Edited version of your private ruling

Authorisation Number: 1012593310388

Ruling

Subject: Deceased estate - CGT

Question 1

Will the trustee of the Estate make a capital gain or loss if the Property is distributed under the proposed deed of arrangement?

Answer

Yes

Question 2

If the Property is distributed under the proposed deed of arrangement, will the entire Property be considered to pass to a beneficiary within the meaning of section 128-20 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 3

If the answer to Question 2 is yes, will the payment represent capital proceeds from a separate CGT event?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2014

The scheme commenced on:

1 July 2013

Relevant facts and circumstances

The Property forms part of the Estate.

The deceased owned the Property; they acquired separate interests in the property on two separate occasions.

The deceased died leaving two wills. The distribution of the assets under the First Will was different to that under the Second Will.

The executor of the Estate, by reason of their concerns regarding the capacity of the deceased at the time they made the Second Will, commenced proceedings seeking a grant of probate for the First Will.

X and Y joined the proceedings as defendants and cross-claimants seeking, inter alia, orders that a grant of probate issue for the Second Will.

Following negotiations, the relevant parties have agreed to enter into a deed of arrangement to distribute the assets of the Estate in place of the First and Second Will. However a condition precedent to the distribution of the assets of the Estate is that probate be granted on the Second Will, failing which the obligations of the parties in accordance with the deed of arrangement will come to an end.

Under the proposed deed of arrangement X and Y's interests in the assets of the Estate are diminished; however, the Property will be transferred to them. Additionally they are required to make a payment to the estate.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 104-25(1)

Income Tax Assessment Act 1997 Subsection 104-25(2)

Income Tax Assessment Act 1997 Section 106-50

Income Tax Assessment Act 1997 Paragraph 108-5(1)(b)

Income Tax Assessment Act 1997 Division 128

Income Tax Assessment Act 1997 Subsection 128-15(2)

Income Tax Assessment Act 1997 Section 128-20

Income Tax Assessment Act 1997 Paragraph 128-20(1)(d)

Reasons for decision

Under Division 128 of the ITAA 1997 when a person dies a capital gain or capital loss from a capital gains tax (CGT) event that results from a CGT asset the person owned just before dying is disregarded. In accordance with subsection 128-15(2) of the ITAA 1997, a legal personal representative (LPR) or a beneficiary is taken to have acquired the asset on the day the deceased died. Any subsequent disposal by the LPR or beneficiary is a CGT event which will result in a capital gain or loss.

Who is the relevant taxpayer?

Where a beneficiary is absolutely entitled to a CGT asset as against the trustee, section 106-50 of the ITAA 1997 states that any act done in relation to the CGT asset by the trustee will be treated as if the act was done by the absolutely entitled beneficiary.

Example:

An individual becomes absolutely entitled to a CGT asset of a trust. The trustee later sells the asset. Any capital gain or loss from the sale is made by the individual, not the trustee.

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.

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.

Where more than one beneficiary has an interest in the trust assets, absolute entitlement can only be established if the assets are fungible and conveniently divisible without prejudice to the other beneficiary.

In this case, following probate and prior to the transfer of the Property, X and Y will not be absolutely entitled to the Property. This case is similar to the example provided at paragraphs 154-158 of TR 2004/D25 in that neither X or Y would be entitled to have the Property transferred to them as to do so would defeat the interest of the other. Similarly, neither X or Y could direct that a half share of the Property be transferred to them as to do so would prejudice the other.

As X and Y will not be absolutely entitled to the Property as against the trustee of the Estate, section 106-50 of the ITAA 1997 will not apply to treat X and Y as the relevant taxpayer in relation to any future disposal of the Property by the trustee. The trustee of the Estate (or LPR) is the relevant taxpayer in relation to any capital gain or loss made as a result of the proposed transfer of the Property.

Will the asset 'pass' under section 128-20 of the ITAA 1997?

Any capital gain or loss made by the trustee of a deceased estate (or LPR) is disregarded if an asset of the estate passes to a beneficiary in accordance with section 128-20 of the ITAA 1997.

Section 128-20 of the ITAA 1997 provides the ways in which an asset can 'pass' to a beneficiary for the purposes of Division 128 of the ITAA 1997. Paragraph 128-20(1)(d) of the ITAA 1997 provides that for CGT purposes an asset 'passes' to a beneficiary in the estate of a deceased person if the beneficiary becomes the owner of the asset under a deed of arrangement provided that:

· the beneficiary entered into the deed to settle a claim to participate in the estate; and

· the consideration given by the beneficiary consisted only of the variation or waiver of a claim to an asset or assets that formed part of the estate.

In this case, the executor of the Estate has disputed the validity of the Second Will. The relevant parties intend to reach a settlement in relation to the dispute and under the proposed deed of arrangement the executor will agree to seek probate of the Second Will. The deed of arrangement will also require that X and Y make a payment to the Estate. Finally, the deed of arrangement will determine the final distribution of the Estate assets.

X and Y's entitlements to assets of the Estate under the deed of arrangement are significantly diminished in comparison to their original entitlements under the Second Will. Accordingly, we do not consider that the payment made under the deed of arrangement represents consideration for the Property.

Rather we consider that the payment is made to the Estate in relation to the settlement of the dispute regarding the validity of the Second Will.

We accept that X and Y will enter into the proposed deed of arrangement to settle their claim to participate in the Estate and we have determined that they have not provided any further consideration in relation to the Property. Accordingly, it will 'pass' to them in accordance with section 128-20 of the ITAA 1997.

Subsequently any capital gain or loss made by the trustee on the transfer of the Property will be disregarded under subsection 128-15(3) of the ITAA 1997.

Does another CGT event occur?

A CGT asset includes a legal or equitable right that is not property (paragraph 108-5(1)(b) of the ITAA 1997). Where an intangible asset, such as a legal or equitable right is disposed of, CGT event C2 occurs under subsection 104-25(1) of the ITAA 1997.

In this case, we consider that the proposed deed of arrangement will also trigger CGT event C2 for the Estate as the executor is disposing of their right to dispute the validity of the Second Will.

Subsection 104-25(2) of the ITAA 1997 states that the time CGT event C2 occurs is:

· when you enter into the contract that results in the relevant asset ending; or

· if there is no contract - when the asset ends.

If a contract is subject to a condition, it does not affect the time of the making of the contract unless it is a condition precedent to the formation of the contract (Taxation Determination TD 94/89). Contracts subject to a condition precedent to the formation of a contract are not binding until that condition is met. No contract would be in existence before the condition is fulfilled, therefore, the time of entering into the contract, for the purposes of CGT event C2, would be the time when the condition is fulfilled.

Accordingly, CGT event C2 will occur when the conditions precedent to the proposed deed of arrangement are fulfilled. The payment from X and Y in relation to the settlement of the dispute will represent the capital proceeds for the C2 event.