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Ruling

Subject: Disposal of assets and associated licences

Question 1

Is the taxpayer assessable on any gain, or entitled to a deduction on any loss, arising from the disposal of the assets to the other entity under Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is the taxpayer assessable on any gain arising from the disposal of the assets licences to the other entity under Part 3-1 of the ITAA 1997?

Answer

Yes

Question 3

Is the cash grant an allowable deduction under section 8-1 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

1 July 2011 - 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The taxpayer has entered into an arrangement with another entity to establish a permanent 'home base' at the other entity's premises.

Under the arrangement, the taxpayer agreed to:

· transfer all its assets for the purchase price of $xxx amount;

· transfer all its licences to use the assets for the purchase price of $yyy amount;

· make a cash payment to the other entity. This payment is a grant and the other entity is not required to repay or refund it to the taxpayer under any circumstances.

In return, the taxpayer has acquired from the other party the right to certain benefits to be provided by the other entity in perpetuity at no cost.

The taxpayer has determined the net annual present value of these benefits primarily based on the Australian government bond rates and discount rates.

The assets have a negligible market value as they are required to be replaced every few years and their adjustable value is much higher than the agreed sale value. The licences are the more valuable assets and the valuation of $yyy was determined by a consultant.

Relevant legislative provisions

Income Tax Assessment Act 1997

Subsection 40-30(1)

Subsection 40-30(2)

Section 40-285

Subsection 40-295(1)

Section 40-300

Section 108-5(1)

Section 104-10

Section 110-25

Section 116-20

Reasons for decision

Question 1

Depreciating assets

A depreciating asset is defined in 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 specifically excludes land, trading stock, and intangible assets except for those listed in subsection 40-30(2).

Subsection 40-295(1) provides that a balancing adjustment event occurs for a depreciating asset if:

(a) you stop holding the asset; or

(b) you stop using it, or having it installed ready for use, for any purpose and you expect never to use it, or have it installed ready for use, again; or

(c) you have not used it and:

if you have had it installed ready for use - you stop having it so installed; and you decide never to use it

For most depreciating assets, a balancing adjustment is worked out under section 40-285 by comparing the asset's termination value with its adjustable value just before the balancing adjustment event occurred. The adjustable value of a depreciating asset at a particular time is the asset's cost less its decline in value (as worked out under Subdivision 40-B) up to that time. Where the termination value exceeds the adjustable value the excess is included in assessable income under subsection 40-285(1). Where the adjustable value exceeds the termination value, the difference is allowed as a deduction: subsection 40-285(2).

The applicable termination value is determined by reference to section 40-300. In the case of the transfer or sale of a depreciating asset, item 1 from the table in subsection 40-300(2) states that the termination value is the market value of the asset when the taxpayer stopped using it or having it installed ready for use.

The assets fall within the definition of depreciating assets in section 40-30 as they have limited effective life and their value decline over the time they are used. A balancing adjustment event arises when the taxpayer disposes of the machines to the other entity. If the termination value of the assets is more than their adjustable value just before the event occurred, the balancing adjustment is included in the assessable income of the taxpayer. Conversely, if the termination value is less than the adjustable value, the balancing adjustment is deductible to the taxpayer in the year when the disposal occurred, that is, the 2011-12 income year.

Question 2

CGT asset 108-5(1)

A CGT asset is:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

The licences grant the taxpayer the legal right to own and operate the assets. Although these two assets work together, they are distinct assets of different nature for tax purposes. The licences are CGT assets in accordance with subsection 108-5(1)(a) and the Commissioner has previously determined in ATO Interpretative Decision ATO ID 2004/123 that similar rights satisfy the definition.

CGT event

Under subsection 104-10(1), CGT event A1 happens when a taxpayer disposes of a CGT asset. A CGT asset is disposed of if there is a change of ownership: subsection 104-10(2) and the time of the event is when the taxpayer enters into the contract for the disposal or, if there is no contract, when the change of ownership occurs: subsection 10410(3).

A change in ownership of the licences occurred when the taxpayer transferred those licences to the other entity under the agreement. This constitutes the happening of CGT event A1 and gives rise to a potential capital gain under Part 3-1 in the 2011-12 income year.

The cost base

The cost base of a CGT asset is defined in section 110-25 and includes the following five elements.

110-25(2)

The first element is the total of:

(a) the money you paid, or are required to pay, in respect of *acquiring it; and

(b) the *market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition)

110-25(3)

The second element is the *incidental costs you incurred. These costs can include giving property: see section 103-5

110-25(4)

The third element is the costs of owning the *CGT asset you incurred (but only if you *acquired the asset after 20 August 1991). These costs include:

(a) interest on money you borrowed to acquire the asset; and

(b) costs of maintaining, repairing or insuring it; and

(c) rates or land tax, if the asset is land; and

(d) interest on money you borrowed to refinance the money you borrowed to acquire the asset; and

(e) interest on money you borrowed to finance the capital expenditure you incurred to increase the asset's value.

These costs can include giving property: see section 103-5

110-25(5)

The fourth element is capital expenditure you incurred:

(a) the purpose or the expected effect of which is to increase or preserve the asset's value; or

(b) that relates to installing or moving the asset.

The expenditure can include giving property: see section 103-5.

110-25(6)

The fifth element is capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset. (The expenditure can include giving property: see section 103-5.

Pursuant to the agreement with the other entity, the taxpayer has transferred two groups of assets (assets and licences) at the agreed prices. It has been determined that the gaming machines are depreciating assets which are subject to the operation of Div 40 and not Part 3-1. For CGT purposes, therefore, the only assets that have been disposed of in return for the right to the benefits are the licences.

The taxpayer did not pay any consideration when it acquired the licences and the first element of cost is therefore zero. If the taxpayer has incurred incidental cost associated with the acquisition, for example legal fees, or any other elements listed in section 110-25, these capital expenses are counted towards the cost base.

Capital proceeds

116-20(1)

The capital proceeds from a CGT event are the total of:

· the money you have received, or are entitled to receive, in respect of the event happening; and

· the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

116-40(2)

If you receive a payment in connection with a transaction that relates to one CGT event and something else, the capital proceeds from the event are so much of the payment as is reasonably attributable to the event.

Under the arrangement, the taxpayer has received, or is entitled to receive, $xxx for the assets and $yyy for the licences plus the right to several types of benefits. The rights are CGT assets as defined in section 108-5(1) and their values are included in the calculation of capital proceeds in accordance with paragraph 116-20(1)(b). As their market values relate to both a balancing adjustment event and a CGT event, the apportionment rule in subsection 116-40(2) applies and the $xxx for the gaming machines are excluded from the calculation of the capital proceeds.

In addition, the taxpayer is required to pay the other entity a cash payment. This payment represents the cost associated with the disposal of the CGT assets in exchange for the benefits and is, accordingly, deducted from the capital proceeds.

In summary, the net capital proceeds are calculated on the basis of the following methodology:

(Agreed value of the gaming licences + MV of the rights to the agreed benefits - MV of the gaming machines - the cash payment)

Capital gain

The amount of the capital gain in relation to the licences is worked out as follows:

(Agreed value of the licences + MV of the rights to the agreed benefits - MV of the assets - the cash payment)

Less

($0 + incidental costs and other capital expenditure relating to the licences)

Note:

The Commissioner has not considered whether the agreed values of the benefits set out in the agreement represents market value in an arm's length transaction as the taxpayer has declined the services of the Australian Valuation Office for a critique of the valuation methodology it has adopted

Question 3

As explained above, the cash payment is an incidental cost incurred in the disposal of the licences in return for the benefits and is subject to the CGT provisions in Part 3-1. It is therefore not deductible under section 8-1.