Edited version of your written advice

Authorisation Number: 1013090127240

Date of advice: 20 September 2016

Ruling

Subject: Capital gains tax - Real property - Subdivision - Family arrangement

Question 1:

Is any profit you make from the sale of Lot 3 to child A treated as your ordinary income?

Answer:

No.

Question 2:

Can you use the 50% capital gains (CGT) discount method in relation to any capital gain you make from the sale of Lot 3 to child A to the extent it relates to the interests you acquired before 19XX?

Answer:

Yes.

Question 3:

Can you use the 50% CGT discount method in relation to any capital gain you make from the sale of Lot 3 to child A to the extent it relates to the interests you acquired under the Partition Agreement?

Answer:

No.

This ruling applies for the following periods:

20AA-BB income year

20CC-DD income year

The scheme commences on:

July 19YY

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You purchased a house before 19XX and it was used as a holiday house for most of this time. Title to the property was placed in your names and the names of child A and child B (your adult children).

From this time, the family grew and the time came to either sell it or to build a new house or units for each family member.

A surveyor was used to assess how many units could be built on the property.

It was originally considered appropriate to build three units on the property but after further family discussions it was decided to build four units.

The strategy behind this decision was that Lot 1 would be gifted to child A, Lot 2 would be gifted to child B and you would keep Lot 4.

Child A would buy Lot 3 from you and use it as an investment property.

A building permit was issued to build the units at an estimated cost of about $X,XXX,XXX.XX.

A building contract was signed and then building commenced.

It was intended that child A would make a contribution toward the funding of the costs of construction as this child was to end up owning Lot 3.

To that end, a contract to sell Lot 3 was signed some years ago with the GST on the margin scheme. Two joint owners are the vendors listed on the contract of sale. The sale price was calculated on the basis of the market value of the land plus the construction costs allocated to Lot 3.

This process was not successful in providing a source of funds as the financial institution refused to advance any funds until settlement of the contract was effected and this wasn't to occur until later on.

The occupancy permit for all of the units was issued some two years ago.

A Partition Agreement was signed by all parties shortly afterward to legally acknowledge the strategy mentioned above being that:

• The property was owned by the four of you as joint owners

• You wish to partition the property into four Lots

• Child A would take the Title to Lot 1

• Child B would take the Title to Lot 2

• Two joint owners would take the Titles to Lots 3 and 4

• No payments were to be made as a result of the partition.

The Title acknowledging subdivision of the land into allotments was issued a couple of weeks later.

Lot 3 was then transferred from the names of all four owners into your names as two joint owners.

Lot 3 was then transferred from your two joint names to child A with settlement of the sale of the property occurring before the end of the month.

Some elements of this strategy have been selected for the purpose of minimising certain charges that have been levied or might otherwise have been levied had the strategy been conducted differently.

You have not sought to maximise the potential sale price of Lot 3 because it was going to a family member. You would have conducted the strategy in a very different manner if you had intended selling Lot 3 to a member of the public.

Certain documents you provided are to be read with and form part of the scheme for the purpose of this ruling.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 6 and

Income Tax Assessment Act 1997 Part 3-1.

Reasons for decision

Question 1

Summary

Any profit you made from the sale of Lot 3 to child A is not treated as your ordinary income.

Detailed reasoning

Profits from the sale of real property are included in your assessable income as ordinary income if they represent profits from the carrying on of a business or they are a profit from an isolated transaction.

The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 which uses the following indicators to determine whether a taxpayer is carrying on a business: 

• whether the activity has a significant commercial purpose or character;

• whether there is repetition and regularity of the activity;

• whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

• whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

• the size, scale and permanency of the activity; and

• whether the activity is better described as a hobby, a form of recreation or a sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

A profit from an isolated transaction will be ordinary income where examination of the abovementioned factors would lead to the conclusion that a business was being conducted but there was no repetition to the activity.

Application to your situation

The arrangement in your case involves the demolition of the existing house and the construction of replacement units that more appropriately suit the members of the family as they are now.

The strategy that you adopted was intended to ensure that contributions to the construction of the replacement units reflected, in part a gift from you to your children and in part a contribution from child A as this child would ultimately be owning a greater share than previously. So while you were initially funding the cost of construction of the units, ultimately, child A was going to contribute for Lot 3.

The strategy also involved timing transfers between the family members so that certain charges that are ordinarily levied on such transfers were reduced or avoided.

You attempted to achieve these outcomes by arranging for child A to borrow funds before the construction commenced, but a problem arose that prevented this alternative from being successful.

Ultimately, you have adopted an alternate method to achieve the underlying strategy.

This is effectively a family arrangement and not an activity that was carried on for the purpose of making a profit. The Commissioner has reached this conclusion because the sale of Lot 3 to child A was a small component of a larger family restructure of the ownership of the property and because it didn't involve any sales to the general public.

Therefore, any profit you made from the sale of Lot 3 to child A is on capital account and not treated as your ordinary income.

Question 2

Summary

You can use the 50% CGT discount method in relation to any capital gain you make from the sale of Lot 3 to child A to the extent it relates to the interests you acquired before 19XX.

Detailed reasoning

In basic terms, the CGT provisions apply to the owner of a CGT asset when a CGT event happens to it. Where the CGT event involves the transfer of the CGT asset from a former owner (the vendor) to a new owner (the purchaser), the CGT provisions apply to the former owner.

The Assets - ownership of the property

The capital gains provisions apply when there is a change to the ownership of real property. When considering property transactions in Australia, the property law determines if there has been a change of ownership.

Legal ownership in Australia is determined by the name or names shown on the title to a property.

You have provided information that shows the legal ownership of Lot 3 changed as follows:

• From the purchase date, the property was owned by the four of you

• After the subdivision, Lot 3 was still owned by the four of you

• The Partition Agreement transferred Lot 3 to two joint owners

• Two joint owners then transferred Lot 3 to child A

It is important to note that the Partition Agreement (which transferred Lot 3 from four names to your two names) was processed before the contract (which transferred Lot 3 from your two names to child A).

The capital gains provisions apply separately to each co-owner and consider each owner to hold an independent asset. The capital gains provisions also treat interests in the one asset that are acquired at different times as separate assets.

Consequently, the four members of the family acquired four CGT assets before 19XX being four one-quarter interests in the property with a separate individual owning each one. The interests could be given the following references to describe their owners:

• Interest W owned by child A

• Interest X owned by rulee A

• Interest Y owned by rulee B and

• Interest Z owned by child B.

After the subdivision the property was split into four lots. The subdivision is not itself a CGT event as there is no change to the ownership. But it does increase the total number of assets. So, each Lot has four owners and the ownership interests can be described as follows:

• Lot 1 has Interests 1W, 1X, 1Y and 1Z

• Lot 2 has Interests 2W, 2X, 2Y and 2Z

• Lot 3 has Interests 3W, 3X, 3Y and 3Z

• Lot 4 has Interests 4W, 4X, 4Y and 4Z

The effect of processing the Partition Agreement was to change the ownership of each of the interests in the Lots as follows:

• Child A would give up Interests 2W, 3W and 4W and receive Interests 1X, 1Y and 1Z (giving child A all of the interests in Lot 1)

• Child B would give up Interests 1Z, 3Z and 4Z and receive Interests 2W, 2X and 2Y (giving child B all of the interests in Lot 2)

• Rulee A would give up Interests 1X and 2X and receive Interests 3WX, 3ZX, 4WX and 4ZX

• Rulee B would give up Interests 1Y and 2Y and receive Interests 3WY, 3ZY, 4WY and 4ZY

Using this method of description, each of Interests, 3WX, 3WY, 3ZX, 3ZY, 4WX, 4WY, 4ZX and 4ZY are one-eighth interests in either Lot 3 or Lot 4 that either rulee A (X) or rulee B (Y) have acquired from either child A (W) or child B (Z).

The effect of processing the contract was for rulee A and rulee B to transfer all of their interests in Lot 3 to child A.

How the capital gains provisions apply to Interests 3X and 3Y

While the property law determines if there has been a change of ownership of real property, the capital gains provisions determine how any capital gains or loss is worked out.

Specifically, the capital gains provisions state that the date of acquisition of a CGT asset and the time of a CGT event are when the relevant acquisition or disposal contract is entered into.

As mentioned above, the splitting of a CGT asset into smaller components without changing ownership is not a CGT event. Similarly, the splitting does not change the acquisition date of the new CGT assets.

Consequently, the interests in Lot 3 that two joint owners acquired before 19XX as joint owners of the whole property continue to have an acquisition date before 19XX for capital gains purposes.

The contract is a legally binding document and it has subsequently been acted upon. However, at that time, you only owned one-half of the interests in Lot 3 and it hadn't been subdivided from the other Lots.

However, this merely means that there were other steps that had to be completed before Interests 3X and 3Y could be transferred to child A.

Therefore, considering Interests 3X and 3Y, the CGT event happened when the contract was made and two joint owners acquired these interests before 19XX.

You can use the 50% CGT discount method in relation to any capital gain you make from the sale of Lot 3 to child A to the extent it relates to the interests you acquired before 19XX because you acquired these interests more than 12 months before the CGT event occurred.

Question 3

Summary

You can't use the 50% CGT discount method in relation to any capital gain you make from the sale of Lot 3 to child A to the extent it relates to the interests you acquired under the Partition Agreement.

Detailed reasoning

The contract is a legally binding document and it has subsequently been acted upon. However, at that time, you only owned one-half of the interests in Lot 3 and it hadn't been subdivided from the other Lots.

This question considers the interests in Lot 3 that two joint owners acquired under the Partition Agreement and didn't own when the contract was made. They are described above as Interests 3WX, 3WY, 3ZX and 3ZY.

While the contract is a legally binding document, it can't be a contract to sell assets that you don't own.

Consequently, the sale of Interests 3WX, 3WY, 3ZX and 3ZY can't occur (contract or settlement) until the transfer of these interests to two joint owners under the Partition Agreement is completed.

The Partition Agreement is the contract under which you have acquired Interests 3WX, 3WY, 3ZX and 3ZY from child A and child B.

Therefore, considering Interests 3WX, 3WY, 3ZX and 3ZY, the CGT event happened about two years ago and two joint owners acquired these interests in the preceding month.

You can't use the 50% CGT discount method in relation to any capital gain you make from the sale of Lot 3 to child A to the extent it relates to the interests you acquired under the Partition Agreement because you acquired these interests less than 12 months before the CGT event occurred.

Note: Both the acquisition and disposal of these interests has occurred under a family arrangement. Therefore, the market value substitution rule will apply to both transactions. It is unlikely that there will be a large capital gain due to the sale of these interests to child A as two joint owners only owned them for less than one month for capital gains purposes.