Edited version of private advice

Authorisation Number: 1052324161091

Date of advice: 31 October 2024

Ruling

Subject: Capital gains tax - use and enjoyment

Question 1

Did you acquire a CGT asset when you entered into the contract of sale, pursuant to section 109-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes.

Question 2

Did CGT event B1 happen to you when you entered into the contract for 'use and enjoyment' and elected to dispose of the property?

Answer 2

Yes.

Question 3

Are the capital proceeds equal to the market value of the property on the date the CGT B1 event happened to you, in accordance with subsection 116-10(2) of the ITAA 1997?

Answer 3

Yes

Question 4

Will the cost base of the property include the purchase price, incidental costs and legal expenses?

Answer 4

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

On XX XX 20XX, you and your spouse (Spouse) signed a Contract of Sale a developer (Developer) and jointly purchased a property (Property) in Country A.

Under the contract, you were to receive delivery and possession of the apartment from the Developer by XX XX 20XX, with the final payment for the purchase to be made by you on that date.

The contract also specified that the transfer and registration of the Property into the names of you and your Spouse, would be affected as soon as a separate Title Deed was issued, provided that you had paid the full purchase price.

The purchase price of the Property was Country A currency XXXX. You contributed a deposit amounting to Country A currency XXXX.

You entered into a mortgage with a Bank (Bank) equivalent to Country A XXXX. The mortgage was arranged in Country B currency for the amount of Country B currency XXXX.

You and your Spouse paid the deposits, made all stage payments and had a mortgage issued with the Bank.

Between late 20XX and early 20XX, construction of the apartment was completed.

Due to several years of backlog, the Country A Land Registry was unable to issue the Title Deed.

The Contract of Sale was deposited at the Land Registry.

Banking irregularities emerged with the Bank and despite you maintaining the mortgage payments, the Bank increased the mortgage from Country B currency XXXX to Country B currency XXXX.

From 20XX, you have been in a legal dispute over the Property, against the Developer and the Bank. You engaged lawyers to assist you.

You joined a class legal action against the Bank. You provided the claim against the Bank and other parties, the document forms part of, and is to be read with, the description of the facts and circumstances of your private ruling.

You were advised by legal counsel not to accept transfer of the Title Deed when available as you would have had to accept the inflated balance of the mortgage.

In the 20XX income year, you and your Spouse reported rental income from the Property in your income tax returns.

You have not been able to use the Property to produce assessable income after this point in time. You have stated that in order to rent the Property in Country A, you were required by law to have a full time employee, which was illogical to do.

The Land Registry has still not issued the Title Deed, and the Bank and the Developer have a lien on the Property, preventing your from accepting the Title Deed or transferring the Property.

On XX XX 20XX, you entered into a contract, to transfer all use and enjoyment of the Property back to the Developer. This contract for use and enjoyment is valid for X months, or to be varied by further agreement if required, or until completion of the Contract of Sale and transfer of the Property is complete.

On XX XX 20XX, the Developer provided you with a Cancellation Contract, which has not yet been signed or finalised. The Cancellation Contract will deliver the Property back to the Developer and acknowledges that you have paid Country A currency XXXX in respect to the purchase contract of the Property.

The Developer, on acquisition of the Property, will make a full and final repayment of the existing bank loan of XXXX. The Cancellation Contract will allow the Developer to sign a new Contract of Sale with another purchaser.

On finalisation of the Cancellation Contract, all financial matters between yourself, the Bank and the Developer will be considered as settled in full.

The Bank is requesting the additional XXXX to repay the loan despite you have paid Country B currency XXXX in mortgage payments.

On XX XX 20XX, you were provided with a document valuing the Property at XXXX; due to the dilapidated state of the dwelling which has suffered water ingress, affecting the walls and ceiling.

You have incurred legal fees, in total your current expenditure amounts to XXXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-25

Income Tax Assessment Act 1997 section 103-10

Income Tax Assessment Act 1997 section 104-15

Income Tax Assessment Act 1997 section 109-5

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 110-35

Income Tax Assessment Act 1997 section 110-55

Income Tax Assessment Act 1997 section 116-10

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-30

Reasons for decision

Question 1

Did you acquire a CGT asset when you entered into the contract of sale, pursuant to section 109-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

You acquire a CGT asset when you become its owner. In your case, the time when you acquired the asset is provided for under section 109-5 of the ITAA 1997 which states that an entity disposes of a CGT asset to you, when the disposal contract is entered into or, if none, when the entity stops being the assets owner. You acquired the CGT asset when you entered into the Contract of Sale to acquire the Property, on XX XX 20XX.

Detailed reasoning

General acquisition rules

Section 109-5 of the ITAA 1997 states that, as a general rule, a taxpayer acquires CGT asset when the taxpayer becomes its owner, and the time when the taxpayer acquires the asset is when the taxpayer becomes its owner.

The contract timing rule for acquisitions ins in subsection 109-5(2) of the ITAA 1997. A taxpayer acquires an asset from another entity under CGT event A1 (disposal of a CGT asset) when the disposal contract is entered into, or if none, when the entity stops being the asset's owner.

TR 94/29 provides guidance on acquiring land under a purchase contract. Paragraphs 5 to 7 of the TR 94/29 explains that generally, the completion of an ordinary contract of sale of land normally takes place at the time of settlement. If the contract falls through before completion a change of ownership will not in fact occur, if no change in ownership occurs then there is no disposal to which the CGT provisions can apply. However, if the contract is completed the time of the disposal and acquisition is taken to be when the contract is made.

In your case, the Developer disposed of its interest to you, on completion of the Contract of Sale on XX XX 20XX. You became the owner of the CGT asset. Settlement of the contract and the possession of the Property occurred between late 20XX and early 20XX, on completion of the Property. Completion of an ordinary contract of sale for land takes place at the time of settlement. At this time the purchaser hands over the balance of the purchase money and the vendor delivers the transfer or some similar instrument together with the title deeds. Generally speaking, the purchaser also obtains possession of the land at this time.

Question 2

Did CGT event B1 happen to you when you entered into the contract for 'use and enjoyment' and elected to dispose of the property?

Summary

CGT event B1 happened to you when you entered into the contract for 'use and enjoyment' and therefore this is the most appropriate CGT event for your disposal of the Property, even if the Cancellation Contract is later finalised.

Detailed reasoning

Section 102-25 of the ITAA 1997 is the provision of that determines how to work which CGT event happens to you. The event that a taxpayer uses, is the one that is the most specific to the situation.

CGT event B1 happens if you enter into an agreement with another entity under which:

(a)           the right to the use and enjoyment of a CGT asset you own passes to another entity; and

(b)           title in the asset will or may pass to the other entity at or before the end of the agreement.

CGT event B1 effectively brings forward the time of a disposal of a CGT asset. For CGT purposes, the owner of the asset is taken to have disposed of the asset at the start of the 'use and enjoyment' agreement, even though the actual title transfer does not take place until the end of the agreement. Similarly, the purchaser (in your case, the Developer) is taken to acquire the asset at the start of the 'use and enjoyment' contract, even though it is actually acquired at the end of the agreement.

Subsection 104-15(2) of the ITAA 1997 provides that when you entered into a contract to transfer the 'use and enjoyment' of the Property to the Developer, the time of the event is when the taxpayer (in this case, the Developer), first obtains the 'use and enjoyment' of the asset.

Subsection 104-15(3) of the ITAA 1997 states that you make a capital gain if the proceeds from the agreement are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the assets reduced cost base.

Subsection 104-15(4) of the ITAA 1997 provides an exception. It states that a capital gain or capital loss you make is disregarded if:

(a)           title in the asset does not pass to the other entity at or before the end of the agreement; or

(b)           you acquire the asset before XX September 19XX.

In your situation, there are two CGT events which may apply. These events are CGT event A1 in section 104-10 of the ITAA 1997, which happens if you dispose of a CGT asset, and CGT event B1 in section 104-15 of the ITAA 1997. Where the 'use and enjoyment' of a CGT asset is effective and remains in place until parties agree to transfer the title in an asset to another entity at or before the end of an agreement, then CGT event B1 is the most appropriate event that occurs for you.

Question 3

Are the capital proceeds equal to the market value of the property on the date the CGT B1 event happened to you, in accordance with subsection 116-10(2) of the ITAA 1997?

Summary

If you received no capital proceeds from the CGT event B1 occurring, you are taken to have received the market value of the CGT asset that is the subject of the event as explained in section 116-30(1) of the ITAA 1997.

Detailed reasoning

Capital proceeds

Subsection 116-10(2) of the ITAA 1997 details the modifications to the general rules when addressing your capital proceeds, is to use the market value substitution rule. This is relevant if:

•                you receive no capital proceeds from a CGT event; or

•                some or all of the capital proceeds cannot be valued; or

•                you did not deal at arm's length with another entity in connection with the event.

The rules about capital proceeds are set out in section 116-20 of the ITAA 1997. 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).

If you received no capital proceeds from the CGT event B1 occurring, you are taken to have received the market value of the CGT asset that is the subject of the event as explained in section 116-30(1) of the ITAA 1997.

In some situations, you are treated as having received money or other property or be entitled to receive it. Section 103-10 of the ITAA 1997 applies to a taxpayer if you had received money or other property if it has been applied for your benefit (including by discharging all or part of a debt you owe) or as you direct.

Question 4

Will the cost base of the property include the purchase price, incidental costs and legal expenses?

Summary

Your cost base when calculating your CGT loss, will include the purchase price, incidental costs plus legal fees. Interest expenses and property holding costs, such as rates and taxed, are not included for a capital loss. The reduced cost base is relevant for working out whether you have made a capital loss.

Detailed reasoning

Cost base elements when CGT event B1 happens

You make a capital gain if your proceeds from the sale of a CGT asset are greater than the cost base for the purchase of that asset, for example, if you receive more for an asset than you paid for it. You make a capital loss if your reduced cost base for the purchase of that asset is greater than the capital proceeds resulting from the sale of that asset, for example, if you receive less for an asset than the amount you paid for it.

Section 110-25 of the ITAA 1997 sets out the elements that form part of the cost base. The cost base is made up of five elements:

1.              the first element is made up of money paid or required to be paid to acquire the CGT asset.

2.              the second element will include incidental costs of acquiring the asset, or costs in relation to the CGT event. Examples are agent's commission, advertising to find a seller or buyer, fees paid to an accountant,

3.              the third element consists of non-capital costs incurred in connection with your ownership of a CGT asset. Examples are interest, rates, repairs and insurance premiums.

4.              the fourth element includes capital expenditure you incur to increase the value of the CGT asset if the expenditure is reflected in the state or nature of the asset at the time of the CGT event.

5.              the fifth element includes capital expenditure you incur to preserve or defend your title or rights to the asset.

Reduced cost base of a CGT asset

When a CGT event happens to a CGT asset and you haven't made a capital gain, you need the asset's reduced cost base to work out whether you have made a capital loss.

The elements of the reduced cost base are identical to the element of the cost base, except for the inclusion of assessable balancing adjustments and the exclusion of the 'costs of owning' the asset.

Section 110-55 of the ITAA 1997 discuss the general rules about the reduced cost base when disposing of a CGT asset. Subsection 110-55(5) of the ITAA 1997 explains that the reduced cost base does not include an amount that you could have deducted for a CGT asset had you used it wholly for the purpose of producing assessable income. The result of subsection 110-55(5) is that the elements of the cost base related to owing the asset (third element) are not included for a capital loss.

Legal expenses

Legal expenses incurred in defending your title or rights to the asset are included in the cost base for a CGT asset under section 110-25 of the ITAA 1997. The fifth element of the cost base of a CGT asset is capital expenditure incurred to establish, preserve or defend the taxpayer's title to the asset or a right over the asset.

In your case, the requirements of the fifth element of the CGT cost baes or reduced cost base are satisfied. As such, legal costs incurred by you form part of the cost base for the Property under subsection 110-25(6) of the ITAA 1997.

Application to your circumstances

Section 102-25 of the ITAA 1997 explains that where more than one CGT event happens, you use the CGT event that happens to you.

CGT event B1 happened for you when you entered into the contract for 'use and enjoyment' and therefore this is the most appropriate CGT event for your disposal of the Property, even if the Cancellation Contract is later finalised. CGT event B1 effectively brings forward the time of a disposal (and the time of a capital gain or loss).

If you received no capital proceeds from the CGT event B1 occurring, you are taken to have received the market value of the CGT asset that is the subject of the event as explained in section 116-30(1) of the ITAA 1997

Your reduced cost base will include the purchase price, incidental costs plus legal fees. Interest expenses and property holding costs, such as rates and taxed, are not included for a capital loss.