Edited version of your written advice

Authorisation Number: 1013133687665

Date of advice: 31 January 2017

Ruling

Subject: Income tax - deductions - black hole expenditure - section 40-880 - gaming machine entitlements

Note: All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Question 1

Is Cee Unit Trust entitled to claim a deduction from its assessable income pursuant to section 40-880, in each income year within the Relevant Period (being the period beginning from the start of the 2010 income year through to the end of 2014 income year) in respect of the gaming machine entitlement (GME) expenditure it incurred in the 2010 income year?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20BB

Year ended 30 June 20CC

Year ended 30 June 20DD

Year ended 30 June 20EE

Year ended 30 June 20FF

The scheme commences on:

1 July 20AA

Relevant facts and circumstances

The ABC Group and Cee Unit Trust

The ABC Group operates and owns numerous hospitality and entertainment venues (via numerous controlled entities) primarily in State B. A number of such venues has been owned and operated by the ABC Group from prior to the 20BB income year to the present day.

The venues each operate a significant number of gaming machines. The operation of each gaming machine requires, among others, the relevant venue's operating entity to hold a valid GME issued by the relevant Government.

Cee Unit Trust is a unit trust that owns and operates the following venues:

● Cee Hotel, a venue consisting of gaming machine, TAB wagering, liquor and dining. Cee Hotel commenced trading over 10 years ago with gaming activities; and

● Fee Hotel, a venue consisting of gaming machine, TAB wagering, liquor and dining. Fee Hotel commenced trading over 10 years ago with gaming activities.

The corporate trustee of Cee Unit Trust is Cee Pty Ltd. The sole unit holder of Cee Unit Trust is the ABC Trust which is a discretionary trust. The potential beneficiaries of ABC Trust include members of the ABC family and other trusts and companies in the ABC Group.

Revenues from gaming machine operations

Cee Unit Trust

During the Relevant Period, of the total revenues generated by Cee Unit Trust in relation to Cee Hotel and the Fee Hotel, the following proportion consisted of revenues associated with gaming machines:

● 20BB - XX%;

● 20CC - XX+Y%;

● 20DD - XX+Y%;

● 20EE - XX+Y+Z%; and

● 20FF - XX+Y+Z%.

Gaming Machine Entitlements - legislative framework

The Gambling Regulation Act 2003 (relevant State) (and Regulations) (together the Gambling Act) provides the regulatory framework under which gaming machines are permitted to be operated in the State B (the State).

Under section 3.4A.1 of the Gambling Act the 'conduct of gaming' in an approved venue is lawful only if the venue operator holds a GME. The 'conduct of gaming' is defined in subsection 3.1.4(1) of the Gambling Act as:

(a) the management, use, supervision and operation of gaming equipment; and

(b) the sale, redemption or use of gaming tokens; and

(c) the installation, alteration, adjustment, maintenance or repair of gaming equipment; and

(d) the use or distribution of proceeds from the conduct of gaming; and

(e) accounting, banking, storage and other acts in connection with or related or incidental to gaming and the conduct of gaming.

The authority conferred by a GME is specified in section 3.4A.2 of the Gambling Act as follows:

(1) A gaming machine entitlement authorises the venue operator that holds the entitlement, subject to this Act, any related agreement referred to in section 3.4A.6 or 3.4A.6A and any conditions to which the entitlement is subject—

(a) to acquire approved gaming machines and restricted components; and

(b) to conduct gaming on one approved gaming machine in an approved venue operated by the venue operator; and

(c) to do all things necessarily incidental to carrying on the activities authorised by the section.

(2) A gaming machine entitlement does not authorise the entitlement holder to engage in any business by way of—

(a) manufacture of gaming machines or restricted components; or

(b) supply of approved gaming machines or restricted components to any person; or

(c) service, repair or maintenance of gaming equipment or games.

Further, the Gambling Act gives broad powers to the Minister for Consumer Affairs, Gaming and Liquor Regulation and the relevant Commission for Gambling and Liquor Regulation (VCGLR) to establish the conditions that must be satisfied in order to acquire GMEs and operate gaming machines.

Currently, to operate a gaming machine in the State, one must:

● hold a current club or hotel venue operator's licence;

● hold a GME;

● have access to approved premises;

● obtain gaming machines and gaming equipment;

● arrange for the gaming machines to be linked to the monitoring system;

● attach GMEs to approved premises;

● employ staff who hold valid Gaming Industry Employee licences to perform the prescribed duties; and

● comply with all legislative and regulatory requirements.

Other features and restrictions of the GME regime include the following:

● the total number of gaming machines that can be operated in the State (outside of X Casino) is less than 30,000. Therefore less than 30,000 GMEs in total can be made available to venue operators;

● no more than 105 gaming machines can be operated in any one venue; and

● each GME authorises a venue operator to operate one gaming machine for a period of 10 years.

Transfer of GMEs

Entitlements may be transferred or traded through a transfer scheme. The VCGLR facilitates the transfer market process through the Entitlement Transfer Market (ETM) set up to allow venue operator licensees to advertise, monitor, request the transfer of entitlements or request amendments to entitlement conditions. Through the ETM, venue operators advertise their wish to transfer or buy one or more GMEs. The transfer of any GME will not be finalised until the VCGLR records the transfer on the ETM. Negotiations regarding the transfer may take place between an existing GME holder and an interested party prior to the transfer being finalised.

Cee Unit Trust's gaming activities before GME regime

Prior to May 20BB, the Gambling Act provided that Tatts Group Limited (Tattersalls) and Tabcorp Holdings Limited (Tabcorp) were the sole holders of licences to operate gaming machines in the State (apart from X Casino).

Each of Tattersalls and Tabcorp held a 'gaming operator's licence' granted under the Gaming Machine Control Act 1991 (relevant state) (Gaming Machine Control Act).

Under section 14 of the Gaming Machine Control Act, a gaming operator's licence authorised the holder to:

(a) to obtain……approved gaming machines and restricted components; and

(b) to manufacture approved gaming machines and restricted components; and

(c) to supply approved gaming machines and restricted components to venue operators; and

(d) to conduct gaming at an approved venue; and

(e) to sell or dispose of gaming equipment with the approval of the Commission; and

(f) to service, repair or maintain gaming equipment through the services of licenced technicians; and

(g) to do all things necessarily incidental to carrying on the activities authorised by this section.

The 'conduct of gaming' was defined in section 3 of the Gaming Machine Control Act as:

(a) the management, use, supervision and operation of gaming equipment; and

(b) the sale, redemption or use of gaming tokens; and

(c) the installation, alteration, adjustment, maintenance or repair of gaming equipment; and

(d) the use or distribution of proceeds from the conduct of gaming; and

(e) accounting, banking, storage and other acts in connection with or related or incidental to gaming and the conduct of gaming.

These licences were not transferable to any other person, nor was there an ability to sub-licence. Tabcorp's 'gaming operator's licence' was later replaced by a 'gaming licence' granted under the Gaming and Betting Act 1994 (relevant state) (Gaming and Betting Act). The Gaming Machine Control Act and the Gaming and Betting Act were both later repealed and materially re-enacted in the Gambling Act.

Operators of licensed premises such as Cee Hotel and Fee Hotel were able to obtain a 'venue operator's licence' which authorised them to operate an 'approved venue' in which gaming activities conducted by Tattersalls or Tabcorp could take place. Cee Pty Ltd as trustee for Cee Unit Trust held venue operator's licences which permitted gaming activities to take place at Cee Hotel and Fee Hotel respectively. These licences later became Hotel Venue Operator's Licences granted under section 3.4.8 of the Gambling Act.

By way of two Venue Operator's Agreement entered into with Tabcorp Manager Pty Ltd (Tabcorp), gaming machines were installed by Tabcorp at Cee Hotel and Fee Hotel. The venue operators also agreed to collect the proceeds of gaming and deposit them into a trust account for the benefit of Tabcorp. As part of the arrangement, venue operators were entitled to retain part of the net proceeds from gaming pursuant to section 136 of the Gaming Machine Control Act and the associated Gaming Machine Control (Returns by Gaming Operators) Regulations 2000.

Under the Venue Operator's Agreement, neither the operator of Cee Hotel nor Fee Hotel had the ability to vary the number of gaming machines without the consent of Tabcorp.

Under this arrangement, Cee Pty Ltd as trustee for Cee Unit Trust had:

● a certain number of gaming machines at Cee Hotel; and

● a certain number of gaming machines at Fee Hotel.

Change to the legislative framework

In 20XX, the relevant Government announced the new GME regime whereby Tattersalls and Tabcorp would no longer exclusively hold their respective gaming operator's licence and gaming licence. Instead, GMEs would be issued to operators of approved venues permitting them to conduct gaming on approved gaming machines in their own right.

In May 20BB, the relevant Government instituted a competitive auction process in respect of GMEs corresponding to the number of gaming machines operated state-wide under the gaming / gaming operator's licences then on issue. The existing licences held by Tattersalls and Tabcorp were allowed to expire (as of DDMMYY) and new entitlements, called GMEs, were offered with a maximum term of 10 years per GME, commencing on DDMMYY. At the point in time at which these GMEs will expire, it is anticipated that a further auction process would take place.

Cee Pty Ltd as trustee for Cee Unit Trust participated in the auction and was successful in its bids to be allocated a GME for each of the gaming machines already operating at Cee Hotel and Fee Hotel in accordance with the respective Venue Operator's Agreement; that is, a total number of GMEs for Cee Pty Ltd. The Entitlements Register shows that Cee Pty Ltd is licensee to GMEs.

As the holder of GMEs, venue operators are now entitled to all the proceeds (net of State taxes) of gaming conducted at their venue and are also responsible for the costs associated with the gaming machines.

No GME has been acquired or disposed of since that time by Cee Unit Trust.

Cee Unit Trust's GME expenditure

In order to acquire the GMEs in the May 20BB auction process, Cee Unit Trust entered into agreements with the State under which Cee Unit Trust was obliged to make certain payments to the State. Payment terms for the GMEs were agreed to in the 'Entitlement Related Agreement for Payment' agreement.

On acquisition of a GME, each vendor had the option to pay the cost of the GME up-front, or pay the fee in instalments. In this instance, Cee Unit Trust elected to pay the GME fees in instalments.

Cee Unit Trust has not previously claimed any deductions for the expenditure incurred to acquire each GME under any provision of the income tax legislation, whether pursuant to section 40-880, or section 8-1, or otherwise.

Cee Unit Trust has recorded GMEs as intangible assets in its financial statements and amortised the assets over their effective lives for accounting purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 8-1(1)

Income Tax Assessment Act 1997 Subsection 8-1(2)

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 Subsection 40-880(1)

Income Tax Assessment Act 1997 Subsection 40-880(2)

Income Tax Assessment Act 1997 Subsection 40-880(5)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(a)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(b)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(d)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(f)

Income Tax Assessment Act 1997 Subsection 40-880(6)

Income Tax Assessment Act 1997 Subsection 110-25(5)

Income Tax Assessment Act 1997 Subsection 110-25(5A)

Reasons for decision

Question 1

Is Cee Unit Trust entitled to claim a deduction from its assessable income pursuant to section 40-880, in each income year within the Relevant Period (being the period beginning from the start of the 2010 income year through to the end of 2014 income year) in respect of the gaming machine entitlement (GME) expenditure it incurred in the 2010 income year?

Summary

No.

The expenditure on acquiring each GME is business capital expenditure incurred in relation to the business of Cee Unit Trust. However, the expenditure is excluded from deductibility under section 40-880 pursuant to the exclusions in paragraphs 40-880(5)(d) and (f). The exception under subsection 40-880(6) does not apply because the expenditure to acquire a GME:

● does not preserve the value of the goodwill of Cee Unit Trust; and

● secures rights with an inherent value such that the value of the right to Cee Unit Trust is not solely attributable to any effect that the right has on preserving goodwill value.

The expenditure on acquiring each GME will instead form part of the cost base of the GME as a separate CGT asset in its own right. As the expenditure is recognised and is taken into account by the CGT provisions, a deduction under section 40-880 is therefore not allowable.

Detailed Reasoning

DEDUCTION FOR BUSINESS RELATED COSTS - SECTION 40-880

Section 40-880

Under section 40-880, taxpayers are entitled to deduct certain business related capital expenditure, known as 'black hole' expenditure, provided certain conditions are met.

Subsections 40-880(1) and (2) state the following:

Object

40-880(1) The object of this section is to make certain business capital expenditure deductible over 5 years if:

(a) the expenditure is not otherwise taken into account;

(b) a deduction is not denied by some other provision; and

(c) the business is, was or is proposed to be carried on for a taxable purpose.

Deduction

40-880(2) You can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur:

(a) in relation to your business; or

(b) in relation to a business that used to be carried on; or

(c) in relation to a business proposed to be carried on; or

(d) to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business.

(emphasis added)

Incurred

The Commissioner accepts that the expenditure in relation to the GMEs was incurred in the 20BB income year. The Commissioner's view of the meaning of 'incurred' is set out In Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions (TR 97/7). Under paragraph 5 of TR 97/7, you broadly incur an outgoing at the time you owe a present money debt that you cannot escape.

The Commissioner considers that the expenditure in relation to the GMEs was incurred by Cee Unit Trust in the 20BB income year, notwithstanding that the payments were allowed to be made in instalments extending beyond the 20BB income year.

Therefore, the expenditure in relation to the GMEs was incurred by Cee Unit Trust in the 20BB income year, notwithstanding that the payments were allowed to be made in instalments extending beyond the 20BB income year.

In relation to a business

The Commissioner also accepts that Cee Unit Trust carry on a business for a taxable purpose, comprising owning and operating:

● Cee Hotel, a venue consisting of gaming machine, TAB wagering, liquor and dining; and

● Fee Hotel, a venue consisting of gaming machine, TAB wagering, liquor and dining.

As explained in paragraph 15 of Taxation Ruling TR 2011/6 Income Tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues (TR 2011/6), the expression 'in relation to' denotes the proximity required between the expenditure and the former, current or proposed business.

For capital expenditure to be 'in relation to' a business, there must be a sufficient and relevant connection between the expenditure and the business. It is clear that the expenditure incurred on each of the GMEs is intimately connected with the ongoing operation of the business of Cee Hotel and Fee Hotel respectively. Therefore the Commissioner accepts that the expenditure was incurred 'in relation to' the business.

Capital expenditure

Expenditure is only deductible under section 40-880 if it is capital expenditure.

The primary authority in determining whether an amount of expenditure is capital in nature is Dixon J's statement in Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 (the Sun Newspapers case) at 363:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing periodic reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

Upon consideration of the factors in the Sun Newspapers case, the Commissioner considers the expenditure on the acquisition of each GME to be capital expenditure for the following reasons:

Character of advantage sought

According to paragraph 67 of TR 2011/6, the character of the advantage sought provides important direction and is the best guidance as to the nature of the expenditure as it says the most about the essential character of the expenditure itself. If the expenditure produces some asset or advantage of a lasting character for the benefit of the business it will be considered to be capital expenditure (British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 at 213-214).

The Commissioner considers that the essential character of the expenditure incurred to acquire each GME by Cee Unit Trust secure an enduring benefit to its businesses; namely, for each GME, the right to operate a gaming machine in an approved venue for 10 years.

As to whether the GME is an enduring asset, the term 'enduring' was referred to by Rich J at page 547 in Herring v. Federal Commissioner of Taxation (1946) 72 CLR 543, who stated that:

by enduring it is not meant that the asset or advantage should last forever. It is a matter of degree and only one element to be considered.

The essential character of this advantage is structural and goes to the profit-yielding structure of the business, rather than the profit-making process. Each GME is part of the structure that is necessary for the earning of profit, and not the operation of the process to obtain regular returns by means of a regular outlay (as per Dixon, J in the Sun Newspapers case at CLR 359). This takes into account the fact that the rights secured by each GME are new additional rights Cee Unit Trust did not possess before.

Prior to the acquisition of GMEs, Cee Unit Trust was merely a venue operator who ran approved venues at which gaming was conducted. The gaming operator was in the case of Cee Unit Trust, Tabcorp who, along with Tattersals, were the only entities entitled to conduct gaming and receive gaming receipts. As holders of the GMEs acquired in the 20BB income year, Cee Unit Trust is now authorised to conduct gaming activities in their own right and directly receive gaming receipts. Without holding a GME, Cee Unit Trust could not legally operate a gaming machine at its premises.

Each GME held by Cee Unit Trust enables the holder to operate one machine (and preclude someone else from holding that GME) and there are statutory caps on the number of GMEs that are issued to an operator of any given venue and to operators within a geographical region. Cee Unit Trust is now also free to vary the number of gaming machines it operate by way of sale or acquisition of one or more GMEs through the transfer scheme, subject to statutory limitations; this is another right Cee Unit Trust previously did not possess. In consideration of the new rights and advantages now enjoyed by Cee Unit Trust, the Commissioner considers that the expenditure goes to the profit-yielding structure of the business and is therefore capital expenditure.

Although an enduring benefit does not require that the taxpayer obtain an actual asset, the Commissioner considers that the expenditure here did in fact secure structural assets in the form of entitlements to operate gaming machines which are transferable - this is discussed in further detail as part of the exclusions to section 40-880 which follows after this section of the ruling.

The above view is also supported by Ausnet Transmission Group Pty Ltd v Federal Commissioner of Taxation [2015] HCA 25; ATC 20-521 (Ausnet case), where the Court ruled that payments made by AusNet Transmission Group Pty Ltd (AusNet) to the State in relation to certain statutory charges imposed as holder of Transmission License transferred to it were capital. In reaching this view, the Courts concluded that the character of advantage sought from the payment was to acquire the Transmission License, which was an intangible asset but was properly viewed as part of the business structure (Ausnet case 2015 ATC 17475 at para 66).

The manner in which it is to be used

Each GME is a prerequisite for the operation of a gaming machine but is not actually used up in the operation of such activity (i.e. is part of the fixed, and not circulating, capital). This indicates a relationship to the profit-yielding structure of the business (comprising the operation of a collection of gaming machines) and that the expenditure is capital.

The means adopted to obtain it

Each GME was obtained through a one-off auction in 20BB, involved the payment of a significant amount of money and secured an advantage lasting 10 years. After the initial incurrence of the expenditure to acquire a GME, no further expenditure will be incurred in relation to the continued holding of, and enjoyment of the privileges and rights conferred by, each GME. Therefore, the outlay is in essence a once-off payment rather than periodical (even though it is paid in instalments) and supports the view that the expenditure is capital.

The facts of this case is to be distinguished from the facts in Federal Commissioner of Taxation v CityLink Melbourne Ltd (formerly known as Transurban City Link Ltd) [2006] HCA 35 (CityLink case), involving concession fees. In this case, the GME expenditure was a one off cost for the GME (for the remainder of its validity period), notwithstanding the GME expenditure is to be paid in instalments. Unlike the CityLink case, there is no correlation between the instalments and the GME period to which the instalments relate to. In any event, the decision made by the Court in CityLink that the concession fees were revenue was not based on consideration of the recurrent nature of the expenditure in isolation, but consideration of the character of the payment - that is, the 'recurrence' factor does not merely mean regular incurrence of any type of expenditure, rather it has to be a type of working expense that is required for the operations of the business instead of expenditure on the structure through which the business is conducted and profits are earned.

Summary of factors

In summary, the indicators discussed in the Sun Newspapers case point to the conclusion that the expenditure incurred on acquiring each GME is capital in nature.

The expenditure incurred in the 20BB income year in relation to each GME may be deductible under section 40-880 unless one of the exclusions in subsection 40-880(5) applies.

EXCLUSIONS TO DEDUCTIBLITY UNDER SECTION 40-880

Subsection 40-880(5) states as follows:

You cannot deduct anything under this section for an amount of expenditure you incur to the extent that:

(a) It forms part of the cost of a depreciating asset that you hold, used to hold or will hold; or

(b) You can deduct an amount for it under a provision of this Act other than this section; or

(c) Not relevant

(d) It is in relation to a lease or other legal or equitable right; or

(e) Not relevant

(f) It could, apart from this section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event

(g) Not relevant

(h) Not relevant

(i) Not relevant

(j) Not relevant

Depreciating asset exclusion - subsection 40-880(5)(a)

Under paragraph 40-880(5)(a), you cannot deduct expenditure under section 40-880 if it forms part of the cost base of a depreciating asset.

A depreciating asset is defined under 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 excludes, amongst others, intangible assets except for those listed in subsection 40-30(2): paragraph 40-30(1)(c). GMEs are not intangible assets listed in subsection 40-30(2) and therefore are not depreciating assets as defined in subsection 40-30(1).

Therefore, the exclusion under paragraph 40-880(5)(a) does not apply and that subsection does not prevent the expenditure incurred on acquiring each GME from being deductible under section 40-880.

Deductible under a provision of this Act other than this section exclusion - paragraph 40-880(5)(b)

Under paragraph 40-880(5)(b), you cannot deduct expenditure under section 40-880 if it is deductible under a provision of the Act (which includes both the ITAA 1997 and the ITAA 1936) other than section 40-880. As the Commissioner has determined above, the expenditure incurred on acquiring each GME is capital in nature and so is excluded from the general deduction under section 8-1. The Commissioner considers there is no other provision of this Act under which the expenditure could be deductible, apart from section 40-880.

Therefore, the exclusion under paragraph 40-880(5)(b) does not apply and that subsection does not prevent the expenditure incurred on acquiring each GME from being deductible under section 40-880.

Lease or other legal/equitable right exclusion - paragraph 40-880(5)(d)

Under paragraph 40-880(5)(d), you cannot deduct expenditure under section 40-880 if it is 'in relation to a lease or other legal or equitable right'.

The expression 'in relation to a lease or other legal or equitable right' or any part of the expression is not defined in the legislation. Paragraph 40-880(5)(d) replicates the former paragraph 40-880(3)(d) that is now repealed.

In respect of paragraph 40-880(5)(d), paragraph 2.68 of the Explanatory Memorandum (EM) to Tax Laws Amendment (2006 Measures No. 1) Bill 2006 states:

This exclusion replicates that found in the repealed section 40-880, having been added in 2002 in the context of the Government's review of the treatment of expenditure incurred on leases or other legal or equitable rights. The 2005-06 Budget announced that the Government would take a case-by-case approach in relation to the taxation of rights.

Since that paragraph states that the exclusion contained in paragraph 40-880(5)(d) replicates that found in the repealed section 40-880, it is relevant to consider the repealed paragraph 40-880(3)(d). In discussing that exclusion, paragraph 3.67 of the EM to the Taxation Laws Amendment Bill (No. 5) 2002 stated:

The Government is reviewing the treatment of expenditure incurred in relation to leases or other legal or equitable rights as part of the consideration of the recommendations of the Review of Business Taxation. The appropriate income tax treatment of capital expenditure incurred in relation to these leases and rights will be determined as part of that review. Consequently, capital expenditure on leases or other legal or equitable rights will be excluded from deduction under section 40-880. For example, expenditure representing lease surrender payments incurred in closing down your business will not be deductible under section 40-880.

(emphasis added)

It is therefore relevant to consider what 'leases and rights' were contemplated in the recommendations of the Review of Business Taxation in order to determine the intended scope of the phrase 'in relation to a lease or other legal or equitable right' in paragraph 40-880(5)(d) and former paragraph 40-880(3)(d).

The proposed review of the taxation of 'leases and rights' was discussed at pages 217-280 of the Review of Business Taxation, A Platform for Consultation, Discussion Paper 2 Volume I, February 1999 (Discussion Paper). Specifically, at paragraph 8.1 on page 217, the following is stated:

What is a lease or right?

Leases and rights are essentially arrangements for transferring some or all of the benefits of ownership of an asset from the owner to the recipient of the lease or right. The following kinds of rights contracts are covered by the discussion:

● leasing and similar contracts which provide rights over physical assets, for example, leases of equipment;

● contracts giving rights over intangible assets, such as spectrum licences and rights in films, patents, copyright, and industrial designs;

● indefeasible rights of use over assets, such as telecommunication cables;

● profits á prendre, that is, a right to take a product such as standing timber from another person's land;

● contracts for services;

● restrictive covenants; and

● rights to receivables arising from 'rights' contracts, for example, lease receivables.

Paragraph 8.2 of the Discussion Paper then states that the paper deals with the following broad category of rights:

i) rights granted over the use of physical and intangible business assets;

ii) rights under financial transactions; and

iii) rights that are trading stock, such as software produced or developed for sale.

The broad categories together with the examples set out above indicate that relevant rights are proprietary rights, whether they are of, or against, the grantor of the right.

Therefore, it is expected that leases and rights of the sorts outlined above in the Discussion Paper would be excluded from deductibility under paragraph 40-880(5)(d).

The Commissioner considers that GMEs are rights which may come within the 'leases and or other legal or equitable rights' that were considered by the Review of Business Taxation. Specifically, the rights attached to a GME cover the use of a physical asset in the form of a gaming machine, and also constitute intangible business assets that are similar in nature to the contracts giving rights over intangible assets identified in the Discussion Paper. Consequently, expenditure incurred on acquiring each GME is in relation to a lease or other legal or equitable right that is excluded from a deduction under section 40-880, pursuant to the exclusion in paragraph 40-880(5)(d).

The Commissioner notes that Cee Unit Trust has conceded that paragraph 40-880(5)(d) could apply.

In the alternative, the Commissioner considers that the expenditure incurred on acquiring each GME would be excluded from being deductible under section 40-880 by the exclusion in paragraph 40-880(5)(f) as explained further below.

Taken into account in working out the amount of a capital gain or capital loss from a CGT event exclusion - paragraph 40-880(5)(f)

Paragraph 40-880(5)(f) excludes expenditure from being deductible under section 40-880 if it could be taken into account in working out a capital gain or loss from any CGT event that may apply. Cee Unit Trust has agreed that the GME expenditure is prima facie excluded from deductibility under this paragraph.

A 'CGT asset' is broadly defined in section 108-5 as 'any kind of property or a legal or equitable right that is not property'. There are a wide range of CGT events. Section 104-5 provides a summary of all the possible CGT events.

Section 100-45 prescribes how to calculate the capital gain or loss for most CGT events. It broadly involves working out your capital proceeds from the CGT event and subtracting the cost base for the CGT asset from the capital proceeds. If the proceeds exceed the cost base, the difference is your capital gain. Otherwise, your capital loss is the excess of the reduced cost base over the capital proceeds. Therefore, a relevant expenditure could be taken into account in working out a capital gain or loss if it forms part of the cost base or reduced cost base of a CGT asset.

GME is a CGT asset

'Property' is not defined in the ITAA 1997 and it instead takes its ordinary legal meaning The following description of 'property' by the Australian Law Reform Commission is a useful starting point:

The term 'property' is used in common and some legal parlance to describe types of property that is both real and personal. 'Real' property encompasses interests in land and fixtures or structures upon the land. 'Personal' property encompasses tangible or 'corporeal' things—chattels or goods. It also includes certain intangible or 'incorporeal' legal rights, also known in law as 'choses in action', such as copyright and other intellectual property rights, shares in a corporation, beneficial rights in trust property, rights in superannuation and some contractual rights, including, for example, many debts. Intangible rights are created by law. Tangible things exist independently of law but law governs rights of ownership and possession in them—including whether they can be 'owned' at all.

In Yanner v. Eaton (1999) 201 CLR 351; [1999] HCA 53; (1999) 73 ALJR 1518, the High Court accepted that property refers not to a thing but to a description of a legal relationship with a thing; and, more specifically, to the degree of power that is recognised in law as permissibly exercised over the thing. There is neither a single test nor a single determinative factor for identifying a proprietary right. Courts have emphasised different characteristics in different circumstances. One formulation that has been applied in Australia is the 'Ainsworth test' - which asks whether a right is definable, identifiable and capable of assumption by third parties, and permanent or stable to some degree.

However, courts have also focused on factors such as excludability (whether it is possible to exclude others from the right in question), commercial value (whether something is treated in commerce as a valuable proprietary right), and enforceability of the right against third parties generally. Accordingly, in determining whether something amounts to property, it is necessary to weigh up a range of factors and to treat none as definitive.

Under Chapter 1 of the Gambling Act, a 'gaming machine entitlement' means an entitlement created under Part 4A of Chapter 3 of the Gambling Act. The authority conferred by a GME is specified in section 3.4A.2 of the Gambling Act. Under subsection 3.4A.2(1) of the Gambling Act, a GME authorises the venue operator that holds the GME to acquire approved gaming equipment and to conduct gaming on one approved gaming machine in an approved venue.

The 'conduct of gaming' is defined in section 3.1.4 of the Gambling Act to include the operation of gaming machines and the use or distribution of proceeds from the conduct of gaming.

GME is 'property'

It is considered that the GME is 'property' for the following reasons:

● definable, identifiable and capable of assumption by third parties: the rights attached to a GME as well as its duration, are defined specifically under the Gambling Act. Each GME is identifiable by a unique ID and each GME is also capable of being assigned or sold to third parties independent of the business, activity or operation conducted in respect of it. The Entitlements Transfer Register (ETR) contains a record of GMEs that have been transferred through the ETM.

● commercial value: based on recorded transfers on the ETR, a GME has commercial value on an active transfer market. The value of each GME is likely to reflect the potential profits that could be earned from acquiring and operating a gaming machine which is one of the rights a GME confers.

● akin to a taxi licence which has been held to be property: in Federal Commissioner of Taxation v Murry (1998) 193 CLR 605; [1998] HCA 42; 98 ATC 4585 (Murry), the majority of the High Court (HC) held that a non-exclusive taxi licence is an item of property because it has economic potential and is capable of being sold or leased for reward to a third party independently of any business conducted in respect of it. The majority of the HC held that the value of the licence would no doubt reflect the profit that could be earned from commencing a business of the kind which the licence authorised. For similar reasons, it is considered that a GME should also be regarded as property.

GME is still a CGT asset even if it is not 'property'

However, even if the GME is not 'property', the GME is still a 'CGT asset' if it is a 'legal or equitable right that is not property' pursuant to section 108-5. There is little doubt that the GME is a statutory right that confers on the holder a bundle of legal rights including the right to conduct gaming (as defined in subsection 3.1.4(1) of the Gambling Act) on one gaming machine, albeit subject to meeting other conditions. The GME is therefore a 'legal or equitable right' and a CGT asset.

CGT events that could happen to the GME

The relevant CGT events that can happen in relation to a GME are CGT event A1 and CGT event C2.

It must be noted that paragraph 40-880(5)(f) refers to expenditures that 'could' be taken into account. Paragraph 2.73 of the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006 makes it clear that a capital gain or loss that has not yet been realised or is disregarded is still caught under the exclusion under paragraph 40-880(5)(f) such that the expenditure 'could…be taken into account in working out the amount of a capital gain or capital loss' from a CGT event.

Paragraph 2.73 of the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006 states as follows:

Where an amount can be taken into account in working out a capital gain or loss from a CGT event, it is not deductible. A capital gain or loss that has not yet been realised or where the capital gain or loss is disregarded (eg, because it is a pre-CGT asset) or reduced is excluded from deduction under section 40-880 by paragraph 40-880(5)(f). An amount is not taken into account in working out a capital gain or loss if the expenditure cannot be included in the cost base or reduced cost base of the asset (eg, expenses related to the sale of a CGT asset that falls through)……

(emphasis added)

Therefore, the expenditure to acquire the GME is capable of being taken into account under CGT events A1 or C2 and prima facie excluded under paragraph 40-880(5)(f), even though no GME has expired or been sold by the Trusts to date.

CGT event A1 - disposal of a GME

Each GME is tradeable on the ETM. When a GME is traded, CGT event A1 'Disposal of a CGT asset' happens under section 104-10 as a result of the change of ownership that occurs from you to another entity. Under subsection 104-10(4), you make a capital gain from CGT event A1 if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

Under section 110-25, the cost base of an asset consists of 5 elements. Under section 110-55, the reduced cost base of a CGT asset consists of the same 5 elements as the cost base (except the third one), but does not include the indexation of those elements.

Under subsection 110-25(2), the first element of the cost base is the total of the money you paid, or are required to pay, in respect of acquiring the CGT asset and the market value of any other property you gave, or are required to give, in respect of acquiring the CGT asset.

Amounts that must be paid to the State in respect of each GME acquired is included in the first element of the cost base/reduced cost base of each GME. Therefore, the expenditure incurred to acquire each GME can be taken into account in working the capital gain or loss from any future disposal of the GME and as such will be excluded from being deductible under section 40-880 pursuant to paragraph 40-880(5)(f).

CGT event C2 - expiry of a GME

Alternatively, upon the expiry of each GME after the 10 year period, CGT event C2 'Cancellation, surrender and similar endings' happens under paragraph 104-25(1)(c).

Under subsection 104-25(1), CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

(a) being redeemed or cancelled; or

(b) being released, discharged or satisfied; or

(c) expiring; or

(d) being abandoned, surrendered or forfeited; or

(e) if the asset is an option - being exercised; or

(f) if the asset is a convertible interest - being converted.

(emphasis added)

The Macquarie Dictionary Online defines an 'intangible asset' as follows:

Noun an asset, such as a patent, copyright, brand name, etc., which has no physical properties but which can be identified, given a monetary value, and therefore recorded on a balance sheet.

The GME is considered to be an intangible asset as it has no physical form but it can be identified and given monetary value.

Given the GME has a specified life, CGT event C2 will happen to the GME at expiry, assuming it is not sold or forfeited earlier.

Under subsection 104-25(3), you make a capital gain from CGT event C2 if the capital proceeds from the ending of the intangible asset are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

As discussed above, amounts that must be paid to the State in respect of each GME acquired is included in the first element of the cost base and reduced cost base of each GME. Therefore, the expenditure incurred to acquire each GME can be taken into account in working out the (likely) capital loss from the expiry of each GME. Accordingly, expenditure incurred on acquiring each GME will be excluded from a deduction under section 40-880 pursuant to the exclusion in paragraph 40-880(5)(f).

Goodwill

Goodwill is a CGT asset that upon disposal can give rise to CGT event A1. Expenditure incurred to acquire goodwill is included in the first element of the cost base of goodwill.

Goodwill is not defined in the ITAA 1997. In TR 1999/16: Income tax: capital gains: goodwill of a business (TR 1999/16), the Commissioner provides his view on what is meant by the goodwill of a business, based on the legal definition of goodwill as explained by the High Court in the Murry case. Paragraph 12 of TR 1999/16 provides a useful summation of the meaning of goodwill:

…goodwill is the product of combining and using the tangible, intangible and human assets of a business for such purposes and in such ways that custom is drawn to it. The attraction of custom is central to the legal concept of goodwill. Goodwill is a quality or attribute that derives among other things from using or applying other assets of a business. It may be site, personality, service, price or habit that obtains custom. It is more accurate to refer to goodwill as having sources than it is to refer to it as being composed of elements. Goodwill is a composite thing. It is one whole. It is an indivisible item of property that is legally distinct from the sources from which it emanates. It is something that attaches to a business and is inseparable from the conduct of a business. It cannot be dealt with separately from the business with which it is associated.

The Commissioner considers that the expenditure incurred on acquiring the GMEs was not incurred to acquire goodwill but to acquire each individual GME. A mere right to enter a market was held in Murry [at 68] not to be goodwill or even a source of goodwill.

“…a licence that authorises the conduct of a business is not a source of goodwill….A taxi licence therefore is simply an item of property whose value is not dependent on the present existence of a business. It is not and does not contain any element of goodwill.”

(emphasis added)

As explained in paragraphs 27 and 126 of TR 1999/16:

27: Goodwill is one CGT asset separate and distinct from other assets of the business such as plant, licences (whether exclusive or non-exclusive), statutory permits, quotas, entitlements, valuable contractual rights and items of intellectual property (for example, a trademark, patent, copyright or registered design).

126: The cost base of goodwill does not include the cost base of other assets of a business…

(emphasis added)

Therefore expenditure incurred on acquiring each GME did not result in the acquisition of goodwill; instead the expenditure will be included in the cost base of the GME as a separate CGT asset of the business carried on by Cee Unit Trust.

Subsections 110-25(5) and 110-25(5A)

Subsection 110-25(5) includes in the fourth element of the cost base of an asset capital expenditure incurred for the purpose or the expected effect of increasing or preserving the value of an asset.

However, subsection 110-25(5A) states that the fourth element of the cost base of an asset does not apply to 'capital expenditure incurred in relation to goodwill.'

Therefore, subsection 110-25(5A) operates to exclude from the fourth element of the cost base of an asset expenditure that has the purpose or the expected effect of increasing or preserving the value of goodwill.

Cee Unit Trust has submitted that the expenditures on the GMEs were incurred in relation to preserving the goodwill of the businesses at Cee Hotel and Fee Hotel. This is on the basis that the gaming related activities could not be carried on without acquiring the GMEs. Cee Unit Trust contend that subsection 110-25(5A) supports their view that expenditure on acquiring the GMEs is deductible under section 40-880 because of the effect that subsection 110-25(5A) has in removing expenditure in relation to goodwill from the fourth element of the cost base, thereby mitigating the exclusion under paragraph 40-880(5)(f) that could otherwise apply to deny the deduction under section 40-880.

The Commissioner does not consider that the proper characterisation of the expenditure incurred on the acquisition of each GME resulted in the acquisition of any goodwill (as already discussed) or was in relation to preserving the goodwill of the businesses at Cee Hotel and Fee Hotel. Rather, it was expenditure incurred for the purpose of acquiring each GME which gave Cee Unit Trust the right to conduct an activity (i.e. gaming) that it previously did not conduct. This right is in the form of a GME - a specifically identifiable asset with its own acquisition cost such that the expenditure incurred to acquire this right properly forms part of the first element of the cost base of this asset.

This is also the appropriate characterisation of the expenditure under the underlying asset approach (see TR 95/35: Income tax: capital gains: treatment of compensation receipts). Under this approach, the relevant underlying asset here is the GME (together with the rights embodied in the GME), not goodwill, and the essential character of the expenditure in question here is expenditure incurred to acquire the GME, not expenditure to increase or preserve goodwill value. Therefore, neither subsections 110-25(5) nor 110-25(5A) can be relevantly engaged.

Further, subsection 110-25(5A) does not have the effect of preventing expenditure to acquire a CGT asset from forming part of the first element of the cost base of an asset (and consequently being excluded from deductibility under section 40-880 by paragraph 40-880(5)(f)); it merely prevents expenditure incurred in relation to goodwill from forming part of the fourth element of the cost base of an asset in order to ensure the expenditure is still eligible for the more concessional treatment under section 40-880. However, this is always subject to the condition that the expenditure is otherwise deductible under section 40-880 which is made clear in the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006 which introduced subsection 110-25(5A), at paragraph 2.144 where it states:

The fourth change is that the element does not apply to capital expenditure incurred in relation to goodwill. A consequence of this exclusion is that expenditure in relation to goodwill already attracting deductibility over five years does not receive less generous CGT treatment by reason of the enlargement of the fourth element.

(emphasis added)

This means that the interaction between subsection 110-25(5A) and section 40-880 allows a section 40-880 relief for a prescribed type of expenditure, being expenditure that preserves the value of goodwill, where the other conditions of 40-880 are otherwise satisfied (or in other words, where no other limb of section 40-880 otherwise operates to deny a section 40-880 deduction).

Therefore, the types of expenditures contemplated by subsection 110-25(5A) are those that merely preserve goodwill value and are not prevented from being deductible because of another condition elsewhere in section 40-880. This would exclude instances where other valuable CGT assets are acquired, the acquisition cost of which is a CGT first element cost base which is in fact excluded in accordance with paragraph 40-880(5)(f).

Therefore on the basis that expenditure incurred on acquiring each GME forms part of the first element of the cost base of the GME, it is not deductible under section 40-880 and subsections 110-25(5) and accordingly, 110-25(5A), are not relevant.

The expenditure is then only deductible if the exception under subsection 40-880(6) applies.

Subsection 40-880(6) - an exception to the exclusions in subsection 40-880(5)

Subsection 40-880(6) states as follows:

The exceptions in paragraphs (5)(d) and (f) do not apply to expenditure you incur to preserve (but not enhance) the value of goodwill if the expenditure you incur is in relation to a legal or equitable right and the value to you of the right is solely attributable to the effect that the right has on goodwill.

Therefore, the exception in subsection 40-880(6) is satisfied if the following conditions are satisfied:

(a) the expenditure is in relation to a legal or equitable right;

(b) the expenditure is incurred to preserve, but not enhance, the value of goodwill; and

(c) the value of the right to you is solely attributable to the effect that the right has on preserving goodwill value.

In relation to a legal or equitable right

As already discussed, in accordance with section 3.4A.2 of the Gambling Act, each GME confers (amongst other rights) the legal right to operate one gaming machine in an approved venue in the State. Therefore, the expenditure incurred on acquiring each GME is in relation to the acquisition of a legal or equitable right. Therefore condition (a) is satisfied.

Preserving, but not enhancing, the value of goodwill

Cee Unit Trust makes the following contentions:

a) the GME only provides for the continuity of Cee Unit Trust's businesses;

b) there has been no change to the day-to-day operations of Cee Unit Trust's gaming businesses;

c) obtaining the GMEs did not confer any new or additional benefit on Cee Unit Trust;

d) the GME expenditure was for the sole purpose of preserving the value of the goodwill of Cee Unit Trust's gaming businesses;

e) but for the successful acquisition of the GME, Cee Unit Trust could not carry on its gaming businesses and all goodwill referable to the gaming businesses would be lost;

f) the GME expenditure has not enhanced the value of the goodwill of Cee Unit Trust's businesses in any way;

g) that Cee Unit Trust did not directly own the rights to operate gaming machines on premises before the introduction of the GME regime is not relevant. What is relevant is that Cee Unit Trust carried on business of operating a combined hotel and gaming venue at all relevant times - both before and after the introduction of the GME regime; and

h) although the GME rights that were acquired were not identical to the rights Cee Unit Trust held before the introduction of the GME regime, this is in no way relevant to why the GME expenditure was incurred. The acquisition of a tradeable asset was not the reason why the GME expenditure was incurred. In reality, Cee Unit Trust would not trade its GMEs as they are fundamental to the operation and maintenance of its business.

New and additional benefits under a GME

Firstly, the Commissioner would like to address these specific contentions:

● the GME only provides for the continuity of Cee Unit Trust's businesses;

● there has been no change to the day-to-day operations of Cee Unit Trust's gaming businesses;

● obtaining the GMEs did not confer any new or additional benefit on Cee Unit Trust;

● Cee Unit Trust did not directly own the rights to operate gaming machines on premises before the introduction of the GME regime is not relevant. What is relevant is that Cee Unit Trust carried on business of operating a combined hotel and gaming venue at all relevant times - both before and after the introduction of the GME regime.

The Commissioner's review of the legislative scheme that operated in the State's gaming industry prior to the introduction of the GME regime established that venue operators such as Cee Unit Trust were not gaming operators but were merely operators of approved gaming venues under a venue operator's licence.

The Venue Operator's Agreement between Tabcorp and Cee Unit Trust, as gaming operators and venue operators respectively, did not create a relationship of agency nor was there a sub-licensing of the gaming licence which in any event appears not permissible under the prevailing legislation. Rather, the agreements simply provided for an arrangement for the installation of gaming machines at the venues and the collection of gaming receipts on behalf of Tabcorp.

Each GME confers the authority to Cee Unit Trust to conduct gaming in its own venue and in its own right. The bundle of rights held by Cee Unit Trust from holding its respective GMEs are substantially different to the limited rights Cee Unit Trust enjoyed under its prior contractual arrangements with Tabcorp.

As essentially the operators of gaming activities rather than merely the operators of a gaming venue at which someone else conducts gaming activities (as was the case prior to the GME regime commencing), Cee Unit Trust became entitled (once the GME regime commenced) to all of the actual proceeds of gaming (net of State charges) rather than merely receiving a specified retained amount.

Critically, the GMEs are clearly severable and can each be individually traded and dealt with (they each have a unique serial number and price) and Cee Unit Trust is (subject to statutory restrictions on the number of GMEs that can be held by any venue operator) at complete liberty to acquire additional gaming machines or reduce the number of gaming machines at its venue by acquiring or disposing of one or more GMEs. In contrast, under the Venue Operator's Agreements in relation to Cee Hotel and Fee Hotel, Cee Unit Trust could only vary the number of machines with the consent of Tabcorp.

Upon the acquisition of the GME, the venue operators effectively became gaming operators, authorised to conduct gaming at their own venues, including accessing the direct receipt of gaming proceeds. Therefore, the Commissioner does not agree with Cee Unit Trust's contentions that there has been no change to the day-to-day operations of its business, and more importantly the contentions that (a) the GME did not confer any new or additional benefits to Cee Unit Trust or (b) Cee Unit Trust did not directly own the rights to operate gaming machines on its premises before the introduction of the GME regime is not relevant; on the contrary, it is clear that Cee Unit Trust now holds in the form of a GME, a bundle of valuable rights it previously did not enjoy as mere holders of a venue operator's licence.

Preserving the value of goodwill

The concept and meaning of goodwill has briefly been discussed in the context of subsection 110-25(5A). To satisfy subsection 40-880(6), the essential character of the expenditure must be to preserve the value of goodwill and have that effect - this is clear because the expenditure cannot have the effect of enhancing goodwill and expenditure which has nothing to do with the value of goodwill will not satisfy subsection 40-880(6).

The test in subsection 40-880(6) is whether objectively, the essential character of the expenditure is to preserve the value of goodwill. The essential character test is appropriate given the context and objects of section 40-880 and the construction of subsection 40-880(6) the scope of which is intended to apply to expenditure of a very limited, prescribed nature. It is also consistent with the 'underlying asset' approach (see TR 95/35: Income tax: capital gains: treatment of compensation receipts) which focuses on the substance/reality of the relevant matter or transaction. The Commissioner considers that the expenditure on each GME was incurred to acquire a specific identifiable asset i.e. the right to operate a gaming machine, and not to preserve the value of goodwill (being the attractive force of custom arising from carrying on the business as a whole).

While the ability to continue the businesses of Cee Unit Trust depended, in part, on acquiring the GMEs, this does not mean that the value of goodwill is preserved merely by the incurrence of the expenditure to acquire the GMEs; to do so would ignore the substance of the expenditure and the important rights inherent in the GMEs themselves. Taking a broad interpretation would permit effectively any business expenditure to fall within the scope of subsection 40-880(6), no matter how remote, since all business expenditure has a connection to the goodwill of the business ultimately. This is contrary to the provision's object which serves to relieve expenditure that does nothing else apart from preserving the value of goodwill of a business.

In the context of the character of the rights enjoyed by Cee Unit Trust as a result of acquiring and holding each GME and how vastly different this is to rights they previously had before acquiring the GME, the Commissioner considers that the essential character of the relevant expenditure was directed at acquiring new assets in the form of GMEs, rather than being in relation to preserving the goodwill value of Cee Unit Trust's businesses. The expenditure simply was not directed at preserving the value of goodwill that emanated from combining the use of all the existing assets of the businesses of Cee Unit Trust, rather it was expenditure that gave rise to a new set of rights and assets which Cee Unit Trust did not previously own or enjoy.

There is no evidence that Cee Unit Trust paid the State a single undivided amount to ensure that it was granted entitlements to the same total number of gaming machines at its venue; rather, the total expenditure incurred by Cee Unit Trust is an aggregation of the individual cost to acquire each GME. The expenditure reflected the number of entitlements and machines Cee Unit Trust wanted to acquire and operate as gaming operators in its own right, rather than being expenditure directed at continuing its existing business which was only as a venue operator.

In summary, the Commissioner does not accept that the essential character of the expenditure is directed solely at preserving the value of the goodwill of Cee Unit Trust. Furthermore, the Commissioner does not accept that Cee Unit Trust has satisfied the remaining condition in subsection 40-880(6) concerning the value of the right being solely attributable to the effect the right has on preserving goodwill value (if indeed any). This is explained further below.

The value to you of the right is solely attributable to the effect that the right has on goodwill

For the exception under subsection 40-880(6) to apply, the Commissioner must also be satisfied that the 'value to you of the right is solely attributable to the effect that the right has on goodwill.' When read in its context, the effect that the right has can only be to preserve the value of goodwill, if the operation of subsection 40-880(6) is to be engaged.

The 'you' referred to in subsection 40-880(6) refers to Cee Unit Trust which have incurred the expenditure.

The Commissioner believes that there are two components to this last requirement in subsection 40-880(6), namely:

(a) what is the value of a right to a taxpayer; and

(b) is the value of the right to the taxpayer solely attributable to the effect the right has on preserving goodwill.

Value to you of the right

In considering the value of a right to a taxpayer, the Commissioner considers that this involves a consideration of the objective value of the right, rather than the subjective value of the right in the mind of the taxpayer. While the Commissioner accepts that the 'value to you' concept has regard to your intention of how you will realise that value, in this case, through holding the GME in order to operate a gaming machine in your own right, rather than through selling or trading it, the meaning of 'value to you' cannot be completely devoid of all objectivity. Nor does 'value to you' preclude the consideration of market value if there is one. A GME confers the right to operate a gaming machine and has a value to you (through use as opposed to through sale) that reflects the net present value of the future profits that you expect to derive from operating the gaming machine as authorised by the GME for the life of the entitlement (this is consistent with what the High Court held in Murry as cited earlier).

The Commissioner does not regard the words 'value to you' in section 40-898(6) as having the effect that the value of the right can only be subjectively determined by the taxpayer. 'Value to you' is not to be interpreted as 'value according to you', 'value in your mind' or 'value to you and you alone' but rather 'value to you or someone in a similar situation to you'.

The expression 'value to you' is required in the context of subsection 40-880(6) because rights which merely preserve the goodwill value attaching to a taxpayer's business can only ever have value to the taxpayer carrying on the business and no one else. They are rights that have no distinct or inherent value other than preserving the goodwill value of a business. Therefore, the term 'value to you' is used essentially to overcome the limitation of the absence of a market for the type of right that falls within the scope of subsection 40-880(6).

The Commissioner notes that the expression 'value to you' is used in section 15-2 of the ITAA 1997 and in the former paragraph 26(e) of the ITAA 1936. However, the use of the expression in that particular instance is of limited significance to the interpretation of subsection 40-880(6) which is worded differently and arises in a completely different context. Whereas the former paragraph 26(e) relates to the determination of whether there is a benefit given, granted or allowed to the taxpayer whose value has to be determined, subsection 40-880(6) is about providing relief as a black hole deduction for certain expenditures that do no more than preserve the value of the goodwill of a business. The context is entirely different and adopting the interpretation under one provision for the purpose of interpreting another is inappropriate and is of limited practical use.

Solely attributable to the effect the right has on preserving goodwill

The Commissioner believes the words 'attributable' involves a relationship of cause and effect, similar to the interpretation of that word in Commissioner of Taxation v. Sun Alliance Pty Ltd (in liq) (2005) 225 CLR 488; [2005] HCA 70; ATC 4955; ATR 560.

The existence of the word 'solely' before 'attributable' requires a narrow nexus between the subject matters (the value of the right and the effect of the right on goodwill value). The reference to 'solely attributable' implies that there can be no other objective reason, effect or purpose in incurring the expenditure and no other value attached to the right other than its effect on preserving goodwill value.

Therefore, the words 'solely attributable' preclude rights which have an inherent value. Support for this is found in the following extracts of the EM which include clear references to the distinct objective or inherent value of the right.

2.70 Expenditure is deductible where it is incurred in relation to a least or other legal or equitable right, and the value of the expenditure to the taxpayer arises solely from the effect that the right has in preserving, but not enhancing, the value of goodwill. For example, capital expenditure may be incurred in relation to a right that is both unlimited in duration, and which merely prevents goodwill from being damaged. Such a right has no distinct value in itself. Its value lies in the effect its existence has upon the value of the goodwill. Such expenditure represents in substance a black hole expense even though it is in relation to an asset.

2.71 Where a taxpayer incurs an expense in relation to a right and that right enhances the value of the goodwill, or has an inherent value in itself then it would not be appropriate to allow a deduction as a business related cost as the expenditure does not represent a loss to the taxpayer.

(emphasis added)

This view is consistent with the view expressed in paragraph 317 of TR 2011/6:

The subsection ensures that expenditure in relation to a right which has no value of itself and does not increase the value of goodwill from what it was before the expenditure took effect is not excluded from deduction under section 40-880.

(emphasis added)

The GME confers valuable statutory rights to the holder and are tradeable, if the holder so chooses, in a regulated transfer scheme. As discussed, the Commissioner considers that a GME is property, and if not property, then at least a valuable right that is not property. The Commissioner considers that the GME is an asset with an inherent value (reflecting the net present value of the expected future profits that can be derived from operating a gaming machine which the GME authorises for 10 years) which precludes it from being a right whose value is solely attributable to the effect the right has on preserving the goodwill value of a business. As a result, a deduction is not allowable for the cost of acquiring this distinct and valuable asset under section 40-880 as a business related cost since the expenditure does not represent a loss to the taxpayer.

Therefore the requirements in subsection 40-880(6) are not satisfied.

This is further confirmed by the addendum to TR 2011/6 published on 13 July 2016 in which example 40A was inserted after paragraph 318 to illustrate the application of subsection 40-880(6) to an analogous factual scenario.

Example 40A

318A. The Koala Hotel and Tavern (KHT) carries on a hospitality business that includes offering authorised gaming activities on gaming machines. Under state gaming regulations, KHT must hold a gaming machine entitlement for each gaming machine operated at its premises. There are statutory caps on the number of entitlements issued state wide, and to each holder and in each region. Each entitlement, identified by its unique serial number, authorises its holder to operate a gaming machine for a 10 year term, after which a reapplication and reallocation process will occur. Each entitlement is tradable on a state regulated entitlement trading market.

318B. KHT applied for, and was granted by the state, an allocation of gaming machine entitlements upon payment of an agreed price per entitlement. The capital expenditure incurred to acquire a gaming machine entitlement constitutes the first element of the cost base of the entitlement and will be taken into account in determining the capital gain or capital loss arising from either the sale or expiry of the entitlement. The expenditure therefore is excluded by the exception in paragraph 40-880(5)(f).

318C. Subsection 40-880(6) does not prevent paragraph 40-880(5)(f) from applying. The value to KHT of the entitlements is not solely attributable to the effect that the entitlements have on the goodwill in KHT's business. Each entitlement has a distinct value to KHT because it permits KHT to conduct authorised gaming activity using a gaming machine at its business premises and thereby earn profits, which it otherwise could not earn, from such conduct for a 10-year period. An entitlement may also be traded on a secondary market. This value arises regardless of whether the expenditure can also be said to be 'to preserve' goodwill to any extent.

318D. As the expenditure is recognised under the capital gains tax provisions, a deduction under section 40-880 is not allowable.

Black hole deductions - measure of last resort

Instead, the expenditure incurred on acquiring each GME will form part of the cost base of the GME as a CGT asset, upon either their disposal or expiration as the case may be. This result is consistent with the policy that the deduction under section 40-880 is for business capital expenditure that is not recognised in some way elsewhere in the tax law. This is reflected in both the objects of section 40-880 and throughout the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006:

The objects of section 40-880, as stated in subsection 40-880(1):

The object of this section is to make certain business capital expenditure deductible over 5 years if:

(a) the expenditure is not otherwise taken into account;

(b) a deduction is not denied by some other provision; and

(c) the business is, was or is proposed to be carried on for a taxable purpose.

(emphasis added)

Paragraph 2.9 and 2.17 of the EM to Tax Laws Amendment (2006 Measures No.1) Bill 2006 states:

2.9 This measure provides treatment for business capital expenditure not recognised in some way elsewhere in the tax law….

2.17 There are a number of exceptions which require, in effect, that the expenditure must not be taken into account in some way elsewhere in the income tax law. This means that the expenditure would not already be deductible, capitalised, amortised or capped in some way under another provision. The expenditure must also not be denied a deduction, including by limiting or capping the deduction, elsewhere in the tax law.

(emphasis added)

Section 40-880 is a provision of last resort and priority is given to the treatment in other provisions of the tax law, as reflected in the list of exclusions under subsection 40-880(5). Accordingly, since the expenditure to acquire each GME is taken into account by the CGT provisions, a deduction under section 40-880 is not allowable.