Edited version of your written advice

Authorisation Number: 1012699476618

Ruling

Subject: Capital gains tax

Question 1

Will capital gains tax (CGT) event D2 happen upon entering a call option agreement with the company?

Answer

No.

Question 2

Upon the death of individual A, will CGT event D2 occur?

Answer

Yes.

Question 3

Upon the death of individual A, will CGT event D2 occur if the option is not exercised by the company?

Answer

Yes.

This ruling applies for the following period

Year ending 30 June 2015

The scheme commences on

1 July 2014

Relevant facts and circumstances

Individual A inherited a property at from their deceased spouse in 200X.

This property was their principal residence.

The property has never been used to produce income and is currently vacant.

Individual A is a director of a company which owns a nearby property. This property was purchased pre 1985 and is a rental property.

The company wishes to secure individual A's main residence to possibly build a unit development or sell both properties as a unit development site.

Currently both properties are residential single house sites.

Individual A and the company propose to enter into a call option agreement whereby individual A grants the company a call option to purchase the property.

A fee payable by the company of $X is proposed on the signing of the agreement.

The call option is proposed to come into effect and be legally enforceable on individual A's death and would be exercisable within X months of individual A's death.

If the company exercises the option it would purchase the property at market value less the option fee.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-40(1)

Income Tax Assessment Act 1997 subsection 104-40(5)

Reasons for decision

Question 1 and 2

Under subsection 104-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997), 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 of the option are more than the expenditure you incurred to grant it. You make a capital loss if those capital proceeds are less.

A call option gives a person the right to acquire an asset from the person granting the right at some specified time and usually at a predetermined price.

ATO ID 2003/1190 considers the timing of CGT event D2. In this scenario, shareholders in a private company entered into a buy - sell agreement to ensure the continuity of ownership of the business in the remaining shareholders if one of the major shareholders dies. Under the agreement, put and call options are granted by each shareholder to the other shareholders to be effective in the event of the death or disablement of any shareholders. ATO ID 2003/1190 states:

Under the buy-sell agreement, put and call options are granted to the parties to the agreement. When these are exercised they will create a legally binding contract to buy and sell shares.

However the granting of the options may not occur at the time of entering into the agreement if there is a specified condition in the agreement that is yet to occur. In this case it was necessary for the death or disability of a major shareholder to occur before the remaining major shareholders obtained legally enforceable options. The buy - sell agreement is a contract with a condition precedent and cannot proceed until that condition is fulfilled. It is necessary to distinguish between a condition precedent to the performance of the contraction and a condition precedent to the formation of the contract as this determines the timing of the D2 event and the subsequent transfer of the shares.

ATO ID 2003/1190 accepts that where it is evident from the terms of the agreement that the parties intend the arrangement to come into effect only at the time of the death or disablement of one of the shareholders, this will be a condition precedent to the formation of the option contract. It therefore follows that the CGT event D2 does not occur at the time the buy - sell agreement is executed. The CGT event will happen when one of the shareholders dies or becomes permanently disabled.

Application to your circumstances

In this case, the call option will not come into effect and be legally enforceable until the death of individual A. We consider the circumstances to be similar to those outlined in ATO ID 2003/1190. Therefore, CGT event D2 will not occur at the time the call option agreement is entered into.

It follows that CGT event D2 will occur when individual A passes away.

Question 3

Under subsection 104-40(5) of the ITAA 1997, a capital gain or loss you make from the grant of the option is disregarded if the option is exercised.

If the company does not exercise the option to purchase the property, the provisions do not prevent CGT event D2 from happening.