Edited version of private ruling

Authorisation Number: 1011325938868

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Assessable income

Question 1

Will the Deferred Delivery Fee be assessable to Company A (as head company of the Company A consolidated group) as an amount of ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. The Deferred Delivery Fee will be assessable to Company A as an amount of ordinary income under section 6-5 of the ITAA 1997.

Question 2

Will the rents derived by Company A under the lease be assessable to Company A (as head company of the Company A consolidated group) as amounts of ordinary income under section 6-5 of the ITAA 1997?

Answer

Yes. The rents derived by Company A under the lease will be assessable to Company A as amounts of ordinary income under section 6-5 of the ITAA 1997.

Question 3

If Company A acquires the Asset and leases it to Company B on or prior to 30 June 2010, then will Company A (as head company of the Company A consolidated group) be entitled to deduct an amount under section 40-25 of the ITAA 1997 equal to the decline in value of the Asset for the income years ending 30 June 2010, 30 June 2011 and 30 June 2012?

Answer

Yes. As Company A acquired the Asset on or prior to 30 June 2010, then Company A will be entitled to deduct an amount under section 40-25 of the ITAA 1997 equal to the decline in value of the Asset for the income years ending 30 June 2010, 30 June 2011 and 30 June 2012.

Question 4

If Company A acquires the Asset and leases it to Company B on or prior to 30 June 2010, then will Company A (as head company of the Company A consolidated group) be entitled to a deduction under sections 41-10 and 41-15 of the ITAA 1997 (at 30%) in relation to its expenditure on the Asset for the income year ended 30 June 2010.

Answer

Yes. As Company A acquired the Asset and leased it to Company B on or prior to 30 June 2010, then Company A will be entitled to a deduction under sections 41-10 and 41-15 of the ITAA 1997 (at 30%) in relation to its expenditure on the Asset for the income year ended 30 June 2010.

Question 5

Will Division 250 of the ITAA 1997 apply to Company A in relation to its acquisition and leasing of the Asset to Company B?

Answer

No. Division 250 of the ITAA 1997 will not apply to Company A in relation to its acquisition and leasing of the Asset to Company B.

This ruling applies for the following periods:

Year ending 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

Relevant facts and circumstances

Company A is the head company of the Company A tax consolidated group (Company A group).

Company B is a subsidiary of the Company F tax consolidated group (Company F group).

Company F and Company G are members of the Company F group and are Australian incorporated and resident companies.

Company A entered into a sale and leaseback arrangement with Company B whereby Company A would:

· acquire the Asset from Company B (immediately upon Company B's acquisition of the Asset from the Manufacturer); and

· lease the Asset to Company B for a two year period.

The Asset purchase arrangements

Company B has entered into an Asset purchase agreement (Supplier's Agreement) to acquire the Asset from the Manufacturer. The Supplier's Agreement was amended by subsequent amendment agreements.

According to the Supplier's Agreement, in consideration of the Manufacturer's obligations to manufacture, sell and deliver the Asset, Company B is required to pay to the Manufacturer the purchase price in the following way:

(i) the first payment due upon Company B's execution of the Supplier's Agreement;

(ii) the second payment due at the First Delivery Time (this took place in the year ended 30 June 2010);

(iii) the balance of the purchase price is due at the Delivery Time;

(iv) the balance owing at Delivery Time for executed Change Orders; and

(v) the balance owing at Delivery Time for any additional Change Orders as may have been agreed to from time to time between the parties for buyer selected options and changes.

Under the Supplier's Agreement:

· In the 2009-10 income year, the Manufacturer completed and presented the unfinished Asset for inspection and acceptance. The unfinished Asset is essentially the base or shell Asset without a series of further fit outs (including the specific fit outs ordered by Company B).

· From the above date to the date of actual delivery of the Asset (the Pre-Delivery Period), the unfinished Asset will remain in the possession of the Manufacturer.

· During the Pre-Delivery Period, the Manufacturer will complete the fit out of the Asset and conduct the testing of the Asset for certification purposes.

· The Asset shall be ready for Company B's inspection and acceptance within 30 days of the Scheduled Delivery Date. Following Company B's inspection, delivery, transfer of possession of and title to the Asset shall occur at the Manufacturer's facility (the Delivery Location).

In 2008-09 income year, Company A entered into an agreement to acquire the Asset from Company B (Purchase Agreement). Under the Purchase Agreement:

· The purchase price to be paid by Company A to Company B for the Asset is set out as follows:

An amount in Australian Dollars equal to the Lesser of:

1 the sum of each Purchase Price Instalment; and

2 the Purchase Price Limit

· The purchase price instalment is defined to mean:

1 in respect of the First Payment Date, the amount requested by the Vendor; and

2 in respect of the Second Payment Date, the amount requested by the Vendor.

· The purchase price is limited to an agreed amount.

· During the 2009-10 income year, Company B became the owner of the legal and beneficial title to the unfinished Asset. Also on the same date, Company A paid the first instalment amount to the Manufacturer and was conveyed legal and beneficial title to the unfinished Asset.

· During the Pre-Delivery Period, Company B is required to pay Company A monthly amounts referred to as the Deferred Delivery Fees (see the Purchase Agreement). The Deferred Delivery Fees represent monthly fees or amounts payable by Company B in compensation for the fact that although Company A has legal title in the unfinished Asset, Company A is not able to lease the Asset to Company B (and therefore is not able to derive rental income) in this period.

· On the Second Payment Date, Company A will receive legal title to the Asset.

Company A has provided/will provide all the funds for the acquisition of the Asset from Company A's pool of working capital.

The lease of the Asset

On the same day that the Purchase Agreement was executed, a lease agreement was entered into between Company A (as Lessor), Company B (as Lessee), Company F and Company G (Lease Agreement).

There is no purchase option within the lease agreement at any time.

The Asset is to be used by the Company F group. The Asset will also be made available for the provision of services to third parties at a commercial rate. The provision of the Asset to third parties will not involve any further sub-lease, licence or the granting of any rights to use or operate the Asset.

During the period of the lease, the Asset will be stored and maintained in Australia.

Under the Lease Agreement:

· The lease term will be for a period of two years from the date that Company A takes full title in the Asset on the Delivery Time.

· The market value of the Asset at the end of the lease term has been assessed by Company A's asset valuation specialists (the Residual Value).

· Company B must pay monthly rentals over the two year lease term.

· On expiry of the lease term, Company B is required to return the Asset to Company A at which time Company A will endeavour to sell the Asset. Neither Company B nor any member of the Company F group (or any connected entity) will have any right or obligation to purchase the Asset from Company A.

· Both Company F and Company G have guaranteed Company B's obligations. As well as these guarantees, Company A as the Lessor, also has the benefit of:

- a personal guarantee;

- fixed and floating charges; and

- a standby letter of credit.

· Company B will enter into a services and management agreement with Company G.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 40-25,

Income Tax Assessment Act 1997 Section 40-40,

Income Tax Assessment Act 1997 Section 41-1,

Income Tax Assessment Act 1997 Section 41-10,

Income Tax Assessment Act 1997 Subsection 41-20(1), and

Income Tax Assessment Act 1997 Division 250.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA of the ITAA 1936 applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA of the ITAA 1936 may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Questions 1 & 2

Division 6 of the ITAA 1997 deals with assessable income and exempt income. Section 6-5 of Division 6 of the ITAA 1997 states:

6-5(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

…

6-5(2) If you are an Australian resident, your assessable income includes the *ordinary income you *derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

…

Therefore, assessable income includes ordinary income that is derived directly or indirectly from all sources during the income year.

Lease payments

The Lease Agreement requires Company B (as Lessee) to pay rent to Company A (as Lessor) in regular payments.

The rent and termination values are provided in a schedule to the Lease Agreement. According to this schedule a monthly payment is payable by Company B to Company A during the lease period.

Taxation Ruling TR 2006/13, which deals with the income tax implications of sale and leaseback arrangements, states at paragraph 15:

Normally a lessor would return income from a lease, including a lease that forms part of a sale and leaseback, by returning the lease payments as assessable income and deducting from that income the deductions for decline in value and any other deductions.

As mentioned earlier, assessable income includes income under ordinary concepts, which is called ordinary income. Broadly, ordinary income includes receipts that are earned, are expected, are relied upon and may have an element of periodicity, recurrence or regularity.

Under the Lease Agreement, rent accrues daily and is payable on the Rent Payment date which occurs monthly. In this case, the payments from Company B to Company A are a return from leasing the Asset to Company B and will be regular and expected by Company A. Plainly, the payment from Company B to Company A is ordinary income and thus is included in Company A's assessable income under section 6-5 of the ITAA 1997.

Deferred Delivery Fee

The Purchase Agreement outlines the terms which Company A (as Purchaser) will acquire the Asset from Company B (as Vendor). The Purchase Agreement sets out Company B's obligations in relation to making payments to Company A during the Pre-Delivery Period. This payment obligation is referred to as the Deferred Delivery Fee and has been described by the applicant as compensation for the fact that although Company A has legal title in the unfinished Asset, Company A will not be able to lease the Asset to Company B (and therefore is not able to derive rental income) during the Pre-Delivery Period.

As Company B will pay to Company A the Deferred Delivery Fee monthly in arrears, the Deferred Delivery Fee meets the concept of ordinary income and is thus included in Company A's assessable income under section 6-5 of the ITAA 1997.

Question 3

Generally, section 40-25 of the ITAA 1997 allows the holder of a depreciating asset an annual deduction for the decline in value of the asset.

To determine whether Company A is entitled to a deduction under section 40-25 of the ITAA 1997 for the decline in value of the Asset, Company A must satisfy the following three requirements:

1. the asset must satisfy the definition of the term 'depreciating assets' under section 40-30 of the ITAA 1997;

2. Company A must be the holder of the depreciating asset under an item of the table in section 40-40 of the ITAA 1997; and

3. to the extent the asset is used for a purpose other than a taxable purpose, Company A is required to reduce the deduction pursuant to subsection 40-25(2) of the ITAA 1997.

Does the Asset satisfy the definition of the term 'depreciating asset' under section 40-30 of the ITAA 1997?

A depreciating asset is defined in subsection 40-30(1) of the ITAA 1997 to be an asset that has a limited effective life and that can reasonably be expected to decline in value over the time it is used.

The Asset will have a limited effective life and is reasonably expected to decline in value over the time it is used. Therefore, the Asset satisfies the definition of the term 'depreciating asset' under section 40-30 of the ITAA 1997.

Is Company A the holder of the Asset under an item of the table in section 40-40 of the ITAA 1997?

In order to be the holder of the Asset, Company A must be identified in column 3 of the table in section 40-40 of the ITAA 1997 as the entity holding the asset under one of the items in the table.

Item 10 of the table in section 40-40 of the ITAA 1997 provides that the holder of any depreciating asset is the owner, or the legal owner if there is both a legal and equitable owner.

On the facts of this case, full and absolute legal and beneficial ownership of the Asset will vest in Company A on the Delivery Time pursuant to the Purchase Agreement. Also, the Lease Agreement acknowledges Company A's legal ownership of the Asset under the lease. However, under the Lease Agreement, Company A will have equitable ownership of the Asset as it has the right to possess and use the Asset exclusively during the term of the lease.

Accordingly, as Company A will be the legal owner and Company B will be the equitable owner of the Asset, Company A will be the holder of the Asset under item 10 of the table in section 40-40 of the ITAA 1997.

This conclusion corresponds with TR 2006/13 concerning sale and leaseback arrangements. Paragraph 12 of TR 2006/13 provides that when the lessor in a sale and leaseback is the legal owner of the asset, they hold the depreciating asset according to item 10 of the table in section 40-40 of the ITAA 1997 and is the entity entitled to a deduction for the decline in value of the asset.

Does any use of the Asset constitute a use other than for a taxable purpose thus requiring a reduction under subsection 40-25(2) of the ITAA 1997 to the deduction for decline in value under subsection 40-25(1) of the ITAA 1997?

The third prerequisite of section 40-25 of the ITAA 1997 requires a consideration of whether Company A uses the depreciating asset for a purpose other than for a taxable purpose.

The combined effect of subsections 40-25(1) and (2) of the ITAA 1997 is that a taxpayer who holds a depreciating asset must work out the decline in value of that asset and then consider whether the deduction for the decline in value should be reduced having regard to any use of the asset for a purpose other than for a taxable purpose.

The meaning of 'a taxable purpose' is provided in subsection 40-25(7) of the ITAA 1997 as 'the purpose of producing assessable income; or…' In this case, Company A's use of the Asset will consist only of leasing the Asset to Company B for a period pursuant to the Lease Agreement. During this period, Company A will derive assessable income in the form of rent.

Accordingly, Company A's use of the Asset is for a taxable purpose as provided by subsection 40-25(7) of the ITAA 1997 and does not constitute a use for a purpose other than a taxable purpose.

Conclusion

Company A will be entitled to a deduction for the decline in value of the Asset under subsection 40-25(1) of the ITAA 1997. Further, there will be no reduction under subsection 40-25(2) of the ITAA 1997 to the amount of that deduction.

Question 4

Small business and general business tax break

Division 41 of the ITAA 1997 allows an additional deduction for certain new business investment in the form of an investment allowance.

Section 41-1 of the ITAA 1997 provides the general criteria for entitlement to an investment allowance:

(a) you can deduct an amount for the decline in value for the asset for the relevant year under Subdivision 40-B; and

(b) you make certain new investments in respect of the asset in the period starting on 13 December 2008 and ending on 31 December 2009; and

(c) the total of those new investments is at least $1000 (for small businesses) or $10,000 (for other businesses).

Entitlement to the investment allowance is subject to meeting the requirements set out in subsection 41-10(1) of the ITAA 1997 as follows:

(a) the asset is a depreciating asset, other than an intangible asset; and

(b) you can deduct an amount under section 40-25 in relation to the asset for the income year; and

(c) the income year is the 2008-09, 2009-10, 2010-11 or 2011-12 income year; and

(d) the total of the recognised new investment amounts for the income year in relation to the asset equals or exceeds the new investment threshold for the income year in relation to the asset.

The Asset is a depreciating asset

The investment allowance is available for tangible, depreciating assets for which a decline in value deduction can be claimed under section 40-25 of the ITAA 1997 (see paragraph 41-10(1)(a) of the ITAA 1997).

In the present circumstances, the Asset is a depreciating asset in accordance with section 40-30 of the ITAA 1997 as it is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used.

You can deduct an amount under section 40-25 of the ITAA 1997

Section 40-25 of the ITAA 1997 allows an entity to deduct from their assessable income an amount equal to the decline in value of a depreciating asset that the taxpayer held to the extent to which the entity uses it or has it installed ready for use for a taxable purpose including the purpose of producing assessable income.

As set out in question 3 above, Company A can deduct an amount equal to the decline in value of the Asset under section 40-25 of the ITAA 1997 for the income years ending 30 June 2010, 30 June 2011 and 30 June 2012.

The recognised new investment amounts for the income year equals or exceeds the new investment threshold

Pursuant to subsection 41-20(1) of the ITAA 1997, an amount is a recognised new investment amount for the income year in relation to the asset if:

(a) either:

(i) the amount is included in the first element of the asset's cost (worked out in accordance with Subdivision 40-C); or

(ii) the amount is included in the second element of the asset's cost under paragraph 40-190(2)(a); and

(b) The *investment commitment time for the amount occurs in the period:

1. starting at 12.01 am, by legal time in the Australian Capital Territory, on 12 December 2008; and

2. ending on 31 December 2009; and

(c) the *first use time for the amount occurs:

1. no later than the end of the income year; and

2. no later than 31 December 2010.

(d) At the first use time for the amount, it is reasonable to conclude that you will use the asset principally in Australia for the principal purpose of *carrying on a *business; and

(e) If the amount is included in the first element of the asset's cost - the first use time is the first time you or any other entity have used the asset, or have it installed ready for use, for any purpose; and

(f) You have not been entitled to a deduction under this Division for any previous income year in relation to the amount.

The asset's cost

Subsection 40-180(1) of the ITAA 1997 provides that the first element of an asset's cost is worked out as at the time when a taxpayer began to hold the depreciating asset and in this case, is:

…

(b) … - the amount you are taken to have paid to hold the asset under section 40-185.

Item 1 of the table in paragraph 40-185(1)(b) of the ITAA 1997 provides that the amount the entity is taken to have paid to hold a depreciating asset is the amount that the entity pays.

The cost of the Asset to Company A is set out in the Purchase Agreement and provides that the purchase price to be paid by Company A to Company B is the lesser of the sum of instalments and a purchase price limit. On the present facts of this case, there is no further amount that would form part of the second element of the Asset's cost under paragraph 40-190(2)(a) of the ITAA 1997.

Thus the new investment amount in relation to the Asset is the purchase price paid by Company A under the Purchase Agreement. Additionally, this amount exceeds the new investment threshold of $10,000 (see paragraph 41-35(b) of the ITAA 1997) as required by paragraph 41-10(1)(d) of the ITAA 1997.

The investment commitment time

Subsection 41-25(1) of the ITAA 1997 provides that the investment commitment time for the amount is:

(a) if the amount is included in the first element of the asset's cost - the time at which you:

(i) enter into a contract under which you hold the asset at that time, or will hold the asset at a later time; or

…

Company A entered into the Purchase Agreement to acquire the Asset during the 2008-09 income year. Therefore, the investment commitment time for the recognised new investment amount is this date.

First use time

Generally, to meet the requirement of paragraph 41-20(1)(e) of the ITAA 1997, the asset must not have been previously used or installed ready for use for any purpose. However, there is an exception in the case where the previous use of the asset 'was merely for the purposes of reasonable testing and trialling' (refer to subsection 41-20(3) of the ITAA 1997).

Prior to Company A receiving possession and title to the Asset, the Manufacturer will use the unfinished Asset for the purposes of conducting tests and other tests for certification purposes.

ATO Interpretative Decision ATO ID 2009/101 sets out factors that should be considered in determining whether the nature and extent of certain use exceeds use that is reasonable for testing or trialling. The factors contained in ATO ID 2009/101 are not present in this case.

The use of the Asset for certification tests constitutes use for the purposes of reasonable testing and trialling for the purposes of subsection 41-20(3) of the ITAA 1997 and is disregarded under paragraph 41-20(1)(e) of the ITAA 1997.

Company A's first use time is scheduled to begin in the 2009-10 income year when Company A acquires full legal title to the Asset, takes possession of the Asset on the Delivery Time and immediately leases the Asset to Company B. As such, this constitutes Company A's first use time.

The purpose test

To meet the requirement of paragraph 41-20(d) of the ITAA 1997, at the first use time it must be reasonable to conclude that the entity will use the asset principally in Australia for the principal purpose of carrying on a business. The words 'for the principal purpose of carrying on a business' in paragraph 41-20(1)(d) of the ITAA 1997 are known as the 'purpose test'.

The words 'you will use the asset' in the purpose test are clear and unambiguous and in this case requires consideration of Company A's use of the Asset. The arrangement contemplates Company A using the Asset for the sole purpose of carrying on its domestic business. Thus the purpose test is satisfied.

Amount of deduction

The amount that can be deducted under Division 41 of the ITAA 1997 is set out in section 41-15 of the ITAA 1997. To be eligible for a deduction of 30% of the total of the recognised new investment amounts for the income year in relation to an asset, the recognised new investment amount must meet the conditions in subsection 41-15(2) of the ITAA 1997. The requirements of subsection 41-15(2) of the ITAA 1997 are that:

(1) the *investment commitment time occurred before 1 July 2009; and

(2) the *first use time occurred before 1 July 2010.

As the investment commitment time occurred in the 2008-09 income year and the first use time will occur before 1 July 2010, Company A will satisfy both the requirements under subsection 41-15(2) of the ITAA 1997 and be entitled to a deduction of 30% of the total of the recognised new investment amounts of the Asset.

Question 5

Section 250-15 of the ITAA 1997 provides that Division 250 applies to you and an asset at a particular time if:

(a) the asset is being *put to a tax preferred use; and

(b) the *arrangement period for the *tax preferred use of the asset is greater than 12 months; and

(c) *financial benefits in relation to the tax preferred use of the asset have been, will be or can reasonably be expected to be, *provided to you (or a *connected entity) by:

(i) a *tax preferred end user (or a connected entity); or

(ii) any *tax preferred entity (or a connected entity); or

(iii) any entity that is not an Australian resident; and

(d) disregarding this Division, you would be entitled to a *capital allowance in relation to:

(i) a decline in the value of the asset; or

(ii) expenditure in relation to the asset; and

(e) you lack a *predominant economic interest in the asset at that time.

The arrangement involves the acquisition and leasing of the Asset by Company A to Company B.

The Asset will primarily be used by the Company F group. The Asset will be operated by Company B as lessee and Company G via an Asset management agreement with Company B under which Company G will provide day to day management of the Asset. Company B and Company G are Australian tax resident companies and are therefore not tax preferred end users. The Asset will be physically located in Australia and will be maintained in Australia.

A third party using the Asset will not be considered an end user for the purposes of section 250-50 of the ITAA 1997 but rather, would merely be receiving a service. None of these uses will involve any sublease, licence or the granting of rights to use or operate the Asset. On these uses it would be Company B/Company G that will continue to operate the Asset. In any case there will not be a significant number of any such third party users as the primary purpose of the Asset is for use by the Company F group.

As the Asset is not being put to a tax preferred use for the purposes of paragraph 250-15(a) of the ITAA 1997, Division 250 of the ITAA 1997 will not apply.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).