Edited version of your written advice

Authorisation Number: 1051504273493

Date of advice: 09 April 2019

Ruling

Subject: The sale of a building by a tax exempt entity

Question 1

Does section 43-55 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the transaction involving the sale of a building between the trustee of a Unit Trust (as purchaser)and a Tax Exempt Entity (as vendor)?

Answer

No

Question 2

Is the undeducted construction expenditure (calculated under Subdivision 43-G of the ITAA 1997) affected by the period that capital works deductions are not available to the Tax Exempt Entity?

Answer

No

Question 3

To the extent the expenditure on the building qualifies as construction expenditure for the purposes of section 43-70 or to the extent the expenditure is otherwise deductible under Division 40 of the ITAA 1997, is the trustee of the Unit Trust entitled to claim deductions under Division 43 or 40 of the ITAA 1997 from the date it acquires the building?

Answer

Yes – if the trustee of the Unit Trust uses the building for deriving assessable income from the date it acquires the building, being the date of settlement.

Question 4

Are Divisions 40 and/or 43 of the ITAA 1997 modified by Division 58 of the ITAA 1997 due to the trustee of the Unit Trust acquiring the building from the Tax Exempt Entity?

Answer

Only Division 40 of the ITAA 1997 is modified by Division 58 of the ITAA 1997.

This ruling applies for the period 1 July 2018 to 30 June 2059

The scheme commences on:

1 February 20XX

Relevant facts and circumstances

The Tax Exempt Entity is a local government entity.

The Tax Exempt Entity is a tax-exempt entity for Australian taxation purposes.

The Tax Exempt Entity is the owner of land.

The Tax Exempt Entity has entered into a construction contract with a third party to construct a multi-purpose centre and the building is currently being constructed on the land.

For the purposes of the ITAA 1997, the Tax Exempt Entity is incurring the expenditure to construct the building on capital account rather than revenue account in constructing the building.

The building is capital works for the purposes of Division 43 of the ITAA 1997.

The building will not be used as a hotel building nor an apartment building for the purposes of Division 43.

The construction contract of the building has a target completion date of xxxx 20XX.

Following completion of the construction contract:

a) the Tax Exempt Entity will sell the entire building to the trustee of a Unit Trust;

b) the sale contract will transfer all rights and obligations of the building to the trustee of the Unit Trust and the Tax Exempt Entity will not have any interest, rights or obligations in the building;

c) the Tax Exempt Entity will remain the owner of the land; and the sale will be subject to the trustee of the Unit Trust entering into a lease for use of the land at an agreed lease payment per annum.

The sale of the building includes units of plant and equipment.

The lease will be a long term lease and on an arm’s length basis (i.e. at market value).

The sale and lease contracts will not be negotiated on the basis of the tax deduction available to the trustee of the Unit Trust.

If the trustee of the Unit Trust is unable to commit to paying the full purchase price of the building, the Tax Exempt Entity is willing to vendor finance the sale of the building, either in part or in full, by entering into either a securitised (mortgaged) full or limited recourse loan with the trustee of the Unit Trust. It is expected the loan would be for a term of 40 years with an applicable interest rate, the capital sum being payable upon termination of the loan. Any such loan will not be negotiated on the basis of the tax deduction available to the trustee of the Unit Trust.

The trustee of the Unit Trust does not have a right to occupy the building at an earlier time. The trustee of the Unit Trust can and intends to commence using the building for income earning purposes from the date of settlement.

It is intended that the building will be used by the trustee of the Unit Trust (or they will make the building available for use) to generate assessable income from the date of acquisition, including but not limited to sub-letting part or all of the land and or letting part or all of building and licencing the naming rights of the building for an estimated amount over 40 years. The Tax Exempt Entity will not have any rights to income, profits or gains derived by the trustee of the Unit Trust under these arrangements.

Any lease between the trustee of the Unit Trust and a third-party (for sub-letting the land and or letting the building) will not exceed 50 years. As such, sections 43-50(3) and 104-115 of the ITAA 1997 will not apply.

The Unit Trust will not lease any part of the building to the Tax Exempt Entity.

The trustee of the Unit Trust is not a tax-exempt entity under Division 50 or a State/Territory body (within the meaning of Division 1AB of Part III of the Income Tax Assessment Act 1936).

The capital works deduction base to be established by the trustee of the Unit Trust will be the original construction expenditure.

Relevant legislative provisions

Division 40 ITAA 1997

Section 40-25 ITAA 1997

Section 40-40 ITAA 1997

Section 40-60 ITAA 1997

Division 43 ITAA 1997

Subsection 43-50(3) ITAA 1997

Section 43-55 ITAA 1997

Section 43-70 ITAA 1997

Section 43-110 ITAA 1997

Section 43-140 ITAA 1997

Subdivision 43-G ITAA 1997

Section 43-230 ITAA 1997

Section 43-235 ITAA 1997

Division 50 ITAA 1997

Division 58 ITAA 1997

Subsection 58-5(2) ITA 1997

Subsection 58-5(4) ITAA 1997

Section 58-10 ITAA 1997

Paragraph 58-10(1)(a) ITAA 1997

Paragraph 58-10(2)(a) ITAA 1997

Paragraph 58-10(2)(b) ITAA 1997

Subsection 58-10(3) ITAA 1997

Section105-115 ITAA 1997

Division 1AB Part III ITAA 1936

Reasons for decision

Question 1

Summary

Section 43-55 of the ITAA 1997 does not apply to the transaction involving the sale of a building between the trustee of a Unit Trust (as purchaser) and the Tax Exempt Entity (as vendor).

Detailed reasoning

Section 43-55 of the ITAA 1997 deals with capital works deductions and arrangements involving tax exempt entities. It contains an anti-avoidance rule to disallow deductions under Division 43 of the ITAA 1997 if the Commissioner is satisfied that the arrangement was entered into between a tax paying entity and a tax exempt entity for a purpose, other than an incidental purpose, of ensuring the benefit of any Division 43 deduction falls to the tax paying entity.

The section is directed at arrangements whereby a taxpayer would otherwise get a capital works deduction in relation to property and the benefit of that deduction is passed on to the tax-exempt entity by the payment of an amount of money, or by the transfer of property, to the tax-exempt entity equivalent to the value of the deduction.

Relevantly, section 43-55 of the ITAA 1997 will apply if:

a) the purchaser nominally entitled to a Division 43 of the ITAA 1997 deduction is to pay an amount or transfer property, whether directly or indirectly, to the local government body;

b) the amount of the payment or the value of the transfer is calculated having regard to the amount of the Division 43 of the ITAA 1997 deduction to which the purchaser is nominally entitled; and

c) a purpose of the arrangement is to ensure that the benefit of the deduction would pass wholly or substantially to the local government body – that purpose must be more than a merely incidental purpose.

It is necessary to consider the arrangement in its entirety to determine whether it contravenes section 43-55 of the ITAA 1997.

In this case:

a) the sale of the building is on an arm’s length basis that does not factor in the capital works deduction that is available to the purchaser;

b) the lease of the land is on an arm’s length basis that does not factor in the capital works deduction that is available to the lessee (the Commissioner expects that the lease will be nominal as the value of the land is likely to be low in these circumstances as the value of the land is affected by the arrangement relating to the building);

c) any vendor loan is on an arm’s length basis and will not factor in the capital works deduction that is available to the purchaser; and

d) the vendor will not have any rights to a share of any income, profits, or gains derived by the purchaser from the use of the building (e.g. from licensing the naming rights to the building or from sub-letting the building).

Consequently, section 43-55 of the ITAA 1997 will not apply to the sale of the building between the trustee of the Unit Trust and the Tax Exempt Entity.

Question 2

Summary

The undeducted construction expenditure (calculated under Subdivision 43-G of the ITAA 1997) is not affected by the period that capital works deductions are not available to the Tax Exempt Entity.

Detailed reasoning

Where ownership of the building changes, the right to claim any undeducted construction expenditure for capital works passes to the new owner.

Subdivision 43-G of the ITAA 1997 explains how to calculate the undeducted construction expenditure. For capital works constructed after 26 February 1992, the undeducted construction expenditure is calculated under sections 43-230 and 43-235 of the ITAA 1997. Broadly, the undeducted construction expenditure is the original construction expenditure less the aggregate of amounts calculated at the rate of 2.5% per annum of that expenditure, from the time the capital works, or a part of it, was first used by any entity for any purpose after completion of the relevant construction.

For the purpose of calculating of the undeducted construction expenditure under sections 43-230 and 43-235 of the ITAA 1997, the capital works can be used by any entity for any purpose after the relevant construction is completed and, therefore, is not affected by the period that the capital works deduction is not available to the taxpayer.

During any period that the property was not used for a taxable purpose no capital works deduction is available to the taxpayer under section 43-10. The deduction for those periods will be forgone or lost. However, this period does not affect the taxpayer's calculation of the undeducted construction expenditure amount under sections 43-230 and 43-235 of the ITAA 1997.

In this case, although no capital works deductions will be available to the Tax Exempt Entity during the period it holds the building, this period will not affect the trustee of the Unit Trust’s calculation of the undeducted construction expenditure. The trustee of the Unit Trust will calculate the undeducted construction expenditure amount, calculated under Subdivision 43- G of the ITAA 1997, as having been written off during this period.

Question 3

Summary

To the extent the expenditure on the building qualifies as construction expenditure for the purposes of section 43-70 or to the extent the expenditure is otherwise deductible under Division 40 of the ITAA 1997, the trustee of the Unit Trust is entitled to claim deductions under Division 43 or 40 of the ITAA 1997 from the date it acquires the building if the trustee of the Unit Trust uses the building for deriving assessable income from the date it acquires the building, being the date of settlement.

Detailed reasoning

Division 43 of the ITAA 1997

Section 43-110 of the ITAA 1997 provides that that a capital works deduction is only available under Division 43 if the taxpayer is the owner, quasi-owner or lessee of a construction expenditure area of capital works. The taxpayer must use that area in a deductible way for the purposes of section 43-140 – which includes using the area for the purposes of producing assessable income.

In this case, to the extent Division 43 of the ITAA 1997 applies in respect of the acquisition of the building, if the trustee of the Unit Trust is only entitled to commence using the building from the date of settlement, and commences to do so from that date, they will be entitled to capital works deductions pursuant to Division 43 of the ITAA 1997 from the date of settlement of the sale contract (being the date when the building’s ownership is transferred from the vendor to the purchaser).

Division 40 of the ITAA 1997

Section 40-25 of the ITAA 1997 allows a deduction for the decline in value (depreciation) of a depreciating asset you hold, to the extent the asset is used for a taxable purpose.

Section 40-40 of the ITAA 1997 determines who holds a depreciating asset. Usually, the owner of a depreciating asset holds the asset for the purposes of Division 40 of the ITAA 1997.

Section 40-60 of the ITAA 1997 identifies the time at which an asset starts to decline in value, being the time from when a taxpayer who has acquired a depreciating asset will be able to begin claiming deductions under section 40-25 of the ITAA 1997 with respect to that asset. Broadly, this is the time that the taxpayer first uses the asset, or has it installed ready for use, for any purpose.

However, subsection 40-25(2) of the ITAA 1997 requires a taxpayer to reduce the deduction otherwise allowed under subsection 40-25(1) by any part of the asset's decline in value attributable to the taxpayer's use of the asset (or having it installed ready for use) for a purpose other than a taxable purpose – ordinarily, an income producing purpose.

In this case, to the extent Division 40 of the ITAA 1997 applies in respect of the acquisition of the building, if the trustee of the Unit Trust is only entitled to commence using the building from the date of settlement, and commences to do so from that date, their entitlement to decline in value deductions pursuant to Division 40 of the ITAA 1997 commences from the date of settlement of the sale contract.

Question 4

Summary

Division 40 of the ITAA 1997 is modified by Division 58 of the ITAA 1997 due to the trustee of the Unit Trust acquiring the building from the Tax Exempt Entity.

Detailed reasoning

Division 58 of the ITAA 1997 sets out special rules that apply in calculating deductions for the decline in value of depreciating assets and balancing adjustments for assets previously owned by an exempt entity.

Division 58 of the ITAA 1997 does not have any application to the Division 43 of the ITAA 1997 capital works deduction base.

However, in relation to Division 40 of the ITAA 1997 depreciating assets, Division 58 of the ITAA 1997 sets out special rules that apply in calculating deductions for the decline in value of depreciating assets and balancing adjustments for assets previously owned by an exempt entity if the assets continued to be owned by that entity after the entity becomes taxable (entity sale situation: subsection 58-5(2)) or are acquired from that entity, in connection with the acquisition of a business, by a purchaser that is a taxable entity (asset sale situation: subsection 58-5(4)).

Relevantly, subsection 58-5(4) of the ITAA 1997 states that:

The second (an asset sale situation ) is where:

(a) at a particular time on or after 1 July 2001, an entity (the purchaser ) whose *ordinary income or statutory income is to any extent assessable acquires a *depreciating asset from the Commonwealth, a State, a Territory or an *exempt entity; and

(b) the asset is acquired in connection with the acquisition of a *business from the Commonwealth, the State, the Territory or the exempt entity.

For Division 58 of the ITAA 1997 to have application under ‘the second (an asset sale situation)’, the asset must have been acquired in connection with the acquisition of a business from the exempt entity. Consequently, sales of assets by an exempt entity, that are unconnected with the sale of a business as described in section 58-10 of the ITAA 1997, do not trigger Division 58 of the ITAA 1997 for the purchaser.

Section 58-10 sets out the circumstances when an asset is acquired in connection with the acquisition of a business:

a) The depreciating asset was used by the tax exempt vendor in carrying on a business and that asset is used by the purchaser or another person to carry on that business - paragraph 58-10(1)(a) of the ITAA 1997. This covers the situation where the purchaser uses the depreciating asset acquired from the tax exempt vendor solely to derive assessable income from the provision of office or residential accommodation where the asset has been used by the tax exempt vendor in carrying on the business of providing office or residential accommodation - subsection 58-10(3) of the ITAA 1997.

b) The depreciating asset was used by the tax exempt vendor in performing functions, or engaging in activities, that did not constitute the carrying on of a business and that asset is used by the purchaser or another person in performing those functions or engaging in those activities as part of the carrying on of a business - paragraph 58-10(2)(a) of the ITAA 1997.

c) The acquisition of the depreciating asset is connected with acquisition of another asset by the purchaser or another person giving them the right or imposing on them the obligation to perform functions or engage in activities as part of carrying on of business or confers on them a commercial advantage or opportunity in connection with the carrying on of a business - paragraph 58-10(2)(b) of the ITAA 1997.

d) The asset is acquired under an arrangement in which the purchaser or another person acquires another asset from the tax exempt vendor or its associate and the other asset is taken to be acquired in connection with the acquisition of a business for the purposes of paragraph 58-10(1)(a), paragraph 58-10(2)(a) or paragraph 58-10(2)(b) of the ITAA 1997. This applies if the other asset is not a depreciating asset, but if it were a depreciating asset it would qualify under one of those three circumstances.

The Explanatory Memorandum to the Taxation Laws Amendment Bill (No.4) 1998, the initial attempt to introduce Division 58 of the ITAA 199, explains the circumstances in which acquisitions from exempt entities would affect the scope of depreciation deductions. Notwithstanding the repeal of section 58-150 pursuant to the New Business Tax System (Capital Allowances – Transitional and Consequential) Bill 2001 and substitution with the new streamlined Division 58 of the ITAA 1997, the explanation in that EM remains relevant for the purposes of current section 58-10 of the ITAA 1997:

Meaning of acquisition of unit in connection with the acquisition of a business

3.92 New subsection 58-150(2) outlines a range of circumstances in which the acquisition of ownership or quasi-ownership of a unit of plant from an exempt entity is taken to be acquired in connection with the acquisition of a business from an exempt entity for the purposes of new paragraph 58-150(1)(b).

3.93 New paragraph 58-150(2)(a)covers situations where the unit was used by the exempt entity in the course of carrying on a business and the unit is then used by the purchaser or other person in the business acquired from the exempt entity.

Example

A private company purchases a printing business operated by an exempt government agency. The sale included the acquisition of units of plant such as printing presses. The company uses the printing presses in carrying on the printing business. The units would be taken to be acquired in connection with the acquisition of a business.

3.94 New paragraph 58-150(2)(b)covers situations where the exempt entity does not carry on a business but performs functions in a business like way and the purchaser or another person continues to perform those functions in a carrying on a business

Example

A hospital owned and operated by an exempt Government body is sold to a privately owned company. The sale includes units of plant. The company then operates the hospital as a business using the units of plant. Units of plant acquired by the company would be taken to be acquired in connection with the acquisition of a business.

3.95 New paragraph 58-150(2)(c)applies in situations where the acquisition of the unit by the purchaser is connected with the acquisition of another asset by the purchaser or another person, in the nature of a collateral advantage. Such an advantage or right would normally come within the definition of asset under Part IIIA of the ITAA 1936.

3.96 For new paragraph 58-150(2)(c)to apply, the other asset must also give the purchaser or other person rights or impose an obligation to perform functions or engage in activities as part of carrying on a business or confer a commercial advantage or opportunity in connection with performing functions or engaging in activities as part of carrying on a business [new subparagraph 58-150(2)(c)(ii)].

3.97 Under new subparagraph 58-150(2)(c)(iii)it is also necessary that the unit be used by the purchaser or other person in performing particular functions or business activities flowing from the ownership of the other asset.

Example

An exempt State Government body operates a bus service in an inner city area. It sells off 100 buses surplus to its requirements to a taxable purchaser on terms including that the purchaser will be issued with a licence by that State Government to exclusively operate a bus service in a defined outer suburban area. The State Government issues the exclusive licence to the purchaser.

In terms of new paragraph 58-150(2)(c), the purchase of the plant (buses) is connected with the acquisition of another asset, being an exclusive licence to run a particular bus service. That other asset enables the purchaser to engage in activities as part of carrying on a business. The particular units of plant (buses) are used by the purchaser in carrying out those business activities. The units of plant would be taken to be acquired in connection with the acquisition of a business

3.98 New paragraph 58-150(2)(d)would apply in circumstances where there is no direct connection between the acquisition of a unit and the obtaining of an immediate collateral advantage or other „CGT asset‟ but there is an arrangement under which the purchaser or other person will obtain another unit of plant or other „CGT asset‟ in such a way that the acquisition of the other asset falls within new paragraph 58-150(2)(a), (b) or (c).

Example

Under an arrangement between an exempt entity and a purchaser, the assets (including plant) of a business conducted by the exempt entity are sold to a purchaser by way of separate sale agreements staggered over a 4 year period. At the end of the 4 year period, the purchaser has effectively acquired the whole of the business previously carried on by the exempt entity.

In these circumstances, paragraph 58-10(2)(b) of the ITAA 1997 would apply to affect the amount of the decline in value of depreciating assets the taxpayer will be eligible to deduct.

The acquisition of the depreciating asset is connected with acquisition of another asset (being the right to possession granted under the long term lease) by the taxpayer giving them the right to perform functions or engage in activities as part of carrying on of business or confers on them a commercial advantage or opportunity in connection with the carrying on of a business.