House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 7 - Partial capital gains tax roll-over for statutory licences

Outline of chapter

7.1 Schedule 7 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to extend the existing statutory licence capital gains tax (CGT) roll-over under Subdivision 124-C to provide for roll-over where one or more new licences are issued in consequence of the ending of one or more licences and to provide for a partial roll-over. A partial roll-over applies where one or more statutory licences end and are replaced by one or more new licences and the licensee also received non-licence capital proceeds such as money.

Context of amendments

7.2 Subdivision 124-C provides a CGT roll-over if a statutory licence expires or is surrendered and a new licence is issued which renews or extends the original licence. The current roll-over is therefore limited to specific types of replacement licences.

7.3 It is appropriate to provide roll-over in a broader range of circumstances where a statutory licence is effectively replaced by another statutory licence. Accordingly, the amended provision focuses on the activity permitted by the licence rather than the way in which the licence comes to an end.

7.4 A licence or licences may be issued to take the place of one or more original licences. These amendments will provide roll-over of capital gains or losses in these cases.

Summary of new law

7.5 These amendments extend the existing statutory licence CGT roll-over in Subdivision 124-C. The roll-over will apply when a statutory licence ends, CGT event C2 happens, and one or more new licences are issued which authorise substantially similar activity to the activity authorised by the original licence or licences. These amendments also provide a partial roll-over where a statutory licence ends and is replaced by a new licence or licences and non-licence capital proceeds are also received.

Comparison of key features of new law and current law

Detailed explanation of new law

Ending of a statutory licence by reference to CGT event C2

7.6 A capital gain or loss made on the ending of a statutory licence will be disregarded in a broader range of circumstances.

7.7 Currently CGT roll-over is subject to the ownership of a statutory licence ending by expiry or surrender. A broader range of endings such as cancellation will be included under these amendments. This is achieved by amending Subdivision 124-C to provide roll-over where the ending of a statutory licence results in CGT event C2 happening. [Schedule 7, item 2, paragraph 124-140(1)(a)]

The substantially similar activity test

Single licence roll-over

7.8 In the simplest case, roll-over will be available when a licence ends and, as a result, a new licence is issued which authorises substantially similar activity as the original licence.

7.9 The new licence must be issued because of the ending of the original licence and so a relationship must exist between the two. The new licence must be received because of the ending of the original licence. [Schedule 7, item 2, paragraph 124-140(1)(b)]

7.10 Further, the new licence must authorise activity which is substantially similar to the activity authorised by the original licence. This requires an analysis of the activity permitted or authorised by the original licence and a comparison with the activity permitted or authorised by the new licence. The test requires that the activities be substantially similar in nature, recognising that the cancellation and issue of a new licence may be required because of changes in the industry, changes in the business practices of the licence owner, or changes in the technology supporting the licence. In determining whether a new licence authorises substantially similar activity it is appropriate to consider whether the skills or infrastructure required to utilise or exploit the rights granted by the original licence are also required to utilise or exploit the rights granted by the new licence. [Schedule 7, item 2, paragraph 124-140(1)(c)]

7.11 The substantially similar activity test accommodates changes between the features of the old and new licences. Therefore, the fact that the new licence may:

•

authorise a use for a longer period of time than the original licence;

•

be granted in perpetuity while the original licence applied for a limited time, or vice versa;

•

authorise changes in volume or quantity available for use;

•

authorise changes in areas or physical locations; or

•

allow non-licence capital proceeds such as cash to be received as part of issuing the new licence,

does not necessarily mean that the activities fail the substantially similar test.

Example 7.1

Caughtya Pty Ltd has a licence (the original licence) to fish for a particular species of fish in the protected waters of Moreton Bay in Southeast Queensland. It is determined by the issuing authority, a government agency, that fishing for that species is not sustainable and so those licences are cancelled. As a result of the cancellation the government agency issues to each affected licence holder a licence to catch a different species of fish in the open waters off Central Queensland. The boats and equipment used for the original licence can not be used in the open waters off Central Queensland. Caughtya Pty Ltd will be required to invest in a bigger boat.

Caughtya Pty Ltd's ownership of the original licence has ended. As a result of that ending it was issued with a new licence for the original licence. While Caughtya was required to purchase a new boat and other equipment, it continues to operate in the fishing industry and to use skills relating to commercial fishing that were used with the original licence. The substantially similar activity test is satisfied.

Multiple licences roll-over

7.12 The more complex cases occur where multiple original or new licences are involved. A reorganisation of an industry can involve the collapsing of original licences into fewer new licences, or the splitting of licences to recognise different aspects of the authorised activity (eg, to permit trading of one part of the original licence).

7.13 Where multiple licences are involved, the roll-over requires that all of the original licences that end, and for which the licensee is issued a new licence or licences, must end as part of a single arrangement. The new licence or licences must be issued as part of that arrangement. [Schedule 7, item 2, paragraph 124-140(1)(a)]

Example 7.2

William owns a farm on two land titles which are dealt with separately by the water authority. On each title William has several bores which are separately operated under their own licences. The water authority intends to cancel the original licences and replace the bore licences with one access licence on each land title. As the original and new licences relate to the extraction of water, the original licences on each title will be the subject of a separate roll-over that recognises that all the licences on each title are replaced with an access licence.

Example 7.3

As William will receive two new access licences, each new licence must satisfy the substantially similar activity test. In William's case the original bore licences all had different volume limits and, as part of a restructure of entitlements in the aquifer on which his property sits, each bore licence is being reduced according to a formula. The new access licence will allow William greater security of a lesser quantity of water and will allow him to sell some or all of his water entitlement. William meets the test for roll-over for each access licence as the activity permitted by the new licence (ie, the extraction of water) is substantially similar to the activity authorised by the new access licence.

Example 7.4

Maurie owns a property on which he grows tobacco, as have the previous three generations of his family. He holds a tobacco licence, which he acquired before September 1985, that permits him to operate in the tobacco industry.

Due to global restructuring in the industry, tobacco will no longer be purchased from this region and his licence, and those of other producers in the region, will be cancelled.

Under this industry restructure, Maurie will receive a payment for the cancelled licence from the relevant licensing authority.

Due to concerns about the economic impact on the region, the state government is keen to assist affected tobacco growers to move into other industries. It plans to establish aquaculture in the region and tobacco growers who have had their tobacco licences cancelled will be offered aquaculture licences, which can be acquired with the proceeds of the cancelled tobacco licences. They will also be provided with assistance with the costs of redeveloping their properties to undertake aquaculture activities.

Roll-over is not available in these circumstances because the aquaculture licence is not issued for the ending of the tobacco licence, even though the proceeds of the cancelled tobacco licence are used to purchase the new licence. In any event, the aquaculture licence does not authorise substantially similar activity to that authorised by the tobacco licence.

7.14 The roll-over applies in a variety of combinations of issues of multiple new licences and the ending of multiple original licences. The consequences of the roll-over are set out in sections 124-145, 124-150, 124-155, 124-160 and 124-165.

Consequences of roll-over

7.15 If the conditions for roll-over are satisfied, any capital gain or loss arising from the ending of the statutory licence is disregarded. [Schedule 7, item 3, section 124-145]

Where all original licences were post-CGT

7.16 A post-CGT licence is a licence that was acquired on or after 20 September 1985. Where one new licence results from the ending of an original post-CGT licence, the cost base of the original licence becomes the first element of the cost base of the new post-CGT licence. [Schedule 7, item 3, section 124-155]

7.17 For the purposes of claiming the CGT discount, the new licence is taken to have been acquired when the original licence was acquired as specified in section 115-30 of the ITAA 1997.

7.18 Where more than one licence ends, or more than one new licence is received, the cost base of each new licence must be determined on a reasonable basis. This allocation of the original cost base or cost bases is by reference to the number, market value and character of the original and new licences. [Schedule 7, item 3, section 124-155]

7.19 Character can refer to volume entitlements or other inherent features of the licence or licences by which meaningful comparisons can be made between various licences. From these inherent features market values can be derived which could also be used as a reasonable basis of apportionment if, for example, the same characteristics appear across all licences. The reference to market value does not require a professional valuation to be obtained but is included as a factor to be considered when selecting a particular characteristic on which to allocate cost bases to achieve the required reasonable allocation of cost bases.

Example 7.5

Modifying Example 7.3, William actually received two new licences on one of the titles, one for high security access and one for low security access. In applying the CGT roll-over, William needs to allocate the cost bases of his two original licences to the two new licences on a reasonable basis.

In doing so William would need to take into account the number of new licences received and the market value and character of each of the new licences and the original licences. A common feature of all the licences is a volume entitlement. William can use this entitlement to allocate cost bases provided the market values for each megalitre of water under each of the original and new licences are not considerably different. In this case they are. The tradable high security water has a much higher market value per megalitre.

William allocates the total of the cost bases of his original licences across his two new licences by using the market values of the new licences.

Where all original licences were pre-CGT

7.20 Where the original licence or licences were all acquired before 20 September 1985 (pre-CGT licences) and a new licence or licences are issued for the original licence or licences, the new licence or licences are taken to have been also acquired before 20 September 1985. [Schedule 7, item 3, section 124-160]

7.21 If any ineligible proceeds result from the disposal of part of a pre-CGT licence, any capital gain or capital loss on the ineligible proceeds will be disregarded (ineligible proceeds are explained in paragraph 7.24).

Where original licences were pre-CGT and post-CGT licences

7.22 Where pre-CGT and post-CGT licences end and a new licence or licences are issued, each new licence is taken to be two separate assets. One of these assets is treated as having been acquired before 20 September 1985, and the other is treated as having been acquired on or after 20 September 1985. [Schedule 7, item 3, subsections 124-165(1) and (2)]

7.23 The cost base of each of those assets is determined by allocating the total of the cost bases of the original post-CGT licences between the new licences in proportion to their market values. The market values are determined when the original licences end. [Schedule 7, item 3, subsection 124-165(3)]

Example 7.6

Edward has three water licences. One was acquired before 20 September 1985 (pre-CGT) and the other two were acquired after 19 September 1985 (post-CGT). The pre-CGT licence has a market value of $100,000. One post-CGT licence has a cost base of $110,000 and a market value of $180,000 and the other post-CGT licence has a cost base of $90,000 and market value of $120,000.

Edward's three water licences are cancelled by the relevant authority, which issues Edward with two new water licences one with a market value of $150,000 and the other with a market value of $250,000.

As the original licences are a mix of pre-CGT and post-CGT licences, each new licence is effectively split into a pre-CGT and post-CGT component with each component being treated as a separate CGT asset.

Edward needs to determine the cost base of each of the post-CGT components of his two new licences. He does this by allocating the total cost bases for his original post-CGT licences to the two new post-CGT assets that he is taken to have acquired.

The total of the market values of all the new licences is:

$150,000 + $250.000 = $4000,000


The total of the cost bases of the original post-CGT licences is:

$110,000 + $90,000 = $200,000


The cost base of the post-CGT component of the new licence with a market value of $150,000 is:

$200,000 * ($150,000/$400,000) = $75,000


The cost base of the post-CGT component of the new licence with a market value of $250,000 is:

$200,000 * ($250,000/$400,000) = $125,000


When Edward disposes of one of the new licences he will have to work out the pre-CGT and post-CGT components of that licence on a reasonable attribution basis as specified in subsection 116-40(1) of the ITAA 1997.

Partial roll-over

7.24 Roll-over does not apply to the extent to which a statutory licence ends and the licence holder receives non-licence proceeds for the ending of the licence. These non-licence proceeds may include other assets, including cash (the ineligible proceeds). It is therefore necessary to determine the capital gain or loss on the ending of the original licence that relates to the ineligible proceeds (ie, for what part of the original licence is the ineligible proceeds received). The capital gain or loss on the ineligible proceeds cannot be rolled over. [Schedule 7, item 3, subsection 124-150(1)]

7.25 Before apportioning the cost base of the original licence or licences to the new licence or licences the cost base of the original licence or licences is reduced by the amount that is attributable to any ineligible proceeds. The amount of the cost base of each licence attributable to ineligible proceeds is calculated on a reasonable basis. [Schedule 7, item 3, subsections 124-150(2) to (4)]

7.26 Where ineligible proceeds relate to a particular licence the cost base of those ineligible proceeds will be part of the cost base of that licence. Where the ineligible proceeds relate to more than one licence the cost base of the ineligible proceeds will be a part of each of the original licences. The cost base of each of these original licences will be reduced to the extent of the cost base of the ineligible proceeds before being allocated to new licences. [Schedule 7, item 3, subsection 124-150(4)]

7.27 As there is no roll-over for the capital gain or loss relating to the ineligible proceeds, and the total capital proceeds may be more or less than the market value of the original licence, the market substitution rule for capital proceeds does not apply. [Schedule 7, item 7, subsection 116-30(2A)]

Example 7.7

Joe has been running a closed narrowcasting television service in his local area for 10 years by means of a low powered radio spectrum licence. The service provides information to local residents about local events and has subscribers who meet the costs of narrowcasting. All content is local and live.

The subscription fee also provides a small return on the costs of the spectrum licence Joe purchased to facilitate his dream of having his own TV station. The licensing authority has compulsorily withdrawn Joe's spectrum licence for the frequency he has been using because another service needs the frequency, and as part of the arrangement the authority has reallocated a licence for another low power frequency.

Since the new frequency will require additional power to transmit, the authority has also provided an additional payment to Joe so that he can continue operating without having to increase his subscription fees to his local subscribers. Roll-over applies to the extent of the receipt of the new licence. Any capital gain arising as a result of the payment of cash will continue to be assessable.

Example 7.8

Bob has two post-CGT land titles and multiple bores on each title. Under a restructure of the water licences, Bob receives a cash payment and a new access licence that replaces all of his original licences on one of the land titles. CGT roll-over will apply to roll-over any capital gain that Bob might make from the ending of his original licences and he will need to determine the capital gain or loss arising from the cash payment.

The effect of the new licence is to restrict his water access by 40 per cent compared to the volume permitted by all of his original licences on the affected land title. On a reasonable apportionment basis Bob can take 40 per cent of the cost base of all of the original licences and reasonably attribute that amount to the cost base of the ineligible proceeds (the cash).

The cost base of the new access licence is then the sum of the remaining cost bases of the original licences (ie, as reduced by the 40 per cent of each cost base attributed to the cash).

Example 7.9

Modifying Example 7.8, Bob has two original licences on the one title, one permitting access to 100 megalitres of water and the other to 500 megalitres of water. Both licences are replaced with one water access licence that gives him access to 200 megalitres of water. The water authority advises Bob that the basis of the allocation of the new licence is that the water entitlements reflect a reduction in volume of 80 per cent of the first licence, and 64 per cent of the second licence. Bob receives a cash payment that fully reflects the loss of water entitlements as well as the new access licence for the cancellation of his original licences.

In determining the cost base of the cash payment, Bob considers the nature of the rights that he had under the original licences, and also the nature of his entitlements under the new licence, and concludes that those entitlements are the same but for the reduction in the volumes of water he is permitted to take. He therefore decides to allocate 80 per cent of the cost base of his first original licence and 64 per cent of the cost base of his second original licence to the cash payment.

Example 7.10

Again modifying Example 7.8, from the calculations provided by the issuer of the licence, Bob is also able to work out how the cash payment was calculated. Bob receives a cash payment and new access licence for the two bore licences (bore 1 and bore 2) on the land title.

The payment was made for the reduction by 30 per cent of Bob's access to water on the licence entitlement on bore 1. Bob receives $10,000, which fully reflects the loss of water entitlements, as part of the package of reforms.

The cost base of the licence of bore 1 is $8,000.

The cost base of the licence of bore 2 is $3,000.

On a reasonable allocation basis Bob can allocate 30 per cent of the cost base of the licence on bore 1 ($2,400) to the cost base of the ineligible proceeds.

The capital gain on the ineligible proceeds will be:

$10,000 - $2,400 = $7,600


Bob has to reduce the cost base of the bore 1 licence by the amount of the cost base of the ineligible proceeds. In calculating the cost base of the new access licence, the adjusted cost base of the licence of bore 1 ($8,000 - $2,400 = $5,600) is added to the cost base of the licence of bore 2 ($3,000).

The cost base of the new access licence is $8,600.

Foreign residents - taxable Australian property

7.28 Where a statutory licence owned by a foreign resident is used in carrying on a business through a permanent establishment in Australia (taxable Australian property) and the new licence or licences are also used in that business, roll-over will be available. [Schedule 7, item 2, subsections 124-140(1A) and (1B)]

Application and transitional provisions

7.29 These amendments will commence on Royal Assent. The amendments will apply to CGT events that happen in the 2006-07 income year and later years.

7.30 The Achieving Sustainable Groundwater Entitlements programme was announced in 2005 to ensure the six major groundwater systems in NSW are sustainable in the longer term.

7.31 Under the Achieving Sustainable Groundwater Entitlements programme, bore licences will be replaced by an aquifer access licence, combined water supply works and use approval and, in some cases, a supplementary licence. The new access licence is granted in perpetuity and is tradable. The supplementary licence is an access licence for a declining amount of water over a period of years and is not tradable. Eligible bore licence holders may also be offered a cash payment based on their former entitlements to water and their history of extraction of water.

7.32 Where Achieving Sustainable Groundwater Entitlements cash payments are received the transitional provisions provide for the use of the 2002 values, which were used to calculate the amounts of the cash payments, in determining the capital gain or loss arising in relation to the cash payment (the ineligible proceeds). These provisions permit the use of readily available values which affected taxpayers have been provided with as part of the adjustment process required under the Achieving Sustainable Groundwater Entitlements programme. These provisions also affect the allocation of the cost base of the original licence between the new aquifer access licence, the combined water supply works and use approval, the supplementary water licence and the ineligible proceeds. [Schedule 7, item 4, sections 124-140, 124-141 and 124-142 of the Income Tax (Transitional Provisions) Act 1997]

7.33 No part of the cost base of the original licence is allocated to a supplementary licence where one is received. The 2002 value ascribed to the new aquifer access licence and the cash payment are treated as the total capital proceeds for the original licence (ie, the supplementary licence and combined approval are effectively ignored). The cost base of the original licence is allocated between the new aquifer access licence and the cash payment. [Schedule 7, item 4, subsections 124-141(1), (3) and 124-142(2) of the Income Tax (Transitional Provisions) Act 1997]

7.34 A supplementary licence is received where the new aquifer access licence is for a lesser amount of water than the historical extraction. It allows for a gradual reduction from the existing extraction levels to the new allocation entitlement amount. While a discount factor is applied against the active water lost to reflect the supplementary water available, this discount is used to calculate the cash payment rather than a valuation of the water available under the supplementary licence. For these reasons the supplementary licence is allocated a nil cost base. The combined water supply works and use approval is also given a nil cost base because it can be obtained from the relevant NSW Government authority at a minimal cost. [Schedule 7, item 4, section 124-142 of the Income Tax (Transitional Provisions) Act 1997]

Example 7.11

McDillon is in the Namoi water basin and subject to the Achieving Sustainable Groundwater Entitlements programme. McDillon acquired a bore licence with the acquisition of her property in October 1985. The property's bore licence, with an entitlement of 163 megalitres per year, has ended and McDillon has been issued a new aquifer access licence, a supplementary licence and combined works and use approval. The new aquifer access licence allows for 52 megalitres per year, which is less than McDillon's history of extraction of 102 megalitres per year.

McDillon also receives a cash payment of $37,000 based on her original entitlement of 163 megalitres per year and the reduction in available water over 10 years from her old extraction rate.

The 2002 value ascribed to the new aquifer access licence is $57,200 (being the new aquifer access licence entitlement of 52 megalitres per year times post plan tradable value of water of $1,100 a megalitre).

The cost base of McDillon's original licence is $20,000, being an appropriate portion of the total cost of acquiring the property, which included the bore licence.

The cost base allocated to the ineligible proceeds (the cash payment) will be $7,856, that is:

$20,000 * $37,000/($37,000 + $57,200)


The capital gain on the ineligible part will be $29,144, that is:

$37,000 - $7,856


The cost base of the new aquifer access licence is $12,144, that is:

$20,000 - $7,856


The cost bases of the supplementary licence and combined works and use approval are nil.

7.35 There may be other programmes where statutory licences end and the licence holders are issued new licences and receive ineligible proceeds such as cash. If the amount of the cash payment is calculated with respect to prescribed values rather than market values, licences issued under such programmes will be considered for listing under the regulations. This listing will mean licence holders receiving cash payments under such programmes will be treated in a similar way to Achieving Sustainable Groundwater Entitlements licence holders. [Schedule 7, item 4, paragraphs 124-140(2)(b) and (3)(b) , 124-141(1)(b) and subsection 124-141(2) of the Income Tax (Transitional Provisions) Act 1997]

Consequential amendments

7.36 There are also amendments tidying up tables, notes and examples that need to be inserted or changed because of the wider application of the roll-over. [Schedule 7, items 5, 6 and 8 to 12]

7.37 A regulation-making power is inserted into the Income Tax (Transitional Provisions) Act 1997 . [Schedule 7, item 13]