1 Did the initial Court orders result in a capital gains tax (CGT) event occurring in respect of the Bankrupt's interest in connection with the Property or otherwise give rise to a new CGT asset?
No. Question 2 Is the vesting in the Trustee for the bankrupt estate of the CGT asset comprising the Bankrupt's beneficial interest in the Property ignored pursuant to section 106-30 of the Income tax Assessment Act 1997 (ITAA 1997), with the effect that any act done by the Trustee in respect of that CGT is treated as having been done by the Bankrupt? Answer Yes. Question 3 Did the vesting of the Property in trustees for the sale of the Property (the Statutory Trustees) under the Court orders result in CGT A1 happening to the Bankrupt's beneficial interest in the Property as vested in the Trustee for the bankrupt estate under the Bankruptcy Act 1966 ? Answer Yes. Question 4 Are the capital proceeds from CGT event A1 happening to the Bankrupt's beneficial interest in the Property, as vested in the Trustee for the bankrupt estate, limited to the $X received by the Official Trustee? Answer Yes. Question 5 Is the Trustee entitled to make the absence choice in section 118-145 of the ITAA 1997 in respect of the Property on behalf of the Bankrupt? Answer Yes. Question 6
If the Bankrupt did not treat any other dwelling as their main residence from when they ceased living in the property until the Property vested in the Statutory Trustees, does a full main residence exemption apply in respect to the Bankrupt's interest in the Property, as vested in the Trustee for the bankrupt estate, so any capital gain or loss on the disposal of the property is disregarded? Answer Yes. Question 7 If the absence choice in section 118-145 does not apply, is the Trustee for the bankrupt estate liable under Division 6 of the ITAA 1936 to pay tax on any capital gain in relation to the disposal of the Property (despite section 106-30 of the ITAA 1997) or as ordinary income? Answer No. Question 8 If the absence choice in section 118-145 of the ITAA 1997 does not apply, did the Trustee for the bankrupt estate derive any income or any profits or gains of a capital nature in their representative capacity for the purposes of section 254 of the Income Tax Assessment Act 1936 (ITAA 1936) in relation to the disposal of the Property? Answer No. This ruling applies for the following period : Year ended 30 June 20XX The scheme commenced on: 1 July 20XX
Individual A and their spouse (spouse) moved into a dwelling (the Property) and occupied it is their main residence. The Property was owned by Individual B. Individual A and the spouse subsequently separated, and Individual A ceased living in the Property. Individual A subsequently became bankrupt (the Bankrupt). The spouse subsequently instituted proceedings in the Family Court of Australia (the Family Court) seeking a property settlement order against the Bankrupt pursuant to section 79 of the Family Law Act 1975 . The Family Court subsequently found that: • arrangements were entered into between Individual B and the Bankrupt with the intent that the Bankrupt would become the beneficial owner of the Property and it would be the matrimonial home in which the Bankrupt and spouse would reside • the Bankrupt paid various amounts totalling $X to Individual B in relation to the Property • Individual B was declared to hold X% of the beneficial interest in the Property in trust for the Bankrupt.
The Federal Circuit and Family Court of Australia (Division 1) subsequently ordered that the Property vest in trustees for the sale of the Property (the Statutory Trustees). The legal title to the Property was subsequently transferred to the Statutory Trustees. The Property was disposed of by the Statutory Trustees to a purchaser. The Federal Circuit and Family Court of Australia (Division 1) subsequently ordered that, pursuant to section 79 of the Family Law Act 1975 , $X be paid to the Trustee for the bankrupt estate with the balance to be paid to the spouse. The Trustee for the bankrupt estate made the CGT main residence absence choice, available in section 118-145 of the ITAA 1997, in respect to the Bankrupt's interest in the Property.
Income Tax Assessment Act 1936 Division 6 Income Tax Assessment Act 1936 section 254 Income tax Assessment Act 1997 section 104-10 Income tax Assessment Act 1997 section 106-30 Income tax Assessment Act 1997 section 108-5 Income tax Assessment Act 1997 section 110-25 Income tax Assessment Act 1997 section 112-20 Income tax Assessment Act 1997 section 118-110 Income tax Assessment Act 1997 section 118-145
Question 1 Did the initial Court orders result in a CGT event occurring in respect of the Bankrupt's interest in connection with the Property or otherwise give rise to a new CGT asset? Answer No. Reasoning It is considered that the effect of the Court orders was to recognise and formalise the existing beneficial interest the Bankrupt held in the Property which was determined to be X%. This beneficial interest is a CGT asset for the purposes of section 108-5 of the ITAA 1997. Therefore, the Court orders did not result in a CGT event occurring or give rise to a new CGT asset. Question 2 Is the vesting in the Trustee for the bankrupt estate of the CGT asset comprising the Bankrupt's beneficial interest in the Property ignored pursuant to section 106-30 of the ITAA 1997, with the effect that any act done by the Trustee in respect of that CGT is treated as having been done by the Bankrupt? Answer Yes. Reasoning Subsection 58(1) of the Bankruptcy Act 1966 (Bankruptcy Act) provides that where a debtor becomes bankrupt:
(a) the property of the bankrupt, not being after-acquired property, vests forthwith in the Trustee or, if, at the time when the debtor becomes a bankrupt, a registered trustee becomes the trustee of the estate of the bankrupt by virtue of section 156A, in that registered trustee; and (b) after-acquired property of the bankrupt vests, as soon as it is acquired by, or devolves on, the bankrupt, in the Trustee or, if a registered trustee is the trustee of the estate of the bankrupt, in that registered trustee. Subsection 106-30(1) of the ITAA 1997 provides that for the purposes of the capital gains tax provisions, the vesting of an individual's CGT assets in the trustee under the Bankruptcy Act is ignored. Further, subsection 106-30(2) of the ITAA 1997 provides that the CGT provisions apply to an act done in relation to a CGT asset of an individual in the following circumstances as if the act had been done by the individual (instead of by the trustee): (a) as a result of bankruptcy by the Trustee in Bankruptcy or a registered trustee, or the holder of a similar office under a foreign law;
(b) by a trustee under a personal insolvency agreement made under Pt X of the Bankruptcy Act, or under a similar instrument under a foreign law; (c) by a trustee as a result of an arrangement with creditors under the Bankruptcy Act or a foreign law. For example, a CGT asset of an individual vests in a trustee because of the bankruptcy of the individual. No CGT event happens as a result of the vesting. The trustee later sells the CGT asset. Any capital gain or loss is made by the individual, not the trustee. Analysis In this case, the individual became bankrupt and: • the X% interest of the Bankrupt in the Property is taken to have vested in the Trustee for the bankrupt estate as a CGT asset of the Bankrupt under subsection 58(1) of the Bankruptcy Act, and • no CGT event happened on the date of vesting in the Trustee as per subsection 106-30(1) of the ITAA 1997. Question 3 Did the vesting of the Property in trustees for the sale of the Property (the Statutory Trustees) under the Court orders result in CGT A1 happening to the Bankrupt's beneficial interest in the Property as vested in the Trustee for the bankrupt estate under the Bankruptcy Act 1966
? Answer Yes. Reasoning Conveyancing Act 1919 (NSW) Section 66G of the Conveyancing Act 1919 (NSW)deals with Statutory trusts for sale or partition of property held in co-ownership. Relevantly in this case: (1) Where any property (other than chattels) is held in co-ownership the court may, on the application of any one or more of the co-owners, appoint trustees of the property and vest the same in such trustees, subject to incumbrances affecting the entirety, but free from incumbrances affecting any undivided shares, to be held by them on the statutory trust for sale or on the statutory trust for partition. (2) Where the entirety of the property is vested in trustees or personal representatives, those trustees or personal representatives shall, unless the court otherwise determines, be appointed trustees on either of such statutory trusts, but subject, in the case of personal representatives, to their rights and powers for the purposes of administration. ............. (7) Where property becomes subject to such statutory trust for sale--
(a) in the case of joint tenancy, a sale under the trust shall not of itself effect a severance of that tenancy, (b) in any case land shall be deemed to be converted upon the appointment of trustees for sale unless the court otherwise directs. Vesting of Property in Statutory Trustees ATO ID 2009/129 Capital gains tax: land vested in a statutory trustee for sale, CGT event A1 or CGT event E1? provides guidance in respect to the situation where a court appoints statutory trustees for the sale of co-owned property and the relevant state conveyancing act specifies that the property is 'converted' on appointment. The ATO ID explains that on the making of the court order, the whole of the co-owners' interests in the property vest in the trustees for the sale of the property, and the co-owners' interests are converted into personalty, that is, into a right to compel due performance of the trust and to share in the proceeds of sale in accordance with their interests.
In the above circumstances, it is considered that the making of the court order effects a disposal of the property from the co-owners to the trustees for sale by operation of law. Therefore, CGT disposal event A1 in section 104-10 of the ITAA 1997 will happen in these circumstances. Analysis In this case, the Federal Circuit and Family Court of Australia ordered that the Property vest in trustees for the sale of the Property (the Statutory Trustees). In respect to subsection 66G(7) of the Conveyancing Act 1919 (NSW), it is accepted that the Court orders did not direct that the Property would not be deemed to be converted on appointment of the trustees for sale. Therefore, CGT event A1 in section 104-10 of the ITAA 1997 happened to the Bankrupt's ownership interest in the Property, as vested in the Trustee for the bankrupt estate, on the making of the Court order. Further, subsection 106-30(2) of the ITAA 1997 applies so that the CGT provisions apply to an act done by the Trustee for the bankrupt estate in relation to a CGT asset of the Bankrupt as if the act had been done by the Bankrupt instead of by the Trustee. Question 4
Are the capital proceeds from CGT event A1 happening to the Bankrupt's beneficial interest in the Property, as vested in the Trustee for the bankrupt estate, limited to $X received by the Trustee? Answer Yes. Reasoning Interaction between the Bankruptcy Act 1966 and the Family Law Act 1975 Bankruptcy Act 1966 Section 59A of the Bankruptcy Act provides that the general vesting rules in sections 58 and 59 of that Act have effect subject to an order under Part VIII (concerning property interests and spousal maintenance) of the Family Law Act 1975 (Family Law Act). Subsection 116(1) of the Bankruptcy Act provides that all property that belonged to, or was vested in, a bankrupt at the commencement of the bankruptcy, or has been acquired or is acquired by him or her, or has devolved or devolves on him or her, after the commencement of the bankruptcy and before his or her discharge is property divisible amongst the creditors of the bankrupt.
However, paragraph 116(2)(q) of the Bankruptcy Act provides that where a trustee is required to transfer property under Part VIII of the Family Law Act to the spouse or former spouse of the bankrupt, such property is not divisible amongst the bankrupt's creditors. Family Law Act 1975 Section 79 in Part VIII of the Family Law Act confers powers on the court to make such orders as it considers appropriate with respect to, among other things, vested bankruptcy property. The effect of that provision is that the Court can make orders that property vested in a trustee in bankruptcy be transferred or otherwise dealt with as part of property settlement proceedings. Specifically: (1) In property settlement proceedings, the court may make such order as it considers appropriate: (a) in the case of proceedings with respect to the property of the parties to the marriage or either of them - altering the interests of the parties to the marriage in the property; or
(b) in the case of proceedings with respect to the vested bankruptcy property in relation to a bankrupt party to the marriage - altering the interests of the bankruptcy trustee in the vested bankruptcy property; including: (c) an order for a settlement of property in substitution for any interest in the property; and (d) an order requiring: (i) either or both of the parties to the marriage; or (ii) the relevant bankruptcy trustee (if any); to make, for the benefit of either or both of the parties to the marriage or a child of the marriage, such settlement or transfer of property as the court determines. It is noted that an order made under Part VIII of the Family Law Act overrides the vesting provisions of the Bankruptcy Act, regardless of whether the Part VIII order was made before or after the debtor became bankrupt (see for example Oliver v Malanos (2011) 199 FCR 136 ( Oliver v Malanos ), Rahman v Rahman [2020] FamCAFC 279).
It is also noted that a court order made under section 79 of the Family Law Act in respect of settling property between husband and wife, including a requirement that there be a transfer of one party's interest to the other, has generally been regarded by the courts as vesting in the transferee an equitable estate or interest in the property. An interest in property is a right of a proprietary nature, not a mere personal right. In examining these issues, the court in Oliver v Malanos [at 48 to 59] referred to Craven v The Official Trustee in Bankruptcy (unreported, Supreme Court, NSW, Needham AJ, 26 July 1991) ( Craven ), Official Trustee in Bankruptcy v Mateo (2003) 127 FCR 217 ( Mateo ) in which the Full Court cited Craven with approval, and Jones v Daniel (2004) 141 FCR 148 in which the Full Court analysed Mateo . In Craven, the Family Court made orders under subsection 79(1) of the Family Law Act concerning the jointly owned property of a husband and wife. The order stated that upon completion of the sale of the matrimonial home, the net proceeds of sale would be paid to the wife. Needham AJ in Craven relied on the principle referred to by Beaumont J at 112 in
Sonenco (No 77) Pty Ltd v Silvia (1989) 24 FCR 105 that 'the trustee in bankruptcy takes the property of the bankrupt subject to "equities"...' . Needham AJ also relied upon the High Court's decision in Mullane v Mullane (1983) 158 CLR 436 in which the majority of the High Court stated at 445: In our opinion, therefore, s 79 on its proper construction refers only to orders which work an alteration of the legal or equitable interests in the property of the parties or either of them. An interest in property is a right of a proprietary nature, not a mere personal right. Needham AJ concluded that the wife was entitled to the whole of the proceeds of the house and found that the consent orders ' created an equitable interest in the land which could be enforced just as a contract of sale could be enforced' ( Oliver v Malanos [48 to 51]). Merkel J in Mateo also approved the findings in Craven at [130] and cited Harris v Walker at [128], stating:
... a court order settling property between husband and wife, including a requirement that there be a transfer of one party's interest to the other, has generally been regarded as vesting in the transferee an equitable estate or interest in the property pending the transfer of the legal estate or interest. Merkel J found that despite an agreement giving rise to the orders of the Family Court, a transfer of an equitable interest was not effected pursuant to the agreement between the parties, rather its force stems from the order itself. Merkel J relied upon the observations of Lord Diplock in De Lasala v De Lasala [1980] AC 546 at 560 in support of such proposition in which Lord Diplock said: ...once they have been made the subject of the court order no longer depend upon the agreement of the parties as the source from which their legal effect is derived. Their legal effect is derived from the court order ( Oliver v Malanos [56-57]). Analysis In this case, as stated above:
• on the making of the Court order which vested the property in the Statutory Trustees, CGT event A1 happened to the ownership interest of the Bankrupt, as vested in the Trustee for the bankrupt estate, and • on the vesting of the property in the Statutory Trustees, the Bankrupt's interests were converted into personalty, that is, into a right to compel due performance of the trust and to share in the proceeds of sale in accordance with their interests. In respect to CGT event A1 happening on the vesting of property in a Trustee for sale and the receipt of capital proceeds, ATO ID 2009/129 states: A capital gain will be made as a result of CGT event A1 happening if the capital proceeds from the event are more than the asset's cost base. The capital proceeds for the event are the total of the money you receive or are entitled to receive in respect of the event happening and the market value of any other property you receive or are entitled to receive in respect of the event happening (refer to subsection 116-20(1) of the ITAA 1997). On the making of the court order, each co-owner's interest in realty is converted to personalty.
It is expected that the market value of this property will equate to the share of net proceeds received. [emphasis added] From the above, the capital proceeds for an A1 event happening to the ownership interest of an individual at the time of vesting in a Trustee for sale is expected to be the share of net proceeds subsequently received from the sale of the property. In this case, the court orders made under section 79 of the Family Law Act varied the respective ownership interests in the property so that a portion of the ownership interest in the Property vested in the spouse, as per Oliver v Malanos . This meant that the Trustee of the bankrupt estate had no rights in respect of the spouses' interest and no part of that interest could be divisible amongst the bankrupt's creditors. Accordingly, the spouse of the Bankrupt was entitled to receive all but $X of the net proceeds from the disposal of the Bankrupt's ownership interest in the property. Therefore, the Trustee for the bankrupt estate was only entitled to receive $X in respect to the bankrupt estate as vested in the Trustee. Question 5
Is the Trustee for the bankrupt estate entitled to make the absence choice in section 118-145 of the ITAA 1997 in respect of the Property on behalf of the Bankrupt? Answer Yes. Reasoning Section 118-145 of the ITAA 1997 provides that if a dwelling that was your main residence ceases to be your main residence, you may choose to continue to treat it as your main residence. As previously stated, subsection 106-30(2) of the ITAA 1997 treats acts done by the bankruptcy trustee as acts of the individual for CGT purposes. In that respect, the Commissioner is of the view that if a trustee in bankruptcy sells the bankrupt's principal residence, and the other relevant criteria are satisfied, the trustee may claim the main residence exemption. Therefore, in this case, the Trustee for the bankrupt estate is entitled to make the absence choice in section 118-145 of the ITAA 1997 in respect of the Property on behalf of the Bankrupt if the Trustee considers the relevant criteria is met by the Bankrupt. Question 6
If the Bankrupt did not treat any other dwelling as their main residence from when they ceased living in the Property until the Property vested in the Statutory Trustees, does a full main residence exemption apply in respect to the Bankrupt's interest in the Property, as vested in the Trustee for the bankrupt estate, so any capital gain or loss on the disposal of the property is disregarded? Answer Yes. Reasoning Subsection 118-110(1) of the ITAA 1997 provides that a capital gain or capital loss you make from a CGT event that happens in relation to a dwelling or your ownership interest in it is disregarded if you are an individual and the dwelling was your main residence throughout your ownership period. Section 118-145 of the ITAA 1997 provides that if a dwelling that was your main residence ceases to be your main residence, you may choose to continue to treat it as your main residence.
If you use the part of the dwelling that was your main residence for the purpose of producing assessable income, the maximum period that you can treat it as your main residence under this section while you use it for that purpose is 6 years. If you do not use the dwelling for that purpose, you can treat it as your main residence indefinitely. If you make the choice, you cannot treat any other dwelling as your main residence while you apply this section (except if section 118-140 about changing main residence applies). In this case, the full main residence exemption applies if the Bankrupt did not treat any other dwelling as their main residence from when they ceased living in the Property. Question 7 If the absence choice in section 118-145 does not apply, is the Trustee for the bankrupt estate liable under Division 6 of the ITAA 1936 to pay tax on any capital gain in relation to the disposal of the Property (despite section 106-30 of the ITAA 1997) or as ordinary income? Answer No. Reasoning Both the bankruptcy trustee and bankrupt have obligations under the tax law. The primary obligation to lodge and be assessed is on the bankrupt under section 106-30 of the ITAA 1997.
Section 254 of the ITAA 1936 imposes obligations on every trustee in respect of any income or any profits or gains of a capital nature derived by them in their representative capacity, creating a secondary tax liability for agents and trustees, ancillary to the primary tax liability. A trustee in bankruptcy is a trustee for the purposes of section 254 in accordance with the definition of 'trustee' in subsection 6(1) of the ITAA 1936. Consequently, in this case, although the Trustee for the bankrupt estate is a 'trustee' as defined in subsection 6(1) of the ITAA 1936, the Trustee does not have a primary obligation to lodge and is therefore not liable to tax under Division 6 of the ITAA 1936; nor is the Trustee for the bankrupt estate liable to tax under the ordinary income rules. Instead, section 254 of the ITAA 1936 creates a secondary tax liability for the Trustee for the bankrupt estate, ancillary to the primary tax liability, should the Trustee derive income or any profits or gains of a capital nature in its representative capacity. Question 8
If the absence choice in section 118-145 of the ITAA 1997 does not apply, did the Trustee for the bankrupt estate derive any income or any profits or gains of a capital nature in their representative capacity for the purposes of section 254 of the ITAA 1936 in relation to the disposal of the Property? Answer No. Reasoning Section 254 of the ITAA 1936 imposes obligations on every trustee in respect of any income or any profits or gains of a capital nature derived by them in their representative capacity, creating a secondary tax liability for agents and trustees, ancillary to the primary tax liability. A trustee in bankruptcy is a trustee for the purposes of section 254 in accordance with the definition of 'trustee' in subsection 6(1) of the ITAA 1936. Cost base The first element of the cost base and reduced cost base of a CGT asset is the sum of any money and the market value of any property given to acquire it (subsection 110-25(2) of the ITAA 1997). Subsection 112-20(1) of the ITAA 1997 provides that the first element of the cost base and reduced cost base of a CGT asset you acquire from another entity is its market value at the time it was acquired if:
(a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from: (i) CGT event D1 happening; or (j) (ii) another entity doing something that did not constitute a CGT event happening; or (b) some or all of the expenditure you incurred to acquire it cannot be valued; or (c) you did not deal at arm's length with the other entity in connection with the acquisition. Subsection 112-20(2) states that despite paragraph (1)(c), if: a) you did not deal at arm's length with the other entity; and b) your acquisition of the CGT asset resulted from another entity doing something that did not constitute a CGT event happening; the market value is substituted only if what you paid to acquire the CGT asset was more than its market value (at the time of acquisition). CGT event E1 happens if a trust over a CGT asset is created by declaration or settlement (section 104-55 of the ITAA 1997). In Kafataris v DFC of T
(2015) ATC 20-523, the Federal Court said that the word 'declaration' in subsection 104-55(1) takes its ordinary meaning and a trust is created by 'declaration' when it is created by the holder of an undivided legal interest in property using words or actions which sufficiently evidence an intention to create a trust over that property. The word 'settlement' also takes its ordinary meaning, and this meaning was considered by the Full Federal Court in Taras Nominees Pty Ltd v FC of T (2015) ATC 20-483. The court said that a key indicator of a 'settlement' was the vesting of property in a trustee for the benefit of others. Analysis In this case, a capital gain or loss is required to be calculated in the hands of the Bankrupt who has the primary liability to tax under section 106-30 of the ITAA 1997. As stated above, capital proceeds of $X were received by the Trustee for the bankrupt estate in respect to the CGT A1 event. As per the Court order, the Bankrupt was deemed to have acquired a beneficial interest of X% in the Property which was purchased for $X.
We note that the market value of the X% interest in the Property when purchased was $X and the Bankrupt was taken by the Court to have paid $X in respect to the Property. In applying the market value substitution rule in section 112-20 of the ITAA 1997, it is considered that the Bankrupt did not deal at arm's length with Individual B in connection with the acquisition of the beneficial interest. Furthermore, CGT event E1 would have been expected to happen to Individual B when the trust was created, so subsection 112-20(2) does not apply. Therefore, the first element of the cost base and reduced cost base of the Bankrupt's beneficial interest in the Property is its market value of $X at the time of acquisition. It is also noted that the Bankrupt would be entitled to include other amounts of expenditure in the other elements of the cost base where appropriate. Consequently, it is evident that the Bankrupt made a capital loss from CGT event A1 happening to the ownership interest in the Property.
Therefore, the Trustee for the bankrupt estate did not derive any income or profits or gains of a capital nature in their representative capacity for the purposes of section 254 of the ITAA 1936.