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Ruling

Subject: Capital Gains Tax Implications

Question 1

Are the properties A and B considered to be pre-CGT and therefore tax-free in the event of disposal?

Answer

No

Question 2

If properties A and B were to form part of amalgamation into a greater development for which the developer gives the entity home units in return, would these units also be CGT free?

Answer

No

This ruling applies for the following periods:

Income year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

The properties A and B have two houses on the land.

The original purchase of these properties occurred before 1985. They were purchased in trust for Organisation C.

The original trustees to this acquisition were E, F and G as evidence by the memorandum of transfer.

In a particular year before 1985, the properties A and B were transferred to new trustees (obviously the committee has changed and new directors were appointed and therefore new trustees were also required).

The new trustees were E, F and H.

From the particular year before 1985 to 1996 Organisation C incorporated a company limited by guarantee called Company I.

In the particular year prior to 1985 the new trustees transferred the properties A and B to this new incorporated company where they are still recorded today.

When the new trustees transferred the properties A and B to Company I, the consideration did not solely consist of non-redeemable shares in the transferee company (Company I). This is because Company I is limited by Guarantee. No shares exist. No dividends are paid to members. The proceeds of income are held for the benefit of the broader membership community, e.g. awards, sponsorships etc.

Company I, at transfer, did not undertake to discharge one or more liabilities in respect of the asset of the business i.e. the two properties. There was no debt at transfer. The transfer was to enable the new trustees at the time to resign from that position and thus, the transfer to Company I was effected.

Because there was no shares transferred to the new trustee as no shares exist in Company I. It was not relevant to consider whether the market value of the shares the trustees received was the same as the market value of the two properties less any liabilities Company I undertakes to discharge in respect of these properties.

The properties did not become the trading stock of Company I just after the disposal. Company I holds the properties purely for investment purposes.

The business or activities that Company I has undertaken since its incorporation some time ago is to hold the two properties for rental returns.

The trust is a resident trust for CGT purposes. Company I is an Australian resident.

After the property transfer, Company I holds the two properties in its own right and not in trust for anyone.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 124

Income Tax Assessment Act 1997 Subdivision 122A and

Income Tax Assessment Act 1997 Subdivision 152-A

Reasons for decision

Issue 1 Question 1

Summary

When the two properties A and B were transferred from the trust to Company I for nil consideration, they were both pre-CGT properties. Hence, no CGT was payable then. Since the transfer was to Company I outright, the company would hold the properties outright. There has been a change in underlying beneficial and legal ownership. Hence, CGT event A1 occurred. This transfer does not satisfy the requirements under subdivision 122A of the ITAA 1997 as Company I (the company transferee) was not wholly owned by the trustee (transferor of the CGT asset) but Organisation C (the beneficiary of the trust).

There will not be a CGT roll-over for the two properties. Hence, they will not retain their pre-CGT in the hands of Company I after the 1997 transfer. Therefore, when Company I disposes of the two properties A and B, they will be post-CGT and subject to CGT.

Detailed reasoning

Where a CGT asset was originally acquired before 20 September 1985 (pre-CGT) and is disposed of after 19 September 1985 (post CGT) for the asset to retain its pre-CGT status, there must either be no change in beneficial ownership or a CGT roll-over available.

CGT event A1 [section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)] occurs when an asset is disposed of (sold). Any capital gain or loss that may arise as a result of the disposal is disregarded if (i) there is no change in beneficial ownership or (ii) the asset was acquired pre-CGT. The asset will be a post-CGT asset in the hands of the acquirer unless one of the exceptions to CGT event A1 apply.

The transfer of the assets was from a trust to a company. Hence, there has been a change in beneficial ownership and the first exception to CGT event A1 will not apply.

The CGT provisions of the ITAA 1997 contain many roll-over provisions. Subdivision 122-A of the ITAA 1997 is a roll-over where a trustee disposes of an asset or assets to a company and the requirements in subdivision 122-A are met.

One of the requirements is that if the trustee receives consideration for the disposal of the asset (or assets) to the company that consideration must include shares in the company (subsection 122-20(1) of the ITAA 1997).

Although subsection 122-20(1) of the ITAA 1997 contemplates that ordinarily a transferee company will issue shares in respect of any assets transferred to it, the provision does not specifically require that consideration must be provided in respect of the transfer. Rather, the requirement is that where consideration is given by the company, it must be either shares in the company or shares in the company and the company undertaking to discharge one or more liabilities in respect of the asset or the assets of the business.

As the taxpayer has received no consideration in respect of the disposal, there is no need to consider the application of section 122-20 of the ITAA 1997.

Section 122-25 of the ITAA 1997 contains further conditions that must be satisfied before rollover can be chosen. Relevantly these are:

the transferor must own all of the shares in the company just after the disposal of the asset (subsection 122-25(1) of the ITAA 1997) - that requirement is not satisfied in this case because the transferor does not own all of the shares in the company. Organisation C is the entity that incorporated the company and not the trustee. Organisation C is the sole beneficiary of the trustee.

the company must not be an exempt entity (subsection 122-25(5) of the ITAA 1997) - that requirement is satisfied in this case, and

if the trust is not a resident trust for CGT purposes or the company is not an Australian resident, the asset must be taxable Australian property (subsection 122-25(7) of the ITAA 1997) - that requirement is satisfied in this case as both entities are Australian resident entities.

Therefore, the trustee is not entitled to choose rollover under Subdivision 122-A of the ITAA 1997. Hence, the two properties lost their pre-CGT status once they were transferred to Company I, and any subsequent disposal of the properties is not tax-free.

Issue 2 Question 1

Summary

In this case, the replacement of a CGT asset (post CGT land and building) with another CGT asset (post CGT building) is not a transaction which comes under a replacement asset roll-over under Division 124 of the ITAA 1997. Also, the Small Business CGT roll-over concession also does not apply. Hence, the sale of the post CGT land and building will be subject to CGT.

Detailed reasoning

It has been determined in the response to question (1) that the 2 properties A and B that were transferred (disposed of) to Company I are post CGT assets in the hands of the Company I.

If the properties are disposed of to a developer in exchange for home units, the home units cannot be CGT free as the properties are post CGT assets. However, the disposal of the properties to the developer may be CGT free if (1) a CGT roll-over under Division 124 of the ITAA 1997 applies or (ii) the CGT small business roll-over under subdivision 152-E applies.

Division 124 of the ITAA 1997 provides a CGT roll-over for a number of situations where the original asset is being replaced by the replacement asset.

Subdivision B relates to asset compulsorily acquired, lost or destroyed which is not the situation in this case.

Subdivision C relates to statutory licences which is not the situation in this case.

Subdivision D relates to strata title conversion which is not the situation in this case.

Subdivision E relates to the exchange of shares or units which is not the situation in this case.

Subdivision F relates to the exchange of rights or options which is not the situation in this case.

Subdivisions G to J does not relate to the situation in this case.

Subdivisions K relates to depreciating assets and not to land and building.

In this case, since there is no replacement asset roll-over, under Division 124 of the ITAA 1997, which can apply, the disposal to the developers of the land will only be CGT free if the CGT small business roll-over under subdivision 152-E applies.

For any of the small business CGT concessions to apply the basic conditions in subdivision 152-A must be satisfied, along with any specific conditions contained within each of the concessions.

The basic conditions in subdivision 152-A are

· a CGT event happens in relation to a CGT asset of yours

· the event would (apart from this Division) have resulted in the gain.

· at least one of the following applies:

· you are a small business entity

· you satisfy the maximum net asset test;

· you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

· the conditions in subsection 152-10(1A) or 152-10(1B) of the ITAA 1997 are satisfied.

The CGT assets satisfy the active asset test in subsection 152-35 of the ITAA 1997.

With regards to the active asset test, paragraph 152-40(4)(c) states that an asset whose main use is to derive interest, an annuity, rent, royalties or foreign exchange gains cannot be an active asset.

You have stated that the properties are used to derive rent. Hence, they cannot be active assets as the active asset condition is not satisfied. There is no need to consider the other conditions in subdivisions 152-A or 152-E of the ITAA 1997 have been satisfied. The failure of one condition in subdivision 152-A of the ITAA 1997 means none of the small business CGT concessions are available.

Therefore, if properties A and B are sold to a developer in exchange for home units, any capital gain made (using the market value of the home unit as consideration for the disposal) is taxable.