Capital gains tax: specifically entitled

Can a beneficiary be specifically entitled to a capital gain made by the trustee of a trust by reason of the happening of CGT event E5 in section 104-75 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. If a trustee of a trust makes a capital gain by reason of CGT event E5 when a beneficiary becomes absolutely entitled to an asset of the trust, the beneficiary can be specifically entitled to the gain.

Pursuant to the will of a deceased individual, a trust was created over the deceased's estate in favour of the deceased's wife for life with his daughter to take in remainder. There were no other beneficiaries.

The trust property included shares that were purchased by the trustee.

The life tenant died during the 2011-12 income year. At that time, pursuant to the will, the daughter as remainder beneficiary became absolutely entitled to the trust assets (including the shares).

The trustee made a capital gain from the shares by reason of CGT event E5 equal to the difference between the market value of the shares at the time of the event (being when the beneficiary became absolutely entitled to the shares) and their cost base. (No capital gain arose in the hands of the beneficiary under subsection 104-75(5) of the ITAA 1997 because the beneficiary acquired their interest for nil consideration (paragraph 104-75(6)(a)).

Some of the trust income for the 2011-12 income year had been distributed to the life tenant before she died.

The capital gains tax streaming provisions in Subdivision 115-C of the ITAA 1997 (which operate in respect of the 2010-11 and later income years following substantial amendments made to the Subdivision) ensure, among other things, that a beneficiary of a trust who is made 'specifically entitled' to a capital gain made by the trustee (a 'trust capital gain') will be assessed on it (rather than the gain being assessed proportionately to the beneficiaries entitled to trust income).

Section 115-228 of the ITAA 1997 sets out when a beneficiary will be regarded as specifically entitled to a trust capital gain (either in whole or in part). To be specifically entitled to the whole gain, one requirement is that the beneficiary must have received, or can reasonably expect to receive, in accordance with the terms of the trust, all of the financial benefit referable to the capital gain (paragraphs (a) and (b) of the definition of 'share of net financial benefit' in subsection 115-228(1) of the ITAA 1997). Another requirement is that the financial benefit be recorded, again in accordance with the terms of the trust, in the accounts or records of the trust in its character as referable to the capital gain (paragraph (c) of the definition).

The issues in this case are: • whether a beneficiary can be said to have received or be expected to receive all of the financial benefit referrable to a capital gain in a situation where the capital gain arises because the beneficiary has been made absolutely entitled to a trust asset as against the trustee and the quantum of the capital gain is worked out by reference to the market value of the asset; and • whether the financial benefit that the beneficiary has received or can be expected to receive has been recorded in the accounts or records of the trust in its character as referable to the capital gain.

As to the first issue, the Explanatory Memorandum to the Bill that on enactment introduced section 115-228 of the ITAA 1997 stated: 2.59 [W]hether a beneficiary can be specifically entitled to a capital gain or franked distribution is a question of fact. For example, when a beneficiary becomes absolutely entitled to a trust asset, it may be reasonable to expect the beneficiary will receive the net financial benefit referable to the deemed (trust) capital gain from CGT event E5.

In this case the financial benefit referable to the capital gain is the asset itself (or the value of that asset) and the absolutely entitled beneficiary is, in accordance with the terms of the trust created by the will, the only one that is expected to receive the asset (and thus that benefit).

As to the second issue, the Explanatory Memorandum stated: 2.63 The accounts or records of the trust would include the trust deed itself, statements of resolution or distribution statements, including schedules or notes attached to, or intended to be read with them. However, a record merely for tax purposes is not sufficient.

In this case, the will which created the trust meets the description of a record of the trust in which is recorded the financial benefit that the daughter is expected to receive in its character as a benefit referable to the capital gain - the will records the daughter's absolute entitlement to the asset.

It follows that the absolutely entitled beneficiary will be regarded as specifically entitled to the capital gain that arose from CGT event E5 happening to the shares. It also follows that no portion of the gain falls to be assessed to the life tenant.