Edited version of private advice

Authorisation Number: 1052128402382

Date of advice: 14 June 2023

Ruling

Subject: CGT - trust

Question

Will the transfer of real property from the trustee of a family trust to the beneficiaries of the trust result in a disposal of that asset for CGT purposes?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

In 2014/2015 income year, the trust acquired a residential property.

The property was to be used and has been used as the main residence by beneficiaries X and Y.

X and Y are the beneficiaries of the Trust.

The reason the property was purchased in the name of the Trust was that X beneficiary had been involved in a failed business some years before and they were concerned about the asset protection in the future, should things go bad.

X beneficiary has been diagnosed with a disease and will suffer from a degeneration of their mental faculties over the next few years.

X and Y want to simplify the current ownership structure of your main residence and transfer the property to their personal names and close the company and trust down as surplus to requirements.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 102-25

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-85

Income Tax Assessment Act 1997 section 106-50

Income Tax Assessment Act 1997 section 118-110

Reasons for decision

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) advises that capital gains tax (CGT) is incurred when a CGT event takes place, and you make a gain from the event.

CGT events are the different types of transactions that may result in a capital gain or capital loss. The most common CGT event is CGT event A1. Section 104-10 of the ITAA 1997 explains that this event occurs whenever there is a change of ownership for a CGT asset, for example, when you dispose of a CGT asset to someone else. Land and buildings are CGT assets. CGT event E7 happens if the trustee of a trust disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part interest, in the trust capital (section 104-85 of the ITAA 1997).

Both CGT event A1 and CGT event E7 will happen if the transfer of legal ownership of the property occurs, and this is treated as a disposal for CGT purposes. CGT event A1 is a general provision about disposals but CGT event E7 is a specific provision related to a form of disposal from a trust to a beneficiary. If more than one event can happen, the one you use is the one that is the most specific to your situation (section 102-25 of the ITAA 1997). CGT event E7 is more specific to this situation.

Main residence exemption

Generally, you can disregard a capital gain or loss from a CGT event that happens to your ownership interest in a dwelling if:

•         you are an individual (paragraph 118-110(1)(a) of the ITAA 1997)

•         the dwelling was your main residence for the whole period it was owned

•         you have not used the dwelling to produce assessable income, and

•         any land on which the dwelling is situated on and adjacent to is two hectares or less.

In your case, as the property is owned by a trust, and a trust is not an individual, you are not entitled to apply the main residence exemption under section 118-110 of the ITAA 1997.

Asset of a trust

A CGT event in relation to an asset of a trust happens to the trustee on behalf of the trust unless a beneficiary is absolutely entitled to the asset. Where a beneficiary is absolutely entitled to a CGT asset as against the trustee, section 106-50 of the ITAA 1997 states that any act done in relation to the CGT asset by the trustee will be treated as if the act was done by the absolutely entitled beneficiary.

Example:

An individual becomes absolutely entitled to a CGT asset of a trust. The trustee later sells the asset. Any capital gain or loss from the sale is made by the individual, not the trustee.

Draft Taxation Ruling TR 2004/D25 discusses the circumstances in which a beneficiary of a trust is considered to be absolutely entitled to a CGT asset of a trust as against its trustee.

A beneficiary is absolutely entitled to an asset of a trust as against the trustee for the purposes of section 106-50 of the ITAA 1997 if the beneficiary is:

•         absolutely entitled in equity to the asset and thus has a vested, indefeasible and absolute interest in the asset; and

•         able to direct the trustee how to deal with the asset.

Multiple Beneficiaries

The core principle underpinning the concept of absolute entitlement is the ability of the beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred at their discretion. However, if there is some basis upon which the trustee can legitimately resist the beneficiary's call for an asset, then the beneficiary will not be absolutely entitled. This derives from the rule in Saunders v. Vautier (1841) 4 BEAV 115; 49 ER 282 applied in the context of the CGT provisions. The relevant test of absolute entitlement is not whether the trust is a bare trust.

TR 2004/D25 states if there is more than one beneficiary with interests in a trust asset, then it will usually not be possible for any one beneficiary to call for the asset to be transferred to them or to be transferred at their direction. This is because their entitlement is not to the entire asset. Paragraph 24 of TR 2004/D25 advises that there is, however, a particular circumstance where such a beneficiary can be considered absolutely entitled to a specific number of the trust assets for CGT purposes. This circumstance is where:

•         the assets are fungible (for example, shares in the same company and with the same characteristics);

•         the beneficiary is entitled against the trustee to have their interest in those assets satisfied by a distribution or allocation in their favour of a specific number of them; and

•         there is a very clear understanding on the part of all the relevant parties that the beneficiary is entitled, to the exclusion of the other beneficiaries, to that specific number of the trust's assets.

Paragraph 54 of TR 2004/D25 states the requirement for absolute entitlement cannot be satisfied if there are multiple beneficiaries for a single asset such as land. While each beneficiary may have an interest in, and therefore be entitled to, a share of the land, no beneficiary is entitled to the whole of it.

Application to your circumstances

This situation involves the trustee having legal ownership in the trust asset being property it's held for the benefit of X and Y.

X and Y are the primary beneficiaries who have interests in this asset of the trust being real property. The trustee intends to distribute the trust asset by way of transfer to X and Y. For a beneficiary to have absolute entitlement, the trust asset is to be a fungible asset and easily divisible. Real property is not a fungible asset and the trust asset cannot be easily divided.

The trust deed does not provide any beneficiary with a vested and indefeasible interest in the whole of the property. Nor does the trust deed authorise any beneficiary alone to call for the property to be transferred to them or be transferred at their sole direction.

Consequently, X and Y is not absolutely entitled to the property as against the trustee. Therefore, CGT event E7 will happen to the trust, as the current owner of the property for CGT purposes, when the property is transferred to X and Y.