Edited version of private advice

Authorisation Number: 1051591687407

Date of advice: 13 February 2020

Ruling

Subject: Capital gains tax

Question 1

Are you fully exempt from paying capital gains tax on the disposal of your ownership interest in the property which you inherited from your parent?

Answer

No

Question 2

Were you and your sibling dealing at arm's length when you were selling your 50% ownership in the property?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

Three siblings (including your parent) inherited the property from their parent in the early 1980's.

At that time, it was a substantially larger parcel of land and included a house circa 1900.

After subdivision and sales by the three siblings, your parent retained the property now comprised of a block of land measuring X hectare and the house situated on that block.

Your parent was the sole owner of this property.

Your parent's ownership interest in this property commenced before 20 September 1985.

The house (House #1) was the main residence of your parents.

In 1985, a second house (House #2) was built on the southern area of the property and became the main residence of your sibling.

Construction on House #2 commenced before 20 September 1985.

Your parents have never received rental income for House #2.

Your parent passed away in the early 2000's.

Your other parent was the sole beneficiary of your parent's estate.

Your other parent continued to live in House #1 until they passed away.

Your other parent died in 2018.

Probate was granted that same year.

You and your sibling are the executors and trustees of your other parent's will.

A valuation report for the property was prepared.

The valuation date is the date of inspection being XX XXXX 2018.

Specific instructions in the valuation report were:

We have been specifically requested to provide two (2) separate values, one being the value of the whole property and the second to value the property excluding/minus the 1985 built dwelling.

House #1, your other parents' main residence, remained vacant between the date of their death and date of settlement.

Your sibling paid you $Y being 50% of the property excluding the main dwelling (House #2) and including the original dwelling (House #1) which was your other parent's main residence. This negotiated amount between you and your brother was to satisfy the terms of your other parent's will. That is, House #2 (which your sibling lived in) was excised from the value of the entire property and the remaining value was split between you and your sibling.

Settlement occurred in 2018.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 128-20

Income Tax Assessment Act 1997 section 118-195

Reasons for decision

Summary

You are not entitled to disregard in full the capital gain made from the transfer of disposal of your ownership interest in the property which you inherited from your parent under section 118-195 of the Income Tax Assessment Act 1997 (ITAA 1997). You will be entitled to disregard the capital gain to the extent that it relates to your other parent's dwelling (House #1).

You will be considered to be acting at arm's length in the transaction between you and your sibling.

CGT and deceased estates

Section 128-20 of the ITAA 1997 explains that where a taxpayer dies, there are no CGT implications where an asset passes to the legal personal representative or beneficiary but CGT may apply when the asset is subsequently disposed of.

Subsection 118-195(1) of the ITAA 1997 allows a beneficiary of a deceased estate to disregard a capital gain or loss from a dwelling if:

·         the property was acquired by the deceased on or after 20 September 1985 and the dwelling was the deceased's main residence just before the deceased's death and;

·         was not then being used for the purpose of producing assessable income, and;

·         your ownership interest ends within 2 years of the deceased's death (the Commissioner has discretion to extend this period in certain circumstances).

Where a dwelling that was acquired post CGT and:

·         was the deceased's main residence just before their death and;

·         was not being used to produce assessable income,

passes to a beneficiary the beneficiary will acquire the dwelling for its market value at the date of death.

Where a dwelling was acquired before 20 September 1985 (pre CGT), the beneficiary will acquire the dwelling for its market value at the date of death.

Assets that were acquired post CGT pass to beneficiaries for the cost base at the date of the deceased's acquisition.

Application of the law to your circumstances

In your case, your other parent's estate consisted of X hectare of land with two dwellings. The original dwelling circa 1900 (House #1) was your other parent's main residence from the time title passed to them as the sole beneficiary of your parent's will on XX XXXX 2000 until the date of their death on XX XXXX 2018.

A second dwelling (House #2) was constructed on the southern part of the property in 1985. This house has been occupied by your sibling from that time. No rental income has been paid.

As your parent acquired their interest in the properties before 20 September 1985 (pre-CGT), your other parent was taken to have acquired their interest in the entire property for its market value at the date of your parent's death.

You and your sibling inherited equal shares in your other parent's estate as tenants in common, excluding an amount equal to the amount by which the value of the property has increased by the erection of House #2 as per the terms of your other parent's will.

A valuation report for the property was prepared which set the total property valuation with both dwellings was $X. The value of the property excluding the value of House #2 was $Y to be shared equally between you and your sibling.

Your one half ownership interest in the property including your other parent's main residence (House #1) was acquired on the date of your other parent's death.

In this case, both properties were acquired by your other parent after 20 September 1985. Therefore you will acquire your other parent's dwelling for its market value at the date of their passing, and your siblings dwelling for its cost base upon your other parent inheriting it.

In the present circumstances you have effectively inherited two properties of which only one is your other parent's main residence.

The Estate has transferred 50% ownership of the whole property to you. You then transferred half of the whole property to your brother for $X which represents 50% of the valuation of your other parent's dwelling. Therefore, you have effectively disposed of two dwellings, of which only one is exempt.

Therefore you cannot disregard your capital gain in its entirety under section 118-195 as House #2 was not your other parent's main residence.

Taxation Determination TD 1999/69

In certain circumstances two units of accommodation that are used together can be considered one place of residence or one 'dwelling' (Taxation Ruling TD 1999/69: Income tax: capital gains: can the term 'dwelling' as defined in section 118-195 of the Income Tax Assessment Act 1997 include more than one unit of accommodation?). However, in this circumstance you have stated that both your other parent and sibling treated each unit of accommodation as separate residences. Therefore, this extension to the meaning of dwelling cannot apply in this case.

Calculation of Capital Gain or loss

How you calculate your capital gain is dependent on whether you were acting at arm's length in the transaction with your brother. This is because if you were not, the market value substitution rule could apply.

Market value substitution rule

Subsection 116-30(2) of the ITAA 1997 states that the capital proceeds from a CGT event are replaced with the market value of the asset where:

·         those capital proceeds are more or less than the market value of the asset and:

·         you and the entity that acquired the asset from you did not deal with each other at arm ' s length in connection with the event.

Arm's length Transaction

Section 995-1 of the ITAA 1997 defines 'arm's length' as:

in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

Whether parties have dealt at arm's length is a question of fact that must be determined in any particular case. The law looks at not only the relationship between the parties but also the quality of the bargaining between them.

An individual is said to be dealing at arm's length with someone if each party acts independently and neither party exercises influence or control over the other in connection with the transaction.

Parties are not at arm's length where the parties are related or associated in some way so that while each party may enter a transaction with some self interest in mind, it may also take into consideration the interests of the other party in making the agreement. Examples of such relationships are transactions between family members and related corporations.

Where parties are not at arm's length it is still possible for the parties to deal at arm's length in relation to a specific transaction. As stated by Davies J. in Barnsdall v Federal Commissioner of Taxation (1988) ATC 4565, 4568:

"The Commissioner is required to be satisfied not merely of a connection between a taxpayer and a person to whom the taxpayer transferred, but also of the fact that they were not dealing with each other at arm's length. A finding as to a connection between the parties is simply a step in the course of reasoning and will not be determinative unless it leads to the ultimate conclusion."

Parties will be dealing at arm's length where they act as arm's length parties would normally do, so that their dealing has an outcome that is the result of normal bargaining (The Trustee for the Estate of the late A W Furse No 5 Will Trust v. FC of T 91 ATC 4007; (1990) 21 ATR 1123 and Granby Pty Ltd v. FC of T 95 ATC 4240; (1995) 30 ATR 400 (Granby)).

In Granby at ATC 4243; ATR 403 Lee J stated that the provision 'dealing with each other at arm's length' invited an analysis of the manner in which the parties conduct themselves in forming the transaction. The question is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs and the expression means, at least, that the parties have acted severally and independently in forming their bargain.

Further, Lee J stated (at ATC 4244; ATR 403-404) that:

"If the parties to the transaction are at arm's length it will follow, usually, that the parties will have dealt with each other at arm's length. That is, the separate minds and wills of the parties will be applied to the bargaining process whatever the outcome of the bargain may be."

In this case, both you and your sibling engaged an independent certified valuer.

You and your sibling took the valuation report at face value and arrived at the consideration of $X as being 50% of the market value of the property less the value of House #2 as per the terms of your other parent's will.

Two independent parties would have behaved the same way and arrived at the same amounts in an arm's length transaction. The parties in this case will be treated as entering into an arm's length transaction and therefore the market value substitution rule will not apply in this case.