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

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. On the passing of the deceased's child does capital gains tax (CGT) event E5 occur to the fungible CGT assets of the trust and are the remainder beneficiaries assessable on any gain from this event? | Yes. | 3. Are the gains to which the non- resident beneficiary is presently entitled arising from CGT events occurring to assets that are not taxable Australian property disregarded under the provisions of either section 855-10 or 855-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Yes.

Relevant facts and circumstances: The deceased passed away some time prior to 20 September 1985. The deceased's Will was granted probate in the Supreme Court. The deceased's Will at clause X established a testamentary trust to provide for his child during their lifetime and provided for the vesting of the trust upon their death. We have outlined Clause X of the Will. The testamentary trust was established and supported the deceased child during their lifetime until their death. The deceased's child's Will was granted probate. It seems the effect of this is that, as there is no appointment by the deceased's child under clause X of her parent's will, their children share the residue of the testamentary trust equally and as tenants in common. Under clause Y of their will, they have made it clear that they aren't making an appointment to confirm that they share the residue equally. The deceased's child had children during their lifetime, one being a non-resident of Australia. All children remain alive to date. At the time of the death of the deceased's child the testamentary trust owned investments in equities listed on the Australian Stock Exchange as well as trustee company common funds. Some of these investments were acquired after 19 September 1985.

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 1997 Section 104-75, | Income Tax Assessment Act 1997 Section 106-50, | 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 the grandchildren with a vested interest in the capital of the estate of the deceased. While the Will does not specifically refer to the income of the estate, it is clear that it can only be applied for the benefit of the grandchildren by addition to the capital in the absence of a clause dealing with income. The will only empowers the trustee of the estate to, firstly, pay the income of the estate to the deceased's child and, after their death, to their children. There are no clauses that provide any discretion to the trustee. Therefore the grandchildren have interests which are both vested and indefeasible. Therefore they have fixed entitlements to all the income and capital of the estate. It follows that the estate is a fixed trust. 2. On the passing of the deceased's child does capital gains tax (CGT) event E5 occur to the fungible CGT assets of the trust and are the remainder beneficiaries assessable on any gain from this event? Section 104-75 of the ITAA 1997 provides that capital gains tax (CGT) event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust of a trust to which Division 128 of the ITAA 1997 applies) as against the trustee (disregarding any legal disability the beneficiary is under). If CGT event E5 happens, there may be CGT consequences for both the trustee and the beneficiary. The time that CGT event E5 happens is whey the beneficiary becomes absolutely entitled to the CGT asset. The trustee will make a capital gain if the market value of the asset is more than the assets cost base. The trustee will make a capital loss if the market value of the asset is less than the assets reduced cost base. For the purpose of the CGT provisions, if a beneficiary is absolutely entitled to a CGT asset as against the trustee of a trust, an act done by the trustee in relation to the asset is deemed to be an act done by the beneficiary. In your situation the beneficiaries became absolutely entitled to the assets of the estate on the passing of the deceased's child. CGT event E5 happened to the assets that were acquired by the trustee of the trust after the deceased's death. 3. Can the gains to which the non-resident beneficiary is presently entitled arising from CGT events occurring to assets that are not taxable Australian property be disregarded under the provisions of either section 855-10 or 855-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? Section 855-10 of the ITAA 1997 disregards any capital gains that are made by a non-resident of Australia unless the 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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