A recent ATO determination on whether a gain or loss made by an investment entity, such as a family trust, should be taxed under the CGT rules or the income tax rules has been labelled as ‘a shock' and ‘confusing' by experts from within the tax profession.

ATO Taxation Determination TD 2011/21 has also been the subject of attention in the national media, including a recent article in the AFR.

Here, special counsel Justin Byrne explains what the determination means and the impact it could have on family trusts in Australia.

Key recommendations

• If you are involved with a family trust that is entering into a transaction which relies on, for example, the small business CGT concessions, you should consider seeking legal advice. It may be that particular terms and powers in the relevant trust deed should be carefully reviewed - and perhaps modified - to maintain eligibility for the small business CGT concessions under the $2 million turnover test.
• Given the general nature of some of the discussion in this determination around income versus capital issues, we can assume that the ATO may have other revenue raising targets in sight, including a renewed compliance focus on the use of tax losses from share and property transactions.

What was the determination about?

The determination concerned whether a gain or loss made by an investment entity (eg a family trust) should be taxed under the CGT rules or income tax rules. Although it may be favourable to have gains taxed on capital account (due to potential eligibility for the 50 percent CGT discount), losses taxed on capital account may only be deductible against other capital gains, and not ordinary income.

There has been a view (arising from established cases such as Charles v FC of T) that because trusts are typically required to preserve capital for beneficiaries, any gains and losses are taxed on capital account. Accordingly, they can never make trading profits but only capital gains, which may be eligible for the 50 percent CGT discount.

It is likely that the Commissioner issued this determination out of concern about taxpayers who have historically claimed CGT treatment at discounted tax rates at 23.25 percent in a rising market, but are looking to claim income tax deductions at 46.5 percent in a falling market.

The Commissioner's position is that although the terms of a trust on which assets are held may be an important consideration in the income tax/CGT analysis, they are not definitive. Rather, they must be weighed up along with other factors (such as the factors in Taxation Ruling TR 92/3) in determining whether the gain should be taxed under the income tax or CGT rules.

The determination provides a number of examples of how this approach could apply, although it's arguable whether these provide much in the way of practical comfort for taxpayers.

Family trust example

The determination gives an example of a family trust, established by a successful professional, that invests in shares with the intention of earning dividends to provide a nest egg for retirement. With a financial crisis looming, the trust disposes of particular shares to build a more defensive portfolio.

In normal circumstances, tax advisers might expect that any gain the trust made would be taxed under the CGT rules, and may be eligible for the 50 percent CGT discount if the relevant asset was held for longer than 12 months. Likewise, any losses would be on capital account, and only able to be offset against capital gains.

However, the determination states that this example does not point strongly to either an income tax or CGT treatment of the gains or losses. Given that this is what appears to be a typical family investment arrangement, this comment by the Commissioner is somewhat surprising.

The legal impact of this determination

From a legal viewpoint, the determination deals with relatively uncontroversial principles of tax law, and does not break any significant new ground when it comes to income tax or CGT analysis of transactions.

The concern advisers generally have with this determination is that it does not provide certainty through useful guidance on how the Commissioner is looking to treat common family trust transactions from an income tax and CGT perspective.

Although the Federal Government has provided a fair degree of certainty for managed investment trusts and superannuation funds by legislating to allow CGT treatment on the sale of most of their assets, there is no such certainty for family trust arrangements. This leaves more room for the Commissioner to argue freely around trusts, which are already a significant focus area for tax audits.

For more information on the impact of Determination TD 2011/21, please contact HopgoodGanim's Taxation and Revenue practice.

Luke Mountford, Partner
Tel +61 7 3024 0339
l.mountford@hopgoodganim.com.au

Justin Byrne, Special Counsel
Tel +61 7 3024 0467
j.byrne@hopgoodganim.com.au

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