Edited version of your written advice

Authorisation Number: 1051373630342

Date of advice: 17 May 2018

Ruling

Subject: Capital gains tax

Question

Will your interest in the property be considered a pre-CGT asset if the unit trust surrenders the life interest to you at some point before your date of death?

Answer

No

Question 2

Will the lease payments to the lessor be included in your assessable income?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are the registered owner of a Property.

The Property was acquired prior to 20 September 1985. No major improvements have been made to the Property, and there is accordingly no post-CGT part of the Property.

The Property is currently leased to an independent third party (the lessee).

The self-managed superannuation fund

You have a regulated and complying self-managed superannuation fund (SMSF).

You are the single member of the SMSF. You are also the sole director and shareholder of the corporate trustee of the SMSF.

You are under 70 years of age.

The Unit Trust

You will establish a Unit Trust.

The corporate trustee of the SMSF will also be the trustee of the Unit Trust and you will be the initial unit holder.

The Unit Trust deed provides that units are deemed to be issued to any person immediately upon the grant of a life interest to the trustee. Persons who are unit holders are entitled to the capital of the trust in the same proportion as the number of units held by each unit holder.

The arrangement

Life interest and valuation

You will grant a legal life interest (life interest) in the Property to the Unit Trust to exclusively possess the Property for your lifetime by executing a deed and registering the interest on the title. The deed will specify that the life interest is a legal life interest. The life interest will be over the entire Property.

In 201X, a valuation of the life interest was obtained which showed the life interest represented XX% of the value of the Property. The remainder interest represents YY% of the value of the Property.

The unit trust will acquire the life interest from you in exchange for an amount equal to XX% of the value of the property. These units will be valued at $1 per unit. These units will be granted to you in accordance with the Unit Trust deed.

Units’ acquisition

The corporate trustee of the SMSF will then apply for ZZZ,ZZZZ units in the Unit Trust at a cost of $1 per unit.

You will apply for redemption of ZZZZ,ZZZZ of the units issued to you. The unit trust will pay you $ZZZ,ZZZZ in return for the redemption of these units.

The corporate trustee of the Unit Trust will resolve to issue the units to the SMSF and redeem the units as requested by you.

The life interest in the Property will be the sole asset of the Unit Trust. You will hold the remainder interest in the Property.

Lease assignment

You will either assign or novate the lease to the Unit Trust and the lessee will remain the same. The Unit Trust will become the lessor in respect of the lease. The lease will be assigned or novated on the same terms as currently exist. You will not be a party to the lease. You will not be entitled to any part of the lease payments.

Surrender of the life interest

It is intended that the life interest will be surrendered by the Unit Trust to you prior to your death.

On surrender of the life interest the right of exclusive possession of the Property will revert to you, as the owner of the estate in fee simple.

If the life interest and the remainder interest are not merged into one title, you will hold the right to exclusive possession of the Property as the owner of the life interest.

In either scenario the Unit Trust will cease to have an interest in the Property.

The surrender of the life interest has not been considered as part of this advice.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 100-35

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 109-5

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (Part IVA) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled.

You have advised us that you do not wish to seek advice in relation to Part IVA.

As such, we have not considered the application of Part IVA to the arrangement, or to an associated or wider arrangement of which that arrangement is part.

Further issues for you to consider – Trust and SMSF consequences

This ruling applies only to the consequences of this arrangement for you. It does not consider the consequences for the Unit Trust nor the SMSF. This ruling expresses no view on whether these arrangements comply with the Superannuation Industry (Supervision) Act 1993 (SISA) or any other act, regulation or ruling governing superannuation.

A separate application was made for SMSF specific advice. In that application (as detailed above) you also specifically advised us you do not wish to seek advice in relation to Part IVA. We note that advice was not able to draw a definitive view regarding the application of section 62 of the SISA as, in this instance, a proper consideration would also require an examination of Part IVA.

Reasons for decision

Capital Gains Tax (CGT) consequences of creating and surrendering a life interest

Legal life and remainder interests

Taxation Ruling TR 2006/14 (TR2006/14) provides guidance on the consequences of creating life and remainder interests in property.

The grant of a life interest in real property creates an estate which entitles the holder to possession of the real property for the lifetime of the life it is measured against. Paragraph 85 of TR 2006/14 specifically deals with legal life and remainder interests and states:

Bringing a legal life interest into existence involves a disposal of part of an existing CGT asset in a similar way to the disposal of a percentage interest in it. The part of the original asset that is not disposed of to the life interest owner is the legal remainder interest.

Legal life and remainder interests are carved out of the existing fee simple and not superimposed on it. Together legal life and remainder interests represent the entire freehold interest in the land.

Grant of legal life interest

Bringing a legal life interest into existence involves a disposal of part of an existing CGT asset in a similar way to the disposal of a percentage interest in it.

If an original owner of real property disposes of a legal life interest to another person CGT event A1 as per section 104-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) would happen. This is because there is a change of ownership of part of the original asset from the original owner to the life interest owner.

Whilst the creation of the legal life interest involves a disposal of part of the real property, the part of the real property that is not disposed of to the life interest owner is the legal remainder interest.

The life interest owner acquires their interest at the time CGT event A1 happens to the original owner under subsection 109-5(2) of the ITAA 1997.

Under section 100-35 of the ITAA 1997, the original owner makes a capital gain from the disposal if the capital proceeds from the event exceed the portion of the cost base of the original asset attributable to the carved out asset that becomes the life interest. They make a capital loss if the capital proceeds are less than that part of the reduced cost base of the original asset. That gain or loss is disregarded if the original property was acquired pre-CGT.

Surrender of legal life interest

Example 9 of TR 2006/14 stipulates that where the life interest owner surrenders the life interest to the remainder interest owner, CGT event A1 happens at the time they enter into the contract as per subsection 104-10(3). The life interest owner may make a capital gain or loss from the event happening. The remainder interest owner acquires the legal life interest at the time of surrender.

Where the remainder interest owner does not merge the life and remainder interests on the title to the property, they continue to own two assets: the legal life interest and the remainder interest. Any subsequent sale of the property triggers a CGT event A1 in respect of the disposal of the life interest and also in respect of the disposal of the remainder interest.

Application to your circumstances

CGT consequences of granting the life interest

You own the Property which was acquired prior to 20 September 1985.

You will grant a life interest in the Property to the Unit Trust in return for units to the value of the life interest.

The life interest is valued to be XX% of the market value of the Property.

By creating a life interest in the Property, you will dispose of XX% of your freehold interest in the Property. CGT event A1 will be taken to happen at the time of entering into the life interest deed. At that point, the life interest is a separate CGT asset that may be disposed of to a third party by the Unit Trust.

As your ownership interests in the property are pre-CGT, you can disregard any capital gain or capital loss that happens as a result of the creation of the life interest.

You will hold the remainder interest in the Property.

CGT consequences of surrendering the life interest

In this situation, the Unit Trust will surrender the life interest prior to the death of the life it is measured against (your life). Example 9 of TR 2006/14 addresses a similar scenario.

Where you, now being the remainder as well as the life interest owner, do not register a merger of the two interests on the title to the property, the life interest will remain a separate asset to the remainder interest. In this situation, only the remainder interest will retain its pre-CGT status. The life interest is a post-CGT asset.

However, where you register a merger of the remainder and legal life interests on the title to the Property, the life and remainder interests end as separate assets. The Property consists now of two parts: a post-CGT part (attributable to the surrendered life interest), and a pre-CGT part (attributable to the remainder interest). In this situation, the part of the property attributable to the life interest is a post-CGT asset, whilst the part of the property attributable to the remainder interest retains its pre-CGT status.

Income tax treatment of lease payments

Income

The grant of a life interest is different from a mere personal right to occupy a property for life. A right of occupancy does not carry with it a right to any income from the property. A life interest in an asset entitles the owner of that interest to any income from that asset.

As long as the life interest exists the owner of the remainder interest has no right to the income that is derived from possession or occupation of the property (e.g. payments from a lease).

Application to this your circumstances

The lessor in the new arrangement will be the Unit Trust. As you are no longer the lessor, you will have no right to the lease payments from the lessee. As such the lease payments will not be included in your assessable income.

This ruling does not affect the income tax treatment of distributions made to you by the Unit Trust.