Private ruling: Capital gains tax – main residence exemption – creating rights – cost base – discount capital gains
Date of advice: 18 September 2018
Published: October 2018
Ruling period: Income year ending 30 June 2018.
Date scheme commenced: 1 July 2017.

Ruling: Q1: Did capital gains tax (CGT) event D1 happen when you entered into the Deed with Person X? | A1: Yes. | Q2: Will the capital proceeds from entering into the Deed be equal to the amount Person X paid to you? | A2: No. | Q3: Can any part of the cost base of Property A be used in calculating the capital gain or loss from entering into the Deed? | A3: No. | Q4: Is any capital gain or loss you make due to entering into the Deed disregarded? | A4: No. | Q5: Can you apply the 50% CGT discount to any capital gain you make due to entering into the Deed? | A5: No. | Q6: Is the payment you made to Person X under the Deed due to the sale of Property A included in the Property A’s cost base and reduced cost base? | A6: Yes. | Q7: Is any capital gain or loss you make due to selling Property A disregarded? | A7: No. | Q8: Are you entitled to a partial main residence exemption due to the sale of Property A? | A8: Yes.

Relevant facts and circumstances: After 20 September 1985, you entered into a contract to purchase a property (Property A). You entered into a Deed with Person X shortly after you entered the contract to purchase Property A from which the following information has been sourced: ● the Licensor – you ● the Licensee – Person X; ● you have entered into a contract to purchase Property A; ● you and Person X agree that Person X shall be entitled to occupy Property A in accordance with the terms of the Deed from the date settlement will occur for a specified period; ● you grant Person X a licence to enter and use the premises from the date settlement occurs in conjunction with the right for you to use Property A; ● you and Person X agree that Person X may lodge a caveat against Property A; ● Person X will pay you a specified amount on the date settlement occurs as consideration; ● if Person X breaches any of the covenants, conditions or terms contained in the Deed, you may by notice in writing give notice to Person X that they are in breach of the licence. Unless the breach is remedied within 7 day of receipt of the notice, then the licence will be determined and Person X shall be required to vacate Property A at the expiration of a specified period; and ● in the event that you sell Property A, Person X shall be paid a specified percentage of the gross sale price of Property A. Settlement on the purchase of Property A occurred during the month after the purchase contract was entered into. During the following month, Person X lodged a caveat against Property A. You moved into Property A a number of months after settlement on the purchase of Property A had occurred. A number of months later you entered into a contract to purchase another property (Property B), with settlement occurring a number of weeks later when you moved out of Property A and moved into Property B. You entered into a contract to sell Property B more than three years after you had commenced residing there. Settlement on Property B’s sale occurred a number of months later, when you moved out of Property B and recommenced residing at Property A. Property A was put on the market in 2018 with a contract of sale being entered into more than four months after you had resumed residing at the property. You moved out of Property A shortly after the contract of sale was entered into, with settlement occurring a number of months after the contract of sale was entered into. You have paid Person X the percentage of Property A’s gross sale price in accordance with the Deed. Assumption This private ruling has been made on the assumption that the market value of the right granted to Person X under the Deed was not the same as the amount they paid in accordance with the Deed.

Relevant legislative provisions: Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 Part 3-3

Reasons for decision: Detailed Reasoning - Question 1:: Did CGT event D1 happen when you entered into the Deed with Person X? | Detailed Reasoning - Creating contractual or other rights: CGT event D1: CGT event D1 of the ITAA 1997 happens under section 104-35 ‘if you create a contractual right or other legal or equitable right in another entity.’ The time of the CGT event D1 will be when the right is created. Application to your situation In this situation, you and Person X signed a Deed and a right was created which gave Person X an enforceable right if you breached the Deed. CGT event D1 occurred when the Deed. | Detailed Reasoning - Question 2:: Will the capital proceeds from entering into the Deed be equal to the amount Person X paid to you? | Detailed Reasoning - Capital proceeds from a CGT event D1: The capital proceeds from creating a contractual or other right are determined in accordance with the normal capital proceeds rules. There are a number of modifications to the application of the general rules when a CGT event D1 occurs, such as the market value substitution rule under section 116-30 of the ITAA 1997. Under subsection 116-30(2) of the ITAA 1997, The capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if: (a) some or all of those capital proceeds cannot be valued (b) those capital proceeds are more or less than the market value of the asset and either: ● the taxpayer and the entity that acquired the asset did not deal with each other at arm's length in connection with the event, or ● the CGT event is CGT event C2. The market value is worked out at the time of the event. The Commissioner considers that situations where capital proceeds cannot be valued will be rare ( Taxation Determination TD 1999/84 ). It is not sufficient that a valuation is merely difficult, costly or inconvenient. If it is possible to value the capital proceeds, the valuation should be done. Application to your situation In this case, Person X paid you the specified amount in accordance with the Deed. Based on the information provided, it cannot be viewed that you and Person X dealt with each other at arm’s length in relation to the Deed. Therefore, your capital proceeds are viewed as being the market value of the right rather than the amount that you actually received if those amounts were different. | Detailed Reasoning - Question 3:: Can any part of the cost base of Property A be used in calculating the capital gain or loss from entering into the Deed? | Detailed Reasoning - Cost base of rights: In accordance with subsection 104-35(3) of the ITAA 1997 you make a capital gain if the capital proceeds received from creating the right are more than the incidental costs incurred in creating it. If the capital proceeds are less than the incidental costs, a capital loss is made. The costs which are incidental costs are specified in section 110-35 of the ITAA 1997. Application to your situation In this case, your cost base of the right will be any incidental costs you have incurred in relation to the Deed, such as the drawing up of the Deed. No part of the acquisition cost of Property A, or any other costs relating to Property A, can be treated as incidental costs. | Detailed Reasoning - Question 4:: Is any capital gain or loss you make due to entering into the Deed disregarded? | Detailed Reasoning - Disregarding any capital gain or loss from CGT event D1: The main residence exemption contained in section 118-110 of the ITAA 1997 only applies if one of the specified CGT events occur as listed in subsection 118-110(2) of the ITAA 1997. This means that if a transaction in relation to a dwelling does not involve one of the specified events, the main residence exemption will not apply. CGT event D1 is not listed in subsection 118-110(2) of the ITAA 1997. Application to your situation In this case, the main residence exemption will not apply as CGT event D1 has occurred, which is not one of the specified CGT events that must occur for that exemption to apply. As there are no other provisions to enable any capital gain or loss made on the creating of the right to be disregarded, you cannot disregard the capital gain or capital loss you have made when CGT event D1 occurred. | Detailed Reasoning - Question 5:: Can you apply the 50% CGT discount to any capital gain you make due to entering into the Deed? | Detailed Reasoning - Discount capital gains: A discount capital gain is a capital gain that satisfies the requirements contained in Subdivision 115-A of the ITAA 1997. One of those requirements is that the CGT asset must have been acquired by the entity making the capital gain at least 12 months before the CGT event under subsection 115-25(1) of the ITAA 1997. A number of CGT events do not qualify for the CGT discount as provided in subsection 115-25(3) of the ITAA 1997. This includes capital gains arising from a CGT event D1 because the CGT asset involved in the CGT event comes into existence at the time of the CGT event and the CGT asset will not have been held for at least 12 months prior to the CGT event. Application to your situation In this case, the right came into existence when you signed the Deed and CGT event D1 occurred at that time. Therefore, as you had not held the right for at least 12 months prior to the CGT event D1 occurring, you are not eligible to apply the 50% CGT discount to any capital gain made when CGT event occurred. | Detailed Reasoning - Question 6:: Is the payment you made to Person X under the Deed due to the sale of Property A included in the Property A’s cost base and reduced cost base? | Detailed Reasoning - Cost base: Subsection 110-25(5) of the ITAA 1997 relates to the fourth element of a cost base and includes capital expenditure you incurred to increase or preserve the asset's value. Application to your situation You paid Person X the specified percentage of the gross sale price received on the sale of Property A in accordance with the Deed. As the requirements of the fourth element of the CGT cost base have been satisfied, the amount you paid to Person X will form part of the cost base of Property A at element four under subsection 110-25(5) of the ITAA 1997. | Detailed Reasoning - Questions 7 and 8:: Is any capital gain or loss you make due to selling the Property A disregarded? Are you entitled to a partial main residence exemption due to the sale of Property A? | Detailed Reasoning - Full Main Residence Exemption: In certain circumstances, there may be an exemption that can apply, which means that the gain or loss created by a CGT event is disregarded. Exemptions from CGT are set out in Division 118 of the ITAA 1997. In particular, Subdivision 118-B of the ITAA 1997 contains the CGT main residence exemption. The exemption disregards a capital gain or capital loss a taxpayer makes from a CGT event that happens to a dwelling, or their ownership interest in a dwelling, which is their main residence. A capital gain or capital loss you make from a CGT event that happens to your main residence is disregarded if: ● you are an individual; ● the dwelling was your main residence throughout your ownership period; ● the property was not used to produce assessable income; and ● any land on which the dwelling is situated is not more than two hectares. For the purpose of the main residence exemption, you have an ownership interest in a dwelling from the date of settlement of the contract of purchase (or if you have a right to occupy it at an earlier time, that time) until the date of settlement of the contract of sale. This period is called your ownership period. If you own more than one dwelling during a particular period, only one of them can be your main residence at any one time except in limited circumstances when moving from one main residence to another. | Detailed Reasoning - Partial main residence exemption: Where a dwelling was your main residence for only part of your ownership period, you will only get a partial exemption for a CGT event that occurs in relation to the dwelling under section 118-185 of the ITAA 1997. | Detailed Reasoning - Rules that may extend the exemption: There are some special rules contained in Subdivision 118-B of the ITAA 1997 which if applicable may extend the main residence exemption. These can affect your entitlement to the main residence exemption depending upon your individual circumstances, and include the following: Absence choice There is an extension to the basic rule which allows you to continue the main residence exemption after the dwelling ceases to be your main residence. This is found in section 118-145 of the ITAA 1997 and is commonly known as the ‘absence rule’. Section 118-145 of the ITAA 1997 provides that if you leave your dwelling, such that it is no longer your main residence, you may choose to continue to treat it as your main residence, even if you have rented it out, provided certain criteria are met. You cannot make this choice for a period before the dwelling first becomes your main residence. The choice only needs to be made for the income year that the CGT event happens to the dwelling, such as the income year in which you enter into a contract. If you make this choice, you cannot treat any other dwelling as your main residence for the period, except for a limited time if you are changing main residences. Under subsection 103-25(1) of the ITAA 1997, the choice needs to be made by the day you lodge your income tax return for the income year in which the relevant CGT event occurred, or within a further time allowed by the Commissioner. If you use the dwelling to produce income, the maximum length of time you can choose to have it treated as your main residence is up to six years after it becomes income producing. If you do not use it to produce income, you can treat the dwelling as your main residence for an unlimited period after you stop living in it. You are entitled to another maximum six years each time the dwelling becomes and ceases to be your main residence. If you choose to apply this exemption, no other property can be treated as your main residence during this period. Application to your situation You entered into the contract to purchase the Property on XX June 201Y, with settlement occurring on XX July 201Y. You resided at the Property during the following periods: ● from the date you originally moved into Property A, which occurred a number of months after settlement on the purchase of Property A occurred, until a number of months later when you moved into Property B; and ● from the date you resumed living at Property A, following the settlement on the sale of Property B, until you moved out of Property A a number of months later after you had signed the sale contract for Property A. For CGT purposes your ownership period of the Property was from the date settlement on the purchase of Property A occurred until the date settlement on the sale of Property A occurred. Based on the information provided, Property A had not commenced being your main residence until you moved into it a number of months after settlement on its purchase occurred. Therefore, the period from settlement on the purchase of Property A until the date you moved into Property A will not be covered by the main residence exemption. Additionally, you had not resided at Property A during the period you lived at Property B and from just after the contract of sale for Property A was entered into until settlement on the sale occurred. Therefore, as we have not been advised of any choices being made in relation to Property A, or any other property/ies, you will not be entitled to claim the main residence exemption for those periods during your ownership period when Property A was not your main residence. However, you will be entitled to a partial main residence exemption for the periods that you resided at Property A and it was your main residence as listed above. Note: As stated above, you can make a choice/s to extend the main residence exemption to include additional period/s not currently covered by the main residence exemption for a property if the choice/s are made by you by the day your income tax return for the relevant income year is lodged. However, the choice/s you make in relation to any property will impact on your eligibility to the main residence exemption for any other property/ies held during the same period.