Edited version of private advice

Authorisation Number: 1052054833371

Date of advice: 4 November 2022

Ruling

Subject: CGT - overseas property

Question 1

Did you acquire a CGT asset during the 20XX income year?

Answer

Yes.

Question 2

Does the Double tax agreement between Australia and Country A prevent you from being taxed in Australia on any capital gain or loss in relation to the sale of the property?

Answer

No.

Question 3

Is the cost base of your CGT asset the market value of your ownership interest in the property at the time you acquired the ownership interest?

Answer

Yes.

Question 4

Do your CGT proceeds received from the sale of the property include the amount paid to Person A?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are an Australian resident for Australian taxation purposes and not a resident of Country A for Country A taxation purposes.

Person A is a Country A resident for Country A taxation purposes.

During the 20XX income year you entered an arrangement with Person A concerning a property that they owned, situated in Country A.

The arrangement split the ownership of the property into three shares.

Person A gifted you and your sibling each a share in the ownership of the property.

The title of the property displays the arrangement.

Person A has the right to use the property, receive all income from it and accepts all responsibility, financial or otherwise for the property until their death.

Person A subsequently decided to sell the property.

The purchaser was a third-party and obtained the property as a single asset

The property was sold at the market value as determined by a broker.

The sale price was agreed upon by the purchaser and Person A.

On sale of the property, you had an entitlement to a portion of the proceeds.

There were other costs associated with the sale such as agent's fees, the notary fee and the estate transfer fee.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 100-45

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 section 109-50

Income Tax Assessment Act 1997 section 108-5

International Tax Agreements Act 1953

Reasons for decision

Question 1

Did you acquire a CGT asset during the 20XX income year?

Summary

Yes, you acquired a CGT asset during the 20XX income year.

Detailed reasoning

Under subsection 108-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997), a CGT asset is:

(a)  any kind of property; or

(b)  a legal or equitable right that is not property.

Paragraph 108-5(2)(a) of the ITAA 1997 provides that a part of, or an interest in, an asset referred to in subsection (1) will be a CGT asset.

In your case, your ownership comprised rights or interests in the property. Those rights or interest were able to be disposed of by Person A. When they were disposed of, you were entitled to receive part of the proceeds from the sale of the property, apportioned to your ownership interest.

Accordingly, it is considered you acquired an ownership interest in a CGT asset under section 108-5 of the ITAA 1997.

Whilst the Country A real property rules operate differently to Australian rules, for taxation purposes we consider that the arrangement entered into during the 20XX income year resulted in a partial disposal for Person A, i.e. a partial disposal of their interest in the land by dividing their ownership interest and passing the a portion of ownership to you and your sibling. This is similar to the creation of inter vivos life and remainder interests in Australia.

Life and remainder interests are dealt with in Taxation Ruling TR 2006/14 Income tax: capital gains tax: consequences of creating life and remainder interests in property and of later events affecting those interests. Paragraphs 192 and 193 of TR 2006/14 state:

192. The Commissioner considers that legal life and remainder interests are not comparable to easements, profits a prendre or licences. Legal life and remainder interests are carved out of the existing fee simple and not superimposed on it in the way that rights attaching to these other interests are. Together legal life and remainder interests represent the entire freehold interest in the land. By 'creating' a life interest, the original owner is actually disposing of part of the freehold interest in the land in a similar way to the disposal of a percentage interest in the property.

193. Therefore, the creation of legal life and remainder interests involves disposals of the original asset by the original owner if created inter vivos or disposals by the legal personal representative or trustee of a deceased estate if the interests were bequeathed under the deceased's will.

In line with TR 2006/14, under section 104-10, a CGT event A1 happens to the grantor in these situations as they dispose of an interest in the CGT asset. The grantor is Person A.

Under Country A law it is possible to create remainder rights without first creating the equivalent of life interests such as a usufruct.

Under Australian law, the property can be split into a life interest and remainder interest. A life interest grants a person the use of a property allowing them to live in the property and receive income from it without full legal ownership. A remainder interest is the future right a person has to the property while the life interest is in place. The owner of the remainder interest will have a legal ownership interest in the property but will not benefit from their interest until the life interest ends.

The ATO view on the treatment of the disposal of a life or remainder interest is contained in TR 2006/14.

For the purposes of the current case, the same treatment is considered to apply to a situation where interests in Country A equivalent to a remainder interest are created by retaining the equivalent of a life interest and granting the remainder interest.

Hence, in applying TR 2006/14 to the current facts, paragraph 86 can be equally relevant to a disposal of a remainder interest:

86. CGT event A1 in section 104-10 of the ITAA 1997 happens if an original owner of real property disposes of a legal life interest to another person, that is, there is a change of ownership of part of the original asset from the original owner to the life interest owner.

The general acquisition rules set out in section 109-5 of the ITAA 1997 provide that where an entity disposes of a CGT asset to you, you acquire the asset when the disposal contract is entered into.

In this context, it is considered that you acquired a CGT asset, being an interest in real property when CGT event A1 happened to Person A and they disposed of their ownership to you and your sibling during the 20XX income year.

Question 2

Does the Double Tax Agreement between Australia and Country A (Country A Agreement) prevent you from being taxed in Australia on any capital gain or loss in relation to the sale of the property?

Summary

No, Australia has a right to tax any capital gain or loss in relation to the sale of the property.

Detailed reasoning

In determining liability to Australian tax in respect of capital gains tax on Country A property, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (the Agreements Act). Sections 4 and 5 of the Agreements Act incorporate that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 and provide that the provisions of a double tax agreement have the force of law.

Article 13 of the Country A Agreement deals with the alienation of property. Paragraph 1 of this Article states:

1.   Income, profits or gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other State.

Article 6 defines immovable property with paragraph 2 stating:

2.   The term "immovable property" shall have the meaning which it has under the law of the Contracting State in which the property in question is situated. The term shall in any case include:

(a) a lease of land or any other interest in or over land;

(b) property accessory to immovable property;

(c) livestock and equipment used in agriculture and forestry;

(d) rights to which the provisions of general law respecting landed property apply;

(e) usufruct of immovable property;

(f)  a right to explore for mineral, oil or gas deposits or other natural resources, and a right to mine those deposits or resources; and

(g) a right to receive variable or fixed payments either as consideration for or in respect of the exploitation of, or the right to explore or exploit, mineral, oil or gas deposits, quarries or other places of extraction or exploitation of natural resources.

In your case, it is considered that your rights in the property can be described as immovable property under the Country A Agreement, being 'any other interest in or over land'.

Pursuant to Article 13, Australia has a right to tax gains derived from the alienation of immovable property in Country A.

Question 3

Is the cost base of your CGT asset the market value of your ownership interest in the property at the time you acquired the ownership interest?

Summary

Yes, the cost base is the market value of your ownership interest on the day you acquired it.

Detailed reasoning

Under section 112-20 of the ITAA 1997, the first element of your cost base and reduced cost base will be the market value of the asset (on the day you acquired it) if you did not deal at arm's length with the previous owner in acquiring the asset. This is the market value substitution rule.

The application of this rule to life and remainder interests is covered in Taxation Ruling TR 2006/14 Income tax: capital gains tax: consequences of creating life and remainder interests in property and of later events affecting those interests. Paragraph 94 states:

94. The life interest and remainder owners acquire their respective interests at the time CGT event A1 happens to the original owner: subsection 109-5(2). If no money or property was given to acquire the interest, or the life interest or remainder owner did not deal at arm's length with the original owner in relation to the acquisition of the interest and the total market value of money or property given was not the same as the market value of the interest, its first element of the cost base and reduced cost base is its market value at the time of acquisition: section 112-20.

In your case, the arrangement is described as a 'gift' and is not considered to be an arm's length transaction for the purposes of section 112-20 of the ITAA 1997. Therefore, the market value substitution rule will apply.

A market value at this date needs to take into account the market value of the unencumbered real estate at this time, less the value of the encumbrance.

Question 4

Do your CGT proceeds received from the sale of the property include the amount paid to Person A?

Summary

No, your CGT proceeds do not include the amount paid to Person A?

Detailed reasoning

Under section 104-10 of the ITAA 1997 CGT event A1 occurs when you dispose of a of a CGT asset, or an ownership interest in a CGT asset. Section 100-45 of the ITAA 1997 provides steps to calculate the capital gain or loss you make from the CGT event that happens to you. To determine any capital gain or loss, you need to work out the capital proceeds from the event.

Section 116-20 of the ITAA 1997 provides that capital proceeds are the total of:

•      the money you have received, or are entitled to receive, in respect of the event happening; and

•      the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

At the time the property was sold Person A was entitled to receive an amount directly from the third party purchaser in relation to her interest in the property. This outcome is prescribed under Country A property rules. You had no entitlement to receive this amount.

You were entitled to receive the balance of your share of the sales price. This amount is your capital proceeds.