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You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of private advice

Authorisation Number: 1052070965532

Date of advice: 14 December 2022

Ruling

Subject: CGT events - use and enjoyment before title passes

Question 1

Did CGT event B1 happen when Person B first obtained the use and enjoyment of the property, as a result of the XXXX Agreement?

Answer

Yes

Question 2

Did CGT event E5 happen on payment for the final amount owing under the XXXX Agreement, by virtue of Person B becoming absolutely entitled to the property against the company?

Answer

We don't need to determine this question. It's possible that CGT event E5 will happen, but CGT event B1 will apply because it's the most specific to this situation.

Question 3

Will the proposed transfer result in a separate CGT event occurring in the AAAA income year?

Answer

We don't need to determine this question. It's possible that CGT event A1 will happen when the trustee transfers legal title to Person B (if CGT event A1 hasn't already happened in XXXX or ZZZZ). However, CGT event B1 will apply in preference to CGT event A1 because it's the most specific to this situation. We don't need to determine the time CGT event A1 will happen (if it hasn't happened yet), or when it happened (if it has already happened).

This ruling applies for the following periods:

XXXX income year

AAAA income year

The scheme commences on:

XXXX income year

Relevant facts and circumstances

1.         A company is the trustee for a family trust, and has always acted in that capacity. Person A and Person A's spouse are the company's shareholders and directors. (We'll just call it 'the trustee' in this ruling.)

2.         The trustee employed Person B many years ago. Person B worked full-time for the trustee for some years.

3.         Person B terminated their employment with the trustee some years ago, and hasn't been engaged by the trustee, Person A, or any associated entity since then.

4.         Person B started looking to purchase a residential property in around XXXX. However, Person B didn't have the financial means to purchase one at the time.

5.         Person B considered resigning as the trustee's employee, to seek employment elsewhere on more financially advantageous terms.

6.         As an alternative, Person A proposed that the trustee could help Person B to buy a residential property through a loan agreement.

7.         In the XXXX income year, Person A entered a contract to buy the property. The contract said that the purchaser was Person A or Person A's nominees, the price was $X+Y, and settlement occurred later in the XXXX income year.

8.         The trust financed the property purchase through $X from its own sources, and a loan of $Y from a bank.

9.         Person A nominated the trustee as the substitute purchaser before settlement.

10.      In the XXXX income year, the trustee entered a deed with Person B about the property. (We'll call it the 'XXXX Agreement'). The key terms of the XXXX Agreement were that:

•                     Person B was required to make 52 fortnightly payments to the trustee, to cover both the trustee's contribution of $X, and the trustee's loan repayment obligations (under the $Y bank loan) for that two-year period

•                     Person B was entitled to use and occupy property as licensee at a nominal licence fee per fortnight

•                     Person B was responsible for paying all rates and taxes for the property and keeping it in a proper state of repair and keeping it insured against loss and damage

•                     if Person B defaulted on Person B's obligation to make fortnightly payments, the trustee was entitled to terminate the licence with Person B by giving notice.

11.      After a 2-year period had expired the trustee would transfer the property to Person B on conditions. The conditions were that:

•                     Person B fully repaid the trustee for the purchase price contribution amount of $X, and the trustee's loan repayment obligations on the $Y bank loan for the two-year period

•                     Person B pays the bank enough to discharge the amounts outstanding on the $Y loan

•                     Person B pays the legal costs, stamp duty, GST, registration fees, and all other charges arising from the supply and transfer of the property by the trustee to Person B.

12.      Person B started living in the property during the XXXX income year as Person B's main residence.

13.      Person B started making payments to the trustee during the XXXX income year.

14.      Person B made all the required fortnightly payments under the XXXX Agreement during the two-year period starting in the XXXX income year.

15.      Person B needed to take out a personal loan under Person B's own name to pay out the bank loan, but wasn't able to get one because of limited finances and salary.

16.      The XXXX Agreement didn't explicitly state what would happen if Person B didn't pay the relevant amounts.

17.      However, Person B, Person A, and the trustee agreed that the XXXX Agreement would be varied so that Person B would instead make payments to the trustee for the bank loan over a longer period.

18.      Person B made further payments to the trustee for some years.

19.      In the YYYY income year, Person B made the final payment to the trustee for the amounts needed to repay the bank loan.

20.      Neither Person B nor the trustee purported to terminate the XXXX Agreement at any time.

21.      In the ZZZZ income year, when preparing to transfer the property, the trustee sent Person B a letter asking for Person B to pay:

•                     $A to cover historical council rates and utilities since starting the loan

•                     $B to pay for the legal services for creating legal documents to transfer ownership.

22.      In the ZZZZ income year, Person B paid $A + $B to the trustee.

23.      The parties now wish to transfer title to Person B under the XXXX Agreement.

24.      No other relationship or arrangements exist between Person B and the trustee.

Table 1: Summary of the XXXX Agreement

Provision

Effect

Recitals

The trustee purchased the property on terms allowing for possession during the XXXX income year.

The property purchase was financed by $X contributed by the trustee, and $Y loan from the bank (secured by the property)

If Person B complies with the terms and conditions, Person B has a licence to use and occupy the property for a two-year period starting in the XXXX income year

After that two-year period expires, if Person B complies with the terms and conditions, the trustee shall transfer the property to Person B or Person B's nominee.

Operative provisions

Person B agrees to reimburse the trustee the money to buy the property by making 52 fortnightly payments of $C, starting in the XXXX income year.

Person B agrees to make 52 fortnightly payments of $D to meet the trustee's obligations to make repayments on the $Y bank loan for the two-year period starting in the XXXX income year.

The trustee shall permit Person B to use and occupy the property as licensee for a nominal fee per fortnight.

Person B's use and occupation is subject to Person B being responsible for paying all rates and taxes and keeping the residence in a proper state of repair and keeping it insured against certain loss or damage.

Person B is responsible for all damage to the property and indemnifies the trustee.

The agreement doesn't create a tenancy and Person B's right to use and occupy the property is subject to this agreement only.

If Person B fails to make fortnightly payments within 14 days of the due date, Person B is in default, and the trustee is entitled to terminate the licence and require Person B to quit.

After two years starting in the XXXX income year, the trustee shall transfer the property to Person B and/or Person B's nominee on the conditions that Person B has paid the 52 fortnightly payments, paid out outstanding amounts on the $YK bank loan, and pays legal costs, stamp duty, GST, registration, and all other charges arising from the supply and transfer of the property from the trustee to Person B.

The trustee warrants that it won't add to the loan or obtain any further loan on the security of the property during the agreement term.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 4-5

Income Tax Assessment Act 1997 section 102-25

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-15

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 section 104-55

Income Tax Assessment Act 1997 section 104-75

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 960-100

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless another act is mentioned.

These reasons explain our answers to all three questions. Our reasons are interrelated; haven't addressed each question in isolation.

General principles about capital gains

25.      Very broadly, capital gains provisions assess capital gains when CGT events happen to CGT assets.

•                     Section 102-5 says you include net capital gains from CGT events in your assessable income.

•                     Broadly 'you' means entities recognised by tax laws generally - which include trusts. See sections 4-5 and 960-100.

•                     CGT events are listed in Division 104; each CGT event prescribes specific conditions about when they happen.

•                     Most (but not all) CGT events happen to CGT assets.

•                     CGT assets include property, and legal and equitable rights that aren't property. See section 108-5. A note to that section says examples of CGT assets include land and buildings.

•                     Section 102-25 is about the order of applying CGT events. Subsection 102-25(1) says if more than one event can happen, the one you use is the one that is the most specific to your situation.

CGT events

26.      Some CGT events which may be relevant to these facts include:

•                     CGT event B1, about the right to use or enjoy a CGT asset before title passes

•                     CGT event A1, about disposing a CGT asset to another entity

•                     CGT event D1, about creating contractual, legal, or equitable rights

•                     CGT event E1, about creating a trust over a CGT asset

•                     CGT event E5, about a beneficiary becoming absolutely entitled to a CGT asset.

We'll address CGT event B1 first because - as we explain at paragraph 37 - it seems most specific to this situation.

CGT event B1

CGT event B1 happens when you grant the right to use and enjoy a CGT asset to another entity before title eventually passes to them

27.      CGT event B1 happens when you agree for the right to use and enjoy a CGT asset to pass to another entity, before title ultimately passes to them. Subsection 104-15(1) says:

CGT event B1 happens if you enter into an agreement with another entity under which:

(a)          the right to the use and enjoyment of a *CGT asset you own passes to the other entity; and

(b)          title in the asset will or may pass to the other entity at or before the end of the agreement.

28.      Subsection 104-15(2) says the time of the event is when the other entity first obtains the use and enjoyment of the asset.

29.      Subsection 102-15(4) says the capital gain or capital loss is disregarded if title didn't pass.

30.      ATO guidance suggests the agreement doesn't need to have a definite period. TD 1999/78[1] says that for CGT event B1 purposes, the agreement doesn't have to be for a fixed or defined period, and can also end on the occurrence of a particular event.

CGT event B1 happened when Person B became entitled to occupy the property

31.      CGT event B1 happened when the parties entered the XXXX Agreement. The agreement allowed Person B to occupy the property, and gave Person B a right to be transferred the property outright if Person B made certain payments. That period was originally two years, but varied by agreement to become an indefinite period. (We don't think it matters that the agreement was varied, and that there may be some doubt about whether the variation was legally enforceable in contract law.[2]) The trustee proposes to transfer title to Person B under that agreement. The elements of CGT event B1 are met.

32.      Here, the time of the event is when Person B became entitled to use and occupy the property in the XXXX income year.

Other CGT events

33.      It's possible that other CGT events may either happen, or have already happened, under this scenario. They may include CGT event A1, CGT event D1, CGT event E1, and CGT event E5. We'll briefly touch on these in Table 2.

Table 2: other possible CGT events

CGT event

Summary of relevant law

Comments

CGT event A1.

Section 104-10 says CGT event A1 happens when there's a disposal to another entity. A disposal happens when there's a change of ownership to another entity, but not where there's a change in legal ownership without a change of beneficial ownership.[3]

The time of the event is either a) the contract, or b) when the change of ownership happens.

When an original agreement is varied by a second agreement, the relevant contract is the one which is properly seen as the source of the disposal.[4]

There will be a disposal, but the time that disposal happened, or will happen, is unclear. Person B's rights to occupy the property (before Person B paid off the debt) wouldn't have amounted to beneficial ownership. Person B will eventually receive outright legal and beneficial ownership when the property is transferred to Person B. It's possible that Person B may have acquired legal or equitable rights to have the property transferred in ZZZZ when Person B made all necessary payments required by the trustee.[5] It's possible that those legal or equitable rights could have made Person B the beneficial owner of the property in ZZZZ.

The time of the event could depend on several factors, including whether the variation to the XXXX Agreement was enforceable, and whether the trustee's obligation to transfer the property is best characterised as stemming from the original agreement or the varied agreement.

CGT event D1

Section 104-35 says CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. But paragraph 104-35(5)(b) says CGT event D1 doesn't happen if the right requires you to do something that is another CGT event that happens to you.

CGT event D1 won't happen here. When it entered the XXXX Agreement, the trust created two rights in Person B. First, Person B received the right to occupy the property. Second, Person B received the right to have the property transferred if Person B made certain payments. Those are contractual or other legal or equitable rights. But both of those rights require the trustee to do things which cause CGT events to happen to it. Granting the right to occupy the property caused CGT event B1 to happen for the reasons explained at paragraph 31. Granting the right to have the property transferred will require the trustee to dispose the property, causing CGT event A1 to happen to it. It follows that the exception in paragraph 104-35(5)(b) applies.

CGT event E5

Section 104-75 says CGT event E5 happens if a beneficiary becomes absolutely entitled to a trust asset, and the trust isn't a unit trust or a deceased estate.

Broadly, the ATO view is that a beneficiary is absolutely entitled to an asset when it can direct the trustee to transfer it. See TR 2004/D25[6] at paragraph 10.

We don't have enough information to determine if CGT event E5 happens here. We don't know if Person B was a beneficiary of the trust, or if Person B became entitled to the property in that capacity. (Even if Person B was a beneficiary, the decision to buy the property and enter the agreement may have been a management decision by the trustee to secure the employee's ongoing services to better run the trust and any business it may carry on.)

It's also possible that the trustee held the CGT asset under a separate constructive trust,[7] but we don't have enough information to determine that either. When Person B paid out the loan in ZZZZ, Person B may have had an equitable entitlement to demand the property be transferred. It's possible that a court may construe those circumstances as creating a separate trust over the property. (In that case, Person B may have been absolutely entitled to the asset.)

CGT event E1

Section 104-55 says CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement.

TD 2019/14[8] at paragraph 57 says that a trust is created by declaration when it is created by words or conduct demonstrating an intention to create an express trust over property. At paragraph 58, it says a trust is created by settlement when property is vested in a trustee for the benefit of others.

 

Not clear if this is met. It's possible that a court might construe these circumstances as having created a constructive trust over the property in favour of Person B from ZZZZ. In that case, there'd be a question about whether any entity had created the trust: arguably it would be created by operation of law, rather than being declared or settled by any relevant entity.

 

34.      We don't need to determine whether other CGT events will happen or have already happened, or the time of those possible CGT events. As we explain at paragraph 37, we think that CGT event B1 is the most specific to this situation. That means it will apply in priority to any other CGT event.

Priority rules

CGT event B1 will apply in preference to the other CGT events, because we think it's the most specific to these circumstances.

35.      Section 102-25 is about the order of applying CGT events. Subsection 102-25(1) says if more than one event can happen, the one you use is the one that is the most specific to your situation. There are exceptions, but they don't seem relevant here.

36.      There's ATO view material suggesting that CGT event B1 will usually be the 'most specific' to a rent-buy situation. ATO ID 2005/216[9] was about a taxpayer transferring property to a child under an agreement with similar features to this case. The taxpayer and child agreed that the child could use and enjoy the property until they repaid the outstanding loan on the house. The transfer happened five years later when the child repaid the loan. ATO ID 2005/216 said that both CGT event A1 and B1 happened, but B1 was the most specific to the circumstances. There were no CGT consequences when title was transferred. Similarly, TD 1999/78 (also about CGT event B1) says that when an asset does pass during or at the end of the relevant period, there are no other consequences.

37.      We'll apply CGT event B1 here, not any other CGT event. The arrangement gives Person B a right to occupy the property before title passes. If title eventually passes, CGT event B1 will happen. CGT event A1 will happen, but that's a generic transfer of ownership. We think B1 is more specific to these circumstances because there are more elements to establish (a change of ownership, and a period of enjoyment beforehand), and they fit this scenario here. This is consistent with ATO ID 2005/216. We think B1 would also be more specific than any event applying to trusts: the purpose of the arrangement was to allow Person B to enjoy the property in the short term, and eventually get outright ownership. There's some doubt about whether CGT event E1 or E5 would happen, but even if they did, we think CGT event B1 is more specific. Person B's entitlements to use and acquire the property seem to have derived from the original agreement: Person B's equitable rights as a possible beneficiary (which might trigger E1 or E5) are arguably consequential or secondary.

38.      Since CGT event B1 is the most specific event, it's the only CGT event that has practical consequences. Following TD 1999/78 and ATO ID 2005/216, there will be no other CGT consequences when the trustee transfers the property to Person B, even though other CGT events may have happened.

Conclusion

39.      We've concluded that CGT event B1 happened in XXXX, and there will be no other practical CGT consequences from the scenario. It doesn't matter whether other CGT events have happened or will happen. CGT event B1 is the most specific to these circumstances, so if other CGT events also happen, CGT event B1 will apply in priority. For completeness, CGT event A1 either will happen or has already happened, and it's possible that CGT event E1 or E5 could also have happened in ZZZZ. We don't need to determine whether they have happened (or will happen), or to work out the time they happened (or will happen).


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[1] Taxation Determination TD 1999/78 Income tax: capital gains: for the purposes of CGT event B1, what is meant by the expression 'at the end of an agreement' in section 104-15 of the Income Tax Assessment Act 1997?

[2] There's some complexity about whether oral variations to written contracts are valid or enforceable. See Carter, JW (2019), Carter on Contract, at Chapter 9, accessed at https://advance.lexis.com on 12 and 13 December 2022.

[3] By implication, a change in ownership will happen if you continue to be the asset's legal owner, but stop being the beneficial owner. This position was approved in the Full Federal Court decision in Ellison and Another v Sandini Pty Ltd and Others [2018] FCAFC 44; (2018) 263 FCR 460 at p.482 [93] (per Jagot J, Siopis J agreeing). See also the ATO Decision Impact Statement on Ellison and Another v Sandini Pty Ltd and Others [2018] FCAFC 44.

[4] Commissioner of Taxation (Cth) v Sara Lee Household & Body Care (Australia) Pty Ltd [2000] HCA 35 (2000) 201 CLR 520 at p.539 [49] per Gleeson CJ, Gaudron, McHugh, and Hayne JJ.

[5] If the variation to the XXXX Agreement was enforceable, Person B may have had rights in contract to have the property transferred (specific performance). There's some complexity about whether oral variations to written contracts are valid or enforceable. If Person B had no contractual rights, he may have had other rights in law or equity, such as under a claim for promissory estoppel. See Carter, JW (2019), Carter on Contract, at Chapters 7 and 9, accessed at https://advance.lexis.com on 12 and 13 December 2022. It's also possible the circumstances might cause a court to recognise a constructive trust. See our discussion of CGT event E5 in Table 2.

[6] 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.

[7] Very broadly, constructive trusts arise where recognised by courts where the circumstances make it unconscionable for the legal owner to retain beneficial ownership. They're recognised by operation of law, not the express intention of a trustee. They're imposed regardless of actual or presumed intention, in circumstances where it would be a fraud, or unconscionable, for a party to deny the trust's existence. However, courts might decline to impose a constructive trust where there's an appropriate alternative equitable remedy. See generally Heydon, JD and Leeming, MJ (2016) Jacob's Law of Trusts in Australia, 8th edn, LexisNexis Butterworths Australia [Chapter 13]. Accessed online at https://advance.lexis.com 29 November 2022.[7]

[8] Taxation Determination TD 2019/14 Income tax: will a trust split arrangement of the type described in this Determination cause a new trust to be settled over some but not all assets of the original trust with the result that CGT event E1 in subsection 104-55(1) of the Income Tax Assessment Act 1997 happens?

[9] ATO Interpretative Decision ATO ID 2005/216 Income Tax Capital gains tax: CGT event B1: right to use property before title passes.


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