Private ruling: Capital gains - Trust distribution
Published: July 2012
Ruling period: 1 July 2011 to 30 June 2012 | 1 July 2012 to 30 June 2013 | 1 July 2013 to 30 June 2014 | 1 July 2014 to 30 June 2015 | 1 July 2015 to 30 June 2016 | 1 July 2016 to 30 June 2017
Date scheme commenced: 1 July 2011

Ruling: Q1: Will the distribution you receive from the Trust be assessable to you as a net capital gain? | A1: Yes

Relevant facts and circumstances: You are one of the founding shareholders in your employer company. After the company was established the founding shareholders had the option of acquiring all the shares then held by another shareholder. If this option had been accepted the founding shareholders would hold all the shares in the employer company. Instead the Trust was established to acquire some of these shares, and the remainder were acquired by selected senior employees of the employer. The trustee of the Trust is a wholly owned subsidiary of the employer. An Incentive Option Plan was established, under which selected senior management were granted options to acquire shares held by the Trust in the employer. The shares vested in the senior manager on satisfaction of predetermined milestones being achieved. The Trust currently has a number of shares which have either never been allocated to any employees or were previously allocated and subsequently bought back by the Trust following the resignation or retirement of the employee. The Incentive Option Plan is no longer meeting the needs of the group's stakeholders, and it is considered to be more appropriate for selected senior managers to acquire shares directly in the employer at market value Therefore, the Trust is proposing to sell its current shareholding of shares in the employer to selected senior managers at market value. These sales are expected to occur over the next three to four years. Following this, the trustee is considering winding up the trust. In accordance with the trust deed, the Trust will distribute a portion of the net income - the capital gains from the sale of the shares - to you.

Relevant legislative provisions: Income Tax Assessment Act 1936 - section 97 | Income Tax Assessment Act 1936 - Division 6E | Income Tax Assessment Act 1997 - subsection 6-5(1) | Income Tax Assessment Act 1997 - Subdivision 115-C | Income Tax Assessment Act 1997 - section 115-100 | Income Tax Assessment Act 1997 - section 115-215 | Income Tax Assessment Act 1997 - section 108-5 | Income Tax Assessment Act 1997 - section 104-10 | Income Tax Assessment Act 1997 - section 115-227 | Income Tax Assessment Act 1997 - Subdivision 115-A | Income Tax Assessment Act 1997 - section 115-228 | Income Tax Assessment Act 1997 - Division 116 | Income Tax Assessment Act 1997 - section 974-160

Reasons for decision: Summary: The distribution to you of a net capital gain from the Trust will be assessable to you in accordance with the provisions contained within Subdivision 115-C of the ITAA 1997. Provided that the Trust has held the shares in the employer for a period in excess of 12 months, you will be eligible for the 50% CGT discount in accordance with section 115-100 and 115-215 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: A capital gain or a capital loss may be made if a CGT event happens to a CGT asset. Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) defines a CGT asset to be any kind or property, or a legal or equitable right that is not property. Shares in a company are CGT assets. Under section 104-10 of the ITAA 1997 a CGT event A1 will occur on the disposal of a CGT asset. The time of the event is when the contract for the disposal of the asset is entered into, or if there is no contract when the change of ownership occurs. | Detailed Reasoning - Assessing trust income: Where a beneficiary of a trust estate is presently entitled to a share of the income of the trust estate, and is not under a legal disability, the beneficiary's share of the net income of the trust estate will be included in their assessable income under subsection 97(1) of the ITAA 1936. However, where the net income of the trust estate exceeds nil and includes a capital gain, Division 6E of the ITAA 1936 will apply. The result of the operation of this Division is that the amount of the assessable income included in a beneficiary's assessable income under subsection 97(1) of the ITAA 1936 is reduced by the amount of the beneficiary's share of the trust's capital gain. The beneficiary's share of the trust's net capital gain is assessed in accordance with Subdivision 115-C of the ITAA 1997. Section 115-227 of the ITAA 1997 states: An entity that is a beneficiary or the trustee of a trust estate has a share of a *capital gain that is the sum of: · the amount of the capital gain to which the entity is *specifically entitled; and · if there is an amount of the capital gain to which no beneficiary of the trust estate is specifically entitled, and to which the trustee is not specifically entitled - that amount multiplied by the entity's *adjusted Division 6 percentage of the income of the trust estate for the relevant income year. If permitted by the trust deed, section 115-228 of the ITAA 1997 sets out the requirements for streaming a capital gain to a particular beneficiary. For streaming to be effective for tax purposes, the beneficiary must be specifically entitled to all or part of the capital gain. Applying the formula in subsection 115-228(1) of the ITAA 1997, to be specifically entitled to an amount of a capital gain made by the trust estate, a beneficiary must identify their relevant 'share of the net financial benefit'. This is defined to mean the amount equal to the financial benefit (as defined in section 974-160 of the ITAA 1997) that, in accordance with the terms of the trust, including in accordance with the exercise of a power conferred by the terms of the trust: · the beneficiary has received or can be reasonably expected to receive (paragraph (a) of the definition); · is referable to the capital gain (paragraph (b) of the definition); and · is recorded in its character as an amount referable to the capital gain in the accounts or records of the trust within 2 months after the end of the income year (paragraph (c) of the definition). A beneficiary's entitlement can be expressed as a dollar amount, a share of the trust gain, such as 25% of the trust capital gain realised on the sale of asset X, or using a known formula provided it refers to the capital gain. The record of a beneficiary's specific entitlement must be contained in the accounts or records of the trust, such as the trust deed, trust accounts, resolutions and distribution statements, including schedules and notes attached to, or intended to be read with, these documents. A record for tax purposes only does not create specific entitlement. A resolution to distribute a specified amount of trust income, a percentage of the trust income or the balance of the trust income does not create a specific entitlement if there is no reference to a capital gain. However, if the capital gain is clearly referred to in another document, such as the trust accounts, the recording requirement may be satisfied. When a beneficiary is specifically entitled to a capital gain, the beneficiary is assessed on the capital gain, with all the associated tax consequences in respect of that distribution applying. Capital gains to which no beneficiary is specifically entitled flow proportionally to beneficiaries and/or the trustee based on their proportional share of the income of the trust estate. Accordingly, a specifically-entitled beneficiary will not be assessed on any share of the trust's net income over and above the amount of the specific entitlement unless they have a present entitlement to other income of the trust. | Detailed Reasoning - Application to your circumstances: The shares in the employer that the Trust owns are CGT assets. Therefore CGT event A1 occurs when the Trust disposes of these shares to senior managers. The Trust will make a capital gain if the proceeds received from the sale of the shares exceeds the total costs associated with the event. Note - because the Trust will be selling the shares to senior managers, if they are sold for an amount below market value, the market value substitution rules in Division 116 will apply. The Trust deed allows the trustee to distribute any income of the Trust to one or more beneficiaries of the Trust at its discretion. As you are an employee of the employer, you are a beneficiary of the Trust. Therefore your share of any capital gain made by the Trust on the sale of the shares will be assessable to you in accordance with the rules contained in Subdivision 115-C of the ITAA 1997. | Detailed Reasoning - Discount capital gain: Under Subdivision 115-A of the ITTA 1997, a capital gain made by a trust from CGT event A1 is a discount capital gain provided that the asset being disposed of was held by the Trust for more than 12 months. | Detailed Reasoning - Is the capital gain assessable under any other provisions?: Subsection 6-5(1) of the ITAA 1997 states that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). Amounts paid in substitution for salary or wages foregone or lost may be ordinary income (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540 at 568; (1952) 10 ATD 82 at 92; (1952) 5 AITR 443 at 456 (per Fullagar J)). Although, in accordance with the trust deed, you are a beneficiary of the Trust because you are an employee of the employer, it is not considered that any distribution that the trustee may make to you following the sale of shares is paid in substitution for salary or wages foregone or lost and will not have the character of ordinary income in your hands.

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