Disposal of a trust asset can result in a capital gain or loss unless a beneficiary is absolutely or specially entitled.
Capital gain or loss
Disposal of a trust asset (or another capital gains tax event) is likely to result in a capital gain or loss for the trust (unless a beneficiary is absolutely entitled to the asset).
Capital gains and losses are taken into account in working out the trust's net capital gain or net capital loss for an income year:
A net capital gain is included in the trust's net income.
A net capital loss is carried forward and offset against the trust's future capital gains.
As part of the net income of a trust, the net capital gain for the year is then allocated proportionately to beneficiaries based on their entitlements to trust income – unless:
- there is a beneficiary that is specifically entitled to the capital gain, or
- the trustee (of a resident trust) chooses to be taxed on a capital gain.
This choice can be made provided all or part of an amount relating to the gain has not been paid to, or otherwise allocated for the benefit of, a beneficiary during or within two months of the end of the income year. This rule allows the trustee to choose to pay tax on behalf of a beneficiary who doesn’t immediately benefit from the gain.
If there is no beneficiary entitled to income (or specifically entitled to the capital gain) the trustee is taxed on the capital gain.
Where the trustee is taxed on trust net income at the top marginal rate, they are not entitled to the CGT discount on the gain.
Absolute entitlement
If a beneficiary is absolutely entitled to a trust asset, the asset is treated for CGT purposes as if it is owned directly by the beneficiary and not the trustee. Any actions taken by the trustee in relation to the asset are taken to have been done by the beneficiary directly. This means that if a capital gains tax (CGT) event happens in relation to the asset, any capital gain or loss will be made directly by the beneficiary and doesn't form part of the trust's net income.
A beneficiary is absolutely entitled to an asset of a trust if they have a 'vested and indefeasible' interest in the entire trust asset – that is, they can direct the trustee to immediately transfer the asset to themselves or to someone else.
For example, on 30 July a trustee makes a beneficiary absolutely entitled to a property held by the trustee. On 30 September the trustee sells the property for $100,000. For CGT purposes, the asset is treated as being the beneficiary's from 30 July and the beneficiary (not the trustee) is taken to receive the capital proceeds of $100,000 from the sale of the property on 30 September.
Specific entitlement
A capital gain can be streamed to a particular beneficiary by making them specifically entitled to the gain.
If a beneficiary is made specifically entitled to a trust capital gain, the capital gain is taken into account in working out their net capital gain for the income year with the benefit of any discounts or concessions they are entitled.
Note that a beneficiary may be specifically entitled to a capital gain even if they don't have an entitlement to income of the trust (for example, because they had an entitlement to trust capital).
Example: Specific entitlement
A trustee derived the following amounts in the 2014–15 income year:
- interest income of $100
- a capital gain of $200 that is eligible for the CGT 50% discount.
The trust deed defines income to include capital gains. The income of the trust estate is therefore $300 ($100 interest income + $200 capital gain) and the net income of the trust is $200 ($100 interest income + $100 net capital gain because the CGT discount is applied to halve the $200 capital gain).
Provided the trust deed doesn't prevent the trustee streaming capital gains, the trustee can make:
Beneficiary B specifically entitled to the $200 capital gain, and
Beneficiary A presently entitled to the remaining $100.
Beneficiary B has a $100 capital gain to take into account in working out their own net capital gain. Because the gain was a discount capital gain, Beneficiary B must gross it up (double it) and apply the CGT discount (if they qualify in their own right for the CGT discount). Beneficiary A has a $100 share of net income.
On the other hand, if the trustee did not stream the capital gain, Beneficiary A is presently entitled to one third of the income of the trust estate and Beneficiary B is presently entitled to two-thirds. Beneficiary A is assessed on $33 net income and has a capital gain of $34 and Beneficiary B is assessed on $66 net income and has a capital gain of $67.