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Edited version of your written advice
Authorisation Number: 1012705079809
Ruling
Subject: Capital gains tax
Question
Should any capital gain or capital loss resulting from the disposal of the property be apportioned according to the legal owners as registered on the title?
Answer
Yes.
This ruling applies for the following period
Year ended 30 June 2014
The scheme commenced on
1 July 2013
Relevant facts and circumstances
You and your spouse purchased a property for your child (to live in while studying and later working after 20 September 1985).
At the time of purchase your child was under 18 years of age. You could not include their name in either the partnership or the titles on advice from your conveyancer.
Your child has had the property as their principal place of residence and still lives in it today.
Your child paid a share of the cost of the property over the years.
The bedrooms that were not used were leased out on a per room basis. Income and expenses from this venture have been documented. Tax has been paid on the net profit from the rental activities.
Your child has been included in the leasing agreements and they have declared a share of the net profits.
Your child has now purchased the balance of the property from you and capital gains tax is to be paid.
A market valuation at the date of the sale has been obtained from a registered property valuer.
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 Subparagraph 116-30(2)(b)(i)
Reasons for decision
All references are to the Income Tax Assessment Act 1997 (ITAA 1997).
Capital gains tax
Section 102-20 advises that you make a capital gain or loss when a CGT event takes place. The disposal of a CGT asset, for example a dwelling, is a CGT event.
A capital gain is included in your annual income tax return. It is not a separate tax, merely a component of your income tax. Your net capital gain is added to your annual income and you are taxed at your marginal tax rate.
You had an ownership interest in a dwelling which you acquired with your spouse for your child while they were studying and later working. Your child contributed a share of the acquisition costs. When you sold the dwelling to your child, you and your spouse each disposed of your interest in the property and a CGT event occurred.
Legal v beneficial ownership
Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners, states at paragraphs 41 and 42:
41. We consider that there are extremely limited circumstances where the legal and equitable interests are not the same and that there is sufficient evidence to establish that the equitable interest is different from the legal title. We will assume where taxpayers are related, e.g., husband and wife, that the equitable right is exactly the same as the legal title.
42. Any capital gain or loss should also be apportioned on the same basis as the rental income or loss.
It follows that in the absence of information to the contrary, a property is considered to be legally and beneficially owned by the person/s registered on the title.
In some cases however, someone may hold a legal ownership interest in a property on behalf of another person in trust. Where the legal and beneficial ownership of a dwelling is different, a trust situation occurs. If this is the case the legal owners are the trustees of the dwelling.
The CGT provisions do not apply to the legal owners of a dwelling if the legal owners held it on trust for another person and the other person was absolutely entitled to that dwelling as against the trustees (section 106-50).
Therefore we need to determine if you were holding your interest in the dwelling in trust and also whether the beneficiary had an absolute entitlement to the dwelling.
Was there a trust created?
The creation of trusts falls within the jurisdiction of equity.
According to G. Teh and B. Dwyer, Introduction to Property Law, at paragraph 606
a trust exists whenever legal title to real or personal property is vested in one person, called a trustee, for the benefit of another person, called a beneficiary.
There are several kinds of trusts, including Express and Bare.
Express Trusts
An express trust is one intentionally created by the owner of property in order to confer a benefit upon another. It is created by express declaration, which can be effected by an agreement or common intention held by all parties to the trust.
For an express trust to be created it is a requirement that there is certainty of the intention to create a trust, certainty of the subject matter of the trust and certainty as to the object of the trust.
While trusts can be created orally, all State Property Law Acts contain provisions derived from the Statute of Frauds that preclude the creation or transfer of interests in land except if evidenced in writing. Therefore express trusts must be evidenced in writing.
You do not have any documentary evidence that supports the fact that you held the property in trust for your child. Such documents would constitute a declaration of trust and make clear the terms of the trust. The absence of such a document means that an express trust cannot exist.
Bare Trust
A bare trust is one where the trustee has no active duties to perform. Gummow J said in Herdegen v. Federal Commissioner of Taxation (1988) 84 ALR 271 at 281:
Today the usually accepted meaning of 'bare' trust is a trust under which the trustee or trustees hold property without any interest therein, other than that existing by reason of the office and the legal title as trustee, and without any duty or further duty to perform, except to convey it upon demand to the beneficiary or beneficiaries or as directed by them, for example, on sale to a third party.
Under a bare trust the beneficiary is entitled to possession of the trust assets and the trustees must act in accordance with the direction of the beneficiary. Ultimately the trustees must deal with the property as directed by the beneficiary, including handing over ownership on request.
You and your spouse purchased the property and your child contributed a share of the acquisition cost. At the time of acquisition your child was under the age of 18 and you were advised that they were not permitted to be included on the title.
Your child occupied only one of the bedrooms in the dwelling. You all agreed to rent out the remaining bedrooms. You apportioned the income and expenses between you.
In order for a bare trust to exist it must be shown that:
• you did not consider the dwelling as yours;
• you must have had no active duties to perform as trustees of the bare trust;
• you merely held the legal title to the property for the benefit of the beneficiary; and
• your role as trustees was to simply hold the property during the beneficiary's lifetime or deal with it at the beneficiary's direction.
Although you may not have considered the dwelling to be yours, you were actively participating in the leasing arrangements for the dwelling.
Absolutely entitled
Where a beneficiary is absolutely entitled to an asset held by a trustee section 106-50 provides that any 'act done by the trustee in relation to the asset' is treated as if it had been an act of the person absolutely entitled. As a result if the act triggers a CGT event, then the taxpayer will be the person subject to any CGT liability rather than the trustee.
A beneficiary is absolutely entitled to an asset of a trust as against the trustee for the purposes of section 106-50 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.
It is clear that your child, who would have been the only beneficiary, did not have a vested, indefeasible and absolute interest in the property. By selling your share of the property to your child you acknowledged that you were part owner and not merely a trustee. Consequently your child could not have been absolutely entitled to the property as against you as one of the trustees of the trust.
Therefore for the purposes of the capital gains tax provisions you, as part owner as listed on the title of the property, will be liable for your share of the capital gain that resulted from the sale of the remaining 75% of the property to your child.
Market value substitution rule
In certain circumstances section 116-30 operates to substitute or replace the actual capital proceeds following a CGT event with a market value amount. Because the disposal took place between related parties and therefore did not deal with each other at arm's length, subparagraph 116-30(2)(b)(i) applies to enforce the market value substitution rule.
It is noted that you obtained the market value of the property at the date of the sale from a registered property valuer.