Edited version of private advice

Authorisation Number: 1052212707972

Date of advice: 7 February 2024

Ruling

Subject: Testamentary trust income - voluntary payment

Question 1

Will the distribution of the Assets to the Beneficiaries under Option 1 satisfy the requirements of section 128-15 of the Income Tax Assessment Act 1997 (ITAA 1997) such that the Trustee will disregard any capital gain?

Answer

Yes

Question 2

Will the distribution of the Assets to the Beneficiaries under Option 2 satisfy the requirements of section 128-15 of the ITAA1997 such that the Trustee will disregard any capital gain?

Answer

Yes

Question 3

If Option 1 is implemented, will the Recipient Beneficiaries be required to include any amount in their assessable income (either as ordinary income or as a capital gain) as a consequence of receiving the payments?

Answer

No

Question 4

If Option 2 is implemented, will the Trustee be required to include an amount in its assessable income (either as ordinary income or as a capital gain) as a consequence of receiving the payments?

Answer

No

This ruling applies for the following periods:

year ending 30 June 2024

year ending 30 June 2025

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

1)    Deceased passed away on XX XX 20XX. Probate was granted on XX XX 20XX.

2)    The Testamentary Trust ("the Trust") was established by the last will and testament ("the Will") of Deceased dated XX XX 20XX. Under the terms of the Will, the residue of the estate was to be held subject to the terms of the Trust.

3)    The primary beneficiaries of the Trust were named as XX XX ("the Primary Beneficiaries").

4)    The initial trustees of the Trust were XXXX. In XX 20XX ("the Trustee").

5)    The Primary Beneficiaries are Australian residents for taxation purposes.

Assets of the Trust

6)    The assets of the Trust include the following XXXX that were owned by the Deceased on their date of death:

-   AA

-   BB

-   CC

-   DD

-   EE

Collectively referred to as "the Assets".

7)    The Trust is also the owner of the following additional assets ("the Surplus Assets"):

-   stock

-   cash; and

-   small parcel of shares in XXXX.

Terms of the Trust

8)    The terms for the Trust are set out in the Will ("the Deed"). The relevant clauses of the Deed have been provided.

Proposal to vest the Trust

9)    The Trustee and the Primary Beneficiaries have agreed that they wish to vest the Trust in the near future. In vesting the Trust, the Trust will distribute its assets to the Primary Beneficiaries.

Deed of amendment

10) To confirm and clarify the Trustee's power to distribute the Trust's assets to the Primary Beneficiaries in-specie on vesting, a deed of amendment ("the Amendment") has been drafted to exercise the Trustee's general variation powers provided at clause XX.

11) The relevant terms of the Amendment have been provided.

Deed to vest the Trust

12) A deed to vest the Trust ("the Vesting Deed") has been drafted. The Vesting Deed is to be signed by the Trustee and all Primary Beneficiaries.

13) The draft Vesting Deed proposes to distribute the assets in-specie on vesting to the Primary Beneficiaries in the following manner:

14) In addition to the distribution of the Assets, the draft Vesting Deed proposes to distribute the residue of the Trust (comprising cash, stock and shares) to the Primary Beneficiaries in equal shares on vesting.

Differences in values of the properties

15) There is a difference in the market values of the individual assets. The Trustee and the Primary Beneficiaries are considering two options to reconcile the differences in the value of the asset distributions.

Option 1

16) Option 1 would involve those Primary Beneficiaries who are to receive assets of greater value (the "Paying Beneficiaries") making gifts to those beneficiaries that have received assets of lesser value ("the Recipient Beneficiaries").

17) Option 1 involves:

•         Paying Beneficiary gifting the amount of $XX to Recipient Beneficiaries;

•         Paying Beneficiary the amount of $XX to Recipient Beneficiaries;

•         Paying Beneficiary gifting the amount of $XX to Recipient Beneficiaries;

•         Paying Beneficiary gifting the amount of $XX to Recipient Beneficiaries; and

•         Paying Beneficiary gifting the amount of $XX to Recipient Beneficiaries.

18) The gifting of the amounts between the beneficiaries would be documented in the Vesting Deed.

Option 2

19) Option 2 involves the Paying Beneficiaries making the payments to Trust (i.e., gifting amounts to the Trust) prior to the vesting of the Trust, as follows:

•         Paying Beneficiary gifting the amount of $XX to the Trust;

•         Paying Beneficiary gifting the amount of $XX to the Trust; and

•         Paying Beneficiary gifting the amount of $XX to the Trust

20) On the vesting of the Trust, in addition to transferring the assets and the Surplus Assets, the Trustee would distribute the following additional cash amounts to the Recipient Beneficiaries:

•         Recipient Beneficiary would receive an additional cash distribution of $XX from the Trust;

•         Recipient Beneficiary would receive an additional cash distribution of $XX from the Trust; and

•         Recipient Beneficiary would receive an additional cash distribution of $XX from the Trust.

21) This would result in all beneficiaries receiving distributions of equal value from the Trust.

22) The gifting of the amounts to the Trust would be documented in the Vesting Deed.

Agreement regarding cost base

23) The Vesting Deed will include a clause under which the Primary Beneficiaries will agree that their acquisition cost for the properties is equal to the Trust's cost base, as specified in Practice Statement PS LA 2003/12.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-1(1)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1936 section 23L

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 Division 128

Income Tax Assessment Act 1997 section 128-10

Income Tax Assessment Act 1997 section 128-15

Income Tax Assessment Act 1997 subsection 128-15(1)

Income Tax Assessment Act 1997 subsection 128-15(2)

Income Tax Assessment Act 1997 subsection 128-15(3)

Income Tax Assessment Act 1997 section 128-20

Income Tax Assessment Act 1997 subsection 128-20(1)

Income Tax Assessment Act 1997 paragraph 128-20(1)(a)

Income Tax Assessment Act 1997 paragraph 128-20(1)(c)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Questions 1 and 2

Summary

Any capital gain or loss made by the trustee of the Trust when the Assets pass to the beneficiaries is disregarded under subsection 128-15(3) of the ITAA 1997 as the Assets were assets the deceased owned just before their death and those assets passed to the beneficiaries in accordance with paragraph 128-20(1)(c) of the ITAA 1997.

Detailed reasoning

Section 102-20 of the ITAA 1997 provides that a capital gain or capital loss is made only if a capital gains tax (CGT) event happens to a CGT asset.

CGT event A1 is the most common CGT event and is described under section 104-10 of the ITAA 1997. CGT event A1 occurs if there is a disposal or part disposal of a CGT asset.

Subsection 104-10(2) of the ITAA 1997 defines a disposal as:

You dispose of a CGT asset if the change in ownership occurs from you to another entity, whether because of some act or event or by operation of the law. However, a change in ownership does not occur if you stop being the legal owner of the asset but continue being the beneficial owner.

A capital gain is made if the capital proceeds from the disposal are more than the cost base of the asset. Conversely, a capital loss arises if the capital proceeds are less than the asset's reduced cost base.

Subsection 108-5(1) of the ITAA 1997 provides that a CGT asset is any kind of property or a legal or equitable right that is not property.

Division 128 of the ITAA 1997 contains rules that apply when an asset owned by a person just before they die, passes to their legal personal representative (LPR) or passes to a beneficiary of a deceased estate.

Relevantly, LPR is defined in subsection 995-1(1) of the ITAA 1997 to mean an executor or administrator of an estate of an individual who has died.

Under section 128-10 of the ITAA 1997, when a person dies, any capital gain or loss from a CGT event that results from a CGT asset the person owned just before dying is disregarded.

Subsection 128-15(1) of the ITAA 1997 sets out what happens if a CGT asset you owned just before dying:

(a) devolves to your LPR; or

(b) passes to a beneficiary in your estate.

Subsection 128-15(2) of the ITAA 1997 provides that the LPR, or beneficiary, is taken to have acquired the asset on the day you died.

Any capital gain or capital loss the LPR makes if the asset passes to a beneficiary in your estate is disregarded under subsection 128-15(3) of the ITAA 1997.

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

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

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

(c) because it is appropriated to the beneficiary by the deceased 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 the deceased 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 the estate.

In relation to the transfer of the deceased's asset under a will the Commissioner has issued Practice Statement PS LA 2003/12 which relevantly provides:

1. What this practice statement is about

This practice statement confirms the Commissioner will not depart from the ATO's long-standing administrative practice of treating the trustee of a testamentary trust in the same way that a legal personal representative is treated for the purposes of Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997), in particular subsection 128-15(3).

2. What is the effect of the practice for the trustee of a testamentary trust?

Broadly stated, the ATO's practice is to not recognise any taxing point in relation to assets owned by a deceased person until they cease to be owned by the beneficiaries named in the will (unless there is an earlier disposal by the legal personal representative or testamentary trustee to a third party or CGT event K3 applies).

...

For PS LA 2003/12 to apply, the trust in question must be a testamentary trust. In the present case, the Trust is a testamentary trust as it was created under the terms of the will.

APPLICATION

Under Option One and Option Two, the Assets are transferred to the beneficiaries of the Trust in accordance with paragraph 128-20(1)(a) of the ITAA 1997. Having regard to PS LA 2003/12, as a result any capital gain or capital loss the Trust makes when the Assets pass to the beneficiaries is disregarded under subsection 128-15(3) of the ITAA 1997.

Questions 3 and 4

Ordinary income

Assessable income is defined in subsection 6-1(1) of the ITAA 1997 as consisting of ordinary income and statutory income.

Under section 6-5 of the ITAA 1997 the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources. "Ordinary income" is defined to mean income according to ordinary concepts.

Section 6-10 of the ITAA 1997 defines statutory income as amounts that are not ordinary income but are included in your assessable income by provisions about assessable income.

An amount is ordinary income if it meets the ordinary meaning of income while an amount is statutory income if it is not ordinary income but is specifically included in assessable income by a provision of the Income Tax Assessment Act (ITAA).

In determining whether an amount is ordinary income, the courts have established the following principles:

•         what receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as a statute dictates otherwise (2 Scott v. FC of T (1935) 35 SR (NSW) 215; (1935) 3 ATD 142 per Jordan CJ at SR 219; ATD 14);

•         whether the payment received is income depends upon a close examination of all relevant circumstances (The Squatting Investment Co Ltd v. FC of T (1953) 86 CLR 570 at 627; (1953) 10 ATD 126 at 146); and

•         it is an objective test (Hayes v. FC of T (1956) 96 CLR 47 at 55; (1956) 11 ATD 68 at 73).

Relevant factors in determining whether an amount is ordinary income include:

•         whether the payment is the product of any employment, services rendered, or any business (5 FC of T v. Harris (1980) 43 FLR 36; 80 ATC 4238; (1980) 10 ATR 869 at FLR 40; ATC 4241; ATR 872; Hayes v. FC of T (1956) 96 CLR 47 at 54; (1956) 11 ATD 68 at 72);

•         the quality or character of the payment in the hands of the recipient (FC of T v. Blake 84 ATC 4661; (1984) 15 ATR 1006 - refer comments of Carter J (at ATC 4664; ATR 1010); Scott v. FC of T (1966) 117 CLR 514; (1966) 14 ATD 286 (at CLR 526; ATD 293); GP International Pipecoaters Pty Ltd v. FC of T (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (at CLR 136; ATC 4419; ATR 6));

•         the form of the receipt, that is, whether it is received as a lump sum or periodically (FC of T v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82 (at CLR 557; ATD 86)); and

•         the motive of the person making the payment. Motive, however, is rarely decisive as in many cases a mixture of motives may exist (Hayes v. FC of T (1956) 96 CLR 47; (1956) 11 ATD 68 (at CLR 55; ATD 72-73)).

Gift

The Federal Court case of FC of T v Co-operative Motors Pty Ltd 95 ATC 4411 considers whether an amount that is paid voluntarily, in the sense that the payer does not have a legal obligation to make that payment, is income in the hand of the recipient and in doing so made the following observations:

In Hayes the question was whether shares in a public company given voluntarily to Mr Hayes by a friend constituted income derived by Mr Hayes. There had been business dealings between Mr Hayes and the donor and a company controlled by the donor. These had ceased some time before the gift was made. Fullagar J held that the shares did not constitute income. His Honour discussed the principles to be applied and at ATD 72; CLR 54 said:

''A voluntary payment of money or transfer of property by A to B is prima facie not income in B's hands. If nothing more appears than that A gave to B some money or a motor car or some shares, what B receives is capital and not income. But further facts may appear which show that, although the payment or transfer was a 'gift' in the sense that it was made without legal obligation, it was nevertheless so related to an employment of B by A, or to services rendered by B to A, or to a business carried on by B, that it is, in substance and in reality, not a mere gift but the product of an income-earning activity on the part of B, and therefore to be regarded as income from B's personal exertion.''

In that passage the reference to ''personal exertion'' can be ignored, the distinction between income from personal exertion and income from property having, for present purposes, disappeared. The only issue was whether the property received was income.

...

It is necessary to apply these principles to the facts found by the Tribunal. There was a finding that the payment of the $500,000 was voluntary but it was made in the context of the business that had been carried on between the Taxpayer and Toyota and the business that was to continue to be carried on between the Taxpayer and Toyota. Until the decision by Toyota to terminate the distributorship agreement, the Taxpayer had been the distributor of Toyota vehicles in the whole of Tasmania and a dealer of Toyota vehicles in Hobart and southern Tasmania. The payment by Toyota, though made voluntarily, was made ''in recognition of past representation as a Distributor for the State of Tasmania on termination of the Company's Distributorship status''. The money was received by the Taxpayer on that basis and the Taxpayer looked ''forward to a continuation of the long standing relationship between the company and Toyota'', see the letter from the Taxpayer to Toyota dated 5 December 1988 set out earlier in these reasons. This refers to the ongoing dealership arrangement between the Taxpayer and Toyota. The continuation of this relationship was one of the reasons found by the Tribunal to explain the ex gratia payment.

All these facts point to the conclusion that the receipt of the $500,000 by the Taxpayer was related to the businesses carried on by the Taxpayer with the result that in substance and reality the sum received was not a mere gift but the product of the income-earning activity on the part of the Taxpayer.

...

Provisions relating to statutory income

Section 6-10 of the ITAA 1997 includes statutory income in assessable income; statutory income includes other amounts that are not ordinary income and are included by provisions about assessable income. For example, a net capital gain is statutory income.

Section 10-5 of the ITAA 1997 lists certain statutory amounts that are included in assessable income but are not ordinary income, including certain payments by trusts.

APPLICATION

In the case of Option One the Recipient Beneficiaries receive the payment directly from the Paying Beneficiaries. The Trustee has the ability to distribute the assets of the deceased's estate at its discretion. The purpose of the payment is to achieve the equitable distribution of value when the Assets are included so that each beneficiary overall receives the same value. These payments do not represent ordinary income and no statutory provisions capture them to be included as assessable income. Consequently, the payment by the Paying Beneficiaries will not be assessable income of the Recipient Beneficiaries.

In the case of Option Two the Paying Beneficiaries will make payments to the Trustee and the Trustee will distribute the amounts to the Receiving Beneficiaries in accordance with the terms of the trust deed. In this case the Trustee is acting as a facilitator to enable the equitable distribution of value of the estate including the Assets to the beneficiaries. The payments do not have the character of income of the Trust and therefore those payments by the Paying Beneficiaries to the Trust will not be assessable income of the Trust.