Edited version of your written advice

Authorisation Number: 1051513021429

Date of advice: 16 May 2019

Ruling

Subject: Grossing up rules in Subdivision 115-C

Question

Where Trust A distributes a capital gain to Trust B of $YY amount, is the trustee of Trust B required to gross up the attributable gain pursuant to subsection 115-215(3) of the of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

For year ended 30 June 20XX

Relevant facts and circumstances

Trust A derived a taxable gross capital gain during the income year ended 30 June 20YY of $XX amount.

The capital gain was eligible to be reduced by the Capital Gains Tax (‘CCT’) General Discount pursuant to Division 115 of the ITAA 1997.

The Trust A was eligible to further reduce its assessable capital gain by the following small business concessions pursuant to Division 152 of the ITAA 1997:

● Small business 50% reduction in Subdivision 152-C of the ITAA 1997; and

● Small business rollover in Subdivision 152-E of the ITAA 1997.

The application of each of the above concessions reduced the assessable capital gain of Trust A to zero for the income year ended 30 June 20YY.

Trust A is unable to identify a replacement asset that it wishes to acquire to utilise the small business rollover, and nor will it do so within the requisite period of time under the income tax provisions.

As a result, the applicant considers that CGT Event J5 in section 104-197 of the ITAA 1997 will occur in the income year ended 30 June 20XX. Consequently, Trust A will realize a capital gain of $XX amount during the 30 June XX income year. Trust A has no capital losses to offset the capital gain of $XX amount.

Trust A will resolve to distribute the capital gain of $XX amount relating to CGT Event J5 to trust beneficiaries, Trust B and Trust C.

Trust B will receive a capital gains distribution of $YY amount.

Each of the above mentioned beneficiaries are eligible beneficiaries under the deed for Trust A to receive a share of the capital gains.

Beneficiary - Trust B

Trust B will be ‘specifically entitled’ within the terms of section 115-228 of the ITAA 1997 to $YY amount of the $XX amount capital gain.

In this regard, Trust B is reasonably expected to receive a financial benefit (economic benefit) equal to the distributed amount of capital gain. Trust A has accumulated the funds in respect of the CGT small business rollover in 20YY income year and is able to provide the financial benefit of the gain to Trust B.

Further, Trust A will, in accordance with paragraph (c) of the definition of the ‘share of net financial benefit’ in subsection 115-228(3) of the ITAA 1997, record the amount that Trust B is reasonably expected to receive, in its character as an amount referable to the capital gain, in its accounts or records within 2 months after the end of income year ended 30 June 20XX.

Trust B has capital losses.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 102(5)(1)

Income Tax Assessment Act 1997 section 104-197

Income Tax Assessment Act 1997 subsection 104-197(1)

Income Tax Assessment Act 1997 subsection 104-197(3)

Income Tax Assessment Act 1997 subsection 104-197(4)

Income Tax Assessment Act 1997 subsection 115-215(3)

Income Tax Assessment Act 1997 paragraph 115-215(3)(a)

Income Tax Assessment Act 1997 section 115-227

Income Tax Assessment Act 1997 subsection 115-227(a)

Income Tax Assessment Act 1997 subsection 115-227(b)

Income Tax Assessment Act 1997 section 115-228

Income Tax Assessment Act 1997 subsection 152-10(4)

Income Tax Assessment Act 1997 subdivision 152-C

Income Tax Assessment Act 1997 subdivision 152-E

Reasons for decision

All future legislative references in this document are references to the Income Tax Assessment Act 1997.

Detailed reasoning

Where an entity chooses the small business rollover contained in Subdivision 152-E, certain requirements must be met within the ‘replacement asset period’. The replacement asset period starts one year before and ends two years after the last CGT event that occurs in the income year for which the rollover is chosen (or further time allowed by the Commissioner).

In the present circumstances, the trustee chose the small business rollover in relation to a CGT event that occurred during the 30 June 20YY income year. The Commissioner has not extended the asset replacement period.

Section 104-197 deals with the consequences that arise if a replacement asset is not acquired within the replacement asset period. Specifically, subsection 104-197(1) states that CGT event J5 will occur if a taxpayer has not acquired a replacement asset by the end of the replacement asset period. The time of the event is at the end of the asset replacement period (see subsection 104-197(3)).

Accordingly, CGT event J5 will occur and Trust A will make a capital gain equal to the amount previously disregarded under the small business rollover (see subsection 104-197(4)) which is $XX amount. In accordance with subsection 104-197(3), the time of the event will occur during the 20XX income year.

Subsection 102-5(1) provides the method of calculating an entity's net capital gain for an income year (‘the method statement’). The following provides a summary of the steps involved:

Step 1. Reduce the capital gains you made during the income year by the capital losses (if any) you made during the income year. ….

Step 2. Apply any previously unapplied net capital losses from earlier income years to reduce the amounts (if any) remaining after the reduction of capital gains under step 1 (including any capital gains not reduced under that step because the capital losses were less than the total of your capital gains)...

Step 3. Reduce by the discount percentage each amount of a discount capital gain remaining after step 2 (if any).

Step 4. If any of your capital gains (whether or not they are discount capital gains) qualify for any of the small business concessions in Subdivisions 152-C, 152-D and 152-E, apply those concessions to each capital gain as provided for in those Subdivisions.

Step 5. Add up the amounts of capital gains (if any) remaining after step 4. The sum is your net capital gain for the income year.

The result from applying the steps set out in the method statement is that the net capital gain for Trust A from CGT Event J5 will equal the capital gain amount of $XX amount.

This is for the reason that Trust A:

● has no capital losses to offset the capital gain of $XX amount (steps 1 and 2 of the method statement);

● is unable to reduce the capital gain of $XX amount under step 3 of the method statement by applying the discount percentage for a discount capital gain. The capital gain from CGT Event J5 is excluded from being treated as a ‘discount capital gain’ under subsection 115-25(3); and

● cannot reduce the capital gain amount by the small business concessions in Subdivision 152-C (small business 50% reduction) and Subdivision 152-E (small business rollover) under step 4 of the method statement.

These small business concessions do not apply to CGT Event J5 - see Note to step 4 of the method statement in section 102-5 and the exclusion in subsection 152-10(4).

Beneficiary - Trust B

Broadly, the rules in Subdivision 115-C operate to ensure, among other things, that a beneficiary of a trust which is made ‘specifically entitled’ to a capital gain will be assessed on it.

Section 115-228 sets out when a beneficiary will be regarded as specifically entitled to a trust’s capital gain.

The amount of the trust’s capital gain that is assessed to a beneficiary is worked out by reference to their attributable gain which is calculated in accordance with subsection 115-225. A beneficiary’s attributable gain is calculated on a gain by gain basis.

Generally, a beneficiary’s attributable gain is their ‘share of the capital gain’ (see section 115-227) multiplied by the trust’s net capital gain. Under section 115-227, a beneficiary’s ‘share of the capital gain’ is any amount of the capital gain to which they are specifically entitled (subsection 115-227(a)) plus their ‘Division 6 percentage’ share of any amount of the capital gain to which no beneficiary is specifically entitled (subsection 115-227(b)).

[However, note the calculation of attributable gain amount is subject to the modification in subsections 115-225(2) and (3). These provisions rateably reduce the taxable amount of the capital gain to ensure that beneficiaries are not assessed on more than the trust’s net income. The reduction applies if the sum of the trust’s net capital gains and franked distributions (less directly relevant deductions) exceeds the trust’s net income (excluding franking credits).]

In the present circumstances, Trust B will be made specifically entitled to a capital gain of $YY amount within the terms of section 115-228.

The amount of the capital gain that Trust B will be assessed on will be determined by reference to the ‘attributable gain’. The amount of the attributable gain is to be worked out in accordance with section 115-225 with regard to the capital gains amount that the taxpayer is specifically entitled to of $YY amount (see the definition of ‘share of capital gain’ in section 115-227 and, also section 115-228).

Extra Capital Gains – Subdivision 115-C

Where a beneficiary makes an attributable gain, section 115-215 requires that the attributable gain be ‘grossed-up’ with ‘extra capital gains’. A beneficiary will be deemed to have made extra capital gains depending on whether the gain was subject to the CGT discount percentage and/or small business 50% reduction at the trust level.

Subsection 115-215(3) states the following:

“If you are a beneficiary of the trust estate, for each *capital gain of the trust estate, Division 102 applies to you as if you had:

(a) if the capital gain was not reduced under either step 3 of the method statement in subsection 102-5(1) (discount capital gains) or Subdivision 152-C (small business 50% reduction) - a capital gain equal to the amount mentioned in subsection 115-225(1); and

(b) if the capital gain was reduced under either step 3 of the method statement or Subdivision 152-C but not both (even if it was further reduced by the other small business concessions) - a capital gain equal to twice the amount mentioned in subsection 115-225(1); and

(c) the capital gain was reduced under both step 3 of the method statement and Subdivision 152-C (even if it was further reduced by the other small business concessions) - a capital gain equal to 4 times the amount mentioned in subsection 115-225(1).”….

The term “capital gain” is defined in section 995-1 as follows:

‘capital gain: for each *CGT event a capital gain is worked out in the way described in that event.’

The capital gain in question is the gain made by Trust A from CGT Event J5.

The amount referred to in the expression ‘amount mentioned in subsection 115-225(1)’ in paragraphs (a) to (c) of subsection 115-215(3) is the amount of a beneficiary’s attributable gain.

Paragraph (a) of subsection 115-215(3) is relevant to the present circumstances. Under paragraph (a) where a capital gain is not reduced at the trust level by both the CGT discount percentage (step 3 of the method statement) and the small business 50% reduction in Subdivision 152-C, no grossing up will be required of a beneficiary’s attributable gain.

As a result, a beneficiary’s capital gain will be equal to its attributable gain (as determined under section 115-225(1)).

As explained earlier in this report, Trust A cannot reduce the capital gain from CGT Event J5 of $XX amount in accordance with step 3 of the method statement in subsection 102-5(1) by the CGT discount percentage.

Further, Trust A is excluded from reducing the CGT Event J5 gain by the small business 50% reduction concession because of the exclusion found in section 152-10(4).

Consequently, as the capital gain arising from CGT Event J5 was not reduced by both the CGT discount percentage (under method 3 of the method statement) and the small business 50% reduction concession, paragraph 115-215(3)(a) will apply to the attributable gain made by Trust B.

As a result, Trust B will not be required under subsection 115-215(3) to ‘gross up’ its attributable gain.