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Edited version of your written advice
Authorisation Number: 5010052047155
Date of advice: 16 October 2018
Ruling
Question 1
Did the sale contract give rise to a right and create a CGT asset for capital gains purposes?
Answer
Yes
Question 2
Is the first element of the cost base, of the right, the difference between the market value of the property and the cash paid for the land?
Answer
Yes
Question 3
Did a Capital Gains Tax (CGT) event C2 occur when the right ended?
Answer
Yes
Question 4
Does the Market value substitution rules apply under section 116-30 of the Income Tax Assessment Act 1997 (ITAA 1997) when calculating the proceeds of the C2 Event?
Answer
Yes
Question 5
Did you acquire Land A when you received the land?
Answer
Yes
Question 6
Do the market value substitution rules apply under section 112-20 ITAA 1997 when calculating the first element of the cost base of Land A?
Answer
Yes
This ruling applies for the following period(s)
Year ended 30 June 20XX
The scheme commences on
1 July 20XX
Relevant facts and circumstances
You received the property (The property) as tenants in common with a relative in XXXX.
The property is X.XX acres.
The contract for the sale of the property to a developer was signed on the XXXX.
The price of the property was $XXX,XXX.
The contract indicates that legal title is transferred to the whole of the parcel of land.
A clause in the contract provides a right to have a block of land from the development transferred to you (The right). The clause allows you the right after completion and subdivision to select at your discretion a subdivided lot within the development, to be transferred back to you following the subdivision.
You were an applicant/respondent (with others) in a court case where the case was primarily concerned with contractual obligations and the application of the Land Sales Act 1984 and if the contract was void.
The clause in the contract was directly referred to in the judgment.
The contract for the sale of the property was settled on XXXX.
As per the clause you received the land (Land A) worth $XXX,XXX a number of years later.
You signed a contract for sale of Land A for $XXX,XXX two years after receiving the land.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 108-5
Income Tax Assessment Act 1997 Section 104-10(3)
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 109-5
Income Tax Assessment Act 1997 Section 110-A
Income Tax Assessment Act 1997 Section 110-25
Income Tax Assessment Act 1997 Subsection 110-25(2)
Income Tax Assessment Act 1997 Section 112-20
Income Tax Assessment Act 1997 Section 116-30
Reasons for decision
A CGT asset is: (a) any kind of property; or (b) a legal or equitable right that is not property. When you sell or otherwise dispose of an asset it's called a capital gains tax (CGT) event [Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997)]. This is when you make a capital gain or loss.
The most common event, CGT event A1, happens when you dispose of an asset to someone else. CGT event A1 happened when you sold the property and again when you sold Land A.
There are other CGT events, such as the loss or destruction of a CGT asset or creating contractual or other rights.
For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset.
Subdivision 110-A of the ITAA 1997 details the general rules of the cost base of a CGT asset. The cost base consists of five elements. You need to add together all of these elements to calculate the cost base. Briefly they are:
1. Money paid or required to be paid for the asset such as the money that you paid to acquire the property.
2. Incidental costs of acquiring the asset, or costs in relation to the CGT event, for example, stamp duty, legal fees, agent’s commission etc.
3. You can include non capital costs of ownership only in the cost base of assets acquired after 20 August 1991, such as land taxes, insurance premiums, rates etc. These costs cannot be used to calculate a capital loss.
4. Capital expenditure you incur to increase the value of the asset such as construction of a shed.
5. Capital expenditure you incur to preserve or defend your title or right to the asset.
Contractual rights: Capital Gains events D1 and C2
D1 CGT event happens if you create a contractual right or other legal or equitable right in another entity (Section 104-35 of the ITAA 1997).
Example: You enter into a contract with your ex-employer, not to operate a similar business in the same town. The contract states that $20,000 was paid for this. You have created a contractual right. If you breach the contract, your ex-employer can enforce that right.
The first element of a cost base is the total of the money you paid, or the market value of the property at the time of acquisition (subsection 110-25(2) of the ITAA 1997). One exception is provided in paragraph 112-20(1)(a)(i) of the ITAA 1997, where CGT event D1 happens and you did not pay or give anything for the acquisition of the asset.
Where a D1 event occurs market substitution can only apply if the transaction is at arm’s length and there has been a payment for the right.
CGT event C2 happens if your ownership of an intangible CGT asset, such as the right created in D1 ends (section 104-25 of the ITAA 1997).
If you received no capital proceeds from a CGT event, you are taken to have received the market value of the CGT asset that is the subject of the event (subsection 116-30(1) of the ITAA 1997).
Application to your situation
When the developer transferred the vacant lot to you it is part of the consideration for the property, even though it is provided in non-monetary form.
The contract, and reinforced by the judgement, allows for an outright transfer of the title of the property when the contract was signed. This is the date that the CGT event A1 for the property arises.
However, a clause in the contract contains a provision that allows you the right after completion and subdivision to select at your discretion a subdivided lot within the development, to be transferred back to you following the subdivision.
The judgement said that the clause does not constitute a sale, and no express trust exists and whilst you can rely on a constructive trust, the judge is not prepared to say that this is a constructive trust.
Meaning, while the developer is the legal owner of the Land A, the land is not held in trust for you – unless you need to rely on it for legal purposes.
It is our opinion that you are the owner to the right to Land A in these circumstances.
The right to acquire Land A (The right)
The right is a capital gains asset.
The creation of the right as part of the sale of the Property, gives rise to the capital gains event D1. The acquisition date of a D1 asset is the date the contract is entered into or the date the right is created.
CGT event C2 occurred when you received Land A and the right ended.
Commercially, it is reasonable to expect that you would choose the vacant lot that is most valuable to you in terms of size, location or value in relation to your expected benefit from the sale of the land when originally negotiated.
We consider that the effect of the arrangement is that you refrained from charging the full price in cash for the parcel of land in return for one of the new subdivided vacant lots at market value.
However, the fact that you did not accept liability for increased stamp duty costs in the event of the lot being assessed at a higher rate or value tends to support the conclusion that the future vacant lot supplied by the developer was of a notional value when determining the amount that you would be prepared to accept for their supply of the whole land.
The first element of the cost base for the right is the total of the money you paid or the market value of the property at the time of acquisition.
Where a D1 event occurs market substitution can only apply if the transaction is at arm’s length and there has been a payment for the right.
On the evidence submitted you have not been able to confirm how much you paid for the ownership of the right, and, the CGT calculations in previous years, seem to suggest that you have not allocated a value for the right, or you have assessed it at no value.
If this is the case the first element of the cost base equates to the difference between the market value of the entire property and the cash paid, and assumes that you have a value for Land A.
The capital proceeds of the right are equal to the market value of Land A in XXXX, being $XXX,XXX.
As you are an individual and have acquired the asset for at least 12 months prior to the CGT event you are eligible for the 50% CGT discount.
Land A
Where there has been no payment for Land A, we can apply the market substitution rules and apply the market value for the first element of the cost base.
The acquisition date is considered to be when you become the owner of the asset, the date you received Land A.
The capital gains event A1 occurs when the contract for sale is signed.
The capital proceeds are the sale price.
As you have held Land A for more than 12 months before disposing of the asset you are eligible for the 50% CGT discount.
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