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Subject: Income Tax - Div 7A - Transfer of property

Issue 1

Question

Will the market value substitution rule in subparagraph 116-30(2)(b)(i) of the Income Tax Assessment Act 1997 (ITAA 1997) apply in relation to the transfer of the property?

Answer

No.

Issue 2

Question 1

Will subsection 109C(4) of the Income Tax Assessment Act 1936 (ITAA 1936) apply to reduce the amount of the payment for the purposes of section 109C of the ITAA 1936 to nil?

Answer

No.

Question 2

Will any other provision of Division 7A of the ITAA 1997 apply in relation to the transfer of the property?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

A company recently purchased land.

At the time of the purchase, it was the company's intention to construct buildings on the land and operate a business.

It was later decided that the construction and business would be carried out in a unit trust. Consequently, the unit trust was established and it was intended that the land would be transferred for its market value to the trust within the same month. This was overlooked by the company's solicitor, however you believed that the transfer had been carried out.

The trust commenced construction of the buildings under this mistaken belief and construction was subsequently completed. The costs of construction were paid for by the trust.

Upon discovering that the transfer was not done, the company now wishes to transfer the land to the trust at its market value (excluding the value of the buildings) so that the land and buildings will become the assets of the trust.

The company is a related party to the trust.

You have stated that subsection 109C(1) of the ITAA 1936 applies in relation to the proposed transfer of the land.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 Section 109C

Income Tax Assessment Act 1936 Section 109RB

Income Tax Assessment Act 1997 Subsection 104-60(1)

Income Tax Assessment Act 1997 Section 108-55

Income Tax Assessment Act 1997 Subparagraph 116-30(2)(b)(i)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Issue 1

CGT event E2

Subsection 104-60(1) of the ITAA 1997 provides that capital gains tax (CGT) event E2 happens if you transfer a CGT asset to an existing trust. The time of the event is when the asset is transferred.

A capital gain will be made if the capital proceeds from the transfer of the asset are more than the asset's cost base. A capital loss will be made if those capital proceeds are less than the asset's reduced cost base.

The relevant CGT asset in this case will be the property consisting of the land and buildings. Under section 108-55 of the ITAA 1997, which relates to when a building is a separate asset from land for CGT purposes, the buildings would only be a separate asset from the land if the balancing adjustment provisions relating to depreciating assets or for research and development applies to the buildings. As neither of these balancing adjustment provisions applies, the buildings will not be a separate asset from the land for CGT purposes.

Market value substitution rule

Subparagraph 116-30(2)(b)(i) of the ITAA 1997 provides that the capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if those capital proceeds are more or less than the market value of the asset, and a person and the entity that acquired the asset from that person did not deal with each other at arm's length in connection with the event.

In this case, the proposed capital proceeds will comprise the current market value of the land disregarding improvements paid for by the trust. The capital proceeds for the CGT asset, that is, the land and buildings, will therefore be less than the market value of the asset, and we will need to consider whether the company and the trust dealt with each other at arm's length in connection with the event.

The question of whether parties are dealing with each other at arm's length is not decided by asking whether the parties were at arm's length to each other. Subsection 995-1(1) of the ITAA 1997 provides:

arm's length: in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

The fact that there is no ownership connection between the parties is not determinative, on its own, of whether the parties deal with each other at arm's length. The question is whether the parties dealt with each other at arm's length (The Trustee for the Estate of the late AW Furse No. 5 Will Trust v. FC of T 91 ATC 4007 at 4014-4015; (1990) 21 ATR 1123 at 1132). This will be determined by considering the terms of the dealing and any other relevant consideration.

In Granby Pty Ltd v. FC of T 95 ATC 4240; (1995) 30 ATR 400 there was no evidence that one party accepted instructions from another party to the exclusion of independent analysis, and accordingly the parties were held to be dealing at arm's length. There, the parties were dealing at arm's length over the acquisition of an asset although the price paid was less than the market value of the asset.

Lee J stated (at ATC 4243; ATR at 403) that the provision 'dealing with each other at arm's length' invited an analysis of the manner in which the parties conduct themselves in forming the transaction. The question is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs and the expression means, at least, that the parties acted severally and independently in forming their bargain.

Further, Lee J stated (at ATC 4244; ATR 403-404) that:

If the parties to the transaction are at arm's length it will follow, usually, that the parties will have dealt with each other at arm's length. That is, the separate minds and wills of the parties will be applied to the bargaining process whatever the outcome of the bargain may be.

However this will not be the case where the parties collude to achieve a particular result, or where one of the parties submits the exercise of its will to the discretion of the other. In such a case the lack of the exercise of an independent will in the formation of the transaction would indicate a lack of real bargaining.

In Collis v. FC of T 96 ATC 4831; (1996) 33 ATR 438, the Federal Court found that the parties were not dealing at arm's length because one party was indifferent to the allocation of the sale price for the parcel of land. This indifference was indicative of a submission of one party's will to the other party's wishes which demonstrated a lack of arm's length dealing.

In the application being considered, the company is a related party to the trust. The crucial issue, however, is that the company and trust dealt with each other at arm's length, in other words, that the arrangement between the company and the trust is a matter of real bargaining. Taking into account the circumstances of this case, and particularly the fact that the trust paid the costs of construction of the buildings due to the belief that the transfer of the property had taken place, it would be reasonable to expect the parties in this case to determine the transfer purchase price of the property as being the market value of the land portion only. It would be reasonable to conclude that the same agreement could have been negotiated between independent parties in the same circumstances.

Therefore, in view of the particular circumstances in this case, the company and the trust would be dealing with each other at arm's length in relation to the transfer of the property. Accordingly, subparagraph 116-30(2)(b)(i) of the ITAA 1997 will not apply to substitute the market value of the property as the capital proceeds from the transfer of the property.

Issue 2

Question 1

You have stated that subsection 109C(1) of the ITAA 1936 applies in relation to the proposed transfer of the land.

Subsection 109C(1) of the ITAA 1936 provides that a private company is taken to pay a dividend to an entity if the private company pays an amount to the entity during the income year and:

· the entity is a shareholder or associate of a shareholder in the company at the time of the payment or

· a reasonable person would conclude that the payment was made because the entity has been a shareholder or associate at some time.

By virtue of paragraph 109C(3)(c) of the ITAA 1936, the definition of payment in subsection 109C(3) of the ITAA 1936 includes a transfer of property to the entity.

Subsection 109C(4) of the ITAA 1936 relates to the value of a payment consisting of a transfer of property, and provides that the amount of the payment is the amount that would have been paid for the transfer by parties dealing at arm's length less any consideration given by the transferee for the transfer. The amount of a payment is nil if the consideration given by the transferee equals or exceeds the amount that would have been paid at arm's length for the transfer.

In this case, we have determined above that the company and trust would be dealing with each other at arm's length in relation to the transfer in the particular circumstances detailed above. Subsection 109C(4) of the ITAA 1936, however, provides that the amount of the payment is the amount that would have been paid for the transfer by parties dealing at arm's length, which in this case would be the value of the whole property, that is, the land and the buildings. As the consideration to be given in this case is only the market value of the land portion of the property, there will be a payment for the purposes of section 109C of the ITAA 1936 amounting to the difference between the value of the whole property and the consideration given.

Subsection 109C(4) of the ITAA 1936 will therefore not apply to reduce the amount of the payment for the purposes of section 109C of the ITAA 1936 to nil.

Note

The amount of the dividend paid is limited to the distributable surplus of the company (section 109Y of the ITAA 1936).

Question 2

Division 7A of the ITAA 1936 treats certain kinds of amounts as dividends paid by a private company. We have determined above for question 2 that section 109C of the ITAA 1936, which is contained in Division 7A of the ITAA 1936, will apply in relation to the transfer of the land. The other provisions in Division 7A of the ITAA 1936 relate to amounts lent by a company and debts owed to a company, and will not apply in relation to the transfer.

Discretion under section 109RB of the ITAA 1936

Section 109RB of the ITAA 1936 provides the Commissioner with a discretion to disregard the operation of Division 7A of the ITAA 1936 where a private company is taken to pay a particular dividend to a particular entity and the result arises because of an honest mistake or inadvertent omission by any of the following entities:

· the recipient

· the private company

· any other entity whose conduct contributed to that result.

The exercise of this discretion has not been considered as part of this private ruling as this was not requested by you in your application. A further application can be made if you require the exercise of this discretion to be considered. Any such application should provide the full circumstances of the honest mistake or inadvertent omission.

Taxation Ruling TR 2010/8 and Practice Statement Law Administration PS LA 2011/29 provide further information about this discretion.

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