The Capital Gains Tax Consequences of Creating Rights
Although most of us think about the disposal of an asset when it comes to Capital Gains Tax (CGT), there are another 53 CGT events that have tax consequences. One of these events, CGT event D1 is where a transaction is entered into by a taxpayer that creates a right in another entity. The time of this event is when the taxpayer enters into the contract or creates the right. Some examples of transactions that will give rise to CGT event D1 are:
- An easement over land;
- A license over an asset;
- A person agrees not to compete with another person for a specified number of years or within a specified location;
- A person agrees to only play sport with a particular club;
- A property owner grants management rights over property; and
- A person grants the right to use a trademark.
For CGT Event D1 to apply, the transaction must be first tested against all other CGT events (except CGT event H2). If no other CGT event applies, then the transaction can be tested against CGT event D1.
There are several situations in which CGT event D1 is specifically stated not to happen. These situations are when:
- The taxpayer created the right by borrowing money or obtaining credit from another entity;
- The right requires the taxpayer to do something that is another CGT that happens to the taxpayer;
- A company issues or allots equity interest or nonequity shares in the company;
- The trustee of a unit trust issues units in the trust;
- A company grants an option to acquire equity interests, non-equity shares or debentures in the company;
- The trustee of a unit trust grants an option to acquire units or debentures in the trust; and
- The taxpayer created the right by creating in another entity a right to receive an exploration benefit under a farm-in farm-out arrangement.
To calculate the capital gain or loss that is made from CGT event D1, the capital proceeds from creating the right needs to be compared with the incidental costs the taxpayer incurred that relate to the event. The capital proceeds are the total of the money and market value of any other property the taxpayer has received or entitled to received in the respect of the event happening. Examples of incidental costs could include fees paid for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser.
Some points to note with CGT event D1:
- No part of the cost base of an asset to which the creation the right relates can be taken into account in working out the capital gain or loss as a result of CGT event D1;
- Any capital gain or loss from CGT event D1 cannot be disregarded because the asset to which the creation of the right relates to was acquired pre-CGT; and
- A capital gain made from CGT event D1 cannot be a discount capital gain.
A capital gain that occurs from CGT event D1 can qualify for the CGT small business concessions. However, the active asset test is modified with the basic condition that the right that the taxpayer creates that triggers CGT event D1, must be inherently connected with a CGT asset of the taxpayer that satisfies the active asset test.
If you have any questions on any of the above, or other matters relating to your tax or financial affairs, please do not hesitate to contact our office on (07) 5504 5700 to speak to one of our trusted advisors.