Edited version of your written advice

Authorisation Number: 1012963564596

Date of advice: 19 February 2016

Ruling

Subject: CGT event E4

Question 1

Can the Commissioner confirm that section 104-70 of the ITAA 97 does not cause a reduction of cost base and the derivation of capital gains by the taxpayer in respect of the different tax and accounting treatment (timing differences) for expenses for the years ended 30 June 20XX and 30 June 20XX?

Answer

Yes.

Question 2

Should the Commissioner consider that section 104-70 of the ITAA 97 applies in respect of the different tax and accounting treatments of these expenses, can the Commissioner confirm that section 118-20(1A) of the ITAA 97 will apply to reduce the capital gain that arises upon the distribution that is sourced from the accounting/tax timing differences for the years ended 30 June 20XX and 30 June 20XX?

Answer

Not necessary to answer.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX.

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

• The taxpayer owns units in a unit trust.

• There have been no changes to unit holdings since creation of the unit trust.

• The trust distributes the net income arising from its business operations in accordance with its trust deed each income year.

• The trust accrues future expenditures in relation to specific items arising from its business operations. These accruals are required by the applicable accounting standards.

• The accruals impact upon the net income of the trust in any given income year, and accordingly, the trust's distributable amount to unit holders.

• The extent to which the business operations have occurred has no bearing on whether the expenditures have been incurred.

• In the course of the trusts business operations, the expenditures have effectively been deferred and are not in line with the business operations. This has necessitated an accrual for accounting purposes.

• Certain expenses, for tax purposes, are deducted in the year in which they are incurred. However for accounting purposes, the expenses do not immediately form part of the profit and loss calculation for the income year that the expense arises. This creates a timing difference that is opposite in effect to the trusts other expenditure.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1936 section 97

Income Tax Assessment Act 1997 Section 104-70

Income Tax Assessment Act 1997 Subsection 118-20(1A)

Income Tax Assessment Act 1997 Subsection 104-70(1)

Income Tax Assessment Act 1997 Paragraph 104-70(1)(a)

Income Tax Assessment Act 1997 Paragraph 104-70(1)(b)

Income Tax Assessment Act 1997 Section 104-71

Income Tax Assessment Act 1997 Subdivision 115-C

Income Tax Assessment Act 1997 Subdivision 207-B

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

The Trust deed provides that the taxpayer is presently entitled to a share of the income of the trust for an income year if there is income available for distribution for that year. The taxpayer was presently entitled to a share of the income of the trust calculated for the 20XX and 20XX income years. They will also be presently entitled to the share of income of the trust for the 20XX income year.

Subject to the operation of Subdivisions 115-C and 207-B of the ITAA 1997, section 97 of the ITAA 1936 requires a beneficiary who is presently entitled to a share of the income of a trust to include in their assessable income the corresponding share of the net income of the trust (as defined in section 95 of the ITAA 1936) for that year.

Timing difference between tax and accounting treatment of expenses

Timing difference for category A expenses

The trust accrues certain future expenditures in relation to certain activities that are required for its business operations. As per the accounting standards, these accruals are recognised as an expense against the income of the trust in each year to the extent operations have been completed in that year. However, for tax purposes these expenses are only deductible when later incurred. That is, the future expenditures so accrued are anticipated expenses that, for accounting purposes, reasonably relate to the current year but will not actually be incurred or paid until sometime in the future.

Timing difference for category B expenses

The taxpayer's category B expenses do not form part of its profit and loss calculation for accounting purposes for the income year that those expenses are incurred. These expenses are only expensed for accounting purposes at a later time. However, for tax purposes these expenses are deductible in the year in which they are incurred. Accordingly, this creates a timing difference that is opposite in effect to the category A expenses.

Netting the category A and B expenses

The category A expenses are significantly greater than the category B expenses in the 20XX and 20XX income years. In 20XX and 20XX income years the net accrued expenses have been expensed for accounting purposes leaving sheltered income that was not distributed. However, in those years that sheltered income remained assessable for tax purposes (as no relevant deduction was at that time allowable) and therefore was assessed under section 97 of the ITAA 1936 in the 20XX and 20XX income years.

In the 20XX and later income years, the accrued expenses incurred and other relevant amounts are deductible for tax purposes, but having already been accrued are not expensed again for accounting purposes. In these income years the trust's distributable income is more that its net income for tax purposes.

It is in the 20XX and later years that there is potential for CGT event E4, section 104-70 of the ITAA 1997 to apply because the unit holders receive an amount that will not be included in their assessable income in the year of receipt.

Subsection 104-70(1) of the ITAA 1997 states:

CGT event E4 happens if:

(a) the trustee of a trust makes a payment to you in respect of your unit or your interest in the trust (except for *CGT event A1, C2, E1, E2, E6 or E7 happening in relation to it); and

(b) some or all of the payment (the non-assessable part) is not included in your assessable income.

To avoid doubt, in applying paragraph (b) to work out what part of the payment is included in your assessable income, disregard your share of the trust's net income that is subject to the rules in subsection 115-215(3).

Note 1: Subsections 104-70(1) (tax-exempted amounts), 104-71(3) (tax-free amounts) and 104-71(4) (CGT concession amounts) can affect the calculation of the non-assessable part.

Note 2: The non-assessable part includes amounts (tax-deferred amounts) associated with the small business 50% reduction, frozen indexation, building allowance and accounting differences in income.

Note 3: A payment made to you after you stop owning the unit or interest in the trust forms part of the capital proceeds for the CGT event that happened when you stopped owning it.

The amount by which the distribution from the trust in 20XX and 20XX income years exceeds the amount assessable in those years is potentially a 'non-assessable' part for the purposes of section 104-70 of the ITAA 1997.

Subject to exclusions in section 104-71 of the ITAA 1997, paragraph 104-70(1)(b) of the ITAA 1997 provides that CGT event E4 happens where some or all of a trust distribution is not included in a unit holders assessable income. If so, the cost base of the unit holders units in the trust must be reduced by the amount of the non-assessable part of the distribution (and a capital gain will arise to the extent the reduction required would otherwise take the cost base below nil).

Treatment of net accrued civil infrastructure expenses

The trust's accounting income exceeded its net income because the accounting income derived in 20XX cannot be distributed in that year to the extent that it is offset by the accrued expenses which have not at that time been paid. Accordingly, the income that has been offset (the sheltered income) is still on hand.

Both the amount of income derived in the 20XX year of income that is distributed, and the amount offset or sheltered by accrued expenses that remain on-hand, form part of the trust's net income for the 20XX year. This is because both the distributed component of this income and the undistributed component of this income (the sheltered income) are assessable, and no offsetting deductions are allowed at that time in respect of the accrued expenses.

The amounts later distributed in the 20XX and 20XX income years therefore could reasonably be comprised in part of funds sourced from amounts of previously taxed sheltered income.

On the basis that the taxpayer kept adequate records which show that the net income sheltered by accrued expenses in 20XX and 20XX income years (income that was still on-hand at the end of those years), the Commissioner accepts that this is the source of the funds that are later distributed in 20XX and 20XX income years.

As the payment representing the expenses has been included in the unitholders' assessable income in the 20XX and 20XX income years, CGT event E4 will not happen, and no adjustment to the cost base or reduced cost base of the unit holders' units is required, when the net expenses reverse in 20XX and is paid to the unitholders.