Private ruling: Termination of Contract
Published: September 2011
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012
Date scheme commenced: 1 July 1993

Ruling: Q1: Will CGT event C2 or C1 of the Income Tax Assessment Act 1997 (ITAA 1997) happen to the company when the trust terminates the contract for sale due to the default by the purchaser? | A1: Yes. | Q2: Will any other CGT event happen to either the company or the trust on the termination of the contract by the trust? | A2: CGT event H1 will apply to the trust. | Q3: Will the market value substitution rule contained in Division 116 of the ITAA 1997 apply to substitute the market value as the capital proceeds in respect of the CGT event C2? | A3: Yes. | Q4: Will the termination of the contract give rise to a divided on ordinary concepts for the purpose of section 44 of the Income Tax Assessment Act 1936 (1936)? | A4: No. | Q5: Will Division 7A of the ITAA 1936 apply to the termination of the contract? | A5: No. | Q6: Will a rescission of the contract constitute a dividend stripping arrangement for the purposes of Section 177E of the ITAA 1936? | A6: Not applicable. | Q7: Will any other provision of Part IVA of the ITAA 1936 apply? | A7: Not applicable.

Relevant facts and circumstances: The trust and a company are parties to a contract of sale entered into with the trust as the vendor. The contract was for a parcel of land. The contract has not been completed. The land is close to the border of an area that will be subject to a development zoning levy. The taxpayer is concerned about a future imposition of the levy. The levy applies when the following events arise: · The issue of a Statement of Compliance relating to a Plan of Subdivision of Land in the contribution area · The making of an application for a Building Permit to carry out building work on the land in the contribution area · The occurrence of a dutiable transaction relating to land in the contribution area. Both the company and the trust are entities ultimately controlled by one individual. The trust originally purchased the land from an unrelated party and sold it to the company for it to be used in business after a short period. The contract was expressed to be a terms contract with the first instalment due at the time of the sale. The balance on the contract was due a number of years later however is still outstanding some years after that date. The company subsequently leased the land after acquiring the land. The company has been advised not to proceed with the purchase of the land due to the impact of the levy should the property become within the zoned boundaries as it will conflict with the aim of the individual's succession planning and desire to retain the land in the family which would be at risk. The specific proposed steps for termination of the contract will be: · The trust will terminate the contract on the basis that the company failed to complete the contract by the due date. · Under general contract law principles, the termination of the contract would allow the trust to retain the deposit and claim any damages from company. · The damages the trust has sustained is lost rental on the property and it has held the deposit for that period. · The trust proposes to retain the deposit without making any claim for lost rental or damages. The trust will recover possession of the property from the company.

Relevant legislative provisions: Income Tax Assessment Act 199 7 Section 104-10 | Income Tax Assessment Act 199 7 Section 104-15 | Income Tax Assessment Act 199 7 Section 104-20 | Income Tax Assessment Act 199 7 Section 104-25 | Income Tax Assessment Act 199 7 Section 104-35 | Income Tax Assessment Act 199 7 Section 104-150 | Income Tax Assessment Act 1936 Section 44 | Income Tax Assessment Act 1936 Division 7A | Income Tax Assessment Act 1936 Paragraph 160M(3)(d) | Income Tax Assessment Act 1936 Subsection 160M(4) | Income Tax Assessment Act 1936 Subsection 160U(7) | Income Tax Assessment Act 1936 Section 177E | Income Tax Assessment Act 1936 Part IVA

Reasons for decision: Summary: CGT event C2 will happen to the company at the time of the termination of the contract of sale. A CGT event H1 will apply to the trust for the amount of the deposit retained at the termination of the contract. | Detailed Reasoning - Detailed reasoning: It is usual for a disposal of land to be an A1 event at the time of entering into the contract for the sale of land. However where a term contract is involved the relevant event is B1 where an entity enjoys the use and enjoyment of the asset before the title passes to them. At the time of this transaction in 1995 a change would have been taken to have occurred under paragraph 160M(3)(d) of the ITAA 1936 as the use and enjoyment of the asset was obtained by the company for a period at the end of which the title to the asset will or may pass. Paragraph 160M(4) states that a change is not taken to have occurred if the ownership of the asset does not pass at the end of the period. As per Taxation Ruling 94/29 (TR 94/29) where a terms contract is involved for the purchase of land the change of ownership and hence the disposal and acquisition are taken to occur at the time when possession of the land is given to the purchaser or the purchaser becomes entitled to the receipt of rents and profits. Subsection 160U(7) of the ITAA 1936, which was in force at the time of the transaction, made it clear that the time of acquisition or disposal would occur when the use and enjoyment of the land was first obtained which would usually occur at the time the contract is made or soon after. The equivalent provision in the ITAA 1997 is 104-15. TR 94/29 goes on to point out that if the contract falls through before completion, title to the land will not pass to the purchaser because the purchaser is not entitled to a conveyance or transfer of the land. Under subsection 160M(4) of the ITAA 1936 a change of ownership is taken not to have occurred if the period for which the purchaser had the use and enjoyment of the land terminates without the title to the land passing to the purchaser. The equivalent provision in ITAA 1997 is subsection 104-15(4) which states that a capital gain or capital loss you make is disregarded if the title in the asset does not pass to the other entity at or before the end of the agreement. Section 104-15 of the Income Tax (Transitional Provisions Act) 1997 (TPA) which was repealed in 2006 states that if you made a capital gain or loss for the 1997-98 or earlier year and the agreement ends after 1997-98 without title passing, then the capital gain or loss is disregarded. In this instance a deposit was paid at the time of entering the contract and the company was entitled to vacant possession of the land in accordance with the sale contract at that date. The company was also entitled to the rents from the property as evidenced by the lease agreements provided. The settlement date is defined in the contract for sale as the date upon which vacant possession of the property and chattels must be given, namely upon acceptance of title and payment of the deposit. The transfer of title has not occurred as the final payment has not been made. Therefore it is considered that the initial event was under paragraph 160M(3)(d) of the ITAA 1936 that as a result of the contract being terminated it is disregarded under section 104-15(4) of the ITAA 1997. | Detailed Reasoning - H1 event for the trust: A CGT event H1 happens if a deposit paid to you is forfeited because a prospective sale or other transaction does not proceed under section 104-150 of the ITAA 1997. The amount of the deposit is reduced by any part of the deposit that is repaid or is compensation that you paid that can be reasonably regarded as a repayment of all or part of the deposit. It cannot be reduced by any part of the payment that you can deduct. A H1 event will occur to the trust on the termination of the contract for the amount of the deposit which is kept. | Detailed Reasoning - C1 or C2 events for the company: When the company entered into the contract to purchase the property, they acquired a number of rights. In particular, they acquired the right to enforce the completion of the contract and have the property transferred to them. Also the trust acquired rights to enforce the completion of the sale. Those rights are intangible CGT assets (section 108-5 of the ITAA 1997). The rights acquired under the contract of sale will be cancelled by the termination of the contract. Where a purchaser defaults it is possible that a C1 or a C2 event occurs. C1 event occurs on the loss or destruction of a CGT asset. While event C2 occurs when your ownership of an intangible CGT asset ends by the asset: · being redeemed or cancelled; or · being released, discharged or satisfied; or · expiring; or · being abandoned, surrendered or forfeited; In determining which event is applicable to the company consideration is given to paragraphs 117 to 123 of TR 1999/19. In particular looking at paragraphs 122 and 123, where the circumstances are of a voluntary nature which results in a surrender, abandonment or forfeiture by the purchaser of their contractual rights then C2 is the more specific CGT event that applies. This is so even if there might also be a destruction of the purchaser's contractual rights. Examples include where a purchaser defaults simply by changing their mind or deciding to invest elsewhere. However where circumstances are of a genuinely involuntary nature there is a loss or destruction of the contractual rights and CGT event C1 applies. In the circumstances of this case the company has simply not paid the remaining balance to complete the transaction therefore forgoing their right to complete the contract. As a result CGT event C2 will happen when the contract is terminated under subsection 104-25(2) of the ITAA 1997. | Detailed Reasoning - Market value substitution: The company will make a capital gain when CGT event C2 happens at the termination of the contract if the capital proceeds from the ending are more than the asset's cost base. They will make a capital loss if those capital proceeds are less than the asset's reduced cost base (subsection 104-25(3) of the ITAA 1997). If no capital proceeds are received from a CGT event, you are taken to have received market value of the asset that is the subject of the event (section 116-30(1) of ITAA 1997). If you need to work out the market value of a CGT asset that is the subject of CGT event C2, work it out as if the event had not occurred and was never proposed to occur (section 116-30(3A) of ITAA 1997). The cost base of a right to enforce a contract is usually the amount of any incidental costs in obtaining legal advice and bringing the taxpayer's right to finality. The cost base will also include any money you paid to acquire the asset under paragraph 110-25(1)(a). The deposit paid on entering into the contract of sale was money paid to acquire the contractual rights. However, any expenditure you have recouped does not form part of the cost base unless the recouped amount is included in your assessable income under subsection 110-45(2). For the company it would include the deposit retained by the trust. The value of the proceeds for the company would be the market value of the land on the date the contract is terminated. | Summary: The rescission of the contract would not result in a dividend paid by the company to the trust. | Detailed Reasoning - Detailed reasoning: Section 44(1) of the ITAA 1936 includes in assessable income of a shareholder all company dividends and non-share dividends paid to the shareholder by the company. The trust is not a shareholder of the company, the individual is the 100% shareholder of the company and the land will not be transferred to them but back to the trust. Therefore there will be no dividend under subsection 44(1) of the ITAA 1936. | Summary: The rescission of the contract would not have consequences under Division 7A of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: Under section 109C of the ITAA 1936 a private company is taken to have paid a dividend when it makes a payment to a shareholder or an associate of the shareholder or a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time. Subsection 109C(3) includes transfer of property as a payment. Subsection 109C(4) values the property as the amount that would have been paid for the transfer if the parties were dealing at arm's length less any consideration given by the transferee for the transfer. Section 318 of the ITAA 1936 defines an associate for the purposes of Division 7A. In this case the shareholder is an individual who also benefits under the trust. Therefore the trust meets the definition of an associate of the shareholder of the company under paragraph 318(1)(d) of the ITAA 1936. However if we accept that the contract has been terminated for breach then there is no change in ownership of the property for the purposes of Division 7A as the trust retains the title. | Summary: Section 177E of the ITAA 1936 has not been addressed as a C2 event occurs. | Summary: Part IVA of the ITAA 1936 will not apply as the amount will be included under assessable income under section 104-25 of the ITAA 1997.

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