Edited version of private advice

Authorisation Number: 1051881244901

Date of advice: 9 August 2021

Ruling

Subject: Trust - specific entitlement

Question 1

Will the beneficiaries be specifically entitled to a share of the capital gain in accordance with section 115-228 of the Income Tax Assessment Act 1997 (ITAA 1997) if the Trustees pass a distribution resolution?

Answer

Yes

Question 2

Will beneficiary A be entitled to apply the capital gains tax (CGT) main residence exemption in accordance with section 118-110 of the ITAA 1997 if that beneficiary specifically entitled to a share of the capital gain on the sale of the property?

Answer

No

Question 3

Will beneficiary B be entitled to apply the CGT main residence exemption in accordance with section 118-110 of the ITAA 1997 if that beneficiary is specifically entitled to a share of the capital gain on the sale of the property?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are the Trustees of Trust A (Trust).

You are two siblings of the Deceased.

The Deceased has two children.

The Deceased acquired the property and became the registered proprietor in 19xx.

The Property is a residential property on which the family home of the Deceased and the children.

A declaration of trust was made in relation to the Property by the Deceased.

The purpose of the Trust was to protect the children's inheritance of the property and to ensure that the family home was maintained for their benefit. Therefore, under the terms of the Trust, the deceased gifted the property to the children and the Trustees agreed to hold the property as trustees "for and on behalf of the children" because at the time that the Property was gifted to them, they were minors.

A Transfer of Land Form was signed by the Deceased to transfer legal title in the Property to the Trustees.

Ad valorem stamp duty was paid upon the transfer of the legal title in the Property to the Trustees at the date of transfer.

A land title search shows that the Trustees were registered as joint proprietors of the Property and on that same day a caveat was registered in the names of the children being the fixed interest beneficiaries of the Trust.

The children continued to reside at the Property.

As joint beneficiaries they have recently directed the Trustees to sell the Property on the market and to distribute the cash proceeds from the sale to them.

Beneficiary B ceased to reside at the Property.

Beneficiary A has resided at the Property entire life, is currently residing at the Property and will continue to reside at the Property until the Property is sold.

The Trustees intend to sign a distribution statement addressed to the beneficiaries which confirms their entitlement to each receive 50% of the capital gains made on the sale of the Property.

The Property has never been rented out.

Both beneficiaries are Australian tax residents.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 106-50

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Subdivision 115-A

Income Tax Assessment Act 1997 Section 115-215

Income Tax Assessment Act 1997 Section 115-227

Income Tax Assessment Act 1997 Section 115-228

Income Tax Assessment Act 1997 Section 115-230

Income Tax Assessment Act 1997 Section 118-110

Income Tax Assessment Act 1997 Section 118-115

Income Tax Assessment Act 1997 Section 118-130

Reasons for decision

Question 1

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 two 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 (subsection 115-215(3) of the ITAA 1997) 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.

A trustee of a resident trust is allowed 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. In this case, the Trustees have not made a choice to be specifically entitled to any of the capital gains under section 115-230 of the ITAA 1997.

Application to your situation

In this case, both beneficiaries are Australian tax residents. As joint beneficiaries, they have recently directed the Trustees to sell the Property on the market and to distribute the cash proceeds from the sale to them. They should receive, or could reasonably expect to receive, an amount of the capital gain in accordance with the terms of the Trust.

The Trustees intend to sign a distribution statement addressed to the beneficiaries which confirms their entitlement to each receive 50% of the capital gains made on the sale of the Property.

Therefore, the two conditions for the beneficiaries of the Trust to be specifically entitled to a capital gain could be met. Accordingly, both beneficiaries would be taxable on their respective share of the capital gains made on the sale of the Property.

Question 2 and 3

When a beneficiary has a specific entitlement to a capital gain, certain tax consequences in respect of that capital gain apply to the beneficiary.

Main residence exemption

Under section 118-110 of the ITAA 1997, a capital gain or capital loss you make from a CGT event that happens in relation to a CGT asset that is a dwelling or your ownership interest in it is disregarded 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 (section 118-130 of the ITAA 1997) in a dwelling or land if:

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

•         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

•         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

Your ownership period (section 118-125 of the ITAA 1997) of a dwelling is the period on or after 20 September 1985 when you had an ownership interest in:

a)    dwelling; or

b)    land (acquired on or after 20 September 1985) on which the dwelling is later built.

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 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.

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. A dwelling is not a fungible asset.

Extra capital gains: section 115-215 of the ITAA 1997

As discussed in Question 1, when a beneficiary is specifically entitled to a capital gain, any resulting extra capital gain (subsection 115-215(3)) will be taken into account in determining the beneficiary's net capital gain to be included in their assessable income.

The purpose of this is so the beneficiary can apply capital losses against the gains and the beneficiary can apply the appropriate discount percentage to the gains.

Draft Taxation Determination TD 2019/D6 Income tax: does Subdivision 855-A (or subsection 768-915(1)) of the Income Tax Assessment Act 1997 disregard a capital gain that a foreign resident (or temporary resident) beneficiary of a resident non-fixed trust makes because of subsection 115-215(3)? explains further that if a trust's net income includes a net capital gain, subsection 115-215(3) may treat a beneficiary as having extra capital gains (that is, in addition to those that the beneficiary has made directly) which are included in the calculation of their net capital gain under the method statement in subsection 102-5(1) and subsection 115-215(4A) makes it clear that the beneficiary is taken to have made these capital gains even though no CGT event has happened directly to the beneficiary (paragraphs 11 and 12).

Application to your situation

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.

The relevant CGT event occurs to the Property which is owned by the Trust. As no beneficiary is absolutely entitled to the Property, the CGT event A1 will happen to the legal owner which is the Trust. The relevant CGT event is happening to the dwelling and associated property which is owned by the trust.

Subsection 118-110(1) of the ITAA 1997 requires the relevant capital gain or loss you make to be from a CGT event that happens in relation to a CGT asset that is a dwelling or your ownership interest in it. The capital gain is not as a result of a CGT event that occurred from the CGT event A1 (disposal of the property). It is the extra capital gain to which both beneficiaries are made specifically entitled. Subsection 115-215(1) states that the beneficiary can apply capital losses and appropriate discount percentages to the capital gains derived under this section. It does not state that it allows a beneficiary to claim the main residence exemption.

Since the beneficiaries were not the legal owners, they did not have an ownership interest in the property. Therefore the property cannot have been their main residence during their ownership period for the purpose of section 118-110 of the ITAA 1997.

Therefore, the capital gain or loss from the sale of the property cannot be disregarded.

Accordingly, as joint beneficiaries, they cannot claim the main residence exemption.