Edited version of private advice

Authorisation Number: 1051993724210

Date of advice: 10 June 2022

Ruling

Subject: CGT - transfer of property under a family settlement

Question

Will the transfer of property from B and C to A under court orders cause a CGT event to happen?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1. This ruling is about whether transferring property under a family law settlement will cause a CGT event to happen. The settlement effectively reversed an earlier property transfer from A, to B and C.
2. The first transfer happened because of a deed which A, B, and C entered in an earlier income year. Under that deed:

•         A transferred the property to B and C jointly

•         A maintained some rights to use the property

•         if B and C sold the property, they would pay a definite monetary sum to A.

3. A transferred the property to B and C jointly under the deed.
4. B and C didn't live in the property, receive any rental income from it, or receive any other direct benefit from owning it.
5. Later, A, B, and C were parties to court proceedings about the transfer.
6. The court proceedings settled by consent. B, C, and A agreed to seek court orders by consent. The relevant court made those orders sometime during the 2022 income year. The court orders included that:

•         B and C held the property as constructive trustees for A

•         the deed, and the earlier transfer from A, to B and C, were set aside as being void ab initio

•         the parties would sign all documents and do all necessary things to reinstate A as the property's legal owner.

7. A hadn't been reinstated in the relevant land titles registry when B and C applied for this ruling application.

Assumption

The relevant land titles registry will register a transfer of property from B and C back to A sometime in the 20XX or 20XX income years. That transfer won't have the effect of cancelling the first transfer (from A, to B and C) for registry purposes. In other words, the title deed won't be backdated. The title deed will continue to show that B and C were the registered property owners for the period from first transfer (from A, to B and C) until when the second transfer (from B and C, to A) takes effect.

Relevant legislative provisions

Section 104-10 of the Income Tax Assessment Act 1997

Section 104-55 of the Income Tax Assessment Act 1997

Section 104-75 of the Income Tax Assessment Act 1997

Section 104-85 of the Income Tax Assessment Act 1997

Section 106-50 of the Income Tax Assessment Act 1997

Section 108-5 of the Income Tax Assessment Act 1997

Section 170 of the Income Tax Assessment Act 1936

Reasons for decision

References to section 170 are to section 170 of the Income Tax Assessment Act 1936.

All other legislative provisions are in the Income Tax Assessment Act 1997.

Summary

8. Section 106-50 will apply so that no CGT event will happen when the property is transferred back to A to comply with the court orders. We think A was absolutely entitled to the trust asset for CGT purposes. Therefore, A will be treated as owning the asset at the relevant times. It follows that no CGT event will happen.

Detailed reasoning

Several CGT events might have happened under this scenario

9. Capital gains are included in your assessable income: section 102-5.
10. Very broadly, capital gains are triggered when a CGT event in Division 104 happens. There are many CGT events: most are specific and occur in limited circumstances. Many, but not all, CGT events are about CGT assets.
11. Subsection 108-5(1) says CGT assets include any kind of property. Note 1 to section 108-5 gives land and buildings as an example.
12. Therefore, the land is a CGT asset.
13. The transfer of property, or creating equitable interests over property, may cause CGT events to happen. For example:

•         CGT Event A1 happens if you dispose of a CGT asset: section 104-10. You dispose of a CGT asset if a change of ownership occurs from you to another entity. However, there's no change of ownership if you stop being the legal owner but continue to be a beneficial owner.

•         CGT Event E1 happens if you create a trust over a CGT asset by declaration or settlement: section 104-55.

•         CGT Event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust as against the trustee: section 104-75.

•         CGT Event E7 happens if a trustee disposes of a CGT asset to a beneficiary to satisfy their interest in the trust capital: section 104-85.

The CGT rules are modified for absolutely entitled beneficiaries: they're deemed to hold the assets outright for CGT purposes

14. The usual CGT consequences are modified where beneficiaries are absolutely entitled to trust assets. Section 106-50 is about absolutely entitled beneficiaries. It applies where you become absolutely entitled to a CGT asset as against the trustee of a trust. It says that for CGT purposes, from just after the time you become absolutely entitled:

•         the asset is treated as being your asset, not the trust's asset, and

•         acts done by the trustee in relation to the asset are treated as if they were done by you, not the trustee.

15. Broadly, a beneficiary is absolutely entitled to a trust asset when they are entitled to have it transferred to them. TR 2004/D25[1] is the ATO view about absolute entitlement for CGT purposes. This draft ruling relevantly says that:

•         a beneficiary has all the interests in a trust asset if no other beneficiary has an interest in it [paragraph 21]

•         that beneficiary will be absolutely entitled to the asset as against the trustee if they can terminate the trust by directing the trustee to transfer it to them, or at their direction [paragraph 22].

16. We need to characterise the effect of the court orders before we can determine whether section 106-50 applies.

Characterising the effect of the court orders: we think that legal title passed under the first transfer, subject to a constructive trust which took effect immediately

17. The 2022 court orders were that:

•         B and C held the property as constructive trustees for A

•         the deed, and the transfer under that deed, were set aside as being void ab initio

•         the parties would sign all documents and do all necessary things to reinstate A as the property's legal owner.

18. We need to review some general law concepts to understand the effect of these court orders: constructive trusts, the phrase 'void ab initio', and land registration.

General legal concepts: constructive trusts, void ab initio, land registration

19. Trusts are a legal relationship between a trustee and a beneficiary, in respect of certain property. According to Jacob's Law of Trusts, the elements of that relationship are that a trustee holds property (usually legal title, but occasionally equitable title), under an obligation to deal with that property, for the benefit of others (or some purpose permitted by law).[2]
20. A constructive trust is recognised by operation of law, not the express intention of a trustee. According to Jacob's Law of Trusts, constructive trusts are:

•         imposed regardless of actual or presumed intention

•         recognised by courts where they interpret (construe) the circumstances as creating equitable or fiduciary obligations

•         recognised where it would be a fraud, or unconscionable, for a party to deny a trust.[3]

21. 'Void ab initio' is a legal phrase meaning that an act is void 'from the beginning' and never any legal effect.[4]
22. Broadly, Australian land law only recognises legal title (as opposed to equitable interests) in land when ownership is registered with the relevant land titles office. This principle has been described as a system of title by registration, not registration of title. In other words, registration creates legal title in land: transactions don't transfer ownership until they have been registered.[5]

Applying these concepts to the court orders

23. Interpreting the court orders is difficult for at least three reasons.

•         First, it isn't clear whether the constructive trust was awarded prospectively or retrospectively. In other words, did the constructive trust take effect when B and C first acquired the property under the first transfer from A? Or was it only effective from the date of the court orders in 2022?

•         Second, it isn't clear whether the court orders cover the registration of the first transfer. The order says that both the deed, and the transfer under that deed, are void as if they never happened. However, does the order mean the registration of the first transfer (from A, to B and C) with the land titles office was legally ineffective? Will the registration of that transfer be cancelled, reversed, or otherwise treated as if never happened?

•         Third, the orders require the parties to reinstate A as the property's legal owner. It isn't clear whether the land titles office will reinstate A prospectively, or retrospectively.

24. We think there are two possible ways to interpret the court orders. First, the registration of the first transfer was void and legally ineffective, as if it never happened. Second, only the deed and the transfer under that deed were void as if they never happened. The registration of the transfer with the land titles office was valid and legally effective.
25. Under the first interpretation, we think there could be no constructive trust.

•         If the registration of the first transfer with the land titles office is treated as having never happened, B and C wouldn't ever have had title over the property.

•         In that case, they wouldn't have had any interest (legal or equitable) in the property at any time.

•         It would follow that B and C couldn't have been constructive trustees because they would have had no property to hold for A's benefit. The elements of a trust wouldn't be present: there would be no trustee holding property subject to equitable obligations to deal with it for another's benefit.

•         We think that would make the first order about a constructive trust inoperative and meaningless.

26.  Under the second interpretation, both the constructive trust and 'void ab initio' orders have some meaning.

•         To repeat, the second order would just cover the instrument to transfer property, rather than the registration of that transfer. In other words, the transfer from A, to B and C, was void, but the registration of that transfer was valid and effective.

•         In that case, B and C would still have taken legal title to the property on registration of the first transfer. They didn't have any equitable rights over it because their underlying agreement with A under the deed was void.

•         B and C still had legal title to property which could have been held on constructive trust for A.

27.  We think the second interpretation is the better one because both the first and second court orders have some meaning. Under the first interpretation, the first order about constructive trusts is meaningless. We're reluctant to interpret a court order as being meaningless.

28. We think B and C's only obligation under the constructive trust is to return the property to A as soon as possible. The orders require the parties to do all things necessary to reinstate A as the property's legal owner. They don't suggest B and C had to hold the property for any other purpose, or for any longer than necessary to register the transfer back to A.
29. We think the constructive trust would take effect from the moment that property was transferred to B and C. If the deed was void, B and C had no equitable rights to the property - just legal title. The constructive trust must have taken effect from the first transfer. If the constructive trust was only effective from the court orders, that suggests the deed and transfer had some legal effect. That can't be right because the court orders said the deed and transfer were void ab initio.
30. We'll state our conclusions about the legal effect of the scenario.

•         A had full legal and equitable title to the property until the transfer (to B and C) under the deed.

•         B and C became the property's legal owners after that.

•         However, they held the property as constructive trustees for A immediately. Their only obligation was to return the property to A. A had an equitable right to have the property returned.

•         When the court ordered transfer from B and C back to A is registered, A will again hold full legal and equitable title to the property.

31. Now we've characterised the effect of the court orders, we can apply the CGT rules discussed earlier.

Do the modified CGT rules about absolutely entitled beneficiaries apply? Yes, A was absolutely entitled under the constructive trust from when it was created.

32. In these precise and unusual circumstances, we think A was absolutely entitled to the trust property from the first transfer.

•         The 20XX court orders had the effect of recognising a constructive trust, with a backdated effect starting from the first transfer.

•         As constructive trustees, B and C's only obligation was to return the property to A.

•         A had equitable rights to have the property returned. We think A could direct B and C to transfer the property (back to A).

•         A was the only beneficiary under that constructive trust.

•         Applying TR 2004/D25 paragraphs 21 and 22, A was absolutely entitled. Absolute entitlement would have commenced immediately after the transfer.

33. Therefore, A will be deemed to have held the property for CGT purposes, not B and C.

•         As explained earlier, section 106-50 deems absolutely entitled beneficiaries to hold property for CGT purposes, rather than the trustees.

•         Under subsection 106-50(1), that deeming rule starts from 'just after the time' the beneficiary becomes absolutely entitled.

•         We think we should understand the phrase 'just after the time' to mean 'on or 'immediately after' in these circumstances. We don't think the phrase necessarily implies a moment in time where B and C owned the asset before the deeming rule in section 106-50 applies.

•         Here, A had legal title up until the transfer, and was an absolutely entitled beneficiary immediately after the transfer.

•         Therefore, for CGT purposes, the property will be treated as having always been A's asset, and never B and C's asset.

34. B and C never held the property for CGT purposes: they didn't have legal title or beneficial ownership and weren't trustees. For CGT purposes, the property was A's asset, not B and C's. At paragraph 20, we explained that the essential elements of a trust are that a trustee holds property subject to obligations to beneficiaries. If there's no trust property, there's no trust. It follows that B and C weren't trustees for CGT purposes.[6]
35. It follows that no CGT events will happen when the property is transferred from B and C back to A, in the precise circumstances presented in this private ruling. For CGT purposes, B and C have no title (legal or equitable) to dispose to another entity. CGT event A1 won't happen. Further, again for CGT purposes, they didn't have any title which they could have held on trust. Therefore, none of the CGT events relevant to trusts will happen either.

Conclusion: no CGT event will happen

36. The transfer of property from B and C to A under the 20XX court orders won't cause a CGT event to happen.

[1] Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997.

[2] Heydon, JD and Leeming, MJ (2016) Jacob's Law of Trusts in Australia, 8^th edn, LexisNexis Butterworths Australia [1.01, 1.04]. Accessed online 9 May 2022.

[3] Heydon, JD and Leeming, MJ (2016) Jacob's Law of Trusts in Australia, 8^th edn, LexisNexis Butterworths Australia [3.08, 13.01]. Accessed online 9 May 2022.

[4] Mann, T (2018) Australian Law Dictionary, 3^rd edn, Oxford University Press. Accessed online 16 May 2022. See the entries for 'void' and 'ab initio' which both explain this phrase.

[5] Carter, J (2016) Halsbury's Laws of Australia, LexisNexis Australia [355-8010]. Accessed online 20 April 2022.

[6] We're not suggesting that there would be no trust for other legal purposes: we're only concerned with the CGT rules.