Edited version of private advice

Authorisation Number: 1051626649906

Date of advice: 17 February 2020

Ruling

Subject: Capital gains tax

Question 1

Does the market value substitution rule apply to the transfer of the property in 200X?

Answer

Yes

Question 2

Was a CGT event triggered in 20XX when your parent passed away?

Answer

Yes

Question 3

Did CGT event A1 occur when the life interest was surrendered in 2019?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2020

The scheme commenced on:

1 July 2019

Relevant facts and circumstances

The property was purchased in 19XX by your parents as joint tenants.

Parent A passed away in 19XX and the property passed to parent B under the joint tenancy rules.

In 200X parent B transferred the property into your and your siblings names as per Parent A's wishes if they were to remarry.

No money changed hands at the time of the transfer of the property.

As part of the transfer to you and your sibling consideration was to grant a life interest to parent B and step parent for parent B to remain living in the property until they died and for your step parent to remain living in the property until they remarried.

Your step parent surrendered the life interest in the property in 2019.

No money was given for the surrender of the life interest by your step-parent.

The property was sold in 20XX.

Relevant legislative provisions

Income Tax Assessment Act1997 Section 102-20

Income Tax Assessment Act1997 Section 104-20

Income Tax Assessment Act1997 Section 116-20

Income Tax Assessment Act1997 Section 116-30

Income Tax Assessment Act1997 Section 128-10

Income Tax Assessment Act1997 Section 995-1

Reasons for decision

Question 1

Market Value Substitution Rule

Section 116-30 of the ITAA 1997 operates so that you are taken to have received the market value of the CGT asset in certain situations.

On the surrender of a life interest, the life interest owner is taken to have received the market value of the interest if:

a)     no capital proceeds are received for the surrender, or

b)     some or all of the capital proceeds from a CGT event cannot be valued; or

c)     the capital proceeds are more or less than the market value of the asset and the parties engaged in a non-arm's length dealing in connection with the CGT event; or

d)     the capital proceeds are more or less than the market value of the asset and the CGT event is a C2 event.

Section 116-20 of the ITAA 1997 provides that capital proceeds from a CGT event are the total of:

a)     the money you have received, or are entitled to receive, in respect of the event happening; and

b)     the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

Section 995-1 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.

Application to your circumstances

The property was transferred in 200X to you and your sibling with no money changing hands. Life interests were granted to Parent B and step-parent by way of an agreement. The market value substitution rule under subsection 116-30(1) of the ITAA 1997 applies for you to use the asset's 'market value' when calculating the capital proceeds for the purposes of working out the capital gain.

The transaction was with a related party, being your parents and no consideration by way of money changed hands when the transaction occurred in 200X. Therefore it will be considered to be a non-arm's length transaction and the market value substitution rule will apply.

Question 2

On the death of the life interest owner, CGT event C1 in section 104-20 happens. The Commissioner does not consider that CGT event C2 happens in this case because the legal life interest is not an intangible asset. If the life interest owner makes a capital gain or capital loss from CGT event C1 happening, it is disregarded under section 128-10.

The death of the life interest owner has no CGT consequences for the remainder owner. The remainder owner does not acquire any asset from the life interest owner; their existing interest is merely enlarged. Consequently, no additional amount can be included in the first element of the cost base of the remainder owner's asset (now a fee simple interest unencumbered by the life interest).

Question 3

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) states that you can make a capital gain or a capital loss if and only if a CGT event happens to a CGT asset. A CGT asset can be a life interest and a CGT event can be the creation or termination of that life interest.

You make a capital gain if the capital proceeds from the surrender are more than the assets cost base. Alternatively, you make a capital loss if the capital proceeds from the surrender are less than the reduced cost base.

Paragraph 66 of Taxation Ruling 2006/14 Income tax: capital gains tax: consequences of creating life and remainder interests in property and of later events affecting those interests states:

If a life interest or remainder owner surrenders or releases their interest, CGT event A1 (in section 104-10 of the ITAA 1997) rather than CGT event C2 (in section 104-25 of the ITAA 1997) happens. The Commissioner considers that CGT event A1 is the applicable event, as there is a change of ownership of the interest from one party to the other, rather than a mere ending of it.

CGT event A1 occurred when your step-parent surrendered their life interest in the property in 2019.