Private ruling: Income Tax: Capital gains tax - other
Date of advice: 11 December 2015
Published: February 2016
Ruling period: Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021 | Year ending 30 June 2022

Ruling: Q1: If the Relevant Land owned by the Rulee is sold, can any capital gain or capital loss be disregarded under paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997), provided that the Relevant Land does not stop being a pre-CGT asset under Division 149 of the ITAA 1997 just before its disposal? | A1: Yes. | Q2: Has the Relevant Land stopped being a pre-CGT asset for the purpose of Division 149 of the ITAA 1997, provided the test is met just before any Capital Gains Tax (CGT) event affecting the Relevant Land happens, for example its disposal? | A2: No. | Q3: Are the buildings and structures constructed on the Relevant Land by the Rulee taken to be separate CGT assets under subsection 108-55(2) of the ITAA 1997? | A3: Yes. | Q4: Are other capital improvements made to the Relevant Land taken to be a separate CGT asset or separate CGT assets under either subsection 108-70(2) or (3) of the ITAA 1997 if there was a disposal of the Relevant Land? | A4: Yes, provided certain conditions are met.

Relevant facts and circumstances: The Rulee is the trustee of a Trust which was established by Trust Deed between the settlor and the trustee. The Trust Deed has been previously amended. The Rulee is a discretionary trust, the beneficiaries of which include: (a) Person, her/his children and grandchildren; (b) the spouses of Person, her/his children and grandchildren; (c) any corporation the shares in which are held by or for the benefit of a beneficiary referred to in (a) or (b) above; and (d) any trust in which a beneficiary referred to in (a) or (b) above is also a beneficiary. The Rulee acquired land (the Relevant Land) shortly after it was established (and before 20 September 1985). The Relevant Land makes up the vast majority of the total site. The Relevant Land has been subdivided into multiple titles. The balance of the total site was acquired by the Rulee after 20 September 1985 by way of acquisition and land swap, or is owned by another company. Prior to development commencing, the Rulee used the Relevant Land for primary production. The Rulee continues to use the undeveloped Relevant Land for primary production. The Relevant Land was zoned rural until late in 1994 when it was rezoned an employment area. The development involves the Rulee constructing buildings to lessee specifications. To date, the Rulee has constructed a number of buildings to lessee specifications. The Rulee has developed a conservation zone providing a habitat corridor (involving the planting of native trees). In addition, an area has also been acquired by another company and set aside as a buffer zone to protect the amenity of residential areas to the north of the site. The Rulee proposes to hold the development on the Relevant Land as an investment for the purpose of deriving income in the form of rent. The Rulee will continue to use the balance of the Relevant Land for primary production but may similarly develop the balance over a period of 10 years or more. The Rulee holds other assets including cash, receivables, land, plant and equipment, and financial assets.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 104-10(1) | Subsection 104-10(2) | Paragraph 104-10(5)(a) | Subsection 108-5(1) | Section 108-55 | Subsection 108-55(2) | Section 108-70 | Subsection 108-70(1) | Subsection 108-70(2) | Subsection 108-70(3) | Section 108-80 | Subsection 112-25(2) | Division 149 | Section 149-10 | Subsection 149-15(1) | Section 149-30

Reasons for decision: Summary: If the Relevant Land owned by the Rulee is sold, any capital gain or capital loss can be disregarded under paragraph 104-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997), provided that the Relevant Land does not stop being a pre-CGT asset under Division 149 of the ITAA 1997 just before its disposal. | Detailed Reasoning - Detailed reasoning: Under subsection 104-10(1) of the ITAA 1997, CGT event A1 happens if you dispose of a CGT asset. The definition of "CGT asset" contained in subsection 108-5(1) of the ITAA 1997 is very broad, being any kind of property or a legal or equitable right that is not property. Disposal occurs if there is a change of ownership from the taxpayer to another entity. It does not matter whether the change of ownership occurs because of the happening of a specific act or event or merely by operation of law (subsection 104-10(2) of the ITAA 1997). A gain or loss is disregarded for assets acquired before 20 September 1985 (paragraph 104-10(5)(a) of the ITAA 1997). If the Relevant Land is sold this will give rise to CGT event A1. However, as the Rulee acquired the land before 20 September 1985, any capital gain or capital loss on the disposal will be disregarded, provided the land has not become a post-CGT asset just before the relevant CGT event. | Summary: The Relevant Land has not stopped being a pre-CGT asset for the purpose of Division 149 of the ITAA 1997, provided the tests are met just before any CGT event affecting the Relevant Land, for example its disposal. | Detailed Reasoning - Detailed reasoning: Section 149-10 of the ITAA 1997 explains what a pre-CGT asset is as follows: A CGT asset that an entity owns is a pre-CGT asset if, and only if: (a) the entity last acquired the asset before 20 September 1985; and (b) the entity was not, immediately before the start of the 1998-1999 income year, take under: i. former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or ii. Subdivision C of Division 20 of former Part IIIA of the Act; to have acquired the asset on or after 20 September 1985; and (c) the asset has not stopped being a pre-CGT asset of the entity because of this Division. Whether the land has stopped being a pre-CGT asset will depend on whether there has been a change in the majority underlying interests in the CGT asset (see section 149-30 of the ITAA 1997). Subsection 149-15(1) of the ITAA 1997 provides that the majority underlying interests in a CGT asset consist of: (a) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and (b) more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset. Taxation Ruling IT 2340 Income tax: capital gains: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date (IT 2340) clarifies how and when section 160ZZS of the Income Tax Assessment Act 1936 (the predecessor to Division 149) will apply to assets held by discretionary trusts. In considering whether majority underlying interests have been maintained in the assets of the trust, the Commissioner will take into account the way in which the discretionary powers of the trustees are in fact exercised. This is discussed, in part, in paragraphs 6 to 8 of IT2340 as follows: 6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion. 7. In such a case the Commissioner would, in terms of subsection 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed ... 8. On the other hand where, by the exercise of a trustee's discretionary powers to appoint beneficiaries or by amendment of the trust deed, there is in practical effect a change of 50% or more in the underlying interests in the trust assets … the section would have its intended application … Therefore, provided that just before any CGT event happens to the Relevant Land there has not been a change of 50% or more in the underlying interests in the Trust assets, as a consequence of a change in beneficiaries, then the Relevant Land will retain its pre-CGT status. | Summary: The buildings and structures constructed on the Relevant Land by the Rulee are taken to be separate CGT assets under section 108-55(2) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: In the absence of Subdivision 108-D of the ITAA 1997, the common law principle that anything attached to land becomes part of the land would apply for all CGT purposes. However, Subdivision 108-D of the ITAA 1997 sets out exceptions to this principle. Under subsection 108-55(2) of the ITAA 1997, where land was acquired by a taxpayer before 20 September 1985 and a building or structure constructed on it on or after that day, the building is taken to be a separate CGT asset from the land. As the Relevant Land was acquired before 20 September 1985 (pre-CGT), the buildings and structures constructed on it on or after that date will be treated as separate post-CGT assets from the pre-CGT land. | Summary: Capital improvements made to the Relevant Land are taken to be a separate CGT asset or assets under either section 108-70(2) or (3) of the ITAA 1997, if there is a disposal of the Relevant Land, provided the cost base or bases of the capital improvements exceeds both the improvement threshold in the relevant year and 5% of the capital proceeds from the event. | Detailed Reasoning - Detailed reasoning: When a CGT asset (the original asset) is split into 2 or more assets (the new assets) and there is no change in beneficial ownership, there is not a CGT event as subsection 112-25(2) of the ITAA 1997 applies. Where pre-CGT land is subdivided after 19 September 1985 the land will maintain its pre-CGT acquisition date because no CGT event has happened (Tax Determination TD 7 Capital Gains: What are the CGT consequences of sub-dividing pre-CGT land? ). In the present case each new lot into which the Relevant Land has been subdivided will retain its pre-CGT status. Subsection 108-70(1) of the ITAA 1997 provides that a capital improvement to (pre or post-CGT) land is treated as a separate CGT asset from the land if one of the balancing adjustment provisions (being subdivision 40-D, or section 355-315 or 355-525 of the ITAA 1997) set out in subsection 108-55(1) of the ITAA 1997 applies to the improvement (Taxation Determination TD 98/24 Income tax: capital gains: what are the CGT consequences of a CGT event happening to post-CGT real property if the property comprises separate CGT assets under Subdivision 108-D in Part 3-1 of the Income Tax Assessment Act 1997 (the 1997 Act) or if the property is sold with depreciable assets? ). Under subsection 108-70(2) of the ITAA 1997, where a CGT asset acquired before 20 September 1985 has had an improvement of a capital nature made to it after 19 September 1985, that improvement may be treated as an asset separate from the original asset when a CGT event happens in relation to that original asset. This will occur if the cost base of the capital improvement (assuming it was a separate CGT asset) exceeds: • the improvement threshold for the relevant income year, and • 5% of the capital proceeds from the event. The issue may arise as to whether or not there is a single improvement or a series of related improvements. Under section 108-70(3) of the ITAA 1997 related improvements are taken together and their cost bases are aggregated in applying the threshold test outlined above. Section 108-80 of the ITAA 1997 sets out the following factors to determine whether capital improvements are related: • the nature of the CGT asset to which the improvements are made; • the nature, location, size, value, quality, composition and utility of each improvement; • whether an improvement depends in a physical, economic, commercial or practical sense on another improvement; • whether the improvements are part of an overall project; • whether the improvements are of the same kind; and • whether the improvements are made within a reasonable period of time of each other. In the present case, the total subdivision and land development costs are considered to be related to each other in accordance with section 108-80 of the ITAA 1997 being, inter alia, part of an overall project. Taxation Determination TD 97/3 Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided in lots ('blocks'), do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)? (TD 97/3) states that the effect of registering separate new titles under a scheme for the subdivision of land is to divide the original land parcel into two or more assets, the subdivided blocks. They are taken to have been acquired by the owner of the original land parcel when that original parcel was acquired. The cost of capital improvements must be allocated over all of the subdivided blocks. On a disposal by the Rulee of a particular lot subdivided from the Relevant Land, if the total capital improvement expenditure applicable to that lot were less than the improvement threshold for the relevant year and 5% of the capital proceeds, then the capital improvements would not be taken to be a separate CGT asset. If, on the other hand, the total capital improvement expenditure applicable to that lot were greater than the improvement threshold and 5% of the capital proceeds, then the capital improvements would be taken to be a separate CGT asset.