Edited version of your written advice

Authorisation Number: 1051359861634

Date of advice: 19 April 2018

Ruling

Subject: Capital gains tax

Question 1

Did you acquire the property before 20 September 1985?

Answer

No.

Question 2

Did you acquire a right to a 50% ownership interest in the property before 20 September 1985?

Answer

No.

Question 3

Does the money you paid to your relation in December 1985 form part of your cost base for the property?

Answer

No.

Question 4

Is the first element of your cost base for the property the market value at the time of acquisition?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2017

The scheme commenced on

1 July 2016

Relevant facts

Your relation (now deceased) owned a property.

In late 1980 you met in a family meeting with an accountant. The meeting was called by your relations to discuss the future arrangements regarding their assets. The Memorandum of Affairs, dated in 1980, was prepared by the accountant and outlined a plan that was being proposed by your relations.

The outcome of the family meeting was that some items 1-4 went ahead as proposed with the exception of an item which was modified.

Instead of buying the property from your relation, you and your sibling were to be jointly given the property.

A business financial report shows that in 1981 there was a liability for your relations to pay you money, and the business cashbook shows that in 1981 you were paid out an amount.

No specified time or event was included in the Memorandum of Affairs as to when the title of the property would actually transfer to you and your sibling.

In early 1985, there were family discussions.

Associated negotiations were very drawn out.

In late-1985 you paid an amount to your sibling.

After this, your relation instructed the lawyer to start the process of transferring title to the property into your name. The titles office record indicates the title to The Shack was registered in your name in mid-1986.

No money was paid to your relation as the property was gifted to you.

From early 1985, you were given full use, control and enjoyment of the property. From 1981 through to early 1985, you had shared in the use and benefit of the property with your sibling.

There is no evidence to show that you paid the rates or other property expenses before mid-1986.

You sold the property in 2017.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 102-25

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-15

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 108-05

Income Tax Assessment Act 1997 section 109-5

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 Subdivision 110-A

Reasons for decision

Capital gains tax provisions

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) states that a capital gain or capital loss is made only if a capital gains tax (CGT) event happens to a CGT asset. The Shack property is a CGT asset (section 108-5 of the ITAA 1997).

CGT event B1 – Use and enjoyment before title passes

CGT event B1 happens if you enter into an agreement with another entity under which the right to the use and enjoyment of a CGT asset you owns passes to the other entity and title in the asset will or may pass to the other entity at or before the end of the agreement (subsection 104-15(1) of the ITAA 1997).

CGT event B1 happens when the other entity first obtains the use and enjoyment of the asset (subsection 104-15(2) of the ITAA 1997).

If an asset is acquired as a result of CGT event B1 happening the asset is acquired when you first obtain the use and enjoyment of the asset (subsection 109-5(2) of the ITAA 1997).

Examples of a CGT event B1 include hire purchase agreements and instalment sale agreements.

The Commissioner considers that, in order for CGT event B1 to happen, the relevant agreement must be one under which title will or may pass at the end of a specific period or, on the occurrence of a specific event. CGT event B1 will not happen if, under a loose family arrangement, title to an asset may pass at an unspecified date in the future.

In your case, the Memorandum of Affairs did not specify a time or event for you and your sibling to purchase the property. As outlined above, these intentions subsequently changed. Although it is acknowledged that family discussions may have occurred in relation to the property in early 1985, there is no evidence to show that there was a binding agreement in place. Rather more a general family arrangement that could be changed depending on family circumstances.

The account of the subsequent family discussions indicates that the property was to pass to you, at an unspecified date in the future. Although the recollections specify events that were to occur before you became the sole owner of the property, these recollections differ to that outlined previously in the Memorandum of Affairs.

As the property arrangements changed from 1980 to early 1985, this indicates that any discussions were more a loose family arrangement rather than a relevant agreement.

You have sought to rely on the decision in McDonald v Federal Commissioner of Taxation [2001] FCA 305; (2001) 46 ATR 426; 2001 ATC 4146 (McDonald’s case). In that case, the taxpayers had made an oral offer on 13 September 1985 (pre-CGT) to purchase a property and the vendor accepted the offer. The vendor’s solicitors forwarded the contract of sale to the taxpayer on that day and wrote that no legal liability was to attach to either party until exchange had been affected. Exchange did not occur until 31 October 1985 (post-CGT) but the contract was dated 13 September 1985.

The outcome of that case, both at first instance, the decision on remittance and on appeal was that the first time at which a contract at common law was entered into was on 31 October 1985 when written contracts were exchanged. The Court was swayed by the convention in the law on the sale of land in NSW that no binding contracts existed until the exchange of contracts.

This convention could be overridden by the parties with mutual intention, but clear evidence of this intention had to be produced. In McDonald’s case, the evidence showed that the first time that the parties had reached a consensus with the intention to form legal relations occurred on exchange and the parties could not rewrite history by backdating the contract.

It was found that an oral agreement was insufficient to bind each of the parties to the agreement. It went on to specify that the procedure for exchange of contracts was so entrenched that a party contending for an intention to precede other than in accordance with established procedure, would need clear evidence to support that contention.

In particular, it was found on the facts of that case that the McDonalds would not have signed the written contract until all that they said needed to have been resolved had actually been resolved to their satisfaction.

Similarly, based on your description of the family discussions, the property was not to be transferred to you until such time that your relation was satisfied that the relevant conditions were satisfied. Consequently, you did not acquire the property until your relation was satisfied that you and your sibling had carried out these conditions. Therefore any verbal discussion that may have occurred between you and your relation was not sufficient to show that you acquired the property for CGT purposes before 20 September 1985.

Although you may have used the property for holidays for many years, there is no evidence to show that this use and enjoyment was as a result of a binding agreement between you and your relation. Rather such use was regarded as a private and family arrangement. There is no evidence to show that there was a mutual intention between you and your relation such that you had a legally binding agreement before June 1986 or that you had a legal or beneficial interest in the property before 20 September 1985.

It is not considered that the family discussions, where your sibling discussed ideas, constitute an agreement between your relation and you for CGT event B1 purposes. Therefore it is considered that CGT event B1 did not happen.

As CGT event B1 does not apply to your situation consideration needs to be given to CGT event A1, and whether you acquired the property under a (verbal) contract.

CGT event A1 – Disposal of a CGT asset

A capital gain or loss you make is disregarded if you acquired the asset before 20 September 1985 (paragraph 104-10(5)(a) of the ITAA 1997).

In general, you acquire a CGT asset when you become its owner (section 109-5 of the ITAA 1997).

When CGT event A1 happens, you acquire the CGT asset when the disposal contract is entered into, or if none, when the entity disposing of the asset stops being the asset’s owner (subsection 109-5(2) of the ITAA 1997).

A contract is a legally binding agreement between two parties. An expression of an intention to gift or donate property to another party does not give rise to a contract between the donor and the intended recipient(s).

A contract is required to have the attributes prescribed by common law for the formation of a contract. Generally, a binding contract is entered into where one party communicates unconditional acceptance of an offer made by the other party. In some cases difficulty may arise in determining at what point of time a binding contract is made. This is particularly so in the case of a contract that is wholly or partly oral.

An oral contract may be a contract, provided it has the attributes required by common law, for example, an intention by both parties to be bound by it.

A number of cases have considered the date when a contract was formed. In Gardiner v FC of T 2000 ATC 2018, the AAT held that a property was acquired when a taxpayer's offer was accepted by the vendor, not when the contracts were formally exchanged two months later. The formal correspondence of the offer and the acceptance of it constituted a contract for the acquisition of the property by the taxpayer.

It is relevant to understand the nature and effect of particular conditions of a contract. There is a clear difference between a condition which is precedent to the formation or existence of a contract (a 'condition precedent to formation of a contract') and a condition which is precedent to the obligation of a party to perform their part of the contract (a 'condition precedent to performance of a contract'). In the former case, non-fulfilment of the condition prevents a binding contract from coming into existence. No contractual rights enforceable by the parties are created unless and until the condition is fulfilled. In the latter case, a binding contract exists which creates rights capable of enforcement, though the obligation of a party to the contract (or perhaps of both parties) to perform their part of the contract depends on fulfilment of the condition. Non-fulfilment of the condition entitles one or both parties to terminate the contract.

The High Court of Australia considered the distinction between conditions precedent to the formation of a contract and conditions precedent to the performance of a contract in Meehan v Jones (1982) 149 CLR 571; 42 ALR 463. In that case, the High Court indicated that a contractual condition, such as obtaining approval for finance by the vendor, will not be a condition precedent to the formation of the contract but rather a condition precedent to the performance of the contract (or a condition subsequent), which in either case the contract is valid from the time the contract is made.

The High Court also made the distinction between:

● an agreement that provides one of the parties an unfettered discretion to conclude the contract (which will be a condition precedent to the formation of the contract), and

● an agreement that requires that if a particular condition is met the contract is concluded, which would be either a condition precedent to the performance of the contract or a condition subsequent.

The Commissioner’s view is that, without anything further, the Memorandum of Affairs or family discussions did not give rise to a contract at common law. That is, your relation had an unfettered discretion to decide whether or not to give the property solely to you and if you had satisfied the relevant conditions. These conditions are regarded as conditions precedent to the formation of any contract. Therefore, any discussions between you and your relation did not give rise to a contract at common law.

There is insufficient evidence to show that a mutual intention to enter into a legally binding relationship existed before 20 September 1985. No consideration for the property was made before 20 September 1985. Although matters in relation to the property were raised in the Memorandum of Affairs in 1980, the intention stated for this property did not go ahead and was later amended. There is no documentary evidence to support you and your sibling’s recollection of events in early 1985 or that a binding oral contract existed before 20 September 1985. The original plan as outlined in the Memorandum of Affairs later changed when your sibling questioned their future use of the property.

In your case, the absence of any contract between you and your relation has led to the conclusion that no binding and enforceable agreement or contract existed.

The family discussions and an expression of an intention to gift or donate the property to you did not give rise to a contract between your relation and you. Therefore, you did not acquire the property under a contract; rather, it was gifted to you.

A gift is complete if the donor has taken all steps necessary to enable the legal transfer of the asset to take place without any further action needed by the donor (Corin v Patton (1990) 169 CLR 540). In your case your relation had not done all to enable the transfer before 20 September 1985. That is, the instructions to the lawyer regarding the transfer were given after December 1985.

As there is no contract, it follows that you acquired the asset at the time when your relation stopped being the asset’s owner, that is, when the title to the property was transferred to you in mid-1986.

As you acquired the property after 20 September 1985 it is a post-CGT asset and any capital gain you make on its disposal will not be disregarded under the exception in paragraph 104-10(5)(a) of the ITAA 1997.

CGT event C2 – Cancellation, surrender and similar endings

Under subsection 104-25(1) of the ITAA 1997, CGT event C2 happens if your ownership of an intangible asset ends by the asset being:

● redeemed or cancelled,

● released, discharged or satisfied,

● expired, or

● abandoned, surrendered or forfeited.

The time of the event is when you enter into the contract that results in the asset ending, or if there is no contract when the asset ends.

An intangible asset is one that lacks a physical presence, for example a debt, a lease, a patent, a copyright or contractual rights.

It is not considered that your sibling had any rights or owned an intangible asset in relation to the property. The family discussions did not create any intangible or legal rights to the property. Therefore CGT event C2 did not happen.

Therefore you did not become the owner of any relevant CGT asset or 50% of the property before September 1985.

Cost base

Section 110-25 of the ITAA 1997 sets out the general rules about cost base. The cost base of a CGT asset consists of five elements.

The general rules may be modified if the market value substitution rule in section 112-20 of the ITAA 1997 applies.

The market value substitution rule generally applies where you did not deal at arm’s length with the other entity in connection with the acquisition.

It is considered you did not deal at arm’s length with your relation in connection with the acquisition as your relation gifted you the property. The market value substitution rule therefore applies.

Under subsection 112-20(1) of the ITAA 1997, the first element of the cost base or reduced cost base of a CGT asset that is acquired from another entity is its market value at the time of acquisition.

Accordingly, the first element of your cost base of the property is the market value of the property at the time of transfer and not the money paid to your sibling.