Tax Office Position Paper – Wraps

The Tax Office is in the process of putting together a Position Paper on Wraps as they can see the very real growth in this activity in the years to come. As I write this, the Position Paper is still in its draft stage and does not officially exist. You should also be aware that the position adopted within the paper could well change by the time that the paper is finalized and released to the public.

Therefore, whilst you are lucky enough to have access to this advance view, you should not rely on it in any way as yet, other than for information purposes.

The Tax Office have used the term "rent/buy" in lieu of wrapping but essentially they are talking about the same thing, which is easily identified through the issues discussed and the definitions of the process involved.

I noted the following points within their paper:

1. They considered whether the wrap is really just a lease and determined that it was not a lease and was in fact, a contract to buy the property through an instalment contract.
   
   
2. They considered Part IVA and the anti avoidance rules and decided that they would not apply because the exercise was profit driven and not tax driven.
   
   
3. The Tax Office considered the tax consequences of a wrap and in particular whether holding the property:
   • For sale in the ordinary course of business
   • As part of a profit making undertaking or scheme
   • For the purpose of providing a long term income stream
     
     
4. The Tax Office noted that there were no direct authorities (court cases) that deal with a situation, such as this, where the land is held for multiple purposes.
   
   
5. Interestingly, the author of the paper concludes that the "vendor is principally 'holding' the asset for the purpose of deriving a regular income stream providing above market value interest rates" and therefore, the Tax Office decided that the properties would not be classified as trading stock. In effect, they're saying that the vendor holds the asset just to ensure that the income will be paid.
   
   
6. The Tax Office accepts that the likely correct way of treating income for a wrap is via "the emerging profits" rule. This is the recommendation made within the Position Paper.
   
   
7. Although it is acknowledged that CGT will apply, it is also acknowledged that the CGT is reduced by the income otherwise declared from the same transactions. In most cases, because income was declared greater than, or equal to, the Capital Gain, there should be no need CGT payable on the sale of the property.
   
   
8. The Tax Office also considered the situation whereby the purchaser defaults on the contract and concludes that the vendor should declare a Capital Gain on the forfeited deposit less any costs incurred in selling the property.

In reading through the Position Paper, I also noticed that the following issued were not noted or considered:

• Short term wraps
• Stamp duty on the purchase of the property
• Costs of buying or selling the property
• Depreciation claims
• Court cases from overseas dealing with wraps
  

I have now discussed these issues with the people involved in drafting the Position paper and they will consider these as part of the next stage in finalizing their paper. Unfortunately, until then, we cannot know their final thoughts or opinions on these matters.

I do note though that the Tax Office have issued only 1 Private Binding Ruling thus far (which they may amend once this Position Paper is finalised); and, that they have only viewed one wrap contract at this stage.

Finally, I have also attached the summary Q & A that the Tax Office included at the end of the Position Paper for your reference.

Q. Should a wrap agreement be characterised as something other than a contract of sale (eg lease)?
A. No. Although a contract of sale entered into for the purposes of implementing a wrap agreement has unusual features, including an element of vendor financing, it is nevertheless a valid contract of sale. The wrap agreement examined to date has not been entered into for the purpose of deriving tax benefits, but instead has been entered into by vendors to obtain extraordinary returns.

Q. Is real property trading stock if the vendor acquires the real property for the sole purpose of entering it into a wrap agreement?
A. No. The ultimate sale of the real estate is a very minor motivating factor for the vendor when compared with the interest income derived over the term of the contract. The real estate is not held for sale but to ensure the continued payment of instalments.

Q. Is the real property trading stock if the vendor acquires real property for the sole purpose of entering it into a wrap agreement in the course of carrying on a business of entering into wrap agreements?
A. No. Ensuring the receipt of above market value interest rates is the dominant purpose for holding onto the real estate.

Q. Is the vendor carrying on a profit making scheme or undertaking in acquiring real property for the purpose of entering into a wrap agreement?
A. Generally yes. Where a significant purpose of acquiring real estate is to make a profit upon sale by entering it into a wrap agreement a profit making undertaking or scheme has been undertaken.

Q. Is the vendor carrying on a profit making scheme or undertaking if property owned and used by a vendor for rental or other purposes is subsequently entered into a wrap agreement?
A. No. If a vendor uses real estate for other purposes, such as investment prior to entering into a wrap agreement, the vendor will not have undertaken a profit making undertaking or scheme.

Q. If a vendor is carrying on a profit making undertaking or scheme how should the profit made on the sale of the property be accounted for?
A. The profit is ordinary income and should be accounted for on a profit emerging basis.

Q. If a vendor is not carrying on a profit making or undertaking or scheme how should the gain made on the sale of the property be accounted for?
A. Capital Gains Tax applies under CGT event B1. The 50% CGT discount may apply if the property has been held for 12 months or more months.

Q. What are the Capital Gains Tax outcomes if a purchaser defaults?
A. Either CGT event H1 or CGT event A1 applies depending upon whether the real estate is subsequently sold as part of a continuum of events.

Proposed_Tax_Treatment.pdf

Author: Dale Gatherum-Goss, 14 May, 2002
Posted to PropertyInvesting.com: 4 July, 2002

Dale Gatherum-Goss is a Certified Practicing Accountant and founder of Gatherum-Goss & Assoc. in Kilsyth, Victoria.
To find out more about Dale, visit his web-site at: http://www.gatherumgoss.com/