Edited version of your written advice

Authorisation Number: 1051464127196

Date of advice: 13 December 2018

Ruling

Subject: Capital proceeds - capital gains tax event A1

Question 1

Will the money received by X Pty Ltd on the settlement date in relation to the capital gains tax (CGT) event A1 under section 104-10 of the Income Tax Assessment Act 1997 (ITAA1997) be declared in the year the settlement took place?

Answer

No

Question 2

Will the retained amount for bad debt and others that will be receive by X Pty Ltd in the year of settlement in relation to the same CGT event be declared in the year of settlement?

Answer

No

Question 3

Will an encumbrance retention amount to be received by X Pty Ltd in relation to the same CGT event be declared in the year the case is settled or in any of the next three years from the year of settlement?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20xx to 20xx

The scheme commences on:

November 20xx

Relevant facts and circumstances

You, X Pty Ltd, conducted a business (the business) from a certain premises.

You entered into a contract with Y Pty Ltd to sell the business.

The contract was entered into in November 20xx (the year of contract). The contract was extended for due diligence in excess of 10 times with several occasions outside of time or date lapsing.

The contract was settled after two years on xx July 20xx (the year of settlement).

On the date of settlement you received part of the purchase price including the retained amount in relation to employee entitlement. Certain amount of the purchase price was retained in relation to two headings, one of which was in relation to bad debt and the other in relation to an ongoing legal proceeding.

You account on cash basis.

You state in your application that you intend to declare:

● the money received on the cessation of the business in the year of settlement

● the retained sum for bad date in the year it was received which happened to be in the year of settlement

● the caveat retention sum in the year the legal proceeding is settled or in any of the next three years but not beyond three years from the year of settlement.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 170

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 116-45

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless specified otherwise.

Question 1

Summary

The money you received in relation to the CGT event will be declared in the year the contract was entered into.

Detailed reasoning

Under subsection 104-10(1), a CGT event happens if you dispose of a CGT asset.

The time of the event, under subsection 104-10(3), is when you enter into the contract for the disposal or if there is no contract – when the change of ownership occurs.

A CGT asset is, as per subsection 108-5(1), any kind of property or a legal or equitable right that is not a property.

In your case, you disposed of your CGT asset, namely, your business and related assets, when you entered into the contract with Y Pty Ltd.

There is a capital gain if the capital proceeds from the disposal are more than the asset’s cost base. A capital loss is made if those capital proceeds are less than the asset’s cost base.

Capital proceeds from a CGT event are the total of the money a taxpayer receives or are entitled to receive in respect of the event happening (subsection 116-20(1)).

In your case, capital proceeds from the sale of your business includes all payments that you have received at the time of settlement as well as those that you are entitled to receive at a later date, i.e., the retrained sum for bad debt and the encumbrance amount.

According to paragraph 1 of Taxation Determination TD 94/89 Income tax: capital gains: in what year of income is a taxpayer required for tax purposes to include a capital gain or loss in relation to land disposed of under a contract which is made in one year of income, but which is settled in a later year of income? (TD 94/89):

Where the contract is settled in a later year of income, a taxpayer is required to include a capital gain or loss in the year of income in which the contract is made, not in the year of income in which the contract is settled.

TD 94/89 reflects the example given in subsection 104-10(3) as follows:

In June 1999 you enter into a contract to sell land. The contract is settled in October 1999. You make a capital gain of $50,000.

The gain is made in the 1998-99 income year (the year you entered into the contract) and not the 1999-2000 income year (the year that settlement takes place).

Accordingly, even though the settlement in your case took place in a different year from the year of contract, you are required to include the capital gain, if any, in the year you entered into the contract.

If you have already lodged the ITR for the year of contract, you need to request for an amendment.

Question 2

Summary

The retained amount for bad debt and others that you will receive in relation to the same CGT event in a year other than the year of contract will be declared in the year of contract.

Question 3

Summary

The encumbrance retention sum that you will receive in relation to the same CGT event once the case is settled will be declared in the year of contract.

Detailed reasons for questions 2 and 3

The retention amounts are part of the capital proceeds that you are entitled to receive in relation to the same CGT event. Therefore, based on the same legal reasons as stated in question 1 above, these amounts are required to be included in your ITR for the year you entered into the contract.

If for some reason you do not receive the total retained amount, the modification rule in section 116-45 will come in play. Subsection 116-45(1) states that

The capital proceeds from a CGT event are reduced if:

(a) you are not likely to receive some or all (the unpaid amount ) of those proceeds; and

(b) this is not because of anything you (or your associate) have done or omitted to do; and

(c) you took all reasonable steps to get the unpaid amount paid.

The capital proceeds are reduced by the unpaid amount.

ATO Interpretative Decision ATO ID 2003/635 Income Tax CGT: Capital proceeds payable by instalments - not all received - no reduction of capital proceeds received illustrates how the actions of a taxpayer can preclude the application of the non-receipt rule under (a) above. The taxpayer originally sold an asset to an unrelated purchaser under a contract that required the purchase price to be paid in 10 annual instalments. Interests was payable on late instalments, but the contract also allowed for a discount to apply if the purchaser paid out the contract early. About six years into the instalment plan (after the early payment discount period had expired), the taxpayer initiated negotiations with the purchaser which resulted in the payment of an amount in full settlement of the contract. The amount agreed on was less than the amount the vendor was entitled to, and also less than the amount that would have applied if the discount had been obtained.

Therefore, if you and your associates have done all to recover the remainder of the capital proceeds or have not done or omitted to do something that led to you not receiving those amounts, you would be able to reduce the capital proceeds by the amount that you have not received.

Although under section 170 of the Income Tax Assessment Act 1936 (ITAA 1936) there are time limits within which a taxpayer is required to make amendment to their tax returns, there are certain exceptions to this rule. One such exception is the modification of capital proceeds for non-receipt as stated in section 116-45 (see table item 80 of subsection 170(10AA) of the ITAA 1936).

Therefore, if you do not receive the entire retained amounts, which as per paragraph 116-20(10)(a) you “are entitled to receive”, section 170 of the ITAA 936 will not prevent you from amending the ITR to reduce the net capital gain.