ATO ID 2012/14: Capital Gains Tax: non-TARP assets and the principal asset test in Division 855
Date of decision: 27 February 2012
Year of income: Year ended 30 June 2008
Business line: Public Groups and International

Issue
What is an 'asset' of an entity for the purposes of the principal asset test in section 855-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
An 'asset' of an entity for the purposes of the principal asset test in section 855-30 of the ITAA 1997 is anything recognised in commerce and business as having economic value to the entity at the time of the relevant capital gains tax event for which a purchaser of the entity's membership interests would be willing to pay.

Facts
The taxpayer, a foreign resident, owns 50% of the shares in Australian resident company A. Australian resident company A owns 100% of the shares in Australian resident company B. Australian resident company A lent a sum of money to Australian resident company B, under an inter-corporate loan agreement. As a result, Australian resident company A acquired an enforceable right to receive payment of money under the loan agreement. Australian resident company A holds an inter-corporate receivable, consisting of funds lent to Australian resident company B under the inter-corporate loan agreement. Australian resident company B holds, among other things, cash received under the inter-corporate loan agreement with Australian resident company A. The foreign resident taxpayer disposed of 20% of its shares in Australian resident company A and made a capital gain on that disposal.

Reasons for decision
Summary: (All legislative references are to the ITAA 1997) Whether a membership interest held by an entity in another entity passes the principal asset test at the time the relevant CGT event happens in relation to the membership interest is part of determining whether the membership interest is an 'indirect Australian real property interest' at that time: see paragraph 855-25(1)(b). An 'indirect Australian real property interest' is one of the categories of CGT assets that are 'taxable Australian property' (see section 855-15). A capital gain or capital loss that a foreign resident, or the trustee of a foreign trust for CGT purposes, makes from a CGT event that happens in relation to a CGT asset that is 'taxable Australian property' is not disregarded under subsection 855-10(1). The purpose of the principal asset test in section 855-30 is to define when an entity's underlying value is principally derived from Australian real property (subsection 855-30(1)). Subsection 855-30(2) provides that a membership interest held by the holding entity in the test entity passes the principal asset test if the sum of the market values of the test entity's 'assets' that are taxable Australian real property exceeds the sum of the market values of its 'assets' that are not taxable Australian real property. Subsection 855-30(3) provides that for the purposes of subsection (2), treat an asset of an entity (the 'first entity') that is a membership interest in another entity (the 'other entity') as if it were instead the following two assets: The market value of the TARP asset and the non-TARP asset are worked out according to the table in subsection 855-30(4). Columns 3 and 4 of item 2 of that table refer to the market values of 'assets' of the other entity. The term 'assets' used in the principal asset test in section 855-30 is not defined. Accordingly, the term takes its ordinary meaning relevant to the context. The Macquarie Dictionary (4th edition) gives several alternative meanings of the term 'assets': In the context of section 855-30, the term 'assets' is considered to carry its ordinary commercial or business meaning. Accordingly, in the context of the principal asset test in section 855-30, an asset of an entity is anything recognised in commerce and business as having economic value to the entity at the time of the relevant CGT event for which a purchaser of the entity's membership interests would be willing to pay. An entity's business or commercial assets are those which a prudent vendor and purchaser would identify as having value when setting the price for sale of a membership interest in the entity. These assets would also come within the scope of a due diligence examination undertaken on behalf of a prudent purchaser of such an entity. The purchaser of the membership interests would usually require warranties from the vendor to be included in the sale agreement in respect of the state and existence of the entity's commercial and business assets that comprise the underlying value of the membership interests being acquired. Accordingly, in the context of the principal asset test in section 855-30, 'assets' of an entity include such things as assets not recognised under accounting standards, items of trading stock, traditional and qualifying securities, depreciating assets and the entity's information assets, provided the thing is identified as a business or commercial asset that has economic value to the entity at the time of the relevant CGT event for which a purchaser of the entity's membership interests would be willing to pay. This broad meaning of 'assets' in the context of section 855-30 is supported by: The reference to 'market values' of the entity's assets suggests the identification of things capable of having a market value, that is things recognised in commerce and business as having economic value to the entity at the time of the relevant CGT event for which a purchaser of the entity's membership interests would be willing to pay. If an asset in the context of section 855-30 is identified, it must be determined whether for the purposes of that section the asset's market value should be disregarded under subsection 855-30(5). Subsection 855-30(5) provides that for the purposes of section 855-30, disregard the market value of any asset acquired by the test entity, or by any other entity, if the acquisition was done for a purpose (other than an incidental purpose) that included ensuring that a membership interest in any entity would not pass the principal asset test. Examples of factors that may be appropriate to take into account in relation to the objective test in subsection 855-30(5) are discussed in Practice Statement Law Administration PS LA 2005/24: Application of General Anti-Avoidance Rules . In the present case, Australian resident company A acquired an enforceable right to the payment of money under an inter-corporate loan agreement. The inter-corporate loan is considered to be something recognised in commerce and business as having economic value to Australian resident company A at the time of the CGT event relating to the foreign resident's disposal of shares in Australian resident company A, for which a purchaser of Australian resident company A's membership interests would be willing to pay. Accordingly, the inter-corporate loan is considered to be an asset of Australian resident company A for the purposes of the principal asset test in section 855-30. However, its market value would be disregarded for the purposes of the principal asset test if subsection 855-30(5) applies. Further, the cash received under the inter-corporate loan from Australian resident company A is considered to be something recognised in commerce and business as having economic value to Australian resident company B at the time of the CGT event relating to the foreign resident's disposal of shares in Australian resident company A, for which a purchaser of Australian resident company B's membership interests would be willing to pay. Accordingly, the cash is considered to be an asset of Australian resident company B for the purposes of the principal asset test in section 855-30. However, its market value would be disregarded for the purposes of the principal asset test if subsection 855-30(5) applies.

Legislative references: Income Tax Assessment Act 1997 subsection 855-10(1) section 855-15 paragraph 855-25(1)(b) section 855-30 subsection 855-30(1) subsection 855-30(2) subsection 855-30(3) subsection 855-30(4) subsection 855-30(5)
Related public rulings and determinations: Taxation Ruling TR 2004/13
Other references: Practice Statement Law Administration PS LA 2005/24
Subject references: Capital gains