Private ruling: Income - CGT - forfeited deposit - continuum of events
Date of advice: 26 July 2021
Published: October 2021
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX | Year ended 30 June 20XX | Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX.

Ruling: Q1: Did CGT event C2 happen when you received the deposits that were subsequently forfeited? | A1: No. | Q2: Did CGT event C2 happen when the first deferred settlement sale contract was terminated, and the three deposits paid were forfeited by the first purchaser? | A2: No. | Q3: Will the forfeited deposits from the first deferred settlement sale contract be included as additional capital proceeds received in relation to the second deferred settlement sale contract of the property? | A3: Yes.

Relevant facts and circumstances: Client 1 and Client 2 (you), Associate 1 and Associate 2 (the Group) each purchased a 1/3 rd share of the Property after 1985. The Property has never been your main residence. The Group decided to sell the Property. The first deferred settlement sale contract is for $X,XXX,XXX. The first purchaser of the property agreed to pay three non-refundable deposits as follows: • $XXX,XXX paid on 20 June 20XX; • $XXX,XXX paid on 20 June 20XX; and • $XXX,XXX paid on 20 June 20XX totalling $XXX,XXX with an option to purchase the property from this point. You received 1/3 rd of the non-refundable deposits being: A short time after the last deposit was made the due date to attend to either of the options expired. Your solicitor advised you that: 'I have not received any correspondence from the purchaser either to exercise the Call Option or to extend the Call Option Period'. In a meeting a few weeks later the Group agreed that in approximately one month the contract would be terminated, and the three deposits paid would be forfeited. One month later the contact was terminated, and the three deposits were forfeited by the purchaser. You have continued the process of selling the property. Approximately six months after the first deferred settlement sale contract was terminated the second deferred settlement sale contract was exchanged for $X,XXX,XXX. A short time later you were advised from your solicitor that: We are pleased to advise that the Call Option Deed has now been exchanged. The second purchaser has now agreed to pay the following: • $XX,XXX on exchange for the due diligence; • 1% of the purchase price (less due diligence fee) within 8 months from the date of the deed; • 1.5% within 12 months from the date of the deed; • 2.5% within 24 months from the date of the deed; • Final payment of 5% within 30 months from the date of the deed; and • The balance at settlement. The second deferred settlement sale contract will expire three years after it was signed if the option is not exercised. Assumption(s) For the purpose of this ruling, it is assumed that on or before the expiry date the option is exercised, and the Property is sold.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 116-20

Reasons for decision: Detailed Reasoning - Detailed reasoning: You can only make a capital gain or a capital loss if a CGT event happens. Most CGT events relate to a specific CGT asset. The Property is the relevant CGT asset if it is sold, however, the rights under the contract are the relevant CGT asset if the Property is not sold. Section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. The time of the event is when you enter into the contract for the disposal or, if there is no contract, when the change of ownership occurs. Section 104-25 of the ITAA 1997 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being abandoned, surrendered or forfeited or being released, discharged or satisfied. The time of the event is when you enter into the contract that results in the asset ending or, if there is no contract, when the asset ends. Taxation Ruling TR 1999/19 explains the capital gains tax ('CGT') consequences of the receipt by a vendor of a forfeited deposit, forfeited instalments of the purchase price and damages. Paragraphs 11, 16, 18 and 67 of TR 1999/19 state: If the underlying asset was acquired by the vendor on or after 20 September 1985 (and is not subject to the main residence exemption), the forfeited deposit adds to a capital gain or reduces a capital loss made on any later disposal of the underlying asset, provided the forfeiture occurred as part of a 'continuum of events' which constituted the disposal of the underlying asset. For a relevant 'continuum of events' to exist, there must be an earlier contract to sell the underlying asset, forfeiture of a deposit and a later bona fide disposal of the underlying asset. It is also necessary, in our view, for continuous and reasonable attempts to be made to resell the underlying asset (for example, real estate) after the earlier contract has fallen through, which end in this later disposal of the real estate. If there is no longer a 'continuum of events' which constitutes a disposal of an underlying asset (e.g., after a 2 year period), a vendor is required to amend their income tax return for the earlier year in which the forfeiture occurred and include the forfeited deposit as assessable income. This is on the basis that the vendor's contractual rights are the most relevant asset and that there has been an acquisition and an ending of ownership of their contractual rights (CGT event C2). Although in the Guy case the Court referred to 'the completed sale ... very soon after' (emphasis added), it is appropriate that the 2 year period be measured from the date of forfeiture of the deposit under the earlier contract for sale to the date of contract of the later resale of the real estate. Using the date of settlement of the later resale, instead of the date of contract, would be complicated by delayed settlements that are sometimes negotiated. However, if it appears a vendor is attempting to manipulate the period and defer a tax liability by entering into a contract of sale with deferred settlement terms (which ultimately may not be completed), the later contract is likely to be disregarded. | Detailed Reasoning - Your situation: In your case you received $XX,XXX from the first purchaser of the property under a deferred settlement sale. As the first purchaser did not exercise their option to finalise the purchase of the property the payments became forfeited. You continued to advertise the property for sale and once again entered into a deferred settlement sale with a second purchaser. Under TR 1999/19 for the continuum of event to be considered the sale of the property needs to be complete within a 2-year period. You entered into the second deferred settlement sale contract within six months of the forfeiture, which is within the 2-year period that the continuum of events conclusion can apply. Given the circumstances of your case, it is reasonable to conclude that the forfeiture has occurred within a continuum of events that will result in the sale of the Property. The consequences for you are: • No CGT event will occur due to receiving the deposits. They are merely pre-payment of amounts that will be included as capital proceeds when a CGT event happens later. At each of those points in time, it was unclear whether that later CGT event would be the sale of the Property or the forfeiture of the deposits. • No CGT event will occur due to the forfeiture of the deposits by the first purchaser as this is part of the continuum of events that will lead to the sale of the Property. The Property is the relevant CGT asset and not the rights under the contract. • The capital proceeds for the sale of the Property under the second deferred settlement sale contract will include the forfeited deposits from the first deferred settlement sale contract and all amounts paid under the second deferred settlement sale contract. | Detailed Reasoning - Status of this private ruling: This private ruling will not become legally binding on the Commissioner unless the option is exercised before the expiry date and the sale of the Property is completed. The option is currently unexercised, so the conditions for a continuum of events do not exist. You should complete your income tax return for the year ended 30 June XXXX in the manner that is correct as at the date of lodgement. That would currently see you declare a capital gain due to the forfeiture of the deposits on the basis that CGT event C2 happened due to the forfeiture. You can self-amend your income tax assessment for the year ended 30 June XXXX if the option is exercised by the expiry date.

$XX,XXX on 20 June 20XX; and | $XX,XXX on 20 June 20XX. (which is $XX,XXX each)