Edited version of private ruling

Authorisation Number: 1011549443759

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Ruling

Subject: Taxable Australian Real Property

Notice of private ruling

Question:

Whether the provisions of paragraph 855-20(a) of ITAA 1997 apply to an 'Agreement for Lease' (Agreement) between Company X and the registered proprietors of land (the owners) in respect of a property (the property) belonging to the owners.

Answer:

Yes. The Agreement is sufficient, for the purposes of paragraph 855-20(a) of ITAA 1997, to deem the Agreement to be a CGT asset which is taxable Australian real property under that paragraph.

This ruling applies for the following periods:

1 July 2009 to 30 June 2010

1 July 2010 to 30 June 2011

The scheme commences on:

10 January 2007

Background

Company X is a resident Australian company which is wholly owned by two foreign resident companies. Company X has several interests in the development of a resource in Australia which is held by its 100% subsidiaries.

Company X entered into an Agreement with the owners of land.

On entering into the Agreement, Company X paid the owners a Sign On Fee.

Company X, at that time, but subject to the investigations of the site's suitability for the purpose, proposed to build a structure on the land belonging to the owners.

In order to build the structure, Company X needed a lease to be entered into in relation to the property.

Prior to the structure being built, Company X wanted to ensure that they were able to obtain the necessary regulatory permissions for its viability.

Should all regulatory permissions be obtained and tests prove satisfactory (or if Company X waived any of these obligations from the need for these criteria to be satisfied), Company X had the right to enter into a lease with the owners in relation to the property. This lease was to be for a period of 25 years with the right for renewal of one further period of up to 25 years.

Attached to the Agreement (and contained as an annexure to the Agreement) was a form for a lease agreement (the Lease) that was to be entered into between Company X and the owners.

The Agreement may be assigned by Company X to another party. The effect of such assignment is that the assignee takes the rights and obligations that originally attached to Company X in relation to the Agreement, however the assignee needed to enter satisfactory covenants in relation to this.

The Agreement was assigned to a wholly owned subsidiary of Company X, Company Y at a later date. It is assumed that all of the necessary covenants have been entered into.

It would appear that the Lease has not been entered into at present.

It would appear that one of the owners of Company X is considering selling its interests in Company X to the other co-owner of Company X.

The question has arisen as to whether the disposal by the part owner of Company X of its interests in Company X gives rise to a CGT event and whether that event is, for the purposes of paragraph 855-20 of the ITAA 1997, in relation to a CGT asset which is taxable Australian real property.

Facts

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Under the Agreement, the owners have agreed to enter into a lease with Company X and Company X agreed to enter into a lease with the owners

Under the Agreement, the lease is stated as a possible future event to commence on the 'Satisfaction Date'

The 'Satisfaction Date' is a defined term and the relevant date is subject to certain events taking place, in particular the provisions of clause 3.1 being satisfied. That clause makes, inter alia, the entering into the lease subject to all relevant approvals and permissions being obtained and that the tests for the site prove satisfactory to demonstrate that a viable construction can be erected on the site. In the absence of such a successful outcome, Company X retains the right to waive such requirements.

Company X has the power, under the Agreement, to 'lodge a caveat over the Land in relation to its leasehold interest under this Deed' [emphasis added]. The owners will have access to a withdrawal of the caveat only in the event of the Agreement being terminated (and then the withdrawal can only be made 30 days after the Agreement is terminated) or there is an insolvency event (defined to mean the appointment of a receiver or liquidator to Company X, Company X entering into a deed of company arrangement or a Court order is made to wind up Company X) by Company X.

Company X may, at its discretion, terminate the agreement if the assessments made in relation to the property result in a finding that a structure on the property is not feasible. Any caveat that may be lodged by Company X in relation to the arrangement would be withdrawn. However, even if Company X terminates the arrangement, there is a right of first refusal given to Company X under the Agreement for Company X to be able to recommence activities on the property. This right will be triggered if economic conditions change or if the owners are approached by another developer. It is noted that this clause does not have any projected end date (implying that it is on-going in perpetuity). Support for the 'in perpetuity' proposition relating to the ongoing rights of Company X in relation to the property can be found in the deed.

The owners are prohibited from allowing any other party other than Company X from carrying out any investigation in relation to the resource, nor can the owners allow anyone else to install any construction or related equipment on the land. This limitation on the powers of the owners is for the term of the Agreement and for the term of any subsequent lease entered into in relation to that Agreement.

The owners are to allow Company X to have access to the property for the purposes of the Agreement. It is noted that the owners will be permitted to remain on the property for the purposes of conducting their activities, however restrictions are placed on the owners in that they can do nothing that interferes with the viability and development of the construction.

If the owners transfer their interests in the property to another who then becomes the registered proprietor of the property, the owners must notify the new owner of Company X's interests in the property under the Agreement, a copy of the Agreement and the lease are to be attached to the contract, Company X is to be notified of the transfer, the new owner is to take subject to the same rights and obligations that attach to the owners. Should either the owners or Company X seek to assign an interest under the Agreement, Company X and the owners (respectively) are to be notified and are to give their written consent to such assignment or transfer.

Company X is able to mortgage the lease and any equipment to any banks that provide finance to Company X; however no reference is made to any such right existing during the period covered by the Agreement.

A copy of the lease that is proposed to be entered into under the Agreement is attached as an annexure to the Agreement. However this does not, of itself, have any direct implications in relation to the lease of the property under that document as the inclusion of the draft lease is to put certainty into the rights that attach to the Agreement as to what is to happen, and what the terms of the document to be entered into if tests prove satisfactory and permissions are granted subsequent to, and as a result of, the parties entering into the Agreement.

Should Company X agree to proceed with the arrangement, the owners are required to enter into a lease with Company X within 10 days of receiving copies of the deed executed by Company X.

The draft lease that is incorporated as an annexure to the Agreement provides for methods of payment of rent, obligations of Company X in relation to its use of the site, compliance with legislation etc). The owners will be permitted to conduct their operations and continue to occupy the property with some limitations, these being that the activities of the owners will not interfere with the operations of Company X in relation to their construction.

Relevant legislative provisions

Income Tax Assessment Act 1997 - paragraph 855-20(a).

Reasons for decision

Detailed reasoning

The first point that needs to be made is that the inclusion of the Lease in an annexure does not, of itself, answer the question of whether a lease is in existence as at the date that the Agreement was signed. The Lease itself was not signed on the same day as the agreement. However that does not necessarily dispose of the matter on the basis that the provisions of paragraph 855-20(a) of the ITAA 1997 cannot apply if the lease document has not been executed.

The provisions of paragraph 855-20(a) of the ITAA 1997 were introduced into the ITAA 1997 by the Taxation Laws Amendment (2009 Measures No 4) Bill 2009 (the 2009 amendment). In relation to this paragraph, the Explanatory Memorandum used to introduce this amendment into the House of Representatives states:

A foreign resident is liable for CGT if the relevant CGT asset is 'taxable Australian property' (as defined). This includes real property in Australia.

The amendment puts beyond doubt that 'taxable Australian real property' in this context includes a lease over land. This accords with the intended application of the provisions when introduced.

A lease in this context would include a sublease.

The amendment applies in relation to CGT events happening on or after 20 May 2009, the date on which the amendment was first foreshadowed.

The amendment is to be disregarded for interpreting the provisions in their previous form in relation to CGT events happening before 20 May 2009. The effect of this is to ensure that no inference can be drawn from the amendment that the law operated differently before the amendment. This is important because the intention of the amendment is not to change the existing law but merely to clarify how it was always intended to apply.

[Schedule 5, items 337 and 338, paragraph 855-20(a)]

This amendment introduced the text '(including a lease of land, if the land is situated in Australia)' after the words 'real property situated in Australia'.

The Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No 4) Bill 2006 (the 2006 amendment) that introduced Division 855 of the ITAA 1997 contains the following reference to the provisions of paragraph 855-20(a) of the ITAA 1997 as first introduced:

The measure makes the following change to the CGT regime as it applies to foreign residents: it] 'narrows the range of assets which may be subject to Australian CGT to Australian real property directly held by a foreign resident and any CGT asset (other than Australian real property) used by the foreign resident at any time in carrying on a business through a permanent establishment in Australia;'

Given the changes that were introduced by the 2009 amendment to the original provisions introduced by the 2006 amendment, it is evident that the intention of the legislature was to broaden the scope of paragraph 855-20(a) of the ITAA 1997, especially in relation to CGT assets comprising real property.

An examination of the text of the Agreement shows that it is designed to ensure that Company X is given access to, and some control over, the property. While this access and control is not 'exclusive' during the Agreement period, it is substantially the same nature of access and control that is to be given to Company X under the proposed lease as annexed to the Agreement. The difference in use that is permitted of Company X under the Agreement relative to that under the Lease is merely the result of the change from preliminary investigation of the site to determine its suitability for the commercial viability of their structure on the property (as per the Agreement) to the actual construction and operation of the project (as per the proposed Lease).

It is noted, however, that the lack of 'exclusivity' only relates to the owners who are permitted to continue to operate their operations on the property. There can be no doubt that, apart from the owners, all others are to be excluded from the land where those others could have some interests that can be seen as being in competition to Company X's use of the property.

There can be no doubt that Company X intended to have some level of control or interest in the property at the time of entering into the Agreement. This control or interest is clearly, and understandably, needed in order for Company X to be able to ensure that its testing of the site for commercial viability is not interfered with and any potential competitors for the site are excluded.

This control or interest can be demonstrated through, for example, the right of Company X, at its discretion, to terminate the arrangement under the Agreement or, in reliance on the Agreement, to enter into a lease for the property. Given that the legislation uses the term 'including a lease of land' [emphasis added], the terms of the Agreement are such that, it grants Company X sufficient control over the property for the Agreement to fall within the ambit of the legislation.

The level of control possessed by Company X is also able to be demonstrated in that the Agreement does not give the owners the right to terminate the arrangement except in the event of a default by Company X

Company X's ability to transfer its interest under the Agreement to a third party and the compulsion for the owners to notify any intending purchasers of the property from them of Company X's interests in the property are further pointers to the interest that Company X has in the property.

While, as stated above, it is evident that Company X has not been given exclusive possession of the site (the owners can remain on site and continue their operations), this is not determinative of whether or not Company X has the appropriate level of interest in the property. What is relevant is the interest that Company X has in relation to the property.

There can be no doubt that the interest and control that Company X possesses under the Agreement is generally indistinguishable from that interest and control that Company X could expect to have under the Lease, once executed.

An examination of the arrangement is sufficient to allow the view to be formed that the Agreement is, in effect, in the nature of a lease or, at least, an arrangement in favour of Company X which cannot be renounced by the owners, where this arrangement allows for Company X, at its own option, to enter into a lease with the owners over the property.

Given that the legislation is intended to expand the meaning of what constitutes 'taxable Australian property', and in doing so uses the term 'including', it would be reasonable to draw the conclusion that the important issue is the interest that is possessed by a party in real property that is situated in Australia, with the entering into of a lease being one of the methods by which this can be achieved (i.e., the use of the word 'including' in the legislation).

It is noted that Company X is permitted to lodge a caveat on the property, thereby registering its interest in the property. The lodging of such a caveat would have the effect of preventing any interests being entered into which are adverse to those of Company X. The ability to lodge a caveat on the property for Company X to protect its interest in the property is indicative of the interest in, and control of, the property that Company X intends the Agreement to give to it.

Further note should be made to the fact that, in relation to the intent of the parties at the time that the Agreement was entered into, the Agreement uses the words 'its leasehold interest under this Deed'. However this can be countered with the subsequent use of the phrase 'during the term of this Deed and the Lease'.

This, of itself, is not determinative of whether or not the Agreement can be properly classified as a lease which, as a result, falls for consideration under paragraph 855-20(a) of the ITAA 1997. However, when the document is considered in the light of all of the other provisions that are contained in the Agreement, the intention of the parties could be stated as being such that Company X and the owners clearly intended for Company X to have an interest in that property. This interest would appear to be greater than someone with a licence in relation to the property would have and is such that this interest is at least in the nature of a lease. This, of itself, is sufficient to bring the Agreement within the operation of the provisions of paragraph 855-20(a) of the ITAA 1997.

However the facts of this matter are such that the Agreement could properly be regarded as being a lease in its own right. It might also be stated that the provisions in the Agreement that provide for Company X and the owners to enter into a lease at the option of Company X is indicative of the level of control that Company X has in relation to the property. This is in addition to the rights that are given to Company X under the Agreement.

The Commissioner, on the basis of the information available, asserts that the Agreement is such that it would qualify as being one that falls within the provisions of paragraph 855-20(a) of the ITAA 1997. As a result, the land in question is a CGT asset which is taxable Australian property because:

(a) the land that is the subject of the arrangement under consideration is property situated in Australia, and

(b) either the Agreement is a lease, or

(c) the provisions of paragraph 855-20(a) of the ITAA 1997, in using the term 'including a lease', is sufficiently wide enough to encompass a document in the nature of the Agreement.

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