Explanatory Memorandum(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)
Capital Gains Tax - Depreciable Property Installed on Crown leases
- Purpose of amendment: To amend the capital gains tax provisions to ensure that they treat disposals of interests in plant installed on Crown leases of land consistently with their treatment under the depreciation Crown lease provisions.
The amendment will prevent capital gains and losses from accruing in respect of plant installed on a Crown lease where a lease is terminated but the lessee retains an interest in the plant. It will also prevent capital losses from accruing in respect of plant installed on a Crown lease where the lease is terminated but an associate of the lessee obtains an interest in the plant.
Date of effect: The amendment applies to disposals occurring after 26 February 1992.
The purpose of section 54AA of the Income Tax Assessment Act 1936 is to enable taxpayers to obtain depreciation deductions for plant they install on land over which they hold a Crown lease.
Taxpayers must own property [subsection 54(1)] if they are to obtain depreciation deductions for that property. In some instances, taxpayers are not treated at law as the owners of plant they install on land owned by others because, owing to the degree of the plant's attachment to the land, the law treats the plant as owned by the person who owns the land.
Section 54AA treats taxpayers, including partnerships, installing plant on land over which they hold a Crown lease, and subsequent holders of the lease, as owners for depreciation purposes if the law would otherwise treat them as not being the owners.
Broadly, a Crown lease for depreciation purposes (after amendments contained in Taxation Laws Amendment Bill (No.5) 1992), means a lease, easement or right, power or privilege over or in connection with land, that was granted by a government or by a tax-exempt authority of a government.
[For convenience, references to leases includes a reference to other interests in land such as easements, licences etc. unless otherwise indicated.]
Leases constitute assets for CGT purposes, so capital gains or losses can accrue on their disposal if acquired after 19 September 1985. A capital gain accrues where the consideration for the disposal of an asset exceeds its indexed cost base at the time of the disposal.
A capital loss accrues where the consideration for the disposal of an asset is less than its reduced cost base at the time of the disposal. Broadly, the reduced cost base of an asset means the cost base of the asset less the amount of that cost that has been allowed as income tax deductions; for instance, that part of the cost of plant that has been allowed as depreciation deductions.
The cost base of a lease would comprise any consideration given for its acquisition; ie. any premium given for the acquisition of a lease either by grant or assignment. It would also include the cost of any capital improvements made by the lessee to the lease; for example, any plant installed on the land by the lessee which the law treats as becoming part of the land. That could happen in one of two ways.
The first would be where the lessee acquires property and affixes it to the land; for example, the lessee acquires materials and constructs a building or other structural improvement on the land. The affixing of the materials comprising the constructed asset would constitute a disposal of those materials to the owner of the land, usually for no gain or loss. The cost of the materials would be treated as expenditure incurred by the lessee in enhancing the value of the lease, and so form part of the cost base of the lease [paragraph 160ZH(1)(c)].
The second would be where a lessee contracts with another person for that person to construct a building or other structural improvement for the lessee on the land. The constructed asset (or its component parts) would never constitute an asset of the lessee. However, the capital expenditure of the lessee in having the asset installed would be treated as expenditure incurred in enhancing the value of the lease.
Subsection 160P(4) specifies that a building or other improvement made to land is to be treated as an asset separate from the land if another, non-CGT, provision of the Act treats the building or improvement as "an asset separate from the land".
This principle would apply, for example, where income tax deductions are allowable for a building (eg, under Division 10D) or plant improvement (eg. under section 54), affixed to land. The fact that income tax deductions are allowable in relation to the building or plant improvement is tantamount to those provisions treating the building or improvement as "an asset separate from the land".
The principle would apply not only to an owner of the land but also to a lessee of the land; that is, a lessee's interest in those separate assets would comprise two assets: one comprising a leasehold interest in land and the other comprising a leasehold interest in the improvement. This would be so irrespective of who was entitled to the deductions in relation to the improvement.
Under CGT, any consideration for the acquisition or disposal of the lease (including any depreciable improvements) would be apportioned between the asset comprising the interest in the improvement and the asset comprising the interest in the land. Expenditure on the installation of an improvement on the land would be attributed to the asset comprising the interest in that improvement.
The reduced cost base of the interest in the improvement would be calculated by reference to the amounts allowed as deductions [section 160ZK].
The general income tax law treats partnerships as if a taxpayer and so the owner of partnership assets eligible for depreciation deductions under the plant depreciation rules.
Under CGT, partnerships are not treated as if a taxpayer and therefore not the owner of partnership assets. Instead, each partner's interest in partnership property is treated as an asset [paragraph 160A(d)]. Thus, on the disposal of property by a partnership, each partner would be treated as disposing of the asset comprising their interest in the property.
In the case of partnership plant affixed to land, the CGT provisions would treat each partner's interest in the plant as an asset separate from the partner's interest in the land itself. Each partner's share of expenditure incurred in acquiring or improving the lease would be apportioned between/attributed to the relevant separate asset.
For reduced cost base purposes, a partner's share of depreciation deductions allowed to the partnership would be deducted from the cost of the partner's interest in the plant [Paragraph 160ZK(3)(a)].
Following the enactment of section 54AA, the plant depreciation and CGT provisions do not apply "symmetrically" in relation to terminations of Crown leases in some circumstances so that taxpayers could inappropriately incur capital losses in respect of the depreciated value of plant affixed to the leased land, or derive capital gains. The CGT provisions are to be amended to prevent such inappropriate outcomes.
Ordinarily, a termination of a lease would constitute a disposal of the lease by the lessee for CGT purposes (and, therefore, of the separate asset comprising the lessee's interest in any plant on the land).
However, if the lease is a "Crown lease" or a "mining asset", section 160ZWA or 160ZZF would provide "automatic" CGT rollover relief for a disposal of the lease that is followed by the grant to the lessee of a relevant replacement interest in the land. The effect of rollover relief is to treat a disposal as if it had not occurred so that no gain or loss accrues under CGT.
Where such CGT rollover relief applies to a disposal of a lease of land it would also apply to the contemporaneous disposal of any separate asset that comprises a lessee's interest in plant affixed to the leased land as that too would constitute either a Crown lease or a mining asset.
However, the meaning of "Crown lease" for depreciation purposes is broader than its meaning under CGT and is different from the meaning of "mining asset".
As mentioned earlier, "Crown lease" for depreciation purposes broadly means a lease, easement or right, power or privilege over or in connection with land, that was granted by a government or by a tax-exempt authority of a government. By comparison, "Crown lease" under CGT means a statutory lease (ordinary meaning) of land granted by the Crown and "mining asset" broadly means a mining right or a prospecting right.
Thus, there could be instances where CGT rollover relief would not apply to a termination of a lease that constituted a disposal of that lease, including leasehold improvements (because the lease is neither a CGT Crown lease nor a mining asset) but the lessee would be treated as continuing to own any plant on the leased land for depreciation purposes (because the lease is a Crown lease for depreciation purposes).
If the termination was due to the expiry of the lease, the lessee would be treated under CGT as disposing of the lease for no consideration. If the plant had not been fully depreciated at the time of expiry, the lessee would incur a capital loss equal to the reduced cost base of the asset comprising the leasehold interest in plant even though entitled to continue to depreciate the plant [in most circumstances, the reduced cost base of an asset comprising an item of plant would correspond with its depreciated value for depreciation purposes].
In the case of a partnership, each partner would incur a capital loss equal to the reduced cost base of their respective interests in the plant even though the partnership could continue to obtain depreciation deductions.
Such outcomes are not appropriate. Correspondingly, it would not be appropriate if a capital gain was to accrue in the same circumstances. That could occur if, for example, a lease was terminated early in return for the grant of a new lease of the same property and the market value of attached plant had increased.
Accordingly, CGT rollover relief is to automatically apply to a disposal of a lessee's, or, if the lessee is a partnership, of each partner's, interest in plant affixed to a Crown lease, if neither section 160ZWA nor section 160ZZF applies, where the depreciation Crown lease provisions treat the lessee as continuing to own the plant for depreciation purposes because the lessee has received a fresh interest - either as lessee or owner - in the plant. Rollover relief will only apply to the interest in plant and not to the disposal of the separate asset comprising the leasehold interest in the land itself. [New section 160ZWC]
Where rollover relief applies, the CGT provisions will not apply to the disposal so neither a capital gain nor a capital loss can accrue. Further, and consistent with other rollover provisions, the Commissioner of Taxation must ensure that rollover relief applies to the fresh interest in the plant.
In practice, that will mean that, if the interest in the plant that was disposed of was acquired by the taxpayer before 20 September 1985, the fresh interest will be treated as acquired before that date, thus preserving its "exempt status" under CGT.
In the case of a disposal of an interest in plant acquired by a taxpayer after 19 September 1985, the fresh interest will be treated as acquired for consideration equal to the cost base, the indexed cost base and reduced cost base of the terminated interest immediately before its disposal for the purposes of calculating a capital gain or loss on its disposal.
On the termination of a Crown lease that is followed by the grant of a fresh interest in the land to an associate of the lessee, the depreciation provisions [paragraphs 54AA(2)(d) and (2)(f)] treat the lessee as disposing of any plant on the leased land for consideration equal to what would be its market value if the lessee owned the land. [The purpose of this rule is to deny balancing losses on the disposal of plant where an associate obtains use of the property and prevent avoidance of assessable balancing adjustments.]
The CGT rules would treat such terminations as a disposal of the assets comprising the leasehold interest in the land and in the plant, usually for no consideration, and a capital loss would be available equal to the reduced cost base, if any, of the lessee's interest (or, as the case requires, each partner's interest) in the plant. That would be inappropriate because an associate has obtained an interest in the property.
To prevent that result, the reduced cost base rules, relevant for calculating capital losses, are to be modified in those circumstances so that the depreciated value of the plant at the time of the termination is deducted from the reduced cost base of the taxpayer's interest in the plant. In the case of plant of a partnership, the portion of the depreciated value of the plant that is attributable to the partner's interest in the plant is to be excluded from the reduced cost base of the partner's interest in the plant. [New section 160ZWD]
As a technical measure, a reference to the rollover relief rules in new Division 5B of Part IIIA is to be inserted in the definition of "notional Part IIIA disposal" in section 110 and 116E . That definition is relevant for the apportionment of gains and losses on disposals of assets, or disposals that would have occurred but for a CGT rollover provision, which are attributable to the various classes of income of life assurance companies and registered organisations. [Reference to Division 5B inserted in sections 110 and 116E definition of "Notional Part IIIA disposal"]
With certain limited exceptions, profits or losses on the disposal of assets by superannuation funds and similar entities are assessed under the CGT provisions rather than the ordinary income provisions. That is achieved by specifying that the relevant revenue provisions do not apply to disposals of assets to which CGT applies or would apply but for the application of a CGT rollover provision [section 304].
As a technical measure, a reference to the rollover rules in new Division 5B of Part IIIA is to be inserted in section 304. [Reference to Division 5B inserted in section 304]
In certain circumstances, the income of a non-resident company can be attributed to its Australian resident controllers.
The CGT provisions are modified for the purposes of calculating whether income is to be attributed and the amount to be attributed. The various CGT rollover provisions are relevant for those purposes. Accordingly, a reference to the rollover rules in new Division 5B of Part IIIA needs to be inserted in the definition of "CGT roll-over provisions" in section 317. [Reference to Division 5B inserted in section 317 definition of "CGT roll-over provisions"]
These amendments were foreshadowed in the Explanatory Memorandum to Taxation Laws Amendment Bill (No.3) 1992, which inserted section 54AA, and apply from the same time as the depreciation Crown lease provisions; that is, to disposals of assets, constituting an interest in plant to which section 54AA has applied, that occur after 26 February 1992. [Clause 14]