Edited version of your private ruling

Authorisation Number: 1012432723890

Ruling

Subject: Capital Allowance deductions under Division 43

Question

Will Company A be entitled to claim capital allowance deductions under Division 43 in respect of capital works expenditure incurred by Company B?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commences on:

1 July 20YY

Relevant facts and circumstances

1. Company B carries on a business on land it owns.

2. Company B carried out capital works at its own cost on land adjacent to its land which is owned by a tax exempt Australian Government Agency ("AGA").

3. The capital works involved excavation of the land owned by the AGA.

4. The capital works have been used by Company B for the purpose of producing assessable income.

5. Company B was granted a non-exclusive licence (the "Licence") by the AGA to access and use the land owned by the AGA prior to Company B carrying out the capital works on the land.

6. The Licence permitted Company B to carry out the capital works.

7. Licence fees have been continuously paid by Company B to the AGA in respect of the Licence.

8. Company B is currently claiming capital works deductions under Division 43 in respect of the capital works expenditure.

9. Company B proposes to lease its land and business to Company A.

10. Company B also proposes to assign its rights under the Licence to Company A.

11. The terms of the Licence contemplate the assignment by Company B of the right to carry out capital works on the land owned by the AGA.

Assumptions

· The capital works have a construction expenditure area in accordance with paragraph 43-10(2)(a); and

· There is a pool of construction expenditure for that area under section 43-10(2)(b).

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 Section 43-10

Income Tax Assessment Act 1997 Paragraph 43-10(2)(a)

Income Tax Assessment Act 1997 Paragraph 43-10(2)(b)

Income Tax Assessment Act 1997 Paragraph 43-10(2)(c)

Income Tax Assessment Act 1997 Section 43-75

Income Tax Assessment Act 1997 Section 43-85

Income Tax Assessment Act 1997 Section 43-115

Income Tax Assessment Act 1997 Section 43-120

Income Tax Assessment Act 1997 Subsection 43-120(1)

Income Tax Assessment Act 1997 Subsection 43-120(2)

Income Tax Assessment Act 1997 Paragraph 43-120(2)(a)

Income Tax Assessment Act 1997 Paragraph 43-120(2)(b)

Income Tax Assessment Act 1997 Paragraph 43-120(2)(c)

Income Tax Assessment Act 1997 Subsection 43-120(3)

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1936 Former subsection 54AA(8)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997, unless otherwise stated.

Law

Division 43 explains how to calculate deductions for capital expenditure on the constructions of capital works.

Section 43-10 provides:

(2) You can only deduct the amount if:

(a) the capital works have a ^*construction expenditure area; and

(b) there is a ^*pool of construction expenditure for that area; and

(c) you use ^*your area in the income year in the way set out in Table 43-140 (Current year use)."

The "construction expenditure area" for capital works started after 30 June 1997 is that part of capital works on which "construction expenditure" has been incurred by an entity that, at that time, was to own or lease the capital works, or hold them as a quasi-owner (section 43-75).

A "pool of construction expenditure" is so much of the "construction expenditure" incurred by an entity on capital works as can be attributed to the "construction expenditure area" relating to those capital works (section 43-85).

For construction expenditure incurred after 30 June 1997, the "use" condition listed in column 3 of the "Time Period 1" row of the table in section 43-140 needs to be satisfied, ie:

"You use you area for the purpose of:

(a) producing assessable income; or

(b) Conducting R&D activities."

Section 43-115 states:

"(1)Your area is the part of the construction area that you own.

(2) Your construction expenditure is the portion of the pool of construction expenditure that is attributable to your area."

Section 43-120 extends the reach of Division 43 beyond owners of capital works to lessees and quasi-ownership right holders in certain circumstances. Also, a lessee or quasi-owner can claim a deduction for capital expenditure incurred by an earlier lessee or quasi owner if certain conditions are satisfied.

43-120(1)

Your area is the part of the ^*construction expenditure area that you lease, or hold under a ^*quasi-ownership right over land granted by an ^*exempt Australian government agency or an ^*exempt foreign government agency, and that:

(a)  is attributable to a ^*pool of construction expenditure that you incurred; and

(b)  You have continuously leased or held since the construction was completed.

Earlier lessees' or holders' expenditure

Your area is the part of the ^*construction expenditure area that you lease, or hold under a ^*quasi-ownership right over land granted by an ^*exempt Australian government agency or an ^*exempt foreign government agency, and that:

(a)  is attributable to a ^*pool of construction expenditure incurred by another lessee or holder of a quasi-ownership right over land; and

(b)  Has been continuously leased or held since the construction was completed by the lessee or holder who incurred the expenditure or an assignee of that lessee's lease or that holder's quasi-ownership right over land.

Your construction expenditure is the portion of the ^*pool of construction expenditure that is attributable to your area.

The term "quasi-ownership right" over land is defined in section 995-1 to mean:

(a) a lease of land; or

(b) an easement in connection with the land; or

(c) any other right, power or privilege over the land, or in connection with the land.

Application of law to facts

As the applicant has asked the Commissioner to assume that the capital works carried out by Company B satisfies sections 43-10(2)(a) and 43-10(2)(b), the central issue in determining Company A's entitlement to the Division 43 deductions is whether paragraph 43-10(2)(c) will be satisfied.

Paragraph 43-10(2)(c) states that you can only deduct an amount for capital works if "you use your area in the income year in the way set out in Table 43-140…". It can be seen that paragraph 43-10(2)(c) requires two conditions to be satisfied, namely the "use" condition and the "your area" condition. Thus, two questions need to be considered in determining Company A's entitlement to the Division 43 deductions. They are:

1. whether the construction expenditure area will be used by Company A in a way set out in the table in section 43-140, ie for the purpose of producing assessable income; and

2. whether the construction expenditure area will be Company A's area. As Company B, rather than Company A, carried out the capital works expenditure, Company A will need to satisfy the conditions contained in section 43-120(2)(a) and (b). That is, Company A will need to satisfy that the construction expenditure area granted to it by Company B:

(a) is attributable to a pool of construction expenditure incurred by another holder

of a quasi-ownership right over land (paragraph 43-120(2)(a)); and

(b) has been continuously held since the excavation was carried out by the holder

who incurred the pool of construction expenditure or an assignee of that holder's quasi-ownership right over land (paragraph 43-120(2)(b)).

These questions are considered below:

1. Whether the construction expenditure area will be used by Company A for the purpose of producing assessable income

Company A will use the construction expenditure area for the purpose of producing assessable income as it will lease Company B's business.

2. Whether the construction expenditure area is Company A's area

(a) Paragraph 43-120(2)(a) - Expenditure incurred by another holder of a quasi-ownership right

(i) Quasi-ownership right of another holder

A quasi-ownership right over land is defined in subsection 995-1(1) as meaning:

· a lease of the land; or

· an easement in connection with the land; or

· any other right, power or privilege over the land, or in connection with the land.

The Joint Explanatory Memorandum to the Income Tax Assessment Bill 1996 at page 165 states that the term "quasi-ownership right" was inserted to describe the rights over land that were previously covered by the definition of Crown lease in former section 54AA of ITAA 1936. The term was introduced so that "Crown lease" could have its ordinary meaning, rather than an extended artificial meaning.

Crown lease as defined in the former subsection 54AA(8) extended the ordinary meaning of the term beyond a lease granted by the Crown. It meant:

· a lease of land;

· an easement in connection with land; or

· any other right, power or privilege over or in connection with land;

where the lease, easement, right, power or privilege was granted by an eligible government body.

The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 1992 which introduced the extended meaning of Crown Lease provided the following explanation:-

[New definition of "Crown lease" to replace existing definition in subsection 54AA(8)].

This new definition does not require leases to be granted under a relevant statute and so ordinary commercial leases are now covered. Further, it extends beyond leases and now covers easements and other rights, powers or privileges over or in connection with land (such as licences and "rights of way").

Also covered are "sub-interests" in land such as sub-leases and licences in relation to easements. For instance, a Commonwealth authority may hold a lease of land granted by a State and a sub-lease of that land granted by the authority would constitute a Crown lease.

Similarly, a State authority may hold an easement over private lands for the purposes of installing water or gas pipes. A licence or other right in relation to that easement granted by the authority will again constitute a Crown lease.

This definition of a quasi-ownership right in subsection 995-1(1) is, and as shown by following the history of the provision intended to be interpreted as, an extremely broad definition. For example, an entity with an easement or licence to occupy would clearly have a 'right, power or privilege over the land or in connection with the land' and they would therefore meet the criteria of holding a quasi-ownership right over land.

In this case, Company B was granted the right to carry out the capital works by the AGA, the freehold title holder of the land. The AGA had the capacity to grant this right to Company B as it is connected with its rights over the land. If it were not for the right to carry out the capital works granted by the AGA under the Licence, the AGA would have an action in trespass against Company B if it accessed the land. It is only by virtue of owning the land that the AGA is able to grant the right to carry out the capital works. The right granted by the AGA can therefore be clearly seen as providing a 'right, power or privilege in connection with the land'.

Consequently, the right to carry out the capital works held by Company B qualifies as a quasi-ownership right over land as defined in subsection 995-1(1).

(ii) Expenditure incurred by another holder of a quasi-ownership right

The right granted to Company B under the Licence constitutes a quasi-ownership right over land granted by an exempt Australian government agency. The capital works expenditure incurred by Company B was carried out under the quasi-ownership right over land. Accordingly, paragraph 43-120(2)(a) will be satisfied.

(b) Paragraph 43-120(2)(b) - Continuously held by assignee

The right to carry out the capital works assigned to Company A must be the right held by Company B when it undertook the capital works, ie the right which was defined in the Licence.

The Licence has been continuously held by Company B and fees have been continuously paid by Company B to the AGA in respect of the Licence.

However, assignment of the rights under the Licence to Company A raises two issues which need to be determined to ensure that the right to carry out capital works will continue to be continuously held after the proposed transaction. They are:

1. can the Licence be assigned?; and

2. if the Licence can be assigned, will the assignment result in a novation of the rights held by Company B?

In Torkington V Magee [1902] 2 KB 247 Channell J, at page 430, defined a "chose in action" as:

"… a known expression used to describe all personal rights of property which can only be claimed or enforced by action, and not by taking physical possession."¹

The right granted under the Licence clearly constitutes a legal chose in action.

In Pacific Brands Sport and Leisure Pty Ltd v Underworks Pty Ltd (2006) 230 ALR 56 (the "Pacific Brands case") Finn and Sundberg JJ said at page 67:

"In consequence, we consider that the proper approach to be taken is that (i) all of a party's contractual rights, being parts of a chose in action, have a proprietary character for assignment purposes and are prima facie assignable but (ii) whether in a given case they or some of them are unassignable will depend upon whether there is a reason which nonetheless precludes assignment. Apart from some prohibitions, created by statute or public policy, the most common such reason will be a contractual prohibition on assignment …"

In the same case, Emmett J said at page 97:

"Rights arising under ordinary commercial contracts are prima facie readily assignable (Chitty, 2004, para 19-055). However, if rights arising under a contract are declared by the contract to be incapable of assignment, a purported assignment by one contracting party will be invalid as against the other contracting party. …"

Although the right under the Licence is a contractual right and is not in the nature of a grant of an interest in land, it is clear (having regard to the Pacific Brands case) that it should be regarded as having a proprietary character for assignment purposes.

The terms of the Licence clearly contemplated assignment of the right to carry out capital works on land owned by the AGA. As such, the Licence can be assigned at law.

When Company B transfers its right under the Licence to Company A, there will be an "assignment" of the quasi-ownership right over land (being the right to carry out the capital works) and Company A will be the "assignee" of that right.

In ALH Group Property Holdings Pty Limited v Chief Commissioner of State Revenue [2012] HCA 6 the majority of the judged of the High Court said at para 12:

"A novation, in its simplest form, refers to a circumstance where a new contract takes the place of an old contract … It is not correct to describe novation as involving the succession of a third party to the rights of the purchaser under the original contract. Under the common law such a description comes closer to the effect of a transfer of rights by way of assignment. Nor is it correct to describe a third party undertaking the obligations of the purchaser under the original contract as a novation. The effect of a novation is upon the obligations of both parties to the original, executory, contract. The enquiry in determining whether there has been a novation is whether it has been agreed that a new contract is to be substituted for the old and the obligations of the parties under the old agreement are to be discharged."

The assignment of the right under Licence to Company A will not result in Company B's existing right being cancelled and a new right being granted. Rather, Company A will effectively assume the position of Company B under the Licence. Accordingly, there will be no novation of the right under the Licence.

As the right under the Licence has been continuously held (by Company B) from completion of the capital works to the time the right is assigned to Company A, Company A will satisfy the "your area" condition in respect of the capital excavation expenditure incurred by Company B. Therefore, section 43-120(2)(b) will be satisfied.

As section 43-10 will be satisfied by Company A in respect of the capital works expenditure incurred by Company B, Company A will be entitled to claim capital allowance deductions in respect of the expenditure in accordance with Division 43.

¹

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