Edited version of private advice

Authorisation Number: 1052000770694

Date of advice: 30 June 2022

Ruling

Subject: Trust distribution

Question 1

Will the distribution of capital from the Family Trust to the Trust Beneficiaries be included in their assessable income under section 6-5 of the Income Tax Assessment Act 1997 as ordinary income?

Answer

No.

Question 2

Will the distribution of capital from the Family Trust to the Trust Beneficiaries be included in their assessable income pursuant to section 97 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 3

Will the distribution of capital from the Family Trust to the Trust Beneficiaries be included in their assessable income pursuant to section 99B of the Income Tax Assessment Act 1936?

Answer

No.

Question 4

Will the distribution of capital from the Family Trust to the Trust Beneficiaries cause CGT event E4 to happen to them under section 104-70 of the Income Tax Assessment Act 1997?

Answer

No.

Question 5

Will the distribution of capital from the Family Trust to the Trust Beneficiaries cause CGT event E5 to happen to them under section 104-75 of the Income Tax Assessment Act 1997?

Answer

No.

Question 6

Will the distribution of capital from the Family Trust to the Trust Beneficiaries cause CGT event E6 to happen to them under section 104-80 of the Income Tax Assessment Act 1997?

Answer

No.

Question 7

Will the distribution of capital from the Family Trust to the Trust Beneficiaries cause CGT event E7 to happen to them under section 104-85 of the Income Tax Assessment Act 1997?

Answer

No.

Question 8

Will the distribution of capital from the Family Trust to the Trust Beneficiaries cause CGT event E8 to happen to them under section 104-90 of the Income Tax Assessment Act 1997?

Answer

No.

Question 9

Will the distribution of capital from the Family Trust to the Trust Beneficiaries cause CGT event A1 to happen to them under section 104-10 of the Income Tax Assessment Act 1997?

Answer

No.

Question 10

Will the distribution of capital from the Family Trust to the Trust Beneficiaries cause CGT event A1 to happen to the Trustee for the Family Trust under section 104-10 of the Income Tax Assessment Act 1997?

Answer

Yes.

Question 11

Will the distribution of capital from the Family Trust to the Trust Beneficiaries cause CGT event C2 to happen to them under section 104-25 of the Income Tax Assessment Act 1997?

Answer

No.

Question 12

Will the distribution of capital from the Family Trust to the Trust Beneficiaries cause CGT event H2 to happen to them under section 104-155 of the Income Tax Assessment Act 1997?

Answer

No.

Question 13

Will a Family Trust Distribution Tax liability arise under section 271-15 of Schedule 2F to the Income Tax Assessment Act 1936 in respect of loans and payments to be made to the Trust Beneficiaries from the Family Trust?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Family Trust

The X Family Trust (the Family Trust), is an Australian resident discretionary trust and forms part of the XYZ Group.

The trustee of the Family Trust is Company A Pty Ltd (Company A).

The Trust Beneficiaries include Beneficiary A, Beneficiary B, Beneficiary C, Beneficiary D who are members of the General Beneficiaries and Default Beneficiaries class.

Beneficiary A, Beneficiary B, Beneficiary C are the children of Beneficiary D.

The Family Trust has made a Family Trust Election (FTE) with Beneficiary D as the specified individual.

The Family Trust has a pre-CGT Capital Profits Reserve with a credit balance of $X.

The Family Trust is seriously considering undertaking a transaction whereby it will make a capital distribution of approximately $Y to the Trust Beneficiaries sourced from the Reserve (the Proposed Transaction) of the Family Trust during the 20XX income year.

Under the Trust Deed, Company A can, in its discretion, appoint (or distribute) capital of the trust.

Background

Historically, the Family Trust held a part share in an Australian private company, namely Company B Pty Ltd (Company B). The Family Trust no longer retains any ownership interests in Company B.

Company B was incorporated before 19 September 1985. The Family Trust acquired a one-third shareholding interest in Company B before 19 September 1985. From this date, Company B was owned in equal shares by three discretionary trusts which were ultimately controlled by different members of the broader Family group. The Family Trust was one such shareholder.

The Company B Group was established to undertake investments and manage the assets of the family.

In addition to its active business operations, the Company B Group also held a significant portfolio of freehold land held on capital account as long-term investments.

Company B and its wholly-owned subsidiaries derived significant capital gains in relation to the disposal of various assets. To the extent that these capital gains related to underlying assets that were acquired by Company B and its subsidiaries prior to the introduction of Australia's CGT regime on 19 September 1985, the capital gain was disregarded for Australian income tax purposes, and credited to a pre-CGT capital profits reserve.

During this time, Company B prepared audited financial statements which record that the capital profits from the sale of pre-CGT assets were credited to a pre-CGT capital profits reserve.

Following the realisation of pre-CGT assets, the cash proceeds of Company B were loaned to associated companies. Company B did not use the proceeds to re-invest in post-CGT assets.

Pre-CGT Capital Reserve

In earlier financial year, the shareholders of Company B appointed external administrators to liquidate the Company B subsidiary entities. This process involved the realisation of assets and the satisfaction of all third-party obligations, followed by the liquidation of entities within the Company B Group. This liquidation process took place using a 'bottom-up' approach.

Pursuant to the Liquidators Resolutions dated 30 June 20XX, the liquidators of Company B made a total liquidator's distribution of $X to the shareholders of Company B, of which one-third was received by the Family Trust. The distribution to the shareholders comprised a return of capital of $X, and a distribution from a pre-CGT capital reserve of $X. The Family Trust's share of this distribution was a return of capital of $X, and a distribution from a pre-CGT capital reserve of $X.

The Family Trust lodged its Australian income tax return for the year ended 30 June 20XX and treated the receipt of the liquidator's distribution as non-assessable capital, pursuant to subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and in accordance with Taxation Determination TD 95/10.

The Family Trust received two further capital distributions from Company B of $X and $X respectively. These amounts have both been treated as a distribution from Company B's capital profits reserve, were credited to the pre-CGT capital profits reserve and were treated as non-assessable income, pursuant to subsection 47(1) of the ITAA 1936.

During the income year ended 30 June 20XX, the Family Trust disposed of its entire one-third shareholding in Company B, which gave rise to a capital profit of $X. As the shares in Company B were acquired prior to the introduction of Australia's CGT regime, the entire capital profit was credited to the pre-CGT capital profits reserve and treated as non-assessable income pursuant to paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997).

Notwithstanding that the pre-CGT capital profits reserve has a balance of $X, the maximum amount that the Family Trust can distribute to its beneficiaries may be less than this amount. This is on the basis that Company A may only be able to distribute an amount that does not exceed the market value of its existing net assets.

The market value of the Family Trust's loan receivables may be significantly less than the current book value of these particular assets due to the financial position of those debtors.

Proposed Trust Beneficiary Distribution

Consequently, under the proposed transaction, the Family Trust will undertake a distribution of capital, sourced directly from the pre-CGT capital profits reserve, to the Trust Beneficiaries.

Each Trust Beneficiary will receive a one-quarter share of the distribution of capital. The distribution of capital will not be paid by way of cash, but by the in-specie transfer of various related-party loan receivables.

The commercial debt forgiveness rules in Division 245 of the ITAA 1997 have never operated to reduce the cost base of the Family Trust's CGT assets (such as cash and receivables).

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 104-10 of the Income Tax Assessment Act 1997

Section 104-25 of the Income Tax Assessment Act 1997

Section 104-70 of the Income Tax Assessment Act 1997

Section 104-75 of the Income Tax Assessment Act 1997

Section 104-80 of the Income Tax Assessment Act 1997

Section 104-85 of the Income Tax Assessment Act 1997

Section 104-90 of the Income Tax Assessment Act 1997

Section 104-155 of the Income Tax Assessment Act 1997

Subsection 47(1) of the Income Tax Assessment Act 1936

Subsection 95(1) of the Income Tax Assessment Act 1936

Section 97 of the Income Tax Assessment Act 1936

Section 99B of the Income Tax Assessment Act 1936

Section 271-15 of Schedule 2F to the Income Tax Assessment Act 1936

Reasons for decision

Question 1

Detailed reasoning

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) relevantly provides that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. This concept is commonly referred to as income according to ordinary concepts. Where an amount is capital, or capital in nature, it will not be income according to ordinary concepts.

Whether an amount distributed to a beneficiary of a trust is capital depends on both the character and the source of the entitlement. Ordinarily, a distribution from a trust will take the same character in the hands of the beneficiary as in the hands of the trustee.

In the present case, Company A will undertake a distribution out of the Trust Funds, representing the accumulated capital of the trust. The accumulated capital arose from non-assessable liquidator's distributions from Company B, as well as a non-assessable capital profit from the disposal of the pre-CGT shares in Company B.

As the amounts represent capital, they do not represent income according to ordinary concepts. Consequently, no amount of the distribution of capital will be included in the assessable income of the Trust Beneficiaries under section 6-5 of the ITAA 1997.

Question 2

Detailed reasoning

Subsection 97(1) of the ITAA 1936 relevantly provides that where any beneficiary who is not under a legal disability is presently entitled to a share of the income of the trust estate, that share of the net income of the trust estate (as determined in accordance with subsection 95(1) of the ITAA 1936) shall be included in the assessable income of the presently entitled beneficiary.

Pursuant to subsection 95(1) of the ITAA 1936, net income, in relation to a trust estate, is defined broadly as the total assessable income of the trust estate calculated under the Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions.

The distributions of capital that will be made by the Family Trust will be made out of trust capital and represent two distinct sources including the non-assessable liquidator's distribution made by Company B in the prior income years and the capital gain made on the disposal of the Family Trust's shareholding in Company B.

The first source was the liquidator's distribution made by Company B in prior income years. These amounts were classified as non-assessable distributions pursuant to the Archer Brothers principle and in accordance with Taxation Determination TD 95/10 (TD 95/10).

TD 95/10 states that the Commissioner generally accepts that a liquidator may rely on the Archer Brothers principle, except where a specific provision of the Act produces a different result. Where the source of funds are from a post CGT asset capital gain that would be subject to taxation, the Commissioner would consider that such amounts would represent income and be a dividend under subsection 47(1) of the ITAA 1936. In the Family Trust's situation, the amounts were derived from pre-CGT asset gains and not subject to taxation.

The second source of the Family Trust's trust capital relates to a capital gain derived by the Family Trust on the disposal of the shares in Company B. The gains were not included in the Family Trust's assessable income as the shares were acquired prior to the introduction of Australia's CGT regime on 19 September 1985 and CGT Event K6 was not triggered in relation to the share disposal.

Therefore, pursuant to section 97 of the ITAA 1936, no amount of the capital distributions is included in the net income of the Family Trust under subsection 95(1) of the ITAA 1936, and consequently, no amount of the proposed distribution can be included in the assessable income of the Trust Beneficiaries.

Question 3

Detailed reasoning

Subsection 99B(1) of the ITAA 1936 provides that where an amount, being property of a trust estate, is paid or applied for the benefit of a beneficiary during a year of income, and the beneficiary was a resident at any time during the year, that amount is included in the assessable income of the beneficiary.

Paragraph 99B(2)(a) of the ITAA 1936 modifies the rule in subsection 99B(1) of the ITAA 1936 and has the effect that the amount included in assessable income under subsection (1) is reduced to the extent that the amount represents corpus of the trust estate, except to the extent to which the amount is attributable to amounts that would be assessable, if they were derived by a resident taxpayer.

The reference to 'corpus of the trust estate' in paragraph 99B(2)(a) is a reference to the corpus, capital or principal of a trust estate determined in accordance with trust law, being something which is not income of the trust estate determined in accordance with trust law.

The distributions that are proposed to be made to the Trust Beneficiaries have accrued from the following sources:

Liquidators Distribution in earlier years

The liquidator's distributions from Company B were made to the Family Trust following the liquidation of several subsidiary entities of the Company B Group. The distributions from the liquidated subsidiaries were sourced from pre-CGT capital reserves following the disposal of assets that were acquired prior to 20 September 1985 (pre-CGT).

Therefore, the amount of the liquidator's distributions would not be a deemed dividend under section 47 of the ITAA 1936.

Capital Gain from disposal of Company B shares

The capital gain from the disposal of the Family Trust's shares in Company B was not included in its assessable income on the basis that its shares in Company B were acquired in prior to the introduction of CGT. Paragraph 104-10(5)(a) of the ITAA 1997 provides that any capital gain or loss on an asset acquired pre-CGT is disregarded and therefore will not be included in a taxpayer's assessable income.

Conclusion

The proposed distribution of capital from the Family Trust to the Trust Beneficiaries will not be included in their assessable income pursuant to section 99B for the following reasons:

(a) the proposed distributions to Trust beneficiaries represent corpus of the trust estate; and

(b) had the amounts been made by an Australian resident taxpayer, it would also not be included in their assessable income as the liquidator's distribution was non-assessable and the shares sold were acquired pre-CGT and CGT Event K6 was not triggered in relation to that share disposal.

Question 4

Detailed reasoning

CGT event E4, which is contained within section 104-70 of the ITAA 1997, happens when a trustee makes a payment to a beneficiary in respect of their unit or their interest in the trust, and some or all of the payment is not included in the beneficiary's assessable income.

CGT event E4 only happens in respect of a unit or an interest in a trust, not in respect of payments made by a discretionary trust to beneficiaries of that trust. This is because a discretionary beneficiary does not have an 'interest in the trust', as is required by section 104-70 of the ITAA 1997.

Taxation Determination TD 2003/28 provides that a discretionary beneficiary, including a 'default beneficiary', under a discretionary trust does not hold an interest in a discretionary trust for the purposes of CGT event E4. Paragraph 3 states:

CGT event E4 does not happen in the circumstances described in paragraph 1 [a non-assessable payment made by a trustee of a discretionary trust to a mere object or a default beneficiary under the trust] because a mere object or default beneficiary is not considered to have an 'interest in the trust' of the nature or character required in paragraph 104-70(1)(a).

In the Family Trust's case, as each of the Trust Beneficiaries are merely discretionary objects and default beneficiaries of the Family Trust, CGT event E4 will not happen.

Question 5

Detailed reasoning

CGT event E5, pursuant to section 104-75 of the ITAA 1997, happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust, except a unit trust or trust to which Division 128 of the ITAA 1997 applies.

Subsection 104-75(6) contains a number of exceptions, including:

(a) the beneficiary acquired the CGT asset that is the interest (except by way of an assignment from another entity) for no expenditure; or

(b) the beneficiary acquired it before 20 September 1985; or

(c) ...

In the Family Trust's case, the trust is not a unit trust and the Trust Beneficiaries incurred no expenditure to acquire their interest in the trust (to the extent that a beneficiary can have any relevant interest).

Consequently, the exception in paragraph 104-75(6)(a) of the ITAA 1997 will apply such that CGT event E5 will not happen.

Question 6

Detailed reasoning

CGT event E6, pursuant to section 104-80 of the ITAA 1997, happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies), disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's right, or part of it, to receive income from the trust.

Under the discretion trust none of the Trust Beneficiaries have a right to receive ordinary or statutory income of the trust.

Therefore, pursuant to section 104-80 of the ITAA 1997, CGT event E6 will not happen.

Question 7

Detailed reasoning

CGT event E7 in section 104-85 of the ITAA 1997, happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest in the trust capital.

Under the discretion trust, none of the Trust Beneficiaries have a vested and indefeasible interest in the trust assets.

Therefore, pursuant to section 104-80 of the ITAA 1997, CGT event E7 will not happen.

Question 8

Detailed reasoning

CGT event E8 in section 104-90 of the ITAA 1997, happens if a beneficiary of a trust (other than a unit trust or a trust to which Division 128 applies), who neither gave any money or property to acquire their interest in the trust capital nor acquired that interest by assignment, disposes of their interest to a person other than the trustee of the trust.

Taxation Determination TD 2009/19 (TD 2009/19) provides the Commissioner's view that, in respect of whether a taker-in-default of trust capital, CGT event E8 will not apply. Paragraph 2 of TD 2009/19 states:

"..only those interests which constitute a vested and indefeasible interest in a share of the trust capital fall within the scope of CGT event E8. The interest of a taker-in-default of the trust capital is defeasible because the trustee may resolve to appoint the capital to another beneficiary".

In the present case, the Trust Beneficiaries are not disposing of any interest they may have in the capital of the Family Trust.

Each of the Trust Beneficiaries do not have a vested and indefeasible interest in the trust capital. The trustee of the Family Trust is exercising its discretion to appoint the capital of the Family Trust to the Trust Beneficiaries.

Consequently, CGT event E8 pursuant to section 104-90 of the ITAA 1997 does not happen.

Question 9

Detailed reasoning

CGT event A1 in section 104-10 of the ITAA 1997 happens where you dispose of a CGT asset. Pursuant to subsection 104-10(2) of the ITAA 1997, you dispose of a CGT asset if a change of ownership occurs.

In respect of the Trust Beneficiaries, CGT event A1 will not happen as they are not disposing of the right to the receivables.

Question 10

Detailed reasoning

CGT event A1 in section 104-10 of the ITAA 1997 happens where you dispose of a CGT asset. Pursuant to subsection 104-10(2) of the ITAA 1997, you dispose of a CGT asset if a change of ownership occurs.

In respect to the XXXX Family Trust, the assignment of its loan receivables to the Trust Beneficiaries as part of the proposed distribution will cause CGT event A1 to occur. This is on the basis that the loan receivable will be transferred to the Trust Beneficiaries who will become the beneficial owner of the receivables.

The capital gain or loss is calculated under subsection 104-10(4) of the ITAA 1997.

Question 11

Detailed reasoning

CGT event C2, pursuant to section 104-25 of the ITAA 1997, happens if a taxpayer's ownership of an intangible asset ends because the asset expires, or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited.

However, consistent with the approach outlined in Commissioner of Taxation v Dulux Holdings Pty Ltd & Ors [2001] FCA 1344, the Commissioner's position has been that it is appropriate to look through the legal rights incidentally created and discharged/satisfied when they are merely facilitating the real transaction, being the distribution of income from a trust to a beneficiary.

Therefore, CGT event C2 will not happen under section 104-25 of the ITAA 1997.

Question 12

Detailed reasoning

CGT event H2 in section 104-155 of the ITAA 1997 happens if an act, transaction or event occurs in relation to a CGT asset that you own, and the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base.

As an act, transaction or event does not result in an adjustment to the asset's cost base, CGT event H2 pursuant to section 104-155 of the ITAA 1997 will not apply.

Question 13

Detailed reasoning

Family Trust Distribution Tax ("FTDT") is an additional tax imposed by section 271-15 of Schedule 2F to the ITAA 1936. FTDT is only payable if a trustee, having made a Family Trust Election (FTE), distributes, or confers a present entitlement to income or capital to a person outside their 'family group'.

In the present matter, the Family Trust has made an FTE with Beneficiary D as the specified individual. Consequently, FTDT will not be imposed provided that the Trust Beneficiaries are within the family group of Beneficiary D.

The concept of family group is addressed in section 272-90 of Schedule 2F of the ITAA 1936. Pursuant to subsection 272-90(2) of Schedule 2F of the ITAA 1936, a member of the primary individual's family is a member of the primary individual's family group in relation to the conferral or present entitlement.

The term 'family' is defined in section 272-95 of Schedule 2F of the ITAA 1936 and includes any child of the test individual.

All Trust Beneficiaries will satisfy the requirement to be within the family group of Beneficiary D as Beneficiary A, Beneficiary B, Beneficiary C are the children of Beneficiary D.

As such, there will be no FTDT liability arising from the distributions of capital from The Family Trust to the Trust Beneficiaries under section 271-15 of Schedule 2F to the ITAA 1936.