Private ruling: Treatment of trust distributions relating to capital gains offset by capital losses
Published: April 2014
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Will the amount of non-assessable part, referred to in section 104-70 of the ITAA 1997, exclude the portion of the payment related to a capital gain to which capital losses or carried forward capital losses have been applied under item 7 of subsection 104-71(4) of the ITAA 1997? | A1: Yes, to the extent that these amounts are reflected in the payment made to the beneficiary

Relevant facts and circumstances: Background facts • The trust is an unregistered managed investment scheme domiciled in Australia. • The trust is a fixed unit trust. • The trust has a default 30 June fiscal year end. • The trust invests in equities, derivatives, unlisted unit trusts, cash and cash equivalents in accordance with the provisions of the trust deed. • The unit holders of the trust are predominantly Australian resident individuals, complying superannuation funds, Australian companies and Australian trusts. • The trust is a managed investment trust and has made the election under section 275-115 fir deemed capital account treatment in respect of covered assets (as defined in section 275-105). • Under the trust deed, unit holders are presently entitled to all of the distributable income of the trust. • For the purpose of this ruling request, it should be assumed that the unit holders in the trust hold their units on capital account.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 102-5(1) | Income Tax Assessment Act 1997 Section 104-70 | Income Tax Assessment Act 1997 Subsection 104-70(1) | Income Tax Assessment Act 1997 Subsection 104-70(4) | Income Tax Assessment Act 1997 Subsection 104-70(5) | Income Tax Assessment Act 1997 Subsection 104-70(6) | Income Tax Assessment Act 1997 Section 104-71 | Income Tax Assessment Act 1997 Subsection 104-71(1) | Income Tax Assessment Act 1997 Subsection 104-71(3) | Income Tax Assessment Act 1997 Subsection 104-71(4) | Income Tax Assessment Act 1997 Subsection 115-215(3) | Income Tax Assessment Act 1997 Subdivision 152-C | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Detailed Reasoning - CGT event E4: According to subsection 104-70(1) of the ITAA 1997, CGT event E4 happens if: (a) the trustee of a trust makes a payment to a taxpayer in respect of the taxpayer's unit or interest in the trust (except for CGT event A1, C2, E1, E2, E6 or E7 happening in relation to it), and (b) some or all of the payment (the non-assessable part) is not included in the taxpayer's assessable income. The non-assessable part that is mentioned in paragraph 104-70(1) of the ITAA 1997 is adjusted by subsection 104-71. The purpose behind such adjustment is that certain concessionally-treated amounts are excluded when working out the "non-assessable part" of the payment for the purposes of section 104-70 of the ITAA 1997. This ensures that CGT event E4 does not clawback tax concessions that are intended to flow through a trust to the ultimate beneficiary or unit holder. Note 1 to subsection 104-70(1) of the ITAA 1997 categorises the excluded amounts as: • tax exempted amount (listed in subsection 104-71(1) of the ITAA 1997) • tax-free amount (listed in subsection 104-71(3) of the ITAA 1997), and • CGT concession amounts (listed in subsection 104-71(4) of the ITAA 1997) Exclusion of the above amounts from the non-assessable part is favourable to the taxpayer as the non-assessable part reduces the cost base of the taxpayer's units or interest in the trust and/or results in a capital gain. Tax deferred amounts are other non-assessable amounts (including indexation received by the entity on its capital gains and, accounting differences in income). These amounts are not included in a unit holder's income or capital gain, but affect the cost base and reduced cost base of their unit or interest in the trust for future income years. Subsection 104-70(4) of the ITAA 1997 provides that a unit holder makes a capital gain from CGT event E4 if the sum of the non-assessable parts of the payment made by the trustee in respect of the unit or interest in the trust exceeds the cost base of the unit or interest in the trust. Subsection 104-70(5) of the ITAA 1997 states that if you make a capital gain, the cost base and reduced cost base of the unit or interest in the trust is reduced to nil. However, if the sum is less than the cost base, the cost base and reduced cost base are reduced by that sum (subsection 104-70(6) of the ITAA 1997). | Detailed Reasoning - Table item 7 of subsection 104-71(4) of the ITAA 1997: Table item 7 of subsection 104-71(4) of the ITAA 1997 applies to an entity to whom payment has been made by a trust who has a capital loss or net capital loss to reduce its capital gain described in subsection 115-215(3) of the ITAA 1997. This can also apply when the payment is made by another trust that is part of the same chain of trusts. The amount that is excluded from the non-assessable part in this situation is the proportion of the capital losses or net capital loss reflected in the payment. Item 7 of the table in subsection 104-71(4) of the ITAA 1997 refers specifically to the capital gain in subsection 115-215(3) of the ITAA 1997. Subsection 115-215(3) of the ITAA 1997 determines the capital gain of a trust (trust gain) received by a beneficiary for the purposes of Division 102 of the ITAA 1997. It considers three scenarios, namely • where the trust gain was not reduced either by step 3 of the method statement in subsection 102-5(1) of the ITAA 1997 or by subdivision 152-C of the ITAA 1997 • where the trust gain was reduced by either step 3 of the method statement in subsection 102-5(1) of the ITAA 1997 or subdivision 152-C of the ITAA 1997 but not by both; and • where the trust gain was reduced under both step 3 of the method statement under section 102-5(1) of the ITAA 1997 and subdivision 152-C of the ITAA 1997 In the second and third scenario, the capital gain is increased two fold and four fold respectively with a view to take into account the reduction made under step 3 of the method statement under 102-5(1) of the ITAA 1997 and under Subdivision 115-C of the ITAA 1997 to calculate the net capital gain of the trust. This is done so that the discount portion is effectively disregarded for the purposes of applying subsection 104-71(4) of the ITAA 1997. However, the current year capital loss or carried forward net capital loss is applied to the capital gain prior to applying step 3 of the method statement or the small business 50% reduction under Subdivision 115-C of the ITAA 1997. Therefore, item 7 of the table in subsection 104-71(4) of the ITAA 1997 applies to the capital gain that would otherwise have existed prior to the application of a discount percentage in step 3 of subsection 102-5(1) of the ITAA 1997 (that is, the gross capital gain). Paragraph 3.23 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No 5) 2001 substantiates this position as follows: 3.23 If the trustee making a payment of a CGT concession amount applied a capital loss or net capital loss against the capital gain before applying the CGT concession, a further reduction may be made to the non-assessable part of the beneficiary. The amount of this reduction is that proportion of the loss reflected in the payment to the beneficiary. Where more than one CGT event happens in relation to the units or interests in the trust in an income year, item 7 of the table in subsection 104-71(4) of the ITAA 1997 needs to be applied to each CGT event separately to determine the amount excluded from the non-assessable part in section 104-70 of the ITAA 1997. This is apparent from the definition of capital gain. Section 995-1 of the ITAA 1997 defines capital gain as: For each CGT event a capital gain is worked out in the way described in that event. | Detailed Reasoning - Application of Item 7 of subsection 104-71(4) to capital gains: Where a trustee distributes the full amount of a gross capital gain to its unit holders and this gain has previously been reduced as a result of the application of current year or prior year capital losses, the payment will include the following elements: (a) current year capital losses and any previously unapplied capital losses (b) CGT discount amount As discussed above, elements a) and b) are not included in the non-assessable part of the payment in subsection 104-70(1) of the ITAA 1997 pursuant to items 1 and 7 of the table in subsection 104-71(4) of the ITAA 1997. Therefore, where a trust realises a net capital gain (after applying carried forward capital losses), a non-assessable distribution by the trust should not require adjustment to the cost base of the unit in the trust to the extent that the non-assessable distribution is attributable to the utilisation of the capital losses. The following example (taken from example 3.3 in the Explanatory Memorandum to Taxation Laws Amendment Bill (No 5) 2001 illustrates the operation of CGT event E4 in circumstances where a capital loss is applied by a trustee against a capital gain to which a beneficiary is entitled. In the 2000-01 income year, the Ready Capital Unit Trust made a capital gain of $1,800. The trust also made a capital loss of $500. After offsetting the capital loss, the trustee applied the CGT discount to the balance of the gain ($1,300) resulting in the trust having a net capital gain of $650. Nahid, a beneficiary of the trust, was presently entitled to all the trust income. On 10 September 2001, the trustee paid Nahid $1,800. The trustee advised Nahid that this amount comprised $650 CGT discount, $650 net income and $500 that represented the capital loss applied by the trustee against the capital gain. In applying CGT event E4 to the payment, Nahid reduces the $1,800 payment by the following amounts: (a) $650, being the amount of the capital gain included in the net income assessed to her under s 97 of the ITAA 1936: s 104-70(1)(b); (b) $650, being the amount that represents the CGT discount allowed against the capital gain made by the trust: Item 1 in the table in s 104-71(4); and (c) $500, being the amount of the loss applied against the capital gain made by the trust and reflected in the payment to Nahid: Item 7 in the table in s 104-71(4). The result for Nahid is the non-assessable part is nil [$1,800 - ($650+$650+$500)]. Thus, as can be seen, item 7 of subsection 104-71(4) of the ITAA 1997 excludes an amount from the non-assessable part of the payment referred to in section 104-70 of the ITAA 1997 for an entity where there is a distribution of a capital gain and a portion of the payment relates to a capital gain to which carried forward capital loss or net capital losses have been applied. This is further confirmed in the ' 2012 standard distribution statement: guidance notes for fund managers '. Note 14 of Part C of the standard distribution statement, titled, 'Components of a distribution' states the following in relation to the CGT concession amount: The CGT concession amount is identified as the amount referred in subsection 104-71(4) of the ITAA 1997 …This amount comprises the non-assessable CGT discount amount paid to the unit holder. Also included is the amount of any capital losses (including unapplied net capital losses carried forward from previous years) applied by the trust (or another trust in a chain of trusts) to reduce capital gains made, which is reflected in the payment to the unit holder. Refer to item 1 and 7 in the table in subsection 104-71(4) of the ITAA 1997. The following example elaborates a situation in which capital losses have been utilised to reduce a capital gain, rather than the CGT concession amount: Assume that during an income year the Trust disposed of an asset that it held for less than 2 years for $100. A capital gain of $60 was made in respect of the disposal. However, the Trust also had a carried forward capital loss of $70. The net capital gain of the trust for the year was calculated under section 102-5 as follows: Step 1: Gross capital gain: $60 Step 2: carried forward capital loss $60 Capital amount $0 Step 3: Apply 50% CGT discount NA Step 4: Apply the small business discount NA Step 5: Net capital gain $0 As at 30 June, the trustee distributes the capital proceeds of $100 to a beneficiary as follows: • $60 offset carried forward capital loss (item 7 of the table in subsection 104-71(4)); and • $40 return of capital On the basis of the above, the $40 return of capital is the non-assessable part of the payment, which is subject to CGT event E4 under section 104-70. Accordingly, to the extent that the net capital losses or carried forward capital losses have been applied by the trust to reduce capital gains made and these amounts are reflected in the payment made to the beneficiary, they will be excluded from the non-assessable portion of the payment.