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Ruling

Subject: Capital Gains Tax

Question 1

Can capital gains tax (CGT) be deferred when an asset is transferred from a family trust to a unit trust where the main beneficiary of the family trust is a unit holder of the unit trust?

Answer

Question 2

Answer

No

Is the family trust able to access the CGT Small Business Concessions in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the disposal of the asset referred to in question 1?

Yes.

This ruling applies for the following periods:

1 July 2006 to 30 June 2007

1 July 2007 to 30 June 2008

1 July 2008 to 30 June 2009

1 July 2009 to 30 June 2010

The scheme commences on:

1 July 2006

Relevant facts and circumstances

The family trust in question sold an asset to a unit trust. The asset had been used in the business of the trust throughout the period that it was held. The consideration received at that time was a certain sum plus a percentage of the units in the unit trust. Further consideration was received subsequently.

The main beneficiary of the family trust is also a unit holder in the unit trust which acquired the asset. His initial allocation of units has since increased. The unit trust currently has several unit holders.

The family trust had an aggregated turnover for both the year in question and the previous year of less than $2 million. The maximum net asset value of the trust, as defined in section 152-15 of the ITAA 1997, is less than $6 million.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-60

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 152-205

Reasons for decision

Unless otherwise stated, all legislative references in the following Reasons for Decision are to the Income Tax Assessment Act 1997.

Question 1

Detailed reasoning

Section 104-60 states that CGT event E2 will occur when a CGT asset is transferred to an existing trust. The timing of the event is the point at which the asset is transferred.

Sub-section 104-60(5) specifies exceptions where event E2 is not deemed to have occurred. The operation of one of those exceptions, former paragraph 104-60(5)(b) has since been repealed. It stated that CGT event E2 did not happen in respect of the transfer of a CGT asset between two trusts if the beneficiaries and terms of both trusts were the same.

However, in the present case the beneficiaries of the family trust and the unit holders in the unit trust are not identical and the terms of the two trusts are not the same. As a consequence, the exception would not have been applicable to the circumstances in question.

The only other exception is paragraph 104-60(5)(a). It provides that E2 does not happen if you are the sole beneficiary of the trust, it is not a unit trust and the beneficiary is absolutely entitled to the asset as against the trustee (excluding any legal disability). That exception would equally not be applicable in this case.

Apart from the former sub-section 104-60(5) there are no exemptions from the operation of event E2 in respect of assets acquired after 19 September 1985. Therefore, in respect of the disposal in question, CGT event E2 will occur. There are no avenues available for deferring the occurrence of the CGT event though the making of a capital gain from that event may be deferred in certain circumstances as discussed below.

Question 2

Detailed reasoning

There are several concessions which may reduce or eliminate liability to pay tax on capital gains associated with the disposal of CGT assets. Those concessions are available, where certain qualifications are met, in respect of assets which are classified as active assets of a business.

In order for you to choose to disregard all or part of a capital gain under the small business concessions, all of the concessions require that at least the basic conditions are satisfied. With the exception of the small business 50% reduction, additional requirements attach to specific concessions.

The basic conditions are set out in section 152-10. They are:

(1) a CGT event happens in relation to an asset that the taxpayer owns: paragraph 152-10(1)(a)

(2) the event would otherwise have resulted in a capital gain: 152-10(1)(b)

(3) one or more of the following applies(152-10(1)(c):

· the taxpayer satisfies the maximum net asset value test

· the taxpayer is a "small business entity" for the income year

· the asset is an interest in an asset of a partnership which is a small business entity for the income year, and the taxpayer is a partner in that partnership, or

· the special conditions for passively held assets in sub-sections 152-10(1A) or 152-10(1B)are satisfied in relation to the CGT asset in the income year (see below) and

(4) the asset satisfies the active asset test: 152-10(1)(d).

In your case, paragraphs 152-10(1)(a) and 152-10(1)(b) are satisfied, as discussed in Question 1 above. A taxpayer will satisfy paragraph 152-10(1)(c) if they are a small business entity - or partner therein - for the whole income year or they satisfy the requirements of section 152-15.

Section 152-15 is the maximum net asset value test which a taxpayer will satisfy if the net value of their assets and those of connected entities does not exceed six million dollars. From the information supplied, you have indicated that the trust would satisfy the maximum net asset value test in section 152-15 and also the definition of a small business entity for the period in question and therefore meet the requirements of paragraph 152-10(1)(c).

Paragraph 152-10(1)(d) requires that the relevant asset must satisfy the active asset test in section 152-35. Section 152-35 provides that a CGT asset satisfies the active asset test if the asset was an active asset of the taxpayer:

· · for a total of at least half the period from when the asset is acquired until the CGT event, or

· · if the asset is owned for more than 15 years, for a total of at least 7½ years during that period.

Section 152-40 of the ITAA 1997 provides the meaning of an active asset. Sub-section 152-40(1) of the ITAA 1997 states:

A CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a *business that is carried on (whether alone or in partnership) by:

(i) you; or


(ii) your *affiliate; or


(iii) another entity that is *connected with you; or

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

You have advised that the asset in question was used by the trust in the course of carrying on a business. On that basis, it would be considered to be an active asset. You have also stated that it was so used for the majority of the period that it was held by the trust. Consequently, the active asset test in section 152-35 would be passed and the requirements of paragraph 152-10(1)(d) satisfied. Consequently, if you have met the requirements of each of the paragraphs of sub-section 152-10(1) then you would meet the basic conditions to utilize the small business concessions.

One of the concessions is the small business 50% reduction. Section 152-205 states that a capital gain may be reduced by 50 per cent provided that the basic conditions detailed above are met. Note that this discount is applied after applying the general discount available in Subdivision 115-A which in the case of trusts is also 50 per cent. The combined effect of the two discounts is to reduce the relevant capital gain by 75 per cent.

Further concessions available are the 15 year asset exemption in Sub-division 152-B, the retirement exemption in Sub-division 152-D and the small business rollover in Sub-division 152-E. Deferring CGT by applying the small business rollover would not be available in the present case as no replacement asset was acquired. The 15 year exemption is only available if the asset in question has been held for fifteen years and certain other conditions are met. However, the retirement exemption may be available provided that the conditions in Sub-division 152-D, as they apply to trusts, are met.

Further general advice

Trusts are entities in their own right and their affairs are entirely separate to the personal affairs of their individual beneficiaries or unitholders. Consequently, amounts owed by one entity to another are independent of and do not attach to the individual beneficiaries or unitholders.

In the present case, the amounts are owed by and owing to the unit trust and the family trust respectively and are not related to the affairs of the individuals of which they are composed. That is the case regardless of the percentage of the interest which an individual holds in the trust.

In respect of the transfer of the asset, the debt owed is an asset of the family trust and a liability of the unit trust. The percentage of units which are held in the unit trust provide a unit holder with an entitlement to a percentage of the income of the trust but does not attach to that unit holder a percentage of individual debts of the trust.