Private ruling: Capital gains tax implications on disposal of property
Date of advice: 24 September 2015
Published: September 2015
Ruling period: Year ended 30 June 2010 | Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1 July 20VV

Ruling: Q1: Does a CGT event occur when the Supreme Court orders that the Property owned by the Co-owners be vested in the Trustee? | A1: Yes | Q2: Does section 106-60 of the Income Tax Assessment Act 1997 (ITAA 1997) prevent a capital gains tax (CGT) event from occurring to the Co-owners at the time the Vesting Order becomes 'legally effective'? | A2: No | Q3: Does section 106-60 of the ITAA 1997 apply such that CGT event A1 happens to the Co-owners on the sale of the Property? | A3: No | Q4: Is it reasonable for the Trustee to treat the Co-owners as non-residents during the years ended 30 June 20YY and 30 June 20ZZ? | A4: Yes | Q5: Is there a capital gain arising in respect of the sale of the Property? | A5: No | Q6: If a capital gain is derived on the ultimate sale of the Property, will it be eligible for the 50% CGT discount? | A6: Not applicable | Q7: Following the sale of the Property, is the Trustee liable to pay any amount of tax under section 254 of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of the tax liability otherwise relating to the Co-owners? | A7: No | Q8: To the extent that section 106-60 of the ITAA 1997 does not apply, does the change of ownership of the Property occur when the stay order was lifted and legal title was able to be transferred during the 20YY year? | A8: Yes | Q9: To the extent that section 106-60 of the ITAA 1997 does not apply, does CGT event A1 occur when the Trustee sold the Property in his capacity as trustee and is he personally liable for any tax thereon? | A9: Yes | Q10: Is the tax cost base of the Property for the Trustee equal to the net sale proceeds received on the sale of the Property in December 20YY and therefore no capital gain arises in the Trust? | A10: Yes | Q11: To the extent that the answer to Question 10 is yes, is the Trustee liable to pay any amount of tax under subsection 254(1) of the ITAA 1936? | A11: No | Q12: To the extent that the answer to Question 8 is no, does the change of ownership of the Property occur when the Vesting Order was made during the 20WW year? | A12: Not applicable | Q13: Does the rental income earned on the Property from the acquisition date by the Trustee to the date that the tenant vacated form part of the net income of the trust for the purposes of Division 6 of Part III of the ITAA 1936? | A13: Yes | Q14: Does the Trustee have the obligation to lodge tax returns for the trust from the date of acquisition of the Property until the date the trust is wound up? | A14: Yes

Relevant facts and circumstances: X and Y (the Co-owners) purchased a property. The Co-owners engaged B to perform works on the property. A dispute arose between the Co-owners and B. Proceedings were commenced. The Co-owners lost the proceedings and appealed to the courts. Over the following years the Co-owners appealed judgements of the courts. B was appointed as trustee of the sale of the Property (the Trustee) by orders of the Supreme Court. The Orders included the following orders: 1) An order that there be a sale of the Property (Sale Order) but this order be stayed until further order of the Supreme Court; 2) That B be appointed Trustee for the sale of the Property (the Trust); 3) The property immediately vests in the Trustee upon the making of the Orders (the Vesting order) The Orders were made to enable B to recover moneys owed to it by the Co-owners, such amounts being secured by a charge over the Property. Later orders corrected and stayed some of the original orders until such further orders. Further orders again amended the original and subsequent orders and lifted the stay of the original orders with effect from late 20XX (Lifting Date). These orders also modified the original orders such that the portion of proceeds to be paid to the Trustee is not only for his costs and expenses in relation to the sale of the Property, but also for costs and expenses incurred by the Trustee in connection with implementing the Orders. The orders required the proceeds from the sale of the property to be distributed, inter alia, as follows: • pay to the defendants (Co-owners) the balance of the proceeds of the sale of the Property after deduction of such of the amounts or further amounts paid to the plaintiff and the trustee's sales costs and/or expenses incurred by the trustee in connection with implementing the Orders The Orders stated that the Trustee was not to conduct a sale of the Property nor incur any costs or expenses in connection with a sale of the Property in the period from the Lifting Date up until two months after the Lifting Date, but did not prohibit them from incurring other costs and expenses in connection with implementing the Orders such as taking steps to have themselves registered as proprietor of the Property, which they did. Later, the Trustee was registered on the title of the Property as proprietor. There was a tenant in the Property as at the Lifting Date. The rental income on the Property was received directly by the Co-owners for the period of occupancy up to late 20XX. Orders made in 20YY provided that the tenant was, among other things, to pay an amount to the trustee and vacate the property. Later, the trustee obtained orders in the Supreme Court, inter alia, in relation to the order for distribution of funds from the sale of the Property and the setting of the reserve price of the Property. The Property was eventually sold. The Trustee has been able to identify that the Co-owners incurred costs in relation to the Property up until the date of the Dispute. The Trustee also incurred costs in relation to the Property: There are also amounts paid to B for legal fees, interest on legal fees and interest on the judgement amount, incurred by the Co-owners in relation to the various court proceedings against B and charged over the property. The legal costs and interest expenses are costs in relation to the Co-owners trying to defend the charge over their property which B was trying to enforce and prevent their property from being sold by the trustee. The Co-owners have, to the best of the trustee's knowledge, been living overseas for the last few years and the only address of the Co-owners known to the Trustee is an address overseas. The trustee does not know of any address that the Co-owners have in Australia. As far as the Trustee is aware, the Co-owners are not persons who are: a. a member of the superannuation scheme established by deed under the Superannuation Act 1990 ; or b. an eligible employee for the purposes of the Superannuation Act 1976 ; or c. the spouse, or a child under 16, of a person covered by sub-subparagraph (a) or (b) The Trustee is unaware of whether the Co-owners are residents or non-residents for income tax purposes and there has been limited communication by the Co-owners with the Trustee.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 104-55 | Income Tax Assessment Act 1997 Section 106-60 | Income Tax Assessment Act 1997 Section 116-20 | Income Tax Assessment Act 1997 Section 110-25 | Income Tax Assessment Act 1936 Section 6 | Income Tax Assessment Act 1936 Section 95 | Income Tax Assessment Act 1936 Section 97 | Income Tax Assessment Act 1936 Section 98 | Income Tax Assessment Act 1936 Section 99 | Income Tax Assessment Act 1936 Section 99A | Income Tax Assessment Act 1936 Section 161 | Income Tax Assessment Act 1936 Section 254

Reasons for decision: Detailed Reasoning - CGT event A1 or E1: Section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that capital gains tax (CGT) event A1 occurs when your ownership in a CGT asset is transferred to another entity. The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs (subsection 104-10(3)). CGT event E1 in section 104-55 of the ITAA 1997 happens if you create a trust over a CGT asset by declaration or settlement (subsection 104-55(1)). The time of the event is when the trust over the asset is created (subsection 104-55(2)). ATO ID 2009/129 explains: CGT event E1 did not happen when the trust was created over the property. That event happens if you create a trust over a CGT asset by declaration or settlement: subsection 104-55(1) of the ITAA 1997.It is considered that this event has no application where the trust is created by order of a court, rather than by the actions of the owners of the property. That is, given the court's role, it is impossible to cast the co-owners in the role of 'you' for the purpose of CGT event E1. | Detailed Reasoning - Application to your circumstances: The effect of the court order is to vest the property in the trustee. This is clear from the terms of the court order itself (which expressly vests the property in the trustee). On the making of the court order the whole of the Co-owners' interests in the property vested in the trustee who was appointed as trustee for the sale of the property; and the Co-owners' interests were converted into personalty, that is, into a right to compel due performance of the trust and to share in the proceeds of sale in accordance with their interests. In equity, conversion is the notional change of land into money (or money into land). Its effect is to turn realty into personalty (or personalty into realty). The principle is that land directed to be sold and turned into money (or money directed to be employed in the purchase of land) is considered to be that species of property into which it is directed to be converted. Refer to Meagher, RP, Heydon, JD, Leeming, MJ, 2002, Meagher, Gummow and Lehane, Equitable Doctrines & Remedies , 4th edn, Butterworths, Lexis Nexis, Australia, pp. 1079-1080; Fletcher v. Ashburner (1779) 1 Bro CC 497; 28ER 1259. It is considered that a change of ownership occurred from the Co-owners to the trustee by virtue of the court order. Therefore, CGT event A1 happens. As there was no contract for the disposal, CGT event A1 is taken to have happened when the change in ownership occurred, which in this case is when the property vested to the trustee on the making of the court order. However, as the court order was stayed until late 20XX, this is when the vesting occurred and consequently when CGT event A1 happens. For the purposes of the capital gains provisions, it is accepted that, on the making of the order the entirety of the interests of the Co-owners in the realty passed to the trustee and was converted into personalty, therefore it is of no concern when the legal title of the property passed. In addition, while the court order specifically prevents the trustee from selling the property until two months after the lifting date, it is still considered that the property vested (and the change of ownership occurred) to the trustee on the date the court orders and the vesting came into effect. The fact that the court orders state that if the payment of the amounts is received by the Trustee within the two month period after the lifting date, the trustee's appointment as trustee for the sale of property is revoked and the property would revest immediately in the defendants, confirms that the vesting (and therefore ownership) changed on the lifting date. | Detailed Reasoning - Effect of section 106-60 of the ITAA 1997: Pursuant to subsection 104-10(2) of the ITAA 1997, a taxpayer is considered to have disposed of a CGT asset if a change of ownership has occurred from the taxpayer to another entity, whether because of some act or event or by operation of law. Whilst such a disposal generally gives rise to a CGT event A1 for the taxpayer (subsection 104-10(1)), paragraph 106-60(1)(a) ignores the vesting of an asset in a security holder, ensuring that, for the purposes of the capital gains tax provisions, the security provider is still treated as the owner of the asset. Subsection 106-60(1) of the ITAA 1997 provides as follows: a) the vesting of a CGT asset in an entity is ignored, if: i. the vesting is for the purpose of enforcing, giving effect to or maintaining a security, charge or encumbrance over the asset; and ii. the security, charge or encumbrance remains over the asset just after the vesting; and b) a CGT asset is treated as vesting in an entity at the time a security, charge or encumbrance ceases to be over the asset, if: i. the entity holds the asset just after that time because the asset vested in the entity at an earlier time; and ii. that earlier vesting was ignored under paragraph (a) because it was for the purpose of enforcing, giving effect to or maintaining the security, charge or encumbrance. Subsection 106-60(2) of the ITAA 1997 reads as follows: This Part, Part 3-3 and Subdivision 328-C apply to an act done by an entity (or an agent of the entity) in relation to a CGT asset for the purpose of enforcing, giving effect to or maintaining a security, charge or encumbrance over the asset as if the act had been done by the entity that provided the security (instead of by the first-mentioned entity or its agent). | Detailed Reasoning - Application to your circumstances: It is considered that section 106-60 of the ITAA 1997 is intended to apply to situations where the vesting of a CGT asset in an entity is made to the security holder (such as occurs when a CGT asset of a borrower vests in a lender as security for a loan), the subsection does not contemplate that the vesting of a CGT asset is ignored when an asset is vested in an entity that is not the security holder (or is not the entity who has a charge over the asset). As per the court orders, the property did not vest in the entity that had a charge over the property (B), it vested in another entity (the trustee). As such, it is considered that the vesting of the asset to the trustee was for the purpose of the sale of the property (and distribution of such proceeds between the interested parties) and not for the purpose of enforcing, giving effect to or maintaining a security, charge or encumbrance over the asset. Accordingly, section 106-60 of the ITAA 1997 will not apply to prevent CGT event A1 from happening to the Co-owners when the property vested in the trustee on the making of the court orders. Residency Subsection 6(1) of the ITAA 1936 explains that a resident of Australia means: a) a person, other than a company, who resides in Australia and includes a person: i. whose domicile is in Australia, unless the Commissioner is satisfied that the person's permanent place of abode is outside Australia; ii. who has actually been in Australia, continuously or intermittently, during more than one-half of the year of income, unless the Commissioner is satisfied that the person's usual place of abode is outside Australia and that the person does not intend to take up residence in Australia; or iii. who is: a. a member of the superannuation scheme established by deed under the Superannuation Act 1990 ; or b. an eligible employee for the purposes of the Superannuation Act 1976 ; or c. the spouse, or a child under 16, of a person covered by sub-subparagraph (a) or (b); and b) a company which is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia. | Detailed Reasoning - Application to your circumstances: Based on the information provided, that is: • the trustee is unaware of any other property held by the Co-owners being located in Australia • the trustee only has details of the Co-owners having a overseas address • the trustee considers that section (iii) of the definition does not apply, and • the Co-owners are not a company it is reasonable to treat the Co-owners as non-residents of Australia for income tax purposes. | Detailed Reasoning - Is there a capital gain arising on the sale of the property?: In general, you make a capital gain if you receive an amount from a CGT event that is more than your total costs associated with that event. You make a capital loss if you receive an amount from a CGT event that is less than the total costs associated with that event. Subsection 116-20(1) of the ITAA 1997 provides that the capital proceeds from a CGT event are the total of: a) the money you have received, or are entitled to receive, in respect of the event happening; and b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). Section 110-25 of the ITAA 1997 provides that the cost base of a CGT asset to a taxpayer consists of five elements. 1) first element - the amount of any money or the market value of any property the taxpayer paid or gave, or was required to pay or give, in respect of the acquisition of the asset (subsection 110-25(2) of the ITAA 1997) 2) second element - the incidental costs the taxpayer incurred to acquire the asset or that relate to a CGT event that happens in relation to the asset. The costs can include giving property (subsection 110-25(3) of the ITAA 1997) 3) third element - the costs of owning the asset provided the asset was acquired on or after 21 August 1991 (this element does not apply to a personal use asset or a collectable) (subsection 110-25(4) of the ITAA 1997). 4) fourth element - the capital expenditure incurred, the purpose or expected effect of which is to increase or preserve the asset's value, or that relates to installing or removing the asset. Expenditure can include giving property (subsection 110-25(5) of the ITAA 1997) 5) fifth element - the capital expenditure incurred by the taxpayer to establish, preserve or defend the taxpayer's title to, or a right over, the asset. The expenditure can include giving property (subsection 110-25(6) of the ITAA 1997). | Detailed Reasoning - Application to your circumstances: On the vesting of the property with the trustee, the trustee undertook an obligation to pay the net proceeds of the sale, less amounts required under the Court Orders to pay B and the trustee's costs, to the Co-owners. That was the trustee's cost in acquiring and holding the asset. The trustee's return on the sale was identical with this cost. This means that the cost base of the property, in the hands of the trustee, is equal to the proceeds received on the disposal of the property. Accordingly, no capital gain accrues to the trustee on the disposal of the property. As no capital gain will accrue to the trustee on disposal of the property, there is no need to consider whether the 50% general CGT discount applies. | Detailed Reasoning - Trust income: The rules in Division 6 of the ITAA 1936 set out the basic income tax treatment of the income and gains generated from a trust estate. Generally, Division 6: • sets out the rules for determining the net (or taxable income of the trust estate (section 95) • assesses the beneficiaries on the net income of a trust for a particular year if they have a present entitlement to the trust income for that year (section 97) • assesses the trustee, in respect of some beneficiaries, such as non-residents or those under a legal disability, if they have a present entitlement to the trust income for that year (section 98) • assesses the trustee directly on any residual net income to which no beneficiary is presently entitled (section 99 or 99A). Subsection 95(1) of the ITAA 1936 defines net income in relation to a trust estate, as: • the total assessable income of the trust estate calculated as if the trustee was a resident taxpayer, less • all allowable deductions, except • deductions under Division 393 of the ITAA 1997 (Farm Management Deposits), and/or • in respect of certain beneficiaries, deductions allowable under Division 36 (the loss provisions) of the ITAA 1997. The principal cases concerning 'present entitlement' are the High Court decisions in Federal Commissioner of Taxation v. Whiting (1942) 68 CLR 199; (1942) 7 ATD 179 ( Whiting ) and Taylor v. Federal Commissioner of Taxation (1970) 119 CLR 444; (1970) 70 ATC 4026;(1970) 1 ATR 582 ( Taylor ). The principles in Whiting and Taylor were conveniently summarised by the High Court in Harmer v. Federal Commissioner of Taxation (1991) 22 ATR 726 at 271 ( Harmer ). According to Harmer , a beneficiary will be presently entitled to a share of the income of a trust estate if at least by the end of the year of income: a) the beneficiary has an interest in the income which is both vested in • interest and • possession, and b) the beneficiary has a present legal right to demand and receive payment of the income. This includes beneficiaries that, but for their legal disability, are vested in interest and possession to that income. This is whether or not: • the precise entitlement can be determined before the end of the relevant year of income, and • the trustee has the funds available for immediate payment. In practice, this means that at the end of the income year, a beneficiary's interest in the income of the trust estate must essentially be vested in possession (not merely vested in interest), and that the income of the trust estate must also be legally available for distribution. To be 'vested in interest' the interest must not be contingent. That is, the beneficiary does not have to fulfil a condition before they can have the legal right to the trust income and/ or corpus. To be 'vested in possession' this term has two parts. That is to be vested in possession: a) the beneficiary has the right to immediate possession or enjoyment of the income and/or corpus. This can also be expressed as a present right of present enjoyment; and b) the interest must not be defeasible. That is, nothing can happen in the future (other than the termination of the trust) that will cause the beneficiary to lose their entitlement. | Detailed Reasoning - Application to your circumstances: The rental income earned from the property was paid directly to the Co-owners for the period of occupancy up to late 20XX and therefore these amounts are taken to be derived by the Co-owners and not by the trust. However, the 20YY Orders provide that the tenant is to pay to the trustee an amount, being rent, to cover the period from late 20XX to 20YY. Accordingly, the rental income received by the trustee for this period must be taken into account in calculating the net income (or loss) of the trust for Division 6 purposes. In addition, as stated in the Court Orders, the trustee has an obligation to pay the net proceeds of the sale of the property, less amounts required to pay B and the trustee's costs, to the Co-owners. It is therefore considered that the Co-owners have an interest in the income of the trust that is both vested in interest and vested in possession. Ultimately, this means the Co-owners have a present entitlement to the income of the trust even though the precise amount of the entitlement is unknown at the time. As it has been established that the Co-owners have a present entitlement to the income of the trust and that it is reasonable for the trustee to treat the Co-owners of the property to be non-residents of Australia for tax purposes, Division 6 will apply to assess the trustee under section 98 of the ITAA 1936, in respect of the non-resident beneficiaries (the Co-owners), as they have a present entitlement to the trust income for that year. Importantly, section 161 of the ITAA 1936 explains that where a trust has derived income (including capital gains), irrespective of the amount of income derived, it will have to lodge a return unless exempted by the Commissioner. Accordingly, the trustee will be required to lodge income tax returns for as long as the trust continues to derive income. Further, as the Co-owners (being the beneficiaries of the trust) are being treated as non-residents of Australia, the trustee will be liable to pay any tax owing on their behalf. | Detailed Reasoning - Section 254 and capital gains: Under paragraph 254(1)(a) of the ITAA 1936, a trustee is answerable as taxpayer for all things required to be done by virtue of this Act in respect of the income, or any profits or gains of a capital nature, that are derived by him or her in his or her representative capacity, or derived by the principal by virtue of his or her agency, and for the payment of tax thereon. In addition, paragraph 254(1)(d) of the ITAA 1936 requires a trustee to retain sufficient funds to pay the tax that is or will become due in respect of that income, profits or gains. Specifically, this paragraph states the following: 'he is hereby authorised and required to retain from time to time out of any money which comes to him in his representative capacity so much as is sufficient to pay tax which is or will become due in respect of the income, profits or gains.' However, if the amounts received are less than the available losses carried forward by the Trust, such that tax is not, and will not become, payable in respect of the income, profits or gains derived by virtue of your representative capacity, then no obligation to retain an amount will arise under paragraph 254(1)(d) of the ITAA 1936. | Detailed Reasoning - Application to your circumstances: As it has already been established that there will be no capital gain arising on the disposal of the property by the trustee, there will be no tax payable in respect of the transaction, accordingly, there will be no obligation to retain any amount from the disposal of the property under paragraph 254(1)(d) of the ITAA 1936. | Detailed Reasoning - Section 254 and rental income: As discussed above, it is only in situations where tax is not, and will not become, payable in respect of the income, profits or gains derived by virtue of your representative capacity that it can be said that no obligations to retain an amount arises under paragraph 254(1)(d) of the ITAA 1936. In relation to the rental income, it has already been established, the trustee will be assessed under section 98 of the ITAA 1936 on the rental income derived by him or her in their representative capacity. Section 254 of the ITAA 1936 does not itself create a liability for tax. Rather, any liability to pay tax is created under the relevant substantive liability provisions of the income tax legislation. Section 254 works in conjunction with these provisions to provide that a representative (trustee) or an agent for a debtor is liable in relation to any such tax liability that arises in the course of their representative capacity or agency. It provides the machinery provisions that set out when a representative or agent is liable to pay the tax. However, the application of section 254 of the ITAA 1936 is currently the subject of a High Court appeal and therefore we cannot provide advice in relation to section 254, (where it is likely that tax is, or will become payable) until such time as the matter is resolved before the Court.