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Capital Gains Tax (“CGT”)
and Instalment Contracts
Commentary
Most tax practitioners will conclude that a vendor selling a
property (that is not their main residence) will be liable
for capital gains tax at the time that they enter into an
Instalment Contract (a Terms Contract), as opposed to the
capital gain being realised in each instalment received
during the term of the Contract, or at the end, when the
Contract is paid out.
In taking this view, they rely upon entry of the Contract
being a CGT event B1.
The following is the law, followed by the ATO
Interpretation, of CGT event B1 –
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The Income Tax Assessment Act (the “ITAA”)
Subsection 104-15(1) of ITAA 1997 provides:
CGT event B1 happens if you enter into an agreement with
another entity under which:
- the right to the use and enjoyment of a CGT asset
you own passes to the other entity; and
- title in the asset will or may pass to the other
entity at or before the end of the agreement.
The provision contemplates the existence of only one
agreement for it to operate.
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The ATO Interpretation of CGT event B1
Entering into a terms contract
CGT event B1 happens to real estate if you enter into
an agreement where the new owner is entitled to possession
of the land or the receipt of rents and profits before
becoming entitled to a transfer or conveyance of the land.
Where this happens under a contract, it is known as a terms
contract and the new owner usually completes the purchase by
paying the balance of the purchase price and receiving the
instrument of transfer and title deeds.
It may also happen where an agreement is made with a
relative or other party to use and enjoy the property for a
specified period after which title to the property passes to
them. It will not happen where, under an arrangement, title
to a property may pass at an unspecified time in the future.
CGT event B1 happens when use and enjoyment of the land is
first obtained by the new owner. Use and enjoyment of the
land from a practical point of view takes place at the time
the new owner gets possession of the land or the date the
new owner becomes entitled to the receipt of rents and
profits.
If the agreement falls through before completion and title
to the land does not pass to the acquirer, you may be
entitled to amend your assessment for the year in which CGT
event B1 happened.
Source
http://www.ato.gov.au/individuals/content.aspx?doc=/content/36904.htm&pc=001/001/038/002/002&mnu=0&mfp=&st=&cy=
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Commentary
This view applies to one-off transactions, but does not
apply to vendors who are carrying on a business. For vendors
carrying on a business, the ATO takes the view that the
trading stock provisions of the ITAA apply, rather than the
capital gains provisions. One consequence is that the
capital component of the instalments of capital received is
counted in the income of the vendor in the tax year of its
receipt, rather than as a capital gain.
This is the ATO interpretation found in Interpretative
Decision 2004/27 –
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ATO Interpretative Decision 2004/27
Income Tax
Derivation of income: residential properties instalment
sales contracts - carrying on a business
FOI status: may be released
Status of this decision: Decision Current
Issue
For a taxpayer carrying on a business, are payments received
from the sale of residential properties under instalment
sales contracts included in assessable income under
subsection 6-5(1) of the Income Tax Assessment Act 1997
(ITAA 1997) in the income year in which the contract is
entered into?
Decision
No. The payments will not be included in the assessable
income of the taxpayer under subsection 6-5(1) of the ITAA
1997 in the income year in which the contract is entered
into, as the income has not yet been derived.
Facts
The taxpayer carries on a business of buying and selling
residential properties. The properties are sold under
instalment sales contracts with vendor finance.
The instalment sales contract has the following features:
- the sale price represents a profit over the
investor's purchase price
- the purchaser will pay the investor a deposit
- vendor finance is provided to the purchaser with
interest charged at a premium above the rate of interest
paid by the investor on their mortgage on the property
- payment of the balance of the price, plus interest,
is by instalments over a substantial period such as 25
years
- the deposit and instalments are not refundable
- the purchaser is licensed to occupy and entitled to
possession of the property during the term of the
instalment contract
- the contract states that this occupation or
possession is not by way of lease
- the purchaser is required to reimburse the investor
for the rates and taxes on the property
- the purchaser is required to keep the property in
good condition and repair
- the investor retains title to the property until the
final instalment is paid and the contract is completed
- if the purchaser defaults on the contract the
deposit and instalments paid are forfeited to the
investor
It is common ground that the interest is included in
assessable income in the year it is received.
The taxpayer did not use the properties for any other
purpose prior to sale. The properties were sold for an
amount that was in excess of the amount paid by the taxpayer
to acquire the property. Each property was sold within six
months of it being acquired by the taxpayer.
The properties are trading stock for the purposes of
subdivision 70-C of the ITAA 1997.
For detailed reasons, go to the ID -
http://law.ato.gov.au/atolaw/view.htm?rank=find&criteria=AND~instalment~basic~exact&target=J
JA&style=html&sdocid=AID/AID200427/00001&recStart=1&PiT=99991231235958&recnum=22&
tot=66&pn=ALL:::J
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