Private ruling: Income tax - CGT - Capital proceeds
Date of advice: 23 April 2021
Published: February 2022
Ruling period: 1 July 20RR - 30 June 20RR
Date scheme commenced: 1 July 20RR

Ruling: Q1: Are the capital proceeds for the purposes of CGT event A1, as received for the 'Sale of A Property', the net proceeds received by B of $Y,YYY,YYY? | A1:  | Q2: Does the cost base of the A Property include some or all of the $YY,YYY,YYY contributed by the B to enable the E to repay debt, release securities and enter the lease with F, as required by the P? | A2:  | Q3: Are the capital proceeds for the purposes of CGT event A1 received in the 'Sale of A Property' equal to the Valuer General's value of the property? | A3:  | Q4: Were the dealings between B and G with respect to the Capitalisation 'dealing(s) at arm's length' and does the market value substitution rule apply to the Capitalisation? | A4: 

Relevant facts and circumstances: 1. B purchased A Property in 2QQQ. 2. The land and buildings on A Property was a hospital. 3. B leased the A Property to G after it was purchased. G was the entity which subsequently operated this hospital. G was previously known as I. 4. B was a unit trust and was the sole shareholder (from 2QQQ) of G. 5. For several reasons, G experienced trading difficulties in recent years and incurred debts which could not be serviced by trading. For the hospital to remain operable, the only option was to sell its assets. 6. Q were engaged in 20RR to sell all the hospital's assets and undertook a process to source potential buyers. The result was that a buyer for G's operations was not found. 7. However, in 20RR, the A Property was sold to H as custodian for F by C as trustee for B. 8. Pursuant to the 'Contract of Sale', H would pay C sale proceeds of $YY.Ymillion for the A Property and other relevant items. C would then transfer the A Property and other relevant items to H. 9. The 'Contract of Sale' was dated RR MM 20RR. 10. The date of settlement, according to the 'Vendor Settlement Statement', was RR XX 20RR. 11. At clause 3.1 of the 'Contract of Sale', there were listed certain 'conditions precedent' which had to be satisfied prior to the sale of the A Property being effected. One these conditions precedent was being a party to the 'P'. 12. G and H had agreed on certain restrictions to be placed on the use of the sale proceeds (of $YY.Ymillion), as set out in clause 2 of the 'P' reproduced below: 2. Use of Land Proceeds 2. It is agreed between E and H that the [sale] Proceeds will be used and applied by E in accordance with the following table but noting that the figures in Items 2 and 3 of the table are estimates only and that any residue of the amount in Item 2 (after attending to the matter set out in Item 2) will be aggregated with amount set out in, and used for the purposes set out in Item 3. Item No Use of Funds Amount 1 Rental Retention $Y,YYY,YYY 2 Recapitalisation of Balance Sheet by discharging debt, tax liabilities, loans (to related parties) and other creditors Approx. $YY,YYY,YYY 3 Surplus cash fir: • Payment of costs • Held as capital and for other operating expenses Approx. $YYY,000 Total: $YY.Y million 2.2 Any Land Proceeds that are to be paid by B to I in order to effect the distributions outlined above will be paid as Share Capital to I in consideration for the issues of further shares in I to B and then distributed or paid by I in accordance with the requirements set out in clause 2. 13. In addition to the sale proceeds (of $YY.Ymillion), H agreed to pay the 'Initial Works Incentive' to the 'E' according to the following terms in clause 3 of P: 3. Initial Works Incentive 3.1 E and H acknowledge and agree that in addition to the [sale] Proceeds and in consideration for I entering into the Lease, H will pay the Initial Works Incentive to E. The Initial Works Incentive will comprise of H funding the capital improvements to the [A] Property set out in Schedule 1 (Initial Works) to the value of $Y,YYY,YYY (plus GST). 14. Clause 4 of the 'P' also relevantly provides the following in relation to the 'Rental Retention' Amount of $Y,YYY,YYY: 4. Rent Retention 4.1 Retention The Rental Retention portion of the [sale] Proceeds to be paid to C at Settlement will be paid to I at Settlement (in accordance with clause 2) and then paid by I to H to be held on trust by H as security for I's obligations under the Lease on the relevant terms set out in this clause 4. 15. Further, H entered into a new (long-term) lease with G over the A Property to enable G to continue operating the hospital, effective from the day before settlement (see clauses 36 and 37 of the 'Lease between H and I' in the'Contract of Sale'). Capitalisation of G 16. According to clauses 2.2 of the 'P' (as reproduced above at paragraph 14), B was required to capitalise G to an agreed amount by way of an injection of capital into G. This is because, at the time of settlement in the Sale of A Property, there was a loan between G and B. As was required under the 'P', G issued further shares to B in satisfaction of this loan (the Capitalisation ). 17. At the time of the Capitalisation B owned 100% of G and they were parties who were not legally, due to their relationship, at arm's length. 18. On RR MM 20RR, there were Y,YYY new G shares issued to B at the issue price of $YY,YYY,YYY. 19. The taxpayer has advised that B and G were 'dealing at arm's length' with respect to the Capitalisation element of the Transaction. The taxpayer also advised that this is because B was not asserting any control over G with respect to the setting of terms in the Capitalisation element of the Transaction. 20. The taxpayer has further advised that it was H who imposed this requirement to be able to enter a lease (on the terms described above at paragraph 15) with a well-capitalised entity (being, G). 21. The advancing of funds by B to G (and the intervening steps between the receipt of funds from H and the issuing of shares to B) formed part of the mechanism whereby the Capitalisation took place. 22. Therefore, the Capitalisation was a fundamental requirement of H (the party at arm's length) and was required for the Transaction to be commercially viable to H. 23. After the Sale of A property, the only assets held by B were the shares in G. A 'Deed of Dissolution' (dated RR MM 20R9) was entered into, where the B unit holders agreed to wind up B and distribute the G shares in specie to B's unit holders.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 6-10(3) | Income Tax Assessment Act 1997 section 102-25 | Income Tax Assessment Act 1997 section 103-5 | Income Tax Assessment Act 1997 section 103-10 | 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 section 112-20 | Income Tax Assessment Act 1997 section 116-10 | Income Tax Assessment Act 1997 section 116-20 | Income Tax Assessment Act 1997 section 116-30 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: 1. The capital proceeds received by B for the sale of the A Property are $YY.Y million. | Detailed Reasoning - Detailed reasoning: CGT event 2. The A Property is a 'CGT asset' within the meaning of that term in section 108-5 in the ITAA 1997. 3. CGT event A1 happened when the A Property was sold by C (as trustee for the B) to H (as custodian for F), as there was a 'disposal' of a CGT asset brought about by a 'change of ownership' from B to F pursuant to section 104-10 of the ITAA 1997. 4. According to subsection 104-10(3) of the ITAA 1997, the time that the A Property was disposed of was when the 'Contract of Sale' was entered into. Capital proceeds 5. According to subsection 116-20 of the ITAA 1997, the capital proceeds from a CGT event is the total of money you receive or were entitled to receive in respect of that CGT event happening. 6. In the current situation, the 'P' was ancillary or collateral to the 'Contract of Sale'. The 'Contract of Sale' was the main contract from which the obligations of H/F (as purchaser) and C/B (as vendor) arose. 7. According to paragraph 110 of the Sara Lee case (quoted above), 'Gere the main contract is relied on as the consideration in whole or part for the promise contained in the collateral contract, it is a wholly inconsistent and impossible contention that the other party is not to have the full benefit of the main contract as made... '. The obligation to sell the A Property arose from the'Contract of Sale'. 8. At item 7 of the 'Contract of Sale', the consideration for the sale (disposal) of the A Property was stated to be $YY.Y million. 9. C (in its capacity as trustee of the B) received $YY.Y million in respect of the disposal (sale) of the A Property. There was no 'other property' C received, or was entitled to receive, in regard to the proceeds from the sale of the A Property. 10. According to section 103-10 of the ITAA 1997, C (in its capacity as trustee of the B) is taken to have received money or other property as consideration for the sale of the A Property as it has been applied as C/B (the seller) directs under the P. It does not matter that the amount/s of consideration might not have directly benefitted C/B. 11. In the ATO's opinion, the commercial purpose of the 'P' is clear. It places restrictions on how the E may use (apply) the $YY.Y million sale proceeds from the A Property. It is a direction of the proceeds that the owner of the A Property agreed to, based on all information available to the ATO, in an arm's length sale. 12. To that end, the ATO notes that a sale and leaseback transaction is a well-established commercial arrangement to raise working capital for the owner of a valuable asset. The lease allows the vendor in the arrangement to become the 'tenant' and have the ongoing use of the property. 13. This goes towards explaining the 'Rent Retention' that was required under clause 4 of the 'P'. The ATO considers that the buyer of the A Property wanted this to ensure that I/G was in a position to pay its lease obligations for the initial period covered by the Rent Retention amount. According to clause 4.1 of the 'P', the 'Rent Retention' will be held on trust by H (the buyer of the A Property) for the E so the beneficial interest in the money remains with the E. Further, clause 4.3(a) of the 'P', provides for all interest accrued on the 'Rent Retention' amount to be the 'absolute property of G'. In due course, G may have a deduction in the course of its business for any rent paid to the owner of the A Property for the lease. 14. The recapitalisation of the E was another direction of the proceeds of the A Property sale, as required by the 'P'. Again, this direction was agreed to by B, the owner of the A Property. Although some of the recapitalisation funds were used to discharge security/ies held over the A Property, we do not place weight on that factor to support a reduction in the CGT sale proceeds. If we were to accept that contention, it would logically mean that any property that had no debt secured over it would have relatively more CGT sale proceeds allocated to it than an equivalent property that had debts secured over it - this argument cannot be accepted and we cannot see any legislative basis for this approach. 15. The 'surplus cash' that was to be held in G/G under clause 2 of the 'P' is another direction of the sale proceeds. 16. The ATO is of the opinion that all the restrictions on the use of the sale proceeds (per clause 2.1 of the 'P') were both negotiated on an arm's length basis and represents a direction of money received for the sale of the A Property under section 103-10 of the ITAA 1997. 17. As noted above, TD 2014/14 also confirms that a loan repayment made on behalf of a related entity cannot be deducted under the relevant provisions of the ITAAs. 18. Even if it was contended that the total $YY.Y million had not been received by C/B, section 103-10 and subsection 6-10(3) of the ITAA 1997 clearly provides that Gere money has been applied: • for C/B's benefit, or • as C/B directs, the $22.5 million it is still taken to have been received by C/B as part of the total capital proceeds for the disposal of the A Property. 19. Therefore, the $YY.Y million was the total amount of capital proceeds received by B for the disposal of the A Property. | Summary: 20. The cost base of the A Property does not include funds paid by B to the E. | Detailed Reasoning - Detailed reasoning: 21. The cost base of the A Property includes: 1) the money that was paid, or was required to be paid, for acquiring the A Property (the first element, per subsection 110-25(2) of the ITAA 1997); 2) the incidental costs that were incurred in acquiring the A Property, or incidental costs in relation to the CGT event that happens to the A Property (including its disposal) (the second element, per subsection 110-25(3) of the ITAA 1997); 3) the costs incurred for owning the A Property (the third element, per subsection 110-25(4) of the ITAA 1997); 4) capital costs to increase or preserve the value of the A Property, or to install or move it (the fourth element, per subsection 110-25(5) of the ITAA 1997); 5) capital costs of preserving or defending the title or rights to the A Property (the fifth element, per subsection 110-25(6) of the ITAA 1997). 22. An amount of $ YY,YYY,YYY.YY was paid by B to the G from the $YY.Y million sale proceeds received for the A Property. 23. This was the amount that G was required to pay in order to discharge its obligations (owed to creditors and other parties) in relation to the A Property. It was not an amount that increased the value of the A Property, as it was an expenditure which was incurred by G to repay debts it had incurred against the A Property (including the in relation to the buildings and/or other fixtures on the land). 24. With reference to the explanation for question 1 above, these ($YY,YYY,YYY.YY) were funds that were directed under the P. 25. As noted above, TD 2014/14 also states that a loan repayment made on behalf of a connected entity is not deductible under the relevant provisions of the ITAAs. 26. Therefore, the $ YY,YYY,YYY.YY paid by B to G does not have the character of 'capital' costs to increase or preserve the value of the A Property and is not capital expenditure within the meaning of subsection 110-25(5) of the ITAA 1997. | Summary: 27. The capital proceeds received for the sale of the A Property is $YY.Y million. | Detailed Reasoning - Detailed reasoning: 28. According to subsection 116-10(2) of the ITAA 1997, the consideration received for the sale of the A Property (being $YY.Y million) can only be substituted with the market value where: 1) no capital proceeds were received as a result of the sale of the A Property; 2) some or all of the capital proceeds from the sale of the A Property cannot be valued; or 3) the sale of the A Property was not at arm's length. 29. In the current situation, scenario (1) and (2) above could not have occurred as capital proceeds were received and were set out as being $YY.Y million in the 'Contract of Sale'. There is nothing in the facts to indicate that this was not the case. 30. In relation to scenario (3), no information has been provided to suggest that the sale of the A Property was not negotiated on an arm's length basis. 31. The sale of the A Property was effected by the 'Contract of Sale' and not any other ancillary contracts (such as the 'P'). As established above, the 'Contract of Sale' was the document that gave rise to the sale of the A Property and which contained the amount of consideration that was to be received by H. 32. Therefore, we cannot see any legal basis for using the market value substitution rule to modify the $YY.Y million amount of capital proceeds received for the sale of the A Property, as none of the situations outlined in subsections 116-10(2) or 116-30(2) of the ITAA 1997 are applicable. 33. According to established case authorities and the Excellar case (quoted above), the best evidence of market value is the selling price negotiated on an arm's length basis between the parties. 34. Therefore, the market value received for the sale of the A Property should be $YY.Y million. 35. Even if the market valuation substitution rule applied, the Valuer General's 'Capital Value' (per the Council Rates Notice dated QQ MM 20RR of $Y.YY million would not be the market value for tax purposes. Market value for tax purposes is assessed at the 'highest and best use' of the asset as recognised in the market. The concept of 'highest and best use' takes into account any potential for a use that is higher than the current use. The best evidence of this market value for the purposes of the sale of the A Property is the sale contract which states that the consideration was $YY.Y million. 36. The 'capital value' assessed by the Valuer General is done under a framework that values properties on a historical basis, not necessarily at the time of signing a contract (which is generally the date that a CGT event occurs, including for CGT event A1). A property's capital value assessment is used to determine council rates. It comes from a Government valuation adopted by council and would not generally be accepted by the ATO as a substitute for market value. 37. We also do not consider there are apportionment issues under section 116-10(3) of the ITAA 1997 that apply. As explained with reference to question 1 above, the relevant CGT event here is A1 for the sale of the A Property. The use of the Land Proceeds in a particular way under the 'P' is a direction of how those proceeds are used and do not impact the calculation of the capital proceeds or cost base in a way contemplated by questions 1 or 2. | Summary: 38. The dealings between B and G with respect to the Capitalisation were 'dealings at arm's length' and the market value substitution rule does not apply to the Capitalisation. | Detailed Reasoning - Detailed reasoning: 39. The question asks "whether the dealings between B and G with respect to the Capitalisation were a 'dealing(s) at arm's length'", which is relevant here for the purposes of the market value substitution rule in section 116-30 of the ITAA 1997. 40. We note that 'arm's length' is a defined term in subsection 995-1 of the ITAA 1997 and used in particular provisions of the tax law, such as the market value substitution rule in suparagraph 116-30(2)(b)(i) of the ITAA 1997. 41. In this case we consider that the relevant limb of the market value substitution rule is in subsection 116-30(2) of the ITAA 1997 relating to where 'There are capital proceeds'. 42. For subsection 116-30(2) of the ITAA 1997 to operate and substitute the capital proceeds with the market value, either of the following conditions need to be met: (a) Some or all of those capital proceeds cannot be valued - this is not the case in this ruling scheme, as the XX new shares subscribed for have an issue price of $YY,YYY,YYY and therefore can be valued; (b) The capital proceeds are more or less than the market value of the asset - in this ruling scheme, the asset was the G shares and it is submitted that the relevant parties (G and B) were not dealing at arm's length. We do not think this limb of the market value substitution rule applies, as even if the capital proceeds are more or less than market value (which could be the case), the parties to the Capitalisation (being G and B) were dealing at arm's length with regard to this aspect of the scheme; or (c) The relevant CGT event is C2 - CGT event C2 is not the correct CGT event applicable to the Capitalisation. 43. On the basis of our reasoning above at paragraph 42 (a), (b) and (c), the ATO view is that the market value substitution rule does not apply to the Capitalisation. We note that this conclusion is in accordance with the submissions of the taxpayer on this question (as outlined above at the 'Relevant facts and circumstances').