Private ruling: CGT - deceased estate
Date of advice: 8 September 2023
Published: 16 October 2023
Ruling period: Income year ended 30 June 2023
Date scheme commenced: 1 July 2021

Ruling: Q1: Is the Beneficiary's cost base and reduced cost base for calculating capital gains tax on assets that were owned by the deceased at the date of death (ie the Private Company shares) and transferred by the Trustee to the Beneficiary determined under subsection 128-15(4) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Is the first element of the cost base and reduced cost base of assets transferred by the Trustee to the Beneficiary (as beneficiary) that were not owned by the deceased at the date of death (Ie the listed shares) the market values of the assets at the date they were acquired by the beneficiary from the Trustee? | A2: Yes

Relevant facts and circumstances: 1. The Beneficiary is an Australian resident. 2. The Beneficiary, is a beneficiary of the Will of the Testator. 3. The Testator executed his Last Will & Testament on XX XX XX. 4. The Testator died on XX XX XX and probate was granted on XX XX XX with AA as the legal personal representative (LPR). 5. Just before the Testator's death the Testator owned the principal place of residence and a share portfolio, which included listed shares and shares in private companies, XXX (together 'Private Companies'). 6. The Private Companies were incorporated after 20 September 1985. 7. At clause XX of the Testator's Will, the residuary of the Testator's estate was to be held on trust (Testamentary Trust) with Trustee. The net annual income of the trust was to be paid to the Testator's Life Interest, XXXX, during their lifetime. 8. At clause XX of the Testator's Will, after the date of death of Life Interest, ('the Vesting Date') the Trustee is to hold the residuary of the estate as to capital and income upon trust for the Beneficiary. 9. The deceased's Life Interest, passed away on XX XX XX. 10. At the date of death of Life Interest, the testamentary trust included assets of a main residence, shares in both listed and the Private Companies and cash. 11. There were no assets owned by the Testator at the date of death that were held by the Trustee at the Vesting Date other than the principal place of residence and the shares in the Private Companies. All listed shares held by the Trustee at Vesting Date were acquired by the Trustee. 12. The Trustee transferred listed share assets to the Beneficiary on XX XX XX. 13. On or about XX XX XX, the Trustee transferred to the Beneficiary their entitlement of shares in the Private Companies. 14. The principal place of residence is not an asset that has been transferred to the Beneficiary.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 104-10 | Income Tax Assessment Act 1997 section 104-55 | Income Tax Assessment Act 1997 section 104-75 | Income Tax Assessment Act 1997 Division 109 | Income Tax Assessment Act 1997 subsection 109-5(1) | Income Tax Assessment Act 1997 subsection 109-5(2) | Income Tax Assessment Act 1997 subsection 110-25(2) | Income Tax Assessment Act 1997 110-55(2) | Income Tax Assessment Act 1997 subsection 112-20(1) | Income Tax Assessment Act 1997 paragraph 112-20(1)(a) | Income Tax Assessment Act 1997 paragraph 112-20(1)(c) | Income Tax Assessment Act 1997 subsection 112-20(2) | Income Tax Assessment Act 1997 Division 128 | Income Tax Assessment Act 1997 section 128-15 | Income Tax Assessment Act 1997 subsection 128-15(2) | Income Tax Assessment Act 1997 subsection 128-15(4) | Income Tax Assessment Act 1997 section 128-20 | Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision: Summary: CGT assets that were owned by the Testator just before their death, i.e. the shares in the Private Companies, that are transferred by the Trustee to the Beneficiary will have the same cost base as the Testator's cost base (or reduced cost base) that each asset had on the day of the Testator's death. | Detailed Reasoning - Distribution of the private company shares owned by the Testator at the date of death: Section 128-15 of the ITAA 1997 sets out what happens to a CGT asset that a decedent taxpayer owned just before their death that devolves to their legal personal representative or passes to a beneficiary in their estate. The term 'legal personal representative' is defined in subsection 995-1(1) of the ITAA 977 and includes an executor or administrator of an estate of an individual who has died. Subsection 128-15(2) of the ITAA 1997 provides that the LPR is taken to have acquired the asset on the day the decedent died. Under section 128-20 of the ITAA 1997, an asset passes to a beneficiary in a decedent's estate if the beneficiary becomes the owner of the asset: (a) under your will, or that will as varied by a court order; or (b) by operation of an intestacy law, or such a law as varied by a court order; or (c) because it is appropriated to the beneficiary by your legal personal representative in satisfaction of a pecuniary legacy or some other interest or share in your estate; or (d) under a deed of arrangement if: i. the beneficiary entered into the deed to settle a claim to participate in the distribution of your estate; and; ii. any consideration given by the beneficiary for the asset consisted only of the variation or waiver of a claim to one or more other CGT assets that formed part of your estate. (It does not matter whether the asset is transmitted directly to the beneficiary or is transferred to the beneficiary by your legal personal representative) The table in subsection 128-15(4) of the ITAA 1997 sets out the modifications to the cost base and reduced cost base of the CGT asset in the hands of the LPR or beneficiary. Relevantly, item 1 of the table in subsection 128-15(4) of the ITAA 1997 provides that where the decedent acquired the asset on or after 20 September 1985, the first element of the acquirer's cost base - the acquisition cost - is the decedent's cost base for the asset on the day they died under item 1 in the table, unless it is covered by another item in the table. When the estate of a decedent is administered and a testamentary trust is created under the will over the assets of the decedent and the trustee holds the assets on behalf of the beneficiaries of the will, CGT event E1 in section 104-55 of the ITAA 1997 happens at the time the trust is created. In this case the Trustee acquires the original asset from the LPR at the date of the Testator's death: subsection 128-15(2) of the ITAA 1997. The Trustee's acquisition cost is determined under subsection 128-15 of the ITAA 1997. Subsection 128-15(4) of the ITAA 1997 provides that assets which the decedent acquired on or after 20 September 1985 (other than trading stock and their main residence) are acquired with a cost base or reduced cost base equal to the decedent's cost base or reduced cost base on the day of death. In this case, as the assets were acquired by the Testator after 20 September 1985 the Trustee's cost base and reduced cost base of the shares in the Private Companies is that of the Testator at the date of death. If, on the ending of the life interest, the remainder owner becomes absolutely entitled, as against the trustee, to a trust asset, CGT event E5 in section 104-75 of the ITAA 1997 may happen. In that case the cost base and reduced cost base of the shares for the beneficiary is the market value (See explanation to Question 2). However, the event does not happen if the trust is a unit trust or a trust to which Division 128 of the ITAA 1997 applies. Relevantly, in relation to the exception for 'a trust to which Division 128 of the ITAA 1997 applies' is considered in TR 2006/14 as follows: 202. Division 128 applies to the passing of an asset from a deceased individual's legal personal representative to a beneficiary in their estate (provided the asset was owned by the deceased individual at the time of their death). 203. Accordingly, 'a trust to which Division 128 applies' requires more than the identification of the trust as a deceased estate. The Commissioner considers that the words 'a trust to which Division 128 applies' should be interpreted as a deceased estate to the extent that it is a trust over an asset originally owned by a deceased individual and which may pass to the beneficiary in accordance with section 128-20 (that is, under the will, by intestacy and so on). 204. In the context of CGT events E5, E6 and E7 this means that the exception applies if subsection 128-15(3) applies to relieve any capital gain or capital loss that arises (or would apply in that way if there were a capital gain or capital loss) when an asset passes from the deceased's legal personal representative to a beneficiary in their estate. 205. In certain circumstances the Commissioner treats the trustee of a testamentary trust in the same way as he treats a legal personal representative in relation to the passing of an asset of the deceased to a beneficiary: Law Administration Practice Statement PS LA 2003/12. This is relevant for the scope of the exception in CGT events E5 to E7 which deal with such a passing of an asset. ... As noted above, the trustee of a testamentary trust (being a trust created under a will or by the operation of statute, such as intestacy laws) is treated in the same manner as the LPR for the purposes of applying Division 128 of the ITAA 1997: ATO Practice Statement Law Administration PS LA 2003/12 Capital gains tax treatment of the trustee of a testamentary trust . As stated in PS LA 2003/12: | Detailed Reasoning - 1. What this practice statement is about: This practice statement confirms the Commissioner's longstanding administrative practice of treating the trustee of a testamentary trust in the same way as a legal personal representative for the purposes of Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997), in particular subsection 128-15(3). | Detailed Reasoning - 2. What is the effect of the practice for the trustee of a testamentary trust?: Broadly stated, the ATO's practice is to not recognise any taxing point in relation to assets owned by a deceased person until they cease to be owned by the beneficiaries named in the will (unless there is an earlier disposal by the legal personal representative or testamentary trustee to a third party or CGT event K3 applies). | Detailed Reasoning - 3. What is the effect of the practice for a beneficiary?: The cost base and reduced cost base of the asset in the hands of the beneficiary is calculated in the same way as it would have been if the asset had passed to them from the deceased's legal personal representative. If the deceased acquired the asset before 20 September 1985 (that is, pre-CGT) the acquisition cost will be equal to the market value at the date of the deceased's death. If the deceased acquired the asset on or after 20 September 1985, the beneficiary's acquisition cost will be determined in accordance with items 1, 2, 3 or 3A of the table in subsection 128-15(4) of the ITAA 1997. Consequently, it follows that when the Trustee made the distribution of the shares of the Private Companies to the Beneficiary the cost base or reduced cost base of those shares is the same as that of the Testator on the day the Testator died. | Summary: CGT assets that were acquired by the Trustee, the listed share assets, that are transferred by the Trustee of the Testamentary Trust to the Beneficiary will have a cost base (or reduced cost base) of the market value at the date of the transfer of the listed share assets. | Detailed Reasoning - Distribution of company shares not owned by the Testator at the date of death: Division 109 of the ITAA 1997 sets out the rules in relation to the acquisition of CGT assets. Subsection 109-5(1) of the ITAA 1997 provides that, in general, you acquire a CGT asset when you become its owner. Subsection 109-5(2) of the ITAA 1997 provides rules in relation the acquisition time of CGT assets in specific circumstances. Relevantly, when CGT event number E5 occurs the beneficiary under a trust becomes absolutely entitled to a CGT asset of the trust as against the trustee (disregarding any legal disability) - therefore the beneficiary acquires the asset when they become absolutely entitled. Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (TR 2004/D25) provides the Commissioner's view on what is meant by the term 'absolute entitlement'. The core principle underpinning the concept of absolute entitlement is the ability of the beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred at their discretion. Paragraph 23 TR 2004/D25 states if there is more than one beneficiary with interests in a trust asset, 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. Paragraph 54 of TR 2004/D25 adds that the requirement for absolute entitlement cannot be satisfied if there are multiple beneficiaries for a single asset such as land. While each beneficiary may have an interest in, and therefore be entitled to, a share of the land, no beneficiary is entitled to the whole of it. The same goes for a single asset that is property. Further, paragraph 72 of TR 2004/D25 states that a beneficiary of a deceased estate does not have any interest in any asset of the estate (and therefore cannot be considered absolutely entitled to any of the estate's assets) until administration of the estate is complete. As there are two remainder owners, they would not usually become absolutely entitled to the trust assets on the death of the life interest owner, unless the assets were fungible and certain other requirements were met: see Taxation Ruling TR 2004/D25 Further under the rules in subsection 109-5(2) of the ITAA 1997 when CGT event number E7 occurs, the trustee disposes of a CGT asset of the trust to you to satisfy your interest, or part of it, in trust capital. The asset is acquired when the disposal occurs. Subsection 104-10 of the ITAA 1997 provides the meaning of dispose of a CGT asset: 104-10(2) 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. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner. Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event A1 will not happen merely because of a change in the trustee. In this case, the listed share assets that were acquired by the Trustee subsequent to the Testator's date of death and are distributed by the Trustee in-specie to the beneficiary, the beneficiary's first element of the cost base and reduced cost base of each share is determined pursuant to subsections 110-25(2) and 110-55(2) of the ITAA 1997. However, there are a number of modifications to the general rules about cost base. The market value substitution rule in subsection 112-20(1) of the ITAA 1997 modifies the general rule by replacing the first element of the cost base and reduced cost base of a CGT asset acquired from another entity with its market value (at the time of acquisition) where: (a) You did not incur expenditure to acquire it, except where your acquisition of the asset resulted from: (i) *CGT event D1 happening; or (ii) another entity doing something that did not constitute a CGT event happening; or (b) some or all of the expenditure you incurred to acquire it cannot be valued; or (c) you did not deal at *arm's length with the other entity in connection with the acquisition. However, despite paragraph 112-20(1)(c) of the ITAA 1997, subsection 112-20(2) states that if a) you did not deal at *arm's length with the other entity; and b) your *acquisition of the CGT asset resulted from another entity doing something that did not constitute a CGT event happening: the market value is substituted only if what you paid to acquire the CGT asset was more than its market value (at the time of acquisition). Having regard to paragraph 112-20(1)(a) of the ITAA 1997, as the Beneficiary did not incur any expenditure to incurred to acquire the listed share assets, the first element of the cost base will be the market value at the time of acquisition.