Edited version of your written advice

Authorisation Number: 1013083631397

Date of advice: 19 September 2016

Ruling

Subject: CGT

Question 1

Is the taxpayer required to disclose in its tax return for the 2016 tax year the 2016 sale or to include any part of the proceeds of the 2016 sale as a net capital gain?

Answer

Yes, the taxpayer is required to disclose in its tax return for the 2016 year the capital gain arising from the 2016 sale of the property.

This ruling applies for the following periods:

Year ended 30 June 2016

The scheme commences on:

Not applicable

Relevant facts and circumstances

1. The property was acquired by X in 19X0.

2. X acquired the property as their principal residence from the date of acquisition.

3. In 20X1, X separated from their spouse.

4. A Family Court order was filed on dd/mm/yyyy between X and their spouse.

5. The Family Court Orders provided that X was to sell the property to P for a consideration of $X no later than XX days after the date upon which contracts are exchanged and then distribute the proceeds as per the Family Law Orders.

6. Following the Family Court orders in 20X6, P and X intended to create legal relations by agreeing that the Taxpayer (the trustee of P's family trust) would acquire the legal title of the property pursuant to the Family Law Order but X would in effect retain the beneficial ownership of the property secured by X having the right to buy back the property at cost. This arrangement was documented in writing by way of a letter from P to X dated dd/mm/yyyy.

7. The letter provided that X was permitted to occupy the property with the right to purchase the property back from the Taxpayer within 18 months of the letter for the same amount it was sold for, being $X plus any costs associated with the transaction.

8. The parties believed at the time of the letter that X would be in a position to buy back the property within the 18 month period. However, particular events prevented X from having the funds to buy back the property within that period.

9. A later agreement (undated) was entered into between P, X and the Taxpayer to re-affirm the agreement that X was to in effect retain the equitable right to live in the property, that is, retain their beneficial ownership, with the right to buy-back the property at some point.

10. The agreement provided that:

• X retains the equitable right to live in the property until such time they buy it back or on-sells it.

• X has the right to acquire the property from the taxpayer for the original price it was sold for, being $X plus any costs incurred by the Taxpayer during its period of ownership; and

• If X chooses to on-sell the property, then X will be entitled to any gain in excess of the original purchase price of $X as a result of the sale.

11. The 20X6 transfer was settled in 20X6. Upon settlement, the Taxpayer paid the consideration of $X as per the terms of the Family Court Order.

12. The legal title of the property was transferred and registered in the name of the Taxpayer in 20X6.

13. Pursuant to the agreement, X continued to occupy the property as his principal place of residence. X did not pay nor were they obligated to pay any rental amount to the Taxpayer.

14. X continued to pay for home and contents insurance, maintenance costs for the property and any expenses associated with renovating the property. This included replacement of the hot water service, repairs to the drains, kitchen floors, carport gate and the deck at the rear of the property.

15. In 20X5, X decided to renovate the property and offer the property for public sale. X retained the services of a builder to perform the relevant works.

16. On dd/mm/yyyy, X instructed the Taxpayer to retain a real estate agent to sell the property at a public auction.

17. The property was sold at auction in 20X6.

18. The proceeds of the 20X6 sale were paid to the Taxpayer.

19. In 20X6, the Taxpayer remitted the net proceeds of the sale to X as per the agreement (paying the excess net proceeds of sale over the original purchase price less expenses and costs incurred by the Taxpayer since acquisition in 20X6).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10.

Income Tax Assessment Act 1997 section 104-25.

Income Tax Assessment Act 1997 section 104-35.

Income Tax Assessment Act 1997 section 110-25.

Income Tax Assessment Act 1997 subsection 110-25(6)

Reasons for decision

The 20X6 transfer

CGT event A1 happens if a taxpayer disposes of a CGT asset (section 104-10 Income Tax Assessment Act 1997). The disposal of a CGT asset takes place if a change of ownership occurs from the taxpayer to another entity, whether because of some act or event or by operation of law.

A change of ownership does not occur merely because there is a change of trustee or if a taxpayer stops being the legal owner of an asset but continues to be its beneficial owner.

The most common example of CGT event A1 is the sale of an asset.

Where the asset is disposed of under a contract, the time of CGT event A1 is when the taxpayer enters into the contract.

A capital gain is made where the capital proceeds from the disposal are more than the cost base of the property.

CGT event A1 occurs in the case of the sale of the property by X to the taxpayer in 20X6, pursuant to Family Court orders. X has disposed of a CGT asset, the property, as a change of ownership occurs from X to the taxpayer by operation of law under the Torrens title system.

The time of CGT event A1 is when X enters into the contract to sell the property to the taxpayer.

It is not the case that a change of ownership has not occurred where X stops being the legal owner of the property but continues to be its beneficial owner. A change of ownership would not occur where a bare trust is created by X transferring the property to the taxpayer as trustee for X to hold the legal title to the property while X continued to be the beneficial owner of the property.

The letter from P to X in 20X6, separate from the contract for the sale of the property, provided that X was permitted to occupy the property with the right to purchase the property back from the Taxpayer within 18 months of the letter at cost. The subsequent agreement (undated) between P and X provided that X retains the equitable right to live in the property until such time as they buy it back or on-sell it.

The terms of these documents do not evidence an intention to create a bare trust by transferring the property to the taxpayer in a capacity as trustee for X. The documents do not provide that the property is held "on trust" for X. In addition, the options granted for X to buy back the property or on-sell it is inconsistent with the existence of a trust relationship. If there was a trust relationship, X would be entitled to call upon the taxpayer to transfer legal title to the property to them. Nor will a resulting trust be taken to arise here, as the property has been transferred to someone who pays market value rather than nothing for the property. In addition, a resulting trust can only be declared by a court.

At the time of CGT event A1, when the contract was entered into, the contract for the sale of land provides for the transfer of the full legal interest in the property to the taxpayer, which carries with it an entitlement to the enjoyment of the property. Accordingly, the legal owner of the property is also the beneficial owner.

Without knowing what the cost base of the property would be, any capital gain to X resulting from the sale of the property would most likely be covered by the CGT main residence exemption.

The granting of the right to reside in the property

The terms of the letter in 20X6 between P and X grant a right in X to reside in the property. This right to reside in the property was subsequently extended in an undated agreement.

CGT event D1 happens if a taxpayer creates a contractual right or other legal or equitable right in another entity (section 104-35).

The time of CGT event D1 is when the taxpayer enters into the contract or creates the other right.

A capital gain is made if the capital proceeds from creating the right are more than the incidental costs incurred that relate to the event.

Paragraph 105 of Taxation Ruling TR 2006/14 states:

105. A right to reside in property for life (or a term of years) is not equivalent to a legal or equitable life interest. The right is a mere personal right which cannot be assigned. CGT event D1 in section 104-35 happens when such a right is granted. These arrangements should be contrasted with mere informal family arrangements where relatives may reside at each other's dwellings for a period but where there is no intention to create legal relations. In these circumstances CGT event D1 will not happen.

In the present circumstances, the right to reside in the property for approximately ten years is not equivalent to a legal or equitable life interest. This right is a mere personal right which cannot be assigned.

CGT event D1 in section 104-35 happens when this right is granted, under the terms of the letter in 20X6.

This arrangement should be contrasted with a mere informal family arrangement where there is no intention to create legal relations. It is apparent from the facts that the parties intend to create legal relations, so as to avoid any complications or unintended consequences. For example, at paragraph 8 of the submissions attached to your private ruling application, you state that "The Letter was merely a mechanism to ensure that X was able to have the legal title returned to them at their prerogative and protect their equity in the Property in the event of a dispute." CGT event D1 occurs in these circumstances.

In the circumstances, as no capital proceeds are received from creating the right and there are no incidental costs incurred relating to the event, then there will be effectively be no capital gain or capital loss flowing from CGT event D1 occurring here.

The ending of the right to reside in the property

The undated agreement recording the agreement between P, X and the taxpayer provided that X retains the right to live in the property until such time they buy it back or on-sell it. X had the right to acquire the property from the taxpayer for the original price it was sold for plus any costs incurred by the Taxpayer during its period of ownership. If X chose to on-sell the property, then X will be entitled to any gain in excess of the original purchase price of $X as a result of the sale.

In 20X6, X instructed the taxpayer to engage real estate agent to sell the property. The property was sold at an auction in 20XX and the taxpayer remitted the net proceeds to X as per the terms of the undated agreement.

CGT event C2 happens if a taxpayer's ownership of an intangible CGT asset ends because it is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered, forfeited or expired (section 104-25).

The time of the event is when the taxpayer enters into the contract which results in the asset ending or, if there is no contract, when the asset ends.

The taxpayer makes a capital gain from CGT event C2 if the capital proceeds from the asset ending are more than the asset's cost base.

X's right to reside in the property expires or is otherwise extinguished upon the sale of the property and the remittance of the net proceeds to them as per the terms of the undated agreement. CGT event C2 occurs in these circumstances.

In the present circumstances, CGT event C2 occurs when the taxpayer enters into a contract to sell the property, as per X's instructions.

X makes a capital gain from CGT event C2.

There are no CGT implications for the taxpayer under CGT event C2 when X's right to reside in the property expires or is otherwise extinguished upon the sale of the property.

The sale of the property in 20X6

The taxpayer is stated as the vendor of the property in the contract for the sale of the property in 20X6.

For the purposes of the disposal of the property under the contract, the taxpayer is the legal and beneficial owner of the property. (The taxpayer became the legal and beneficial owner of the property upon the transfer of the property to it in 20X6.)

CGT event A1 under section 104-10 occurs in the case of the sale of the property by the taxpayer in 2016. The taxpayer has disposed of a CGT asset, the property, as a change of ownership occurs from the taxpayer to the purchaser by operation of law under the Torrens title system.

The time of CGT event A1 is when the taxpayer entered into the contract to sell the property.

A capital gain is made where the capital proceeds from the disposal are more than the cost base of the property.

The five elements of the cost base of an asset are set out in section 110-25. The fifth element is capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset.

The taxpayer makes a capital gain from CGT event A1.

The payment of the net proceeds from the sale of the property by the taxpayer to X does not form part of the fifth element of the cost base of the property, or any other element of the cost base of the property.

You have submitted that the payment can be described as a cost incurred to remove an equitable right or interest over the property to enable clear title to pass to the purchaser. This is then comparable to a landowner paying out the remainder of the term of a tenant's lease to enable a sale of vacant possession. This cost would then come within the fifth element of cost base, as capital expenditure incurred to establish, preserve or defend the taxpayer's title to the asset or a right over the asset.

However, as stated previously, X's right to reside in the property for approximately ten years is not equivalent to a legal or equitable life interest. This right is a mere personal right which cannot be assigned (see paragraph 105 of Taxation Ruling TR 2006/14). The payment cannot then be described as a cost incurred to remove an equitable right or interest over the property to enable clear title to pass to the purchaser.

In addition in Emmerson v. Computer Time Ltd (in liq) [1977] 2 All ER 545, it was held that the payment of arrears of rent by a lessee for the purpose of obtaining the lessor's consent to the assignment of the lease was not a payment that was incurred for the purpose of establishing, preserving or defending the tenant's title to the lease. In that case Orr LJ said that it was not possible to fit the performance of obligations under a lease which are an incident of the tenant's title within the phrase "establishing, preserving or defending title". His Lordship said further that the phrase "expenditure …incurred in establishing or preserving or defending his title to, or a right over, the asset" applied to such matters as evicting a squatter or registering a charge over property, but had no application to the performance of a tenant's obligations under a lease.

Similarly, the payment of the net proceeds by the taxpayer to X merely amounts to the performance of the taxpayer's obligations under its agreement with X which is an incident of the taxpayer's title to the property. It cannot be described as capital expenditure incurred to establish, preserve or defend title to the asset, or a right over the asset (which may come within subsection 110-25(6)).

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).