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Capital Gains Tax Exemptions [2015 Amendments]

 

On 19 March, 2015, the Federal Parliament passed a number of amendments to the Income Tax Legislation dealing with the taxation of Life Insurance Policies.

Some of the amendments applied to the taxation of insurance policies held by Insurance Trusts.

Original Section 118-300 (Death Benefits)

The original section 118-300 granted an exemption to the “Original Beneficial Owner” of the Insurance Policy.

Some commentators believed that this requirement created an uncertainty as to whether the Trustee itself was entitled to an exemption.

However, this approach overlooked the general provisions with respect to the taxation of Trusts.

The Tax Legislation does not tax Trusts in their own right.

Instead, it taxes distributions of Trust Income to the Beneficiaries (i.e., when they become “presently entitled” to the Trust Income).

If there is some Trust Income to which none of the Beneficiaries are presently entitled, then the Trustee may be liable to tax on that part of the Trust Income.

However, if the Beneficiaries are presently entitled to all of the Trust Income, there is no Trust Income upon which the Trustee might be assessable.

If the Beneficiaries are entitled to a CGT exemption on any Trust Income to which they are presently entitled, then the Trust Income is also exempt in the hands of the Trustee.

If this were not the case, then taxation of the Trust Income in the hands of the Trustee would reduce the net after tax Trust Income available for distribution to the Beneficiaries and effectively deprive the Beneficiaries of their CGT exemption.

In summary, the original section 118-300:

  • Expressly granted an exemption to the presently entitled Beneficiaries who receive the Insurance Proceeds; and
  • Impliedly granted an exemption to the Trustee.

Amended Section 118-300 (Death Benefits)

The 2015 amendments changed the basis upon which the CGT entitlement was granted.

It now grants the exemption to the “Original Legal Owner” of the Insurance Policy.

In the case of a Trust-owned Policy, the exemption is then expressly extended to a Beneficiary who receives the Trust Income from the Trustee as a beneficiary of the Trust.

In summary, the amended section 118-300:

  • Expressly grants an exemption to the Trustee; and
  • Expressly grants an exemption to the presently entitled Beneficiaries who receive the Insurance Proceeds.

In a way, the amendment reverses the path by which we arrive at the same exemptions. It goes anticlockwise rather than clockwise to get to the same destination.

Meaning of “Receive”

The word “receive” is not defined in section 118-300 or in the general definitions section (section 995-1). However, it is affected by a deeming provision in section 103-10:

“This Part and Part 3-3 apply to you as if you had received money or other property if it has been applied for your benefit (including by discharging all or part of a debt you owe) or as you direct.”

This section means that the Beneficiary ”receives” the Insurance Proceeds, if it directs the Trustee to apply them for its benefit or if it applies the Insurance Proceeds as the Beneficiary directs.

This section allows the Beneficiary to obtain a CGT exemption for any Insurance Proceeds which it directs the Trustee to pay to a third party.

Original Section 118-37 (Non-Death Benefits)

Section 118-300 does not apply to Non-Death Benefits. Instead, they are dealt with by section 118-37.

The original section concerns compensation or damages payments with respect to a wrong, injury or illness the taxpayer (or their relative) suffers personally.

Unlike section 118-300, section 118-37 does not expressly mention Insurance Policies.

The section has always had a broader application than the proceeds of Insurance Policies.

As a result, the section does not grant the exemption on the basis of Ownership (whether Legal or Beneficial Ownership) of the Policy.

It is totally silent and neutral with respect to Policy Ownership.

As a result, the considerations that apply to this section are different to those that apply to section 118-300.

What was required was a “payment” to either:

  • The injured person; or
  • A relative of the injured person.

Taxation Determination TD 14 confirmed that the exemption extended to compensation payments “when paid to trustees on behalf of the Beneficiary who suffered the wrong, injury or illness”.

Where there is a presently entitled Beneficiary, that Beneficiary is the relevant taxpayer.

The exemption applies to the Beneficiary as taxpayer, regardless of whether the Insurance Proceeds have been:

  • paid directly to the Beneficiary by the Insurance Company; or
  • paid to the Trustee and then distributed by the Trustee to the Beneficiary.

Again, the Insurance Proceeds are not assessable in the hands of the Trustee, if the Beneficiaries are presently entitled to the whole of the Insurance Proceeds.

Amended Section 118-37 (Non-Death Benefits)

The drafting of the new exemptions in section 118-37 is specific to the particular taxpayer in its capacity as a Trustee or a Beneficiary of a Trust.

The Life Insured must be:

  • a Beneficiary of the Trust; or
  • a relative of a Beneficiary of the Trust.

Most relatives of any particular discretionary Beneficiary will be discretionary Beneficiaries of the Discretionary or Family Trust.

However, it isn’t a condition of the exemption that the Life Insured be a Beneficiary of the Trust in their own right.

Trustee’s Exemption

Section 118-37(b)(ii) grants an exemption to:

“(b) compensation or damages you receive as the trustee of a trust (other than a trust that is a *complying superannuation entity) for:
(ii) any wrong, injury or illness a Beneficiary of the trust, or the Beneficiary’s relative, suffers personally.”

This is an express grant of an exemption to the Trustee.

Beneficiary’s Exemption

Section 118-37(ba)(ii) grants an exemption to:

(ba) a *CGT asset you receive, as a Beneficiary of a trust, from the trustee of the trust to the extent that the CGT asset is attributable to compensation or damages that the trustee receives as described in paragraph (b) for:
 (ii) any wrong, injury or illness you or your relative suffers personally;

This is an express grant of an exemption to the Beneficiary.

Meaning of “Receive”

The word “receive” is not defined in section 118-37 or in the general definitions section (section 995-1). However, it is affected by a deeming provision in section 103-10:

“This Part and Part 3-3 apply to you as if you had received money or other property if it has been applied for your benefit (including by discharging all or part of a debt you owe) or as you direct.”

This section means that the Beneficiary ”receives” the Insurance Proceeds, if it directs the Trustee to apply them for its benefit or if it applies the Insurance Proceeds as the Beneficiary directs.

This section allows the Beneficiary to obtain a CGT exemption for any Insurance Proceeds which it directs the Trustee to pay to a third party.

IGS Absolute Entitlement Trust

The Trust established by an IGS Complete Succession Agreement is an Absolute Entitlement Trust under section 106-50.

The amendments do not seek to override the normal operation of section 106-50 (which applies generally unless overridden).

Thus, section 106-50 still applies. As a result, an Absolute Entitlement Trust would still obtain an exemption:

  • under section 118-300 if the Trustee was the original Owner of the Policy and a distribution was made to the Absolutely Entitled Beneficiary; and
  • under section 118-37, if the Absolutely Entitled Beneficiary was the Life Insured or a Relative, and a distribution was made to one or more of them.

The requirements of sections 118-300 and 118-37 are actually less onerous than section 106-50 in terms of the relationship between the Trustee and the Beneficiary.

 

 

Copyright: Ian Gray Solicitor

 

 

Adviser Tip

Trust ownership is an indirect form of self-ownership.

The Life Insured is the "beneficial owner" for legal and tax purposes under the roof of the Trust.

See more Adviser Tips

 

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