Contents
- What is CGT Event E4?
- What Time Does the CGT Occur?
- How is the Capital Gain Calculated
- Discounting the Capital Gain Made Under CGT Event E4
- Common Inclusions in the Non Assessable Part
- The Risk of Double Taxation
- Instances Where the CGT Event Will Not Apply
- When the Capital Gain from the CGT Event can be Disregarded
- Adjustments to the Calculation of the Non Assessable Part
What is CGT Event E4?
CGT event E4 establishes a trigger for capital gains tax in a situation where a payment is made by the trustee of a trust to a beneficiary of that trust (in respect of an interest that beneficiary holds in the trust) where any part of that amount is not assessable (the non assessable part) to the beneficiary.
The rules addressing the operation of the CGT event are contained in section 104-70 and section 104-71 of the Income Tax Assessment Act 1997.
What Time Does the CGT Occur?
The time of the CGT event depends on the relevant circumstances as described below.
- If another CGT events happens in relation to the trust interest for example, if CGT event A1 occurs in relation to a unit in the trust because the unit is sold by the beneficiary then, CGT event E4 will happen just before the time of that relevant CGT event.
- Otherwise, CGT event E4 will occur just prior to the end of the income year in which the trustee makes the payment. For most taxpayers, this will be 30 June.
How is the Capital Gain Calculated
In essence, CGT event E4 is designed to address a circumstance where there is a difference between the amount the trustee of a trust pays to a beneficiary and the amount of that payment that is included in the assessable income of that beneficiary.
Specifically, the way the event works is that the sum of the amounts of the non assessable parts of the payment made during the income year by the trustee of the trust in respect of the unit or trust interest must be applied against (to reduce) the cost base of the unit or trust interest.
To the extent the sum of the amounts of the non assessable parts of the payment exceed the cost base of the unit or trust interest, the excess is treated as a capital gain. Once the cost base is soaked up (and assuming no other cost base additions occur e.g. any non deductible interest in respect of a loan taken out by the beneficiary to acquire the units or the trust interests), any subsequent non assessable parts of payment by the trustee to the beneficiary will be treated as a capital gain (as there is no longer a cost base to be reduced).
Note that CGT event E4 cannot provide an increase to the cost base of a unit or trust interest in the situation where a payment is made and where the amount included in the taxpayer’s assessable income exceeds the amount of the payment.
The taxpayer must calculate the sum of non assessable parts of trust payments on a yearly basis. The taxpayer would then be advised to update cost base records on an annual basis. By so doing, the taxpayer can also determine whether a capital gain needs to be calculated as a result of the cost base of a unit or trust interest being reduced to nil.
Note that it would not be uncommon for multiple payments (with non assessable components) to be made during the course of an income year. For example, where the trustee of a managed fund makes 2 separate distributions to a beneficiary within an income year.
Discounting the Capital Gain Made Under CGT Event E4
If a capital gain is made by the beneficiary under CGT event E4, the capital gain can be discounted by the beneficiary (under the CGT discount or the small business CGT concessions) if they satisfy the respective eligibility criteria in Division 115 of the ITAA 1997 and Division 152 of the ITAA 1997.
AASB 7 Financial Instruments: Disclosures intersects with the concept of accounts receivable ageing through its requirements for disclosing credit risk associated with financial instruments. It emphasises the importance of disclosing information that helps in understanding the credit risk exposure of financial assets, including receivables.
This includes detailing the extent of exposure to credit risk and how it is managed, which aligns with the objectives of accounts receivable ageing.
Such disclosures ensure that stakeholders are well informed about the potential risk of financial losses due to receivables that may become uncollectible, thereby highlighting the relevance of the ageing process in financial reporting and risk management.
Common Inclusions in the Non Assessable Part
The non assessable part is essentially any part of the payment from the trustee which is not assessed to the taxpayer (i.e. not included in their assessable income).
A basic example is where a trustee of a trust distributes $100 to a beneficiary in respect of units held in the trust. The $100 payment comprises a $80 assessable component and a $20 non assessable component. Here, the beneficiary is only assessed on $80. The remaining $20 is not assessed to the beneficiary. Therefore, the $20 is the non assessable part that is subject to treatment under CGT event E4.
Common amounts that will be included in the non assessable part include:
- Where there is a timing difference between recognition of an outgoing for tax purposes compared with the recognition of that outgoing under the trust according to the way the trust defines income of the trust estate (if at all).
- Where there is an amount that is deductible for tax purposes but does not involve an actual depletion of the trust. For example, a capital works deduction entitlement inherited from another entity.
- Where a tax concession or exemption applies to reduce the tax imposed on a particular amount but where no similar concession or exemption is recognised in the trust (therefore creating a misalignment between the amount of the receipt recognised in the income of the trust estate and the amount of the receipt which is assessable).
The misalignment between income of the trust estate and total income assessed to the beneficiaries is often dependant on the way the trust deed defines the income of the trust estate (if at all) and the way receipts and outgoings are characterised (if such a re characterisation power exists under the trust deed).
The Risk of Double Taxation
CGT event E4 can potentially result in double taxation outcomes. The most common risk of this is where there is an inherited capital works deduction.
Let’s take an example. Assume David holds units in a trust which he acquired for a particular price.
Assume the trustee uses those funds (David’s purchase price) to acquire real property. The unit trust claims a capital works deduction which has been inherited from the previously registered proprietor. The capital works represent funds expended to build a house on the property. Here, there is no depletion to the trust which matches the depreciation recognised for tax purposes. In this situation, the depreciation deduction will influence the calculation of the non assessable part of any payments made to beneficiaries of the trust.
Assume David is entitled to 100% of the distributable income of the trust and receives a payment from the trust. The fact the payment includes a non assessable amount (i.e. the capital works deduction) triggers CGT event E4 for David. The cost base of the units he holds will be decreased by his share of the non assessable amount (100% this income year). This has the effect of increasing any future capital gain on the realisation of his units by David’s share of non assessable amount (taxation point 1).
Then, assume the trustee eventually sells the property triggering CGT A1. In calculating the capital gain on the property, the cost base of the property will decrease by the cumulative value of all capital works deductions in respect of the property. This has the effect of increasing the capital gain by the non assessable amount (taxation point 2).
As you can see, the capital works deduction increases CGT at the the unit holder level (by reducing the cost base of the units held by the taxpayer). It also increases CGT at the unit trust level (by reducing the cost base of the relevant asset held by the trust).
The risk of double tax is also possible where a beneficiary is assessed on an amount in a particular income year (first year) and is then taxed on that same amount (first reduced by the cost base of the trust interest) in a subsequent income year when that amount is paid to the beneficiary and CGT event E4 is triggered. There may be techniques to avoid such an amount. For example, by making certain payments to the beneficiary in an income year in which net income exceeds distributable income.
Instances Where the CGT Event Will Not Apply
CGT event E4 will not usually apply to payments from discretionary trusts. This is because the beneficiaries of the trust do not hold a defined interest in the trust (only the right to be considered to receive a distribution). See Taxation Determination 2003/28 for further explanation.
CGT event E4 will not happen if CGT event A1, C2, E1, E2, E6 or E7 happen in relation to the payment. These events will have priority under the CGT regime to treat the relevant payment.
CGT event E4 will not happen in respect of a payment to a foreign resident to the extent that payment is reasonably attributable to income from a foreign source. However, note this exemption is not available if the relevant trust is a public trading trust.
CGT event E4 will not happen if the unit or trust interest is held in an Attribution Managed Investment Trust (AMIT).
When the Capital Gain from the CGT Event can be Disregarded
A capital gain from CGT event E4 can be disregarded if the unit or trust interest is acquired by the taxpayer prior to 20 September 1985 (i.e. as a pre CGT asset).
It is unclear if CGT event E4 will happen where a non assessable part of a payment can be reasonably traced to funds sourced from amounts previously taxed to the beneficiary (i.e. where the only reason an amount is non assessable is because of timing differences between the recognition of receipts and outgoings in the trust and according to tax law).
Adjustments to the Calculation of the Non Assessable Part
Subsection 104-71(1) and subsection 104-71(3) of the Income Tax Assessment Act 1997 outline a number of adjustments that will need to be made in calculating the non assessable part of a payment.
Specifically, the following amounts should be excluded from the calculation of the non assessable part:
- an amount of non assessable non exempt income; or
- an amount that has been assessed to the trustee; or
- an amount paid that is personal services income and included in the beneficiary’s assessable income, or another entity’s assessable income, under section 86-15; or
- a payment to which paragraph 118-37(1)(ba) applies (about compensation paid through a trust); or
- a payment to which subsection 118-300(1A) applies (about insurance and annuity payments paid through a trust); or
- an amount repaid by the beneficiary; or
- compensation the beneficiary paid that can reasonably be regarded as a repayment of all or part of the payment; or
- an amount referred to in section 152- 125 (which exempts a payment of a small business 15 year exemption amount) as an exempt amount; or
- an amount that is not included in the assessable income of an entity because of section 124ZM or 124ZN (which exempt income arising from shares in a PDF) of the Income Tax Assessment Act 1936; or
- an amount that is not included in the assessable income of an entity because of section 51-52 or subsection 51-54(1) or (1A) of this Act; or
- capital proceeds from a CGT event that happens in relation to shares in a company that was a PDF when that event happened; or
- capital proceeds from a CGT event if:
- the CGT event relates to an eligible venture capital investment; and
- the share of a partner in an ESVCLP in a capital gain or capital loss from the CGT event is disregarded under section 118-407; or
- that part of the capital proceeds from a CGT event, relating to an eligible venture capital investment, for which there is a partial exemption under section 118-408; or
- capital proceeds from a CGT event if a capital gain made from the event may be disregarded under subsection 360-50(4).
There are further exclusions to the calculation of the non assessable part which are outlined in the table contained in section 104-71(4) and summarised below:
| Item 1 (applicable to any entity) | so much of the amount of a discount capital gain excluded from the net capital gain of the trust making the payment because of step 3 of the method statement in section 102-5(1) (i.e. where the 50% discount is applied). |
| Item 2 (only applicable to an individual, company or trust that uses a capital loss or net capital loss to reduce its capital gain described in paragraph 115-215(3)(b) where the trust gain referred to in subsection 115-215(3) is reduced under Subdivision 152-C) | the amount excluded is ½ of the amount of the capital loss or net capital loss applied.
|
| Item 3 (only applicable to an individual or trust that has a capital loss or net capital loss to reduce its capital gain described in paragraph 115-215(3)(c))
| the amount excluded is ¼ of the amount of the capital loss or net capital loss applied. |
| Item 4 (only applicable to a company that has a capital loss or net capital loss to reduce its capital gain described in paragraph 115-215(3)(c) where that capital loss or net capital loss is more than ½ of the trust gain referred to in subsection 115-215(3); and that trust gain is reduced by an amount (the reduction amount) under Subdivision 152-C) | the amount excluded is the excess of the reduction amount over the Subdivision 152-C reduction to the paragraph 115-215(3)(c) amount.
|
| Item 5 – 6 (only applicable to superannuation entities not addressed in this article. | Not addressed. |
| Item 7 (applicable to an entity receiving the payment where the trust making the payment, or another trust that is part of the same chain of trusts, has a capital loss or net capital loss to reduce its capital gain described in subsection 115-215(3)) | the amount excluded is the proportion of the capital loss or net capital loss reflected in the payment. Note this rules does not apply in respect of a managed investment trust. |
It is perhaps best to understand the operation of these above adjustments and exclusions to the calculation on the non assessable part by considering a few examples.
However, there a few key highlights from those exclusions and adjustments worth flagging.
- An amount which is non assessable non exempt income will not be included in the non assessable part.
- A tax free component of a discounted capital gain will not be included in the non assessable part.
- A capital loss used to reduce a gross capital gain calculated under section 115-215(3) (i.e. the section of the legislation that deals which assesses presently entitled beneficiaries on capital gains flowing to them from a trust) will reduce the amount included in the non assessable part by either a ¼ or ½ of the amount of the capital loss (whichever is relevant in the circumstances).
Example 1
The trustee of a trust makes a capital gain of $1,000 and distributes the gross gain to one of the trust beneficiaries, David. The trust was eligible for the CGT discount and the 50% active asset concession in respect of the realised asset. The payment to the beneficiary (being the gross capital gain of $1,000) is therefore made up of the following components:
- $500 CGT discount component.
- $250 small business CGT discount component.
- $250 taxable component.
David has a capital loss of $200. Therefore, according to the relevant net capital gain method statement, he must first reduce the gross capital gain of $1,000 by $200 before the other CGT discounts and concessions can be applied. The $800 (gross capital gain of $1,000 less capital losses of $200) is discounted by 50% (under the CGT discount) to $400 and further reduced by 50% (under the 50% active asset concession) to $200.
Therefore, David has a net capital gain of $200 for the income year.
For the purposes of applying CGT event E4, it first appears that the non assessable part is $750 as this is the amount of the capital gain that is tax free pursuant to the application of the CGT discount and the 50% active asset concession. The $250 taxable component of the capital gain is obviously not required to be included in the non assessable part.
However, applying the non assessable part exclusion and adjustment rules (listed above), the non assessable part should be reduced by $500 (per item 1 of the table in section 104-71(4)) as this is the part of the discounted gain excluded from the calculation of the net capital gain for the trust making the payment.
The non-assessable part should then be reduced by $50 (per item 3 of the table in section 104-71(4)) which is ¼ of the amount of the capital loss ($200) applied by the taxpayer to reduce the capital gain.
Therefore, the non assessable part of the $1,000 payment received by David is $200.
That is:
$1,000 (payment representing gross gain) less $250 (part of gross gain which is not discounted or reduced) less $500 (part of gain which is discounted to the trust) less $50 (¼ of the capital loss applied by David against his gross capital gain).
As you can see, the tax-free component of a CGT discounted capital gain is excluded from the calculation of the non assessable part. However, there is no equivalent exclusion where the small business CGT concessions apply.
Example 2
David receives a payment from a trust in respect of a unit he holds in that trust. The distribution comprises:
- A discounted capital gain of $10,000 (gross gain is $20,000).
- A non discounted capital gain of $5,000.
- A tax deferred amount of $1,000.
David has no other capital gains or capital losses (including no unapplied capital losses from prior years).
The cost base of the unit is $20,000. Here, the receipt of the $1,000 tax deferred amount is a non assessable part that triggers CGT event E4. The cost base of the unit should be reduced by $1,000 to reflect the tax deferred amount. Therefore, the new cost base at year end is $19,000.
Remember that the tax free component of a discounted capital gain is excluded from the non assessable part per item 1 of the table at section 104-71(4).
Example 3 & 4
These are based on the examples provided by the ATO in Taxation Determination 2006/71. The taxation determination addresses the interaction between the small business CGT concessions and CGT event E4. The examples have been simplified and are summarised below:
Example 3
The Trustee of the Gillies Family Unit Trust carries on a business. Gilbert and the only other beneficiary have each owned one unit in the trust for ten years (so they are both significant individuals). The trust and Gilbert are eligible to access the small business CGT concession 50% active asset reduction in respect of all relevant CGT assets. The trustee makes a capital gain of $4,000 (capital proceeds $9,000 less cost base $5,000) from the disposal of an active asset owned for eight months. The trust is not able to access the CGT discount as the asset has not been held for at least 12 months. However, the trust satisfies the conditions for the small business 50% active asset reduction and the gain is reduced to $2,000. The net income of the trust is $2,000. The trustee distributes the capital proceeds of $9,000 equally to Gilbert and the other beneficiary in the income year in which the capital gain is made. The tax consequences for Gilbert are:
| Gilbert’s trust income under section 97 of the ITAA 1936 | $1,000 |
| Gilbert calculates his capital gain: |
|
| Gross up trust gain ($1,000 x 2) | $2,000 |
| Less: SB 50% reduction | $1,000 |
| Capital gain | $1,000 |
| Gilbert calculates his non assessable part under CGT event E4: |
|
| Payment of capital proceeds made by trustee | $4,500 |
| Less: trust net capital gain assessed under s 97 | $1,000 |
| Non assessable part of payment | $3,500 |
| The cost base of Gilbert’s unit in the trust is $500. Therefore, the non assessable part of the payment exceeds the cost base. Gilbert must reduce the cost base of his unit to nil and he makes a capital gain under CGT event E4 as follows: |
|
| Non assessable part of payment | $3,500 |
| Less: cost base of unit | $500 |
| Capital gain under CGT event E4 | $3,000 |
| Gilbert may then apply CGT concessions at a personal level to reduce the capital gain resulting from CGT event E4. Here, he has owned the units for at least 12 months and is therefore eligible for the CGT discount. He is also eligible for the small business 50% reduction because he satisfies all the basic conditions in Subdivision 152-A. Therefore, the capital gain from CGT event E4 is reduced as follows: |
|
| Capital gain under CGT event E4 | $3,000 |
| Less: 50% CGT discount | $1,500 |
| Less: small business 50% reduction | $750 |
| Reduced capital gain | $750 |
The net tax result for Gilbert is that he is taxed on a net capital gain of $1,750 (i.e. $1,000 capital gain under Subdivision 115-C plus $750 from the CGT event E4 capital gain).
Example 4
Assume the same facts as in Example 3, except that the realised asset had been owned by the trust for more than 12 months and therefore the capital gain can be reduced by the 50% CGT discount and the 50% small business reduction. The tax consequences for Gilbert are as follows:
| Gilbert’s trust net income under section 97 of the ITAA 1936 | $500 |
| Gilbert calculates his capital gain under Subdivision 115-C: |
|
| Gross up trust gain ($500 x 4) | $2,000 |
| Less: CGT discount reduction. | $1,000 |
| Less: 50% active asset reduction | $500 |
| Net capital gain | $500 |
| Gilbert calculates his non assessable part under CGT event E4: |
|
| Payment of capital proceeds made by the trustee | $4,500 |
| Less: trust net capital gain assessed under section 97 of the ITAA 1936 | $500 |
| Less: CGT discount adjustment (per item 1 from the table in section 104-71(4). | $1,000 |
| Non assessable part | $3,000 |
| The cost base of Gilbert’s unit in the trust is $500. Since the non assessable part of the payment exceeds the cost base, Gilbert reduces the cost base of his unit to nil and makes a capital gain under CGT event E4: |
|
| Non assessable part of payment | $3,000 |
| Less: cost base | $500 |
| Capital gain under CGT event E4 | $2,500 |
| Gilbert has satisfied the conditions for the CGT discount and the small business 50% active asset reduction in respect of his unit holding. Therefore, his capital gain under CGT event E4 can be reduced as follows: |
|
| Capital gain under CGT event E4 | $2,500 |
| Less: 50% CGT discount | $1,250 |
| Less: small business active asset reduction of 50% | $625 |
| Reduced capital gain | $625 |
The net tax result for Gilbert is that he is taxed on a net capital gain of $1,125 (i.e. $500 capital gain under Subdivision 115-C plus $625 CGT event E4 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.