Edited version of your private ruling

Authorisation Number: 1012446299403

Ruling

Subject: Capital Gains Tax for a deceased estate

Question 1

Will the court order directing the transfer of interests in the various properties from X Pty Ltd to the administrators of the estate give rise to a CGT event?

Answer

Yes

Question 2

Is the cost base of the interests in the various properties that were originally acquired by the deceased prior to 20 September 1985, the market value of the properties on the date of the deceased's death?

Answer

No

Question 3

Is the cost base of the interests in the various properties that were originally acquired by the deceased after 20 September 1985, the deceased's original acquisition cost?

Answer

No

Question 4

Will the cost base of the interests in the various properties be their market value on the date the court order was issued?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

The deceased's will provided that the deceased's spouse was to be appointed as executor of the deceased's estate.

The deceased's spouse passed away prior to applying for a grant of probate in respect of the deceased's will. As a result a number of the deceased's children were appointed as administrators of the deceased's estate.

X Pty Ltd was incorporated in the 2002-03 financial year.

Y was the sole director of X Pty Ltd. Y was also a shareholder along with Z and their children.

X Pty Ltd is, and has been, the trustee of the M Trust.

X Pty Ltd is, has been, the trustee of the N Trust.

Until a point in time during the 2002-03 financial year, the deceased and their spouse were the registered proprietors, as tenants in common in equal shares, of a property. A portion of this land was acquired by the deceased and their spouse prior to 20 September 1985 and the remainder was acquired after 20 September 1985.

Additionally, the deceased and their spouse were the registered proprietors, as tenants in common in equal shares, of an additional property. This property was acquired by the deceased and their spouse after 20 September 1985.

The deceased purported to transfer their interest in the various properties to X Pty Ltd as trustee of the respective trusts.

The transfers were effectively made without consideration as the deceased forgave the debts arising from the transfer of the properties and reimbursed any proceeds that they did receive.

Following the transfers the deceased and their spouse commenced court proceedings against Y, Z, X Pty Ltd, and others.

The deceased and their spouse alleged, amongst other things:

Unconscionable conduct, undue influence and breaches of fiduciary duty against various defendants

That the deceased ultimately received no consideration for the transfers of their interests in the various properties

That X Pty Ltd was a company that the deceased did not control.

The deceased and their spouse sought an order directing, amongst other things:

X Pty Ltd to transfer the interests in the various properties to the deceased free of encumbrance

The Registrar of Titles to rectify the entry in the register book by recording the deceased as the registered proprietor of the interests in the properties

The claim was settled at mediation. The terms of the settlement were set out in a deed of settlement. The deed provided, amongst other things:

The exclusion of Y, Z and their children as beneficiaries of the M and N Trusts

Y's resignation as director and secretary of X Pty Ltd

The transfer of all shares in X Pty Ltd held by Y, Z and their children to the deceased and their spouse

Agreement that all necessary steps be taken to determine the M Trust

One of the deceased's children was appointed as director of X Pty Ltd following the settlement, and at that point they were not aware that the interests in the various properties had not been transferred back to the deceased following the settlement.

After becoming aware that the interests in the properties were never transferred back to the deceased, the administrators of the deceased's estate commenced further court proceedings seeking an order directing X Pty Ltd as trustee for the respective trusts to transfer the interests in the various properties to the administrators of the estate.

A court order was issued that declared that X Pty Ltd in its capacity as trustee of the relevant trusts holds the interests in the relevant properties on trust for the administrators of the deceased's estate. The court also directed that the properties be transferred to the administrators of the deceased's estate.

Pursuant to the court order, steps have been taken to transfer the interests in the various properties to the administrators of the deceased's estate. The transfers have been assessed to be exempt from duty and have been lodged with the land titles office for registration.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 104-10(2)

Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 Section 112-20

Reasons for decision

Detailed reasoning

You dispose of a CGT asset, and CGT event A1 occurs when change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner (subsection 104-10(2) of the ITAA 1997).

In this case, the legal title for the deceased's interests in the various properties was transferred to X Pty Ltd. It was contended that this transfer was as a result of unconscionable conduct and undue influence and that the deceased ultimately received no consideration for the transfer. The deceased and their spouse took legal action to this affect and sought, in addition to other things, that X Pty Ltd transfer the interests in the various properties back to the deceased free of encumbrance.

However, as a result of mediation, all parties concerned signed a deed in settlement of the claim. This deed confirmed that the registered proprietor of the interests in the various properties was X Pty Ltd. Instead of returning the legal title of the properties to the deceased, it was agreed that control of the trustee company, X Pty Ltd, would pass to the deceased and their spouse and that Y, Z and their children would be excluded as beneficiaries of the respective trusts. Additionally it was agreed that all necessary steps would be taken to determine the M Trust.

You contend that the transfer of control over X Pty Ltd was to facilitate the transfer of the legal titles of the properties to the deceased. However, this did not occur prior to the deceased's death.

Although the intention may have been to ultimately return the legal ownership of the interests in the properties to the deceased at some point in the future, the settlement deed effectively confirmed the legal and beneficial interests in the various properties remained with X Pty Ltd as trustee for the respective trusts.

Following the deceased's death the administrators of the deceased estate commenced a second court proceeding seeking to obtain an order to have the interests in the various propertied transferred from X Pty Ltd to the administrators of the estate. This court proceeding was successful and a court order was issued determining that the interests in the various properties were held on trust for the administrators of the estate and directing that those same interests be transferred to the administrators of the estate.

Steps have been taken to transfer the interests in the various properties to the administrators of the deceased's estate. Transfers have been lodged with the land titles office and await registration.

Constructive trust

A constructive trust is a trust imposed by operation of law, whenever equity considers it unconscionable for the party holding title to the property in question to deny the interest claimed by another. The existence of a constructive trust is dependent upon the order of the court, even though that order may operate retrospectively by dating the origin of the trust from some earlier wrongful act.

The court order created a constructive trust over the interests in the various properties. The court order did not however, provide that the origin of the constructive trust was to predate the order as a result of any alleged earlier wrongful act. Therefore, the constructive trust did not come into effect until the date of the court order.

Accordingly, prior to the creation of the constructive trust, the interests in the various properties were held by X Pty Ltd as trustee of the respective trusts. Although the deceased was a beneficiary of these trusts, beneficial ownership of the interests in the various properties would not rest with the deceased unless he was absolutely entitled to those assets as against the trustee.

Absolute entitlement

Draft Taxation Ruling TR 2004/D25 discusses the circumstances in which a beneficiary of a trust is considered to be absolutely entitled to a CGT asset of a trust as against its trustee. TR 2004/D25 explains that the provisions dealing with capital gains and losses treat an absolutely entitled beneficiary as the relevant taxpayer in respect of the asset.

The core principle underpinning the concept of absolute entitlement in the CGT provisions is 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.

The most straight forward application of this core principle is one where a single beneficiary has all the interests in the trust asset. However, TR 2004/D5 states at paragraph 13 that an object of a discretionary trust cannot be absolutely entitled prior to any exercise of the trustee's discretion in their favour.

The interests in the various properties were held by X Pty Ltd as trustee of the respective trusts. Both trusts were discretionary in nature and did not state any particular asset was held for any particular beneficiary.

While the properties were held by X Pty Ltd as trustee of the respective trusts the deceased did not have absolute entitlement. Accordingly, beneficial ownership of the properties did not remain with the deceased following the transfers to X Pty Ltd.

However, upon the creation of the constructive trust by operation of the court order, the deceased's estate became absolutely entitled to the interests in the various properties. This is because the deceased's estate was the sole beneficiary of the constructive trust and had a vested and indefeasible right to the assets.

CGT event E5 occurred when the administrators of the deceased's estate became absolutely entitled to the interests in the various properties.

Cost base

Under the general cost base and reduced cost base rules, the first element of the cost base and reduced cost base of a CGT asset is the sum of the amount paid (or required to be paid) and the market value of property given (or required to be given) in respect of acquiring it. The general rules may be modified if the market value substitution rule in section 112-20 of the ITAA 1997 applies.

The market value substitution rule generally applies where a taxpayer:

· did not incur any expenditure to acquire that asset

· incurred expenditure which cannot be valued in whole or in part, or

· did not deal at arm's length with the other entity in connection with the acquisition.

If the market value substitution rule applies, the first element of the cost base or reduced cost base of a CGT asset that is acquired from another entity is its market value at the time of acquisition (subsection 112-20(1) of the ITAA 1997).

The market value substitution rule applies in the case as the assets were acquired as a result of a court order and no expenditure was incurred to acquire it. Accordingly, the cost base of the interests in the various properties will be their market value on the date of the court order.