Private ruling: Testamentary trust - fixed trust - non resident beneficiary
Published: February 2012
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Questions and answers | 1. Do the beneficiaries of the testamentary trust created from the rest and residue of the estate have fixed entitlements to all the income and capital of the trust as defined in section 995-1 of Income Tax Assessment Act 1997 (ITAA 1997) and subsection 272-5(1) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936)? | Yes. | 2. Is the non-resident beneficiary presently entitled to a share of all capital gains after the death of the deceased? | Yes. | 3. Is a capital gain that the foreign resident remainder beneficiary is presently entitled to, disregarded if the capital gain is made on an asset that is not taxable Australian property? | Yes.

Relevant facts and circumstances: The deceased passed away some time prior to 20 September 1985 leaving the rest and residue of their estate to their spouse and their child as life tenants. The spouse was entitled to 'up to one-half of the net income of the residuary estate….' with the balance to their child. The deceased's spouse passed away prior to 20 September 1985 after which the deceased's child was entitled to all of the net income of the trust. The will at a specific clause provides; SUBJECT to the beforementioned provisions in favour of my spouse and my child respectively TO PAY transfer and set over as well the capital as the income of my residuary estate to such of the children of my child as shall survive the survivor of my said child and me and who have attained or shall attain twenty-one years of age and if more than one in equal shares each share for his or her separate and individual use and benefit absolutely…. The deceased's grandchildren children - were alive at the time of the deceased's childs death and were all aged over twenty-one. One of the grandchildren is a non-resident of Australia and has a permanent residence overseas. The deceased child passed away some time after 20 September 1985 leaving their children presently entitled to equal shares in the income and corpus of the residual estate. In the 2011 income year the non- resident beneficiary may be presently entitled to a share of net capital gain on non-taxable Australian property.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subsection 272-5(1) of Schedule 2F, | Income Tax Assessment Act 1936 Subsection 272-5(2) of Schedule 2F, | Income Tax Assessment Act 1936 Section 272-65 of Schedule 2F, | Income Tax Assessment Act 1936 Subsection 95A(2), | Income Tax Assessment Act 1997 Section 995-1, | Income Tax Assessment Act 1997 Subsection 995-1(1) , | Income Tax Assessment Act 1997 Section 855-10 and | Income Tax Assessment Act 1997 Section 855-40.

Reasons for decision: Summary: 1. Do the beneficiaries of the testamentary trust created from the rest and residue of the estate have fixed entitlements to all the income and capital of the trust as defined in section 995-1 of Income Tax Assessment Act 1997 (ITAA 1997) and subsection 272-5(1) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936)? Summary The terms of the trust instrument do provide the beneficiaries with vested and indefeasible interests in the income and capital of the trust. Detailed reasoning Generally A 'fixed trust' is defined in similar terms in subsection 995-1(1) of the ITAA 1997 and section 272-65 of Schedule 2F to the ITAA 1936. The latter definition provides that: A trust is a fixed trust if persons have fixed entitlements to all of the income and capital of the trust. The definition of 'fixed entitlement' in subsection 995-1(1) of the ITAA 1997 provides: '…an entity has a fixed entitlement to a share of the income or capital of a trust if the entity has a fixed entitlement to that share within the meaning of Division 272 in Schedule 2F to the Income Tax Assessment Act 1936 .' Subsection 272-5(1) of Schedule 2F to the ITAA 1936 defines a fixed entitlement in a trust: If, under a trust instrument, a beneficiary has a vested and indefeasible interest in a share of income of the trust that the trust derives from time to time, or of the capital of the trust, the beneficiary has a fixed entitlement to that share of the income or capital. The word 'interest' is a word that is capable of many meanings. In the absence of a definition one must infer its meaning from the context in which it is found (see Gartside v Inland Revenue Commissioner [1968] AC 553 at 602-602 and 617-618 Commissioner of Stamp Duties (Queensland) v Livingston (1964) 112 CLR 12 at 28-29; and CPT Custodian Pty Ltd v Commissioner of State Revenue 2005 HCA 53). There may be circumstances in which the word 'interest' could be interpreted broadly to include any right or advantage that a person might be able to claim with respect to the income or capital of the trust and/or in respect of the trustee, whether present or future, ascertained or potential. In the context of Schedule 2F, however, it is clear that for an interest to be recognised as a fixed interest it must be a right with respect to a share of the income or of the capital of the trust that is susceptible to measurement. To adopt the words of Lord Wilberforce in Gartside v Inland Revenue the right must have 'the necessary quality of definable extent'. The term 'vested and indefeasible' is not defined in the taxation legislation and to date there is no precedential 'ATO view' which defines or clarifies the term. However the Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 does discuss its ordinary meaning at some length, at paragraphs 13.4 to 13.9. In Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16 Stone J stated at [97] that in the absence of a definition, and subject to qualification in subsection 272-5(2) of Schedule 2F, the term 'indefeasible' bears its ordinary meaning when applied to an interest, that is that 'the interest cannot be terminated, invalidated or annulled'. The meaning of the term 'vested and indefeasible' (in the context of Schedule 2F to the ITAA 1936) also appears in subsection 95A(2) of the ITAA 1936 and has been considered in that context by the courts - refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4525; Walsh Bay Developments Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4378; Dwight v Commissioner of Taxation (1992) 92 ATC 4192; Harmer v FC of T (1991) 173 CLR 264; 91 ATC 5000. Also relevant are MSP Nominees Pty Ltd v Commissioner of Stamps (SA) (1999) 198 CLR 494; 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54; Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490. It is an essential element of subsection 272-5(1) of Schedule 2F to the ITAA 1936 that in order to have a fixed entitlement to a share of income or capital there must be a vested or indefeasible interest "under a trust instrument". In all cases, the determining factor in deciding if fixed entitlements exist will be the terms of the trust instrument under which the trust is constituted. Neither the form of the trust nor the labels that are attached to it can determine this question. The first step in determining whether a beneficiary has a vested and indefeasible interest in a share of the income or capital of a trust is to ascertain the terms of the trust upon which the relevant trust property is held. As the High Court recently stated in CPT Custodians Pty Ltd v Commissioner of State Revenue (Vic); Commissioner of State Revenue (Vic) v Karingal 2 Holdings Pty Ltd (2005) 224 CLR 98 at [15], in taking this step: '… a priori assumptions as to the nature of unit trusts under the general law and principles of equity [will] not assist and would be apt to mislead. All depends, as Tamberlin and Hely JJ put it in Kent v SS "Maria Luisa" (No 2) , upon the terms of the particular trust.The term "unit trust" is the subject of much exegesis by commentators. However, "unit trust", like "discretionary trust", in the absence of an applicable statutory definition, does not have a constant, fixed normative meaning which dictate the application to particular facts of the [relevant statutory definition]…' There will be some circumstances in which a trust instrument must be read subject to the operation of a particular legal rule, whether by common law, statute or statutes. See, for example, the provisions of Chapter 5C of the Corporations Act 2001 which, if inconsistent with the constitution of a registered managed investment scheme, can have the effect of altering or modifying the scheme's constitution. It is possible for a constitution to be altered or modified by operation of law irrespective of whether the trust instrument itself expressly recognises the relevant common law rule or statute, and the entitlements of a beneficiary under the trust instrument are those as so altered or modified by operation of law. The important question is whether the vested and indefeasible interests represent 100% of the income and 100% of the capital of the trust. The fact that a power held by the trustee or manager has not yet been exercised is not relevant when determining if the power results in an interest being defeasible. The exercise of the power determines if an interest has in law been defeased, not if it is defeasible. The real question is whether the power, if exercised, would result in a defeasance of some or all of the unitholder's rights to the income and/or capital of the trust. Specifically For the purposes of subsection 272-5(1) of Schedule 2F to the ITAA 1936, the trust instrument consists of the will of the deceased. It is accepted that the will provides each of the three children of the deceased's child with a vested interest in the income and capital of the testamentary trust. At the time of the death of the deceased, the deceased estate/testamentary trust was a fixed trust as to income as their surviving spouse and child were entitled to all the income even though the actual share each could receive could be varied depending on the wishes of the deceased's spouse. On their death it continued to be fixed as to income. In neither case was there an entitlement to capital. On the death of the deceased's child their entitlement to income ceased and the entitlement of the deceased's grandchildren vested. It is clear that the grandchildren then had a fixed entitlement to the income and capital of the testamentary trust as there are no clauses in the will that authorises the trustee to do anything that would cause their entitlement to be defeased. A specific clause requires them to 'pay transfer and set over as well the capital as the income of my residuary estate…' taxable income the surviving children. Until their death that entitlement was merely contingent on them surviving at the time of her death. Their interest is both vested and indefeasible and the testamentary trust is a fixed trust for the purposes of subsection 272-5(1) of Schedule 2F of the ITAA 1936. 2. Is the non-resident beneficiary presently entitled to a share of all capital gains after the death of the deceased? The term 'present entitlement' is not defined in the ITAA 1936. It is therefore necessary to rely on the meaning which has been given to the term by the Courts. Present entitlement is discussed at length in the High Court cases Federal Commissioner of Taxation v. Whiting (1943) 68 CLR 199; 7 ATD 179 ( Whiting ) and Taylor Trust, Trustees of v. Federal Commissioner of Taxation (1970) 119 CLR 444; 70ATC 4026. The Courts in these cases held that in order for a beneficiary to be presently entitled to trust income, the following two conditions must be satisfied: § the beneficiary must have an indefeasible, absolutely vested, beneficial interest in possession in the trust income. That is, the interest must not be continent. This means that the beneficiary must have the right to demand immediate payment. § the income must be legally available for distribution to the beneficiary. In the case of a deceased estate, the beneficiaries will not be presently entitled to income until it is possible to ascertain the residue with certainty. Until the estate is fully administered the corpus and income of the residuary estate is the property of the executors and not of the residuary beneficiaries. In Whiting's case Latham CJ and William J said: "The words presently entitled to a share of income refer to a right of income 'presently' existing - i.e. a right of such a kind that a beneficiary may demand payment of the income from the trustee, or that, within the meaning of sec 19 of the Act, the trustee may property reinvest, accumulate, capitalise, carry to any reserve, sinking fund or insurance fund however designated or otherwise deal with it or as he directs on his behalf". Whiting's case is concerned with the situation of beneficiaries who had an interest in a deceased estate which had not been administered. Such beneficiaries had no right to demand payment of any part of the estate prior to the completion of the administration. Indeed the suggestion made in the passage just referred to that such beneficiaries have a 'vested right to income' of the estate prior to the completion of administration must be heavily qualified. Their honours then cite the decision of the High Court in Robertson V DFC of Land Tax (1941) 65 CLR 338 as authority for the proposition that "until an estate has been fully administered by payment or provision for the payment of funeral and testamentary expenses, death duties, debts, annuities, and legacies and the amount of the residue thereby ascertained, the income is that of the executors and not of the residuary beneficiaries". To overcome the harshness of situations such as that which arose in Whiting's case the judicial interpretation of presently entitled was extended by subsection 95A(2) of the ITAA 1936, which provides that where a beneficiary has a vested and indefeasible interest in income without present entitlement, present entitlement is deemed to exist. In your situation, the non resident beneficiary has a vested and indefeasible interest in the income and capital of the testamentary trust and is presently entitled to the capital gains made by the trust in proportion to their interest. 3. Is a capital gain that the foreign resident remainder beneficiary is presently entitled to, disregarded if the capital gain is made on an asset that is not taxable Australian property? Section 855-10 of the ITAA 1997 disregards any capital gains that are made by a non-resident of Australia unless the capital gains tax (CGT) event relates to a CGT asset that is taxable Australian property. Section 855-40 of the ITAA 1997 disregards any capital gain made in respect of a non-resident's interest in a fixed trust unless the CGT event relates to a CGT asset held by the fixed trust that is taxable Australian property. Accordingly, any capital gain, that arises as a result of a CGT event happening to non taxable Australian property, which was distributed to the non resident beneficiary, will be disregarded by both the beneficiary and the trust.

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