Edited version of your written advice

Authorisation Number: 1051285145356

Date of advice: 13 February 2018

Ruling

Subject: Project pools under Subdivision 40-I

Question 1

Is the relevant design of the new improvements and related experimental land reclamation and monitoring activities a Project for the purposes of Subdivision 40-I of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2(a)

If the answer to question 1 above is yes, will the Project start to operate, for the purpose of section 40-855 of the ITAA 1997, by the time the Project Committee was formed?

Answer

Not applicable.

Question 2(b)

If the answer to question 2(a) is no, will the Project start to operate, for the purposes of section 40-855 of the ITAA 1997, by the time civil works carried out during Stage 1 commenced?

Answer

Not applicable.

Question 3

If the answer to question 1 is no, is the Project, for the purposes of Subdivision 40-I of the ITAA 1997, the construction and operation of the new improvement?

Answer

Yes.

Question 4(a)

If the answer to question 3 is yes, will the Project start to operate, for the purposes of section 40-855 of the ITAA 1997, by the time the Project Committee was formed?

Answer

No.

Question 4(b)

If the answer to question 4(a) is no, will the Project start to operate, for the purposes of section 40-855 of the ITAA 1997, by the time civil works carried out during Stage 1 commenced?

Answer

No.

Question 4(c)

If the answer to question 4(b) is no, will the Project start to operate, for the purposes of section 40-855 of the ITAA 1997, by the time the taxpayer commences to derive assessable income in the form of customer charges levied by the taxpayer prior to the completion of the new improvement?

Answer

No.

Question 4(d)

If the answer to question 4(c) is no, will the Project start to operate, for the purposes of section 40-855 of the ITAA 1997, by the time the new improvement is completed and put to use as intended?

Answer

Yes.

This ruling applies for the following periods:

A specified period

The scheme commences on:

1 July 2010

Relevant facts and circumstances

X Limited (X Co) is an Australian resident company.

X Co as head company formed a tax consolidated group. Y Pty Ltd (Y Co) and Z Pty Ltd are subsidiaries of the tax consolidated group.

Y Co holds the land in relation to the precinct for a specific purpose under a lease (Lease). The Lease was granted to Y Co by the Lessor for a set period with an option to renew.

The terms of the Lease provide Y Co with the right to operate and develop the precinct. Y Co must develop the site at its own cost with regard to the actual and anticipated future growth of the precinct.

At the end of the lease term Y Co does not have the ability to purchase the land. The reversionary interest is held by the Lessor.

The principal activity of Y Co is the operation and development of the precinct.

The Project

X Co through its subsidiary Y Co, is planning to build and operate new improvements contained within the boundaries of the precinct.

The new improvements entail the construction of land based infrastructure involving land reclamation activities.

The design of the new improvements provides maximum flexibility for the design and development of future infrastructure between the existing and new structures.

The new construction will be undertaken in various stages with the relevant stages being:

● Stage 1Civil works

● Stage 2 Foundation works. This stage involves undertaking certain ground treatments to improve geotechnical conditions of the site, sourcing and transport of soil to the site as well as ground settlement monitoring activities, and

● Stage 3 Construction of the new improvement.

X Co uses a pre-defined methodology (M1) to negotiate and set pricing charges with the users of the precinct. These charges are set in advance for a period of five years, based on an agreed rate of return on the relevant capital assets and an estimation of number of customers over the relevant period.

Broadly, M1 is used to determine a revenue amount (Amount X) that is equal to the sum of the underlying components of M1. The components of M1 generally consist of capital expenditure, the return on capital expenditure (or agreed return), and expenditure relating to the operation of the capital assets.

Capital expenditure on which an agreed return is calculated includes the historic asset base (i.e. the historical costs of assets), current period additions and future spend on capital assets.

The reasoning behind the use of this methodology is that it seeks to recover the cost of assets (with an allowed economic benefit or return) over their life. Further, this methodology seeks to match allowable revenue with all relevant costs from day 1 of the relevant asset’s effective life.

In X Co’s case, Amount X is used to set a charge per customer for the use of the improvement. This charge is purely a means to spread the agreed sum total of Amount X over the life of X Co’s asset base (which is effectively considered to be a single asset of X Co’s for the purpose of M1) which, in turn, makes up part of the assessable income derived by X Co.

Accordingly, X Co maintains that its assessable income (i.e. its Amount X) is inextricably linked to its capital expenditure and asset base for its improvement (which includes capital expenditure on the improvement).

Relevant legislative provisions

Income Tax Assessment Act 1997 (ITAA 1997) Subdivision 40-I

ITAA 1997 section 40-25

ITAA 1997 paragraph 40-25(7)(a)

ITAA 1997 section 40-830

ITAA 1997 subsection 40-830(1)

ITAA 1997 subsection 40-830(2)

ITAA 1997 subsection 40-832(1)

ITAA 1997 section 40-835

ITAA 1997 section 40-845

ITAA 1997 section 40-855

ITAA 1997 subsection 995-1(1)

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Question 1

The Project, for the purposes of Subdivision 40-I is not the geotechnical design of the new improvement and related experimental land reclamation and monitoring activities. The relevant Project, for the purposes of Subdivision 40-I is the construction and operation of the new improvement.

The ‘geotechnical design of the new improvement and related experimental land reclamation and monitoring’ “Project”

X Co contends that because of the experimental elements of Phases 1 and 2 Foundation works, it regards the ‘geotechnical design of the new improvement and related experimental land reclamation and monitoring activities’ as the relevant ‘Project’ for the purposes of Subdivision 40-I.

X Co states that the activities that encompass this Project include:

● Formation of the new improvement Committee (this is contended to be the first step undertaken in relation to the Project)

● Stage 1 Civil works, and

● Stage 2 Foundation works (this is contended to be the last activity in the Project and will end when either suitable ground conditions have been achieved or it is determined that suitable ground conditions will be unachievable without significant further work).

The ‘construction and operation of the new improvement’ “Project”

In the alternative, X Co considers the ‘construction and operation of the new improvement’ as the relevant ‘Project’ for the purposes of Subdivision 40-I. This Project includes the following activities:

● Formation of the new improvement Committee (this is considered to be the first step undertaken in relation to the Project)

● Stage 1 Civil works

● Stage 2 Foundation works

● Stage 3 Construction of the new improvement, and

● Operation of the new improvement post construction as part of the broader operations of the precinct.

What is the relevant “Project”- the Commissioner’s view

Subdivision 40-I allows a deduction over the project life for project amounts allocated to a project pool, subject to the conditions in that Subdivision.

For expenditure to be a ‘project amount’ within subsection 40-840(2), a number of requirements must be satisfied. One of these is that the amount must be directly connected with a ‘project’ the taxpayer carries on or proposes to carry on for a taxable purpose: paragraph 40-840(2)(c).

Similarly, the term ‘project life’ is defined in section 40-845 as the length of time (in years, including fractions of years) from when the ‘project’ starts to operate until it stops operating.

While the terms ‘project amount’ and ‘project life’ are defined in Subdivision 40-I, the word ‘project’ is not defined,

Taxation Ruling TR 2005/4 Income tax: capital allowances - project pools - core issues (‘TR 2005/4’) provides guidance to taxpayers on determining whether the activity or activities that they are undertaking (or propose to undertake) qualify as a ‘project’ for the purpose of Subdivision 40-I:

● the word ‘project’ should take its ordinary meaning shaped by the context in which it is found (paragraph 20 of TR 2005/4)

● the word ‘project’, in general terms, means a plan, scheme or undertaking of sufficient substance and be able to be sufficiently identified (paragraph 21 of TR 2005/4)

● a project must be carried on (or proposed to be carried on) for a taxable purpose (paragraphs 23 to 30 of TR 2005/4)

● a project must have a finite life (paragraphs 31 to 33 of TR 2005/4), and

● a project is an activity which is, or a set of related activities which are, distinct from any activity on which the capital expenditure which constitutes a project amount is incurred. That is, a project cannot be the same activity, or a set of related activities, which constitutes a project amount for the purposes of paragraph 40-840(2)(d) (paragraph 22 of TR 2005/4). In this respect, project amounts are often incurred before the project starts to operate (see the binding examples in TR 2005/4 and the explanation in paragraph 91).

Paragraph 49 of TR 2005/4 states that a project is an activity or a set of activities where the activities undertaken and the outcome or outcomes to which they are directed assist in the identification of the project.

The question of whether the activity or set of related activities can amount to a ‘project’ for the purposes of Subdivision 40-I also requires consideration of the remaining factors provided in TR 2005/4 – that is whether the set of activities (project):

● is carried on for a taxable purpose, and

● has a finite life.

i. Project you ‘carry on or propose to carry on’ for a taxable purpose

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):

● the term ‘carry on’ should take its ordinary meaning shaped by the context in which it is found (paragraph 24 of TR 2005/4)

● 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 25 of TR 2005/4)

● holding a passive investment would not have sufficient activity to constitute the ‘carrying on’ of a project (paragraph 26 of TR 2005/4), and

● the words ‘propose to carry on’ require a commitment of some substance to the activity or activities identified as constituting the project (paragraph 27 of TR 2005/4).

ii. Project you carry on or propose to carry on ‘for a taxable purpose’

Paragraph 40-25(7)(a) defines ‘taxable purpose’ as ‘the purpose of producing assessable income’ .

Something is done for the ‘purpose of producing assessable income’ (as defined in subsection 995-1(1)) if it is done:

a) for the purpose of gaining or producing assessable income, or

b) in carrying on a business for the purpose of gaining or producing assessable income.

For a project to be carried on for the purpose of producing assessable income:

● the project itself must be capable of being carried on to produce assessable income (paragraph (a) of the definition), or

● the project must be carried on in the course of carrying on an existing business for the purpose of gaining or producing assessable income (paragraph (b) of the definition).

A project is carried on in the course of carrying on an existing business for the purpose of gaining or producing assessable income if the carrying on of that project occurs in the course of and as an integral part of carrying on that business. This is confirmed in paragraph 30 of TR 2005/4:

30.…a project that is not, of itself, carried on or proposed to be carried on for the purpose of gaining or producing assessable income is, nonetheless, one carried on or proposed to be carried on for a taxable purpose if it is carried on or proposed to be carried on in carrying on a business for the purpose of gaining or producing assessable income. It is not enough that the project merely be carried on or proposed to be carried on while the business is being carried on. Rather, the carrying on or proposed carrying on of the project must occur in the course of and as an integral part of carrying on a business. [emphasis added]

In X Co’s case, the Commissioner notes that the business of X Co and its wholly owned subsidiaries is the operation, development and maintenance of the precinct in accordance with the Lease.

According to the Lease, X Co must develop the precinct at its own cost, having regard to the actual and anticipated future growth of the precinct.

The Commissioner therefore concludes that X Co is in the business of operating and maintaining the precinct in accordance with the terms of the Lease, including developing the site having regard to the actual and anticipated future growth of the precinct.

Given the above observations and conclusions about X Co’s overall business, the Commissioner considers that the construction together with the operation (construction and operation) of a new improvement, intended to provide maximum flexibility between the existing and new structures, is an integral part of X Co’s business as the operator of the precinct.

The Commissioner is satisfied that the series of activities X Co has engaged demonstrates a commitment to carry on the ‘Project’, being the construction and operation of the new improvement. On that basis, the Commissioner considers the ‘carried on’ requirement for the Project is satisfied.

Viewed in this light, the Commissioner considers that the following series of activities comprising the ‘geotechnical design and reclamation activities’:

● Formation of the new improvement Committee

● Stage 1 Civil works, and

● Stage 2 Foundation works

which were completed when the site was accepted as being suitably prepared for the commencement of construction of the required assets are activities that may involve evaluation and design activities, and otherwise represent preparation of the site for the construction of the new improvement (which might involve other depreciating assets and capital works).

The activities (described as geotechnical design of the new improvement and related experimental land reclamation and monitoring activities) do not result in the commencement of construction, or the operation, of a structure such that customers are able to use it. Instead the activities are limited to resolving the geotechnical challenges presented by the chosen setting such that the design and construction of the new structure may commence.

Therefore, the Commissioner does not accept that the activities undertaken during the period which X Co describes as the ‘geotechnical design of the new improvement and related experimental land reclamation and monitoring activities’ constitute a project for the purpose of Subdivision 40-I.

It is the Commissioner’s view that the relevant ‘project’ which X Co is committed to, is the construction and operation of the new improvement at the precinct. The various steps X Co has undertaken, and will be required to undertake in the coming years, are all directed at this specific outcome, namely, the construction and the operation of the new improvement.

In this context, the Commissioner considers the following activities constitute a series of related activities or steps in X Co’s overall project, being the construction and operation of the new improvement:

● Formation of the new improvement Committee (the point at which it is possible that ‘project amounts’ started being incurred, for example, ‘obtaining information for the project’ or ‘feasibility studies for the project’)

● Stage 1 Civil works, and

● Stage 2 Foundation works.

The Commissioner understands that up until the point these ‘Stage1 and 2’ activities are complete, as far as Divisions 40 and 43 are concerned, no depreciating asset(s) have yet begun construction. Therefore the relevant capital expenditures occasioned by what is described in respect of the relevant stages to this point that are factually prior to the commencement of construction of the relevant depreciating assets or capital works are the incurrence of project amounts.

The Commissioner’s view is that, in respect to actual designed and controlled movements and placements of earth, these represent the incurrence of capital expenditure on ‘site preparation for depreciating assets including draining swamp and low-lying land and clearing land’. TR 2005/4 is clear on the incurrence of project amounts prior to a project having commenced operation. See also ATO ID 2009/96 which deals with near identical activities.

● Stage 3 - Construction of the new improvement

From the commencement of the construction of new improvement, the Commissioner expects that most of the incurrence of the cost, or construction expenditure as relevant, to be that of depreciating assets and capital works.

● Operation of the new improvement post construction as part of the broader operations of the precinct

At a point prior to the new improvement becoming operational (when users commence using the new improvement as part of the overall precinct), the relevant depreciating assets, ‘installed ready for use’ or ‘completion of construction of capital works’, have their ‘start time’ or ‘completion of construction’ for the purposes of commencement of decline in value deductions or Division 43 deductions respectively. Consistently and coherently, when the new improvement becomes operational, the project ‘starts to operate’ for the purposes of deductions calculated with respect to the ‘project pool balance’.

iii. A project must have a finite project life

A further essential element of a project for the purposes of Subdivision 40-I is that it must have a finite life that can be objectively and reasonably determined, regardless of whether the project life has yet been quantified by estimation.

Paragraphs 32 and 33 of TR 2005/4 state:

32. A finite project life, then, is an element of a Subdivision 40-I project, not merely a condition which must be present to enable a deduction to be claimed for project amounts allocated to a project pool. If the project is not identified to the point where it can be objectively and reasonably determined that it has a finite project life, there is no project for the purposes of the legislation. Similarly, if the project is identified and it can be objectively and reasonably determined that it does not have a finite project life, there is no project for the purposes of Subdivision 40-I.

33. It necessarily follows that for capital expenditure to be a project amount, a project with a finite project life must exist at or before the time at which the expenditure is incurred. If there is no finite project life, there is no project for the purposes of Subdivision 40-I. If there is no such project, it cannot be said that the expenditure incurred is directly connected with a project carried on or proposed to be carried on for a taxable purpose and the expenditure would not constitute a project amount.

In determining the ‘project life’ of the construction and operation of the new improvement, X Co needs to have regard to a range of factors, including the length of its Lease and the possibility of renewal, and not allow its own intentions regarding carrying on the activity to be a determining factor. In essence, the determination must be made reasonably and objectively and be re-evaluated annually to calculate each year’s deduction calculated by reference to the remaining pool balance.

As a lease is a CGT asset, it is useful to consider the treatment of an option to renew a lease under the CGT provisions, when determining the finite life of the project. Under the CGT provisions, an option to renew a lease, when exercised, is treated as a new lease. This view is supported by the position under the general law, see for example, Gerraty v. McGavin & Anor (1914) 18 CLR 152; (1914) 20 ALR 182, The Minister v. New South Wales Aerated Water and Confectionery Company Ltd (1916) 22 CLR 56; (1916) 23 ALR 10, Rider v. Ford [1923] 1 Ch 541 at 547, and 195 Crown Street Pty Ltd v. Hoare [1969] 1 NSWR 193 at 199.

Although the CGT provisions treat the option to renew as a separate lease, the issue in this case is whether there is a finite life for the operation of the new improvement.

Under expiration or early termination of the Lease, X Co does not have the ability to purchase the land. The reversionary interest is held by the Lessor and the Lease does not provide any other compensation rights in favour of X Co in relation to other infrastructure/ improvements acquired or developed by X Co.

Given X Co’s considerable investment in planning to build and operate the new improvement, and the relatively short time the new improvement can potentially be operational prior to the end of the initial lease, it is reasonable for the Commissioner to conclude that X CO will exercise its option to renew the lease.

The Commissioner understands that should X Co renew the lease, there are no further options for renewal available. This means that the longest possible project life for the new improvement would be marked by the end of the second lease.

The Commissioner considers that an objective determination of the project life of the new improvement would involve an assessment of how long X Co reasonably considers the new improvement would be capable of being operated once it is being used by customers, capped at the expiration of the second lease.

Conclusion

The Commissioner considers that the construction and operation of the new improvement is the relevant ‘project’ for the purpose of Subdivision 40-I. The Commissioner is satisfied that the construction and operation of the new improvement is being carried on for a taxable purpose, in that the building and operation of the new improvement is integral to X Co’s business as the operator of the precinct. X Co will earn assessable income through the operation of the new improvement (in the form of Charges). The project will also have a finite life, as the operation of the new improvement is limited by its design life and ultimately the terms of the Lease.

While the geotechnical design of the new improvement and related experimental land reclamation and monitoring activities are a set of related activities conducted to prepare the site for the construction and operation of the new improvement, they cannot be considered to be a ‘project’ in their own right.

The Commissioner is satisfied that the capital expenditures incurred on the geotechnical design of the new improvement and related experimental land reclamation and monitoring activities are directly connected with the construction and operation of the new improvement and fall within paragraph 40-840(2)(d). Therefore these expenditures constitute project amounts that can be allocated to a project pool and can be deducted over the period from when the new improvement becomes operational until it is expected it cannot continue to be operated from an engineering design standpoint, capped at the expiration of the second lease.

Question 2(a)

As the answer to question 1 is no, it is not necessary to answer this question.

Question 2(b)

As the answer to question 2(a) is not applicable, it is not necessary to answer this question.

Question 3

In line with the reasoning applicable to question 1, the Commissioner considers the ‘Project’ for the purposes of Subdivision 40-I to be the construction and operation of the new improvement.

Question 4(a)

The Project does not start to operate, for the purposes of section 40-855 by the time the new improvement Committee was formed.

Section 40-830 allows certain capital expenditure directly connected with projects (project amounts) carried on or proposed to be carried on by a taxpayer to be allocated to a project pool and deducted over the life of that project (project life). Where a project starts to operate on or after 9 May 2006, the amount of the deduction available in each income year is determined according to the formula contained in subsection 40-832(1). Provided all other legislative requirements are met, section 40-855 provides that you can start to deduct an amount for a project pool ‘for the first income year when the project starts to operate.’

Project amounts can be allocated to a project pool at any time, including before the project starts to operate: see paragraph 91 of TR 2005/4. However, no deduction for any project amount can deducted under subsection 40-830(2) until the first year the project starts to operate: see paragraph 92 of TR 2005/4.

Therefore, the notion of when a project starts to operate is critical in determining when project amounts can be deducted (section 40-855) and the amount of the deduction available in each income year (section 40-845).

The phrase ‘starts to operate’ is not defined for the purposes of Subdivision 40-I, and therefore takes its ordinary meaning shaped by the context in which it is found.

The Oxford dictionary defines ‘operate’ to mean manage, work or keep in functional state, be in action, function.

In the context of Subdivision 40-I, the phrase ‘starts to operate’ was considered by the AAT in Case 9/2009 ATC 1-013. The facts of the case were that a taxpayer, who was a scientist employed within a hospital, undertook a laboratory based project separate to his employment within his own home. At the end of the relevant income year the project had not progressed beyond the experimentation stage, and the taxpayer claimed a deduction in respect of a project amount. In relation to the claim Deputy President Block observed:

36. The project starts to ‘operate’ when the construction or preparatory stage of the project is completed. A project is something that a taxpayer carries on (or proposes to carry on) for a taxable purpose, and so it does not begin to ‘operate’ until the taxpayer starts to do the things that themselves will support that purpose. This means that a project will start to operate when the taxpayer starts to do the things which themselves will produce assessable income. The example given in the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances Bill) 2001 is that, if the project is carrying on a mining operation to produce assessable income, the project will start to operate when the taxpayer starts the extraction activities.

The explanatory memorandum to the New Business Tax System (Capital Allowances) Bill 2001 (the EM) states at paragraph 8.13:

8.13… Because a project is something you carry on (or propose to carry on) for a taxable purpose, it does not begin to operate until you start to do the things that themselves will support that purpose. Generally, your taxable purpose of producing assessable income; a project with that purpose will start to operate when you start to do the things which themselves will produce assessable income. For example, suppose the project is carrying on a mining operation to produce assessable income. The project will start to operate when you start the extraction activities. [emphasis added]

X Co submits that a project to construct something, such as the new improvement, that does not of itself produce assessable income or is independently operated but forms part of the ongoing operation of the precinct, would ‘start to operate’ when the construction commences. X Co argues that the view that a project that involves the construction of an asset only starts to operate when the construction of the asset is complete is nothing more than a convenient way to attribute the period over which associated project pool amounts should be claimed to the period over which other capital allowances would be claimed. However there is no distinction in Subdivision 40-I between projects that yield tangible assets with a finite operating life and projects that do not yield such results. Therefore it seems contrived to attribute when a project ‘starts to operate’ (where that project involves the construction of an asset) to when construction of the asset is complete when other projects (that do not involve the construction of an asset) seem to ‘start to operate’ at the point in time when the project itself starts.

The Commissioner does not accept X Co’s arguments for the reasons outlined in TR 2005/4.

In relation to when deductions may commence, paragraphs 91 and 92 of TR 2005/4 state:

91. Project amounts can be allocated to a project pool at any time, including before a project starts to operate. For example, a feasibility study on whether or not to conduct a project would necessarily be undertaken when it is proposed to carry on the project. Capital expenditure on that feasibility study could be a project amount which can be allocated to a project pool.

92. However, no deduction for any project amounts could be claimed under subsection 40-830(2) until the first year the project starts to operate: section 40-855. [emphasis added]

TR 2005/4 provides guidance on determining when a project starts to operate through a binding example at paragraph 39 (example 1), in which a taxpayer carrying on a business undertakes a project to build and operate a depreciating asset for 30 years. The taxpayer is to build the asset in the first two years (the preparatory phase) and operate the asset for the next 28 years (the operational phase). The asset may have an effective life of 40 or more years.

TR 2005/4 concludes that in the first year of operation, the ‘project life’ is estimated at 28 years, which is the period over which the taxpayer can operate the asset. The taxpayer ‘starts to operate’ the project once the asset is built at the completion of the preparatory phase. That is, if a project involves the construction and operation of an asset, it cannot be held that the project ‘starts to operate’ at any point in time during the construction phase. The construction of the asset is an essential prerequisite to the operation of that asset in instances where the ‘project’ itself involves the construction and operation of the asset.

This demonstrates the Commissioner’s view that a project has a preparatory stage which is distinct from an operational stage. The view is expanded upon in TR 2005/4, at paragraph 49:

49. A project has a start and a finish and is an entirety in itself. However, the point when a project ‘starts’ may be earlier than the point when the project ‘starts to operate’. For example, a project undertaken in carrying on your business which is the construction and operation of a depreciating asset for use in the business has a construction phase before it begins to operate for a taxable purpose… [emphasis added].

The above passage acknowledges the nexus between ‘operation’ and the relevant income producing activities of the taxpayer. That is, the depreciating asset starts to operate when it begins to be operated for a taxable purpose. ‘Taxable purpose’ is defined in subsection 995-1(1) as having the meaning given in section 40-25. Paragraph 40-25(7)(a) defines a taxable purpose relevantly as ‘the purpose of producing assessable income’.

In summary, the Commissioner’s view, as outlined in TR 2005/4, and supported by the above passages, is that a project to build and operate a depreciating asset does not start to operate until:

● the construction phase is completed, and

● the depreciating asset itself starts to be operated to produce assessable income.

The Commissioner’s view is that that when the new improvement Committee was formed, the construction and operation of the new improvement (the ‘Project’ for the purposes of Subdivision 40-I) was still in the preparatory phase, and the construction of the asset has not commenced. Accordingly the Commissioner does not consider the Project to have started to operate for the purposes of section 40-855 when the Committee was formed.

Question 4(b)

In line with the preceding discussion applicable to question 4(a), it is the Commissioner’s view that by the time civil works was carried out during Stage 1, the Project was still in the preparatory phase. Accordingly the Commissioner does not consider the Project to have started to operate for the purposes of section 40-855 at this point.

Question 4(c)

The Project does not start to operate, for the purposes of section 40-855, when X Co commences to derive assessable income in the form of customer charges levied by X Co prior to the completion of the new improvement.

See the discussion under question 4(a) above regarding determining when a relevant ‘project’ starts to operate for the purposes of section 40-855.

X Co argues that the Project started to operate when it began earning assessable income in the form of customer charges referable partially to X Co’s capital expenditure on the Project. Accordingly, X Co argues that it has negotiated to earn a return on its capital investment in the new improvement with its customers, before the new improvement is opened.

The Commissioner disagrees. The Project itself will only produce assessable income when the new improvement forms part of the precinct which X Co operates in accordance with the Lease.

When X Co sets its charges for the use of the precinct in advance using a pre-defined methodology (M1) based on an agreed rate of return on the relevant capital assets and an estimation of number of customers over the relevant period, the new improvement was not yet constructed and therefore cannot be part of the precinct. The new improvement is not yet in action or in function per the ordinary meaning of the word ‘operate’. The fact that the charges are referrable to the capital expenditure incurred in the preparatory stage of the new improvement does not mean that the new improvement itself has begun to operate.

Accordingly, X Co has not satisfied the two elements necessary to signal that its Project had ‘started to operate’ as at the point in time when it commences to derive assessable income in the form of customer charges, namely:

● the construction phase is not completed, and

● the depreciating asset itself has not started to be operated to produce assessable income.

This view is consistent with the ordinary meaning of the word ‘operate’, the example in the EM, the decision in Case 9/2009 and the Commissioner’s view in TR 2005/4. The Project has a preparatory phase which includes planning and construction, and an operating phase, where users will begin to use the completed new improvement as part of the precinct. The preparatory phase has not yet been completed, nor has an asset been built, and therefore the new improvement cannot be said to be operational at this point in time.

The new improvement will only start to operate when it forms part of the operational precinct, for which a charge is then payable.

Question 4(d)

In line with the preceding discussion applicable to question 4(c), by the time customers start using the new improvement as part of the overall precinct, X Co has satisfied the two elements necessary to signal that the Project has started to operate, namely:

● the construction phase is completed, and

● the asset itself has started to be operated to produce assessable income.

Therefore, the Project starts to operate, for the purposes of section 40-855 by the time customers start using the new improvement as part of the overall operation of the precinct.

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