Edited version of your written advice

Authorisation Number: 1051357994478

Date of advice: 6 April 2018

Ruling

Subject: The forgiving of a debt by the executors of a deceased estate.

Question 1

Does the release of the Debt give rise to a capital loss of the forgiven amount for the Executors in their capacity as executors of the Estate under section 100-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, to the extent that the reduced cost base amount is greater than the market value of the loan.

Question 2

If the Trustee of the Trust were to resolve to distribute a share of the income of the Trust to the Estate in the income year, will the executors in their capacity as executors of the estate:

(a) be presently entitled to a share of the net income of the trust under section 97 of the ITAA 1997 for the income year and

(b) to the extent that the Trust makes a capital gain in the year and no person is made specifically entitled to that capital gain, be presently entitled to a share of the net capital gain under section 115-215 ITAA 1997 for the income year?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The loan

Prior to death the individual made a loan to a Related Trust (the Debt) to facilitate a loan to a Third Party. Under the loan arrangement the deceased was entitled to receive interest on the loan amount on the same terms as the Related Trust’s entitlement to receive interest from its loan to the Third Party.

The Related Trust on-loaned the money to the Third Party

An amount was paid to the Related Trust in relation to their loan to Third Party and that amount was then on paid to the individual to reduce the capital amount owed by the Related Trust on the Debt.

The individual died in 20WW.

The individual had not made a decision to write off or release the debt owed by the Related Trust prior to death.

In March 20XX probate was granted to the executors of the individual’s will.

The estate of the individual (the Estate) is a resident entity for taxation purposes.

The Executors of the Estate have determined that there is little chance of the Related Trust being able to repay the Debt.

The Executors of the Estate have released the Related Trust from any obligation to repay the Debt.

The distribution from the Trust

The Trust was registered with the Office of State Revenue (N.S.W. Treasury).

The Trust has not vested.

The Trust has a ‘net income of the trust’ (section 97 of the ITAA 1936) for the income year.

The Trust has made a net capital gain for the income year.

No beneficiary has been made specifically entitled to the Trust’s net capital gain.

In accordance with clause 3(1) of the Trust’s deed (the Trust Deed), the Trustees of the Trust) resolve to distribute a share of the income of the Trust to the Estate.

The following clauses in the Trust’s Deed affect the Trustee’s ability to make a distribution of the income of the Trust:

′ Clause 3 (1)

The trustee may prior to the Vesting Day at any time and from time to time during any Accounting Period and without creating a Perpetuity with respect to all or any part or parts of the net income of the Trust Fund for such Accounting Period determined:-

(a) To pay apply or set aside the same for any more of the General Beneficiaries living or in existence at the time of the determination;

...

′ Clause 1

“General beneficiaries” shall subject to the provisos contained in paragraphs (h) and (i) of this definition mean and include:

…

(b) the parents, brothers, sisters, spouses, de facto partners, widows, widowers, children and grandchildren of each member of the Appointed Class (if any) and the spouses, de facto partners, widows, widowers, children and grandchildren of such parents, brothers, sisters, spouses, de facto partners, widows, widowers, children and grandchildren;

(c) any of the following persons or entities wheresoever resident or incorporated namely:

(i) the trustees (in their capacity as such) of any Eligible Trust;

…

(e) such individuals or corporations if any (not being a member of the Excluded Class) as are for the time being in existence before the Vesting Day and are the subject of the a nomination duly made and not withdrawn pursuant to clause 44 hereof,

…

“Eligible Trust” shall mean any trust or settlement under which at the date upon which it is necessary to determine whether it is an Eligible Trust any Beneficiary or class of General Beneficiaries (as defined in this deed) has any interest including any trust or settlement where any Beneficiary or class of General Beneficiaries is included in the objects of a discretionary power for the application if the corpus or income thereof and the date upon which it is necessary to determine whether it is an Eligible Trust shall be the date upon which the Trustees will if it is an Eligible Trust exercise a power given to them under or pursuant to this deed in favour of the Trustees of that Trust which may only be exercised in their favour if it is an Eligible Trust provided always that no trust shall be an Eligible Trust unless the interests of the beneficiaries thereunder vest within the perpetuity Period as hereinafter defined;

…

′ Clause 44

(1) The Trustees may with the written consent of the Appointer at any time or times before Vesting Day and without creating a Perpetuity nominate one or more individuals or corporations (none of whom is a member of the Excluded Class) to be a member or members of the Appointed Class and/or the class of General Beneficiaries…

Relevant legislative provisions

Section 97 of the ITAA 1936

Section 6-1 of the ITAA 1997

Section 100-35 of the ITAA 1997

Section 100-40 of the ITAA 1997

Section 100-45 of the ITAA 1997

Paragraph 104-25(1)(b) of the ITAA 1997

Section 102-30 of the ITAA 1997

Section 108-20 of the ITAA 1997

Section 108-5 of he ITAA 1997

Section 110-25 of the ITAA 1997

Subsection 110-25(2) of the ITAA 1997

Section 110-55(2) of the ITAA 1997

Subsection 110-55 of the ITAA 1997

Section 116-30 of the ITAA 1997

Division 128 of the ITAA 1997

Subsection 128-15(2) of the ITAA 1997

Subsection 128-15(4) of the ITAA 1997

Reasons for decision

Question 1

Summary

The release of the Debt results in a capital loss to the extent that the reduced cost base amount is greater than the market value of the loan of the forgiven amount for the Executors in their capacity as executors of the Estate under section 100-35 of the Income Tax Assessment Act 1997.

Detailed reasoning

The debt owed to the Estate by the Related Trust is a CGT asset for the purposes of section 108-5 of the ITAA 1997 as it was a debt owed to the individual.

On the death of a taxpayer, the property of the deceased taxpayer passes to his or her estate, legal control over which is exercised by their legal personal representative (LPR) also known as an executor or administrator. The LPR, in effect, steps into the shoes of the deceased and winds up the deceased's personal affairs.

In this case the Debt passes to the Estate and legal control over which is exercised by the Executors of the Estate.

Division 128 of the ITAA 1997 sets out what happens when a taxpayer dies and a CGT asset they owned just before dying devolves to their LPR.

In accordance with subsection 128-15(2) of the ITAA 1997, when a person dies a LPR is taken to have acquired the asset on the day the deceased died. Any subsequent disposal by the LPR is a CGT event which will result in a capital gain or loss.

Section 100-35 of the ITAA 1997 provides that for most CGT events a capital loss is made if the capital proceeds are less than the reduced cost base of the asset. Sections 100-40 and 100-45 of the ITAA 1997 provide guidance on the calculation of a capital loss for most CGT events.

Subsection 128-15(4) of the ITAA 1997 sets out the cost base rules for the CGT asset in the hands of the LPR.

Subsection 128-15(4) provides that assets which the deceased acquired on or after 20 September 1985 (other than trading stock and their main residence) are acquired by the LPR for an amount equal to the deceased's cost base or reduced cost base.

On the day that the individual died the executors of the Estate are taken to have acquired the debt/loan and the cost base or reduced cost base is that of the individual at the date of death.

The rules for calculating the cost base and reduced cost base are set out in section 110-25 and 110-55 of the ITAA 1997 respectively.

The first element of the cost base and reduced cost base of the debt, pursuant to subsections 110-25(2) and 110-55(2) of the ITAA 1997 is the amount of money loaned to the Related Trust.

CGT event C2 happens when ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied (paragraph 104-25(1)(b) of the ITAA 1997). Whether a capital gain or loss occurs on the disposal of the debt depends firstly on the consideration received for the disposal and the appropriate cost base of the debt.

Accordingly, when the Executors forgive or release the Related Trust from the Debt CGT event C2 happens in relation to that debt. The amount of capital loss from the release of the Debt is worked out by deducting the capital proceeds in respect of the CGT event happening from the Debt's reduced cost base as per section 100-45 of the ITAA 1997.

However, pursuant to section 116-30 of the ITAA 1997, if the lender receives no consideration for the disposal of the debt, the lender is taken to have received an amount equal to the market value of the debt at the time of the disposal. The lender is also taken to receive market value on the disposal of the debt when the consideration is less than the market value of the debt. The market value of the debt at the time of its disposal is worked out as though the debtor was and was never intended to be released from the debt.

In this case, as no amount was received for the Debt, the Executors will need to determine the market value of the Debt at the time when it was waived.

If the market value of the Debt is less than the reduced cost base of the Debt the difference is a capital loss in relation to CGT event C2 on the release of the Debt.

However, a capital loss is not allowed on the disposal of a non-listed personal-use asset (section 102-30 – Item 2 and section 108-20 of the ITAA 1997). In some cases, a debt will be a personal-use asset of the lender (section 108-20 of the ITAA 1997).

These are:

● when the debt relates to an asset that was previously a personal-use asset of the taxpayer; or

● when the debt was not owed to the lender in the course of gaining or producing income or carrying on a business by the lender.

The debt owed to the individual was in relation to a loan on which income was to be received in the form of interest, being assessable income pursuant to section 6-1 of the ITAA 1997. Therefore the Debt is not a personal use asset.

CGT event C2 happens when the LPRs of the Estate forgive the Debt owed to the Estate by the Related Trust. A capital loss will be made if the total costs associated with the event exceed the total capital amounts received (or the LPRs are entitled to receive) from the event.

Question 2

Summary

The Estate is not an ‘Eligible Trust’ for the purposes of the Trust Deed. Nor can the Trustees nominate the Estate or the Executors of the Estate to be a member of the Appointed Class and/or class of General Beneficiaries. Consequently, the Executors of the Estate will not be a ‘General Beneficiary’ of the Trust and in their capacity as executors will not be presently entitled to a share of the net income of the Trust under section 97 of the ITAA 1997.

Detailed reasoning

The provisions that relate to the taxation of trust income are contained in Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

Where a resident beneficiary of a trust estate who is not under a legal disability is presently entitled to a share of the income of the trust estate, section 97 of the ITAA 1936 operates to include in the assessable income of the beneficiary, their share of the net income of the trust. This income must be included as assessable income, by the beneficiary, in the year of income in which it was received or entitled to be received.

The term 'present entitlement' is not defined in the ITAA 1936. Present entitlement to the income of a trust estate will occur where the beneficiary has an indefeasible, absolutely vested interest in the income and the right to demand immediate payment of the income.

The Commissioner has set out his views on the meaning of the term ‘present entitlement’ in Taxation Ruling No. IT 347 Trust Estates: Present Entitlement. At paragraph 5 the Commissioner sets out the following requirement for a beneficiary to presently entitled to income of a trust estate as follows:

… the trustee, in formally passing the resolution or making the determination in question, has acted genuinely and irrevocably in the exercise of his powers to distribute income of the trust and has intended to vest the income in the beneficiary concerned. In deciding this question, what the trustee has actually done with the trust moneys concerned is considered relevant though not decisive. Other circumstances to be taken into account, but which may or may not have a bearing on the question depending on the facts of each individual case, are the wording of the resolution or determination and whether the beneficiary has been advised of the resolutions etc.

6. If the action of the trustee falls within the requirements previously accepted in connection with the application of the trust income for the purposes of section 101 there is, of course no problem as the beneficiary will be deemed to be presently entitled.

Further, the case of the Federal Commission of Taxation v. Ramsden [2005] FCAFC 39; 2005 ATC 4136; (2005) 58 ATR 485F supports the view that for an entity to be a valid beneficiary of a trust, the specific provisions of the trust deed must be satisfied.

For a beneficiary to be presently entitled to a distribution from a trust, the trust must not have vested and any resolution made by the trustee to distribute The Trust's income or capital is consistent with the terms of the deed and the beneficiary’s entitlement must be vested indefeasibly in the beneficiary before the end of the income year.

Subdivision 115-C of the ITAA 1997 sets out rules that affect the calculation of a beneficiary's net capital gain if the beneficiary is assessed on a share of the net income of the trust which includes a capital gain.

Where a beneficiary is presently entitled to a share of the income of a trust estate, paragraph 97(1)(a) of the ITAA 1936 requires the beneficiary to include in their assessable income that share of the trust's net income. In Commissioner of Taxation v. Bamford [2010] HCA 10, the High Court endorsed the proposition that beneficiaries can only be presently entitled to whatever is generally regarded as the distributable income of the trust (that is, the amount which can be distributed to beneficiaries or accumulated by the trustee). Further, the Court held that the reference to 'that share' meant the income to which the beneficiary was presently entitled as a proportion of the total trust income.

In this case it is necessary consider whether the Estate is an ‘Eligible Trust’ (and respectively, that the Executors of the Estate are trustees of an Eligible Trust’ – such that the Trustees of the Trust can resolve to distribute a share of the income of the Trust to the Estate in a given income year

Relevantly, Clause 3 of the trust deed provides the trustees with the powers to make a distribution of the Trust income to the General Beneficiaries living or existing at the time of the determination - Clause 3(1)(a) of the Trust Deed of the Trust provides that the trustee may prior to the vesting day determine to pay, apply or set aside the net income of the Trust Fund for the accounting period for any one or more of the general beneficiaries living or in existence at the time of the determination.

In order for the Executors of the Estate to be presently entitled to a share of the net income of the Trust under section 97 of the ITAA 1936, they must be a ‘general beneficiary’ of the Trust.

Relevantly, ‘General Beneficiaries’ is defined to mean and include ‘ the trustees (in their capacity as such) of any Eligible Trust’. An ‘Eligible Trust’ in turn is defined as meaning ‘any trust or settlement under which … any beneficiary or class of general beneficiaries has any interest …’ (emphasis added).

The Commissioner considers that the term ‘trust’ takes its ordinary meaning. The estate of a deceased person is not a trust for the purposes of trust law (Commissioner of Stamp Duties v Livingston [1964] 3 All ER 692). Consequently, the Estate cannot be a trust for the purposes of the definition of ‘Eligible Trust’.

As such, the Estate will not be an ‘Eligible Trust’ and correspondingly, the Executors of the Estate will not be the trustees of an ‘Eligible Trust’.

Furthermore, the Commissioner considers that Clause 44 (Clause 44(1)) does not allow the Trustees to nominate the Estate or the Executors of the Estate to be a member of the Appointed Class and/or class of General Beneficiaries (in this case - to include the Estate of a deceased member of the Appointed Class as a General Beneficiary of the Trust estate) for the following reasons:

a) the Estate will not satisfy the requirement that the nomination relates to a ‘person’ or ‘corporation’; and

b) the Trust Deed requires that nominations to extend the scope of beneficiaries is made with the written consent of the Appointers.. – that is, during the lifetime of the Appointers.

As such, the Executors of the Estate cannot be made a ‘General Beneficiary’ of the Trust.

As the Estate will not be an ‘Eligible Trust’ and correspondingly, the Executors of the Estate will not be the trustees of an ‘Eligible Trust’, it follows that the Executors of the Estate will not be a ‘General Beneficiary’ of the Trust and in their capacity as executors will not be presently entitled to a share of the net income of the trust under section 97 of the ITAA 1997.