Private ruling: Division 6AA of the Income Tax Assessment Act 1936 (ITAA 1936)
Date of advice: 23 June 2017
Published: October 2017
Ruling period: Income year ending 30 June 2017 | Income year ending 30 June 2018 | Income year ending 30 June 2019 | Income year ending 30 June 2020 | Income year ending 30 June 2021
Date scheme commenced: 1 July 2016

Ruling: Q1: Will a prescribed person’s share of the net income as a beneficiary of the Testamentary Trust from a distribution made by the family trust (including the dividend sourced from the liquidation of the company), be excepted trust income of the beneficiary within the meaning of subsection 102AG(2)? | A1: Yes | Q2: Will the Commissioner exercise his discretion under subsection 99A(2) so that the trustee of the Testamentary Trust is assessed and liable to pay tax under section 99 on the share of the net income of the Testamentary Trust referable to the trust income to which no beneficiary is presently entitled provided that the assets of the Testamentary Trust remain as described in the private binding ruling (PBR) application, as invested, realised and reinvested from time to time? | A2: Yes Upon the vesting of the family trust: | Q3: Will a prescribed person’s share of the net income as a beneficiary of the Testamentary Trust derived from money or property distributed to it by the family trust be excepted trust income of the beneficiary within the meaning of subsection 102AG(2)? | A3: Yes | Q4: Will the Commissioner exercise his discretion under subsection 99A(2) so that the trustee of the Testamentary Trust is assessed and liable to pay tax under section 99 on the share of the net income of the Testamentary Trust referable to the trust income to which no beneficiary is presently entitled provided that the assets of the Testamentary Trust remain as described in the PBR application, including the proceeds of investment of those assets as invested, realised and reinvested from time to time? | A4: Yes

Relevant facts and circumstances: 1. The deceased died leaving a will and an estate comprising personal and business assets. At the time of their death, a substantial part of the assets which the deceased accumulated as a result of their business activities were held by the company. All the shares in the company are held by the trustee company in its capacity as trustee of the family trust. The shares in the company were acquired prior to 20 September 1985. 2. At the time of their death, the deceased was a director and secretary of both the company and trustee company and they were also the guardian and appointer of the family trust. The deceased had a partner, adult children and grandchildren (including minors). The deceased’s children and accountant, XY, are the executors and trustees of the will (estate trustees). 3. In the will, the deceased made specific bequests for the benefit of their partner and children. The will then provides for the deceased’s residuary estate to be held equally upon four discretionary testamentary trusts for the grandchildren, one of which is the Testamentary Trust. The trustees of the testamentary trusts are capable of inclusion as income and capital beneficiaries of the family trust. 4. The deceased sought to ensure that the shares in the trustee company (and consequently the assets of the family trust) were effectively treated as assets of their estate. In particular, clause X of their will provides: To transfer my shares in [the trustee company] as trustee of the [family trust] (a discretionary trust) to my trustees so that each hold an equal number of shares in that company upon condition that: (a) all decisions of both directors and shareholders must be by no less than four of them one being the said [XY]; (b) subject to clause [Y] of this will the company will sell and convert into cash all the assets of the [family trust] and distribute one half of the proceeds between my children in equal shares and the other half equally between each of the four trusts established for my grandchildren under clauses [D, E and F] of this will. 5. The Testamentary Trust’s representative has advised that, notwithstanding the intention and desire on the part of the deceased to impose specific testamentary trust obligations in respect of the shares in the trustee company, those obligations would have the effect of fettering the discretion of the estate trustees in the discharge of their obligations under the trust deed. Accordingly, what were clearly wishes of the deceased with regard to the trust assets is a matter which would be taken into account by the estate trustees in the exercise of their discretion, but would not be binding upon them. 6. The shares in the trustee company have been transferred to each of the estate trustees. The estate trustees have determined that YY (one of the deceased’s children) should be sole director of the trustee company. YY, as sole director of the trustee company, after consultation with their siblings and applying their independent will, is disposed to honour the deceased’s wishes and to cause the trustee company to make the distributions referred to in clause X of the will. 7. The Testamentary Trust’s representative has advised that the assets of the company have now been disposed of and the company holds only cash. The trustee company (as sole shareholder of the company) and the directors of the company will cause the company to be placed in voluntary liquidation and appoint a liquidator. The proceeds of the liquidation will be received by the family trust and disposed of in accordance with the determination of YY as sole director of the trustee company. 8. The Testamentary Trust’s representative indicates that on the assumption that the decision is made in accordance with the deceased’s wishes as stated in clause X of the will, the proceeds of the liquidator’s distribution will be divided into equal parts for distribution to the children and the grandchildren’s four testamentary trusts. The proposed trust distributions will be made by the trustee company as part of the vesting of the family trust. 9. The trust deeds for the family trust and the four testamentary trusts contain no definition of 'income’ or 'capital’. It is acknowledged by the Testamentary Trust’s representative that the liquidator’s distribution and the amount distributed upon vesting of the family trust to the testamentary trusts will both be characterised as capital of the trust. 10. The minor grandchildren will all be a 'prescribed person’ under subsection 102AC(1) for the purposes of Division 6AA and none will be an 'excepted person’ for the purposes of subsection 102AC(2). Assumptions 11. Administration of the estate will be completed prior to the year ending 30 June YYYY and each of the grandchildren’s testamentary trusts will receive an equal share of the deceased’s residuary estate in the year ending 30 June YYYY. 12. The company will be put into liquidation during the year ending 30 June YYYY. There will be no liquidator’s distribution from the family trust to the grandchildren’s testamentary trusts during the year ending 30 June YYYY. Rather, the liquidator’s distribution will form part of the capital distributions made by the family trust in favour of the testamentary trusts in the income year in which the vesting of the family trust occurs. 13. The family trust will vest in favour of the testamentary trusts during the year ending 30 June ZZZZ following the completion of the liquidation of the company. 14. Following administration of the estate and the vesting of the family trust, each of the grandchildren’s testamentary trusts will have received an equal share of the deceased’s residuary estate; an equal share of the liquidator’s distribution upon the winding up of the company; and an equal share of any interest income derived by the family trust from the short-term investment of the proceeds of the liquidator’s distribution.

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 1936 subsection 99A(3) | Income Tax Assessment Act 1936 Division 6AA | Income Tax Assessment Act 1936 subsection 102AA(1) | Income Tax Assessment Act 1936 subsection 102AC(1) | Income Tax Assessment Act 1936 subsection 102AC(2) | Income Tax Assessment Act 1936 section 102AG | Income Tax Assessment Act 1936 subsection 102AG(1) | Income Tax Assessment Act 1936 subsection 102AG(2) | Income Tax Assessment Act 1936 paragraph 102AG(2)(a) | Income Tax Assessment Act 1936 subparagraph 102AG(2)(a)(i) | Income Tax Assessment Act 1936 subsection 102AG(3) | Income Tax Assessment Act 1936 subsection 102AG(4)

Reasons for decision: Summary: A prescribed person’s share of the net income as a beneficiary of the Testamentary Trust from a distribution made by the family trust (including the dividend sourced from the liquidation of the company) will be excepted trust income of the beneficiary within the meaning of subsection 102AG(2). | Detailed Reasoning - Detailed reasoning: 1. Section 102AG specifies the circumstances in which Division 6AA will apply to trust income. Specifically, subsection 102AG(1) provides that where a beneficiary of a trust estate is a prescribed person, Division 6AA will apply to so much of the beneficiary’s share of the net income of the trust estate as, in the opinion of the Commissioner, is attributable to the assessable income of the trust estate that is not, in relation to the beneficiary, excepted trust income. 2. Subsection 102AG(2) specifies the types of trust income that will be 'excepted trust income’. Subsections 102AG(3) and (4) are anti-avoidance provisions that may apply to exclude income from being excepted trust income in certain circumstances. It is therefore necessary to consider the operation of subsections 102AG(2), (3) and (4) to determine whether a minor grandchild’s (prescribed person’s) share of the net income as a beneficiary of the Testamentary Trust from a distribution made by the family trust will be excepted trust income of the beneficiary. | Detailed Reasoning - Subsection 102AG(2): 3. Subparagraph 102AG(2)(a)(i) provides that an amount included in the assessable income of a trust estate is excepted trust income in relation to a beneficiary of the trust estate to the extent to which the amount is assessable income of a trust estate that resulted from a will. 4. It is therefore necessary to determine whether the assessable income of the Testamentary Trust is 'excepted trust income’ because it resulted from a will within the meaning of subparagraph 102AG(2)(a)(i). A question of construction arises as to whether the words 'resulted from’ relate to the 'assessable income’ or to the 'trust estate’ referred to. 5. In The Trustee for the Estate of the Late AW Furse No. 5 Will Trust v Federal Commissioner of Taxation 21 ATR 1123; 91 ATC 4007 ( Furse ) , counsel for the Commissioner argued for the former interpretation. The Commissioner’s submission that for subparagraph 102AG(2)(a)(i) to operate it was necessary that the assessable income of the trust estate be sourced in the will or property of the deceased, was not accepted. In Furse , the trustee of the A.W. Furse No. 5 Will Trust borrowed funds and used the borrowed funds to invest in such a way to derive assessable income from the investment. The consequence of such an investment was that assessable income was derived by the trust estate so that income was 'assessable income of a trust estate’ and the trust estate was one that resulted from a will. 6. In obiter, Hill J (91 ATC 4007 at page 4018) said: With respect, I do not accept the Commissioner’s submission. It requires that the words in sec. 102AG(2)(a) 'that resulted from’ refer to the assessable income rather than to the words in subsection (i) 'a will’ etc. or in subsection (ii) 'an intestacy’ etc. In my opinion all that is necessary to fall within sec. 102AG(2)(a) is that the assessable income be assessable income of the trust estate, that trust estate being one of the forms of trust estate referred to in sec.102AG(2)(a)(i) or (ii) (that is to say not an inter vivos trust) … In my view the consequence of such an investment was that assessable income was derived by the trust estate so that the income was 'assessable income of the trust estate’ and clearly enough the trust estate was one that resulted from the will of the late Mr Furse. 7. In the present case, under the will, four testamentary trusts are to be established for the deceased’s grandchildren. As each of the testamentary trusts are created by clause F of the deceased’s will they will be trust estates that resulted from a will under subparagraph 102AG(2)(a)(i). 8. Following Furse , it seems that all that is necessary for the assessable income of a trust estate to fall within subparagraph 102AG(2)(a)(i) is that the assessable income be the assessable income of the trust estate and that the trust estate be one of the forms of trust estate referred to in paragraph 102AG(2)(a) - which includes a trust estate resulting from a will. To the extent that any amounts representing a distribution from the family trust to the Testamentary Trust are assessable income of the Testamentary Trust, the amounts in each case will, on that reasoning, be 'assessable income of a trust estate that resulted from a will’ for the purposes of subparagraph 102AG(2)(a)(i) and, unless excluded by the operation of any of the subsequent subsections of section 102AG, will be 'excepted trust income’. 9. It is therefore necessary to consider whether subsections 102AG(3) or (4) then apply to exclude the 'assessable income of a trust estate that resulted from a will’ from being excepted trust income within the meaning of subsection 102AG(2). | Detailed Reasoning - Subsection 102AG(3): 10. Subsection 102AG(3) excludes income from being excepted trust income in circumstances where that income is derived from transactions (or there is an act or transaction directly or indirectly connected with the derivation of that income) between parties who are not dealing with each other at arm’s length in relation to the derivation of that income. 11. The expression 'not dealing with each other at arm’s length’ was discussed by Hill J. in Furse (91 ATC 4007 at page 4014 – 4015) where he concluded: The first of the two issues is not to be decided solely by asking whether the parties to the relevant agreement were at arm’s length to each other. The emphasis in the subsection is rather upon whether those parties, in relation to the agreement, dealt with each other at arm’s length. The fact that the parties are themselves not at arm’s length does not mean that they may not, in respect of a particular dealing, deal with each other at arm’s length. 12. In Granby Pty Ltd v Federal Commissioner of Taxation; (1995) 30 ATR 400, Lee J. accepted that (in the context of section 160ZH) parties are at arm’s length where they have acted severally and independently in forming their bargain. Lee J, at page 403, added: The expression 'dealing with each other at arm’s length’ involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction. What is asked is whether the parties behaved in the manner in which parties at arm’s length would be expected to behave in conducting their affairs. Of course, it is relevant to that enquiry to determine the nature of the relationship between the parties, for if the parties are not at arm’s length the inference may be drawn that they did not deal with each other at arm’s length. 13. In relation to the derivation of the excepted trust income, there are two parties: the trustee company as trustee of the family trust and the trustee of the testamentary trusts as the trustee beneficiary. 14. The issue to be considered, therefore, is whether subsection 102AG(3) applies such that the income distributed by the trustee company to the trustee beneficiary would not be excepted trust income on the basis that the respective trustees, being parties to the derivation of the income, or acts or transactions connected with the derivation of income, were not dealing with each other at arm’s length. 15. In the present case, the relevant transactions or dealings between the trustee company and the trustee beneficiary involve the respective trustees exercising their powers of appointment. The exercise of a power of appointment is a unilateral act of the trustee. A trustee derives authority to make the appointment entirely from the trust deed and a beneficiary has no standing or capacity whatsoever in the decision making process of the trustee. 16. In deriving the excepted trust income, the trustee beneficiary has done nothing other than not disclaiming what has been appointed in their favour. There has been no meeting of minds between the trustee company and the trustee beneficiary in terms of the formation of a bargain as to whether there has been a dealing in the context of the phrase not dealing with each other at arm’s length . There has been no dealing in terms of the derivation of the excepted trust income as there has been no conduct on the part of the trustee company and the trustee beneficiary inter se which amounts to the forming of anything. 17. As to whether there is an 'act or transaction directly or indirectly connected with the derivation of the excepted trust income’, the issue may arise as to whether the distribution by the trustee company as trustee of the family trust in accordance with clause X of the will gives rise to a dealing between the deceased and the estate trustees. However, as stated in paragraph 5 of the ruling, what were clearly wishes of the deceased with regard to the trust assets is a matter which would be taken into account by the estate trustees in the exercise of their discretion, but would not be binding upon them. In this context, there could be no dealing as the estate trustees, whilst acting in accordance with the wishes of the deceased, did not act at his direction. 18. As a result, subsection 102AG(3) will not apply to exclude any assessable income derived by a beneficiary of the Testamentary Trust from a distribution made by the family trust from being excepted trust income under subparagraph 102AG(2)(a)(i). | Detailed Reasoning - Subsection 102AG(4): 19. Subsection 102AG(4) has the effect that an amount will not be excepted trust income under subsection 102AG(2) if it is assessable income derived directly or indirectly under or as a result of an agreement that was entered into or carried out by any person for the purpose, or for purposes that included the purpose, of securing that that assessable income would be excepted trust income. 20. The term 'agreement’ is defined in subsection 102AA(1) to mean any agreement, arrangement, undertaking or scheme, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable by legal proceedings. Although the definition of 'agreement’ for the purposes of Division 6AA in subsection 102AA(1) is very wide, the word 'agreement’ itself would appear to preclude a unilateral act. 21. As noted above, the relevant transactions or dealings between the trustee company and the trustee beneficiary involved the respective trustees exercising their powers of appointment. The exercise of a power of appointment in each case is a unilateral act of the trustee. As such, in securing the assessable income that would be the excepted trust income, there has been no conduct amounting to a dealing, or the formation of a bargain, on the part of the trustee company and the trustee beneficiary. Accordingly, a determination by the trustee company to distribute assessable income from the family trust to the trustee beneficiary is a unilateral act that will not constitute an 'agreement’ for the purposes of subsection 102AG(4). 22. As to whether there is an 'agreement’ between the deceased and the estate trustees under subsection 102AG(4), it is considered that the reasoning applied in paragraph 17 above is equally relevant in this context. The estate trustees have taken into account the wishes of the deceased under clause X of the will but have not been bound to follow these wishes and have exercised the discretion of the trustee of the family trust independently and not at the direction of the deceased. Therefore, there is no 'agreement’ between the deceased and the estate trustees for the purposes of subsection 102AG(4). 23. As a result, subsection 102AG(4) will not apply to exclude any assessable income derived by a beneficiary of the Testamentary Trust from a distribution made by the family trust from being excepted trust income under subparagraph 102AG(2)(a)(i). | Detailed Reasoning - Conclusion: 24. A minor grandchild’s (prescribed person’s) share of the net income as a beneficiary of the Testamentary Trust from a distribution made by the family trust will be excepted trust income of the beneficiary within the meaning of subsection 102AG(2). | Summary: The Commissioner will exercise his discretion under subsection 99A(2) so that the trustee of the Testamentary Trust is assessed and liable to pay tax under section 99 on the share of the net income of the Testamentary Trust referable to the trust income to which no beneficiary is presently entitled provided that the assets of the Testamentary Trust remain as described in the PBR application, as invested, realised and reinvested from time to time. | Detailed Reasoning - Detailed reasoning: 25. The practical effect of assessing the income of the Testamentary Trust under section 99 as opposed to section 99A is that it is assessed at ordinary marginal rates (without the benefit of the tax free threshold) as opposed to the penal rate of the top marginal tax rate. 26. Subsection 99A(2) states: This section does not apply in relation to a trust estate in relation to a year of income, being a trust estate: (a) that resulted from: (i) a will, a codicil or an order of a court that varied or modified the provisions of a will or a codicil; or … if the Commissioner is of the opinion that it would be unreasonable that this section should apply in relation to that trust estate in relation to that year of income. 27. Subsection 99A(3) outlines the factors the Commissioner shall have regard to in forming an opinion for the purposes of subsection 99A(2). 28. As the assessable income derived by a beneficiary of the Testamentary Trust can be treated as excepted trust income for the purposes of subparagraph 102AG(2)(a)(i), the Commissioner is of the opinion that he should exercise his discretion under subsection 99A(2) that the section does not apply. 29. The Commissioner has had regard to the factors in subsection 99A(3) and considers it reasonable to apply the discretion in these circumstances, provided that the assets of the testamentary trust remain as described in Question 2. | Detailed Reasoning - Question 3: For the same reasons provided in explanation to the answer to Question 1, a prescribed person’s share of the net income as a beneficiary of the Testamentary Trust derived from money or property distributed to it by the family trust will be excepted trust income of the beneficiary within the meaning of subsection 102AG(2). | Detailed Reasoning - Question 4: For the same reasons provided in explanation to the answer to Question 2, the Commissioner will exercise his discretion under subsection 99A(2) so that the trustee of the Testamentary Trust is assessed and liable to pay tax under section 99 on the share of the net income of the Testamentary Trust referable to the trust income to which no beneficiary is presently entitled provided that the assets of the Testamentary Trust remain as described in the PBR application, including the proceeds of investment of those assets as invested, realised and reinvested from time to time.

Subject: Division 6AA of the Income Tax Assessment Act 1936 (ITAA 1936): All legislative references are to the ITAA 1936.