Edited version of your private ruling

Authorisation Number: 1012167665625

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 fac 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. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Acquisition of an intangible asset

Question 1

Will the intangible asset be a separately identifiable asset for the purposes of Part 3-90 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

If the intangible asset is a separately identifiable asset for the purposes of Part 3-90 of the ITAA 1997, is the tax cost setting amount allocated to it taken to be an outgoing incurred by the head company at the joining time according to subsection 701-55(6) of the ITAA 1997 and deductible under section 8-1 of the ITAA 1997?

Answer

A ruling is not required in view of the answer on question 1.

Question 3

If the intangible asset is a separately identifiable asset for the purposes of Part 3-90 of the ITAA 1997, is the tax cost setting amount allocated to it form the cost of a depreciating asset under Division 40 of the ITAA 1997 in accordance with subsection 701-55(2) of the ITAA 1997?

Answer

A ruling is not required in view of the answer on question 1.

Question 4

If the intangible asset is a separately identifiable asset for the purposes of Part 3-90 of the ITAA 1997, is the tax cost setting amount allocated to it form part of the cost base of a CGT asset under Part 3-1 of the ITAA 1997 in accordance with subsection 701-55(5) of the ITAA 1997?

Answer

A ruling is not required in view of the answer on question 1.

Question 5

If the intangible asset is a separately identifiable asset for the purposes of Part 3-90 of the ITAA 1997, is the tax cost setting amount allocated to it taken to be an outgoing incurred by the head entity at the joining time according to subsection 701-55(6) and deductible over 5 years in accordance with section 40-880 of the ITAA 1997?

Answer

A ruling is not required in view of the answer on question 1.

This ruling applies for the following periods:

Year ended 30 June 2008

Relevant facts and circumstances

In the year ended 30 June 2008, the head entity of a tax consolidated group acquired all of the shares of a joining entity. At the date of acquisition, the joining entity's balance sheet recorded an accounting asset in respect of an intangible asset.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 701-10

Income Tax Assessment Act 1997 Section 701-55

Income Tax Assessment Act 1997 Division 705

Income Tax Assessment Act 1997 Section705-35

Reasons for decision

Note: Unless otherwise specified, the legislative references below are to the Income Tax Assessment Act 1997.

Question 1

Summary

The intangible asset is not recognised as a separately identifiable asset for the purposes of Part 3-90.

Detailed reasoning

Subsection 701-10(4) provides that:

Each asset's tax cost is set at the time the entity becomes a *subsidiary member of the group at the asset's *tax cost setting amount.

Subsection 701-10(2) identifies the assets to which this provision applies. It states:

This section applies in relation to each asset that would be an asset of the entity at the time it becomes a *subsidiary member of the group, assuming that subsection 701-1 (the single entity rule) did not apply.

The object of this section, and Division 705 to which it relates, is to recognise the cost to the head company of such assets as an amount reflecting the group's cost of acquiring the entity (subsection 701-10(3)).

The asset's tax cost setting amount is worked out in accordance with Division 705. In particular, subsection 705-35(1) provides:

For each asset of the joining entity (a reset cost base asset) that is not a retained cost base asset or an asset (an excluded asset) covered by subsection (2), the asset's tax cost setting amount is worked out by:

· first working out the joined group's allocable cost amount for the joining entity in accordance with section 705-60; and

· then reducing that amount by the total of the tax cost setting amounts in accordance with section 705-25 for each retained cost base asset (but not below zero); and

· finally allocating the result to each of the joining entity's reset cost base assets (other than excluded assets) in proportion to their market values.

The term 'asset' is not defined in the ITAA 1997. The Explanatory Memorandum to the New Business Tax System (Consolidation) Bill (No. 1) 2002 states at paragraph 5.19 that:

An asset, for the purpose of the cost setting rules, is anything of economic value which is brought into a consolidated group by an entity that becomes a subsidiary member of the group (emphasis added).

Taxation Ruling TR 2004/13 deals with the meaning of an asset for the purposes of Part 3-90 of the ITAA 1997. TR 2004/13 at paragraphs 5 and 6 states that:

an asset for the purpose of the tax cost setting rules is anything recognised in commerce and business as having economic value to the joining entity at the joining time for which a purchaser of its membership interests would be willing to pay. The business or commercial assets of a joining entity would include the things that would be expected to be identified by a prudent vendor and purchaser as having value in the making of a sale agreement in respect of all the membership interests in an entity and its business. These assets would also come within the scope of a due diligence examination undertaken on behalf of a prudent purchaser of such an entity and business.

The commercial or business meaning of an asset in Part 3-90 is not limited to assets that would be recognised under accounting standards or statements of accounting concepts. Internally generated assets would not normally be disclosed in the financial statements of a joining entity prepared in accordance with generally accepted accounting principles when they do not possess a cost or other value that can be measured reliably. However, these assets would be identified under the wider criteria that apply for the consolidation tax cost setting rules (emphasis added).

All assets of a joining entity that exist at the joining time are recognised as assets for tax cost setting purposes. Goodwill is one of those assets. TR 2005/17 provides guidance as to the identification and valuation of goodwill for the purposes of Part 3-90. Paragraph 5 states that:

Goodwill can be valued for the purposes of Part 3-90 of the ITAA 1997 using a residual value approach except in situations where the law has recognised that a residual value approach will not identify goodwill, as legally defined.

The residual value approach entails working out the difference between the market value of each business of the entity and the market value of the net identifiable assets of each business of the entity. Paragraph 7 of TR 2005/17 states:

In identifying assets and liabilities for the purpose of working out the value of the net identifiable assets of each business of the entity, both the commercial notion of assets and liabilities and the commercial basis of working out their value are used. This is because assets in consolidation cost setting are the assets that would be identified for commercial or business purposes in an acquisition (emphasis added).

Paragraph 9 of TR 2005/17 states:

The assets taken into account for the commercial residual value calculation are the commercial or business assets of the business. The identity of these assets may differ from assets identified in accounting reports and the values may also be different.

The taxpayer contends that based on the relevant accounting standards the intangible asset was recognised in the accounts of the taxpayer after the acquisition of the joining entity and as this asset is recognised for accounting purposes it should also be separately identified for the purpose of Part 3-90.

However, this view should be considered in context, particularly with reference to paragraph 19 of TR 2004/13 which states:

the presence of a legislative definition of a liability [in subsection 705-70(1) of the ITAA 1997] and the absence of such a definition for an asset shows that the identification and recognition of an asset for tax cost setting rules is not simply to be found by reference to definitions in accounting standards and statements of accounting concepts (emphasis added).

Firstly, it is clear from the reading of TR 2004/13 and TR 2005/17 as a whole, that for the purposes of the tax cost setting process, the focus is on the recognition of an asset from a commercial and business sense in that the thing being recognised must have economic value for which a purchaser of its shares or other membership interests would be willing to pay.

The reference to assets not being limited to those recognised under accounting standards, in paragraph 6 of TR 2004/13, is made in the context of assets that are not recognised for accounting purposes despite the fact that they have economic value for which an acquirer is willing to pay. It is stated at paragraph 27 of TR 2004/13 that:

[t]he financial statements of a joining entity would not usually record assets such as goodwill, mining information, patents, licences, and copyrights which have been generated internally. These assets are not recognised for financial reporting purposes when they do not have a cost or other value that can be measured reliably. However these assets would be recognised by a purchaser and vendor as having some value and would be reflected in the sale price of the membership interests and business of the entity. They would also be within the scope of a due diligence examination carried out on behalf of a prudent purchaser. They are consequently commercial or business assets.

These assets are recognised as assets for tax cost setting purposes despite not being recognised as assets for accounting purposes.

Consequently an asset recognised for accounting purposes is not necessarily, nor automatically, recognised as an asset for tax cost setting purposes unless it falls within the scope of what constitutes a commercial or business asset. Therefore the taxpayer's reliance on accounting standards to demonstrate that the intangible asset is a separately identifiable asset for Part 3-90 purposes is not persuasive.

As stated above in relation to TR 2004/13, to be recognised as an asset for tax cost setting purposes the 'thing' must be recognised in commerce and business as having economic value to the joining entity at the joining time for which a purchaser of its membership interests would be willing to pay.

This is an objective test, which can be framed, relative to these facts, as what 'thing' of the joining entity can be recognised in commerce and business as having economic value to the joining entity at the joining time for which a purchaser would be willing to pay? To this end, it needs to be considered, would an acquiring entity consider the intangible asset having an economic value when considering acquiring membership interests in another entity?

At the joining time, the joining entity attributes some value to the intangible asset. At this point in time, this value was solely available to the joining entity, i.e., at that point in time, the joining entity can discontinue to make certain payments under a contract until a specified period of time ('payment holiday').

The payment holiday can be of economic value to an entity as it potentially represents future cost savings. However the actual value of the economic benefit is directly correlated to the likelihood/probability of the payment holiday continuing. In determining whether the payment holiday available to the joining entity at the joining time had economic value to the joining entity, reference can be made as to whether a purchaser would be willing to pay for it.

On the basis of available evidence, the potential asset to be recognised for tax cost setting purposes, being the payment holiday available to the joining entity at the joining time, had no economic value for which a purchaser was willing to pay. In which case there is no commercial or business asset to be recognised for tax cost setting purposes on these facts, notwithstanding that an accounting surplus existed in relation to the assets and liabilities at the date of acquisition.