Edited version of private advice

Authorisation Number: 1051550563340

Date of advice: 22 July 2019

Ruling

Subject: Replacement asset CGT roll-over

Question 1

Is Company A as trustee for the B Trust (Coy A) entitled to obtain relief from capital gains tax (CGT) under subdivision 124-B of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the compulsory acquisition of the Property?

Answer

Yes

Question 2

Will expenditure on acquiring real property or properties for investment purposes constitute Coy A incurring "expenditure in acquiring another CGT asset" under paragraph 124-75(2)(a) of the ITAA 1997?

Answer

Yes

Question 3

Will expenditure on acquiring an interest in a commercial property (already owned by an entity within the wider group) qualify as Coy A incurring "expenditure in acquiring another CGT asset" under paragraph 124-75(2)(a) of the ITAA 1997 and satisfy the use test under section 124-75(4) of the ITAA 1997?

Answer

Yes

Question 4

Does Coy A have "special circumstances" under paragraph 124-75(3)(b) of the ITAA 1997, having regard to the director's situation, to obtain an extension of time up until 31 December 20xx from the Commissioner to incur "at least some of the expenditure"?

Answer

Yes

This ruling applies for the following period:

Years ended 30 June 20xx - 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Coy A is an Australian resident company that was incorporated in 199X.

Coy A is trustee of the B Trust.

Coy A is part of a wider group of companies. Members of the Group own residential, commercial and industrial real estate for the purposes of earning rental income.

Property Z:

Coy A owns Property Z. Coy A acquired this property in 199X for property investment purposes.

At the time of purchase, Property Z was leased to an unrelated service business, and has since been leased to other unrelated business until 20xx, with some minor developments made to the site over that time.

A portion of the Property was compulsorily acquired by a Government agency in 20xx, in order to widen a road along one side of Property Z.

Due to damage caused by neighbouring construction, the Property was unable to be leased for a few months in early 20xx.

Property Z is currently available and being marketed for lease.

Compulsory Acquisition:

A portion of Property Z was compulsorily acquired by a Government agency in 20xx.

The agency made an opening offer to acquire that portion of Property Z, which was significantly less than Coy A would accept.

Coy A and the agency subsequently engaged in protracted legal proceedings to dispute the compensation amount.

An initial instalment of compensation was paid in 20xx. This sum had been proposed by a 3^rd party as a suitable value for the acquisition. Coy A rejected that determination.

In 20xx the court ordered acquisition compensation of a significantly greater amount be paid to Coy A.

Coy A received the balance of compensation approximately x months later.

Replacement assets:

Coy A intends to acquire one or more replacement assets with all of the compensation proceeds. On this basis, no capital gain or loss was recognised in the trust's tax return for the 20xx income year.

Despite receiving the initial instalment compensation amount in 20xx, Coy A could not responsibly purchase any replacement assets due to the uncertainty of the ultimate decision, whether or not they would accept Coy A's position as to the value of the property, the compensation ultimately to be awarded, and whether there would be unknown costs and possible appeals.

Coy A has not yet finalised exactly which replacement asset(s) will be purchased at the time of making this application.

One possibility is to acquire one or more properties from unrelated parties for investment and development purposes. These properties will not be vacant land, but will have some form of existing commercial or industrial premises, from which Coy A will receive rental income.

Another option being considered is to acquire a part interest in a commercial property already owned within the Group. The purchase of this interest in this property would be conducted on arms-length terms.

Under the contemplated arrangement, Coy A would acquire a portion of the property so that it and the related entity would be tenants-in-common. The funds from Coy A's part-acquisition would enable necessary refurbishments to be made. Coy A and the related entity would share the rental income from the various third party tenants.

The director:

The director is a shareholder and director of Coy A. The director is responsible for the day to day management of each entity focussing on property investment within the Group.

The director is not the only director of Coy A, but is the guiding mind and the only person actively involved in the day to day management. S/he is the only director of Coy A that is suitably qualified and experienced to make the complex and substantial investments that Coy A undertakes in relation to its property investment business.

The director has a record of ill-health. This history has been provided to the Commissioner as part of the ruling application.

Now that the final amount of compensation has been determined and received, the Director intends to seek out replacement assets and plans to acquire them within the time frames expressed in this ruling (being no later than 31 December 20xx to incur at least some of the expenditure).

The director anticipates it will take a significant period of time to locate one or more suitable replacement assets on behalf of Coy A, satisfying the investment criteria, and his/her medical condition will also impact their ability to source those replacement assets.

Relevant legislative provisions

Subdivision 124-B of the Income Tax Assessment Act 1997

Section 124-70 of the Income Tax Assessment Act 1997

Section 124-75 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Subdivision 124-B of the ITAA 1997 contains a roll-over for when assets are compulsory acquired, lost or destroyed. Section 124-70 of the ITAA 1997 sets out the circumstances in which the roll-over relief may be available. You must make a positive choice to avail yourself of the roll-over.

Paragraph 124-70(1)(a) of the ITAA 1997 provides that you may be able to choose a roll-over if a CGT asset you own is compulsorily acquired by an Australian government agency.

For the purposes of subdivision124-B, "Australian government agency" takes its meaning from subsection 995-1(1) of the ITAA 1997:

(a) the Commonwealth, a state or a territory, or

(b) an authority of the Commonwealth or of a state or territory.

In FC of T v Bank of Western Australia Ltd, FC of T v State Bank of New South Wales Limited 96 ATC 4009,Hill J listed some of the relevant issues with determining whether an entity is a public authority. Hill J stated that for an entity to be an authority of a state or the Commonwealth, the entity must be an agency or instrument of government set up to exercise control or execute a function in the public interest. It must exist to achieve a government purpose. Hill J also stated the entity must perform a traditional or inalienable function of government and have governmental authority for doing so.

In this case, the property was compulsorily acquired in 20xx by a Government Agency.

Paragraph 124-70(2)(a) of the ITAA 1997 provides that the roll-over is only available if you receive either money or another CGT asset, or both, as compensation for the original asset being compulsorily acquired.

Coy A received money as compensation for the asset being compulsorily acquired.

Under subsection 124-75(3) of the ITAA 1997, the expenditure must be incurred within a period starting one year before the compulsory acquisition event and ending one year after the end of the income year in which the event occurred, or such further time as the Commissioner allows in special circumstances.

Under subsection 124-75(4) of the ITAA 1997, if you received money as compensation for the involuntary disposal of a CGT asset, you must incur expenditure to acquire another CGT asset (but not certain depreciating assets) to avail yourself of the roll-over. The replacement asset (or assets) must be used for a same or similar purpose as the compulsorily acquired asset.

Coy A has always intended to acquire a replacement asset (or assets) with the compensation money received from the compulsory acquisition. To that end they made a choice to apply the roll-over so that no capital gain or loss was recognised in the trust's tax return in the 20xx year of income.

Coy A is therefore entitled to obtain roll-over relief on the compulsory acquisition, subject to meeting further requirements within the Subdivision. The use of the replacement assets and the timing of the acquisition of the replacement property is discussed in more detail in the questions below.

Question 2

Taxation Determination TD 2000/42 Income tax: capital gains: what is the scope of the words 'use the other asset ... for the same purpose ... or for a similar purpose' in subsection 124-75(4) of the Income Tax Assessment Act 1997 in relation to a replacement asset? provides that whether an asset is used for the same or similar purposes as another asset is a question of fact and degree.

In this instance, Property Z was acquired for property investment purposes.

The property had a commercial business on it at the time of purchase, and has since had a number of other commercial businesses leasing the property. Coy A has regularly derived rental income from these businesses for the use of Property Z through lease agreements.

It is intended that any replacement property or properties would already be developed, at least to the extent of a commercial business or similar already on them, and Coy A will derive rental income from those properties. This means the use of any newly acquired property or properties to derive rental income is the same as the use of the compulsorily acquired Property.

Therefore, a property of this nature would satisfy the use test and constitute Coy A incurring expenditure in acquiring another CGT asset.

Paragraph 13 of Taxation Determination TD 2000/41 Income tax: capital gains: are the two requirements in subsection 124-75(4) of the Income Tax Assessment Act 1997 for a CGT asset acquired to replace an original asset alternative and mutually exclusive requirements? provides that there is no restriction on the number of CGT assets which may be treated as replacement assets for an original asset, provided that they each satisfy the requirements of Subdivision 124-B of the ITAA 1997.

This means that Coy A could acquire multiple properties to replace the compulsorily acquired land, provided that each property separately meets the "use" test, and at least some of the expenditure is incurred on each property no later than one year after the event, or further time as allowed (see question 4 below).

Question 3

As per Question 2, the replacement asset must be a property that is used for some form of commercial or business purpose, in such a way that Coy A derives rental income from the property.

There is no provision in the legislation that specifically prevents a replacement property, or a share of a property, being purchased from a related entity. The applicant has advised that the acquisition of a share in this property would be acquired from the related entity on arm's-length terms.

The property is already a commercial property and Coy A, along with the related entity, would refurbish the property and continue to share in the rental income that property earns.

This means the property does, and will continue to, serve the same purpose as the property which was compulsorily acquired.

This property would therefore meet the 'use' test as required by subsection 124-75(4) of the ITAA 1997.

It is important to note that the replacement asset would only be the purchase of the interest in the property. Any additional cost of refurbishments or fit outs to the building on that property cannot form part of the replacement asset in accordance with subsection 124-75(5).

Question 4

Subsection 124-75(3) of the ITAA 1997 requires that for you to avail yourself of the replacement-asset roll-over provided for in subdivision124-B of the ITAA 1997, you must incur expenditure in acquiring another CGT asset within a period starting one year before the compulsory acquisition and ending one year after the end of the income year in which the compulsory acquisition occurred.

However, in special circumstances, paragraph 124-75(3)(b) gives the Commissioner the discretion to allow further time after the end of the income year in which the compulsory acquisition occurred for the expenditure to be incurred.

Taxation Determination TD 2000/40 Income tax: capital gains: what are 'special circumstances' for the purposes of subsection 124-75(3) of the Income Tax Assessment Act 1997 sets out the Commissioner's views on what special circumstances are for the purposes of the replacement-asset roll-over in subdivision124-B.

TD 2000/40 provides that the expression 'special circumstances', by its nature, is incapable of a precise or exhaustive definition, and that what constitutes 'special circumstances' depends on the facts of each particular case.

Examples given in TD 2000/40 include ones where a taxpayer is subject to lengthy legal disputes, or delays in receiving compensation. This is applicable in this situation.

Property Z was compulsorily acquired in 20xx. However, the resolution of the legal process did not happen until 20xx, with final compensation not being received until just over 2 years after the compulsory acquisition.

This meant Coy A was not really able to proceed to look for a replacement asset or assets prior to that time due to the uncertainty of the compensation amount, and then the further delay in actually receiving that amount.

Also, during and since that time, the director has been battling with his/her extensive medical conditions. This has prevented the director from being able to devote the required time and effort required to locate suitable properties, and to negotiate a fair acquisition price for them.

The Commissioner accepts that locating and purchasing suitable properties can take significant time, effort and resources, and the director's ill health is a major factor that would see this process take even longer than might otherwise be considered acceptable for taxpayers who do not have such health issues.

For these reasons, the Commissioner accepts that Coy A has special circumstances to obtain an extension of time until 31 December 20xx to incur at least some of the expenditure to acquire a replacement asset or assets.