Edited version of private ruling

Authorisation Number: 1011862860792

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: Balancing adjustment event under section 40-295 of the Income Tax Assessment Act 1997

Did a balancing adjustment event under section 40-295 of the Income Tax Assessment Act 1997 (ITAA1997) happen for the seller in relation to the disposal of a part interest in the intangible depreciating asset on the Completion Date of the sale agreement?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2009.

The scheme commences on:

1 July 2008.

Relevant facts and circumstances

· Pursuant to a written contract of sale (the sale agreement), the seller agreed to sell to the purchaser part of its interest in the intangible depreciating asset (the asset).

· The sale agreement was executed on the Execution Date.

· Completion of the sale agreement was subject to conditions precedent.

· Under the terms of the sale agreement, the sale and purchase of the asset was deemed to have taken place with effect on and from the Effective Time. The risk and benefit of that asset also passed to the purchaser on and from the Effective Time.

· The sale agreement was completed on the Completion Date.

· The transfer of ownership in the asset was subject to requirements under State laws.

· Simultaneously on the Execution Date, the seller and the purchaser executed a joint operating agreement (JOA) with respect to the asset.

· Under the JOA, the seller and purchaser agreed to carry out certain activities with respect to the asset from the Effective Date of the JOA.

· Pursuant to the JOA, the seller would carry out the activities on behalf of both parties.

· The Effective Date of the JOA was defined to mean the Completion Date under the sale agreement.

Reasons for decision

Summary

A balancing adjustment event occurred under section 40-295 of the ITAA 1997 for the seller when the seller stopped holding a part interest in the intangible depreciating asset on the Effective Date of the JOA, being the Completion Date of the sale agreement.

Detailed reasoning

Under section 40-295 of the ITAA 1997 a 'balancing adjustment event' occurs for a depreciating asset if, among other things, the entity stops holding all or part of the asset.

Depreciating asset

A depreciating asset is defined in section 40-30 of the ITAA 1997. Pursuant to paragraph 40-30(1)(c) of the ITAA 1997, an intangible depreciating asset is excluded from the definition of a depreciating asset unless it is specifically listed in subsection 40-30(2) of the ITAA 1997. On the facts, the asset is an intangible depreciating asset listed in subsection 40-30(2) of the ITAA 1997.

The holding rules in Division 40 of the ITAA 1997

The table in section 40-40 of the ITAA 1997 is used to work out who holds a depreciating asset. The first nine items are specific items because they apply to particular depreciating assets in different circumstances. Item 10 of the table in section 40-40 applies to any depreciating asset. As the specific items of the table apply in preference to the general item, item 10 applies as a default rule.

In this case, Item 5 of the table in section 40-40 of the ITAA 1997 is the relevant item to consider.

Item 5 of the table in section 40-40 of the ITAA 1997

Item 5 of the table in section 40-40 of the ITAA 1997 provides that the economic owner, and not the legal owner, is the holder of an intangible depreciating asset that is a right, if the following four requirements are satisfied:

1. There is an intangible depreciating asset which is a right that an entity legally owns (the legal owner)

The asset is a part interest in an intangible depreciating asset which is a right that was legally owned by the seller at the Completion Date.

2. Another entity (the economic owner) exercises the right, or has a right to exercise it immediately

The second requirement of item 5 of the table in section 40-40 of the ITAA 1997 is discussed in paragraph 1.35 of the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 (the EM), which introduced Division 40. Paragraph 1.35 of the EM provides that another entity must exercise the 'subject matter' of the right, or have the right to exercise it immediately.

In this case, in order for the purchaser to be exercising the subject matter of the right for the purposes of item 5 of the table in section 40-40 of the ITAA 1997, the Commissioner considers that the purchaser must be exploiting the inherent character of that right. The Commissioner considers that the purchaser may appoint another entity to exploit the inherent character of the right on their behalf.

On the facts, the purchaser was exploiting the inherent character of the right on and from the Effective Date of the JOA under which the seller performed contractual obligations on behalf of the purchaser. The purchaser became the economic owner of the right on and from the Effective Date of the JOA.

As the Effective Date of the JOA was defined as the Completion Date of the sale agreement, it can be said that at the Completion Date the purchaser was able to exercise the subject matter of the right.

3. The economic owner has a right to become the right's legal owner

The sale agreement gave the purchaser the contractual right to acquire the asset. This right arose on and from the Execution Date. The sale agreement contained conditions precedent to performance of the agreement, but those conditions did not extinguish the purchaser's right to become the legal owner of the asset until such time as those conditions were not met and the agreement was terminated.

The purchaser's contractual right to become the legal owner in this circumstance is sufficient for the purposes of this requirement.

4. It is reasonable to expect that the economic owner will become the legal owner of the right; or the right will be disposed of at the direction and for the benefit of the economic owner

Taxation Ruling TR 2005/20 Income tax: the interaction of deemed ownership under Division 240 of the Income Tax Assessment Act 1997 with the 'holding' rules in Division 40 of the ITAA 1997, considers the meaning of 'reasonable to expect' in the context of item 6 of the table in section 40-40 of the ITAA 1997. Paragraph 28 of TR 2005/20 states that:

The cases suggest for it to be 'reasonable to expect' something to occur requires a sufficiently reliable prediction that it will occur, or at least an expectation or prediction based on reasonable grounds.

It is the Commissioner's view that the meaning of 'reasonable to expect' in item 6 of the table in section 40-40 of the ITAA 1997 will be the same for the purposes of item 5 of the table in section 40-40.

By entering into the sale agreement and the JOA, the purchaser has, on the facts, accepted economic ownership in the asset and the risks and benefits that accompany such ownership by committing to these risks and financial obligations. It is considered that the purchaser would not have entered into the sale agreement and accepted these risks and financial obligations if it did not have a sufficiently reliable prediction, based on reasonable grounds, that it would become the legal owner of the asset.

Accordingly, it is reasonable to expect that the purchaser will become the legal owner of the asset from the Execution Date of the sale agreement and JOA.

In conclusion, all the requirements of item 5 of the table in section 40-40 of the ITAA 1997 were satisfied at the Effective Date of the JOA (being the Completion Date under the sale agreement) and therefore, the asset was held by the economic owner (i.e. the purchaser) on and from that date.

Pursuant to paragraph 40-295(1)(a) of the ITAA 1997, a balancing adjustment event occurred when the seller stopped holding the asset. The seller stopped holding the asset when the purchaser started to hold the asset as the asset's economic owner under item 5 of the table in section 40-40 of ITAA 1997 on the Effective Date of the JOA (i.e. the Completion Date under the sale agreement). Accordingly, on the facts, a balancing adjustment event occurred for the seller on the Effective Date of the JOA, being the Completion Date under the sale agreement.