Edited version of private advice

Authorisation Number: 1051606400623

Date of advice: 8 November 2019

Ruling

Subject: Trust capital gains tax-non-resident beneficiary

Question 1

Is the Estate of Person A a 'fixed trust' for the purposes of section 272-65 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) and subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Can a non-resident residual beneficiary disregard a capital gain made from a CGT event happening in respect of their interests, that are not Taxable Australian Property, in a fixed trust under subsection 855-40(2) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Probate has been granted and there was and will not be any challenges to the entitlements of the residual beneficiaries.

The only real property in the estate will be subject to the main residence exemption.

The trustee will be assessable pursuant to certain income of the non-resident beneficiary pursuant to section 98 of the Income Tax Assessment Act 1936.

Relevant legislative provisions

Income Tax Assessment Act 1936

Section 272-5 of Schedule 2F

Subsection 272-5(1) of Schedule 2F

Section 272-65 of Schedule 2F

Subsection 95A(2)

Income Tax Assessment Act 1997

Section 855-15

Section 855-40

Subsection 855-40(2)

Paragraph 855-40(2)(a)

Subparagraph 855-40(2)(b)(i)

Subparagraph 855-40(2)(c)(i)

Subsection 995-1(1)

Reasons for decision

Question 1

Summary

Given that the interests of the residuary beneficiaries in the income and capital of the estate are vested and indefeasible, then fixed entitlements exist in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936. As such, the estate is a fixed trust in accordance with section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997 following the death of Person A.

Detailed reasoning

Fixed Trust

Section 272-65 of Schedule 2F to the ITAA 1936 provides that a trust is a 'fixed trust' if persons have fixed entitlements to all of the income and capital of the trust. Subsection 995-1(1) of the ITAA 1997 provides that a trust is a fixed trust if entities have fixed entitlements to all of the income and capital of the trust.

Subsection 272-5(1) of Schedule 2F to the ITAA 1936 provides that, in relation to the meaning of the term fixed entitlement:

If, under a trust instrument, a beneficiary has a vested and indefeasible interest in a share of income of the trust that the trust derives from time to time, or of the capital of the trust, the beneficiary has a fixed entitlement to that share of the income or capital.

It is an essential element of subsection 272-5(1) of Schedule 2F to the ITAA 1936 that in order to have a fixed entitlement to a share of income or capital there must be a vested or indefeasible interest 'under a trust instrument'. In all cases, the determining factor in deciding if fixed entitlements exist will be the terms of the trust instrument under which the trust is constituted.

The meaning of the term 'vested and infeasible' (in the context of the Schedule 2F) has not been judicially considered. However, the term appears in Division 6 in subsection 95A(2) of the ITAA 1936 and in the context of that subsection, the term has been considered by the courts; for example, refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4, 525; Walsh Bay Developments Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4378; Dwight v Commissioner of Taxation (1992) 92 ATC 4192; Harmer v FC of T (1991) 91 ATC 5000.

Also relevant are MSP Nominees Pty Ltd v Commissioner of Stamps (SA) (1999) 198 CLR 494; 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490.

The term 'vested and indefeasible' is not defined in the taxation legislation and to date there is no 'ATO view' which defines or clarifies the term.

The Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 which introduced the trust loss measures gives an explanation in relation to the meaning of 'vested and indefeasible' interest (see paragraphs 13.3 to 13.9).

What is a vested interest?

The EM states:

13.4 A person has a vested interest in something if the person has a present right relating to the thing. Stated simply, a vested interest is one that is bound to take effect in possession at some point in time. A vested interest is to be contrasted with a 'contingent' interest which may never fall into possession. If an interest of a beneficiary in income or capital is the subject of a condition precedent, so that an event must occur before the interest becomes vested, the beneficiary does not have a vested interest to the income or capital since such an interest is instead 'contingent' upon the event occurring.

13.5 In traditional legal analysis, a person can be said to be either 'vested in possession' or 'vested in interest'. A present interest, i.e. one that is being enjoyed, is said to be 'vested in possession'; a future interest, i.e. one which gives its holder a present right to future enjoyment, is said to be 'vested in interest'. A person is vested in possession where the person has a right to immediate possession or enjoyment of the thing in question. In the definition of fixed entitlement, 'vested' includes both vested in possession and vested in interest.

13.6 Because vested interests include future interests, a person can have a vested interest in a thing even though the person's actual possession and enjoyment of the thing is delayed until sometime in the future.

When is a vested interest indefeasible?

The EM states:

13.7 A vested interest is indefeasible where, in effect, it is not able to be lost. A vested interest is defeasible where it is subject to a condition subsequent that may lead to the entitlement being divested. A condition subsequent is an event that could occur after the interest is vested that would result in the entitlement being defeated, for example, on the occurrence of an event or the exercise of a power. For example, where a beneficiary's vested interest is able to be taken away by the exercise of a power by the trustee or any other person, the interest will not be a fixed entitlement.

13.8 Where the trustee exercises a power to accumulate income or capital of the trust in accordance with the trust deed, the accumulation does not result in a beneficiary's interest being taken away or defeased as long as the beneficiary nevertheless remains entitled at some future time to enjoy his or her share of the income or capital which has been accumulated.

Vested and indefeasible interests and a deceased estate

ATO Interpretative Decision ATO ID 2006/279 expresses the view that the terms of the Will governing the disposition of the property in the deceased estate confer fixed entitlements to all of the income and capital of the estate upon the residuary beneficiaries. The ATO ID explains that the interest of the residuary beneficiaries in the income and capital of the estate is indefeasible. There is no condition in the trust instrument, the Will (and Codicil of the Will), by which any of the residuary beneficiaries could lose their interest in the estate.

In relation to vesting, it is considered that for any interest to be 'vested in interest', the following conditions are present (Evans, M Equity & Trusts, Sydney: Butterworths 2003 at 354):

1. The person or persons entitled to the interest must be ascertained;
2. The interest must be ready to take effect in possession immediately upon termination of the prior interest;
3. The gift must not be subject to any contingency; and
4. Where the gift is in favour of a class, every member of the class must be ascertained (that is, identified), and the exact share of the each must also be ascertained.

Defeasible v indefeasible

With reference to the certainty of their duration, interests are divided into defeasible interests and indefeasible or absolute interests (Fearne, C An Essay on the Learning of Contingent Remainders and Executory Devises, (Colorado: Rothman, 10th ed 1980), Vol. 2, at 30).

A defeasible interest is an interest that is subject to be defeated by the operation of a subsequent or mixed condition;

An indefeasible interest, or an absolute interest as opposed to a defeasible interest, is one that is not subject to any condition.

In relation to the term 'defeasance' Fearne provides that (at 9):

Defeasances are provisos of the same import and efficacy as proper conditions subsequent, but are contained in a distinct deed, either delivered at the same time with the deed to which the condition relates, or, except in the case of things executory or chattels, delivered after the deed to which the condition relates.

Do vested and indefeasible interests exist in the income and capital of the Trust?

In relation to the income and capital of the 'estate' in this case:

a)    The beneficiaries entitled are the X children of relative B:

b)    The X children are ready to take possession of their interest in possession after the death of relative A.

c)    No contingencies exist.

By the time relative A died, the five residual beneficiaries had all attained the age of 21 years and all are living.

d)    Each of the beneficiaries is entitled to 1/X share of the Estate pursuant to the Will and subsequent Codicil of the Will.

In this case, there are no conditions subsequent or any indication that anything external to the Will or to the Codicil of the Will that will have the effect of a condition subsequent in relation to the capital of the Estate, by which the beneficiaries could lose their interests in the Trust.

Therefore the residual beneficiaries have a vested and indefeasible interest in the income and capital of the Estate.

Conclusion

Given the interests of the residual beneficiaries in the income and capital of the Estate are vested and indefeasible, then fixed entitlements exist in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936. As such the Estate is a fixed trust in accordance with section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997 following the death of relative A.

This conclusion is consistent with the view expressed in ATO ID 2006/279.

Question 2

Summary

Given that the Estate is found to be a fixed trust, the non-resident beneficiary of the Estate can disregard any capital gain they makes in respect of their interest in the Trust under subsection 855-40(2) of the ITAA 1997 that does not consist of Taxable Australian Property.

Detailed reasoning

CGT exemption in section 855-40 of the ITAA 1997

Section 855-40 provides a CGT exemption for foreign residents making a capital gain in respect of their interest in a fixed trust (including a managed fund).

Relevantly, subsection 855-40(2) provides that a capital gain you make in respect of your interest in a fixed trust is disregarded if:

·         you are a foreign resident when you make the gain: paragraph 855-40(2)(a); and

·         the gain is attributable to a CGT event happening to a CGT asset of a trust (the CGT event trust) that is the fixed trust: subparagraph 855-40(2)(b)(i); and

·         the asset is not taxable Australian property for the CGT event trust at the time of the CGT event: subparagraph 855-40(2)(c)(i).

In the present case, the relevant conditions in subsection 855-40(2) of the ITAA 1997 are satisfied in respect of the interests of the non-resident beneficiary in the Estate that are not Taxable Australian Property.

This is because you are a non-resident, the deceased estate is a fixed trust at the time of the E4 event and the assets subject to this ruling are not Taxable Australian Property for the purposes of Division 855 of the ITAA 1997.