Private ruling: Capital gains tax - investment property - gifting of 50% interest to spouse
Published: August 2012
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Will a capital gains tax (CGT) event occur upon the transfer of a 50% interest in your investment property to your spouse? | A1: Yes. | Q2: Are you entitled to interest deductions on the new loan used to refinance your original investment property loan? | A2: Yes.


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 116-10 | Income Tax Assessment Act 1997 Section 116-30

Reasons for decision: Detailed Reasoning - Capital gains tax - general: The most common capital gains tax (CGT), event CGT event A1 occurs when you dispose of an asset to someone else. The time of the event is when you enter into the contract for the disposal of the asset, or if there is no contract, when the change of ownership occurs. When you transfer a 50% interest in your investment property into your spouse's name, you will trigger a CGT event A1, as there will be a change of ownership. | Detailed Reasoning - Gifting: In some cases, if you receive nothing in exchange for a CGT asset (for example: if you give a CGT asset as a gift) you are taken to have received the market value of the asset at the time of the CGT event. You may also be taken to have received the market value if: · your capital proceeds are more or less than the market value of the CGT asset, and · you and the purchaser were not dealing with each other at arm's length in connection with the event. You are said to be dealing at arm's length with someone if each party acts independently and neither party exercises influence or control over the other in connection with the transaction. The law looks at not only the relationship between the parties but also the quality of the bargaining between them. If you do not deal at arm's length the market value substitution rule is applicable. Under this rule, you are taken to have disposed of your interest in the asset at market value on the date of disposal. There are a number of methods for determining the market value but two methods available to you are: · obtaining a valuation from a qualified valuer; or · compute your own valuation based on reasonably objective and supportable data. | Detailed Reasoning - How this applies to your situation: In your situation, the transfer (disposal) of a 50% ownership interest in the property to your spouse will be for no proceeds, so the market value substitution rules will be applicable. There are no exceptions or exemptions for transferring an asset to your spouse except in the circumstances of a marriage breakdown. Therefore, when calculating your capital gain or capital loss you will be taken to have received capital proceeds equal to the market value of the 50% share of the property that you transferred to your spouse on the date of the transfer. | Detailed Reasoning - Co-owners - dividing of income and expenses: Co-owners who are not carrying on a rental property business must divide the income and expenses for the investment property in line with their legal interest in the property. Where they are joint tenants, they each hold an equal interest in the property. Therefore, all rental income and ownership expenses must be attributed to each co-owner according to their legal interest in the property, despite any agreement between the co-owners, either oral or in writing, stating otherwise. | Detailed Reasoning - Deductibility of interest: Section 8-1 of the Income Tax Assessment Act 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature. Interest is deductible to the extent that is incurred in gaining or producing your assessable income or in carrying on a business for that purpose. For example you can only include deductions you incurred to produce assessable income such as interest paid on a loan taken out for an investment property. Taxation Ruling TR 2004/4 discusses the issue of deductions for interest incurred prior to the commencement of, or following the cessation of relevant income earning activities. Paragraph 10 of TR 2004/4 states that where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and the relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing the assessable income if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period. Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgement about the nexus between the outgoing and the income earning activities. An outgoing of interest will not fail to be deductible merely because: · the loan is not for a fixed term; · the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty; or · the original loan is refinanced, whether once or more than once. However, if the taxpayer: · keeps the loan on foot for reasons unassociated with the former income earning activities; or · makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred, · the nexus between the outgoings of interest and the relevant income earning activities will be broken. Paragraph 50 of TR 2004/4 states that, in weighing the factors of a case, the following should be observed: The less the financial resources of the taxpayer, the more likely it is that an inference could be drawn that the existence of a continuing obligation to pay interest is a burdensome legacy of the past rather that a result of the taxpayer choosing to keep the loan on foot for reasons unassociated with the former income activities. The more liquid the resources of the taxpayer, the more likely the inference could be drawn that the loan is being kept on foot for reasons unassociated with the former income earning activities. The inference is unlikely to be drawn if it would be unreasonable in the circumstances to expect the taxpayer to apply their liquid resources against the loan; The realisation or exchange of assets without a diversion of these resources in repayment of the principal will tend to indicate a breaking of any nexus that might previously have been maintained even after the cessation of the income earning activities. The greater the time since the cessation of the income earning activities, the more likely it is that an inference could be drawn that the continuing obligation to pay interest is a result of the taxpayer choosing to keep the loan on foot for reasons unassociated with the former income earning activities; and Refinancing of a loan does not of itself break the nexus between the outgoings of interest under the loan and the prior income earning activities. However, the decision to refinance may, in all the circumstances, lead to the inference being drawn that the taxpayer has made a conscious decision to extend the loan, and has done this in order to derive an ongoing commercial advantage. | Detailed Reasoning - How this applies to your situation: In your case, you will transfer a 50% interest in your investment property to your spouse. Upon the transfer of this interest you will then make the changes to your loan. We now need to look at the 'use' test in relation to what the drawings from the new loans are being used for. In your situation, you and your spouse are obtaining finance in the form of two new loans with the financial institution B. You and your spouse's intentions are to take out two new loans which enable you to use the equity in the investment property to allow the purchase of your primary place of residence. You are undertaking this by refinancing the investment property which will enable to share the ownership interest of the investment property with our spouse and also allow you both to purchase a primary place of residence. You cannot include any interest deductions on the new loan taken out to acquire your primary place of residence as you will not be deriving any assessable income on this interest and it is your primary place of residence used for private and domestic purposes. Regardless of whether you take out separate loans or joint loans upon the refinancing of the investment property, only the interest deductions that relate to the outstanding balance on the original loan can be included as interest deductions. Therefore, upon refinancing of your investment property you can only include the interest deductions on the balance of outstanding monies on the original loan you took out to acquire the investment property. For more information on rental properties please see our website - www.ato.gov.au.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Relevant facts: You currently own an investment property solely in your name. | You will gift a 50% interest in your investment property to your spouse, so that you and your spouse can both share in the benefits of owning the investment property. | You will pay stamp duty on the transfer of the 50% interest in the investment property to your spouse. | Your current loan for the investment property is with financial institution A. | You will refinance your investment property upon the transfer of this interest to your spouse. | You and your spouse will take out two new loans with financial institution B, one to refinance the investment property, the other to acquire your primary place of residence. | The loan period for the investment property will be for a period exceeding the current loan period. | Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. | If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. | For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.