Disclaimer
This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1012797342111

Ruling

Subject: Division 250 of the Income Tax Assessment Act 1997

Question 1

Will the Commissioner exercise his discretion to not apply Division 250 of the Income Tax Assessment Act 1997 (ITAA 1997) to the taxpayer's asset which is being put to tax preferred use?

Answer

Yes

This ruling applies for the following periods:

Income year ending 1 July 20XX to 30 June 20YY

The scheme commences on:

30 June 20XX

Relevant facts and circumstances

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.

The taxpayer entered into an arrangement in June 20XX involving the acquisition of an office building (the asset) that was leased to a government department.

The costs of acquisition were funded by % debt and the remainder by equity.

The taxpayer would ordinarily be entitled to a deduction in respect of assets subject to Division 40 of the ITAA 1997 (Division 40 assets) and Division 43 of the ITAA (Division 43 assets).

The taxpayer's aggregated turnover is greater than $2 million per annum.

At the time of entering the contract of sale, the asset was leased to a tax preferred entity as defined by section 995-1 of the ITAA 1997.

It is advised that the lease commenced on 1 June 20ZZ and had an expiry date of late May 20WW (Lease agreement). It was extended presumably at the time of sale (May/June 20XX) to May 20YY, as it is advised the remaining term became 10 years.  

On settlement of the asset, the Lease agreement between the vendor and the lessee was assigned to the taxpayer (lessor).

The Lease agreement does not allow the option for the lessee to purchase the asset at the end of the lease period.

The nominal values of the lease payments over the life of the Lease agreement are greater than $50 million.

The lessee is unable to cancel the lease without the consent or approval of the taxpayer unless another government agency (or a tax preferred entity), takes possession of the lease.

Division 40 assets will be replaced as required, and the likelihood that assets will be replaced increases in the period that assets continue to be used after the end of their period of effective life. Capital allowance deductions will only be claimed in the period of an asset's remaining effective life and will not be claimed in respect of assets that continue to be used after the end of their effective life.

Assumptions

The limited recourse debt test under section 250-115 of the ITAA 1997 and right to acquire asset test under section 250-120 of the ITAA 1997 are not satisfied.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 250-15

Income Tax Assessment Act 1997 section 250-45

Income Tax Assessment Act 1997 section 250-125

Income Tax Assessment Act 1997 section 250-135

Reasons for decision

Section 250-10 of the ITAA 1997 states that Division 250 applies to an asset at a particular time if the general test in section 250-15 is satisfied and none of the exclusions in sections 250-20, 250-25, 250-30, 250-40 and 250-45 apply.

The asset is being put to a tax preferred use for the purposes of paragraph 250-15(a). The asset is leased to a tax preferred end user.

The arrangement period between the taxpayer and the tax preferred entity is the period that the taxpayer is party to the lease, being the time of acquisition. The arrangement period for the taxpayer is therefore from the time of purchase (10 years) rather than the time the lease was originally entered into (20 years). As the period of the arrangement is greater than 12 months, paragraph 250-15(b) is satisfied.

Financial benefits are provided (in the form of rent) for the tax preferred use of the assets and paragraph 250-15(c) is consequently satisfied.

The taxpayer would in the absence of Division 250 applying be entitled to capital allowances in relation to both a decline in the value of the assets and expenditure in relation to the assets. Paragraph 250-15(d) is therefore satisfied.

In order to determine whether there is a lack of predominant economic interest for the purpose of paragraph 250-15(e), four tests will need to be considered:

The taxpayer will lack a predominant economic interest in an asset at a particular time if one or more of the above tests apply to the taxpayer and the asset at that time.

Section 250-115 & section 250-120:

The applicant advises that the limited recourse debt test (section 250-115) and right to acquire asset test (section 250-120) are not satisfied. Therefore for the purpose of this ruling no further consideration will be given to the application of section 250-115 and section 250-120.

Section 250-125 & section 250-135:

The applicant advises that two tests of a predominant economic interest are satisfied; the effectively non-cancellable, long term arrangement test in subparagraph 250-125(b)(ii) and the level of expected financial benefits test in section 250-135.

It is advised that for the purposes of paragraph 250-15(e) a predominant economic interest is lacking in the depreciable Division 40 assets but not for the Division 43 improvements.

The ruling will now address each of the above two tests in detail.

250-125(1) You lack a predominant economic interest in an asset at a particular time if:

Division 250 applies to each asset in the arrangement with the consequence that it might apply to some assets but not others. This is true between asset type (Division 40 and Division 43) and to assets within a type. As such, long effective life assets might not be satisfied whereas shorter effective life assets might be satisfied.

It is advised that the remaining effective life of Division 40 assets when being tested as a group is 5 years, but that some individual assets have an effective life remaining of 10 years.

As a group, the arrangement period as a percentage of the remaining effective life for Division 40 assets is 100% or more. If the arrangement involved goods and therefore only involved the use / lease of Division 40 assets then the likelihood that the effective life of the assets would be expended during the period of the lease would be a significant factor indicative that economic ownership belonged with the entity with physical use of the asset.

The arrangement for the use of the assets however also involves an arrangement for the use of other assets (Division 43) of a much longer effective life, and the arrangement might entail a replacement of Division 40 assets should their effective life actually terminate during the period of the lease, or an absence of capital allowance deductions if the exhausted assets are not replaced.

Assets with a shorter effective life, including those that are older or second hand will more easily satisfy the test under section 250-125. If the arrangement period exceeds the period of an assets remaining effective life then it would indicate that deductions for capital allowances will not be claimed during a portion of the arrangement because of the limited remaining effective life.

Division 250 denies deductions for capital allowances to a holder of an asset where under an arrangement the holder does not retain a predominant economic interest in the asset; Division 250 presupposes that capital allowances are being claimed during the arrangement that is being examined. It is the inappropriate access to these deductions given the nature of the taxpayer's interest that Division 250 seeks to deny.

In the present case, although paragraph 250-15(d) will have been satisfied because capital allowance deductions were claimed in years 1 - 5 of the arrangement, the fact that (as a group) they are not claimed in years 6 - 10 but income is returned would indicate that capital allowance deductions for Division 40 assets would provide a reduced benefit arising from ownership during the arrangement.

Some assets having an effective life of up to 10 years will give rise to capital allowance deductions, but the majority of assets it would appear would not be in this category and Division 250 could only apply during this shorter effective life even though such assets if not replaced will be used throughout the arrangement period,

If an asset is replaced at the end of a typical effective life of 5 years, the remainder of the arrangement period might not be sufficient to recoup cost of the replacement asset. It would be a risk borne by the taxpayer who would either need to deploy such assets through the term of their effective lives, or sell the assets and or the property to which the assets are attached or affixed in order for a recovery of asset cost and a derivation of gain.

The actual replacement of assets is hypothetical and any replacement asset would need to be tested separately under Division 250, but the risk arising in replacing existing assets would seem to increase in the period beyond the effective life.

An arrangement period that extended beyond the effective life of an asset would seemingly involve an economic risk to the owner; the greater the arrangement period extended beyond the effective life of an asset, the greater the risk that the asset will fail and need to be replaced during the arrangement. The reduced risk in the period that the arrangement period equates to the effective life of such assets is balanced by an increased risk in the period that the arrangement period extends beyond the effective life of the asset.

That the period of the arrangement for the tax preferred use of Division 40 assets will be equal to or exceed the remaining effective life might cause the test to be satisfied in a more than marginal way, but the percentage to which an arrangement period might extend beyond the effective life of an asset might not accurately indicate the presence of reduced risk. It might in fact indicate increased risk, because the risk in the subject assets cannot be assessed in isolation but would need to take account of the commercial factors governing their use including the period of use and the economic risk retained in other assets.

Further, the absence of capital allowance deductions being concomitant with the more than marginal nature of the breach of section 250-125 indicates that capital allowances are not being inappropriately accessed by the owner given either the ongoing exploitation of the asset under the arrangement after capital allowances have expired, or the replacement of the asset at the cost of the owner.

Effective guarantee or indemnity for value of asset

Likely financial benefits exceeding 70% limit

It is advised that the sum of present values for the Division 43 assets is less than the 70% threshold as required by paragraph 250-136(2)(b). However, Division 40 assets have marginally breached the level of expected financial benefits test as the level is some 71.29%. A breach of this level is close to the benchmark such that the breach can be considered marginal. the taxpayer recovers most but not all of the cost of the asset through derivation of recurrent arrangement payments, and the extent to which cost is not recovered is sufficiently large to indicate that sufficient economic risk in Division 40 assets is retained by the taxpayer rather than having been passed through to the tax preferred end user.

As above, the arrangement is not simply for the use of Division 40 assets but is part of a larger arrangement involving use of and economic risk in other assets. The arrangement would entail an obligation to replace Division 40 assets as required, and the cost of replacing such assets would be a risk borne and retained by the taxpayer where the cost might not be recouped from the tax preferred end user under the arrangement being tested.

The taxpayer retains a predominant economic risk in the Division 43 assets and being one arrangement it is not the case that the taxpayer can look to the Division 40 assets as sufficient to provide it with a return on its investment. The Division 40 assets are a component of its return, and the exposure in the Division 43 assets would collectively provide an indication of the relevance of the breach for Division 40 assets.

Exclusions

The Commissioner accepts that the taxpayer is unable to access the following exclusions:

The fifth exclusion under section 250-45 allows the Commissioner to make a determination to not apply Division 250 to the asset, which has been considered further.

Division 250 applies to an asset if section 250-15 is satisfied. Two tests of lacking a predominant economic interest are satisfied, and hence section 250-15 is satisfied.

One test of lacking a predominant economic interest is sufficient to satisfy paragraph 250-15(e). Subsection 250-115(1) provides that you lack a predominant economic interest in an asset at a particular time only if one or more of the sections listed under that provision apply to you and the asset at that time.

The fact that two tests are satisfied would constitute part of the circumstances, but not the only circumstance, that the Commissioner would have regard to in determining whether it was appropriate to exercise a determination that the Division not apply.

Given the circumstances applicable to the lack of a predominant economic interest in the Division 40 assets that cause Division 250 to apply, the Commissioner would be able to determine that it is unreasonable that Division 250 should apply to the taxpayer and the asset.

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).