Senate

Replacement Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P)

Chapter 11 Capital Gains Tax Amendments

Summary of proposed amendments

The Bill will amend the capital gains tax (CGT) provisions (Part IIIA) of the Income Tax Assessment Act 1936 (the ITAA) to clarify the operation of subsections 160M(6) and 160M(7). In particular, the amendments will provide that where a person creates a right in another person, the CGT provisions can apply to tax any consideration the person receives for creating the right. For example, the amendments will make it clear that a payment received by a person for entering into a restrictive covenant, exclusive trade tie or similar agreement can be taxable under the CGT provisions.

The Bill will make other technical amendments associated with the operation of subsections 160M(6) and 160M(7). It will also:

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clarify the circumstances in which subsections 160M(6) and 160M(7) apply to non-residents; and

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provide that subsection 160M(7) does not apply between 20 September 1985 and 22 May 1986 (inclusive) where the asset referred to in subsection160M(7) is owned by a person other than the taxpayer.

Background to the legislation

The broad scheme of the CGT provisions is that capital gains made upon the realisation of assets will be included in assessable income and subject to income tax. The provisions generally apply where a person disposes of an asset which he or she acquired after 19 September 1985. However, subsections 160M(6) and 160M(7) were intended to apply in situations where there was not an actual disposal of an asset.

Subsection 160M(6) applies where a person disposes of an asset that did not exist (either by itself or as part of another asset) before the disposal, but is created by the disposal. Examples of the situations to which subsection 160M(6) is intended to apply include where a person creates an asset by granting a lease or by granting an option; the person is taken to acquire and then dispose of the lease or option.

Subsection 160M(7) seeks to tax as capital gains certain capital payments not received in respect of the disposal of an asset. It applies where an act or transaction takes place in relation to an asset or an event affecting an asset occurs. Where a person receives or is entitled to receive an amount of money or other consideration by reason of that act, transaction or event, the amount of that consideration (less incidental costs) is deemed to be a capital gain to that person. To provide for the acquisition and disposal of an asset to which Part IIIA can apply, the person is deemed to have disposed of a fictional asset for a consideration equal to the amount of the money or other consideration received. The cost base of the fictional asset includes only the incidental costs of its disposal.

Both subsections have been the subject of recent consideration by the courses. However, the question of which (if either) provision applies in a particular situation where there is no disposal of an asset has largely remained uncertain. In particular, the meaning and application of subsection 160M(6), including the extent to which it applies to the creation of a new asset, have remained unresolved.

The Bill will amend Part IIIA to provide a clear scheme for the taxing of capital payments not received in respect of the disposal of an asset or of part of an asset. The principal amendment proposed by the Bill will clarify the operation of subsection 160M(6). The effect of the amendment will be that where a person creates an incorporeal asset (an asset other than a form of corporeal property) in another person, any consideration received by the first-mentioned person for creating the asset, less incidental costs, will be a capital gain to that person. Subsection 160M(7) will have a residual operation to tax payments not received in respect of the disposal or creation of an asset.

By taxing these payments under the CGT provisions rather than under the general income provisions of the ITAA, taxpayers will be able to offset unused capital losses incurred in the same or earlier years against a capital gain accruing as a result of the receipt of the capital payment. Also, any tax payable on that capital gain will be calculated using the notional averaging provided for by the Income Tax Rates Act 1986.

Explanation of the proposed amendments

What will be an asset for CGT purposes?

Under the existing provisions, an asset for the purposes of Part IIIA is defined to mean any form of property, and to include specified things, such as options, debts, choses in action, other rights and goodwill. The Bill will amend the reference to an option, a debt, a chose in action and any other right in two respects [Clause 23(a) - new paragraph 160A(a)].

First, it will be made clear that an option, debt, chose in action or other right will be an asset, whether it is legal or equitable.

Not all things often referred to as "rights" will be assets for CGT purposes. To be an asset, a right must be recognised and protected by law - a court of law or equity will assist in enforcing it. Personal liberties and freedoms, such as the freedom to work or trade or to play amateur sport, are not legal or equitable rights and accordingly will not be assets for CGT purposes. [But this does not mean that money or other consideration received in relation to personal liberties and freedoms can not be taxed under the CGT provisions - see later notes.]

Secondly, it will be made clear that a legal or equitable option, debt, chose in action or right will not have to be a form of property to be an asset. That is, while the primary meaning of asset for CGT purposes is any form of property, it is extended to include things which are not a form of property.

A form of property is generally regarded as something that is capable of assignment or transmission. The amendment will make it clear that an option, a debt, a chose in action or a right will not need to be forms of property if they are to be assets for CGT purposes. They will be assets even if they are not assignable or transmissible.

Accordingly, a legal right of a personal character which is not capable of assignment, such as the rights under a contract of personal services, will be an asset. Other examples might include the rights of a party to a restrictive covenant or exclusive trade tie agreement, and the rights of a sporting club under an agreement that a sportsperson play for that club.

The Bill will also remove from the definition of "asset" the reference to any form of property which is created or constructed or which otherwise comes to be owned without being acquired [Clause 23(b)] . The amendments proposed by the Bill will serve the same purpose. Clause 25 will clarify the CGT consequences of the construction or creation of all assets, including [as a result of the amendments proposed by clause 23(a)] those assets which are not a form of property.

Creation of an incorporeal asset in another person.

Existing subsection 160M(6) will be replaced with provisions which apply where a person creates an asset which is not a form of corporeal property and which is vested in another person on its creation. The amount of the consideration received for creating the asset, less incidental costs of the creation, will be a capital gain to the person who creates the asset. [Clause 25(b)]

Corporeal property is any property which has a physical or tangible existence, such as land or material goods. An incorporeal asset (an asset other than a form of corporeal property), therefore, is any asset (as defined in section 160A) of a non-physical or intangible nature. Examples include rights under a contract, a patent and goodwill. As a result of the amendment proposed to the definition of "asset", new subsection 160M(6) will also apply to the creation of legal or equitable rights that are not a form of property.

The new provisions are intended to apply to a wide range of circumstances where a person receives consideration for creating incorporeal assets in another person. It is not practicable for the legislation to refer specifically to all those circumstances. Rather, the new subsection 160M(6) will provide the general criteria for the application of the new provisions; that a person creates an asset, the asset is not a form of corporeal property, and on its creation the asset is vested in another person. Hence it is to apply in much the same way as subsection 25(1) of the ITAA applies to include "gross income" in assessable income.

Where a particular fact situation fits within these general criteria, the new provisions will then operate in the following manner:

In relation to the person creating the asset:

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The person creating the asset will be taken to acquire the asset and to commence to own it [New paragraph 160M(6A)(a)]

Where the asset is created under a contract, the time of acquisition by that person will be immediately before the time of the making of the contract [New subparagraph 160U(6)(a)(ii)] . In any other case, the time of acquisition will be immediately before the time the asset vests in the other person [New subparagraph 160U(6)(b)(ii)].

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The person creating the asset will be taken to have subsequently disposed of the asset to the person in whom it is vested on its creation [New paragraph 160M(6A)(b)].

Where the asset is created under a contract, the time of the disposal will be the time of the making of the contract [New subparagraph 160U(6)(a)(iii)] , or in any other case, the time when the asset vests in the other person [New subparagraph 160U(6)(b)(iii)] .

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The person who created the asset will have included in the cost base of the asset only expenditure incidental to the disposal of the asset. [New paragraph 160M(6A)(c)]

Because that person will be taken to acquire and then immediately to dispose of the asset, it may not be possible to determine which costs are incidental to the disposal (as opposed to the acquisition) of the asset. To clarify the issue, the incidental costs of the disposal of the asset are specified to be (non-deductible) expenditure incurred in connection with the creation of the asset, such as legal fees, costs of registration of any instrument and stamp duty. [Clause 30(b) - new subsections 160ZH(7A) and 160ZH(7B)]

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Where the person who created the asset receives no consideration in respect of that creation, the rule in paragraph 160ZD(2)(a) will not apply [New paragraph 160M(6A)(d)] . [Paragraph 160ZD(2)(a) provides for the market value of the asset to be taken as the consideration received by the person disposing of an asset.] This will ensure that the person who creates the asset will only have a capital gain if he or she actually receives as consideration an amount of money or property for creating that asset. [NOTE: Market value will be substituted for the actual consideration, if the consideration received is greater or less than the market value and the transaction is not an arm's length transaction.]

In relation to the person in whom the asset is vested on its creation:

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The person in whom the asset is vested on its creation will be taken to have acquired the asset from the person who created it, and to commence to own it [New paragraph 160M(6B)(a)].

Where the asset is created under a contract, that person is taken to acquire the asset at the time of making of the contract [New subparagraph 160U(6)(a)(i)]. In any other case, the person is taken to acquire the asset at the time it vests in him or her [New subparagraph 160U(6)(b)(i)].

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Where the person does not give any consideration in respect of the creation of the asset, the rule in paragraph 160ZH(9)(a) will not apply [New paragraph 160M(6B)(b)]. [In these circumstances, paragraph 160ZH(9)(a) would otherwise have provided for the market value of the asset to be taken as the consideration paid by the person acquiring the asset.] This ensures that the cost base of the person in whom the asset is vested on its creation will not include any amount as consideration in respect of the acquisition of the asset if that person does not pay or give any money or property for the creation of the asset. [NOTE: Market value will be substituted for the actual consideration, if the consideration paid is greater or less than the market value and the transaction is not an arm's length transaction.]

In practical terms, these provisions will only have an impact where a person receives consideration for creating an incorporeal asset in another person, and where a person incurs some incidental costs of creating the asset. The following examples illustrate the practical application of the new provisions:

Example 1 - Consideration is received for creating an incorporeal asset

On 7 July 1992, Mary Smith enters into a restrictive covenant agreement with her employer, Hi-Tech Ltd. Mary agrees not to work for a competitor of Hi-Tech Ltd in the same State for a period of three years. Mary receives $50,000 for entering into the agreement, and incurs $250 in legal fees in connection with the agreement.

Mary has created an asset (viz, the rights of Hi-Tech Ltd under the agreement) which, on its creation, is vested in Hi-Tech Ltd. Under the new provisions, Mary will be taken to acquire and to own the asset immediately before the time the agreement is made on 7 July 1992; and then to have disposed of it to Hi-Tech Ltd at the time the agreement is made. The consideration Mary receives in respect of the disposal of the asset is $50,000, and the cost base to Mary of the asset is $250 (the legal fees which are not deductible under any provision of the ITAA). Accordingly, a capital gain of $49,750 will accrue to Mary on 7 July 1992.

Hi-Tech Ltd will have an asset (its rights under the agreement) which it acquired on 7 July 1992. Its consideration in respect of the acquisition of the asset is $50,000. If Hi-Tech Ltd incurs legal fees of $1,000 in connection with the agreement and has no other costs included in the cost base of the asset, it may incur a capital loss of $51,000 on 7 July 1995 when the agreement expires. The expiry of an asset (in this case the agreement) will be taken by paragraph 160M(3)(b) to be a disposal of the asset. [NOTE: If Hi-Tech Ltd was entitled to a deduction for the $50,000 it paid to Mary, that amount will not be taken into account in determining the amount of any capital loss available to it -section 160ZK.]

Example 2 - No consideration is received for creating an incorporeal asset, and no costs are incurred in creating the asset

On 23 July 1992, John Jones contracts with Brown Manufacturing Pty Ltd that he be the manager of Brown's sales division for a period of two years on a commission basis. John receives no inducement or other payment for entering into the contract, nor does he incur any expenses in connection with the creation of the asset.

John has created an asset (viz, the rights of Brown under the contract to require John to perform his duties as sales manager for the period of two years) which, on its creation, vests in Brown. John is taken to acquire, own and then dispose of the asset to Brown. However, as John receives no consideration in respect of the disposal and the cost base to him of the asset is nil, he will not have a capital gain or a capital loss as a result of creating the asset.

Example 3 - Consequences where the person in whom the asset is created incurs costs in respect of the asset

On 15 August 1992, Smallco Pty Ltd contracts with CMR Management Services Pty Ltd for CMR to provide management services to Smallco for a period of four years. No consideration is paid in respect of the making of the contract. Smallco incurs non-deductible legal expenses of $2,000 in respect of its rights under the contract. CMR does not incur any legal or other incidental expenses.

Smallco's rights under the contract (its rights to require CMR to provide the management services for the period of four years) will be an asset. Smallco is taken to have acquired those rights from CMR. (By creating the rights, CMR is itself taken to have acquired and then disposed of them to Smallco.) Smallco did not give any consideration to acquire that asset, and paragraph 160ZH(9)(a) will not apply. However, the cost base to Smallco of that asset will include the legal fees of $2,000, being incidental costs incurred by Smallco in respect of the acquisition of the asset. When the contract expires on 15 August 1996 and Smallco is taken to have disposed of the asset, it will (assuming no other amounts are included in the cost base) incur a capital loss of $2,000.

Example 4 - Consequences where the person in whom the asset is vested receives consideration on a subsequent disposal of the asset

In example 3, CMR's rights under the contract will be an asset, even if they are not assignable. They were acquired from Smallco on 15 August 1992, when the contract was made. The cost base to CMR of that asset is nil - it paid no consideration to acquire it and paragraph 160ZH(9)(a) does not apply. If after 2 years, Smallco terminates the contract and pays CMR compensation of $40,000, a capital gain of $40,000 will accrue to CMR. It has disposed of an asset with a nil cost base for a consideration of $40,000. [NOTE: If that $40,000 is also assessable under the general provisions of the ITAA, the amount of the capital gain would be reduced to nil by the operation of subsection 160ZA(4).]

Examples of when new subsection 160M(6) will apply

The following is a not exhaustive list of the circumstances in which the new provisions would also apply. In any particular case, consideration will need to be given to the operation of the other provisions of the ITAA. If the consideration received is also included in the taxpayer's assessable income under those provisions, subsection 160ZA(4) may reduce the amount of the capital gain to nil.

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A person agreeing not to compete with another person for a specified number of years or within a specified location.

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A person agreeing to enter into an exclusive trade tie agreement with another person.

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A person agreeing to only play sport with a particular club.

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A person agreeing to play only a particular sport, eg a rugby union footballer agreeing to play rugby league.

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An actor agreeing with a film company not to appear in a film made by another company.

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A person agreeing to withdraw an objection to a town-planning application.

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A property owner who grants management rights over the property.

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A person agreeing to endorse the use of particular goods and services.

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The grant of a right to use a trademark.

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An agreement for the supply of mining information in the possession of the taxpayer.

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An agreement to vary a contract, where the variation does not amount to a disposal of the whole or of part of the rights under the contract.

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An agreement for the assignment of an expectancy or of a right which is yet to come into existence, such as an agreement to assign interest which may accrue in the future upon an existing loan repayable without notice.

Matters incidental to the operation of new subsection 160M(6)

The general structure of the CGT provisions is that they apply where there is a disposal of an asset which, immediately before its disposal was owned by a person who acquired it after 19 September 1985. A capital gain or capital loss accrues to the person who owns the asset at the time of its disposal. The new provisions outlined above are designed to fit within that general structure by deeming an asset which is not a form of corporeal property to have been acquired, owned and disposed of by the person who created the asset even though, in fact, the person never owned it - the asset on its creation is vested in another person.

To dispel any suggestion that the new provisions will not have their intended effect because they do not fit within the general structure of the CGT provisions, the amendments make it clear that these provisions apply whether or not the asset is created out of, over or otherwise in connection with an existing asset, and whether or not the person creating the asset owned or disposed of anything at the moment of creation of the asset. [New subsection 160M(6C)]

The CGT provisions apply to a resident of Australia in respect of an asset whether it is "situated in Australia or elsewhere" - subsection 160L(1). In the case of incorporeal assets, it might be argued that the asset is not situated "in Australia or elsewhere". However, several provisions in Part IIIA, including the definition of asset, specifically contemplate that the CGT provisions will apply to incorporeal assets. Given their nature, it would defeat the clear intention of the provisions to say that incorporeal assets are not situated in Australia or elsewhere. However, to remove any uncertainty on the point, subsection 160L(1) will be amended to also refer to assets which are not situated anywhere. [Clause 24]

How will subsection 160M(7) operate under the new provisions?

Subsection 160M(7) will have a residual application where the other CGT provisions, including the new provisions dealing with the creation of incorporeal assets, have not applied to a transaction. While both new subsections 160M(6) and 160M(7) will be subject to the provisions of Part IIIA, subsection 160M(6) [which is not subject to subsection 160M(7)] will apply in precedence to subsection 160M(7). This will mean that subsection 160M(7) will only apply where the receipt of an amount of money or other consideration is not in respect of the disposal of an asset or the creation of an incorporeal asset.

Subsection 160M(7) will generally apply as it does at the moment. However, because most payments originally sought to be taxed under subsection 160M(7) will now fall within the new subsection 160M(6), it will apply in fewer cases. A number of minor technical amendments are proposed to clarify the operation of subsection 160M(7).

Subsection 160M(7) applies when an act or transaction has taken place in relation to an asset, or an event affecting an asset has occurred. The amendments will make it clear that the act or transaction need not affect the asset. Where the act, transaction or event does affect the asset, it will not matter whether the asset is affected adversely or beneficially, or whether it is neither adversely nor beneficially affected. [Clause 25(c) - new subsection 160M(7)(a)]

As presently enacted, it is not necessary that the person who receives the amount of money or other consideration by reason of the act, transaction or event to which subsection 160M(7) applies also owns the asset mentioned in the subsection. Accordingly, subsection 160M(7) will apply to a payment received, for example,. for entering into a restrictive covenant agreement, where the entering into the agreement took place in relation to, or affected, the goodwill of the taxpayer's employer. However, this and most other situations were subsection 160M(7) could presently apply will now fall within the new provisions dealing with the creation of incorporeal assets. Subsection 160M(7) will not need to have such a broad scope. The amendments will therefore provide for subsection 160M(7), in its future operation, to be limited to situations where the act, transaction or event takes place in relation to an asset owned by the taxpayer. [Clause 25(d)]

Paragraph 160M(7)(b) refers to some situations to which the subsection could apply. One such situation is where money or other consideration is receive in return for the forfeiture or surrender of a right. Subsection 160M(7) applies subject to the other provisions of Part IIIA. That is, subsection 160M(7) will not apply where a transaction falls within another provision of Part IIIA. By paragraph 160M(3)(b), the forfeiture or surrender of a right constitutes a disposal of the right. Therefore, subsection 160M(7) can not apply where a taxpayer receives consideration for the forfeiture or surrender of a right. The Bill will remove the ambiguity of the present provisions by omitting from paragraph 160M(7)(b) the reference to the surrender or forfeiture of a right. [Clause 25(e)]

Where subsection 160M(7) applies, the taxpayer is taken to dispose of a fictional asset which is created by the disposal. This deemed creation and disposal of the fictional asset have been interpreted as according with the general structure of the CGT provisions which require the acquisition, ownership and disposal of an asset owned by the taxpayer. However, this interpretation is not readily apparent. To put the issue beyond doubt, the Bill will make it clear that the fictional asset is acquired and owned by the taxpayer immediately before its disposal. [Clause 25(f) - new subsection 160M(7)(e)]

Construction or creation of an asset, other than under new subsection 160M(6)

The amendments proposed by the Bill will clarify the CGT treatment in other circumstances where a person constructs or creates an asset. [Clause 25(a)]

Construction or creation of an asset by a person for himself or herself.

Where a person constructs or creates an asset which, on its construction or creation, does not vest in another person (that is, it vests in the person constructing or creating it), the person who constructs or creates the asset will be taken to acquire it. [New paragraph 160M(5)(b)]

The time of the acquisition of the asset by the person will continue to be the same as under the existing provisions - that is, the time when the construction of the asset commenced or the time when the work on, or work that resulted in, the creation of the asset commenced. [New subsection 160U(5)]

Construction or creation of corporeal property for another person.

Where a person constructs or creates a form of corporeal property which, on its construction or creation, vests in another person (that is, it is constructed or created for another person), that other person will be taken to acquire the asset [New paragraph 160M(5)(c)] . Corporeal property is any property which has a physical or tangible existence, such as land or goods. The proposed new paragraph 160M(5)(c) will apply, therefore, where a person constructs or creates a building, painting, statue or any other physical object for another person.

Where the asset was constructed or created under a contract, the time of acquisition by that other person will be the time of making of the contract [New subparagraph 160U(6)(a)(i)] . In any other case, the time of acquisition by the other person will be the time when the asset vests in that person [New subparagraph 160U(6)(b)(i)]. In this latter case, the time of acquisition will depend on the operation of the general law to the circumstances which gave rise to the construction or creation. For example, where a person constructs a building on another person's land [which was acquired before 20 September 1985, so that the building will be taken to be an asset separate from the land by subsection 160P(2)], the other person will acquire the building when the construction commenced - the building, being a fixture to the land, is acquired by the land owner as soon as it is attached to the land.

Where a person constructs or creates a physical asset for another person, it will often be the case that the payment to the person for constructing or creating the asset will be assessable income under section 25 of the ITAA. For example, a payment to a well known artist for creating a painting. In other cases, the payment may not be assessable as it is received in respect of a hobby.

Vested

The provisions that will deal with the construction or creation of an asset [new paragraphs 160M(5)(b) and 160M(5)(c) and subsection 160M(6)] refer to the asset being vested in a particular person. In some contexts, "vest" has a specific legal meaning. For example, "vest" is often used in the context of creating property in a person - that is, creating a right (for example) which is capable of assignment. "Vested" can also be used in distinction to "contingent" - a contingent interest is capable of being defeated if the contingency does or does not occur, whereas a vested interest cannot be so defeated.

In the context in which "vested" is used in the proposed provisions, it has the broader meaning of the person being placed in possession or control of the asset. The use of this broader meaning is dictated by the fact that "asset" will now include rights which are not forms of property. [New subsection 160M(6D)]

Time of acquisition and disposal where an asset is NOT created or disposed of under new paragraphs 160M(5)(b) or (c) or subsection 160M(6)

Where a specific provision of Part IIIA applies in respect of the construction or creation of an asset, new paragraphs 160M(5)(b) or (c) and subsection 160M(6) will not apply. Section 160U, which provides the time of acquisition and disposal of assets, will be amended by the Bill to provide the time of acquisition and disposal by reference to the new provisions. The time of acquisition and disposal for asset construction and creation cases not covered by those provisions will be determined as if they had applied. [Clause 28 - new subsection 160U(6A)]

The grant of a lease is an example of where new subsection 160U(6A) will apply. If section 160ZS did not apply to the grant (or creation), new subsection 160M(6) would apply. The time of acquisition and disposal of the lease by the lessor will therefore be determined as if new subsection 160M(6) applied to the creation of the lease. The lessor would have been taken to have acquired the lease by virtue of new subsection 160M(6A)(a). The time of acquisition of the lease by the lessor will therefore be the applicable time under new subsection 160U(6) - immediately before the time of making the contract where the lease was granted under a contract [new subparagraph 160U(6)(a)(ii)]. The lessor would also be taken to have disposed of the lease [new paragraph 160M(6A)(b)] at the time of making the contract [new subparagraph 160U(6)(a)(iii)]. The lessee would have been taken to have acquired the lease [new paragraph 160M(6B)(a)] at the time of making the contract [new subparagraph 160U(6)(a)(i)].

Another situation in which new subsection 160U(6A) will provide for the time of acquisition of an asset is where a person creates a debt by borrowing money or obtaining credit. New subsection 160MA(1) provides that new subsection 160M(6) will not apply in these circumstances, but that the person who provided the money or credit will be taken to acquire the debt. Had new subsection 160M(6) applied, this person would have been taken to acquire the asset at the time of the making of the contract under which the money or credit was provided. The person will therefore be taken to acquire the debt at the time of making the contract which created the debt.

Situations in which new subsection 160M(6) and subsection 160M(7) will NOT apply

Where the other provisions of Part IIIA apply.

Both new subsections 160M(6) and 160M(7) will apply subject to the provisions of Part IIIA. This means that if either subsection 160M(6) or 160M(7) and another provision of Part IIIA could apply to a particular transaction, that other provision will apply. Subsection 160M(6) and 160M(7) will not apply. This will be the case, for example, where the transaction constitutes the disposal of the whole or of part of the existing asset for the purposes of Part IIIA, even if the asset was acquired before 20 September 1985.

For example, the owner of a block of land may sell part of his interest in the land to another, thereby creating a tenancy in common. Because the sale constitutes a disposal by the person of part of his land, neither subsection 160M(6) nor 160M(7) will apply.

Sections 160M(6) and 160M(7) will also be subject to section 160ZB, which provides for the exemption of certain capital gains and losses from the CGT provisions. For example, a capital gain is not taken to have accrued to a taxpayer who receives compensation for personal injury.

In addition, a capital gain or capital loss does not arise from betting, a lottery or other forms of gambling or games with prizes [subsections 160ZB(2) and (3)]. However, a capital gain may arise on a subsequent disposal of an asset obtained from these activities. It is not clear that this extends to the receipt of prizes from a competition. To put the issue beyond doubt, subsections 160ZB(2) and (3) will be amended to also refer to a competition with prizes [Clause 29] . However, if the winnings are assessable income under the general provisions of the ITAA, they will continue to be assessed as income.

Creation of a debt.

When a person borrows money or obtains credit, he or she creates an asset (a debt) in the provider of the money or the credit. To preclude any argument that the person has received the amount of money borrowed or credit obtained as consideration for creating the debt, subsection 160M(6) and 160M(7) will not apply to the creation of the debt. However, the person who advanced the money or credit (the person in whom the debt is created) will be taken to have acquired the debt. The time when that person acquired the debt will, by virtue of the operation of new subsection 160U(6A), be the time determined under new subsection 160U(6). [Clause 26 - new subsection 160MA(1)]

Creation of a right to require the disposal of an asset.

When a person, A, agrees to sell property to another person, B, the transaction will give rise to a disposal of that property for CGT purposes. A capital gain could accrue to A, depending on when the property was acquired, its cost base and the amount of consideration received. By entering into the agreement, A has also created in B a right to require A to transfer the property to B.

It would be argued that A has received, as consideration for creating that right, the amount of the consideration payable for the disposal of the property. If that were the case, new subsections 160M(6) and 160M(6A) would apply to deem the whole of the consideration to be a capital gain to A. However, it is unlikely that the consideration for the disposal of the property could also be the consideration for the creation of the right.

To put the issue beyond doubt, subsections 160M(6) and 160M(7) will not apply to the creation of a right to require the disposal of an asset. The other provisions of Part IIIA will continue to apply to the disposal of the asset. [Clause 26 - new subsection 160MA(2)]

Subsection 160MA(2) will apply even though Part IIIA does not apply to the disposal of the asset, eg because the asset was acquired before 20 September 1985. The requirement of new paragraph 160MA(2)(b) is that there be a disposal "for the purposes of this Part" - generally that there be a change of ownership of the asset within section 160M. It is not required that it be a disposal of an asset to which the Part applies.

Some motor vehicles and interests in motor vehicles are not assets for the purposes of Part IIIA - section 160A excludes them from the definition of asset. Part IIIA will therefore not apply to the disposal of those motor vehicles or interests. However, a right to require the transfer of a motor vehicle will be an asset for CGT purposes. As that right is not a right to require the disposal of an asset, proposed subsection 160MA(2) will not otherwise apply. To avoid any possibility that a capital gain can arise from the creation of a right to transfer a motor vehicle or an interest in a motor vehicle, subsections 160M(6) and 160M(7) will also not apply to the creation of such a right. [Clause 26 - new subsection 160MA(3)]

Application of subsections 160M(6) and 160M(7) to non-residents.

The CGT provisions apply to a non-resident in respect of the disposal of a taxable Australian asset, as described in section 160T, owned by the non-resident. Where a non-resident constructs or creates an asset for himself or herself [new paragraph 160M(5)(b)], or another person constructs or creates a corporeal asset for a non-resident [new paragraph 160M(5)(c)], the non-resident will be taken to acquire the asset. The asset will be a taxable Australian asset to the non-resident if it falls within any of the existing paragraphs of section 160T.

Specific rules will determine whether a non-resident will be subject to tax where new subsections 160M(6) or 160M(7) apply to the non-resident [Clause 27].

Where subsection 160M(6) applies to deem a non-resident to have disposed of an asset because that person created an incorporeal asset in another, the non-resident will be subject to tax if consideration received for creating the asset is derived from a source in Australia [new paragraph 160T(1)(l)] . The asset the non-resident is taken to acquire and dispose of by paragraph 160M(6A) will be a taxable Australian asset.

Whether the consideration is derived from a source in Australia is to be determined in the same way as it is for income. For these purposes, if the consideration received for creating the asset is not of an income nature, it is taken to be of an income nature [new subsection 160T(2)] . Whether consideration is derived from a source in Australia will depend on the circumstances of each particular case. Factors which may be taken into account include: where the contract was negotiated and made, the place of payment of the consideration and source of funds used as the consideration; the subject matter of the contract; where the contractual obligations are to be performed.

New subparagraph 160T(1)(l)(iii) also provides for the situation where no consideration is received by a non-resident for creating an incorporeal asset. This allows for a non-resident who has incurred incidental costs in connection with the creation of an asset to be entitled to a capital loss equal to the amount of those incidental costs.

Where subsection 160M(7) applies, the taxpayer is deemed to have disposed of a fictional asset. It has been suggested that subsection 160M(7) will not apply where the taxpayer is a non-resident - because the fictional asset is not a taxable Australian asset. The Government does not accept this view. The context of subsection 160M(7) indicates an intention to assess certain capital payments, including a payment received by a non-resident. Nevertheless, to remove any uncertainty on this point, it will be made clear that the fictional asset is a taxable Australian asset where the underlying asset in respect of which subsection 160M(7) applies is a taxable Australian asset. That underlying asset, because of the amendments proposed by clause 25(d), will be a taxable Australian asset owned by the non-resident. [Clause 27(b) - new paragraph 160T(1)(m)]

Application of existing subsection 160M(7) between 20 September 1985 and 22 May 1986

When the introduction of CGT was announced on 19 September 1985, it was said that the CGT provisions would apply to real gains made on the disposal of assets acquired on or after 20 September 1985. Where subsection 160M(7) applies in relation to assets acquired before 20 September 1985, the effect is to deem the CGT provisions to apply to the disposal of a separate, fictional asset which is taken to be acquired at the time of the relevant act, transaction or event. The consideration received will be subject to tax.

Because it could not have been anticipated from the announcement of 19 September 1985 that the CGT provisions would operate in that way, subsection 160M(7A) was introduced to provide that subsection 160M(7) would not operate in certain circumstances on or before 22 May 1986 (the date of introduction of the CGT legislation into Parliament). Those circumstances are that the taxpayer (the person who received the money or other consideration to which subsection 160M(7) applies) acquired the relevant asset before 20 September 1985, and the act, transaction or event took place between 20 September 1985 and 22 May 1986 (inclusive).

It is now clear that subsection 160M(7) can also apply where an act, transaction or event takes place in relation to an asset not owned by the taxpayer. Hence, it is possible that any consideration received by the taxpayer will be taxed under the CGT provisions, even though the underlying asset was not owned by the taxpayer. Again, the taxpayer could not have anticipated from the 19 September 1985 announcement that the CGT provisions would apply to the money or consideration received. In these circumstances, the Bill will amend subsection 160M(7A) to provide that subsection 160M(7) also does not apply where an act, transaction or event took place in relation to an asset between 20 September 1985 and 22 May 1986 (inclusive), and the asset was acquired by a person other than the taxpayer before 23 May 1986. [Clause 25(g) - new subsections 160M(7A) and 160M(7B)]

Commencement date

New subsections 160M(7A) and 160M(7B) will apply where the relevant act, transaction or event took place between 20 September 1985 and 22 May 1986 (inclusive).

The amendment to section 160ZB will apply to participation in a competition with prizes after 25 June 1992.

The amendments to subsection 160M(7) and new paragraph 160T(1)(m) will apply in relation to an act, transaction or event which takes place after 25 June 1992.

The other amendments apply to the construction or creation of assets after 25 June 1992.

Clauses involved in the proposed amendments

Clause 23: Amends the definition of asset in section 160A.

Clause 24: Amends section 160L to provide for incorporeal assets not situated anywhere.

Clause 25: Amends section 160M to substitute the provisions dealing with the construction and creation of assets, and clarify the operation of subsections 160M(7) and 160M(7A).

Clause 26: Inserts section 160MA to provide for situations where the creation of an asset will not constitute an acquisition and disposal.

Clause 27: Inserts paragraphs 160T(1)(l) and (m) and subsection 160T(2) to clarify the circumstances in which subsections 160M(6) and 160M(7) will apply to non-residents.

Clause 28: Amends section 160U so that the rules for the time of acquisition and disposal of assets is consistent with the new provisions dealing with the construction and creation of assets.

Clause 29: Amends subsection 160ZB to make it clear the CGT provisions apply to prizes from a competition in the same way as a prize from a game.

Clause 30: Inserts new subsections 160ZH(7A) and 160ZH(7B) to describe the costs which will be allowed as incidental costs incurred in connection with the creation of an incorporeal asset.

Clause 31: Sets out the commencement date of the amendments.