CGT: When is the Contract of Sale Entered Into?

The income year in which you enter into a contract to sell an asset is crucial for Capital Gains Tax (CGT) purposes. 

This is because it will be in that income year that you make a capital gain or loss on the sale of the asset – and not the income year in which “settlement” of the contract takes place, if that occurs in a later income year.

And this may have certain important consequences. For example, you may realise a capital loss in that year which you can then use to offset or reduce any capital gains made in that year also. On the other hand, you may delay entering into a contract of sale so as to defer any capital gain to the next income year where it may be taxed more generously.

This illustrates that there are important tax planning opportunities around planning the time in which you enter a contract to sell an asset – albeit, it can also raise the issue of tax avoidance in certain cases. 

For example, “wash sales” will attract the tax avoidance provisions. This occurs whereby you deliberately sell shares (or other such assets) before the end of the financial year to beneficially generate capital losses and then buy back the shares at roughly the same price in the next financial year. It can also apply where you transfer shares (or other such assets) to a related entity (e.g., a family trust) for the same purpose.

Nevertheless, simply arranging the time at which you enter into a contract to sell an asset would generally not be considered to be tax avoidance – but merely valid “tax planning”.

(And in this regard, note also that in relation to the denial of a CGT main residence exemption for a foreign resident, the time at which you determine whether a person is a foreign resident is when they enter the contract – and, again, there are important practical consequences here.)

However, there will be no CGT consequences in respect of entering into a contract for the sale of the asset if the contract does not proceed to “settlement”. This is because there has been no “change in the ownership” of the asset for CGT purposes – albeit, there will be CGT consequences in respect of the forfeiture of any deposit and/or the payment of any damages.

But how does this timing rule work in the case where a contract is subject to conditions (such as “subject to obtaining finance – as is often the case in land sale contracts).

Well, in this case, the ATO draws a distinction between contracts where the “performance” of the contract is subject to meeting a condition (e.g., a finance condition) and contracts where the “coming into existence” of the contract itself is subject to conditions.

In the former case, the contract is entered into from the start regardless of when the condition is satisfied; in the latter case, the contract is only entered into when the condition is satisfied, and the contract comes into existence.

Usually, it is relatively easy to determine the distinction between these two types of contracts – but this is not always the case. In these circumstances, professional advice is a must.

On the other side of the coin, the time at which you enter into a contract to acquire an asset also has important CGT consequences – the first and foremost of these is that it is relevant to qualifying for the 12-month holding period for the purposes of accessing the 50% CGT discount.

However, it also, for example, relates to assets acquired on the exercise of an option. In this case, the ATO takes the view that the asset is acquired when the resulting contract of acquisition is entered into and not when the option is entered into (on the basis that the option itself is not the relevant contract of acquisition).

And, again, this is important for qualifying for the 12-month holding period for the purposes of accessing the 50% CGT discount.

Once again, these are important CGT matters which you need to speak to us about in relation to any contract for the sale or purchase of an asset you have entered into.

In any of these scenarios we are here to help – as this is a matter which clearly requires the expertise of a tax professional. Email us at [email protected] or call us on (08) 7078 3505