Edited version of private ruling

Authorisation Number: 1011677950081

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Ruling

Subject: Capital gains tax

Question and answers:

1. Are you entitled to disregard any capital gain or loss that results from the transfer of legal ownership of Lot 1 from you to your child?

Answer: Yes

2. Did a CGT event B1 occur when your child moved into the dwelling at Lot 1?

Answer: Yes

3. Are you entitled to disregard any capital gain or loss that resulted from the CGT event B1?

Answer: No.

This ruling applies for the following period:

Year ended 30 June 1998

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You inherited one tenth of a property after 20 September 1985. The remaining nine tenths you held as executrix.

The property consisted of a main residence and an old dwelling at the rear of the property.

You occupied the front dwelling of the property as your main residence.

You subsequently inherited the remainder of the property as sole beneficiary under the will of your late parent.

The property was held by you and your spouse as joint tenants.

You entered into a verbal agreement with your child to sell Lot 1 to them which contained the old dwelling for the market value.

The price was the market value of Lot 1 at that time.

The verbal agreement contained the provision that your child would make the payment of the market value upon your death to your estate. When the payment was made title of Lot 1 would then be transferred to your child.

After the agreement was made, your child moved into the old dwelling at the back of the property and began carrying out renovations.

After your child completed the renovations on old dwelling on Lot 1 you arranged for a market valuation of Lot 1 from your local real estate agent.

The market value had increased.

Your spouse passed away and you became sole registered owner of the property.

Three years later you prepared your last will and testament. In your will you made mention of the verbal agreement between you and your child.

Approximately 1 year later, in accordance with your earlier agreement, the property was subdivided into two lots.

As a result of the subdivision the address of your main residence (Lot 2) changed with the address occupied by your child (Lot 1) retaining the original address.

Approximately 2 years later, you gifted your child a further small parcel of land realigning the rear boundaries.

Your other children are all aware of the agreement and have no grievances.

From the date that the verbal agreement was made, your child has had exclusive use of the property and has contributed towards all services, insurance premiums and council rates and taxes in proportion to their liability.

You state that:

· You have held the property on trust for your child since the verbal agreement was made, although there is documentation to evidence that a trust had been created.

· From the date of the agreement the parties have always dealt with each lot separately and each has had exclusive possession.

· Your child is not a licensee or tenant but is in possession as the owner of Lot 1.

The parties have acted in accordance with the agreement.

No other party has challenged your child's right to be in possession of Lot 1.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 160M(3)(d)

Income Tax Assessment Act 1997 Section 102-25(1)

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-15

Income Tax Assessment Act 1997 Section 106-50

Income Tax Assessment Act 1997 Section 109-5(2)

Income Tax Assessment Act 1997 Section 115-15

Income Tax Assessment Act 1997 Section 116-30

Income Tax Assessment Act 1997 Section 106-50

Reasons for decision

Capital gains tax

Capital gains tax (CGT) is the income tax you pay on any net capital gain you make and include in your annual income whenever a CGT event takes place.

CGT events are the different types of transactions that may result in a capital gain or capital loss. Section 102-25(1) of the Income Tax Assessment Act 1997 (ITAA 1997) explains that in those circumstances where more than one event may be applicable, the one you use is the one that is the most specific to your situation.

CGT event A1 - disposal of a CGT asset

Section 104-10 of the ITAA 1997 explains that you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. The time of the event is when the contract for disposal or acquisition is entered into or, if none, when the change of ownership occurs.

CGT event B1 - use and enjoyment before title passes

Section 104-15 of the ITAA 1997 discusses CGT event B1 which occurs if you enter into an agreement under which the right to the use and enjoyment of a CGT asset you own passes to another person and title in the asset will or may pass to the other person at the end of the agreement. The person who eventually acquires the asset when title passes is taken to have acquired it when they first obtained the use and enjoyment of it (section 109-5(2) of the ITAA 1997).

Taxation Determination TD 1999/78 discusses the meaning of the expression 'at the end of an agreement' and explains that an agreement may come to an end for the purposes of CGT event B1 either:

(a) at the end of the period for which the agreement runs; or

(b) during that period.

This is so whether the term of the agreement is for a fixed period, for a defined period, or for a period that is to end on the occurrence of a particular event. If under the agreement which provides the right to the use and enjoyment title will or may pass at the end of the agreement, CGT event B1 is triggered and you make any capital gain or capital loss when the other person first obtains the use and enjoyment of your asset.

CGT event B1 effectively brings forward the time of a disposal (and the time of a capital gain or loss) under such an agreement from the time when the actual disposal takes place to the time when the use and enjoyment of the asset changed hands. In other words, the asset is treated as if it was disposed of when the use and enjoyment of the asset changed rather than waiting until the time when the CGT event A1 takes place.

Paragraph 5 of TD 1999/78 also advises that if the asset does pass, in fact, during or at the end of the period (i.e. at the end of the agreement), there is no further impact at that time.

In your case:

· You entered into a verbal agreement with your child whereby the title of Lot 1 will pass to your child upon your death once they make a payment of the market value as at the date of the verbal agreement to your estate.

· Your child moved in and had exclusive use of the property as soon as the agreement was made.

· The agreement allowed your child the use and enjoyment of the property with intention that they would become legal owner, as stated in your Will, when they pay your estate the agreed amount.

Thus, your child began use and enjoyment when they moved in to the property. The payment of the agreed amount to your estate upon your death will be the occurrence of a particular event which will end the agreement.

Calculating the capital gain or loss of CGT event B1

Section 104-15(3) advises that a capital gain is made if the capital proceeds from the agreement are more than the asset's cost base, while a capital loss arises if those capital proceeds are less than the asset's reduced cost base. Effectively the capital gain or capital loss is the excess or deficiency of the capital proceeds over the relevant cost base.

Capital proceeds from a CGT event is the total of the money you received, or are entitled to receive, in respect of the event and the market value of any other property you have received, or are entitled to receive, in respect of the event happening, worked out at the time of the event (section 116-20 of the ITAA 1997).

Section 116-30 of the ITAA 1997 advises that if you did not receive any 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 at the time the event occurred.

Therefore, in your case the proceeds from CGT event B1 are the market value of the asset at the time of the event.

Cost base

Section 110-25 of the ITAA 1997 advises that the cost base of a CGT asset is made up of 5 elements. The elements include the amount paid in order to acquire the asset in question, plus most other incidental costs incurred along the way to maintain, preserve or dispose of the asset.

The five elements are:

1. The money paid, or required to be paid, in respect of acquiring the CGT asset, or the market value of any other property given, or required to be given, in respect of acquiring the CGT asset.

2. Incidental costs of acquiring the asset, or costs in relation to the CGT event. These costs include stamp duty, legal fees, agent's commission, fees paid for professional services.

3. Non-capital costs incurred in connection with ownership, for example, interest, rates, land tax, repairs and insurance premiums. They also include non-deductible interest on loans used to finance capital expenditure incurred to increase an asset's value.

4. Capital expenditure incurred to increase the value of the asset, if the expenditure is reflected in the state or nature of the asset at the time of the CGT event, for example, extensive renovations undertaken to the CGT asset.

5. Capital expenditure incurred to preserve or defend the title or rights to the asset.

Should a capital loss be made in relation to the sale of the property, the third element is excluded from the cost base. The resulting cost base is known as a reduced cost base.

Please note that expenditure is not included in the cost base to the extent that:

1. it is allowable as a deduction; or

2. there is a non-assessable recoupment in respect of the expenditure.

The steps to follow in determining whether there is a capital gain or capital loss for most CGT events are:

1. determine the capital proceeds from the CGT event;

2. determine the cost base for the CGT asset;

3. subtract the cost base from the capital proceeds;

4. where the proceeds exceed the cost base, the difference is the capital gain;

5. if the proceeds do not exceed the cost base then determine whether there is a capital loss by working out the reduced cost base of the asset;

6. if the reduced cost base exceeds the capital proceeds, the difference is the capital loss; and

7. if the capital proceeds are less than the cost base but more than the reduced cost base then there is neither a capital gain or a capital loss.

You will then have your total capital gain.

You then calculate your net capital gain as follows:

8. Reduce the capital gains for the income year by any capital losses for the income year. If the capital losses exceed the capital gains, the difference is your net capital loss. A net capital loss is not deductible from your assessable income but it can be carried forward for offset against capital gains in later years.

9. Reduce any remaining capital gains by any unapplied net capital losses for previous income years.

Note that section 115-15 of the ITAA 1997 advises that a discount capital gain is not applicable to CGT events that took place before 11.45 am (by legal time in the Australian Capital Territory) on 21 September 1999.

The existence of a trust situation

You state that you held Lot 1 on trust for your child since you entered into the verbal agreement.

In most cases, in the absence of evidence to the contrary, property is considered to be owned absolutely by the person(s) registered on the title. It is possible for legal ownership to differ from beneficial ownership. In such cases, a trust relationship exists with the legal owner (trustee) holding the property in trust for the beneficial owner (beneficiary). The CGT provisions do not apply to the legal owner of a dwelling if that legal owner holds it in trust for another person and that other person was absolutely entitled to that dwelling as against the trustee (section 106-50 of the ITAA 1997).

In your Will you have stated that your trustees are to sell the subdivided lot to your child for the agreed amount. This situation disqualifies the existence of a trust as your child could not be said to be absolutely entitled to the property as against the trustee.

Conclusion

As CGT event B1 occurred before the CGT event A1, that occurs when your name is subsequently removed from the title, event A1 will be disregarded in accordance with paragraph 5 of TD 1999/78 and under section 102-25(1) of the ITAA 1997.