Edited version of private advice

Authorisation Number: 1052332528471

Date of advice: 29 November 2024

Ruling

Subject: Replacement rollover - compulsorily acquired property

Question

Can the Trust choose to apply the roll-over in Subdivision 124-B to disregard the capital gain that would otherwise arise upon the compulsory acquisition of its rental property by the government?

Answer

Yes.

This ruling applies for the following period:

1 July 2024 to 30 June 2026

The scheme commenced on:

1 July 2024

Relevant facts and circumstances

1.         The Trust owns an investment property (the Property) from which it derives income.

2.         The Trust acquired the Property and it continues to hold the Property as a long term investment on capital account.

3.         The Property has never been used, installed or in the process of being installed ready for use in a business carried on by the Trust.

4.         It is anticipated that the state government will compulsorily acquire the Property from the Trust during the Ruling Period.

5.         If the Property is compulsorily acquired:

•      the government will pay the Trust an amount of cash, equal to the market value of the Property, and

•      the Trust intends to use any cash received from the government to purchase a passive investment portfolio (investment portfolio) as a replacement asset(s) for the Property.

6.         The CGT assets that make up the investment portfolio will be held by the Trust on capital account as long-term investments and used by the Trust to derive passive income in the form of dividends or other income distributions.

7.         The following assumptions have been provided for the purpose of the private ruling application:

•         The Trust will be a resident trust for CGT purposes in the income year in which the Property is compulsorily acquired by the government.

•         The compulsory acquisition of the Property by the government will satisfy the requirements of section 124-70(1).

•         Upon the compulsory acquisition of the Property, the Trust will receive an amount of money from the government equal to the market value of the Property at the time of that compulsory acquisition.

•         The Trust will incur expenditure (equal or greater to the amount received from the government) to acquire one or more replacement CGT assets which will together make up the investment portfolio and relevantly comprise shares or units in listed companies, managed funds or unit trusts (or any similar investments).

•         The expenditure to acquire the replacement CGT assets will be incurred no later than one year after the end of the income year in which the Property is compulsorily acquired.

•         In relation to the Trust's ownership of the underlying CGT asset(s) making up the investment portfolio, those CGT asset(s) will not:

­   be depreciating asset(s) of the Trust the decline value in which is worked out under Division 40 or deductions for which are calculated under Division 328

­   become an item of trading stock of the Trust; or

­   become a registered emissions unit of the Trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 124-B

Income Tax Assessment Act 1997 section 124-70

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

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

Income Tax Assessment Act 1997 section 124-75

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 decision

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

Issue

Question 1

Summary

The Trust can choose to apply the roll-over in Subdivision 124-B upon the compulsory acquisition of its rental property by the government, as the proposed sale of the Property meets the conditions contained in in Subdivision 124-B. The intended acquisition of CGT assets like shares or units in listed companies and interests in managed funds or unit trusts held for long term investment as part of an investment portfolio will satisfy the 'same or similar' purpose test in subsection 124-75(4) and meet the requirements of acquiring another CGT asset for the purposes of the CGT replacement asset roll-over.

Detailed reasoning

Roll-over relief for the compulsory acquisition of a CGT asset is available where the conditions outlined in Subdivision 124-B 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.

Under subsection 124-70(1), 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).

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

A further requirement of Subdivision 124-B 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)). On satisfying these conditions, section 124-75 provides other requirements which must be satisfied if money is received for the event happening.

Subsection 124-75(2) requires that the owner of the asset must incur expenditure in acquiring another CGT asset.

Paragraph 124-75(3)(b) 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) 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)), nor become a 'registered emissions unit' just after the acquisition (subsection 124-75(6)).

As the Property was never used, installed or in the process of being installed ready for use in a business the Trust carries or carried on just before the event, subsection 124-75(4) therefore requires the Trust 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 the Trust used the original asset just before the event under paragraph 124-70(1) happened.

Same or similar purpose

As the terms 'same' and 'similar' in subsection 124-75(4) are not defined in the Income Tax Assessment Act, guidance may be drawn from the ordinary meaning of the terms.

The Macquarie Dictionary (Macquarie Dictionary Online, 2024) defines:

•         'same' to mean, 'identical with what is about to be or has just been mentioned...' and

•         'similar' to mean, 'having likeness or resemblance, especially in a general way'.

Further, 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? (TD 2000/42). 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.

At Example 3:

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.

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 which became their main residence. The distinction is that in the first example, both assets would be subject to income tax upon disposal, whereas in the second example, where the replacement asset is a main residence, the subsequent sale should be tax-free (due to the CGT main residence exemption).

Application to your circumstances

The proposed arrangement satisfies the following conditions for the Subdivision 124-B rollover:

•         the Property will be compulsorily acquired by an Australian government agency satisfying the condition in paragraph 124-70(1)(a)

•         the Trust expects to receive money as compensation for the compulsory acquisition of the Property satisfying the condition in paragraph 124-70(2)(a)

•         the Trust proposes to acquire another CGT asset(s) within the specified time frame satisfying the conditions in paragraph 124-75(2)(a) and subsection 124-75(3), and

•         the proposed replacement asset(s) will satisfy the conditions in subsection124-75(5) and 124-75(6) as they will not be

o   a depreciating asset of the Trust the decline value in which is worked out under Division 40 or deductions for which are calculated under Division 328

o   become an item of trading stock of the Trust; or

o   become a registered emissions unit of the Trust.

Same or similar

In relation to the special rules in subsection 12-75(4), the Property was never used, installed or in the process of being installed ready for use in a business the Trust carries or carried on.

Therefore, the relevant test to be applied in determining whether this condition is satisfied is whether the investment portfolio will be used by the Trust for the 'same' or 'similar' purpose to the purpose for which the Trust used the Property just before it is compulsorily acquired.

As discussed above whether a particular CGT asset is used for the 'same' or 'similar' purpose as another asset is a question of fact and degree.

Original asset - purpose (use)

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

Specifically, the acquisition and continued ownership of the property is for the mixed purpose of long-term capital growth and earning rental income.

The state government has raised the intention to compulsorily acquire the 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 for a mixed purpose. It is held on capital account for the purpose of long-term capital investment and for earning rental income.

Other asset - purpose (use)

The purpose for which the investment portfolio is to be used is also a mixed purpose. The Trust proposes to hold the CGT asset(s) for the purpose of long-term capital investment, while also earning income from trust distributions 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

Both assets are acquired for the mixed purpose of capital growth and earning income. In the case of the Property the Trust used it for the purpose of generating capital growth and leasing it to third party tenants to generate rental income.

The Trust proposes to use the investment portfolio for the purpose of long-term capital growth and for deriving income from the trust or dividends from the company (in the case of shares).

While the Trust's use, as registered proprietor, of the rental property is not the 'same' in that the Property is used to derive rental income whereas the investment portfolio will derive income from dividends and trust distributions, there is no requirement that the replacement asset's use be the same or an identical kind of asset to the compulsorily acquired asset, it is enough to be 'similar'.

The purpose of an investment property is considered to be used for the 'same' or 'similar' purpose as the investment portfolio as:

•         both assets are used for a mixed purpose

•         both are investments on capital account

•         there is the prospect of capital growth

•         both investments are used to generate passive income

•         both assets are taxed similarly on disposal

•         the risks of each asset are similar in that prices of the CGT assets can fluctuate

•         both assets have ongoing costs, and

•         both assets have costs to enter and exit the investment.

In this case the Trust uses a replacement asset for a purpose that has the same attributes and has a likeness or resemblance, especially in a general way to the purposes for which the Trust used the compulsorily acquired asset.

While not the 'same', in both the investment property and the investment portfolio, the capital investment is used to derive passive income, making it similar for the purposes of the 'same' or 'similar' purpose test.

As the Trust proposes 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 the Trust used the original asset just before the event under paragraph 124-70(1) happened, the condition in subsection 124-75(4) is satisfied.

Conclusion

The Trust can choose to apply the roll-over in Subdivision 124-B upon the compulsory acquisition of its rental property by the government as the proposed sale of the Property meets the conditions contained in in Subdivision 124-B. The intended acquisition of CGT assets like shares or units in listed companies and interests in managed funds or unit trusts held for long term investment as part of an investment portfolio will satisfy the 'same' or 'similar' purpose test for the purposes of subsection 124-75(4) and meet the requirements of acquiring another CGT asset for the purposes of the CGT replacement asset roll-over.