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Ruling

Subject: Minor beneficiaries of deceased estate

Questions and Answers:

Will the distribution by you (the trustee of a discretionary trust) of the entire capital gain derived from the sale of an asset to the deceased estate of your former beneficiary be treated as excepted income of the deceased estate and qualify for concessional tax treatment under subsection 102AG(2) of the Income Tax Assessment Act 1936 (ITAA 1936)?

No.

Will the distribution by you of 50% of the capital gain derived from the sale of an asset to the deceased estate of your former beneficiary be treated as excepted income of the deceased estate and qualify for concessional tax treatment under subsection 102AG(2) of the ITAA 1936?

Yes.

If a part of your distribution does not qualify as excepted income, will the Commissioner exercise his discretion and tax the distribution made by you to the deceased estate under section 99 rather than section 99A of the ITAA 1936?

Not applicable.

Does the sale of your asset qualify for 50% discount capital gains and the small business 50% active asset reduction?

Yes.

This ruling applies for the following period:

30 June 2012

30 June 2013

The scheme commences on:

1 July 2011

Relevant facts and circumstances

X and partner Y purchased an asset and established you (the trustee company) and discretionary trust (the Trust) to conduct the asset business. The family relationship subsequently broke down a few years later.

Later, a Family Court Order was made allowing both X and Y to continue holding the beneficial interest in the asset through the Trust. The Family Court Order provided that, upon the ultimate sale of the asset, the profit and capital gain be shared equally. In addition, any capital gains tax payable was also to be shared equally.

Attempts were made by X and Y to sell the asset but no acceptable offer was forth-coming. Y continued operating the asset but eventually it was disposed of. The Trust then leased the asset to another operator and continued to look for a buyer of the asset.

Later, for the purpose of Y's Centrelink entitlements, the AAT found that Y had control over you (the trustee company) and the Trust.

Later, Y died. The asset was eventually sold. The beneficiaries of Y's estate are Y's children.

As a result of Y's death, X became your sole director and, in that capacity, has discretionary power to determine the distribution of the income of the Trust. X wishes to distribute the entire proceeds from the sale of the asset to the deceased estate.

The child beneficiaries are not 'excepted persons' as defined in subsection 102AC(2) of the ITAA 1936. X's CGT assets and those of X's connected entities do not exceed $6 million. The deceased estate was granted probate and the deceased estate is now fully administered.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 98

Income Tax Assessment Act 1936 Section 99

Income Tax Assessment Act 1936 Section 99A

Income Tax Assessment Act 1936 Section 102AG

Income Tax Assessment Act 1997 Section 115-10

Income Tax Assessment Act 1997 Section 115-25

Income Tax Assessment Act 1997 Section 115-100

Income Tax Assessment Act 1997 Section 115-215

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 Rates Act Schedule 10

Income Tax Rates Act Schedule 12

Income Tax Rates Act Section 12

Reasons for decision

Beneficiaries of sale of asset

Taxation Determination TD 2001/26 is about the capital gains tax consequences for a beneficiary of a discretionary trust who renounces their interest in the trust. It explains:

The Social Security Act 1991 and the Veterans Entitlements Act 1986 ('Social Security Acts') have been amended by the Social Security and Veterans' Entitlements Legislation Amendment (Private Trusts and Private Companies - Integrity of Means Testing) Act 2000. The amendments, which will affect social security payments from 1 January 2002, provide for the income and assets of private trusts to be attributed to controlling individuals for the purposes of the means testing provisions of the Social Security Acts.

An affected beneficiary of a discretionary trust may wish to renounce their interest in the trust.

A renunciation by a beneficiary of an interest in a discretionary trust (the interest being a CGT asset) would give rise to CGT event C2 for the beneficiary because it is an abandonment, surrender or forfeiture of the interest (section 104-25 of the Income Tax Assessment Act 1997 ('ITAA 1997')).

In your case, we consider the beneficiaries, in equal shares of sale of the trust assets, are X and the estate of Y, as determined by the Family Court. We consider the AAT decision, for the purpose of upholding a Centrelink payment decision, does not change the determination made by the Family Court. The AAT decision deemed Y to be the "controller" of the trust assets for the purposes of administering the Social Security (Attributable Stakeholders and Attribution Percentages) Principles 2000. We consider such a decision has no bearing on family law or on beneficial and ownership interests under taxation law.

The fact that TD 2001/26 explains an affected beneficiary of a discretionary trust must renounce their controlling interest in a trust to preserve their eligibility for social security payments shows Centrelink means testing based on controlling interests does not alter ownership interests for capital gains tax purposes. If Centrelink means testing based on controlling interest altered ownership interests for capital gains tax purposes then renouncing controlling interests, which gives rise to a CGT event, would not be necessary.

As described in TD 2001/26, Ms Y was required to make a 'renunciation declaration' to relinquish her beneficial interest (before the disposal of the asset). As this did not occur, we consider the beneficiaries in equal shares of sale of the trust assets are X and the Estate of Y, as determined by the Family Court.

Trust distribution to deceased estate

Division 6AA of Part III of the ITAA 1936 applies to tax at higher rates the income of minors. These provisions are designed to prevent taxpayers diverting income or the capacity to earn income to children for the purpose of avoiding or reducing income tax. A minor who comes within Division 6AA is referred to as a 'prescribed person'. The whole of such a minor's assessable income, other than 'excepted assessable income', is subject to higher rates under Division 6AA.

Subsection 102AG(2) in Division 6AA of Part III of the ITAA 1936 is about 'excepted trust income'. It recognises certain income of minors, derived through certain trusts, should not be taxed at a higher rate, which includes income from deceased estates.

Taxation Ruling IT 2622 is about present entitlement during the stages of administration of deceased estates. It states until the estate of a testator has been fully administered and the net residue ascertained, a residuary beneficiary has no proprietary interest in (i.e., cannot enjoy present entitlement to) the corpus and income of the estate. IT 2622 includes a definition of 'fully administered', as follows:

…an estate has been fully administered by payment or provision for the payment of funeral and testamentary expenses, death duties, debts, annuities and legacies and the amount of the residue thereby ascertained…

IT 2622 provides, where the administration of a deceased estate is completed during the course of an income year, if a beneficiary is under a legal disability, the relevant share of the net income of the estate would be assessed in the manner required by section 98 of the Act.

Where a trustee of a trust estate who is liable to be assessed and to pay tax under section 98, where Division 6AA of Part III of that Act also applies, Schedule 12 of the Income Tax Rates Act 1986 provides the "eligible part" (i.e., the excepted trust income) is taxed as if one were an individual, where as the net income of the trust estate where Division 6AA of Part III of that Act applies is taxed at a rate of 45%.

Sections 99 and 99A of the ITAA 1936 are applicable where there is no beneficiary presently entitled to the income and corpus of a trust. Section 99A of the ITAA 1936 provides it does not apply in relation to a trust estate that results from a will, if the Commissioner is of the opinion that it would be unreasonable to apply section 99A in relation to that trust estate in relation to a year of income.

Schedule 10 of the Income Tax Rates Act 1986 provides a trustee who is liable to be assessed and to pay tax under section 99 will be taxed at individual tax rates where a resident trust estate is of a deceased person who died less than 3 years before the end of the year of income.

Subsection 12 of the Income Tax Rates Act 1986 provides the rate of tax payable by a trustee in respect of the net income of a trust estate in respect of which the trustee is liable, under section 99A of the Assessment Act, to be assessed and to pay tax is 45%.

In your case, as the deceased estate has been fully administered, the trustee of the deceased estate will be liable to pay tax under section 98 of the ITAA 1936 in respect to a distribution of capital gain you make to it. As the deceased estate only has beneficiaries who are prescribed persons under Division 6AA of Part III of the ITAA 1936, the assessable income of the deceased estate, arising from the will of Y, will be excepted trust income, liable to tax at individual tax rates.

However, any distributions from the Trust in relation to X's share of the asset will not be excepted trust income and will be taxed at the highest marginal tax rate of 45%.

As for sections 99 and 99A, these do not apply because the deceased estate has presently entitled beneficiaries (under legal disability).

Capital gains tax reduction & discount

Section 115-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides a discount capital gain can be made by an individual, complying superannuation fund and trust (but not by a company).

Section 115-25 provides, to be a discount capital gain, the capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the gain at least 12 months before the CGT event.

Section 115-100 provides the discount percentage is 50% if the gain is made by an individual or trust.

Section 115-215 sets out rules about how presently entitled beneficiaries are to calculate their net capital gain when using the method statement in subsection 102-5(1) of the ITAA 1997.

Section 152-10 of the ITAA 1997 lists the basic conditions that must be satisfied by a taxpayer to be eligible for CGT small business relief, which are:

(a) a CGT event happens in relation to a CGT asset of yours in an income year;

(b) the event would (apart from this Division) have resulted in the gain;

(c) at least one of the following applies:

(i) you are a small business entity for the income year;

(ii) you satisfy the maximum net asset value test (see section 152-15);

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

(d) the CGT asset satisfies the active asset test (see section 152-35).

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the net value of the CGT assets of yours and entities connected with you does not exceed $6,000,000.

The CGT asset satisfies the active asset test if you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period beginning when you acquired the asset and the happening of CGT event.

Under section 152-40, a CGT asset is an active asset at a time if, at that time:

b) 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…

Subsection 152-10(2) also has additional basic conditions for shares in a company or interests in a trust, namely:

If the CGT asset is a share in a company or an interest in a trust (the object company or trust), one of these additional basic conditions must be satisfied just before the CGT event:

c) you are a CGT concession stakeholder in the object company or trust; or

d) CGT concession stakeholders in the object company or trust together have a small business participation percentage in you of at least 90%.

In your case, you qualify for the 50% discount capital gain and satisfy the basic conditions for CGT small business relief under sections 152-10 and 152-40 of the ITAA 1997 because your relevant CGT assets do not exceed $6,000,000 and because your asset was an active asset, used in a business, for at least half your ownership period (which is confirmed by the expenses lodged in your tax returns).

Subsection 152-10(2) does not apply because your CGT asset, is not a beneficial 'interest in a trust' but, instead, merely an asset of a trust.

You reduce your capital gain in the following sequence: - first, you offset capital losses against capital gains; then you apply:

· the CGT discount

· the small business CGT concessions.

Also, section 115-215 sets out rules about how presently entitled beneficiaries are to calculate their net capital gain when using the method statement in subsection 102-5(1) of the ITAA 1997.