The timing of capital gains tax (CGT) liabilities can be a significant impediment to facilitating real property transactions. There are a number of ways to manage these timing issues, including put and call options and an often overlooked ATO Tax Determination that is particularly relevant to terms and instalment contracts. In the current economic environment, where it has become increasingly difficult for vendors and purchasers to access finance, why not use the ATO as your financier?

CGT on sale of real property

Where real property is held on capital account (i.e. not as trading stock), the sale of that property will trigger a capital gains tax event. CGT event A1 (section 104-10 of the Income Tax Assessment Act 1997) happens if a taxpayer "disposes of an asset". A taxpayer disposes of an asset if "a change of ownership occurs". Importantly, the time of CGT event A1 is when the taxpayer "enters into the contract for the disposal". This timing rule can have significant cash flow implications for the vendor where entry into a sale contract and settlement of the sale contract straddle two or more income years. However, it is important to note that if the contract does not settle and the disposal does not occur, CGT event A1 does not happen (although other CGT events may occur if the purchaser's deposit is forfeited).

TD 94/89

ATO Taxation Determination TD 94/89 (Determination) sets out the ATO position on "when" a capital gain must be reported in relation to land disposed of under a contract which is made in one income year but which is settled in a later income year. The Determination provides that:

  • the taxpayer is required to include the capital gain in the year of income in which the contract is made (not settled) but not until an actual change of ownership occurs, i.e. it is only once settlement occurs that the requirement to return the capital gain is triggered
  • if an assessment has already been made for the income year in which the contract was entered, the taxpayer will need to have that assessment amended once the contract settles, and
  • where an assessment is amended to include a net capital gain, and a liability for interest arises, the discretion to remit the interest (i.e. not impose the interest) will ordinarily be exercised in full where the request for amendment is lodged with the ATO within a reasonable time after the date of settlement (in most cases, one month after settlement would be considered to be a reasonable period).

The Determination is particularly important in the context of terms and instalment contracts that may not settle for many years. Vendors are often not aware of the Determination and may have returned capital gains and payed CGT earlier than they are required to.

Put and call options

Put and call options can be a useful planning tool when disposing of real property towards the end of an income year. Entry into a contract of sale on 1 June 2009 that settles on 1 August 2009 would trigger a CGT liability for the vendor in the 2008/09 income year. However, entry into a put and call option on 1 June 2009 exercisable on or after 1 July 2009 (with a sale contract that comes into existence on exercise of the put and call option and that settles on 1 August 2009) would not trigger the CGT liability until the 2009/10 income year.

While the use of a put and call option will be effective to defer the time of the CGT event, it will not generally be effective to satisfy the 12-month holding period required to access the CGT discount concession. For example, where the vendor (an individual) in the above example acquired the real property on 30 June 2008, the vendor would not be able to apply the 50% discount concession because the put and call option was entered on 1 June 2009, i.e. within 12 months.

How can the Determination or put and call options assist you?

The Determination is important for both vendors and purchasers in facilitating existing and new transactions in the current environment.

From a vendor's perspective, application of the Determination may allow real property to be realised more easily or at a higher price as a result of waiving (existing contracts) or not requiring (new contracts) large up-front payments from the purchaser to cover CGT liabilities.

From a purchaser's perspective, application of the Determination may prevent the purchaser from defaulting on its payment obligations under an existing contract (depending on its terms) or may allow a new acquisition to proceed, i.e. the numbers may stack up if the purchaser is not required to finance the vendor's CGT liability.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.