Edited version of private advice

Authorisation Number: 1051866575367

Date of advice: 15 July 2021

Ruling

Subject: Absolute entitlement - main residence exemption

Question

Are you entitled to the main residence exemption to disregard the capital gains or losses upon the sale of the property?

Answer

No

This ruling applies for the following period periods:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The land was purchased by two individuals jointly in 20XX.

A dwelling was built on the property in 20XX to 20XX.

The property was transferred to the trust in the 20XX income year.

This was done to mitigate any potential litigious issues and asset protection purposes. The transfer was done with a full valuation and proper sale.

The Trustee of trust is a corporate trustee.

The trust is a discretionary trust.

In the Schedule to the Trust deed is states who the specified class is:

1)    Individual X and the spouse, de facto partner, children and remoter issue of Individual X

2)    The spouses, de facto partners and children of each of those children and their descendants

3)    Any company, wherever incorporated or having its corporate office, in which any of the persons mentioned in clauses 1 and 2 holds shares or is a director; and

4)    Any trust of which any of the persons mentioned in clauses 1 and 2 is a beneficiary, whether discretionary, contingent or vested

The dwelling has not been used for generating income. A shed on the property was rented out for X years of the trust ownership.

Individual X and their family, who are beneficiaries of the trust, have always lived in the house.

The property sold in the financial year ending 30 June 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 section 118-130

Income Tax Assessment Act 1997 section 125-60

Income Tax Assessment Act 1997 section 106-50

Reasons for decision

Summary

You cannot use the main residence exemption to disregard the capital gain or loss upon sale of your property.

Detailed reasoning

Main residence exemption

Generally, you can ignore a capital gain or loss you make on the disposal of a dwelling that was your main residence if:

•                    you are an individual, and

•                    the dwelling was your main residence throughout your ownership period, and

•                    the interest did not pass to you as a beneficiary in, and you did not acquire it as a trustee of, the estate of a deceased person.

You have an ownership interest in a dwelling or land if:

a)            for land - you have a legal or equitable interest in it or a right to occupy it, or

b)            for a dwelling that is not a flat or home unit - you have a legal or equitable interest in the land on which it is erected, or a licence or right to occupy it, or

c)            for a flat or home unit - you have:

      I.        a legal or equitable interest in a stratum unit in it; or

    II.        a licence or right to occupy it; or

   III.        a share in a company that owns a legal or equitable interest in the land on which the flat or home unit is erected and that gives you a right to occupy it

In most cases the full exemption will apply where an individual or individuals own a dwelling and occupy it as a main residence.

Ordinarily a trust cannot apply the main residence exemption as the entity making the gain must be an individual. However, where a beneficiary is absolutely entitled as against the trustee to the dwelling and it is the main residence of that beneficiary the main residence exemption would be available.

Asset treated as belonging to absolutely entitled beneficiary

Under section 106-50 of the Income Tax Assessment Act 1997 (ITAA 1997), once a beneficiary of a trust becomes absolutely entitled to an asset as against the trustee, the CGT provisions apply as if the asset were vested in the beneficiary, and as if any acts of the trustee were acts of the beneficiary.

For example, the subsequent actual distribution of the asset to the beneficiary would not have any CGT consequences and a sale of the asset by the trustee to a third party would be treated as a sale by the beneficiary.

Absolute entitlement

Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997, examines the meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust'.

The foundation that supports the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a secured and unbeatable interest in the entire trust asset, to call for that asset to be transferred to them or to be transferred to someone else at their direction. If there is more than one beneficiary with interests in the trust asset, then it will usually not be possible for any one beneficiary to be absolutely entitled to the asset. In such cases, absolute entitlement can only be established if the assets are fungible. Land is not a fungible asset.

An object of a discretionary trust cannot be absolutely entitled prior to any exercise of the trustee's discretion in their favour as before that point they have no interest in the trust's assets.

Application to your circumstances

The trust is a discretionary trust. The trustee has discretion in allocating income or property of the trust. The trust deed does not provide that one specific beneficiary has ownership of the property. When the asset is not fungible and there is more than one beneficiary potentially entitled to the asset, no one beneficiary can be considered absolutely entitled to the asset. No beneficiary could have an interest in the property until that property is appointed to them by the trustee. That has not occurred in this case. Any beneficiary would not have been absolutely entitled from the time the property was transferred to the trust until it was sold.

The relevant CGT event occurs to the property which is owned by the trust. As discussed above, as no beneficiary is absolutely entitled to the property, the CGT event A1 disposal event will happen to the legal owner which is the trust. The beneficiaries would have a right to occupy the property which would be sufficient to satisfy the definition of ownership interest in section 118-130 of the ITAA 1997. However, the CGT event is not happening to their ownership interest being the right to occupy. It is happening to the dwelling and associated property which is owned by the trust. Therefore, the individual beneficiaries cannot claim the main residence exemption.

As the entity disposing of the trust is not an individual, the trust cannot use the main residence exemption to disregard any capital gains or losses from the disposal of the property.

No beneficiary is absolutely entitled to the asset therefore they would have no ability to use the main residence exemption either.