Edited version of your written advice

Authorisation Number: 1051346929823

NOTICE

This private ruling was revised following issue. This edited version has therefore been replaced with the edited version of the private ruling with the authorisation number of 1051468978579

Date of advice: 13 March 2018

Ruling

Subject: Capital gains tax – disposal of contractual rights

Question 1

Will the proceeds from the assignment of a right under a contract by the Trustee constitute a capital gain or be assessable as ordinary income?

Answer

The disposal of the contractual rights constitutes a profit making scheme or undertaking and the profits are included in your assessable income by virtue of subsection 15-15(1) of the Income Tax Assessment Act 1997 (ITAA 1997)

Question 2

If the proceeds from the assignment of the right are on capital account, what is the relevant CGT event?

Answer

A CGT event A1 will happen when the contractual rights under the contract are disposed of. However any capital gain will be reduced by the operation of section 118-20 of the ITAA 1997.

Question 3

What is the CGT asset(s) that is the subject of the CGT event(s)?

Answer

Refer response to question 2.

Question 4

Will the capital gain be treated as a discount capital gain as defined in section 115-5 of the ITAA 1997?

Answer

Not necessary to consider as there will not be a capital gain.

Question 5

Can any part of the capital gain be reduced or disregarded under the small business concessions in Division 152 of the ITAA 1997?

Answer

Not necessary to consider as there will not be a capital gain.

This ruling applies for the following period:

1 July 2017 to 30 June 2018

The scheme commences on:

The scheme has not yet commenced

Relevant facts and circumstances

(As per ruling application)

The Trustee is owned and controlled by two individuals are both directors and shareholders of the Trustee. Each of them holds 12 ordinary fully paid shares in the Trustee. On or around September 20xx, the Trustee entered into a Contract.

Under the terms of the Contract, relevantly:

(a) The Vendors agreed to sell and the Trustee agreed to buy the Property on the terms of the Contract;

(b) A deposit of $xxxx was payable as follows:

(i) $xxxx was payable when the contract is signed; and

(ii) $xxxx was payable on or before the “Possession Date”;

(c) The deposit would be released to the Vendors once certain conditions are satisfied, after which the Trustee would be entitled to occupy the Property under the terms of a lease agreement to be entered into by the parties;

(d) Settlement is due 5 years after the date of the Contract, and the balance of the purchase price is payable on settlement

(e) The Trustee may effect early settlement by paying the purchase price in full, in which case it would be entitled to a reduction in the purchase price of $xxxx for each year the settlement date is brought forward;

(f) The right to settle the Contract cannot be assigned by the Trustee without the prior written consent of the Vendors;

(g) The Trustee may nominate a substituted or additional purchaser, but it will remain personally liable for the due performance of all its obligations under the Contract.

The Trustee proposes to enter into arm’s length negotiations and transfer its rights to acquire the Property under the Contract to an unrelated third party (the Nominee) for market value consideration. It proposes to do so at least 12 months after the date of the Contract.

Specifically, the Trustee proposes to nominate the Nominee as a substitute purchaser under the existing terms of the Contract in exchange for a payment by the Nominee to the Trustee, and the Nominee will then purchase the Property as a substituted purchaser from the Vendor under the existing terms of the Contract.

The parties have also entered into a Lease in respect of the Property, which commenced soon after the Contract to purchase the property was entered into.

There is also a Sale of Business Agreement between the vendor of the property and a private company associated with the Trustee as purchaser. The private company is also owned and controlled by the same two individuals who control the Trustee company.

The Trustee has provided the following documents which form part of the ruling application:

● Contract for Sale of Real Estate

● Lease agreement for the property that is the subject of the sale agreement

● Sale of Business Agreement between the Vendor and the Trustee.

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 6-5

Subsection 15-15(1)

Part 3-1

Subsection 102-25(1)

Section 104-10

Section 104-25

Section 104-60

Section 108-5

Paragraph 108-5(1)(b)

Section 115-10

Section 115-15

Section 115-20

Section 118-20

Reasons for decision

Question 1

Disposal of contractual rights - capital gains or ordinary income?

Subsection 15-15(1) of the ITAA 1997 states that your assessable income includes profits arising from the carrying on or carrying out of a profit-making undertaking or plan. Whether profits from isolated transactions are taxable depends on whether there was a profit-making intention. Paragraph 13 of Taxation Ruling TR 92/3 (Income tax: whether profits on isolated transactions are income) lists the following factors to be considered:

(a) the nature of the entity undertaking the operation or transaction

(b) the nature and scale of other activities undertaken by the taxpayer

(c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained

(d) the nature, scale and complexity of the operation or transaction

(e) the manner in which the operation or transaction was entered into or carried out

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction

(g) if the transaction involves the acquisition and disposal of property, the nature of that property, and

(h) the timing of the transaction or the various steps in the transaction.

The following observations on income derived from isolated transactions were made by the High Court in Federal Commissioner of Taxation v. The Myer Emporium Ltd.87 ATC 4363 (at 4366):

Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case.

Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a "one-off" transaction preclude it from being properly characterized as income (F.C. of T. v. Whitfords Beach Pty. Ltd. 82 ATC 4031 at pp. 4036-4037, 4042; (1982) 150 C.L.R. 355 at pp. 366-367, 376).

Paragraph 16 of TR 92/3 goes on to say (in relation to entities not carrying on a business):

If a taxpayer not carrying on a business makes a profit, that profit is income if:

(a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and

(b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

The inclusion of the clause in the contract to allow the Trustee to nominate a substitute buyer and to receive a payment for the disposal of the rights under the contract suggests that the arrangement was entered into for a profit making purpose. And as stated at paragraph 8 of TR 92/3:

It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

Although the contract allows the Trustee to purchase the property, the stated intention of the Trustee is to exercise its right under the contract to nominate a substitute purchaser and to dispose of its right to purchase the property. This suggests that dominant reason for entering into this scheme is to make a profit from the sale of the right. It would not appear that the acquisition of the property by the Trustee was an over-riding reason for entering into the contract. Shortly afterwards the Trustee entered into a lease agreement for a period of xx years which enabled the Trustee to occupy the property at least until the contract for sale is settled.

The contract for the sale of the property allows for a settlement period of up to xx years from the time the deposit was paid. As it is likely that the value of the property will increase over this time, there will also be a corresponding increase in the value of the rights to acquire the property. This reinforces the view that profit making is a significant part of the overall transactions.

The creation and subsequent disposal of the contractual rights can be properly described as a profit making plan or undertaking, as there is an expectation that the rights to acquire the property will be sold for a profit.

Although a CGT event A1 will occur when the Trustee’s rights under the contract are disposed of to the Nominee, the proceeds will not be on capital account. Under section 118-20 of the ITAA 1997 a capital gain you make from a CGT event is reduced if a provision of the ITAA 1997 includes that amount in your assessable income. In this instance the profits from the transaction are included in assessable by the operation of subsection 15-15(1) of the ITAA 1997.

Question 2 & Question 3

CGT assets - rights under a contract & CGT events

Whether all the rights under a contract comprise one single asset or each right is a separate asset, will depend on the facts of each case. Generally, however, the initial approach will be to regard the totality of rights as the one asset for the purposes of parts 3-1 and 3-3 of the ITAA 1997 (see TD 93/86).

Section 108-5 of the ITAA 1997 defines a CGT asset as (a) any kind of property; or (b) a legal or equitable right that is not property.

Under the contract the Trustee acquired a number of rights including the right to acquire the property or to nominate a substitute purchaser. These rights are intangible CGT assets.

In this case the bundle of rights acquired by the trust under the contract includes the right to nominate a substitute purchaser and the right to acquire the property. The right to nominate a substitute purchaser can be identified as a separate CGT asset because upon the exercise of this right all the other rights under the contract are transferred to the substitute purchaser and the right to nominate ends.

What are the CGT events?

A CGT event A1 occurred on or about September 20xx when the Trustee and the Vendor agreed to the sale of the property. The disposal of the property is taken to have occurred at the time the parties entered into the contract – refer subsection 104-10(3) of the ITAA 1997.

When the Trustee exercises its right to nominate a substitute purchaser (the Nominee), the following CGT events will be triggered:

′ The disposal of the trust’s right to acquire the property and all other rights under the contract to the substitute purchaser will result in a CGT event A1 occurring.

′ In the event that the Nominee is a trust, CGT event E2 may be the more relevant event.

′ The satisfaction of the trust’s right to nominate a substitute purchaser will result in a CGT event C2 occurring.

CGT Event A1

Subsection 104-10(1) of the ITAA 1997 states that “CGT event A1 happens if you dispose of a CGT asset”. Subsection 104-10(2) of the ITAA 1997 explains that a disposal requires a change of ownership to occur whether because of some act or event or by operation of law.

Subsection 104-10(3) of the ITAA 1997 states that a CGT event A1 will happen at the time of entering into a contract for the disposal of the CGT asset, or if there is no contract, when the change of ownership occurs.

Subsection 104-10(4) of the ITAA 1997 explains that you make a capital gain from a CGT event A1 if the capital proceeds from the disposal are greater than the asset’s cost base. You will make a capital loss if those proceeds are less than the asset’s reduced cost base.

CGT event E2

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

Subsection 102-25(1) of the ITAA 1997 states:

If more than one event can happen, the one you use is the one that is the most specific to your situation.

If the rights under the contract are transferred to an existing trust, then CGT event E2 will be the more specific event that applies.

Subsection 104-60(3) of the ITAA 1997 provides that you will make a capital gain from CGT event E2 if the capital proceeds of the transfer are more than the asset’s cost base. You will make a capital loss if the capital proceeds are less than the asset’s reduced cost base.

CGT Event C2

Section 104-25 of the ITAA 1997 sets out the circumstances in which a CGT event C2 happens. CGT event C2 happens if your ownership of an intangible asset ends by the asset being satisfied. The time of the CGT event is when the asset ends, unless you enter into a contract that results in the asset ending.

You make a capital gain as a result of a CGT event C2 happening if the capital proceeds from the ending are more than the asset’s cost base. You make a capital loss if those capital proceeds are less than the asset’s reduced cost base.

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).