Edited version of private advice

Authorisation Number: 1052253938840

Date of advice: 28 May 2024

Ruling

Subject: CGT - deceased estates

Question

Does the disposal of two-thirds of the share portfolio constitute a CGT event A1 under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, CGT event A1 has occurred when the Executors disposed a portion of the estates share portfolio under section 104-10 of the ITAA 1997.

CGT event K3 has not been triggered as the assets had not passed to the tax-exempt beneficiaries before the disposal event occurred.

This ruling applies for the following period:

Year ended XX XXXX 20YY

The scheme commenced on:

XX XXXX 20YY

Relevant facts and circumstances

On XX XXXX 20YY, the Deceased passed away.

The Deceased was an Australian resident for tax purposes.

On XX XXXX 20YY, Probate of the Will of the Deceased was granted to the Executors by the Supreme Court of the relevant State.

The Inventory of Probate was provided showing the gross value of estate assets situated in the relevant State of $XX.

At the date of death, the Deceased owned shares in companies listed on the Australian Stock Exchange (the share portfolio) valued at $XX.

All of the shares were acquired after 20 September 1985.

Other assets owned solely by the deceased include: Deposit $XX, money in banks or financial institutions $XX and Superannuation Fund Entitlements $XX.

The Will of the Deceased provided broad and various discretionary powers to the Executors, including the power to sell, retain and partition any asset in the estate without a requirement to obtain consent.

The Will of the Deceased named three residuary beneficiaries, Beneficiary 1, Beneficiary 2 and Beneficiary 3.

Beneficiaries 1 and 2 are tax residents of Country A and Country B.

Beneficiary 3 is an Australian tax resident.

On XX XXXX 20YY, the Executors commenced making interim cash distributions to the residuary beneficiaries.

Beneficiaries 1 and 2 instructed the Executors to dispose of their respective two-thirds of shares within the estates share portfolio.

The Executors sought instructions from the residuary beneficiaries and their financial advisors as to whether one or more of the residuary beneficiaries wished to take and in-specie transfer of their one-third share of the share portfolio.

Beneficiary 1 and 2 instructed the Executors to dispose of their respective two-thirds of shares within the estates share portfolio.

Beneficiary 3 instructed the Executors that they would receive an in-specie transfer for their respective one-third share in the share portfolio.

On XX XXXX 20YY, Beneficiary 3 received one-third of the share portfolio pursuant to off-market transfers.

On XX XXXX 20YY, the Executors instructed a stockbroking firm, to sell approximately two-thirds of the share portfolio at market price of the shares on the date of sale.

The gross sale proceeds were $XX with brokerage costs of $XX.

On XX XXXX 20YY, the net proceeds of sale of the shares of $XX were received.

The sum of $1XX (being part of the share sale proceeds) has been distributed to the beneficiaries.

The Will of the Deceased was not varied in relation to the shares. The Executors have administered the estate in accordance with the Will.

The balance of the sale proceeds, together with other funds held by the Estate have been retained and are currently held in the Estate Accounts operated by an Australian Financial Institution. The total funds are being retained for the purpose of paying Estate administration, fees and expenses, Executor's fees and expenses, legal fees and disbursements, accountancy fees and such income tax as might be assessed against the Estate.

The Estate has not been fully administered.

The beneficiaries are not able to demand immediate payment of any income in the Estate.

The residue of the Estate will be legally available for distribution after the Estate has been fully administered.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-215

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 128-10

Income Tax Assessment Act 1997 section 128-15

Income Tax Assessment Act 1997 section 128-20

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

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 if 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. Assets include shares acquired on or after 20 September 1985.

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 in 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.

Broadly stated, the ATO's practice is not to 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 LPR or testamentary trustee to a third party of CGT event K3 applies).

CGT event K3 in section 104-215 of the ITAA 1997 happens if a CGT asset owned by a deceased person just before they die passes to a beneficiary in their estate that, when the asset passes, is a tax-exempt entity or is the trustee of a complying superannuation entity or is a foreign resident.

If the asset passes to a beneficiary who is a foreign resident, CGT event K3 happens only if the deceased was an Australian resident just before dying and the asset (in the hands of the beneficiary) is not taxable Australian property.

Under subsection 104-215(3) of the ITAA 1997, CGT event K3 is taken to happen just before the deceased's death. The trustee of the estate must include in the date of death return any net capital gain for the income year when the deceased died (section 104-215 (4) of the ITAA 1997). There is an exception for certain philanthropic testamentary gifts under section 118-60 if the ITAA 1997.

The Commissioner has issued Taxation Determination, TD 2004/3, which deals with the question whether an asset 'passes' to a beneficiary of a deceased estate under section 128-20 if the beneficiary becomes "absolutely entitled" to the asset as against the trustee of the estate. According to the ruling, if the estate has been fully administered but legal ownership of an asset has not been transferred to the beneficiary who is entitled to the asset, a sale of the asset by the LPR will give rise to a capital gain in the hands of the beneficiary, rather than in the hands of the LPR.

Draft 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 offers insight into the Commissioner's view on the concept of absolute entitlement.

Paragraph 13 of TR 2004/D25 outlines persons that cannot be absolutely entitled because they do not have an interest in the trust's assets and includes a beneficiary of a deceased estate prior to completion of its administration.

This is further explained at paragraph 72 of TR 2004/D25. A beneficiary of a deceased estate does not have an interest in any of the estate (and therefore cannot be considered absolutely entitled to any of the estate's assets) until the date the estate is fully administered (Commissioner of Stamp Duties (Queensland) v. Livingstone (1964) 112 CLR 12; [1965] AC 694; [1965] ALR 803; [1964] 3 All ER 692; [1964] 3 WLR 963, Probert v. Commr of State Taxation (SA) (1998) 72 SASR 48; (1998) 98 ATC 5176; (1998) 40 ATR 261, Taxation Ruling IT 2622).

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 (paragraph 10 of TR 2004/D25).

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.

Fungible assets and separate classes

TR 2004/D25 details that 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 can 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.

Paragraph 100 of TR 2004/D25 states that assets must be conveniently divisible in order for a trustee to satisfy a demand from a beneficiary that their share be satisfied by the transfer of an asset of the trust (or its allocation in favour of the beneficiary). This condition must be applied separately in respect of each class of fungible assets. Shares or units in publicly listed entities are generally considered capable of convenient division without prejudice to other beneficiaries (assuming they are of the same asset class).

TR 2004/D25 provides a similar case example at paragraphs 169-70 as referenced below.

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

The Deceased passed away on XX XXXX 20YY at which time the share portfolio owned by the Deceased was transferred to the Executors of the Deceased's estate. For CGT purposes, the Executors are taken to have acquired the shares on the date of the Deceased's death as per section 128-15(2) of the ITAA 1997.

The Executors, following the instructions of the respective beneficiaries, sold two-thirds of the estate's share portfolio. Consequently, as the Executors sold the assets within the estate before the completion of the estates administration process, the two respective beneficiaries are not absolutely entitled to these assets.

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) an interest in each share.

The assets in the form of the estates share portfolio cannot be said to have 'passed' in the way required by section 128-20 of the ITAA 1997. As the assets owned by the deceased just before death did not pass to the two tax-exempt beneficiaries, CGT event K3 has not been triggered. CGT event A1 occurs instead due to a disposal of the assets by the Executors.