Edited version of private advice

Authorisation Number: 1052197960806

Date of advice: 28 November 2023

Ruling

Subject: CGT rollover

Question:

Will the Commissioner allow the Trust a Capital Gains Tax (CGT) rollover for the purchase of an investment portfolio pursuant to subsection 124-75(4) of the Income Tax Assessment Act 1997 (ITAA 97)?

Answer:

No

This private ruling applies for the following period:

DD MM YYYY to DD MM YYYY

The scheme commenced on:

DD MM YYYY

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect, and you cannot rely on it.

Background information

The Trust owns a residential rental property and derives rental income from it.

The state government will possibly be acquiring the residential rental property, resulting in the Trust having to make an involuntary disposal of the property.

If the state government purchases the rental property they will pay the Trust, in cash, the equivalent of the rental property's market value.

Assuming that the state government does purchase the rental property, paying the Trust the market value in cash, the Trust intends to purchase a passive investment portfolio from Entity X with the money they received from the state government.

This passive investment portfolio will be purchased within one year after the end of the tax year by which the rental property would be acquired.

The investment portfolio would be a long-term investment to derive passive income.

The investment portfolio is also not being held by the Trust as trading stock, but rather as a capital investment in the same way that the rental property was held.

Information provided

You have provided a number of documents containing detailed information in relation to the Trust, including the Private Binding Ruling (PBR) Application, dated DD MM YYYY.

We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 124-B

Income Tax Assessment Act 1997 paragraph 124-70(1)(c)

Income Tax Assessment Act 1997 subsection 124-70(1A)

Income Tax Assessment Act 1997 paragraph 124-75(3)(b)

Income Tax Assessment Act 1997 subsection 124-75(4)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for the decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Summary

The Commissioner will not allow the Trust a Capital Gains Tax rollover for the intended purchase of an investment portfolio pursuant to subsection 124-75(4) of the ITAA 1997. The purchase of an investment portfolio as replacements assets will not be used for the same purpose as, or for a similar purpose to, the purpose for which the Trust used the residential rental property just before a compulsory acquisition of the property would occur for the purposes of subsection 124-75(4) of the ITAA 1997. As a result, incurring expenditure in acquiring the investment portfolio will not meet the requirements of acquiring another CGT asset for the purposes of the CGT replacement asset roll-over.

Detailed reasoning

Replacement asset roll over relief

Roll-over relief for the compulsory acquisition of a CGT asset is available where the conditions outlined in Subdivision 124-B of the ITAA 1997 are met. 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) of the ITAA 1997, an entity may be able to choose a replacement asset rollover if a CGT asset owned by the entity is compulsorily acquired by an Australian government agency as per paragraph 124-70(1)(a) of the ITAA 1997.

A replacement-asset rollover allows you, in special cases, to defer the making of a capital gain or loss from one CGT event until a later CGT event happens.

Subsection 995-1(1) of the ITAA 1997 defines an Australian government agency as a Commonwealth, a State or a Territory, or an authority of Commonwealth or of a State or Territory.

Subdivision 124-B- of the ITAA 1997 deals with assets compulsorily acquired, lost or destroyed. Specifically, section 124-70 of the ITAA 1997 outlines the events giving rise to a CGT roll-over, as follows:

(1)          You may be able to choose a roll-over if one of these events happens to a CGT asset (the original asset) you own:

(a)          it is compulsorily acquired by an Australian government agency;

(aa)       it is compulsorily acquired by an entity (other than an Australian government agency or a foreign government agency) under a power of compulsory acquisition conferred by a law covered under subsection (1A);

(b)          it, or part of it, is lost or destroyed;

(c)          you dispose of it to an entity (other than a foreign government agency) in circumstances meeting all of these conditions:

(i)            the disposal takes place after a notice was served on you by or on behalf of the entity;

(ii)           the notice invited you to negotiate with the entity with a view to the entity acquiring the asset by agreement;

(iii)         the notice informed you that if the negotiations were unsuccessful, the asset would be compulsorily acquired by the entity;

(iv)         the compulsory acquisition would have been under a power of compulsory acquisition conferred by a law covered under subsection (1A)

Additional requirements if money is received

A further requirement is that the owner of the original asset must receive money or another CGT asset or both, for the CGT event to be eligible for a rollover (subsection 124-70(2) of the ITAA 1997). On satisfying these conditions, section 124-75 of the ITAA 1997 provides other requirements which must be satisfied if money is received for the event happening.

Paragraph 124-75(2)(a) of the ITAA 1997 states 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).

Paragraph 124-75(3)(b) of the ITAA 1997 requires you to incur expenditure in acquiring a replacement CGT asset no later than one year after the CGT event, or within such further time as the Commissioner allows in special circumstances.

Subsection 124-75(4) of the ITAA 1997 requires that the replacement asset acquired must be used for the same or similar purpose as the taxpayer used the original asset. This replacement asset cannot become an item of trading stock just after the acquisition or be a depreciating asset (subsection 124-75(5) of ITAA 1997), nor become a 'registered emissions unit' just after the acquisition (subsection 124-75(6) of ITAA 1997).

Section 125-75 of the ITAA 1997 outlines the other requirements if you receive money for the CGT event happening, as follows:

(1)           If you receive money for the event happening, you can choose to obtain a roll-over only if these other requirements are satisfied.

Note: The roll-over consequences are set out in section 124- 85.

(2)           You must:

(a)           incur expenditure in acquiring another CGT asset (except a depreciating asset whose decline in value is worked out under Division 40 or deductions for which are calculated under Division 328); or

(b)           if part of the original asset is lost or destroyed--incur expenditure of a capital nature in repairing or restoring it.

(3)           At least some of the expenditure must be incurred:

(a)           no earlier than one year, or within such further time as the Commissioner allows in special circumstances, before the event happens; or

(b)           no later than one year, or within such further time as the Commissioner allows in special circumstances, after the end of the income year in which the event happens.

Special rules if you acquire another asset

(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.

(5)           The other asset cannot become an item of your trading stock just after you acquire it, nor can it be a depreciating asset whose decline in value is worked out under Division 40 or deductions for which are calculated under Division 328.

(6)           The other asset cannot become a registered emissions unit held by you just after you acquire it.

Subsection 124-75(4) of the ITAA 1997 therefore requires taxpayers to use the replacement asset (for a reasonable time after it is acquired) for the same purpose as, or for a similar purpose to, the purpose for which taxpayers used the original asset just before the event under paragraph 124-70(1) happened.

Same or similar purpose

The Commissioner has previously considered the application of this rule in Taxation Determination TD 2000/42 "Income tax: 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?". Specifically, TD 2000/42 states that whether an asset is used for the same or similar purpose as another asset is a question of fact and degree.

TD 2000/42 illustrates that there is no requirement for the replacement asset to be a similar asset, it must merely be used for the same or a similar purpose. Example 3 states:

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. (emphasis added)

Based on the above example, the 'same' or 'similar' purpose test should be satisfied where one income producing asset held on capital account is compulsorily acquired, and another income producing asset that is also held on capital account is acquired as the replacement.

In contrast, the similar purpose test would not appear to be satisfied where an income producing asset was compulsorily acquired, but the taxpayer acquired an asset that is used for a different purpose, such as a main residence. The distinction is that in the first example, both assets would be used to derive rent. In the second example, where the replacement asset is used as a main residence, the use does not fall within the scope of the same or similar purpose test.

The overall object of the requirement in subsection 124-75(4) is to ensure that taxpayers maintain the use of the asset within the scope of the same or similar purpose test and cannot reduce or eliminate income tax by acquiring a replacement asset that is subject to a different taxing outcome in the event of a subsequent sale.

Application to your circumstances

Original asset - purpose (use)

The original property is held by the Trust as a long-term residential rental property investment, from which rental income from tenants is derived.

Specifically, the acquisition and continued ownership of the property is for the long term as it is held primarily for the purposes of earning rental income.

The state government has raised the intention to compulsorily acquire the residential rental property, for which they will pay the Trust the equivalent of the rental property's market value in cash.

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

Other asset - purpose (use)

The purpose for which the investment portfolio is to be used is as a capital investment, 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.

Comparison - same or similar purpose

Where both assets are acquired for the broader purpose of earning income, in general it is not itself sufficient to satisfy the terms of subsection 124-75(4) of the ITAA 1997, 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 investment portfolio, 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 residential rental property. The residential rental 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 residential rental property was used is different from the purpose for which the investment portfolio is 'used'.

This approach is consistent with that taken by the Commissioner in TD 2000/42. As stated above, Example 3 considers a scenario involving real property acquired for rental purposes.

Subsection 124-75(4) of the ITAA 1997 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 residential rental property was acquired to earn rental income, the same cannot be said for the investment portfolio. Unlike the residential rental property, the investment portfolio cannot (and cannot in any respect be itself regarded as) rental property from which rental income is derived.

Further, even where the replacement asset is an investment portfolio that invests in property investments, the investment portfolio fails the same or similar purpose test, because the Trust may obtain a beneficial interest in the investment portfolio and obtain the right to distributions or dividends rather than rental income.

Conclusion

The Commissioner will not allow the Trust a Capital Gains Tax rollover for the intended purchase of an investment portfolio pursuant to subsection 124-75(4) of the Income Tax Assessment Act 1997. The purchase of an investment portfolio as replacements assets will not be used for the same purpose as, or for a similar purpose to, the purpose for which the Trust used the residential rental property just before a compulsory acquisition of the property would occur for the purposes of subsection 124-75(4) of the ITAA 1997. As a result, incurring expenditure in acquiring the investment portfolio will not meet the requirements of acquiring another CGT asset for the purposes of the CGT replacement asset roll-over.

ATO view documents

Taxation Determination TD 2000/41 Income tax: capital gains: are the two requirements in subsection 124-75(4) of the Income Tax Assessment Act 1997 for a CGT asset acquired to replace an original asset alternative and mutually exclusive requirements?

Taxation Determination TD 2000/42 Income tax: 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?

Key words

Capital Gains Tax rollover

Investment portfolio

Residential rental property

Compulsory acquisition by state government department