How to avoid CGT when buying a home for your child

miao123

It is a very good case law study just read from CCH and it teaches you how to avoid the CGT trap when buying a home for your child.

   
How not to buy a home for your children, 21 November 2013


Contributed by Anthony J Cordato, Business and Property Lawyer, Cordato Partners Lawyers

Look out for the CGT trap

Parents like to help their children to buy a home.


Parents help their children in different ways.


Some parents expect nothing in return, so they gift the money to help buy the home.


Other parents like to keep control of the money, so they loan the money to “bridge the deposit gap” to help buy the home.


Yet other parents like to both keep control of the money and take an ownership share, so they become a joint owner in the home.


The joint ownership alternative creates a CGT trap for the parent. The child pays no CGT — they are exempt from CGT because they live in the home as their main residence. But the parent cannot use the main residence exemption because they live elsewhere.


Is there a way for the parent to be a joint owner and qualify for the main residence exemption, or some other exemption from CGT? These ways were explored in the Gerbic decision.


The Gerbic decision

In the decision of Gerbic v FC of T [2013] AATA 664, the AAT reviewed three arguments raised by Gerbic, to avoid the CGT trap on the sale proceeds of a townhouse which he owned jointly with his son.


The facts

Gerbic purchased a townhouse at Mount Coolum in Queensland in April 2002 for his adult son Justin to reside in. He purchased it in his and son’s names as joint tenants.


Gerbic used his own funds to purchase the townhouse. His son made no contribution to the purchase price and paid no rent. Gerbic no doubt wanted to be a joint owner to protect the money he contributed and also to exercise control over the property.


His son lived in the townhouse and paid for the outgoings: the council rates, strata levies, and electricity and telephone bills; and paid for bathroom improvements and a new water heater.


When the townhouse was sold in September 2007, the Commissioner assessed Gerbic on 50% of the net capital gain arising from the sale, based on his owning a one-half share in the property.


The arguments Gerbic raised to avoid the CGT trap

1. Does buying as joint tenants mean that the son’s main residence exemption can cover all of the capital gain?

The argument rested on the fact that father and son held the title as joint tenants. Joint tenancy means owning the whole property jointly. It is like owning a whole apple jointly — each has ownership of the whole apple.


The argument might have succeeded but for s 108-7 of ITAA 1997, which provides that individuals who own a CGT asset as joint tenants are treated as if they each owned a separate CGT asset. This means that they are treated as having separate interests as tenants in common, in equal shares. It is like each owning one-half of an apple, after it has been cut in two.


2. Is CGT payable only if there is a profit-making intent?

The argument was that joint ownership of the home was intended to protect his “inexperienced” son of 23 from doing anything “silly”, such as selling “on a whim”.


The AAT decided that intent was not relevant — only the nature of ownership was relevant. So no profit-making intent is needed for CGT to be payable.


Nor was it relevant that Gerbic directed that the proceeds of sale be paid to reduce bank debt on another property. He was treated as if he received the money (see s 103-10 of ITAA 1997).


3. Did Gerbic hold his half share as trustee in trust for his son?

The argument was that the CGT provisions do not apply to the legal owner, if they hold the asset in trust for someone else.


The tax law will recognise this argument if the beneficiary has an absolute entitlement to the asset as against the trustee under the trust (see s 106-50 of ITAA 1997). This is why a custodian trust deed is signed when a self managed superannuation fund (SMSF) buys property with loan funds. The property is purchased in the name of the custodian trustee and deed gives the SMSF the right to require the custodian trustee to transfer the property to it at any time (when the loan is repaid).


In this case, Gerbic argued s 106-50 applied because although he was registered on the title as legal owner, his son had the equitable (beneficial) interest in the property.


This argument might have succeeded but for the fact that Gerbic was unable to produce a bare trust acknowledgement or a custodian trust deed, signed by him and his son. None existed, presumably because Gerbic wanted to maintain control. Nor could Gerbic argue that a constructive trust had been created, as his son had paid no rent or other money towards the purchase.


The result was that AAT rejected all of these arguments and upheld the tax assessment on Gerbic to pay tax on a 50% share of the net capital gain.


Conclusion

The joint ownership structure that Gerbic used to buy the townhouse as a home for his son was not effective to qualify for the main residence exemption under s 118-110 of ITAA 1997, nor any other exemption. Therefore, Gerbic was caught by the CGT trap.


If a parent requires joint ownership, then a custodian trust deed could be used to avoid the CGT trap.


Alternatively, the parent must forego joint ownership and use a loan arrangement. The loan could be secured by a mortgage or a caveat registered on the title to the property.

angelaleewi99

好长啊。。。

miao123

angelaleewi99 发表于 2013-11-22 11:16
好长啊。。。

You can read the conclusion  only. this is the point.

3IX37

a very interesting read. Thanks for sharing.

In addition to all the points AAT contended, even if the capital gain was allowed to attributed to Gerbic's Son, would it indicate that Gerbic surrendered his equitable right towards the underlying property?  This in turn would have resulted a CGT event C2. and market value substitution  rule would then apply, under which he would not only pay tax on the capital gain, but also might even lose 50% discount benefit.

Overall, he should really be happy that AAT rejected his arguement, because he might end up paying tax on his 100% capital gain of his 50% interest of property.  

Echo0531

Good case

黑山老妖

Interesting read for future reference.
Thank you for sharing.

黑山老妖

Interesting read for future reference.
Thank you for sharing.

miao123

3IX37 发表于 2013-11-22 15:02
a very interesting read. Thanks for sharing.

In addition to all the points AAT contended, even if  ...

I don't think this case decision will lead to your presumption. My understanding is that Gerbic already had his main residence when he purchased the townhouse for his son. Namely, it is an investment property. Because Gerbic and his son purchased property in the form of joint tenants which mean they equally take the ownership of this townhouse. For Gerbic's son, this property is his main residence, as a result, he will not be taxed on the 50% of the profit out of the sale because main residence exemption applies to him. However, Gerbic has to pay CGT on the other half profit out of the sale and CGT discount might still apply upon conditions are satisfied. According to AAT, there are two ways  to avoid the CGT.

1. Gerbic has a custodian trust deeds with his son. Tax is only levied on beneficiary but not legal owner. In this case, Gerbic is the legal owner of the property, he can confer beneficary (his son) with 100% interest on gain or profit over the sale of property. In that case, neither Gerbic nor his son need to pay CGT.

2. Through a loan agreement with the son, however, in this way, Gerbic might lose the control on ownership the property as his original intention was to keep his son from selling the property without his permission.

Hope my explanation does make sense to you.

3IX37

miao123 发表于 2013-11-22 16:20
I don't think this case decision will lead to your presumption. My understanding is that Gerbic al ...

I think you mis-understood me. I totally agree Deputy President Molloy's decision on the objection.

What i was trying to point out is purely hypothetical.

After reading the case decision, it is obvious that,
1) there was a disposal of property
2) there was a capital receipt, which resulted a capital gain.
3) the property was used as a main residence by Gerbic's son.

and It is also obvious that Gerbic's the so-called the strongest argument is that although he is the legal owner of the property, he was holding it on trust of his son, which was objected by Deputy President Molloy. I concur.

In relation to your interpretation of the case, although AAT pointed out there was no trust deeds or loan agreement to support the finding of constructive trust, it doesn't necessarily means, like you interpreted, that under the current case the CGT could had been avoided by signing a custodian trust deed or loan agreement. Of course i would read further in respect to the Baumgartner case and Muschinski case referred by the AAT in my leisure time.


But, if, and only if Gerbic's argument were allowed and AAT agreed he actually held the property on the trust of his son, the following issues would need to be considered.

1) Because Gerbic was the legal owner of the house, he and his son were joint tenant, as a result even if the 100% capital receipt from the disposal could be attributable to his son, Gerbic would still have the legal and/or equitable right to claim his 50% of the proceeds from the sale. Please note that here a whole new CGT asset - the legal or equitable right of receiving the proceeds, is the object.

2) by attributing all capital proceeds to his son, Gerbic effectively abandoned or surrounded his right, which would result a CGT event C2. s.104-25(1)

3) The time of acquiring CGT asset: The time Gerbic acquired his legal/equitable right of the proceeds is when he started to have the right to receive his 50% share of sale proceeds, which could only be after the sale of house was made, because only then there would be a right to receive the money, and only then the disposal proceeds came to existence.

4) time of CGT event C2: It is the time when Gerbic ended his legal/equitable right - the CGT asset, by surrounding or abandoning this right, which would generally instant after the sale of house, when he acquired his right.  Nevertheless, the holding period would not be longer than 12 months. No 50% capital gain discount would be allowed as a result.

5) Capital proceeds: under s.116-30(2)(b) the market value substitution rule, the capital proceed should be no less or more than market value when there is a CGT event C2. and the market value for Gerbic's right would generally be or close to be his 50% share of sale proceeds face value.

6) cost base: is there any cost incurred by Gerbic for acquiring or maintaining his right? the answer is "No, not likely". If so, it might only be some minimal legal cost. Generally there is none.

As the result, if Gerbic's first argument stood, he might end up being assessed on nearly 100% of his 50% share of house sales, with no cost base, and no 50% capital gain discount benefit due to the holding period of his right is shorter than 12 month.

This is a typical bad tax planning, as the first intention does not stand, even if it stood, it would give commissioner more reason to tax it under anther CGT event as 100% with not cost and no discount to reduce the capital gain.

I hope this makes some senses to you.

Cheers

  

  

jeffxia

生活在澳洲是比较累人的，什么都得懂，不然输大钱

xlin8703

3IX37

What George Gerbic should have done in a more practical and easier fashion is:
either to write a registered mortgage with his son, no stamp duty would be chargeable generally. Or
make a conditional loan to his son Justin on the grant of an equitable charge over the property and lodging a caveat over the property.

Further to my point above, AAT didn't object George Gerbic's argument based on the fact that there was not custodian trust deed.  AAT objected based on there is no need to exam due to no facts supporting Appellant's argument.  

Even if it were objected based on there was no trust deed, it definitely does NOT mean that with the trust deed the CGT can be avoided. Because with a trust deed, more facts would have to be considered, the result can't be determined just merely by the existence of custodian trust deed itself.

I hope this makes some sense to people.

Cheers

Poweregg

The result was that AAT rejected all of these arguments and upheld the tax assessment on Gerbic to pay tax on a 50% share of the net capital gain.
=============================

最后还是被要求付CGT，亏了

hualala

没看明白，谁给讲讲

Poweregg

hualala 发表于 2013-11-23 08:28
没看明白，谁给讲讲

就是老爸出钱买房给儿子

联名户头

儿子用来自住和付日常账单

结果卖房不算自住房，老爸那部分要求交CGT

miao123

3IX37 发表于 2013-11-22 21:12
I think you mis-understood me. I totally agree Deputy President Molloy's decision on the objection ...

Well, if I am not wrong, you questions are based on the hypothesis where Gerbic already had a trust in place, how CGT will affect his share of net gains from the sale. Honestly, I am not very familiar with trust and my limited knowledge on trust was obtained from study in CPA taxation course.  There are a few different roles being required to set up a trust that includes legal owner, trustee, beneficiary and trust deeds.  For example, Legal owner of the assets can appoint a trustee to manage his funds and through trust deeds, the beneficiaries are appointed as well as their entitlement as to how share of the interest on the assets can be allocated. From tax perspective, income tax or CGT are payable by beneficiary. In rare circumstances where the trustee is liable for tax, that is when the beneificary is a minor (under 18years old) or in mental incapacity. In this case study, Gerbic and son are both legal owner, when the trustee deeds is set up, Gerbic's son can be appointed as only beneficiary with 100% interest on gain out of the sale of property. Since his son is neither a minor nor mental disability, thus he is liable for CGT for net gain, however, main residence exemption applies. With my explanation, all your hypothetical issues are proved to be never exist.

yzh1999

miao123 发表于 2013-11-23 10:16
Well, if I am not wrong, you questions are based on the hypothesis where Gerbic already had a trus ...

你们俩不在讨论同一个问题

LadyMary

感谢分享，今天分分用完了。
请问你是用 traker news 然后email 给你的吗？如何可以定制在CCH  tax news email给自己呢？

3IX37

miao123 发表于 2013-11-23 09:16
Well, if I am not wrong, you questions are based on the hypothesis where Gerbic already had a trus ...

All your theory are sound, I agree with you.

I am not here to challenge but purely technical discussion.

there are a few facts, which cannot be ignored.
1) the house was bought under a joint name. It wasn't bought under a trust name. If a trust was set up after the purchase, there would have been another CGT event when the title was changed.

PS. under a joint name, his beneficial entitlement is undeniable. even if a trust deed is set-up, Gerbic would still be facing the waiving his right. A event C2 would be triggered.

2) if a trust was set up for the purchase before the purchase, you analysis is correct, except there might still be a C2 implication.
(What i am trying to raise here is the awareness of CGT event C2, which have been neglected by most for too long)

Because the fund used to purchase the house was all from George Gerbic. Of course, he could have simply just gave it to his son as a gift, but he didn't. Instead he set-up a complicated structure, which might trigger C2 implication. Bear mind that waving an outstanding loan is CGT event C2 as well.(Integrated insurance planning case).

I can't say I am an expert of trust, it has been too long since last time i was involved in a trust issue, and Trust taxation has changed in last year. But when CGT comes to a trust, Commissioner just loves to use C2 to whack taxpayers. People, investors and even professionals are often overlook this, which should really be taken with care.

miao123

LadyMary 发表于 2013-11-23 10:59
感谢分享，今天分分用完了。
请问你是用 traker news 然后email 给你的吗？如何可以定制在CCH  tax news em ...

We are corporate client of CCH. Company pays for the subscription and it is quite expensive tho.

3IX37

yzh1999 发表于 2013-11-23 09:56
你们俩不在讨论同一个问题

No, we are not ;) but we are discussing what possible outcome(s) could be :)

I welcome all healthy discussion. Thanks for pointing it out though :)

miao123

3IX37 发表于 2013-11-22 21:12
I think you mis-understood me. I totally agree Deputy President Molloy's decision on the objection ...

CGT is a very complex tax regime, even though I am not a CGT expert, I don't think your interpretation on these hypothetical issues are correct.

Firstly, CGT event A1 must apply on the disposal of townhouse rather than CGT event C2. When Gerbic sold his property, the Capital proceeds is the money he received from the other party as per the sales agreement and cost base was the cost of purchase including cost of the property, stamp duty, interest and etc...

CGT event C2 applies on cancellation, surrender or similar ending of an intangible CGT assets only. Noted it refers to intangible. Obviously the townhouse is a tangible asset. If we assume Gerbic and his son entered into a contract in which Gerbic lent money to his son for him to purchase the townhouse. In this scenario, a legal and equitable rights arises for Gerbic and if he forgive the debt and release his son from obligation for repayment, CGT event C2 then applies. You can read below example which will help you to understand CGT event C2 and how capital proceeds and cost base are calculated.


Example 6.6
Alpha owes her mother a debt of $10,000. Out of natural love and affection Alpha’s mother forgives the debt and releases Alpha from all obligations to repay it. Assume that at all times Alpha had the financial means to repay the debt in full. This gives rise to CGT event C2. There are no actual capital proceeds for the event. Subsection 116-30(1) will mean that the market value of the debt will be substituted for the actual capital proceeds. Subsection 116-30(3A) will mean that the market value of the debt will be calculated as if CGT event C2 had not occurred and was never proposed to occur. This should mean that the market value of the debt is equal to its face value of $10,000. Hence, Alpha will not make a capital loss on the forgiveness of the debt.Note that, unless the debt arose in gaining or producing Alpha’s assessable in- come or in carrying on business for that purpose, it will be a personal use asset to Alpha. This will mean that, as discussed in [6.75], any capital loss that arises in relation to it will be disregarded.

In addition, the document through below link from Lexisnexis on introduction of CGT is quite useful and you can read it when you have time.
http://www.lexisnexis.com.au/aus ... ilders/pdf/ch06.pdf

3IX37

miao123 发表于 2013-11-23 17:47
CGT is a very complex tax regime, even though I am not a CGT expert, I don't think your interpreta ...

You are right that A1 only applies to disposal, C2 applies to intangible asset

The property is sold under joint name. By claiming his 50% share of proceeds is what George Gerbic held on trust for Justin, his son. it is arguable that he abandoned his right to claim his lawful receipt. don't you think so? and that right is an intangible asset.

Whether C2 only prevents people from creating CGT loss or it would also prevent people from reducing CGT gain, I will re-visit the legislation and related cases.

Cheers

3IX37

miao123 发表于 2013-11-23 17:47
CGT is a very complex tax regime, even though I am not a CGT expert, I don't think your interpreta ...

I just refreshed my memory with the Australian leading case in relation to CGT event C2 - FC of T v Orica Ltd [1998]

For those, who are not familiar with the case, the short brief as the follows:

Relevant case facts:
- Orica formerly was known as ICI, it is still referred as Orica here;
- It issued debentures with a face value of $ 98 million, with maturity between 1986 and 2000;
- While it needed to retain a certain liability ratio in order to protect its shareholders' interest, it saw a new business opportunity, which required it to acquire extra funding to expand its activities;
-  it then entered a Principal Assumption Agreement (PAA) with the Melbourne and Metropolitan Board of Works (MMBW), under which Orica paid MMBW $ 62 million - the net present value of $ 98 mm, in return MMBW would assume the debenture repayment obligations when they are matured.  

Case result:
Without getting into all those lengthy details, the case results are briefly summaried as below:

a) the High Court dismissed the Commissioner's submission that Orica made an ordinary income of $ 36 million ($98m - $62m) from this transaction. It stated that this $ 36 million was not an income, instead it was merely a saving from Orica incurring expenditures.   

b) In relation to capital gain from CGT event C2, the Commissioner contended, which was upheld by the Hight Court, that

1) the contractual right Orica had, which compelled MMBW to assume its repayment obligation is indeed a CGT asset regardless of its alienability.
2) The High Court also decided that every time when a repayment was made by MMBW between 1987 and 2000, it was a part disposal of Orica's intangible right to compel MMBW to pay the public under CGT event C2 and Orica made capital gains from those events.

Further, in TD 2008/22, the Commissioner states in his example when a taxpayer paid $ 10,000 for a property, which is to be delivered later, if the property increases its market value to $ 15,000 when it is delivered, there is a CGT event C2, and the taxpayer would make a capital gain $ 5,000. (taxpayer has the right to receive the property, and the right is discharged upon the delivery, when CGT event C2 occurs. With the market value substitution rule, taxpayer makes a capital gain of $5,000)
Despite that fact that in the later section of the determination, the Commissioner states that he will apply underlying asset approach and not to look at this gain, TD 2008/22 confirms the Commissioner's position that there is CGT event C2 when one discharges, surrenders or abandons his/her right, even for a right of receiving purchased property like the one in example, and there potentially is a capital gain or loss.

Back to our Gerbic case, same principal could apply that George Gerbic has the right of his 50% share of property sales proceed, since his name is one of the joint name. By abandoning his right with attributing 100% proceed to his son Justin, who was to claim the whole proceeds under his main residence exemption, George incurred a CGT event C2. Without repeating the market value substitution rule, George would then arguably and most likely create a capital gain under C2 without noticing it.

What are your thoughts on this? I hopefully did some enlightening here :) if so, don't be shy about giving me some credits.

I know none of these are certain, they are just hypothetical assumption. But again they are still things to consider when we are making a tax planning. Gerbic is a perfect example of what a wrong planning can stuff up things very badly, even for those everyone thinks are sure things.  

http://www.austlii.edu.au/cgi-bi ... ;query=Orica%201998

miao123

3IX37 发表于 2013-11-24 23:39
I just refreshed my memory with the Australian leading case in relation to CGT event C2 - FC of T  ...

My view still remains the same. If there is alreay a trust in place, the benefits from trust assets will be distributed to beneficiary only. In this case, if Gerbic set up the tust and his son is the only beneficiary documented in trust deeds, Gerbic will never be impacted by CGT.

Where no trust has been setup, your explanation on how CGT event C2 occur does make sense. When Gerbic forego his share of interest in the jointly owned townhouse, CGT event C2 is attracted. However, the market substitution rule must apply as the Capital proceeds is treated as 50% of market value of the townhouse and thus Gerbic must make a capital gain. In another words, Gerbic choose to give up or retain his rights in the townhouse, he will be taxed on CGT in either way finally. The only difference is the timing and the different type of CGT event applies.  

- given up the rights, C2 applies and the timing of CGT is when the asset is surrendered
- retain the rights, A1 applies and the timing of CGT is when the asset is disposed.

lucyliu8472

answer: do not buy a house for your child, no CGT

3IX37

miao123 发表于 2013-11-25 14:10
My view still remains the same. If there is alreay a trust in place, the benefits from trust asset ...

I am glad that now we are on the same page.

anne

3IX37 发表于 2013-11-22 21:12
I think you mis-understood me. I totally agree Deputy President Molloy's decision on the objection ...

Thanks for your contribution.

Are you sure about the cost base discussion under your scenario 2C? He may lose 50% discount, but he should be able to claim the 50% purchase price as his cost base.

3IX37

anne 发表于 2013-11-26 05:27
Thanks for your contribution.

Are you sure about the cost base discussion under your scenario 2C ...

I think you perhaps are right,

but it is also possibly arguable that

- the original purchase cost is only attributable to the house obviously, and perhaps the right to enjoy the usage of the house, and other rights attached with the property, etc. However
- Is the right of payment from the sales one of those rights resulted from the purchase or one right merely resulted from the sale?
- the answer for that is rather possible to be considered that the right of payment George Gerbic has is the result from sale, which only bears minimal cost.

In my humble opinion, under the CGT event C2 implication, the relevant CGT asset - the right to receive the sale proceeds, is very much possible to be determined by the Commissioner with minimal cost from the sale.   

anne

3IX37 发表于 2013-11-26 09:24
I think you perhaps are right,

but it is also possibly arguable that

I don't think ATO would go down that path, George would easily argue that the right given away is only the gain he had made on the sales.