Summary
When a person inherits property, the gain enjoyed by the estate of the deceased on the transfer is based on the transfer value of the property. Given that it is a related-party transaction, the transfer value in such a transaction is the market value of the property at the time of transfer to the beneficiary. This transaction is exempt from income tax.
Should the beneficiary opt to dispose of the inherited property to an independent third party, the gain on the disposal shall be deemed to be the transfer value (sale price and related costs) less the adjusted cost. In such an instance, the adjusted cost shall be the sum of the market value of the property and any other allowable costs.
In a recent decision, the Tax Appeals Tribunal (“TAT”) held that the cost of acquisition of inherited property for Capital Gains Tax (“CGT”) computation purposes on the subsequent sale of inherited property shall be the market value of the property at the time of inheritance between related persons.
The dispute
In 2015, three siblings inherited two parcels of land from their late father and contracted an independent valuer to issue a valuation report for the two parcels as at 2015. The transfer of the parcels to the taxpayers by inheritance was exempted from CGT under Paragraph 36 (f) of the First Schedule to the Income Tax Act (“ITA”). This fact was not disputed.
In 2020, the siblings sold the parcels to an unrelated developer. When computing the CGT payable on the sale of the parcels, the siblings declared the transfer values as the exact amounts they received from the developer but declared the property values as per the valuation report as the costs of acquisition of the properties. Given that the transfer value was lower than the market value of the properties upon acquisition, the siblings (through one KRA PIN) declared losses on the disposals for CGT purposes. Given that they did not enjoy a gain for CGT purposes, they did not pay any CGT on the disposals.
After the disposal, the Commissioner of Domestic Taxes reviewed the transaction documents and amended the siblings’ self-assessment to reflect an acquisition cost of zero on the basis that they did not incur the acquisition cost. The Commissioner resultantly claimed that the siblings enjoyed a gain on the disposal of the parcels which the Commissioner demanded taxes on.
Whereas the siblings objected to this additional assessment, the Commissioner rejected their arguments and upheld the assessment, necessitating the appeal to the TAT.
The Appellant’s case
The siblings, represented by RSM and Oraro & Company, argued that a gain crystalized during the transfer of the properties during execution of the grant of probate and that this gain was exempted from CGT under Paragraph 36(f) of the First Schedule to the Income Tax Act. The siblings further argued that the transfer of the properties to the developer was a separate transaction from the inheritance transactions.
The siblings argued that the Eighth Schedule to the Income Tax Act provided for a general method of determination of the cost of acquisition of property for CGT purposes and had an exception for instances where the acquisition was not at arm’s length. Specifically, Paragraph 9 of the Eighth Schedule provided (in mandatory terms) that the cost of acquisition in related party transactions is not the actual cost but is the market value at the time of transfer. The siblings had availed an independent valuer’s report for the year 2015 detailing the value of the property at the time of inheritance.
Given that the cost of acquisition (market value) exceeded the transfer value (selling price), the siblings made a loss for CGT purposes thus there was no chargeable gain.
The siblings also argued that the Commissioner erred by inferring that the value of the property at the time of inheritance was zero and by assessing taxes on only one of the siblings instead of apportioning the same amongst the siblings.
The Commissioner’s case
The Commissioner largely agreed with the sequence of events as stated by the Appellants but differed on the interpretation of law. Specifically, the Commissioner argued that CGT computations were filed by the Appellants and that the Commissioner was not bound by the information provided by the Appellants. Further the Commissioner argued that it was empowered to assess additional taxes based on any other available information.
The Commissioner argued that the Appellants deducted an acquisition cost that they neither realized nor spent on.
Tribunal’s determination
The Tribunal noted that Paragraph 8 and 10 of the Eighth Schedule to the Income Tax Act were the provisions of law that were relevant in the determination of the contested adjusted costs. It further noted that Paragraph 9 to the Eighth Schedule made an exception to the determination of the adjusted cost in instances where such an acquisition was not carried out at arm’s length. Particularly, Paragraph 9 provided for the use of the fair market value at the time of acquisition as the cost of acquisition in this circumstance.
The Tribunal held that Paragraphs 8 and 10 of the Eighth Schedule could not be applied in isolation of Paragraph 9 when the latter applied.
In view of the above, the Tribunal found that the Commissioner erred by claiming that the properties had no acquisition cost as Paragraph 9 effectively provided for the determination of the cost basis upon the disposal of inherited property.
The Tribunal further found that the transfer upon inheritance fell within the ambit of Paragraph 9 and that the independent valuer’s report was a sound basis for the determination of the fair market value of the properties.
Accordingly, the Tribunal allowed the appeal by finding that the Appellants had correctly used the fair market value at the time of acquisition as the cost of acquisition and that the Commissioner erred by adjusting the cost of acquisition to zero.