Private ruling: Testamentary trust
Date of advice: 22 July 2015
Published: July 2015
Ruling period: 01 July 2014 to 30 June 2016
Date scheme commenced: 01 July 2014

Ruling: Q1: Will the Commissioner treat Division 128 of the ITAA 1997 as applying to disregard any capital gain or capital loss made on the distribution of Assets from the Trust directly to individual beneficiaries of the Trust? | A1: Yes | Q2: Will the Commissioner treat Division 128 of the ITAA 1997 as applying to disregard any capital gain or capital loss made on the distribution of Assets from the Trust directly to one or more trustee beneficiaries of the Trust? | A2: Yes | Q3: Do CGT events A1, E1 or E2 of the ITAA 1997, happen upon the execution of a Deed of Variation to the Trust Deed? | A3: No | Q4: If the Scheme is implemented will section 102AG(2) of the ITAA 1936 apply to treat any income derived from the Assets which is received by an infant beneficiary via the Inter Vivos Trust as 'excepted trust income'? | A4: No | Q5: Will Part IVA of the ITAA 1936 apply to the Scheme? | A5: No

Relevant facts and circumstances: The Trust is a testamentary trust established under the Will of the Deceased. The Will provided for the creation of a testamentary trust (the Trust) as per the Schedule to the Will (the Trust Deed). The Deceased had X children who are: • Executors of the Decease Estate • The Trustees of the Trust; • The Specified Beneficiaries; • The Appointors. The following transactions are intended to occur: • certain assets owned by the Trustees of the Trust will be distributed directly to Beneficiaries of the Trust; • the Trust Deed will be varied to clarify that the definition of 'General Beneficiaries' includes 'eligible trusts' and 'eligible corporations' (as defined in the Trust Deed); • relying on the Deed of Variation, certain other Assets will be distributed directly to Inter Vivos Trust trustees. The Trust Deed defines General Beneficiaries as 'The Specified Beneficiaries and the children, grandchildren and remoter issue of the Specified Beneficiaries.' • The Trust Deed also contains the following definitions: 'eligible corporation' shall mean any corporation at least one share in which is beneficially owned or held by any beneficiary (including the trustees of any eligible trust); 'eligible trust' shall mean any trust or settlement (including a trust or settlement of which the Trustees of this Trust for the time being are the Trustees) under which any beneficiary or class of General Beneficiaries has any interest including (without limitation) or trust or settlement (whether presently in existence or formed hereafter) in or under which any other trust or settlement (under which any beneficiary or class of General Beneficiaries has any interest) has any interest from time to time including (without limitation) any interest as a Unit Holder in any Unit Trust for so long as such interest continues; Certain other clauses in the Trust Deed refer to the definitions of 'eligible corporation' and 'eligible trust'. The Trustees propose to transfer some of the Trust assets which were previously owned by the deceased to Inter Vivos trusts which come within the definition of 'eligible trust'. The reasons for seeking to implement the Scheme are: • to improve the administration of the Assets held by the family; • asset protection objectives of the children, • each of the children are adults and have their own families, their own lives and their own investment objectives; • the ever increasing complexity of the taxation legislation in this area has meant that some family members wish to avoid having to deal with trusts at all (hence the intended distributions to General Beneficiaries individually), while other family members have different attitudes to the level of compliance costs they are willing to incur in administering the trusts.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 102-25(1) | Section 104-10 | Section 104-55 | Section 104-60 | Section 104-75 | Section 104-80 | Section 104-85 | Division 128 | Section 128-10 | Section 128-15 | Subsection 128-15(3) | Section 128-20 | Subsection 128-20(1) | Paragraph 128-20(1)(a) | Subsection 128-20(2) | Income Tax Assessment Act 1936 Division 6AA | Section 102AC | Subsection 102AC(2) | Section 102AG | Subsection 102AG(1) | Subsection 102AG(2) | Paragraph 102AG(2)(a) | Subparagraph 102AG(2)(a)(i) | Part IVA | Subsection 177A(1) | Subsection 177C(1) | Section 177CB | Subsection 177CB(2) | Subsection 177CB(3) | Section 177D | Subsection 177D(2) | Section 177F | Subsection 177F(1)

Reasons for decision: Summary: Will the Commissioner treat Division 128 of the ITAA 1997 as applying to disregard any capital gain or capital loss made on the distribution of Assets from the Trust directly to individual General Beneficiaries? Yes Division 128 of the ITAA 1997 deals with the CGT consequences when the owner of a CGT asset dies. Generally, any capital gain or capital loss that results from a CGT event happening to an asset owned by a person just before their death is disregarded (section 128-10 of the ITAA 1997). Section 128-15 of the ITAA 1997 sets out the CGT consequences for a CGT asset owned by a deceased person just before dying that: (a) devolves to an LPR; or (b) passes to a beneficiary of that person's estate. The term 'legal personal representative is defined in subsection 995-1(1) of the ITAA 1997 and relevantly includes, 'an executor or administrator of an estate of an individual who has died…' Section 128-20 of the ITAA 1997 defines when a 'CGT asset passes to a beneficiary' in a person's estate. This will relevantly happen if the person becomes the owner under the deceased's will (paragraph 128-20(1)(a)). Subsection 128-20(2) of the ITAA 1997 provides that a CGT asset does not pass to a beneficiary in your estate if the beneficiary becomes the owner of the asset because your LPR transfers it under a power of sale. Subsection 128-15(3) of the ITAA 1997 provides that any capital gain or capital loss the LPR makes if the asset 'passes to a beneficiary in your estate' (as defined in section 128-20) is disregarded. In your case, the Trustees of the Trust are not LPRs for the purposes of subsection 128-15(3) of the ITAA 1997. The responsibilities of the LPR are similar to, though legally separate and distinct from, those of a testamentary trustee. A deceased estate represents a legal entity or relationship quite separate from that of a testamentary trust (paragraph 5, IT 2622). And although 'trustee' is defined in section 6 of the ITAA 1936 to include an LPR, the reverse is not the case. The LPRs were able to disregard any capital gain or loss from assets that the deceased owned which were transferred to the Trustee However Division 128 of the ITAA 1997 will not apply to disregard any capital gain or capital loss made on the distribution of Assets from the Trust directly to individual General Beneficiaries. | Detailed Reasoning - Effect of Practice Statement PS LA 2003/12: The question to be answered by the Commissioner contemplates an in specie distribution of Assets of the Trust to individual beneficiaries of the Trust in their individual capacities (i.e., not in their capacities as the trustee of any trust) who are General Beneficiaries. Practice Statement PS LA 2003/12 confirms that: '…the Commissioner will not depart from the ATO's long-standing administrative practice of treating the trustee of a testamentary trust in the same way that a legal personal representative is treated for the purposes of Division 128 of the ITAA 1997, in particular subsection 128-15(3).' (Paragraph 2) In terms of Division 128 of the ITAA 1997 and PS LA 2003/12, for a distribution by a testamentary trust to be treated in the same way as an LPR (for the purposes of subsection 128-15(3)) the following circumstances need to exist: • The relevant trust must be a 'testamentary trust'. That is, it needs to have been created under the deceased's will (refer to paragraph 4 of IT 2622). • In your case, the Trust is a testamentary trust for relevant purposes, as it was created under the terms of the Will. • Relevantly, subsection 128-20(1)(a) needs to be satisfied, i.e., the CGT asset must pass to '… a beneficiary in your estate … under your will…' • In your case the Trust established by the will identifies the beneficiaries as those who satisfy the definition of Specified and General Beneficiaries. As the conditions of PS LA 2003/12 are satisfied, the treatment provided for LPRs under subsection 128-15(3) of the ITAA 1997 will also apply to the Trustee in this instance such that any capital gains or capital losses from assets distributed to the individual General Beneficiaries will be disregarded. | Detailed Reasoning - Question 2: Will the Commissioner treat Division 128 of the ITAA 1997 as applying to disregard any capital gain or capital loss made on the distribution of Assets from the Trust directly to one or more of the Inter Vivos Trust beneficiaries? | Detailed Reasoning - Answer: Yes The relevant legislative provisions have already been provided for in the reason for the decision to Question 1, above. Those reasons point out that the Trustees of the Trust are not LPRs for the purposes of subsection 128-15(3) of the ITAA 1997. In addition, the trustees of the Inter Vivos Trusts were identified as beneficiaries of the Trust set out in the Will of the deceased. Therefore, the Commissioner's practice in PS LA 2003/12 of treating trustees of testamentary trusts as LPRs for the purposes of subsection 128-15(3) of the ITAA 1997 will apply such that the Trustees will be able to disregard any capital gains or capital losses from assets distributed to one or more of the Inter Vivos Trust beneficiaries. | Detailed Reasoning - Question 3: Do CGT events A1, E1 or E2 of the ITAA 1997, happen upon the execution of a Deed of Variation to the Trust Deed which varies the Deed to include the Inter Vivos Trusts as beneficiaries of the Trust? | Detailed Reasoning - Answer: No CGT event A1 of the ITAA 1997 happens if you dispose of a CGT asset to someone else (section 104-10). CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement (section 104-55). CGT event E2 happens if you transfer a CGT asset to an existing trust (section 104-60). However, none of these events happen merely because of a change of trustee. If more than one CGT event can happen, then you use the one that is the most specific to your situation (subsection 102-25(1) of the ITAA 1997). Where the particular facts involve a trust, CGT event E1 or CGT event E2 of the ITAA 1997, if relevant, will be the more specific CGT events rather than CGT event A1 because they are specifically directed to trusts [ Taras Nominees Pty Ltd v. Federal Commissioner of Taxation - (28 January 2015) - [2015] FCAFC 4; (2015) 2015 ATC 20-483 - Federal Court of Australia; Healey v. Federal Commissioner of Taxation - (23 March 2012) - [2012] FCA 269; (2012) 2012 ATC 20-309; (2012) 208 FCR 300; [2013] ALMD 3073; [2013] ALMD 3074; (2012) 87 ATR 848 - Federal Court of Australia Healey v. Federal Commissioner of Taxation - (21 December 2012) - [2012] FCAFC 194; (2012) 208 FCR 333; (2012) 2012 ATC 20-365; (2012) 91 ATR 671 - Federal Court of Australia]. Taxation Determination TD 2012/21 provides the ATO view on whether CGT event E1 or E2 in section 104-55 or 104-60 of the ITAA 1997 happen if the terms of a trust are changed pursuant to a valid exercise of a power contained within the trust's constituent document, or varied with the approval of a relevant court. An assumption has been made for the purposes of section 357-110 of the TAA 1953 as follows: In accordance with the carrying out of the scheme the subject of this private ruling application a Deed of Variation of Trust: • will be prepared with a purpose to vary the Trust Deed to clarify that the definitions of 'eligible trust' and 'eligible corporation' (as defined in the Trust Deed) should have been included in the definition of 'General Beneficiaries'; • will be executed; and • will be legally effective with Court approval being obtained if required. Following the decision in Federal Commissioner of Taxation v. Clark and Anor [2011] FCAFC 5 (and the High Court's refusal to grant the Commissioner leave to appeal that decision) the Commissioner issued Taxation Determination TD 2012/21, which says in part: 24. Even though Clark and Commercial Nominees were decided in the context of whether changes in a continuing trust were sufficient to treat that trust as a different taxpayer for the purpose of applying relevant losses, the ATO accepts the principles set out in these cases have broader application. Relevantly, the principles established by those cases are also relevant to the question of the circumstances in which CGT event E1 or E2 may happen as a result of changes being made to the terms of an existing trust pursuant to a valid exercise of a power in the deed (including a power to amend). In light of those principles, the ATO accepts that a change in the terms of the trust pursuant to exercise of an existing power (including an amendment to the deed of a trust), or court approved variation, will not result in a termination of the trust and, therefore, subject to the observation in paragraph 27 below, will not result in CGT event E1 happening. ……………. 27. Even in instances where a pre-existing trust does not terminate, it may be the case that assets held originally as part of the trust property commence to be held under a separate charter of obligations as a result of a change to the terms of the trust - whether by exercise of a power under the deed (including a power to amend) or court approved variation - such as to lead to the conclusion that those assets are now held on terms of a distinct (that is, different) trust. [footnotes removed and emphasis added] Whether the proposed Deed of Variation of Trust will amount to an amendment to the Trust Deed pursuant to an existing power of amendment is a matter of fact. Relevant considerations which would support a conclusion that the proposed amendment is merely a clarification (or correction of a drafting error) of an already existent term in the Trust Deed (i.e., that the definition of 'General Beneficiaries' erroneously omits a reference to 'eligible corporation' and 'eligible trust' even though the intention of the Testator was that these be included) are: • the relevant definitions of 'eligible corporation' and 'eligible trust' are included in the Trust Deed; and • other clauses in the Trust Deed refer to the terms 'eligible corporation' and 'eligible trust'. Having regard to the above considerations, on balance, it is concluded that the proposed amendments will comply with and are within the power to amend in the Trust Deed. It is therefore considered that the execution of the proposed Deed of Variation of the Trust Deed, would be in accordance with an existing power in the Trust Deed and will not result in the termination of the Trust. Further, as the proposed amendment does no more than clarify the class of beneficiaries of the Trust it will not cause any assets held as part of the trust property of the Trust immediately before the execution of the Deed of Variation to commence to be held under a separate charter of obligations. Therefore, a change to the Trust Deed in the form proposed will not cause CGT event E1 in section 104-55 of the ITAA 1997 to happen. In addition, this conclusion necessarily precludes CGT event A1 or CGT event E2 of the ITAA 1997 from happening. | Detailed Reasoning - Question 4: If the Scheme is implemented will section 102AG(2) of the ITAA 1936 apply to treat any income derived from the Assets which is received by an infant beneficiary via the Inter Vivos Trust as 'excepted trust income'? | Detailed Reasoning - Answer: No Division 6AA of the ITAA 1936 operates to tax certain income derived by minors who are 'prescribed persons' at penalty rates. A minor will be a 'prescribed person' for the purposes of Division 6AA of the ITAA 1936 if, in relation to a year of income, they are: • less than 18 years of age on the last day of the income year; and • not an 'excepted person' in relation to the year of income. 'Excepted persons' are defined in section 102AC(2) of the ITAA 1936. A minor who is a beneficiary of the Inter Vivos Trust will not be an 'excepted person' for the purposes of Division 6AA. Section 102AG(1) of the ITAA 1936 specifies the circumstances in which Division 6AA will apply to trust income. Specifically, where a beneficiary of a trust estate is a 'prescribed person', Division 6AA will apply to so much of the beneficiary's share of the net income of the trust estate as, in the opinion of the Commissioner, is attributable to the assessable income of the trust estate that is not, in relation to the beneficiary, 'excepted trust income'. Subsection 102AG(2) of the ITAA 1936 specifies the types of trust income that will be 'excepted trust income'. In particular, subparagraph 102AG(2)(a)(i) relevantly provides that 'excepted trust income' includes '…assessable income of a trust estate that resulted from … a will..' Is the relevant income '…assessable income of trust estate that resulted from… a will…' ? The application of Re Trustee of the Estate of the Late AW Furse; A/C Jessica N Delaney and A/C Skye Nea Delaney) v the Commissioner of Taxation [1990] FCA 470 (27 November 1990) (Furse) In Furse , it was not in dispute that the trust estate resulted from a will. What was in dispute (among other things) was whether, for paragraph 102AG(2)(a) of the ITAA 1936 to apply, it is necessary that the assessable income of the trust estate itself be sourced in the will or property of the deceased. The Federal Court did not accept that argument, but it did emphasise that the trust estate must result from a will and not be an inter vivos trust: With respect, I do not accept the Commissioner's submission. It requires that the words in sec. 102AG(2)(a) ``that resulted from'' refer to the assessable income rather than to the words in subpara. (i) ``a will'' etc. or in subpara. (ii) ``an intestacy'' etc. In my opinion all that is necessary to fall within sec. 102AG(2)(a) is that the assessable income be assessable income of the trust estate, that trust estate being one of the forms of trust estate referred to in sec. 102AG(2)(a)(i) or (ii) (that is to say not an inter vivos trust). (at 4018) [emphasis added] In your case, as outlined above, the Inter Vivos Trusts do not result from the Will of the Deceased. That Will contained no instruction to the executors to create the Inter Vivos Trusts. The decision to create the Inter Vivos Trusts was made by certain beneficiaries of the Trust. As any relevant income derived by a minor as a beneficiary of an Inter Vivos Trust will not be '… assessable income of a trust estate that resulted from… a will… ' such income will not be 'excepted trust income' for the purposes of paragraph 102AG(2)(a)(i) of the ITAA 1936. | Detailed Reasoning - Question 5: Will Part IVA of the ITAA 1936 apply to the Scheme? | Detailed Reasoning - Answer: No. Part IVA of the ITAA 1936 is a general anti-avoidance provision, giving the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would (but for section 177F) have been obtained, by a taxpayer in connection with a scheme to which Part IVA applies. PS LA 2005/24 provides instruction and practical guidance to tax officers on the application of Part IVA of the ITAA 1936 and other General Anti-Avoidance Rules (GAARs). In order for Part IVA of the ITAA 1936 to apply, the following requirements must be satisfied: • there is a 'scheme' to which Part IVA applies; • a 'tax benefit' was or would (but for subsection 177F(1)) have been obtained; • the identified 'tax benefit' was or would have been obtained in connection with the identified scheme; and • the person who entered into or carried out the identified scheme (or any part of the scheme) did so for the purpose of enabling the relevant taxpayer to obtain a 'tax benefit'. | Detailed Reasoning - Scheme: A 'scheme' is broadly defined in subsection 177A(1) of the ITAA 1936 as: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme plan, proposal, action, course of action or course of conduct. Under this definition, a scheme can be a series of steps taken together or a single step. What constitutes a scheme is ultimately meaningful only in relation to the tax benefit that has been obtained since the tax benefit must be obtained in connection with the scheme. Likewise, the dominant purpose of a person entering into or carrying out the scheme, and the existence of the tax benefit, must both be considered against a comparison with an alternative. The Scheme for the purposes of section 177A(1) of the ITAA 1936 is the series of steps including: • the amendment of the Trust Deed to clarify that the definitions of 'eligible trust' and 'eligible corporation' (as defined in the Trust Deed) should have been included in the definition of 'General Beneficiaries'; • the distribution of Assets by the Trustees to one, or more of the trustees of the Inter Vivos Trusts; and • the distribution of income derived from the Assets by the trustees of the Inter Vivos trusts to one, or more, infant beneficiaries. | Detailed Reasoning - Tax Benefit: Having established the existence of a 'scheme', Part IVA will only apply if it is determined that a tax benefit was or would have been obtained in connection with that scheme. Broadly, subsection 177C(1) of the ITAA 1936 identifies four types of tax benefits as follows: • an amount not being included in the taxpayer's assessable income; • a deduction being allowable to the taxpayer; • a capital loss being incurred by the taxpayer; and • a foreign tax credit being allowable to the taxpayer. In order to determine that a tax benefit has been obtained, it is necessary to compare the tax consequence of the scheme in question with the tax consequences that would have arisen, or might reasonably be expected to have arisen, if the scheme had not been entered into or carried out. | Detailed Reasoning - Section 177CB of the ITAA 1936 - The bases for identifying tax benefits: For schemes entered into or carried out on or after 16 November 2012 newly enacted section 177CB of the ITAA 1936 provides the framework for deciding under section 177C whether any of the following tax effects would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out: (a) an amount being included in the assessable income of the taxpayer; (b) the whole or part of a deduction not being allowable to the taxpayer; (c) the whole or part of a capital loss not being incurred by the taxpayer; (d) the whole or part of a foreign income tax offset not being allowable to the taxpayer; (e) the taxpayer being liable to pay withholding tax on an amount. The 'would have' and 'might reasonably be expected to' limbs of subsection 177C(1) of the ITAA 1936 are separate and distinct bases upon which the existence of a tax effect can be demonstrated. 1 Subsection 177CB(2) of the ITAA 1936 confirms that a decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme) (the annihilation approach). In considering such a postulate, the scheme must be assumed never to have happened, that is, it is annihilated, deleted or extinguished to determine the tax effects based on the remaining events or circumstances. Generally the annihilation approach will be applicable where there are no economic consequences from the scheme other than the tax benefit. As this Scheme involves the distribution of Assets to the Inter Vivos Trust trustees and the distribution of income by those trustees to minors, the annihilation approach is not appropriate as annihilating the Scheme would result in no capital gain or trust income. Subsection 177CB(3) of the ITAA 1936 explains that a decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme (the reconstruction approach). In determining whether such a postulate is a reasonable alternative, particular regard must be had to the substance of the scheme and any result or consequence for the taxpayer that is or would be achieved by the scheme. Any results in relation to the operation of the Act (as defined) that would be achieved by the postulate for any person (whether or not a party to the scheme) must be disregarded. As outlined above, if the Scheme was implemented any relevant income derived by a minor as a beneficiary of an Inter Vivos Trust will not be 'excepted trust income' for the purposes of paragraph 102AG(2)(a)(i) of the ITAA 1936 (Question 4). | Detailed Reasoning - Dominant Purpose: Section 177D of the ITAA 1936 provides that Part IVA applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of: (a) enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme; or (b) enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme; whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers. Subsection (2) states that you have regard to the following matters: (a) The manner in which the scheme was entered into or carried out; (b) The form and substance of the scheme; (c) The time at which the scheme was entered into and the length of the period during which the scheme was carried out; (d) The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; (e) Any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result from the scheme; (f) Any change in the financial position of any person who has, or has had any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; (g) Any other consequences for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out; (h) The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f). You have variously described the reasons for seeking to implement the Scheme as: • to improve the administration of the Assets held by the family; • asset protection objectives of the children, • each of the children are adults and have their own families, their own lives and their own investment objectives; • the ever increasing complexity of the taxation legislation in this area has meant that some family members wish to avoid having to deal with trusts at all (hence the intended distributions to General Beneficiaries individually), while other family members have different attitudes to the level of compliance costs they are willing to incur in administering the trusts. | Detailed Reasoning - Conclusion: Considering the scheme in the context of whether or not it was entered into for the dominant purpose of obtaining a tax benefit requires a comparison to an alternative. As the Scheme follows the ordinary course of family estate planning and asset protection arrangements in relation to a deceased estate there does not appear to be an alternative that seems reasonable in terms of subsection 177CB(3) of the ITAA 1936 that generates a tax benefit where no distribution of the Assets to the beneficiaries of the Trust occurs. In light of the family estate planning and asset protection objectives of the scheme as described in the facts and having regard to substance of the scheme and the eight matters listed above, the Commissioner does not consider that any party to the Scheme will enter into the Scheme for the sole or dominant purpose of obtaining a tax benefit. 1 Explanatory Memorandum to tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013, paragraph 1.44.