Edited version of private advice

Authorisation Number: 1052209094975

Date of advice: 6 February 2024

Ruling

Subject: CGT - exemptions

Question

Will any exemption, concession or other rule in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to exempt or disregard the amount of any capital gain arising from the CGT event A1 you make under section 104-10 of the ITAA 1997 as a result of the transfer of your property to a registered charity that is not endorsed as a deductible gift recipient (DGR)?

Answer

Yes, a partial main residence exemption and the 50% discount capital gain will apply.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You are an individual who is an Australian resident.

You own a property located in Australia (the Property).

You acquired the Property after 20 September 1985.

You originally purchased the property for $XXX.

The current estimated value of the Property is $XXX.

The Property has a dwelling with adjacent land of greater than 2 hectares.

The Property was your main residence for the whole of the ownership period.

The property was not used to produce income.

Your interest in the property did not pass to you as a beneficiary in, and you did not acquire it as a trustee of the estate of a deceased person.

You have owned the property for more than 12 months.

You are proposing to donate the Property to a Charity.

The Charity is a not-for-profit organisation registered as a charity with the Australian Charities and Not for Profits Commission (ACNC).

The Charity is endorsed by the Australian Taxation Office as tax exempt.

The Charity is not endorsed as a deductible gift recipient (DGR).

The Charity is not currently eligible for endorsement as a DGR.

You are proposing to make a voluntary transfer of the property.

The Charity will pay $X as consideration for the transfer of the property.

You will not receive any material benefit or advantage from the transfer other than $X.

You are currently a director of the Charity's board.

The market value substitution rule will determine the capital proceeds for tax purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 30-15

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 section 115-1

Income Tax Assessment Act 1997 section 115-10

Income Tax Assessment Act 1997 section 115-15

Income Tax Assessment Act 1997 section 115-20

Income Tax Assessment Act 1997 section 115-25

Income Tax Assessment Act 1997 section 116-5

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-25

Income Tax Assessment Act 1997 paragraph 116-30(2)(b)

Income Tax Assessment Act 1997 subparagraph 116-30(2)(b)(i)

Reasons for decision

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

Question

Summary

You are able to claim a partial main residence exemption from CGT for your dwelling and up to 2 hectares of the land (including the area of the land on which the dwelling is built). Any capital gain or capital loss attributable to the remaining land, in excess of 2 hectares, cannot be disregarded as it is not covered by the main residence exemption.

As you are an Australian individual who has owned the property for 12 months or more, in calculating your CGT you will be entitled to a discount capital gain of 50% under Division 115. This means you pay tax on only half of the net capital gain on that asset.

There are no other CGT exemptions, concessions, or rules that apply to totally exempt or disregard your capital gain arising from the CGT event A1 you make under section 104-10 as a result of the transfer of your property to the registered charity.

In addition, there is no general Commissioner's discretion that exists to allow you to disregard capital gains arising from the transfer of property to the tax-exempt charity.

Detailed reasoning

A capital gain or capital loss will occur when a capital gains tax (CGT) event happens to a CGT asset. The most common CGT event is CGT event A1 which occurs when a CGT asset is disposed of.

Under subsection 108-5(1) CGT assets include any kind of property, and a legal or equitable right which isn't property. Note 1 says examples of CGT assets include land and buildings.

Under CGT subsection 104-10(3), event A1 happens either when you enter a contract, or when the change of ownership occurs.

In your situation, as the land and building property it is a CGT asset, under 108-5, CGT event A1 will happen to you at the time you transfer the property to the charity.

Broadly, a capital gain happens when the proceeds from disposing of a CGT asset exceed its cost base.

Under subsection 104-10(4) you make a capital gain from CGT event A1 where the capital proceeds from disposal of the CGT asset are more than the assets cost base.

Capital proceeds

Section 116-5 provides that section 116-20 sets out the general rules about capital proceeds.

Section 116-20 provides that the capital proceeds from a CGT event are the total of:

(a) the money you have received, or are entitled to receive, in respect of the event happening; and

(b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

Section 116-25 provides a table of modifications to the general rules. Modifications 1, 2, 3, 4, 5 and 6 can apply to CGT event A1.

Market value substitution rule

Modification 1, the market value substitution rule, contained in paragraph 116-30(2)(b) will apply if there are proceeds from the disposal of a CGT asset triggering CGT event A1 and:

(a)...

(b) those capital proceeds are more or less than the market value of the asset and:

(i) you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event; or

(ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings).

For the market substitution rule under subparagraph 116-30(2)(b)(i) to apply to the proceeds from the transfer of the property, the circumstances of the arrangement need to be considered to determine whether the parties are dealing with each other at arm's length in connection with the event.

Meaning of 'at arm's length

Section 995-1 defines 'arm's length' as:

In determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

In ACI Operations Pty Ltd v. Berri Ltd (2005) 15 VR 312 (ACI Operations Pty Ltd), Dodds-Streeton J said (at [223]) that the authorities establish:

... an arm's length relationship is that of strangers, or parties who are unaffected by existing mutual duties, liabilities, obligations, cross-ownership of assets, or identity of interests which present a capacity in either party to influence or control the other, or an inducement to serve that common interest, which might operate to modify the terms on which strangers would deal.

The market value substitution rule requires consideration to be given to the nature of the dealings between parties to a transaction and not simply their relationship. As Dodds-Streeton J explained in ACI Operations Pty Ltd at [224]-[226]

The concept of an arm's length relationship is distinct from that of an arm's length dealing or transaction, despite the potential overlap. Unrelated parties may collude or otherwise deal with each other in an interested way, so that neither the dealing nor the resultant transaction may properly be considered arm's length. Where the parties are not in an arm's length relationship, it is recognised that the inference may be drawn that they did not deal with each other at arm's length. It may further be inferred that the resultant transaction is not arm's length. Related parties may nevertheless, in some circumstances, demonstrate a dealing which displaces the inference based on their relationship. They may engage in the disinterested bargaining characteristic of strangers, applying independent separate wills. The circumstances of the impugned transaction may be such that, despite the parties' connection or common interest, the interposition of some independent process (such as the sale of shares on the stock exchange) ensures that the transaction itself is arm's length, in the sense that it could equally have been concluded by unrelated parties, consulting their own self-interest and uninfluenced by any particular association or interest in common.

Whether parties have dealt at arm's length is a question of fact that must be determined in any particular case. The law looks at not only the relationship between the parties but also the quality of the bargaining between them. Relevant factors to consider include the following:

•         the circumstances of the transaction and the context in which it occurred with a view to determining whether or not the parties have conducted the transaction in a way which one would expect of parties dealing at arm's length in such a transaction;

•         existing mutual duties; liabilities, obligations, cross-ownership of assets, or identity of interests which might enable either party to influence or control the other, or induce either party to serve a common interest and so modify the terms on which strangers would deal

•         where the parties are not in an arm's length relationship, one may infer that they did not deal with each other at arm's length, and that the resultant transaction is not at arm's length

•         related parties may, in some circumstances, conduct a dealing so as to displace any inference based on relationship

•         unrelated parties may, on occasions, deal with each other in such a way that the resultant transaction may not properly be considered to be at arm's length.

Edmonds and Gordon JJ in their joint judgement in Commissioner of Taxation v. AXA Asia Pacific Holdings Ltd [2010] FCAFC 134; (2010) 189 FCR 204 observed at paragraphs 105 - 106 as follows:

105 Any assessment of whether parties were dealing at arm's length involves "an assessment [of] whether in respect of that dealing they dealt with each other as arm's length parties would normally do, so that the outcome of their dealing is a matter of real bargaining": Trustee for the Estate of the late AW Furse No 5 Will Trust v Federal Commissioner of Taxation (1991) 21 ATR 1123 at 1132 per Hill J. The reference in Furse 21 ATR 1123 to "real bargaining" is significant. It focuses on actual dealing between the parties: see also Re Hains (deceased); Barnsdall v Federal Commissioner of Taxation (1988) 81 ALR 173. That is not surprising. It is the same mental process as that described by Griffith CJ in Spencer v The Commonwealth (1907) 5 CLR 418 at 432.

106 The question of whether parties dealt with each other at arm's length in respect of a particular dealing is one of fact in each case: Granby v Federal Commissioner of Taxation (1995) 129 ALR 503 at 507. What is required is that "parties to a transaction have acted severally and independently in forming their bargain": Granby 129 ALR 503 at 507. Put another way, it requires consideration of how "unrelated parties, each acting in his or her own best interest, would carry out a particular transaction": Australian Trade Commission v WA Meat Exports Pty Ltd (1987) 75 ALR 287 at 291.

The underlying principles discussed above have been summarised by McKerracher J in Healey v. FC of T [2012] FCA 269 [at 95] (Healey's case). In that case, in determining whether or not parties were dealing at arm's length with one another, it was held that the authorities establish the following principles:

1. Whether the parties dealt at arm's length is a question of fact: Trustee for the Estate of the late AW Furse No 5 Will Trust v. Commissioner of Taxation 91 ATC 4007 (at 4017) (Trustee for the Estate of the late AW Furse No 5 Will Trust); Granby Pty Ltd v. Federal Commissioner of Taxation 95 ATC 4240; (1995) 129 ALR 503 (at 507) (Granby); Commissioner of Taxation v. AXA Asia Pacific Holdings Ltd [2010] FCAFC 134; (2010) 189 FCR 204 (at [106]) (AXA Asia Pacific Holdings Ltd).

2. There is a distinction between dealing at arm's length and an arm's length relationship (ACI Operations Pty Ltd (at [224])). Whether the parties did not deal at arm's length is not to be decided by answering whether the parties were not in an arm's length relationship. The fact that the parties are themselves not at arm's length does not mean that they have not, in respect of a particular dealing, dealt with each other at arm's length: Re Hains; Barnsdall v. Commissioner of Taxation 88 ATC 4565; (1988) 81 ALR 173 (at 177); Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4014-4015).

3. Whether the parties dealt at arm's length involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction: Granby (at 506).

4. At issue is whether the parties have acted separately and independently in forming their bargain: Granby (at 507); ACI Operations Pty Ltd (at [226]) (did the parties apply 'independent separate wills'); AXA Pacific Holdings Ltd (at [105]). There should be an assessment of whether the parties dealt with each other as arm's length parties would be expected to behave so that the outcome is a matter of real bargaining: Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4015); Granby (at 506 and 507); AXA Pacific Holdings Ltd (at [105]).

5. It is relevant to consider the nature of any relationship between the parties: Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4015); Granby (at 506).

6. If the parties are not at arm's length the inference may be drawn that they did not deal with each other at arm's length: Granby (at 506); ACI Operations Pty Ltd (at [225]).

Cost Base

Once the capital proceeds are determined they are applied to the cost base to work out the difference and in turn the capital gain or loss. The cost base includes 5 elements (section 110-25). The first is the money paid to acquire the CGT asset. Some incidental costs, capital expenditure and ownership costs may also be included under other elements.

Exemptions

In general, a capital gain or loss made from a CGT event is included in your tax return for the income year in which the event happens. However, in some cases an exemption, concession and other special treatment may apply that allows a taxpayer to reduce, or disregard (and therefore not include in their tax return), any gain or loss made as a result of the CGT event. Where applicable, such exemptions are provided for by the tax law.

Disposing of a pre-CGT asset

Under subsection 104-10(5) capital gains or losses from CGT Event A1 are disregarded if the taxpayer acquired the asset before 20 September 1985.

Main residence exemption

Section 118-110 operates to allow individuals to disregard a capital gain from a dwelling (or their ownership interest in it) if that dwelling was their main residence.

Broadly your main residence is exempt from CGT if you are an Australian resident and the dwelling:

•         has been the home of you, your partner and other dependants for the whole period you have owned it

•         has not been used to produce income - that is, you have not run a business from it, rented it out or bought it to renovate and sell at a profit

•         is on land of 2 hectares or less.

A dwelling is defined in section 118-115 and includes land adjacent to a dwelling to the extent that the land was used primarily for private or domestic purposes in association with the dwelling (section 118-120). The total area of land covered by the exemption is 2 hectares (subsection 118-120(3)).

Land area greater than two hectares

Under section 118-120 the main residence exemption extends to a maximum of two hectares of land adjacent to the dwelling (including the area of the land on which the dwelling is built). Where a property exceeds 2 hectares you can apply the main residence exemption to whichever area of land you choose in addition to the land on which your dwelling is situated.

Taxation Determination 1999/67 Income tax: capital gains: if your land (including land on which your dwelling is situated) exceeds 2 hectares, can you select which 2 hectares the main residence exemption in Subdivision 118-B applies to and, if so, how do you calculate any capital gain or capital loss you make on the remainder of your land?(TD 1999/67)applies when calculating the capital gain or capital loss.

TD 1999/67 states at paragraphs 3 to 5:

3. If your selected area of land can be separately valued, you can calculate your capital gain or capital loss on the remainder of your land by apportioning the capital proceeds and the cost base or reduced cost base (if applicable) on the basis of the valuation. This is relevant if the value of the remainder of the land is of a greater or lesser value than your selected area of land.

4. If your selected area of land cannot be separately valued, you calculate your capital gain or loss on the remainder of your land by apportioning the capital proceeds and the cost base or reduced cost base (if applicable) on an area basis.

5. The amount of the capital gain or loss attributable to the remainder of your land must be reasonable in the circumstances.

It is clear from paragraph 3 of TD 1999/67 that where the value of the selected area of land for the main residence exemption is greater or less than the remainder of the land and both areas are valued separately, the capital gain or capital loss is calculated by apportioning the capital proceeds and the cost base, or reduced cost base, on the basis of valuation. However, paragraph 5 of TD 1999/67 further provides that the amount attributable must be reasonable in the circumstances.

A gift made through a will to a deductible gift recipient

Under subsection 118-60(1) a capital gain or capital loss from a testamentary gift of property is disregarded if the gift would have been deductible under section 30-15, had it not been a testamentary gift.

This applies if the charity is endorsed as a deductible gift recipient and the deceased would have been entitled to claim a deduction during their lifetime for a gift of the property, any CGT liability will be disregarded.

Subsection 30-15(1) provides that entities can deduct a gift in the situations set out in the table in section 30-15. The table sets out who the recipient of the gift can be, the type of gift that can be made, how much can be deducted and any special conditions that apply.

Item 1 of the table sets out one of the situations in which a gift can be deducted. Under that item a gift of property must:

•         be made to a DGR that is in Australia

•         satisfy any gift conditions affecting the type of deductible gifts the recipient can receive, and

•         be property that is covered by one of the listed gift types.

Rollovers

If a rollover applies a capital gain or capital loss may be deferred or disregarded until a later CGT event happens. There are various types of rollovers available including for

•         marriage breakdowns

•         where there is the loss, destruction or compulsory acquisition of an asset

•         scrip for scrip where you can defer the capital gain if you dispose of your shares in a company or interest in a trust as a result of a takeover.

•         Demergers where you may be able to defer a capital gain or capital loss if a CGT event happens to your shares in a company or interest in a trust as a result of a demerger

•         Other replacement asset rollovers.

CGT 50% discount

Under Division 115 a discount capital gain will allow you to reduce your capital gain by 50% if the asset was acquired at least 12 months before the CGT event and you are an Australian resident for tax purposes.

Section 115-1 provides that a discount capital gain remaining after the application of any capital losses and net capital losses from previous years is reduced by the discount percentage when working out the net capital gain.

Division 115 sets out the requirements for a capital gain to be a discount capital gain as follows:

•         the gain must be made by, an individual, a complying superannuation entity, a trust, or a life insurance company (section 115-10 )

•         the CGT event must happen after 11.45am on 21 September 1999 (section 115-15)

•         the cost base must be calculated without reference to indexation (subsection 115-20(1)), and

•         the CGT asset must have been acquired at least 12 months before the CGT event (subsection 115-25(1)).

Commissioner's discretion

There is no general Commissioner's discretion in relation to capital gains tax that enables an individual to disregard capital gains arising from donations of property made to a tax-exempt entity.

Application to your circumstances

The disposal of your property to the charity will be a CGT A1 event. This will result in a capital gain if your capital proceeds exceed your cost base.

As you are proposing to transfer the property to the charity for consideration of $X, which is less than its market value, the market value substitution rule in subparagraph 116-30(2)(b)(i) needs to be considered. Where you and the charity are not dealing with each other at arm's length, subparagraph 116-30(2)(b)(i) will operate to replace the capital proceeds with the property's market value.

The property's market value is then applied to the cost base which includes the money you paid to acquire the property. A capital gain arises to the extent the proceeds exceed the cost base.

If an exemption, concession or other special treatment applies, you can reduce, or disregard (and therefore not include in your tax return), any gain or loss made as a result of the CGT event.

Possible exemptions, concessions and other treatments.

The possible exemptions to consider in the circumstances are summarised in the table below.

Table 1: Summary of possible exemptions.

Conclusion

You are able to claim the main residence exemption from CGT for your dwelling and up to 2 hectares of the land (including the area of the land on which the dwelling is built). Any capital gain or capital loss attributable to the remaining land cannot be disregarded as it is not covered by the main residence exemption.

As you are an Australian individual who has owned the property for 12 months or more, in calculating your CGT you will be entitled to a capital gains discount of 50% under Division 115. This means you pay tax on only half of the net capital gain on that asset.

There are no other CGT exemptions, concessions, discretions or rules that apply to totally exempt or disregard your capital gain arising from the CGT event A1 you make under section 104-10 as a result of the transfer of your property to the registered charity.

In addition, there is no general Commissioner's discretion that exists that allows you to disregard capital gains arising from your transfer of property to the tax-exempt charity.