A CGT event E4 can only happen in relation to a fixed or hybrid trust interest.
CGT Event E4
A CGT event E4 happens if the trustee of a fixed or hybrid trust makes a distribution and some or all of the payment is non-assessable income. This non-assessable part will reduce the cost base of the relevant fixed trust interest or result in a capital gain.
Common Triggers
Common scenarios that trigger a CGT event E4 are distributions from a fixed trust relating to the small business 50% reduction in Subdiv 152-C, depreciation of furniture and fittings in Div 40 and building structures in Div 43.
Think of it this way. Let’s say a unit trust makes a profit of $1m and now has $1m sitting in the bank. It claims a Div 43 depreciation of $100,000, so now its net income is only $900,000. But it still has the $1m sitting in the bank and pays it out to unit holders. So the unit holders received $1m but only pay tax on $900,000. CGT event E4 is about this gap of $100,000.
CGT event
The distribution of a non-assessable amount gives rise to CGT event E4: Capital payment for trust interest.
This is because the trustee of the trust makes a payment to a unit holder. And this payment is not included in the unit holder’s assessable income. This part is referred to as “the non-assessable part”.
Non-Assessable Part
Section 104-70 (1) provides that the cost base of the units is reduced by the amount of the non-assessable part paid to the unit holder.
s104-70 (1): CGT event E4 happens if: (a) the trustee of a trust makes a payment to you in respect of your unit or your interest in the trust…and (b) some or all of the payment (the non-assessable part) is not included in your assessable income.
(4): You make a capital gain if the sum of the amounts of the non-assessable parts of the payments made in the inomce year made by the trustee in respect of the unit or interest is more than its cost base. Note: You cannot make a capital loss.
(5) If you make a capital gain, the cost base and reduced cost base …are reduced to nil.
Capital Gain
If the non-assessable part is more than the cost base, the cost base decreases to nil. And the excess is a capital gain. The capital gain may qualify for the 50% discount – ATO Interpretative Decision (ID) 2010/84.
The reduction of cost base can happen over a number of years as each annual distribution contains a non-assessable payment. So even though a capital gain might not happen in the first few years, eventually it can. The cumulative total of the non-assessable payments over all years might exceed the cost base of the units or interests.
The capital gain is equal to the amount by which the non-assessable part is more than the cost base of the units. The cost base of those units is nil. Here is an example.
Bob has units with a cost base of $50 each and during each income year the trustee makes four non-assessable payments of $2 per unit.
So in the first income year, the payments will reduce Bob’s cost base by $8, giving it a new cost base of $42. But by Year 6 the cost base will hit zero and any further non-assessable payments will result in a capital gain.
Adjustments
The non-assessable part is adjusted for certain amounts. These adjustments are listed in s104-71 (1), (3) and (4) ITAA97.
Tax-Exempted Amounts
The first type of adjustment comes through s104-71 (1) for tax-exempted amounts. In working out the non-assessable part, you disregard any non-assessable non-exempt income (NANE), any amounts assessed to the trustee, any PSI included in your assessable income and any capital gains exempt under the 15-year exemption in Subdiv 152-B. You also disregard compensation or insurance and annuity payments paid through a trust.
Tax-Free Amounts
The second type of adjustment relates to tax-free amounts. It is less common and only applies to very specific cases. You can find these in s104-71 (3). The non-assessable part is adjusted to exclude amounts attributable to PDFs, infrastructure borrowings, eligible venture capital investments, ESVCLPs and a range of other things.
CGT Discounts and Concessions
And the third type of adjustment comes through s104-71 (4). It relates to the 50% CGT discount in Div 115 and the small business CGT concessions in Div 152.
50% CGT Discount
There is a specific exemption in the legislation for non-assessable amounts relating to the 50% discount. So any non-assessable amount relating to the 50% CGT discount does not result in an E4 cost base adjustment.
Small Business 50% Reduction
A common trigger for a CGT event E4 is the small business 50% asset reduction in Subdiv 152-C. This makes the small business 50% asset reduction a lot less attractive to fixed and hybrid trusts. It basically negates the benefit of the reduction upon distribution to unit holders.
Even if there is no capital gain, the non-assessable part will nevertheless reduce the cost base. And hence increase a future capital gain. So there is still an adverse effect. But the adverse effect is deferred until the structure is wound up.
If there is no distribution of the capital gain in the year it is derived, the benefit of the small business 50% reduction will be lost anyway through application of the gross-up rules.
Example
Here is an example per s104-71.
The trustee of a unit trust pays Claude $100. The trustee advises that the amount consists of $100 gross capital gain less 50% CGT discount less small business 50% reduction resulting in a net capital gain of $25.
In applying Subdiv 115-C ITAA97 Claude takes the gross amount $100 and reduces it by a $20 net capital loss from an earlier year. He then reduces the remaining $80 gain by the 50% CGT discount and the small business 50% reduction, leaving a net capital gain of $20.
To calculate the non-assessable part, Claude starts with the $100 and deducts the $25 net capital gain assessed to him under s97 ITAA36. He then deducts the 50% CGT discount of $50 – using the trustee’s numbers. He then deducts a quarter of his capital loss (25% of $20 is $5) to get from the trustee’s calculation to his own. So the cost base adjustment is $20.
Discretionary Trusts
Section 104-70 does not apply to discretionary trusts as no beneficiary has an interest in the trust. This means that discretionary trusts can distribute “tax-free” amounts without adverse CGT consequences (see TD 2003/28).
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