Edited version of private advice

Authorisation Number: 1052148598796

Date of advice: 9 August 2023

Ruling

Subject: CGT - capital proceeds

Question 1

Did the time of the CGT event A1 occur in the 20XX income year in relation to the disposal of Couple A's interest in the Property?

Answer

>Yes.

Question 2

Will the market value substitution rule apply to the disposal of Couple A's interest in the Property so that the capital proceeds received will be the market value of their interest in the Property at the time of the event?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

XX July 20XX

Relevant facts and circumstances

On or about XX November 19XX, Person A and Person B (Couple A) together with their children, Child A and Child B, purchased a property (the Property) for $X

The Property was owned by the following parties:

•                     Couple A as joint tenants, a one third ownership interest

•                     Child A, a one third ownership interest

•                     Child B, a one third ownership interest.

The purchase was funded by a loan from a bank in the names of Couple A, Child A and Child B, secured by a mortgage over the Property.

In about late 20XX, Child B decided they wanted to sell their share in the Property for $X, and Couple A, Child A and Child B agreed that Person C, Child A's spouse, would become a co-owner of the Property.

On or about XX May 20XX, Child B sold their share of the Property in equal parts to Person C and Child A (Couple B), and Couple A.

The bank loan was increased by $X which was then paid to Child B. Couple A and Couple B were the borrowers.

The Property was now owned by the following parties:

•                     Couple A as joint tenants, a one half ownership interest.

•                     Couple B as joint tenants, a one half ownership interest.

The Property was tenanted, and the rent was used to pay the loan and other costs associated with the Property.

In about December 20XX/January 20XX, the tenants in the Property moved out and Couple B and their children moved in.

Couple B began to pay rent of $X per week, which was used to pay the bank loan.

Both Couple A and Couple B paid $X per month to a joint account for the payment of other expenses associated with the Property.

In approximately February 20XX, Couple A and Couple B entered into a binding oral contract, for Couple A to sell their 50% ownership interest in the Property to Couple B for the amount of $X. This is not the market value of Couple A's interest in the Property in 20XX.

There has been some dispute between Couple A and Couple B about the nature of the agreement surrounding Couple A's disposal of their interest in the Property to Couple B.

On XX October 20XX Couple A received legal advice from Barristers, that the Sale Agreement was a legally binding agreement that was formed in 20XX.

Couple A will transfer their interest in the Property to Couple B before the end of the 20XX-XX income year.

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 104-10(3)

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

Detailed reasoning

CGT event A1 occurs when you dispose of a CGT asset.

For CGT purposes, disposal is defined in subsection 104-10(2) of the Income Tax Assessment Act 1997 (ITAA 1997) as being when a change in ownership occurs from one entity to another because of some act or event or by operation of law.

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

While the time of a disposal is deemed to take place when a contract is made, paragraph 3 of Taxation Determination TD 94/89 states that a taxpayer is not required to include any capital gain or loss in the appropriate year until an actual change of ownership occurs.

It is settlement that effects a change of ownership and a disposal.

Application to your situation

Couple A entered into a binding oral contract with Couple B in approximately February 20XX, to dispose of their interest in the Property to Couple B. Legal advice received from Barristers confirms that the Sale Agreement was a legally binding agreement that was formed in 20XX.

The time of the event for the disposal of Couple A's interest in the Property is when they entered into the contract with Couple B, being approximately February 20XX.

The transfer of Couple A's interest in the Property has not yet taken place. It will take place before the end of the 20XX-XX income year.

Therefore, once the actual change of ownership takes place, Couple A will be required to include the capital gain made on the disposal of their interest in the Property in their income tax returns for the relevant year. If an assessment has already been made for that year of income, they will need to have that assessment amended. There is no time limit to make an amendment of this nature.

Question 2

Detailed reasoning

Subsection 116-20 of the ITAA 1997 states that the capital proceeds from a CGT event are the total of:

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

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

The general rules may be modified if the market value substitution rule in section 112-20 of the ITAA 1997 applies.

The capital proceeds from a CGT event are replaced with the market value of the CGT asset that is subject to the event if:

(a)          Some or all of those proceeds cannot be valued; or

(b)          Those capital proceeds are more or less than the market value of the asset and:

(i)            you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event; or

(ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings).

The market value is worked out as at the time of the event.

Whether parties have dealt at arm's length is a question of fact that must be determined in any particular case. The law looks at not only the relationship between the parties but also the quality of the bargaining between them.

An individual is said to be dealing at arm's length with someone if each party acts independently and neither party exercises influence or control over the other in connection with the transaction.

Parties are not at arm's length where the parties are related or associated in some way so that while each party may enter a transaction with some self interest in mind, it may also take into consideration the interests of the other party in making the agreement. Examples of such relationships are transactions between family members and related corporations

Application to your situation

In approximately February 20XX, Couple A and Couple B entered into a binding oral contract, for Couple A to sell their 50% ownership interest in the Property to Couple B for the amount of $X.

However, this is not the market value of Couple A's interest in the Property in 20XX. In fact, in late 20XX, Child B sold their one third interest in the Property for the same amount.

As the capital proceeds that Couple A will receive for their interest in the Property is not the market value of that interest, and Couple A and Couple B are not dealing with each other at arm's length in connection to the event, the capital proceeds Couple A will receive for the disposal of their interest in the Property will be replaced by the market value of their interest in February 20XX.