Edited version of private advice

Authorisation Number: 1052072584542

Date of advice: 31 January 2023

Ruling

Subject: CGT - beneficial ownership

Question 1

Will CGT event A1 happen on the transfer by Individual A of their legal ownership interest in various properties to Individual B and Individual C?

Answer

Yes.

Question 2

Will CGT event A1 happen on the transfer by Individual B and Individual C of their legal ownership interests in various properties to Individual A?

Answer

Yes.

Question 3

In respect to the transfer by Individual A of their legal ownership interest in various properties to Individual B and Individual C will the transfer be a taxable supply and, if yes, by which entity or entities?

Answer

Yes. The transfer of Individual A's ownership interest in the properties will be a taxable supply by the tax law partnership.

Question 4

In respect to the transfer by Individual B and Individual C of their legal ownership interest in various properties to Individual A will the transfer be a taxable supply and, if yes, by which entity or entities?

Answer

Yes. The transfer of Individual B and Individual C's ownership interests in the properties will be a taxable supply by the tax law partnership.

This private ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Individual A, B and C (you) are a tax law partnership.

Individual B and Individual C are married and have been friends with Individual A for a period of time.

In or around 20XX, Individual B and Individual C (X% jointly) and Individual A (X%) purchased a number of rental properties.

All the properties are owned as tenants in common and not as joint tenants. Individual B/Individual C and Individual A have no other properties in common ownership.

Each property was leased at the date of acquisition and, at all relevant times from acquisition, each property has been leased or available for lease to third party tenants on commercial terms.

The rents from the properties are received by Individual B, Individual C and Individual A as partners in the partnership. There is no written partnership agreement, being a tax law partnership in receipt of income jointly.

Under the lease, the tenant of each property is responsible for rates, insurances, and other expenses of the property.

Under the lease, Individual B, Individual C and Individual A, as the landlord, are responsible for the landlord's expenses of the property, including rates and land tax but may be reimbursed certain expenses from the tenant under the lease.

The rents are received into a Bank Account and landlord expenses are paid from the Bank Account in the names of Individual A, Individual B and Individual C.

The loan to acquire the properties has been repaid from the rents accumulated over time.

At all relevant times since acquisition, the properties have been managed by real estate agents with the current agents.

The intent at acquisition was to lease the properties and hold them as long-term investments to support the parties in retirement.

Individual A, Individual B and Individual C discussed and agreed on the allocation of property ownership before acquiring the properties. The allocation was based on the value of the properties at the time of acquisition. That ownership had been discussed with their accountant.

A File Note dated purports to evidence the intention for equitable ownership of separate titles subsequently prepared by your accountant at the time.

The financier required you to take one loan for all properties and be on the title to each property for security purposes.

The individuals are now able to refinance or discharge any finance in respect of the properties so that the title to each property can be transferred into the intended ownership in preparation for retirement.

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 104-55(4)

Income Tax Assessment Act 1997 subsection 104-75(1)

Income Tax Assessment Act 1997 subsection 106-50

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 38-325

Reasons for decision

Questions 1 and 2

Capital gains tax (CGT) is the tax you pay on any capital gain you make. You make a capital gain as a result of a CGT event (section 102-20 of the ITAA 1997).

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the (ITAA 1997)).

You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner (subsection 104-10(2) of the ITAA 1997).

A beneficial owner is the person or entity who is beneficially entitled to the income and proceeds from the CGT asset. A legal owner is the individual who has their name on the legal documents associated with the asset, such as a title deed. An individual can be the legal owner but have no beneficial ownership in an asset. It is the beneficial owner of a CGT asset that is liable for capital gains tax upon disposal of the asset, not the legal owner.

Legal and beneficial ownership

Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners (TR 93/32) provides:

•         Co-ownership of rental property is a partnership for income tax purposes but is not a partnership at general law unless the ownership amounts to the carrying on of a business (para. 3)

•         Where co-ownership is a partnership for income tax purposes only, the income/loss from the rental property is derived from co-ownership of the property and not from the distribution of partnership profits/losses (para. 4)

•         Because co-owners of rental property are generally not partners at general law, a partnership agreement, either oral or in writing, has no effect on the sharing of income/loss from the property (para. 5)

•         Accordingly, the income/loss from the rental property must be shared according to the legal interest of the owners except in those very limited circumstances where there is sufficient evidence to establish that the equitable interest is different from the legal title

•         The definition of partnership is wider for income tax purposes than it is at general law. Subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) defines partnership as 'an association of persons carrying on business as partners or in receipt of income jointly but does not include a company' (para. 24)

•         Under the extended income tax definition of partnership, it is not necessary that persons carry on a business for their association to be treated as a partnership for income tax purposes. They need only to be in receipt of income jointly. Therefore, co-owners of rental property come within the definition of "partnership" for income tax purposes, not because they are necessarily partners at general law, but because they are in receipt of income jointly (para. 25)

•         It has been said that if the equitable interest does not follow the legal title, there is some basis for the profit/loss to be distributed on the equitable and not the legal basis (para. 38)

•         We consider that there are extremely limited circumstances where the legal and equitable interests are not the same and that there is sufficient evidence to establish that the equitable interest is different from the legal title. We will assume where taxpayers are related, e.g., husband and wife, that the equitable right is exactly the same as the legal title (para. 41), and

•         Any capital gain or loss should also be apportioned on the same basis as the rental income or loss (para. 42).

Absolute entitlement

Section 106-50 of the ITAA 1997 explains that if you are absolutely entitled to a CGT asset as against the trustee of a trust (disregarding any legal disability), Part 3-1 and Part 3-3 apply to an act done by the trustee in relation to the asset as if you had done it.

Draft Taxation Ruling TR 2004/D25 discusses the circumstances in which a beneficiary of a trust is considered to be absolutely entitled to a CGT asset of a trust as against its trustee.

The core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction.

The most straight forward application of this core principle is one where a single beneficiary has all the interests in the trust asset.

Paragraphs 23 and 24 of TR 2004/D24 state that:

If there is more than one beneficiary with interests in the trust asset, then it will usually not be possible for any one beneficiary to call for the asset to be transferred to them or to be transferred at their direction. This is because their entitlement is not to the entire asset.

There is, however, a particular circumstance where such a beneficiary can be considered absolutely entitled to a specific number of the trust assets for CGT purposes. This circumstance is where:

•         the assets are fungible;

•         the beneficiary is entitled against the trustee to have their interest in those assets satisfied by a distribution or allocation in their favour of a specific number of them; and

•         there is a very clear understanding on the part of all the relevant parties that the beneficiary is entitled, to the exclusion of the other beneficiaries, to that specific number of the trust's assets.

Assets are fungible if each asset matches the same description such that one asset can be replaced with another. Note that land would rarely be fungible because each parcel of land is unique.

Application to your circumstances

Legal and beneficial ownership

In this case all properties are owned as tenants in common by Individual A, Individual B and Individual C. The properties have been used to derive rental income since they were acquired.

In order to accept that a CGT event will not occur as a result of the proposed transfers we need to be satisfied that there is no change to the beneficial ownership of each property. As discussed, the beneficial owner is the person who is entitled to the income and proceeds from the asset.

Based on the information provided, the income derived in relation to the properties was split between Individual A, Individual B and Individual C in accordance with legal title rather than the intended ownership of the properties. Therefore, we consider that Individual A, Individual B and Individual C have a beneficial ownership interest in accordance with the legal title of each of the properties.

CGT event A1 will occur (for each property) when Individual A transfers their legal ownership interest in properties 1, 2 and 3 to Individual B and Individual C.

CGT event A1 will occur (for each party and each property) when Individual B and Individual C transfer their legal ownership interests in properties 4, 5 and 6 to Individual A.

Absolute entitlement

As discussed in TR 2004/D25, if there is more than one beneficiary with interest in the trust asset, then it will usually not be possible for any one beneficiary to call for the asset to be transferred to them. This is because their entitlement is not to the entire asset. The only circumstance where such a beneficiary can be considered absolutely entitled is where the assets are fungible.

We do not consider there is any evidence to suggest that certain properties were being held in trust for the benefit of a specific party/parties given the income and expenses were reported by each of the relevant parties in accordance with the legal title of each property.

Further, the properties in question are not fungible assets as each property is unique. Therefore we do not accept that any of the relevant parties were absolutely entitled to specific properties.

Questions 3 and 4

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a taxable supply if:

(a)  you make the supply for consideration; and

(b)  the supply is made in the course or furtherance of an enterprise that you carry on; and

(c)   the supply is connected to the indirect tax zone (Australia); and

(d)  you are registered or required to be registered for GST.

However, the supply will not be a taxable supply to the extent the supply is GST-free or input taxed.

Goods and Services Tax Ruling GSTR 2004/6 Goods and services tax: tax law partnerships and co-owners of property (GSTR 2004/6) sets out the Commissioner's view of how the GST law applies to transactions involving tax law partnerships.

118. If an enterprise partnership is formed when two or more entities enter into a contract to acquire an income producing property, the acquisitions of the property and any conveyancing services required for that acquisition are made by the partnership in the course of the commencement of its enterprise. The partnership is entitled to claim input tax credits for these acquisitions if they are creditable acquisitions under section 11-5.

In your case, the tax law partnership was formed when Individual A, Individual B and Individual C entered into the contracts to purchase the properties that would become income producing through the commercial leasing enterprise.

100. Our view that a tax law partnership can have partnership assets relies in part on comments made by Fitzgerald J in Walsh. In that case, his Honour in his comments in relation to whether or not there was a partnership under the second limb of the definition of a partnership in subsection 6(1) of the ITAA 1936, said:

The other basis upon which the Commissioner contended that, for income tax purposes, a partnership existed between Syncarpia and the other two companies was that they were in receipt of income jointly.

...The only income which might have been received jointly by Syncarpia and its co-venturers for present purposes is the profit arising from the sale: sec.26(a) and 26AAA of the Act.

The only asset of any such partnership was again the land. Again the partners held the legal title to the land as tenants in common. There is nothing in the Act of which I am aware which attributes to such a notional partnership for income tax purposes any of the consequences of a true partnership under the general law. Each of the partners accordingly also held the beneficial title to its interest in the land as a tenant in common.

...The partnership, or at least the partners, sold the land. The partners paid off their joint debts and were left with the profit.

103. We agree with the Tribunal's view that a tax law partnership does not have capital. We further take the view that partners in a tax law partnership have neither interests in the capital of a partnership, nor interests in the partnership. The only interest that a partner in a tax law partnership has is an interest in the property, coupled with a right to a share of the net income or losses in accordance with that interest.

105. We consider that the comments made by Fitzgerald J in Walsh add support to the view that a tax law partnership can have assets.

The acquisition of the properties was the initial activity that commenced the enterprise of the tax law partnership. Without the properties, there is no income. Therefore, the properties are an asset of the tax law partnership.

This is supported by the expensing and depreciation claims for the properties in the tax law partnership's taxation returns.

Therefore, it is the tax law partnership that is making the supply of each party's interest in the properties. As all of the requirements in section 9-5 of the GST Act are met, the supplies will be taxable supplies.

Additional information

Where each property is the subject of an ongoing commercial lease, a tax law partnership may be able to supply the property along with the reversion of the lease as a going concern.

The supply of a going concern is GST-free if the requirements of subsection 38-325(1) are met. Those requirements are:

•         the supply is for consideration; and

•         the recipient of the supply is registered or required to be registered; and

•         the supplier and the recipient have agreed in writing that the supply is of a going concern.

We consider that an enterprise partnership can make a supply of a going concern. The partnership makes a supply of a going concern under subsection 38-325(2) if the supply is made under an arrangement under which:

•         the partnership supplies to the recipient all of the things necessary for the continued operation of an enterprise; and

•         the partnership carries on or will carry on the enterprise until the day of the supply.