Edited version of your written advice

Authorisation Number: 1051252515182

Date of advice: 17 July 2017

Ruling

Subject: Capital Gains Tax - Life and Remainder Interest

Questions and Answers

1. Will an assessable capital gain or loss arise on the surrender of the life interest by Person A?

2. Yes

3. Is the assessable capital gain on the surrender of the life interest in respect to certain property the difference between the market value of the life interest at the date of surrender less the market value of the life interest at the date of death of Person B?

4. Yes

5. Is Mr Person A entitled to enjoy the 50% general discount under section 115 of the ITAA 1997 as the life interest was held for more than 12 months by Person A?

6. Yes

7. Can a life interest be an active business asset for small business CGT concession purposes under Division 152 of the ITAA 1997?

8. Yes

9. Can Person A enjoy small business CGT relief under Division 152 of the ITAA 1997 in respect to;

a. Subdivision 152-C Small Business 50% reduction

b. Subdivision 152-D Small Business Retirement Exemption

c. Subdivision 152-E Small Business Rollover

Yes

10. On the understanding that the CGT event on the surrender of the life interest was to happen in connection with Person A’s retirement, could Person A enjoy small business relief under Subdivision 152B – Small Business 15 year exemption if the surrender occurs after 30 June 2017?

No

11. On the surrender of the life interest does the remainder interest simply pass to the remainder beneficiaries in accordance with the Will (section 128-15 of the ITAA 1997)?

12. Yes

This ruling applies for the following periods

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

1 July 2019 to 30 June 2020

1 July 2020 to 30 June 2021

The scheme commences on

1 July 2017

Relevant facts and circumstances

The Will of the late Person B bequeaths a life interest in certain property to Person A and upon Person A’s death this property is to be left equally to Person C and Person D at the date of Person A’s death.

It is proposed that:

a. Person A surrender their life interest in one or more of the properties he currently holds a life interest in.

b. At some future date after the properties have been transferred to remainder beneficiaries (being Person C and Person D), that Person D will transfer their 50% interest in some or all of the property received from the Estate of Person B to Person C. Person C may also transfer their 50% interest in certain property to Person D.

The Family Trust has operated the property in question since 1 July 2001. Except for a loss year (2004), Person A and their spouse have received distributions from the Trust in each tax year and the minimum combined distribution they have received in any year was X%.

Person A is also the sole Appointor for the Family Trust.

Person C and Person D are beneficiaries of the Trust.

The Family Trust carries on a business which uses exclusively the property that Person A has a life interest in.

Person B passed away after 20 September 1985.

The land owned by the late Person B was pre CGT land at the date of their death.

Person A is over 55 years old.

The combined market value of the assets Person A, their spouse and The Family Trust are less than $X.

The turnover of the Family Trust is less than $X.

Except for the loss year (2004) every year has had at least one individual who has received a trust distribution of X% or more since 1 July 2001.

Person A has previously claimed a small business retirement exemption amount of $X

The surrender of the life interest will not be made in connection with Person A’s retirement. Person A will not index the cost base of the life interest.

It is contemplated that Person C and Person D will transfer certain portions of their property to each other sometime over the next two financial years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 subsection 116-30(1)

Income Tax Assessment Act 1997 subsection 116-30(2)

Income Tax Assessment Act 1997 subsection 128-15(4)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 paragraph 152-40(4)(e) Subsection 152-40(4A)

Income Tax Assessment Act 1997 section 152-47

Income Tax Assessment Act 1997 subsection 152-110

Income Tax Assessment Act 1997 section 152-205

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 Subdivision 152-E

Income Tax Assessment Act 1997 subsection 328-125(1)

Income Tax Assessment Act 1997 paragraph 328-125(2)(a)

Income Tax Assessment Act 1997 subsection 328-125(3)

Income Tax Assessment Act 1997 section 328-130

Income Tax Assessment Act 1997 section 328-130(2)

Reasons for decision

If a life interest owner surrenders or releases their interest CGT event A1 happens. A capital gain is the difference between the capital proceeds and the cost base.

If the surrender or release is for no capital proceeds the market value substitution rule in subsection 116-30(1) of the Income Tax Assessment Act 1997 (ITAA 1997) applies to determine the amount of capital proceeds from the event.

If capital proceeds are given for the surrender, the market value substitution rule applies if those proceeds are more or less than the market value of the interest surrendered and the parties did not deal at arm's length: subsection 116-30(2) of the ITAA 1997.

Subsection 128-15(4) of the ITAA 1997 provides the cost base and reduced cost base for CGT assets in the hands of the legal personal representative or beneficiary. The cost base and reduced cost base of a CGT asset acquired by the deceased before 20 September 1985 is the market value of the asset on the day the deceased died.

Where life and remainder interests are created a reasonable apportionment of the cost base and reduced cost base of the asset must be made. An apportionment based on the relative market values of the interests created at the time of creation would be reasonable.

An assessable capital gain may be reduced by the CGT discount in Division 115 of the ITAA 1997. To be a discount capital gain, a capital gain must:

● be made by an individual, a complying superannuation entity, a trust, or by a life insurance company from a CGT event in respect of a CGT asset that is a complying superannuation/First Home Saver Account (FHSA) asset

● result from a CGT event happening after 11.45 am EST on 21 September 1999

● be worked out without the cost base being indexed, and

● result from a CGT event happening to a CGT asset owned by the taxpayer for at least 12 months.

Taxation Determination TD 2002/10 advises that the 12-month period does not include the day of acquisition and the day of disposal.

Person B is and individual, the CGT event will happen after 21 September 1999, they will not index the cost base and has owned the life interest since 2001. Therefore they are able to apply the discount to any capital gain made on the surrender of the life interest.

Section 152-35 of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

● you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or

● you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 ½ years during the test period.

The test period:

● begins when you acquired the asset, and

● ends at the earlier of

− the CGT event, and

− when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

As Person B has owned the life interest since 7 June 1990, the life interest must be an active asset for a total of approximately 2,700 days.

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset’. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with’ you, in the course of carrying on a business.

If the asset is an intangible asset – you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

An interest in a non-widely held trust is an active asset where the trust is a resident trust for CGT purposes, and:

The total of:

i. The market value of the active assets of the trust; and

ii. The market value of any financial instruments of the trust that are inherently connected with the business that the trust carries on; and

iii. Any cash of the trust that is inherently connected with such a business;

is 80% or more of the market value of all of the assets of the trust.

Paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset cannot be an active asset if its main use by its owner is to derive rental income. However, in determining the main use of the asset any use by an affiliate, or an entity that is connected with the owner, is treated as the owners use (Subsection 152-40(4A) of the ITAA 1997).

Therefore, the use by any affiliate, or entity that is connected must be considered.

An affiliate is defined by section 328-130 of the ITAA 1997 as being an individual or company who acts or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

For small business relief purposes, a spouse or child under 18 years may also be an affiliate under section 152-47 of the ITAA 1997.

Trusts, partnerships and superannuation funds cannot be your affiliates. However a trust, partnership or superannuation fund may have an affiliate who is an individual or company.

Whether a person acts or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, is a question of fact. Relevant factors that may support a finding that a person acts in such a manner include:

● the existence of a close family relationship between the parties

● the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

● the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations, and

● the actions of the parties.

Another business will not be acting in concert with you if they:

● Have different employees

● Have different business premises

● Have separate bank accounts

● Do not consult you on business matters

● Conduct their business affairs independently in all regards.

Section 328-130(2) of ITAA 1997 provides that an individual or a company is not an affiliate merely because of the nature of the business relationship shared by the entity and the individual or company.

The meaning of a connected entity is defined under subsection 328-125(1) of the ITAA 1997 which states:

An entity is connected with another entity if:

a. either entity controls the other entity in the way described in this section; or

b. both entities are controlled in a way described in this section by the same third entity.

Paragraph 328-125(2)(a) of the ITAA 1997 provides that an entity controls a another entity if the entity, its affiliates, or the entity together with its affiliates beneficially own or has the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive a percentage (control percentage) that is at least 40% of:

a. Any distribution of income by the other entity, or

b. Any distribution of capital by the other entity.

Subsection 328-125(3) if the ITAA 1997 provides that an entity controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

Person B, their spouse and Persons C and D are the trustees of the Trust, therefore it can reasonably be expected that the trustee acts in accordance with your and your affiliates wishes.

Therefore, the trust is connected with you. As the property is used by the trust to conduct a business, the life interest is an active asset.

You get a small business 50% reduction if the basic conditions for CGT small business relief are met (section 152-205 of the ITAA 1997). As the basic conditions are met, the amount of capital gain remaining after applying step 3 of the method statement is reduced by 50%.

You may choose to disregard all or part of a capital gain under the small business retirement exemption if you satisfy certain conditions.

Subdivision 152-D of the ITAA 1997 contains the Small Business Retirement Exemption and provides that an individual can choose to disregard all or part of a capital gain if:

● you satisfy the basic conditions

● if you are under 55 just before you make the choice – you contribute an amount equal to the asset’s CGT exemption amount to a complying superannuation fund or an RSA

● the contribution is made at the later of when you made the choice and when you received the proceeds

● you keep a written record of the amount you choose to disregard (the exempt amount), and

● your CGT retirement exemption limit is not exceeded.

An individual’s lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption.

As you satisfy the basic conditions, are over 55 and have not reached your lifetime CGT retirement, you can choose to disregard all or part of the gain under the small business retirement exemption.

You can choose to obtain a roll-over under subdivision 152-E of the ITAA 1997 (small business roll-over) for a capital gain if the basic conditions are satisfied for the gain. As you have met the basic conditions for the gain you can choose to disregard all or part of the capital gain to which this subdivision applies.

The small business 15-year exemption takes priority over the other small business concessions and the CGT discount. If the small business 15-year exemption applies, you entirely disregard the capital gain so there is no need to apply any further concessions. Further, you do not reduce the capital gain by any capital losses before you apply the 15-year exemption concession.

Subsection 152-110 of the ITAA 1997 provides that an individual can disregard any capital gain arising from a CGT event if all of the following conditions are satisfied:

a) the basic conditions are satisfied for the gain;

b) the individual continuously owned the CGT asset for the 15-year period ending just before the CGT event;

c) if the CGT asset is an interest in a trust – the trust had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which you owned the CGT asset; and

d) the individual was either:

i. 55 or over at that time and the event happened in connection with the individual's retirement; or

ii. permanently incapacitated at that time.

The basic conditions are met and you have owned the asset for the 15-year period ending just before the CGT event, however as the event is not happening in connection with your retirement, you are not entitled to the 15 year exemption.

If a life interest owner surrenders their interest CGT event A1 happens and the interest owner determines their capital gain or capital loss. The surrender of a life interest in a property is different to transferring the legal title of a property to someone. At the end of the life tenancy the asset is dealt with according to what is stated in the will.

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).