Senate

Supplementary Explanatory Memorandum

(Circulated by authority of the Minister for Housing and Assistant Treasurer the Hon Michael Sukkar MP)

Chapter 1 - Amendment to the Treasury Laws Amendment (2019 Tax Integrity and Other Measures No. 1) Bill 2019

Outline of chapter

1.1 The amendments to Schedule 3 to the Bill make clear that deductions are available for entities that incur costs in holding land:

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that becomes or is treated as being vacant due to significant and unusual events or occurrences outside the reasonable control of the entity, such as fire, flood, or substantial building defects;

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while carrying on a business of primary production; or

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that is used by another entity in carrying on a business.

1.2 The amendments ensure that the integrity rules set out in Schedule 3 do not adversely affect:

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entities solely because land the entity holds is affected by a natural disaster or other unforeseeable event beyond their control;

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primary producers because of the ways in which many forms of primary production make use of land; and

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land being used for business purposes under arm's length arrangements.

1.3 All legislative references in this Chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

1.1 The income tax law allows taxpayers to claim the costs of holding vacant land if it is held for the purpose of gaining or producing assessable income or carrying on a business for the purpose of gaining such income. However, some taxpayers have been claiming deductions for costs associated with holding vacant land when it is not genuinely held for the purpose of gaining or producing assessable income.

1.2 As the land is vacant, there is often limited evidence about the taxpayer's intent other than statements by the taxpayer. The reliance on a taxpayer's assertion about their current intention leads to compliance and administrative difficulties.

1.3 Schedule 3 to the Bill amends the ITAA 1997 to deny deductions for losses or outgoings incurred that relate to holding vacant land. However, the restriction on deductions for the costs of holding vacant land does not apply to any losses or outgoings relating to holding vacant land to the extent to which it is:

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used or held available for use by the entity in the course of carrying on a business in order to earn assessable income; or

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used or held available for use in carrying on a business by;

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an affiliate, spouse or child of the taxpayer; or

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an entity that is connected with the taxpayer or of which the taxpayer is an affiliate.

1.4 The restriction also does not apply to taxpayers that are:

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corporate tax entities, superannuation plans (other than self managed superannuation funds), managed investment trusts or public unit trusts; or

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unit trusts or partnerships of which all the members are entities of the above types.

1.5 Schedule 3 applies to losses and outgoings incurred on or after 1 July 2019.

Detailed explanation of the amendments

Exceptional circumstances

Overview

1.6 The amendments provide that the restriction on deducting the costs of holding vacant land does not apply if:

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during the period the entity held the land, the land contained a substantial and permanent structure;

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if that structure was residential premises that was constructed or substantially renovated while you hold the land, it was lawfully able to be occupied and was either rented out or made available for rent;

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as a result of a circumstance, the entity would otherwise not be able to deduct the costs of holding the land as either there is no longer a substantial and permanent structure in use or available for use on the land or, if the structure is residential premises, it is no longer able to be either rented out or made available for rent;

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the circumstance was exceptional and not within the reasonable control of the entity or related entities; and

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the critical time for the loss or outgoing was incurred no more than three years after the land ceased to contain a usable substantial and permanent structure or ceased to be able to be rented out or made available for rent, or such further time as the Commissioner may allow.

[Amendment 1, subsection 26-102(6)]

1.7 The amendments establish an additional set of circumstances in which the restriction on deducting the costs of holding vacant land does not apply. They ensure that that the integrity rules set out in Schedule 3 do not adversely affect an entity solely because land the entity holds is affected by a natural disaster or other unforeseeable event beyond their control.

1.8 The amendments do not affect the entitlement of entities to deduct amounts in other circumstances.

Change in status of substantial and permanent structure or ability to rent

1.9 The restriction on deducting the costs of holding vacant land does not apply if an exceptional circumstance outside of the reasonable control of the entity were to occur which wholly or mainly affects the structure on the property in such a way there is no usable substantial and permanent structure on the land for the purposes of the restriction. [Amendment 1, paragraph 26-102(6)(a)]

1.10 Residential premises are treated as not being a substantial and permanent structure if they have been constructed or substantially renovated while the entity held the land and the premises are not able to be occupied under the law or are not either rented or available for rent - see paragraphs 3.39 to 3.41 of the Explanatory Memorandum to the Bill. If an exceptional circumstance affects residential premises and as a result the premises are treated as not being a substantial and permanent structure then this satisfies the requirement that the circumstances have resulted in there being no usable substantial and permanent structure for the purposes of the restriction.

1.11 Relevant exceptional circumstances can involve the structure being destroyed or damaged to the point where it cannot be used (for example, by a fire). They can also involve something that affects the property when first held or is later discovered to be affecting the property that prevents it being used. In the case of residential premises of the sort identified in paragraph 1.10 above, relevant exceptional circumstances can involve the premises being rendered unable to be made available for rent or lawfully occupied. This could, for example, include the discovery of asbestos or a substantial building defect that render the building unsafe for occupation). [Amendment 1, paragraph 26-102(6)(b)]

1.12 For this exemption to apply, there must have been a substantial and permanent structure on the land prior to the time the exceptional circumstance or circumstances occurred.

1.13 If the substantial and permanent structure was residential premises, then the residence must have, prior to the time of the circumstance, been treated as being a substantial and permanent structure. That is, if the residential premises was constructed or substantially renovated while the entity held the land, it must have been able to be occupied under the law and have been either rented out or have been available to be rented prior to the circumstance occurring. [Amendment 1, paragraph 26-102(6)(a)]

1.14 In effect, the entity must have satisfied the general requirements to deduct the cost of holding the relevant land despite the restriction before the exceptional circumstance occurred.

1.15 For further information on substantial and permanent structures, see paragraphs 3.18 to 3.24 of the Explanatory Memorandum to the Bill.

Exceptional circumstances

1.16 For the exemption from the restriction to apply, there must have been an exceptional circumstance outside the control of the entity or related entities (see paragraphs 3.35 to 3.36 of the Explanatory Memorandum to the Bill for more details on what are related entities). [Amendment 1, paragraphs 26-102(6)(b) and (c)]

1.17 In this context, exceptional circumstances mean significant and unusual events or occurrences such as natural disasters, major building fires and substantial building defects. A circumstance will be outside the reasonable control of the entity if the entity did not cause the circumstances and there was nothing a reasonable person in the position of the entity should have reasonably done to prevent the circumstance. [Amendment 1, paragraph 26-102(6)(c) ]

1.18 The exemption applies if the circumstance has the effect of wholly or mainly affecting an existing structure so that it is no longer a substantial and permanent structure that is in use or available for use, or, if it is residential premises, is no longer treated as a substantial and permanent structure.

1.19 The exemption does not apply to circumstances that do not affect the structure - for example if the individual suffers financial hardship that delays the completion of renovations.

1.20 In some cases the absence of a structure may arise both from exceptional circumstances beyond the control of the entity and other circumstances. In this case, the exemption will apply if the exceptional and uncontrollable circumstance is the main cause of the absence.

1.21 For example, the absence of a substantial and permanent structure on land may result from two circumstances, the destruction of a prior structure by fire and delays in the construction of a replacement structure. In general, the exceptional circumstance of the fire would be expected to be the main circumstance resulting in the absence of a substantial and permanent structure. While the building delays are also a circumstance contributing to the absence of a structure, their effect would usually be considered to be incidental to the effect of the fire.

Three year limit

1.22 Deductions can be claimed for three years from the date the exceptional circumstance first results in there being no substantial and permanent structure on the land for the purposes of the restriction using this exception. This ensures that this exception does not provide indefinite access to deductions for vacant land even after the effect of the circumstances are likely to have passed. [Amendment 1, paragraph 26-102(6)(d)]

1.23 This period can be extended by the Commissioner. It is expected the Commissioner would allow an extension where the reasons for the failure to replace the structure are beyond the control of the individual or due to the size of the structure it is unable to realistically be completed in that time.

Record keeping

1.24 The amendments require the entity that relies upon the exemption to keep written records of the circumstance and its effect on the affected structure for the entity for five years after the end of the income year in which the cost was incurred. [Amendment 1, subsection 26-102(7)]

1.25 If the entity fails to keep the written records, the administrative penalty for failure to keep or retain records in section 288-25 of Schedule 1 to the Tax Administration Act 1953 applies.

Land held by primary producers

Overview

1.26 The amendments also provide that the restriction on deducting the costs of holding vacant land does not apply if, at the critical time:

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the land was leased, hired or licensed to another entity;

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the entity holding the land, or a related entity is carrying on a business of primary production;

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the land did not contain residential premises; and

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residential premises are not being constructed on the land.

[Amendment 1, subsection 26-102(8)]

1.27 This addresses stakeholder concerns that primary production activities may be inappropriately affected by the integrity measure as such activities often involve the use and management of significant areas of vacant land, not all of which is held by the entity carrying on the primary production business.

Lease hire or licence

1.28 For this primary production exception to apply, the land must be leased, hired or licensed to another entity. [Amendment 1, paragraph 26-102(8)(a)]

1.29 Effectively this means that the land must be being used to generate income from rent. The other entity can be related to the entity that holds the land.

Carrying on a primary production business

1.30 For the exception to apply, either the entity that holds the land or a related entity must carry on a primary production business. Primary production business is broadly defined in subsection 995-1(1) and includes all forms of plant or animal cultivation and many related activities. [Amendment 1, paragraph 26-102(8)(b)]

1.31 An entity is a related entity for this purpose in the same circumstances as an entity will be a related entity for the purposes of the general requirement that the land is used in carrying on of a related business test in Schedule 3 to the Bill - see paragraphs 3.35 and 3.36 of the Explanatory Memorandum to the Bill). Broadly, it includes entities that control or are controlled by the holder of the land, a spouse or child below the age of 18 and an entity that is connected with the holder of the land.

1.32 Primary production is often closely tied to land and many entities involved in primary production will often have significant landholdings associated with the primary production activities. Often this land will not contain any substantial and permanent structures because of its link to primary production activities and may be held under different arrangements to reflect business needs and personal circumstances.

1.33 This exception ensures that arrangements undertaken by entities linked to a primary production business do not result in deductions being denied for the cost of holding this land if it is rented to produce income.

Exclusion of residential premises

1.34 However, this exception does not apply to land that contains residential premises or on which residential premises are being constructed. [Amendment 1, paragraphs 26-102(8)(c) and (d)]

1.35 Residential premises has the same meaning as it does in A New Tax System (Goods and Services Tax) Act 1999.

1.36 When construction commences is determined based on the facts and circumstances, consistent with the rules for determining the deductibility of the capital costs under Division 43.

1.37 Land being used for residential purposes is distinct from land that is usually held in connection with a primary production business. It also presents particular integrity risks as residential premises can be readily used for private purposes in addition to being available for rent. Excluding such land from this exception means that it addresses any potential consequences for landholdings relating to primary production without giving rise to these integrity risks.

Land being used in carrying on a business

Overview

1.38 The amendments also provide that the restriction on deducting the costs of holding vacant land does not apply if, at the critical time:

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the land was leased, hired or licensed to another entity on an arm's length basis;

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the land was in use or available for use in carrying on a business;

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the land did not contain residential premises; and

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residential premises were not being constructed on the land.

[Amendment 1, subsection 26-102(9)]

1.39 This addresses stakeholder concerns that certain income producing activities involving making land available for business use may not have constituted carrying on a business by the holder of the land.

Lease, hire or licence

1.40 For this exception to apply, the land must be leased, hired or licensed to another entity. [Amendment 1, paragraph 26-102(9)(a)]

1.41 Effectively this means that the land must be being used to generate income from rent. The other entity can be related to the entity that holds the land.

1.42 However, while the parties to the rental arrangement may be related, the arrangement must be entered into on an arm's length basis. This means that, even if the parties are related, the arrangement must be consistent with what independent parties in the same situation might agree to.

1.43 This ensures that the exception only applies to genuine commercial arrangements and land cannot be provided to related businesses at nominal rates to avoid the integrity rules established by Schedule 3 to the Bill.

Use in carrying on a business

1.44 For the exception to apply, the land must be used or available for use in carrying on a business. [Amendment 1, paragraph 26-102(9)(b)]

1.45 While there was already an exception in Schedule 3 to the Bill for land being used by the entity or certain related entities in carrying on a business, the exception applies if land is used by another entity in carrying on a business.

1.46 Land is not in use or available for use by a business if the land is being used or is available for use by a business solely for the purpose of providing services or other supplies to the entity that holds the land.

Exclusion of residential premises

1.47 This exception does not apply to land that contains residential premises or on which residential premises are being constructed. [Amendment 1, paragraphs 26-102(9)(c) and (d)]

1.48 This is consistent with the exclusion for land held by an entity linked to a primary production business - see paragraphs 1.34 to 1.37.

Application and transitional provisions

1.49 These amendments apply to losses and outgoings incurred on or after 1 July 2019, in the same way as Schedule 3 to the Bill.

1.50 The application of these amendments is retrospective, but wholly beneficial to affected taxpayers, as they mean that those taxpayers are not subject to the restriction on claiming deductions otherwise introduced by Schedule 3 to the Bill.