Edited version of private advice

Authorisation Number: 1051746163096

Date of advice: 28 August 2020

Ruling

Subject: Trust entitlements

Question 1

Can the Trustee of the Clause X Trust make a choice under section 115-230 of the Income Tax Assessment Act 1997 (ITAA 1997) that subsection 115-230(4) applies in respect of the capital gains ('Pre-surrender and Surrender Gains') made by the Trust in the 2020 income year and those Surrender Gains made by the Trust in the 2021 income year?

Answer

Yes

Question 2

Will the Commissioner form an opinion under subsection 99A(2) of the Income Tax Assessment Act 1936 (ITAA 1936) that it is unreasonable in these circumstances for the Trustee of the Clause X Trust to be assessed under section 99A on its net capital gains for the 2020 income year and 2021 income year?

Answer

Yes

Question 3

Can the Trustee of the Clause Y Trust make a choice under section 115-230 of the ITAA 1997 that subsection 115-230(4) applies in respect of the 'Future Capital Gains' expected to be made by the Trust in the 2020 to 2024 income years?

Answer

Yes

Question 4

Will the Commissioner form an opinion under subsection 99A(2) of the ITAA 1936 that it is unreasonable in these circumstances for the Trustee of the Clause Y Trust to be assessed under section 99A on its net capital gains in relation to the 'Future Capital Gains' expected to be made by the Trust for the 2020 to 2024 income years?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

Year ending 30 June 2024

The scheme commences on:

1 July 2019

Relevant facts and circumstances

The deceased passed away in the late 1980's.

At the time of the deceased's death he had:

a)    Three children:

b)    Several grandchildren

At the time of the deceased's death he owned a property (Property).

He left a Will.

Under deceased's Will, two testamentary trusts were created:

a)    The Clause X Trust; and

b)    The Clause Y Trust.

Some of the grandchildren are the trustees of the Clause X Trust.

One of the grandchildren is the trustee of the Clause Y Trust

Under the terms of the Will the Property was held under the terms of the Clause X Trust

i)              Individual A was entitled to receive the income but was required to pay the rates, taxes, insurance premiums, repairs and other outgoings in relation to the Property.

ii)             On Individual A's death the Property would form part of the residuary estate and dealt with under Clause Y of the Will (that is, the Clause Y Trust).

Under a State Act, Individual A, as an income beneficiary, had the right to require the trustee to sell the property and invest the funds in approved government investments. This right however did not give Individual A any capital rights over the property or the proceeds from the sale of the Property.

i)              In the 2018 income year, Individual A's solicitor provided notice under the State Act requiring the trustee to sell the Property.

ii)             A Contract of Sale was entered into in relation to the Property in the 2018 income year (and settlement occurred in the same financial year)

iii)           The Trustee of the Clause X Trust made a choice under section 115-230(3) of the 1997 Act that section 115-230(4) of the 1997 Act applied in respect of any capital gain arising in relation to the sale of the Property. This meant that the trustee was specifically entitled to the capital gain and therefore was liable for the capital gains tax.

After the Property was sold

i)              The net proceeds from the sale of the Property have been either invested in CGT assets or the bank account of the Clause X Trust.

ii)             On XX XXXX 2020 Individual A entered into a Deed of Settlement under which they surrendered their life interest in the Clause X Trust.

iii)           Up until the date that Individual A surrendered their life interest:

a)    The trustee of the Clause X Trust disposed of some of the CGT assets resulting in the Clause X Trust deriving capital gains (Pre Surrender Gains); and

b)    Individual A received the net income derived from the assets of the Clause X Trust.

Note: Individual A was not entitled to the capital gains derived by the Clause X Trust.

iv)           As a result of Individual A surrendering their life interest in the Clause X Trust:

a)    The capital of the Clause X Trust (including the Pre Surrender Gains) will form part of the Clause Y Trust

b)    The Clause X Trust will have a capital gain in respect of any CGT asset's which it holds at the surrender date in either the 2020 income year or 2021 income year when they are either sold or are passed to the Clause Y Trust (Surrender Gains)

This is because the CGT assets were not held by the deceased at the time of his death and therefore any capital gain will not be disregarded under Division 128 of the 1997 Act.

Under Clause Y of the Will, the residue of the Estate was to be held on a trust under which:

i)              The deceased's children would receive the income during their lifetime; and

ii)             Upon the death of the survivor, the capital would be distributed amongst the deceased's surviving grandchildren (and possibly some great-grandchildren).

iii)           One of the children passed away in the early 2010's, and since that date the other child has received 100% of the income of the Clause Y Trust

iv)           As a consequence of Individual A surrendering their life interest, the capital of the Clause X Trust will be held on the terms of the Clause Y Trust.

v)            Until one of the children's death, the Clause Y Trust is likely to derive capital gains from its assets to which the other child will not be entitled to receive but will form part of the capital of the Clause Y Trust (Future Capital Gains)

The Clause X and Y Trusts are resident trusts.

No trust property representing any of the capital gains has been paid or applied for the benefit of a beneficiary.

Any assets which are acquired by the Clause Y Trust will be acquired as a result of or be funded in one of the following ways:

·         As a result of assets passing from the Clause X Trust under the terms of the Will.

·         The cash resources of the Clause Y Trust (including any cash passing from the Clause X Trust under the terms of the Will).

·         Income generated from assets held by the Clause Y Trust.

·         The proceeds of sale of assets held by the Clause Y Trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 115-215

Income Tax Assessment Act 1997 Section 115-220

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

Income Tax Assessment Act 1997 Section 115-228

Income Tax Assessment Act 1997 Section 115-230

Income Tax Assessment Act 1997 Subsection 115-230(3)

Income Tax Assessment Act 1997 Subsection 115-230(4)

Income Tax Assessment Act 1997 Section 128-10

Income Tax Assessment Act 1936 Section 99

Income Tax Assessment Act 1936 Section 99A

Income Tax Assessment Act 1936 Subsection 99A(2)

Income Tax Assessment Act 1936 sub-paragraph 99A(2)(a)(ii)

Income Tax Assessment Act 1936 Subsection 99A(3)

Reasons for decision

Pre-Surrender and Surrender Gains

Specifically entitled beneficiaries

Subdivision 115-C of the ITAA 1997 sets out the rules for calculating a beneficiary's net capital gain if they are entitled to a distribution from a trust that includes a net capital gain.

Section 115-228 of the ITAA 1997 outlines when a beneficiary will be regarded as specifically entitled to a trust capital gain (either in whole or in part). A beneficiary is specifically entitled to a capital gain if the following two conditions are satisfied:

·         The first condition for a beneficiary to be specifically entitled to a capital gain is that the beneficiary receives, or is reasonably expected to receive, an amount equal to their share of the net financial benefit that is referable to the capital gain. A beneficiary's entitlement can be expressed as a dollar amount, a share of the trust gain or distribution, or using a known formula provided it refers to the capital gain.

·         The second condition for a beneficiary to have a specific entitlement to a capital gain is that the beneficiary's entitlement to the amount is recorded in its character as referable to the capital gain, in the accounts or records of the trust no later than 2 months after the end of the income year. This record must be contained in the accounts or records of the trust, such as the trust deed, trust accounts, resolutions and distribution statements, including schedules and notes attached to, or intended to be read with, these documents. A record for tax purposes only does not create specific entitlement.

When a beneficiary is specifically entitled to a capital gain, any resulting extra capital gain (section 115-215(3)) will be taken into account in determining the beneficiary's net capital gain to be included in their assessable income. Alternatively, capital gains to which no beneficiary is specifically entitled flow proportionally to beneficiaries and/or the trustee based on their proportional share of the income of the trust estate.

In accordance with the Will, the Testamentary Trust's deed, the only beneficiary entitled to the capital gains is the Clause Y Trust and therefore would reasonably expect to receive the financial benefit representing the capital gain.

The Will which created the Testamentary Trust meets the description of a record of the trust and records the financial benefit that the beneficiaries are expected to receive in its character as referable to the capital gain.

The two conditions for the Clause Y Trust of the deceased's estate to be viewed as being specifically entitled have been met. The Clause Y Trust has been made specifically entitled to the capital gain for the purposes of section 115-228.

Choice for resident trustee to be deemed as specifically entitled - section 115-230

Broadly, section 115-230 of the ITAA 1997 allows a trustee of an Australian resident trust to choose to be assessed on a capital gain of the trust where no trust property representing the capital gain has been paid or applied for a beneficiary of the trust.

Subsection 115-230(3) of the ITAA 1997 explains the circumstances in which the trustee is able to make a choice to be assessed on a capital gain as:

a)    where the capital gain is taken into account in working out the net capital gain of the trust in the income year, and

b)    the trust property representing all or part of the capital gain has not been paid or applied for the benefit of a beneficiary of the trust by two months after the end of the relevant income year.

If the trustee makes a choice to be assessed on the capital gain, subsection 115-230(4) of the ITAA 1997 provides that:

a)    sections 115-215 and 115-220 do not apply in relation to the capital gain, and

b)    the trustee is taken to be specifically entitled to all of the capital gain for the purposes of the income tax legislation.

In order for section 115-230 of the ITAA 1997 to apply, the trustee must make the aforementioned choice within 2 months of the last day of the income year or a later day permitted by the Commissioner, pursuant to subsection 115-230(5).

Application to your circumstances

Whether the Clause Y Trust can make the choice

The capital gains involved, being the pre-surrender gains from the sales of various CGT assets and the surrender gains from the transfer of assets to the Clause Y Trust that are not subject to the exemption in section 128-10 ITAA 1997, are not the capital gains of the Clause Y Trust. The capital gains event occurred in the Clause X Trust. The residuary beneficiary of the Clause X Trust, being the Clause Y Trust, received the capital gain in its capacity as beneficiary of the Clause X Trust.

In subsection 115-230(1) it states the following:

(1)  The purpose of this section is to allow a trustee of a resident trust to make a choice that has the effect that the trustee will be assessed on a capital gain of the trust if no trust property representing the capital gain has been paid to or applied for the benefit of a beneficiary of the trust.

The phrase 'capital gain of the trust' in that subsection above indicates that this section is only regarding the capital gains derived from CGT events occurring from assets owned by the relevant trust.

While the trust is a resident Australian trust, the capital gain will not be taken into account in working out the net capital gain of the relevant trust and therefore will not meet the requirements in subsection 115-230(3) ITAA 1997.

Therefore the Clause Y Trust cannot chose to be made specifically entitled to the amount of the capital gain representing the pre-surrender and surrender gains.

Whether the Clause X Trust can make the choice

The Clause X Trust is an Australian resident trust and the capital gain will be taken into account when calculating the net capital gain for the year ended 30 June 2020. You also state that no trust property representing all or part of the capital gain will be paid or applied for the benefit of a beneficiary of the trust prior to the end of 2 months after 30 June 2020. Consequently the criteria in subsection 115-230(3) of the ITAA 1997 will be met such that the subsection will also be satisfied.

As a result of satisfying the abovementioned requirements, the trustee of the Clause X Trust is therefore entitled to make a choice no later than 31 August 2020 pursuant to section 115-230 that it will be assessed on the capital gain made in respect of the sale of the CGT assets and the gain from the transfer of the assets to the Clause Y Trust. If the trustee elects to make this choice, sections 115-215 and 115-220 of the ITAA 1997 will not apply to the capital gains and the trustee will be taken to be specifically entitled to all of the capital gain, in accordance with subsection 115-230(4).

The consequence of making this decision will be that the Clause Y Trust will not be taken to be specifically entitled to the pre-surrender and surrender date gains.

Future Capital gains

The same considerations are relevant to the future capital gains. In their case however, the capital gains will be gains of the Clause Y Trust. This means that the Trustee of the Clause Y can choose to be made specifically entitled to the capital gains from the sale of the various assets of the Clause Y Trust as they meet the other conditions described above being:

- it is an Australian resident trust;

- the capital gain will be taken into account when calculating the net capital gain for the relevant income year

- no property representing part of the capital gain will be applied for the benefit of the beneficiary of the trust prior to the end of 2 months after the end of the relevant income year

Accordingly the Trustee of the Clause Y Trust can choose to be specifically entitled to the Future Capital Gains.

Section 99A

Broadly, section 99A of the ITAA 1936 provides certain circumstances in which a trustee of a trust estate will be liable to pay tax on the net income of the trust estate at a rate declared by Parliament.

Subsection 99A(2) of the ITAA 1936 provides that section 99A will not apply to a trust estate if, among other things, the trust resulted from a will or codicil and the Commissioner is of the opinion that it would be unreasonable that section 99A apply to the trust.

In forming the opinion, subsection 99A(3) of the ITAA 1936 provides that:

a)    the Commissioner shall have regard to the circumstances in which the condition, if any, upon which, at any time property (including money) was acquired by or lent to the trust estate, income was derived by the trust estate, benefits were conferred on the trust estate or special rights or privileges were conferred on or attached to property of the trust estate, whether or not the rights or privileges have been exercised;

b)    if a person who has, at any time, directly or indirectly:

(i)            transferred or lent any property (including money) to, or conferred any benefits on, the trust estate; or

(ii)           conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of the trust estate whether or not the right or privilege has been exercised;

has not, at any time, directly or indirectly:

(iii)          transferred or lent any property (including money) to, or conferred any benefits on, another trust estate; or

(iv)          conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of another trust estate, whether or not the right or privilege has been exercised;

the Commissioner shall have regard to that fact; and

c)    the Commissioner shall have regard to such other matters, if any, as he or she thinks fit.

Consequently, as explained by Menzies J in Giris Pty Ltd v Federal Commissioner of Taxation 69 ATC 4015 (1969) (Giris)[1], section 99A of the ITAA 1936 will apply to trust income unless the Commissioner forms the opinion that it would be unreasonable for the section to apply. That is, it is necessary for the Commissioner to form the opinion otherwise section 99A will apply in the relevant year.

Meaning of the term "unreasonable"

Although subsection 99A(3) of the ITAA 1936 specifies some circumstances to which the Commissioner shall have regard in forming his opinion pursuant to subsection 99A(2), the legislation does not prescribe the weight to be given to these specified factors. As stated by Menzies J in Giris, the legislation provides "no guidance upon what significance should be given to the presence or absence of the fact" to those circumstances. Furthermore, the legislation does not prescribe a full set of facts and circumstances in which the opinion should or should not be formed. Rather, paragraph 99A(3)(b) merely provides that the Commissioner shall consider such matters as he thinks fit.

Windeyer J in Giris states "[the legislative purpose] I take it is to enable the Commissioner to keep sec 99A as an instrument to prevent avoidance of taxation by the medium of trusts, but not to use it when to do so would seem to him not in accordance with that purpose".

This purpose is reproduced by the Explanatory Memorandum (EM) to the Income Tax Laws Amendment Act 1980 (EM to ITLAA 1980), which substituted the current subsection 99A(2) of the ITAA 1936. The EM to ITLAA 1980 explains that the introduction of the then new law was to give effect to the policy that only in limited circumstances would accumulated trust income be taxed pursuant to section 99 rather than section 99A. It states that by the Commissioner considering whether it would be unreasonable for section 99A to apply, the new law will enable the result that unless there are tax avoidance connotations, income of a trust estate will continue to be taxed pursuant to section 99 on the same basis as prior to the new law.

The EM also states that the purpose behind the amendments to the former section 99A was to broaden the imposition of the maximum individual tax rate on trust income where there is no beneficiary presently entitled to that trust income.

Application to your circumstances

The Clause X and Y Trusts were established as a result of the will of the deceased and therefore are testamentary trusts. Consequently, sub-paragraph 99A(2)(a)(ii) of the ITAA 1936 has been satisfied and the Commissioner can form the opinion that it would be unreasonable for section 99A to apply.

In considering whether it would unreasonable for section 99A of the ITAA 1936 to apply to both the Clause X and Y Trusts, the Commissioner has had regard to the factors provided in subsection 99A(3). Specifically, the Commissioner has taken into account the fact that:

a)    you state that there has been no injection of property into the trusts, only that the proceeds from the sale of the property that was part of the Will has been used to purchase income producing assets

b)    the choice available to the trustee pursuant to section 115-230 of the ITAA 1997 operates to deem the trustee specifically entitled to the gain and therefore to generally make available to the trustee the same concessions as are available to a specifically entitled beneficiary, and

c)    there does not appear to be any tax avoidance motive behind the arrangement, rather it appears it has been implemented in accordance with the intended purpose of section 115-230 of the ITAA 1997.

As such, and consistent with the statements of Windeyer J in Giris and EM to ITLAA 1980, the Commissioner has determined that it would be unreasonable for section 99A of the ITAA 1936 to apply to your circumstances.

Consequently:

·         the Trustee of the Clause X Trust will be assessed under section 99 in relation to the pre-surrender gains and the surrender gains to which section 115-230 of the ITAA 1997 applies.

·         The trustee of the Clause Y Trust will be assessed under section 99 in relation to the future capital gains to which section 115-230 of the ITAA 1997 applies.

[1] It should be noted that the High Court decision reached in Giris was made in relation the constitutional validity of former sections 99 and 99A of the ITAA 1936. Although these sections have since been amended, the requirement for the Commissioner to form an opinion that that it would be unreasonable for section 99A to apply remains the same in the current provisions.