Private ruling: Trust income - Commissioner's discretion and forfeited deposits
Date of advice: 13 November 2017
Published: March 2018
Ruling period: Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2015

Ruling: Q1: Will the Commissioner exercise his discretion not to apply the provisions of section 99A of the Income Tax Assessment Act 1936 (ITAA 1936) and assess the trust estate under section 99 of the ITAA 1936? | A1: Yes Issue 2 | Q2: Are the forfeited deposit and extension fee received included in the capital proceeds from the eventual disposal of the property? | A2: Yes

Relevant facts and circumstances: The deceased died on XX November 20XX. The assets of the estate came directly from the assets of the deceased. The main asset of the estate was property (the property). No beneficiaries were presently entitled to the assets of the estate between XX November 20XX and XX June 20XX. The administration of the estate was delayed by challenges to the estate and delays experienced in disposing of the property. The first contract for sale for the property was entered into in May 20XX. This contract was terminated in March 20XX due to the purchaser failing to settle the contract. $X forfeited deposit was retained by the estate as well as a $X extension fee after termination of the first contract. The second contract for sale for the property was entered into in June 20XX, but was later terminated by the purchaser in August 20XX. The third contract for sale for the property was entered into in January 20XX and settled in August 20XX. The property has either been under contract of sale, optioned, in negotiation or advertised for sale from 20XX until its sale in 20XX. No private or business use was conducted on the property since the deceased’s death. No loans between the estate and the beneficiaries have been entered into. Interim distributions have been made to the beneficiaries after the settlement of the property, but administration of the estate had not been finalised.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 99, | Income Tax Assessment Act 1936 Section 99A, | Income Tax Assessment Act 1936 Subsection 99A(2) | Income Tax Assessment Act 1997 Section 104-5 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 104-25 | Income Tax Assessment Act 1997 Section 104-50 | Income Tax Assessment Act 1997 Section 104-150

Reasons for decision: Detailed Reasoning - Issue 1: Sections 99 and 99A of the ITAA 1936 apply to assess the trustee on income to which no beneficiary is presently entitled, which is retained or accumulated by the trustee. In considering these sections, we must first consider section 99A. Section 99A applies in relation to all trusts unless: ● the trust is a deceased estate; subparagraph 99A(2)(a)(i) and (ii) ● the trust is bankrupt estate; paragraphs 99A(2)(b) and (c) ● the trust is a trust that consists of property referred to in paragraph 102AG(2)(c) and the Commissioner forms the opinion that it would be unreasonable to apply section 99A in such circumstances. Subsection 99A(2) of the ITAA 1936 outlines the circumstances when the Commissioner may apply his discretion for section 99A not to apply. The relevant part of subsection 99A(2) states that the discretion may be exercised where a trust estate resulted from a will, a codicil or an order of a court that varied or modified the provisions of a will or a codicil. The discretion is exercised where the Commissioner is of the opinion that it would be unreasonable for section 99A to apply. Consequently, the favourable exercise of the Commissioner's discretion under subsection 99A(2) means the highest rate of income tax does not apply to trust estates resulting from a will, codicil, etc. These include both the estate of a deceased person and 'testamentary' trusts established pursuant to the terms of a will. In forming an opinion pursuant to section 99A(2) whether it would be unreasonable for section 99A to apply to a particular trust estate in relation to a particular year of income, the Commissioner is directed by subsection 99A(3) to have regard to certain matters. It specifies the matters to be considered to include: ● The manner and price at which the trust acquired its assets; ● Whether any special rights or privileges are attached to, or conferred on or in relation to, the trust property; and ● Such other matters as the Commissioner thinks fit. These matters look at the source of the trust capital, including whether any loans have been made to the trust. The source(s) of the trusts income are also considered, as are any benefits conferred upon the trust, and any rights and privileges conferred on or attached to property held by the trust. In determining the weight to be given to the matters described in subsection 99A(3) , Windeyer J has stated in Giris Pty Ltd v FCT (1969) 119 CLR 365; 69 ATC 4015; (1969) 1 ATR 3 that: The Commissioner is to ask himself whether it would be unreasonable that section 99A of the ITAA should apply to any particular trust estate …. That purpose I take it is to enable the Commissioner to keep sec 99A as an instrument to prevent avoidance of taxation by the medium of trusts, but not to use it when to do so would seem to him not in accordance with that purpose. In these circumstances, the trust has been created through a will satisfying the eligibility for the Commissioner’s discretion. It was a trust whose assets come directly from the assets of the deceased and no loan or other arrangements have been entered into between the executor and the beneficiaries. There are no other suggestions that the manner in which the trust was created was for any reason other than the ordinary and traditional kind. Therefore it would be reasonable for the Commissioner to apply his discretion to allow section 99 of the ITAA 1936 to apply. | Detailed Reasoning - Issue 2: Section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. The time of the event is when you enter into the contract for the disposal or, if there is no contract, when the change of ownership occurs. Section 104-25 of the ITAA 1997 provides CGT event C2 happens if your ownership of an intangible CGT asset ends. The time of the event is when you enter into the contract that results in the asset ending or, if there is no contract, when the asset ends. Section 104-150 of the ITAA 1997 provides CGT event H1 happens if a deposit paid to you is forfeited because a prospective sale or other transaction does not proceed. The time of the event is when the deposit is forfeited. Taxation Ruling TR 1999/19 explains the capital gains tax ('CGT') consequences of the receipt by a vendor of a forfeited deposit, forfeited instalments of the purchase price and damages. Paragraph 11, 16, 18 and 148 of TR 1999/19 state: If the underlying asset was acquired by the vendor on or after 20 September 1985 (and is not subject to the main residence exemption), the forfeited deposit adds to a capital gain or reduces a capital loss made on any later disposal of the underlying asset, provided the forfeiture occurred as part of a 'continuum of events' which constituted the disposal of the underlying asset. For a relevant 'continuum of events' to exist, there must be an earlier contract to sell the underlying asset, forfeiture of a deposit and a later bona fide disposal of the underlying asset. It is also necessary, in our view, for continuous and reasonable attempts to be made to resell the underlying asset (for example, real estate) after the earlier contract has fallen through, which end in this later disposal of the real estate. If there is no longer a 'continuum of events' which constitutes a disposal of an underlying asset (e.g., after a 2 year period), a vendor is required to amend their income tax return for the earlier year in which the forfeiture occurred and include the forfeited deposit as assessable income. This is on the basis that the vendor's contractual rights are the most relevant asset and that there has been an acquisition and an ending of ownership of their contractual rights (CGT event C2). As a result of the decision in Brooks v FC of T [2000] FCA 721; 2000 ATC 4362; (2000) 44 ATR 352, in Taxation Ruling TR 1999/19A – Addendum , the Commissioner clarified that if the forfeiture of a deposit under a contract for the sale of real estate does not occur within a 'continuum of events' as that expression is used in TR 1999/19, the forfeited deposit is assessable under CGT event H1 in section 104-150 of ITAA 1997 (rather than assessable under CGT event C2 in section 104-25). Apart from these aspects, no other change to TR 1999/19 is necessitated by the decision in the Brooks case. We note the timing of the CGT event in both CGT event C2 and H1 is the same. In your case, the forfeited deposit and extension payment received will form part of the proceeds received from the CGT event A1 arising from the eventual disposal of the property.