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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1051185912395

Date of advice: 31 January 2017

Ruling

Subject: INCOME TAX - DEDUCTIONS - BLACK HOLE EXPENDITURE - SECTION 40-880

Question 1

Is each Trading Trust entitled to claim a deduction under section 40-880, in respect of the gaming machine entitlement (GME) instalment expenditure incurred by each entity following the acquisition of the gaming businesses carried on at the Relevant Venues?

Answer

No.

Question 2

Is each Trading Trust entitled to claim a deduction under section 40-880, in respect of the GME expenditure incurred by each entity following the acquisition of the gaming businesses carried on at the Relevant Venues, by way of reimbursement (GME Reimbursements) to the unrelated third party vendors of those businesses?

Answer

No.

Question 3

If the answer to Question 1 and/or Question 2 is 'Yes', has each of the relevant Trading Trust:

in respect of each income year during the Relevant Period?

Answer

Not applicable, as the answer to Question 1 and Question 2 is No.

Question 4

If the answer to Question 1 and/or Question 2 is 'yes', and the answer to Question 3 is also 'Yes', does the Commissioner further agree that each beneficiary of the relevant Trading Trusts has included an excessive amount of 'Net Income' in their assessable income for each distribution received from those trusts during the Relevant Period, pursuant to section 97 of the ITAA 1936?

Answer

Not applicable, as the answer to Question 1 and Question 2 is No.

Question 5

If the answer to Questions 1 and/or Question 2 is 'Yes', and the answers to Questions 3 and 4 are also 'Yes', will the Commissioner agree to the amendment of either the Assessment (where the relevant review period remains open) or the Losses Schedule for each affected taxpayer?

Answer

Not applicable, as the answer to Question 1 and Question 2 is No.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

Year ended 30 June 2020

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Family Group is a family owned group of businesses that operates licenced venues in a particular State.

Certain entities in Family Group (collectively, the Trading Trusts) each purchased a gaming and hospitality business at the Relevant Venues during the income years between 20xx and 20xx.

Each Relevant Venue carried on a gaming and hospitality business and had bottle shop operations at the relevant date of acquisition. TAB operations were also provided at some Relevant Venues.

Each Relevant Venue operates a number of gaming machines. The operation of each gaming machine requires, among others, the Relevant Venue's operating entity to hold a valid GME issued by the State.

This ruling has considered the following information provided by Family Group:

This ruling also considers the following publicly available information:

Move to a new regulatory regime of GMEs

In 20xx, the Relevant Government announced the new GME regime whereby Tattersalls and Tabcorp would no longer exclusively hold their respective gaming operator's licence and gaming licence. Instead, GMEs would be issued to operators of approved venues permitting them to conduct gaming on approved gaming machines in their own right.

The then vendors of the Relevant Venues participated in an auction process in May 20xx to obtain their GMEs, or otherwise purchased GMEs from other unrelated venue operators.

GMEs

The Gambling Regulation Act 2003 (X) (and Regulations) (together the Gambling Act) provides the regulatory framework under which gaming machines are permitted to be operated in the State.

Under section 3.4A.1 of the Gambling Act the 'conduct of gaming' in an approved venue is lawful only if the venue operator holds a GME. The 'conduct of gaming' is defined in subsection 3.1.4(1) of the Gambling Act as:

The authority conferred by a GME is specified in section 3.4A.2 of the Gambling Act as follows:

Currently, to operate a gaming machine in the State, one must:

Other features and restrictions of the GME regime include the following:

Payment terms for the GMEs

On acquisition of a GME, each vendor had the option to pay the cost of the GME up-front, or pay the fee in instalments over a period of 6 years beginning in 2010 and ending in 2016. Each of the vendors of the businesses acquired by the Trading Trusts elected to pay the GME fees in instalments.

The 'Entitlement Related Agreement for Payment' specifies the minimum payment terms that a venue operator must comply with consisting of 18 instalments:

Transfer of GMEs

Entitlements may be transferred or traded through a transfer scheme. The Relevant State facilitates the transfer market process through the Entitlement Transfer Market (ETM) set up to allow venue operator licensees to advertise, monitor, request the transfer of entitlements or request amendments to entitlement conditions. Through the ETM, venue operators advertise their wish to transfer or buy one or more GMEs. The transfer of any GME will not be finalised until the Relevant State records the transfer on the ETM Register. Negotiations regarding the transfer may take place between an existing GME holder and an interested party prior to the transfer being finalised.

Transfer of GMEs from venue operator (vendor) to Trading Trusts

Section 3.4A.17 of the Gambling Act states that GMEs must be transferred in accordance with the “gaming machine entitlement allocation and transfer rules” which are determined by the Relevant Government. Further, section 3.4A.17A states that GMEs cannot be transferred unless the transferee has entered into an Entitlement Related Agreement for Venues agreement with the Minister for Gaming (the Minister).

The current GME Allocation and Transfer Rules, effective on and after 3 August 20xx, are detailed in Relevant Government Special Gazette Number S205 dated 22 July 2015. The key points are as follows:

On 15 March 20xx, the Minister amended the GME Allocation and Transfer Rules to enable venue operators to transfer ownership of GMEs on 'deferred payment terms'; essentially a schedule of regular interest-free instalments. Previously, entitlements acquired on the ETM had to be paid for upfront and in full before the Relevant State could record the transfer. The process for transferring GMEs on deferred payment terms is detailed in Gambling Information Sheet 'Deferred payment terms of transferred entitlements' as follows:

The transfer of the GME and the recording of the transfer on the ETM usually occur on the same day as settlement.

Each Trading Trust entered into a Deed of Assumption on the specified dates. Following the acquisition of the Relevant Venues, the Trading Trusts applied to the Relevant State to transfer the respective GMEs held by each vendor to each relevant Trading Trust.

Accordingly, the Trading Trusts were (as of the date of transfer), and continue to be, entitled to operate gaming machines in accordance with the GMEs in respect of each gaming machine.

GME Instalment expenditure

On transfer of the GMEs to the relevant Trading Trust, the Trading Trusts incurred a liability in respect of the outstanding instalments payable on the GMEs under the deferred payment terms (GME Instalments).

GME Reimbursements

In addition to incurring the GME Instalments on the purchase of the relevant business, each Trading Trust also incurred expenditure to reimburse the vendors of the Relevant Venues for a certain amount of the GME instalments previously paid by the vendors in respect of each GME (GME Reimbursements). The GME Reimbursements have been calculated as the difference between the GME instalments paid by the vendor and the proportion of the total cost of the GMEs that relates to the period during which the GME was in effect, as a proportion of the ten years for which the GME is valid. Effectively, it represents an amount paid by the vendor for a period subsequent to the sale of the business.

The BSAs for the purchase of each Relevant Venue by the Trading Trusts contains provisions for adjustments to take into account the GME Reimbursements. The BSAs also contain clauses to the effect that each contract is conditional upon the Relevant State approving the transfer of the GMEs. The Statement of Adjustments for each settlement of the Relevant Venues indicates the amount allowed by the Trading Trust (as purchaser) to each former Vendor on account of the GME Reimbursements agreed upon in the BSA.

The Trading Trusts have not claimed any amount of their GME costs (GME Instalments and GME Reimbursements) as a deduction in any income year.

The Trading Trusts have, in all material respects, continued to operate the venues in the same manner with which the venues were operated prior to acquisition. Relevantly, the Trading Trusts carry on the gaming business that was acquired from the vendors at the same business premises, under the same trading name and serving the same, or substantially the same, customers who attend the venues to use the gaming machines and access the accompanying liquor and dining services.

The accounting treatment of the GMEs has been to recognise an intangible asset, recorded at fair value, being the present value of the GMEs. The intangible asset is amortised over the useful life of the GMEs, being the period to 15 August 20xx.

Revenue from the operation of gaming machines forms a significant proportion of the total revenues generated by the business acquired by each Trading Trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 8-1(1)

Income Tax Assessment Act 1997 Subsection 8-1(2)

Income Tax Assessment Act 1997 Section 15-2

Income Tax Assessment Act 1997 Subsection 40-30(1)

Income Tax Assessment Act 1997 Subsection 40-30(2)

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 Subsection 40-880(1)

Income Tax Assessment Act 1997 Subsection 40-880(2)

Income Tax Assessment Act 1997 Paragraph 40-880(3)(d)

Income Tax Assessment Act 1997 Subsection 40-880(5)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(a)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(b)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(d)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(f)

Income Tax Assessment Act 1997 Subsection 40-880(6)

Income Tax Assessment Act 1997 Subsection 104-25(1)

Income Tax Assessment Act 1997 Paragraph 104-25(1)(c)

Income Tax Assessment Act 1997 Subsection 104-25(3)

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Subsection 110-25(2)

Income Tax Assessment Act 1997 Subsection 110-25(5)

Income Tax Assessment Act 1997 Subsection 110-25(5A)

Income Tax Assessment Act 1997 Section 112-35

Reasons for decision

Under section 40-880, taxpayers are entitled to deduct certain business related capital expenditure, known as 'black hole' expenditure, provided certain conditions are met.

Subsections 40-880(1) and (2) state the following:

Subject to satisfying all the requirements in section 40-880, each Trading Trust that has incurred GME Instalments would be able to deduct the expenditure, in equal proportions over five income years starting in the year in which the expenditure is 'incurred'.

Incurred

This term is not defined in the ITAA 1997. Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions, sets out the Commissioner's view of the meaning of the term 'incurred'. Under paragraph 5 of that Ruling, you broadly incur an outgoing at the time you owe a present money debt that you cannot escape. The taxpayer must be “definitively committed” to the liability or has “completely subjected” itself to the liability (FC of T v James Flood Pty Ltd (1953) 88 CLR 492 at 506). The taxpayer must be “subject to an immediate obligation to pay the sum referred to, notwithstanding that payment is not in fact made in the year in question” (De Simone and Anor v FC of T [2009] FCA 446; 2009 ATC 20-101 paragraph 8).

Here, the obligation of the Trading Trusts to pay the GME Instalments arises from the transfer of the GMEs and the Deed of Assumption each has entered into to effect the transfer. The process for transferring GMEs from one venue operator to another is governed by the GME Allocation and Transfer Rules, as published in Relevant Government Gazette No S 205. Rule 7 of the GME Allocation and Transfer Rules states that a transfer of GMEs is only valid if it is recorded by the Relevant State on the ETM Register. The process is also summarised in Gambling Information Sheet 'Deferred payment terms for transferred entitlements' published by the Relevant State. This document makes it clear that the venue operator who has acquired the GMEs is responsible for making all subsequent instalments once the Relevant State records the transfer of the GMEs on the ETM.

The Commissioner considers that the GME Instalments are incurred by each Trading Trust only when the transfer of the GMEs on deferred payment terms is finalised and recorded on the ETM Register by the Relevant State. It is only from this point that the venue operator who has acquired the GMEs will be responsible and “definitively committed” for making all subsequent instalments to the State as per the deferred payment schedule. The Commissioner does not consider that a liability was created when the Deed of Assumption was entered into because the transfer is still conditional upon and subject to the approval of the Minister. As explained in TR 97/7, a liability that is contingent will not be a presently existing liability.

Therefore, the GME Instalments were incurred by each Trading Trust in the income year the transfer of the GMEs was recorded by the Relevant State on the ETM Register; from that point in time each Trading Trust became responsible for making all subsequent instalments to the State as per the deferred payment schedule.

'In relation to' a business

The Commissioner accepts that each of the Trading Trusts carries on a business for a taxable purpose, comprising owning and operating the venues offering hospitality (including food, drink and accommodation where relevant), gambling through TAB facilities (where relevant) and gaming machines.

As explained in paragraph 15 of Taxation Ruling TR 2011/6 Income Tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues, the expression 'in relation to' denotes the proximity required between the expenditure and the former, current or proposed business.

For capital expenditure to be 'in relation to' a business, there must be a sufficient and relevant connection between the expenditure and the business. It is clear that the GME Instalments were incurred in connection with the hospitality and gaming venue business acquired and then carried on by the respective Trading Trusts. The business acquired by each Trading Trust generates a significant proportion of their total revenue from the operation of gaming machines - typically more than 40%. Therefore, the Commissioner accepts that the expenditure is incurred 'in relation to' each business.

Capital expenditure

Expenditure is only deductible under section 40-880 if it is capital expenditure.

The Commissioner agrees with Family Group that the GME Instalments are capital in nature.

The primary authority in determining whether an amount of expenditure is capital in nature is Dixon J's statement in Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 (Sun Newspapers) at 363:

Upon consideration of the factors in Sun Newspapers, the Commissioner considers the GME Instalments are capital expenditure for the following reasons:

Character of advantage sought

According to paragraph 67 of TR 2011/6, the character of the advantage sought provides important direction and is the best guidance as to the nature of the expenditure as it says the most about the essential character of the expenditure itself. If the expenditure produces some asset or advantage of a lasting character for the benefit of the business it will be considered to be capital expenditure (British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 at 213-214).

The Commissioner considers that the essential character of the GME Instalments was to secure the GMEs which provides an enduring benefit to the business; namely, for each GME, the right to operate a gaming machine in an approved venue for a maximum period of ten years from 16 August 2012.

As to whether a GME is an enduring asset, the term 'enduring' was referred to by Rich J at page 547 in Herring v. FCT (1946) 72 CLR 543, who stated that:

The essential character of this advantage is structural and goes to the profit-yielding structure of the business, rather than the profit-making process. Each GME is part of the structure that is necessary for the earning of profit, and not the operation of the process to obtain regular returns by means of a regular outlay (as per Dixon, J in the Sun Newspapers case at CLR 359). Each GME enables the holder to operate one gaming machine (and preclude someone else from holding that GME) and there are statutory caps on the number of GMEs that are issued to an operator of any given venue and to operators within a geographical region.

In AusNet Transmission Group Pty Ltd v Federal Commissioner of Taxation [2015] HCA 25; ATC 20-521 (AusNet), the High Court ruled on the characterisation of certain payments made by AusNet to the Relevant State of X made in connection with its acquisition of an electricity transmission business. Relevantly, the majority (French CJ, Kiefel and Bell JJ) in AusNet stated at paragraph 18:

In terms of approaching the characterisation of a payment, the majority in AusNet at paragraph 24, cited with approval Fullager J's approach in Colonial Mutual Life Assurance Society Ltd v FCT (1953) 89 CLR 428 at 454 in asking the question in every case (1) “What is the money really paid for? and (2) Is what it is really paid for, in truth and in substance, a capital asset? The majority also reiterated at paragraph 22, the observation of Dixon J in Hallstroms Pty Ltd v FCT (1946) 72 CLR 634 at 646, that characterisation involves considering what the expenditure is calculated to effect from a “practical and business point of view.”

Expanding on this approach, the majority of the High Court in AusNet stated at paragraph 46:

Their answer to this question was that the expenditure was capital on the following basis:

Following the approach in AusNet, the Commissioner considers that the GME Instalments are, from a practical and business point of view, capital payments:

The manner in which it is to be used

Each GME is a prerequisite for the operation of a gaming machine, but is not actually used up in the operation of such activity (i.e. is part of the fixed, and not circulating, capital). This indicates a relationship to the profit-yielding structure of the business (comprising the operation of a collection of gaming machines) and that the expenditure is capital.

The means adopted to obtain it

The GMEs were secured by the Trading Trusts entering the Deed of Assumption under which the Trading Trusts assumed responsibility for making all subsequent and outstanding instalment payments to the State. Therefore, the outlay is in essence a once-off payment rather than periodical (even though it is paid in instalments) and supports the view that the expenditure is capital.

Summary of factors

In summary, the indicators discussed in Sun Newspapers and the approach in AusNet point to the conclusion that the GME Instalments are capital expenditure.

The GME Instalments incurred in the relevant income year by each Trading Trust would be deductible under section 40-880 unless one of the exclusions in subsection 40-880(5) applies.

EXCLUSIONS TO DEDUCTIBLITY UNDER SECTION 40-880

Subsection 40-880(5) states, as is relevant to your circumstances, as follows:

Depreciating asset exclusion - subsection 40-880(5)(a)

Under paragraph 40-880(5)(a), you cannot deduct expenditure under section 40-880 if it forms part of the cost base of a depreciating asset.

A depreciating asset is defined under subsection 40-30(1) as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. The definition excludes, amongst others, intangible assets except for those listed in subsection 40-30(2): paragraph 40-30(1)(c). The GMEs do not fall within one of the types of intangible assets listed in subsection 40-30(2) and therefore are not depreciating assets as defined in subsection 40-30(1).

Therefore, the exclusion under paragraph 40-880(5)(a) does not apply to prevent the GME Instalments from being deductible under section 40-880.

Deductible under a provision of this Act other than this section exclusion - paragraph 40-880(5)(b)

Under paragraph 40-880(5)(b), you cannot deduct expenditure under section 40-880 if it is deductible under a provision of the Act (which includes both the ITAA 1997 and the ITAA 1936) other than section 40-880. As the Commissioner has determined above, the GME Instalments are capital in nature and therefore excluded from the general deduction under section 8-1. Family Group also agrees with this categorisation in its ruling application. The Commissioner considers there is no other provision of this Act under which the expenditure could be deductible, apart from section 40-880.

Therefore, the exclusion under paragraph 40-880(5)(b) does not apply to prevent the GME Instalments from being deductible under section 40-880.

Lease or other legal/equitable right exclusion - paragraph 40-880(5)(d)

Under paragraph 40-880(5)(d), you cannot deduct expenditure under section 40-880 if it is 'in relation to a lease or other legal or equitable right'.

The expression 'in relation to a lease or other legal or equitable right' or any part of the expression is not defined in the legislation. Paragraph 40-880(5)(d) replicates the former paragraph 40-880(3)(d) that is now repealed.

In respect of paragraph 40-880(5)(d), paragraph 2.68 of the Explanatory Memorandum (EM) to Tax Laws Amendment (2006 Measures No. 1) Bill 2006 states:

Since that paragraph states that the exclusion contained in paragraph 40-880(5)(d) replicates that found in the repealed section 40-880, it is relevant to consider the repealed paragraph 40-880(3)(d). In discussing that exclusion, paragraph 3.67 of the EM to the Taxation Laws Amendment Bill (No. 5) 2002 stated:

It is therefore relevant to consider what 'leases and rights' were contemplated in the recommendations of the Review of Business Taxation in order to determine the intended scope of the phrase 'in relation to a lease or other legal or equitable right' in paragraph 40-880(5)(d) and former paragraph 40-880(3)(d).

The proposed review of the taxation of 'leases and rights' was discussed at pages 217-280 of the Review of Business Taxation, A Platform for Consultation, Discussion Paper 2 Volume I, February 1999 (Discussion Paper). Specifically, at paragraph 8.1 on page 217, the following is stated:

Paragraph 8.2 of the Discussion Paper then states that the paper deals with the following broad category of rights:

The broad categories together with the examples set out above indicate that relevant rights are proprietary rights, whether they are of, or against, the grantor of the right. Therefore, it is expected that leases and rights of the sorts outlined above in the Discussion Paper would be excluded from deductibility under paragraph 40-880(5)(d).

The Commissioner considers that GMEs are rights which may come within the 'leases and or other legal or equitable rights' that were considered by the Review of Business Taxation. Specifically, the rights attached to a GME cover the use of a physical asset in the form of a gaming machine, and also constitute intangible business assets that are similar in nature to the contracts giving rights over intangible assets identified in the Discussion Paper. Consequently, the GME Instalments, which are expenditures incurred on acquiring the GMEs, are in relation to a lease or other legal or equitable right that is excluded from a deduction under section 40-880, pursuant to the exclusion in paragraph 40-880(5)(d).

The Commissioner notes that the Trading Trusts have conceded that paragraph 40-880(5)(d) could apply.

The Commissioner considers that the GME Instalments would also be excluded from being deductible under section 40-880 by the exclusion in paragraph 40-880(5)(f) as explained further below.

Taken into account in working out the amount of a capital gain or capital loss from a CGT event exclusion - paragraph 40-880(5)(f)

Paragraph 40-880(5)(f) excludes expenditure from being deductible under section 40-880 if it could be taken into account in working out a capital gain or loss from any CGT event that may apply. The Trading Trusts agree that the GME expenditure is prima facie excluded from deductibility under this paragraph.

A 'CGT asset' is broadly defined in section 108-5 as 'any kind of property or a legal or equitable right that is not property'.

GME is a CGT asset

'Property' is not defined in the ITAA 1997 and it instead takes its ordinary legal meaning. The following description of 'property' by the Australian Law Reform Commission (Traditional Rights and Freedoms - Encroachments by Commonwealth Laws (ALRC Interim Report 127), 3 August 2015)) is a useful starting point:

In Yanner v. Eaton (1999) 201 CLR 351; [1999] HCA 53; (1999) 73 ALJR 1518, the High Court accepted that property refers not to a thing but to a description of a legal relationship with a thing; and, more specifically, to the degree of power that is recognised in law as permissibly exercised over the thing. There is neither a single test nor a single determinative factor for identifying a proprietary right. Courts have emphasised different characteristics in different circumstances. One formulation that has been applied in Australia is the 'Ainsworth test' - which asks whether a right is definable, identifiable and capable of assumption by third parties, and permanent or stable to some degree.

However, courts have also focused on factors such as excludability (whether it is possible to exclude others from the right in question), commercial value (whether something is treated in commerce as a valuable proprietary right), and enforceability of the right against third parties generally. Accordingly, in determining whether something amounts to property, it is necessary to weigh up a range of factors and to treat none as definitive.

Under Chapter 1 of the Gambling Act, a 'gaming machine entitlement' means an entitlement created under Part 4A of Chapter 3 of the Gambling Act. The authority conferred by a GME is specified in section 3.4A.2 of the Gambling Act. Under subsection 3.4A.2(1) of the Gambling Act, a GME authorises the venue operator that holds the GME to acquire approved gaming equipment and to conduct gaming on one approved gaming machine in an approved venue. The 'conduct of gaming' is defined in section 3.1.4 of the Gambling Act to include the operation of gaming machines and the use or distribution of proceeds from the conduct of gaming.

GME is 'property'

It is considered that a GME is 'property' for the following reasons:

GME is still a CGT asset even if it is not 'property'

However, even if a GME is not 'property', a GME is still a 'CGT asset' if it is a 'legal or equitable right that is not property' pursuant to section 108-5. There is little doubt that a GME is a statutory right that confers on the holder a bundle of legal rights including the right to conduct gaming (as defined in subsection 3.1.4(1) of the Gambling Act) on one gaming machine, albeit subject to meeting other conditions. A GME is therefore a 'legal or equitable right' and a CGT asset.

CGT events that could happen to the GME

The relevant CGT events that could happen in relation to a GME are CGT event A1 (Disposal of a CGT asset) and CGT event C2 (Cancellation, surrender and similar endings).

It must be noted that paragraph 40-880(5)(f) refers to expenditures that 'could' be taken into account. Paragraph 2.73 of the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006 makes it clear that a capital gain or loss that has not yet been realised or is disregarded is still caught under the exclusion under paragraph 40-880(5)(f) such that the expenditure 'could…be taken into account in working out the amount of a capital gain or capital loss' from a CGT event.

Paragraph 2.73 of the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006 states as follows:

(emphasis added)

Therefore, the expenditure to acquire the GMEs is capable of being taken into account under CGT events A1 or C2 and prima facie excluded under paragraph 40-880(5)(f), even though no GME has expired or been sold by the Trading Trusts to date. This view is reflected in paragraph 318B of TR 2011/6 which has recently been amended to include Example 40A which is relevant to GMEs:

Example 40A

(emphasis added)

CGT event A1 - disposal of a GME

Each GME is tradeable on the ETM. When a GME is traded, CGT event A1 'Disposal of a CGT asset' happens under section 104-10 as a result of the change of ownership that occurs from you to another entity.

The first element of the cost base of a CGT asset under subsection 110-25(2) is the total of:

The phrase "in respect of" has been said to have the widest possible meaning of any expression intended to convey some connection or relation between the two subject matters to which the words refer (Trustees, Executors and Agency Co Ltd v Reilly (1941) VLR 110 at p 111). It is immaterial whether or not the consideration is paid or given to the seller of the asset. Paragraph 101 of Taxation Ruling TR 95/35: income tax: capital gains: treatment of compensation receipts, states that money or property are regarded as paid or given in respect of the acquisition of an asset if there is some direct and substantial link between the money or property and the acquisition of the asset.

The Commissioner considers that the GME Instalments are money paid 'in respect of' acquiring the GMEs and therefore form part of the first element of the cost base or reduced cost base of the GMEs. The GME Instalments are payments made in direct connection to the acquisition of the GMEs by each Trading Trust entering into the Deed of Assumption as part of the transfer of the GMEs from the vendors of the Relevant Venues. Therefore, the GME Instalments can be taken into account in working the capital gain or loss from any future disposal of the GMEs and, as such, will be excluded from being deductible under section 40-880 pursuant to paragraph 40-880(5)(f) unless subsection 40-880(6) applies.

Assumption of liability

Alternatively, the Commissioner considers that the GME Instalments also form part of the first element of the cost base of the GME assets under the assumption of liability rule. Under section 112-35, if you acquire a CGT asset from another entity that is subject to a liability, the first element of your cost base and reduced cost base of the asset includes the amount of the liability you assume. Given the GMEs were acquired with the Trading Trust entering into the Deed of Assumption to assume the liabilities to the State for the remaining instalments, section 112-35 could also apply.

CGT event C2 - expiry of a GME

Alternatively, if the Trading Trusts do not dispose of the GMEs, CGT event C2 'Cancellation, surrender and similar endings' will happen under paragraph 104-25(1)(c) upon the expiry of each GME after the 10 year period on 15 August 2022.

Under subsection 104-25(1), CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

The Macquarie Dictionary Online defines an 'intangible asset' as follows:

A GME is considered to be an intangible asset as it has no physical form but can be identified and given monetary value. Given a GME has a specified life, CGT event C2 will happen to a GME at expiry, assuming it is not sold or forfeited earlier.

Under subsection 104-25(3), you make a capital gain from CGT event C2 if the capital proceeds from the ending of the intangible asset are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

As discussed above, the GME Instalments that must be paid to the State in respect of the GMEs acquired is included in the first element of the cost base and reduced cost base of each GME. Therefore, the expenditure incurred to acquire each GME can be taken into account in working out the (likely) capital loss from the expiry of each GME. Accordingly, expenditure incurred on acquiring each GME will be excluded from a deduction under section 40-880 pursuant to the exclusion in paragraph 40-880(5)(f) unless subsection 40-880(6) applies.

Goodwill

Goodwill is a CGT asset that upon disposal can give rise to CGT event A1. Expenditure incurred to acquire goodwill is included in the first element of the cost base of goodwill.

Goodwill is not defined in the ITAA 1997. In Taxation Ruling TR 1999/16: Income tax: capital gains: goodwill of a business, the Commissioner provides his view on what is meant by the goodwill of a business, based on the legal definition of goodwill as explained by the High Court in the Murry case. Paragraph 12 of TR 1999/16 provides a useful summation of the meaning of goodwill:

The Commissioner considers that the GME Instalments incurred on acquiring the GMEs was not incurred to acquire goodwill but to acquire individual GMEs. A mere right to enter a market was held in Murry [at 68] not to be goodwill or even a source of goodwill.

As explained in paragraphs 27 and 126 of TR 1999/16:

Therefore the GME Instalments incurred on acquiring the GMEs did not result in the acquisition of goodwill; instead the GME Instalments are included in the cost base of the GMEs as separate CGT assets of the business acquired and then carried on by each of the Trading Trusts.

Subsections 110-25(5) and 110-25(5A)

Subsection 110-25(5) includes in the fourth element of the cost base of an asset capital expenditure incurred for the purpose or the expected effect of increasing or preserving the value of an asset. However, subsection 110-25(5A) states that the fourth element of the cost base of an asset does not apply to 'capital expenditure incurred in relation to goodwill.'

Therefore, subsection 110-25(5A) operates to exclude from the fourth element of the cost base of an asset expenditure that has the purpose or the expected effect of increasing or preserving the value of goodwill.

Family Group submit that the GME Instalments were incurred in relation to preserving the goodwill of the businesses acquired and then operated by the Trusts. This is on the basis that:

Family Group further contend that subsection 110-25(5A) supports their view that the GME Instalments on acquiring the GMEs is deductible under section 40-880 because of the effect that subsection 110-25(5A) has in removing expenditure in relation to goodwill from the fourth element of the cost base, thereby mitigating the exclusion under paragraph 40-880(5)(f) that could otherwise apply to deny the deduction under section 40-880.

The Commissioner does not consider that the proper characterisation of the GME Instalments resulted in the acquisition of any goodwill (as already discussed) or was in relation to preserving the goodwill of the Trading Trusts. Rather, it was expenditure incurred for the purpose of acquiring each GME which gave each Trading Trust the right to conduct a gaming business that it previously did not conduct. This right is in the form of a GME - a specifically identifiable asset with its own acquisition cost such that the expenditure incurred to acquire this right properly forms part of the first element of the cost base of this asset.

This is also the appropriate characterisation of the expenditure under the underlying asset approach (see TR 95/35: income tax: capital gains: treatment of compensation receipts). Under this approach, the relevant underlying asset here is the GME (together with the rights embodied in the GME), not goodwill, and the essential character of the expenditure in question here is expenditure incurred to acquire the GME, not expenditure to increase or preserve goodwill value. Therefore, neither subsections 110-25(5) nor 110-25(5A) can be relevantly engaged.

Further, subsection 110-25(5A) does not have the effect of preventing expenditure to acquire a CGT asset from forming part of the first element of the cost base of an asset (and consequently being excluded from deductibility under section 40-880 by paragraph 40-880(5)(f)). It merely prevents expenditure incurred in relation to goodwill from forming part of the fourth element of the cost base of an asset in order to ensure that such expenditure is still eligible for the more concessional treatment under section 40-880 if prescribed conditions are met.

Therefore on the basis that the GME Instalments are expenditures incurred to acquire each GME, they form part of the first element of the cost base of each GME and are not deductible under section 40-880; accordingly subsections 110-25(5) and 110-25(5A) are not relevant.

On the basis of the above explanation the GME Instalment expenditure would only be deductible to the Trading Trusts if the exception under subsection 40-880(6) applies.

Subsection 40-880(6) - an exception to the exclusions in subsection 40-880(5)

Subsection 40-880(6) states as follows:

Therefore, the exception in subsection 40-880(6) is satisfied if the following conditions are satisfied:

In relation to a legal or equitable right

As already discussed, in accordance with section 3.4A.2 of the Gambling Act, each GME confers (amongst other rights) the legal right to operate one gaming machine in an approved venue in the State. Therefore, the expenditure incurred to acquire the GMEs is in relation to the acquisition of a legal or equitable right. Therefore condition (a) is satisfied.

Preserving, but not enhancing, the value of goodwill

Family Group contend that the GME Instalments preserve but do not enhance the value of the goodwill of the business acquired by each Trading Trust. Relevantly, Family Group contends that for each Trading Trust:

Preserving the value of goodwill

The concept and meaning of goodwill has briefly been discussed in the context of subsection 110-25(5A). To satisfy subsection 40-880(6), the essential character of the expenditure must be to preserve the value of goodwill and have that effect - this is clear because the expenditure cannot have the effect of enhancing goodwill and expenditure which has nothing to do with the value of goodwill will not satisfy subsection 40-880(6).

The test in subsection 40-880(6) is whether objectively, the essential character of the expenditure is to preserve the value of goodwill. The essential character test is appropriate given the context and objects of section 40-880 and the construction of subsection 40-880(6) - the scope of which is intended to apply to expenditure of a very limited, prescribed nature. It is also consistent with the 'underlying asset' approach (see TR 95/35: income tax: capital gains: treatment of compensation receipts) which focuses on the substance/reality of the relevant matter or transaction. The Commissioner considers that the GME Instalments were incurred to acquire a specific identifiable asset i.e. a GME which is a right to operate a gaming machine, and not to preserve the value of goodwill (being the attractive force of custom arising from carrying on the business as a whole).

While the ability to continue the business acquired by each Trading Trust depended, in part, on acquiring the GMEs, this does not mean that the value of goodwill is preserved merely by the incurrence of the expenditure to acquire the GMEs. To do so would ignore the substance of the expenditure and the important rights inherent in the GMEs themselves. Taking a broad interpretation would permit effectively any business expenditure to fall within the scope of subsection 40-880(6), no matter how remote, since all business expenditure has a connection to the goodwill of the business ultimately. This is contrary to the provision's object which serves to relieve expenditure that does nothing else apart from preserving the value of goodwill of a business.

The Commissioner considers that the essential character of the relevant expenditure was directed at acquiring assets in the form of GMEs, rather than being in relation to preserving the goodwill value of the business acquired by each Trading Trust. The expenditure simply was not directed at preserving the value of goodwill that emanated from combining the use of all the existing assets of the business of the Trading Trusts, rather it was expenditure to acquire a set of rights and assets.

In summary, the Commissioner does not accept that the essential character of the expenditure is directed solely at preserving the value of the goodwill of the Trading Trusts. Furthermore, the Commissioner does not accept that the Trading Trusts have each satisfied the remaining condition in subsection 40-880(6) concerning the value of the right being solely attributable to the effect the right has on preserving goodwill value (if indeed any). This is explained further below.

The value to you of the right is solely attributable to the effect that the right has on goodwill

For the exception under subsection 40-880(6) to apply, the Commissioner must also be satisfied that the 'value to you of the right is solely attributable to the effect that the right has on goodwill.' When read in its context, the effect that the right has can only be to preserve the value of goodwill, if the operation of subsection 40-880(6) is to be engaged. The 'you' referred to in subsection 40-880(6) refers to each of the Trading Trusts which have incurred the GME Instalments.

The Commissioner believes that there are two components to this last requirement in subsection 40-880(6), namely:

Value to you of the right

In considering the value of a right to a taxpayer, the Commissioner considers that this involves a consideration of the objective value of the right, rather than the subjective value of the right in the mind of the taxpayer. While the Commissioner accepts that the 'value to you' concept has regard to your intention of how you will realise that value, in this case, through holding the GME in order to operate a gaming machine, rather than through selling it, the meaning of 'value to you' cannot be completely devoid of all objectivity. Nor does 'value to you' preclude the consideration of market value if there is one. A GME confers the right to operate a gaming machine and has a value to you (through use as opposed to through sale) that reflects the net present value of the future profits that you expect to derive from operating the gaming machine as authorised by the GME for the life of the entitlement. It is an item of valuable property in accordance with the High Court's observations in Murry (as cited earlier in this ruling with respect to CGT assets).

The Commissioner does not regard the words 'value to you' in subsection 40-880(6) as having the effect that the value of the right can only be subjectively determined by the taxpayer. 'Value to you' is not to be interpreted as 'value according to you', 'value in your mind' or 'value to you and you alone' but rather 'value to you or someone in a similar situation to you'.

The expression 'value to you' is required in the context of subsection 40-880(6) because rights which merely preserve the goodwill value attaching to a taxpayer's business can only ever have value to the taxpayer carrying on the business and no one else. They are rights that have no distinct or inherent value other than preserving the goodwill value of a business. Therefore, the term 'value to you' is used essentially to overcome the limitation of the absence of a market for the type of right that falls within the scope of subsection 40-880(6).

The Commissioner notes that the expression 'value to you' is used in section 15-2 and in the former paragraph 26(e) of the ITAA 1936. However, the use of the expression in that particular instance is of limited significance to the interpretation of subsection 40-880(6) which is worded differently and arises in a completely different context. Whereas the former paragraph 26(e) of the ITAA 1936 relates to the determination of whether there is a benefit given, granted or allowed to the taxpayer whose value has to be determined, subsection 40-880(6) is about providing relief as a black hole deduction for certain expenditures that do no more than preserve the value of the goodwill of a business. The context is entirely different and adopting the interpretation under one provision for the purpose of interpreting another is inappropriate and is of limited practical use.

Solely attributable to the effect the right has on preserving goodwill

The Commissioner believes the words 'attributable' involves a relationship of cause and effect, similar to the interpretation of that word in Commissioner of Taxation v. Sun Alliance Pty Ltd (in liq) (2005) 225 CLR 488; [2005] HCA 70; ATC 4955; ATR 560.

The existence of the word 'solely' before 'attributable' requires a narrow nexus between the subject matters [the value of the right and the effect of the right on goodwill value]. The reference to 'solely attributable' implies that there can be no other objective reason, effect or purpose in incurring the expenditure and no other value attached to the right other than its effect on preserving goodwill value.

Therefore, the words 'solely attributable' preclude rights which have an inherent value. Support for this is found in the following extracts of the EM which include clear references to the distinct objective or inherent value of the right.

This view is consistent with the view expressed in paragraph 317 of TR 2011/6:

A GME confers valuable statutory rights to the holder that are also tradeable, if the holder so chooses, in a regulated transfer scheme. As discussed, the Commissioner considers that a GME is property, and if not property, then at least a valuable right that is not property. The Commissioner considers that a GME is an asset with an inherent value (reflecting the net present value of the expected future profits that can be derived from operating a gaming machine which a GME authorises for ten years) which precludes it from being a right whose value is solely attributable to the effect the right has on preserving the goodwill value of a business. As a result, a deduction is not allowable for the cost of acquiring this distinct and valuable asset under section 40-880 as a business related cost since the expenditure does not represent a loss to the taxpayer.

Therefore the requirements in subsection 40-880(6) are not satisfied. This view is reflected in Example 40A of TR 2011/6 which has recently been amended to include that example. Although the example is in relation to the application of subsection 40-880(6) to an ongoing gaming and hospitality business, the Commissioner considers that the same principles would apply to the purchase of an ongoing business where the expenditure in question under section 40-880 involves the purchaser assuming liabilities for the GME Instalments.

Black hole deductions - measure of last resort

Instead, the GME Instalments incurred on acquiring each GME will form part of the first element of the cost base of each GME as a CGT asset, upon either their disposal or expiration as the case may be. This result is consistent with the policy that the deduction under section 40-880 is for business capital expenditure that is not recognised in some way elsewhere in the tax law. This is reflected in both the objects of section 40-880 and throughout the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006:

The objects of section 40-880, as stated in subsection 40-880(1):

Paragraphs 2.9 and 2.17 of the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006 state:

(emphasis added)

Section 40-880 is a provision of last resort and priority is given to the treatment in other provisions of the tax law, as reflected in the list of exclusions under subsection 40-880(5). Accordingly, since the expenditure to acquire each GME is taken into account by the CGT provisions, a deduction under section 40-880 is not allowable.

Question 2

Detailed reasoning

The GME Reimbursements are expenses each Trading Trust incurred on the purchase of their business for which they were contractually obliged under each contract of sale of business to reimburse the vendor. The GME reimbursements have been calculated as the difference between the GME Instalments paid by the vendor and the proportion of the total cost of the GMEs that relates to the period during which the GME was in effect (for the vendor), as a proportion of the ten years for which the GME is valid.

The deduction available under section 40-880(2)

Under subsection 40-880(2), you can deduct, in equal proportions over a period of five income years starting in the year in which you incur it, capital expenditure that is incurred 'in relation to your business' or 'in relation to a business proposed to be carried on.'

Family Group makes the following contentions with respect to the GME Reimbursements:

Business capital expenditure

The Commissioner agrees that the GME Reimbursements are capital expenditures in relation to the prospective business each Trading Trust proposed to carry on at the time it entered into the contract to purchase the business. As discussed in the context of the GME Instalments, the Sun Newspapers and AusNet decisions provide guidance on the characterisation of an expense. For the same reasons applicable to the GME Instalments, the Commissioner regards the GME Reimbursements to be capital receipts on the basis that from a practical and business point of view, the GME Reimbursements are:

Incurred

A review of each BSA reveals that although there is provision for the purchaser to make the GME Reimbursements, this is conditional in each case on the Relevant State/Minister granting approval for the transfer. Without such an approval, no liability to make the payment will arise. As explained in TR 97/7, for an expense to be incurred a presently existing liability must exist and a liability that is contingent will not be a presently existing liability. The Commissioner's view is that the GME Reimbursement expenses are conditional on the Relevant State/Minister approving the transfer and therefore are only 'incurred' when this happens. Despite the BSA, a pecuniary liability did not exist at this time because it was still conditional on the approval and registration of the transfer by the Relevant State. The liability to pay was not due until settlement of the sale and the actual transfer of the GMEs.

Support for this outcome can be found in the Full Federal Court case of FC of T v Malouf [2009] FCAFC 44; ATC 20-099. In this case, a taxpayer's obligation to pay the balance of the purchase price under a contract for the sale of land was conditional on the vendor completing the first stage of the development project. The court held that the contract was not an unconditional agreement and the taxpayer's obligation to pay under the contract was “dependent upon… the happening of events which were anticipated but were under the control of neither party.” Therefore, the liability was not incurred upon entering of the contract but upon the satisfaction of the condition.

In summary, the obligation of the Trading Trust to make the GME Reimbursements are provided for in the BSA and are therefore business capital expenditure incurred by each Trading Trust on the date when the Relevant State approves each transfer. The expenditures would be deductible under subsection 40-880(2) in the year they are incurred, provided the exclusions under subsection 40-880(5) do not apply.

EXCLUSIONS TO DEDUCTIBLITY UNDER SECTION 40-880

Depreciating asset exclusion - subsection 40-880(5)(a)

As discussed in Question 1, the GMEs are not among the intangible assets listed in subsection 40-30(2) and therefore are not depreciating assets as defined in subsection 40-30(1). Therefore, the GME Reimbursements do not form part of the cost of a depreciating asset and paragraph 40-880(5)(a) does not apply.

Deductible under a provision of this Act other than this section exclusion - paragraph 40-880(5)(b)

As the Commissioner has already determined above, the expenditures incurred on acquiring
the GMEs are capital in nature and therefore excluded from the general deduction under section 8-1. The Commissioner considers there is no other provision of this Act under which the expenditure could be deductible, apart from section 40-880.

Therefore, the exclusion under paragraph 40-880(5)(b) does not apply to prevent the GME Reimbursements from being deductible under section 40-880.

Lease or other legal/equitable right exclusion - paragraph 40-880(5)(d)

For the same reasons given in Question 1 in relation to the GME Instalments, the Commissioner considers that the exclusions under paragraph 40-880(5)(d) can apply. This is on the basis that the GME Reimbursements are in relation to acquiring GMEs which are a 'legal right' to operate a gaming machine. This has been accepted by Family Group in its private ruling application.

Taken into account in working out the amount of a capital gain or capital loss from a CGT event exclusion - paragraph 40-880(5)(f)

The first element of the cost base of a CGT asset under subsection 110-25(2) is the total of:

Family Group recognises the possibility that the reimbursements could be taken into account when calculating the capital loss incurred by the Trading Trusts upon expiration of its GMEs.

For similar reasons given in respect of the GME Instalments, the Commissioner considers that there is a direct link between the GME Reimbursements and the acquisitions of the GMEs such that the GME Reimbursements are monies paid 'in respect of' acquiring the GMEs and therefore are included in the first element of the cost base of a GME asset. Therefore, the GME Reimbursements are expenditures that could be taken into account in working out the amount of a capital gain or capital loss from the disposal of a GME (CGT event A1) or expiry of a GME (CGT event C2).

In summary, both the exclusions in paragraphs 40-880(5)(d) and (f) could apply to the GME Reimbursements. Therefore, it is necessary to consider the application of the exception to the exclusions under subsection 40-880(6).

Subsection 40-880(6) exception

Family Group makes the following contentions on why they believe the exception under subsection 40-880(6) should apply:

As discussed, the exception in subsection 40-880(6) is satisfied if the following conditions are satisfied:

In relation to a legal or equitable right

As already discussed, in accordance with section 3.4A.2 of the Gambling Act, each GME confers (amongst other rights) the legal right to operate one gaming machine in an approved venue in the State. Therefore, the GME Reimbursements incurred on acquiring the GMEs is in relation to the acquisition of a legal or equitable right.

Therefore condition (a) is satisfied

Preserving the value of goodwill

As discussed in the context of the GME Instalment expenditures in Question 1, the Commissioner's view of this requirement is as follows:

The Commissioner considers that the essential character of the relevant expenditure was directed at acquiring assets in the form of GMEs, rather than being in relation to preserving the goodwill value of the businesses acquired by each Trading Trust. While the ability to continue the business acquired by each Trading Trust depended, in part, on acquiring the GMEs, this does not mean that the value of goodwill is preserved merely by the incurrence of the expenditure to acquire the GMEs. To do so would ignore the substance of the expenditure and the important rights inherent in the GMEs themselves.

In summary, the Commissioner does not accept that the essential character of the expenditure is directed solely at preserving the value of the goodwill of the businesses acquired by the Trading Trusts. Furthermore, the Commissioner does not accept that the Trading Trusts have each satisfied the remaining condition in subsection 40-880(6) concerning the value of the right being solely attributable to the effect the right has on preserving goodwill value (if indeed any). This is explained further below.

The value to you of the right is solely attributable to the effect that the right has on goodwill

In relation to the 'value to you' aspect of subsection 40-880(6), the Commissioner's view as already discussed above is as follows:

In relation to whether the value of the right is 'solely attributable' to goodwill, the Commissioner considers that:

The Commissioner considers that a GME is an asset with an inherent value (reflecting the net present value of the expected future profits that can be derived from operating a gaming machine which the GME authorises for 10 years) which precludes it from being a right whose value is solely attributable to the effect the right has on preserving the goodwill value of a business.

As a result, a deduction is not allowable for the cost of acquiring this distinct and valuable asset under section 40-880 as a business related cost since the expenditure does not represent a loss to the taxpayer. Therefore the requirements in subsection 40-880(6) are not satisfied.

This is consistent with Example 40A which has recently been inserted in TR 2011/6 and already cited.

Black hole deductions - measure of last resort

The GME Reimbursements will form part of the cost base of the GME as a CGT asset, upon either their disposal or expiration as the case may be. This result is consistent with the policy that the deduction under section 40-880 is for business capital expenditure that is not recognised in some way elsewhere in the tax law. This is reflected in both the objects of section 40-880 and throughout the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006. Section 40-880 is a provision of last resort and priority is given to the treatment in other provisions of the tax law, as reflected in the list of exclusions under subsection 40-880(5). Accordingly, since the GME Reimbursements incurred to acquire the GMEs are taken into account by the CGT provisions, a deduction under section 40-880 is not allowable.

Question 3

Summary

Not applicable, as the answer to Question 1 and Question 2 is No.

Question 4

Summary

Not applicable, as the answer to Question 1 and Question 2 is No.

Question 5

Summary

Not applicable, as the answer to Question 1 and Question 2 is No.

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