Edited version of private advice

Authorisation Number: 1052177860290

Date of advice: 27 October 2023

Ruling

Subject: Pre-CGT asset

Question 1

Is the sale of the building all pre-CGT?

Answer

No

Question: 2

Is the sale of the building pre-CGT for the existing pre-CGT units, but post-CGT for the units sold afterwards?

Answer:

No the sale of the building is all post CGT

Question 3

If the latter, is the CGT calculation based on the market value at date of purchase to the extent of the percentage owned?

Answer:

No

Question: 4

Is there a Commissioner's discretion to allow the building to be regarded as pre-CGT?

Answer:

No

This ruling applies for the following period:

Year ending 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

The Trust was settled by deed on DD MM YYYY.

The Trust was formed to purchase a property before 20 September 1985 when Capital Gains Tax was introduced (pre-CGT).

The original Trust unit holders were practising doctors.

The Trust unit holders together with other doctors run a business in partnership (Partnership).

Not all partners in the Partnership have held units in the Trust, but all Trust unit holders are partners in the Partnership.

Over the years some of the doctors that have left the practice have sold their Trust units, either to existing unit holders or to the new doctors commencing practice as partners in the Partnership.

The property originally purchased by the Trust pre-CGT was leased to the group of doctors to run their business and rent was paid by the Partnership to the Trust.

The property was sold during 20XX financial year.

The Trust made a capital gain from the sale of the property.

At the date of sale, approximately 20% of the units in the Trust were still owned through a family trust, by one of the original owners who owned the units immediately before 20 September 1985.

80% of the Trust units have changed hands since the original purchase of the building before 20 September 1985, being sold by exiting partners to new partners within the practice partnership.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(5)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 108-5(2)

Income Tax Assessment Act 1997 Division 110

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Subdivision 149-B

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 subsection 149-30(2)

Income Tax Assessment Act 1997 section 149-35

Income Tax Assessment Act 1997 section 149-50

Reasons for decision

These reasons for decision accompany the Notice of private ruling for the Trust and others.

This is to explain how we reached our decision. This is not part of the private ruling.

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

Summary

Division 149 will operate to deem the property held in the Trust to be post-CGT due to the change in the majority underlying ownership of the CGT asset. In the circumstances, the Commissioner is not satisfied, and does not find it reasonable to assume that the majority underlying interests have been maintained in the property for the purposes of subsection 149-30(2). Accordingly, the asset stops being a pre-CGT asset when the majority underlying interests in the asset were not held by the same ultimate owners who had the majority underlying interests immediately before 20 September 1985. As there is no Commissioner's discretion that allows the CGT asset to retain its pre-CGT status, the capital gain arising from the sale of the asset cannot be disregarded under subsection 104-10(5).

In calculating the capital gains tax, under section 149-35, the first element of its cost base is the asset's market value at the time it stops being a pre-CGT asset as a result of the change in the majority underlying interest.

Detailed reasoning

A CGT asset is defined in subsection 108-5(1) as any kind of property or a legal or equitable right that is not property. Paragraph 108-5(2)(a) further highlights that part of, or an interest in, an asset referred to in subsection 108-5(1) is a CGT asset. Note 1 to section 108-5 lists land and buildings as examples of CGT assets.

The building is property and therefore, is a CGT asset as defined by section 108-5.

Subsection 104-10(1) provides that CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

Subsection 104-10(5)

A capital gain or loss arising from the disposal of a CGT asset acquired before 20 September 1985 (Pre-CGT), will be disregarded, pursuant to subsection 104-10(5).

Division 149

Division 149 contains the provisions under which an asset acquired before 20 September 1985 is treated as having been acquired after that date, that is, the asset stops being a pre-CGT asset. Subdivision 149-B provides for when the asset of an entity stops being a pre-CGT asset for entities that are not covered by section 149-50. Effectively, Subdivision 149-B deals with non-public entities.

A CGT asset is a pre-CGT asset if it was last acquired before 20 September 1985 and no income tax provision has operated to treat it as having been acquired after that date.

Section 149-10 provides as follows:

149-10 A CGT asset that an entity owns is a pre-CGT asset if, and only if:

(a) the entity last acquired the asset before 20 September 1985; and

(b) the entity was not, immediately before the start of the 1998-99 income year, taken under:

(i) former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or

(ii) Subdivision C of Division 20 of former Part IIIA of that Act;

to have acquired the asset on or after 20 September 1985; and

(c) the asset has not stopped being a pre-CGT asset of the entity because of this Division.

Section 149 is the rewritten form of previous subsection 160ZZS(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and applies from the start of the 1998/1999 income year with former subsection 160ZZS(1) of the ITAA 1936 applicable to earlier income years.

Majority underlying interest

Subsection 149-15(1) states that majority underlying interests in a CGT asset consist of:

(a) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and

(b) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.

Subsection 149-15(2) defines an underlying interest in a CGT asset as a beneficial interest that an ultimate owner has (whether directly or indirectly) in the asset or in any ordinary income that may be derived from the asset.

Subsection 149-15(3) relevantly defines an 'ultimate owner' to include an individual.

Subsections 149-15(4) and (5) provide that an ultimate owner has an indirect beneficial interest in a CGT asset of another entity if they would receive for their own benefit any capital or ordinary income distributed by the entity through interposed entities.

When a CGT asset stops being a pre-CGT asset

Subsections 149-30(1), (1A) and (2) provide the following:

(1) The asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not had by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

(1A) Also, Part 3-1 and this Part (except this Division) apply to the asset as if the entity had acquired it at that earliest time.

(2) If the Commissioner is satisfied, or thinks it reasonable to assume, that at all times on and after 20 September 1985 and before a particular time majority underlying interests in the asset were had by ultimate owners who had majority underlying interests in the asset immediately before that day, subsections (1) and (1A) apply as if that were in fact the case.

Taxation Ruling IT 2340

Taxation Ruling IT 2340 Income tax: capital gains: deemed acquisitions of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date (IT 2340) is a public ruling of the application of section 160ZZS of the Income Tax Assessment Act 1936. It applies when a taxpayer has acquired assets prior to 20 September 1985 and on or after that date there is a change of 50 per cent or more in the majority underlying ownership of the assets.

IT 2340 explains that where such a change occurs the provision operates to deem the assets to have been acquired after 19 September 1985 so that any subsequent real capital gain on the assets will fall within the tax base. Paragraph 2 of IT 2340 also states that the clear policy of the law permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be "looked through" in order to determine whether there has been a change in the effective interests of natural persons in the assets.

Where within those chains of entities there is a discretionary trusts, IT 2340 states:

5. In relation to what are generally referred to as discretionary trusts, i.e., family trusts, the trustees of which have discretionary powers as to the distribution of trust income or property to beneficiaries, in considering the question of whether majority underlying interests have been maintained in the assets of the trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised.

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. That is consistent with the role of the section to close potential avenues for avoidance of tax in cases where there is a substantial change in underlying ownership of assets and the legislative guidance contained in Subdivision G of Division 3 of Part III of the Act. On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act.

There is no overarching Commissioner's discretion that allows a CGT asset to retain its pre-CGT status.

Cost base

Division 110 provides that the cost base and reduced cost base of an asset has five elements. The first element is the money paid for, and the market value of any property given to acquire the asset. The other elements are expenditure in respect of the asset, such as incidental costs of acquisition, and otherwise non-deductible costs of ownership.

Section 149-35 modifies the general rules in Division 110.

Where Division 149 is triggered to convert the asset into a post-CGT asset, the asset is deemed to have a new date of acquisition (the date the majority underlying interest changed). Section 149-35 provides that the deemed first element acquisition costs for the purposes of determining the cost base (and reduced cost base), will be the market value of the asset at the time of change.

Application to your circumstances

The building held by the Trust is a CGT asset as defined by section 108-5 and is the CGT asset that is the subject of this private ruling.

There may be other CGT assets in this arrangement including the units held in the Trust by the unit holders which have not been considered as part of this private ruling.

Subsection 104-10(1) provides that CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

The Trust disposed of the property and therefore, pursuant to subsection 104-10(1), CGT event A1 occurred.

In the present case the building is a CGT asset acquired prior to 20 September 1985 and was held by a unit trust. Under paragraph 104-10(5)(a) a capital gain or loss you make is disregarded if you acquire the asset before 20 September 1985. To determine whether the asset retains its pre-CGT status, the underlying interests in the property must be traced through intermediary entities to the ultimate owners which in this case are individuals under subsection 149-15(3). The individuals with interests in the property prior to 20 September 1985 collectively must continue to hold more than 50% of the beneficial interests in the underlying asset (the property) and in any ordinary income that may be derived from the asset. As long as they continue to hold the majority underlying interests in the asset, the asset will retain its pre-CGT status.

Over the years, as doctors left the practice, they sold their Trust units, either to existing unit holders or to the new doctors commencing practice as partners. Units in the Trust traced to the ultimate owners for the period from and including 20 September 1985 indicate that at the date of sale of the property, approximately 20% of the units in the Trust were owned by only one of the original owners, through a family trust, who owned the units immediately before 20 September 1985. As the underlying interest of ultimate individual beneficiaries collectively is less than the requisite 50 percent required for a majority underlying ownership, Division 149 will operate to stop the asset from being a pre-CGT asset.

In circumstances where only 20 percent of the units in the Trust were owned by the original owners, the Commissioner is not satisfied, and does not find it reasonable to assume that at all times on and after 20 September 1985 the majority underlying interests were held by ultimate owners who held majority underlying interests in the asset immediately before that day. In other words, for the purposes of subsection 149-30(2), the Commissioner is not satisfied, nor considers it reasonable to assume, that the majority underlying interests in the assets have not changed.

As a result, the asset stops being a pre-CGT asset from the time the majority underlying interests in the asset were not held by the ultimate owners who held the majority underlying interests immediately before 20 September 1985. As there is no Commissioner's discretion that allows the CGT asset to retain its pre-CGT status a capital gain from sale of the asset cannot be disregarded.

In calculating the capital gain under section 149-30, section 149-35 modifies the general cost base rules in Division 110.

The CGT provisions apply to the property as if the taxpayer had acquired it at the time when the majority underlying interests changed.

Under section 145-35, when the asset stops being a pre-CGT asset, the first element of its cost base and reduced cost base is the asset's market value at the time it becomes a post-CGT asset.

In your case you will be deemed to have acquired the property at the market value on the date Trust units were sold and the sale resulted in a change in the majority underlying interest in the property that led to the property ceasing to be a pre-CGT asset.