Issue
Where an entity contributes depreciating assets to the taxpayer in return for the allotment of ordinary shares in the taxpayer at a defined future time, does Item 2 or Item 5 in the table in paragraph 40-185(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) apply in working out the first element of cost of the depreciating assets that began to be held by the taxpayer?
Decision
No. Neither Item 2 nor Item 5 in the table in paragraph 40-185(1)(b) of the ITAA 1997 applies in working out the first element of cost of depreciating assets that began to be held by the taxpayer.
Facts
The taxpayer raises funds by entities making contributions under a written agreement. Contributions that the contributing entities are obliged to make to the taxpayer under the agreement can be made in the form of depreciating assets, to which Division 40 of the ITAA 1997 applies. On receiving contributions, the taxpayer begins to hold the depreciating assets under Item 10 in the table in section 40-40 of the ITAA 1997.
Under the terms of the agreement, by contributing depreciating assets, the contributing entities will be entitled to be allotted, but not obligated to accept, ordinary shares in the taxpayer, at a defined future time. The terms of the agreement allow the contributing entities, at their absolute discretion, to elect not to be issued shares.
Reasons for Decision
The first element of cost is worked out as at the time when the asset starts to be held (section 40-180 of the ITAA 1997). In certain circumstances, the cost is the amount specified in the table in subsection 40-180(2) of the ITAA 1997. Otherwise, the cost is worked out under section 40-185 of the ITAA 1997 (subsection 40-180(1) of the ITAA 1997).
No item in the table in subsection 40-180(2) of the ITAA 1997 applies to the taxpayer's circumstances. The amount the taxpayer is taken to have paid to hold the depreciating assets must, therefore, be worked out under section 40-185 of the ITAA 1997.
Item 5 in the table in subsection 40-185(1) of the ITAA 1997 (Item 5) includes in cost an amount you are taken to have paid to hold a depreciating asset in the case where you incur a liability to provide a non-cash benefit. Non-cash benefit means all property and services that are not money (subsection 995-1(1) of the ITAA 1997). Item 2 applies where you incur or increase a liability to pay an amount.
The meaning of 'incurring a liability' has been considered in a number of judicial decisions and ATO rulings in the context of determining when a loss or outgoing is incurred for the purpose of section 8-1 of the ITAA 1997 (or former subsection 51(1) of the Income Taxation Assessment Act 1936 ). Taxation Ruling TR 97/7 discusses the meaning of 'incurred'. The principles evident in these judicial decisions and ATO rulings apply when considering whether a liability has been incurred for the purpose of Items 2 or Item 5.
The agreement stipulates that the taxpayer will issue shares to the contributing entities at a defined future time if certain conditions are satisfied or created.
On entering into the agreement, the taxpayer creates a form of contractual obligation to issue shares in the taxpayer to the contributing entities at a defined future time.
Because of the terms of the agreement, including the fact that the contributors may not necessarily accept the allotment of shares, the obligation to issue shares expressed in the agreement is no more than pending, threatened or expected and cannot be said to be a liability incurred at the time of starting to hold the depreciating asset. This is the case notwithstanding that the taxpayer expects, as a matter of commercial practicality, that most of the contributing entities will create or meet the conditions and exercise their entitlement to be issued shares in the taxpayer.
The taxpayer's form of contractual obligation to issue shares is subject to such contingencies that the taxpayer has not incurred a liability at the time it begins to hold the contributed depreciating assets. Neither Item 2 nor Item 5 in the table in paragraph 40-185(1)(b) of the ITAA 1997 applies to determine the first element of cost of contributed depreciating assets held by the taxpayer.