Edited version of private advice

Authorisation Number: 1051817522007

Date of advice: 22 March 2021

Ruling

Subject: Royalty rights

Question

Is the consideration received by the Trustee of the Trust from the sale of Rights assessable under the Capital Gains Tax (CGT) provisions in Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

1 July 2020 to 30 June 2021

The scheme commences on:

1 July 2020

Relevant facts and circumstances

Background

The Trust is adiscretionary trust established by a trust deed.

The Trust has no history of trading in Rights or in assets generally. It is not and has never carried on a business, deriving its income only from passive long-term investment assets held on capital account.

The Trust has previously derived income, profits or gains from the sale of assets held on capital account; it has not derived any income from the sale of revenue assets, its investment portfolio all bearing the characteristics of capital assets.

The Trust's recurring income has principally arisen from the receipt of dividends.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 15-20

Income Tax Assessment Act 1936 subsection 6(1)

Reasons for decision

Summary

The consideration received by the Trustee of the Trust from the sale of the Rights is assessable under the Capital Gains Tax (CGT) provisions in Part 3-1 of the ITAA 1997.

Detailed reasoning

The sale of rights can be assessable under section 6-5 of Income ITAA 1997 if they are income in nature, and under section 6-10 of ITAA 1997 if they are capital in nature.

Subsection 6-5(1) of the ITAA 1997 states that:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

Profit or gain arising from an isolated business or commercial transaction will generally be ordinary income if the taxpayer's purpose in entering into the transaction was to make a profit. This would be the case even if the transaction was not part of the taxpayer's ordinary course of business.

The proceeds from the sale of the rights can also be treated as statutory income under the CGT provisions (sections 10-5 and 102-5 of the ITAA 1997) on the basis that a capital gain has been realised from the disposal of a CGT asset under CGT event A1.

The facts outline that the sale of the rights was not considered part of the Trust's ordinary business operations.

Isolated business transaction or a profit-making undertaking

While holding an asset for a considerable period of time may seem to indicate that it is a long-term capital asset, the intention of the taxpayer at the time of acquisition and throughout the ownership period is a crucial aspect.

Taxation Ruling TR 92/3 - Income tax: whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are income and therefore assessable. In the Ruling the term 'isolated transactions' refers to:

(a) transactions outside the ordinary course of business of a taxpayer carrying on a business, and

(b) transactions entered into by non-business taxpayers.

The Ruling sets out the view of the Commissioner as to the application of the decision of the Full Court of the High Court of Australia in FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer Emporium). Profits arising from an isolated business or commercial transaction will be assessable income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business.

The principles in Myer Emporium are not conclusive statutory tests. They are general principles to be considered in deciding whether a profit is income.

Whether a profit from an isolated transaction is income according to ordinary concepts depends on the circumstances of the case. It is generally income when both of the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

The intention or purpose of the taxpayer (of making a profit or gain) is the taxpayer's intention or purpose discerned from an objective consideration of the facts. Paragraph 9 of TR 92/3 states:

The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

In terms of the sale of the Rights the intention or purpose of the Trustee of the Trust at the time of acquiring the rights is an important consideration.

Some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are not limited to but include the following:

•         the nature of the entity undertaking the transaction;

•         the nature and scale of other activities undertaken by the taxpayer;

•         the manner in which the transaction was entered into or carried out;

•         the nature of the property; and

•         the timing of the transaction or the various steps in the transaction.

Applying principles from cases and TR 92/3 to the facts, the Commissioner considers that the proceeds from the sale of the Rights will not be ordinary income derived from a profit-making undertaking or scheme.

On this basis, the requisite profit-making purpose has not occurred during or after the trustee of the Trust's acquisition of the Rights, to establish that proceeds received by the Trustee of the Trust from the sale of the Rights will be considered ordinary income derived from a profit-making undertaking or scheme.

Therefore, proceeds from the sale of the Rights will not constitute ordinary income for the Trustee of the Trust under section 6-5 of the ITAA 1997.

Capital Gains Tax (CGT) provisions in Part 3-1 of the ITAA 1997

Under section 6-10 of the ITAA 1997, assessable income also includes amounts that are not ordinary income but are included as assessable income by provisions of the tax law. These amounts are called 'statutory income'. Capital gains are an example of statutory income.

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes their net capital gain (if any) for the income year. As a general rule, a taxpayer is required to include in their assessable income any capital gain they make from a CGT event that happens to a CGT asset the taxpayer acquired on or after 20 September 1985. Pursuant to section 108-5 of the ITAA 1997, a CGT asset is any kind of property, or a legal or equitable right that is not property. Accordingly, rights are CGT assets.

In this case the proceeds the Trustee of the Trust has received from the sale of its interest in the Rights are not assessable as ordinary income.

The Trustee of the Trust held its interest in the Rights as a capital asset. As a mere realisation of a capital asset, the proceeds from the sale of the Rights will be subject to the CGT provisions provided in Part 3-1 and Part 3-3 of the ITAA 1997.

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