Private ruling: Capital gains tax – nomination of a substitute purchaser under a contract for sale of real estate
Date of advice: 20 December 2018
Published: February 2019
Ruling period: Year ended 30 June 2019 | Year ended 30 June 2020
Date scheme commenced: 1 July 2016

Ruling: Q1: If the trustee executes its right to nominate under a Contract for Sale of Real Estate in respect of a property and nominates a substitute purchaser that is not a related entity, will any gain made be treated as being on capital account? | A1: Yes | Q2: What is the relevant CGT asset(s)? | A2: The relevant CGT assets are the rights under the contract. The right to nominate a substitute purchaser and the remaining rights under the contract will be treated as separate assets for CGT purposes. | Q3: What is the CGT event(s) that will happen? | A3: CGT events C2 and A1 will happen. | Q4: If, as a result of those CGT event(s), the trustee makes a capital gain, will that gain be treated as a discount capital gain as defined in section 115-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A4: Yes

Relevant facts and circumstances: A trust was established in anticipation of the trustee of the trust entering into a contract in respect of the acquisition of property. A related company of the trust purchased a business. At the same time, the trustee entered into a contract for the purchase of the property on which the business was being conducted. The trustee paid a deposit for the purchase of the property. Settlement for the purchase of the property is due five years after the date of the contract, and the balance of the purchase price is payable on settlement. The trustee also entered into the lease agreement with the property vendors in the same income year for the lease of the property. The related company conducts the business from the property. The intention of the trustee in purchasing the property was to hold it on trust so the related company could conduct the business on the property. Intention to nominate a substitute purchaser Due to serious changes in the personal circumstances of the controllers of the trust, the trustee now wishes to exit the contract by finding a substitute purchaser. The trustee proposes to enter into arm’s length negotiations and transfer its rights to acquire the property under the contract to an unrelated third party for market value consideration. The trustee proposes to exercise its right under the contract to nominate a substitute purchaser. In exchange for a payment by the nominee to the trustee, the nominee will purchase the property as a substituted purchaser from the vendor under the existing terms of the contract. There has not been any change to the terms of the contract. There are currently no proposed changes to the terms of the contract.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 Parts 3-1 and 3-3 | Income Tax Assessment Act 1997 subsection 108-5(1) | Income Tax Assessment Act 1997 section 102-20 | Income Tax Assessment Act 1997 subsection 104-24(1) | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 104-60 | Income Tax Assessment Act 1997 section 115-5 | Income Tax Assessment Act 1997 section 115-10 | Income Tax Assessment Act 1997 section 115-15 | Income Tax Assessment Act 1997 subsection 115-20(1) | Income Tax Assessment Act 1997 subsection 115-25(1) | Income Tax Assessment Act 1997 subsection 115-25(3)

Reasons for decision: Summary: If the trustee executes its right to nominate a substitute purchaser under the contract and nominates a substitute purchaser that is not a related entity, any gain made is treated as being on capital account. | Detailed Reasoning - Detailed reasoning: The issue for determination is whether the proceeds from the satisfaction or disposal of contractual rights under the contract will be treated as either: ● assessable ordinary income under section 6-5 from carrying on a business or as part of a profit-making undertaking or scheme ● the mere realisation of a capital asset, where the receipts are treated as a capital gain under Part 3-1 and Part 3-3. The determination of the appropriate tax treatment of the proceeds from the disposal of the contractual rights will be a question of fact and degree. Where the satisfaction or disposal of a CGT asset is considered a ‘mere realisation’, the receipts will not be considered ordinary income but will be treated as a capital gain to which the capital gains tax (CGT) rules under Part 3-1 and Part 3-3 will apply. A sale that is more than a ‘mere realisation’ will be on revenue account and assessable under section 6-5. The expression 'mere realisation' is used to distinguish a mere realisation from a business operation or a commercial transaction carrying out a profit-making scheme. Profits made on the realisation of capital assets can still be ordinary income if the activities go beyond a mere realisation and instead become a separate business operation or commercial transaction even though the taxpayer did not have a purpose of profit-making at the time of acquiring the asset. The principle has been established that profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693). Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance on whether profits from isolated transactions are income or capital. Paragraph 35 of TR 92/3 provides that a profit from an isolated transaction is generally income when both of the following elements are present: (a) The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain (b) The transaction was entered into, and the profit was made, in the course of carrying on a business or carrying out a business operation or commercial transaction. Paragraph 40 of TR 92/3 states that it is not necessary that the intention or purpose of profit-making be the sole of dominant intention or purpose for entering into the transaction. It is sufficient if the profit-making is a significant purpose. In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. In the present case, the trustee entered into the contract with the intention of purchasing the property on which a related company conducts its business and holding it for the continued use of that related company. Due to the changed personal circumstances of the controllers of the trust, the trustee now seeks to exit the transaction for the purchase of the property by nominating a substitute purchaser. The trustee intends to achieve this by entering into arms-length negotiations with an unrelated substitute purchaser for market value consideration. The Commissioner considers that the trustee will not be nominating a substitute purchaser for the purpose of profit-making, but is merely realising a capital asset for market value consideration. Consequently, any gains realised when the trustee nominates a substitute purchaser will constitute capital receipts. | Summary: The relevant CGT assets are the rights under the contract. The right to nominate a substitute purchaser and the remaining rights under the contract will be treated as separate assets for CGT purposes. | Detailed Reasoning - Detailed reasoning: Pursuant to section 108-5(1): A CGT asset is: (a) any kind of property; or (b) a legal or equitable right that is not property. Taxation Ruling TR 1999/19 Income Tax capital gains: treatment of forfeited deposits (TR 1999/19) provides guidance on the treatment of contractual rights for CGT purposes. Paragraphs 114 and 115 of TR 1999/19 state: It seems clear that the purchaser’s bundle of contractual rights, e.g., the right to a transfer of the property, is an asset for CGT purposes. Being proprietary rights, they are an asset as defined both before and after 26 June 1992. These rights are created by the vendor in the purchaser and are taken to have been acquired by the purchaser when the purchaser becomes the owner of the rights, that is, when the contract is entered into (subsection 109 5(1)). The Commissioner’s view on whether the totality of rights under a contract are considered one asset or separate assets is considered in Taxation Determination TD 93/86 Income tax: capital gains: are the totality of rights under a contract considered to be the one asset, or is each right considered to be a separate asset for CGT purposes? (TD 93/86). Paragraph 1 of TD 93/86 states that: Whether all the rights comprise one single asset, or each right is a separate asset, will depend on the facts of each case. Generally, however, the initial approach will be to regard the totality of rights as the one asset for the purposes of Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997. (emphasis added) This suggests that the rights under the contract entered into by the trustee was a single CGT asset for the purposes of section 108-5, incorporating both the right to nominate a substitute purchaser and all other contractual rights in relation to the acquisition of the property. Paragraph 2 of TD 93/86 further states: Depending upon the circumstances of each particular case, an assignment of one of the rights contained in a contract is usually treated as a disposal of part of the asset (i.e. the contractual rights); the individual right that is severed from the contract is, if it continues to exist , regarded as a separate asset for CGT purposes. (emphasis added) In this case, the trustee has the right to nominate a substitute purchaser under the contract. This clause stipulates that while the trustee can nominate an additional or substitute purchaser, it remains liable for the due performance of all of its obligations under the contract. This suggests that the trustee’s right to nominate a substitute purchaser is exclusive to the trustee. Under the terms of the contract, a nominated substitute purchaser would not in turn acquire its right to nominate another substitute purchaser. Thus, this particular right cannot be disposed of or transferred to the nominated substitute purchaser, but will cease to exist once the nomination process is complete. Accordingly, pursuant to subsection 104-25(1), it is considered that the trustee’s right to nominate a substitute purchaser will be satisfied by the completion of the nomination process. Accordingly, the right to nominate a substitute purchaser will be treated as a separate asset for CGT purposes from the remaining rights under the contract. | Summary: When the trustee entered into the contract, it acquired a bundle of rights, including the right to nominate a substitute purchaser. As a consequence of nominating a substitute purchaser under the contract, the right to nominate a substitute purchaser will be satisfied, such that CGT event C2 will happen to that particular right under the contract. The process of nomination will also result in either the disposal or transfer of the other rights acquired by the trustee under the contract. When the trustee disposes of its remaining rights to the nominated substitute purchaser, CGT event A1 will happen. | Detailed Reasoning - Detailed reasoning: Section 102-20 states that a capital gain or capital loss is made only if a CGT event happens to a CGT asset. Right to nominate CGT event C2 is contained within Subdivision 104-C, and deals with the ‘end of a CGT asset.’ Subsection 104-25(1) states that: CGT event C2 happens if your ownership of an intangible * CGT asset ends by the asset: (a) being redeemed or cancelled; or (b) being released, discharged or satisfied; or (c) expiring; or (d) being abandoned, surrendered or forfeited; or (e) if the asset is an option - being exercised; or (f) if the asset is a *convertible interest - being converted. (Items marked with an asterisk (*) are defined in the dictionary at section 995-1). As outlined in the detailed reasoning in question 2 above, it is considered that the trustee’s right to nominate a substitute purchaser will be satisfied by the nomination of a substitute purchaser. Therefore, CGT event C2 will happen to the right to nominate a substitute purchaser when the trustee makes the nomination. Remaining rights As a consequence of the nomination of a substitute purchaser, the trustee will dispose of or transfer its remaining rights under the contract to the nominated substitute purchaser. As CGT event C2 only applies to the ‘end of an asset’, it cannot apply to the remaining rights, which will continue to exist after their disposal or transfer to the nominated substitute purchaser. CGT event A1 happens if the ownership of a CGT asset changes (section 104-10). CGT event E2 happens if a CGT asset is transferred to an existing trust (section 104-60). If more than one CGT event happens in respect of a transaction, the most specific event for the situation is to be used (subsection 102-25(1)). ATO Interpretative Decision ATO ID 2003/559 Income Tax: Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2 (ATO ID 2003/559) provides the Commissioner’s view on which CGT event happens when an asset is disposed of to a trust that is not connected with a taxpayer in any way. ATO ID 2003/559 notes that CGT event A1 is the most specific event where the parties are completely unconnected and are dealing with each other at arm’s length. As the nominated substitute purchaser will be an unrelated third party to the trustee, it is considered that CGT event A1 will be the event that happens when the trustee disposes of or transfers (including to a trust) its remaining rights under the contract. | Summary: If the trustee makes a capital gain, the gain will be treated as a discount capital gain. | Detailed Reasoning - Detailed reasoning: To be a discount capital gain under section 115-5, the capital gain must: ● be made by an individual, a complying superannuation entity or a trust (section 115-10) ● result from a CGT event happening after 11.45am on 21 September 1999 (section 115-15) ● be worked out without reference to indexation at any time (subsection 115-20(1)) ● result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event (subsection 115-25(1) ● not be one of the specified ineligible CGT events in subsection 115-25(3). In this case, any capital gain on the satisfaction, disposal or transfer of the rights under the Contract will: ● be made by a trust ● result from a CGT event happening after 11.45am on 21 September 1999 ● not have an indexed cost base since the CGT assets were acquired after 11.45am on 21 September 1999 ● result from a CGT event happening (CGT event C2 and A1) to CGT assets that were held for greater than 12 months ● not result from one of the ineligible CGT events in subsection 115-25(3). Accordingly, any capital gain will be treated as a discount capital gain as defined in section 115-5.