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Ruling Subject: CGT Event E5

Question 1

Did a Beneficiary of the Trust become absolutely entitled on any date during the income year ended 30 June 2012 to one or more of the shares in Company A held by the Trustee of the Trust, such that CGT event E5 in section 104-75 of the Income Tax Assessment Act 1997 (ITAA 1997) happened?

Answer

No.

Note: This ruling has only considered the application of CGT event E5 in section 104-75 ITAA 1997. It has not considered (and therefore cannot be taken as expressing a view on) whether any other CGT event may have happened in respect of a CGT asset of the Trust in the income year ended 30 June 2012.

This ruling applies for the following periods:

1 July 2011 to 30 June 2012

Relevant facts and circumstances

A clause of the Trust deed provides a "Vesting Date" which occurred during the 2012 income year.

The assets of the Trust include shares in a private company.

As of the 'vesting date' the trustee holds the shares (and any income not previously paid, applied or set aside for a beneficiary) in trust for the beneficiaries in equal shares.

The vesting date occurred during the 2012 income year

There is no understanding or agreement between the trustee and any of the beneficiaries that any specific share is held separately from the other shares solely for any beneficiary. The trustee has not appropriated any specific share to any beneficiary in satisfaction of their interest under the trust. No beneficiary has demanded an appropriation or transfer of any number of shares.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-75(1)

Ruling

Subject: Capital Gains Tax Events

Summary

No beneficiary of the Trust became absolutely entitled as against the trustee to any share in Company A held by the trustee of the Trust - either on the vesting date or on any other date in the income year ending 30 June 2012. Therefore, CGT event E5 in section 104-75 of the ITAA 1997 did not happen in that income year in respect of any of the shares held by the trustee of the Trust.

Detailed reasoning

Subsection 104-75(1) of the ITAA 1997 says:

(1) CGT event E5 happens if a beneficiary becomes absolutely entitled to a *CGT asset of a trust (except a unit trust or a trust to which Division 128 applies) as against the trustee (disregarding any legal disability the beneficiary is under).

Note: Division 128 deals with the effect of death.

If CGT event E5 happens, then the trustee makes a capital gain if the market value of the asset at the time of the event is more than its cost base: subsection 104-75(2).

The beneficiary may also make a capital gain if the market value of the asset at the time of the event is more than the cost base of beneficiary's interest in the trust capital to the extent it relates to the asset - though there are exceptions, including if the beneficiary acquired their interest for no expenditure and other than by way of assignment from another entity: subsections 104-75(5) and (6).

Each of the Company A shares held by the trustee of the Trust is a CGT asset. The Trust is not a unit trust or a trust to which Division 128 applies.

Draft Taxation Ruling 2004/D25 (TR) explains the circumstances in which a beneficiary of a trust is considered to be absolutely entitled to a CGT asset of the trust as against the trustee. The core principle underpinning the concept of absolute entitlement in the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997 is explained in paragraph 10 of the TR as follows:

…. the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction. This derives from the rule in Saunders v. Vautier applied in the context of the CGT provisions (see Explanation paragraphs 41 to 50). The relevant test of absolute entitlement is not whether the trust is a bare trust (see

Explanation paragraphs 33 to 40).

The TR's cover sheet provides the following information (though it is not part of the ruling):

The Tax Office is consulting with Treasury in relation to absolute entitlement and in particular the problem areas of joint and multiple beneficiaries, and the trustee's indemnity. TR 2004/D25 will not be finalised while this consultation is occurring. TR 2004/D25 will not be withdrawn and still represents the Tax Office view of the law. [emphasis added]

Before the vesting date the trustee's discretion to appoint income and capital meant the beneficiaries did not have a vested and indefeasible interest in the shares. Therefore, no beneficiary was absolutely entitled to any of the shares before the vesting date.

The fact that the trustee had a power of sale and a power to vary investments may also be regarded as inconsistent with the existence of absolute entitlement (refer Kafataris v. Deputy Commissioner of Taxation [2008] FCA 1454; 2008 ATC 20-048; 73 ATR 531; and the Decision Impact Statement issued by the Commissioner in respect of that decision).

Following the vesting date, each beneficiary has an interest in each of the Company A shares held by the trustee. But that means there are multiple beneficiaries with an interest in each share. In those circumstances, generally no one of the beneficiaries could be said to be absolutely entitled to any specific one of the shares. Relevantly, paragraph 23 of the TR says:

23. If there is more than one beneficiary with interests in the trust asset, then it will usually not be possible for any one beneficiary to call for the asset to be transferred to them or to be transferred at their direction. This is because their entitlement is not to the entire asset.

While paragraph 24 of the TR (set out immediately below) explains a circumstance in which such a beneficiary can be considered absolutely entitled to a number of the trust assets, it is considered that this circumstance is not present in this case.

24. There is, however, a particular circumstance where such a beneficiary can be considered absolutely entitled to a specific number of the trust assets for CGT purposes. This circumstance is where:

• the assets are fungible;

• the beneficiary is entitled against the trustee to have their interest in those assets satisfied by a distribution or allocation in their favour of a specific number of them; and

• there is a very clear understanding on the part of all the relevant parties that the beneficiary is entitled, to the exclusion of the other beneficiaries, to that specific number.

This is further explained in paragraphs 121 to 126 of the TR, which serve to show the very high evidentiary standard, in respect of the final dot point, required of relevant parties who would seek to assert absolute entitlement in these kinds of circumstances:

121. The fact that a specific number of fungible assets of a single asset class are held for each beneficiary must be consistent with any trust instrument and be evidenced by a contemporaneous written record, made by the trustee, of the number held for each beneficiary. However, where there is a trust instrument, and its terms unambiguously indicate a specific number of assets are for each beneficiary, then the trust instrument will be sufficient evidence of the number held for each beneficiary.

122. The requirement that there be a record of allocation means that when the trustee deals with a recorded asset, whether by distribution or otherwise (or there is any other occurrence that has CGT consequences such as an adjustment to the assets' cost base) they will specify which beneficiary's assets were the subject of that dealing. That is, it will be clear which beneficiary's asset was the subject of the dealing.

123. The records must be in writing. There is no prescribed form in which they must be made. The only requirement is that they clearly state the number of assets of an asset class to which a particular beneficiary is entitled for their own benefit to the exclusion of the other beneficiaries and, if applicable, the CGT attributes of each such asset.

124. Because the relevant situation is one where there are both shared interests and the holding of a specific number of assets for each beneficiary, a written record of allocation by the trustee (or a clear unambiguous trust instrument) is required. The record serves as confirmation that the trust is administered on the basis that a specific number of assets are held for each beneficiary, rather than on the basis of the shared interests. In the absence of such evidence it is considered that absolute entitlement is not established, regardless of the terms of the trust instrument.

125. In the absence of a record of asset allocation it would be reasonable to conclude that shared interests in the trust assets, by their very nature, prevent absolute entitlement. For example, if there are three assets and three beneficiaries who the trust deed says are to share equally in the assets, no one beneficiary is absolutely entitled to an asset unless the trustee has also recorded an allocation.

126. As this record of allocation is the final requirement for absolute entitlement, the making of the record may, if all of the other requirements for absolute entitlement are established, cause the beneficiaries named in the record to become absolutely entitled to the number of assets that the record shows as theirs. If it does, then CGT event E5 in section 104-75 of the ITAA 1997 will happen. In some circumstances, this event will trigger a taxing point for both the trustees and the beneficiaries.

As set out in the description of the scheme being the subject of this ruling, there is no agreement or understanding that a specific number of shares sis held for particular beneficiaries. Therefore, the vesting of the trust did not cause a beneficiary to become absolutely entitled to one or more of those shares as against the trustee.

Further, this state of affairs did not change at any time between the vesting date and the end of the relevant income year on 30 June 2012.

It is therefore considered that no beneficiary became absolutely entitled as against the trustee to any of the relevant Company A shares at any time during the income year ending 30 June 2012, and, on that basis, CGT event E5 did not happen in respect of any of the Company A shares in that income year.

As stated previously, this ruling discusses whether CGT event E5 happened during the 2012 income year (and concludes that it did not happen). It does not discuss whether any other CGT event happened in that income year and therefore cannot be taken as providing a view as to whether any other CGT event happened in that income year.