Edited version of private advice

Authorisation Number: 1052206210877

Date of advice: 16 January 2024

Ruling

Subject: Trustee in bankruptcy - obligations

Question 1

Will receipt of settlement income on a property interest give rise to a capital gains tax liability for the trustee in their capacity as Trustee for The Bankrupt Estate of Paul Dimitriadis having regard to the operation of section 106-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, Limited to the extent of obligations created by section 254 of the ITAA 1997.

Question 2

Will the cost base of a settlement payment CGT event be valued at market value consistent with section 112-20 of the ITAA 1997?

Answer

No.

Question 3

In your capacity as trustee for a bankrupt estate are you required to lodge a tax return and include any capital gain as an agent consistent with section 254(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 4

In your capacity as trustee for a bankrupt estate are you required to retain funds as an agent consistent with section 254(1)(d) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes, subject to a relevant assessment being made by the Commissioner of Taxation.

Question 5

In your capacity as trustee for a bankrupt estate is the settlement sum ordinary income consistent with section 6-5 of the ITAA 1997?

Answer

No.

Question 6

In your capacity as trustee a bankrupt estate is the settlement sum statutory income consistent with section 6-10 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 2022 to 30 June 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

The bankrupt purchased property with two other individuals in after 20 September 1985.

One of the individuals' interests was transferred to the bankrupt and another individual following a survivorship application.

You were appointed as trustee in bankruptcy in respect of the bankrupt individual (the Trustee in Bankruptcy).

On your date of appointment, the vested interest in the property passed to you.

You entered into discussions with the remaining individual who had a joint interest in the property for that individual to acquire the interest of the bankrupt by way of a Deed of Settlement and Release.

As a result of the Deed of Settlement and release, the Trustee in Bankruptcy held a certain amount of cash at bank.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 254

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 106-30

Income Tax Assessment Act 1997 section 112-20

Does IVA apply to this private ruling?

No.

Reasons for decision

Question 1

Under section 106-30 of the ITAA 1997, the vesting of an individual's capital gains tax (CGT) assets in a trustee under the Bankruptcy Act 1966 or under a similar foreign law is ignored.

Section 106-30 of the ITAA 1997 operates such that when vested bankruptcy property is disposed of, whether by the trustee in bankruptcy or by a mortgagee exercising power of sale, the primary tax liability for any capital gain made on the sale falls to the bankrupt individual.

Section 254 of the ITAA 1936 imposes obligations on every trustee in respect of any income or any profits or gains of a capital nature derived by them in their representative capacity, creating a secondary tax liability for agents and trustees, ancillary to the primary tax liability.

A trustee in bankruptcy is a trustee for the purposes of section 254 in accordance with the definition of 'trustee' in section 6(1) of the ITAA 1936. As such, section 106-30 of the ITAA 1997 does not negate a trustee in bankruptcy from their obligations under section 254 of the ITAA 1936.

Question 2

Section 112-20 of the ITAA 1997 allows for the market value of a CGT asset to be substituted for the cost base and reduced cost base of a CGT asset if;

(a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from:

(i)      CGT event D1 happening; or

(ii)     Another entity doing something that did not constitute a CGT event happening; or

(b)         Some or all of the expenditure you incurred to acquire it cannot be valued; or

(c)         You did not deal at * arm's length with the other entity in connection with the acquisition

A trustee in bankruptcy is a trustee for the proposes of section 254 of the ITAA 1936. Where income, profits and gains have been derived in a representative capacity post-sequestration, the primary obligation be assessed and pay the tax on any capital gain is on the bankrupt.

In the hands of the bankrupt the general rules about cost base pursuant to section 110-25 of the ITAA 1997 apply to capital gains unless the criteria of section 112-20 of the ITAA 1997 applies to the transaction to substitute the cost base for a market valuation. Where the bankrupt did incur expenditure to acquire the asset, not from a result of CGT event D1 or another entity doing something that did not constitute a CGT event happening and that expenditure can be valued and was as a result of an arm's length dealing, the market value substitution rule in section 112-20 of the ITAA 1997 will not apply.

Question 3

Section 254 of the ITAA 1936 is triggered at the moment a trustee derives income, profits, or gains in his or her representative capacity. In FCT v Australian Building Systems Pty Ltd (in Liq) & Ors [2015] HCA 48 (ABS), the High Court described subsection 254(1) of the ITAA 1936 as both a liability-imposing provision and a collecting provision. It imposes a tax liability on the trustee, which is ancillary to the primary tax liability. It also provides a means of collecting the liability from the trustee in certain circumstances.

Section 254(1)(a) of the ITAA 1936 makes a trustee in bankruptcy answerable as taxpayer for the payment of tax on any income, profits or gains they derive in their representative capacity. The Commissioner is of the view that you as trustee of the bankrupt derived gains from the settlement dated 25 May 2023 for the 50% interest in the property owned by the bankrupt. As such, you as trustee are answerable under section 254(1)(a) for these gains.

If the Commissioner requires a trustee in bankruptcy to lodge a return under section 254(1)(b) of the ITAA 1936 the trustee in bankruptcy must do so, but in their representative capacity only. Similarly, if the trustee is assessed on the gain under section 254(1)(b), they are assessed in their representative capacity only. Gordon J explained the purpose of section 254(1)(b) in ABS (at paragraph 174):

What s 254(1)(b) does is emphasise that in respect of the income or profits or gains referred to in sub-s(1)(a), the obligation of an agent or trustee to make a return and be assessed (as if the taxpayer) is in their representative capacity only. It is [an] ancillary liability. Its purpose is to ensure payment of the tax; tax which at least ordinarily will be primarily payable by another person or entity.

Paragraph 209 of Practice Statement Law Administration (PS LA) 2011/5 provides that 'an agent or trustee has the same responsibilities as the entity for complying with income tax law in respect of the income, or any profits, or gains of a capital nature, derived in a representative capacity or derived by the principal by virtue of an agency, and for payment of tax.'

Therefore, in their capacity as trustee for the bankrupt estate, where a trustee derives income, profits, or gains in a representative capacity, they are required to make returns, be assessed, and pay tax that is assessed on that income, profits, or gains.

Question 4

Section 254(1)(d) provides that a trustee of a bankrupt estate is authorised and required to retain money that is received in their representative capacity so much is as sufficient to pay tax which is or will become due in respect of the income, profits, or gains.

The High Court in the ABS decision considered the point where a trustee or agent comes under the retention obligation in section 254(1)(d) of the ITAA 1936 in respect of income, profits or gains derived by them in their representative capacity. The facts and circumstances of the case are not dissimilar to the present facts and circumstances to the extent that a trustee has derived income, profits, or gains in their capacity as trustee of the bankrupt.

Consistent with the Decision Impact Statement issued by the Commissioner in respect of ABS. The Commissioner accepts a trustee or agent has no obligation to retain monies under section 254(1)(d) of the ITAA 1936 until an assessment has first issued in respect of the income, profits, or gains.

The decision reflects the Commissioner's view that section 254 of the ITAA 1936 does not require the trustee to be assessable to tax under Part III, Division 6 of the ITAA 1936 in order for the retention obligation to be imposed.

While the primary obligation to retain the income, profits or gains and pay any resulting tax liability on those income, profits, or gains rests with the Bankrupt. Section 254(1)(b) creates a secondary obligation to also retain funds once a relevant assessment is made by the Commissioner of Taxation. The bankruptcy trustee is not required to calculate or estimate the tax liability consistent with the decision held in ABS.

Once the Commissioner of Taxation has made a relevant assessment, the obligations under section 254(1)(d) are enlivened that the bankrupt trustee must retain, from funds on hand or that subsequently come to them, enough money to pay the tax that has been assessed on the income, profits or gains derived in their representative capacity that the Commissioner can legally recover.

Question 5

Section 6-5 of the ITAA 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts. The Income Tax Assessment Acts do not explain the meaning of 'income according to ordinary concepts', however, a substantial body of case law exists which identifies likely characteristics.

In GP International Pipecoaters Pty Ltd v Commissioner of Taxation (Cth) [1990] HCA 25 it was stated:

"To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity, or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture, or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture, or business."

Amounts that are periodical, regular, or recurrent, relied upon by the recipient for their regular expenditure and paid to them for that purpose are likely to be ordinary income, as are amounts that are the product in a real sense of any employment of, or services rendered by the recipient. Amounts paid in substitution for salary or wages. foregone or lost may also be ordinary income. No single factor is determinative of the receipt's character, but some factors may be more relevant than others in light of the circumstances of the case.

Distributions received from a Settlement Deed and Release is a one-off lump sum payment in the nature of sale of a 50% holding in a property. Accordingly, the distribution received under the Settlement Deed and Release does not possess the characteristics of ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.

Question 6

An amount that is not ordinary income may still be included in assessable income as a result of the operation of section 6-10 of the ITAA 1997 which includes statutory income in assessable income. Statutory income relevantly includes net capital gains under section 102-5 of the ITAA 1997.

The Settlement Deed and Release is in relation to the payment of a 50% interest in Australian Real Property to the trustee of a bankrupt estate. The character of the income has been summarised in the detailed reasoning of question 5 and is consistent with a one-off lump sum payment that is no periodical, regular or recurrent.