at least by the time of the first subdivision plans had been made to split Original Property into separate parcels of land owned by Landholder and the Family Trust respectively. A specified area was recognised as being Family Trust property. By this time it seems that the Family Trust did not hold a Majority Undivided Interest in Lot 1. Other information in the objection includes copies of letters which mention the specified area again. They include a copy of a letter after the death of Landholder from an executor to beneficiaries, making proposals for dealing with the deceased estate, including this (X-Y) number of acres; '… still owing to the trust'. A copy of another letter from the above mentioned solicitor to an executor discusses transfer of title for this remaining (X-Y) acres of Family Trust land, which was still in the name of the (by then) deceased estate.

A trustee of Family Trust made a Statutory Declaration to assist us. The trustee states that just prior to the first subdivision, Landholder informed them that they wanted to transfer part of Original Property into the Family Trust and that this required subdivision of the property, as it was all registered on the one title. They confirm that, as described above, Landholder subdivided an area of 'Y' acres onto a separate title and transferred that title into the name of the Family Trust immediately after subdivision. That Y acres was the area sold soon after to an unrelated buyer, and was less than the 'X' acres to which the Family Trust's Majority Undivided Interest in Original Property equated. The trustee believed this transfer of title was in partial completion of the pre-CGT contract. The trustee further stated that based on their discussions at the time with both Landholder and the former solicitor, they believe that your Second Outcome is correct to the extent that Landholder did partition Lot 2 to the Family Trust. However they are unaware of any partition agreement that may have been made.

They further believe that Landholder decided not to subdivide and transfer the remaining (X-Y) acres owing to the Family Trust at that time because there were no immediate plans to sell that area of land, and Landholder did not see the need to incur the expense of further subdivision at that time. Landholder often spoke about a particular section of Original Property/Lot 1 being allocated to the Family Trust for commercial use.

The specified area was physically part of the area described as Lot 1a (created by the later subdivision of Lot 1) then Lot A (created by subdivision after the death of Landholder).

After the death of Landholder, discussions occurred with their former solicitor about the trust's remaining area and its physical location. They state that the former solicitor was instructed by Landholder their intention that a specified area remained as owing by them to the Family Trust and that the location was something that had been at the discretion of Landholder. But the actual location had not been discussed with the former solicitor at the time of the sale of Lot 2.

In conclusion, the balance of evidence indicates that Landholder was not holding Sub lot in any trust on behalf of the Family Trust. The more appropriate view is that the disposal contract had a very long settlement period and title to Sub lot could not be transferred until settlement.

Having considered all the factors we believe it is reasonable to conclude that for CGT purposes, the Family Trust acquired Sub lot pre-CGT. Landholder and the original trustee for the Family Trust, agreed prior to the first subdivision into Lots 1 and 2, that the Family Trust was to own Sub lot. The exact date of their agreement is unknown. However after weighing all the evidence we concluded it is more likely that the agreement was made pre-CGT than later. Therefore for CGT purposes, a contract was made pre-CGT and the Family Trust acquired its 100% interest in Sub lot as a result of that pre-CGT contract.

Issue 2 Question 2

Summary

Reasoning

Can the Family Trust disregard the capital gain it made on the disposal of Sub lot?

The Family Trust acquired Sub lot before 20 September 1985 (pre-CGT). When it disposed of Sub lot in the financial year ended 30 June 2010, CGT event A1 at section 104-10 of the ITAA 1997 happened. A capital gain from CGT event A1 is disregarded if the CGT asset was acquired pre-CGT.

Issue 2 Question 3

Summary

How is the capital gain from the disposal of Lot A to be apportioned between the Family Trust and the deceased estate?

Summary

Lot A was sold as one parcel of land, therefore a reasonable way to apportion the capital proceeds and the cost base between the two entities' interests has to be found.

We can view the disposal of Lot A as two CGT events. One happened to Sub lot belonging to the Family Trust. The other happened to the remaining area of Lot A belonging to the deceased estate.

It is the responsibility of the executors/trustee to determine the correct apportionment of the cost base and capital proceeds. They may be required to obtain professional valuations.

In making apportionments, the executors/trustee must be able to justify their apportionment. If one area of land can be separately valued, they must calculate the capital gain on the other area of land by apportioning the capital proceeds and the cost base on the basis of the valuation. If separate valuations are not possible the apportionment may be made on an area basis. However cost base elements which clearly relate to one area of land must be applied to that area of land only.

Detailed reasoning

Lot A was sold as one parcel of land. For CGT purposes it consisted of two CGT assets:

· Sub lot owned by the Family Trust; and

· The remaining area of Lot A owned by the deceased estate.

Our decision above is that the Family Trust acquired Sub lot pre-CGT and the capital gain made by the Family Trust will be disregarded.

The remaining area of Lot A was acquired by the deceased estate after 19 September 1985 (post-CGT). The capital gain on that remaining area is assessable income of the deceased estate. To the extent that the beneficiaries of the deceased estate are presently entitled to shares of the income of the deceased estate, they will be assessable rather than the executors of the deceased estate.

As the contract was for one parcel of land, a reasonable way to apportion the capital proceeds and the cost base between the two entities' interests has to be found, so that the appropriate capital gain for each of the Family Trust and the deceased estate may be determined.

We can view the disposal of Lot A as two CGT events. The rule in subsection 116-40(1) of the ITAA 1997 can then be applied to the capital proceeds. The important principle is that; 'the capital proceeds from each event are so much of the payment as is reasonably attributable to that event.' Guidance and examples of the practical application of subsection 116-40(1) of the ITAA 1997 are provided by the Commissioner in Taxation Determination TD 98/24. This Taxation Determination looks at post-CGT assets which consist of real property, which comprises separate CGT assets under Subdivision 108-D of the ITAA 1997. However the principles used apply to the situation of the Family Trust and deceased estate. The Commissioner states in part that:

2. On a CGT event happening to the real property, that CGT event happens to each separate asset comprising the property and a separate capital gain or loss calculation is necessary for each CGT asset. The capital proceeds from each CGT event are so much of the overall capital proceeds as is reasonably attributable to that event (subsection 116-40(1)).

3. If the property is disposed of under a contract and parties dealing with each other at arm's length allocate the overall capital proceeds to the separate assets in the contract, we will accept the allocation for the purpose of subsection 116-40(1).

5. In the absence of an agreed allocation, each party needs to make their own reasonable apportionment of the capital proceeds to the separate assets. In making this apportionment, it is expected that each party would generally have regard to, and be able to justify, their reasonable apportionment based on the relevant market values of the separate assets at the time of the making of the contract.

It is important to note that; 'In making this apportionment, it is expected that each party would ... be able to justify, their reasonable apportionment based on the relevant market values of the separate assets at the time of the making of the contract.' (TD 98/24, paragraph 5).

Similarly, the Commissioner provides guidance about apportioning the cost base in TD 1999/67 and ATO Interpretative Decision ATO ID 2002/691. The situations addressed are different to that of the Family Trust and deceased estate. For example, the question in ATO ID 2002/691 is:

Where a taxpayer purchased a block of land exceeding 2 hectares and subsequently constructed a main residence on it, can the cost base of the land be calculated on a pro rata area basis Rather than a valuation basis in determining the amount of capital gain to be disregarded under section 118-110 of the Income Tax Assessment Act 1997 (ITAA 1997)?

In spite of the different situation, the principles set out in the body of the ATO Interpretative Decision apply to the situation of the Family Trust and deceased estate. You should note particularly the following paragraphs from ATO ID 2002/691:

Where a taxpayer has land that exceeds 2 hectares, Taxation Determination TD 1999/67 states at paragraphs 3 to 5:

  '3. If your selected area of land can be separately valued, you calculate your capital gain or capital loss on the remainder of your land by apportioning the capital proceeds and the cost base or reduced cost base (if applicable) on the basis of the valuation. This is relevant if the value of the remainder of the land is of a greater or lesser value than your selected area of land.

  4. If your selected area of land cannot be separately valued, your capital gain or loss on the remainder of your land may be calculated by apportioning the capital proceeds and the cost base or reduced cost base (if applicable) on an area basis.

  5. The amount of the capital gain or capital loss attributable to the remainder of your land must be reasonable in the circumstances.'

It is clear from paragraph 3 of TD 1999/67 that where the value of the selected area of land for the main residence exemption is greater or less than the remainder of the land, and both areas can be valued separately, the capital gain or capital loss is calculated by apportioning the capital proceeds and the cost base, on the basis of valuation. However, paragraph 5 of TD 1999/67 further provides that the amount attributable must be reasonable in the circumstances.

It is the responsibility of the executors/trustee to determine the correct cost base and capital proceeds for Lot A and make the correct apportionments. This may include the need to obtain professional valuations.

Issue 3 Question 1

Detailed reasoning

Is each beneficiary's share of the deceased estate's capital gain, from its interest in Lot A assessable to the beneficiary?

Reasoning

The deceased estate acquired Lot A after 19 September 1985 (post-CGT). Its capital gain on the area of Lot A which is its interest in Lot A, is assessable income of the deceased estate. As such it is included in the calculation of its net income for the financial year ended 30 June 2010, under subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936). Each beneficiary is presently entitled to a share of the income of the deceased estate. Therefore each beneficiary's assessable income for the financial year ended 30 June 2010 includes a share of the net income of the deceased estate (subparagraph 97(1)(a)(i) of the ITAA 1936).

The meaning of the expressions, 'income of the trust estate' and 'share' referred to above, were considered by the High Court in its decision in Commissioner of Taxation v. Phillip Bamford & Ors; Phillip Bamford & Anor v. Commissioner of Taxation (Bamford ) [2010] HCA 10. As a result, uncertainty exists about the application of the Division in which the above expressions appear (Division 6 of Part III of the ITAA 1936). Therefore we have given detailed consideration to the will of Landholder and the information given to us about the finances of the deceased estate. The will provides that; 'the rest and residue of' Landholder's estate goes to the four beneficiaries; 'in equal shares as tenants in common'. The information you provided about the accounts states in part that:

… the financial statements for both trust estates have not been finalised to date. However we can confirm that [the deceased estate] did have net ordinary income in the 2010 financial year. Such net ordinary income does not include any statutory income ….

As a result we are satisfied that the executors of the deceased estate have correctly distributed its capital gain to the beneficiaries.

The correct amount of the deceased estate's capital gain to be included in the assessable income of each beneficiary is worked out under subdivision 115-C of the Income Tax Assessment Act 1997 (ITAA 1997). We believe that the deceased estate will reduce its capital gain by the CGT discount. Each beneficiary therefore has to double the amount which is their share of the deceased estate's net capital gain. Each can then reduce this by their personal his capital losses, if any. Each then reduces any remaining capital gain amount by 50%.

Issue 3 Question 2

Reasoning

Can each beneficiary disregard their share of the Family Trust's capital gain from Sub lot?

The capital gain which the Family Trust made from Sub lot is disregarded by it, because it acquired Sub lot before 20 September 1985 (pre-CGT). Therefore this capital gain is not included in the assessable income of the Family Trust for the financial year ended 30 June 2010. Thus, the capital gain is not used in working out its net income under subsection 95(1) of the ITAA 1936.

If a beneficiary is presently entitled to a share of the Family Trust's income for the financial year ended 30 June 2010, their assessable income will include a share of its net income (subparagraph 97(1)(a)(i) of the ITAA 1936). Since the capital gain from Sub lot was not used in the calculation of the net income, it cannot form part of the calculation of a beneficiary's assessable income from a share of the Family Trust's net income. So each beneficiary can disregard their share of the Family Trust's capital gain from Sub lot.