Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Capital Expenditure on Traveller Accommodation
Summary of proposed amendment
7.1. The write-off rate for capital expenditure on constructing buildings used to provide short-term accommodation for travellers is to increase to 4 per cent per annum (formerly 2.5 per cent per annum).
7.2. The higher rate will apply to buildings commenced to be constructed after 26 February 1992.
Background to the legislation
7.3. At present, capital expenditure incurred in constructing income-producing buildings, or extensions, alterations or improvements to buildings, is eligible for write-off over 40 years at the rate of 2.5 per cent per annum under Division 10D of the Act.
7.4. Short-term traveller accommodation describes buildings covered by Division 10C. That Division applied to buildings constructed after 21 August 1979 and before 18 July 1985 which were for use in the provision of short-term traveller accommodation. During that period, residential buildings only qualified for deduction when used for that purpose.
7.5. Division 10C ceased to apply to buildings commenced to be constructed after 17 July 1985, the date from which all new income-producing buildings were eligible for deduction under Division 10D, whatever their use.
Explanation of proposed amendment
7.6. The higher rate of deduction is to apply to buildings covered by Division 10C. The broad effect of the amendment is to "resurrect" that Division which will operate similarly as before.
7.7. As mentioned earlier, Division 10C formerly applied at a time when residential buildings did not qualify for deduction unless used as short-term traveller accommodation; there were no deductions at all while a building was used for other purposes. Similarly, a change in use of part of a building could terminate entitlement to deductions in relation to that part of the building.
7.8. However, as residential income-producing buildings now qualify for deduction, it is no longer appropriate that Division 10C should deny deductions when short-term traveller accommodation buildings are used for other income-producing purposes; for instance, converted for use in the provision of long-term accommodation, or partly converted as shops or offices.
7.9. Accordingly, Division 10C is to be changed so that deductions will be available at the lower rate of 2.5 per cent per annum for any part of a traveller accommodation building not used as short-term traveller accommodation but nevertheless used in producing assessable income.
7.10. The following explains how the Division will operate after the amendments.
7.11. Deductions will be available to owners (including certain lessees) of buildings, or of parts of buildings, in respect of which there is an amount of qualifying expenditure.
7.12. Qualifying expenditure is essentially the capital cost of the building work. That is so much of the capital expenditure incurred on the construction of a building (including a complex of buildings), or extension, alteration or improvement to a building, as is attributable to the relevant part of the building.
7.13. The relevant building, or part of a building, must have at least 10 bedrooms or units for use wholly or principally for traveller accommodation. More precisely, the building or part must be:
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- for use wholly or principally for the purpose of operating a hotel, motel or guest house containing at least 10 bedrooms wholly or principally for use as short-term accommodation for travellers ("qualifying hotel expenditure"); or
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- containing at least 10 apartments, units or flats, for use wholly or principally as short-term accommodation for travellers, and any principally associated facilities ("qualifying apartment expenditure").
7.14. Three kinds of facilities are specifically excluded. First, expenditure on facilities not for use wholly or principally in operating a hotel, motel or guest house, or apartments, units or flats would not qualify; for example, that part of a hotel development used as a shopping mall or commercial offices.
7.15. Also, expenditure on facilities not commonly provided in Australia in a hotel, motel or guest house will also not qualify. For example, a casino, cinema or amusement park operated in conjunction with a hotel or tourist resort are not facilities commonly provided in hotels, motels or guest houses in Australia.
7.16. Also excluded is expenditure on accommodation for private use of owners or shareholders, beneficiaries or partners of owners.
7.17. However, expenditure on those excluded facilities would qualify for deduction at the lower rate of 2.5 percent per annum under Division 10D where used for income-producing purposes.
7.18. Expenditure for which an owner is entitled to deductions under the plant depreciation provision is also excluded.
7.19. The cost of a building includes certain preliminary expenditures, including architects fees, engineering fees, buildings permits, etc. and the cost of excavating foundations. It does not include the cost of land and site clearing and levelling, nor landscaping.
7.20. Associated facilities such as carparks, driveways, fencing, retaining walls and recreational facilities such as tennis courts are not part of the building. However, their cost may qualify for deduction at the rate of 2.5 per cent annum under separate amendments relating to structural improvements, contained in this Bill. (see chapter 9)
7.21. An important change is that the concession will extend to buildings constructed outside Australia. Formerly, only buildings constructed in Australia could qualify. This change is consistent with an earlier removal of a similar restriction under Division 10D, brought about by the termination of the general tax exemption of foreign sourced income.
[Amended paragraphs 124ZB(1)(a) and (2)(a)]
7.22. Entitlement to deductions commences once the relevant construction is completed and is used in producing assessable income. Deductions are available for each day that the part of a building in respect of which there is either an amount of qualifying hotel expenditure (a "hotel part") or an amount of qualifying apartment expenditure (an "apartment part") is used in producing assessable income.
7.23. The amount of the deduction will depend on the income-producing use of the hotel or apartment part. [New subsections 124ZC(2A) and 124ZC(4A)]
7.24. For periods during which the whole of a hotel or apartment part is used in the prescribed manner, whether by the owner or another person, deductions will be at an annual rate of 4 per cent of the amount of qualifying expenditure. Broadly, use in the prescribed manner means use in the manner required for there to be an amount of qualifying expenditure as described above.
7.25. During periods in which the whole of a hotel or apartment part is not used in the prescribed manner, but is used to produce assessable income, deductions will be at an annual rate of 2.5 per cent of the amount of qualifying expenditure.
7.26. In instances where a hotel or apartment part is only partly used in the prescribed manner at a particular time, the portion of the qualifying expenditure that relates to the part of the part used in the prescribed manner will be deductible at 4 per cent and the balance that is used in producing assessable income will be deductible at 2.5 percent.
7.27. If two or more persons own separate parts of the same building, the amount of qualifying expenditure in relation to the building is apportioned between each part. The rules for calculating deductions then work in the same manner, as described above, for each owner's separate part.
7.28. The following examples illustrates how the new rules for calculating deductions will operate.
Example
A taxpayer owns a motel comprising 20 units and associated facilities in a country town. The taxpayer usually makes the whole of the motel available for use by travellers. Qualifying expenditure in relation to the motel is $500,000.
One year, a mining company commmences exploration activities in the area and the taxpayer grants a 12 month lease of 15 of the units to the company as accommodation for its employees. The lease commences on 1 January.
The taxpayer's claim for that year would be calculated as follows:
During the period 1 July to 31 December, the whole of the motel was used in the prescribed manner. The number of days in that period is 184. So the deduction for that would be calculated as follows:
$500,000 x 0.04 x 184/365 = $10,082
For the period 1 January to 30 June, only 5 units were used in the prescribed manner. This is less than the required minimum of ten, so the rate of deduction will reduce to 2.5 per cent. The deduction for the period 1 January to 30 June, a period of 181 days, would be calculated as:
$500,000 x 0.025 x 181/365 =$6,199
Summary of deductions allowable: $ Period 1 July to 31 December 10,082 Period 1 January to 30 June 6,199 Total 16,281
Deductions at the higher rate of 4 per cent per annum would become available once at least ten of the units were used in the provision of short-term traveller accommodation.
7.29. The total amount of deductions allowable cannot exceed the amount of qualifying expenditure in relation to that building. That is achieved by specifying that a deduction in a year in relation to an amount of qualifying expenditure must not exceed the amount of residual capital expenditure in relation to the amount of qualifying expenditure at the beginning of the year or, if the building was acquired during the year, immediately after the time of acquisition. [New subsections 124ZC(5A)and (5B)]
7.30. The meaning of residual capital expenditure is described later in detail; broadly, it means the amount of qualifying expenditure less deductions allowed or allowable; that is, the amount of qualifying expenditure remaining for deduction.
7.31. That method of setting the limit on deductions is a change from the existing rules which specify a fixed period for which deductions are available; for example 25 years at 4 per cent per annum. That is not appropriate now that the rate of deduction can vary according to circumstances of use and so vary the time over which deductions ought to be available.
7.32. A deduction is available on the destruction, or part destruction, of a hotel or apartment part to the extent that the amount of any residual capital expenditure at the time of destruction attributable to the destroyed part exceeds any compensation received.
7.33. Under the existing rules, a requirement for deduction is that the hotel or apartment part be used in the prescribed manner (that is, as short-term traveller accommodation) immediately before the destruction, or if not so used, that the last use was in that manner. So, a deduction would not be available where the destroyed part was being used for other purposes.
7.34. That would not be appropriate now that residential buildings are eligible for deduction where used for any income-producing purpose. Accordingly, the requirement will now be that the last use of a post-26 February 1992 building before it is destroyed not be other than for producing assessable income. [New paragraph 124ZE(7)(b)]
7.35. The existing requirement that the last use be in the provision of short-term traveller accommodation will continue to apply to buildings commenced to be constructed before 18 July 1985.
7.36. As described above, residual capital expenditure is relevant for determining the total amount of available deductions and calculating any deductible loss on the destruction of a building.
7.37. In essence, the amount of residual capital expenditure in relation to an amount of qualifying expenditure at a particular point in time is the excess of the amount of qualifying expenditure over the sum of deductions allowed or that would have been otherwise allowable during periods when the relevant building was not used for income-producing purposes.
7.38. Reflecting that the rate of deduction may vary according to the circumstances of use of a building, the calculation of residual capital expenditure requires a determination of the periods of time during which a hotel or apartment part was used in the prescribed manner and periods when not so used, commencing from the time when the building was first used for any purpose. [New subsections 124ZA(16A) and (16B)]
7.39. For periods during which the whole of a hotel or apartment part was used in the prescribed manner, the relevant amount of qualifying expenditure is reduced at the rate of 4 per cent per annum of that amount, reflecting that deductions have been allowed at that rate.
7.40. During periods in which the whole of a hotel or apartment part is not used in the prescribed manner, perhaps because it is used for another income-producing purpose or for no income-producing purpose, the relevant amount of qualifying expenditure will be reduced at the rate of 2.5 per cent per annum of the amount of qualifying expenditure.
7.41. If a hotel or apartment part is only partly used in the prescribed manner at a particular time, the portion of the qualifying expenditure that relates to the part of the part used in the prescribed manner will be reduced at the rate of at 4 per cent and the balance at 2.5 per cent.
7.42. In instances where different parts of a building are owned by different taxpayers, a separate calculation will be made of the amount of residual capital expenditure applicable to each part. The reason for that is that each owner may use their part in a different manner and so obtain different rates of deductions. In those circumstances, the time period for deductions should reflect each owner's circumstances.
7.43. A person selling a building, or a lease of a building, to which this amendment applies is to be required to pass on sufficient information to the purchaser to enable the purchaser to know how Division 10C will apply to the purchaser's holding of the building. The same rule applies to disposals of a part of a building.
7.44. That requirement would be satisfied by specifying the amount of qualifying expenditure and residual capital expenditure in relation to the building or part of the building. Without that information, a purchaser would not know what deductions were available.
7.45. That information must be given within 6 months of the end of the year of income in which the disposal occurs. The purchaser must retain that information for 5 years after the earlier of the purchaser ceasing to be the owner of the building or the destruction of the building. So the purchaser will be able to give the information if they, in turn, sell the building or lease. [New subsections 262A(4AF) and (4AG)]
Commencement date
7.46. The amendment applies to buildings, or extensions, alterations or improvements to a building, commenced to be constructed after 26 February 1992.
7.47. Construction of a new building or an extension is taken to commence at the time of commencement of work on the foundations; for example, the excavation of foundations or sinking of pilings.
Clauses involved in proposed amendment
Clause 39(a): inserts a number of new definitions into subsection 124ZA(1) regarding the time of construction of buildings. Those definitions facilitate a number of amendments relating to residual capital expenditure, the method of calculating deductions and deduction limits.
Clause 39(b): specifies that the existing definition of residual capital expenditure (subsection 124ZA(16)) applies only where construction commenced before 18 July 1985.
Clause 39(c): inserts new subsections 124ZA(16A) and (16B) which specify how residual capital expenditure is to be calculated where construction commences after 26 February 1992.
Clause 40(a): removes the present restriction of the concession to buildings constructed in Australia.
Clause 40(b) & (c): amend the existing definitions of qualifying expenditure (section 124ZB) to include a reference to buildings, extensions, etc. commenced to be constructed after 26 February 1992.
Clause 41(a): amends the existing rules for calculating deductions (section 124ZC) so that they apply only where construction commenced before 18 July 1985.
Clause 41(b) & (c): insert new subsections 124ZC(2A) and (4A) which specify how deductions are to be calculated where construction commences after 26 February 1992.
Clause 41(d): amends subsection 124ZC(5) which governs the period during which deductions are available so that it applies only where construction commenced before 18 July 1985.
Clause 41(e): inserts new subsection 124ZC(5A) and (5B) which specify the limits on deductions where construction commenced after 26 February 1992.
Clause 42(a) & (b): amend paragraph 124ZD(5)(a) (dealing with reductions of deductions on destruction of buildings) to reflect the new requirement that residual capital expenditure is to be calculated separately in respect of each part of a building that is owned by different persons. The amendment does not change the effect of that provision.
Clause 43(a) & (e): amend paragraphs 124ZE(1)(e), (2) (e), (3)(e) and (4)(e) and insert new subsection 124ZE(7) to change the present requirement that the last use of a destroyed, or partly destroyed, building, be in the provision of short-term traveller accommodation to a requirement that the last use be in producing assessable income, where construction commenced after 26 February 1992.
Clause 43(b) to (d): make minor consequential amendments to section 124ZE (which deals with deductions on the destruction of buildings) to reflect the new method of calculating residual capital expenditure. The effect of that provision is not affected by the amendments.
Clause 44: inserts new subsection 124ZG(2C) (Division 10D income-producing buildings) to prevent double deductions for expenditure to which these amendments relate.
Clause 45: inserts new subsections 262A(4AF) and (4AG) containing the record keeping requirements.
Clause 46: removes the restriction that construction be in Australia where construction commenced after 26 February 1992.