Private ruling: The application of section 23AH(3)(b) of the ITAA 1936
Date of advice: 24 May 2017
Published: September 2017
Ruling period: The year ending 30 June 2017
Date scheme commenced: The year ending 30 June 2017

Ruling: Q1: Can AustCo disregard a realised capital gain made from the disposal of a CGT asset pursuant to subsection 23AH(3) of the Income Tax Assessment Act 1936 ? | A1: Yes

Relevant facts and circumstances: AUSTCO AUSTCO is an Australian incorporated company that is an income tax resident of Australia. AUSTCO is the head company of an Australian income tax consolidated group. AUSTCO is listed on the Australian Stock Exchange. Foreign country operations AUSTCO holds an interest in the relevant contract (the Contract) via a foreign branch registered in the relevant country. AUSTCO's Foreign Country branch The foreign branch is a Permanent Establishment (PE) of AUSTCO. The foreign branch has a registered office in the relevant country. The foreign branch maintains separate books and records. For accounting purposes, AUSTCO recognises an investment in the foreign branch which is akin to equity (the Investment). From an Australian income tax perspective, all costs relating to this foreign branch have been treated as non-deductible. The foreign branch has a resident (in-country) manager who provides logistics and administration support (including government relations and business development activities) in country. CGT asset transfer AUSTCO is required to transfer its interest in the relevant contract (the CGT asset) from the foreign branch into a company that is incorporated and resident in the relevant foreign country pursuant to domestic legal requirements in that country. AUSTCO will transfer the CGT asset to a wholly owned foreign company of AUSTCO, being ForCo. This transfer from the foreign branch to ForCo will be executed at historical cost.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subsection 6(1) | Income Tax Assessment Act 1936 Section 23AH | Income Tax Assessment Act 1936 Subsection 23AH(3) | Income Tax Assessment Act 1936 Subsection 23AH(8) | Income Tax Assessment Act 1936 Paragraph 23AH(3)(a) | Income Tax Assessment Act 1936 Paragraph 23AH(3)(b) | Income Tax Assessment Act 1936 Section 317 | Income Tax Assessment Act 1936 Subsection 317(1) | Income Tax Assessment Act 1936 Section 320 | Income Tax Assessment Act 1997 Paragraph 8-1(1)(b) | Income Tax Assessment Act 1997 Subsection 104-10(1) | Income Tax Assessment Act 1997 Subsection 104-10(2) | Income Tax Assessment Act 1997 Subsection 104-10(4) | Income Tax Assessment Act 1997 Subsection 108-5(1) | Income Tax Assessment Act 1997 Section 110-25 | Income Tax Assessment Act 1997 Section 855-15 | Income Tax Assessment Act 1997 Section 855-20 | Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision: Summary: Any capital gain received by AUSTCO from the foreign branch's disposal its CGT asset to ForCo will be disregarded pursuant to subsection 23AH(3) of the ITAA 1936. AUSTCO is a resident of Australia for income tax purposes and used the interest wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE in an unlisted country. The CGT asset is not taxable Australian property | Detailed Reasoning - Detailed reasoning: Section 23AH of the ITAA 1936 deals with when foreign branch income of Australian companies is not assessable. Relevantly, subsection 23AH(3) of the ITAA 1936 states: 23AH(3) Subject to this section, a capital gain from a CGT event happening to a CGT asset is disregarded for the purposes of Part 3-1 of the Income Tax Assessment Act 1997 if: (a) the gain is made by a company that is a resident; and (b) the company used the asset wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE of the company in a listed country or unlisted country; and (c) the asset is not taxable Australian property. Subsection 23AH(8) of the ITAA 1936 contains exceptions to subsection 23AH(3) as follows: 23AH(8) Subsection (3) or (4) does not apply to a capital gain or capital loss if: (a) the PE is in an unlisted country; and (b) the gain or loss is from a tainted asset. A capital gain from a CGT event happening to a CGT asset Subsection 104-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that: CGT event A1 happens if you dispose of a CGT asset. Subsection 104-10(2) of the ITAA 1997 states that: You dispose of a *CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner. Subsection 995-1(1) of the ITAA 1997 states that CGT asset has the meaning given by section 108-5. Subsection 108-5(1) of the ITAA 1997 relevantly states: A CGT asset is: (a) any kind of property; or (b) a legal or equitable right that is not property. The CGT asset held by AUSTCO is a contractual right and is therefore a CGT asset within the meaning of section 108-5 of the ITAA 1997. AUSTCO will transfer the CGT asset to ForCo in return for consideration. This transfer of the CGT asset from AUSTCO's foreign branch to ForCo will trigger CGT event A1. Capital gain Subsection 104-10(4) of the ITAA 1997 states: You make a capital gain 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. Section 110-25 of the ITAA 1997 sets out the general rules about cost base and states that the cost base of a CGT asset consists of five elements. Where the capital proceeds from the transfer exceed the cost base as worked out by AUSTCO under section 110-25 of the ITAA 1997, a capital gain would be realised by AUSTCO. The gain is made by a company that is a resident Paragraph 23AH(3)(a) of the ITAA 1936 requires the gain to be made by a company that is a resident. Subsection 6(1) of the ITAA 1936 relevantly defines a resident as - (b) a company which is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia. AUSTCO is an Australian incorporated company that is an income tax resident of Australia for the purposes of section 6(1) of the ITAA 1936, thereby satisfying paragraph (a) of subsection 23AH(3). The company used the asset wholly or mainly for the purposes of producing foreign income in carrying on a business at or through a PE of the company in a listed or unlisted country Paragraph 23AH(3)(b) of the ITAA 1936 requires that the company used the asset wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE of the company in a listed country or unlisted country. Section 320 of the ITAA 1936 defines an 'unlisted country' as being a country that is not a foreign country declared by the regulations to be a listed country for the purposes of Part X of the ITAA 1936. The regulations do not list the relevant foreign country as a listed country so it is therefore an 'unlisted country'. AUSTCO carries on its business through a foreign branch in the relevant foreign country. The foreign branch is a permanent establishment of AUSTCO. As discussed above, the relevant foreign country is an unlisted country. AUSTCO has not produced any foreign income through the business it carries on via the foreign branch. No foreign income will be produced prior to the transfer. Paragraph 8-1(1)(b) of the ITAA 1997 similarly applies to expenses incurred and relevantly states: '…for the purpose of gaining or producing your assessable income' For the purposes of section 8-1 of the ITAA 1997 it is considered that a loss or outgoing may be deductible under either of the positive limbs even though it produces assessable income in an income year later than the year in which the loss or outgoing was incurred. In Steele v. DFC of T (1999) 197 CLR 459 (Steele's case), the majority view of the High Court was that it is not necessary for the expenditure that was incurred to be referrable to income produced in the same tax year in order for that expenditure to be deductible. Ronpibon Tin NL v. FC of T (1949) 8 ATD 431 at p 436; (1949) 78 CLR 47 at p 57 their Honours said: '…it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.' In this instance, AUSTCO has yet to produce income. AUSTCO holds the CGT asset via the foreign branch. While no foreign income has been produced, the Commissioner considers that the interest in the CGT asset is used by AUSTCO wholly or mainly for the purpose of producing foreign income or with the expectation of producing assessable foreign income at or through a permanent establishment in an unlisted country. Paragraph 23AH(3)(b) of the ITAA 1936 is satisfied. The asset is not taxable Australian property Section 855-15 of the ITAA 1997 sets out when an asset is taxable Australian property in the five Items contained in the table. Relevantly, taxable Australian property includes taxable Australian real property (Item 1), a CGT asset that is an indirect Australian real property interest (Item 2), or a CGT asset that has been used in carrying on a business through a permanent establishment in Australia (Item 3). Section 855-20 of the ITAA 1997 states: 855-20 Taxable Australian real property A *CGT asset is taxable Australian real property if it is: (a) real property situated in Australia (including a lease of land, if the land is situated in Australia); or (b) a *mining, quarrying or prospecting right (to the extent that the right is not real property), if the *minerals, *petroleum or quarry materials are situated in Australia. The interest in the CGT asset held by the foreign branch (the permanent establishment) is not real property situated in Australia or a right relating to minerals or petroleum or quarry materials which are situated in Australia. Therefore, the interest is not taxable Australian property for the purposes of paragraph 23AH(3)(c) if the ITAA 1936. Is the PE in an unlisted country and the gain or loss from a tainted asset? As discussed above, the relevant foreign country is an unlisted country, so it is therefore necessary to determine whether the gain or loss is from a tainted asset. Section 317 of the ITAA 1936 defines a tainted asset in relation to a company as: tainted asset , in relation to a company, means: (a) any of the following: (i) loans (including deposits with a bank or other financial institution); (ii) debenture stock, bonds, debentures, certificates of entitlement, bills of exchange, promissory notes or other securities; (iii) shares in a company; (iv) an interest in a trust or partnership; (v) futures contracts; (vi) forward contracts; (vii) interest rate swap contracts; (viii) currency swap contracts; (ix) forward exchange rate contracts; (x) forward interest rate contracts; (xi) life assurance policies; (xii) a right or option in respect of such a loan, security, share, interest, contract or policy; (xiii) any similar financial instrument; or (b) an asset that was held by the company solely or principally for the purpose of deriving tainted rental income; or (c) an asset other than: (i) trading stock; or (ii) any other asset used solely in carrying on a business; but does not include a commodity investment. Paragraph (a) is not applicable as the interest in the CGT asset does not contain any of the assets listed in that paragraph while paragraph (b) is not applicable as the interest in the CGT asset is not an asset that was held by AUSTCO solely or principally for the purpose of deriving tainted rental income. In addition, while the interest in the CGT asset is not trading stock it is used solely in carrying on AUSTCO's business in the relevant foreign country. Therefore, the interest in the CGT asset is not a tainted asset as defined in subsection 317(1) of the ITAA 1936. | Detailed Reasoning - Conclusion: Any capital gain received by AUSTCO from the foreign branch's disposal of its interest in the CGT asset to ForCo will be disregarded pursuant to subsection 23AH(3) of the ITAA 1936. This is because the gain would be made by AUSTCO, a resident of Australia for income tax purposes, which used the interest in the CGT asset wholly or mainly for the purpose of producing foreign income in carrying on a business at or through a PE in an unlisted country. Furthermore, the interest in the CGT asset is not taxable Australian property and none of the exceptions to subsection 23AH(3) apply.