Edited version of your written advice

Authorisation Number: 1051212058140

Date of advice: 11 July 2017

Ruling

Subject: Trust - section 99 and small business CGT concessions

Issue 1

Question 1

Will the trustees be entitled to treat any capital gain arising on the sale of Z as a gain that qualifies for the small business 50% active asset reduction under Division 152-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the trustees be entitled to treat any capital gain arising on the sale of Y as a gain that qualifies for the small business 50% active asset reduction under Division 152-C of the ITAA 1997?

Answer

Yes

Issue 2

Question 1

Will the Commissioner exercise his discretion not to apply the provisions of section 99A of the Income Tax Assessment Act 1936 (ITAA 1936) and assess the trust under section 99 of the ITAA 1936?

Answer

Yes

Issue 3

Question 1

Under the proposed arrangement, will M make a capital gain or loss on the release or surrender of their life interest in the trust?

Answer

No

Question 2

Will the remainder beneficiaries, A, B, C and D be entitled to disregard any capital gain made in relation to the payment made from the trust under the proposed arrangement?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The deceased died in 20XX.

The deceased left a will.

Under the terms of the deceased's will:

● M, A and B (the trustees) were appointed as executors and trustees.

● After payment of debts, the residue of the estate was to be held for “M to have the use and occupation thereof and to receive the net income therefrom during their lifetime”.

● If the properties are sold, the trustees are to hold the proceeds of the sale of assets of the trust and reinvest those proceeds on the basis that M would continue to be entitled to receive all the income of the trust during their lifetime.

● Following M's death, and the transfer of some specific assets and the payment of some lump sum amounts to certain beneficiaries, the balance of the trust is to be split equally between A, B, C and D (remainder beneficiaries).

The main assets of the trust are two properties. These properties comprise Z, a XXX hectare property and Y, an adjoining property of XX hectares.

The majority of Y consists of open land area, with buildings taking up the remainder of the land.

Prior to the deceased's death, the deceased and their spouse, M conducted a business on Z and had derived income from operating a business on Y.

The deceased acquired these two properties before 20 September 1985.

Following the deceased's death, the Z business has continued to be conducted at the Z property.

Initially, A was responsible for managing the Z business on behalf of the trust. From 1 October 20XX, a partnership to conduct the Z business was established between A and the Trustees.

Following the deceased's death, the trustees have continued to operate the Y business at the Y property.

The trustees derive income from a number of activities conducted as part of the Y business. The type of activity and approximate fees received in the 20XX-XX financial year were:

● Storing items under T arrangement on the Y property - approximately $XX,XXX;

● Storing items under old style licence arrangement - approximately $XX,XXX;

● Storing items under new lease arrangement (exclusive possession to building) - approximately $XX,XXX;

● Agreement with S to conduct their business on Y property and the right to occupy one of the buildings (exclusive possession to building only; shared use of land area)- approximately $XX,XXX;

● Lease with C providing right to occupy a building on the Y property and right to carry out activities relating to their business (exclusive possession of building) - approximately $XX,XXX; and

● Maintenance fees received for the maintenance of physical facilities at the Y property and arrangement of item maintenance (provided by B, an organisation associated with C) - approximately $XX,XXX.

Under a T arrangement, item owners have certain limited rights to store their item on Y property. The item owners do not obtain exclusive access to any part of the Y property.

The old-style licence arrangement provides item owners with certain limited rights to store items in a building at the Y property. These arrangements are similar in nature to the T arrangement as the item owners do not obtain exclusive access to any part of the Y property.

Under the new lease agreement, the lessees are provided with full freehold rights, including exclusive possession of the relevant sites within Y property, for X years with X further options of X years each. Under this agreement the occupant pays rent and certain property outgoings.

The combined annual turnover from the Z business conducted on the Z property and the Y business conducted at Y property is less than $2 million per annum.

The trustees and beneficiaries are proposing the following arrangement (proposed arrangement):

The trustees propose to sell the Z and the Y properties and wind up the trust by:

(a) paying an amount to M (as the life estate beneficiary of the trust) in full satisfaction of their life interest in the trust; and

(b) distributing the balance of the trust equally to between A, B, C and D as the remainder beneficiaries of the trust.

M will receive an amount equal to the market value of their interest in the trust at the time that the trust is finalised.

The value of M's interest in the trust at the commencement of the life interest and at the time the trust is wound up will be calculated by an actuary.

The trustees propose to make the election under section 115-230 of the ITAA 1997 to be treated as specifically entitled to the capital gain.

The trustees will not pay or apply any proceeds representing all or part of the capital gain for the benefit of any beneficiary of the trust prior to September in the income year following the disposal of the properties.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-80

Income Tax Assessment Act 1997 paragraph 104-85(6)(a)

Income Tax Assessment Act 1997 Subdivision 115-C

Income Tax Assessment Act 1997 section 115-230

Income Tax Assessment Act 1997 Division 128

Income Tax Assessment Act 1997 section 128-20

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-35(1)

Income Tax Assessment Act 1997 subsection 152-40(4)

Income Tax Assessment Act 1997 paragraph 152-40(4)(e)

Income Tax Assessment Act 1936 section 99

Income Tax Assessment Act 1936 section 99A

Income Tax Assessment Act 1936 subsection 99A(2)

Reasons for decision

Issue 1

Question 1 and 2

Summary

The trust satisfies the basic conditions necessary to access the capital gains tax concessions for small business. As such the trust is eligible to apply the 50% small business active asset reduction.

Detailed reasoning

Small business CGT concession eligibility

Section 152-10 of the ITAA 1997 contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year.

(b) the event would have resulted in the gain

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(a) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

To be eligible to apply the small business CGT concessions you must satisfy all four of the basic conditions above.

In this case, the trust intends to dispose of the Z and the Y properties, triggering CGT event A1 and it is anticipated that the event will result in a capital gain, satisfying conditions (a) and (b) for each of the property disposals.

In relation to the Z property, the trust is a partner in a partnership carrying on a business with A and the Z property is used within the business of the partnership.

In relation to the Y property, the trust is operating as a small business entity running the operations of the Y business.

The trust would therefore satisfy the conditions of (c)(i) and (c)(iv) for the Z and Y respectively.

Active asset test

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

● you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period of ownership, or

● you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 and a half years.

Importantly, subsection 152-40(4) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset.

Taxation Determination TD 2006/78 discusses whether there are circumstances in which a premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the ITAA 1997, notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997. The taxation determination explains that whether an asset's main use is to derive rent will depend on the particular circumstances of each case.

A key factor in determining whether an occupant of premises is a lessee is whether the occupier has a right to exclusive possession (Radaich v Smith (1959) 101 CLR 209; Tingari Village North Pty Ltd v Commissioner of Taxation [2010] AATA 233 at paragraphs 44-66, 2010 ATC 10-131, 78 ATR 693 and associated Decision Impact Statement 2008/4646 and 2008/4647).

If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are unlikely to be rent.

Ultimately, these are questions of fact depending on all the circumstances involved. Relevant factors to consider in determining these questions (in addition to whether the occupier has the right to exclusive possession) include the degree of control retained by the owner and the extent of any services provided by the owner such as room cleaning, provision of meals, supply of linen and shared amenities (Allen v Aller (1966) 1 NSWR 572), Appah v Parncliffe Investments Ltd [1964] 1 All ER 838 and Merchant v Charters [1977] 3 All ER 918).

If an asset is used partly for business and partly to derive rent at any given time, it will be a question of fact dependent on tall the circumstances as to whether the main use of the asset at that time is to derive rent. No one single factor will necessarily be determinative and resolving the matter is likely to involve a consideration of a range of factors such as:

● the comparative areas of use of the premises (between deriving rent and other uses); and

● the comparative levels of income derived from the different uses of the asset.

In this case, the Z would be considered an active asset as the Z property was actively used within the Z business.

In the case of the Y, the use will need to be determined on the facts. On the basis of land area usage, the majority of the Y property is used for purposes other than the derivation of rental income. The majority of the land consists of open land area, to which no person has exclusive access.

On the basis of income earned from the Y business activities, the fees received under the new lease arrangements and the lease to C have the character of rental payments as they provide the holder with exclusive access to identifiable areas of the Y property. The arrangement with S allows S to both conduct operations at the Y property and the right to occupy one of the buildings. The right to occupy the building is an exclusive right, however S does not have exclusive access to any other areas on the Y property.

The total fees characterised as rental payments, collected under the new lease arrangements, the C lease and the S arrangement total approximately $XX,XXX of the $XXX,XXX income generated by the Y property, or XX% of total fees collected. Therefore XX% of the Y property income is from activities which would not constitute the character of rental payments as they are either for services provided, or do not grant exclusive access to the y property, or a portion thereof, merely the right to use the facilities.

Therefore, as the majority of the Y property is used for purposes other than the derivation of rental income and the majority of the income earned from the Y activity is derived from sources other than that of rent, the Y property would be considered an active asset.

The trust acquired the properties at the time of the deceased's death approximately X years ago. The properties have both been used as active assets for the Z and the Y businesses for the entire period, therefore meeting the active asset test.

The trust therefore satisfies the basic conditions necessary to access the capital gains tax concessions for small business. As such the trust is eligible to apply the 50% small business active asset reduction concession.

Issue 2

Question 1

Summary

It would be considered reasonable for the Commissioner to apply his discretion to allow section 99 of the ITAA 1936 to apply.

Detailed reasoning

Subdivision 115-C of the ITAA 1997 provides the taxation treatment of trusts and their beneficiaries where the trust derives a net capital gain during an income year. The effect of the provisions is to directly tax the beneficiaries on their specific entitlements to, and their share of other, capital gains made by the trust solely under the CGT provisions.

A trustee can be made specifically entitled to an amount of a capital gain by choosing to be assessed on it provided it is permitted under the trust deed and no trust property representing the capital gain is paid to or applied for the benefit of a beneficiary of the trust by the end of two months after the end of the financial year (section 115-230 of the ITAA 1997).

In this case, M was provided with a life interest in the trust, established under the deceased's will. On that basis, M is entitled to the income of the trust; however M is not entitled to the capital of the trust. Under the will, M is not entitled to proceeds of sale of a capital asset of the trust; therefore M cannot be specifically entitled to the capital gain.

The remainder beneficiaries would also not be considered specifically entitled to the capital gain. Although they will ultimately derive benefit of the capital gain, they cannot be said to have 'received or can be reasonably expected to receive the financial benefit attributable to the capital gain in the year in which the gain was realised.

Under the proposed arrangement, the trustees will make the election under section 115-230 of the ITAA 1997 to be made specifically entitled to the capital gains of the estate.

Sections 99 and 99A of the ITAA 1936 apply to assess the trustee on income to which no beneficiary is presently entitled, which is retained or accumulated by the trustee. In considering these sections, we must first consider section 99A.

Section 99A applies in relation to all trusts unless: 

● the trust is a deceased estate; subparagraph 99A(2)(a)(i) and (ii)

● the trust is bankrupt estate; paragraphs 99A(2)(b) and (c)

● the trust is a trust that consists of property referred to in paragraph 102AG(2)(c)

and the Commissioner forms the opinion that it would be unreasonable to apply section 99A in such circumstances. 

Subsection 99A(2) of the ITAA 1936 outlines the circumstances when the Commissioner may apply his discretion for section 99A not to apply. The relevant part of subsection 99A(2) states that the discretion may be exercised where a trust resulted from a will, a codicil or an order of a court that varied or modified the provisions of a will or a codicil. The discretion is exercised where the Commissioner is of the opinion that it would be unreasonable for section 99A to apply. 

Consequently, the favourable exercise of the Commissioner's discretion under subsection 99A(2) means the highest rate of income tax does not apply to trusts resulting from a will, codicil, etc. These include both the estate of a deceased person and 'testamentary' trusts established pursuant to the terms of a will.

The Commissioner will generally exercise the discretion to assess under section 99 where there is no tax avoidance involved and the estate is of the ordinary and traditional kind whose assets come directly from the assets of the deceased person.

In this case, the trust is a trust that resulted from a will. As the will of the deceased specifically provides that the properties are to the held for M's benefit during M's lifetime, the trustees of the estate are not in a position to wind up the estate. The proposed agreement will allow the trustees to wind up the estate by disposing of the capital assets of the trust, making a payment to M in satisfaction of her life interest and distribute the balance of the trust to the remainder beneficiaries.

In this case, it would be reasonable for the Commissioner to apply his discretion to allow section 99 of the ITAA 1936 to apply.

Issue 3

Question 1

CGT event E6 under section 104-80 of the ITAA 1997, happens if the trustees 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 in satisfaction of the beneficiary's right, or part of it, to receive income from the trust. Taxation Ruling TR2006/14 considers the capital gains tax consequences relating to life interests in property.

The exception provides that the event does not happen if the trust is a unit trust or a trust to which Division 128 of the ITAA 1997 applies. If the exception applies, the Commissioner takes the view that it is not necessary to consider whether any other CGT event has happened.

Division 128 of the ITAA 1997 applies to the passing of an asset from a deceased individual's legal personal representative to a beneficiary in their estate (providing the asset was owned by the deceased individual at the time of their death).

Accordingly, 'a trust to which Division 128 applies' requires more than the identification of the trust as a deceased estate. The Commissioner considers that the words 'a trust to which Division 128 applies' should be interpreted as a deceased estate to the extent that it is a trust over an asset originally owned by a deceased individual and which may pass to the beneficiary in accordance with section 128-20 of the ITAA 1997 (that is, under the will, by intestacy and so on).

In this case, it is considered that the trust is one to which Division 128 of the ITAA 1997 would apply, as such the exemption would apply to disregard the triggering of CGT event E6 at the time when M surrenders or releases their life interest in the trust. Therefore M will not make a capital gain or capital loss under the proposed arrangement on the surrender of their life interest in the trust.

Question 2

Under the proposed arrangement, once M releases or surrenders the life interest in the estate and receives payment in satisfaction of her interest, the trustees will be able to distribute the balance of the estate to the residual beneficiaries under the terms of the will.

The payment to the beneficiaries will end their capital interest in the estate, as such CGT event E7 will be triggered. As the beneficiaries acquired their interests in the estate for no consideration, any capital gain or capital loss on the disposal of the interest is disregarded under paragraph 104-85(6)(a) of the ITAA 1997.