Edited version of private advice

Authorisation Number: 1052176686601

Date of advice: 18 July 2024

Ruling

Subject: CGT - deceased estate

Issue 1

CGT issues for the Executor for the Estate of the deceased

Question 1

Will Division 128 of the Income Tax Assessment Act (ITAA 1997) apply to the proposed arrangement when the properties are passed to the beneficiaries as part of the Estate distribution?

Answer

Yes. The properties passed to the three beneficiaries as outlined in the Will under paragraph 128-20(1)(a) of the ITAA 1997.

Issue 2

CGT issues for Beneficiary A

Question 1

Will the cost base of the three properties be the market value as at the deceased's date of death?

Answer

No.

The first element of the cost base for beneficiary A's interest in the main residence will be the market value on the day the deceased passed away.

The first element of the cost base for beneficiary A's interest in the remaining properties, will be the assets' respective cost bases on that same day.

Question 2

Will beneficiary A's disposal of their interest in the properties result in CGT event A1 pursuant to section 104-10 of the ITAA 1997?

Answer

Yes.

This private ruling applies for the following period:

Year ending X June 20XX.

Year ending X June 20XX.

The scheme commenced on:

X July 20XX.

Relevant facts and circumstances

The deceased passed away on X December 20XX.

The deceased is survived by their three children, Beneficiary A, Beneficiary B and Beneficiary C.

The deceased owned three blocks of land, one of which included a main residence.

All three properties were purchased prior to 1985 by the deceased's spouse and held entirely in their name until their death in November 20XX. At this point, 100% of the properties were transferred to the deceased.

The Estate also includes approximately $XX in cash.

The Will states that the residue of the Estate is to be distributed equally between the beneficiaries.

Beneficiary A wishes to relinquish their interest in the Estate Property and allow the remaining beneficiaries, B and C, to receive the real property.

It has been agreed by the three beneficiaries that Beneficiary A is to receive a net sum of $X from this arrangement.

It is proposed in a draft deed of arrangement that Beneficiary A will receive $X from the Estate and Beneficiary's B and C will each pay Beneficiary A additional monetary contributions to bring the total to the agreed amount.

Specifically, the proposed deed of arrangement stipulates at clause 5.4:

In consideration for the distributions set out in clauses 5.2 and 5.3, B and C, jointly and severally, unconditionally and irrevocably, agree to pay beneficiary A, within X days of the execution of this Deed and in any event prior to beneficiary A executing any transfer instrument concerning real property of the Estate the following:

(a) an amount of approximately $X, but it may be more or less depending on the final balance of the liquid assets in the Estate that the Executor actually pays to beneficiary A under clause 5.1(a); and

(b) a further amount, to reimburse beneficiary A for any and all taxation consequences that flow from the distributions made under this Deed in the form set out in this clause 5, and subject always to clause 5.5, to the intent that the parties agree that beneficiary A will receive a net sum of $1X.

Beneficiaries B and C will divide the Properties between them in equal shares.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 section 128-20

Reasons for decision

Issue 1

CGT issues for the Executor for the Estate of the deceased.

Question 1

Summary

The Properties passed to the beneficiaries under the Will of the deceased under paragraph 128-20(1)(a) of the ITAA 1997.

Detailed reasoning

Under subsection 128-20(1) of the ITAA 1997, an asset passes to a beneficiary in a decedent's estate if the beneficiary becomes the owner of the asset:

(a) under your will, or that will as varied by a court order; or

(b) by operation of an intestacy law, or such a law as varied by a court order; or

(c) because it is appropriated to the beneficiary by your legal personal representative in satisfaction of a pecuniary legacy or some other interest or share in your estate; or

(d) under a deed of arrangement if:

(i) the beneficiary entered into the deed to settle a claim to participate in the distribution of your estate; and

(ii) any consideration given by the beneficiary for the asset consisted only of the variation or waiver of a claim to one or more other CGT assets that formed part of your estate.

Taxation Ruling No IT 2622 (the Ruling) considers the income tax liabilities of executors or administrators and of beneficiaries under the estates of deceased persons during the stages of administration of deceased estates. The Ruling outlines the stages of administration of an estate of a deceased person as follows:

1.  Burial of deceased.

2.  Executor appointed by will or administrator appointed by Court.

3.  Probate applied for and granted by Court.

4.  Assets vest in executor who pays debts and testamentary expenses:

•         Initial stage - net income of estate is applied to reduce debts, etc.

•         Intermediate stage - part of the net income of estate that is not required to pay debts, etc., may be paid to beneficiaries.

•         Final stage - debts, etc., are paid or provided for in full and net income of estate is available for distribution.

Paragraph 16 of the Ruling states that '[o]nce the executor has provided for all debts incurred by the deceased before his or her death and for debts incurred in administering the estate (e.g. funeral expenses) and provided for distributions for specific assets or legacies, it will be possible to ascertain the residue with certainty, even though the executor may not have actually made all the transfers necessary to satisfy these demand son the estate.'

Once the residue of the estate is ascertained, the residuary beneficiaries enjoy present entitlement to income derived by the estate. The estate does not need to be wound up in order for the beneficiaries to enjoy present entitlement (paragraphs 15-16 of the Ruling).

According to 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, a beneficiary of a deceased estate acquires an interest in the assets of the estate when 'the assets of the estate have been called in and the deceased's debts and liabilities have been paid' (paragraph 72).

Application to your circumstances

The Estate of the deceased is in the final stage of administration as the Executors are ready to distribute the residual assets of the Estate. As a result, the residual beneficiaries are presently entitled to the residual assets as per the Will of the deceased. For tax purposes, this means that the assets passed to the beneficiaries under paragraph 128-20(1)(a). Consequently, as per the terms of the Will, each beneficiary is to receive a one third interest in the Estate. This result is irrespective of the deed of arrangement.

The assets of the Estate will not pass to the beneficiaries under paragraph 128-20(1)(d) (deed of arrangement). This is because the consideration to be given to Beneficiary A for their interest in the properties under the draft deed of arrangement does not solely consist of a variation or waiver of a claim to other CGT assets in the Estate as required by subparagraph 128-20(1)(d)(ii).

Issue 2

CGT issues for Beneficiary A

Question 1

Summary

The respective cost bases of beneficiary A's interest in the properties will be affected by the rules in section 128-15 of the ITAA 1997.

Detailed reasoning

Section 110-25 of the ITAA 1997 outlines the 5 elements of the cost base of a CGT asset.

Subsection 128-15(4) outlines the cost base rules for beneficiaries of a deceased estate.

Item 1 of the table in subsection 128-15(4) states that for assets acquired on or after 20 September 1985, the first element of the asset's cost base (the acquisition cost) is the cost base of the asset on the day the deceased died.

Item 3 of the table states that for a dwelling that was the deceased's main residence just before they died, the first element of the asset's cost base is the market value of the dwelling on the day the deceased died.

Application to your circumstances

The first element of the cost base for beneficiary A's interest in the main residence, will be the market value of that portion of the dwelling on X December 20XX, the day the deceased passed away.

The first element of the cost base for beneficiary A's interest in the remaining properties, will be the assets' respective cost bases as on X December 20XX.

The respective cost bases of the properties will then be calculated following the method outlined in section 112-25.

Question 2

Summary

The transfer of the Property under the deed of arrangement will result in CGT event A1 for beneficiary A. This transaction will occur after beneficiary A has already received their entitlements from the Estate under the Will.

Detailed reasoning

CGT event A1 happens if you dispose of a CGT asset under subsection 104-10(1) of the ITAA 1997. You will make a capital gain if the capital proceeds from the disposal of the property are more than the cost base. You will make a capital loss if those capital proceeds are less than the cost base of the property.

The time of the CGT event is when you enter into the contract for the disposal or, if there is no contract, when the change of ownership occurs.

Capital proceeds

Generally, the capital proceeds from a CGT event comprise the sum of the money you have received, or are entitled to receive, in respect of the event happening and the market value of any other property you have received, or are entitled to receive, in respect of the event happening (section 116-20 of the ITAA 1997).

The money the seller is entitled to receive in respect of the CGT event (paragraph 116-20(1)(a) of the ITAA 1997) is limited to the known or ascertainable amounts that are receivable in respect of the CGT event. This includes any fixed amounts which the seller is entitled to receive at a later time (section 103-10 of the ITAA 1997).

Section 116-30 of the ITAA 1997 contains the capital proceeds market value substitution rule. Under subparagraph 116-30(2)(b)(i) the capital proceeds from a CGT event are replaced with the market value of the CGT asset if the capital proceeds are more or less than the market value of the asset and you are not acting at arm's length.

Application to your circumstances

As outlined above, you, beneficiary A, are held to have received your interest in the Estate under the Will as the Estate is in the final stage of administration. This final state of administration means you have a present entitlement to the assets of the Estate. As per the Will, you are entitled to a one third interest in the Estate.

You will dispose of your ownership interest in an asset to beneficiaries B and C when you enter into the deed of family arrangement. Therefore, the time of the CGT event is when you sign the deed of family arrangement.

Under Clause 5.4 of the proposed deed of arrangement, you have elected to relinquish your ownership interest in the three properties and receive a sum of money instead. A portion of the sum will derive from the funds available in the Estate and two additional monetary contributions are to be made by Beneficiaries B and C.

The market substitution rule will apply as the capital proceeds will be less than the market value of the asset and you are not acting at arm's length as outlined in section 116-30(2)(b)(i) of the ITAA 1997.

In addition, the draft Deed states that Beneficiaries B and C will compensate you for any tax consequences that arises from this arrangement.

Under section 103-10 of the ITAA 1997, additional amounts paid by Beneficiary B and C to compensate you for any tax liability are also considered a capital proceed as they arise out of the initial CGT event. All additional sums paid to you under this arrangement are considered capital proceeds and are themselves subject to tax.

For the avoidance of doubt, 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.

In your case, CGT event E8 does not apply as the assets passed from the estate to the beneficiaries under the terms of the Will of the deceased as per paragraph 128-20(1)(a).