Edited version of private advice

Authorisation Number: 1051950388698

Date of advice: 15 February 2022

Ruling

Subject: CGT - pre and post CGT interests

Question 1

Will the capital gain made on the disposal of the property be exempt from capital gains tax (CGT) under paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will a portion of the capital gain made on the disposal of the property be exempt from CGT under paragraph 104-10(5)(a) of the ITAA 1997?

Answer

Yes.

This private ruling applies for the following period:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

This private ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are different from these facts, this private ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The company purchased a property prior to September 1985.

The company shareholders have not changed since March 1985.

When purchased, the property had a xxxx building and a xxxx building.

In 20XX the company began leasing part of the property on which the xxxx building was erected (the first lease) to company B.

In accordance with the provision of the first lease, company B demolished the xxxx building and built the existing building.

Company B owns the building. The company did not pay for any of the costs of demolition and construction of the existing building.

The term of the first lease was X years with X successive options to renew, each for a period of X years.

The current lease remains on foot but the company intends to end the lease and place the property on the market for sale. The current lease contains a provision that requires the tenant, at the end of the lease, to either:

•         demolish the building (but not the slab) capping services at the level of the building slab and removing structures external to the building or

•         remove certain items and make good the premises including repainting the whole of the premises

The current lease does not require the company to compensate the tenant for the value of the building and improvements which transfer to the company at the end of the lease.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection paragraph 104-10(5)(a)

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 section 116-30

Reasons for decision

CGT event A1 happens if you dispose of a CGT asset as per subsection 104-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997).

Subsection 104-10(2) of the ITAA 1997 provides that you dispose of a CGT asset if a change in ownership occurs from you to another entity, whether because of some act or event or by operation of law.

A capital gain on the disposal of an asset can be disregarded under paragraph 104-10(5)(a) of the ITAA 1997 if it was acquired prior to 20 September 1985.

Taxation Determination TD 98/23 considers the CGT consequences of a lessee incurring capital expenditure on improvements to a leased property.

2. If the lessee owns the improvements (see Taxation Determination TD 46), the cost base of the improvements includes the amount of capital expenditure incurred in making the improvements. On a CGT event happening to the improvements, the amount of any capital proceeds received will determine whether a capital gain or loss is made. If the improvements remain affixed to the land on the expiry or termination of the lease, CGT event A1 (disposal of a CGT asset - section 104-10 of the Income Tax Assessment Act 1997) happens to the improvements. The improvements are disposed of by the lessee to the lessor.

3. If the parties are not dealing with each other at arm's length or no capital proceeds are received, sections 116-30 and 112-20 apply and the lessee is taken to have received, and the lessor to have paid, the market value of the improvements.

In this case, the building was constructed and owned by company B, the lessee. When the lease comes to an end CGT event A1 will occur and the building will be disposed of by company B to the company. As the lease does not require any payment, the company will be taken to have acquired the building for market value on the date the lease ends.

Therefore the company has both a pre and post CGT interest in the property. The company can only disregard the portion of the capital gain that relates to the pre CGT interest in the property under paragraph 104-10(5)(a) of the ITAA 1997. The capital proceeds that relate to the interest in the property that is acquired on the ending of the lease will not be exempt.