Edited version of private advice

Authorisation Number: 1052016612452

Date of advice: 8 August 2022

Ruling

Subject: Capital gains tax - disposal of ownership interests - subdivision and partition agreement

Question:

Will a capital gains tax event A1 occur for both of you on the transfer of your respective ownership interests in one of the subdivided lots to the other in accordance with the Partition Agreement?

Answer:

Yes. Capital gains tax event A1 occurred on the date the Partition Agreement was entered.

This ruling applies for the following periods:

Income year ended 30 June 20XX.

Income year ended 30 June 20XX.

Income year ending 30 June 20XX.

The scheme commences on:

1 July 20XX.

Relevant facts and circumstances

You, being Person A and Person B, entered a contract to jointly purchase a property (the Property) after 20 September 1985, with settlement occurring after a short period.

The Property had an older style house constructed on it.

The Property had been marketed as a private sale, with plans and permits to build X town houses on individual titles.

You have always intended proceeding with the development given the state of the Property at the time it was purchased, with the Property not complying with the a Government's change to the Residency Tenancy Act without significant capital being put into the house, which was not cost effective.

An Agreement for Partition (Partition Agreement) between you was dated and executed during the following year after the Property was purchased which included the following information:

•         You will each take in severalty the freehold property of one of the subdivided lots and mortgage in relation to that subdivided lot as follows:

o        Lot A - will be Person B's lot; and

o        Lot B - will be Person A's lot

•         Date of transfer proposed to occur between you on the date the contract of purchased was entered into

•         You shall be entitled to the exclusive possession of your respective allotments and shall be liable to pay the outgoings in respect of thereof from the date of appointment for the completion of partition, and necessary for the portion to be made.

A tenant was in the Property when settlement occurred, who continued to reside at the Property for a significant period until a notice to vacate was served, which enabled you to proceed in demolishing the house located on the Property.

You had entered building contracts several months prior to the tenant vacating the Property and have experienced ongoing delays due to COVID and building supply issues. The builder is currently constructing a townhouse on each of the proposed subdivided lots with the construction currently at the slab stage, with some of the framing having been erected.

You wish to subdivide the Property into X lots, with an equal value of each lot.

The subdivision is ready for registration with the final stages. You anticipate lodging the subdivision application with the council during the ruling period.

As a result of the subdivision of the Property, titles for the X subdivided lots will be issued in which you will each have an equal ownership interest.

It is your intention to transfer your respective ownership interest in one of the subdivided lots to the other under the Partition Agreement so that:

•         Person B will have X% legal ownership of Lot A; and

•         Perso A will have X% legal ownership in Lot B.

It is anticipated that:

•         the change of the legal titles for the X subdivided lots to reflect the change of ownership will occur within several weeks of the subdivision plan being registered

•         during the ruing period the following will occur:

o        the subdivision plan will be registered; and

o        lodgement of the transfer of the titles under the Partition Agreement will occur.

You both anticipate retaining your respective subdivided lots and using them to earn rental income, but that will be dependent on your job security and interest rates.

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 108-5

Income Tax Assessment Act 1997 Section 112-25

Income Tax Assessment Act 1997 Section 116-20

Income Tax Assessment Act 1997 Section 118-130

Reasons for decision

Capital gains tax

A Capital Gains Tax (CGT) event A1 occurs when there is a change in legal ownership of a CGT asset under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997).

You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if the capital proceeds are less than the asset's reduced cost base.

Subsection 104-10(3) of the ITAA 1997 provides that the time the CGT event A1 happens is when you enter into the contract for the disposal or, if there is no contract, when the change of ownership occurs.

The time when a contract is entered into is the time when it comes into existence for general law purposes.

If a contract is subject to a condition, an issue arises whether the condition is a condition precedent to its formation or whether it is a condition precedent to performance of the contract. In the first case, the contract does not come into existence until the condition is met. In the second case, the condition does not prevent the creation of the contract - non-fulfilment of the condition merely entitles a party to terminate the contract.

Subdivision of land

Under section 112-25 of the ITAA 1997, the subdivision of land itself does not constitute a CGT event if there is no change of ownership. It is at the time of the disposal that any capital gain or capital loss may arise.

Where a property that was acquired as one asset is subdivided, the new assets are treated as though they were always separate assets. The subdivided blocks will retain the acquisition date of the original property in accordance with the principles contained in Taxation Determination TD 2000/10.

Subdivision and partitioning of land

Where land is held by co-owners and they simply wish to subdivide it and retain their respective interests as co-owners in each of the subdivided lots, as outlined above there will be no CGT event and no disposal. It is at the time of the disposal that any capital gain or capital loss may arise, such as the future transfer or disposal of the ownership interest/s in the subdivided lot.

However, if the subdivision is carried out in conjunction with a partition of the property, with the result each of the previous co-owners becomes the sole owner of one or more of the subdivided lots, then there will at the time of partition be:

•         a CGT event happening in relation to interests of the previous co-owners in each of the subdivided lots that they do not become the sole owners of after the partition; and

•         acquisitions by each of the previous co-owners who become sole owners of one or more of the subdivided lots of the interests of all other previous co-owners in those subdivided lots.

CGT Determination Number 45 TD 45 (Withdrawn) outlines that were a taxpayer, being a tenant in common of land, acquires the interest of the other tenant in common, the co-ownership ceases.

The CGT implications of joint owners subdividing land and each taking X% ownership in one block is considered in Taxation Determination TD 92/148 which outlines that the Commissioner's view is that if the joint owners take individual blocks it involves disposals and acquisitions of ownership interests in the blocks by the joint owners.

The principles contained in TD 92/148 are supported by the comments made by Senior Member McCabe in Johnson v. FC of T 2007 ATC 2161 (Johnson) at paragraphs 15 and 16:

15.... Dividing the parcel in two for the purposes of a transfer to each joint owner effectively requires those owners to relinquish ownership of the CGT assets in the shares in the other parcel in return for clear title to the shares in the parcel they are acquiring. It is as if the CGT assets contained in each share have to be unpacked and redistributed so that the taxpayer ends up holding half the number of shares in his or her own right- and those shares do not contain any CGT assets belonging to the other (former) joint owner.

16. This rearrangement and reallocation of the ownership of CGT assets constitutes a disposition of the CGT asset, and is therefore a CGT event: s 104-10. Subject to the legislation, tax is levied on the capital proceeds from a CGT event less the cost base of the asset. The capital proceeds are the sum of the money received in respect of the transaction (no money changed hands in this case) and the market value of any other property received (in this case, the market value of the interest acquired in the shares): s 116-20.

The Commissioner considers that, although the comments made by Senior Member McCabe in Johnson were in relation to the division of jointly owned shares, the comments expressed in that case can also relate to the reallocation of the ownership interests in the jointly held subdivided lots into being solely held by one of the joint owners as being viewed as a CGT event A1 for the owner transferring their ownership interest to the other joint owner.

For CGT purposes, where one co-owner acquires the interest of the other co-owner in land, the taxpayer would have full ownership of the land derived from the acquisition of the two interests, being the co-owner's original ownership interest and the ownership interest acquired from the other co-owner. Taxation Determination TD 2000/31 outlines that the interests remain separate CGT assets for CGT purposes. This means that when a CGT event happens to the two interests, such as a future disposal, there will be a separate date of acquisition and a separate cost base for each interest, and capital proceeds will be determined separately for each interest.

Application to your situation

You jointly acquired the Property in which you each had X ownership interests that you intend subdividing into X lots and transferring your ownership interest in X of the subdivided lots to the other so that you each solely own X of the subdivided lots in accordance with the Partition Agreement.

A CGT event will not occur when the subdivision of the Property occurs. However, for CGT purposes you will each have an equal ownership interest in each of the X subdivided lots.

You entered into the Partition Agreement in which you both agreed that it was your intention to subdivide the Property and transfer your respective ownership interest in one subdivided lot to the other resulting in you each having X% ownership of one of the X subdivided lots.

It is viewed that the Partition Agreement is a contract and the conditions contained in it indicated the obligations both you were required to perform as part of the Partition Agreement. There was a mutual intention by both of you to create a legal relationship and for it to have legal effect. All the actions following the date the Partition Agreement was entered into were in relation to you each obtaining the sole ownership in X subdivided lots.

Therefore, it is viewed that CGT event A1 occurred when you entered into the Partition Deed and not when the title of X of the subdivided lots is transferred to you.

The CGT provisions will apply to you when you entered into the Partition Agreement and any capital gain or capital loss made on the disposal of your respective ownership interest in one of the subdivided lots to the other is counted toward the calculation of your net capital gain.

Note: While this could be viewed as a property for property transfer, with the subdivided lots having an equal value, for CGT purposes the capital proceeds you will each receive as a result of the transfer of your respective ownership interest in one of the subdivided lots to the other will be the market value of the ownership interest in the subdivided lot transferred to you as at the date the Partition Agreement was entered under the market value substitution rules contained in section 116-20 of the ITAA 1997 as you did not deal with each other at arm's length in relation to the transfer of your respective ownership interests.