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Ruling

Subject: IT PBR: CGT- Year in which CGT event occurred and if the organisation is assessable for the capital gain made.

Question 1:

Did CGT event A1 happen in relation to the disposal of the property, in income year Y when the executor entered into the contract for the disposal of the property, or income year X when the now deceased entered into an option agreement with the tenant of the property?

Answer:

Yes

Question 2:

On the basis that the contract for the disposal of the property was entered into in income year Y, is the organisation assessable on the capital gain made when the purchaser of the property exercised its option to acquire the property from the executors of the estate of the deceased person (the 'estate')?

Answer:

Yes

This ruling applies for the following period:

1 July 2007 to 30 June 2008

The scheme commences on:

1 July 2007

Relevant facts and circumstances

In income year Y, an individual and the unrelated entity ("the company") entered into an option agreement for the sale and purchase of a property. A copy of the option agreement details are as follows:

This Deed was made in Year V between the individual and the entity (the "Purchaser").

The individual was the legal and beneficial owner of the property.

The individual died in income year X2.

The company exercised its option to acquire the property in Year Y. The executors received sale proceeds of the sale of the property.

The property was sold to the entity.

The will of the deceased stipulated that the organisation had to make an undertaking before they were entitled to the residue of the estate.

The beneficiaries were paid from the assets of the deceased. The organisation got 100% of the sale of the property plus other monies from the balance of the estate

Probate was granted in income year Y.

The executors resolved to make distributions to all beneficiaries, except for the company income year Z.

The organisation, the residual beneficiary, requested the executors to realise the estate's assets so that their present entitlement to (all of the) estate's income and capital be settled in cash, rather than in-specie asset transfers immediately prior to the end of the income year Y.

The organisation provided the required undertaking before the end of income year Y.

Relevant legislative provisions

Income Tax Assessment Act 1936 sub section 95(1)

Income Tax Assessment Act 1997 section 104 - 10

Income Tax Assessment Act 1997 section 104 - 40

Income Tax Assessment Act 1997 sub section 104 - 40(2)

Income Tax Assessment Act 1997 sub section 104 - 40(5)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 116-65

Income Tax Assessment Act 1997 section 134 - 1

Reasons for decision

Question 1:

Summary

The CGT event A1 happened in relation to the property, in the 2008 income year, the income year in which the option was exercised.

Detailed reasoning

On 1 September 2005 an Individual entered into an option with (The Company) for the company to purchase the property after his/her death.

Options

Although an option is given as an example of an "asset" in section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997), the term itself is not defined in the Act. In FC of T v Guy 96 ATC 4520, the Full Federal Court said (at p 4526):

"The word 'option' itself suggests a right in one party unilaterally to require another party to enter a new set of jural relations or to extend or continue an existing jural relationship. Put and call options, options to purchase and options to renew leases are, perhaps, the most common illustrations"'

Options are therefore considered as rights to accept an irrevocable offer within a specified time and the acceptance of the offer creates a contract. A call option provides the grantee of the option the right to acquire an asset from the grantor of the option at a specified price before a specified date.

The Capital Gains Tax (CGT) consequences of granting an option

Section 104-40 of the ITAA 1997 provides, where relevant:

"(1) CGT event D2 happens if you grant an option to an entity, or renew or extend an option you had granted.

The time of the event is when you grant, renew or extend the option.

You make a capital gain if the capital proceeds from the grant, renewal or extension of the option are more than the expenditure you incurred to grant, renew or extend it. You make a capital loss if those capital proceeds are less.

The expenditure can include giving property. However, it does not include an amount you have received as *recoupment of it and that is not included in your assessable income, or an amount to the extent that you have deducted or can deduct it.

Exceptions

A capital gain or a capital loss you make from the grant, renewal or extension of the option is disregarded if the option is exercised".

The granting of an option by the rule is therefore a CGT event D2. Pursuant to section 104-40(2) of the ITAA 1997, the date of the event is when the option was granted. However, as per subsection 104-40(5) of the ITAA 1997, when an option is exercised, as in this case, CGT event D2 is taken not to have happened.

The Capital Gains Tax consequences of exercising an option

It may be the following year or a subsequent year before the option is exercised. Provisions of the ITAA 1997 in combination; sub section 104-40(5), section 134-1 and section 116-65 provide that if the option is exercised, the granting of the option on a particular date and the exercise of the option is treated as a single transaction in relation to the grantor (i.e. the rulees).

Taxation Determination TD 16 confirms that the date of disposal of an asset under an option is the date of the transaction entered into as a result of the exercise of the option. Accordingly, the date of disposal of the property is the date that the option is exercised.

That is, the original CGT event D2 is disregarded under subsection 104-40(5) of the ITAA 1997, when the option is exercised.

The subsequent sale of the property from exercising the option will be a CGT event A1, pursuant to section 104-10, of the ITAA 1997, as there is a change in ownership of the property.

In this case the option to acquire the property was exercised on 20 August 2007. The formal contract for the sale of the property was signed either the same day as the option was exercised or soon thereafter.

Therefore, in accordance with Tax Determination TD 16 the disposal of the property occurred in income year Y, because the exercise of the option constitutes a binding contract, and under CGT event A1 the date of disposal is when the contract for sale is entered into. The date of disposal of the property is not the date the formal contract for sale of the property was signed, unless of course it is the same day as the option was exercised.

Issue 2

Question 2

Summary

The contract for the disposal was entered into by the executors in income year Y, the capital gain made when the executors sold the property should be assessable to the Company rather than the executors.

Detailed reasoning

In determining which entity is liable for any tax payable on the disposal of the property, the estate of the late deceased individual or Company, it needs to be determine if Company was presently entitled to the property before its disposal to the company on the date the property was disposed of to the entity.

The High Court decision in IT 2622 FC of T v Whiting (1943) 68 CLR 199; 7 ATD 179 (Whiting case) is cited as the leading Australian case on present entitlement during the administration of a deceased estate.

It held that a beneficiary of a deceased estate cannot be presently entitled to the income of the estate until the estate has been fully administered:

"….until an estate has been fully administered by payment or provision for the payment of funeral and testamentary expenses, death duties, debt, annuities and legacies and the amount of the residue thereby ascertained, the income of the residuary estate is income of the executors and not of the residuary beneficiaries" (Latham CJ and Williams J, CLR at 216).

As per the tests, the estate was fully administered on or before the end of income year Y. All relevant costs had been paid or provided for, and the residue ascertained.

Therefore, on or before 30 June Year Y, the executors had paid or provided for all debts and made or provided for distributions of specific assets and legacies.

Upon ascertaining the residue of the estate and in doing so fully administrating the estate, the executors could distribute (all of) the residue of the estate to the residuary beneficiary, the Company.

The will of the individual in placed a condition on the Company receiving the residue of his/her estate. The condition was recognised by the executors of the estate, as having been fulfilled the week after probate was granted. As the property had been disposed of before condition had been satisfied, the organisation was never presently entitled to the property. However, the week after probate was granted, before the end of income year Y, the organisation was presently entitled to the residual of the estate which includes the income of the estate.

It is well established that the "net income of the estate" for the purposes of section 95(1) of the Income Tax Assessment Act 1936 and whether any beneficiary is presently entitled to a share of the income of the estate is determined on the last day of the income year (see Union Fidelity Trustee Co of Australia v FC of T (1969) 119 CLR 177 and FC of T v Gillard 86 ATC 4885) paragraph 19 and following of IT 2622

IT 2622, paragraph 16 and 17)..

The Commissioner's view of the present entitlement during the administration of the estate is set out in Taxation Ruling No IT 2622 paragraphs 19 and following of IT 2622 state the principle derived from the case law mentioned above.

This means that as the organisation had become presently entitled to the residue of the estate including the income of the estate before the end of the income year Y. All other beneficiaries were paid out of proceeds of the disposal of assets, the disposal of which did not produce any income as calculated under section 95 of the Income Tax Assessment Act 1936.

Therefore, as the organisation was presently entitled to the income of the estate as at 30 June year Y, the Company is taxable on the capital gain made on the disposal of the estate.