Edited version of private advice

Authorisation Number: 1052234701118

Date of advice: 3 April 2024

Ruling

Subject: Ownership interests - usufruct agreement

Question 1

Will the Usufructuaries be assessed on any rental income derived from the Property?

Answer

Yes.

Question 2

Will there be any capital gains tax liability for the Usufructuaries and the Bare Owners on entering into a Usufruct Agreement?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20xx

The scheme commences on:

xx/xx/20xx

Relevant facts and circumstances

Parent 1 and Parent 2 are collectively referred to as the "Usufructuaries".

Child 1 and Child 2 are collectively referred to as the "Bare Owners".

The Usufructuaries and Bare Owners are Australian tax residents for Australian tax purposes.

The Usufructuaries are the parents of the Bare Owners. The parents wish to buy a residential investment property (the Property) located in Country A. The estimated purchase price is $XXX. It is intended that the Property will be rented out to third parties to derive rental income.

Under Country A's law, for estate planning purposes the parents wish to have a usufruct agreement with the children in relation to the Property. The Property is to be purchased in usufruct in the part of 50% by Parent 1 and in the part of 50% by Parent 2, with Child 1 and Child 2 each holding 50% of the legal ownership of the Property as Bare Owners of the Property. The Sale Contract for the purchase of the Property contains a Usufruct Agreement, which was translated to English language on xx/xx/20xx, which confirmed the arrangement as described.

Under Country A's tax rules, to acquire a property with a bare ownership with a usufruct arrangement, the funding comes from both the bare owners and the usufructuaries, with a ratio that is determined by reference to the age of the usufructuaries. The usufructuary's capital contribution is considered to reflect the value of the usufruct right in the Property. In the present case, xx% of the purchase price will be provided by the Usufructuaries and xx% of the purchase price will be provided by the Bare Owners. The legal title of the Property will be with the Bare Owners. The Usufructuaries will provide $XXX as their capital contribution in respect of the usufruct rights in the Property. The Usufructuaries will gift funds of $XXX to each Bare Owner, totalling $XXX as the Bare Owners' capital contribution to purchase the Property.

For Country A's tax purposes, the Usufruct Agreement sets out the rights acquired by the parties, the purchase price of the bare ownership, the value of the usufruct, the responsibilities of the Usufructuaries and Bare Owners, and the relationship between the Usufructuary and the Bare Owner.

Under the Usufruct Agreement, the Usufructuary shall have the use and enjoyment of the Property and be responsible for maintenance & repairs and insurance costs etc in relation to the Property to ensure the preservation of the Property.

The Usufruct Agreement also provides that should the Property be sold the sale proceeds will be divided between the Usufructuaries and Bare Owners. The allocation of the property value will depend on the age of the Usufructuaries at that time under the Country A's law.

The Usufruct Agreement will end on the death of the Usufructuaries. The Property will not be part of the Usufructuaries' estate when they pass away. The Property will then belong to the Bare Owners'.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 108-5

International Tax Agreements Act 1953

Reasons for decision

Taxation of Rent to Usufructuaries and not to Bare Owners

Pursuant to Article 578 of the French Civil Code, a usufruct is the right to enjoy things of which another has ownership in the same manner as the owner, but on condition that their substance be preserved. Usufruct is the right of use and enjoyment of the property, i.e., the right to use it and earn the income from it. In the case of house or flat, that means the right to live in it or to rent it out. The usufruct holder has no power to sell the property. The usufructuary has the right to use the property and is entitled to income arising from the use of the property.

Both the Bare Owners and Usufructuaries have ownership interests in the property. However, the rights of each party are of different natures and comprise the whole of the ownership interest together. Only the Usufructuaries have entitlements to income arising from the use of the property. This characterisation of the rights and taxation liability can be considered to be addressed for similar circumstances in current ATO views.

ATO views on life and remainder interests are considered relevant with respect to usufructuary agreements.

Australian taxation of life and remainder interests are dealt with in Taxation Ruling TR 2006/14 Income tax: capital gains tax: consequences of creating life and remainder interests in property and of later events affecting those interests (TR 2006/14). Paragraphs 192 of TR 2006/14 explains the situation in Australia where such interests are ordinarily created via a will in respect of real property of a deceased estate:

"192. The Commissioner considers that ...legal life and remainder interests are carved out of the existing fee simple... Together legal life and remainder interests represent the entire freehold interest in the land...."

Although such situations in Australia involve the creation of two interests out of existing ownership of real property, the core aspect is that the two sets of interest in the property are of differing natures and are not merely a proportionate share of ownership of the property. The party that has the rights to income is the party required to declare the amounts received as assessable.

Australian right to tax rent under International Taxation Agreements

In determining liability to Australian tax in respect of rental income on French property, it is necessary to consider not only Australian income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (the Agreements Act). Sections 4 and 5 of the Agreements Act incorporate that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 and provide that the provisions of a double tax agreement (DTA) have the force of law.

Article 6 of the French Agreement (Article 6) deals with income from real property.

Under this standard international taxation agreement clause Australia has the right to taxing rental income from sources in France for Australian residents. For the purposes of Article 6 the term 'real property includes usufruct rights of immovable property:

"2....

...(b) in the case of France, means such property which, according to the law of France, is immovable property and shall in any case include:

(i) property accessory to immovable property;

(ii) livestock and equipment used in agriculture and forestry;

(iii) rights to which the provisions of the general law respecting landed property apply; and

(iv) usufruct of immovable property..."

Question 2

Will there be any capital gains tax liability for the Usufructuaries and Bare Owners on entering into a Usufruct Agreement?

Summary

There will be no CGT liability for the Usufructuaries and Bare Owners on entering into a Usufruct Agreement. A CGT event will happen when the Usufructuaries and the Bare Owners dispose of an interest in the CGT asset, not when they acquire it. As noted above, the Usufructuaries and Bare Owners each pay for separately and acquire separately interests in the Property that together make up the whole of the existing property ownership that will be transferred. There is not a prior holding by one set of owners which is followed by granting of rights to Property to the other parties, as is the common situation in Australia for situations such as deceased estates where a trust is created over a real property. This ordinarily involves life tenancy and remainder interests being 'carved out' of existing property ownership.

Application of CGT

Under subsection 108-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997), a CGT asset is:

(a)  any kind of property; or

(b)  a legal or equitable right that is not property.

In this case both the Usufructuaries and the Bare Owners have acquired rights that fit within the definition of a CGT asset. The Usufructuaries will have separate CGT cost bases for their share of their CGT asset, in comparison to the Bare Owners share of their CGT asset.

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