Edited version of your written advice

Authorisation Number: 1051183568319

Date of advice: 27 January 2017

Ruling

Subject: Capital gains tax - trust

Question 1:

Did CGT event B1 occur at the time of the formation of the Trust due to the use and enjoyment by the beneficiaries in respect of the property, prior to any future transfer of the property to the beneficiaries?

Answer:

No

Question 2:

Have the three beneficiaries been absolutely entitled to the property as against the trustee of the Trust?

Answer:

No

Question 3:

Is the Trust a fixed trust?

Answer:

No.

Question 4:

Is the Trust a discretionary trust?

Answer:

Yes.

Question 5:

Is the first element of the cost base of the property in the hands of the Trust the market value of the property at the date it was acquired by the Trust?

Answer:

Yes.

Question 6:

Did a CGT event happen in relation to the property on XX/XX/XXXX?

Answer:

No.

Question 7:

If no CGT event happened on XX/XX/XXXX, will the beneficiaries inherit the cost base of the property that was applicable to the Trust when the beneficiaries become legal owners of the property?

Answer:

No.

Question 8:

Alternatively, is the cost base of the property that is applicable to the beneficiaries of the Trust equal to the market value of the property at XX/XX/XXXX?

Answer:

No.

Question 9:

Will CGT event E7 happen when the trustees of the Trust transfer the ownership of the property to the beneficiaries of the Trust?

Answer:

Yes.

Question 10:

In relation to CGT event E7, are the trustees of the Trust assessable on any capital gain made under subsection 104-85(3) of the Income Tax Assessment Act 1997 when ownership of the property is transferred to the beneficiaries of the Trust?

Answer:

Yes.

Question 11:

After the property is transferred to the three beneficiaries, will the first element of the cost base for each beneficiary's one-third share of the property be one-third of the market value of the property on the date that the trustees transfer the title of the property to them?

Answer:

Yes.

Relevant facts and circumstances

Z was the sole owner of Property One.

Z and W lived together and held joint ownership of Property Two.

Z and W had three children.

Z and W separated a number of years ago.

Z and W entered into a property agreement in which Property One was to be transferred to W as trustee for the three children and Property Two was to be transferred to Z.

The Trust was established by deed.

Shortly afterwards Property One was transferred to W as trustee of the Trust.

The beneficiaries of the Trust are the three children of Z and W.

Property One is the only asset held by the Trust.

Later Y was appointed a joint trustee of the Trust with W. Property One was then transferred from W as trustee to Y and W as joint trustees.

The Trust has provided a copy of the Trust Deed. The Trust Deed is part of the arrangement being ruled on and should be read in conjunction with the description of the arrangement.

The Recitals of the Trust Deed state the following:

A· The Settlor wishes to gift money to establish a trust;

(i) to provide benefits for those who are named as beneficiaries under this Deed; and

(ii) under which the Trust is empowered to acquire and deal with investments in its absolute discretion.

B. The Trustee agrees to act as the first trustee of the Trust

C. The terms on which the Trust is established are set out in this Deed

Clause 1.3 of the Trust Deed states the primary purposes of establishing the Trust are:

(i) to directly or indirectly provide financial assistance to varying degrees for the maintenance, education and benefit in life of any one or more of the beneficiaries;

(ii) to invest or utilise all or any part of the trust fund to achieve the purpose in paragraph 1.3 (i) without the necessity to have regard to generating income or accretion of capital;

(iii) to assist. or benefit a beneficiary without regard to the taking of security or the possibility of incurring a loss of capital; and

(iv) to give to the Trustee the widest possible discretion in the exercise of its powers whether investment or otherwise.

The trustee has vesting powers under the Trust Deed (clause 9.1) which states:

9.1 The trust must wind up and terminate on XX/XX/XXXX.

Under clause 9.2 of the Trust Deed the following is stated:

Subject to the provisions of this deed which limits or restricts distributions of capital, the Trustee must at the vesting day:

(a) pay out or otherwise discharge and satisfy all debts and liabilities in relation to the Trust;

(b) distribute or otherwise deal with the income in- any manner expressly provided by this deed and any income not so dealt with will form part of the capital;

(c) distribute or otherwise deal with capital in any manner expressly provided by this Deed.

Under clause 9.3 of the Trust Deed the following is stated

9.3 In the winding up of the Trust, the Trustee may distribute property comprised in the trust fund in specie in satisfaction of a part of the trust fund to which the beneficiary is entitled.

W and the three children lived in Property One until XX/XX/XXXX. Since that time one of the children moved out of property. W and the other two children continue to live in Property One.

Property One has not been transferred to the beneficiaries of the Trust or been sold.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 102UC(4)

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

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

Income Tax Assessment Act 1997 Subsection 102-25(1)

Income Tax Assessment Act 1997 Subsection 104-15(1)

Income Tax Assessment Act 1997 Section 104-55

Income Tax Assessment Act 1997 Section 104-60

Income Tax Assessment Act 1997 Section 104-85

Income Tax Assessment Act 1997 Section 106-50

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Subsection 112-20(1)

Reasons for decision

All subsequent legislative references are to the Income Tax Assessment Act 1997 unless noted otherwise.

CGT event B1

Subsection 104-15(1) states that:

CGT event B1 happens if you enter into an agreement with another entity under which:

(a) The right to the use and enjoyment of a CGT asset you own passes to the other entity; and

(b) Title in the asset will or may pass to the other entity at or before the end of the agreement.

The children's use of the property was not a right set out in an agreement entered into between W and the children. No such agreement was arrived at between the children and W. Rather the children's use of the property was provided for by the trust that was created as a consequence of the property settlement agreement between W and Z. Under the trust, W as trustee had an equitable obligation to hold the property for the benefit of the children being the beneficiaries of the trust.

Although the trustee holds property for the benefit of the beneficiaries, this does not mean the trustee and the beneficiaries entered into an agreement. The trustee's obligation came into existence when the trust deed was made between the settlor and the trustee rather than any agreement between the trustee and the beneficiaries.

As the children's use of the property was provided for by the trust rather than an agreement arrived at between W and the children, CGT event B1 is not applicable in the present circumstances.

Absolute entitlement

Broadly, the provisions dealing with capital gains and losses treat an absolutely entitled beneficiary as the relevant taxpayer in respect of the asset.

This means that if a CGT event happens in relation to the asset, the beneficiary (and not the trustee) is responsible for any resulting capital gain or loss.

It also means that a CGT event will generally be triggered when a beneficiary becomes absolutely entitled.

Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 explains the circumstances in which a beneficiary of a trust is considered to be absolutely entitled to a CGT asset of the trust as against its trustee.

The core principal underpinning the concept of absolute entitlement is the ability of the beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred at their discretion. However, if there is some basis upon which the trustee can legitimately resist the beneficiary's call for an asset, then the beneficiary will not be absolutely entitled. This derives from the rule in Saunders v. Vautier (1841) 4 BEAV 115; 49 ER 282 applied in the context of the CGT provisions. The relevant test of absolute entitlement is not whether the trust is a bare trust.

Paragraph 23 of TR 2004/D25 states:

If there is more than one beneficiary with interests in the trust asset, then it will usually not be possible for any one beneficiary to call for the asset to be transferred to them or to be transferred at their direction. This is because their entitlement is not to the entire asset.

However, paragraph 24 of TR 2004/D25 advises that there is a particular circumstance where such a beneficiary can be considered absolutely entitled to a specific number of the trust assets for CGT purposes. This circumstance is where:

● the assets are fungible (for example, shares of the same class)

● the beneficiary is entitled against the trustee to have their interest in those assets satisfied by a distribution or allocation in their favour of a specific number of them, and

● there is a very clear understanding on the part of all the relevant parties that the beneficiary is entitled, to the exclusion of the other beneficiaries, to that specific number of the trust's assets.

Paragraph 54 of TR 2004/D25 states the requirement for absolute entitlement cannot be satisfied if there are multiple beneficiaries for a single asset, such as land. While each beneficiary may have an interest in, and therefore be entitled to, a share of the land, no beneficiary is entitled to the whole of it.

In this case, as there are multiple beneficiaries and a single asset, none of the beneficiaries are considered to be absolutely entitled.

Fixed trust or discretionary trust

A fixed trust is one in which the entitlement of the beneficiaries to all of the income and capital is fixed by the trust deed. The trustee has no discretion to alter the entitlement of the beneficiaries.

Subsection 102UC(4) of the Income Tax Assessment Act 1936 (ITAA 1936) defines discretionary trust as a trust that is not a fixed trust within the meaning of section 272-65 of Schedule 2F to the ITAA 1936.

The determining factor in deciding whether a trust is fixed or discretionary will be the terms of the trust instrument under which the trust is constituted.

In this case a review of the Trust Deed shows that it provides the trustees with discretionary powers and as such the Trust is a discretionary trust rather than a fixed trust.

Cost base for the Trust

Where a trust is created over an asset or an asset is transferred to a trust, and no beneficiary is absolutely entitled to the asset, the first element of the asset's cost base for the trustee is its market value when the trust was created over the asset or when the asset was transferred to the trust, whichever is applicable (subsections 104-55(4) and 104-60(4)).

Therefore, the first element of the cost base of Property One in the hands of the Trust is the market value of the property at the date it was acquired by the Trust.

CGT events A1 and E7

The Trust Deed stated that the trust was to terminate on XX/XX/XXXX. However, Property One was not transferred to the beneficiaries or sold on that date or since that date, that is, the legal title to Property One has not changed.

The trustees continue to hold Property One for the benefit of the beneficiaries. As discussed previously, none of the beneficiaries are considered to be absolutely entitled.

As there has been no change in ownership of Property One and none of the beneficiaries have become absolutely entitled, no CGT event has occurred as yet with respect to the property since it was transferred to the trust.

A CGT event will happen when legal title to Property One is transferred to the beneficiaries.

Both CGT event A1 (disposal of a CGT asset) and CGT event E7 (disposal of a CGT asset to end beneficiary's interest in the trust's capital) is capable of applying to the transfer.

Where more than one CGT event is capable of applying, the event you use is the one that is the most specific to your situation (subsection 102-25(1)).

In this case, CGT event E7 is more specific to the trust's situation. Therefore, it will be used when determining how the capital gains provisions apply when the Trust transfers title to Property One to the beneficiaries.

CGT event E7 happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary to satisfy all or part of the beneficiary's interest in trust capital (section 104-85).

The time of CGT event E7 is when the disposal occurs.

If an asset is acquired by a trust beneficiary as a result of CGT event E7, it is acquired by the beneficiary at the time of that CGT event.

A trustee of a trust makes a capital gain from CGT event E7 if the market value of the asset at the time of the disposal is more than its cost base.

A beneficiary makes a capital gain from CGT event E7 if the market value of the asset at the time of the disposal is more than the cost base of the beneficiary's interest in trust capital. If that market value is less than the reduced cost base of that interest, a capital loss is made.

A capital gain or loss made from CGT event E7 by a beneficiary is disregarded if:

● the trust interest was acquired for no expenditure (except where it was assigned from another entity)

● the trust interest was acquired before 20 September 1985, or

● the gain or loss made by the trustee was disregarded under the main residence exemption, for example due to being a special disability trust (section 104-85(6)).

In this case, the Trust is not a unit trust and it is not a deceased estate to which Division 128 applies. Therefore the exceptions with respect to CGT event E7 do not apply.

As of XX/XX/XXXX the trustees were no longer obliged to hold Property One for the benefit of the beneficiaries and it was from this point in time the trustees could resolve to transfer Property One to the beneficiaries.

When the trustees do transfer Property One to the beneficiaries, CGT event E7 happens to the trustees. The trustees of the Trust will make a capital gain if the market value of Property One at the time of the transfer to the beneficiaries is more than Property One's cost base. As explained further above, the first element of the cost base of Property One in the hands of the trustees is the market value of the property at the date it was acquired by the Trust.

For the beneficiaries, any capital gain they make under CGT event E7 is disregarded as the beneficiaries acquired their interests in the Trust at no cost.

However, the beneficiaries may be subject to CGT in the future if they dispose of their share of the property that is transferred to them. In accordance with the market value substitution rule in subsection 112-20(1), as the beneficiaries will not incur any expenditure to acquire the property, the first element of the cost base on the acquisition of the property from the trustees will be the market value of the asset at the time of acquisition by the beneficiaries.