CGT - Call Option Deed

1 Will CGT event D2 under section 104-40 of the Income Tax Assessment Act 1997 (ITAA 1997) happen to Person A when they grant the Call Option to Person B or Company A as trustee for Person B's Trust (B's Trust) under the terms of the Call Option Deed?

1 Yes. Question 2 For the purposes of subsection 104-40(3) of the ITAA 1997, will the market value substitution rule under subsection 116-30(2) of the ITAA 1997 apply to determine the capital proceeds received by Person A from the grant of the Call Option to Person B or B's Trust? Answer 2 No. Question 3 Will any capital gain or capital loss made by Person C on their death in respect of their life interest in the Life Estate Land be disregarded pursuant to section 128-10 of the ITAA 1997? Answer 3 Yes. Question 4 Will a CGT event under Division 104 of the ITAA 1997 happen to Person A, Person B or the Trustee for the Estate of Person D either on Person C's death or on the transfer of the legal interest in the Life Estate Land to Person A and Person B? Answer 4 No. Question 5 If Person B or B's Trust exercises the Call Option, will the capital gain or capital loss made by Person A in respect of CGT event D2 happening on the grant of the Call Option be disregarded pursuant to subsection 104-40(5) of the ITAA 1997, and will CGT event A1 under section 104-10 of the ITAA 1997 happen to Person A in respect of their interest in the Life Estate Land? Answer 5 Yes. Question 6

Will any capital gain or capital loss made by Person B or B's Trust from exercising the Call Option be disregarded pursuant to subsection 134-1(4) of the ITAA 1997? Answer 6 Yes. Question 7 If Person B or B's Trust exercises the Call Option, will the market value substitution rule under subsection 112-20(1) of the ITAA 1997 apply to determine the first element of the cost base and reduced cost base of the interest in the Life Estate Land that is acquired from Person A? Answer 7 No. Question 8 If Person B or B's Trust exercises the Call Option, will the market value substitution rule under subparagraph 116-30(2)(b)(i) of the ITAA 1997 apply to determine the capital proceeds received by Person A from the disposal of their interest in the Life Estate Land? Answer 8 No. This ruling applies for the following periods: Income year ending 30 June 2025 and all subsequent income years until, and including, the income year in which the Call Option is exercised by Person B or B's Trust.

Person C was born in the 19XXs. Person C is the child of Person D. The family have for many generations conducted an agricultural business and the family assets and businesses are held by various individuals and entities. The assets relevant to the ruling is the Farming Land. Person D died in the 19XXs leaving their final will and testament dated DD MM YYYY (Person D's Will). Probate was granted in respect of Person D on DD MM YYYY. Pursuant to clause 3(b) of Person D's Will, Person D left part of their residuary estate to their executors to hold on trust as follows: Extract of Person D's will provided In accordance with clause 3(b) of Person D's Will, Person C and another individual, as executors of Person D's estate (Trustees), acquired the 50% legal interest in each of the properties that make up the Farming Land (Life Estate Land) to be held on trust established under Person D's Will subject to: •                     an equitable life interest in the Life Estate Land for Person C; and •                     an equitable remainder interest in the Life Estate Land for Person A and Person B (Person C's children) in equal shares.

The remaining XX% interest in each of the properties that make up the Farming Land was held by Person D's spouse (and Person C's parent), until they passed in the 20XXs. Pursuant to their last will and testament the XX% interest is now held by Person C as trustee for the Person C Testamentary Trust, a trust for Person C (as the Primary Beneficiary) and members of Person C's family which broadly includes their spouses, children and remoter issue (and their spouses), siblings, the children and remoter issue of those siblings, and the trustee of any trust in which Person C has any contingent or vested beneficial interest. Person C's succession planning In recent years, Person C has undergone a process of succession planning, with the desire that the farming business remain in the family for future generations. For many years, Person B has worked in the farming business, and in recent years has increased their involvement in part to assist Person C, but also as Person C stepped back from their involvement in the family farming business. Person A has not been involved in the farming business for some time, but has a reputable career outside the family business.

It is Person C's desire that the family assets be divided in a fair and equitable way between Person B and Person A, and in such a way as to maintain the Farming Land and farming activities in the family for future generations. Accordingly, it is Person C's desire to keep all the Farming Land (and other farming assets) with Person B, and for all non-farming assets to pass to Person A. Person C's succession planning has caused division between Person A and Person B and has resulted in a significant breakdown in the family relationship between Person A and their parent and sibling. Other than in respect of the negotiations regarding Person C's succession planning, Person A and Person B have not communicated with each other since 20XX and to the extent they have communicated in respect of Person C's succession planning, it has entirely been through Person A's lawyer. Except for the purposes of obtaining this ruling, Person A has had separate legal representation to Person C, and Person A has also taken their own independent advice.

The parties have recently reached agreement in respect of the family assets and how they should be dealt with moving forward and, in particular, on the death of Person C. This will be ultimately dealt with in a family agreement which intends, broadly, to separate the ownership and control of the non-farming assets (which will be owned and controlled by Person A or entities controlled by Person A) from the farming assets (which will be owned and controlled by Person B or entities controlled by Person B). Throughout the negotiations between the parties, the Life Estate Land has represented a particular tension point, in part because of the nature of the interest Person A holds in the Life Estate Land being subject to the life of Person C. After protracted negotiation between Person A and Person B, they have agreed to deal with the Life Estate Land in accordance with the Proposal. The Proposal Under the Proposal Person A, Person B and the Trustees will enter into a call option deed in relation to what will become Person A's interest in the Life Estate Land after Person C has died (Call Option Deed). The Call Option Deed provides:

•                     details of Call Option Deed provided. Should the Call Option be granted and/or exercised by an entity as directed by Person B, that entity will be B's Trust. The Call Option Fee has been calculated using the Black-Scholes model on the basis of the following inputs: underlying price per acre, exercise price per acre, time, risk free and volatility. The Call Option Deed provides several separate and distinct advantages for each of Person A and Person B. These include: •                     The challenges associated with Person A's interest in the Life Estate Land currently being subject to Person C's life. •                     Person B not wanting to pay full market value now for an asset they (or entities they controls) will not be able to use without entering into a lease or licence agreement with Person C until an unknown date in the future (that is, on Person C's death). •                     Both Person A and Person B's desire to ensure there is a fair and equitable split of the family's assets after Person C's death, which necessitates a dealing with the Life Estate Land either now or on the death of Person C.

Person A and Person B have each obtained separate and independent advice. In respect of Person A, that advice has been obtained through their separate legal representation. In respect of Person B, they have relied on their own knowledge of the Farming Land, their previous professional experience and old work colleagues. Person A and Person B, after obtaining independent advice, negotiated the Call Option and negotiated the Call Option Fee and the Exercise Price. The amount of the Call Option Fee and Exercise Price represent what Person A and Person B believe to be the market value of the Call Option, them having both considered, after obtaining independent advice, what they believe to be the current market value of the Life Estate Land and any future changes (including possible increases or decreases) to the value of the Life Estate Land that may arise before the Call Option can be exercised. Person A and Person B agreed to the Call Option Fee and Exercise Price after long, protracted and difficult negotiations over the many years in relation to the Life Estate Land.

In determining the Call Option Fee and the Exercise Price, Person A and Person B have also taken into account that the Call Option may only be exercised at a future inevitable, although uncertain, time, that being on or shortly after Person C's date of death. It is also informed by their understanding of the current market value of XX% of the Life Estate Land (not the market value of the remainder interest in the Life Estate Land). Accordingly, it is the amount that they each consider is a fair price.

Income Tax Assessment Act 1936 subsection 170(10AA) Income Tax Assessment Act 1997 Division 104 Income Tax Assessment Act 1997 section 104-10 Income Tax Assessment Act 1997 subsection 104-10(2) Income Tax Assessment Act 1997 subsection 104-10(3) Income Tax Assessment Act 1997 section 104-25 Income Tax Assessment Act 1997 paragraph 104-25(1)(e) Income Tax Assessment Act 1997 section 104-40 Income Tax Assessment Act 1997 subsection 104-40(1) Income Tax Assessment Act 1997 subsection 104-40(2) Income Tax Assessment Act 1997 subsection 104-40(3) Income Tax Assessment Act 1997 subsection 104-40(5) Income Tax Assessment Act 1997 section 104-75 Income Tax Assessment Act 1997 section 104-80 Income Tax Assessment Act 1997 section 104-85 Income Tax Assessment Act 1997 Subdivision 112-A Income Tax As

All subsequent legislative provisions are to the ITAA 1997, unless otherwise specified. Question 1 Summary CGT event D2 under section 104-40 will happen to Person A when they grant the Call Option to Person B or B's Trust under the terms of the Call Option Deed. Detailed reasoning Section 104-40 states: (1) CGT event D2 happens if you grant an option to an entity, or renew or extend an option you had granted. (2)           The time of the event is when you grant, renew or extend the option. (3)           You make a capital gain if the capital proceeds from the grant, renewal or extension of the option are more than the expenditure you incurred to grant, renew or extend it. You make a capital loss if those capital proceeds are less . (4)           The expenditure can include giving property: see section 103-5. However, it does not include an amount you have received as recoupment of it and that is not included in your assessable income, or an amount to the extent that you have deducted or can deduct it. Exceptions (5)           A capital gain or capital loss you make from the grant, renewal or extension of the option is disregarded if the option is exercised.

Option is not defined in the Income Tax Assessment Act. However, in FCT v Guy the Federal Court defined option as follows: [1] The word "option" itself suggests a right in one party unilaterally to require another party to enter into a new set of jural relations or to extend or continue in an existing jural relationship. Put and call options, options to purchase and options to renew leases are, perhaps, the most common illustrations. The Call Option granted by Person A to Person B or B's Trust pursuant to the Call Option Deed will be an option for the purposes section 104-40 and CGT event D2 under that section will happen to Person A at the time the Call Option is granted (subsections 104-40(1) and (2)). Any capital gain or capital loss made by Person A from the grant pursuant to subsection 104-40(3) is subject to any subsequent application of subsection 104-40(5) (see question 5 of this ruling). Question 2 Summary For the purposes of subsection 104-40(3), the market value substitution rule under subsection 116-30(2) will not apply to determine the capital proceeds received by Person A from the grant of the Call Option to Person B or B's Trust. Detailed reasoning

As a general rule, section 116-20 provides that the capital proceeds from a CGT event includes the money received, or entitled to be received, in respect of the CGT event happening. The money Person A will receive, or is entitled to receive, in respect of CGT event D2 happening will be the Call Option Fee of $X.XX in accordance with the terms of the Call Option Deed. However, there are 5 modifications to the general rule in section 116-20 that may be relevant to CGT event D2. The first modification is known as the market value substitution rule contained in section 116-30. Subsection 116-30(2) is relevant where capital proceeds are received from a CGT event and provides: (2)           The capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if: (a)           some or all of those proceeds cannot be valued; or (b)           those capital proceeds are more or less than the market value of the asset and: (i)            you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event; or

(ii)           the CGT event is CGT event C2 (about cancellation, surrender and similar endings). (The market value is worked out as at the time of the event) Relevantly, subparagraph 116-30(2)(b)(i) provides that capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if: •                     those capital proceeds are more or less than the market value of the asset; and •                     the taxpayer and the entity that acquired the asset from the taxpayer did not deal with each other at arm's length in connection with the event. Section 995-1 provides that 'in determining whether parties deal at arm's length , consider any connection between them and any other relevant circumstance.' In determining whether or not parties are dealing at arm's length with one another, McKerracher J held in Healey v FC of T [2] that the authorities established the following principles: 1.            Whether the parties dealt at arm's length is a question of fact...

2.            There is a distinction between dealing at arm's length and an arm's length relationship... Whether the parties did not deal at arm's length is not to be decided by answering whether the parties were not in an arm's length relationship. The fact that the parties are themselves not at arm's length does not mean that they have not, in respect of a particular dealing, dealt with each other at arm's length: Re Hains; Barnsdall v. Commissioner of Taxation 88 ATC 4565; (1988) 81 ALR 173 (at 177); Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4014-4015). 3.            Whether the parties dealt at arm's length involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction: Granby (at 506). 4.            At issue is whether the parties have acted separately and independently in forming their bargain: Granby (at 507); ACI Operations Pty Ltd (at [226]) (did the parties apply 'independent separate wills'); AXA Pacific Holdings Ltd

(at [105]). There should be an assessment of whether the parties dealt with each other as arm's length parties would be expected to behave so that the outcome is a matter of real bargaining: Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4015); Granby (at 506 and 507); AXA Pacific Holdings Ltd (at [105]). 5.            It is relevant to consider the nature of any relationship between the parties: Trustee for the Estate of the late AW Furse No 5 Will Trust (at 4015); Granby (at 506). 6.            If the parties are not at arm's length the inference may be drawn that they did not deal with each other at arm's length: Granby (at 506); ACI Operations Pty Ltd (at [225]). The consideration of whether there has been 'real bargaining' between the parties has received some recent consideration in the Federal Court. In particular, it has been stated by Logan J in Kilgour & Ors v FCT ( Kilgour ): [3]

... Although [the description "real bargaining"] is used in some cases, one must be careful not to substitute it for the text of the statute. It is nothing more than a turn of phrase in which the adjective "real" provides the intended elucidation. In particular, the subject is not to be approached as if an arm's length dealing can only occur if it is attended with an atmosphere of higgling, haggling and hassling which one might perhaps find in the purchase of a carpet in the Grand Bazaar. I respectfully doubt that the description "real bargaining" was ever intended to convey that understanding. One might equally say genuine offer and acceptance. The chronology offered [in the circumstances of the decision] shows there was bargaining and that bargaining was certainly not a mere façade or sham. It was "real". But it is perfectly possible for a dealing at arm's length in connection with the disposal of an asset to occur in circumstances where the only outwardly evident bargaining is an offer made to buy or sell at a particular price which is accepted without demur. That bargaining can also be "real". The definition of arm's length envisages a multi-factorial, inherently dealing specific, factual analysis in which but one factor, which may or may not be determinative, is a connection between the parties.

The phrase 'dealt with each other at arm's length' is also not to be construed as meaning for a fair price or for market price. The market value of the Call Option is likely to be an amount for which reasonable minds of expert valuers will differ because of the Call Option being subject to Person C's life interest (as well as the challenges of valuing the Life Estate Land itself, it being farming land of which the value can change based on changing farming conditions which vary year to year). However, Logan J in Kilgour also stated: [4]

In the same way ... the proof that a disposal was "fair", or at market value, is not sufficient to show that the dealing was at arm's length, so, too, is proof that a disposal was not "fair", or not at market value, is not sufficient to show that the dealing in connection with the disposal was not at arm's length. What in hindsight, and sometimes even in prospect, are advantageous or disadvantageous disposals of assets can occur between parties who have dealt with each other at arm's length. This is just a feature of business and private life in relation to the disposal of assets. A "price taker" is not necessarily a purchaser who has dealt with the vendor other than at arm's length in connection with the disposal of an asset. He may just want the asset for some reason, have the requisite means and be content to pay the price requested. Despite the familial relationship between Person A and Person B, the facts upon which this ruling is based indicate that they are dealing with each other at arm's length in connection with their entry into the Call Option Deed and the granting of the Call Option. The basis for this conclusion includes the following:

•                     Person A and Person B have their own distinct goals and aspirations. Person B wishes to continue in the farming activities of the family while Person A does not undertake farming activities and intends to continue to maintain the non-farming assets of the family after their parent's death. •                     Neither Person A nor Person B have any influence or control over each other, nor do either of them have any capacity to influence or control Person C, nor does Person C have the capacity to influence or control Person A and Person B. This is evident from the long and protracted dealings between the parties which has prevented Person C from finalising their succession planning and resulted in significant disharmony within the family. •                     Except in relation to the tax matters relating to the Life Estate Land and this private ruling application, Person A and Person B are independently represented from a legal, financial, and tax perspective.

•                     In arriving at the Call Option Fee and Exercise Price, Person A and Person B have acted in their own interests severally and independently in the negotiation process and, as necessary, sought independent advice and guidance from third parties. •                     There is no evidence that the outcome of the dealings between Person A and Person B is anything other than a matter of a real bargaining process between 2 independent parties. The granting of the Call Option and the price at which both Person A and Person B are willing to accept enables each of them to pursue their own independent goals. Subparagraph 116-30(2)(b)(i) is therefore not satisfied and the market value substitution rule will not apply (for the purposes of subsection 104-40(3)) to modify the rule under section 116-20. Accordingly, the capital proceeds received by Person A from the grant of the Call Option to Person B or B's Trust will be the amount of the Call Option Fee. Question 3 Summary Any capital gain or capital loss made by Person C on their death in respect of their life interest in the Life Estate Land will be disregarded pursuant to section 128-10. Detailed reasoning

Section 104-25 provides: (1) CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset: (a)           being redeemed or cancelled; or (b)           being released, discharged or satisfied; or (c)           expiring; or (d)           being abandoned, surrendered or forfeited; or (e)           if the asset is an option - being exercised; or (f)            if the asset is a convertible interest - being converted. (2)           The time of the event is: (a)           when you enter into the contract that results in the asset ending; or (b)           if there is no contract - when the asset ends. (3)           You make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base. Taxation Ruling TR 2006/14 [5] sets out the CGT consequences of creating life and remainder interests in property and of any subsequent dealings in those interests. In the case of an equitable life interest, TR 2006/14 (at paragraph 40) confirms that CGT event C2 happens when the measuring life for the life interest dies because the interest expires at that time.

Accordingly, on Person C's death, CGT event C2 under section 104-25 will happen to Person C in relation to their interest in the Life Estate Land. Division 128 sets out what happens when a person dies and a CGT asset they owned just before dying devolves to a legal personal representative or passes to a beneficiary in their estate. In this regard, section 128-10 provides: When you die, a capital gain or capital loss from a CGT event that results for a CGT asset you owned just before dying is disregarded. Accordingly, when Person C dies, any capital gain or capital loss they make in respect of CGT event C2 happening on the ending of their life interest in the Life Estate Land will be disregarded. Question 4 Summary A CGT event will not happen to Person A, Person B or the Trustees either on Person C's death or on the transfer of the legal interest in the Life Estate Land to Person A and Person B. Detailed reasoning The death of a person by whose life a life interest is measured may also have CGT consequences for the trustee and the remainder owner. The CGT events under Division 104 of relevance to these circumstances are:

•                     CGT event A1 under section 104-10 which happens if you dispose of a CGT asset; •                     CGT event E5 under section 104-75 which happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies) as against the trustee; •                     CGT event E6 under section 104-80 which happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's right, or part of it, to receive income from the trust; and •                     CGT event E7 under section 104-85 which happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital. As noted, CGT events E5 to E7 contain an exception which provides that the events do not happen if the trust is a trust to which Division 128 applies. The scope of this exception is explained in TR 2006/14:

202. Division 128 applies to the passing of an asset from a deceased individual's legal personal representative to a beneficiary in their estate (provided the asset was owned by the deceased individual at the time of their death). 203. Accordingly, 'a trust to which Division 128 applies' requires more than the identification of the trust as a deceased estate. The Commissioner considers that the words 'a trust to which Division 128 applies' should be interpreted as a deceased estate to the extent that it is a trust over an asset originally owned by a deceased individual and which may pass to the beneficiary in accordance with section 128-20 (that is, under the will, by intestacy and so on). 204. In the context of CGT events E5, E6 and E7 this means that the exception applies if subsection 128-15(3) applies to relieve any capital gain or capital loss that arises (or would apply in that way if there were a capital gain or capital loss) when an asset passes from the deceased's legal personal representative to a beneficiary in their estate.

205. In certain circumstances the Commissioner treats the trustee of a testamentary trust in the same way as he treats a legal personal representative in relation to the passing of an asset of the deceased to a beneficiary: PS LA 2003/12. This is relevant for the scope of the exception in CGT events E5 to E7 which deal with such a passing of an asset. Pursuant to paragraph 128-20(1)(a), a CGT asset passes to a beneficiary in your estate if the beneficiary becomes the owner of the asset and, pursuant to subsection 128-15(3), any capital gain or capital loss a legal personal representative makes if the asset passes to a beneficiary in the estate is disregarded. Person D's estate (a deceased estate) is a trust over the Life Estate Land created pursuant to the terms of Person D's Will, i.e. a testamentary trust. Where, on Person C's death, Person A and Person B's call on the Trustees to transfer the Life Estate Land to them, the asset will pass to Person A and Person B in accordance with Person D's Will (and pursuant to paragraph 128-20(1)(a)). [6]

As the trustee of a testamentary trust is treated in the same way as a legal personal representative in relation to the passing of an asset of the deceased to a beneficiary, subsection 128-15(3) will apply to release any capital gain or capital loss that arises when the Life Estate Land passes from the Trustees to Person A and Person B. As a consequence, Person A and Person B are beneficiaries of a trust to which Division 128 applies such that the exception in CGT events E5 to E7 prevents them from happening. While any capital gain or capital loss the legal personal representative would make from CGT event A1 happening would be disregarded by subsection 128-15(3), there is no provision to disregard capital gains or capital losses that the life interest or remainder owners may make in respect of the ending of their trust interest. It is nevertheless noted (at paragraph 98 of TR 2006/14) that '[i]t is improbable that the legislature would have intended that a beneficiary in a deceased estate be in a worse position than one who acquired their interest for no expenditure in an inter vivos trust.'

Paragraphs 77 and 97 of TR 2006/14 therefore state that it is not necessary to consider whether any other CGT event (including CGT event A1) has happened where CGT events E5 to E7 cannot happen because of the exception for trusts 'to which Division 128 applies'. Question 5 Summary If Person B or B's Trust exercises the Call Option: •                     the capital gain or capital loss made by Person A in respect of CGT event D2 happening on the grant of the Call Option will be disregarded pursuant to subsection 104-40(5); and •                     CGT event A1 under section 104-10 will happen to Person A in respect of their interest in the Life Estate Land. Detailed reasoning A capital gain or capital loss made from the grant of the option to an entity is disregarded if the option is exercised (subsection 104-40(5)). Accordingly, if Person B or B's Trust exercises the Call Option, any capital gain or capital loss made by Person A in respect of CGT event D2 happening on the grant of the Call Option will be disregarded. In accordance with table item 50 of subsection 170(10AA) of the Income Tax Assessment Act 1936

, Person A can request an amendment of their assessment in respect of CGT event D2 happening at any time where subsection 104-40(5) applies. For the purposes of CGT event A1, you dispose of a CGT asset if a change of ownership occurs from you to another entity (subsection 104-10(2)). If Person B or B's Trust exercises the Call Option, there will be a change in ownership in the relevant portion of the Life Estate Land from Person A to Person B or B's Trust (as applicable) and CGT event A1 under section 104-10 will happen to Person A because they will dispose of their legal interest in the Life Estate Land. The time of CGT event A1 will be when Person B or B's Trust exercises the Call Option and signs the separate sales contract or, if a sales contract is not signed, the date Person A's interest in the Life Estate Land is transferred to Person B or B's Trust (subsection 104-10(3)). Pursuant to subsection 116-65(2), Person A's capital proceeds from the disposal of their interest in the Life Estate Land will include the Call Option Fee. Question 6 Summary

Any capital gain or capital loss made by Person B or B's Trust from exercising the Call Option will be disregarded pursuant to subsection 134-1(4). Detailed reasoning At the time Person B or B's Trust exercises the Call Option, their ownership of the Call Option (an intangible asset) ends by being exercised and CGT event C2 happens in relation to the Call Option pursuant to paragraph 104-25(1)(e). However, subsection 134-1(4) states that a capital gain or capital loss the grantee makes from exercising the option is disregarded. Accordingly, if Person B or B's Trust exercises the Call Option pursuant to the Call Option Deed, any capital gain or loss made by them under section 104-25 will be disregarded. Question 7 Summary If Person B or B's Trust exercises the Call Option, the market value substitution rule under subsection 112-20(1) will not apply to determine the first element of the cost base and reduced cost base of the interest in the Life Estate Land that is acquired from Person A. Detailed reasoning

Table item 1 of subsection 134-1(1) sets out the effects of the exercise of a call option on the first element of the cost base and reduced cost base for the CGT asset acquired by the grantee of the option. It provides that the first element of the grantee's cost base and reduced cost base for the CGT asset is what the grantee paid for the option (or to renew or extend it) plus any amount the grantee paid to exercise it. Accordingly, if Person B or B's Trust exercises the Call Option to acquire Person A's legal interest in the Life Estate Land, the first element of their cost base or reduced cost base for that CGT asset is the sum of the amount paid for the Call Option on entry into the Call Option Deed and the amount paid to exercise the Call Option. The amount paid to exercise the Call Option may, however, be modified subject to the general modifications in Subdivision 112-A. The first cost base modification is known as the market value substitution rule contained in section 112-20. Subsection 112-20(1) provides: The first element of your cost base and reduced cost base of a CGT asset you acquire from another entity is its market value (at the time of acquisition) if:

(a)           you did not incur expenditure to acquire it ... (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. As concluded in relation to question 2 of this ruling, the facts upon which this ruling is based indicate that Person A and Person B are dealing with each other at arm's length in connection with their entry into the Call Option Deed and the granting of the Call Option. It follows that either Person B or B's Trust (as applicable) is dealing at arm's length with Person A in connection with their acquisition of Person A's interest in the Life Estate Land. This is so regardless of whether or not the Exercise Price paid by Person B or B's Trust is more or less than the market value of the CGT asset at the time of the exercise (see ATO ID 2009/68 [7] ). Paragraph 112-20(1)(c) is therefore not satisfied and the market value substitution rule will not apply to modify the first element of either Person B's or B's Trust's cost base and reduced cost base of the CGT asset.

Accordingly, for the purposes of table item 1 of subsection 134-1(1), the first element of their cost base or reduced cost base in the CGT asset acquired from Person A will be the amount paid to Person A on entry into the Call Option Deed (the Call Option Fee) and the amount paid to Person A to exercise the Call Option (the Exercise Price). Question 8 Summary If Person B or B's Trust exercises the Call Option, the market value substitution rule under subparagraph 116-30(2)(b)(i) will not apply to determine the capital proceeds received by Person A from the disposal of their interest in the Life Estate Land. Detailed reasoning The money Person A will receive, or is entitled to receive, in respect of CGT event A1 happening in relation to their interest in the Life Estate Land will be the money they receives, or is entitled to receive, in respect of the disposal (i.e. the Exercise Price, pursuant to section 116-20) and (as noted in relation to question 5 of this ruling) the payment they receive for granting the Call Option (i.e. the Call Option Fee, pursuant to subsection 116-65(2)).

As noted, the market value substitution rule in subparagraph 116-30(2)(b)(i) provides that capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if: •                     those capital proceeds are more or less than the market value of the asset; and •                     the taxpayer and the entity that acquired the asset from the taxpayer did not deal with each other at arm's length in connection with the event. Given the conclusion (based on the facts upon which this ruling is based) that Person A and Person B are dealing with each other at arm's length in connection with their entry into the Call Option Deed, the granting of the Call Option and the acquisition of Person A's interest in the Life Estate Land (refer questions 2 and 7 of this ruling), subparagraph 116-30(2)(b)(i) is not satisfied and the market value substitution rule will not apply to determine the capital proceeds received by Person A from the disposal of their legal interest in the Life Estate Land at the time of the disposal.

This outcome does not change in the event that the Exercise Price paid by Person B or B's Trust is more or less than the market value of that interest in the Life Estate Land at the time of the exercise (see ATO ID 2009/68). > [1] 96 ATC 4520, 4526. [2] [2012] FCA 269, [95]. [3] [2024] FCA 687, [95]. [4] [2024] FCA 687 [112]. [5] Income tax: capital gains tax: consequences of creating life and remainder interests in property and of later events affecting those interests . [6] Person A and Person B will determine the first element of their cost base or reduced cost base in respect of their respective parcel of the Life Estate Land in accordance with subsection 128-15(4). [7] Income Tax Capital Gains Tax: cost base modification of CGT asset acquired from exercise of put option .