Edited version of private advice

Authorisation Number: 1052149689690

Date of advice: 18 August 2023

Ruling

Subject: CGT - legal v beneficial ownership

Question

Is the cost base for calculating capital gains tax (CGT) on the disposal of the real property calculated under item 4 of the table in subsection 128-15(4) of the Income Tax Assessment Act (ITAA 1997)?

Answer

No

This ruling applies for the following period:

year ended 30 June 20XX

Relevant facts and circumstances

1.    In 19XX your Parents bought the property as vacant land pre-CGT.

2.    In 19XX your Parents built a house.

3.    Your Parents lived in the house as their main residence from the completion of the construction until 19XX.

4.    In 19XX your Parents lent the certificate of title to a friend who mortgaged the property to the Bank for approximately $XXX,000.

5.    The friend defaulted on the loan and the Bank notified your Parents that they would sell the house.

6.    You jointly agreed to assist your Parents by taking on a mortgage over the property as tenants in common, to pay back the debt to the Bank created by the friend's default as you did not have enough funds to pay the debt outright.

7.    You took on the mortgage to assist your Parents to retain their home and you had no intention to hold the property beneficially or for your own benefit.

8.    On DDMMYYYY a transfer of ownership to you and a registered mortgage was recorded on the certificate of title, post CGT.

9.    You were recorded on the certificate of title as tenants in common.

10.  You state that the transfer of ownership on the certificate of title was done by the Bank and not under your instruction or at your request.

11.  Your Parents paid for all the expenses associated with living in the house.

12.  In 19XX your Parents moved to be closer to you and they lived in another house purchased by you.

13.  Your Parents did not own any other real estate property.

14.  The Property was used as a family holiday house after your Parents moved out.

15.  In MMYYYY your father passed away.

16.  In MMYYYY your mother passed away.

17.  The Property was disposed of on DDMMYYYY.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 Division 102

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 section 109-5

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 Division 128

Income Tax Assessment Act 1997 subsection 128-15(2)

Income Tax Assessment Act 1997 subsection 128-15(3)

Income Tax Assessment Act 1997 subsection 128-15(4)

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Unless otherwise stated, all legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997).

Question 1

Summary

The legal and beneficial ownership of the Property transferred from your Parents to you post CGT.

Your disposal of the property in 20XX triggered CGT event A1 when your ownership ended. You will make a capital gain if the capital proceeds exceed the cost base.

The calculation of the cost base in section 110-25 is modified by the market value substitution rule in section 112-20. Under the market value substitution rule you are taken to have acquired your ownership interest in the property for its market value in 19XX when the contract to dispose of the asset was entered into or if there was no contract, the time of disposal is when the change of ownership occurred.

As the deceased did not own the property just before dying Division 128 has no application and as a result the cost base will not be calculated using the table in subsection 128-15(4).

Detailed reasoning

Capital gains tax

Section 102-20 states that a capital gain or capital loss is made if a CGT event happens to a CGT asset. CGT assets include any kind of property or a legal or equitable right that is not property. Note 1 to section 108-5 lists land and buildings as an example.

Section 104-5 sets out a list of CGT events. Capital gains are triggered when a CGT event in Division 104 happens. Of relevance is CGT event A1 which happens if you dispose of a CGT asset (section 104-10).

Where an asset has been acquired on or after 20 September 1985, if a CGT event happens, you may make a net capital gain or loss from the event. Generally, you make a capital gain when the capital proceeds exceed the cost base. You make a capital loss when the reduced cost base exceeds the capital proceeds (subsection 104-10(4)). Broadly, capital proceeds include the money and market value of property you receive (or are entitled to receive) when an event happens (section 116-20). The cost base includes the money and market value of property you provide (or are required to provide) to acquire a CGT asset, and some other costs (section 110-25).

Division 102 includes net capital gains from CGT events in your assessable income.

Section 102-20 provides that capital gains tax (CGT) is incurred when a CGT event takes place, and you make a gain from the event.

There are exceptions to the general rule, and of relevance is paragraph 104-10(5)(a) that states that a capital gain or capital loss is disregarded if you acquired the asset before 20 September 1985.

'Acquire' is defined in section 995-1:

(a) a CGT asset: you acquire a CGT asset (in its capacity as a CGT asset) in the circumstances and at the time worked out under Division 109 (including a provision listed in Subdivision 109-B); and...

You acquire a CGT asset when you become its owner and the time when you acquire the asset is when you become its owner (subsection 109-5(1)). Subsection 109-5(2) has specific rules for the circumstances in which, and the time at which, you acquire a CGT asset as a result of a CGT event happening.

Essentially, a CGT asset acquired before 20 September 1985 remains a pre-CGT asset if the majority underlying interests in the asset have not changed since 20 September 1985 (Division 149). A change of ownership after 20 September 1985 will result in an asset losing its pre-CGT status.

CGT event A1- disposal of a CGT asset

CGT event A1 is the disposal of a CGT asset pursuant to subsection 104-10(1). Subsection 104-10(2) states that a taxpayer will dispose of a CGT asset if a change of ownership occurs from the taxpayer to another entity.

Paragraph 104-10(3)(a) provides that the timing of the CGT event will be when the contract to dispose of the asset is entered into by the taxpayer. Paragraph 104-10(3)(b) explains that if there is no contract, the time of disposal will be when the change of ownership occurred.

Subsection 104-10(1) provides that CGT event A1 happens when you dispose of an asset and there is a change of ownership from one entity to another. It clarifies that a change of ownership doesn't occur if you stop being the legal owner but continue to be the beneficial owner (Subsection 104-10(2)).

When considering the disposal of real property, the most important element in the application of the CGT provisions is ownership. In absence of evidence to the contrary, property is considered to be owned by person(s) registered on the certificate of title.

Legal and beneficial (equitable) ownership

A person's legal interest in a property is determined by the legal title to that property. The legal owner of the property is recorded on the certificate of title for the property issued under that State's or Territory's legislation. A beneficial owner is a person or entity who is beneficially entitled to the income and proceeds from the asset.

Generally, the legal and beneficial ownership are the same. Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners (TR 93/32) sets out the principle that equitable interest is presumed to follow the legal interest and the Commissioner considers that there are extremely limited circumstances where the legal and equitable interests are not the same. Where it is contended that the beneficial ownership and legal ownership of a property are not the same, there must be strong evidence to show that the legal owner holds the property in trust for the beneficial owner.

Trusts

Broadly trusts may be of three kinds: constructive, resulting or express.

Express Trust

An express trust is one intentionally created by the owner of property in order to confer a benefit upon another. It is created by express declaration, which can be affected by some agreement or common intention held by the parties to the trust.

For an express trust to be created it is necessary that there is certainty of the intention to create a trust, subject matter and the object of the trust. While trusts can be created orally, all State Property Law Acts contain provisions that preclude the creation or transfer of interests in land except if evidenced in writing.

Constructive Trusts

A constructive trust is a trust imposed by operation of law, regardless of the intentions of the parties concerned. It applies whenever equity considers it unconscionable for the party holding title to the property in question to deny the interest claimed by another. The existence of a constructive trust is dependent upon the order of the court.

Resulting or implied trusts

On the purchase of real property, a resulting trust may be presumed where the legal title that vests in one or more of the parties does not reflect the respective contributions of the parties to the purchase price.

Cost base

Where the CGT event A1 occurs, you make a capital gain when the capital proceeds exceed the cost base. The general rules about cost base are set out in section 110-25. Subsection 110-25(1) of the ITAA 1997 states that the cost base of a CGT asset is made up of five elements.

Subsection 110-25(2) of the ITAA 1997 provides that:

The first element is the total of:

(a) the money you paid, or are required to pay, in respect of acquiring it; and

(b) the market value of any other property you gave, or are required to give, in respect of acquiring the asset (worked out as at the time of acquisition)

The market value substitution rule

There are a number of modifications to the general rules about cost base. The market value substitution rule in section 112-20 modifies the general rule by replacing the first element of the cost base and reduced cost base of a CGT asset acquired from another entity with its market value (at the time of acquisition) where:

(a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from:

(i) CGT event D1 happening; or

(ii) Another entity doing something that did not constitute a CGT event happening; or

(b) some or all of the expenditure you incurred to acquire it cannot be valued; or

(c) you did not deal at arm's length with the other entity in connection with the acquisition.

Division 128

Division 128 of the ITAA 1997 contains rules that apply when an asset owned by a person just before they die, passes to their legal personal representative (LPR) or passes to a beneficiary in a deceased estate, and includes modifications to the cost base.

Subsection 128-15(2) of the ITAA 1997 provides that the legal personal representative, or beneficiary, is taken to have acquired the asset on the date of death.

Subsection 128-15(3) of the ITAA 1997 provides special rules for legal personal representatives and states that any capital gain or capital loss the legal personal representative makes if the asset passes to a beneficiary of the deceased estate is disregarded.

Generally, if you are a beneficiary, you are taken to have acquired the asset on the day the person died, but CGT does not apply when you acquire the asset. However, a subsequent sale by the beneficiary may be subject to capital gains tax.

Subsection 128-15(4) of the ITAA 1997 contains a table that sets out the modifications to the cost base and reduced cost base of the CGT asset in the hands of the legal personal representative or beneficiary depending on the kind of CGT asset. Specifically, it sets out at item 4 of the table in 128-15(4) provides that for a CGT asset the deceased acquired before 20 September 1985, the first element of the cost base or reduced cost base is the market value of the asset on the date of death.

Discount capital gains

Division 115 of the ITAA 1997 provides the conditions for a discount capital gain.

You make a discount capital gain if the following requirements are satisfied:

• you are an individual
• a CGT event happens to a CGT asset of yours after 11:45am (by legal time in the Australian Capital Territory) on 21 September 1999
• you acquired the CGT asset at least 12 months before the CGT event, and
• you do not choose to use the indexation method.

For Australian resident individuals the discount percentage is 50%. However, you can only reduce your capital gain after applying all your capital losses for the year and any unapplied net capital losses from earlier years.

Application to your circumstances

The real property is a CGT asset under subsection 108-5(1).

Your Parents acquired the property in 19XX, before 20 September 1985, therefore the asset is at that time a pre-CGT asset.

In 19XX, post CGT the property was transferred into your names as tenants in common. At that time you became legal owners of the property. The loan to finance the amount owing on the property was also in your names as tenants in common. You used your personal funds to cover the costs of the mortgage.

Your Parents remained living in the property for a further X years and after they moved out it was kept as a holiday home.

In this situation there is no evidence that beneficial ownership remained with your Parents. No documentary evidence was provided to establish that the property was held in trust for your Parents from the time legal ownership transferred to you. Therefore, there are no grounds to consider the creation of an express trust. There is also no court order to establish the creation of a constructive trust.

As your contributions to the mortgage over the property are proportionate to your legal interest in the property, a presumption of a resulting trust does not arise.

In your case you are responsible for the mortgage over the property, and you are also the persons listed on the certificate of title as tenants in common. Therefore, it is presumed that the beneficial interests reflect the respective contributions to the purchase cost of the property.

Legal ownership transferred to you when you were recorded on the certificate of title as tenants in common in 19XX. While you stated that it was not your choice to transfer legal title and ownership of the property and in fact it was your intention at the time of taking on the mortgage that your Parents retain ownership of the house, in the absence of evidence to support the creation of a trust, under the principle in TR 93/32 beneficial ownership is presumed to follow legal ownership. In your case this is supported by the facts which indicate you had legal ownership of the property at a time when you also had beneficial ownership as mortgagors paying the mortgage out of your own personal funds.

We consider your actions of allowing your Parents to reside in the property until 19XX, where they remained responsible for their costs incurred in maintaining the property are more consistent with a private family arrangement rather than evidence that beneficial ownership remained with your Parents.

The property was sold in 20XX and as you were the owners of the property, CGT event A1 occurred when your legal ownership ended. The disposal of the property as a CGT asset triggered CGT event A1 pursuant to subsection 104-10(1). The timing of the CGT event was when the contract to dispose of the property was entered into (paragraph 104-10(3)(a)). As you acquired the asset from your Parents in 19XX which is after 20 September 1985, it was a post CGT asset. You will make a capital gain if the capital proceeds exceed the cost base. You make a capital loss when the reduced cost base exceeds the capital proceeds (subsection 104-10(4)).

The cost base includes the money and market value of property you provided (or are required to provide) to acquire the CGT asset, and some other costs (section 110-25). As your Parents' ownership of the property was transferred to you in 19XX, it was not part of your Parents' estate when they died. Therefore Division 128 has no application as the CGT property was not an asset owned by a person just before they died and as a result the cost base will not be calculated using the table in subsection 128-15(4).

To calculate the cost base in your case, the general rules about the cost base in section 110-25 will be modified by the market value substitution rule in section 112-20. Under the market value substitution rule the first element of the cost base and reduced cost base of a CGT asset acquired from another entity is replaced with its market value (at the time of acquisition). Therefore, you are taken to have acquired your ownership interest in the property for its market value in 19XX when the contract to dispose of the asset was entered into or if there was no contract, the time of disposal would be when the change of ownership occurred.

Your capital proceeds include the money and market value of property you received (or are entitled to receive) when the event happened (section 116-20).

Where there is a capital gain because you held your ownership interest in the property for greater than 12 months before selling it, you are entitled to apply the 50% CGT discount under Division 115 to any capital gain you made from the sale.