Private ruling: Subjects: Income Tax - Trusts - Trust income - Present entitlement; and
Date of advice: 12 January 2016
Published: June 2017
Ruling period: Year ended 30 June 201X | Year ended 30 June 201X
Date scheme commenced: 1 July 201X

Ruling: Q1: Were the 15 charitable institutions that are the residuary beneficiaries of the Estate, presently entitled to all of the income (including the capital gains) of the Estate for the income year ended 30 June 201X? | A1: No. | Q2: Will the 15 charitable institutions that are the residuary beneficiaries of the Estate, be presently entitled to all of the income of the Estate in the 201X income year? | A2: No. | Q3: Did CGT event K3 happen in respect of the deceased's share portfolio just before their death? | A3: No.

Relevant facts and circumstances: The deceased's date of death was in late 201X. The Executors of the Will and are also the Trustees of the Estate. Probate of the Will was granted in early 201X. Under the terms of the deceased's last Will: 1. In accordance with the Will at Clause 4, a related Trust was released from any debts owing to the Estate. 2. In accordance with the Will at Clause 5, the Estate bequeathed cash and other assets to a number of individuals. These cash bequests and payments were all made on or before mid-late 201X. The Estate has set aside cash bequeathed to individuals under the age of 18 and holds these funds on trust for these beneficiaries. 3. In accordance with the Will at Clause 6, the residue of the Estate is to be distributed to 15 charitable institutions in equal proportions. In early-mid 201X, a letter was sent to the 15 charitable institutions notifying them of their inclusion in the Will of the deceased. A further letter was sent to the same 15 charities in mid-late 201X advising of the sale of the private residence and outlining the capital gains tax implications surrounding the transfer or sale of the share portfolio for the 15 charities. In late 201X, the Estate disposed of its share portfolio and realised cash proceeds. The disposal of the share portfolio resulted in a net capital gain for the Estate after utilising carry forward capital losses and applying the 50% CGT discount. In early-mid 201X, the Estate made interim distribution payments to the 15 charitable institutions. In mid 201X, the Estate made its final payment to the ATO in respect of income tax due by the Estate for the period from the date of death of the deceased to 30 June 201X. The Estate had no other debts or dues following payment to the ATO in June 201X. For the income year ended 30 June 201X, the Estate had taxable income, comprising: ● Income from various public listed trading trusts ● Interest income from various bank accounts ● Dividend income derived from the share portfolio prior to its disposal in late 201X ● Net capital gains on disposal of the share portfolio ● Less deductions for expenses incurred by the Estate. The tax return of the Estate for the year ended 30 June 201X was lodged on the basis that the 15 charitable institutions were presently entitled to all of the income of the Estate in equal proportions in accordance with clause 6 of the deceased's Will. In mid-late 201X, the Estate made further interim distribution payments of the residuary of the Estate to the 15 charitable institutions. No further payments have been made. All 15 charitable institutions are ACNC endorsed charities and income tax exempt, however only 14 are deductible gift recipients. The cash bequests set aside for the beneficiaries under the age of 18 are contingent on and only payable on each of the respective beneficiaries attaining the age of 18. If a particular beneficiary does not attain the age of 18, the cash bequest set aside will fall back into the residuary estate. The executors of the Estate have not established testamentary trusts for the monies bequeathed to the beneficiaries under the age of 18. These monies will continue to be held on trust by the deceased estate until the last beneficiary reaches 18 years of age.

Relevant legislative provisions: Income Tax assessment Act 1936 section 95 | section 97 | section 99 | section 99A | Income Tax Assessment Act 1997 Division 50 | section 104-215 | section 128-10 | subsection 128-15(1) | subsection 128-15(2) | subsection 128-15(3) | section 128-20 | subsection 995-1(1)

Reasons for decision: Summary: The 15 charitable institutions that are the residuary beneficiaries of the Estate, were not presently entitled to all of the income (including the capital gains) of the Estate for the income year ended 30 June 201X. The 15 charitable institutions that are the residuary beneficiaries of the Estate will not be presently entitled to all of the income of the Estate in the 201X income year. | Detailed Reasoning - Present entitlement: The term 'present entitlement' is not defined in the Income Tax Assessment Act 1936 (ITAA 1936). It is therefore necessary to rely on the meaning which has been given to the term by the Courts. The leading Australian case on present entitlement under a trust arising during the course of administration of an estate is the decision of the High Court of Australia in Federal Commissioner of Taxation v. Whiting (1943) 68 CLR 199; 7 ATD 179 ( Whiting's case ). The Court held that a beneficiary of a deceased estate cannot be presently entitled to the income of the estate until the estate has been fully administered. In Taylor v FC of T (1970) 119 CLR 444; 70 ATC 4026; (1970) 1 ATR 582 ( Taylor's case ) the High Court held that a beneficiary that is under a legal disability has an absolute and indefeasible vested interest in the trust income, where the terms of trust specify that the accumulated income of the trust is held for the beneficiary until the beneficiary ceases to be a minor or, if the beneficiary dies earlier, for their estate. However, where the terms of the trust provide for the income to go to another person in the event of the beneficiary's death before the beneficiary attains age of majority, the beneficiary is not presently entitled as the beneficiary's interest is considered contingent, and therefore defeasible. Whiting's case , along with this case, has established 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 contingent, and ● 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 (after provision for debts, legacies, etc). Section 38 of the Wills Act 1997 provides the following in regards to income on contingent or future dispositions: A contingent, future or deferred disposition of property, whether specific or residuary, includes any intermediate income of the property which has not been disposed of by the will. Taxation Ruling IT 2622 Income Tax: present entitlement during the stages of administration of deceased estates (IT 2622) provides the Commissioners view on present entitlement during the administration of deceased estates. Paragraph 7 of IT 2622 provides that whether a beneficiary of a deceased estate is presently entitled to a share of the income of a trust estate for the purposes of Division 6 of Part III of the ITAA 1936 depends on: (a) The stage reached in the administration of the deceased estate; (b) The terms of the deceased's will or codicil, trust law and principles enunciated and orders made by the Courts; and (c) Whether any discretionary payments have been made to the beneficiaries by the executor or trustee. Paragraph 9 of IT 2622 provides that the income of a deceased estate before the administration of the estate is complete is the income of the executors or the administrators and is not the income of a beneficiary. Paragraph 13 of IT2622 also expresses the view that until the estate of a testator has been fully administered and the net residue ascertained, a residuary beneficiary has no proprietary interest in the corpus or income of the trust. However, in paragraph 14 of IT 2622, it goes on to state that during the intermediate stage of administration of a deceased estate, the point may be reached where it is apparent that to the executor that part of the net income of the estate will not be required to either pay or provide for debts, etc. The executor in this situation might exercise their discretion and pay some of the income to, or on behalf of, the beneficiaries. In this situation the beneficiaries will be presently entitled to the income to the extent of the amounts actually paid to them or actually paid on their behalf. The fact that the estate has not been fully administered does not prevent the beneficiaries in this situation from being presently entitled to the income actually paid to, or on behalf of, them. The “net income of the trust estate” and whether any beneficiary is presently entitled to a share of the income of the estate are determined on the last day of the financial year. As Chief Justice Barwick said in Union Fidelity Trustee Co. of Australia v FC of T (1969) 119 CLR 177 at 182; 69 ATC 4084 at 4087; 1 ATR 200 at 202: “The time as at which to determine the assessable income of a taxpayer is in general the concluding day of the taxation year. There is no provision which takes the calculation under s.95 in that respect out of the general scheme of the Act.” This means that, on the last day of the income year, provided a beneficiary has become presently entitled to a share of the income of the trust estate on or before that day, the beneficiary is assessable on that share of the “net income of the trust estate” calculated in accordance with section 95 of the ITAA 1936. The calculation required by section 95 of the ITAA 1936 includes in the “net income of the trust estate” the assessable income derived by the trust estate for the whole of the income year concerned. | Detailed Reasoning - Application to your circumstances: On or before mid-late 201X, in accordance with the deceased's Will at clause 5, the Estate set aside an amount, being cash bequeathed to individuals who are under the age of 18 years (i.e. the specific/minor beneficiaries) and held these funds on trust for these beneficiaries. These funds are contingent on and only payable on each of the respective beneficiaries attaining the age of 18. If a particular beneficiary does not attain the age of 18 years, their bequest will fall back into the residuary of the Estate. In late 201X, the executors disposed of the Estates share portfolio and realised cash proceeds. The disposal of the share portfolio resulted in a net capital gain for the Estate after utilising carry forward losses and applying the 50% CGT discount. In early-mid 201X, the Estate made interim distribution payments to the 15 charitable institutions (i.e. the residuary beneficiaries) named in the Will. In mid 201X, the Estate made its final payment to the ATO in respect of income tax. The residuary beneficiaries were not presently entitled to all of the income of the Estate for the income year ended 30 June 201X; they were only presently entitled to the extent of the interim distributions they received. For the 201X income year the residuary beneficiaries would only be presently entitled to any interim distributions they receive from the residuary of the Estate. In relation to the monies set aside for the specific/minor beneficiaries, none of the beneficiaries are presently entitled to that money, or the interest earned on that money, as these gifts remain contingent and therefore defeasible. Therefore, the Trustees will be assessed on the income earned on that retained money (under section 99 of the ITAA 1936) until those bequests individually cease to be contingent. For the income year ended 30 June 201X, the Trustees determined that a portion of Estate interest income was attributable to the retained money. As a result, the total amount that is assessed to the Trustees under section 99 of the ITAA 1997 for the year ended 30 June 201X will depend on whether the residuary beneficiaries were specifically entitled to the capital gains. If the residuary beneficiaries weren't specifically entitled then the Trustees will also be assessed on a proportion of the capital gains. For the year ended 30 June 201X, the Trustees will be assessed on any interest earned on the retained money. | Summary: CGT event K3 did not happen in respect of the deceased's share portfolio just before their death. | Detailed Reasoning - Deceased estates: The capital gains tax (CGT) provisions that deal with the effect of death are located in Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997). When a person dies, the assets that make up their estate can: ● Pass directly to a beneficiary (or beneficiaries), or ● Pass directly to their legal personal representative (for example, their executor) who may dispose of the assets or pass them on to the beneficiary (or beneficiaries). A legal personal representative can be either: ● The executor of a deceased estate (that is, a person appointed to wind up the estate in accordance with the will) ● An administrator appointed to wind up the estate if the person does not leave a will. Subsections 128-15(1) and 128-15(2) of the ITAA 1997 explain that if a CGT asset you owned just before dying devolves to your legal representative or passes to a beneficiary in your estate, the legal personal representative, or beneficiary, is taken to have acquired the asset on the day you died. Subsection 128-15(3) of the ITAA 1997 provides that any capital gain or loss the legal personal representative makes if the asset passes to a beneficiary in your estate is disregarded. Section 128-20 of the ITAA 1997 sets out the circumstances when an asset is taken to pass to a beneficiary and states (as relevant): 'A CGT asset passes to a beneficiary in your estate if the beneficiary becomes the owner of the asset: (a) under your will, or that will as varied by the court order; or…' Where there is more than one beneficiary who is entitled to the residue of a deceased estate, it will still be a trust to which Division 128 of the ITAA 1997 applies. | Detailed Reasoning - CGT Event K3 - Asset passing to tax-advantaged entity: When a person dies, any capital gain or loss made by them in respect of a CGT asset they owned just before dying is disregarded, unless CGT event K3 applies (sections 128-10 and 104-215 of the ITAA 1997). Subsection 104-215 (1) of the ITAA 1997 states (as relevant): 'CGT event K3 happens if you die and a CGT asset you owned just before dying passes to a beneficiary in your estate who (when the asset passes): (a) is an exempt entity; or…' An exempt entity is one whose ordinary and statutory income is exempt from income tax because of Division 50 of the ITAA 1997 (subsection 995-1(1) of the ITAA 1997). Under subsection 104-215(3) of the ITAA 1997, CGT event K3 is taken to happen just before the deceased's death, which means that any resulting capital gain or loss is accounted for in the final income tax return lodged on behalf of the deceased. Therefore, CGT event K3 will happen when the deceased's CGT asset passes from the deceased estate to the beneficiary, who is an exempt entity. Taxation Determination TD 2004/3 provides that an asset will 'pass' to a beneficiary of a deceased estate when the beneficiary becomes absolutely entitled to the asset as against the estate's trustee (whether or not the asset is later transmitted or transferred to the beneficiary). Draft Taxation Ruling TR 2004/D25 explains the circumstances in which a beneficiary of a trust is considered to be absolutely entitled to a CGT asset of the trust as against its trustee. Paragraphs 23 to 25 of TR 2004/D25 states the following where there is more than one beneficiary with interests in a trust asset: If there is more than one beneficiary with interests in the trust asset, then it will usually not be possible for any one beneficiary to call for the asset to be transferred to them or to be transferred at their direction. This is because their entitlement is not to the entire asset. There is, however, a particular circumstance where such a beneficiary can be considered absolutely entitled to a specific number of the trust assets for CGT purposes. This circumstance is where: ● the assets are fungible; ● the beneficiary is entitled against the trustee to have their interest in those assets satisfied by a distribution or allocation in their favour of a specific number of them; and ● there is a very clear understanding on the part of all the relevant parties that the beneficiary is entitled, to the exclusion of the other beneficiaries, to that specific number of the trust's assets. Because the assets are fungible, it does not matter that the beneficiaries cannot point to particular assets as belonging to them. It is sufficient in these circumstances that they can point to a specific number of assets as belonging to them… | Detailed Reasoning - Application to your circumstances: In accordance with the deceased's Will at Clause 6, the residue of the Estate is to be distributed to 15 charitable institutions (i.e. the residuary beneficiaries) in equal proportions. The residue of the Estate was partly made up of a share portfolio owned by the deceased prior to their death. Each of the residuary beneficiaries are an exempt entity as defined by subsection 995-1(1) of the ITAA 1997. The share portfolio was sold by the Executors of the Estate in late 201X and a capital gain realised. In early-mid 201X, the Estate made interim distribution payments to the residuary beneficiaries named in the Will. Despite the shares being potentially fungible assets, the residuary beneficiaries could not be considered to be absolutely entitled to a specific number of them. This is because the shares could not be conveniently divided between the residuary beneficiaries without prejudice. Therefore, the shares cannot be said to have 'passed' in the way required by section 128-20 of the ITAA 1997. As the shares owned by the deceased just before death did not pass to the residuary beneficiaries, CGT event K3 did not happen.