Capital gains tax - cost base/reduced cost base - debt

Is the first element of the cost base and reduced cost base of a debt that arose from the provision of services to a debtor nil?

Yes, the first element of the cost base and reduced cost base of the debt is nil. The provision of services is not money paid, or other property given, to acquire the debt for the purposes of calculating the first element of the cost base and reduced cost base under subsections 110-25(2) and 110-55(2) of the Income Tax Assessment Act 1997 (ITAA 1997). Further, the market value substitution rule in section 112-20 of the ITAA 1997 does not apply to treat the debt as having been acquired for its market value.

A taxpayer carries on a business of providing services to clients.

The taxpayer entered into an agreement with a client to provide the contracted services on a deferred payment basis.

A debt owed to a provider of services is a CGT asset of that person under section 108-5 of the ITAA 1997 (see Taxation Determination TD 2).

The general rules for working out the cost base and reduced cost base of a CGT asset are in Division 110 of the ITAA 1997. They may be modified by the rules in Subdivision 112-A of the ITAA 1997 (and, in some cases, by other rules in the Income Tax Assessment Acts).

Under the general rules, the first element of the cost base and reduced cost base of a CGT asset is the total of the money paid, or required to be paid, to acquire the asset. It also includes the market value of any property given, or required to be given, for the asset: subsections 110-25(2) and 110-55(2) of the ITAA 1997.

Clearly, no money was paid to acquire the debt. It needs to be determined whether the services provided by the taxpayer constituted other property given to acquire the asset.

In Case S43 85 ATC 343; (1985) 28 CTBR (NS) Case 49 , the Tribunal, when considering whether the provision of services amounted to a gift of money or property for the purposes of paragraph 78(1)(a) of the Income Tax Assessment Act 1936 said 'It is self-evident that services are neither money nor property.'

Equally, the provision of services which results in the acquisition of a CGT asset does not involve the giving of money or other property.

Market value substitution rule

Paragraph 112-20(1)(a) of the ITAA 1997 provides that, if you did not incur any expenditure to acquire a CGT asset from another entity, the first element of the cost base and reduced cost base of the asset is its market value.

In Allina Pty Ltd v. Federal Commissioner of Taxation (1991) 28 FCR 203; 91 ATC 4195; (1991) 21 ATR 1320 it was held that, in this context, the acquisition of an asset from another encompasses the case where another person creates an asset which at the same time comes into your possession, or is obtained by you. This would apply for example where a debt is created in the creditor.

However, the market value is not substituted for the first element of the cost base and reduced cost base of a CGT asset where its acquisition resulted from: • CGT event D1 happening (subparagraph 112-20(1)(a)(i) of the ITAA 1997), or • another entity doing something that did not constitute a CGT event happening (subparagraph 112-20(1)(a)(ii) of the ITAA 1997).

You acquire a CGT asset as a result of CGT event D1 happening if an entity creates a contractual right or other legal or equitable right in you (subsections 109-5(2) and 104-35(1) of the ITAA 1997). However CGT event D1 does not happen if the right was created by obtaining credit from you (paragraph 104-35(5)(a) of the ITAA 1997). In this case, CGT event D1 does not happen because the debtor has obtained credit from the taxpayer who provided the service on a deferred payment basis.

However, the debtor has agreed, pursuant to the service contract, to pay the taxpayer in return for the provision of the services. That agreement to pay is the doing of something that does not constitute a CGT event happening to that debt. As a result, subparagraph 112-20(1)(a)(ii) of the ITAA 1997 is satisfied.

Therefore the market value substitution rule does not apply to modify the first element of the cost base and reduced cost base of the debt calculated under subsections 110-25(2) and 110-55(2) of the ITAA 1997.

Accordingly, the first element of the cost base and reduced cost base of a debt that arises from the provision of services is nil.