Edited version of private advice

Authorisation Number: 1052134866210

Date of advice: 30 August 2023

Ruling

Subject: CGT - trust vesting - absolute entitlement

Question

Will vesting of the Trust trigger CGT Event E5 under section 104-75 of the Income Tax Assessment 1997 (ITAA 1997)?

Answer

No

Question

If the proposal is put into effect, will Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply?

Answer

No

This ruling applies for the following periods:

Income year ending 30 June 2023

Income year ending 30 June 2024

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

1.    Trustee is the corporate trustee of Trust A (the Trust), a family discretionary trust established by deed dated XX XXX XXXX (Deed).

2.    The only assets of the Trust are the XX issued shares of Company (Company), which was incorporated in XX.

3.    Company's business has been operated on the basis that most of the profits are retained in the company for reinvestment purposes.

4.    There are significant accrued capital gains on the shares in Company.

5.    The Deed provides:

(a)  At clause XXXX

(b)  Clause X of the Deed provides that:

XX

6.    Beneficiary 1 has Children.

7.    In the long-term Beneficiary 1 would like the children to become the owners of the assets of the Trust.

8.    The Deed has an early vesting date of XX XXX XXXX and an amending clause 13 that would not allow the date to be changed without approval of the Supreme Court, which may be difficult to obtain.

9.    To facilitate family succession the proposal is:

(a)  to accept the early vesting date and in fact bring it forward, and

(b)  to vest the Trust on the basis that the capita beneficiaries of the Trustee will distribute as tenants in common a 75% interest the shares to Beneficiary 1 and 25% interest to Beneficiary 2 so that:

(c)   during their lifetime Beneficiary 1 will remain in control, and

(d)  in their will Beneficiary 1 can give children a yet to be decided share of their 75% interest to be held in trust until they turn at least 18, and

(e)  deal with the remaining percentage as circumstances dictate as years go by.

10.  The proposed structure going forward will be:

(a)  Trustee remains the trustee of the Trust;

(b)  the shares in Company stay in the name of Trustee,

(c)   all the provisions in the Deed will continue except for (A) the power of the trustee to distribute the income or capital other than to Beneficiary 1 and Beneficiary 2 in the 75/25 parentages, and (B) the vesting date is no longer is an issue because the trust has vested.

11.  Beneficiary 1 will retain full control of the whole structure because:

(a)  as the sole shareholder Beneficiary 1 decides on the directors of Trustee, and

(b)  the directors of Trustee exercise all the shareholder votes in Company and therefore decide on the directors of Company, and

(c)   Beneficiary 2 will not be intitled to demand that his 25% beneficial shareholding be transferred to them.

12.  Beneficiary 1 will continue as the sole shareholder and director of Trustee for their lifetime unless they decide otherwise.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 Subsection 104-75(1)

Income Tax Assessment Act 1997 Subsection 104-75(3)

Income Tax Assessment Act 1997 Subsection 104-75(4)

Income Tax Assessment Act 1936 section 177D

Reasons for decision

Question 1

Summary

When the Trust vests CGT event E5 under section 104-75 will not happen as the beneficiaries are not absolutely entitled to the capital distribution.

Detailed reasoning

CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies) as against the trustee (subsection 104-75(1)).

The trustee makes a capital gain if the market value of the asset (at the time of the event) is more than its cost base or a capital loss if that market value is less than the asset's reduced cost base (subsection 104-75(3).

A capital gain or capital loss is disregarded if the assets were acquired before 20 September 1985 (subsection 104-75(4)).

Determining whether or not a CGT event happens on vesting depends on the terms of the deed. This will include consideration of the effect of vesting on the beneficial interests in the trust, and the nature of the property held on trust.

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 (TR 2004/D25) explains the circumstances in which a beneficiary of a trust is considered to be absolutely entitled to a CGT asset of the trust as against its trustee:

10. The core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction...

13. [An object of a discretionary trust prior to the exercise of the trustee's discretion in their favour cannot be absolutely entitled because they do not have an interest in the trust assets.]

23. 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 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.

24. 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;

•         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.

25. Because the assets are fungible, it does not matter that the beneficiaries cannot point to particular assets as belonging to them. It is sufficient in these circumstances that they can point to a specific number of assets as belonging to them.

Assets are fungible if each asset matches the same description such that one asset can be replaced with another. Assets are fungible if they are of the same type (for example, shares in the same company and with the same characteristics).

Fungible assets form a separate class for the purpose of determining the number and type of assets to which each beneficiary is regarded as being absolutely entitled.

Relevantly, TR 2004/D25 explains that that multiple beneficiaries with an interest in a share as tenants in common have no absolute entitlement to the share:

Example 8: multiple beneficiaries (no absolute entitlement)

169. Augustus settled shares in a listed public company on trust for his two daughters as tenants in common in equal shares.

170. Notwithstanding that the shares may be fungible and that each daughter may be able to demand that her interest be satisfied by a distribution in specie of one half of the number of shares to her, neither daughter is absolutely entitled. The reason is that under the trust it is clear that the settlor intends that each daughter has an interest in each share. Therefore, any capital gain or loss made by the trustee in respect of the shares will be included in the net income of the trust.

Application to your circumstances:

In accordance with clause 6 of the Deed, on the Vesting Day the Trustee intends to vest the Trust Fund in two individual beneficiaries (Beneficiary 1 and Beneficiary 2).

The Trust Fund consists of company shares of the same class. In accordance with the proposed resolution of the Trustee, upon the trust vesting the trust fund capital (comprising the shares) will be distributed to, as tenants in common, 75% to Beneficiary 1 and 25% to Beneficiary 2. The Trustee does not intend allocating particular shares to particular beneficiaries on vesting and will continue to hold the Trust Fund for the beneficiaries on vesting.

Similar to Example 8 in TR 2004/D25, notwithstanding that the shares may be fungible neither beneficiary is absolutely entitled as the settlor has granted the trustee the power to provide that each beneficiary (in whose favour the discretion has been exercised) has an interest in each share.

Accordingly, CGT event E5 will not happen when the Trust vests.

Question 2

Summary

In these circumstances, it is reasonable to accept that any potential tax benefits (incidental or otherwise) would not lead to the conclusion that the arrangement was entered into for the sole or dominant purpose of obtaining a tax benefit.

Detailed reasoning

GENERAL ANTI-AVOIDANCE

Part IVA is a general anti-avoidance provision. Broadly, it allows the Commissioner the discretion to cancel a tax benefit obtained by a taxpayer in relation to a scheme where the sole or dominant purpose of the scheme was to obtain a tax benefit.

Scheme

Part IVA requires the consideration of a 'scheme', which is defined in subsection 177A(1) of the ITAA 1936 as:

(a)  any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable by legal process; and

(b)  any scheme, plan, proposal, action, course of action or course of conduct.

Guidance of the meaning of the term 'scheme' can be found in case law. In Federal Commissioner of Taxation v. Hart (2004) 55 ATR 712 (Hart), per Gummow and Hayne JJ:

[43] [The] definition is very broad. It encompasses not only a series of steps which together can be said to constitute a "scheme" or a "plan" but also (by its reference to "action" in the singular) the taking of but one step.

Tax Benefit

There must be a tax benefit obtained by the taxpayer in order for Part IVA to potentially apply. Section 177C of the ITAA 1936 broadly provides that a tax benefit in relation to a scheme relates to:

(a)  amounts not being included in assessable income that would otherwise have been included in assessable income;

(b)  amounts included as an allowable deduction that would otherwise not have been included as an allowable deduction;

(c)   capital losses incurred that would otherwise not have been incurred;

(d)  foreign income tax offsets being allowable that would otherwise not have been allowable; and

(e)  no liability to withholding tax on an amount that would otherwise have had a liability.

Dominant purpose

Part IVA also requires consideration of the purpose for which the scheme was entered into. Specifically, section 177D of the ITAA 1936 refers to the purpose of the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme. The person need not be the taxpayer.

The meaning of the purpose is clarified by subsection 177A(5) of the ITAA 1936, which explains that, where there are two or more purposes, the purpose includes the dominant purpose:

(5) A reference in this Part [Part IVA] to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.

When determining whether the purpose of the scheme was to enable a tax benefit, the Commissioner must also have regard to the following eight factors specified in subsection 177D(2) of the ITAA 1936:

(a)  the manner in which the scheme was entered into or carried out;

(b)  the form and substance of the scheme;

(c)   the time the scheme was entered into and the length of time during which the scheme was carried out;

(d)  the result that, but for the operation of Part IVA, would be achieved by the scheme;

(e)  any change (being a change that has resulted from, will result of or may reasonably be expected to result from, the scheme). in the financial position of the relevant taxpayer that has resulted, or will result from, the scheme;

(f)    any change (being a change that has resulted from, will result of or may reasonably be expected to result from, the scheme) in the financial position of any person who has, or has had, any connection with the relevant taxpayer;

(g)  any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f) of the scheme having been entered into or carried out; and

(h)  the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Focusing on the various elements of Part IVA should not obscure the way in which the Part as a whole is intended to operate. What constitutes a scheme is ultimately meaningful only in relation to the tax benefit that has been obtained since the tax benefit must be obtained in connection with the scheme. Likewise, the dominant purpose of a person in entering into or carrying out the scheme, and the existence of the tax benefit, must be considered against a comparison with reasonable alternative schemes capable of carrying out the commercial objectives of the arrangement.

In summary, section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which a taxpayer has obtained a tax benefit if, after having regard to the eight specified factors, it would be concluded that any person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the relevant taxpayer to obtain the tax benefit.

The identification of a tax benefit requires consideration of the tax consequences of a 'counterfactual', or alternative hypothesis, that would have resulted had the scheme not been entered into. As stated by Gummow and Hayne JJ in Hart:

[66] When [section 177C(1)] is read in conjunction with [former] s177D(b) it becomes apparent that the inquiry directed by Pt IVA requires comparison between the scheme in question and an alternative postulate. To draw a conclusion about purpose from the eight matters identified in [former] s177D(b) will require consideration of what other possibilities existed.

Guidance for identifying the counterfactuals of the scheme can be found in Practice Statement PS LA 2005/24: Application of the General Anti-Avoidance Rules (PS LA 2005/24). In particular, paragraph 109 lists the following considerations for determining the counterfactuals:

•         the most straightforward way of achieving the commercial and practical outcomes;

•         commercial norms, such as standard industry behaviour;

•         social norms, such as family obligations;

•         behaviour of the parties around the time of the scheme compared with the period of the scheme's operation; and

•         actual cash flow.

PS LA 2005/24 further explains that if:

•         the scheme had no effect other than obtaining the tax benefit, it is reasonable to assume that nothing would have happened if it was not carried out (paragraphs 75 and 110), and

•         a tax benefit is obtained in connection with the scheme which also achieves a wider commercial objective, then it would be reasonable to expect that in absence of the scheme the wider commercial objectives would have been pursued by an alternative arrangement (paragraph 76 and 111).

In Peabody v Federal Commissioner of Taxation (1993) 40 FCR 531 the Court explained that although the Commissioner has to consider each of the factors provided by former subsection 177D(b) of the ITAA 1936, this doesn't mean that each of the factors must point to the dominant purpose, stating that:

Some of the matters may point in one direction and others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against that [former] s177D requires in order to reach the conclusion to which 177D refers.

The Commissioner's support of this view is provided in PS LA 2005/24 which states at paragraph 126 that all factors of subsection 177D(2) of the ITAA 1936 need to be taken into account with regard to the relevant evidence, and weighed together, to identify the dominant purpose of the scheme.

Cancellation of tax benefit

Where the Commissioner has made a determination under paragraph 177F(1)(a) of the ITAA 1936 that an amount is to be included in a taxpayer's assessable income, subsection 177F(2) provides that this amount shall be deemed to be included in the taxpayer's assessable income.

Application to your circumstances

The proposed arrangement would satisfy the requirements for a scheme pursuant to subsection 177A(1) of the ITAA 1936.

Tax benefit

Arguably, a potential benefit is the delay in the payment of tax in relation to the capital gain that would otherwise have been paid if the shares were distributed to the beneficiaries.

It is noted the fact that a taxpayer pays less tax if one form of the transaction rather than another is adopted, does not by itself demonstrate that Part IVA applies (paragraph 109 of PS LA 2005/24).

Dominant purpose

Whether your purpose in entering into the arrangement is to obtain a tax benefit, is determined with reference to the eight factors specified in subsection 177D(2) of the ITAA 1936:

(a)  The manner in which the scheme is entered into or carried out;

(b)  The form and substance of the scheme;

(c)   The time at which the scheme was entered into and the length of the period during which the scheme will be carried out;

(d)  The result in relation to the operation of this Act, but for this part, would be achieved by the scheme;

(e)  Any change in the financial position of the relevant taxpayer that has resulted, will result, or may be reasonably expected to result, from the scheme;

(f)    Any change in the financial position of any person who has, or has had, any connection with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(g)  Any other consequences for the relevant taxpayer or person connected; and

(h)  The nature of any connection between the relevant taxpayer and any person referred to in subparagraph (f).

Conclusion

Based on the available information and having regard to the 8 factors in section 177D of the ITAA 1936, a reasonable person would more likely than not conclude that there are potential 'benefits' arising from the scheme - being the delay in the payment of the tax related to the capital gain that would otherwise arise upon the trust vesting and the distribution being made to the beneficiaries.

Taking into account the various considerations, it is reasonable to accept that any tax benefits (incidental or otherwise) are outweighed by justification of the scheme.

TR 2018/6 explains that the vesting of beneficial interests in a trust does not ordinarily cause the trust to come to an end, nor cause a new trust to arise. Vesting does not mean trust property must be transferred to the takers on vesting on the vesting date, or that the trust must be wound up either immediately or within a reasonable period (although the deed may require these events to occur after vesting).

On a trust's vesting date, the interests in the property of the trust become vested in interest and possession. In the case of a discretionary trust, from the time the trust vests the trustee no longer has any discretionary power to appoint the income or capital of the trust. Rather it holds the trust property for the absolute benefit of those beneficiaries specified as the takers on vesting.

Where the deed does not imply or provide that the trustee must thereafter distribute the trust fund and so bring the trust to an end, the trustee may, if empowered to do so, hold the trust estate for the takers in vesting as tenants in common.

Where a trustee continues to hold property for takers on vesting, the property is held on the same trust as existed pre-vesting; albeit the nature of the trust relationship changes.

In the following income years, the takers on vesting will usually have a fixed entitlement to the income of the trust estate and be assessable on their corresponding share of the net income. Because all of the income of the trust will flow to a beneficiary post-vesting according to their entitlement, none of the net income will fall to be assessed to the trustee.

In this case, the Trustee is merely doing what is recognised and allowed for under the Deed and the consequence of this arrangement is that the beneficiaries are not absolutely entitled to the shares for the purposes of CGT event E5. The Trustee will hold the shares for the absolute benefit of those beneficiaries specified as the takers on vesting (i.e. Beneficiary 1 and Beneficiary 2) as tenants in common.

Consequently, any potential tax benefit from the changes to the vesting date and the Trustee making the distribution is not considered to be a purpose (whether it is the sole or dominant purpose of the scheme) that will cause Part IVA to apply to the scheme.