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Edited version of your written advice
Authorisation Number: 1051199301606
Date of advice: 10 March 2017
Ruling
Subject: Income Tax - Capital Gains Tax
Question 1
Did the lessee, upon the execution of the agreement for the sale of leasehold improvements under subsection 104-10(2) of the ITAA 1997, dispose of the leasehold improvements paid for by the lessee and affixed to the lessor's land and buildings?
Answer
Yes.
Question 2
Will the gain or loss on the disposal of the leasehold improvements be accounted for under subsection 104-10(4) of the ITAA 1997?
Answer
Yes.
This ruling applies for the following periods:
1 July 20YY to 30 June 20ZZ
The scheme commences on:
1 July 20YY
Relevant facts and circumstances
● Since 20XX, the lessee operates a licensed gaming venue business that is based out of premises owned by a related entity and is governed by a lease agreement.
● Prior to 30 June 20ZZ, the lessee incurred expenditures and paid for the leasehold improvements made to the leased premises. Leasehold improvements relate to initial fit out of the premises, fixtures, plant and equipment and renovations to the leased premises carried out by licensed builders.
● It was agreed by the lessee and the lessor that ownership of the leasehold improvements incurred and paid for by the lessee belongs to the lessee.
● There were no repairs and furniture, plant and equipment transactions included in the leasehold improvements property register.
● The leasehold improvements property register consists only of capital expenditures incurred in respect of the construction of capital works owned by the lessee.
● Deductions in leasehold improvements were accounted for under Division 43 of the ITAA 1997 for both accounting and taxation purposes by the lessee.
● In mid 20ZZ, the lessee and the lessor entered into an Asset Sale Agreement whereby the lessee conveyed its interest in the leasehold improvements to the lessor for a sum equal to the original cost incurred by the lessee in constructing the leasehold improvements.
● Other fixed assets which continued to be owned by the lessee were specifically identified and itemized in a schedule. These items remained the property of the lessee.
● In mid 20ZZ, a new lease agreement was signed between the lessee and the lessor. The new lease agreement has an annexure that has a list of other fixed assets which continued to be owned by the lessee.
● Under the new lease agreement, the lessee does not have ownership of any fixtures and fittings and other leasehold improvements that are affixed to the leased premises, other than those listed in the agreement's annexure.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 104-10.
Income Tax Assessment Act 1997 Section 108-5.
Income Tax Assessment Act 1997 Section 40-285.
Income Tax Assessment Act 1997 Section 40-30.
Income Tax Assessment Act 1997 Section 40-45.
Income Tax Assessment Act 1997 Section 43-20.
Reasons for decision
Question 1
Did the lessee, upon the execution of the agreement for the sale of leasehold improvements under subsection 104-10(2) of the ITAA 1997, dispose of the leasehold improvements paid for by the lessee and affixed to the lessor's land and buildings?
Summary
Leasehold improvements is considered a Capital Gains Tax (CGT) asset and due to the change in legal and beneficial ownership upon execution of the Asset Sale Agreement, the event is considered a CGT asset disposal pursuant to subsection 104-10(2).
Detailed reasoning
The lessee has paid for and installed leasehold improvements in the leased premises to make the property suitable for its gaming venue business. At the time of the construction, it was agreed by both the lessee and the lessor that ownership of the leasehold improvements stays with the lessee.
A CGT asset is defined as any kind of property under section 108.5 of the ITAA 1997 and therefore leasehold improvements are considered CGT assets.
Upon the execution of the Asset Sale Agreement between the lessee and the lessor, both legal and beneficial ownership to the asset were transferred to the lessor thereby triggering a CGT event.
The event is classified as a CGT event A1, Disposal of a CGT asset pursuant to section 104.10 of the ITAA 1997.
Question 2
Will the gain or loss on the disposal of the leasehold improvements be accounted for under subsection 104-10(4) of the ITAA 1997?
Summary
Deductibility of leasehold improvements were accounted for under Division 43 of the ITAA 1997 for both accounting and taxation purposes in the records of the lessee therefore gain or loss on disposal is accounted for pursuant to subsection 104-10(4) of the ITAA 1997.
Detailed reasoning
Gains and losses on asset disposals are either accounted for as a balancing adjustment event under subsection 40-285(1) of the ITAA 1997 for depreciating assets or capital gain or loss pursuant to subsection 104-10(4) of the ITAA 1997 for Capital Gains Tax (CGT) assets.
Leasehold improvements can be considered depreciating assets pursuant to section 40-30. In addition, subsection 40-285(1) states that a balancing adjustment arises when an owner stops holding a depreciating asset such as when you sell the depreciating asset. However, subsection 40-45(2) also states that Division 40 does not apply to capital works for which you can deduct amounts under Division 43 of the ITAA 1997.
Division 43 on the other hand is about deductions for capital works and capital works are defined under subsection 43-20(1) as being building, or an extension, alteration or improvement to a building. As leasehold improvements fits the definition of capital works and deductions on leasehold improvements were accounted for under Division 43, the disposal is not considered a balancing adjustment event under subsection 40-285(1) and subsection 40-45(2) applies. Therefore gain or loss on disposal is accounted for as a capital gain or loss pursuant to subsection 104-10(4) of the ITAA 1997.
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