Edited version of private advice

Authorisation Number: 1012680923280

Ruling

Subject: Capital gains tax

Question and answer

Is the Company assessable on the capital gain made from the sale of the dwelling?

Yes

The ruling applies for the following periods:

Year ended 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

Two individuals, Person A and their spouse, Person B signed a contract to purchase a dwelling on date W, after 20 September 1985.

Person A and Person B paid a deposit of 10% of the purchase price.

A few weeks later, under a Purchaser's Declaration, Person A and Person B nominated a company (the Company) as the purchaser and transferred the dwelling to the Company. It is not known why this was done.

The purchase of the dwelling and the purchase contract were settled with the nominated purchaser, the Company, taking transfer of the dwelling.

The purchase price of the dwelling consisted of a significant loan from a bank, savings of Person A and Person B and funds from the sale of two properties owned by Person A and Person B.

The directors and shareholders of the Company were Person A and Person B.

Person A and Person B had some children.

Person A and Person B both used the dwelling as their main residence.

Person A died on date X in the 200X income year leaving a will.

Prior to the death of Person A, Person B was moved to a nursing facility.

Person A's will provided for the inheritance, use and occupation of the property by Person B and also provided for one of the children (Person C) to continue to reside at the property.

Following the death of Person A, Person C and a sibling continued to reside in the dwelling as their family home.

Person B died on date Y in the 200Y income year without a will.

The dwelling was sold on date Z in the relevant income year for a significant gain.

The dwelling was not used to earn assessable income at any time.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 106-50

Income Tax Assessment Act 1997 Subsection 118-110(1)

Income Tax Assessment Act 1997 Subsection 118-195(1)

Income Tax Assessment Act 1997 Section 118-200

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Ownership

When considering the gains that may arise from the disposal of a property, the most important element in the application of the capital gains tax (CGT) provisions is ownership; it is essential to determine who the owner of the asset is.

Generally speaking, and in the absence of evidence to the contrary, real property is considered to be owned by the person(s) registered on the title. An exception to this principle is the case in which one person is holding the property on trust for another. In this situation the legal owner and the beneficial owner will be two different people.

There are limited circumstances in which the legal and beneficial interests are not the same and where there is sufficient evidence to establish that the beneficial interest is distinct from the legal title. Where it is contended that the legal and beneficial ownership of a property differ evidence must be produced that satisfies the Commissioner that this is the case.

In the present case, the Company is the legal owner of the dwelling in question, as evidenced by the title to the property. Person A and their spouse, Person B signed a contract to purchase a dwelling on date W, after 20 September 1985. Person A and Person B paid a deposit of 10% of the purchase price. A few weeks later, under a Purchaser's Declaration, Person A and Person B nominated a company (the Company) as the purchaser and transferred the dwelling to the Company. The purchase of the dwelling and the purchase contract were settled with the nominated purchaser, the Company, taking transfer of the dwelling.

Main residence exemption

Subsection 118-110(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a capital gain or capital loss made by a taxpayer from a CGT event that happens in relation to a CGT asset that is a dwelling or to an ownership interest in a dwelling is disregarded if the dwelling was their main residence throughout their ownership period.

Subsection 118-110(1) of the ITAA 1997 makes it clear that in the general case, the main residence exemption is only available to an individual (defined in subsection 995-1(1) of the ITAA 1997 as a natural person). Subsection 960-100(4) of the ITAA 1997 goes on to provide that if a provision refers to an entity of a particular kind, it refers to the entity in its capacity as that kind of entity and not in any other capacity.

As a company or trust is not a natural person it cannot satisfy the condition in subsection 118-110(1) of the ITAA 1997 that the taxpayer be an individual. Accordingly, the main residence exemption in subdivision 118-B of the ITAA 1997 is not available where the ownership interest is held by a company.

However where a beneficiary of a trust is absolutely entitled as against the trustee to the dwelling, an exemption may be available to the beneficiary if the dwelling is the principal residence of the beneficiary.

This is because pursuant to section 106-50 of the ITAA 1997, a beneficiary that is absolutely entitled to a CGT asset as against the trustee is treated as the relevant taxpayer in respect of the asset for the purposes of the CGT provisions.

If a beneficiary of a trust is absolutely entitled to a CGT asset as against a trustee, any act done by the trustee is treated as if it was carried out by the beneficiary under section 106-50 of the ITAA 1997. 

It is considered that a beneficiary is absolutely entitled to an asset of a trust as against the trustee if the beneficiary is:

• absolutely entitled in equity to the asset and thus has a vested, indefeasible and absolute interest in the asset; and

• able to direct the trustee how to deal with the asset.

Where more than one beneficiary has an interest in a trust's assets, absolute entitlement can only be established if the assets are fungible.

The assets of a trust must be able to be divided up evenly in order to satisfy a demand from a beneficiary in respect of each fungible asset.

If there is more than one beneficiary with interests in the trust asset, then it will usually not be possible for any one beneficiary to call for the asset to be transferred to them or to be transferred at their direction. This is because their entitlement is not to the entire asset. If the asset was divided, each asset would be different from the original trust asset. This is confirmed in paragraph 125 of TR 2004/D25 - Capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 where it says that if there is a shared interest in the trust assets, this prevents absolute entitlement.

There is, however, a particular circumstance where such a beneficiary can be considered absolutely entitled to a specific number of the trust assets for CGT purposes. This circumstance is where:

• each asset matches the same description such that one asset can be replaced with another, they are of the same type, it is fungible (for example, shares in the same company and with the same characteristics). However, land would rarely be fungible because each parcel of land is unique;

• the beneficiary is entitled against the trustee to have their interest in those assets satisfied by a distribution or allocation in their favour of a specific number of them; and

• there is a very clear understanding on the part of all the relevant parties that the beneficiary is entitled, to the exclusion of the other beneficiaries, to that specific number of the trust's assets.

In your case there are two beneficiaries. As the asset in your case is real property with more than one beneficiary; it is considered that no beneficiary will be absolutely entitled to the property. Accordingly, section 106-50 of the ITAA 1997 does not apply.

Therefore, the main residence exemption is not available when the property was sold on date Y in the relevant income year and the capital gain is assessable to the Company.

How to calculate the capital gain

The Company acquired the dwelling in question after 20 September 1985. CGT event A1 occurred on date Y when the dwelling was sold and a capital gain was made.

The capital gain is calculated by subtracting the cost base of the property from the capital proceeds received from the sale.

Cost base

The cost base of an asset is generally what it costs the entity. It is made up of five elements (section 110-25 of the ITAA 1997):

1. money paid or property given for the asset

2. incidental costs of acquiring or selling it (for example, brokerage and stamp duty)

3. costs of owning it

4. costs associated with increasing or preserving its value or installing or moving it, and

5. what it has cost the entity to preserve or defend their title or rights to it.

Third element of the cost base

The third element of the cost base of a CGT asset includes the costs of owning an asset, such as rates, land tax and insurance premiums. However, these costs cannot be included in the cost base if the asset was acquired before 21 August 1991.

CGT calculation methods

There are basically two methods available to calculate the capital gain, the CGT discount method and the indexation method.

CGT discount method

Section 115-10 of the ITAA 1997 is the provision which states who can make a discount capital gain. To be eligible for the capital gains tax discount the capital gain must have been made by:

(i)  an individual,

(ii) a complying superannuation entity,

(iii) a trust; or

(iv) a life insurance company in relation to a discount capital gain from a capital gains tax event in respect of a capital gains tax asset that is a virtual PST asset.

As companies are not covered by this provision, the Company in your case is not entitled to any CGT discount.

Indexation method of calculating capital gain

A company cannot use the discount method, however the indexation method can be used where the entity is a company and the following conditions are met:

• a CGT event happened to an asset the entity acquired before 21 September 1999, and

• the entity owned the asset for 12 months or more

A company (other than a listed investment company) must use the indexation method to calculate the capital gain. Under the indexation method each amount included in an element of the cost base is increased by an indexation factor using the consumer price index. We refer you to our website www.ato.gov.au. The relevant information can be found by typing code QC 17158 in the search box.