Edited version of your written advice

Authorisation Number: 1012934518986

Date of advice: 11 January 2016

Ruling

Subject: Income tax ~ assessable income

Question 1

Is the sale proceeds of $W be treated as termination value for Y Ltd's asset for the purpose of calculating the balancing adjustment under section 40-285 of the Income Tax Assessment Act 1997 (ITAA 1997)

Answer

Yes.

Question 2

Is the remainder of the proceeds of $X also be treated as part of the termination value for the Y's assets for the purposes of calculating the balancing adjustment under section 40-285 of the ITAA 1997?

Answer

No.

Question 3

If the answer to question 2 is "no", is the remainder of the proceeds characterised as capital proceeds for capital gains tax (CGT) event D1 under section 104-35 of the ITAA 1997?

Answer

Yes.

Question 4

If the answer to question 3 is "yes", is the amount of the capital gain from the CGT event D1 reduced by the anti-overlap provision under subsection 118-20(1) of the ITAA 1997?

Answer

No.

This ruling applies for the following periods

1 July 20xx to 30 June 20xx

Scheme commenced on

1 July 20XX

Relevant facts and circumstances

You, Y Ltd, are an approved gaming machine venue operator.

You have worked out the gaming machines decline in value under Subdivision 40-B of the ITAA 1997 using the diminishing value method.

You experienced financial difficulties in recent years. As a result, you decided to enter into a Sale and a Service Agreement (the Agreements) with another gaming machine operator, Z Pty Ltd.

Under the Sale Agreement, you will receive amount $W for the sale of the gaming machines.

Under the Service Agreement, you will receive $X for venue renovation, system upgrade and venue relaunch. By entering into the Service Agreement, you have created a number of contractual rights in favour of Z Pty Ltd as follows, in breach of which Z Pty Ltd has the right to terminate this agreement:

• right to have the required renovation works carried out within agreed time;

• right to have the required renovation works carried out within the agreed time following the Service Commencement Date so the gaming machines can be installed, (if they are no so installed);

• right to have the gaming machines leased by you and to have the gaming machines serviced by Z Pty Ltd for a daily payment of a fixed amount per machine for a term of number of years;

• right not to have the lease and service payment delayed beyond certain time

• right to be informed if there is any changes to your gaming machine entitlements;

• right to have all your responsibilities carried out to facilitate Z Pty Ltd the provision of services to the gaming machines;

• right not to have acquisition or assertion of ownership right to any of the Z Pty Ltd's gaming equipment.

The amount of $X will be paid to you on a reimbursement basis as and when the required works are undertaken.

Apart from the Agreements, there is no relationship between you and Z Pty Ltd and you were acting at arm's length when entering into the Agreements and determining the apportionment of the proceeds.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 30-305

Income Tax Assessment Act 1997 section 40-30

Income Tax Assessment Act 1997 section 40-40

Income Tax Assessment Act 1997 section 40-285

Income Tax Assessment Act 1997 section 40-295

Income Tax Assessment Act 1997 section 40-300

Income Tax Assessment Act 1997 section104-35

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 118-20

Reasons for decision

All legal references of the section below are to the ITAA 1997 unless otherwise specified.

Question 1

Summary

The sale proceeds of $W is treated as the termination value for the gaming machines for the purpose of calculating the balancing adjustment under section 40-285.

Detailed reasoning

According to subsection 40-285(1)

An amount is included in your assessable income if:

(a) a balancing adjustment event occurs for a depreciating asset you held and;

(i) whose decline in value you worked out under Subdivision 40-B; or

(ii) whose decline in value you would have worked out under that Subdivision if you had used the asset; and

(b) The asset's termination value is more than its adjustable value just before the event occurred.

The amount included is the difference between those amounts, and it is included for the income year in which the balancing adjustment event occurred.

A depreciating asset according to subsection 40-30(1) is one that has limited effective life and can reasonably be expected to decline in value over the time it is used except:

(a) land; or

(b) an item of trading stock; or

(c) an intangible asset …..

According to paragraph 40-295(1)(a), a balancing adjustment event occurs for a depreciating asset if you stop holding the asset.

The term "hold a depreciating asset" is a defined term under subsection 995(1) which directs one to section 40-40. Section 40-40 provides the table to work out who holds a depreciating asset. In this table, column 2 describes the kind of depreciating asset and column 3 describes the entity by whom such depreciating asset is held. Under table item 10 of section 40-40, for "any depreciating asset" the entity by whom such asset is held is "the owner, or the legal owner if there is both a legal and equitable owner".

In your case, the gaming machines are depreciating assets as it has limited effective life of 7 years as per the Commissioner of Taxation's determination.

You are the legal and equitable owner of the gaming machines. Therefore, as per table item 10 of section 40-40, you hold the gaming machines.

A balancing adjustment event under paragraph 40-295(1)(a) took place when you stopped holding the gaming machines Z Pty Ltd paying you $W. Although you and Pty Ltd agreed that the gaming machines will not be removed physically from your venue, you no longer hold the legal or equitable ownership of the gaming machines once you received $W. Therefore, you satisfy paragraph 40-285(1)(a).

You have worked out the gaming machines decline in value under Subdivision 40-B using the diminishing value method. Therefore, you satisfy subparagraph 40-285(1)(a)(i).

Termination value of a depreciating asset at the time of a balancing adjustment event is given the meaning of an amount specified under column 3 of table items of either subsection 40-300(2) or subsection 30-305(1). None of the balancing adjustment events specified in the table items under subsection 40-300(2) apply in your case. Since you have received $W for the gaming machines on settlement, table item 1 of subsection 40-305(1) applies to you. As per column 3 of the table item in this subsection, where one receives an amount for a balancing adjustment event, it is the 'amount received'.

Therefore, the amount you received, namely $W for the balancing adjustment event of stopping to hold the gaming machines is the termination value which you will be able to use to calculate your assessable income as per subsection 40-285(1).

Question 2

Summary

The remainder of the proceeds of $X is not treated as part of the termination value for the gaming machines for the purposes of calculating the balancing adjustment under section 40-285.

Detailed reasoning

Although $X forms part of the settlement price under the Service Agreement, this amount was paid by Z Pty Ltd to you specifically for renovation of your venue, system upgrade and venue relaunch, and not in relation to the depreciating asset, namely the gaming machines.

Again, this amount is not guaranteed to you unless you carry out the required renovation and other works as per specification and within specified time. Therefore, it is clear that $X does not form part of the termination value for the gaming machines for the purpose of calculating the balancing adjustment under section 40-285.

Question 3

Summary

The remainder of the proceeds $X is characterised as capital proceeds for CGT event D1 under section 104-35.

Detailed reasoning

A CGT event D1 happens if an entity creates a contractual right or other legal or equitable right in another entity: section 104-35(1).

In your case, when you entered into the Service Agreement with Z Pty Ltd, you have created several contractual rights in favour of Z Pty Ltd as follows, in breach of which Z Pty Ltd will have the right to terminate the Service Agreement:

• right to have the required renovation works carried out within agreed time;

• right to have the required renovation works carried out within the agreed time following the Service Commencement Date so gaming machines can be installed, (if they are no so installed);

• right to have the gaming machines leased by you and to have such machines serviced by Z Pty Ltd for a daily payment of certain amount per machine for the term of the Service Agreement).

• the right not to have the lease and service payment delayed beyond certain time;

• the right to be informed if there is any changes to your gaming machine entitlements;

• the right to have all venue operators responsibilities carried out to facilitate the provision of service to the gaming machines;

• the right not to have acquisition or assertion of ownership right to any of the gaming machines after the ownership is passed to Z Pty Ltd.

In exchange for entering into the Service Agreement, Z Pty Ltd will pay you amount $X which includes renovation contribution and further financial assistance.

Capital proceeds from a CGT event under paragraph 116-20(1)(a) is the money you received or are entitled to receive in respect of the event happening. In your case, you will receive $X for creating the contractual right in favour of Z Pty Ltd, which as stated above, is CGT event D1.

Subsection 104-35(5) includes the exceptions when CGT event D1 does not happen. It states that CGT event D1 does not happen if:

(a) you created the right by borrowing money or obtaining credit from another entity; or

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

(c) a company issue or allots equity interests or non-equity shares in the company; or

(d) the trustee of a unit trust issues units in the trust; or

(e) a company grants an option to acquire equity interests, non-equity shares or debentures in the company; or

(f) the trustee of a unit trust grants an option to acquire units or debentures in the trust

None of these exceptions apply to you in relation to the CGT event.

Therefore, CGT event D1 happens to you when you created the contractual rights under the Service Agreement in favour of Z Pty Ltd and amount $X is the capital proceeds for the event.

Question 4

Summary

The amount of the capital gain from the CGT event D1 will not be reduced by the anti-overlap rule at section 118-20 because the amount is not considered included in your assessable income as ordinary income.

Detailed reasoning

Under paragraph 118-20(1)(a), a capital gain that a taxpayer makes from a CGT event is reduced if, because of the event, a provision of this Act, outside Part 3-1 includes an amount in the taxpayer's assessable income or exempt income. The aim of this provision, known as anti-overlap provision, is to reduce double taxation.

In your case, capital gain from the CGT event D1 would be reduced if the gain is also included in your assessable income as ordinary income under section 6-5.

Subsection 6-5(1) states that your income includes income according to ordinary concepts, which is commonly known as ordinary income. The legislation does not define what "income according to ordinary concepts" is. Instead it relies on the principles developed by the courts to determine its meaning.

The expression "income according to ordinary concepts" was first used by the NSW Supreme Court in Scott v. FC of T (NSW) (1935) 3 ATD 142. Since that decision the courts have applied the 'ordinary concept' test in determining whether or not a particular receipt is income or not.

The concept of ordinary income was considered by the Full Federal Court in FC of T v. Cooke & Sherden 80 ATC 4140. In a joint decision, their Honours stated:

Whether a receipt is to be treated as income or not is determined according to 'the ordinary concepts and usages of mankind' (per Jordan C.J. in Scott v. F.C. of T. (1935) 35 S.R. (N.S.W.) 215 at p. 219), except where statute sweeps in particular receipts or amounts which would not ordinarily be taken to fall within the concept.

Later, in FC of T v. The Myer Emporium 87 ATC 4363 (the Myer case), the Full High Court said (at p 4370):

The periodicity, regularity and recurrence of a receipt has been considered to be a hallmark of its character as income in accordance with the ordinary concepts and usages of mankind.

The cases dealing with "income according to ordinary concepts" have identified the following (non-exhaustive) factors which may be relevant in determining whether an amount is ordinary income and therefore assessable under subsection 6-5(1):

• whether the amount has the characteristics of periodicity, recurrence or regularity

• whether it is convertible into money or money's worth

• whether it is associated with business activities or services rendered, as distinct from the mere sale of property, and

• whether it is solicited, as distinct from a windfall

Although the courts have referred to 'periodicity, regularity and recurrence' as 'hallmarks' of ordinary income, they are not necessarily decisive factors. Ordinary income can be received as a lump sum and capital amounts may be paid in instalments. Receipts from isolated transactions can be ordinary income if they are derived in the course of a business or under a profit making scheme or undertaking. As the High Court explained in the Myer case:

Valuable though these considerations may be in categorising receipts as income or capital in conventional situations, their significance is diminished when the receipt in question is generated in the course of carrying on a business, especially if it should transpire that the receipt is generated as a profit component of a profit-making scheme.

In Scott v. FC of T (1966) 117 CLR 514 Windeyer J held (at p 526):

Whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

Again, in The Federal Coke Company Pty Ltd v. FC of T 77 ATC 4255, Bowen CJ held (at p 4264):

When one is considering the character of an amount received by a taxpayer, the enquiry must start with the question: what is the character of the receipt in the hands of the taxpayer?

More recently, the High Court held in GP International Pipecoaters Pty Ltd v. FCT (1990) 21 ATR 1:

Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes by the character of a right or thing disposed of in exchange for the receipt; sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment.

In your case, the amount of $X that you will receive from Z Pty Ltd is consideration for entering into the Service Agreement which created certain contractual rights in favour of Z Pty Ltd. This consideration is to be used for venue renovation, system upgrade and venue relaunch. If the required renovations and other works are not done within prescribed time and according to specification, Z Pty Ltd reserves the right to terminate the contract and not pay this consideration.

Although the amount of $X is not going to be paid in a lump sum and might be given as and when the renovation and system upgrades are undertaken and invoiced to Z Pty Ltd, this does not mean that there is periodicity, regularity and recurrence of payment. It is the same agreed amount between the parties that will be given to you on a reimbursement basis as Z Pty Ltd receives invoices of the work completed.

However, a one off transaction can still be of income nature if the intention is to make profit or if the amount is received in the course of carrying on a business. Although the renovation and system upgrade will result in better facilities for your patrons and greater income generation in future, you entered into the Service Agreement to solve your imminent financial problems, not to make profit. You have provided the facts that over the terms of the Service Agreement, you will spend more in lease and service of the gaming machines then what you will receive for entering into the Service Agreement. Again, you are not carrying on a business of venue renovation or system upgrade.

Considering the above, the amount of $X is the capital proceeds for CGT D1 under section 140-35 and not income according to ordinary concepts under section 6-5.

Accordingly, $X is not reduced under the anti-overlap provision under subsection 118-20(1).