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Ruling

Subject: CGT losses and capital gains discount

Question 1

In respect of capital growth payments made to the lessee under a Lease and assuming the amounts are capital payments and not revenue in nature, will the payment trigger CGT event C2 happening under section 104-25 of the ITAA 1997 and does the rulee make a capital loss equal to the amount of the payment as a result of CGT event C2 happening?

Answer

No.

Question 2

Will the receipt of an amount under the Lease in respect of the decline in value of the dwelling trigger CGT event C2 happening under section 104-25 of the ITAA 1997 and will that give rise to capital gain being made as a result of CGT event C2 happening rather than a revenue gain?

Answer

Yes.

Question 3

If the receipt of an amount under the Lease in respect of the decline in value of the dwelling gives rise to a capital gain being made as a result of CGT event C2 happening, where the Lease is entered into at least 12 months prior to the termination of the Lease and the other eligibility conditions of Division 115 of the ITAA 1997 are met, will there be a discount percentage for an amount of a discount capital gain?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

Year ended 30 June 2023

The scheme commences on:

01 July 2011

Relevant facts and circumstances

The company is a private Australian resident company which acts as trustee of the Trust which is conducting a business.

The agreement to lease, the loan and other documents provided form the facts for the rulee's circumstances.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 110-35

Income Tax Assessment Act 1997 Section 110-55

Income Tax Assessment Act 1997 Division 115

Reasons for decision

Question 1

Summary

The ending of the Lease results in CGT event C2 happening under subsection 104-25(1) of the ITAA 1997. However, the rulee will not make a capital loss under subsection 104-25(3) of the ITAA 1997 as a result of the capital growth payments made to the lessee under the Lease. This is because the capital proceeds from the ending of the ownership of the intangible CGT asset are not less than the asset's reduced cost base.

Detailed reasoning

Under the Lease, when the owner receives the new loan amount, the owner pays to the lessee or legal personal representative an amount by which that new loan amount exceeds the loan amount. This excess (if any) is the capital growth payment and is on capital account.

CGT event C2

Under paragraph 108-5(1)(b) of the ITAA 1997, a CGT asset is a legal or equitable right that is not property. A right to enforce a contractual obligation is an example of a CGT asset (see Note 1 to subsection 108-5(2) of the ITAA 19907).

Under the Lease, the Lease has a right to receive certain monthly payments from the lessee during the period of the lease. Accordingly, the Trust has the right to enforce the contractual obligation of the resident to pay such fees under the lease agreement during the period of the lease.

Under paragraph 104-25(1)(a) of the ITAA 1997, CGT event C2 happens if the ownership of an intangible CGT asset ends by the asset being redeemed or cancelled. The rulee's rights to enforce the contractual obligation of the lessee to pay such monthly fees under the Lease, being the intangible CGT asset, are cancelled once the lease is terminated in accordance with the provisions of the Lease. Accordingly, upon the termination of the lease, the rulee's ownership of the intangible CGT asset ends and CGT event C2 happens.

Is a capital loss made?

Under subsection 104-25(3) of the ITAA 1997, a capital loss is made if the capital proceeds from the ending of the intangible CGT asset are less than the asset's reduced cost base.

Subsection 116-20(1) of the ITAA 1997 provides that the capital proceeds include the total of the money received by the CGT asset owner in respect of the CGT event happening.

Subsection 110-25(1) of the ITAA 1997 provides that the cost base of a CGT asset consists of 5 elements. The only potentially applicable element to the capital growth payment is the second element of the cost base which is the incidental costs incurred by the CGT asset owner (see subsection 110-25(3) of the ITAA 1997).

What are the incidental costs included in the cost base of a CGT asset?

Subsection 110-35(1) of the ITAA 1997 states that there a number of incidental costs that may have been incurred, and with one exception, these are costs that a taxpayer may have incurred to acquire a CGT asset or that relate to a CGT asset.

Of the ten incidental costs listed in subsections 110-35(2) to 110-35(11) of the ITAA 1997, the only one that is potentially applicable to the capital growth payment is subsection 110-35(11) of the ITAA 1997. That subsection provides that the tenth incidental cost is termination or other similar fees incurred as a direct result of the ownership of the CGT asset ending.

The expression 'termination or other similar fee' is not defined in the ITAA 1997. The ordinary meaning of the expression 'termination fee' from the Macquarie Dictionary definition of the words 'termination' and 'fee' is 'a payment or charge for the act of terminating or ending something'.

The Explanatory Memorandum to the Tax Laws Amendment (2010 Measures No. 4) Bill 2010, which inserted subsection 110-35(11) into the ITAA 1997, explains at paragraph 2.84 that:

Typically, termination fees (and exit fees) are contractual fees imposed by one party on the other as a result of the second party breaking the contract.

A capital growth payment is not a termination or exit fee. It is not paid by the rulee to the lessee on termination of the Lease for the purpose of penalising the rulee for breaking the contract. In actual fact, it is often the lessee who will terminate the Lease and, in such situations, the lessee is still entitled to the capital growth payment under the Lease. This entitlement remains because the lessee's right to the capital growth payment exists under the Lease for entirely different purposes to that of a termination or exit fee. The capital growth payment is in fact paid when the new lessee pays the new loan amount. The requirement to pay the capital growth payment therefore does not actually arise when the lease is terminated, rather the entitlement arises when the new lessee pays the new loan amount.

The capital growth payment is paid to the lessee for the purpose of reflecting the lessee's entitlement to a percentage of the capital appreciation of the asset of owning the right to utilise the premises over a period of time under the lease. The capital growth payment is triggered by the timing of the rulee receiving the new loan amount. As such, it is not paid as compensation for the early termination of the lease by either party. Accordingly, the capital growth payment does not have the requisite characteristics of a termination or exit fee.

Therefore, the capital growth payment is not an incidental cost under section 110-35 of the ITAA 1997. Further, the payment does not fall within any of the other four elements of the cost base of a CGT asset under section 110-25 of the ITAA 1997. As such, the capital growth payment is not included in the reduced cost base of the intangible CGT asset. Accordingly, the rulee would not make a capital loss equal to the amount of the capital growth payment upon termination of the lease being when the rulee's ownership of the intangible CGT asset ends.

Question 2

Summary

The ending of the Lease results in CGT event C2 happening under subsection 104-25(1) of the ITAA 1997. The rulee will make a capital gain under subsection 104-25(3) of the ITAA 1997 as a result of the payments received from residents under the Lease provided that the capital proceeds from the ending of the ownership of the intangible CGT asset are more than the asset's cost base.

Detailed reasoning

As discussed above upon the termination of the lease, the rulee's ownership of the intangible CGT asset ends and CGT event C2 happens.

Under subsection 104-25(3) of the ITAA 1997, a capital gain will be made if the capital proceeds from the ending of the CGT asset are more than the asset's cost base. Subsection 116-20(1) of the ITAA 1997 provides that the capital proceeds include the total of the money received by the CGT asset owner in respect of the CGT event happening. The cost base is determined under section 110-25 of the ITAA 1997.

Therefore, if the capital proceeds exceed the cost base, there will be a capital gain made from CGT event C2 happening in respect of the payments received by the rulee for the decline in the value of the premises.

Question 3

Summary

If the receipt of an amount under the Lease in respect of the decline in value of the premises gives rise to a capital gain being made as a result of CGT event C2 happening, where the Lease is entered into at least 12 months prior to the termination of the Lease and the other eligibility conditions of Division 115 of the ITAA 1997 are met, there will be a discount percentage for an amount of a discount capital gain.

Detailed reasoning

As discussed at question 2, if the capital proceeds exceed the cost base, there will be a capital gain made from CGT event C2 happening in respect of the payments received by the rulee for the decline in the value of the dwelling.

Under subsection 115-25(1) of the ITAA 1997, to be a discount capital gain, the capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event.

Therefore, where the Lease is entered into at least 12 months prior to the termination of the Lease and the other eligibility conditions of Division 115 of the ITAA 1997 are met there will there be a discount percentage for an amount of a discount capital gain.

Further issues for you to consider

Subdivision 115-C of the ITAA 1997 should be considered by the Trust, as eligibility to the capital gains discount is dependent on the entity assessed and the capacity in which they are assessed on the capital gain.

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