Private ruling: Trust-capital gains tax-non-resident beneficiary
Date of advice: 24 May 2018
Published: July 2018
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is the Trust B a ‘fixed trust’ for the purposes of section 272-65 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) and subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Can a non-resident residual beneficiary disregard a capital gain made from a CGT event happening in respect of their interests in a fixed trust under subsection 855-40(2) of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: An individual died leaving family members A, B and C. The individual had a Will with a Codicil to the Will. Probate to the Will and the Codicil to the Will were granted by the Supreme Court of the relevant State. Based on the Will and the Codicil to the Will, the residual estate of the deceased individual was divided into three testamentary trusts. A percentage of the residual estate was allocated to each family member namely Trust A, Trust B and Trust C. Each family member’s shares of the residual estate are held on trust by the Trustee to pay income to the family members during their lifetime. Family members B and C have a number of children and they are the grandchildren of the deceased individual. Based on the Will and the Codicil to the Will, the grandchildren are the residual beneficiaries of the estate of the deceased individual. All of the residual beneficiaries have met the age conditions specified in the Will and the Codicil to the Will. When family member A died their life interest in the Trust A ended. The residual beneficiaries who are the grandchildren of the deceased individual received their entitlement to equal shares of the Trust A based on the terms of the Will and the Codicil to the Will. As such the Trust A was vested and closed. Similarly, when family member B died, their life interest in the Trust B ended. The remaining income and capital of the Trust B will be distributed to the residual beneficiaries, the grandchildren of the deceased individual, on equal shares as provided in the Will and the Codicil to the Will. One of the residual beneficiaries is a non-resident of Australia for tax purposes. The remaining trust (Trust C) is still operating paying income to family member C for life. On the death of family member C, the trust fund will also be distributed to the grandchildren who are residual beneficiaries or to their respective estates. It’s confirmed that the administration of the Trust B is based on the terms of the Will and the Codicil to the Will. No formal deed was executed for any of the three testamentary trusts. It’s also confirmed that the assets held in the Trust B comprise of securities and unlisted managed funds and that these assets are not taxable Australian property for the purposes of Division 855 of the ITAA 1997.

Relevant legislative provisions: Income Tax Assessment Act 1936 S ection 272-5 of Schedule 2F | Subsection 272-5(1) of Schedule 2F | Section 272-65 of Schedule 2F | Subsection 95A(2) | Income Tax Assessment Act 1997 Section 855-15 | Section 855-40 | Subsection 855-40(2) | Paragraph 855-40(2)(a); | Subparagraph 855-40(2)(b)(i) | Subparagraph 855-40(2)(c)(i) | Subsection 995-1(1)

Reasons for decision: Detailed Reasoning - Fixed Trust: Section 272-65 of Schedule 2F to the ITAA 1936 provides that a trust is a 'fixed trust' if persons have fixed entitlements to all of the income and capital of the trust. Subsection 995-1(1) of the ITAA 1997 provides that a trust is a fixed trust if entities have fixed entitlements to all of the income and capital of the trust. Subsection 272-5(1) of Schedule 2F to the ITAA 1936 provides that, in relation to the meaning of the term fixed entitlement: 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. 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. The meaning of the term 'vested and infeasible' (in the context of the Schedule 2F) has not been judicially considered. However, the term appears in Division 6 in subsection 95A(2) of the ITAA 1936 and in the context of that subsection, the term has been considered by the courts; for example, refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4, 525; 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) 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; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490. The term 'vested and indefeasible' is not defined in the taxation legislation and to date there is no 'ATO view' which defines or clarifies the term. The Explanatory Memorandum (EM) to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 which introduced the trust loss measures gives an explanation in relation to the meaning of ‘vested and indefeasible’ interest (see paragraphs 13.3 to 13.9). | Detailed Reasoning - What is a vested interest?: The EM states: 13.4 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. A vested interest is to be contrasted with a 'contingent' interest which may never fall into possession. If an interest of a beneficiary in income or capital is the subject of a condition precedent, so that an event must occur before the interest becomes vested, the beneficiary does not have a vested interest to the income or capital since such an interest is instead 'contingent' upon the event occurring. 13.5 In traditional legal analysis, a person can be said to be either 'vested in possession' or 'vested in interest'. A present interest, i.e. one that is being enjoyed, is said to be 'vested in possession'; a future interest, i.e. one which gives its holder a present right to future enjoyment, is said to be 'vested in interest'. A person is vested in possession where the person has a right to immediate possession or enjoyment of the thing in question. In the definition of fixed entitlement, 'vested' includes both vested in possession and vested in interest. 13.6 Because vested interests include future interests, a person can have a vested interest in a thing even though the person's actual possession and enjoyment of the thing is delayed until sometime in the future. | Detailed Reasoning - When is a vested interest indefeasible?: The EM states: 13.7 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. 13.8 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. | Detailed Reasoning - Vested and indefeasible interests and a deceased estate: ATO Interpretative Decision ATO ID 2006/279 expresses the view that the terms of the Will governing the disposition of the property in the deceased estate confer fixed entitlements to all of the income and capital of the estate upon the residuary beneficiaries. The ATO ID explains that the interest of the residuary beneficiaries in the income and capital of the estate is indefeasible. There is no condition in the trust instrument, the Will (and Codicil of the Will), by which any of the residuary beneficiaries could lose their interest in the estate. In relation to vesting, it is considered that for any interest to be ‘vested in interest’, the following conditions are present (Evans, M Equity & Trusts , Sydney: Butterworths 2003 at 354): a. The person or persons entitled to the interest must be ascertained; b. The interest must be ready to take effect in possession immediately upon termination of the prior interest; c. The gift must not be subject to any contingency; and d. Where the gift is in favour of a class, every member of the class must be ascertained (that is, identified), and the exact share of the each must also be ascertained. | Detailed Reasoning - Defeasible v indefeasible: With reference to the certainty of their duration, interests are divided into defeasible interests and indefeasible or absolute interests (Fearne, C An Essay on the Learning of Contingent Remainders and Executory Devises, ( Colorado: Rothman, 10th ed 1980), Vol. 2, at 30). A defeasible interest is an interest that is subject to be defeated by the operation of a subsequent or mixed condition; An indefeasible interest, or an absolute interest as opposed to a defeasible interest, is one that is not subject to any condition. In relation to the term ‘defeasance’ Fearne provides that (at 9): Defeasances are provisos of the same import and efficacy as proper conditions subsequent, but are contained in a distinct deed, either delivered at the same time with the deed to which the condition relates, or, except in the case of things executory or chattels, delivered after the deed to which the condition relates. | Detailed Reasoning - Do vested and indefeasible interests exist in the income and capital of the Trust?: In relation to the income and capital of the Trust B in this case: a). The beneficiaries entitled are the grandchildren of the deceased individual. The grandchildren were all identified and ascertained. b). The grandchildren are ready to take possession of their interest in possession after the death of family member B (life tenant). The residual beneficiaries are able to take possession of their interests in the income and capital of the Trust B after the death of family member B as provided in the Will and the Codicil to the Will. c). No contingencies exist. By the time family member B died, the residual beneficiaries have all attained the age conditions specified in the Will and the Codicil to the Will and they are all living. d). Each of the beneficiaries is entitled to equal shares of the Trust B based on the terms of the Will and the Codicil to the Will. In this case, there are no conditions subsequent or any indication that anything external to the Will or in the Codicil to the Will that will have the effect of a condition subsequent in relation to the capital of the Trust B, by which the beneficiaries could lose their interests in the Trust. Therefore the residual beneficiaries have a vested and indefeasible interest in the income and capital of the Trust B. | Detailed Reasoning - Conclusion: Given the interests of the residual beneficiaries in the income and capital of the Trust B are vested and indefeasible, then fixed entitlements exist in accordance with subsection 272-5(1) of Schedule 2F to the ITAA 1936. As such the Trust B is a fixed trust in accordance with section 272-65 of Schedule 2F to the ITAA 1936 and subsection 995-1(1) of the ITAA 1997 following the death of family member B. This conclusion is consistent with the view expressed in ATO ID 2006/279. | Detailed Reasoning - CGT exemption in section 855-40 of the ITAA 1997: Section 855-40 provides a CGT exemption for foreign residents making a capital gain in respect of their interest in a fixed trust (including a managed fund). Relevantly, subsection 855-40(2) provides that a capital gain you make in respect of your interest in a fixed trust is disregarded if: ● you are a foreign resident when you make the gain: paragraph 855-40(2)(a); and ● the gain is attributable to a CGT event happening to a CGT asset of a trust (the CGT event trust) that is the fixed trust: subparagraph 855-40(2)(b)(i); and ● the asset is not taxable Australian property for the CGT event trust at the time of the CGT event: subparagraph 855-40(2)(c)(i). In the present case, the relevant conditions in subsection 855-40(2) are satisfied in respect of the interests of the non-resident residuary beneficiary in the Trust B. This is because the residuary beneficiary is a non-resident of Australia for tax purposes when the beneficiary makes the capital gain attributable to the CGT event trust that is a fixed trust and the assets held by the Trustee in the Trust B are not taxable Australian property for the purposes of Division 855 of the ITAA 1997. Also the beneficiary’s interest in the Trust B, an Australian resident trust, falls outside the definition of taxable Australian property in section 855-15 of the ITAA 1997. | Detailed Reasoning - Conclusion: Given that the Trust B is found to be a fixed trust, the non-resident beneficiary of the Trust B can disregard any capital gain made in respect of their interest in the Trust under subsection 855-40(2) of the ITAA 1997.