I currently have a number of properties wrapped under Instalment Sales Contracts in Qld and today my accountant sent me the following Interpretive Decision (ID2004/58 – CGT: Sale of house – instalment sales contract) that has been issued from the ATO in March 04. This decision has serious implications to wrapping using an ISC and I’m wondering what advice, thoughts there are out there regarding this issue. Here is the decision in its entirity.
“Even though the sale of a property is under an instalment contract and title to the property will not pass until the final instalment is paid, a disposal for CGT purposes occurs when use and enjoyment of the property passes under the contract.
Facts
A taxpayer enters into a contract to sell a house under an instalment sale agreement.
Under the agreement, the purchaser makes weekly payments which consist of principal and interest components.
The purchase price is due to be paid to the vendor in full no later than 15 years from the date of the contract. Until the full purchase price is paid to the vendor, the title to the property will not transfer to the purchaser.
During the contractual period, the purchaser occupies the property and is responsible for the outgoings such as rates and insurance.
If an instalment is not paid within a certain number of days of the due date, the vendor may terminate the agreement.
Reasons for Decision
Capital gains tax applies when a taxpayer enters into an agreement with another entity under which:
(a) the use and enjoyment of a CGT asset passes to another entity; and
(b) title in the asset will or may pass to the other entity at or before the end of the agreement.
The time of the event is when the other entity first obtains the use and enjoyment of the asset.
Under the instalment sale agreement, a purchaser obtains the right to use and enjoy the porperty upon entering into the contract.
However there is no change of ownership of the property at that time.
As the purchaser has the use and enjoyment of the property, and the title to the property will or may pass at some future time, the CGT provisions are triggered at that time (S. 104-15 – CBT event B1).”
We are about to lodge our company tax return and are faced with this situation being relevent from when CGT first commenced.
Any advice would be greatly appreciated.
Thanks.Why has no one replied to this?
What do the experienced wrappers out there have to say about this ATO decision, which if true, effectively kills wrapping via an Instalment Sales Contract.
Shit!
Terryw
Discover Home Loans
North Sydney
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Just remember this is only an interpretive decision, not law. The ATO will probably pick a test case and go to court.
Imagine if you had wrapped in properties in one year, each with a $20,000 markup. You would not receive this capital gain untill years down the track, but may be required to pay $200,000 in CGT upfront!
What happens if the contract is terminated after you pay this CGT, and then you decide to just rent the property out normally.
You should probably start preparing now. Maybe lease options can overcome this. Maybe structuring the deal differently. Eg no markup, just a higher interest rate with a ‘fee’ at settlement.
Terryw
Discover Home Loans
North Sydney
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
I just did some searching.
ID 2004/58 can be found at:
http://law.ato.gov.au/atolaw/view.htm?find=%222004%2F58%22&docid=AID/AID200458/00001and
Also see:
ID 2004/59 Capital gains tax: sale of house – instalment sales contract – consequences of sale not proceeding
http://law.ato.gov.au/atolaw/view.htm?locid='AID/AID200459‘Which states that the CG will be disregarded if the contract does not proceed.
Terryw
Discover Home Loans
North Sydney
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
We have been spent hours looking into this issue and consulted with accountants and are now thinking that perhaps our houses are considering trading stock ID 2004/25. If this is the case then CGT is not relevant to our situation.
However, i would suggest that if this is true that people wrapping are very careful that their houses fulfill the trading stock criteria for the ATO.
Any further ideas would be welcomedJairus,
I had a quick read of the ATO article on trading stock. It would be most appreciated if you or anyone else can give a simple example on how trading stock is valued and assessible income calculated.
Thanks!Sounds like you are subject to captial gains…..
Not sure if houses could be considered ‘trading stock’ If someone stays there for 30 yrs – how could that be stock.
Oh well – at least you are helping someone into their own home. Maybe next time allow for CGT when bumping up the price.
Is noone worried about this?????????????????
Yes, of course, they are worried. They are so worried that they are frozen with fear. Can’t type.
Read your Tax Acts and you will see that if you on-sell at a profit, then the tax is payable on that profit at the time you “make” the profit.
It’s like invoicing, you are deemed to have received the money you haven’t really received.
Look, I know it may not be fair and it may not be easy, but that’s the way it is in the land down-under.
I have it on good authority that wrappers are going to be targeted (in a BIG way) and that they will be sent huge bills for the taxes they have not paid on profits they have made but not received.
And, where are they going to get the money? Sell other assets (if they have any), borrow on their family homes (if they have any equity left) or go broke.
It’s not pleasant and, as I said, it may not be fair. But it’s fact and, like the scene from Towering Inferno, “it’s outta control and headed your way.”
Baton down the hatches, wrappers, the taxation firestorm is headed your way.
It’s gonna ruin some of those positive cash flow figures, that’s for sure.
Good luck
Bec
P.S. And no shooting the messenger here, please!
The ATO often has two sets of rules for the one “industry” or “activity”, depending on the level to which you are active.
For example, if you trade shares, then if you only do a few trades a year you will be classified as an investor, and your tax will be handled one way. If, however, you are more active, you can be classified as a trader, treated as a business, and the tax treatment is quite different. Your shares are classed as trading stock etc etc
It may well be that a similar situation arises with wraps. If someone does one a year, they may well be treated one way, and this CGT issue will be applied. If, however, they are doing a dozen using a company, they may be treated as a wraps business, the houses become trading stock, and the tax treatment may well be quite different.
It will be interesting to see how it all pans out. I’m waiting with bated breath for my accountant to return from holidays and explain it all to me and how it affects my situation! [eh]Keep smiling
Felicity
While FW is right that different consequences might happen depending on whether one is “in business” or not in many areas of taxation, it would seem to me that the taxation consequences for many wrappers would not differ significantly as even if someone was not in business, if they wrapped within 12 months of the date of their purchase contract CGT event A1 would apply and there would be no 50% discount of the capital gains
Hi,
When you understand the tax consequences it’s not so bad.
CGT should almost never have been relevant for wraps as the 50% discount only applies if you owned the property for more than 12 months.
Bye,
Steve McKnight
**********
Remember that success comes from doing things differently.
**********Steve McKnight | PropertyInvesting.com Pty Ltd | CEO
https://www.propertyinvesting.comSuccess comes from doing things differently
But isn’t it so Steve, that the discount does not apply at all if you own the property for less time? So that, even if you put the wrap in the person’s name, and that is within less than 12 months, you’ll then be paying 100% CGT?
kay henry
…you’ll then be paying 100% CGT?No. You actually pay 0% CGT [wink]
Bye,
Steve McKnight
**********
Remember that success comes from doing things differently.
**********Steve McKnight | PropertyInvesting.com Pty Ltd | CEO
https://www.propertyinvesting.comSuccess comes from doing things differently
Kay, I am with you. Confused. Steve could you explain the 0% a little more.
Cheers
CDCastleDreamer
I pay 0% CGT as there is no CGT to pay!
Cheers,
Steve McKnight
**********
Remember that success comes from doing things differently.
**********Steve McKnight | PropertyInvesting.com Pty Ltd | CEO
https://www.propertyinvesting.comSuccess comes from doing things differently
Thanks for that explanation, Steve…
I think the interpretive decision suggests wrappers *will* be paying CGT.
kay henry
Sorry but I agree with ID 2004/58 it is simply explaining a point that is already covered in legislation so it does not matter that it is only an ID. The following is an article I wrote on wraps back in February:
Wraps – Vendor Finance Arrangements
Newsflash 74, 15th February 04If the Vendor Finance arrangement has the following features the income stream received, once the wrap arrangement has begun, is considered to be principle and interest by the ATO. The income stream received before the wrap arrangement is entered into is considered rent. Reference ID2003/968.
Typical Features of a Wrap (Vendor Finance Arrangement)
1) The purchaser pays a deposit at the time of entering into the arrangement.
2) The settlement (change of the title deed to the purchaser) does not take place for several years after the arrangement is entered into.
3) The purchaser has the right to occupy the property prior to settlement
4) The purchaser pays a weekly amount (regardless of the name it is given in the arrangement) for the right to occupy the property
5) As part of the arrangement the purchaser pays the rates, taxes and insurances on the property.
6) The balance of the purchase price to be paid on settlement of the arrangement is reduced by the weekly instalments.
7) If the purchaser fails to complete the arrangement the deposit and weekly instalments are forfeited.Now what about the profit on the sale of the property? Is that normal income or capital gain and when is it taxable? Assuming an agreement similar to that described above the answer to this question revolves around whether the vendor is in the business of selling houses or an investor just realising an investment. The key issues in differentiating here, according to ID2004/25, 26 & 27 are:
1) The Vendor did not use the property for any other purpose than to enter into the wrap. A straight rental of a property before entering into a wrap arrangement would avoid this point.
2) The property was sold at a profit
3) The wrap arrangement was entered into within 6 months of the vendor purchasing the property.
4) The Vendor is in the business of purchasing properties to resell. It would be difficult for the ATO to argue this case if the Vendor only bought and sold one property.If you are caught by all of the above then CGT cannot apply to the sale of the property as the profit on the sale is revenue in nature. If a transaction is caught as income, CGT does not apply or in other words CGT is the last option if income tax doesn’t catch it. But even if you weren’t caught by the above and CGT applied there would be no discount if the property was held for under 12 months. If you did hold the property for less than 12 months before entering into the wrap it is better to argue that you are in business and caught by the above because the profit on sale would be revenue in nature and as a result not assessable until settlement which could be 25 years away (ID2004/27). If you hold the property for less than 12 months but it is subject to CGT you don’t qualify for the discount but would be assessable on the profit when entering into the wrap.
Section 104-15(1) of ITAA 1997 states that a CGT event happens when the owner of a property enters into an arrangement with another party to allow them to live in the property and title may transfer at the end of the arrangement. Section 104-10(3) states that the time the CGT event happens is the time of entering into a contract for the disposal of the asset, not when settlement (title passes) takes place.
For example this means that the vendor who enters into a wrap on a property that has been previously used as a rental and held for more than 6 months will be subject to CGT on the property in the financial year the wrap agreement is entered into. Accordingly, if at this stage the property has not been held for 12 months no CGT discount will be available even if they eventually end up holding the property for 25 years under the arrangement.Excellent explanation Julia.
Keep smiling
Felicity
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