Edited version of private advice

Authorisation Number: 1052197978584

Date of advice: 2 February 2024

Ruling

Subject: CGT - disposal of other separate assets

Question 1

Will Person A and Person B, who incurred expenditure of a capital nature to build and affix a dwelling to Company A's (the Company) land, be treated as the owners of that dwelling for capital gain purposes?

Answer

No.

Question 2

Is the dwelling a separate CGT asset to the land on which it is constructed pursuant to section 108-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 3

On the disposal of the land on which the dwelling is constructed (which would necessarily bring about the termination of the lease), are Person A and Person B entitled to disregard their capital gain from the disposal of the dwelling as their main residence under section 118-110 of the ITAA 1997?

Answer

No.

Question 4

On termination of the lease, will the Company be deemed to have acquired the dwelling at a cost base of market value of the dwelling as at the date of termination of the lease under section 112-20 of the ITAA 1997 if Person A and Person B will not be recompensed by the Company for the value of the dwelling at arm's length?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 2024

Year ending 30 June 2025

Year ending 30 June 2026

Year ending 30 June 2027

Year ending 30 June 2028

The scheme commenced on:

1 July 1998

Relevant facts and circumstances

A family company (First Company) purchased a property (the Land) before 20 September 1985.

After 20 September 1985, Person A and Person B constructed and paid for a dwelling (the dwelling) to be built on the Land.

There was never a written lease agreement between the parties.

Person A and Person B moved into the dwelling mid-19yy when it was completed and it was considered their main residence from this time.

All funds required for the construction of the dwelling were provided by Person A and Person B, the Company having no means of its own to do so.

Other funds were provided directly from Person A and Person B to the relevant suppliers and service providers and other funds were provided to the Company from Person A and Person B and recorded on the Company's book as loans without any terms of the loans ever having been agreed, and then paid to the relevant suppliers and service providers.

Person A and Person B have never been paid, nor have they ever charged interest on the loans made to the Company to allow it to pay those costs.

Some time after the dwelling was completed, the title of the Land was transferred to the Company, as an in specie distribution to shareholders upon the First Company's voluntary liquidation.

The Land was transferred with nil encumbrances.

Since its acquisition of the land, the Company remains the only proprietor of the Land.

Person A and Person B continue to live in the dwelling.

Person A and Person B pay rent to the Company for the lease of the Land. The rent is purely payment for the use of the Land and being set at the approximate cost of the outgoings incurred by the Company.

The dwelling is not, and has not been, used to produce assessable income at any time.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 108-55

Income Tax Assessment Act 1997 subsection 109-5(1)

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 section 118-130

Reasons for decision

Question 1

Under section 108-5 of the ITAA 1997, a CGT asset is defined as any kind of property or part of a property; therefore, leasehold improvements are considered a CGT asset.

If a lessee (tenant) incurs expenditure of a capital nature on making improvements to a leased property, the CGT consequences depend on whether the lessee or the lessor is the owner of the improvements. A general principle of property law is that the owner of land also owns the fixtures attached to that land (including buildings).

CGT Determination TD 46 Capital Gains: What are the CGT consequences where a lessee affixes to the lessor's land an asset which continues to be owned by the lessee? provides that a lessee will be treated as continuing to be the owner of an asset which the lessee has affixed to the lessor's land where:

• the law of the relevant State or Territory provides for the ownership of the asset to remain with the lessee
• the lessee is regarded as being the owner of the asset within the terms of Taxation Ruling IT 175 Depreciation: improvements and fixtures on leasehold property (IT 175).

Taxation Ruling IT 175 discusses the depreciation provisions of the Income Tax Assessment Act 1936 in the context of improvements and fixtures on leasehold property. At paragraph 4(i) of IT 175 it states:

If there is no written lease, or if the lease does not provide a right of removal, then, prima facie, the fixtures become part of the realty and will remain the property of the lessor. The lessee cannot be regarded as the owner, and unless he has some other right sufficient to constitute ownership for the purposes of section 54, he is not entitled to depreciation on them.

In this case, Person A and Person B incurred expenses to build a dwelling on the land owned by the Company. They also lent money to the Company which it used to pay some suppliers. As there is no written agreement, the principles in IT 175 suggest that the dwelling is owned by the landowner unless another right exists. While we acknowledge that Person A and Person B incurred expenses in relation to the construction of the dwelling, the Company also paid for some of the expenses. Consequently, it cannot be said that Person A and Person B have an economic right sufficient to constitute ownership of the dwelling.

Question 2

Section 108-5 of the ITAA 1997 provides that land and buildings are CGT assets.

Generally, it is viewed that what is attached to land is part of the land. That is, the land and what is attached is considered one asset. However, for CGT purposes, there are exceptions to this rule which may treat the land and what is attached to it as separate assets. Where this is the case:

• any capital gain or loss must be determined separately for each asset, and
• depending on the date of acquisition of each asset, it may not be possible to apply the CGT discount to both assets.

For CGT purposes, the exceptions to the rule that what is attached to the land is part of the land are considered in Subdivision 108-D of the ITAA 1997.

Under subsection 108-55(2) of the ITAA 1997 a building or structure that is constructed on land that you acquired before 20 September 1985 is taken to be a separate CGT asset from the land if you entered into a contract for the construction on or after that day.

In this case, the Company acquired the property when the First Company went into voluntary administration after 20 September 1985. When the company acquired the land the dwelling had already been constructed on the land. Consequently, section 108-55 of the ITAA 1997 will not apply and the dwelling and land will be a single CGT asset in the Company's hands.

Question 3

Section 118-110 of the ITAA 1997 provides that you can disregard a capital gain or capital loss made from a CGT event that happens to a dwelling that is your main residence. As discussed earlier, a CGT event will not happen to Person A and Person B upon the disposal of the dwelling and therefore they will not make a capital gain or need to give consideration to the main residence exemption.

Question 4

Under subsection 109-5(1) of the ITAA 1997, in general, you acquire a CGT asset when you become its owner. As discussed earlier, the Company is already the owner of the dwelling. Consequently, there will not be an acquisition of the dwelling by the Company in the future upon termination of the lease.