CGT Event E2

 

What is CGT Event E2?

CGT Event E2 involves a situation where a taxpayer transfers a CGT asset to an existing trust.

This is distinct from CGT event E1 which applies where a taxpayer creates a new trust over a CGT asset by way of declaration or settlement.

The rules dealing with CGT Event E2 are primarily contained in section 104-60 of the Income Tax Assessment Act 1997 (ITAA).

When does CGT Event E2 occur?

CGT Event E2 occurs at the time the asset is transferred. This is when ownership changes and not necessary at the time the parties enter into the contract governing the transfer as is the case under CGT event A1. In terms of real property, CGT Event E2 occurs at the time of settlement. Or in terms of shares, when the company share registry is updated.

The timing of CGT events is capable of having a significant impact on tax outcomes. Consider the general CGT discount. For a taxpayer to be eligible for that concession the relevant CGT event must happen no sooner than 12 months after the CGT asset is acquired. Now let’s take the example of a taxpayer who acquired real property on 1 January 2024. The taxpayer intends to transfer the property to an existing trust and enters into a contract for sale on 20 December 2024. Settlement is scheduled for 10 January 2025. Since CGT Event E2 is triggered on the settlement date, the 12-month rule is available to reduce the taxpayer’s capital gain. That would not be the case under CGT event A1 because that event happens on the contract date.

How to calculate CGT Event E2 capital gain or capital loss

The taxpayer makes a capital gain if (and to the extent) capital proceeds from the transfer exceed the asset’s cost base.

Conversely, the taxpayer makes a capital loss if (and to the extent) capital proceeds are less than the asset’s reduced cost base.

The market value substitution rule can apply to dictate capital proceeds in any of the following instances, as described in section 116-10 of the ITAA:

  • the taxpayer receives no capital proceeds from the CGT event; or
  • some or all of the capital proceeds cannot be valued; or
  • the taxpayer did not deal at arm’s length with another entity in connection with the event.

Instances where CGT Event E2 might or might not occur

Since CGT Event E2 relates to the transfer of ownership in property, CGT A1 is also typically relevant. In circumstances where two or more CGT events apply, it is the event which is most specific to the situation that gets priority application (per section 102-25 ITAA). CGT Event E2 is generally the most specific event in the context of transfer of ownership in property to a trust. However, as set out in ATO ID 2003/559, CGT event A1 would tend to be more specific where the transferor is indifferent as to the identity of the transferee as a trustee because the parties are unconnected. For example, where the taxpayer was simply selling to the highest bidder at any auction and that so happened to be the trustee of a trust.

CGT Event E2 can occur where a trust is re-settled according to trust law principles. Remember that a re-settlement is essentially where there is a change to a trust that causes it to end and a new trust to commence. In TD 2012/21 (in response to the Clark decision), the ATO outline a list of changes that could potentially trigger a re-settlement:

  • The terms of the trust are changed in a way that is not a valid exercise of power conditioned in the trust deed;
  • The effect of the change or court approved variation is such as to lead to a particular asset being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust.
  • There is a lack of continuity of property (i.e. trust assets) or membership (i.e. beneficiaries) of the trust.

Section 104-60 of the ITAA clarifies that CGT Event E2 will not apply simply because there is a change in the identity of the trustee of a trust.

Exceptions

CGT Event E2 will not happen where all the following apply:

  • the taxpayer is the sole beneficiary of the trust; and
  • the taxpayer is absolutely entitled to the asset as against the trustee (disregarding the impacts of any legal disability); and
  • the trust is not a unit trust.

If this exception applies, it is likely that CGT event A1 would apply to account for any capital gain or loss.

In TR 2004/D25, the ATO addresses the meaning of absolutely entitled. A beneficiary will tend to be absolutely entitled to a particular trust asset if they have the ability to call for its transfer to them or at their direction. The right to make this call is grounded in the beneficiary having a vested and indefeasible interest in the entire trust asset i.e. a legally recognised interest that cannot be defeated. The most common examples of absolute entitlement are observed in trusts with a single beneficiary. Note, a beneficiary will tend not be absolutely entitled to a CGT asset if the trustee has a legal basis to legitimately resist a call for the asset.

Further, a capital gain or capital loss will need to be disregarded if the CGT asset transferred to the existing trust was acquired prior to 20 September 1985 (i.e. pre-CGT).

CGT discounts and concessions

The general CGT discount (Division 115 ITAA) and the small business CGT concessions (Division 152 ITAA) may be available to discount or eliminate a capital gain under CGT Event E2 so long as eligibility conditions are satisfied.

If the asset transferred is a dwelling, the main residence exemption (Subdivision 118-B ITAA) may also be available to disregard part or all of a capital gain.

This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.