Edited version of your private ruling

Authorisation Number: 1012569478259

Ruling

Subject: Assessable income and GST

Issue 1

Income tax consequences of transferring X

Question 1

Are the profits derived from transferring X to your private company in return for shares in that private company included in your assessable income as ordinary income or as income from a profit-making undertaking or plan?

Answer

Yes

Question 2

Are the profits derived from transferring X to your private company in return for shares in that private company assessable as a capital gain?

Answer

Yes, however any assessable capital gain that may arise from this transaction will be reduced to the extent that it is included in your assessable income by another provision in accordance with section 118-20 of the Income Tax Assessment Act 1997 (ITAA 1997).

Issue 2

GST consequences of transferring X

Question 1

Is the transfer of X to another entity a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2013

Year ending 30 June 2014

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

You invested a substantial amount in X with the purpose of making substantial profit.

You are an Australian resident who is registered for Goods and Services Tax (GST).

You transferred a portion of X to a private Australian company (the Company) that you created, and in return you received a number of shares in the Company. The Company is registered for GST.

You will retain the remaining portion of X that is not transferred to the Company.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 21

Income Tax Assessment Act 1936 Section 21A

Income Tax Assessment Act 1936 Subsection 21A(5)

Income Tax Assessment Act 1997 Division 6

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Subsection 6-10(4)

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 15-15

Income Tax Assessment Act 1997 Division 70

Income Tax Assessment Act 1997 Subsection 70-10(1)

Income Tax Assessment Act 1997 Subsection 102-5(1)

Income Tax Assessment Act 1997 Subsection 104-35(1)

Income Tax Assessment Act 1997 Subsection 104-35(2)

Income Tax Assessment Act 1997 Subsection 104-35(3)

Income Tax Assessment Act 1997 Subsection 104-35(5)

Income Tax Assessment Act 1997 Paragraph 108-5(1)(a)

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Division 775

Income Tax Assessment Act 1997 Subsection 775-15(4)

Income Tax Assessment Act 1997 Subsection 960-50(1)

Income Tax Assessment Act 1997 Section 995-1

A New Tax System (Goods and Services Tax) Act 1999 Section 9-5

A New Tax System (Goods and Services Tax) Act 1999 Section 9-10

A New Tax System (Goods and Services Tax) Act 1999 Section 9-85

A New Tax System (Goods and Services Tax) Act 1999 Subsection 13-20(2A)

A New Tax System (Goods and Services Tax) Act 1999 Subsection 40-5(2)

A New Tax System (Goods and Services Tax) Act 1999 Subsection 117-5(1A)

A New Tax System (Goods and Services Tax) Act 1999 Section 195-1

A New Tax System (Goods and Services Tax) Regulations 1999 Regulation 40-5.12

A New Tax System (Goods and Services Tax) Regulations 1999 Subregulation 40-5.09(1)

A New Tax System (Goods and Services Tax) Regulations 1999 Subregulation 40-5.09(3)

Reasons for decision

Issue 1 - Income tax

Division 6 of the ITAA 1997 sets out what amounts are included in the taxpayer's assessable income. It provides that the following amounts are included:

· income according to ordinary concepts; that is, ordinary income (section 6-5 of the ITAA 1997), or

· an amount which is included by a specific provision about assessable income; that is, statutory income (section 6-10 of the ITAA 1997).

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal service, income from property and income from carrying on a business.

Subsection 6-10(4) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes statutory income derived directly or indirectly from all sources during the income year.

Section 10-5 of the ITAA 1997 lists provisions which include statutory income in a taxpayer's assessable income. Included in this list are capital gains under section 102-5 of the ITAA 1997.

Subsection 102-5(1) of the ITAA 1997 provides that a taxpayer's assessable income includes their net capital gain for the income year.

Where a transaction gives rise to both ordinary income and a capital gain for capital gains tax (CGT) purposes, the full amount of ordinary income is included in assessable income and the capital gain is reduced by that amount (as per section 118-20 of the ITAA 1997).

Are you carrying on business?

The common law has identified a number of indicators that are relevant in determining whether a taxpayer's activities constitute the carrying on of a business. The question whether a taxpayer's activities should be characterised as a business is primarily a matter of general impression and degree (Ferguson v. Federal Commissioner of Taxation 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884).

The courts have held that the following indicators are relevant to the question of whether a taxpayer's activities amount to the carrying on of a business:

(a) whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

(b) whether the taxpayer has more than just an intention to engage in business;

(c) whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

(d) whether there is repetition and regularity of the activity;

(e) whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

(f) whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

(g) the size, scale and permanency of the activity; and

(h) whether the activity is better described as a hobby, a form of recreation or a sporting activity.

Overall, your activities relating to X indicates that you are carrying on a business for tax purposes. You invested a very large amount of money. The level of investment indicates that your purpose and intention was to make a substantial profit. Your activities were of a considerable size and scale and were conducted routinely and systematically, and with a high degree of sophistication. The nature of the activities was recurrent and regular.

What is X for tax purposes?

Is X 'property'?

From a legal perspective, property refers to specific form of legal relationship that an individual has over an object or resource, whether that object or resource is tangible or intangible in nature. A holder of a property relationship will have an enforceable right to exclude against the rest of the world.

A holder of X does not have an enforceable right to exclude the rest of the world. Accordingly, X is not property and is incapable of being privately owned.

Is X trading stock?

Subsection 70-10(1) of the ITAA 1997 provides that "trading stock includes:

(a) anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of a *business; and

(b) *livestock."

The term 'anything' is not defined in the Assessment Acts and therefore takes its ordinary meaning taking into account the legislative context in which the term is used. According to the Macquarie Dictionary, the term 'anything' means "any thing whatever; something, no matter what; a thing of any kind". Based on this broad definition, X could constitute trading stock as they are anything produced and held for the purpose of sale or exchange in the ordinary course of your business.

However, the Commissioner considers the ordinary meaning of the term 'anything' when considered in its legislative context has a narrower meaning than the dictionary definition of the term.

Throughout Division 70 of the ITAA 1997, trading stock is referred to as something that a taxpayer 'holds' or has 'on hand'. It is clear that the legislative context is one which is referring to a thing that is capable of ownership, that is, some form of property.

Accordingly, the ordinary meaning of 'anything' in the subsection 70-10(1) of the ITAA 1997 definition of trading stock, taking into account its legislative context, means any thing that is capable of legal ownership. As X is not property and is not capable of legal ownership rights, X is not trading stock for the purposes of subsection 70-10(1) of the ITAA 1997.

Ordinary income

The transfer of X to the Company in return for the Company issuing you shares in the Company is considered to be a transaction undertaken in the course of you carrying on business. Amounts received as a result of carrying on a business are ordinary income under section 6-5 of the ITAA 1997.

Non-cash benefit received

In this case you did not receive an amount of money in exchange for X, rather you received shares in the Company.

Taxation Determination TD 93/234 explains that section 21 of the Income Tax Assessment Act 1936 (ITAA 1936) applies where consideration is given other than in cash, and in such cases the money value of the consideration is deemed to have been paid or given.

Section 21A of the ITAA 1936 was enacted to address some of the practices adopted to exploit the principle in Federal Commissioner of Taxation v. Cooke and Sherden 80 ATC 4140, that an amount is not ordinary income if it is not received as money, or is not convertible into money or money's worth. The effect of section 21A of the ITAA 1936 is to treat a non-cash business benefit as income according to ordinary concepts even if it is not convertible into cash, provided it is otherwise of an income nature. The benefit is brought into account at its arm's length value.

Subsection 21A(5) of the ITAA 1936 provides that:

In this section:

non-cash business benefit means property or services provided after 31 August 1988:

(a) wholly or partly in respect of a business relationship; or

(b) wholly or partly for or in relation directly or indirectly to a business relationship.

arm's length value, in relation to a non-cash business benefit, means:

(a) the amount that the recipient could reasonably be expected to have been required to pay to obtain the benefit from the provider under a transaction where the parties to the transaction are dealing with each other at arm's length in relation to the transaction; or

(b) if such an amount cannot be practically determined - such amount as the Commissioner considers reasonable.

Accordingly, the arm's length value of the shares at the time of transfer to you will be included as income derived by you for the purpose of determining your assessable income under section 6-5 of the ITAA 1997.

Profit making Undertaking or Plan

Section 15-15 of the ITAA 1997 includes in a person's assessable income profit arising from the carrying on or carrying out of a profit-making undertaking or plan.

If section 6-5 of the ITAA 1997 did not apply, the profit from the transaction at issue in your case would be assessable income under section 15-15 of the ITAA 1997 as the transfer of X in return for shares in the Company would be considered to amount to a profit-making undertaking or plan.

Capital gains tax (CGT)

Is X a CGT asset?

Under paragraph 108-5(1)(a) of the ITAA 1997, a 'CGT asset' is:

(a) any kind of property; or

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

As discussed above, X is not property.

The reference in the definition of a CGT asset to 'a legal or equitable right' clearly requires that, to be a CGT asset, a right which is not property must be recognised by the law or equity and presumably be enforceable by legal or equitable proceedings. Mere personal rights and freedoms are not included.

The holder of X has no legal or equitable rights in relation to X. For example, a person who holds X has no ability to legally require payment of the possible monetary value of X at any particular time. A holder X merely has the personal freedom to hold X, keep it private, or transfer it to someone else.

Thus a X is not 'a legal or equitable right' and accordingly not a CGT asset.

Does the transfer of X give rise to a CGT event?

As X is not a CGT asset, the transfer of X to the Company does not give rise to CGT event A1 under subsection 104-10(1) of the ITAA 1997 because it does not involve the disposal of a CGT asset.

Under subsection 104-35(1) of the ITAA 1997, "CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity."

However, under subsection 104-35(5) of the ITAA 1997 "CGT event D1 does not happen if:

…

(b) the right requires you to do something that is another *CGT event that happens to you; or

(c) a company issues or allots *equity interests or *non-equity shares in the company.

…

Example:

You agree to sell land. You have created a contractual right in the buyer to enforce completion of the transaction. The sale results in you disposing of the land, an example of CGT event A1. This means that CGT event D1 does not happen.

Therefore, the issue of shares by the Company, as equity interests in the Company, does not cause CGT event D1 to happen to the Company because it is covered by the exception in paragraph104-35(5)(c) of the ITAA 1997.

However, CGT event D1 will happen to you because you have created a contractual right in the Company to enforce completion of the contract, i.e. to require you to transfer X to the Company in return for the Company issuing shares to you. When you complete the contract (i.e. transfer X to the Company), this does not result in the disposal of a CGT asset as X is not a CGT asset. Accordingly, no other CGT event happens and the exception in paragraph 104-35(5)(b) of the ITAA 1997 does not apply in your circumstances.

Under subsection 104-35(2) of the ITAA 1997, the time of CGT event D1 is when you enter into the contract with the Company.

Under subsection 104-35(3) of the ITAA 1997, the taxpayer makes a capital gain from CGT event D1 if the capital proceeds from creating the right are more than the incidental costs the taxpayer incurred that relate to the CGT event. A capital loss is made if the capital proceeds are less than the incidental costs.

However any capital gain you make will be reduced to the extent that you have included the amount in your assessable income under section 6-5 of the ITAA 1997.

Rollover relief

Under Subdivision 122-A of the ITAA 1997, an individual can choose to obtain roll-over relief from certain CGT events, including CGT event D1, if certain conditions are satisfied.

In your particular circumstances, subsection 122-20 of the ITAA 1997 requires that the consideration you received for the CGT event D1 happening must only be shares in the company, and they cannot be redeemable shares. The market value of the shares you receive for the CGT event D1 happening must be substantially the same as the market value of the CGT asset created in the Company (i.e. the contractual right to enforce transfer of X to the Company in return for the issue of shares).

You must also own all the shares in the Company just after the time of CGT event D1. The asset created in the Company must not be one of the assets excluded under subsection 122-25(2) of the ITAA 1997, all of which are not relevant to your circumstances in this case. Lastly, you and the Company must both be Australian residents at the time of CGT event D1.

Accordingly, in order for the Commissioner to determine whether roll-over relief is available to you under section 122-15, further information would need to be provided. In particular, the Commissioner would need to know whether you owned all of the shares in the Company just after the time of that CGT D1 happened.

Issue 2 - GST

Section 9-5 of the GST Act defines a taxable supply as follows:

You make a taxable supply if:

(a) you make the supply for *consideration; and

(b) the supply is made in the course or furtherance of an *enterprise that you *carry on; and

(c) the supply is *connected with Australia; and

(d) you are *registered, or *required to be registered.

However, the supply is not a *taxable supply to the extent that it is *GST-free or *input taxed.

(Items marked with an asterisk (*) are defined in the Dictionary at section 195-1 of the GST Act).

For a supply to be a taxable supply, all the requirements of section 9-5 of the GST Act must be satisfied; that is, where one element of the legislation is not met the whole section is not met.

Subsection 9-10(1) of the GST Act defines the term 'supply' as any form of supply whatsoever. Without limiting the meaning of supply in subsection 9-10(1) of the GST Act, specific things are added in the broad definition including the creation, grant, transfer, assignment or surrender of any right (paragraph 9-10(2)(e) of the GST Act) and a financial supply (paragraph 9-10(2)(f) of the GST Act).

Paragraph 76 of Goods and Services Tax Ruling GSTR 2006/9 Goods and services tax: supplies (GSTR 2006/9) explains that the broad definition of supply as any form of supply whatsoever is the ordinary meaning of the term and that the meaning is 'arguably extended by' the specific things listed in subsection 9-10(2) of the GST Act.

The sale of X satisfies the broad definition of supply as any form of supply whatsoever.

There is no provisions in the GST Act that would deem the supply of X from you to the Company as a GST-free supply.

As you will be making the supply of X to the Company for consideration, in the course of furtherance of an enterprise that you carry on, the supply is connected with Australia and you are registered for GST, the remaining requirements of section 9-5 of the GST Act are met.

Therefore, your sale of X to the Company will be a taxable supply in accordance with section 9-5 of the GST Act.