Edited version of private advice

Authorisation Number: 1051856723608

Date of advice: 05 August 2021

Ruling

Subject: CGT - disposal of property by corporation to shareholders

Question 1

Does a trust relationship exist between the corporate entity and the two shareholders who used the dwelling as their main residence?

Answer

No.

Question 2

Will an A1 CGT event occur when the corporate entity transfers legal title to the two shareholders, resulting in the company being liable to pay tax on the capital gain?

Answer

Yes. There is no discretion under the income tax law to exempt any capital gain occurring in relation to this transfer. The main residence exemption under s 118-110 of the Income Tax Assessment Act 1997 (Cth) does not apply to corporations.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Taxpayer A and Taxpayer B purchased the Property in 19XX, using their own funds.

At the time of purchase, based on advice of their lawyer, Taxpayer A and Taxpayer B placed 50 percent of the legal title with a corporate entity and the remaining 50 percent equally with themselves (25% each). The corporate entity was established with the sole purpose of holding the property to protect their financial interests and from the possibility of creditor claims.

The property has been used by Taxpayer A and Taxpayer B as their principal place of residence since the Property's purchase. This is supported by two documents, both addressed to Taxpayer A and Taxpayer B in an individual capacity, and also a letter from the Electoral Commission, confirming that Taxpayer A and Taxpayer B's enrolled address has been the Property since 20XX.

No evidence has been provided that the corporate entity holds the property on trust for Taxpayer A and Taxpayer B, at the time the Property was purchased. However, statutory declarations were provided by Taxpayer A and Taxpayer B that the property was at all times their principle place of residence and the company did not have beneficial ownership of the property.

The taxpayers claim the company never in its over twenty year ownership claimed any tax deductions in respect of the property.

Tax records show the business address of both taxpayer A and B as the same address as their residential address.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 116-10

Income Tax Assessment Act 1997 section 118-105

Income Tax Assessment Act 1997 section 118-110

Reasons for decision

Question 1

Summary

You have stated you obtained legal advice when the property was purchased and put 50% ownership of the property into a company for the purposes of legal protection. No evidence has been provided that the company held the property as trustee of a trust but rather held the property in its own right. A company is a separate legal entity to its owners (shareholders). The shareholders provide the capital and the directors manage the business or in this case asset. The fact that the shareholders and directors are the same individuals, in this case Taxpayer A and Taxpayer B, does not change the fact that the company is a separate and distinct legal entity. The statutory declarations and rates notices are not sufficient evidence that a trust relationship exits.

Detailed reasoning

When considering the sale of the property, the most important element in the application of the CGT provisions is ownership. It must be determined who is the legal owner of the property.

A person's legal interest in a property is determined by the legal title to that property under the legislation in the State or Territory the property is situated. The legal owner of the property is recorded on the title deeds for the property issued under that legislation.

Section 23C of the Conveyancing Act 1919 contains provisions that preclude the creation or transfer of interests in land except if evidenced in writing. The absence of writing does not make the declaration of trust over land void, but merely unenforceable.

In absence to the contrary, the property is considered to be owned by the person(s) registered on the title. It is possible for legal ownership to differ from beneficial ownership. Where beneficial ownership and legal ownership of an asset are not the same, there must be evidence that the legal owner holds the property in trust for the beneficial owner.

There are limited circumstances where the legal and equitable interests are not the same, and there is sufficient evidence to establish that the equitable interest is different from the legal title. Where individuals are related, for example parent and child, we generally consider that the equitable right is exactly the same as the legal title.

Trusts may be of three kinds: express, resulting or constructive.

Where it is asserted that the beneficial ownership and legal ownership of a property are not the same, there must be evidence to show that the legal owner holds the property in trust for the beneficial owner.

We have considered the facts provided in order to determine whether a trust has been created in relation to the property and our determinations are as follows:

•                 An express trust is one intentionally created by the owner of property in order to confer a benefit upon another. It is created by express declaration, which when relating to the transfer of interests in land, must be evidenced in writing. In this case, there is no documentary evidence that the property was held on trust. Such documents would constitute a declaration of trust and make clear the terms of the trust. The absence of such a document means that an express trust cannot exist.

•                 A constructive trust is a trust imposed by operation of law. The facts of this case do not indicate the existence of a court order, and therefore it can be concluded that a constructive trust does not exist.

•                 A resulting trust, sometimes called an implied trust, is one that is implied from the presumed intention of the owner of the property. The most common circumstance where a trust can be implied from an objective consideration of the facts is where someone purchases property in the name of another. The facts of your case do not indicate the existence of a resulting trust. You have stated that the property was put in the name of the company for asset protection purposes. It is therefore concluded that no resulting trust exists or existed in relation to the property.

Question 2

Summary

As no trust relationship exists, implying that Taxpayer A and Taxpayer B do not have absolute entitlement, the corporate entity as the legal owner of 50 percent of the property, will be liable for any capital gain or loss arising on its share from the Property's disposal. The main residence exemption does not apply to corporations.

Detailed reasoning

The capital gains tax (CGT) provisions are contained in Part 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997). You make a capital gain or a capital loss when a 'CGT event' happens (section 102-20 of the ITAA 1997). The most common CGT event A1 happens when you dispose of the asset to another party (for example disposal of a dwelling) (section 104-10 of the ITAA 1997).

Therefore, when the corporate entity transfers its 50% interest to taxpayer A and taxpayer B, who will become the sole owners, this will trigger a CGT event. As the company will not receive any capital proceeds in relation to this event, a market value substitution rule applies (section 116-10(2) of the ITAA 1997). It is deemed that the company will receive capital proceeds equal to 50% of the market value of the CGT asset, that is, 50% of the market value of the Property at the time of the CGT event.

A capital gain or capital loss you make from a CGT event that happens to your main residence is disregarded if you are an individual and the dwelling was your main residence throughout your ownership period (section 118-110 of the ITAA 1997).

Section 118-110 of the ITAA 1997 provides that you can disregard a capital gain or capital loss made from a CGT event that happens to a dwelling or your ownership interest in it if, you use the dwelling as your main residence. You qualify for an exemption if:

•                 you are an individual

•                 the property is less than two hectares

•                 the dwelling was your main residence throughout your ownership period

•                 the ownership interest did not pass to you through a trust or a deceased estate

Section 118-105 of the ITAA 1997 allows you to treat a dwelling (that was your main residence) as your main residence and be fully exempt from capital gains tax where the dwelling has not been used to earn assessable income. If the dwelling has been used to earn assessable income and also been your main residence a partial exemption may apply. However, the exemption only applies to individuals. As the company is not an individual, it does not qualify for the main residence exemption even though both the directors and shareholders of the company are individuals who used the dwelling as their main residence.

Further information on capital gains tax and the main residence exemption can be found on the ATO web site by searching QC 22166.