Edited version of your private ruling

Authorisation Number: 1012613859571

Subject: Capital gains tax - disposal - real property - trust

Question 1:

Does capital gains tax (CGT) event C2 in section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) happen when you nominate company A in its capacity as trustee for B trust as the purchaser under a contract for sale?

Answer:

Yes.

Question 2:

Does CGT event A1 in section 104-10 of ITAA 1997 happen when you nominate company A in its capacity as trustee for B trust as the purchaser under the contract?

Answer:

No.

Question 3:

Does CGT event E2 in section 104-10 of ITAA 1997 happen when you nominate company A in its capacity as trustee for B trust as the purchaser under the contract?

Answer:

Yes.

This ruling applies for the following periods:

Year ending 30 June 2014

The scheme commenced on:

1 July 2013

Relevant facts

On 23 July 2003, you and X (X) entered into an 'Agreement for Sale of Land' ('the contract'). The land to which the contract related was formerly the site of a service station (Y).

You have provided a number of documents which should be read with and forms part of this private ruling:

We have obtained the following information from these documents:

The GST exclusive purchase price was an amount, with a ten per cent GST inclusive deposit.

Under the terms of the contract, the 'Purchaser' of the land was you 'and/or nominee'.

The purchaser under the terms of the contract was not required to contribute any additional amounts due to the delay in settlement of the contract or in nominating a substituted purchaser.

According to Clause 5 of the contract:

If the contract states that the property is to be sold to the named Purchaser "and/or nominee" (or similar words), the named Purchaser may, at least 14 days before the settlement date, nominate a substitute or additional Purchaser, but the named Purchaser remains personally liable for the due performance of all the Purchaser's obligations under the contract.

Settlement of the contract was conditional on X providing a 'Validation Report'.

This report was intended to confirm that the level of contamination (if any) in relation to the Y property would be of a level which allowed for the development of the Y property for residential use.

During negotiations with X and prior to the signing of the contract, it was your intention that the ultimate purchaser would be a new charitable entity that would acquire the property with the aim to redevelop the property into a high-density residential project to provide accommodation for low income earners in the community.

The only reason you entered into the Contract with X, rather than the new charitable entity, was the new charitable entity had not been established prior to the signing of the Contract.

You instructed your tax agent to create a charitable entity after a period of time.

Due to the failure of X to provide the Validation Report, settlement did not occur in the relevant income year.

X did not exercise its right under clause 2.5 to rescind the contract.

You and X agreed that settlement would occur once X had completed remediation and provided the purchaser with the Validation Report. In accordance with General Condition 5 of the Contract, at least 14 days before the revised settlement, the taxpayer could nominate a substitute purchaser and/or additional purchaser of the Property.

Clauses 2.5 and 2.6 of the contract state that:

2.5 Remediation

If the Vendor, in its sole and honest opinion forms the view that it:

d) cannot achieve remediation of the Property to the standard referred to in SC 12.3; or

e) cannot complete the remediation work for a total cost of less than $150,000; or

f) anticipates that it will be unable to complete the remediation work on or before the settlement date;

the Vendor may rescind this Contract by providing not less than 7 days' notice in writing to the Purchaser or the Purchaser's solicitor.

2.6 Rescission of Contract

Upon rescission of the contract pursuant to the SC the Vendor shall refund to the Purchaser the deposit together with all the interest earned upon investment thereof (if applicable) and neither party shall have any rights against the other on any account whatsoever arising out of or in any way related to this contract.(emphasis added)

Clause 12.5(a) of the contract further states that:

Subject to the Vendor exercising its rights under SC 2, notwithstanding that the Validation Report to be supplied pursuant to SC 12.3 is not available prior to the settlement date, the parties remain obligated to complete this contract provided that the Vendor shall provide the Validation Report to the Purchaser as contemplated as soon as it is received by the Vendor from the independent consulting engineers retained to prepare it. If the Vendor exercises its rights under SC 2.5 then this provision (SC 12.5) is no longer of force or effect.

Company A was incorporated to act as trustee for the B trust in the 2006 income year.

In the 2007 income year, B trust received income tax exemption as a charity under Item 1.1 of the table in section 30-5 of the Income Tax Assessment Act 1997 that applied retrospectively from a date in 2006.

In the 2013 income year, company A provided the Validation Report to you.

The property settled on in the 2014 income year and company A as trustee for B trust is listed as the purchaser under the Contract.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 102-25

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 104-60

Reasons for decision

Summary

You acquired a bundle of rights through the contract, including the right to nominate a substitute purchaser.

As a consequence of the nomination of the substitute purchaser under the contract, the right to nominate a substitute purchaser was 'satisfied', such that CGT event C2 happens to that particular right under the contract.

However, the process of nomination also resulted in either the disposal or transfer of the other rights acquired by you under the contract from you to the nominee, such that both CGT event A1 and CGT event E2 happened. However, as CGT event E2 is the more specific CGT event, this is the CGT event which happened.

The 'look through' / 'underlying asset' approach does not apply to the transfer of your remaining rights in relation to the land to the nominee, as you did not acquire an underlying asset as a consequence of the disposal / transfer of your remaining rights under the contract.

Detailed reasons for decision

It is our view that:

• you did not act in the capacity as an agent for company A in entering into the contract; and

• company A did not have any rights under the contract prior to nomination by you.

Thus, the nominee could not have had any interest or contractual rights in relation to the Y property, and thus acquired it for CGT purposes, at the time of the entering into of the contract between you and X.

Therefore, it is necessary to consider if the contract resulted in the later transfer or disposal of a CGT asset or assets from you to the nominee, such that a CGT event happened.

Equitable interest

By exercising the right under the contract to nominate a substitute purchaser, it could be argued that you transferred your existing equitable interest in and/or rights in the Y property to the nominee.

Pursuant to subsection 108-5(1) of the ITAA 1997:

A CGT asset is:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

A note to section 108-5 of the ITAA 1997 identifies land as a CGT asset.

Paragraph 34 of Taxation Ruling TR 94/29 Income tax: capital gains tax consequences of a contract for the sale of land falling through (dealing with former section 160M of the ITAA 1936) states that:

The capital gains tax provisions in the use of the term 'asset' adopt both senses of the word 'property' to which Jordan CJ referred and also specifically recognise various forms of proprietary rights. For instance: the definition of 'land' in subsection 160K(1) is expressed to include (paragraph (a)) 'a legal or equitable estate or interest in land'; paragraph 160M(3)(b) recognises interests or rights in or over property, at law or in equity, as assets….

Further, paragraph 51 of TR 94/29 states that:

When the Livingston case was before the High Court of Australia, Dixon CJ said that an equitable interest is not ownership; but it is proprietary. A person acquiring such an interest can nonetheless dispose of it and for CGT purposes the interest will then be considered as a separate asset.

It is our view that you had an equitable interest and/or rights in the property from the time you entered into the contract and that this is a CGT asset.

Tanwar Enterprises Pty Ltd

Prior to the decision in Tanwar, case law precedent indicated that the purchaser of land acquired an equitable interest in the land at the time of the contract of purchase. In Real Property Law 3rd edition, (Sydney, Thomsons, 2009) Samantha Hepburn notes that:

In Lysaght v Edwards (1876) 2 Ch D 499 it was clearly held by Jessel MR that the moment a valid contract for sale is established and a deposit is paid, the vendor becomes a trustee in equity for the purchaser of the estate sold and the beneficial ownership passes to the purchaser. Up until settlement date, the vendor will hold the legal title on trust for the purchaser who is the beneficiary under the trust. The vendor will have a right to the purchase money and a charge, or "equitable lien", on the estate for the security of the purchase money, combined with a right to retain possession of the estate until the purchase money is paid.

The High Court also affirmed in KLDE Pty Ltd v Commissioner of Stamp Duties (Qld) HCA 63; (1984) 155 CLR 288 that:

…a purchaser under a contract for the sale of land which is specifically enforceable has a beneficial interest in the land, albeit one conditional on, amongst other things, payment of the price. (at para 17)

However, it is further stated at page 52-53 in Real Property Law that:

This position has been revised by the High Court in Tanwar Enterprises Pty Ltd v Cauchi 77 ALJR 1853 where it was suggested that the interest of a purchaser under a contract for the sale of land is more akin to an equitable lien over the deposit than an equitable beneficial title under a constructive trust. (page 52-53)

The decision in Tanwar and applied to your circumstances suggests that you did not have an equitable beneficial interest in the property following the signing of the contract, and thus could not transfer such an interest to RHP Ltd.

The question of a taxpayer's equitable interest in property at the time of a contract is also considered in Taxation Ruling TR 94/29, where it is suggested that the view that:

41… The case law on the matter express varying opinions as to the existence, nature and effect of that interest. The cases show a divergence of opinion as to when the equitable interest, in whatever form, actually passes to the purchaser. There is support for the view that the equitable interest does not pass until completion of the contract as well as for the view that the equitable interest passes at the time of the contract. We have also noted that equitable interests are recognised as assets for CGT purposes just as much as legal interests and the objects themselves.

42. Support for the preferred view may be got from the following passages from the joint judgment of Deane and Dawson JJ in Stern v. McArthur (1988) 165 CLR 489 which discuss the nature of the equitable interest. At 521-523 they say:

'It has been said in a variety of ways that a vendor under a valid contract for the sale of land holds the land as trustee for the purchaser. He is, however, a trustee only in a qualified sense and the qualifications are such as to rob the proposition of much of its significance or, for some purposes, its validity. The vendor must make title before there can be any alteration in the equitable ownership of the land, although the alteration may then relate back to the date of contract. Even so the vendor retains a substantial interest in the property until the whole of the purchase money is paid. He is entitled, subject to the contract, to possession and to the rents and profits in addition to a lien on the land as security for any amount outstanding. Any right to equitable ownership on the part of the purchaser is contingent only, being subject to the payment of the purchase money and being said to exist only so long as the contract remains specifically enforceable at his suit.

In line with these later case law precedents, it has been suggested by one academic observer that:

…a buyer only acquires an equitable interest where he or she (expressly or implicitly) accepts the seller's title and, on tendering the balance of the purchase money may insist on the seller delivering a transfer of the land to the buyer.

On the basis of the reasoning in Tanwar and Stern v. McArthur, and the ATO view in TR 94/29, it is our view that you had no equitable interest in the property prior to (or after) nomination of the substitute purchaser, and thus that there could be no CGT event in relation to equitable interest at the time of the nomination.

Rights

However, even if it is accepted that you did not have an equitable interest in the Y property between the date of the contract and the nomination of the substitute buyer, it is our view that you had rights in relation to the Y property as a consequence of the contract, and that the rights under this contract, in total, constituted an 'asset'.

Paragraphs 114 and 115 of Taxation Ruling 1999/19 Income tax capital gains: treatment of forfeited deposits state that:

It seems clear that the purchaser's bundle of contractual rights, e.g., the right to a transfer of the property, is an asset for CGT purposes. Being proprietary rights, they are an asset as defined both before and after 26 June 1992.

These rights are created by the vendor in the purchaser and are taken to have been acquired by the purchaser when the purchaser becomes the owner of the rights, that is, when the contract is entered into (subsection 109 5(1)).

As stated in paragraph 1 of Taxation Determination 93/86 Income tax: capital gains: are the totality of rights under a contract considered to be the one asset, or is each right considered to be a separate asset for CGT purposes? (TD 93/86):

Whether all the rights comprise one single asset, or each right is a separate asset, will depend on the facts of each case. Generally, however, the initial approach will be to regard the totality of rights as the one asset for the purposes of Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997. (emphasis added)

This suggests that the rights under the contract entered into by you was a single CGT asset for the purposes of section 108-5 of the ITAA 1997, incorporating both the right to nominate a substitute buyer and all other contractual rights in relation to the acquisition of the Mobil property.

CGT treatment of right to nominate

However, for the reasons outlined below, it is considered that the capital gains tax treatment of the right to nominate a substitute buyer should be considered separately for CGT purposes from that of the other rights acquired under the contract.

CGT event C2 is contained within Subdivision 104-C of the ITAA 1997, and deals with the: 'End of a CGT asset.' Subsection 104-25(1) of the ITAA 1997 states that:

CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

a) being redeemed or cancelled; or

b) being released, discharged or satisfied; or

c) expiring; or

d) being abandoned, surrendered or forfeited; or

e) if the asset is an option - being exercised; or

f) if the asset is a *convertible interest - being converted.

As stated in paragraph 2 of TD 93/86:

Depending upon the circumstances of each particular case, an assignment of one of the rights contained in a contract is usually treated as a disposal of part of the asset (i.e. the contractual rights); the individual right that is severed from the contract is, if it continues to exist, regarded as a separate asset for CGT purposes. (emphasis added)

In this case, you had the right to nominate a substitute purchaser.

Your right to nominate a substitute purchaser was exclusive to you - under the terms of the contract, a nominated substitute purchaser would not in turn acquire your right to nominate another substitute purchaser.

Thus, this particular right could not be disposed of or transferred to the substitute purchaser, but ceased to exist once the nomination process was complete. Accordingly, pursuant to subsection 104-25(1) of the ITAA 1997, it is accepted that your right to nominate a substitute purchaser was satisfied by the nomination of company A.

Equally, therefore, the right to nominate a substitute purchaser was not either disposed of to A (CGT event A1) or transferred to A (CGT event E2).

Capital gain on disposal/transfer of remaining rights

While it is considered that the right to nominate a substitute purchaser was satisfied through the process of nomination, it is also considered that, as a consequence of the nomination process, you disposed of or transferred your remaining rights under the contract to the nominee.

As CGT event C2 only applies to the 'end of an asset', it cannot apply to the remaining rights, which continued to exist after their disposal or transfer to the nominee at the time of the nomination.

Equally, therefore, it is necessary to consider the capital gains tax treatment of these rights.

CGT events

Pursuant to subsection 104-10(2) of the ITAA 1997, for the purposes of CGT event A1:

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. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Further, subsection 104-10(3) of the ITAA 1997 states that:

The time of the event is:

a) when you enter into the contract for the *disposal; or

b) if there is no contract - when the change of ownership occurs.

It appears to be implicit in subsection 104-10(3) of the ITAA 1997 that the change in beneficial ownership will occur at the time the contract is entered into, rather than at settlement.

Thus, by disposing of or transferring his remaining rights in the Y property to company A as a consequence of the nomination process, there was a change in the beneficial ownership of the rights under the contract in relation to the Y property at the time of the transfer.

Equally, however, subsection 104-60(1) of the ITAA 1997 states that: 'CGT event E2 happens if you transfer a CGT asset to an existing trust.'

You disposed of or transferred your rights to company A in its capacity as trustee of the B trust. Thus, it is considered that CGT event E2 happened on the transfer of the rights from you to company A. In this case, the time of the event pursuant to section 104-60(2) of the ITAA 1997 is '…when the asset is transferred.'

Section 102-25(1) of the ITAA 1997 states, in part, that:

If more than one event can happen, the one you use is the one that is the most specific to your situation.

As you transferred your rights to company A as trustee, it is considered that CGT event E2 is the 'most specific' CGT event which applies.

Calculation of capital gain or loss

As indicated above, it is considered that CGT events happened in relation to:

• the right to nominate the substitute purchaser; and

• the remaining rights acquired by you.

Thus, it is necessary for you to determine the relevant cost bases and capital proceeds in relation to these CGT events, including any apportionment of the cost base of the rights which were the subject of separate CGT events.

'Look through' \ 'Underlying asset' approach

The 'look through' or 'underlying asset' approach has been adopted as an ATO view specifically in relation to compensation receipts Taxation Ruling 95/35 Income tax: capital gains: treatment of compensation receipts) and property ATO Interpretative Decision 2003/790.

Paragraph 3 of TR 95/35 states that:

The look-through approach is the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related. It is also referred to in this Ruling as the underlying asset approach.

As your case deals with property rather than compensation receipts, ATOID 2003/790 is the more relevant ATO view. This considers whether CGT event C2 happens '…when the taxpayer's contractual rights for the purchase of the asset are satisfied by the actual transfer of ownership of the asset'. In part, the ATOID states that:

An executory contract for the transfer of a CGT asset is, by definition, itself a CGT asset. The subsequent performance of the contract discharges and satisfies the contractual rights and on the face of it may cause a CGT event C2 to happen.

However, in such circumstances, the real transaction is the acquisition of the underlying CGT asset (the property) rather than the ending of the rights that merely facilitate that acquisition. This approach is consistent with the view expressed in Taxation Ruling 95/35 regarding compensation receipts and identifying the relevant asset for the purposes of the CGT provisions.

In determining what the most relevant asset or transaction is, it is often appropriate to adopt a 'look-through' approach to the transaction or arrangement.

Accordingly, where the change of ownership of a CGT asset occurs under a contract, the CGT provisions of the ITAA 1997 will apply only to the acquisition of the underlying asset and not to the rights that merely facilitate the transaction.

However, this ATO view is intended to apply in circumstances where the entity which is the owner of the right to acquire the property is the same entity which ultimately acquires the property.

Following the nomination of company A by you as the purchaser of the Y property, company A rather than you, it is this entity which will acquire the property from X through the exercise of their rights under the contract.

By contrast, you do not acquire any underlying asset as a consequence of your nomination of company A. You simply transfer your remaining rights under the contract to company A, which then acquires the Y property. Thus, the ATO view contained in ATOID 2003/790 is not directly applicable to your particular circumstances.

The ATO view contained in ATOID 2003/790 can only potentially apply to the acquisition of the underlying asset by the nominee in satisfaction of their right/obligation to acquire this property.

Indeed, a note to ATOID 2003/790 states that:

This ATO Interpretive Decision does not address the situation where the purchaser deals with the contractual rights other than by simply completing the purchase in accordance with the contract, for example, by assigning the contractual right to have the property conveyed. Such dealings are likely to be CGT events.

Thus, it is our view that the 'look through' / 'underlying asset' approach cannot apply either to the nomination by you, or to the transfer of your remaining rights.

Discount capital gain

Given that you held the rights under the contract for greater than twelve months, the 50% CGT discount is applicable in relation to any capital gain made on the satisfaction, disposal or transfer of these rights.