Edited version of private advice

Authorisation Number: 1051858181633

Date of advice: 28 June 2021

Ruling

Subject: CGT event A1 and the effect of court orders

Question 1

Do the Court Orders have the effect that CGT event A1 did not occur in respect of the disposal of either Property under subsection 104-10(1) of the Income Tax Assessment Act 1997 (Cth) during the 20XX income year?

Answer

Yes

Question 2

Does the transfer of the Properties by X Co to the Trust pursuant to the Court Orders constitute the receipt of assessable income by the Trust under the Income Tax Assessment Act 1997 (Cth)?

Answer

No

Question 3

Does the receipt by the Trust of payment on account of the profits derived by X Co constitute the receipt of assessable income under the Income Tax Assessment Act 1997 (Cth)?

Answer

Yes

Question 4

If the answer to Question 3 is "Yes", is the amount received assessable under the Income Tax Assessment Act 1997 (Cth) in the income year in which the appeals against the Court Orders weredismissed (that is, during the year ended 30 June 20XX)?

Answer

Yes

Question 5

Having regard to section 109-5 of the Income Tax Assessment Act 1997 (Cth), is each Property taken to have been acquired by the Trust when it was first acquired by the Trust?

Answer

Yes

Question 6

Having regard to Division 110 of the Income Tax Assessment Act 1997 (Cth), is the first element of the cost base of each Property the purchase price paid by the Trust when the Property was first acquired by the Trust?

Answer

Yes

Question 7

Is the Trust able to self-amend the 20XX Trust Return (including the distribution statements) under section 170 of the Income Tax Assessment Act 1936 (Cth) to reverse the capital gains from the disposal of the Properties?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trust was established as a discretionary trust for the benefit of members of a family.

X Co

Mr X was one of two directors and one of two shareholders of X Co.

Sale of properties

The Trust owned 2 properties.

In 20XX, the Trust entered into a contract with Mr X under which Mr X or his nominee agreed to purchase the properties from the Trust. At that time, Trustee Co was the trustee of the trust.

Mr X nominated X Co as the purchaser of both Properties.

After the sale, X Co held and derived rental income from the Properties.

The Trust tax return 20XX

The Trust's income tax return for the year ended 30 June 20XX (20XX Trust Return)

included capital gains in respect of the Property sales.

Beneficiaries' present entitlement

Trustee Co resolved that beneficiaries of the Trust would be presently entitled to the net income (including the capital gains from the disposal of the Properties) of the trust.

Litigation and court orders

Following litigation commenced alleging misappropriation of the Properties from the Trust and other family entities, the court ruled that the relevant directors of Trustee Co were in breach of fiduciary duty which they owed to Trustee Co in disposing of the Properties to X Co; and that they had exercised their powers as directors for the improper purpose of obtaining substantial and direct personal benefits.

The Court made the following orders:

•         A new trustee (new Trustee) was appointed as trustee of the Trust.

•         The Contracts for Sale were set aside.

•         X Co held the Properties on constructive trust for the Trust.

•         X Co was required to transfer the Properties to the Trust and the Trust was

•         required to repay the consideration that had been paid by X Co for the Properties; and

•         X Co was required to pay the Trust all profits derived by X Co (that is, the net rent) from its ownership of the Properties which was to be set off against the amounts to be paid to X Co.

An appeal was lodged against the Court Orders. Following the lodgment of the appeal, the new trustee and the judgment debtors agreed not to enforce the judgement, but the new Trustee's interests from the judgement was secured by the provision of mortgages in favour of the new Trustee over certain real properties held by the judgment debtors pending the outcome of the appeal.

The appeal was ultimately dismissed.

The transfers and payments under the Court Orders were finally made in the 20XX income year and the mortgages were discharged.

Relevant legislative provisions

Subsection 6-5(2) of the Income Tax Assessment Act 1997

Subsection 104-10(1) of the Income Tax Assessment Act 1997

Section 109-5 of the Income Tax Assessment Act 1997

Division 110 of the Income Tax Assessment Act 1997

Section 170 of the Income Tax Assessment Act 1936

Reasons for decision

Question 1

Do the Court Orders have the effect that CGT event A1 did not occur in respect of the disposal of either Property under subsection 104-10(1) of the Income Tax Assessment Act 1997 (Cth) during the 20XX income year?

Summary:

Yes, the Court Orders have the effect that CGT event A1 did not occur in respect of the disposal of either Property under subsection 104-10(1) of the Income Tax Assessment Act 1997 (Cth) during the 20XX income year.

Detailed reasoning

CGT event A1 does not occur if the transaction giving rise to it is rendered void from the beginning such that, in law, it is treated as never having come into existence. In this regard:

•         Paragraph 23 of Taxation Ruling TR 94/29 provides as follows:

However, in some circumstances a contract may fall through after completion for reasons which will render the contract void from the beginning, that is, the contract is treated in law as never having come into existence. One example would be where the contract is set aside because of the fraud of one of the parties and the fraud is discovered after completion. In these types of cases the innocent party may rely on the fraud to have the contract of sale declared a nullity from the beginning. The position from a CGT point of view would then be that a change in the ownership of land is taken never to have occurred since the contract of sale was a nullity from the beginning.

•         It is also noted that, while it may not strictly apply to the Trust (given that no assessment is issued to the Trust), the premise on which subsection 170(9D) is based is that where a contract is found to be void ab initio, the CGT provisions will be taken always to have applied to the contract as if the contract had never been made.

The question is whether the orders made by the court in this matter have the effect of nullifying the transactions regarding the sale of the Properties. In this case, the court had made an order that the contracts of sale be set aside, and this is taken to have retrospective effect. In this regard:

•         The court found that X Co held the Properties on constructive trust for the new Trustee.

•         Declarations as to the above were made with retrospective operation on the basis that the constructive trusts were 'institutional constructive trusts', which take effect from the date of the circumstances giving rise to the imposition of the constructive trust, rather than the date when the trust was declared.

•         The finding of constructive trust itself requires that the relevant contracts and transfers in respect of the Properties are rendered void.

As the contracts and consequent transfers are void ab initio, the change in ownership upon which CGT A1 was based is taken never to have occurred, the consequence of which CGT A1 will be taken not to have occurred.

Question 2

Does the transfer of the Properties by X Co to the Trust pursuant to the Court Orders constitute the receipt of assessable income by the Trust under the Income Tax Assessment Act 1997 (Cth)?

Summary:

No, the transfer of the Properties by X Co to the Trust pursuant to the Court Orders does not constitute the receipt of assessable income by the Trust under the Income Tax Assessment Act 1997 (Cth).

Detailed reasoning

As discussed in the reasoning provided in respect of question 1 above, the nullification from the outset of the contracts of sale carries the result that there has been no change of ownership of the Properties.

As the trustee of the Trust continues to own the Properties, the return of the Properties by X Co does not result in CGT event A1: there has been no legal change of ownership from the Trust trustee for the period between the time at which the Properties were initially transferred to X Co, and, subsequent to the court order, returned to the Trust.

We also note that;

•         CGT event E1 has no application in this case, as X Co has not created a trust over the Properties by declaration or settlement.

•         In respect of the application of Division 7A, section 109J would apply to preclude the operation of section 109C in this case.

Question 3

Does the receipt by the Trust of payment on account of the profits derived by X Co constitute the receipt of assessable income under the Income Tax Assessment Act 1997 (Cth)?

Summary:

Yes, the receipt by the Trust of payment on account of the profits derived by X Co constitutes the receipt of assessable income under the Income Tax Assessment Act 1997.

Detailed reasoning

Subsection 6-5(2) provides that a taxpayer's assessable income 'includes the ordinary income you derived directly or indirectly from all sources, whether in our out of Australia, during the income year'.

The court found that X Co was liable to disgorge the profits it made from holding the Properties.

The Properties were held on constructive trust for the Trust and profits were subject to a separate order for disgorgement as a supplement to the declaration of constructive trust.

The amounts are in the same nature as the payments they replace (FCT v Dixon (1982) 10 ATD 82) being in substitution of earnings which would have been earned but for the transfer; that is being in the form of a 'back-pay' of income that the Trust would have derived but for the transfer of the Properties to X Co.

As per the principle in the Dixon case, they are consequently income under subsection 6-5(2)

Question 4

If the answer to Question 3 is "Yes", is the amount received assessable under the Income Tax Assessment Act 1997 (Cth) in the income year in which the appeals against the Court Orders weredismissed (that is, during the year ended 30 June 20XX)?

Summary:

Yes, the amount received assessable under the Income Tax Assessment Act 1997 (Cth) in the income year in which the appeals against the Court Orders weredismissed (that is, during the year ended 30 June 20XX).

Detailed reasoning

Where a taxpayer accounts for profits on an accruals basis and the relevant income is subject to a bona fide dispute, that income is derived when the dispute is settled: BHP Billiton Petroleum (Bass Strait) Pty Ltd & Anor v FCT 2002 ATC 5169. It is accepted in this case that the dispute was a genuine bona fide one, having been subject to formal legal proceedings by way of an appeal lodged against the Court Orders. It is a further reflection of the bona fide nature of the dispute that, as security for new Trustee's interests from the original judgement, the judgment debtors agreed to the grant of mortgages in favour of new Trustee over certain real properties held by the debtors pending the outcome of the appeal.

Accordingly, the amount is assessable in the year ended 30 June 20XX.

Question 5

Having regard to section 109-5 of the Income Tax Assessment Act 1997 (Cth), is each Property taken to have been acquired by the Trust when it was first acquired by the Trust?

Summary:

Yes, having regard to section 109-5 of the Income Tax Assessment Act 1997 (Cth), each Property is taken to have been acquired by the Trust when it was first acquired by the Trust.

Detailed Reasoning

It was determined in question 1 that the contracts and resulting transfers for the sale of the Properties are void ab initio. As a result, the change in ownership upon which CGT A1 was based is taken never to have occurred, the consequence of which CGT A1 will be taken not to have occurred.

It follows from this that each Property is acquired by the Trust when it was first acquired by the Trust, not on the transfer made pursuant to the court orders.

Question 6

Having regard to Division 110 of the Income Tax Assessment Act 1997 (Cth), is the first element of the cost base of each Property the purchase price paid by the Trust when the Property was first acquired

by the Trust?

Summary:

Yes, having regard to Division 110 of the Income Tax Assessment Act 1997 (Cth), the first element of the cost base of each Property is the purchase price paid by the Trust when the Property was first acquired by the Trust.

Detailed Reasoning

Following from the determination in question 1 and question 5, the cost base of each Property is determined in accordance with the cost base provisions in Division 110 of the ITAA 1997, which apply with reference to the times at which they were acquired by the Trust.

Accordingly, for the purposes of working out the first element of the cost base of each of the Properties under subsection 110-25(2), the money paid or value of property given for the acquisition of the relevant Property will be such money or property given at the time the Property was first acquired by the Trust.

Question 7

Is the Trust able to self-amend the 20XX Trust Return (including the distribution statements) under section 170 of the Income Tax Assessment Act 1936 (Cth) to reverse the capital gains from the disposal of the Properties?

Summary:

Yes, the Trust is able to self-amend the 20XX Trust Return (including the distribution statements) under section 170 of the Income Tax Assessment Act 1936 (Cth) to reverse the capital gains from the disposal of the Properties.

Detailed Reasoning

The Trust is not issued an assessment (or deemed to have been issued an assessment). In particular, it is not a 'full self-assessment taxpayer' as defined in subsection 6(1) of the ITAA 1936.

There is no assessment issued in respect of the Trust and consequently the time limits applicable to assessments under section 170 of the ITAA 1936 do not apply.

As such, it may amend its tax return for the 20XX income year.