Edited version of your written advice

Authorisation Number: 1012710391905

Ruling

Subject: CGT - bankrupt estate - trustee obligations

Question 1

Is X, as trustee of Y's bankrupt estate, assessed under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997) on the capital gains arising from Y Transaction 1 or Y Transaction 2?

Answer

No

Question 2

Is X, as trustee of Z's bankrupt estate, assessed under Part 3-1 of the ITAA 1997 on the capital gains arising from Z Transaction 1 or Z Transaction 2?

Answer

No

Question 3

Is X, as trustee of Y's bankrupt estate, assessed under Part 3-1 of the ITAA 1997 on any capital gains which may arise from Y Transaction 3?

Answer

No

Question 4

Is X, as trustee of Z's bankrupt estate, assessed under Part 3-1 of the ITAA 1997 on any capital gains which may arise from Z Transaction 3?

Answer

No

Question 5

Does section 106-30 of the ITAA 1997 apply to all of the transactions with the result that any resulting capital gains are calculated as if they were derived by Y and Z respectively?

Answer

Yes

Question 6

Does the operation of section 106-30 of the ITAA 1997 negate any of X's (in his capacity of trustee of Y and Z's bankrupt estates) obligations under section 254 of the Income Tax Assessment Act 1936 (ITAA 1936) in relation to any capital gains that arise from any of the transactions?

Answer

No

Question 7

Is X, as trustee of Y's and Z's bankrupt estates, required to include any capital gain which may arise from any of the transactions in an income tax return lodged by them as trustee for the bankrupt estates?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ending 30 June 2015

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Y and Z acquired shares as a result of the sale of their business. Terms of the sale placed restrictions on when these shares could be disposed of.

Y was declared bankrupt and the Previous Y Trustees were appointed as trustees of Y's bankrupt estate. On this date, Y's shares vested in the Previous Y Trustees under the Bankruptcy Act 1966 (BA).

During the Previous Y Trustees' appointment, they sold a number of the shares (Y Transaction 1).

Subsequently, the Previous Y Trustees were removed as trustees, and in replacement, X was appointed as trustee. On this date, Y's remaining shares vested in X as trustee of the bankrupt estate under the BA.

Y's remaining shares were sold by X under Y Transaction 2 and 3.

Z was declared bankrupt and the Previous Z Trustee was appointed as trustee of Z's bankrupt estate. On this date, Z's shares vested in the Previous Z Trustee under the BA.

During the Previous Z Trustee's appointment, a number of Z's shares were sold under Z Transaction 1 and 2.

Subsequently, the Previous Z Trustee was removed as trustee, and in replacement, X was appointed as trustee. On this date, Z's remaining shares vested in X as trustee of the bankrupt estate under the BA.

Z's remaining shares were sold by X under Z Transaction 3.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Section 254

Income Tax Assessment Act 1997 Section 106-30

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

Subsection 106-30(1) of the ITAA 1997 states that for the purposes of Part 3-1 and Part 3-3 of the ITAA 1997, the vesting of an individual's capital gains tax (CGT) assets in the trustee under the BA is ignored.

The Explanatory Memorandum to the Income Tax Assessment Amendment (Capital Gains) Bill of 1986 explaining section 160W of the ITAA 1936 (the equivalent provision to section 106-30 of the ITAA 1997) stated that:

The effect of this section is that the asset is still considered to be owned by the insolvent person or company, notwithstanding that the asset is vested in a trustee or liquidator. Accordingly, no disposal takes place on the vesting of the asset in the trustee or liquidator but a disposal of the asset by the trustee or liquidator is considered to be a disposal by the insolvent person or company.

All of the relevant transactions occurred following the vesting of Y's and Z's assets in a trustee under the BA. Accordingly, section 106-30 of the ITAA 1997 will apply to all of the relevant transactions such that any capital gain made on the sale of the shares will be assessed to Y and Z respectively.

Section 254

Subsection 254(1) of the ITAA 1936 provides that if a trustee or agent derives income, profits or gains of a capital nature in their representative capacity, then the trustee or agent has various obligations and responsibilities to meet under section 254 of the ITAA 1936.

The gateway to the operation of subsection 254(1) of the ITAA 1936 is paragraph 254(1)(a) of the ITAA 1936. Paragraph 254(1)(a) of the ITAA 1936 provides that every agent or trustee is:

… answerable as taxpayer for the doing of all such things as are required to be done by virtue of this Act in respect of the income, or any profits or gains of a capital nature, derived by him or her in his or her representative capacity, or derived by the principal by virtue of his or her agency, and for the payment of tax thereon.

X, being a registered trustee under the BA, is a 'trustee' as defined in subsection 6(1) of the ITAA 1936.

For paragraph 254(1)(a) of the ITAA 1936 to apply to X as trustee, X must have derived income, profits or gains of a capital nature in their representative capacity. It is therefore necessary to determine whether the sale of the shares results in X as trustee deriving profits or gains of a capital nature for the purposes of section 254 of the ITAA 1936 and whether the operation of section 106-30 of the ITAA 1997 affects this.

Purpose

Section 254 of the ITAA 1936 does not of itself create a liability for the substantive tax (Fermanis v. Cheshire Holdings Pty Ltd (1990) 1 WAR 373; 90 ATC 4201 at 4203; (1990) 20 ATR 1862 at 1865, per Murray J). Rather any liability on the trustee under section 254 of the ITAA 1936 arises by reference to the substantive liability arising under other provisions of the tax acts. Its purpose and object is to provide the machinery provisions to ensure that the reporting, collection and other obligations under subsection 254(1) of the ITAA 1936 are carried out by the agent or trustee, who has undertaken the relevant action; and is not to be read as an assessing provision.

Draft Taxation Determination TD 2012/D6 explains the scheme of section 254 of the ITAA 1936 as follows:

'… the provision contemplates: income, profits or gains are derived or made; funds representing that income, profits or gains are received by an agent or trustee; the agent or trustee retains a sufficient amount from these funds to cover the income tax consequences arising from the derivation of the relevant income, profits or gains, or risks personal liability'.

This suggests that section 254 of the ITAA 1936 attempts to impose the obligations on the person who both acts in such a way that income, profits or gains are derived, and who receives that money such that they are in a position to pay the tax liability.

In the case of a trustee in bankruptcy, where the tax liability is imposed on the bankrupt (pursuant to section 106-30 of the ITAA 1997) but the bankrupt is unable to discharge their debt/s and the proceeds are received by the trustee, this purpose suggests that section 254 of the ITAA 1936 should operate to place tax obligations on the trustee in bankruptcy.

Gains of a capital nature

Section 254 of the ITAA 1936 as originally enacted, only referred to 'income derived by him in his representative capacity' (emphasis added).

When the CGT regime was introduced in 1986, section 254 of the ITAA 1936 was amended as follows:

Section 254 of the Principal Act is amended -

(a) by inserting ", or any profit or gains of a capital nature," after "income" in paragraph (1)(a);

(b) by inserting ", or those profits or gains," after "income" in paragraph (1)(b); and

(c) by inserting ", profits or gains" after "income" in paragraphs (1)(d) and (e).

The Explanatory Memorandum to the Income Tax Assessment Amendment (Capital Gains) Bill 1986, which introduced the above amendments, states at clause 33:

Sub-clause 33(a) proposes to amend paragraph 254(1)(a) by ensuring that agents and trustees are also answerable for things required to be done by virtue of the Act in respect of any profits or gains of a capital nature as well as in respect of income derived.

Where a legislature could have used the same word but chose to use a different word, it is presumed that the intention was to change the meaning (Pearce DC and Geddes RS, Statutory Interpretation in Australia 6th Edition, Butterworths, Australia 2006, at page 118). Even though there was a consequential amendment to section 254 of the ITAA 1936 when the CGT provisions were introduced in 1986, the words used in section 254 of the ITAA 1936 are not the same as the words used in the CGT provisions. Section 254 of the ITAA 1936 was amended to include 'gains of a capital nature' and did not refer to 'capital gains' or 'net capital gains' as used in Part 3-1 and Part 3-3 of the ITAA 1997. Therefore, the presumption is that the legislature intended that the words would have a different meaning.

In the present case, the shares had vested in the Previous Y and Z Trustees and subsequently in X as trustee who sold them and received the proceeds from those sales; however, the substantive liability arises under the CGT provisions and, pursuant to section 106-30 of the ITAA 1997, is imposed on the bankrupts.

It is, however, the Previous Y and Z Trustees and X in their representative capacity who legally owned and disposed of the shares. X received the proceeds of the sales; in relation to Y and Z Transaction 1 and Z Transaction 2, the proceeds were received as a result of the change in trustee and in relation to the remaining transactions, the proceeds were received directly. Therefore, it makes administrative sense for section 254 of the ITAA 1936 to operate in this instance such that X has the obligations in respect of 'gains of a capital nature'.

There is no context to suggest that 'gains of a capital nature' means the same thing as 'capital gains' or 'net capital gains' for the purposes of section 254 of the ITAA 1936.

As such, it is considered that 'gains of a capital nature' in the context of section 254 of the ITAA 1936, is a wide concept, that will include, but is also distinct from, making 'capital gains' and 'net capital gains'.

Are the gains of a capital nature 'derived' by the trustee in his representative capacity?

The term 'derived' is not defined in the ITAA 1936 or the ITAA 1997. It therefore takes its ordinary meaning in the context in which it appears.

In SCCASP Holdings Ptd Ltd as Trustee for the H&R Super Fund v. Commissioner of Taxation 2013 ATC 20-390, at [61], Lander, Siopis and Gilmour JJ said:

It is not possible, in our opinion, to discern from the ITAA 36 or ITAA 97 a technical meaning of the word "derived". It must bear whatever meaning is relevant, having regard to the context in which is appears in the Acts and by reference to the purpose for which the provision in which it is included is designed.

In Commissioner of Taxation v. Clarke (1927) 40 CLR 246 at 261, Isaacs ACJ said:

"Derived" only means "obtained" or "got" or "acquired". All income is derived from something and by someone … Paragraph (a) of s 52 of the Act 1915-1918 shows that income may be "derived" by an "agent" in his representative capacity.

In FCT v. Thorogood (1927) 40 CLR 454 at 458, Isaacs J added that 'derived' does not necessarily mean actually received, although receipt is the ordinary mode of derivation. An extension of this idea appears in IRC (NZ) v. NV Phillips' Gloeilampenfavrieken [1955] NZLR 868 at 884 per Gresson J:

The word "derived" means more than received; it connotes the source of origin, rather than the fund or place, from which the income is taken. It means flowing, springing, emanating from, or arising from or accruing.

In Commissioner of Taxes (SA) v. Executor Trustee and Agency Co of South Australia Ltd (1938) 63 CLR 108, it was said that essentially, income is derived when it 'comes in' or 'comes home', in whatever sense is most appropriate in the particular circumstances.

These passages demonstrate that the meaning of the word 'derived' is extremely wide and must be applied with consideration of the particular context in which it is used.

In section 254 of the ITAA 1936, derived is used in the context of 'gains of a capital nature', which, as concluded above, is a wide concept which is different to 'capital gains' and 'net capital gains'.

The CGT provisions in Part 3-1 and Part 3-3 of the ITAA 1997 do not use the term 'derived' to describe the making of a 'capital gain'. Rather, the CGT regime is premised on CGT events happening and the calculation of a capital gain or capital loss which a taxpayer makes from the event, such that a person 'makes' a capital gain. As the meaning of 'gains of a capital nature' is broader than the meaning of 'capital gain' or 'net capital gain', it follows that the concept 'derives' a gain of a capital nature will be different and broader than the concept of 'making' a capital gain for the purposes of Part 3-1 and Part 3-3 of the ITAA 1997.

As discussed above, the context and purpose of section 254 of the ITAA 1936 suggests that it is intended to work in situations where the primary means of reporting and collection (such as payment by the entity that is liable) may not work.

There is no context to suggest that a trustee of a bankrupt estate should be exempted from the obligations under section 254 of the ITAA 1936 by the operation of section 106-30 of the ITAA 1997. Were section 106-30 of the ITAA 1997 to apply to treat a bankrupt as deriving a gain of a capital nature for the purposes of section 254 of the ITAA 1936, such that there is a mismatch between the representative (acting in the capacity as trustee) and the derivation of the gain (the gain being made by the bankrupt), it would appear inconsistent with the intended operation of section 254 of the ITAA 1936.

The wording of paragraph 254(1)(a) of the ITAA 1936 is premised on the assumption that, if the representative is a trustee, they will derive the income, profits or gains; and if the representative is an agent, the principal will derive the income, profits or gains; which is the usual and natural incident of those relationships. Section 106-30 of the ITAA 1997 changes this for bankruptcy for the specific purpose of applying Part 3-1 and Part 3-3 of the ITAA 1997, but the context suggests that this change does not extend to the operation of section 254 of the ITAA 1936.

The Commissioner is of the view that deriving a gain of a capital nature for the purposes of section 254 of the ITAA 1936 means that the trustee 'obtains', 'gets' or 'receives' the proceeds from the disposal of a capital asset in a general law, rather than tax law sense. There is the receipt of monies, being the proceeds from a capital transaction by the trustee as the entity legally entitled to receive the sale proceeds, as it is the registered trustee who is the legal owner of the bankrupt's property. As such, for the purposes of section 254 of the ITAA 1936, X as trustee derives 'gains of a capital nature' in his representative capacity as a result of 'obtaining' or 'receiving' the proceeds from the sale of the shares (either directly or indirectly through the previous trustees), even though the CGT liability is imposed on the bankrupts.

Conclusion

Accordingly, section 106-30 of the ITAA 1997 does not operate to negate any obligations X may have under section 254 of the ITAA 1936 as a result of any capital gains made from any of the relevant transactions.

Lodgment

As discussed, section 106-30 of the ITAA 1997 applies to treat the bankrupts, Y and Z, as having derived any capital gain from the disposal of the shares under Part 3-1 of the ITAA 1997. Accordingly, the respective capital gains should be disclosed and assessed in the bankrupt individuals' returns, not in returns lodged by X as trustee of the bankrupt estates.