Edited version of your written advice

Authorisation Number: 1013084019075

Date of advice: 14 October 2016

Subject: Trust-capital gains tax-non-resident beneficiary

Question 1:

Is the Estate of the deceased (the Trust) a 'fixed trust' for the purposes of section 272-65 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) and subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

Question 2:

Can the non-resident beneficiary disregard a capital gain made from a CGT event happening in respect of their interests in a fixed trust under section 855-40 of the ITAA 1997?

Answer:

Yes.

This ruling applies for the following period:

Year ended 30 June 2015

The scheme commenced on:

1 July 2014

Relevant facts and circumstances

Person A passed away a number of years ago.

The Will of Person A was granted probate by a court.

Person A (the deceased) had only one child at the date of their death.

The child now an adult (Y) resides overseas and is a non-resident of Australia for taxation purposes.

As provided in Clause X of the Will, all income of the Trust has been distributed to Y since the death of person A. The Trustee has power under the Will to distribute capital to the beneficiary if and when needed.

Clause X of the Will further provides that the Trust should vest 100% as to income and capital to the only child of the deceased (Y) at any time Y ceasing to be the spouse of YZ. This condition is satisfied when the beneficiary and their spouse divorced.

The Trustee of the Trust holds trust funds invested in various assets including unit trust managed investment funds.

The shares and units held in managed investment funds are not taxable Australian property for the purposes of Division 855 of the ITAA 1997.

There were no other clauses, codicils or other such instructions attached to the Will.

Relevant legislative provisions

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 Section 272-5 of Schedule 2F

Income Tax Assessment Act 1936 Subsection 272-5(1) of Schedule 2F

Income Tax Assessment Act 1936 Section 272-65 of Schedule 2F

Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 Subsection 855-10(1)

Income Tax Assessment Act 1997 Section 855-20

Income Tax Assessment Act 1997 Section 855-40

Income Tax Assessment Act 1997 Subsection 855-40(2)

Income Tax Assessment Act 1997 Subsection 855-40(3)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Fixed Trust

Section 272-65 of Schedule 2F to the ITAA 1936 provides that a trust is a 'fixed trust' if persons have fixed entitlements to all of the income and capital of the trust. Subsection 995-1(1) of the ITAA 1997 provides that a trust is a fixed trust if entities have fixed entitlements to all of the income and capital of the trust.

Subsection 272-5(1) of Schedule 2F to the ITAA 1936 where it provides that, in relation to the meaning of the term fixed entitlement:

If, under a trust instrument, a beneficiary has a vested and indefeasible interest in a share of income of the trust that the trust derives from time to time, or of the capital of the trust, the beneficiary has a fixed entitlement to that share of the income or capital.

It is an essential element of subsection 272-5(1) of Schedule 2F to the ITAA 1936 provides that in order to have a fixed entitlement to a share of income or capital there must be a vested or indefeasible interest 'under a trust instrument'. In all cases, the determining factor in deciding if fixed entitlements exist will be the terms of the trust instrument under which the trust is constituted.

The meaning of the term 'vested and infeasible' (in the context of the Schedule 2F) has not been judicially considered. However, the term appears in Division 6 in subsection 95A(2) of the ITAA 1936 and in the context of that subsection, the term has been considered by the courts; for example, refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4,525; Walsh Bay Developments Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4378; Dwight v Commissioner of Taxation (1992) 92 ATC 4192; Harmer v FC of T (1991) 91 ATC 5000.

Also relevant are MSP Nominees Pty Ltd v Commissioner of Stamps (SA) (1999) 198 CLR 494; 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490.

The term 'vested and indefeasible' is not defined in the taxation legislation and to date there is no 'ATO view' which defines or clarifies the term.

The Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 which introduced the trust loss measures gives an explanation in relation to the meaning of 'vested and indefeasible' interest (see paragraphs 13.3 to 13.9).

What is a vested interest?

The EM states:

13.4 A person has a vested interest in something if the person has a present right relating to the thing. Stated simply, a vested interest is one that is bound to take effect in possession at some point in time. A vested interest is to be contrasted with a 'contingent' interest which may never fall into possession. If an interest of a beneficiary in income or capital is the subject of a condition precedent, so that an event must occur before the interest becomes vested, the beneficiary does not have a vested interest to the income or capital since such an interest is instead 'contingent' upon the event occurring.

13.5 In traditional legal analysis, a person can be said to be either 'vested in possession' or 'vested in interest'. A present interest, i.e. one that is being enjoyed, is said to be 'vested in possession'; a future interest, i.e. one which gives its holder a present right to future enjoyment, is said to be 'vested in interest'. A person is vested in possession where the person has a right to immediate possession or enjoyment of the thing in question. In the definition of fixed entitlement, 'vested' includes both vested in possession and vested in interest.

13.6 Because vested interests include future interests, a person can have a vested interest in a thing even though the person's actual possession and enjoyment of the thing is delayed until sometime in the future.

When is a vested interest indefeasible?

The EM states:

13.7 A vested interest is indefeasible where, in effect, it is not able to be lost. A vested interest is defeasible where it is subject to a condition subsequent that may lead to the entitlement being divested. A condition subsequent is an event that could occur after the interest is vested that would result in the entitlement being defeated, for example, on the occurrence of an event or the exercise of a power. For example, where a beneficiary's vested interest is able to be taken away by the exercise of a power by the trustee or any other person, the interest will not be a fixed entitlement.

13.8 Where the trustee exercises a power to accumulate income or capital of the trust in accordance with the trust deed, the accumulation does not result in a beneficiary's interest being taken away or defeased as long as the beneficiary nevertheless remains entitled at some future time to enjoy his or her share of the income or capital which has been accumulated.

Vested and indefeasible interests and a deceased estate

ATO Interpretative Decision 2006/279 expresses the view that the terms of the Will governing the disposition of the property in the deceased estate confer fixed entitlements to all of the income and capital of the estate upon the residuary beneficiaries. The ATO ID explains that the interest of the residuary beneficiaries in the income and capital of the estate is indefeasible. There is no condition in the trust instrument, the Will, by which any of the residuary beneficiaries could lose their interest in the estate.

Do vested and indefeasible interests exist in the income and capital of the Trust?

In relation to the income and capital of the Trust the residuary beneficiary is Y the child of person A.

In relation to the income and capital of the Trust the residuary beneficiary is Y who is the only child of person A.

As provided in Clause X of the Will, the only child of the deceased Y is able to take possession of their interest in the income of the Trust. She is also able to take possession of their interest in the capital of the Trust if and when required subject to the Trustee's discretion.

By the provisions in the Will, the Trust cannot be vested while Y is still married to their spouse YZ. This condition prevents Y absolute entitlement to the capital of the Trust.

By the time Y divorced their spouse YZ the existing contingency was removed. As such the Trust can now vest under the terms of the Will and the trust fund will be distributed 100% to the only child of the deceased as the residuary beneficiary.

There is no existing condition in the trust instrument, the Will, by which the residuary beneficiary Y could lose their interest in the estate. Therefore the residuary beneficiary has a vested and indefeasible interest in the income and capital of the Trust.

Division 855 of the ITAA 1997

Section 855-40 of the ITAA 1997 provides a CGT exemption for foreign residents making a capital gain in respect of their interest in a fixed trust (including a managed fund).

Relevantly, subsection 855-40(2) provides that a capital gain you make in respect of your interest in a fixed trust is disregarded if:

• you are a foreign resident when you make the gain: paragraph 855-40(2)(a) of the ITAA 1997 ; and

• the gain is attributable to a CGT event happening to a CGT asset of a trust (the CGT event trust) that is the fixed trust: subparagraph 855-40(2)(b)(i); and

• the asset is not taxable Australian property for the CGT event trust at the time of the CGT event: subparagraph 855-40(2)(c)(i) of the ITAA 1997.

In the present case, the relevant conditions in subsection 855-40(2) are satisfied in respect of the interests of Y (residuary beneficiary) in the Trust.

This is because Y is a non-resident of Australia for taxation purposes when she makes the capital gain attributable to the CGT event of the trust that is a fixed trust; and their interest in the Australian resident trust falls outside the definition of taxable Australian property in section 855-15 of the ITAA 1997.

Conclusion

Given that the interests of the residuary beneficiary in the income and capital of the Trust are vested and indefeasible, it is concluded that fixed entitlements exist in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936. As such the Trust is a fixed trust in accordance with section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997.

The decision is supported by the view expressed in ATO ID 2006/279.

Because the Trust is a fixed trust, Y, the non-resident beneficiary can disregard the capital gain made in respect of their interest in the Trust under subsection 855-40(2) of the ITAA 1997.

Subsection 855-40(3) of the ITAA 1997 provides that a Trustee is not liable to pay tax in respect of an amount to the extent that the amount gives rise to a capital gain that is disregarded for a beneficiary under subsection 855-40(2) of the ITAA 1997. As such, to the extent that the amount relates to the capital gain that is disregarded by the non-resident beneficiary under subsection 855-40(2) of the ITAA 1997, the Trustee is not liable to pay tax in respect of that amount.