28 October 2013 Mr Dean Karlovic Large Business and International Australian Taxation Office GPO Box 9977 MELBOURNE VIC 3001 Dear Mr Karlovic Clarification as to the application of TR 2002/14 in certain circumstances The Retirement Living Council (RLC), a division of the Property Council of Australia, is the peak industry body for retirement village operators in Australia. The RLC represents over 800 village and associate members nationally, including both commercial and not-forprofit village operators. Taxation Ruling 2002/14 (TR 2002/14) provides guidance on the taxation of retirement village operators. This letter seeks clarification, by way of binding guidance, on the application of a certain aspect of the ruling. Specifically, TR 2002/14 confirms that section 118-20 ITAA97 (the anti-overlap rule ) applies to ensure that village operators will not be subject to double taxation where they sell a village that was taxed in accordance with TR 94/24. However, there is the potential for double taxation of the same economic gain where village operators sell shares in a company which owns a retirement village, and such a sale results in the company leaving an income tax consolidated group. These sales are common in the retirement village industry. The uncertainty arises because a sale of a village gives rise to CGT event A1, while a sale of shares that results in the deconsolidation of a subsidiary gives rise to CGT event L5. TR 2002/14 deals with asset sales but is silent on CGT event L5. This problem can be easily fixed. We request the Commissioner issue binding guidance confirming that: double taxation will not occur; and paragraph 73 of TR 2002/14 extends to the sale of shares in a company that gives rise to CGT event L5. The binding guidance may be in the form of a clarifying amendment to TR 2002/14 or a new tax ruling dealing expressly with the issue. The Retirement Living Council acknowledges the continued support of our Corporate Partners
The attached Appendix details these issues further. All statutory references in this letter are to the Income Tax Assessment Act 1997 (ITAA97) unless otherwise stated. If you have any queries about this letter, please contact Ms Leida Pirts, Senior Policy Manager, on (07) 3225 3007. We would welcome the opportunity to meet with yourself and relevant officers to discuss the issue and possible solutions further. Yours sincerely Mary Wood Executive Director Retirement Living Council 2
APPENDIX 1. Outline of TR 2002/14 TR 2002/14 replaced Taxation Ruling 94/24 (TR 94/24) which provided guidance on taxation amounts received by retirement village owners from incoming residents. TR 94/24 was withdrawn on 19 April 2000 but has some continued application in certain circumstances. As outlined below, where a village operator has operated, or continues to operate retirement villages in accordance with TR 94/24, paragraphs 72 and 73 of TR 2002/14 state in respect of the subsequent sale of such a TR 94/24 village: 72. When a retirement village owner who has claimed the development costs of a village in accordance with Taxation Ruling TR 94/24, sells that village, the sale proceeds are assessable under section 6-5: see paragraph 11 of TR 94/24. The sale of the village is also a CGT event. In calculating a capital gain, the vendor must include an amount in the capital proceeds to take into account liabilities assumed by the purchaser of the village. 73. However, any capital gain is reduced in accordance with section 118-20 to the extent the amount is included in assessable income. To avoid double taxation, it is accepted that the inclusion of the gain on the granting of the initial leases under Taxation Ruling TR 94/24 and the gain included under the CGT provisions upon sale of the retirement village arise from the same event for the purposes of section 118-20... [emphasis added]. In other words, if section 118-20 did not apply as per paragraph 73, there is a potential for double taxation of the same economic gain. Hence paragraph 73 of TR 2002/14 sets out the ATO s interpretation, with which we agree, that the capital proceeds from the sale of the retirement village should be reduced under section 118-20 to ensure the same economic gain is not taxed twice. We have set out an example below to illustrate this. A Co acquired land pre 19 April 2000 and total development expenditure of $34.9m was allowed as a deduction under TR 94/24. Subsequently, A Co derived assessable income [of $46.5m] upon receipt of Ingoing Contributions in accordance with TR 94/24 and/or TR 2002/14. Upon sale of the village assets, A Co received $5.1m in proceeds which represents the net value of the investment property in A Co s accounts. Therefore, the economic benefit derived by A Co from the development is: 3
Taxable Income $(million) Development Costs (34.9) Ingoing Contributions from residents 46.5 Sale Proceeds 5.1 Net Economic Benefit 16.7 A Co is assessable on the $5.1m sale proceeds on revenue account in accordance with TR 94/24. As stated in paragraph 72 of TR 2002/14 a CGT event also occurs in respect of the sale and, for CGT purposes, the sale proceeds are grossed up to include the liabilities assumed by the purchaser, being the resident liabilities (i.e. the Ingoing Contributions). Therefore, absent section 118-20 applying to reduce the capital gain in respect of assessable ingoing resident contributions, the net taxable income position of the development lifecycle would be: Taxable Income $(million) Development Profit (Development Costs 11.6 Ingoing Contributions) Sale of Village sale proceeds assessable on 5.1 revenue account per TR 94/24 and TR 2002/14 transitional provisions Sale of Village CGT event Sale Proceeds 5.1 Gross-up Resident Liabilities 46.5 Minus cost base (none for TR 94/24) 0 Section 118-20 reduces capital gain by sale proceeds taxable on revenue account (5.1) 46.5 Net Taxable Income 63.2 That is, if section 118-20 did not apply to reduce the capital gain as described in paragraph 73 of TR 2002/14, the income tax payable by A Co over the life cycle of the development of this retirement village would be $18.96m [being the net taxable income of $63.2m x the tax rate of 30%], which exceeds the economic benefit of the development. As set out in paragraph 73, however, section 118-20 further reduces the capital gain to the extent that the resident s Ingoing Contribution was assessable to A Co on receipt of the Ingoing Contributions. 4
Applied to the above example, section 118-20 further reduces the capital gain to nil and the taxable income of A Co to $16.7m (which is the same as the economic benefit), as follows: Taxable Income $(million) Development Profit (Development Costs 11.6 Ingoing Contributions) Sale of Village sale proceeds assessable on 5.1 revenue account per TR 94/24 and TR 2002/14 transitional provisions Sale of Village CGT event Sale Proceeds 5.1 Gross-up Resident Liabilities 46.5 Minus cost base (none for TR 94/24) 0 Section 118-20 reduces capital gain by sale proceeds and Ingoing Contributions taxable on revenue account (51.6) 0 Net Taxable Income 16.7 Thus, para 73 ensures that the Net Taxable Income is equal to the economic benefit arising to the vendor taxpayer. 2. Deemed capital gains (CGT event L5) Due to the timing of the preparation and finalisation of TR 2002/14, the ruling does not cover any specific interaction with the income tax consolidation rules in Part 3-90 of the ITAA 1997. Specifically, paragraph 73 is expressed in terms of asset sales only and is unclear as to whether the interpretation set out in it extends to the sale of a subsidiary member of an income tax consolidated group. As illustrated below, in this case, the relevant capital gain is created through CGT event L5, not CGT event A1. Consider that A Co is a subsidiary member of an income tax consolidated group of which B Co is the head entity, and A Co has no activity other than the retirement village. B Co sells the shares in A Co for the same amount, $5.1m. Exit ACA calculation A Co Carrying Terminating TR 94/24 Step 1 Terminating Value of Assets Cash at Bank (assume dividend paid pre-sale) $0m $0m Investment Property $51.6m $0m $51.6m $0m Step 2 Value of Deductions Inherited - 5
Step 3 Liabilities Owed by Members of Old Group - (Assume none/all forgiven prior to leaving time) Step 4 Liabilities of the Leaving Entity Resident Loans ($46.5m) ($46.5m) Net ACA of Leaving Entity / (Deemed L5 Gain) ($46.5m) Sale Proceeds $5.1m Net Taxable Income Development Profit (Development Costs Ingoing 11.6m Contributions) CGT event L5 capital gain 46.5m Sale of Shares CGT event A1 capital gain (sale proceeds nil cost base as exit ACA is negative) 5.1m 63.2m Similar to the example above, the B Co income tax consolidated group will have a net taxable income that is far in excess of the net economic benefit of the development. However, should s 118-20 apply to reduce the CGT event L5 and A1 capital gains by the amount of the ingoing contributions received from initial residents of the retirement village, the net taxable income equals the net economic benefit: Exit ACA calculation A Co Carrying Terminating TR 94/24 Step 1 Terminating Value of Assets Cash at Bank (assume dividend paid pre-sale) $0m $0m Investment Property $51.6m $0m $51.6m $0m Step 2 Value of Deductions Inherited - Step 3 Liabilities Owed by Members of Old Group - (Assume none/all forgiven prior to leaving time) Step 4 Liabilities of the Leaving Entity Resident Loans ($46.5m) ($46.5m) Net ACA of Leaving Entity / (Deemed L5 Gain) ($46.5m) Sale Proceeds $5.1m Net Taxable Income Development Profit (Development Costs Ingoing 11.6m Contributions) CGT event L5 capital gain 46.5m Sale of Shares CGT event A1 capital gain (sale proceeds nil cost base as exit ACA is negative) 5.1m 63.2m Section 118-20 reduction Net Taxable Income (CGT events L5 and A1, after s 118-20) (46.5m) $16.7m As the above example illustrates, if the Commissioner takes the view that section 118-20 does not also apply to reduce the CGT event L5 capital gain by the otherwise assessed 6
Ingoing Contributions, this will effectively preclude a share sale of transitional retirement village operators which had historically applied TR 94/24 to the development of a village. This appears to be contrary to the objects and purpose of Part 3-90 and to the efficient administration of the tax law. This inconsistency is removed where the Commissioner takes the view that section 118-20 does apply to reduce the CGT event L5 capital gain. * * * * On the basis of the above, we request the Commissioner confirm in a binding manner that section 118-20 should apply to reduce CGT event L5 in the same manner as it reduces the capital proceeds from an asset sale. 7