Private ruling: Capital gains tax-vesting of a trust
Date of advice: 15 July 2016
Published: August 2016
Ruling period: Year ended 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: 1 July 2015

Ruling: Q1: Can the non-resident beneficiary disregard their share of the trust capital gain under section 855-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No

Relevant facts and circumstances: The Trust was created by Deed. A company is the Trustee of the trust. The company Trustee is an Australian resident for income tax purposes. The Trust is a 'resident trust estate' as defined in paragraph 95(2)(a) of the Income Tax Assessment Act 1936 (ITAA 1936). The Trust is a discretionary trust and it is not a unit trust. Division 128 of the ITAA 1997 does not apply to the Trust. There are a number of directors of the, Trustee company. One director (X) of the trustee company is a non-resident. The X owns 100% of the shares held in the trustee company. The applicant has provided a copy of a Trust Deed. Under the Trust Deed X controls the Trust and X has the power to replace the Trustee. By the terms of the Trust Deed, X is: • the appointor (clause 19.1); • the primary beneficiary of the trust (clause 1.1); • the default beneficiary as to income and capital of the trust (clause 3.3). The Trustee has vesting powers under the Trust Deed (clause 1.1). The Trustee proposes to vest the Trust in accordance with the terms of the Deed. Upon vesting of the trust the CGT assets of the Trust will be distributed by the Trustee in specie to X in accordance with the terms of the Trust. Subject to resolutions of the Trustee to facilitate the distribution of the trust assets: • X will become absolutely entitled to all of the CGT assets • The Trust will generate an assessable capital gain; • The Trustee will resolve that X is specifically entitled to the entire capital gain based on section 115-228 of the ITAA 1997; and • The Trustee will resolve that X is presently entitled to all of the income of the trust. X is a non-resident of Australia for tax purposes All the CGT assets held by the Trust are not taxable Australian property for the purposes of section 855-15 of the ITAA 1997. X is the principal lender of funds to the Trust which provided the Trust with the capacity to acquire Trust assets.

Relevant legislative provisions: Income Tax assessment Act 1936 Subsection 95(1) | Income Tax assessment Act 1936 Section 95AAA | Income Tax assessment Act 1936 Section 95AAB | Income Tax assessment Act 1936 Section 97 | Income Tax assessment Act 1936 Section 98 | Income Tax assessment Act 1936 Subsection 98(3) | Income Tax assessment Act 1936 Subsection 98A(1) | Income Tax assessment Act 1936 Subsection 98A(2) | Income Tax assessment Act 1936 Section 99 | Income Tax assessment Act 1936 Section 99A | Income Tax assessment Act 1936 Section 102 | Income Tax assessment Act 1936 Subsection 102-5(1) | Income Tax assessment Act 1936 Section 102UX | Income Tax Assessment Act 1997 Subsection 102-25(1) | Income Tax Assessment Act 1997 Subsection 104-10(1) | Income Tax Assessment Act 1997 Section 104-75 | Income Tax Assessment Act 1997 Subsection 104-75(1) | Income Tax Assessment Act 1997 Subsection 104-75(2) | Income Tax Assessment Act 1997 Subsection 104-75(3) | Income Tax Assessment Act 1997 Subsection 104-75(5) | Income Tax Assessment Act 1997 Paragraph 104-75(6)(a) | Income Tax Assessment Act 1997 Section 115-215 | Income Tax Assessment Act 1997 Subsection 115-215(3) | Income Tax Assessment Act 1997 Subsection 115-215(4A) | Income Tax assessment Act 1936 Section 115-220 | Income Tax assessment Act 1936 Section 115-225 | Income Tax assessment Act 1936 Subsection 115- 225(1) | Income Tax assessment Act 1936 Section 115-227 | Income Tax Assessment Act 1997 Section 115-228 | Income Tax Assessment Act 1997 Section 855-10 | Income Tax Assessment Act 1997 Section 855-15 | Income Tax Assessment Act 1997 Subsection 855-10(1) | Income Tax Assessment Act 1997 Section 855-40 | Income Tax assessment Act 1936 Section 960-100 | Income Tax assessment Act 1936 Subsection 960-100(1) | Income Tax assessment Act 1936 Subsection 960-100(2) | Income Tax assessment Act 1936 Subsection 960-100(3)

Reasons for decision: Detailed Reasoning - CGT event E5: CGT event E5 in section 104-75 of the ITAA 1997 happens when a beneficiary of a trust becomes absolutely entitled to a CGT asset of the trust as against the trustee (disregarding any legal disability the beneficiary is under). There is an exception to CGT event E5, that is, if the trust is a unit trust or it is a trust to which Division 128 applies (refer to subsection 104-75(1) of the ITAA 1997). The timing of the event is when the beneficiary becomes absolutely entitled to the asset - subsection 104-75(2) of the ITAA 1997. The trustee makes a capital gain if the market value of the asset (at the time of the event) is more than its cost base. The trustee makes a capital loss if that market value is less than the asset's reduced cost base - subsection 104-75(3) of the ITAA 1997. The beneficiary may also make a capital gain or capital loss from the event subject to certain exceptions - subsections 104-75(5) and 104-75(6) of the ITAA 1997. In this case, the Trust is not a unit trust and it is not a deceased estate. Therefore the exceptions in CGT event E5 do not apply. The circumstances in which a beneficiary of a trust is considered to be absolutely entitled to an asset of the trust for the purpose of the CGT provisions are set out in Draft Taxation Ruling TR 2004/D25. It says the core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary who has a vested and indefeasible interest in the entire trust asset to call for the asset to be transferred to them or to be transferred at their direction (paragraph 10). TR 2004/D25 says the requirements for absolute entitlement can only be satisfied by a single beneficiary in respect of a single trust asset. In the circumstances of this case, the requirements for absolute entitlement will be satisfied when the Trustee appropriates 100% share of each trust asset for the absolute benefit of X. That is, when the Trustee resolves to distribute in specie all CGT assets of the Trust to X at vesting day. Therefore, CGT event E5 happens when the Trustee resolves to distribute in specie the assets of the Trust to X on vesting day. The requirements for absolute entitlement will not be satisfied prior to the Trustee's resolution to distribute in specie the assets of the Trust to X for his absolute benefit. The exception for the beneficiary in paragraph 104-75(6)(a) of the ITAA 1997 will apply and any capital gain or capital loss the beneficiary makes from CGT event E5 is disregarded. As confirmed by your tax agent, it's expected the Trust would make a capital gain from CGT event E5. The Trustee wishes to apply section 115-228 of the ITAA 1997 and make X (non-resident beneficiary) specifically entitled to 100% share of the Trust's capital gain from CGT event E5. The issue then is whether the non-resident beneficiary can disregard that share of the Trust's capital gain under section 855-10 of the ITAA 1997. | Detailed Reasoning - Division 6 and Division 6E of Part III of the ITAA 1936 and Subdivision 115-C of the ITAA 1997: Section 95AAA of the Income Tax Assessment Act (ITAA 1936) provides the simplified outline of the relationship between Divisions 6 and 6E of the ITAA 1936 and Subdivision 115-C of the ITAA 1997. Divisions 6 and 6E of the ITAA 1936 Division 6 of the ITAA 1936 sets out the basic income tax treatment of the net income of the trust estate. Generally: • it has the result of assessing beneficiaries on a share of the net income of the trust estate based on their present entitlement to a share of the income of the trust estate; and • it has the result of assessing the trustee directly on any residual net income; and • as a collection mechanism, it has the result of assessing the trustee in respect of some beneficiaries, such as non-residents or those under a legal disability. If the trust estate has capital gains, this basic treatment is modified by Division 6E of the ITAA 1936 for the purposes of excluding amounts relevant to capital gains from the calculations of assessable amounts under sections 97, 98, 99, 99A and 100 of the ITAA 1936. Subdivision 115-C of the ITAA 1997 provides the corresponding taxation treatment for those capital gains. In this case, Division 6E will apply to exclude any capital gain made by the Trustee of the Trust as a result of CGT event E5 happening from the modified net income of the Trust to the extent that it otherwise forms part of the net capital gain of the Trust calculated under subsection 102-5(1) of the ITAA 1997 and the Trust has a positive net income. This ensures the capital gain will not be taken into account in working out the amount assessed to the beneficiary under section 97 or 98A of the ITAA 1936. The capital gain will instead be dealt with under the rules in Subdivision 115-C of the ITAA 1997. Where Division 6E of the ITAA 1936 applies, the amount assessed to a beneficiary (or to the trustee) is worked out under Division 6 of the ITAA 1936 on the assumption that the trust had no capital gains remaining after relevant reductions - section 102UX of the ITAA 1936. That is, the core concepts of trust income, the amount of that income to which a beneficiary is presently entitled and trust net income are worked out ignoring the trust's capital gains. Subdivision 115-C of the ITAA 1997 The rules in Subdivision 115-C will apply to treat the beneficiary as having made a capital gain to the extent the capital gain otherwise forms part the Trust's net capital gain calculated under subsection 102-5(1) of the ITAA 1997 and the Trust has a positive net income, grossed up for any relevant CGT discount applied by the Trust at step three of the method statement in subsection 102-5(1) of the ITAA 1997 and for any of the small business CGT concessions applied by the Trust at step four of the method statement in subsection 102-5(1) of the ITAA 1997. The beneficiary will then be entitled to apply any relevant discounts and concessions as are available to them to the capital gain they are taken to have made. The manner in which Subdivision 115-C of the ITAA 1997 allocates a trust capital gain depends on whether, and the extent to which, a beneficiary is 'specifically entitled' to that capital gain. In this case, subject to the Trustee's resolution, the non-resident beneficiary will be made specifically entitled (for the purposes of section 115-228 of the ITAA 1997) to the entire amount of capital gain made by the Trustee from CGT event E5. That amount will be the beneficiary's share of the capital gain under section 115-227 of the ITAA 1997. The beneficiary is not simply treated as then having made their share of the capital gain for the purpose of working out their own net capital gain or loss. The way in which the Trustee has worked out its own net capital gain affects the way in which the beneficiary calculates their capital gain. Firstly, the rules in section 115-225 of the ITAA 1997 are applied to work out that part of the trust capital gain remaining after the Trustee has applied any capital losses or net capital losses to the capital gain and after applying any CGT discounts - subsection 115-225(1) of the ITAA 1997. That means, if the Trustee has applied its own capital losses or net capital losses in working out its net capital gain, this will be reflected in (and will reduce) the capital gain the beneficiary is taken to have made. The result obtained following the application of section 115-225 of the ITAA 1997 is then doubled if the Trustee applied the 50% CGT discount in working out its own net capital gain: subsection 115-215(3) of the ITAA 1997. That is the amount treated as a capital gain of the beneficiary which is then taken into account (along with the beneficiary's other capital gains and losses) in working out the beneficiary's net capital gain or loss under section 102-5 of the ITAA 1997. In doing so, the beneficiary can apply their own capital losses and net capital losses and any relevant CGT discount. It is noted that the CGT discount for foreign residents was removed by Tax Laws Amendment (2013 Measures No.2) Act 2013 with effect from the day it received Royal Assent on 29 June 2013. | Detailed Reasoning - Division 855 of the ITAA 1997: Section 855-10 of the ITAA 1997 provides that a person who is a foreign resident can disregard a capital gain or capital loss from a CGT event if the CGT event happens in relation to a CGT asset that is not a taxable Australian property as the term defined by section 855-15 of the ITAA 1997. In this case, your tax agent has confirmed that the CGT assets held by the Trust are not taxable Australian property for the purposes of section 855-15 of the ITAA 1997. Hence the second condition in subsection 855-10(1) of the ITAA 1997 is satisfied. An issue arises as to whether the 'capital gains' made by the foreign resident beneficiary because of the operation of section 115-215 of the ITAA 1997 can be disregarded under section 855-10 of the ITAA 1997. As explained above, where a trust's net income includes a net capital gain, subsection 115-215(3) of the ITAA 1997 treats relevant beneficiaries as having extra capital gains (that is, in addition to those that the beneficiary has made directly) which are included in the calculation of their net capital gain under section 102-5 of the ITAA 1997. Subsection 115-215(4A) of the ITAA 1997 makes it clear that the beneficiary is taken to have made these capital gains even though no CGT event has happened in respect of the beneficiary. A capital gain that a non-resident beneficiary of a trust makes because of the operation of subsection 115-215(3) of the ITAA 1997 is not a capital gain from a CGT event that happens to that person - subsection 855-10(1) of the ITAA 1997. In this case, the 'capital gains' and the 'extra capital gains' that X is taken to have made as a foreign resident beneficiary of the Trust is not from the happening of a CGT event. Rather the 'capital gains' arise from the operation of section 115-215 of the ITAA 1997. As such the requirements of subsection 855-10(1) of the ITAA 1997 are not sufficiently satisfied. Therefore, X in their capacity as non-resident beneficiary of the Trust who by the Trustee's resolution will be made specifically entitled to the entire trust capital gain is not eligible for the CGT exemption in Division 855 of the ITAA 1997. Accordingly, X cannot disregard his 100% share of the Trust capital gain under section 855-10 of the ITAA 1997. | Detailed Reasoning - The 2011 amendments: The amendments made by Tax Laws Amendment (2011 Measures No.5) Act 2011 ensure that in appropriate circumstances, a trustee will continue to be assessed and liable to pay tax under section 98 of the ITAA 1936 in respect of amounts now dealt with under the rules in Subdivision 115-C of the ITAA 1997. Where a beneficiary who is treated under Subdivision 115-C of the ITAA 1997 as having an 'extra capital gain' is a non-resident at the end of the income year in which the capital gain was made by the trustee, the trustee may be assessed under subsection 98(3) of the ITAA 1936 on all or some part of the beneficiary's extra capital gain - despite the rules in Division 6Eof the ITAA 1936. This outcome arises by operation of section 115-220 of the ITAA 1997. If section 115-220 of the ITAA 1997 applies to assess the trustee under section 98 of the ITAA 1936 in respect of a trust capital gain, then the amount of the capital gain assessed to the trustee is the beneficiary's attributable gain worked out under section 115-225 of the ITAA 1997 with reference to section 115-227 of the ITAA 1997. This is, broadly, so much of the capital gain to which the beneficiary was specifically entitled as remains following application of the trustee's capital losses and relevant CGT discounts and CGT concessions. It is the gain the beneficiary is taken to have made before it is doubled or grossed up by the beneficiary as required under subsection 115-215(3) of the ITAA 1997. Consequently, in respect of the capital gain made by the Trustee from CGT event E5: • The Trustee may be assessed and liable to pay tax under subsection 98(3) of the ITAA 1936; • The beneficiary may be taken to have an 'extra capital gain' under Subdivision 115-C of the ITAA 1997 which the beneficiary must take into account in working out their own net capital gain or loss under section 102-5 of the ITAA 1997. As such both the Trustee and the beneficiary may have a liability to tax. In those circumstances, each is separately and independently liable. However, the income tax assessed to the beneficiary is effectively reduced by any tax paid by the Trustee. If the tax paid by the Trustee exceeds the tax assessed to the beneficiary, then the Commissioner shall pay that excess to the beneficiary: subsection 98A(2) of the ITAA 1936. While the application of Division 6E of the ITAA 1936 means the beneficiary will not have been assessed under subsection 98A(1) of the ITAA 1936, which would normally have been the trigger for a subsection 98A(2) of the ITAA 1997 credit, section 95AAB of the ITAA 1936 ensures that the amount included in the Beneficiary's assessable income because of Subdivision 115-C of the ITAA 1997 is deemed to be included in their assessable income under subsection 98A(1) of the ITAA 1936 for the purpose of the credit provision in subsection 98A(2) of the ITAA 1997. | Detailed Reasoning - Conclusion: The non-resident beneficiary of the Trust will not be eligible for the CGT exemption in Division 855 of the ITAA 1997. Therefore, the non-resident beneficiary cannot disregard their share of the trust capital gain under section 855-10 of the ITAA 1997.