Edited version of your private ruling

Authorisation Number: 1012569283614

Ruling

Subject: Capital gains tax

Questions and answers:

1. Will the Commissioner regard that:

(a) the retained capital gains on sale of the assets post 30 June 2011 are not within the Australian taxing provisions of Subdivision 115-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

(b) the references to the calculation of net income for the purposes of Division 6 of the Income Tax Assessment Act 1936 (ITAA 1936), in section 115-210(1) of the ITAA 1997 do not bring within the Australian statues any of the non-Australian income and gains of these two foreign trusts as far as you are concerned;

Yes.

(c) the generation of the foreign capital gains that are retained within the country X fixed trusts are not assessable income to you?

Yes.

2. In respect of assets acquired by the foreign trusts before 20 September 1985 and disposed of by their trustees on or after the date you are regarded as becoming again an Australian tax resident, would the Commissioner agree that such capital gains and losses are to be disregarded pursuant to section 104-10(5)(a) of the ITAA 1997?

Yes.

Vesting of Trust 1

3. In respect of assets acquired by trust 1 and disposed by their trustees to you on vesting of that trust, if you are a tax resident of Australia (but also a foreign tax resident and so a dual tax resident of country X and Australia, will the Commissioner regard that:

(a) Any assets acquired before 20 September 1985 by the trust 1's trustees will be regarded as being acquired by you before 20 September 1985 such that future capital gains or losses on any subsequent disposal by you would be disregarded pursuant to section 104-15(4)(b) of the ITAA 1997?

No.

(b) In the alternative to (a) above, as you already are an income beneficiary, i.e. life tenant, and you were so before 20 September 1985 (and no further income beneficiaries were nor could have been added after that date), you can be regarded as already owning part of each of the assets in this trust that were acquired before 20 September 1985, that part being the capitalised value of the income flows from each asset in this trust, divided by the capital value of each of those assets, measured at the time of vesting for the purposes of section 104-10(5) of the ITAA 1997?

No.

(c) That in the alternative to (a) and/or (b) above you would be regarded as acquiring all assets that you are entitled to on vesting of trust 1 at their A$ values on the date of vesting and that these values would form the cost base of these assets pursuant to Subdivision 110-A of the ITAA 1997?

Yes.

Vesting of the foreign Estate

4. In respect of assets acquired by the foreign Estate and disposed by their trustees to you on vesting of that Estate, if you are a tax resident of Australia (but also a country X tax resident and so a dual tax resident of country X and Australia), will the Commissioner regard that:

(a) the foreign Estate is a trust to which Division 128 of the ITAA 1997 applies?

Yes.

(b) Any assets acquired from the foreign Estate's trustees from the foreign Estate will be regarded as being acquired by you on the date the deceased died pursuant to section 128-15(2) and for a cost base that equals the market value of those assets at date of death pursuant to section 128(4) item 4?

Yes.

(c) That in respect of those assets which are deemed to have been acquired at the date of death as they would be deemed to have been acquired by you before 20 September 1985, any future capital gains or losses on any subsequent disposal by you would be disregarded pursuant to section 104-15(4)(b) of the ITAA 1997?

Yes.

(d) That in respect of the document creating a sub-fund for half of the assets earmarked for your benefit should you reach a specified age under the foreign Estate, that this appointment is not the creation of a new trust but only a separate fund, such that assets received by you on vesting would be deemed to have been acquired by you before 20 September 1985, any future capital gains or losses on any subsequent disposal by you would be disregarded pursuant to section 104-15(4)(b)?

Yes.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You are a resident of Australia for taxation purposes.

You are a resident of country X for taxation purposes.

For the purposes of the DTA, you are a resident of country X for taxation purposes.

You are an income beneficiary of two foreign fixed trusts where your share of those trusts' net income cannot be accumulated and must be paid out to you.

The two foreign trusts are not resident trusts.

The first trust is Trust 1 which was settled prior to 20 September 1985.

The second trust is the deceased estate of your late relative who passed away prior to 20 September 1985.

These foreign trusts have made capital gains from the disposal of non-Australian assets.

There is no definition of income or capital in the foreign trust deeds.

You have no entitlement to capital, or to receive capital gains, until you reach a certain age in the future, as set out in the relevant trust deeds.

On failure to reach this age due to death, your children automatically become the capital beneficiaries.

In the meantime you are entitled to:

- 100% of the income from the deceased Estate which is an advancement of the assets under the Will of your relative who died prior to 20 September 1985;

- for Trust 1 you are entitled to 100% of the income in the Sub Fund that has assets earmarked for you once you reach the set age in the future; and

- 33.33% of the income in the remainder which you share with your two siblings.

A lot of the assets in these two trusts at their dates of establishment still remain in those trusts today and there have not been a lot of newly acquired assets nor have many disposals of assets been made.

The trustees of these two foreign trusts have made disposals of assets in the Australian tax year ended 30 June 2013 and also will make or are contemplating making capital gains on the sale of non-Australian shares and investments during the year ended 30 June 2014. The gains on these are retained within those trusts.

The Estate consists of shares in three foreign listed companies.

You were an Australian tax resident for a period of approximately five years whilst studying, however you did not have any vested and indefeasible interest in the corpus of Trust 1 nor in the remainder of the Estate since you had not attained the vesting age as required by those deeds.

You will attain vesting age in the 2014-15 financial year and so the entitlements under the Estate will definitely vest and Trust 1 may also then vest - the latter is not certain at this stage.

You are seeking clarification of the cost base of the assets that will vest to you and whether any of the trusts' assets will be regarded as being acquired before 20 September 1985 in your hands, should you then make a later disposal.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6
Income Tax Assessment Act 1936 Section 95
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 1997 Section 6-5
Income Tax Assessment Act 1997 Section 102-25
Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 Section 104-85
Income Tax Assessment Act 1997 Subdivision 108-A

Income Tax Assessment Act 1997 Subdivision 115-C
Income Tax Assessment Act 1997 Subdivision 128
Income Tax Assessment Act 1997 Subdivision 855-B

Convention between the Government of Australia and the Government of United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains Article 13.

Reasons for decision

Assessable income and the Convention between Australia and country X

As a general principle, section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) explains that an Australian resident is subject to tax in Australia on income derived from all (worldwide) sources, whereas a foreign resident is only subject to tax in Australia on income from Australian sources. A third category of taxpayer, one like yourself who is a dual resident of both Australia and country X, has their tax liability administered by the Convention between the Government of Australia and the Government of country X for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains (the agreement).

In these circumstances we are guided by the agreement for each category of income derived by the taxpayer. The agreement may state that one of the two countries has exclusive taxing authority over a particular form of income. Conversely, where the agreement does not specify one country has taxing rights, you may be subject to tax in both country X and Australia.

You have asked about the assessability of income derived from capital gains that is currently being retained by the trustees of the two foreign trusts for which you are a beneficiary.

The agreement between Australia and country X discusses liability to capital gains under the relevant Article (alienation of property). The Article states:

1. Income or gains derived by a resident of a Contracting State from the alienation of real property situated in the other Contracting State may be taxed in that other State.

4 Income or gains derived by a resident of a Contracting State from the alienation of any shares or other interests in a company, or of an interest of any kind in a partnership, trust or other entity, where the value of the assets of such entity, whether they are held directly or indirectly (including through one or more interposed entities, such as, for example, through a chain of companies), is principally attributable to real property situated in the other Contracting State, may be taxed in that other State.

8 The situation of interests or rights referred to in paragraph 2 of Article 6 shall be determined for the purposes of this Article in accordance with paragraph 3 of Article 6.

The agreement explains the meaning of 'real property' to include

(a) a lease of land or any other interest in or over land;

(b) property accessory to real property;

(c) livestock and equipment used in agriculture and forestry;

(d) usufruct of real property;

(e) a right to explore for mineral, oil or gas deposits or other natural resources, and a right to mine those deposits or resources; and

(f) a right to receive variable or fixed payments either as consideration for or in respect of the exploitation of, or the right to explore or exploit, mineral, oil or gas deposits, quarries or other places of extraction or exploitation of natural resources.

Ships and aircraft shall not be regarded as real property.

The agreement further states:

3 Any interest or right referred to in paragraph 2 shall be regarded as situated where the land, mineral, oil or gas deposits, quarries or natural resources, as the case may be, are situated or where the exploration may take place.

Another Article of the agreement covers all other income not otherwise dealt with. It says:

1 Items of income beneficially owned by a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.

2 The provisions of paragraph 1 of this Article shall not apply to income, other than income from real property as defined in paragraph 2 of Article 6 of this Convention, derived by a resident of a Contracting State who carries on business in the other Contracting State through a permanent establishment situated therein and the right or property in respect of which the income is paid is effectively connected with such permanent establishment. In that case the provisions of Article X of this Convention shall apply.

3 Notwithstanding the provisions of paragraphs 1 and 2 of this Article, items of income of a resident of a Contracting State not dealt with in the foregoing Articles of this Convention from sources in the other Contracting State may also be taxed in the other Contracting State.

4 Where, by reason of a special relationship between the person referred to in paragraph 1 of this Article and some other person, or between both of them and some third person, the amount of the income referred to in that paragraph exceeds the amount (if any) which might reasonably have been expected to have been agreed upon between them in the absence of such a relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such a case, the excess part of the income shall remain taxable according to the laws of each Contracting State, due regard being had to the other applicable provisions of this Convention.

5 A person may not rely on this Article to obtain relief from taxation if it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the rights in respect of which the income is derived to take advantage of this Article by means of that creation or assignment.

The agreement does not state that either country X or Australia has exclusive taxing rights and therefore you may be subject to tax in both country X and Australia on income from capital gains.

For clarification we will examine Australia's domestic taxation laws further.

Assessability of trust income

Division 6 of the Income Tax Assessment Act 1936 (ITAA 1936), which comprises sections 95AAA to 102, provides for the assessment of income tax on the income of a trust estate and on amounts of income distributed by the trust estate.

Section 97 of the ITAA 1936 provides, in effect, that where a beneficiary is presently entitled to a share of the income of a trust estate and is not under a legal disability he is liable to be assessed on so much of that share of the net income as is attributable to Australian sources. He is also assessable on so much of that share as is attributable to sources out of Australia and to a period when the beneficiary was a resident.

You are not presently entitled to your share of the capital or capital gains of either trust and therefore section 97 of the ITAA 1936 does not apply to you.

Section 98 of the ITAA 1936 applies where a beneficiary of a trust estate who is under a legal disability is presently entitled to a share of the income of the trust estate, the trustee of the trust estate shall be assessed and liable to pay tax in respect of:

(a) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident; and

(b) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia;

(c) as if it were the income of an individual and were not subject to any deduction.

You are not under a legal disability: section 98 of the ITAA 1936 does not apply to either of the trusts.

Where there is income of the trust estate to which no beneficiary is presently entitled, then the trustee is assessable under sections 99 and 99A of the ITAA 1936.

Trusts with net capital gains

The income of a trust estate is the amount that, under trust law principles and the relevant terms of the trust deed, is treated as income of the trust estate. In other words, it is the trustee who ascertains the income of the trust estate according to appropriate accounting principles and the trust deed.

Subdivision 115-C of the ITAA 1997 sets out rules for dealing with the net income of trusts that have net capital gains. The rules treat parts of the net income attributable to the trusts' net capital gain as capital gains made by the beneficiary entitled to those parts. As you are not yet entitled, Subdivision 115-C has no application.

You are a beneficiary of two foreign trusts. The first trust Trust 1 was settled prior to 20 September 1985 and you acquired your right to your share of the trust prior to the introduction of capital gains tax (CGT) legislation which came into effect from 20 September 1985. Therefore your right to trust 1 is a pre-CGT asset.

The second trust is the deceased estate of your late relative who passed away prior to 20 September 1985. Hence, you acquired your right to your share of the deceased estate on the date of death and this is also a pre-CGT asset.

Subdivision 108-A explains what a CGT asset is and includes a legal or equitable right that is not property at paragraph 108-5(1)(b).

You became a resident of Australia for tax purposes after 20 September 1985 and as a beneficiary of the two foreign trusts Subdivision 855-B of the ITAA 1997 applies. Under section 855-45 of the ITAA 1997, when you become an Australian resident you are taken to have acquired each CGT asset that you own just before becoming an Australian resident for its market value at the time of becoming an Australian resident, except for an asset:

(a) that is taxable Australian property as defined in section 855-15 of the ITAA 1997; or

(b) that was acquired before 20 September 1985.

On becoming an Australian resident you had rights to your share of two foreign trusts which you had acquired pre-CGT. You were not presently entitled to the capital or capital gains of either trust. Pursuant to section 855-45(b) of the ITAA 1997, because your rights were pre-CGT assets you did not acquire them when you became an Australian resident.

Section 115-210 of the ITAA 1997 explains that Subdivision 115-C applies if a trust estate has a net capital gain for a financial year that is taken into account in working out the trust estate's net income (as defined in section 95 of the Income Tax Assessment Act 1936 (ITAA 1936)) for the financial year.

Section 95 of the ITAA 1936 requires the trustee of a trust estate to calculate the net income of the trust as if the trustee were a taxpayer in respect of that income and a resident. As we have discussed above, residents of Australia are required to include capital gains or capital losses from all sources in the calculation of their net capital gain for a year of income.

Section 115-222 of the ITAA 1997 explains that where a trustee makes a capital gain, the trustee is assessed under either section 99 or section 99A of ITAA 1936. Sections 99 and 99A of ITAA 1936 are interrelated and must be read together in order to determine which provision applies in a particular situation.

Section 99A of the ITAA 1936, which imposes a penalty rate of tax, applies automatically unless the capital gain comes within an exclusion in section 99A(2) and the Commissioner considers that it is unreasonable for section 99A to apply. Trusts normally excluded from section 99A include testamentary trusts.

· The deceased estate is a testamentary trust and therefore section 99A of the ITAA 1936 does not apply to that trust; therefore section 99 applies.

Because section 98 of the ITAA 1936 is not applicable to trust 1, the rules of section 99A of the ITAA 1936 are applied to that trust.

Application of section 99 and 99A to non-resident trust estates

The rules in sections 99 and 99A of the ITAA 1936 (regarding the assessment of income in the hands of the trustee if there is a portion of the income of the trust estate to which no beneficiary is presently entitled) apply only to the part of the net income of the trust estate arising from Australian sources.

Section 99(4) of the ITAA 1936 explains that where there is no part of the net income of a trust estate that is not a resident trust estate:

(a) that is included in the assessable income of a beneficiary under section 97,

(b) in respect of which the trustee is assessed and liable to pay tax under section 98, or

(c) that is attributable to sources out of Australia,

the trustee is assessed and is liable to pay tax on the net income as if it were the income of an individual and not subject to any deduction.

Section 99(5) of the ITAA 1936 goes on to explain that where there is a part of the net income of a trust estate that is not a resident trust estate that does not meet the conditions in (a) to (c) above, the trustee is assessed and is liable to pay tax on that part of the net income as if it were the income of an individual and not subject to any deduction.

Subsections 99(4) and 99(5) of the ITAA 1936 ensure that only Australian source income to which no beneficiary is presently entitled is assessed to the trustee of a non-resident trust estate.

You are a beneficiary of the two non-resident trusts which both have retained foreign capital gains to which you are not presently entitled. The trusts are not resident trusts and the capital gains are not attributable to sources within Australia. The capital gains are therefore not assessable in Australia.

CGT implications - post vesting

Section 102-25 of the ITAA 1997 sets out the ordering rules as to which CGT event happens in a particular situation or circumstance. CGT event E5 or E7 will happen on the vesting of each of the trusts, depending on how promptly the assets of the trusts are transferred to you.

Section 104-75 of the ITAA 1997 says that CGT event E5 happens when a beneficiary becomes absolutely entitled to a CGT asset of a trust as against the trustee. The event applies to both the trustee and the beneficiary.

CGT event E7 happens if the trustee of a trust 'disposes of' a CGT asset of the trust to a beneficiary so as to satisfy the beneficiary's interest, or part of an interest, in the capital of the trust (section 104-85(1)).

In some cases there may be a delay before the transfer of ownership passes to a beneficiary and in these instances, CGT event E5 will occur. Alternatively, if the transfer of ownership is immediate, a CGT event E7 takes place. There is no variance in the outcome of each event as they apply to you; either will have the same result.

Trust 1

CGT event E5 does not happen to a trustee if the trustee acquired the asset before 20 September 1985 (section 104-75(4)).

CGT event E5 does not happen to a beneficiary if the asset to which the beneficiary becomes absolutely entitled was acquired before 20 September 1985 or if the beneficiary's interest in the trust was acquired before that date (section 104-75(6)).

Because the trustee acquired the assets of the 1958 trust before 20 September 1985, CGT event E5 will not happen to the trustee when you become absolutely entitled to the assets of the trust.

Similarly, because you acquired the rights to the assets of trust 1 before 20 September 1985, CGT event E5 will not happen to you as beneficiary when you become absolutely entitled to the assets of the trust.

If CGT event E7 occurs for both the trustee and yourself on vesting of trust 1 it will be disregarded under section 104-85(6). This is because the trustee will be disposing of a pre-CGT asset to you and you will dispose of your pre-CGT right to the asset on vesting. Note, however, that your consequential acquisition of your share of the assets of the trust will not retain their pre-CGT status. You will acquire all assets as an Australian resident for market value on the date of vesting.

Deceased estate

In the case of a person who died before 20 September 1985, any asset that formed part of the estate that passed to the legal personal representative or to a beneficiary in the estate is taken to have been acquired by the legal personal representative or beneficiary at the date of the person's death (i.e. before 20 September 1985), notwithstanding that it may not be transmitted to the legal personal representative or beneficiary at any time after 20 September 1985 (section 128-15(2) of the ITAA 1997).

Typically and as is the situation here, CGT event E5 happens when a beneficiary reaches a certain age and under the terms of the trust, becomes absolutely entitled to an asset held in trust.

Taxation Determination TD 2004/3 Income tax: capital gains: does an asset 'pass' to a beneficiary of a deceased estate under section 128-20 of the Income Tax Assessment Act 1997 if the beneficiary becomes absolutely entitled to the asset as against the trustee of the estate? states that CGT event E5 does not apply where a beneficiary of a deceased estate becomes absolutely entitled to an asset of the estate as this satisfies the requirements for the "passing" of an asset to a beneficiary of the estate under the rules in Division 128 of the ITAA 1997.

In this case any capital gain or capital loss will be disregarded by the roll-over relief effect of section 128-15(3) of the ITAA 1997.

As mentioned above, CGT event E5 does not happen to either the trustee or a beneficiary if the asset to which the beneficiary becomes absolutely entitled was acquired before 20 September 1985 or if the beneficiary's interest in the deceased estate was acquired before that date (section 104-75(6)).

Because the deceased died before 20 September 1985, the trustee acquired the assets of the deceased estate before 20 September 1985. CGT event E5 will not happen to the trustee when you become absolutely entitled to the assets of the deceased estate.

Similarly, because you acquired the rights to the assets of the deceased estate before 20 September 1985, CGT event E5 will not happen to you as beneficiary when you become absolutely entitled to the assets of the deceased estate.

CGT event E7 does not happen if the trust is one to which Division 128 of the ITAA 1997 applies. Division 128 deals with the effect of a taxpayer's death. As the deceased estate falls under Division 128 it is not affected by CGT event E7.

The assets that formed part of the deceased estate at the time of death of your uncle are taken to be acquired by you on the date of his death and they retain their pre-CGT status on vesting.

However, any assets acquired by the estate after death and after 20 September 1985, would transfer to you at their market value on the vesting date and will not be pre-CGT assets.