Edited version of your written advice

Authorisation Number: 4130048100039

Date of advice: 14 August 2018

Ruling

Subject: Trust and other entities in relation to the majority underlying interests.

Question 1

Will the Commissioner be satisfied, or consider it reasonable to assume, that, for the purposes of subsection 149-30(2) of the Income Tax Assessment Act 1997, at all times on and after 20 September 1985 until present, the majority underlying Interests in the two assets, described in this submission as the Property, held by the M Pty Ltd as trustee for the M Unit Trust were held by persons who, immediately before 20 September 1985, held the majority underlying interests in the Property?

Answer

Yes

Question 2

Would the gain arising from the sale of the Property acquired by the M Unit Trust be included in its assessable income under section 6-10 of the ITAA 1997 in the financial year the properties are disposed of if the requirements of subsection 149-30(2) are met and continue to be met until the properties are sold?

Answer

No – refer to assumptions made by the Commissioner

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The M Unit Trust (Unit Trust) was settled by Mr S by the Deed of Unit Trust dated 1 November 19XX.

The trustee of the Unit Trust is a non - public entity, M Pty Ltd. The original shareholders of M were RS and EZ.

On XX December 200X, EZ transferred his share in M Pty Ltd to his daughter MS. The directors of M Pty Ltd at various times were E, his wife AZ, their daughter M and her husband RS.

The original unit holders of the Unit Trust were:

● 10 ordinary units held by EZ ATF the EZ Family Trust

● 10 ordinary units held by RS ATF the S Family Trust

The trustee has the power to issue Special Equity Units and Special Par Units of $1.00 each. To date neither of these units have been issued by the trustee.

The trustee has the power to make determinations as to the amount of income to the unit holders.

Around XX March 19XX M Pty Ltd acquired various Lots XXXX - collectively the lots referred to as ‘Property’. An undated Deed of Declaration was stamped by the State Revenue Office on xx April 1984, declaring that M Pty Ltd as trustee held the Property.

The Property was a business asset of the Unit Trust. The Unit Trust ceased business on xx December 20XX.

The Trust Deeds for each of EZ and S are in substantively identical terms.

EZ Family Trust

EZ, a discretionary trust, was settled via the Deed dated x November 1983. The appointer, guardian and initial trustee was EZ. On xx June 19XX V Pty Ltd replaced EZ as trustee for EZ pursuant to clause xx of the Trust Deed.

The shareholders and directors of V Pty Ltd at various times have been EZ, AZ and M who is the daughter of E and AZ.

The primary beneficiaries of EZ are the children of E and AZ. The general beneficiaries are EZ and AZ and any Body Corporate or Trustee of any trust who makes a donation to the above named beneficiaries, who may be nominated by the Trustee to be a general beneficiary. There have been no changes to any class of beneficiaries of EZ.

From inception of the trust the only beneficiaries presently entitled to the income and capital has been EZ, his spouse AZ and their daughter M.

Since the establishment of the trust up to 20XX/20XX, the distributions have been made to EZ and AZ and since then to M.

Pursuant to clause 21 of the Trust Deed, variations to the Deed were executed on xx May and x November 1991 to include net capital gains as income, differentiate between different types of income and allow for streaming of capital gains and franked dividends.

S Family Trust

S, a discretionary trust, was settled via the Deed dated 1 November 19XX. The appointer, guardian and initial trustee was Mr RS. On xx November 1990 the corporate trustee, R Pty Ltd replaced RS as the trustee, pursuant to Clause xx of the Trust Deed.

The shareholders and directors of R Pty Ltd at various times were the S family members - RS, M, J and S.

The primary beneficiaries of S are the children of RS and M and the general beneficiaries are RS and M and any Body Corporate or Trustee of any trust who makes a donation to the above named beneficiaries, who may be nominated by the Trustee to be a general beneficiary. There have been no changes to any class of beneficiaries of S.

Pursuant to clause xx of the Trust Deed, variations to the Deed were executed on xx May and x November 1991 to include net capital gains as income, differentiate between different types of income and allow for streaming of capital gains and franked dividends.

The deeds of settlement or variations provided with your application for this ruling forms part of the description of the scheme.

Transfer of Units

On xx December 20XX, V Pty Ltd ATF for EZ transferred 9 units in the Unit Trust to R Pty Ltd ATF S.

Assumptions

The Commissioner considers that the answers to Questions 2 of your ruling application on the assessability of any future gains on the sale of the Property would depend upon certain assumptions about future events.

The assumptions are:

● Each of the family trusts continue to align with the capital and income entitlements established in the past i.e., that is the trustees of the EZ and S family trusts continue to exercise their discretion in respect of income and capital of the respective trusts for the income years up until the Property has been sold, in such a way that the same beneficiaries continue to hold the beneficial interests in the income and capital from the pre – CGT asset.

● The sale will not be part of a profit making scheme nor will it occur in the course of carrying on any business.

Relevant legislative provisions

Division 149 of the ITAA 1997

Section 149-10 of the ITAA

section 149-15 of the ITAA 1997

section 149-30 of the ITAA 1997

former section 160ZZS of the ITAA 1936

subsection 82KZC(1) of the ITAA 1936

Reasons for Decision

Summary

Division 149 will not stop the asset (the Property) of the Unit Trust being a pre-CGT asset, following the amendment to the trust deeds of the respective trusts or on the transfer of units from EZ to S.

Detailed reasoning

Division 149 of the ITAA 1997 determines when an asset acquired on or before 19 September 1985 stops being a pre-CGT asset.

Section 149-10 of the ITAA 1997 states:

A CGT asset that an entity owns is a pre-CGT asset if, and only if:

(a) the entity last acquired the asset before 20 September 1985; and

(b) the entity was not, immediately before the start of the 1998-99 income year, taken under:

(i) former subsection 160ZZS(1) of the Income Tax Assessment Act 1936 (ITAA 1936); or

(ii) Subdivision C of Division 20 of former Part IIIA of that Act;

to have acquired the asset on or after 20 September 1985; and

(c) the asset has not stopped being a pre-CGT asset of the entity because of this Division.

In the present case, the pre-CGT asset is the property referred to as the Property that is subject to this ruling.

Paragraph (a)

In respect to paragraph 149-10(a) of the ITAA 1997, the Unit Trust is a private unit trust which purchased the Property in 1984.

Hence, it is accepted that you acquired the Property before 20 September 1985.

Paragraph (b)

In respect to paragraph 149-10(b) of the ITAA 1997, you state you were not taken immediately before the start of the 1999 income year to have acquired the asset on or after 20 September 1985 under either of:

● former subsection 160ZZS(1) of the ITAA 1936, or

● Subdivision C of Division 20 of former Part IIIA of that Act.

Former subsection 160ZZS(1) of the ITAA 1936 stated:

For the purposes of the application of this Part in relation to a taxpayer, an asset acquired by the taxpayer on or before 19 September 1985 shall be deemed to have been acquired by the taxpayer after that date unless the Commissioner is satisfied, or considers it reasonable to assume, that, at all times after that date when the asset was held by the taxpayer, majority underlying interests in the asset were held by natural persons who, immediately before 20 September 1985, held majority underlying interests in the asset.

Taxation Ruling IT 2340 provides guidance on the administration of former 160ZZS of the ITAA 1936.

In order for an asset not to be deemed to have been acquired after 19 September 1985 due to the operation of former subsection 160ZZS(1) of the ITAA 1936, the Commissioner must be satisfied or consider it reasonable to assume, that the majority underlying interests in the asset have not changed during the period 19 September 1985 to 30 June 2018.

Former subsection 160ZZS(3) of the ITAA 1936 defined majority underlying interests when applying 160ZZS(1) as having the same meaning as in Subdivision 3G of Part III.

Majority underlying interests is defined in subsection 82KZC(1) of the ITAA 1936 to mean more than one-half of:

(a) The beneficial interests that natural persons hold (whether directly or through one or more interposed companies, partnerships or trusts) in the property, and

(b) The beneficial interests held by natural persons (whether directly or through one or more interposed companies, partnerships or trusts) in any income that may be derived from the property.

To identify the ultimate owners who held beneficial interests in the asset and income just before 20 September 1985, it is necessary to look at the individual beneficiaries who would have been entitled to receive any capital and income distributions made by the trust at that time.

Paragraph (c)

In respect to paragraph 149-10(c) of the ITAA 1997, it must be determined whether the Property has not stopped being a pre-CGT asset because of current Division 149.

As you are a private unit trust, Subdivision 149-B applies to you in relation to non-public entities.

Subsection 149-30(1) of the ITAA 1997 states:

The asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the assets were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

Subsection 149-15(1) of the ITAA 1997 defines majority underlying interests as

Majority underlying interests in a CGT asset consist of:

(a) More than 50% of the beneficial interest that ultimate owners have (whether directly or indirectly) in the asset; and

(b) More than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.

Subsection 149-15(2) of the ITAA 1997 defines an underlying interest as:

An underlying interest in a CGT asset is a beneficial interest that an ultimate owner has (whether directly or indirectly) in the asset or in any ordinary income that may be derived from the asset.

An ultimate owner is defined in subsection 149-15(3) of the ITAA 1997 to include an individual or a company whose constitution prevents it from making any distribution, whether in money, property or otherwise to its members.

Subsection 149-15(4) of the ITAA 1997 states:

An ultimate owner indirectly has a beneficial interest in a CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of the capital of the other entity if:

(a) The other entity were to distribute any of its capital, and

(b) The capital were then successively distributed by each entity interposed between the other entity and the ultimate owner.

Subsection 149-15(5) of the ITAA 1997 states:

An ultimate owner indirectly has a beneficial interest in ordinary income that may be derived from a CGT asset of another entity (that is not an ultimate owner) if he, she or it would receive for his, her or its own benefit any of a dividend or income if:

(a) The other entity were to pay that dividend or otherwise distribute that income, and

(b) The dividend or income were then successively paid or distributed by each entity interposed between the other entity and the ultimate owner.

The expression ‘beneficial interest’ as used in the definition of ‘majority underlying interests’ is not defined. Under ordinary legal concepts, where there is a discretionary trust deed, no beneficiary is entitled to income or capital of the trust until the trustee exercises its discretion to distribute income or to make an appointment of capital. As the beneficiary of a discretionary trust does not hold an interest in any asset of the trust or in the ordinary income derived from the asset until the trustee's discretion is exercised, it would not be possible for a discretionary trust to satisfy the continuing majority underlying interests test set out in subsection 149-30(1) of the ITAA 1997.

Taxation Ruling IT 2340 reflects on an approach of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936), which preceded Division 149 of the ITAA 1997.

Among other issues, the ruling deals with questions regarding the application of section 160ZZS of the ITAA 1936 ‘to assets held by trustees of family trusts where the trustees are vested with discretionary powers as to distributions from the trusts.

Under this approach the Commissioner can ‘look through’ an entity to determine the natural persons who hold beneficial interests in assets, as stated in paragraph 2.

The terms “underlying interest” and “majority underlying interests”, on the basis of which the provision operates, have the same meanings as they have in Subdivision G of Division 3 of Part III of the Act – which deals with the income tax treatment of interest in relation to “negatively geared” investments in rental property. In both cases (and like other provisions of the Act concerned with the measurement of ownership interests) underlying interests in relation to the assets concerned mean beneficial interests held by natural persons. The clear policy of the law thus permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be “looked through” in order to determine whether there has been a change in the effective interests of natural persons in the assets.

The ruling correctly reflects the position that section 160ZZS of the ITAA 1936, by its terms, necessarily supplants normal legal concepts of interests in assets. For the purposes of section 160ZZS, a beneficiary of a discretionary trust is treated as having a beneficial interest in the trust's assets.

The ruling at paragraph 5 states that it will be relevant to take into account the way in which the discretionary powers of the trustee are exercised when considering the question whether majority underlying interests have been maintained in the assets of the trust. IT 2340 continues:

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. That is consistent with the role of the section to close potential avenues for avoidance of tax in cases where there is a substantial change in underlying ownership of assets and the legislative guidance contained in Subdivision G of Division 3 of Part III of the Act. On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act....

In order to determine the underlying interests and majority underlying interests in the ownership of Unit Trust’s pre –CGT assets, the ownership of the Unit Trust needs to be examined. The unit holders of the Unit Trust are two discretionary trusts- S and EZ. Where the unit holders of the trust themselves are discretionary trusts, it is necessary to apply the ‘look- through’ approach through the chain of trusts and trace the natural persons with majority underlying interests in the pre-CGT asset.

A partial change of ownership occurred from one discretionary trust to another after 19 September 1985 that is; S acquired 9 units in the Unit Trust from EZ on xx December 2005. The issue is whether the majority underlying ownership has changed post transfer of the units.

For the purposes of subsection 149-15(2), at all times since the establishment of each of E and S family trusts, the family trusts have made distributions to the beneficiaries as specified in their respective trust deeds – that is the distributions have been made to the same combination of individuals – EZ and AZ and their daughter – M for EZ and RS, M and their children in case of S.

Hence the members of the EZ and S families at all times have held beneficial interests in the income and capital of their respective family trusts. Furthermore no new class of beneficiaries have been introduced since the establishment of those trusts.

The issue arises as to whether the proposed exercise of the discretionary powers of the trustees of the respective trusts to amend their trust deeds to incorporate the amended definitions of ‘income of the trust’, change of trustee and insertion of the capital gains/franked distribution streaming provisions, is in practical effect a change of 50% or more in the ultimate owners with majority underlying interests in the trust assets.

In this instance the Commissioner is satisfied that the changes occurring from the amending deed in November 1991 was a proper exercise of a power of amendment did not interrupt the continuity of the trusts as the distribution patterns confirm that the trustees of each of S and EZ continued to administer the trusts for the benefit of the S and EZ family groups respectively. The amendments solely addressed the administrative provisions of the trusts. To this end, the changes do not affect the majority underlying interests in the pre – CGT assets of the Unit Trust.

Accordingly, the Commissioner is satisfied that at all times the underlying interests in the Unit Trust have been held by the same ultimate owners, as those who had the majority underlying interests in the Property of the Unit Trust as at 19 September 1985.

The Property remains the pre-CGT asset of the Unit Trust for the purposes of Division 149.

Question 2

The gain arising from the sale of the Property by the Unit Trust will not be included in the assessable income of the Unit Trust in the financial year the Property is disposed of, provided that the requirements of subsection 149-30(2) are met and continue to be met until the disposal of the property.

Detailed reasoning

As the taxpayer is a trust, the 'net income' in relation to a trust estate is determined in accordance with subsection 95(1) of the ITAA 1936 and means:

… the total assessable income of the trust estate calculated under the Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions……

Assessable income consists of income according to ordinary concepts ('ordinary income') and other amounts which are included in assessable income under provisions of the ITAA 1936 or ITAA 1997 ('statutory income'). Statutory income includes net capital gains under section 102-5 of the ITAA 1997.

Statutory income is defined in subsection 6-10(2) of the ITAA 1997 as:

Amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income.

The Note 2 to subsection 6-10(2) of the ITAA 1997 provides a reference to section 10-5 of the ITAA 1997 which provides a summary list of statutory income provisions provided in the ITAA 1997 and the ITAA 1936. This list includes section 102-5 of the ITAA 1997 relating to capital gains which is the provision relevant to treatment of receipt from the sale the Property.

CGT events occurring under provisions contained in Division 104 of the ITAA 1997 (including section 104-10 of the ITAA 1997) give rise to assessable income under Division 102 of the ITAA 1997.

Section 104-10 of the ITAA 1997 contains CGT event A1 and provides that a CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997).

Paragraph 104-10(5)(a) of the ITAA 1997 however provides an exception to the application of section 104-10 of the ITAA 1997 to asset disposals where the asset was acquired before 20 September 1985. Assets acquired before this date are referred to as pre-CGT assets.

If the Property is sold this will give rise to CGT event A1. However as the Property was acquired prior to 20 September 1985, any gain/loss on disposal happening as a consequence of the proposed sale is disregarded pursuant to paragraph 104-10(5)(a) of the ITAA 1997 provided the land has not become a post-CGT asset just before the relevant CGT event.