Edited version of your written advice

Authorisation Number: 1012973786991

Date of advice: 22 February 2016

Ruling

Subject: Capital Gains Tax

Question 1.

Will capital gains tax event C2 occur when, following a change in the method of accounting from cash to accruals basis, debts that arose to the Company from the provision of services prior to the change are discharged?

Answer

Yes

Question 2.

Are the trade debtors of the Company active assets under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Company changed its method of reporting income and expenses for tax purposes from cash to accruals. The GST accounting method was also changed at this date.

The net assets of the company and any entities connected or affiliated with the company are less than $6million.

Relevant legislative provisions

Income Tax Assessment Act 1997   

subsection 104-25(1)

subsection 104-25(2)

section 108-5

subsection 116-20(1)

subdivision 152-A

paragraph 152-10(1)(a)   

paragraph 152-40(1)(b)

subparagraph 152-10(1)(c)(ii)

paragraph 152-10(1)(d)

subsection 152-40(1)   

subsection 152-40(3)

paragraph 152-40(3)(b)

paragraph 152-40(4)(d)

Reasons for decision

Question 1.

A debt owed to a taxpayer is a capital gains tax (CGT) asset under section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Under subsection 104-25(1) of the ITAA 1997, CGT event C2 happens when the ownership of an intangible asset ends by the asset being satisfied or discharged. The time of the event is when the contract is entered into, or if there is no contract, when the asset ends (subsection 104-25(2) of the ITAA 1997).

In this case the Company changed its method of reporting income and expenses for tax purposes from cash to accruals. At this time there were debts owing to the Company.

In accordance with section 108-5 of the ITAA 1997 the debts owed to the Company are intangible assets. The payment of these debts will give rise to CGT event C2, under subsection 104-25(1) of the ITAA 1997, since ownership of the debts has ended by them being satisfied or discharged. The capital proceeds from discharging the debts are the amounts received, or entitled to be received, by the Company from its debtors (subsection 116-20(1) of the ITAA 1997).

Question 2.

For a CGT asset of a business to be an active asset for the purposes of Division 152 of the ITAA 1997 it must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997.

Subsection 152-40(1) states:

A *CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a *business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your *affiliate; or

(iii) another entity that is *connected with you; or

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

It was established in Question 1 that debts owed to the Company are intangible assets. The question arises as to whether the trade debtors are 'inherently connected' with the Company's business. The Advanced Guide to Capital Gains Tax Concessions for Small Business provides guidance:

Inherent connection necessarily requires something more than just some form of connection between the financial instrument and the business. A thing might be regarded as inherently connected to a business when it is a permanent or characteristic attribute of the business - for example, goodwill, or trade debtors.

Where a business makes sales on credit in the normal course of its operations the resulting trade debtors can reasonably be seen as being 'inherently connected' with that business. The trade debtors of the Company are therefore intangible assets inherently connected with the business and hence satisfy paragraph 152-40(1)(b) of the ITAA 1997.

The question then arises as to whether the trade debtors are excluded from being an active asset by way of being a financial instrument under paragraph 152-40(4)(d) of the ITAA 1997:

However, the following *CGT assets cannot be active assets:

(d) financial instruments (such as loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts and a right or option in respect of a share, security, loan or contract)

It is considered that trade debtors are not financial instruments but rather a business facilitation mechanism that assists in the conduct of the business.

Accordingly, the trade debtors of the Company are active assets under section 152-40 of the ITAA 1997.