Capital gains tax: CGT event E7 - disposal to end capital interest

Will CGT event E7 in section 104-85 of the Income Tax Assessment Act 1997 (ITAA 1997) happen when the trustee of a trust disposes of a CGT asset to a remainder beneficiary, pursuant to a deed of arrangement that varied a will of a deceased person?

No. CGT event E7 in section 104-85 of the ITAA 1997 will not happen when the trustee disposes of the trust asset to a remainder beneficiary because the exception relating to deceased estates applies.

The deceased died after 19 September 1985. Under the deceased's will the income from their estate was to be held on trust and paid to the deceased's children for life (life tenants). The capital of the trust was to be accumulated for the deceased's grandchildren (remainder beneficiaries). The assets of the estate are shares in public companies and cash.

The life tenants were dissatisfied with the terms of the deceased's will. The life tenants and remainder beneficiaries entered into a deed of arrangement to alter the distribution of assets as provided for in the deceased's will. On entering into the deed of arrangement to wind up the estate, the life tenants agreed to receive the present capital value of their life interests and the remainder of the trust was to be paid to the remainder beneficiaries.

The only consideration the remainder beneficiaries gave for entering into the deed of arrangement was the waiver of any further claim to participate in the distribution of the estate.

Subsection 104-85(1) of the ITAA 1997 provides that CGT event E7 happens: '...if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital.'

If CGT event E7 happens there may be consequences for the trustee under subsection 104-85(3) and for a beneficiary under subsection 104-85(5) of the ITAA 1997.

The scheme of the legislation is that a trustee makes a capital gain or capital loss when a trust asset is disposed of to a beneficiary except where Division 128 of the ITAA 1997 applies in relation to the asset. If Division 128 of the ITAA 1997 applies, any capital gain or capital loss the trustee makes is disregarded and the beneficiary assumes the trustee's cost base or reduced cost base for the asset.

Division 128 of the ITAA 1997 applies in relation to the transfer of shares to the beneficiaries in this case, because they are taken to have passed to a beneficiary in the estate of a deceased person by virtue of paragraph 128-20(1)(d) of the ITAA 1997.

Further, it is considered that the effect of the deed of arrangement is that the beneficiaries did not have an interest in the trust capital as contemplated by subsection 104-85(1) of the ITAA 1997. The deed was entered into when the estate was still in administration and the remainder beneficiaries' right to trust capital had not crystallised. It is considered that by entering into the deed of arrangement, the deceased's original will was effectively altered and the remainder beneficiaries are regarded as never having had a potential right to the capital of the estate. As the remainder beneficiaries did not have a right to the capital of the estate, CGT event E7 cannot happen.

In addition, even if CGT event E7 did happen in this situation, there would be no CGT consequences for the remainder beneficiaries because the exception in subsection 104-85(5) of the ITAA 1997 would apply. This exception provides that any capital gain or capital loss the beneficiaries make from this CGT event is disregarded if they acquired their interest for no expenditure.

CGT event E7 is the most appropriate CGT event to be applied in this situation. As it does not happen, it is considered that the trustee and remainder beneficiaries will not make a capital gain or capital loss as a result of entering into the deed of arrangement to vary the distribution of assets under the deceased's will.