Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)Chapter 8 - Capital gains tax
Overview
8.1 The amendments made in Part 9 of Schedule 1 of the Bill will subject certain transactions which effectively assign non-corporeal interests to appropriate capital gains tax (CGT) treatment.
Summary of the amendments
8.2 To ensure that certain transactions involving the creation of assets which effectively assign non-corporeal interests are subject to appropriate CGT treatment. [Item 59]
8.3 This amendment will apply to assets created after 12.00 midday Eastern Summer Time on 12 January 1994. [Item 71]
Background to the legislation
8.4 Currently subsection 160M(6) of the Income Tax Assessment Act 1936 (the Act) ensures that if a person creates an incorporeal asset which, on its creation, is vested in another person, there is a disposal of the asset to that other person for CGT purposes.
8.5 If the created asset is held by the creator as trustee of a discretionary trust, subsection 160M(6) would not apply. This is the case even though subsection 160M(6) could apply if the created asset was vested in another person to hold as trustee.
8.6 The identity of the trustee of a trust is generally not important as far as the beneficiaries are concerned. This is because it is the position of trustee rather than the identity of the trustee which is important. The functions of a trustee, and the trustee's relation to the trust property and the beneficiaries of the trust is the same, irrespective of the personal identity of the trustee. Therefore the application of CGT should be indifferent to whether the relevant interest is vested in the creator of an asset as trustee or in another person as trustee.
8.7 The proposed amendments will ensure that in circumstances where subsection 160M(6) would apply but for the fact that the asset is held by the creator as trustee, there will be a deemed disposal and reacquisition of the asset by the creator. An example of where this deemed disposal and reacquisition rule would apply is in the case of an assignment of a prospective interest in a partnership, also known as a pre-admission Everett assignment.
Pre-admission Everett assignments
8.8 A partner has a vested beneficial interest in partnership assets and in the future income of the partnership. The assignment of a partnership interest to another person (the assignee) has the effect that the partner holds his or her partnership interest on trust for the assignee. This means that the assignee holds the beneficial interest in the partnership interest while the partner holds the legal title to the interest in the partnership. This was established by the High Court in FC of T v Everett (1980) 143 CLR 440 at 448; 80 ATC 4076 at 4080; 10 ATR 608 at 612.
8.9 A person may enter into an agreement before becoming a partner. Under such an agreement, the prospective partner agrees, for nominal consideration, that upon becoming a partner he or she will hold a share of the partnership interest on trust for another person, or will assign that share to the person. These arrangements are known as pre-admission Everett assignments.
8.10 A pre-admission Everett assignment is a purported assignment of a mere expectancy. The effect of such an assignment is determined by the principles set out in Norman v FC of T (1963) 109 CLR 9; 13 ATD 13 and Booth v FC of T (1987) 164 CLR 159; 87 ATC 5100; 19 ATR 514. Those principles establish that when a person agrees, for value, to assign property to be acquired in the future, the assignor becomes trustee of the property for the assignee as soon as that property comes into existence. In the context of a pre-admission Everett assignment, the property to be acquired in the future is the assigned share of the partnership interest. Since the assignment is for value, the share is held on trust by the partner for the assignee as soon as that share comes into existence (when the prospective partner joins the partnership).
What were the CGT consequences of pre-admission Everett assignments before these amendments?
8.11 The share of the beneficial interest in the partnership which is effectively assigned in a pre-admission Everett assignment is the relevant incorporeal asset for the purposes of subsection 160M(6). It is created by the partner when he or she becomes a partner. If the assignment is made to a particular person, then the beneficial interest vests in that person. Therefore subsection 160M(6) would apply to deem a disposal of the beneficial interest by the partner. If the parties are not dealing with one another at arm's length, subsection 160ZD(2) deems the consideration given for the disposal to be the market value of the asset.
8.12 However, the partner may hold the share as trustee for a discretionary trust. In such a case the partner holds the interest on trust for the beneficiaries, but the beneficial interest does not vest in the beneficiaries themselves. It is arguable that the beneficial interest in this situation is not vested in another person as required by subsection 160M(6) so that the subsection would not apply.
What are the CGT consequences of pre-admission Everett assignments under the proposed amendments?
8.13 Pre-admission Everett assignments will be liable to CGT regardless of whether the interest created is held by the partner as trustee of a discretionary trust or by a third person as trustee.
8.14 If the share in the partnership subject to the assignment is held by the partner as trustee of a discretionary trust, the partner is deemed to have disposed of the asset and then reacquired it. The partner is deemed to have received consideration equal to the market value of the asset for that disposal.
8.15 The current application of subsection 160M(6) to pre-admission Everett assignments where the assignment is to a particular person is unchanged.
Explanation of the amendments
Pre-requisites for deemed disposal and reacquisition rule to apply
8.16 The deemed disposal and reacquisition of a created asset will be triggered where the following four elements contained in new subsection 160M(6BA) are satisfied.
(a) A person creates an asset that is not a form of corporeal property
8.17 A person must create an asset that is not a form of corporeal property. In this context, a person includes a company. 'Corporeal property' is undefined and takes its ordinary meaning. [Item 60 - new paragraph 160M(6BA)(a)]
8.18 As with current subsection 160M(6), the deemed disposal and reacquisition rule may apply whether or not there is an existing asset from which the asset is created, and whether or not there is an actual disposal of an asset at the time of the creation [Item 60 - amended subsection 160M(6C)]
(b) The asset is held by the creator as trustee
8.19 At the time of its creation, the asset must be held by the creator in the creator's capacity as trustee of a trust estate. This may be an express, implied or other type of trust. For instance, in the context of a pre-admission Everett assignment, it would include a trust which automatically comes into existence because of the operation of the principles referred to in Norman's case (cited above). [Item 60 - new paragraph 160M(6BA)(b)]
(c) The beneficial interest is not held by beneficiaries
8.20 At the time of the asset's creation, the beneficial interest in the asset should not be held by a beneficiary or beneficiaries of the trust. This would be the case in a discretionary trust, where the beneficiaries have no beneficial interest in the trust property. [Item 60 - new paragraph 160M(6BA)(c)]
8.21 The beneficial interest in an asset is itself an asset for the purposes of Part IIIA. Therefore, if it is held by a beneficiary or beneficiaries, current subsection 160M(6) applies to the beneficial interest in the created asset. The proviso in new paragraph 160M(6BA)(c) ensures that there will be no deemed disposal and reacquisition of the created asset under new subsection 160M(6BB) if subsection 160M(6) applies to the beneficial interest in that asset.
8.22 For example, if a prospective partner enters into a pre-admission Everett assignment by which a 50% share of his or her interest in the partnership is to be held on trust for the trustee of a family trust, subsection 160M(6) would apply. This is because the beneficial interest in the share is vested in the trustee of the family trust (it does not matter that it is vested in the trustee for the benefit of other beneficiaries). The effect of new paragraph 160M(6BA)(c) is that the deemed disposal and reacquisition rule would not apply, since a beneficial interest in the assigned share is held by the trustee of the family trust. If, on the other hand, the prospective partner agrees to enter into the partnership and hold the share as trustee of a discretionary trust, no beneficial interest in the asset is held by the beneficiaries of the trust and therefore the deemed disposal and reacquisition rule will apply.
8.23 However, new paragraph 160M(6BA)(c) will not have the effect of allowing a taxpayer to overcome the application of proposed new subsection 160M(6BA) by simply declaring him or herself to be the trustee of an interest in a partnership under both a fixed trust and a discretionary trust. For example, a prospective partner may declare that she will hold 50% of her interest in a partnership on trust; 10% under a fixed trust as described at paragraph 8.22 above, and 40% as the trustee of a discretionary trust.
8.24 In this example, the 10% held on the fixed trust would be taken to be an asset disposed of under existing subsection 160M(6). The remaining 40% interest would also be taken to be a separate asset subject to a deemed disposal and re-acquisition pursuant to new subsection 160M(6BB) . That is, each interest in the partnership will be a newly created asset, separate from other interests in the partnership, and will be subject to CGT only once.
(d) Consideration received in respect of the creation of the asset
8.25 The deemed disposal and reacquisition will only apply if consideration (ie. an amount of money or property) is received in respect of the creation of the asset. In this regard, an amount received for entering into a contract to create an asset is an amount received for creation of that asset. This is consistent with current subsection 160M(6) since the creator of an asset will only have a capital gain under that subsection if he or she actually receives as consideration an amount of money or property for creating the asset. [Item 60 - new paragraph 160M(6BA)(d)]
Application of the deemed disposal and reacquisition rule
8.26 The deemed disposal and reacquisition rule which is triggered if the above prerequisites are met is contained in new subsection 160M(6BB) .
8.27 Under this rule, the person creating the asset is taken to have acquired and commenced to own the asset at the time immediately before the making of the contract or, if the asset was not created under a contract, at the time of its creation. [Item 60 - new paragraph 160M(6BB)(a); items 64 and 68 - amended subparagraph 160U(6)(a)(ii) and new subparagraph 160U(6)(b)(iv)]
8.28 The person is then deemed to have disposed of the asset and immediately to have reacquired the asset. The disposal is taken to have occurred at the time of the making of the contract or, if the asset was not created under a contract, immediately after the time of its creation. [Item 60 - new paragraph 160M(6BB)(c); items 67 and 68 - amended subparagraph 160U(6)(a)(iii) and new subparagraph 160U(6)(b)(v)]
8.29 In relation to that disposal, the cost base, reduced cost base or indexed cost base of the asset is restricted to expenditure incidental to the disposal. The amendment effects this by providing that, in respect of the creation of the asset, the person is taken not to have paid or given any consideration or incurred any costs or expenditure referred to in certain paragraphs of section 160ZH. However, this applies only in respect of the creation of the asset (which gives rise to the acquisition referred to in new paragraph 160M(6BB)(a) ) and not to any subsequent disposal of the asset after its creation (ie. after the deemed disposal and reacquisition of the asset). [Item 60 - new paragraph 160M(6BB)(b)]
8.30 Subsection 160ZH(7A) (as amended) provides what costs are incidental to the disposal of the asset. [Item 70 - amended subsection 160ZH(7A)]
8.31 The person is deemed to have received consideration equal to the market value of the asset for the disposal. This amount is also taken to have been paid for the deemed reacquisition of the asset. Therefore it will be included in the cost base, indexed cost base or reduced cost base for the purposes of a later disposal of the asset. [Item 60 - new paragraph 160M(6BB)(d)]
8.32 The market value of the asset is to be determined at the time of its disposal. The time of disposal for assets created under a contract is the time the contract was made. Since the asset does not exist at that time, the relevant market value is the amount that would have been the market value of that asset if it had existed then. For example, in a pre-admission Everett assignment, the market value of the assigned share at the time of contract is the market value that an identical share in the partnership would have had if it had existed at that time. In this regard, the calculation of market value of a created asset is no different from subsection 160M(6).
Application of amendments to non-residents
8.33 Paragraph 160T(1)(l) of the Act provides that, where the specified conditions are satisfied, there will be a disposal of a taxable Australian asset if, because of the application of subsection 160M(6), there is a disposal of an asset under paragraph 160M(6A)(b). Paragraph 160T(1)(l) is to be amended so that it also applies to a disposal under new subsection 160M(6BB) because of the application of new subsection 160M(6BA) . Therefore a non-resident will be liable to CGT under new subsection 160M(6BA) if consideration received for creating the asset is derived from a source in Australia. [Item 62 - amended paragraph 160T(1)(l)]