Edited version of your written advice

Authorisation Number: 1012800354278

Ruling

Subject: Deductions for project amounts

Question 1

Can capital expenditure Company A incurred in relation to Company B Infrastructure Costs, Third Party Infrastructure Costs and Company B Land Contribution constitute project amounts which can be allocated to a project pool and deducted pursuant to section 40-830 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

If the answer to Question 1 is 'yes', is the project life 40 years under section 40-845 of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Income tax year ended 30 June 20ZZ to income tax year ended 30 June 2061.

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.

Background to Asset A

Company A is a taxable entity, and is the head entity of a tax consolidated group which includes the wholly owned non-operating subsidiaries Company C and Company D.

Company A owns or leases infrastructure across Australia. Company A operates infrastructure commercially with the objective of making a profit by charging fees for accessing the infrastructure. Company A reinvests any profits it generates into its business which includes the maintenance and further development of infrastructure.

Company A has constructed Asset A.

A number of documents governed the construction and operation of Asset A including:

• Asset A Development Agreement which Company A and Company B entered into on 1 July 20XX and which was amended on 1 July 20YY when Company A and Company B entered into the Deed of Variation of Asset A Development Agreement (Amended Asset A Development Agreement).

• Asset A Deed of Lease and Licence which was entered into by Company A and Company B on 1 July 20ZZ (Asset A Deed of Lease and Licence)

• the Asset B Transfer Deed which was entered into by Company A and Company B on 1 July 20ZZ.

• the Asset C Transfer Deed which was entered into by Company A and Company B on 1 July 20ZZ.

Construction Phase

Asset A was constructed under the terms of the Amended Asset A Development Agreement.

Under the terms of the Amended Asset A Development Agreement during construction of Asset A Company A was obligated to:

• construct and complete Asset A at its own cost and risk;

Asset A was constructed upon land owned by Company B. Company A has no ownership interest in the land upon which Asset A has been constructed. Company A was granted a construction licence by Company B under the Amended Asset A Development Agreement to enable construction of Asset A.

Company A has legal ownership of Asset A which is an asset for the purposes of Division 40 of the ITAA 1997.

Company B Land Contribution

Company B acquired additional land in order for Company A to be able to construct Asset A. Company A paid half the costs of acquiring the additional land (and one half of the reasonable costs and expenses of Company B in acquiring the additional land) as per the Amended Asset A Development Agreement (Company B Land Contribution). Company A have advised that the amount was paid into a bank account which is administered as if it were a joint trust account by Company B. Company A have not received a final reconciliation of the account but have been advised that the amount was only used for the purposes of acquiring additional land.

Company B Infrastructure Costs and Third Party Infrastructure Costs

Company A in fulfilling obligations under the Amended Asset A Development Agreement incurred expenditure undertaking work on assets over which Company A had no existing or prospective legal rights or interests. The assets that work was undertaken on can broadly be divided into assets owned by Company B (Company B Infrastructure Costs) and assets owned by other third parties such as local councils and utility providers (Third Party Infrastructure Costs).

The Company B Infrastructure Costs and Third Party Infrastructure Costs included work on:

• preliminary feasibility studies and design work;

• electricity and water infrastructure held by utility providers;

• car parks; and

• access roads owned by various government entities.

Operation Phase

Asset A was completed in two separate stages. Asset A Stage 1 was completed on 1 July 20AA and a lease and licence to use the area covered by Asset A Stage 1 was issued to Company A by Company B under the Amended Asset A Development Agreement (Asset A Stage 1 Lease). The Asset A Stage 1 Lease ceased on 1 July 20ZZ as per the Asset A Deed of Lease and Licence.

The Asset A Deed of Lease and Licence (signed 1 July 20ZZ) commenced on the final commencement date of 1 July 20ZZ and extends until 1 July 2060.

The Asset A Deed of Lease and Licence:

• Acknowledges that Company B retains ownership and exclusive possession of land upon which Asset A has been constructed by Company A.

• Acknowledges that nothing in in the Asset A Deed of Lease and Licence grants any proprietary interest in land upon which Asset A is constructed to Company A.

• Grants a lease of the land in Asset B from Company B to Company A.

• Grants a lease of infrastructure to operate Asset A to Company A.

• Grants a licence for Company A to operate Asset A.

• Provides that Company B may at any time during the term of the Asset A Deed of Lease and Licence terminate or partially terminate the lease and require the transfer of all or any part of Company A assets provided certain conditions are satisfied. The conditions which must be satisfied include that Company B grant to Company A a lease of equivalent functionality in respect of that part of the infrastructure the subject of termination or transfer and a licence to operate Asset A as contemplated by the Asset A Deed of Lease and Licence.

• Provides that Company A must throughout the term of the Asset A Deed of Lease and Licence:

• ensure that Asset A is available; and

• control Asset A.

• Provides that Company A must maintain and repair Asset A until the end of the term of the Asset A Deed of Lease and Licence.

• Provides that the lease and licence will only terminate if an earlier lease terminates or is surrendered.

• Provides that at the end of the term of the Asset A Deed of Lease and Licence Company A are required to return or transfer all assets and land associated with Asset A and Asset B to Company B.

Company A operated the Asset A Stage 1 area of Asset A between 1 July 20AA and 1 July 20ZZ. Company A continues to operate Asset A and has done so since 1 July 20ZZ.

Relevant legislative provisions

Income Tax Assessment Act 1997 40-25

Income Tax Assessment Act 1997 40-25(7)

Income Tax Assessment Act 1997 40-830

Income Tax Assessment Act 1997 40-830(3)

Income Tax Assessment Act 1997 40-832(1)

Income Tax Assessment Act 1997 40-840

Income Tax Assessment Act 1997 40-840(2)

Income Tax Assessment Act 1997 40-840(2)(a)

Income Tax Assessment Act 1997 40-840(2)(b)

Income Tax Assessment Act 1997 40-840(2)(c)

Income Tax Assessment Act 1997 40-840(2)(d)

Income Tax Assessment Act 1997 40-845

Income Tax Assessment Act 1997 995-1

Reasons for decision

All references to legislative provisions in this Ruling are to the ITAA 1997 unless otherwise stated.

Section 40-830 allows project amounts to be allocated to a project pool and for project amounts allocated to the project pool to be deducted according to the formula contained in subsection 40-830(3) or subsection 40-832(1) as appropriate.

Project amount

The definition of a project amount is contained in section 40-840. Subsection 40-840(2) relevantly states:

(2) Another amount of capital expenditure you incur is also a project amount so far as:

(a) it does not form part of the cost of a depreciating asset you hold or held; and

(b) you cannot deduct it under a provision of this Act outside this Subdivision; and

(c) it is directly connected with a project you carry on or propose to carry on for a taxable purpose; and

(d) it is one of these:

(i) an amount paid to create or upgrade community infrastructure for a community associated with the project; or

(ii) an amount incurred for site preparation costs for depreciating assets (except, for horticultural plants, in draining swamp or low-lying land or in clearing land); or

(iii) an amount incurred for feasibility studies for the project…

In order for an amount to qualify as a project amount it must satisfy paragraphs 40-840(2)(a), 40-840(2)(b) and 40-840(2)(c) as well as one of the subparagraphs contained in paragraph 40-840(2)(d).

Paragraphs 40-840(2)(a) and 40-840(2)(b)

Each item of expenditure included in the Company B Infrastructure Costs, Third Party Infrastructure Costs and Company B Land Contribution must be evaluated by the rulee to determine whether or not it satisfies paragraphs 40-840(2)(a) and 40-840(2)(b).

Paragraph 40-840(2)(c)

Each item of expenditure included in the Company B Infrastructure Costs, Third Party Infrastructure Costs and Company B Land Contribution must also be evaluated by the rulee to determine whether or not it satisfies paragraph 40-840(2)(c). Each item of expenditure must be directly connected with a project that Company A carries on or proposes to carry on for a taxable purpose in order to satisfy the requirements of paragraph 40-840(2)(c).

The word 'project' is not defined in the ITAA 1997. Taxation Ruling 2005/4: Income tax: capital allowances - project pools - core issues states (TR 2005/4) provides guidance in relation to what constitutes a project for the purposes of paragraph 40-840(2)(c):

• paragraph 44 of TR 2005/4 states that the word project should take its ordinary meaning shaped by the context in which it is found.

• paragraph 47 of TR 2005/4 states that the word project, in general terms, means '…a plan, scheme or undertaking.'

• paragraph 49 of TR 2005/4 states that a project is an activity or a set of related activities, that has a start and a finish and which may or may not involve a large undertaking.

• paragraph 50 of TR 2005/4 states that a project is not the same activity as the activity on which capital expenditure is incurred and which constitutes a project amount for the purposes of paragraph 40-840(2)(d).

The term 'carry on' is also not defined in the ITAA 1997. TR 2005/4 provides guidance in relation to what it means to 'carry on' or 'propose to carry on' a project for the purposes of paragraph 40-840(2)(c):

• paragraph 24 of TR 2005/4 states that the term 'carry on' should take its ordinary meaning shaped by the context in which it is found.

• paragraph 25 of TR 2005/4 states that the term 'carry on' requires some form of continuing activity and if that activity ceases it is a question of fact whether the project is still being carried on or has been abandoned.

• paragraph 26 of TR 2005/4 states that holding a passive investment would not have sufficient activity to constitute the 'carrying on' of a project.

• paragraph 27 of TR 2005/4 states that the words 'propose to carry on' require a commitment of some substance to the activity or activities identified as constituting the project.

The expression 'taxable purpose' is defined in section 995-1 as having the meaning given by section 40-25. Subsection 40-25(7) relevantly states:

(1) Subject to subsection (8), a taxable purpose is:

(a) the purpose of producing assessable income; or

(b) the purpose of exploration or prospecting; or

(c) the purpose of mining site rehabilitation; or

(d) environmental protection activities.

Company A has undertaken activities involving the operation of the Asset A Stage 1 section of Asset A as per the Asset A Stage 1 Lease. Company A has undertaken and will continue to undertake activities involving the operation of Asset A as per the licence it holds from Company B pursuant to the Asset A Deed of Lease and Licence. The activities of Company A have a start time as determined by the Asset A Stage 1 Lease which commenced on 1 July 20AA. The activities of Company A have a finish time as determined by the Asset A Deed of Lease and Licence which will expire on 1 July 2060.

Company A is obligated pursuant to the Asset A Deed of Lease and Licence to ensure that Asset A is available throughout the term of the Asset A Deed of Lease and Licence. Company A is also obligated pursuant to the Asset A Deed of Lease and Licence to ensure that Asset A is maintained throughout the term of the Asset A Deed of Lease and Licence.

Company A has operated Asset A since it was granted the Asset A Stage 1 Lease and will continue to operate Asset A throughout the term of the Asset A Deed of Lease and Licence with a purpose of producing assessable income by charging for access to Asset A.

The operation of Asset A by Company A will therefore meet the requirements of a project as outlined in TR 2005/4 and will also be a project carried on by Company A for a taxable purpose for the purposes of paragraph 40-840(2)(c). However, each item of expenditure included in the Company B Infrastructure Costs, Third Party Infrastructure Costs and Company B Land Contribution must still be evaluated by the rulee to determine whether or not it is directly connected with the project for the purposes of paragraph 40-840(2)(c).

Subparagraphs contained in paragraph 40-840(2)(d)

Each item of expenditure included in the Company B Infrastructure Costs, Third Party Infrastructure Costs and Company B Land Contribution must be evaluated by the rulee to determine whether or not it satisfies any of the subparagraphs contained in paragraph 40-840(2)(d).

Conclusion

As there exists a project carried on by Company A for a taxable purpose as required by paragraph 40-840(2)(c), any capital expenditure that is included in Company B Infrastructure Costs, Third Party Infrastructure Costs and Company B Land Contribution and which, as determined by the rulee, satisfies paragraphs 40-840(2)(a), 40-840(2)(b) and 40-840(2)(c) (in respect of 'directly connected') and any one of the subparagraphs contained in paragraph 40-840(2)(d), will be a project amount for the purposes of 40-840 that can be allocated to a project pool and for which an amount can be deducted pursuant to section 40-830.

Question 2

Detailed reasoning

Section 40-845 states that:

You work out the project life of a project by estimating how long (in years, including fractions of years) it will be from when the project starts to operate until it stops operating.

TR 2005/4 provides the following guidance in relation to working out project life under section 40-845:

• paragraph 83 of TR 2005/4 states that project life is estimated from when a taxpayer starts to operate the project.

• paragraph 84 of TR 2005/4 states that section 40-845 and the extrinsic material that accompanied its introduction do not provide any criteria for estimating project life; however, paragraph 84 of TR 2005/4 does state that the period of time that a taxpayer intends to carry on the activity would not be a determining factor.

• paragraph 85 of TR 2005/4 states that it is expected that in estimating project life a taxpayer would need to have regard to factors outside of their control and recognises that the factors to be considered would vary from case to case.

• paragraph 86 of TR 2005/4 states that the estimate of project life must be undertaken each year in calculating the deduction for project amounts allocated to a project pool.

Asset A Stage 1 Lease commenced on 1 July 20AA and ended on 1 July 20ZZ. The Asset A Deed of Lease and Licence commenced on 1 July 20ZZ and will expire on 1 July 2060. Company A will therefore undertake activities involving the operation of Asset A for a total term of 48 years.

The Asset A Deed of Lease and Licence states that Company B may at any time during the term of the Asset A Deed of Lease and Licence terminate or partially terminate the lease and require the transfer of all or any part of Company A assets provided certain conditions are satisfied. The conditions which must be satisfied include that Company B grant to Company A a lease of equivalent functionality in respect of that part of the infrastructure the subject of termination or transfer and a licence to operate Asset A as contemplated by the Asset A Deed of Lease and Licence.

The Asset A Deed of Lease and Licence provides that Company A must throughout the term of the Asset A Deed of Lease and Licence:

• ensure that Asset A is available; and

• control Asset A.

The Asset A Deed of Lease and Licence provides that Company A must maintain and repair Asset A until the end of the term of the Asset A Deed of Lease and Licence.

The Asset A Deed of Lease and Licence provides that the Asset A Deed of Lease and Licence will terminate if another lease is terminated or surrendered.

The Asset A Deed of Lease and Licence provides that Company A must upon expiration or earlier determination of the Asset A Deed of Lease and Licence, at no cost to Company B, return or transfer all assets and land associated with Asset A and Asset B to Company B.

You have said that Asset A has an effective life of 40 years which is provided by Taxation Ruling 2014/4: Income tax: effective life of depreciating assets (applicable from 1 July 2014) (TR 2014/4). You consider that the physical deterioration of Asset A over its effective life will preclude it from being used after a maximum period of 40 years. You submit that in order for Asset A to be used beyond 40 years you would need to undertake substantial work to replace Asset A. You therefore consider that the project life should be limited to the economic useful life of Asset A.

We do not agree that the project life is limited to the effective life of Asset A as determined by TR 2014/4. Section 40-845 clearly states that project life is determined by estimating how long (in years, including fractions of years) it will be from when a project starts to operate until it stops operating.

We consider that Company A started to operate the project when it had the ability to start operating the Asset A Stage 1 section of Asset A from 1 July 20AA. We consider that the above clauses demonstrate that Company A has obligations throughout the term of the Asset A Deed of Lease and Licence. We recognise that although Asset A will physically deteriorate over the time that it is used Company A are obligated to maintain and repair Asset A throughout the period of the Asset A Deed of Lease and Licence. If the Asset A Deed of Lease and Licence were to be terminated by Company B prior to its expiration date of 1 July 2060 then Company A will remain in a position to continue its project for what would have been the remaining duration of the Asset A Deed of Lease and Licence as a lease and licence of equivalent functionality will be granted to it by Company B. We consider that Company A will stop operating the project on 1 July 2060.

Conclusion

On the basis of the reasoning provided above, we consider that the project life will be 52.20 years under section 40-845.

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