Edited version of your written advice

Authorisation Number: 1012915057442

Date of advice: 27 November 2015

Ruling

Subject: Capital gains tax: Transfer of dwelling/redemption of units

Question 1

Will CGT event C2 in section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) happen when your units in the Unit Trust are redeemed by the Trustee?

Answer

Yes.

Question 2

Will you be assessable under section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of a capital gain made by the Unit Trust?

Answer

No, because after your units are redeemed you will not be a unitholder and therefore you will be incapable of being presently entitled to any income of the trust.

Question 3

Will section 118-20 of the ITAA 1997 operate to reduce your capital gain from the CGT event C2 to the extent an amount is included in your assessable income under section 97 of the ITAA 1936 as a result of the in specie distribution?

Answer

Not applicable, as no amount will be included in your income under section 97.

Question 4

Will you be entitled to the main residence exemption when you dispose of half of your tenancy in common interest in the property that has been transferred into your name to your spouse?

Answer

Yes.

Question 5

Will you be entitled to the main residence exemption when you dispose of your tenancy in common interest in the property to a third party?

Answer

Yes.

Question 6

Will the arrangement whereby you and the Unit Trust (and subsequently you, your spouse and the Unit Trust) own the property as tenants in common give rise to a partnership within the meaning of section 995-1 of the ITAA 1997?

Answer

No.

Question 7

Will Part IVA of the ITAA 1936 apply to you in respect of this arrangement?

No.

This ruling applies for the following period(s)

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

1 July 2019 to 30 June 2020

1 July 2020 to 30 June 2021

1 July 2021 to 30 June 2022

1 July 2022 to 30 June 2023

1 July 2023 to 30 June 2024

1 July 2024 to 30 June 2025

The scheme commences on

1 July 2015

Relevant facts and circumstances

The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents, or relevant parts of them, as the case may be, form part of and are to be read with this description. The relevant documents or parts of documents incorporated into this description of the arrangement are:

(a)   The application for private ruling dated together with all other documents, information and views attached to that application; and

(b)   Email provided, together with all of the attachments provided with that email including the trust deed of the Unit Trust.

The Unit Trust was established in the 1990s.

The trustees of the Unit Trust are you and your spouse.

The Unit Trust owns a residential property, consisting of a dwelling on a block of land that is less than 2 hectares in area (the property). The property was acquired after 20 September 1985.

The unit holders of the Unit Trust are you and the trustee of a self-managed super fund (the Super Fund).

You hold over 50% of the units and the Super Fund holds the remaining units. This structure was set up pursuant to professional advice received at the time the property was acquired.

The members of the Super Fund at all relevant times have been you and your spouse.

The tenants of the property at all relevant times have been you and your spouse. You and your spouse as tenants have paid on a regular basis an arm's length amount of rent to the Unit Trust as the landlord. The Unit Trust then distributes on a regular basis the net income of the Unit Trust to the unit holders pursuant to the terms of the deed of the Unit Trust.

The property has at all relevant times been the main residence of you and your spouse.

You and your spouse now wish to simplify their tax affairs and acquire an ownership interest in their main residence, and as such propose to undertake the following course of action.

Stage 1:

In the 20XX income year, the Unit Trust will redeem your units in the Unit Trust for their market value. Rather than the Unit Trust redeeming the units for cash, it will redeem the units for an in-specie transfer of a greater than 50% tenancy in common interest in the property. This interest will be equal to the value of your units, i.e. greater than 50% of the total value of the property.

You would then have a greater than 50% tenancy in common interest in the property and the Unit Trust would own the rest of the property.

You and your spouse as tenants will then pay a percentage of the market value of the rent to the Unit Trust. The payments of rent will be made in respect of the less than 50% tenancy in common interest that will be held by the Unit Trust. The percentage of the property that you will own will not be income generating.

It is anticipated that the Unit Trust will make a capital gain from the disposal of a greater than 50% interest in the property to you, and that you will make a capital gain from the redemption of your units in the Unit Trust.

The trust deed of the Unit Trust does not give the trustees the power to make any unitholder 'specifically entitled' to capital gains, as defined in section 115-228 ITAA 1997.

At the end of the 20XX income year, the Super Fund will be the sole unit holder and, as such, will be presently entitled to all the net income of the Unit Trust, which will include the capital gain from the disposal of the greater than 50% interest in the property.

Stage 2:

It is proposed that, following the redemption of your units, you will transfer half of your interest in the property to your spouse. At a later time, the property will be sold to an unrelated entity. That is, you and your spouse together with the Unit Trust will sell your respective interests in the property to an unrelated entity.

The sale is anticipated to happen sometime in the next 10 years. The dwelling will be your main residence and your spouse's main residence throughout the period in which you hold an ownership interest in the property. During your ownership period, you will not use the property to produce any assessable income.

Relevant legislative provisions

Section 97 of the Income Tax Assessment Act 1936

Section 104-10 of the Income Tax Assessment Act 1997

Section 104-25 of the Income Tax Assessment Act 1997

Section 118-20 of the Income Tax Assessment Act 1997

Subdivision 115-C of the Income Tax Assessment Act 1997

Part IVA of the Income Tax Assessment Act 1997

Anti-avoidance rules

Part IVA of the Income Tax Assessment Act 1936

Reasons for decision

CGT event A1 and CGT event C2

When a beneficiary redeems their units in a unit trust for an in-specie transfer of property from the unit trust's assets, there are consequences for both the trustee and the unit holders of the unit trust.

CGT event A1 in section 104-10 of the ITAA 1997 happens if the trustee of a trust disposes of a CGT asset of the trust via an in-specie transfer to a beneficiary to redeem a beneficiary's interest in the trust. The trustee will make a capital gain if the capital proceeds are more than the cost base of the asset at the time it is disposed of.

In addition, CGT event C2 in section 104-25 of the ITAA 1997 happens to the unit holder upon redemption of their units. The unit holder will make a capital gain if the capital proceeds from the redemption are more than the cost base of the unit in the unit trust.

In this case, the Unit Trust will make a capital gain under CGT event A1 upon the in-specie transfer of a proportion of the property to you. You will make a capital gain under CGT event C2 as a result of the redemption of the units in the Unit Trust.

Section 97 of the ITAA 1936

Section 97 of the ITAA 1936 provides that a taxpayer who is not under a legal disability and who is presently entitled to a share of the income of a trust estate must include in their assessable income that share of the net income of the trust calculated under section 95 of the ITAA 1936.

Paragraph 97(1)(a) of the ITAA 1936 provides that the assessable income of a presently entitled beneficiary who is not under a legal disability comprises:

• so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident of Australia, whatever the source of the income, and

• so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia.

From the 2010-11 income year, subdivision 115-C of the ITAA 1997 modifies the rules for trusts with net capital gains. Where permitted by the trust deed, the capital gains of a trust can be effectively streamed to beneficiaries for tax purposes, by making them 'specifically entitled' to those gains. Generally, a beneficiary will be considered specifically entitled to an amount of a capital gain if the beneficiary has received (or can reasonably be expected to receive) an amount referable to that gain.

A beneficiary specifically entitled to a capital gain will generally be assessed in respect of that gain, regardless of whether the benefit they receive or are expected to receive is income or capital of the trust. That is, unlike the law that applied prior to the amendments, under the new trust provisions, a beneficiary may be assessed based on a specific entitlement to a capital gain of the trust, even though they do not have a present entitlement to income of the trust estate.

Capital gains to which no beneficiary is specifically entitled will be allocated proportionately to beneficiaries based on their present entitlement to income of the trust estate (excluding amounts to which any entity is specifically entitled). This proportion is known as the beneficiary's 'adjusted Division 6 percentage'. If there is some income to which no beneficiary is entitled (apart from capital gains and/or franked distributions to which any entity is specifically entitled) the trustee may be assessed under section 99 or 99A of the ITAA 1936.

It is clear from the Unit Trust deed that present entitlement to trust income is established by the trustee at year end. As you will dispose of your units in the Unit Trust during the year, you will not be a unit holder at year end. Consequently, you will not be presently entitled to any income of the Unit Trust.

There is no provision in the Unit Trust deed for the trustee to make a beneficiary specifically entitled to any capital gains of the Unit Trust.

Anti-overlap rule

The anti-overlap rule in section 118-20 of the ITAA 1997 provides that a capital gain you make from a CGT event is reduced if, because of the event, a provision (other than a CGT provision) includes an amount in your assessable income.

As no amount will be included in your assessable income under any other provision of the tax law as a result of the CGT event C2 happening to your units, section 118-20 has no application.

Main residence exemption

You disregard any capital gain or capital loss you make when you dispose of your main residence if it is your main residence throughout your ownership period and it was not used to produce assessable income (section 118-110 of the ITAA 1997).

In your situation you will acquire your ownership interest in the property on redemption of your units in the Unit Trust, and you will occupy the property as your main residence for the entire time you hold an ownership interest. Therefore, any capital gain or capital loss you make on disposing of all or part of your interest to another entity will be disregarded.

Creation of a partnership interest

Taxation Ruling TR 93/32 provides guidance on the division of net income between co-owners. Ownership conveys an entitlement to exercise the maximum legally permissible rights over what is owned. Generally a legal interest in land is achieved by the owner being the registered proprietor of the legal title to the land. Where there is more than one person with a concurrent legal interest in the same land, those persons are co-owners of the land.

Partnership is defined in the various State and Territory partnership acts as "the relation which subsists between persons carrying on a business in common with a view of profit"¹. Subsection 6(1) of the ITAA 1936 defines partnership as 'an association of persons carrying on business as partners or in receipt of income jointly but does not include a company'.

An important ingredient of the definition is "carrying on a business". As noted at paragraph 15 of TR 93/32, without this ingredient there can be no partnership at general law.

In your case you, your spouse and the Unit Trust will hold your respective interests in the property as tenants in common. You and your spouse will pay rent to the Unit Trust at less than 50% of the market value of the rental property reflecting your use and enjoyment of the dwelling in accordance with the Unit Trust's ownership interest. There is only one property owned by the parties as tenants in common.

Owning and renting one property does not amount to carrying on a business. Accordingly there is no partnership interest created between yourself, your spouse and the Unit Trust at general law.

Furthermore, as you and your spouse will be paying rent to the Unit Trust for the use and enjoyment of its interest in the property, you, your spouse and the Unit Trust will not be in receipt of income jointly, and therefore will not be a 'partnership' under the extended definition of that term in subsection 995-1(1) of the ITAA 1997.

Part IVA

Part IVA of the ITAA 1936 may apply to a transaction if it is determined that there is:

a) a tax benefit; and

b) the sole or dominant purpose of entering into the transaction or scheme was to obtain the tax benefit.

It is arguable that this is a scheme to obtain a tax benefit, being the reduction in tax attributable to your eventual claiming of the CGT main residence exemption. If not for you and the other associated entities undertaking the scheme, on eventual sale of the property to an unrelated party the Unit Trust could make a capital gain which would be assessable income of the unit holders, of which you would be one, under section 97 of the ITAA 1936. By entering into this scheme, there will be a tax benefit being the tax on the capital gain that is disregarded under the CGT main residence exemption. However, that tax benefit will only arise if you make a capital gain. It is not certain you will make a gain - it is possible you will make a loss, in which case there will be no tax benefit at all. In fact, in that situation there will be a capital loss which you won't be able to claim.

Furthermore, the tax law should not be an obstacle to a taxpayer who wishes to acquire an asset of the type that many taxpayers own, such as the dwelling in which they live. There is no conceivable reason for a policy that deters taxpayers from acquiring an ownership interest in their own main residence.

The purpose of the scheme is to simplify your tax affairs and to acquire an ownership interest in your main residence. We accept that this is a reasonable thing for you to want to do, and is an extremely common thing for taxpayers generally to do.

As such, we accept that this scheme will not be entered into with the sole or dominant purpose of obtaining a tax benefit. The dominant purpose is to acquire an ownership interest in your main residence. Further, any tax benefit is not guaranteed - it will only occur if you make a capital gain on eventual disposal of your interest. Accordingly, Part IVA will not apply to you in relation to the scheme.

¹ The Partnership Act of 1891 (QLD, SA, TAS); The Partnership Act of 1892 (NSW); The Partnership Act of 1958 (VIC); The Partnership Ordinance of 1963 ACT.