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In the case of delayed property settlements that are on capital
account and subject to Capital Gains Tax, these taxpayers should be
aware of taxation consequences for delayed settlements as well as
how these issues may be circumvented. The payment of CGT tax may
arise well before the receipt of sale proceeds at settlement.
Our Taxation team have frequently given advice on the taxation
consequences in delayed property settlements and have successfully
enabled clients to delay their taxation responsibilities until the
settlement proceeds are available. As such, this article will
discuss:
- The ATO’s treatment of delayed property settlements in the
context of CGT Event A1 as well as the issues that arise; and - How interest may be remitted from the above when the settlement
of the property has been delayed months or even years after the
initial contract of sale has been executed.
ATO’s Treatment of Delayed Property Settlements
During the sale of a property, there are two notable events; the
execution of the contract where both parties agree to the sale, and
the settlement date where the property is transferred to the buyer.
The completion of the contract usually takes place at the time of
settlement where the purchaser hands over the monies over to the
vendor and title is transferred from the vendor to the
purchaser.
Ordinarily CGT event A1 applies to when the CGT asset, the
property, is disposed of, this would be during the contract date.
Section 104.10(3) Income Tax Assessment Act 1997 states that the
time of the event is when “you enter into the contract for the
disposal”. Therefore, the CGT event occurs when you enter into
the contract of sale. Due to this, the capital gain made from the
property must ordinarily be included in the income year in which
the contract has been entered into. For example, if a contract for
the sale of land is entered into on 31 May 2023 and settled on 31
July 2027, CGT will be assessed on the year ending 30 June
2023.
However because the proceeds received by the taxpayer
for the sale often occurs after the contract is signed, often over
a period of several years, the vendor would not have received the
capital proceeds to pay tax related to the sale of the
property. This is especially concerning when the vendor
has invested significant capital into the development of the
property meaning they would have little to no funds to pay the
capital gains tax that arises when they enter into the
contract.
Another issue is that per section 5.15 of the Income Tax
Assessment Act 1997, interests accrues on the unpaid CGT daily for
the unpaid amount. This is a significant expense
especially when the settlement date has been delayed for months or
years at a time. As a reminder, the current General Interest Charge
rates are 10.46% annually or 0.0287% if calculated daily.
It seems that the vendor has two options here:
- Pay off the CGT during the income year when the contract of
sale is entered into and prior to being paid for the transfer of
the property; or - Wait until the capital proceeds arrive on settlement day and
pay the additional interest (GIC) that accrues for failing to pay
CGT in the previous income years.
How this issue may be avoided and interest remitted
entirely
A method to circumvent this issue is not found in legislation
but rather the taxation determinations and rulings provided by the
ATO. It should be noted that although these rulings and
determinations include references to provisions that have been
replaced or repealed, they are still binding on the ATO.
Taxation Determination 94/89 acknowledges that a taxpayer is not
required to include any capital gains in the appropriate year, when
they enter into the contract, until an actual change of ownership
occurs. Further, when settlement occurs, the taxpayer is then
required to include any capital gains in the year of income in
which the contract was made.
What this means is that if a contract of sale of land is entered
into on 31 May 2023 and settled on 31 July 2027, the CGT event does
not need to be declared on the year ending 30 June 2023 but rather
the vendor/taxpayer can amend their returns for that income year
following the settlement on 31 July 2027. Resultantly, the taxpayer
would not need to pay CGT during the income year when they entered
into the contract and the capital proceeds have not been paid.
Despite this, interest still accrues under the former section
170AA(1). Taxation Ruling 94/29 states that the discretion under
former section 170AA(11) would be exercised to remit interest in
full where requests for amendment are lodged, and where relevant,
self-amendments are made within a reasonable time after the date of
settlement.
Usually, the ATO considers that a period of one month following
settlement to be a reasonable time after settlement. No specific
guidance has been provided to indicate what else a reasonable time
is if the vendor is experiencing fails to amend their returns
within the one month period. However, our opinion is that this will
be assessed on a case-by-case basis of each taxpayer’s
individual circumstances if they fail to meet that one month
timeline following settlement and reference may be had to PSLA
2006/8. As such, it would be appropriate for vendors/taxpayers to
amend their returns as soon as possible following settlement to
avoid paying any interest that accrues as a result of the delayed
sale of property.
Takeaway
- When selling properties where the execution of contract of sale
and settlement date are months or years apart, vendors may wait
until after settlement date to report a CGT event for entering into
the contract; and - Vendors should however amend their returns to include the CGT
event as soon as possible after settlement to avoid paying sizeable
interest for the sale One month after settlement is the period
allowed by the ATO.
Where the one month rule is not met, then consideration needs to
be made for an application for remission to the ATO under PSLA
2006/8.
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.
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