CGT Newsletter 2009/10 - Issue 1
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» Exercise of put option: market value substitution rule
The market value substitution rule in sec 112-20(1) ITAA 1997 did not apply to amounts paid by the grantor on the exercise of a put option where the grantor and grantee were members of the same wholly-owned entity group, the terms of the exercise were in accordance with the market value conditions at the time of granting the put option and the exercise price paid by the grantor of the put option was more than the asset's market value at the time of the exercise (ID 2009/68).
The facts considered in this interpretative decision were that the taxpayer (grantor) granted a put option, in relation to a CGT asset. The grantor and the grantee were members of the same wholly-owned entity group. The terms of the exercise of the option were in accordance with market value conditions. The option was exercised and at the time of exercise the amount payable was greater than the market value of the CGT asset.
The interpretative decision makes these points:
- sec 134-1 ITAA 1997 sets out the consequences of an option being exercised and treats the grant of the option and the transaction that supports the exercise of the option as a single transaction (being, in the case of a put option, the acquisition by the grantor of the CGT asset that is the subject of the option); generally, the terms of the exercise of an option are struck at the time of its granting. In this case, the terms of the exercise were struck accordingly and in accordance with market value conditions. For options, both grantor and grantee are subject to the market whether, if and when the option is exercised, the market value of the asset, the subject of the option, is higher, lower or equal to, the exercise price. In the case of a put option, only the grantee is at liberty, if and when, to initiate the exercise of the option; and
- accordingly, in this case, when invoking the notion of the "single transaction" in sec 134-1 ITAA 1997, coupled with the fact that the grantor of the option had no control over the market value of the asset the subject of the option when the option was exercised, the market value substitution rule did not apply to the amount referred to as "any amount paid to exercise the option" in item 2 of the table in sec 134-1(1) ITAA 1997.
» Temporary resident acting as trustee
A capital gain or capital loss that an individual makes from a CGT event in their capacity as trustee of a trust is not disregarded under sec 768-915 ITAA 1997 if the individual is a temporary resident just before, or at the time of, the CGT event (ID 2009/88).
A foreign resident individual who came to Australia and was a temporary resident (as defined) created a trust of which he was the trustee. The trust was a resident trust for CGT purposes. As trustee of the trust, the individual acquired some shares in an Australian company that were non-taxable Australian property and later (when still a temporary Australian resident) disposed of the shares and made a capital gain Section 768-915 ITAA 1997 has the effect of allowing a taxpayer to disregard a capital gain or capital loss they make from a CGT event if they are a temporary resident when, or immediately before, the CGT event happens provided the capital gain or capital loss would have been disregarded (under Div 855 ITAA 1997) if the taxpayer were a foreign resident at that time.
A capital gain or capital loss that a taxpayer makes from a CGT event happening in relation to non-taxable Australian property is disregarded (under sec 855-10(1) ITAA 1997) if the taxpayer is a foreign resident, or the trustee of a foreign trust for CGT purposes, just before the CGT event happens. By referring to both taxpayers who are a foreign resident and taxpayers who are the trustee of a foreign trust, sec 855-10(1) ITAA 1997 provides separately for capital gains or capital losses that a particular taxpayer makes in their personal capacity and capital gains or capital losses that the same taxpayer makes in their capacity as trustee of a trust.
In contrast, sec 768-915(b) ITAA 1997 only makes reference to a taxpayer who is a foreign resident. The interpretative decision states that this strongly suggests that it is only capital gains or capital losses that a temporary resident makes in his or her personal capacity that can be disregarded under that provision. Had it been intended to also disregard capital gains or capital losses that the temporary resident makes in their capacity as trustee of a trust, then the provision would also have made reference to a taxpayer who is the trustee of a foreign trust.
Accordingly, a capital gain or capital loss that an individual makes in their capacity as trustee of a trust is not disregarded under sec 768-915 ITAA 1997 as only capital gains or capital losses that an individual makes in their personal capacity can be disregarded under that provision.
» CGT event E1: creating a trust
Where a new trustee was appointed to CGT assets forming part of the property of a trust and those assets were transferred to the new trustee, CGT event E1 happened because a new trust was created (by settlement) in respect of the CGT assets to which the new trustee was appointed (ID 2009/86).
The facts considered in the interpretative decision were as follows. A family discretionary trust (the X Family Trust) was settled for the primary purpose of benefiting members of the X family. However, the class of persons entitled to benefit under the trust was widely-drawn, and the trustee also had the power to appoint income and capital to members of the Y family (who were relatives of the X family). In June 2008, pursuant to a power contained in the trust deed, the appointor of the X Family Trust appointed a new trustee to CGT assets forming part of the trust property (namely 100 units in a unit trust). These assets were to be held on the same terms as contained in the original settlement in respect of the X Family Trust. The remainder of the trust's property continued to be held by the original trustee.
The trust deed governing the X Family Trust also provided that, on the appointment of a new trustee, the original trustee was obliged to convey relevant assets to the new trustee and to take all steps necessary to enable that to happen. It also made provision for the trust in respect of the assets transferred to the new trustee to have a different appointor from those assets retained by the original trustee.
The appointment of the new trustee (which was a company controlled by the Y family) was part of a broader family restructure designed to split certain assets between the X and Y families. The broader arrangement was supported by a family agreement under which the X family undertook to hold on a bare trust for the Y family any distributions received by the X family in respect of the assets to which the new trustee was appointed (as such assets were intended to benefit the Y family). It was contended that no CGT event was triggered because, following the split, there continued to be a single trust.
The interpretative decision concludes that a new trust was created in respect of those CGT assets of the X Family Trust to which a new trustee was appointed. There had been a substantial alteration of the trust relationship in respect of the transferred assets. The trustees' rights would be altered in that the assets to which the new trustee was appointed would be excluded from the class of assets from which the original trustee was entitled to be indemnified for expenses properly incurred. Also, the rights of beneficiaries were altered in that the class of persons who could benefit from the transferred assets had essentially been narrowed. That is, it was clear that the assets held by the new trustee were to be held for the exclusive benefit of the Y family. Further, the conditions for the same beneficiaries and terms (the "trust cloning") exception to the happening of CGT event E1 were not met. Differences which prevented the application of the exception included the prospect that the two trusts might have different appointors, and the fact that the two trusts had widely-drawn beneficiary clauses (such that the trustee of the new family trust was a beneficiary of the original X Family Trust and vice versa, but neither was a beneficiary of itself). It should be noted that the trust cloning exception to the happening of CGT events E1 and E2 is being abolished from 31 October 2008 (subject to special rules for fixed trusts).
» Demutualisation of friendly societies
The Tax Laws Amendment (2009 Measures No 4) Bill 2009 contains amendments which will provide CGT relief to members and insured entities of friendly societies that have a life insurance business and/or a private health insurance business and the friendly society demutualises to a for-profit entity.
The amendments are to apply to demutualisations that occur on or after 1 July 2008.
» Pre-CGT double tax agreements
In a decision impact statement released on 29 July 2009 the Commissioner stated that he accepts the decisions in Virgin Holdings SA v FCT ([2008] FCA 1503; 2008 ATC ¶20-051) and Undershaft (No 1) Ltd and Undershaft (No 2) BV v FCT ([2009] FCA 41; 2009 ATC ¶20-091) as to the interpretation of pre-CGT double tax treaties.
Accordingly, he will, where appropriate, apply the decisions in respect of similar matters involving entities making taxable capital gains under the ITAA 1997 which are residents of countries where a DTA (worded similarly to the DTAs considered in the decisions) signed prior to the introduction of a comprehensive CGT regime in 1985 applies. It means that, under the DTA, the Commissioner is denied the right to include capital gains in the assessable income of residents of those countries that make capital gains in Australia from the sale of similar assets in circumstances covered by the two cases.
The decision impact statement notes that, as Australia has renegotiated a number of the DTAs that were in force in 1985, including those with many of Australia's significant treading partners (for example, the USA, the UK, New Zealand and Canada), the decisions will have a somewhat limited application. As further DTAs are renegotiated, the potential impact of the decisions will lessen.
Further, the ongoing significance of this issue with respect to the disposal of shares is reduced due to the narrowing of the range of assets held by foreign residents that are subject to CGT following legislative changes enacted by the Tax Laws Amendment (2006 Measures No 4) Act 2006 with effect from 12 December 2006. The direct and indirect interests in real property (including certain options and rights) held by foreign residents, and business assets of a foreign resident's permanent establishment in Australia, are subject to the CGT provisions. It is noted that both the remaining pre-CGT tax treaties and those subsequently negotiated generally allocate the right to tax capital profits from the alienation of these types of assets.
