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Ruling

Subject: Capital Gains Tax - Cost base - right of occupation

Question 1

Is the market value of the Tenant's right of occupation of the Residence included in the Trustee's cost base in calculating the Trustee's capital gain upon the disposal of the Residence?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2007

The scheme commences on:

1 July 2006

Relevant facts and circumstances

· The Trust was established by a Deed of Settlement.

· The Trust has a corporate Trustee. The sole director of the Trustee is also a primary beneficiary of the Trust.

· There are two primary beneficiaries of the Trust.

· The Trustee was the registered proprietor of the Residence until disposal in 200X.

· The Residence was acquired by the Trustee for the sole and exclusive use of the Tenant, being the two primary beneficiaries of the Trust.

· This was confirmed by a resolution passed by the Trustee at the time of establishing the Trust which has since been mislaid as per the Statutory Declaration signed by the director in 200X.

· A statement made by a chartered accountant has been supplied with the application for a private ruling. The statement is called a "Trust Deed Statement", dated 200Y.

· Until a certain year, the Tenant paid to the Trust the costs of ownership of the Residence, which were the rates and interest. From the certain year the Tenant began paying those costs of ownership directly.

· The Trustee is unable to locate the resolution regarding the non payment of rent by the Tenant and is unable to recall why this arrangement changed at the certain year.

· The arrangement concerning ownership of the Residence was that the Tenant had the exclusive right of possession of the Residence for as long as the Tenant wished, the Tenant would pay for rates, electricity fees and other applicable charges or outgoings for occupying the Residence from the certain year and the Trustee could not dispose of the Residence without terminating the Right of Occupation.

· Since the time the right of occupancy had been granted by the Trustee, the Residence had been used solely as the principal place of residence by the Tenant until it was sold by the Trustee in 200X.

· No rent or nominal rent was payable by the Tenant to the Trustee for the right to occupy the Residence, other than the payment of outgoings as described.

· The proceeds of sale of the Residence were paid to the Tenant.

· A letter from the Trust's accountant was supplied with the application for a private ruling. This letter purports to provide a calculation of the net present value of the rent foregone by the Trust in respect of the Residence from 200X until the end of 2033. This time period represented the likely life expectancy of the Tenant as at 200X based on statistical data from the Australian Bureau of Statistics.

· You have reiterated that your accountant determined the market value of the Right of Occupation and that the proceeds of sale of the Residence were paid to the Tenant however you have not explicitly stated that this amount or any other amount was actually paid to the Tenant to terminate the Right of Occupation.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 section 110-35

Income Tax Assessment Act 1997 section 109-5

Property Law Act (1974) (Qld) section 137

Reasons for decision

Summary

The market value of the Tenant's right of occupation would not be included in the cost base or reduced cost base by the Trustee when calculating the capital gain or loss on the disposal of the Residence.

Detailed reasoning

Licence or Lease

Taxation Ruling TR 2006/14 considers the capital gains tax (CGT) consequences of creating life and remainder interests in property and of any subsequent dealings in those interests. It also considers the CGT consequences of granting a lifetime right to reside in property.

As there is no evidence of an intention to create a life interest in the property we have not considered this aspect in our reasons for decision.

Paragraph 105 of TR 2006/14 provides that a right to reside in property for life (or a term of years) is not equivalent to a legal or equitable life interest. The right is a mere personal right to occupy a property for life which cannot be assigned.

However, whilst you have stated that the Trustee granted a right of occupation to the Tenant, the facts you have provided indicate that the arrangement was in fact a lease.

The right to exclusive possession of land is the decisive characteristic of a lease which distinguishes it from a licence which only confers a right to occupy. This principle was confirmed by the High Court in Radaich v Smith (1959) 101 CLR 209; [1959] ALR 1253 where Windeyer J said at p222:

What then is the fundamental right which a tenant has that distinguishes his position from that of a licensee? It is an interest in land as distinct from personal permission to enter the land and use it for some stipulated purpose or purposes. And how is it to be ascertained whether such an interest has been given? By seeing whether the grantee was given a legal right of exclusive possession of the land for a term or from year to year or for a life or lives. If he was, he is a tenant. And he cannot be other than a tenant, because a legal right of exclusive possession is a tenancy and the creation of such a right is a demise.

In construing the parties' agreement to determine whether a lease has been granted, the Courts will look to the substance of the transaction and the conduct of the parties to ascertain the character of the rights that have been created.

If the particular facts and circumstances show that there is an intention to confer a right to exclusive possession of the land, then there will be a lease under the common law, regardless of the type of tenancy that is created. The tenancy may be for a fixed term, or may be a periodic lease or a tenancy at will.

It is acknowledged that the Tenant never paid rent to the Trustee for use of the property. The Tenant only ever paid outgoings such as those described in the facts, either to the Trustee up until 30 June the certain year or directly to the supplier after that date. This however does not preclude the agreement between the Trustee and the Tenant from being a lease as can be seen in Francis Longmore & Co Ltd v Stedman [1948] VLR 322 where Barry J said at p323:

It suited the plaintiff to have Stedman living there, but there was nothing in the original arrangement under which he went into possession of the premises to justify any conclusion that the relationship was other than that of landlord and tenant. The only necessary characteristic of any tenancy is that it should give the right to exclusive possession for an ascertainable period of time (Lace v Chantler, [1944] 1 K.B. 368, per Greene M.R. at p. 370); reservation of rent is not essential (Landale v. Menzies, [1909] 9 C.L.R. 89, per Griffith C.J., at pp. 100-101, per Barton J., at p. 111; Commonwealth Life Assurance Co. v Anderson [1946] 46 S.R. (N.S.W.) 47, at p. 49; Burns v Dennis, [1948] 65 W.N. (N.S.W.) 55, at p. 56), and the subsequent arrangement by which the plaintiff relieved Stedman of the obligation to pay rent did not alter the character of the occupation.

This is further supported in Burns v Dennis, (1948) 48 SR (NSW) 266 where Jordan C.J. said at p267:

The present claimant is described as lessor and the defendant as a lessee who is to be at liberty to use and occupy the basement as tenant. This is not conclusive, but it is significant and important: cf. British India Steam Navigation Co. v. Commissioners of Inland Revenue (1881) 7 Q.B.D. 165 at 172. It is true that no rent was to be paid for twelve months from the date of the document; but "the reservation of the rent is not of the substance of the lease, for a lease may consist without any reservation": Knight's case (1588) 5 Co. Rep. 54b at 55a. No doubt this document was of itself inoperative to create a lease, but the defendant, with the claimant's consent, occupied the basement in accordance with its terms up to the termination of twelve months calculated from its date. At common law she was at least tenant at will during this period.

A tenancy at will is a type of lease. LexisNexis Butterworths, Halsbury's Laws of Australia, Volume 16 (at 6 June 2011), 245 Leases and Tenancies, 'Tenancy at will' at paragraph 245-85 notes that:

A 'tenancy at will' is a lease created by a lessee entering into, or remaining in, possession of the demised premises with the consent of the lessor but with either party having a right to determine the lease at any time without notice to quit. While it can be expressly created, it is more frequently held to arise by implication. Occupation without the payment of rent is a usual feature of the tenancy at will.

A tenancy at will cannot be assigned or have a sublease granted out of it. The tenant at will is considered to be lawfully in possession of the premises and the landlord cannot recover the premises in an action for recovery of land without a previous demand for possession or the determination of the tenancy.

In Commonwealth Life (Amalgamated) Assurance Ltd v Anderson, (1945) 46 SR (NSW) 47, Jordon CJ, Halse, Rogers and Street JJ concurring at p49 stated:

But the only essential characteristic of any lease is that it should give the right of exclusive possession of premises to a tenant. So long as the letting is of this character, and is for a specified period, it is a lease for a term, however short the period or periods, continuous or discontinuous, during which it confers rights of exclusive possession; and it creates an estate in the land: R. v. St. Martin in the Fields (1842) 3 QB 204; Joel v. International Circus and Christmas Fair (1920) 124 L.T. 459. A tenancy at will exists whenever, by virtue of an express or implied agreement between the land-owner and another person, the other is in exclusive possession of the land, otherwise than as servant or agent of the owner, for an estate which is not of freehold or for a term. A tenancy at will is subject to many inconveniences. It is necessarily terminable at the will of either party by demand of possession, express or implied. It differs in this respect, as in others, from a licence: Minister of Health v. Bellotti [1944] KB 298, in that no period of notice is necessary for its termination;' although, on ' termination by the owner, the tenant has a reasonable time to enter and remove his goods, but not a right to exclusive possession for the purpose: Doe d. Nicholl v. M'Kaeg (1830) 10 B & C 721.

It is further noted at paragraph 245-85 of LexisNexis Butterworths, Halsbury's Laws of Australia, Volume 16 (at 6 June 2011), 245 Leases and Tenancies, 'Tenancy at will' that:

The tenancy at will will be determined if either party dies or does any act inconsistent with the continuance of the tenancy. The tenancy at will is determined if the landlord impliedly or expressly demands possession of the premises, or conveys away his or her right of reversion in the estate.

Some of the common law principles regarding tenancies have been codified into statutes. Relevantly, section 137 of the Property Law Act (1974) (Qld) provides:

137 Notice to terminate other tenancies

(1) A notice to terminate a tenancy, including a tenancy at will, must be for a reasonable period.

(2) What constitutes a reasonable period of notice depends on the circumstances, including the nature of the tenancy, the circumstances surrounding the creation of the tenancy, the terms (if any) of the tenancy, and any proper implications from the agreement (if any) of the parties with respect to the tenancy.

(3) Subsection (1) does not apply to-

(a) a tenancy for which a period of notice has, expressly or impliedly, been agreed on by the parties; and

(b) a weekly, monthly, yearly or other periodic tenancy subject to this Act with respect to notices to terminate; and

(c) a tenancy at will arising because of the abolition by this Act of the implication of a tenancy from year to year.

Notification to terminate a tenancy at will has to be for a reasonable period, per subsection 137(1) of the Property Law Act (1974) (Qld) but the parties can also come to an agreement to have any period for notice to terminate a tenancy at will, per paragraph 137(3)(b) of the Property Law Act (1974) (Qld).

As one of the tenants was also the controlling mind of the Trustee who owned the property it can be concluded that per paragraph 137(3)(a) of the Property Law Act (1974) (Qld), the parties had impliedly agreed to a mutual termination of the tenancy at will upon the completion of the sale of the property.

Furthermore by entering and completing a contract of sale of the property, the Trustee conveyed away its right of reversion in the estate which also determines the tenancy at will - Doe d Davies v Thomas (1851) 6 Exch 854 at 857; 155 ER 792; Doe d Dixie v Davies (1851) 7 Exch 89 at 93. When the sale of the property was completed, the Tenant's lease over the property expired at that time and so too did the Trustee's right of reversion.

As the Trustee did not acquire the lease from the Tenant upon the termination of the tenancy at will there was no compulsion or reason for the Trustee to make an actual lease surrender payment to the Tenant. It also follows that it was not necessary for the Trustee to calculate a deemed lease surrender payment for the purposes of section 112-20 of the Income Tax Assessment Act 1997 (ITAA 1997), based on an amount of imputed foregone rent.

Therefore the amount of a deemed lease surrender payment is not to be added to the cost base of the property for working out the capital gain or capital loss upon the sale of the property.

Conclusion

The market value of the Tenant's right of occupation would not be included in the cost base or reduced cost base by the Trustee when calculating the capital gain or loss on the disposal of the Residence.