Issue
Are a discretionary trust and a company, whose shareholders are beneficiaries of the trust, connected with each other for the purposes of the maximum net asset value test under sub-paragraph 152-15(a)(ii) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
Yes. As the company controls the discretionary trust, the trust and the company are entities that are connected with each other for the purposes of the maximum net value asset test .
Facts
The discretionary trust carried on a primary production business on land which was the property of the trust. The trust disposed of the land and a capital gain was realised on disposal of that land. The trust seeks to apply the provisions allowing small business relief in respect of that capital gain.
The trust acknowledges that the sum of the net value of its CGT assets and the net assets of a company, if connected, may be assumed to exceed $5,000,000. On that basis, the trust would not satisfy the maximum net asset value test for the purposes of section 152-15 of the ITAA 1997 if the trust were required to include the net value of CGT assets of the company for the purposes of paragraph 152-15(a) of the ITAA 1997.
According to the Deed of Settlement of the discretionary trust, there are five individual 'primary beneficiaries'. Each of these five individuals can be said to control the trust by the operation of subsection 152-30(5) of the ITAA 1997 as each is entitled to receive 100% of the distributions from the trust.
The Deed of Settlement also nominates other 'discretionary beneficiaries', including any company or trust in which the 'primary beneficiaries' are shareholders or beneficiaries. The company has as its beneficial shareholders three of the individual 'primary beneficiaries'.
Reasons for Decision
To determine if an entity is eligible for the capital gains tax concessions for small business, the maximum net value of assets of the entity, entities connected with it and the entity's CGT affiliates must not exceed $5 million under section 152-15 of the ITAA 1997.
Subsection 152-30(1) of the ITAA 1997 describes how entities are connected with each other. It says that an entity will be connected to another entity if: • either entity controls the other entity; or • both entities are controlled by the same third entity.
In relation to discretionary trusts, subsection 152-30(5) of the ITAA 1997 describes how a trust can be controlled by a beneficiary.
To determine if a beneficiary controls a discretionary trust that beneficiary is taken to have an interest in any distribution of income or capital of the trust equal to the maximum percentage of the income or capital that the trustee could distribute to that beneficiary under the trust deed, regardless of the actual distribution. If that interest is at least 40% the beneficiary is taken to control the family trust . This may, depending on the terms of the trust deed, result in several or all of the beneficiaries of a discretionary trust being taken to control the trust.
As the shares in the company are either legally or beneficially owned by the 'primary beneficiaries' of the trust, the company is a discretionary beneficiary. This is because the Deed of Settlement states that the trustee can in its discretion pay or apply the income of the trust to any one of the beneficiaries named in the clause including a company in which the 'primary beneficiaries' are shareholders.
The company is a beneficiary of the trust and according to the trust deed is capable of receiving all the income of the trust to the exclusion of all other beneficiaries, thus making the company connected with the trust in terms of subsection 152-30(5) of the ITAA 1997.
The company therefore controls the trust in the way described in subsection 152-30(5) of the ITAA 1997. As the company controls the trust they are connected to each other. The net value of the CGT assets of the company must be taken into account when applying the maximum net asset value test to the trust.