Edited version of private advice

Authorisation Number: 1051744753416

Date of advice:15 October 2020

Ruling

Subject: Capital gains tax

Question

Is the capital gain on the disposal of the Lot disregarded under paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Prior to 20 September 1985, Person A's parents acquired a property. Person A's parents wished to subdivide the property however this would require further works on the property which would cost $XX,XXXX.

Prior to 20 September 1985, Person A and Person B agreed to borrow the monies required to assist Person A's parents in funding the works.

The subdivision was completed and most of the subdivided lots were sold.

As at 20 September 1985, none of the subdivided lots had been transferred to Person A or Person B.

Over 10 years later, Person A's parent transferred titled of a Lot of the subdivision to Person A and Person B.

The Lot remained vacant until it was sold by Person A and Person B in 20XX.

Contentions of the taxpayers

The following contentions have been made by the taxpayers:

·         The $XX,XXX contributed by Person A and Person B was approximately the sale price of two lots in the subdivision.

·         Prior to 20 September 1985, Person A's parents agreed that in return for the $XX,XXX contribution made by Person A and Person B, the Lot in the subdivision would be transferred to Person A and Person B.

·         There was also discussion between Person A and their parent about the possibility of Person A and Person B receiving the proceeds of sale of one other lot

·         There was no further discussion with Person A's parents about transferring the Lot and no additional funds were ever received by Person A or Person B.

·         The agreement to transfer the Lot was legally binding; however, the second part of the arrangement concerning the payment to them of the proceeds of sale of another lot was not pursued.

·         The Lot was always regarded as belonging to Person A and Person B and until they wished to sell it or build on it there was no necessity to formally transfer it.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 106-50

Reasons for decision

Summary

It is not considered that Person A and Person B contractually acquired the Lot under a purported oral agreement made prior to 20 September 1985.

Also, although Person A and Person B may have had some type of legal claim against Person A's parents with respect to the $XX,XXX provided to them, we do not consider that this amounted to an ownership interest in the Lot prior to legal title being transferred.

Even if it was accepted that Person A and Person B had a beneficial ownership interest in the Lot such that it was being held in trust for them, this is not enough for it to be considered their asset for capital gains tax (CGT) purposes. For a beneficiary to be treated as the owner of a trust asset for CGT purposes, the beneficiary must be absolutely entitled to the asset. As land is not fungible, it is not possible for multiple beneficiaries to be absolutely entitled to land held in trust for them. Therefore, even if the Lot was held in trust for Person A and Person B, they were not absolutely entitled to the asset and consequently cannot be treated as the owners of the asset for CGT purposes until title was transferred to them. As this occurred after 20 September 1985, Person A and Person B cannot disregard the capital gain on the sale of the property pursuant to paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Paragraph 104-10(5)(a) of the ITAA 1997 states that a capital gain or loss you make is disregarded if you acquired the asset before 20 September 1985.

Section 109-5 of the ITAA 1997 states that you acquire a CGT asset from another entity when the disposal contract is entered into, or if there was no such contract, when the other entity stopped being the asset's owner.

Therefore, whether Person A and Person B acquired the Lot under a contract entered into prior to 20 September 1985 must be considered.

Purported oral agreement

A contract is a legally binding agreement between two parties. A contract is required to have the attributes prescribed in common law for the formation of a contract.

Generally, a binding contract is entered into where one party communicates unconditional acceptance of an offer made by the other party. In some cases difficulty may arise in determining at what point in time a binding contract is made. This is particularly so in the case of a contract that is wholly or partly oral.

An oral contract may be a contract, provided it has the attributes required by common law, for example, an intention by both parties to be bound by it.

A number of cases have considered the date when a contract was formed. In Gardiner v. FC of T 2000 ATC 2018, the AAT held that a property was acquired when a taxpayer's offer was accepted by the vendor, not when the contracts were formally exchanged two months later. The formal correspondence of the offer and acceptance of it constituted a contract for the acquisition of the property by the taxpayer.

While it is contended that the parties agreed that the Lot would be transferred in consideration of the $XX,XXX contributed towards property works, there was also discussion about Person A and Person B additionally receiving the proceeds of sale of another lot, as this would mean that the consideration totalled approximately $XX,XXX over the two lots. This did not eventuate.

For the oral agreement to be a legally binding sale contract it would be expected that more specifics would be required, such as, the period of time that would be permitted by all the parties for the development to take place.

Person A and Person B have contended that part of the arrangement was legally binding (being the transfer of the Lot) and part of it was not (being the receipt of sale proceeds of another lot).

The Commissioner does not consider that the terms of any purported oral agreement prior to 20 September 1985 to be sufficiently specific or clear enough to constitute a binding contract.

Absolutely entitled beneficiaries

It has also been contended that prior to legal title being transferred to Person A and Person B, the Lot was being held in trust for them by Person A's parents.

We do not consider that this amounted to an ownership interest in the Lot such that it was being held in trust for them.

However, even if it was being held in trust for them, this would not be sufficient for Person A and Person B to be treated as the owners of the Lot for CGT purposes prior to them acquiring legal title.

Where an asset is held in trust, the trustee is treated as the owner of the trust asset for CGT purposes unless section 106-50 of the ITAA 1997 applies.

Section 106-50 of the ITAA 1997 deems a beneficiary who is absolutely entitled to a trust asset as against the trustee of a trust to be the owner of the asset for CGT purposes instead of being an asset of the trust.

Taxation Ruling TR 2004/D25 contains the Commissioner's view on the meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the ITAA 1997.

The core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction. This derives from the rule in Saunders v. Vautier (1841) 4 BEAV 115; 49 ER 282 applied in the context of the CGT. The relevant test of absolute entitlement is not whether the trust is a bare trust.

Where there is more than one beneficiary with interests in the trust asset, then it will usually not be possible for any one beneficiary to call for the asset to be transferred to them or to be transferred at their direction. This is because their entitlement is not to the entire asset.

There is, however, a particular circumstance where such a beneficiary can be considered absolutely entitled to a specific number of the trust assets for CGT purposes. This circumstance is where:

§  the assets are fungible;

§  the beneficiary is entitled against the trustee to have their interest in those assets satisfied by a distribution or allocation in their favour of a specific number of them; and

§  there is a very clear understanding on the part of all the relevant parties that the beneficiary is entitled, to the exclusion of the other beneficiaries, to that specific number of the trust's assets.

Assets are fungible if each asset matches the same description such that one asset can be replaced with another. Assets are fungible if they are of the same type (for example, shares in the same company and with the same characteristics).

Assets within the class need not be exactly identical and in this regard it is enough that a beneficiary might reasonably be expected to be indifferent between them. For example, in the case of shares, the mere fact that each share is allocated a unique number in the company's share register is not enough to prevent those shares being treated as fungible. Therefore, shares in a listed public company can be fungible. However, land would rarely be fungible because each parcel of land is unique.

In this case, if there was a trust in existence, Person A and Person B were both beneficiaries with an interest in the Lot, being a non-fungible asset. It was not possible for either of them to call for the asset to be transferred to them or transferred at their discretion as their entitlement was not to the entire asset. Consequently, neither Person A nor Person B would have had absolute entitlement to the Lot if it had been held in trust for them.

Therefore, even if a trust did exist the trustee would have been treated as the owner of the Lot for CGT purposes rather than Person A and Person B. It follows that Person A and Person B did not acquire the Lot for CGT purposes until they acquired legal title after 20 September 1985. They cannot disregard the capital gain on their disposal of the property in 20XX pursuant to paragraph 104-10(5)(a) of the ITAA 1997.

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