Edited version of private advice

Authorisation Number: 1051664463468

Date of advice: 23 April 2020

Ruling

Subject: Capital gains tax - market value substitution rule - disposal

Question

Will the market value substitution rule in section 116-30 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the disposal of your interest in the dwelling?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2020.

The scheme commences on

1 July 2019.

Relevant facts

You and your spouse were married in 19xx and you have one child (A).

You and child A purchased a property for $X a number of years ago. (The property) Settlement occurred a short time later.

You and child A are registered on the title as tenants in common.

From settlement child A made various improvements to the property and was responsible for all utility costs.

Around 20XX the relationship between you and child A broke down and remains acrimonious.

You and spouse were divorced in 20xx.

On the xx 20xx you commenced legal proceedings to have a Trustee appointed for the sale of the property.

On xx 20xx child A filed a cross claim seeking additional contributions made by them to the property.

On the xx 20xx your former spouse commenced proceedings for an adjustment in relation to any claim of interest in the property and monies that you were entitled to in relation to the property.

On the xx 20xx a valuation was obtained which indicated that the value of the property was $X.

You and child A agreed to settle the proceedings and entered into a deed of settlement.

The deed of settlement is confidential and you have not provided a copy.

You received an amount as a settlement sum pursuant to the deed.

You transferred your interest in the property.

You made a capital gain upon disposal of the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 116-20

Income Tax Assessment Act 1997 Section 116-30

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Capital Proceeds - 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.

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."

However this will not be the case where the parties collude to achieve a particular result, or where one of the parties submits the exercise of its will to the discretion of the other. In such a case the lack of the exercise of an independent will in the formation of the transaction would indicate a lack of real bargaining.

In Collis v. FC of T 96 ATC 4831; (1996) 33 ATR 438 (Collis) the Federal Court found that the parties were not dealing at arm's length because one party was indifferent to the allocation of the sale price for the parcel of land. This indifference was indicative of a submission of one party's will to the other party's wishes which demonstrated a lack of arm's length dealing.

Application to your circumstances

In your case, you have obtained a market valuation which considers the value of the property as $X.

The transaction was not conducted at arm's length. The transaction was with a related party.

Each party was legally represented. The parties have entered into a deed which is confidential.

You did not receive the market value for the property and instead agreed to receive a settlement sum.

In these circumstances you are considered to have received the asset's 'market value' at the time of disposal. It is not an outcome of a normal bargaining process as discussed in Granby and Collis.

In your case, even if the parties were at arm's length, the parties did not deal with each other at arm's length.