Edited version of private ruling

Authorisation Number: 1011531510843

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: CGT event D1 - is the asset inherently connected with an active asset

Question 1

At the time of the capital gains tax event, were the rights to the renewable energy certificates (RECs) attached to an active asset of the business being the premises and business?

Answer: No.

Question 2

Can the 50% active asset discount be applied to the capital gain made on the sale of the rights to the RECs?

Answer: No.

This ruling applies for the following period:

1 July 2008 to 30 June 2009.

The scheme commences on:

1 July 2008.

Relevant facts and circumstances

You operate a business and have purchased solar hot water systems for the business. You have assigned the right to create RECs to the agent who sold you the solar hot water systems. At the time of assigning the right to the RECs to the agent the solar hot water systems had not been installed.

The agent in return has provided you with a discount on the purchase price of the solar hot water systems. The solar hot water systems were installed some time later.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 108-5.

Income Tax Assessment Act 1997 Subsection 108-5(1).

Income Tax Assessment Act 1997 Section 104-35.

Income Tax Assessment Act 1997 Subdivision 110-A.

Income Tax Assessment Act 1997 Division 152.

Income Tax Assessment Act 1997 Subsection 152-10(1).

Income Tax Assessment Act 1997 Section 152-12.

Income Tax Assessment Act 1997 Subsection 152-40(1A).

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Capital gain

A capital gains tax (CGT) asset is defined under section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as any kind of property or a legal or equitable right that is not property.

The right to create a REC which attaches to the purchase of eligible solar hot water systems is a tradeable statutory right and as such is a CGT asset as defined in subsection 108-5(1) of the ITAA 1997. The right to create the REC can be assigned to an agent, or the purchaser of the eligible solar hot water system can create the REC independently. The REC can then be traded for financial return.

Section 104-35 of the ITAA 1997 provides that CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. You make a capital gain if the proceeds from creating the right are more than the incidental costs you incurred that relate to the event.

Cost base

Subdivision 110-A of the ITAA 1997 provides the rules for the cost base of a CGT asset. The cost base of a CGT asset is made up of five elements:

1. money or property given for the asset

2. incidental costs of acquiring the CGT asset or that relate to the CGT event

3. costs of owning the asset

4. capital costs to increase or preserve the value of your asset or to install or move it

5. capital costs of preserving or defending your ownership of or rights to your asset.

Small business concessions

For the capital gain to qualify for the small business concessions contained within Division 152 of the ITAA 1997, the four basic conditions in subsection 152-10(1) of the ITAA 1997 must generally be satisfied. Those conditions are:

(a) a CGT event happens in relation to a CGT asset of yours in an income year;

(b) the event would have resulted in a gain;

(c) at least one of the following applies:

- you are a small business entity for the income year;

- you satisfy the maximum net asset value test;

- you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership;

(d) the CGT asset satisfies the active asset test.

However, the effect of subsection 152-12(1) of the ITAA 1997 is that paragraphs 152-10(1)(a) and 152-10(1)(d) of the ITAA 1997 do not apply in the case of CGT event D1. Instead, subsection 152-12(2) of the ITAA 1997 requires that the right giving rise to CGT event D1 must be inherently connected with another CGT asset which satisfies the active asset test.

The active asset test

This test requires the CGT asset to be an active asset for:

- 7 years, if owned for more than 15 years, or

- half of the ownership period if owned for 15 years or less.

An active asset may be a tangible asset or an intangible asset.

A tangible or intangible asset is a CGT active asset if it is owned by you and is used or held ready for use in the course of carrying on a business by:

- you

- your affiliate, or

- an entity connected with you.

Inherently connected

The expression 'inherently connected' is not defined in the legislation. However, the expression is discussed at paragraph 1.38 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.7) Bill 2006 which introduced subparagraph 152-40(3)(b)(ii) into the ITAA 1997.

It discusses the requirement 'inherently connected' which is an alternative test for intangible assets, because it will be difficult for some intangible assets to meet the requirement that it is used, or held ready for use, in carrying on a business. The example considered in the Explanatory Memorandum is goodwill. Goodwill is not 'used' in a business, but is inherently connected with it.

Application to your circumstances

You have purchased solar hot water systems for your business. The solar hot water systems were eligible for the purposes of creating RECs. You assigned your right to create the RECs to the agent who supplied the solar hot water systems in return for a discount on the purchase price of the solar hot water systems.

When you purchased the solar hot water systems you acquired two separate assets being the solar hot water system and the statutory right to create RECs.

The cost of the solar hot water systems for depreciation purposes is the full invoiced cost, including the discount received.

When you assigned your right to create the RECs to the agent you effectively disposed of a CGT asset by creating a legal right for the agent to create the RECs. CGT event D1 occurred at this time.

Your capital proceeds from this CGT event is the amount of the discount on the purchase price of the solar hot water systems that the agent provided in return for the assignment of the right to create the RECs.

You did not pay an amount to acquire the right to create the REC and as such there is no amount for the first element of your cost base. You will make a capital gain equal to the amount of the discount received on the purchase of the solar hot water systems from the agent.

To qualify for the small business concessions the rights must be connected to a CGT asset that is an active asset.

The right to create the RECs is connected to the solar hot water systems. The right to create the RECs would not have occurred unless you entered into a contract to purchase the solar hot water systems. The right to create the RECs did not exist in relation to the premises or the business.

The right to create the RECs is an asset that is inherently connected to the solar hot water systems; it is not an asset that is inherently connected to the premises or the business.

Therefore to enable the small business concessions to apply, the solar hot water systems need to be used or installed ready for use in the course of carrying on a business.

At the time of the CGT event the solar hot water systems were not being used nor were they installed ready for use. In fact it was not until some time later that the solar hot water systems were installed.

The small business concessions will not apply to the capital gain made on the disposal of the right to create the RECs.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).