Edited version of private advice

Authorisation Number: 1052164399280

Date of advice: 11 September 2023

Ruling

Subject: Replacement asset roll-over - compulsorily acquired

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

Question:

Will the Commissioner allow CGT rollover if the taxpayer incurs expenditure in acquiring replacement CGT asset(s), such as Real Property Investment Trusts or direct shares in listed property trusts, for the same or similar investment purpose as the original CGT asset, under subsection 124-75(4) of the Income Tax Assessment Act 1997, following the compulsory acquisition of the taxpayer's original investment asset?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

1.      In MM YYYY the Trust purchased a commercial complex via auction.

2.      The original asset was held as an investment asset.

3.      The Trust self-managed the asset, receiving rental income from tenants. It did not charge management fees.

4.      In late YYYY, the government announced that the site would be required for a project.

5.      From MM YYYY, the main building became vacant under the threat of compulsory acquisition. The Trust received no further income from the main building. The Trust received monthly rental income from the remaining tenant.

6.      Just before the asset was compulsorily acquired, the CGT asset was used and held for an investment purpose.

7.      The original asset was compulsorily acquired by the Government on DD MM YYYY.

8.      There was a protracted legal dispute with the Government over the quantum of the compensation that took more than a decade to resolve.

9.      The full compensation payment was received in early YYYY.

10.   An extension of time has been provided to the taxpayer on the basis that the amount of compensation had not been determined.

11.   The taxpayer has been actively looking for replacement properties similar to the compulsorily acquired property, however, the amount of compensation received is based on the market price of the compulsorily acquired property in YYYY and as the market price of similar properties have increased dramatically since YYYY, the amount of compensation received is not enough to purchase similar commercial properties at today's market. The taxpayer has been the under bidder on several commercial properties.

12.   The taxpayer is contemplating purchasing publicly listed company shares and/or direct shares in a listed property trust as replacements assets.

13.   Private Rulings providing extensions of time to purchase a replacement asset(s) have been issued.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 124-B

Income Tax Assessment Act 1997 section 124-75

Reasons for decision

Summary

The use of publicly listed company shares or units in a listed property trust as replacement assets will not be for the same purpose as, or for a similar purpose to, the purpose for which the Trust used the Commercial Property just before the compulsory acquisition of the property for the purposes of subsection 124-75(4) of the ITAA 1997. As a result, incurring expenditure in acquiring the units or shares will not meet the requirements of acquiring another CGT asset for the purposes of the CGT replacement asset roll-over.

Detailed reasoning

Subdivision 124-B outlines the requirements for a replacement asset roll-over where an original asset has been compulsorily acquired, lost or destroyed. A replacement asset rollover allows an entity to defer the making of a capital gain or loss from one CGT event until a later CGT event happens.

Under subsection 124-70(1) you may be able to choose a roll-over if a CGT asset is compulsorily acquired by an Australian Government agency.

Additional requirements if money is received

Subsection 124-75(1) and paragraph 124-75(2)(a) state that if you receive money for the CGT event happening you can choose to obtain a roll-over if you incur expenditure in acquiring another CGT asset (except a depreciating asset whose decline in value is worked out under Division 40 or deductions which are calculated under Division 328).

Subsection 124-75(3) states that at least some of the expenditure must be incurred:

(a) no earlier than one year before the event happens, or

(b) no later than one year after the end of the income year in which the event happens.

Special rules if you acquire another asset

There are special rules if you acquire another asset. Subsection 124-75(4) provides as follows:

124-75(4) If just before the event happened the original asset:

(a) was used in your business; or

(b) was installed ready for use in your business; or

(c) was in the process of being installed ready for use in your business;

the other asset must be used in the business, or be installed ready for use in the business, for a reasonable time after you acquired it.

Otherwise, you must use the other asset (for a reasonable time after you acquired it) for the same purpose as, or for a similar purpose to, the purpose for which you used the original asset just before the event happened.

Same or similar purpose

Whether a CGT asset is used for the same or a similar purpose as another asset is a question of fact and degree.

Taxation Determination TD 2000/42 Income tax: capital gains: what is the scope of the words 'use the other asset ... for the same purpose ... or for a similar purpose' in subsection 124-75(4) of the Income Tax Assessment Act 1997 in relation to a replacement asset? (TD 2000/42) provides general guidance on the application of the requirement in subsection 124-75(4) in its outline of the following principles:

1.The words 'use the other asset... for the same purpose... or for a similar purpose' should be read in their context in subsection 124-75(4) of the Income Tax Assessment Act 1997.

2. Whether a CGT asset is used for the same or a similar purpose as another asset is a question of fact and degree....'

Application to your circumstances

Original asset - purpose

The original Commercial Property was held by the Trust as a long-term investment from which rental income from tenants was derived. Specifically, the acquisition and continued ownership of the property was for the long term, as it was held primarily for the purposes of earning rental income.

From MM YYYY, the main building became vacant under the threat of compulsory acquisition. The Trust received no further income from the main building. The Trust received monthly rental income from the only remaining tenant.

Just before the asset was compulsorily acquired the CGT asset was used and held for the purpose of deriving rental income.

Other asset - purpose

The purpose for which the publicly listed company shares or direct shares in listed property trusts are to be used by the Trust is considered below.

It is noted that under the proposal:

•                     The 'other asset' is not real property but shares in an investment trust or a listed property trust.

•                     The income derived by the Trust from the shares is the return stemming from its entitlements as a shareholder or unit holder of the property trust.

•                     More specifically, the source of such income is derived, not from lease agreements entered into with third party tenants in respect of the real property owned by the Trust, but from the terms governing the investment trust or listed property trust. The Trust as a shareholder or unitholder is conferred a beneficial interest in the company or trust fund.

•                     The broad purpose for which the shares/ units are to be 'used' by the Trust might be described as the derivation of trust income, or trust capital, or dividends in the case of shares.

Comparison: same or different purpose?

Where both assets are acquired for the broader purpose of earning income, in general is not itself sufficient to satisfy the terms of subsection 124-75(4), which requires a consideration of how the asset is put to use for the earning of that income; that is, the provision requires that regard be had to the specific 'use' of the asset by the taxpayer.

As mentioned above, the use of the units or shares, from the perspective of the Trust, is for the purpose of deriving trust income or capital, or dividends (in the case of shares), however it arises, and when it becomes payable pursuant to the relevant agreement with the trust or company. The entitlement arises from the Trust's beneficial interest in the trust fund as a unitholder or share as a shareholder.

This is fundamentally different from the Trust's use, as registered proprietor, of the original Commercial Property. The original Commercial Property was specifically acquired and held, for the purpose of leasing to third party tenants; and earning rental income. At the outset therefore it would appear that the purpose for which the original Commercial Property was used is different from the purpose for which the shares and units are 'used'.

This approach is consistent with that taken by the Commissioner in TD 2000/42. Examples 1 and 3 in paragraphs 3 and 5 respectively consider scenarios involving real property acquired for rental purposes:

Example 1

3. Steve owned machinery for use in his manufacturing business. The machinery is destroyed by a fire. He replaces the machinery with a rental property. The rental property is not used for the same or a similar purpose to the purpose for which the machinery was used.

4...

Example 3

5. Marina owns a house near the sea which she has always rented out. The house has, for capital gains purposes, been treated as an asset separate from the land on which it is situated - the land having been acquired in 1980 - because of the operation of Subdivision 108-D. The house is destroyed by a cyclone and she has the choice of either:

(a) acquiring a city unit for rental purposes; or

(b) rebuilding the house to use as her main residence.

For the purposes of Subdivision 124-B, the use of the city unit will fall within the scope of the same or similar purpose test. The use of the new building as a main residence will not.

As per example 1, the use of property for the derivation of rental income is separate and distinct from the use of an asset as machinery in a manufacturing business; both earn income, but each is used for different purposes in the earning of that income. Subsection 124-75(4) requires that the use of the asset be for the same or a similar purpose: as per example 3, if the original property is used for rental purposes, the replacement asset must also be rental property.

In the present case, while the original Commercial Property was acquired to earn rental income, the same cannot be said for the shares or units in the property trust. Unlike the original Commercial Property, the shares or units are not (and cannot in any respect be themselves regarded as) rental property from which rental income is derived.

Further, even where the replacement asset is shares or units in a trust that invests in property investments, the shares or units fail the same or similar purpose test, because the Trust obtains a beneficial interest in the trust fund or company and obtains the right to distributions or dividends rather than rental income. Each unit confers an equal undivided interest in the trust fund as a whole, but no unit confers an interest in a particular asset.

Conclusion

Under the proposed arrangement, units or shares in listed property trusts or companies, will not be acquired for the same or similar purpose for which the taxpayer used the original property before the compulsory acquisition, for the purposes of subsection 124-75(4). As a result, incurring expenditure in acquiring the units or shares will not meet the requirements of acquiring another CGT asset for the purposes of the CGT replacement asset roll-over.