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Edited version of private advice
Authorisation Number: 1051541912895
Date of advice: 05 July 2019
Ruling
Subject: Capital gains tax
Question
Will capital gains tax (CGT) event D2 happen on the signing of the Option Deed?
Answer
No.
This ruling applies for the following periods
Year ended 30 June 20XX
Year ending 30 June 20XX
The scheme commenced on
1 July 20XX
Relevant facts
You own assets including some business assets.
You no longer have an active role in the businesses which are carried on with certain close relatives (the grantees under the Option Deed).
Previously, you undertook that you would leave your interest in the businesses at the date of your death to the grantees under your will.
You want to ensure that your wishes and the undertakings you have given to the grantees cannot be defeated as a consequence of a challenge to your wills.
To avoid this risk, you propose to grant options to the grantees to purchase your interest in the businesses subject to the terms of the draft Option Deed.
The Option Deed is personal to the grantees (that is, the option cannot be assigned by the grantees) and it states that it will be subject to the conditions precedent that the grantor must have died; and
¢the business interests are not left to the grantees under the will of the deceased grantor; or
¢the business interests are left to the grantees under the grantor's will but there is a dispute in relation to the estate prior to the first anniversary of the date of death of the relevant grantor.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 102-20
Income Tax Assessment Act 1997 section 104-40
Income Tax Assessment Act 1997 section 108-5
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. An option is a CGT asset (section 108-5 of the ITAA 1997).
CGT event D2 - Granting an option
Under subsection 104-40(1) of the ITAA 1997, CGT event D2 happens if you grant an option to an entity, or renew or extend an option you had granted.
The time of the event is when you grant, renew or extend the option.
As outlined in ATO Interpretative Decision ATO ID 2003/1190 Income Tax Capital gains tax: business succession agreement - put and call options - CGT event D2 a call option gives a person the right to acquire an asset from the person granting the right at some specified time and usually at a predetermined price.
ATO ID 2003/1190 further explains that the granting of options may not occur at the time of entering into the agreement if there is a specified condition in the agreement that is yet to occur. For example, where it was necessary for the death or disability of a major shareholder to occur before the remaining major shareholders obtained legally enforceable options, then the buy-sell agreement is a contract with a condition precedent and cannot proceed until that condition is fulfilled. It is necessary to distinguish between a condition precedent to the performance of the contract and a condition precedent to the formation of the contract as this determines the timing of the CGT event D2 and the subsequent transfer of the shares.
Therefore where it is evident from the terms of an agreement that the parties intend the arrangement to come into effect only at the time of the death or disablement of one of the asset holders, this will be a condition precedent to the formation of the option contract. It therefore follows that the CGT event D2 will not occur at the time the buy-sell agreement is executed. The CGT event D2 will happen when one of the asset holders die or becomes permanently disabled.
Application to your circumstances
In this case, the call option will not come into effect and be legally enforceable until the death of the grantor and the other condition precedent occurs.
We consider the circumstances to be similar to those outlined in ATO ID 2003/1190. Therefore, CGT event D2 will not occur at the time the Option Deed is entered into.
It follows that CGT event D2 will occur when the grantor passes away and the other condition precedent occurs. This may create a CGT liability for the deceased estate.