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.
Should you wish to discuss the above, please contact Anthony Pointon of our Taxation Team.
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