Edited version of your written advice

Authorisation Number: 1013134171713

Date of advice: 1 December 2016

Ruling

Subject: Capital gains tax: Deceased estate - main residence exemption

Question 1

Will the Commissioner exercise his discretion to extend the time period in subsection 118-195(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to disregard the capital gain made from the sale of the deceased's main residence where the trustee of the deceased estate sold the main residence more than two years after the deceased's death?

Answer

No.

Question 2

Will the Commissioner exercise his discretion under section 99A of the Income Tax Assessment Act 1936 (ITAA 1936) to tax the deceased estate under section 99 of the ITAA 1936?

Answer

No.

This ruling applies for the following periods:

1 July 199X to 30 June 201X.

The scheme commences on:

1 July 199X.

Relevant facts and circumstances

In 199X the deceased purchased a Property which was his main residence where they lived with their spouse.

On purchase of the Property, legal ownership of the home was transferred to the deceased and they remained the sole legal owner of the Property until their death.

The deceased passed away in 199X.

The Executors of the Estate (the Executors) were the deceased's spouse and child. Probate was granted in mid-late 199X.

The Will of the deceased stated the following relevant clauses:

UPON TRUST for my wife for her life it being the principal intention that my Trustees shall provide for my wife such suitable and reasonable accommodation as she may request during her lifetime AND I DIRECT that all rates, taxes, insurances and maintenance and repairs in respect of any such property in which my said wife resides shall be borne my estate;

MY Trustee shall have the following powers:-

(1) to sell such parts of my estate as my Trustee thinks fit;

(2) to retain for so long as my Trustee thinks fits any of my real or personal estate notwithstanding that such property may be of a terminable or wearing out nature or may be a hazardous investment;

(3) to invest in the following securities in addition to those authorised by the law of the Commonwealth or any State or Territory of the Commonwealth for investment of trust funds:

(a) similar investments to those in which any part of my estate may be invested at my death;

(b) land of any tenure;

(c) on deposit with any public company, bank, credit union or building society;

(d) the shares, stock units, debentures, debenture stocks, notes or similar securities or any company listed on a stock exchange; or

(e) the units or interests of or in a trust including a fixed or flexible trust.

(4) to apply for the benefit of any beneficiary as my Trustee thinks fit the whole or any part of the income and capital to which the beneficiary is entitled or may in future be entitled.

The deceased's spouse resided in the home until 200X when they then vacated the premises to move into assisted accommodation care.

The Executors were advised by their solicitor that they could not sell the property in case the deceased's spouse reoccupied the home.

The house was kept vacant and maintained by the Executors after the deceased's spouse went into assisted accommodation care.

In 201X the Executors decided to rent the home, in order to defray some ongoing holding and maintenance costs.

The home was leased out to tenants up until the property was sold in 201X.

The deceased's spouse passed away in 201X.

After the deceased's passing, the spouse did not contribute to any of the costs of the dwelling on the Property with the exception of electricity and water usage.

For the period between the deceased's passing and until the Property was tenanted, the costs of the dwelling including rates, insurance, repairs and maintenance were met equally by the beneficiaries.

The Property was sold in 201X.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 99

Income Tax Assessment Act 1936 section 99A

Income Tax Assessment Act 1936 subsection 99A(2)

Income Tax Assessment Act 1936 subsection 99A(3)

Income Tax Assessment Act 1936 paragraph 99A(3)(c)

Income Tax Assessment Act 1997 section 115-222

Income Tax Assessment Act 1997 section 118-145

Income Tax Assessment Act 1997 subsection 118-145(4)

Income Tax Assessment Act 1997 section 118-195

Income Tax Assessment Act 1997 subsection 118-195(1)

Income Tax Assessment Act 1997 section 118-200

Income Tax Assessment Act 1997 Division 128

Income Tax Assessment Act 1997 subsection 128-15(3)

Income Tax Rates Act 1986 subsection 12(6)

Income Tax Rates Act 1986 Part 1 of Schedule 10

Tax Laws Amendment (2011 Measures No. 9) Act 2012 (12 of 2012)

Please note that all legislative references referred to below are in relation to the Income Tax Assessment Act 1997 unless otherwise specified.

Reasons for decision

Question 1

Summary

The Commissioner will not exercise his discretion to extend the time period in subsection 118-195(1) of the ITAA 1997 to disregard the capital gain made from the sale of the deceased's main residence where the trustee of the deceased estate sold the main residence more than two years after the deceased's death.

Detailed reasoning

Dwelling acquired from a deceased estate

According to subsection 118-195(1), for property acquired by the deceased on or after 20 September 1985, which was the deceased's main residence just before they died and was not then being used for the purpose of producing assessable income, you will be entitled to disregard any capital gain made on the disposal of the property if:

1. your ownership interest ends within two years of the deceased's death, or within a longer period allowed by the Commissioner; or

2. the dwelling was, from the deceased's death until your ownership interest ends the main residence of one or more of:

(a) the spouse of the deceased immediately before the death (except a spouse who was living permanently separately and apart from the deceased); or

(b) an individual who had a right to occupy the dwelling under the deceased's Will; or

(c) an individual beneficiary to whom the ownership interest passed and that person disposed of the dwelling in their capacity as beneficiary.

Commissioner may extend the two year period

The Commissioner has discretion to extend the two year time period where the trustee or beneficiary of a deceased estate's ownership interest ends after two years from the deceased's death.

A trustee or beneficiary of a deceased estate may apply to the Commissioner to grant an extension of the two year period, where a CGT event happens in the 2008-09 income year or later income years. Subsection 118-195(1) was amended by No 12 of 2012 and the Explanatory Memorandum to this Act states:

The Commissioner would be expected to exercise the discretion in situations such as where:

● the ownership of a dwelling or a will is challenged

● the complexity of a deceased estate delays the completion of administration of the estate

● a trustee or beneficiary is unable to attend to the deceased estate due to unforeseen or serious personal circumstances arising during the two-year period (for example, the taxpayer or a family member has a severe illness or injury)

● settlement of a contract of sale over the dwelling is unexpectedly delayed or falls through for circumstances outside the beneficiary or trustee's control.

These examples are not exhaustive.

In exercising the discretion the Commissioner will also take into account whether and to what extent the dwelling is used to produce assessable income and for how long the trustee or beneficiary held the ownership interest in the dwelling.

Application to your circumstances

Item 1 in Column 3 of the table:

You have requested that the Commissioner exercise his discretion to extend the two year period in order that any capital gain you make from the disposal of the dwelling is disregarded. The deceased passed away in 199X, and the dwelling was not sold within two years of the deceased's death. You have stated that the delay was due to the dwelling being occupied by the deceased's spouse. This prevented the Executor from being able to dispose of the dwelling until the deceased's spouse had passed away, which happened in 201X. According to the deceased's Will after their spouse passed away the trustee was to hold the property on trust for the children of the deceased 'as tenants in common in equal shares for their own use and benefit', which suggests that the trustee was not to distribute the property to the beneficiaries but had to retain it for their use and benefit. Under the Will, the trustee had the power to retain and sell the property, but not to rent the property. The Property was sold in 201X.

Whilst the circumstances of the delay may be considered as being outside of the control of the trustee, some 15 years had elapsed between the date that the deceased passed away and the date that the dwelling was sold. Where a dwelling has been used by the deceased's spouse as their main residence, the more appropriate item to examine is Item 2 in Column 3 in subsection 118-195(1). Consequently, the Commissioner's discretion will not be exercised to extend the two year period under subsection 118-195(1). The trustee will not be entitled to disregard any capital gain made on the disposal of the dwelling.

Item 2 in Column 3 of the table:

This item examines whether one of the following people occupied the dwelling as their main residence from the deceased's death until the ownership interest ends:

(a) the spouse of the deceased; or

(b) an individual who had a right to occupy the dwelling under the deceased's Will; or

(c) an individual beneficiary if they are disposing of the dwelling in their capacity as beneficiary.

It is your view that following the death of the deceased, the dwelling was occupied by their spouse as they had a right to occupy the dwelling under the Will as a life tenant. Clause 3(1) of the Will states:

UPON TRUST for my wife for her life it being my principal intention that my Trustees shall provide for my wife such suitable and reasonable accommodation as she may request during her lifetime AND I DIRECT that all rates, taxes, insurances and maintenance and repairs in respect of any such property in which my said wife resides shall be borne my estate; and

It is the Commissioner's view that on a plain reading of Clause 3(1), the spouse did not have a right to occupy the dwelling owned by their late husband. All they had was the right to have suitable and reasonable accommodation provided to them. Based on the facts provided, the other assets of the estate were not sufficient to pay for the deceased's funeral costs. It would have been open to the Executors to sell the Property to pay the outstanding costs instead of these costs being paid by the beneficiaries. Moreover, all the costs pertaining to the dwelling were meant to have been paid by the Estate, but instead were also paid by the beneficiaries.

It would seem that the spouse was allowed to stay in the dwelling at their request pursuant to the operation of Clause 3 of the Will. The question that arises is whether their request to stay in the dwelling and agreement by the trustee for them to remain in the Property gave them a right to occupy the dwelling that was 'under' or 'under the authority of' the terms of the Will: see Evans v Friedmann (1981) 52 FLR 229 at 238. The Commissioner agrees with the Executor's solicitor that the spouse more than likely had a right to occupy the dwelling, as they had the right to request to stay in a suitable and reasonable accommodation, which could have been this dwelling.

The issue of whether the spouse had a right to occupy the dwelling is not determinative of whether Item 2 in Column 3 has been satisfied. From the facts provided, the requirement in Item 2(a) in Column 3 is satisfied. The question that then arises is whether the dwelling was the spouse's main residence from the deceased's death until the date that the trustee's ownership interest in the dwelling ends.

There is no requirement in subsection 118-195(1) that the spouse of the deceased actually reside in the property in the period between the date of the deceased's death and the date that the trustee's ownership interest ends. The requirement is that the dwelling be the main residence of the spouse of the deceased and continues to be for the relevant period. It is the status of the dwelling as a main residence that is relevant.

Section 118-145 provides that an individual can choose to treat a property as their main residence even though they no longer reside in it and/or the dwelling is used for income producing purposes (up to a six year time limit). However, subsection 118-145(4) states that if this choice is made, no other dwelling can be treated as that person's main residence during that period.

In your case, the deceased passed away in 199X. The deceased's spouse continued to occupy the dwelling as their main residence until they moved into assisted accommodation care in 200X.

The dwelling can still be regarded as the spouse's main residence even after this date if you as trustee elect to continue to treat the dwelling as the spouse's main residence after they vacated the dwelling. As the dwelling was used to produce income, the choice is effective for a period of up to six years. However, as the spouse passed away in 201X the choice is only effective up to this date. Since the dwelling was disposed of by the trustee in 201X the conditions in Item 2 in Column 3 have not been satisfied, as the dwelling was not the main residence of the deceased's spouse up to when the trustee's ownership interest ended.

Other Information

Where a trustee or beneficiary of a deceased estate cannot access the full exemption under section 118-195, section 118-200 may provide a partial exemption.

Question 2

Summary

The Commissioner will not exercise his discretion under section 99A of the ITAA 1936 to tax the deceased estate under section 99 of the ITAA 1936.

Detailed reasoning

Certain trust income to be taxed as income of an individual

Generally, if no beneficiary of a trust estate is presently entitled to the net income of the estate, the trustee is assessed under either section 99 or section 99A of the ITAA 1936. Section 99A applies a penalty rate of tax (equivalent to the top personal marginal rate of tax), whereas under section 99 the trustee is assessed at the normal personal marginal rates of tax.

Sections 99 and 99A of the ITAA 1936 are interrelated and must be read together in order to determine which provision applies in a particular situation: see Giris Pty Ltd v FCT 69 ATC 4015; (1969) 119 CLR 365. Barwick CJ said in Giris that the Commissioner must decide in each case and in respect of each income year whether it is unreasonable to apply section 99A rather than section 99. Moreover, that the Commissioner must hold the opinion, but indicated the width of the Commissioner's discretion and the lack of discernible criteria by reference to which the propriety of its exercise could be tested.

Subsection 99A(2) of the ITAA 1936 states that section 99A does not apply in relation to a trust estate in relation to a year of income, being a trust estate that resulted from a Will, if the Commissioner considers that it would be unreasonable to do so.

In forming an opinion pursuant to subsection 99A(2) of the ITAA 1936 whether it would be unreasonable for section 99A to apply to a particular trust estate in relation to a particular income year, the Commissioner is directed by subsection 99A(3) to have regard to certain matters. These are:

(a) the circumstances in which and the conditions, if any, upon which, at any time:

(i) property (including money) was acquired by or lent to the trust estate

(ii) income was derived by the trust estate

(iii) benefits was conferred on the trust estate, or

(iv) special rights or privileges were conferred on or attached to property of the trust estate, whether or not they have been exercised

(b) whether any person, who has at any time, directly or indirectly:

(i) transferred or lent any property (including money) to, or conferred any benefits on, the trust estate, or

(ii) conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person(s), that has resulted in the conferring or attaching of any special right or privilege, on or to property of the trust estate, whether or not the right or privilege has been exercised,

has at any time, directly or indirectly, done any similar thing in relation to any other trust estate.

(c) such other matters, if any, as the Commissioner thinks fit.

Where the Commissioner exercises this discretion, the trustee is not liable to pay tax at the top personal marginal rate of tax on the income to which no beneficiary is presently entitled. Instead the trustee is taxed under section 99 of the ITAA 1936.

The rates of tax for trustees assessed under section 99 of the ITAA 1936 are found in subsection 12(6) of the Income Tax Rates Act 1986 (ITRA 1986), which directs attention to Schedule 10 of the ITRA 1986. Part 1 of Schedule 10 of the ITRA 1986 identifies two classes of trustees for the purpose of determining the rates of tax that are to apply.

In the first class are trustees who are liable to be assessed under section 99 of the ITAA 1936 in respect of resident trust estates of a deceased person where the income is derived in the year of death of the deceased or in any one of the following two years. These trustees are liable to pay tax at the rates applicable to resident individuals.

The second class of trustees identified in Part 1 of Schedule 10 of the ITRA 1986 comprises trustees liable to be assessed under section 99 of the ITAA 1936 in respect of income of a resident trust estate, other than the estate of a person who died fewer than three years before the end of the income year.

These trustees (including the trustees of testamentary trusts) are liable to tax at the rates specified for resident individuals except that they do not benefit from the tax-free threshold.

There is no discretion available to the Commissioner to extend the three year period to apply the lower rates of tax or vary the rates of tax applicable under section 99 of the ITAA 1936.

Application to your circumstances

A testamentary trust is a trust created by a Will and does not come into effect until the death of an individual. Testamentary trusts are created as soon as executors assume control of the deceased's estate to pay out debts and expenses and make distributions according to the terms of the Will or intestacy laws. These testamentary trusts arise and are administered and dissolved during the relatively short period that usually applies between the date of death of the deceased and the date that assets are finally distributed to beneficiaries. This is commonly referred to as the 'Will trust' period. What has become referred to as a testamentary trust may be created due to the provisions of the Will. That is, after the Will trust period has ceased and entitlements of beneficiaries are relatively certain, some assets are required to be held upon stated trust for particular beneficiaries or classes of beneficiaries.

It has been the Commissioner's long standing administrative practice to treat the trustee of a testamentary trust in the same way as a legal personal representative for the purposes of Division 128 of the ITAA 1997. This is to ensure that when the trustee of a testamentary trust transfers assets to beneficiaries pursuant to the terms of the Will that no capital gains tax consequences arise to the trustee: see subsection 128-15(3) of the ITAA 1997.

In your case, the Will gave the whole of deceased's estate to the two trustees, and required them to create testamentary trusts as follows:

(a) to provide the spouse with suitable and reasonable accommodation as they may request during their lifetime and for the estate to pay all costs relating to any such property; and

(b) after the death of the spouse, to hold the Property for the use and benefit of their children as tenants in common in equal shares.

The Will set out the trustees' powers, as follows:

(a) to sell such parts of his estate as they thought fit;

(b) retain for as long as they thought fit any of their real or personal estate;

(c) to invest in certain securities for investment of trust funds;

(d) to apply for the benefit of any beneficiary as they thought fit the whole or part of the income and capital to which that beneficiary is entitled or may in future be entitled.

From the information provided, it is the Commissioner's opinion that, after consideration of all 'such other matters, it is not unreasonable for the net rental income derived and any capital gain made from the sale of the property to be assessed to the trustee of the testamentary trust under section 99A of the ITAA 1936. In arriving at this opinion, the Commissioner took into consideration the following:

(a) the trustees only had the power to sell or retain the property, and not to rent the Property;

(b) the trustees' only ability to derive income was if they exercised the power to invest in certain securities;

(c) the trustees did not have to retain the deceased's home for the spouse to live in, but could have bought another property or rented a property for them to live in;

(d) the trustees could have sold the property to pay the costs of the estate, instead of the beneficiaries paying these costs, e.g. outstanding funeral costs, all property costs from the date of the deceased's death and for the spouse's assisted accommodation care;

(e) the Property was not sold for approximately 20 months after the spouse passed away and continued to be rented out by the trustee; and

(f) the trustee chose to accumulate the income of the trust, instead of distributing the income to the children, who are the beneficiaries of the trust.

Other Information

See also section 115-222 of the ITAA 1997 for rules about assessing trustees under section 99A of the ITAA 1936 and in particular, calculation of capital gains.