Edited version of private advice

Authorisation Number: 1052394232998

Date of advice: 30 May 2025

Ruling

Subject: CGT - legal vs beneficial

Question 1

Did the transfer of the dwelling on the rear property to Person A and Person B in early 20XX result in the happening of capital gains tax (CGT) event A1 in section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes.

Question 2

Can the dwelling construction costs be included in the fourth element of the cost base?

Answer 2

No.

Question 3

Are the capital proceeds received in regard to the transfer of the dwelling to Person A and Person B apportioned to both the land and the dwelling as separate CGT assets?

Answer 3

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The deceased owned a property which was their main residence up until the time of death.

The land and the dwelling were both acquired pre-CGT.

In mid-201X, the deceased along with the deceased's grandchild (Person A) and their spouse (Person B) entered into a deed of agreement (the Deed) which stated that that the deceased (grantor) granted a call option to Person A and Person B (the grantees) to purchase 'the lot' at the rear of the property:

•                     The Deed stated that the grantees were constructing a dwelling at the rear of the property.

•                     The grantees could exercise the option at any time during the 'option period' being the period commencing on the day after the date of death of the grantor and ending 60 days after the death of the grantor, or when the grantor placed the property on the market, whichever came first.

•                     The Deed stated that the construction costs would be reimbursed to the grantees by the grantor if the option was not exercised, or the grantor sold the original property.

•                     Following completion of the dwelling, the grantees were to ensure that all conditions of the development consent had been complied with and the final occupation certificate had been issued.

•                     Neither the grantees or the executor of the deceased's estate were to be liable for any costs in relation to the subdivision or construction of the dwelling on the rear lot.

•                     The grantees were to indemnify the grantor for any costs incurred in regard to the development application and also any increase in payments affecting the land such as council rates and water rates.

•                     The grantees were required to take out and keep in force a public risk insurance policy and contractors all risk policy in relation to the building.

During 201X-201X, approximately $X was spent by Person A and Person B to construct the dwelling.

In mid-to-late 201X, the property was subdivided, and the rear property became a recognised different address.

In late 201X, a formal valuation of the rear of the property occurred. The property was valued at $X, with the land valued at $X and the improvements valued at $X.

In early 202X, the rear property was transferred to Person A and Person B for $X.

In early 202X, the deceased passed away.

In mid 202X, Probate of the deceased Will, dated a few years earlier was granted to the deceased's child (the executor).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 108-55(2)

Income Tax Assessment Act 1997 subsection 108-70

Income Tax Assessment Act 1997 subdivision 110-A

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 section 116-40

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 section 118-125

Reasons for decision

Detailed reasoning

Section 102-20 of the ITAA 1997 provides that a capital gain or capital loss results from a CGT event occurring. The most common CGT event, event A1, occurs with the disposal of a CGT asset. CGT event A1 may arise when a property is sold.

When considering the sale of property, the most important element in the application of the CGT provisions is ownership. It must be determined who had ownership of the property. An individual can be a legal owner but have no beneficial ownership in an asset. Under subsection 104-10(2) of the ITAA 1997, a change of ownership is not deemed to have occurred if you stop being the legal owner of the asset but continue to be its beneficial owner.

The legal owner of the property is recorded on the title deed for the property issued under that State's legislation. However, it is possible for legal ownership to differ from beneficial ownership. Where beneficial ownership and legal ownership of an asset are not the same, there must be evidence that the legal owner holds the property on trust for the beneficial owner. We consider that there are extremely limited circumstances where the legal and equitable interests are not the same and that there is sufficient evidence to establish that the equitable interest is different from the legal title.

To prove that a different equitable interest exists, there must be evidence that a trust has been established - such that one party is taken merely to hold their interest in the property for the benefit of the other.

Trusts may be of three kinds: constructive, resulting or express. There are limited circumstances where the legal and equitable interests in an asset are not the same, and there is sufficient evidence to establish that the equitable interest is different from the legal title.

Express Trust

An express trust is one intentionally created by the owner of property in order to confer a benefit upon another. It is created by express declaration, which can be effected by some agreement or common intention held by the parties to the trust.

For an express trust to be created it is necessary that there is certainty of the intention to create a trust, subject matter and the object of the trust. While trusts can be created orally, all State Property Law Acts contain provisions that preclude the creation or transfer of interests in land except if evidenced in writing.

Constructive Trusts

A constructive trust is a trust imposed by operation of law, regardless of the intentions of the parties concerned. It applies whenever equity considers it unconscionable for the party holding title to the property in question to deny the interest claimed by another. The existence of a constructive trust is dependent upon the order of the court.

Resulting or implied trusts

On the purchase of real property, a resulting trust may be presumed where the legal title that vests in one or more of the parties does not reflect the respective contributions of the parties to the purchase price.

A resulting trust arises by operation of law and falls into two broad categories. One such category is where someone purchases property in the name of another (Calverley v Green). A trust is presumed in favour of the party providing the purchase money.

If an individual purchases and then pays for a property, but legal title is transferred to another person at their direction, the presumption of a resulting trust arises - the property is held in trust for them. The law presumes that the purchaser, as the person providing consideration for the purchase intended to retain the beneficial interest, although the legal interest is in the others name.

However, there are instances where this application may not apply. This is where the property is transferred to the purchaser's immediate family such as a spouse or a child. In such circumstances, the presumption of a resulting trust is replaced by the 'presumption of advancement'.

The rebuttable presumption of advancement deems the purchaser to have prima facie intended to advance the interests of the family members (i.e. an absolute gift).

Presumption of Advancement

A presumption of advancement is an equitable principle where a person puts property in the name of a spouse, child or other person. The presumption only applies to transfers and purchases made by people who stand in particular relationships, such as parents and their children.

Under a presumption of advancement, the property is transferred with the intention of transferring both the beneficial interest in the property as well as the legal title. The parties hold their equitable interests in the property in the same proportions as their legal interests.

In Calverley v Green, three important principals in relation to the presumption of advancement Gibb CJ found:

•                     Where one party purchases property in the name of the other, it will be presumed that the first party did not intend the other to take a beneficial interest unless there is such a relationship between the parties as gives rise to a presumption of advancement.

•                     The sort of relationship where the presumption will arise is where the relationship is such that it is more probably than not that a beneficial interest was intended to be conferred.

•                     The presumption of advancement may be rebutted by evidence of the actual intention of the purchaser at the time of purchase. If two parties have contributed to the purchase and the legal interest does not reflect the proportions of their contributions, the intentions of both parties at the time of purchase are important.

The onus of rebutting the presumption of advancement lies with the party who is considered as having gifted the property to another (usually the purchaser). Evidence is required that demonstrates that the purchaser did not intend the property to be a gift to the other party.

Separate asset

Generally, land and any building on it is considered a single CGT asset. However, where the land was acquired pre-CGT and the building was constructed post-CGT, they may be deemed to be separate CGT assets under section 108-55 of the ITAA 1997.

Where there was a contract for the construction, the building will only be considered a separate CGT asset acquired post-CGT if the construction contract was entered into post-CGT (paragraph 108-55(2)(a) of the ITAA 1997).

Application to your circumstances

In this case, the land and original dwelling were purchased by the deceased prior to 1985 and the contract for the construction of the building on the rear of the property was entered into in 20XX. Therefore, the building is deemed to be a separate post-CGT asset by section 108-55 of the ITAA 1997.

In 20XX, the deceased sold the rear subdivided lot containing the newly built dwelling to Person A and Person B and CGT event A1 in section 104-10 of the ITAA 1997 happened to the deceased.

As the deceased purchased the land comprising the rear lot prior to 20 September 1985 and continued to own the land until its transfer to Person A and Person B, the land did not stop being a pre-CGT asset prior to its disposal. Therefore, the deceased could disregard any capital gain on the sale of the land itself because it was a separate CGT asset from the newly constructed dwelling.

Therefore, as the dwelling is a separate CGT asset, it needs to be determined if Person A and Person B were the beneficial owners of the dwelling, despite the deceased being the legal owner of the land.

As previously stated, we consider that there are extremely limited circumstances where the legal and equitable interests are not the same and that there is sufficient evidence to establish that the equitable interest is different from the legal title.

A written agreement was in place (the Deed) which outlined that Person A and Person B were constructing a dwelling at the rear of the property. Although the Deed states that construction costs would be reimbursed to Person A and Person B by the deceased if the option was not exercised, or if the grantor sold the original property, the deed itself does not provide sufficient evidence that a trust existed in any form or that the building was held in trust by the deceased for Person A and Person B.

In this case, the deceased controlled the property as the legal owner and there is insufficient evidence for the Commissioner to determine that Person A and Person B were the beneficial owners of the building.

Question 2

As the dwelling constructed on the rear lot is a separate CGT asset, its cost base and capital proceeds received in relation to its disposal must be determined.

Cost base

Subdivision 110-A of the ITAA 1997 contains the rules for working out the cost base of a CGT asset.

Section 110-25 of the ITAA 1997 provides the general rules regarding cost base. The cost base consists of five elements:

•                     Acquisition costs (the money you paid, or are required to pay, in respect of acquiring it)

•                     Incidental costs

•                     Non-capital ownership costs which are not deductible elsewhere

•                     Amounts which increase or preserve the value of the asset

•                     Amounts incurred in establishing, preserving or defending your title to the asset, or right over the asset

Fourth element of the CGT cost base

Subsection 110-25(5) of the ITAA 1997 relates to the fourth element of a cost base and includes capital expenditure 'you incurred' to:

•                     increase or preserve the asset's value; or

•                     install or move the asset.

For expenditure to be included in the fourth element of the cost base of an asset, it must be incurred to enhance the value of the asset, that is, for the purpose of enhancing the value of an asset. It is immaterial whether or not the expenditure in fact enhances the value of the asset.

In this case, the construction costs cannot be added to the cost base as the deceased did not incur the costs themselves, as the building was funded by Person A and Person B.

Question 3

Capital proceeds

Section 116-40 of the ITAA 1997

Where a payment in connection with a transaction that relates to more than one CGT event, the capital proceeds from each event are so much of the payment as is 'reasonably attributable' to that event: see section 116-40 of the ITAA 1997.

Taxation Determination TD 98/24 applies where the sold property comprises separate CGT assets under Subdivision 108-D of the ITAA 1997. At paragraph 5 it states that '...in the absence of an agreed allocation, each party needs to make their own reasonable apportionment of the capital proceeds to the separate assets. In making this apportionment, it is expected that each party would generally have regard to, and be able to justify, their reasonable apportionment based on the relevant market values of the separate assets...'.

According to the valuation undertaken the 'unimproved land' pre-CGT asset that was transferred represented X/Y or X% of the value of the property. Correspondingly, the dwelling, as a separate CGT asset, would be X% of the value of the transferred asset.

As the pre-CGT land CGT event A1 capital gain is disregarded under section 104-10 (5) of the ITAA 1997 the remaining issue to be considered is the application of CGT event A1 to the dwelling asset recognised under Subdivision 108 D of the ITAA 1997.

The CGT proceeds for the CGT event for the dwelling can reasonably be said to be X% of the total CGT proceeds of $X or $X.

Section 116-30 of the ITAA 1997

The market value substitution rule in section 116-30 of the ITAA 1997 can apply where particular conditions are met. This rule sets the CGT proceeds as being the market value of the CGT asset.

Subsection 116-30(1) of the ITAA 1997 applies where there are no CGT proceeds for the CGT asset. It does not apply if there was an amount of CGT proceeds for a CGT asset.

Subsection 116-30(2) of the ITAA 1997 applies as follows:

The capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if...(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...

As regards the requirement in subsection 2 that you did not 'deal with each other at arm's length in connection with the event' this was summarised in Moloney v FCT (2024 ATC 10-726) as follows:

45. In Federal Commissioner of Taxation v AXA Asia Pacific Holdings Ltd, Edmonds and Gordon JJ observed:

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 YYY 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.

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] FCA 1217; (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 [1995] FCA 1217; 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.

Although the option was not exercised in the required time period, the terms of the deed provide relevant context for the transfer that occurred. Both parties had rights and obligations that can reasonably be viewed as acting in 'his or her own best interest'. The price at which the property was sold was consistent with an arm's length dealing.

In applying the above principles to your situation, it is considered that the deceased dealt with the purchaser at arm's length in connection with the CGT event.

Accordingly, as the deceased dealt with the purchaser at arm's length on sale of the property, subsection 116-30 of the ITAA 1997 does not apply.