1 Will the proposed payments be regarded as assessable income of the Beneficiaries pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?
1 No. Question 2 Will section 100A of the ITAA 1936 apply to the proposed payments such that the Beneficiaries will be deemed not to be, and never to have been, presently entitled to trust income? Answer 2 No. Question 3 If the answer to Question 2 is yes, will section 99A apply to the Trust such that the trustee shall be assessed and liable to pay tax on the net income of the Trust? Answer 3 Not applicable. This private ruling applies for the following periods: Years ended 30 June 20XX to 30 June 20XX, inclusive. The scheme commences on: 1 July 20XX Background: Individual A and B are spouses. Their only child is Individual C. Individual C is not married and does not have any children. In 20XX, Individual C moved to a foreign country to live and work. At the time of Individual C's departure from Australia, they had no intention of returning. In the 20XX year, Individual C permanently departed the foreign country and arrived back in Australia. Since this time, Individual C reported that they have continuously been an Australian resident. Individual A and B have, at all relevant times, been Australian residents. The XX Trust (the Trust)
In 19XX, the Trust was settled between a Settlor and Company A (an Australian resident company), as trustee. The joint Appointors of the Trust were Individual A and B. The current Appointors of the Trust are Individual B and C. At all times since settlement, the Trust has been an Australian resident trust. Relevant clauses of the Trust Deed Subclause X(X) and the Schedule of the Trust Deed broadly provide that the beneficiaries of the Trust are Individual A and B, children, grandchildren, parents, siblings, spouses of their children, grandchildren and parents, any company in which any of the proceeding individuals holds shares, any fund, authority or institution as described in paragraph 78(1)(a) of the ITAA 1936, any trust in which the proceeding individuals have any interest and any sibling or child of Individual C's parents. Clause X(XX) of the Trust Deed provides that: Assets attributed to the trust have been provided by the taxpayer. after deducting all costs and expenses incurred in or about deriving or earning each separate class of income in such manner as the Trustee in its absolute discretion shall determine for each Financial Year.
Subclause X(XX) of the Trust Deed (as amended) states that: 'Net Gain' has the same meaning as defined in Section 102-5 of the Tax Act. The Trustee's power to distribute income of the Trust Fund is provided in clause X of the Trust Deed. In particular, subclause X.X provides that: Subclause X.X details provided by the taxpayer. Subclause X(X) of the Trust Deed states: Subclause X.(X) details provided by the taxpayer. Clause X of the Trust Deed provides that: Subclause X details provided by the taxpayer. Clause X(X) of the Trust Deed is drafted similar to clause X(X) in relation to losses and outgoings. Broadly, clause X of the Trust Deed provides the Trustee with the power to determine to accumulate all or any of the income of the Trust Fund prior to 30 June in a particular year. Clause X of the Trust Deed states that: Subclause XX details provided by the taxpayer. Year ended 30 June 20xx - Disposal of capital assets by the Trust: During the year ended 30 June 20XX, the Trustee of the Trust disposed of X capital assets such that it realised a capital gain of $XX. After the application of the 50% discount, the net capital gain was $XX.
By resolution dated 30 June 20xx, the Trustee of the Trust resolved not to alter the operation of subclause X(X) of the Trust Deed. Consequently, the distributable income of the Trust was calculated in the same manner as net income as determined for tax purposes. The resolution also provided for the distributions of various classes of Distributable Income as follows: • Individual C as to X% of the Interest, which is a separate class based on the definition of Class of Distributable Income of the Trust Fund; of this amount, the Trustee shall retain an amount sufficient to settle the obligation for withholding tax and shall remit the balance to the Beneficiary • XXXX • Individual C, out of the income of the Trust Fund comprising that Class of Distributable Income referred to as a Net Capital Gain, the following amount to Individual C, namely $XX. Of this amount, the Trustee shall retain an amount sufficient to settle the Trustee's liability to income tax on the Net Capital Gain and shall remit the balance to the Beneficiary • Individual A as to XX% of the remainder of Net Capital Gain of the Trust Fund
• Individual B as to XX% of the remainder of Net Capital Gain of the Trust Fund • Individual A as to XX% of all other income of the Trust Fund • Individual B as to XX% of all other income of the Trust Fund. As a consequence of the Trustee's determination of the income of the Trust pursuant to subclause X(X) of the Deed, the Trustee was therefore of the view that the correct manner of recording the discount component of the net capital gain was to accumulate it to the Trust Fund (which, in accordance with clause X(X) of the Deed, can include accumulations of capital). Each of the beneficiaries reported their share of the Trust income in accordance with the Trustee resolution in their respective income tax returns for the year ended 30 June 20XX. The financial statements of the Trust recorded half of the capital gain (net of losses), being $XXX, as income and the other half as an accretion to the Trust Fund. The Trustee paid its income tax liability pursuant to section 98 and paid of the tax liabilities of Individuals A and B by drawing upon the then balance of their entitlements in respect of the 2010 distribution.
Year ended 30 June 20XX - distribution of prior year accumulated income On or about X XXX 20XX, in accordance with subclause XX(X) of the Trust Deed (as amended), the Trustee determined to pay a portion of the Trust Fund accumulated in the year ended 30 June 20XX from the discount component of the discount capital gain to Individuals A, B and C in the same proportions in which they participated in the income of the Trust Fund in respect of that year. Individual A and B decided not to fully draw upon their proportional entitlement of the Trust Fund comprising the discount component of the capital gain. They instead directed the Trustee adjust their respective shares to allow Individual C to withdraw in priority their balance of their discount capital gain component. Following the above payment of the $XX discount component of the discount capital gain to Individual C, the balance of the beneficiaries' entitlement to the discount component of the discount capital gain for the year ended 30 June 20XX, but yet to be paid, was as follows: Table 1: Payments made to individuals A, B and C Beneficiaries' entitlements Individual A ($) Individual B ($) Individual C ($)
Discount component of the capital gain xx xx xx Cash receipt xx xx xx Remainder of discount component of capital gain xx xx xx No further distributions of the remainder of the discount component of the capital gain which arose in the year ended 30 June 20XX have been made by the Trustee such that total balance of the unpaid amount of the discount component is $XX. Next 5,000 streamlined review of Individual B On XX XXX 20XX, the Commissioner notified Individual B that he had commenced a streamlined assurance review (assurance review) Individual B and their group for the years ended 30 June 20XX and 30 June 20XX. On XX XXX 20XX, the Commissioner issued a finalisation letter (Finalisation Letter) for the assurance review, which states at 2.3 Significant and new transactions in relation to $XX million of trust corpus [of the Trust]: We have reviewed the transactions in relation to the $XXm in trust corpus. We note that, any profit not included in the assessable income is deemed to be a profit on capital account, pursuant to the Trust Deed.
We understand the Trust distributed the gross capital gain to the beneficiaries of approximately $XXm, with the beneficiaries reporting a (XX%) discounted net gain. However, the discount component was treated as corpus of the trust. In the Commissioner's view this may constitute a re-characterisation of trust income and potentially affect the discount available to the recipient beneficiary. At 2.5 Recommendations for future years, the Finalisation Letter further stated: Retention by a trust of the discount portion of a net capital gain may have income tax consequences. We recommend all future capital gains arising in the trust are distribution in full by the trust. We refer you to section 100A of the Income Tax Assessment Act 1936 and PCG 2022/2. However, despite the Commissioner's concerns with regards to the treatment of the gross capital gain of $XX million in the year ended 30 June 20XX, the Finalisation Letter states that the Commissioner will not take any future action given the historical nature of the transactions. Will of Individual A
Individual A passed away on XX XXX 20XX. At the time of the application for this private binding ruling, Individual A's Estate had not yet been finalised. By Will dated XXX, Individual A appointed Individual A and B as the Executors of their Estate. Individual B renounced their position of Executor on XXX. Individual A made specific bequests, predominantly to their spouse and child. Broadly, clause X of the Will provides that, subject to the payment of their debts and funerary expenses, the balance of their Estate not specifically provided for is bequeathed to their child. Proposed arrangement: In accordance with subclause X(X) of the Trust Deed, the Trustee proposes to pay to the beneficiaries the remaining of the discount component of the net capital gain accumulated in the year end 30 June 20XX, being an amount of $XX. In particular, the Trustee proposes to pay $XX each to Individual B and the Estate of Individual A. As Individual A has passed away, their entitlement will be passed to their Estate and then applied in accordance with their Will.
The Trustee submits that there are no tax consequences for the Trustee or the beneficiaries from the proposed arrangement. The Trustee explains that this because the amount to be released has been previously reported for income tax purposes and the inadvertent retention, until now, of the amount does not represent a recharacterization of the amount. As such, the Trustee submits that the distribution will be from the corpus of the Trust Fund. The Trustee also submits that by exercising its powers as provided in the Trust Deed, the allocation and crediting of the entirety of the remainder of the discount component of the capital gain, being $XX, is nothing more than a release to the respective beneficiaries of the unpaid entitlement of an amount previously included as assessable income by them.
Income Tax Assessment Act 1936 , section 97 Income Tax Assessment Act 1936 , section 99A Income Tax Assessment Act 1936 , section 100A Income Tax Assessment Act 1997 , section 6-5 Income Tax Assessment Act 1997 , section 6-10 Income Tax Assessment Act 1997 , section 102-5
Question 1 Will the proposed payments be regarded as assessable income of the Beneficiaries pursuant to section 6-5 of the ITAA 1997? Detailed reasoning Ordinary Income Section 6-5 of the ITAA 1997 provides that a taxpayer's assessable income includes income according to ordinary concepts, known as ordinary income. However, the legislation does not provide guidance on the meaning of 'income according to ordinary concepts' in section 6-5. As such, guidance on the meaning of the term and for determining whether a receipt will be ordinary income can be found in case law, which broadly provide the main characteristics that are generally applicable to a receipt being considered as income are: • received periodically and regularly • received for personal services (for example, salary and wages) • received from property and investment returns (for example, dividends and interest) • relied upon or expected • earned • for the replacement of income, and • derived by way of a profit-making intention or carrying on a business.
Therefore, ordinary income generally bears a direct relationship to some form of input or investment made by the taxpayer. It is important to note however, that it is not necessary for all of these characteristics to exist in order for a receipt to be considered under ordinary concepts. Ordinary income or statutory income? Not every receipt of cash or non-cash benefit by a taxpayer is ordinary income according to the legislation. Capital receipts are not ordinary income and are not assessable under section 6-5 of the ITAA 1997. However, subsection 102-5(1) of the ITAA 1997 provides that capital receipts, being net capital gains, are to be included in a taxpayer's assessable income as statutory income and explains the manner in which a net capital gain is to be calculated as follows: [1] • reduce the capital gain by any capital loss made during the year • apply any unapplied net capital losses from earlier years • reduce any discount percentage • if any of the capital gain qualifies for the small business concessions [2] , apply those concessions, and
• add up any amounts of capital gains remaining after step 4 (paragraph 3.d). The sum is the capital gain. Division 115 of the ITAA 1997 sets out the discount on capital gains and the circumstances in which they are available to a taxpayer. A taxpayer is entitled to a discount on any capital gains made if they satisfy the requirements outline in section 115-5 of the ITAA 1997. The necessary requirements are that: • the taxpayer is an individual, complying superannuation entity, trust or certain life insurance companies [3] • the capital gain is made after 21 September 1999 [4] • the capital gain does not have an indexed cost base [5] , and • the capital gain was made on an asset held for at least twelve months. [6] , as per. Sections 115-10 and 115-100 of the ITAA 1997 state that the discount percentage is 50% if the capital gain is made by an individual or a trust (that is not a complying superannuation entity or FHSA trust. Application to your circumstances
During the year ended 30 June 20XX, the Trustee of the Trust disposed of X capital assets such that it realised a capital gain of $XX. By resolution dated XX XXX 20XX, the Trustee of the Trust resolved not to alter the operation of subclause X(X) of the Trust Deed. Subclause X(X) broadly provides that any receipt by the Trustee of any property which is: a. included in the assessable income of the Trust Fund for tax purposes will be income of the Trust Fund, and b. not included in the assessable income of the Trust Fund for tax purposes will form part of the capital of the Trust Fund. In accordance with Division 115 of the ITAA 1997, the Trustee determined that the net capital gain in the year ended 30 June 20XX after the application of the XX% discount was $XX. As this amount represents assessable income for tax purposes, subclause X(X) of the Trust Deed requires the $XX to form part of the income of the Trust Fund and the remaining (discount proportion) of the capital gain was an accretion to the Trust Fund.
2. In accordance with subclause XX(X) of the Trust Deed, the Trustee proposes to pay to the beneficiaries the remaining of the discount component of the net capital gain accumulated in the year end 30 June 20XX. In particular, the Trustee proposes to pay $XX each to Individual B and the Estate of Individual A in the current and future years. The discount capital component amount will not have the general characteristics of ordinary income when paid to Individual B and the Estate of Individual A. That is, the proposed distribution will not be received for personal services, from investment returns, earned, the replacement of income nor will the amounts be derived by way of a profit-making intention or carrying on a business. Consequently, the proposed distributions will not be income according to ordinary concepts and will not be included in the assessable income of the beneficiaries pursuant to section 6-5 of the ITAA 1997. Question 2 Will section 100A of the ITAA 1936 apply to the proposed payments such that the Beneficiaries will be deemed not to be, and never to have been, presently entitled to trust income? Explanation of the legislation
Present entitlement arising from a reimbursement agreement Section 100A of the ITAA 1936 is an anti-avoidance measure which broadly provides that if a beneficiary is presently entitled to income of a trust and this entitlement is as a result of a reimbursement agreement, the beneficiary shall be deemed to not have been presently entitled to that income. As a consequence, the trustee will be assessed on this income of the trust pursuant to section 99A. Subsection 100A(1) of the ITAA 1936 provides that: Where: (a) apart from this section, a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate; and (b) the present entitlement of the beneficiary to that share or to a part of the that share of the income of the trust estate (which share or part, as the case may be, is in this subsection referred to as the relevant trust income ) arose out of a reimbursement agreement or arose by reason of any act, transaction or circumstance that occurred in connection with, or as a result of, a reimbursement agreement;
the beneficiary shall, for the purposes of this Act, be deemed not to be, and never to have been, presently entitled to the relevant trust income [emphasis added]. Therefore, subsection 100A(1) of the ITAA 1936 applies to a beneficiary of a trust who is not under a legal disability and has been made presently entitled to income of a trust as a result of a reimbursement agreement. If the subsection applies, the beneficiary is deemed not to be present entitled to the income and, as a result the trustee will be liable to tax pursuant to section 99A. Present entitlement In order for section 100A of the ITAA 1936 to apply, there must be present entitlement to income of a trust estate. The concept of 'present entitlement' refers to a beneficiary's interest in the income of the trust estate that is vested in interest and possession, and one that the beneficiary has present legal right to demand payment. [7] Present entitlement arose from or in connection with a reimbursement agreement
Paragraph 100A(1)(b) of the ITAA 1936 requires that the beneficiary's present entitlement must have arisen 'out of a reimbursement agreement or arose by reason of any act, transaction or circumstance that occurred in connection with, or as a result of, a reimbursement agreement'. Therefore, there are two elements that must be present to satisfy paragraph 100A(1)(b), being: a. a reimbursement agreement, and b. a connection between the reimbursement agreement and the present entitlement of the beneficiary. Reimbursement agreement The second element which must be present under subsection 100A(1) of the ITAA 1936 is that the beneficiary's present entitlement must have arisen as a result of a reimbursement agreement. Reimbursement agreement is a label not a descriptor and 'reimbursement' does not control the meaning of 'reimbursement agreement'. [8]
The term takes its meaning from subsections 100A(7) to (10) and (13) of the ITAA 1936. By those provisions, an agreement can be an arrangement or an understanding, which would extend to a case where parties have a common view regarding the maintenance of a particular state of affairs, whether or not that state of affairs or course of conduct is universally created or involves some element of mutual obligation. A reimbursement agreement must involve the payment of money, transfer of property or provision of services or other benefits to a person other than the presently entitled beneficiary. Subsection 100A(13) of the ITAA 1936 provides that the meaning of the term 'agreement' for the purposes of section 100A is: ... any agreement, arrangement or understanding, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings, but does not include an agreement, arrangement or understanding entered into in the course of ordinary family or commercial dealing. Entered into in the course of an ordinary family or commercial dealing
As noted in above, where an arrangement is entered into in the course of an ordinary family or commercial dealing, the definition of agreement in subsection 100A(13) of the ITAA 1936 will not be met. Reduction or elimination of tax With reference to subsection 100A(7) of the ITAA 1936, subsection 100A(8) limits the scope of a reimbursement agreement to one with a purpose of reducing tax, providing that: A reference in subsection (7) to an agreement shall be read as not including a reference to an agreement that was not entered into for the purpose, or for purposes that included the purpose, of securing that a person who, if the agreement had not been entered into, would have been liable to pay income tax in respect of a year of income would not be liable to pay income tax in respect of that year of income or would be liable to pay less income tax in respect of that year of income than that person would have been liable to pay if the agreement had not been entered into. Application to your circumstances
The proposed arrangement in which Individual B and the Estate of Individual A will each receive a corpus payment $XX will not result in a beneficiary of the Trust being presently entitled to a share of income of the trust estate. Consequently, paragraph 100A(1)(a) will not be satisfied. Question 3 If the answer to Question 5 is yes, will section 99A apply to the Trustee of the Trust such that the Trustee shall be assessed and liable to pay tax on the net income of the Trust? Certain trust income to be taxed at special rate Broadly, section 99A of the ITAA 1936 provides certain circumstances in which a trustee of a trust estate will be liable to pay tax on the net income of the trust estate at a rate declared by Parliament. Subsection 99A(2) of the ITAA 1936 provides that section 99A will not apply to a trust estate if, among other things, the trust resulted from a will or codicil and the Commissioner is of the opinion that it would be unreasonable that section 99A apply to the trust. In forming the opinion, subsection 99A(3) of the ITAA 1936 provides the factors that the Commissioner shall have regard to. Application to your circumstances:
As explained under Question 2, section 100A of the ITAA 1936 will not apply to the proposed arrangement and consequently, section 99A will not apply to the Trustee of the Trust in relation to the proposed payments. > [1] section 6-10 of the ITAA 1997 broadly provides that a taxpayer's assessable income also includes statutory income. [2] in Subdivisions152-C, 152-D and 152-E. [3] Section 115-10 of the ITAA 1997. [4] Section 115-15 of the ITAA 1997. [5] Section 115-20 of the ITAA 1997. [6] Section 115-25 of the ITAA 1997. [7] See, for example: FC of T v Whiting (1943) 68 CLR 199: 7 ATD 179, Union Fidelity Trustee Co of Australia & Anor v FC of T (1969) 119 CLR 177; 69 ATC 4084; (1969) 1 ATR 200, Taylor v FC of T (1970) 119 CLR 444; 70 ATC 4026; (1970) 1 ATR 582, FC of T v Totledge Pty Ltd 82 ATC 4168; (1982) 12 ATR 830, and Harmer v FC of T (1991) 173 CLR 264; 91 ATC 5000; (1991) 22 ATR 726. [8] Commissioner of Taxation v Prestige Motors Pty Ltd as Trustee of the Prestige Toyota Trust [1998] FCA 221; 98 ATC 4241 ("Prestige Motors") at 4261 per Hill and Sackville JJ.