Beneficiary becomes absolutely entitled to trust asset - whether any capital gain or loss arises

Will a capital gain or loss be made by a beneficiary, under subsection 104-75(5) of the Income Tax Assessment Act 1997 (ITAA 1997), upon the vesting of the trust with the beneficiaries becoming absolutely entitled to the trust assets (shares in a company)?

No, a capital gain or loss will not arise under subsection 104-75(5) of the ITAA 1997 when the beneficiary becomes absolutely entitled to the shares as against the trustee.

A discretionary trust was established prior to 20 September 1985. The trust property comprises shares (acquired prior to 20 September 1985) in a private company. It is proposed to vest the trust, with the beneficiaries becoming absolutely entitled to the shares.

When a beneficiary becomes absolutely entitled to a CGT asset of the trust (in this case, shares) as against the trustee, the beneficiary makes a capital gain if the market value of the shares at that time is more than the cost base of the beneficiary's interest in the trust capital to the extent it relates to the shares. A capital loss will arise if that market value is less than the reduced cost base of that beneficiary's interest in the trust capital to the extent it relates to the shares (subsection 104-75(5) of the ITAA 1997).

Taxation Determination TD 97/15 (as amended by Addendum TD 97/15A) explains that CGT event E4 (section 104-70 of the ITAA 1997) does not apply to a non-assessable payment made by a trustee to a beneficiary of a discretionary trust. One of the reasons for this position as set out in paragraph 1 of TD 97/15 is: '... because a discretionary beneficiary does not hold an "interest ... in the trust" of the nature or character referred to in subsection 104-70(1)

Paragraph 3 of Taxation Determination TD 97/15 expresses the following view: 'The interest that a discretionary beneficiary has in a discretionary trust (to have the trust estate properly administered and to be considered by the trustee in exercising a power or appointment to distribute income or corpus of the trust) is of a different nature from the type of interest in a trust referred to in subsection 104-70(1).'

However, in the case of CGT event E5 (subsection 104-75(5) of the ITAA 1997) refers not to the beneficiary's 'interest in the trust' as in section 104-70 of the ITAA 1997, but to the beneficiary's 'interest in the trust capital to the extent it relates to the asset'.

The cost base of the beneficiary's interest, if the beneficiary did not incur expenditure to acquire it, would be subject to the market value substitution rule set out in subsection 112-20(1) of the ITAA 1997, which would make the first element of the cost base of the interest its market value at the time the beneficiary acquired the interest. That time would be when the beneficiary became absolutely entitled to the asset constituted by the interest, as the beneficiary would not have any interest in the trust capital prior to becoming absolutely entitled to the trust asset.

As the market value of the shares at the time the beneficiary becomes absolutely entitled to them, and the cost base of the beneficiary's interest in the trust capital to the extent it relates to the shares are the same, there will be no CGT consequences for the beneficiary upon becoming absolutely entitled to the shares.