Edited version of your written advice

Authorisation Number: 1051187331130

Date of advice: 6 February 2017

Ruling

Subject: Capital gains tax and absolute entitlement

Question 1

Does Capital Gains Tax apply to the transfer of the property from you to the beneficiaries?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

You purchased a block of land (the property) in 19AA.

You purchased the property due to your family member's legal impediment.

A house was built on the property and your family member's moved into the property in 19BB.

The deposit for the land was paid for by another family member as a gift. This money was paid directly to you to pay the deposit on the property.

Your parents have made all re-payments on the land and house loans.

The land was purchased for $XXX in 19BB.

The building of the house cost $XXX.

The property is currently valued at approximately $XXX.

Your family members continue to reside at the property.

You have never lived at the property.

A declaration of trust was produced and signed.

Your family member's now wish to have the title of the property transferred into their names.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-75

Income Tax Assessment Act 1997 section 104-85

Income Tax Assessment Act 1997 subsection 104-85(6)

Income Tax Assessment Act 1997 section 106-50

Income Tax Assessment Act 1997 section 108-5

Reasons for decision

Detailed reasoning

Under section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997), an entity will make a capital gain or a capital loss if a CGT event happens to a CGT asset.

When considering the disposal of a property, the most important element in the application of the CGT provisions is ownership. It must be determined who is the legal owner of the property and if that legal owner is also the beneficial owner.

Absolute Entitlement

If the beneficiary of a trust is absolutely entitled to a CGT asset as against a trustee, any act carried out by the trustee is treated as if it was carried out by the beneficiary. In these cases, as an example, if the trustee disposes of a CGT asset, then it is seen that the beneficiary was the one who actually disposed of the asset, not the trustee.

Section 106-50 of the Income Tax Assessment Act 1997 (ITAA 1997) and CGT event E5 in section 104-75 of the ITAA 1997 are the main provisions to which the concept of absolute entitlement is relevant. These provisions apply if a beneficiary is (or becomes) absolutely entitled to a CGT asset of the trust as against the trustee (disregarding any legal disability).

These provisions apply separately to each beneficiary and asset of the trust. They require absolute entitlement to the whole of a CGT asset of the trust.

While a beneficiary's interest in the trust, or in the trust property, may also be a CGT asset as that term is defined in section 108-5 of the ITAA 1997, neither is the CGT asset to which the relevant provisions refer.

Taxation Ruling TR 2004/D25 explains the circumstances in which the beneficiary of a trust is considered to be absolutely entitled to a CGT asset of the trust against a trustee.

The most straight forward application of the core principle is one where a single beneficiary has all the interests in the trust asset.

If there is more than one beneficiary with an interest 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 discretion. This is because their entitlement is not to the entire asset.

There are particular circumstances where such a beneficiary can be considered absolutely entitled to a specific number of the trust assets for CGT purposes. These circumstances are where:

● The assets are fungible;

● 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 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.

If all these factors are present, then the beneficiary will be considered absolutely entitled to that specific number of the trust's assets for CGT purposes.

Assets are fungible if each asset matches the same description such that one asset can be replaced with another.

Land is rarely fungible because each parcel of land is unique (paragraph 94 of TR 2004/D25). Real estate is traded based on the actual sale price, not the sale price per unit. This is because the value of one part of the land may, for example have better views and access to the main street than another part of the land and therefore be worth more. Unlike fungible commodities, parcels of real estate do not have equal value.

In your case, the property title is in your name as trustee for your family members. This means there are multiple beneficiaries equally entitled to the property of the trust, and the property is not a fungible asset. Accordingly, the beneficiaries of the trust cannot be absolutely entitled to the property of the trust as against the trustee.

Consequently, as the requirements for absolute entitlement within the context of the CGT provisions cannot be satisfied, CGT event E5 will not occur.

CGT event E7 happens if the trustee of a trust disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital (section 104-85 of the ITAA 1997). The timing of the event is when the disposal occurs.

When CGT event E7 occurs, there is the potential for both the trustee and the beneficiary to make a capital gain or capital loss, unless they meet one of the exemptions (section 104-85 of the ITAA 1997).

In your case, when the beneficiaries jointly direct the trustee to terminate the trust and transfer the legal title of the trust property to them, CGT event E7 will trigger.

At the time of disposal (transfer to the beneficiaries), the trustee will be assessed on any capital gain or capital loss made.

Any capital gain or capital loss made at this time by the beneficiaries will be disregarded as they meet the 'acquired the CGT asset that is their interest in the trust for no expenditure' exception in subsection 104-85(6) of the ITAA 1997.

Further issues for you to consider

As the beneficiaries are not absolutely entitled to the property at the time of transfer and neither the trust nor the trustee ever lived in the property main residence exemption will not apply.