ATO ID 2006/34: Capital Gains Tax: main residence exemption - testamentary trust - CGT event brought about by individual to whom ownership interest passed
Date of decision: 6 February 2006
Year of income: Year ended 30 June 2006
Business line: Private Groups and High Wealth Individuals

Issue
Can a capital gain or capital loss made by a testamentary trust on the transfer of an interest in a dwelling by the trustee to an individual beneficiary be disregarded under item 2(c) in the table in subsection 118-195(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. Item 2(c) in the table in subsection 118-195(1) of the ITAA 1997 can apply only if a relevant CGT event happens to an individual beneficiary to whom an ownership interest in a dwelling has passed.

Facts
A taxpayer acquired a dwelling before 20 September 1985 which was their main residence throughout the period they owned it. The taxpayer died in the 1998-99 income year. Under the taxpayer's will, the dwelling was to be held on trust for five individuals. The individuals were not the deceased's spouse nor were they granted a right to occupy the dwelling under the will. Immediately after the deceased died, one of the beneficiaries (with the consent of the other beneficiaries) started to occupy the dwelling as their main residence. In the 2005-06 income year, the beneficiaries and the trustee agreed to transfer ownership of the dwelling to the beneficiary who had been residing there. In order to achieve this, the trustee transferred a 1/5th interest in the dwelling directly to that beneficiary consistent with their entitlement in the trust. The trustee sold the remaining 4/5th interest to that same beneficiary in accordance with the trustee's power of sale.

Reasons for decision
Summary: CGT event A1 in section 104-10 of the ITAA 1997 happened when the trustee of the testamentary trust disposed of the 4/5th interest in the dwelling to the beneficiary under the trustee's power of sale. The capital gain from this CGT event happening is not disregarded under Division 128 of the ITAA 1997 as this interest in the dwelling did not pass to the beneficiary under the deceased's will in the ways set out in section 128-20 of the ITAA 1997. Subsection 128-20(2) of the ITAA 1997 provides that an asset does not pass to a beneficiary in your estate if it is transferred to them under a power of sale. Section 118-195 of the ITAA 1997 sets out the circumstances in which a full main residence exemption is available to an individual beneficiary or a trustee of a deceased estate. To determine if the trustee's capital gain qualifies for the exemption in section 118-195, both the meaning of 'trustee of a deceased estate' and the requirements set out in item 2(c) of the table in subsection 118-195(1) of the ITAA 1997 must be considered. | Detailed Reasoning - Meaning of 'trustee of a deceased estate': The words 'trustee of a deceased estate' as used in section 118-195 of the ITAA 1997 are not limited to a legal personal representative but include the trustee of a testamentary trust. This view is supported by comments made in the Explanatory Memorandum to the Taxation Laws Amendment Bill 1990 which introduced changes to section 160ZZQ of the Income Tax Assessment Act 1936 (ITAA 1936) to provide an exemption for the period a dwelling was occupied by an individual under the terms of the deceased's will. The Explanatory Memorandum provided: The amendments are being made to allow the sole or principal residence exemption to apply to the dwelling of a deceased person for any period since the date of the deceased person's death during which the dwelling had been the sole or principal residence of the spouse of the deceased person or of a person who had the right to occupy the dwelling (life tenant) under the terms of the deceased person's will. At present no account is taken of the time during which a dwelling owned by a trustee of a deceased person's estate was the sole or principal residence of a life tenant. As a life tenancy would only arise after administration of an estate has been completed, the phrase 'trustee of a deceased estate' in section 118-195 of the ITAA 1997 must be interpreted as including the trustee of a testamentary trust to give effect to the intended policy. | Detailed Reasoning - Main residence requirements in the table in subsection 118-195(1) of the ITAA 1997: Item 2 in the table insubsection 118-195(1)of the ITAA 1997 provides that where the deceased owned the interest before 20 September 1985 an exemption is available if the dwelling was from the deceased's death until the ownership interest ends, the main residence of one or more of: Item 1 - the ownership interest ends within two years of the deceased's death, or within a longer period allowed by the Commissioner, or within a longer period allowed by the Commissioner, or Item 2 - the dwelling was from the deceased's death until the ownership interest ends, the main residence of one or more of: (a) the spouse of the deceased immediately before the death (except a spouse who was living permanently separately and apart from the deceased); or (b) an individual who had a right to occupy the dwelling under the deceased's will; or (c) if the CGT event was brought about by the individual to whom the ownership interest passed as a beneficiary - that individual. For item 2(b) purposes, 'under the deceased's will' is limited to circumstances where a right to occupy has been expressly granted under the terms of the will to an individual specifically named in the will. The phrase 'under the deceased will' does not extend to a right under a testamentary trust (or any other separate agreements) because the deceased's will is separate and distinct from a testamentary trust. In this case, the issue is the proper construction of item 2(c). In rewriting the former section 160ZZQ of the ITAA 1936, section 118-195 of the ITAA 1997 combined exemptions for beneficiaries and trustees that had previously been dealt with in separate provisions. In particular, section 118-195 of the ITAA 1997 rewrote subsection 160ZZQ(15) and introduced item 2 (c) in the table. No exemption previously existed for a trustee in respect of a period that the dwelling was the sole or principal residence of a beneficiary. It is clear from the wording of the legislation that the changes were only intended to determine the beneficiary's eligibility for the main residence exemption. In this context and having regard to section 1-3 of the ITAA 1997, item 2(c) in the table in subsection 118-195(1) of the ITAA 1997 only applies to a CGT event which happens to an individual to whom the ownership interest 'passed' as a beneficiary, within the meaning of section 128-20 of the ITAA 1997. For example, if the beneficiary brings about the sale of the interest in the dwelling which has passed to them. A trustee would have no need to apply item 2(c) to a capital gain or loss that arises in respect of an ownership interest which passes to a beneficiary because it would be disregarded under Division 128 of the ITAA 1997, irrespective of who occupied the dwelling as their main residence from the date of the deceased's death. In any case,item 2(c) cannot apply to a trust capital gain, where the relevant ownership interest (the 4/5th interest) did not 'pass' to the individual as a beneficiary, but as a purchaser (see 128-20(2) of the ITAA 1997). The transfer of this interest was also not 'brought about' by that individual, but rather by the trustee and the other beneficiaries by agreement. For all these reasons, the capital gain made by the trustee on the sale of the 4/5th interest in the dwelling to the beneficiary is not disregarded.

Legislative references: Income Tax Assessment Act 1936 section 160ZZQ subsection 160ZZQ(15)
Other references: Explanatory Memorandum to the Taxation Laws Amendment Bill 1990 Draft Taxation Determination TD 2026/D1 Income tax: deceased estates  meaning of 'right to occupy the dwelling under the deceased's will' in item 2(b) of column 3 of the table in subsection 118-195(1) of the Income Tax Assessment Act 1997
Subject references: Capital gains tax CGT deceased estates CGT events CGT main residence exemption Wills