Edited version of administratively binding advice

Authorisation Number: 1012433247791

Advice

Subject: Availability of deductions under Division 40 and Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of depreciating assets and capital works.

Question 1

Will Company A ‘hold’ depreciating assets leased from Company B under the Lease in accordance with section 40-40 of the ITAA 1997?

Answer

Yes.

Question 2

Will Company A be entitled to claim deductions under Division 43 of the ITAA 1997 in respect of capital works leased from Company B under the Lease?

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 (the “Land”).

2. Depreciating assets are affixed to the Land.

3. Company B carried out capital works on the Land.

4. Company B is currently claiming depreciation deductions under Division 40 in respect of the depreciating assets affixed to the Land.

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

6. Company B proposes to grant a 60 year lease (“the Lease”) of the Land and its business to Company A.

7. The terms of the Lease give Company A exclusive possession of the Land and the right to remove depreciating assets from the Land at any time.

Assumptions

· The capital works have a construction expenditure area in accordance with paragraph 43-10(2)(a) of the ITAA 1997; and

· There is a pool of construction expenditure for that area under section 43-10(2)(b) of the ITAA 1997.

· Company A will use the capital works in the way set out in the table in section 43-140 of the ITAA 1997, ie for the purposes of producing assessable income.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Section 40-25

Income Tax Assessment Act 1997 Section 40-40

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 Subsection 43-50(3)

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 104-110

Income Tax Assessment Act 1997 Section 104-115

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

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

Law

Division 40 contains the capital allowance provisions which allow deductions for the decline in value of depreciating assets.

Section 40-25 provides:

“(1) You can deduct an amount equal to the decline in the value for an income year (as worked out under this Division) for a *depreciating asset that you *held for any time during the year.”

The definition of “held” in section 995-1 refers to the definition of “hold” in that section. Paragraph (b) of the definition of “hold” in section 995-1 refers to the meaning given by section 40-40.

Item 2 of the table in section 40-40 applies to a depreciating asset that is fixed to land subject to a quasi-ownership right where the owner of the quasi ownership right has the right to remove the asset. In that situation, the owner of the quasi-ownership right will hold the depreciating asset.

In relation to item 2 of the table in section 40-40, paragraph 1.43 of the Explanatory Memorandum to New Business Tax System (Capital Allowances) Bill 2001 states:

“Where … a depreciating asset is fixed to land where the owner of the quasi-ownership right has a right to remove the asset, the uniform capital allowances system recognises them as the holder while the right to remove exists.”

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

There are two requirements that Company A needs to satisfy to hold the depreciating assets fixed to the Land under item 2 of the table in section 40-40. They are:

(a) Company A must own a quasi-ownership right over the Land; and

(b) Company A must have the right to remove the assets fixed to the Land.

(a) Quasi-ownership right

The term “quasi-ownership right” over land is defined in section 995-1 to include a lease of the land. The term “lease” is not defined in the ITAA 1936 or the ITAA 1997. LexisNexis Encyclopaedic Australian Legal Dictionary states that the term “lease” in relation to real property means:

“A right to exclusive possession of land given by one person (lessor or landlord) to another person (lessee or tenant), usually in return for rent: Radaich v Smith (1959) 101 CLR 209: [1959] ACLR 1253 … “

The Lease gives Company A the right to exclusive possession of the Land subject to Company B’s rights of inspection etc, that would normally be found in a lease.

As lessee under the Lease, Company A will own the quasi-ownership right for the purposes of applying item 2 of the table in section 40-40.

(b) Right to remove

In ATO ID 2012/9, the Commissioner stated that a taxpayer has the right to remove depreciating assets for the purposes of item 2 of the table in section 40-40 if the taxpayer has the right to remove the assets during the term of the quasi-ownership right even though the taxpayer does not have the right to remove the assets at the end of the term of the quasi-ownership right.

In the fact scenario considered in ATO ID 2012/9, the taxpayer had the right to remove obsolete assets, and to remove assets as the taxpayer considered necessary or desirable in the proper conduct of its business. Once the assets were removed from the land, the taxpayer became their legal owner. The taxpayer did not have the right to remove the assets at the end of the lease.

In his Reasons for Decision, the Commissioner stated:

“… The right of the taxpayer to remove obsolete assets and those which it considers necessary or desirable to remove for the proper conduct of its business is a right to remove for the benefit of the taxpayer. As the taxpayer obtains the legal title to the assets that are removed, the removed assets are for the taxpayer’s benefit rather than the lessor’s benefit.

Therefore, as the taxpayer has the right to remove the depreciating assets during the term of its quasi-ownership right and the meaning of ‘right to remove’ in item 2 of the table in section 40-40 is not limited to the right to remove assets at the end of the term of the quasi-ownership right, the taxpayer has a right to remove for the purposes of item 2 of the table in section 40-40.”

The Lease grants Company A the right at any time to remove improvements. Company A therefore has the right during the term of the Lease to remove improvements and deal with them for their own benefit.

As the conditions in item 2 of the table in section 40-40 are satisfied, Company A will hold the existing depreciating assets affixed to the Land leased from Company B under the Lease.

Question 2

Law

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

Section 43-10 provides:

“(1) You can deduct an amount for capital works for an income year.

(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.”

Subsection 43-50(3) states:

“You will be taken not to be the owner of any part of capital works that are the subject of a lease to which you have chosen to apply section 104-115 (CGT event F2). The lessee or sublessee will be taken to be the owner of that part.”

Section 104-115 sets out the requirements for an effective CGT event F2 choice. They are:

(i) The lessor must grant a lease over land;

(ii) The lease must be for a term of at least 50 years;

(iii) At the time the lease is granted, it must be reasonable to expect that the lease will continue for at least 50 years;

(iv) The terms of the lease, as they apply to the lessee, must be substantially the same as those under which the lessor owns the land; and

(v) The lessor must choose to apply section 104-115 rather than 104-110.

Application of law to facts

The applicant has asked the Commissioner to assume:

(i) that the assets leased by Company B to Company A include capital works to which section 43-20 of the ITAA 1997 applies;

(ii) the conditions in sections 43-10(2)(a) and 43-10(2)(b) are satisfied; and

(iii) Company A will use the capital works in the way set out in the table in section 43-140, ie for the purposes of producing assessable income.

Thus, 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. The Commissioner has been asked to assume that the “use” condition is satisfied. Thus, the question that needs to be considered in determining Company A’s entitlement to the Division 43 deductions is whether the construction expenditure area will be Company A’s area.

If Company B can satisfy the requirements in section 104-115 for an effective CGT event F2 election, then Company A will be the owner of the capital works by virtue of section 43-50 and will satisfy the “your area” condition in paragraph 43-10(2)(c).

Pursuant to section 104-115, there are five key conditions that will need to be satisfied for an effective CGT event F2 choice to be made by Company B and for Company A to own the capital works. These are as follows:

1. Condition 1 – Company A grants a lease over land

Under the Lease, Company B will grant Company A a lease of the Land.

2. Condition 2 – The lease must be for a term of at least 50 years

The Lease specifies that the term of the lease is 60 years.

3. Condition 3 – At the time the lease is granted, it is reasonable to expect that the lease will continue for at least 50 years

The Explanatory Memorandum to Taxation Laws Amendment Bill (No.4) 1989 (the “160ZSA Explanatory Memorandum”) which inserted section 160ZSA (the predecessor of section 104-115) of the ITAA 1936) provides:

“… The reasonable expectation requirement means that the duration of a lease will be determined at the time the lease is granted. Thus, a lease will not be an eligible long term lease in circumstances where the lease is for a term of more than 50 years but includes a provision for the determination of the lease on the occurrence of an event which is likely to occur before 50 years have elapsed.

… where a new lease contains a term providing that the lease my be determined by the lessor giving notice, then ordinarily it would not be reasonable to expect that the lease would continue beyond the earliest date upon which the lease may be determined by the lessor giving such notice. …”

The following factors indicate that the Lease will continue for the full 60-year term:

· The Lease does not include any terms that allow Company B to terminate the lease by giving notice to the lessee;

· There will be no separate arrangement, agreement or understanding (whether express or implied) between the parties at the time that the Lease is granted that the lease should run for less than 50 years.

· Both Company B and Company A will be legal entities. There is nothing to suggest that it is likely that neither will exist in 50 years time.

4. Condition 4 – The terms of the lease, as they apply to Company A, must be substantially the same as those under which the Company B owns the land

The 160ZSA Explanatory Memorandum states:

“… a lessee should be able to use the land and buildings in the same manner as the owner of the freehold interest in the land. …”

The Lease agreement grants Company A all the usage and access rights over the Land which Company B currently holds.

Company A will obtain the right to full enjoyment of the Land without any restriction for 60 years.

As such, the terms of the Lease as they apply to Company A are substantially the same as the terms under which Company B currently owns the Land.

5. Condition 5 – Company B must choose for CGT event F2 to apply

Company B will choose to apply section 104-115 (ie make a CGT event F2 choice). Therefore, this condition will be satisfied.

On the basis of the above analysis, Company B will be able to make a CGT event F2 choice. As a consequence, where such a choice is made, subsection 43-50(3) will apply to treat Company A as the owner for the purposes of section 43-115 of the capital works included in the Land. Thus, the construction expenditure area will be Company A’s area.

Where Company A incurs construction expenditure in relation to new facilities it would have a construction expenditure area under subsection 43-120(1) as it will hold a quasi-ownership interest on which the new facilities are constructed. Company A would be able to claim Division 43 deductions in respect of the capital works on the basis of satisfying the “your area” condition in paragraph 43-10(2)(c).

Accordingly, given the assumptions outlined at the beginning of this question, Company A will be able to claim capital works deductions under Division 43.

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