Private ruling: Deceased estate and capital gains tax
Published: October 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Questions and Answers | 1. Does the Remainder Beneficiary of the Trust created from the deceased estate have a fixed entitlement 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 Life Tenant, did capital gains tax (CGT) event E5 occur to the CGT assets of the Trust? | Yes. | 3. Does section 855-40 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to disregard the capital gain to which the non-resident beneficiary is absolutely entitled? | Yes.

Relevant facts and circumstances: The Deceased, a resident of Australia, passed away leaving a spouse and children including the Life Tenant. Under the Deceased's will (the Will), the residual estate (the Trust) was to be divided into parts: • some parts were to be held on trust by the Trustee to pay the income to the spouse during their life and after their death on trust for all the children of the Deceased; • the remaining parts were to be held on trust by the Trustee for all the children of the Deceased in equal shares. The Will also imposed a further condition on the share of the Trust funds held on trust for the Life Tenant. Specifically: • such share was to be held on trust by the Trustee to pay the income from that share to the Life Tenant during their life; and • after the death of the Life Tenant, that share was to be held on trust for children of the Life Tenant in such shares and in such manner as the Life Tenant shall appoint; and • in default of such appointment, that share was to be held on trust for the children of the Life Tenant who shall attain 21 years of age in equal shares, and if there shall be only one such child, the whole to be in trust of that one child. The Life Tenant passed away, leaving one child, the Remainder Beneficiary. The Life Tenant did not make any inter vivos or testamentary appointment or nomination in relation to their share of the Trust funds. The Remainder Beneficiary is at all relevant times a non-resident for tax purposes and is at least 21 years of age. The Trust comprises of the following assets: • a term deposit; • a wholesale managed investment fund, which has been redeemed for cash; and • shares in listed companies. The assets in the Trust were all acquired by the Trustee after 19 September 1985 and none of them are taxable Australian property. At the date of death of the Life Tenant, the value of the shares exceeded their respective cost bases.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subsection 272-5(1) of Schedule 2F | Income Tax Assessment Act 1997 Section 104-75 | Income Tax Assessment Act 1997 Subsection 104-75(3) | Income Tax Assessment Act 1997 Subsection 104-75(5) | Income Tax Assessment Act 1997 Subsection 104-75(6) | Income Tax Assessment Act 1997 Section 115-228 | Income Tax Assessment Act 1997 Section 855-10 | Income Tax Assessment Act 1997 Subsection 855-40(2) | Income Tax Assessment Act 1997 Subsection 855-40(3) | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Detailed Reasoning - Fixed trust: Under section 995-1 of the ITAA 1997, a 'fixed trust' is defined as: A trust is a fixed trust if entities have *fixed entitlements to all the income and capital of the trust. 'Fixed entitlement' is explained in section 995-1 of the ITAA 1997 as: An entity has a fixed entitlement to a share of the income or capital of a company, partnership or 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 trust as: If, under a trust instrument, a beneficiary has a vested and i ndefeasible 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. 'Vested and indefeasible' is not defined in taxation legislation, nor is there a precedential ATO view which defines or explains the term. However, paragraph 13.4 of the Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 describes a 'vested interest' as: A person has a vested interest in something if the person has a present right relating to the thing. Stated simply, a vested interest is one that is bound to take effect in possession at some point in time. Paragraph 13.7 of the EM proceeds to explain that a vested interest is indefeasible where: "…in effect, it is not able to be lost. A vested interest is defeasible where it is subject to a condition subsequent that may lead to the entitlement being divested. A condition subsequent is an event that could occur after the interest is vested that would result in the entitlement being defeated, for example, on the occurrence of an event or the exercise of a power. For example, where a beneficiary's vested interest is able to be taken away by the exercise of a power by the trustee or any other person, the interest will not be a fixed entitlement." Paragraph 13.8 of the EM further explains that: "Where the trustee exercises a power to accumulate income or capital of the trust in accordance with the trust deed, the accumulation does not result in a beneficiary's interest being taken away or defeased as long as the beneficiary nevertheless remains entitled at some future time to enjoy his or her share of the income or capital which has been accumulated." Under the Will, the Life Tenant's share of the Trust funds passed to the only child, the Remainder Beneficiary, on death. Consequently, the Remainder Beneficiary had a vested interest in the Life Tenant's share of the Trust funds at the date of death. This is because when the Remainder Beneficiary reached 21 years of age, under the Will, their interest in the Life Tenant's share of the Trust funds is bound to take effect in possession at some time. At the time the Life Tenant passed away, the Remainder Beneficiary would have an indefeasible interest in the Life Tenant's entire share of the Trust funds. This is because, when the Life Tenant passed away, it is clear that there would not be another person that may have a vested interest in the Life Tenant's share of the Trust funds and that the Life Tenant had not appointed the Trustee to hold their share of the Trust funds in such manner as to divest the Remainder Beneficiary of the entitlement to the Life Tenant's share of the Trust funds. Furthermore, there is nothing else in the Will which allows the Remainder Beneficiary's entitlement be defeated on the occurrence of an event or the exercise of a power. While the Will does not specifically refer to the income of the Trust over the Life Tenant's share of the Trust funds, in the absence of a clause dealing with income, it is clear that the income can only be applied for the benefit of the Remainder Beneficiary. On that basis, the Remainder Beneficiary has, under the Will, a vested and indefeasible interest in all of the income and capital of the Life Tenant's share of the Trust funds, and thus has a fixed entitlement to the income and capital of the Life Tenant's share of the Trust funds. Consequently, the Trust is a fixed trust for the purposes of subsection 272-5(1) of the ITAA 1936. | Detailed Reasoning - Consequences of CGT event E5: Section 104-75 of the ITAA 1997 provides that CGT event E5 occurs if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 of the ITAA 1997 applies) as against the trustee (disregarding any legal disability the beneficiary is under). The trustee makes a capital gain if the market value of the asset at the time of the event is more than its cost base (subsection 104-75(3) of the ITAA 1997). The beneficiary makes a capital gain if the market value of the asset at the time of the event is more than the cost base of the beneficiary's interest in the trust capital to the extent it relates to the asset (subsection 104-75(5) of the ITAA 1997). However, a capital gain the beneficiary makes is disregarded if the beneficiary acquired the CGT asset that is the interest (except by way of an assignment from another entity) for no expenditure (subsection 104-75(6) of the ITAA 1997). In this case, • the Trust was not a trust to which Division 128 applies as the assets of the Trust were acquired after the date of death of the Deceased; • the Remainder Beneficiary became absolutely entitled to the assets of the estate upon the passing of the Life Tenant as they had a vested and indefeasible interest at that time; and • the Remainder Beneficiary acquired the CGT asset that is the interest for no expenditure. Therefore, CGT event E5 happened in regard to the assets of the Trust, namely the shares, on the date of death of the Life Tenant. Further, the capital gain the beneficiary made is disregarded under subsection 104-75(6) of the ITAA 1997 and the Trustee of the Trust made a capital gain under subsection 104-75(3) of the ITAA 1997. Section 115-228 of the ITAA 1997 states that a beneficiary of a trust estate can be 'specifically entitled' to an amount of a capital gain made by the trust estate if the beneficiary has received or can be reasonably expected to receive an amount referrable to the gain under the terms of the trust. ATO ID 2013/33 Income Tax - Capital gains tax: specifically entitled provides that where a trustee of a trust makes a capital gain by reason of CGT event E5, the beneficiary can be specifically entitled to the gain under Section 115-228 of the ITAA 1997. In this case, it has already been established that the Trustee of the Trust made a capital gain by reason of CGT event E5 and the Remainder Beneficiary will receive an amount in relation to the capital gain under the terms of the trust. Therefore, the Remainder Beneficiary is specifically entitled under Section 115-228 of the ITAA 1997 and the capital gain is able to be distributed by the Trustee to the Remainder Beneficiary. | Detailed Reasoning - Section 855-40 of the ITAA 1997: Section 855-40 of the ITAA 1997 deals with the tax treatment of capital gains and losses made by foreign residents through fixed trusts. Subsection 855-40(2) of the ITAA 1997 provides that a person who is a foreign resident may disregard a capital gain made where the CGT event happens to a CGT asset of a fixed trust that is not 'taxable Australian property'. Further, subsection 855-40(3) of the ITAA 1997 specifies that the trustee of a fixed trust is not liable to pay tax on a capital gain that is disregarded for a beneficiary under subsection (2). In this case, • the Remainder Beneficiary is a foreign resident; • the Trust is a fixed trust; and • the Trustee of the Trust has stated that the CGT assets of the Trust, the shares, are not taxable Australian property. Therefore, section 855-40 of the ITAA 1997 applies so that the capital gain made by the non-resident Remainder Beneficiary from the CGT assets of the fixed trust is disregarded and the Trustee is not liable to pay tax on the gain.