Edited version of your written advice

Authorisation Number: 1012845689043

Date of advice: 22 July 2015

Advice

Subject: The application of Division 58 of the Income Tax Assessment Act 1997

Question

Will Division 58 have application to the proposed transaction in light of the specific exclusion of the provision of office or residential accommodation in subsection 58-10(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice

Yes

This advice applies for the following period:

Income year ending 30 June 20xx

The arrangement commences on:

X xx 2015

Relevant facts and circumstances

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

Entity A is an exempt entity within the meaning of subsection 995-1(1) of the Income Tax Assessment Act 1997.

The transaction

Entity A is proposing to divest its interest in the Property.

Assumption

That the future purchaser of the building will acquire the building with all current leases in place such that the purchaser at acquisition time is using the assets to carry on the business.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 58

Income Tax Assessment Act 1997 section 58-5

Income Tax Assessment Act 1997 subsection 58-5(2)

Income Tax Assessment Act 1997 subsection 58-5(4)

Income Tax Assessment Act 1997 section 58-10

Income Tax Assessment Act 1997 subsection 58-10(1)

Income Tax Assessment Act 1997 paragraph 58-10(1)(a)

Income Tax Assessment Act 1997 paragraph 58-10(2)(a)

Income Tax Assessment Act 1997 paragraph 58-10(2)(b)

Income Tax Assessment Act 1997 paragraph 58-10(2)(c)

Income Tax Assessment Act 1997 subsection 58-10(3)

Income Tax Assessment Act 1997 section 58-65

Income Tax Assessment Act 1997 subsection 58-70(5)

Anti-avoidance rules

Part IVA is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

Further issues for you to consider

If the purchaser is not a taxable entity or does not use the assets to carry on the business than Division 58 of the ITAA 1997 will not apply.

We have covered this outcome under Option 2 in the detailed reasoning below so that the purchaser has guidance on the taxation outcomes in relation to the depreciating assets regardless of whether or not they use the assets to carry on the business.

The purchaser may seek a ruling based on the facts specific to their circumstances if they are unsure whether they will use the assets to carry on the business.

Reasons for advice

All legislative references are to the Income Tax Assessment Act 1997

Summary

The details of how the purchaser will use the assets acquired will determine the application of Division 58. There are two options:

• Option 1- that the property is purchased by an entity that continues carrying on the business in which the relevant asset was used prior to sale, or

• Option 2- that the property is purchased by an entity that does not continue carrying on the business in which the relevant asset was used prior to the sale.

Option 1

The direct sale of the Property will be an asset sale situation under section 58-5 where the purchaser of the Property uses the asset in carrying on the business of gaining assessable income through the leasing of the Property. Therefore, the special rules in Division 58 will apply to set the amount of future capital allowance deductions available to the purchaser.

Option 2

The direct sale of any of the Property will not be an asset sale situation under section 58-5 where the purchaser of the relevant Property does not use the asset in carrying on the business of gaining assessable income through the leasing of the relevant Property. Therefore, Division 40 will operate to set the amount of future capital allowance deductions available to the purchaser.

Detailed reasoning

Background

Division 58 sets out special rules that apply in calculating deductions for the decline in value of depreciating assets and balancing adjustments for assets previously owned by an exempt entity if the assets continued to be owned by that entity after the entity becomes taxable (entity sale situation) or are acquired from that entity, in connection with the acquisition of a business, by a purchaser that is a taxable entity (asset sale situation).

Subsection 58-5(1) provides that Division 58 applies in 2 situations:

• entity sale situation: subsection 58-5(2), and

• asset sale situation: subsection 58-5(4).

An asset sale situation is relevant in this case for the sale of the Property.

Asset sale situation

Relevantly, paragraphs 58-5(4)(a) and (b) provide that an asset sale occurs where an entity whose income is assessable acquires a depreciating asset from the Commonwealth, a State, a Territory or an exempt entity and the asset is acquired in connection with the acquisition of a business from the Commonwealth, State, Territory, or exempt entity.

Entity A is an exempt entity within the meaning of 995-1(1).

Section 58-10 defines when an asset is acquired in connection with the acquisition of a business.

Subsection 58-10(1) provides that a depreciating asset is taken to be acquired in connection with the acquisition of a business from the Commonwealth, the State, the Territory or the exempt entity if and only if:

(a) The assets were used by the Commonwealth, the State, the Territory or the exempt entity in carrying on a business and the purchaser or another entity uses the asset in carrying on the business, or

(b) Subsection 58-10(2) applies.

The asset sale situation requires the identification of an acquisition. 'Acquire' is not defined in Division 58 and therefore takes its ordinary meaning within the context in which it appears. The meaning given in the Macquarie Dictionary, sixth edition, October 2013, of 'acquire' is 'to come into possession of; get as one's own'. For Division 58 purposes, a purchaser is taken to have acquired the depreciating asset from the exempt entity when the purchaser starts to hold the depreciating asset. Section 40-40 provides the meaning of 'hold' a depreciating asset.

Subsection 995-1(1) defines 'business' to include any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Whether the letting of property constitutes the carrying on of a business will depend on the circumstances of each case (California Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 TC 159. Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual. If a company's objects are business objects and are, in fact, carried out it carries on business, (IRC v Westleigh Estates [1924] 1 KB 390 at pp 408-9 per Sir Ernest Pollock, M.R.). In American Leaf Blending Co. Sdn Bhd v. Director-General of Inland Revenue (Malaysia) [1978] 3 All E.R. 1185 at p 1189 Lord Diplock concluded that it would be difficult to displace the prima facie inference that the gainful use of a company's property in letting it out for rent would constitute the carrying on of a business.

Entity A's business object (or one object) is to derive rental income, it is considered that Entity A is carrying on a business by letting that Property for rent.

As the prospective purchaser/s of the properties may or may not use the assets acquired to carry on the business both options have been considered below.

Option 1: the Property is purchased by an entity that continues carrying on the business in which the relevant asset was used prior to the sale pursuant to paragraph 58-10(1)(a)

The purchaser, an entity whose income is assessable, acquires the Property when it becomes the legal owner of the asset upon completion of the sale. The purchaser continues to carry on the business in which the asset was used prior to the sale, that is, the letting of the Property to obtain rental income.

Accordingly, at that time there is an asset sale situation under section 58-5 and the special rules in Division 58 apply.

For the purposes of Division 58:

• Entity A is the tax exempt vendor

• The time when the Property is acquired by the purchaser will be the Acquisition Time

• The income year in which the Acquisition Time occurs is the acquisition year, and

• Each depreciating asset the purchaser acquires from Entity A at the Acquisition Time is the privatised asset.

In this case the requirement in subsection 58-10(1) will be met. There is no exception for the provision of office or residential accommodation in respect to 58-10(1) as subsection 58-10(3) only operates to limit subsection 58-10(2).

In this case the purchaser has the choice of method to work out the cost of the privatised asset. They may choose the notional written down value of the asset or the undeducted pre-existing audited book value (section 58-65).

This amount will then form part of the first element of the cost for each privatised asset (subsection 58-70(5)).

Option 2: the Property is purchased by an entity that does not continue carrying on the business in which the relevant asset was used prior to the sale pursuant to paragraph 58-10(2)(b)

The purchaser, an entity whose income is assessable, acquires the Property when it becomes the legal owner of the relevant asset upon completion of the sale. The purchaser does not continue to carry on the business in which the assets were used prior to the sale, that is, they are not letting the properties to obtain rental income. In this case paragraph 58-10(1)(a) is not met and the requirements in subsection 58-10(2) need to be considered.

Paragraph 58-10(2)(a) does not apply as the asset was used by Entity A in the carrying on of a business.

Paragraphs 58-10(2)(b) and (c) do not apply as the acquisition of the asset was neither connected with the acquisition of another asset, nor was the asset acquired under an arrangement where the purchaser or another entity acquired another asset from the Commonwealth, the State, the Territory or the exempt entity.

Where paragraphs (a) to (c) of subsection 58-10(2) apply, paragraph 58-10(3) would apply to carve out those paragraphs where the asset was used by the purchaser solely to derive assessable income from the provision of office or residential accommodation. However, as stated above, none of the paragraphs in subsection 58-10(2) will apply in this case, so paragraph 58-10(3) will have no application.

Therefore, the special rules in Division 58 will not apply as the Privatisation is not an asset sale situation under section 58-5.

The standard rules in Division 40 will apply.

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).