Edited version of private advice

Authorisation Number: 1051844500124

Date of advice: 31 May 2021

Ruling

Subject: CGT: pre-CGT status and exemption

Question 1

Is a property held by Company X a pre-CGT asset under section 149-10 of the Income Tax Assessment Act 1997?

Answer

No

Question 2

Does section 118-12 of the Income Tax Assessment Act 1997 operate to disregard any capital gains or losses made from the disposal of a property held by Company X?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2021

Year ending 30 June 2022

The scheme commences on:

1 MM 19XX

Relevant facts and circumstances

Company X is a not for profit entity established to provide specific services for its members. This includes the use of properties owned by Company X.

Company X is not an income tax exempt entity under Division 50 of the Income Tax Assessment Act 1997 (ITAA 1997).

Company X acquired a property ('Property') as an unincorporated association prior to the introduction of Capital Gains Tax (prior to 20 September 1985).

Effective 1st MM 19XX (date after 20 September 1985), Company X was incorporated under Associations Incorporation Act 1984 (NSW) (AIA).

Company X is actively investigating the sale of the Property to non-members/third parties.

The Property is yet to be sold and an auction date is currently being set.

The Property is leased to members of Company X who pay a discounted rate for the period they stay.

Company X is governed by its constitution called the Rules. The Rules of Company X includes the following:

• the objects of Company X are to provide certain activities for its Members. This can include the use of properties as is owned by Company X at the time of incorporation or is subsequently acquired.
• different categories of members
• how Company X will derive its funds in pursuance of the objects of Company X
• winding up clause - upon winding up or cancellation of the incorporation of Company X, the remaining assets are to be disposed of in accordance with the AIA, specifically section 53 of the AIA.

•         an extract of section 53 of the AIA is attached to the Rules. That section prevents distributions to be made to any member unless that member is an association whose constitution prohibits distributions to its members (this requirement is replicated in section 65 of the Associations Incorporation Act 2009).

Relevant legislative provisions

Income Tax Assessment Act section 59-35

Income Tax Assessment Act section 118-12

Income Tax Assessment Act section 104-10

Income Tax Assessment Act subparagraph 118-12(a)(ia)

Income Tax Assessment Act section 149-10

Associations Incorporation Act 1984 (NSW) section 53

Associations Incorporation Act 2009 (NSW) section 65

Reasons for decision

Summary

Company X incorporated on 1 December 1989. Upon incorporation under the Associations Incorporation Act 1984 (NSW) (AIA),there was a disposal of the pre-CGT Property from the unincorporated association to the incorporated association. The Property held by Company X after incorporation is not a pre-CGT asset under section 149-10 of the ITAA 1997.

Detailed reasoning

Under section 149-10 of the Income Tax Assessment Act 1997 (ITAA 1997) a CGT asset that an entity owns is a pre-CGT asset if the entity last acquired the asset before 20 September 1985.

Section 149-10 of the ITAA 1997 states:

149-10 What is a pre-CGT asset?

A *CGT asset that an entity owns is a pre-CGT asset if, and only if:

(a)  the entity last acquired the asset before 20 September 1985; and

(b)  the entity was not, immediately before the start of the 1998-99 income year, taken under:

                            (i)        former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or

                           (ii)        Subdivision C of Division 20 of former Part IIIA of that Act;

to have acquired the asset on or after 20 September 1985; and

(c)   the asset has not stopped being a pre-CGT asset of the entity because of this Division.

In the present case, the Property was acquired by Company X when it was an unincorporated association prior to 20 September 1985.

Company X incorporated on 1 December 1989 under the AIA. The AIAis the predecessor of Association Incorporation Act 2009 (NSW).

In ATO Interpretive Decision ATO ID 2002/808 Income Tax Capital gains tax: conversion from unincorporated association to incorporated association under Associations Incorporation Act 1981 (Qld) (ATO ID 2002/808), the Commissioner considered if there is a change of ownership of the asset upon an unincorporated association converting into an incorporated association under the Associations Incorporation Act 1981 (Qld) (AIA (QLD)).

ATO ID 2002/808 considers the case of Kibby v. Registrar of Titles and Another [1999]1VR 861 and explains:

An unincorporated association has no separate or distinct existence apart from its members. It is a voluntary combination of persons with some object or purpose in common (see Kibby v. Registrar of Titles and Another [1999]1VR 861; [1998] VSC148). Hence, an unincorporated association is not an entity at general law.

In respect to the incorporation process it explains:

The legislation under which incorporation is effected (the AIA (QLD)) does not provide for the continuation of the same legal entity. These provisions merely provide for registration of the association (section 14 of the AIA (QLD)) and set out the effects of incorporation (sections 22,23 and 24 of the AIA (QLD))....

....

Therefore, as the incorporated association is not the same entity as the unincorporated association and there is a change in ownership of the assets upon incorporation, CGT event A1 (section 104-10 of the ITAA 1997) will happen to the assets of the unincorporated association on the conversion to an incorporated association.

ATO ID 2002/808 concludes that an unincorporated entity and the later incorporated association are not the same company.

In the present case, Company X was incorporated under the AIA. The AIAis now the predecessor of the Associations Incorporation Act 2009.

The relevant Act under consideration in ATO ID 2002/808 was the AIA(QLD). However, the content of the Association Incorporation Act 2009 (NSW) (and the predecessor AIA) provisions are consistent with the provisions in the Queensland Act outlined in ATO ID 2002/808.

Therefore, in this case when Company X incorporated on 1 MM 19XX a new legal entity was formed. There was a disposal of the Property from the unincorporated association to the incorporated association at the time of incorporation by Company X.

When applying section 149-10 of the ITAA 1997, the time of incorporation is after the introduction of CGT on 20 September 1985. The Property held by Company X is not a pre-CGT asset under section 149-10 of the ITAA 1997, having been acquired by Company X after the introduction of CGT.

Conclusion

As Company X was incorporated after 20 September 1985, upon incorporation, there was a disposal of the pre-CGT Property from the unincorporated association to the incorporated association. The Property held by Company X after incorporation is not a pre-CGT asset under section 149-10 of the ITAA 1997.

Question 2

Summary

Section 118-12 of the ITAA 1997 does not operate to disregard any capital gains or losses arising out of the sale of the Property held by Company X.

Detailed reasoning

Under section 118-12 of the ITAA 1997, a capital gain or capital loss you make from a CGT asset that was used solely to produce exempt income or non-assessable non-exempt income (NANE) is disregarded.

Section 118-12 of the ITAA 1997 states:

Section 118-12 Assets used to produce exempt income etc.

118-12(1)

A *capital gain or *capital loss you make from a *CGT asset that you used solely to produce your *exempt income or *non-assessable non-exempt income is disregarded.

118-12(2)

However, the exemption does not apply if the asset was used to gain or produce an amount that is *non-assessable non-exempt income because of:

(a)  any of these provisions of this Act:

......

(ia) section 59-35 (amounts that would be mutual receipts but for prohibition on distributions to members or issue of MCIs);

However, under subparagraph 118-12(2)(ia) of the ITAA 1997, the exemption does not apply if the asset was used to gain or produce an amount that is NANE because the requirements of section 59-35 of the ITAA 1997 are met.

Section 59-35 of the ITAA 1997 states:

SECTION 59-35

59-35 Amounts that would be mutual receipts but for prohibition on distributions to members or issue of MCIs

An amount of * ordinary income of an entity is not assessable income and not * exempt income if:

(a)  the amount would be a mutual receipt, but for:

                                    (i)        the entity ' s constituent document preventing the entity from making any * distribution, whether in money, property or otherwise, to its members; or

                                   (ii)        the entity's constituent document providing for the entity to issue MCIs (within the meaning of the Corporations Act 2001) or to pay *dividends in respect of one or more MCIs; and

                                  (iii)        the entity having issued one or more MCIs (within the meaning of the Corporations Act 2001) or having paid dividends in respect of one or more MCIs; and

(b)  apart from this section, the amount would be assessable income only because of section 6-5.

As such the general exemption is not available where pursuant to paragraph 59-35(a)(i) of the ITAA 1997 the income is NANE because the amount would have been a mutual receipt but for the entity's constituent document preventing a distribution to its members.

The Rules of Company X

The Rules of Company X after Incorporation includes the following:

• the objects of Company X are to provide certain activities for its Members. This can include the use of properties as is owned by Company X at the time of incorporation or is subsequently acquired.
• different categories of members
• how Company X will derive its funds in pursuance of the objects of Company X
• winding up clause - upon winding up or cancellation of the incorporation of Company X, the remaining assets are to be disposed of in accordance with the AIA, specifically section 53 of the AIA.

•         an extract of section 53 of the AIA is attached to the Rules. That section prevents distributions to be made to any member unless that member is an association whose constitution prohibits distributions to its members (this requirement is replicated in section 65 of the Associations Incorporation Act 2009).

The mutuality principle

The mutuality principle is a legal principle established by case law. It is based on the proposition that an organisation cannot derive income from itself.

The principle provides that where a number of persons contribute to a common fund created and controlled by them for a common purpose, any surplus arising from the use of that fund for the common purpose is not income.

The principle does not extend to include income that is derived from sources outside that group.

The characteristics of organisations that can access mutuality typically include:

•         The organisation is carried on for the benefit of its members collectively, not individually.

•         The members of the organisation share a common purpose in which they all participate or are entitled to do so.

•         The main purpose for which the organisation was established, and is operated, is the common purpose of the members.

•         There is a common fund that gives effect to the common purpose and all the members contribute to it.

•         All the contributions to the common fund are applied for the collective benefit of all the members, in line with the common purpose.

•         Different classes of memberships may exist with varying subscription rates, rights and entitlements to facilities.

•         The members have ownership and control of the common fund.

•         The contributors to the common fund must be entitled to participate in any surplus of the common fund.

As a result of the mutuality principle:

•         receipts derived from mutual dealings with members are not assessable income (these are called mutual receipts)

•         expenses incurred to get mutual receipts are not deductible.

Where an organisation transacts with members collectively to produce a surplus of common funds, the activity is for a non-taxable purpose and is a mutual arrangement.

Mutuality ceases to apply when a member individually 'contributes' - say by paying rent - to secure a right over the use of a collectively owned asset (where that right is not available to members as a class), and the member benefits from the use of that asset for their own purposes. This breaks the complete identity between contributors and participants as a class in the common fund.

The Property in this case is leased to members who pay a discounted rate for the period they stay at the Property. The Property is available for lease by all members of Company X. In this case, it is considered that the payments from members for the use of the Property is a mutual receipt because of the mutual relationship between members and the link to the common fund of Company X. (see also Taxation Ruling TR 2015/3 Income tax: matters relating to strata title bodies constituted under strata title legislation paragraphs 23 to 25).

Application of subparagraph 118-12(2)(ia) of the ITAA 1997

As outlined above the exemption under section 118-12 of the ITAA 1997 does not apply if the asset was used to gain or produce an amount that is NANE and the requirements of section 59-35 of the ITAA 1997 are met (subparagraph 118-12(2)(ia) of the ITAA 1997).

In this case section 59-35 of the ITAA 1997 is satisfied as the amount of the Company X's income from renting the Property would be a mutual receipt, except for the Rules which prevent distributions to its members (clause 22 and clause 36 of the Rules).

This means that the requirements of subparagraph 118-12(2)(ia) of the ITAA 1997 will be satisfied as the Property is used to produce NANE and the requirements of section 59-35 of the ITAA 1997 are met.

Therefore, the exemption to disregard capital gains made from a CGT asset that solely produces NANE will not apply. The capital gain or capital loss made from the disposal of the Property will not be disregarded.

Conclusion

As the Property was solely used to produce NANE, the general exemption under section 118-12 of the ITAA 1997 would apply. However, in the present case under subparagraph 118-12(2)(ia) of the ITAA 1997, the exclusion to the general rule will apply. Consequently, the general exemption available under section 118-12 of the ITAA 1997 will not operate to disregard any capital gain or capital loss made from the disposal of the Property.