Edited version of your written advice

Authorisation Number: 1051363300828

Date of advice: 23 May 2018

Ruling

Subject: Am I conducting a business and the deductibility of capital expenses.

Question 1

Are you carrying on a business?

Answer 1

No

Question 2

Can you claim deductions under section 8-1 of the Income Tax Assessment Act 1997 (ITTA 1997) in relation to interest incurred on your loan to purchase land for the purposes of establishing a guesthouse?

Answer 2

No

Question 3

Can you claim deductions under section 40-880 of the ITAA 1997 on capital expenses relating to a proposed guesthouse?

Answer 3

No

Question 4

Can you include expenses you have incurred in the cost base of the land?

Answer 4

Yes

This ruling applies for the following periods:

Year ending 20XX

Year ending 20XX

Year ending 20XX

Year ending 20XX

Year ending 20XX

Year ending 20XX

Year ending 20XX

Year ending 20XX

Year ending 20XX

Year ending 20XX

Year ending 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You, being L and M are business partners operating Z entity which provides consultative services (consultative services).

These consultative services were established in 20XX

You have registered Z as a business name and obtained an ABN in 20XX.

The consultative services you provide include events and the production of visual material.

For the income years from 20XX to 20XX, L recorded business/ non primary production income in X income years.

You have projected that consultative service income L will derive in the 20XX-XX income year will be $X,XXX.

M works full time. L previously worked full time until the 20XX income year.

You jointly purchased land (the land), with settlement of the sale occurring on 20XX.

The purchase price for the land was $XXX,XXX. You took out a loan for the amount of $XXX,XXX which covered the purchase price, stamp duty and disbursements. This loan was an investment loan with a maturity date of 20XX.

The land is regulated by a covenant on the title.

You are proposing to build short term guesthouse accommodation (guesthouse), and an onsite manager’s residence (manager’s residence) which you propose to live in, and to fit-out an existing building to create additional space for guests staying in the guesthouse The guesthouse and manager’s residence will all be joined together under one roof line.

The existing building has been rented since 20XX-XX income year and the $XX,XXX annual rent received is used to meet some of the holding costs of the land.

The guest house would be offered as short term accommodation for families and private hirers and would showcase sustainable development and interact with the existing walking trails..

The land and proposed guesthouse will be used to undertake activities as part of your consultative services, such as events and workshops. You have not undertaken any consultative or event activities on the land, but are planning to run an event this year and commercially cater and set up tents for this event.

You developed in 20XX a business plan for your consultative services (business plan), which incorporates details of your guest house. The plan identified your strengths and weaknesses and opportunities to attract intrastate, interstate and overseas guests. You identified the following unique qualities of your proposed guesthouse:

● Your accommodation is in proximity to open space and tourism facilities.

● Few consultative services offer the service and have the experience that you can offer.

Your business plan contains projections on the profits you expect to derive from the proposed guesthouse in years 1 to 3. Income derived from your proposed activities will consist of rental income, consultative service income and income from operating the guesthouse.

You both spend on average 10 hours per week in undertaking Z activities, including overseeing contractors, general maintenance of the land, undertaking consultative services and event management functions and liaising with stakeholders to develop the guesthouse proposal.

You engaged professionals to liaise with and obtain development approval through the Council (Council).

You engaged an architect during 20XX-XX to prepare conceptual plans to obtain Council approval. The conceptual plans dated 20XX originally showed X separate buildings, a proposed new residence near the existing building and parking spaces.

Structural footing and slab plans were developed in 20XX.

You engaged a town planner consultant (town planner) from 20XX-XX.

Throughout 20XX-XX, the town planner liaised with and or met with a number of stakeholders to obtain their support and approval for the guesthouse. These stakeholders included:

● Discussions with the C

Discussion between the town planner and a representative from C in relation to the environmental report occurred in 20XX. From 20XX, you, the town planner and a representative from the C made changes to the environmental report.

● Discussions with the architect

Discussions with the architect and town planner occurred in 20XX and comments and plans were exchanged.

● Meeting with the Council staff.

The town planner met with the council town planner in 20XX to discuss the tourism and environmental impacts of the development. Further discussions occurred with the town planner and Council town planner in 20XX. You and the town planner discussed in 20XX the agenda and presentation that will be made to Council in relation to your business plan.

In 20XX, you, the town planner and Council planner met to discuss your business proposal.

From 20XX, the town planner spoke to the council planner and other officers of Council requesting a letter of support from the Council for the subdivision and development of the guesthouse. The planner wrote to the Council regarding the zoning requirements of the land in 20XX. The planner met with Council staff in 20XX on the land to discuss the clearing area for the development and access. Throughout this time, correspondence was received from Council, and the town planner and you discussed Council’s requirements.

● Interaction with D

The town planner wrote to D in 20XX regarding the conservation restriction and received correspondence from D that the conservation order was approved in 20XX.

The town planner met D in 20XX to discuss the conservation restriction.

In 20XX, the town planner wrote to a number of other stakeholders in relation to the conservation restriction.

● Interaction with the F

The town planner reviewed the quotation prepared by F in 20XX. A plan was prepared by B in 20XX.

● Interaction with the environmental consultant

In 20XX, a meeting occurred with you, the town planner and environmental consultant.

● Other authorities the town planner engaged with included the following:

The town planner reviewed the requirements of R in 20XX.

The town planner held discussions with W in 20XX.

In 20XX, you obtained conditional approval from Council to subdivide the land. The subdivision was conditional on development approval being granted for the guesthouse.

A contractor was engaged in 20XX to complete the driveway to allow safe access to the land.

A quotation submitted by W was reviewed and discussed with you in 20XX.

The consultant completed a report in 20XX.

An agency approved the guesthouse, including the manager’s residence being constructed within the building envelop in 20XX.

In 20XX, the town planner held further discussions with the Council and D in relation to the existing building being included in the tourism proposal. The town planner wrote to a representative from the D in 20XX to obtain support for the guesthouse and approval was received in 20XX.

In 20XX, W completed services on the land.

Extensive site coverage on your land have restricted the scale of your guesthouse, with a requirement that all buildings being contained within a building envelop. As a result of these restrictions, you modified your original conceptual plans for separate guesthouses, to include one building which would contain X separate guesthouse rooms, a shared congregation space and a manager’s residence. The architectural services to obtain planning consent were submitted in 20XX and included the design and development of conceptual plans.

In 20XX the town planner wrote to Council seeking support for the guesthouse.

In 20XX, the town planner discussed the conservation restriction and building envelop requirements and modification of plans to meet the building envelop requirements with a number of stakeholders.

In 20XX, a development application was submitted to Council for approval. At the same time, a presentation was made to Council highlighting the eco-tourism and conservation benefits of the guesthouse and various design options.

From 20XX, the town planner negotiated with various government stakeholders in relation to the development approval and building envelop requirements for the existing building to be included in the approval..

Council approval was granted in 20XX. Some of the conditions of approval restrict the scale and operation of the guesthouse.

Subdivision approval relating to a portion of the land was approved by Council in 20XX following development approval being granted by the council for the guesthouse.

The conservation restriction was approved in 20XX.

Your business plan has identified and quantified other expenses associated with the construction of the guesthouse, including power connection costs, driveway, crossovers and firebreaks. Some of these capital expenses relating to construction works have already been incurred by you. You have also incurred considerable capital expenses in producing reports and studies to obtain Council development approval and approval from other stakeholders in relation to the proposed guesthouse.

You have also incurred considerable Interest expenses from 20XX-XX.

In 20XX, you engaged a real estate agent to sell a portion of the land that you had subdivided to raise finance to fund the guesthouse. The land was sold in 20XX. The area of the land sold was approximately XX% of the original area you acquired in 20XX.

You intend to proceed with the guesthouse, attached manager’s residence and refurbishments to the existing building even though your original Council development approval lapsed in 20XX.

Following planning approval in 20XX, you weren’t able to commence construction of the guesthouse due to the following reasons:

● Your borrowing capacity was reduced because of the drop in the valuation of your land.

● The property market had experienced a down turn and it took some time to sell part of your subdivided land.

● You had concerns around the financial viability of the guesthouse given you had to scale back your original concept of X guesthouses to one building containing X rooms for guests and a managers residence. Restricting the activities conducted in the existing building to only guests residing in the guesthouse, meant that your income would be affected.

You have estimated the construction costs of the guesthouse and manager’s residence as approximately $XXX,XXX. In 20XX you obtained pre- approved bank finance for a loan to the value of $XXX,XXX to meet these construction costs. You have also identified $XX,XXX in shares that you hold which will be liquidated to finance the construction costs.

In 20XX you discussed with the town planner you had previously engaged to obtain information on how to renew your development approval with Council and the ramifications of making modifications to the original development approval.

The feedback from the town planner was that Council was likely to re-issue development approval for the guesthouse and manager’s residence based on the original designs approved by Council in 20XX.

You successfully obtained a grant in 20XX to assist you in your consultative services. The grant was used to register your website domain, register your consultancy service business name and establish your consultancy service as a partnership in 20XX. You are currently designing a website and plan for it to be operational this year. Events being conducted by Z and bookings for the guesthouse will be promoted via an online presence. When the guesthouse is constructed it will be promoted through online booking agencies.

You both wish to develop the guesthouse and manager’s residence along with your consultative services to generate sufficient income which would allow you to operate the activity full time.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 40-880

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Summary

Your activities in investigating and planning for the construction of a proposed guesthouse do not constitute the carrying on of a business. The proposed short term guesthouse and consultative services undertaken as part of Z are independent activities of a preliminary nature. The leasing of the existing building is a passive subsidiary activity aimed at meeting your land holding costs.

Detailed reasoning

There are two potential treatments of the development of your guesthouse and manager’s residence. These are:

● Your activities are considered to be carrying on a business, or

● Your activities are a capital development.

Carrying on a business

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

Whether or not a business is being carried on is a question of fact and is determined in the weighing up of the relevant indicators. These indicators are outlined in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production (TR 97/11) and include:

● whether the activity has a significant commercial purpose or character

● whether the taxpayer has more than just an intention to engage in business

● whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

● whether there is regularity and repetition of the activity

● whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

● whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

● the size, scale and permanency of the activity, and

● whether the activity is better described as a hobby, a form of recreation or sporting activity.

TR 97/11 states the indicators must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case.

TR 97/11 provides that where the overall profit motive appears absent and the activity does not look like it will ever produce a profit, it is unlikely that the activity will amount to a business.

Your activities have been evaluated against the indicators in TR 97/11 as follows:

Significant commercial purpose

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

TR 97/11 states that to show a significant commercial purpose or character, it may be helpful to know whether the taxpayer has ensured that the size and scale of the activity is sufficient for a commercial enterprise.

Your business plan contains forecasted income for Z as consisting of income from separate and discrete activities including consultative services, a proposed guesthouse which will provide short term accommodation and the continuation of leasing the existing building for the first year of operating the guesthouse. All these activities are independent of each other, in terms of the activities providing different services at different locations. The consultative services you have provided consist largely of no more than two contract services per income year, that generate income through a combination of events and using a range of mediums. You have only organised one event which will be conducted on your land in 20XX.

Your activities are preliminary in nature and consist of:

● Developing and registering your business structure and website and social media presence for Z which has been facilitated by a grant you received in 20XX.

● You are still trying to renew your existing development approval for the guesthouse and manager’s residence which lapsed in 20XX.

Intention of the taxpayer

The carrying on of a business is not a matter merely of intention, It is also a matter of activity. It is appropriate to look at when the activities started and whether they add up to more than a mere intention to conduct a business.

You had an intention to develop a guesthouse for short term accommodation. While you had conceptual plans developed in 20XX and funded the purchase of the land through an investment loan, the exact nature and scale of your guesthouse was subject to negotiations and approvals from a range of stakeholders. These negotiations and approvals resulted in new plans being developed 20XX for what was essentially a scaled back development. Following development approval in 20XX, you delayed commencement of construction of the guesthouse because of concerns around the profitability of a smaller scale guesthouse. Your development approval lapsed in 20XX and it was during 20XX to 20XX calendar year that you attempted to sell part of the land you had subdivided to fund the construction costs of the guesthouse. You renewed discussions with your town planner in 20XX to reapply for development approval again, still unclear whether to seek approval based on the original plans approved in 20XX or modifications to these plans.

Prospect of profits

The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business of the taxpayer.

TR 97/11 states that it is important that the taxpayer is able to show how the activity can make a profit. Stronger evidence of an intention to make a profit occurs when the taxpayer has conducted research into his/her proposed activity, consulted experts or received advice on the running of the activity and the profitability of it before setting up the business (FC of T v JR Walker 85 ATC 4179.

You and the town planner you engaged had detailed discussions with stakeholders during 20XX to 20XX. You have demonstrated interest in reviving your guesthouse in 20XX when you instructed the town planner to make contact with the Council to obtain new approval. You have sought pre- approved finance for the construction of the guesthouse in 20XX, which was only possible due to the additional finances you achieved through the sale of part of your subdivided land. No activities have been undertaken by you to realise a profit from providing short term accommodation.

Your consultative service activities have generated net losses during the 20XX to 20XX income years. You made a net profit in the 20XX-XX income year. From the 20XX to 20XX income years you generated no income through your consultative service.

Repetition and regularity

The taxpayer's activities should involve repetition and regularity and have an air of permanence about them.

There has not been any repetition or regularity in activities undertaken by you for the purposes of generating assessable income through your proposal to develop a guesthouse. Pre development approval discussions occurred with various stakeholders predominantly from 20XX to 20XX, but you haven’t commenced any actual construction since acquiring the land in 20XX. Your original development approval lapsed in 20XX and at this time the guesthouse development was contingent on you selling part of the land you had subdivided and placed on the market for sale in 20XX. You have recently re engaged your town planner to renew your development approval.

Your consulting activities consist of no more than 1-2 projects that L undertakes each year and during the income years from 20XX-20XX no income from these consultative services was derived.

Income derived from leasing out the existing building is not considered income derived from carrying on a business and is considered passive income that contributes to meeting the holding costs of the land.

Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business

If a taxpayer carries out their activity in a manner similar to other taxpayers in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer's operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business (IR Commissioners v. Livingston 11 TC 538).

This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to the fact that a business exists.

You have not demonstrated the continuation of activities that amount to carrying on a business since acquiring the land. There was a significant time delay in developing conceptual plans and an engineering report. The engagement of the town planner from 20XX to 20XX who renegotiated with various stakeholders, demonstrated a commitment to develop the guesthouse, however your activities became latent and resulted in development approval lapsing. No building works or eco- tourism activities, with the exception of one event planned for 20XX have been conducted on your land.

Organisation in a business-like manner, the keeping of books, records and the use of a system

The activities conducted by or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If the activities are carried out on the taxpayer's behalf by someone else, there should be regular reports provided to the taxpayer on the results of those activities.

Prior to obtaining development approval, you held discussions with various stakeholders researching land use and zoning requirements, but you have not progressed these discussions into any activity that has the potential to generate income.

The size and scale of the activity

The business should be large enough to make it commercially viable.

The original development approval for the alterations to the existing building limited usage to guesthouse residents, which is restricted to no more than X guests being on your land at any one time. This condition restricts the income earning potential of the existing building being used as a space by guests. You have provided financial projections for the guesthouse operations which, includes income from leasing the existing building, restricting the income from activities that can be conducted on your land.

The size and scale of your guesthouse has been restricted to one building within the building envelop that contains a single guesthouse with accommodation for X guests and an attached manager’s residence. You are currently investigating renewing your development approval that had lapsed and submitting either the same or modified plans to council.

Conclusion

At this time, your activities of investigating and planning a guesthouse, manager’s residence and the fit out of the existing building to create a space for guests are preliminary and still subject to Council approval.

Your proposed guesthouse would be considered to be a capital investment.

Your activities in undertaking consultative services are independent activities from the guesthouse proposal and lack repetition and regularity and a scale to be considered a business. You have only since 20XX obtained funding to establish the business structure and website for this activity.

The leasing income from hiring out the existing building is not considered income derived through operating a business, but passive income that meets the holding costs of your land.

Question 2

Summary

Interest incurred on a loan taken out to purchase land for your proposed guesthouse and manager’s residence is not deductible under section 8-1 of the ITAA 1997 as there is not a sufficient nexus between the payments of interest and the carrying on of a business for the purpose of gaining or producing your assessable income.

Detailed reasoning

Subsection 8-1(1) of the ITAA 1997 allows a deduction for any loss or outgoing to the extent that:

1. it is incurred in gaining or producing your assessable income; or

2. it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

However, subsection 8-1(2) of the ITAA 1997 provides that a loss or outgoing is not deductible to the extent that:

1. it is a loss or outgoing of capital, or of a capital nature;

2. it is a loss or outgoing of a private or domestic nature;

3. it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

4. a provision of [the ITAA 1997 or the ITAA 1936] prevents you from deducting it.

The deductibility of interest is typically determined through an examination of the purpose of the borrowings and the use to which the borrowed funds are put.

In Softwood Pulp and Paper Ltd v FC of T 76 ATC 4439, the outgoing was incurred functionally too soon and it was held that expenses relating to establishing a paper production industry was not deductible as they were held to be entirely preliminary and directed at deciding whether or not an undertaking would be established to produce assessable income.

In Steele v FC of T 97 ATC 4239 (Steele’s Case), the Federal Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production in the form of a mote. The court held that where interest is a recurrent payment to secure the use of funds for a limited time, the interest is regarded as a revenue item and its character is not altered by reason of the borrowed funds being used to purchase a capital asset to be used to generate assessable income in the future.

In Steele’s case and Taxation Ruling TR 2000/17 Income tax: deductions for interest following the Steele’s decision, interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances:

● The interest is not incurred ‘too soon’, is not preliminary to the income earning activities, and is not a prelude to those activities;

● The interest is not private or domestic;

● The period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is not lost;

● The interest is incurred with one end in view, the gaining or producing of assessable income;

● Continuing efforts are undertaken in pursuit of earning assessable income.

The court in Steele’s case held that continuing efforts should not be taken to require constant site development activity. The court said

“However, if a venture becomes truly dormant and the holding of the asset is passive, relevant interest will not be deductible even if there is an intention to revive that venture sometime in the future”.

The full Federal Court in Steele’s case referred to comments by Justice Lockhart in FC of T v Total Holdings (Australia) Pty Ltd (1979) 79 ATC 4279 qualified the availability of a deduction for interest in the following circumstances:

“…..If a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income earning activities, whether those activities are properly characterised as the carrying on a business or not, generally the payment by him of that interest will be an allowable …”

“I say generally as some qualification may be necessary in appropriate cases for instance, where interest is paid by a taxpayer as a prelude to his being in a position whereby he may commence to derive income. In such cases the requirements that the expenditure be incidental and relevant to the derivation of income may not be satisfied”.

Application to your circumstances

Your circumstances are distinguished from the facts in Steele’s case. In your case, interest incurred by you on the loan taken out to purchase land occurred over a long period before any plans were developed, submitted and approved by various stakeholders, including Council. For example, it took over X years from purchasing the land until conceptual plans were developed and a further XX months after the conceptual plans were developed before the structural report and soil test were carried out. There was a period of dormancy of XX months after the engineering plans were developed before you engaged a town planner. From 20XX to 20XX, there is evidence that you and the town planner liaised with, met and negotiated with stakeholders to obtain approval, quotations and environmental reports in order to submit plans to Council in 20XX to obtain development approval. From 20XX to 20XX further negotiations were undertaken by the town planner, Council and other stakeholders to obtain approval for the development. This additional consultation was necessary due to you having to modify your scale, size and layout of your guesthouse in order to comply with the land restrictions and to incorporate the existing building into your proposed guesthouse development.

In your case, no building works have ever commenced on the land, except the installation of drainage and a driveway cross- over. No income has been derived from the use of the land as a guesthouse except income associated with a subsidiary activity involving the leasing of the existing building. You developed conceptual plans in 20XX based on a budget, but the scale of the development was modified to comply with the building envelop requirements. Your development approval lapsed in 20XX and it was only in 20XX that you investigated renewing this approval and possibly modifying the development.

The level of uncertainty surrounding the development in terms of what council would approve and the scale of activities that will allow you to derive a profit and the time that has elapsed since you acquired the land demonstrates that your activities were of a preliminary nature to establishing any assessable income in carrying on a business.

Your circumstances are in contrast with Steele’s case, where there was no uncertainty surrounding the zoning and use of the land and scale of development that would be approved by Council. Mrs Steele satisfied herself that the necessary approvals would be given before entering into a contract to purchase the property. She engaged an architect and construction company and obtained reports in respect of the proposed building works and submitted a plan to Council within 12 months of purchasing the land. Mrs Steele also entered into an agreement with a third person within 13 months after acquiring the land to work through Council issues and to fund the development. She obtained ‘in principal’ approval from Council within 14 months from the date of acquiring the land. Plan changes and a new approval were issued by Council within 2 years, 5 months from the land acquisition date. Due to a breakdown in the relationship between Mrs Steele and a third party, the land remained undeveloped and a decision was made to auction the land within 4 years, 7 months following the original date of acquisition. The land eventually sold after legal proceedings between Mrs Steele and the third party, which occurred 6 years after she had originally acquired the land.

In your case, you can apportion the deduction on interest expenses relating to the periods in which you leased the existing building located on your land on a reasonable basis in accordance with the first limb of section 8-1 of the ITAA 1997. The interest on that proportion of the money borrowed to acquire the land for the purposes of constructing a guesthouse can form part of the third element of the cost base.

Question 3

Summary

Consultancy expenses, Council development fees, expenses associated with developing plans and conceptual drawings and capital construction expenses are not deductible under section 40-880 of the ITAA 1997 as:

1. they were not incurred in carrying on a proposed business for the purposes of gaining or producing assessable income and

2. can be included in the cost base of the land.

Detailed reasoning

Section 8-1 of the ITAA 1997 allows you to claim a deduction for a loss or outgoing that is incurred in gaining or producing your assessable income, or necessarily incurred in carrying on a business to gain or produce assessable income. These deductions are limited by the exclusion of losses or outgoings that are capital, private or domestic in nature.

What constitutes capital expenditure?

Generally, expenditure which produces some asset or advantage of a lasting or enduring character for the benefit of the business will be considered capital expenditure. As stated in Sun Newspapers Ltd and Anor v Federal Commissioner of Taxation 61 CLR 337, an enduring benefit does not require that the taxpayer obtains an actual asset, it may be a benefit which endures, in the way that fixed capital endures.

Purpose of section 40-880 of the ITAA 1997

The object of section 40-880 of the ITAA 1997 is to make certain business capital expenditure deductible over five years if the expenditure is:

● not deductible under another part of the Act; and

● another provision of the Act does not deny a section 40-880 of the ITAA 1997 deduction; and

● the expenditure relates to a business which is, was or is proposed to be carried on for a taxable purpose.

Limitations and exceptions to the operation of section 40-880

1. You must be proposing to carry on a business for a taxable purpose

A deduction is limited under subsection 40-880(3) of the ITAA 1997 to the extent that the taxpayer carries on a business or proposed business for a taxable purpose.

The taxpayer’s subjective intentions are not sufficient evidence of whether there is a proposed business. At the time they incur the expenditure they need to be able to identify the business they propose to carry on and demonstrate a real commitment to commence that business. The taxpayer needs to demonstrate more than just a vague or imprecise idea to start a business.

Subsection 40-25(7) of the ITAA 1997 defines a taxable purpose to mean “the purpose of producing assessable income”. Section 995-1 of the ITAA 1997 further provides that something is done for a taxable purpose if it is done for the purpose of gaining or producing assessable income or in carrying on a business for the purpose of gaining or producing assessable income.

The taxable purpose of the business is tested at the time the expenditure is incurred. Where expenditure is incurred for a proposed business, the test takes into account the known or predictable facts about the taxable purpose of the business in the future, not just the year in which the expenditure is incurred.

The proposed business must be carried on within a reasonable time

Section 40-880(7) of the ITAA 1997 states that:

“You cannot deduct an amount under paragraph 2( c) in relation to a business proposed to be carried on unless, having regard to any relevant circumstances, it is reasonable to conclude that the business is proposed to be carried on within a reasonable time”

In considering the term ‘proposed to be’, paragraphs 2.31, 2.32 and 2.33 of the Explanatory Memorandum to Tax laws Amendment (2006 measures No. 1) Bill 2006 states:

“2.31 For a business to be proposed to be carried on for the purposes of this provision, the taxpayer needs to be able to demonstrate a commitment of some substance to commence the business, and sufficient identity about the business that is proposed to be carried on. The deductibility of expenses in advance of the business being carried on will rest on the facts of each case, but his commitment and identify must be tangible; that is, there would need to be some evidence that would enable an objective assessment of the existence of that commitment and identity.

2.33 Such a commitment could be shown by, but is not limited to, at least some of the following:

● A business plan

● The establishment of a business premises;

● Research into the likely markets or profitability of the business; and

● Capital investment in assets of the investment”.

b. The capital costs form part of the cost base of the land

Section 40-880(5)(f) states

You cannot deduct anything under this section for an amount of expenditure you incur to the extent that:

…………

(f) it could apart from this section be taken into account in working out the amount of a capital gain or capital loss from a CGT event.

Application to your circumstances

Section 40-880 of the ITAA 1997 allows capital expenditure incurred by a proposed business to be deducted in either the income year in which it occurs for specific expenditure and for other capital expenditure incurred in relation to a proposed business to be deductible in equal proportions over five income years.

In your case, consultancy fees to engage professionals and architectural plans prepared for the purposes of obtaining Council approval are non-recurrent expenses of a capital nature made for the purpose of obtaining an enduring benefit, that is, allowing a proposed short term accommodation business to operate on your land. Similarly drainage works and a driveway cross- over are capital in nature.

You can only deduct the expenditure for a business you propose to carry on for a taxable purpose. Whether a business is proposed to be carried on is determined objectively by assessing the level of commitment and whether sufficient identity about the business that is proposed to be carried exists.

A business that is proposed to be carried on must be carried on within a reasonable time so that the requisite relationship between the expenditure and the proposed business can be satisfied.

In your case, there have been significant temporal delays since acquiring the land in 20XX as demonstrated by the following:

(a) It has taken a substantial period of time from acquiring the land until conceptual plans were developed in 20XX.

(b) It took approximately X years from acquiring the land in 20XX until structural plans were developed for the guesthouse.

(c) While there is demonstrated continuous activity by you and the town planner you engaged throughout 20XX to 20XX to obtain approval from a number of stakeholders, your development approval granted by Council in 20XX lapsed in 20XX without any significant construction works commencing.

(d) Following Council’s development approval granted in 20XX, your proposed development has remained dormant and there was a level of uncertainty and lack of identity around the economic viability of a scaled back development, which hindered your progress and also ability to attract finance to meet the construction expenses.

(e) While you attempted to sell a portion of the land that you subdivided to fund the guesthouse in 20XX, you discontinued your activities in advancing the guesthouse until 20XX when you re opened conversations with the town planner you originally engaged to reapply for approval. While we can appreciate that it took you some time to sell the subdivided land which would provide you with funds to construct the guesthouse, you did not continue to advance the guesthouse until 20XX, which involved you obtaining pre- approved finance more recently. Even know, you are still awaiting approval from Council to obtain development approval.

These temporal delays and dormancy in progressing your guesthouse leads to a conclusion that the expenses incurred by you don’t have the necessary nexus with carrying on a proposed business for the purposes of gaining or producing your assessable income.

Furthermore, the operation of section 40-880 of the ITAA 1997 is limited in your case by the operation of section 40-880(5)(f) which prohibits a deduction under this section if the deduction could be taken into account in working out the amount of a capital gain or loss. Such capital costs identified in this ruling can form part of the cost base of the land in which you own.

Question 4

Summary

The capital expenses you incurred can be included in your cost base.

Detailed reasoning

Capital gains tax (CGT) is the tax you pay on certain capital gains you make. You may make a capital gain or capital loss as a result of a CGT event (section 102-20 of the ITAA 1997).

The most common event is CGT event A1. CGT event A1 happens when you dispose of an asset to someone else, for example, you sell your property. The sale of the block of land constitutes CGT event A1 (section 104-10 of the ITAA 1997).

Section 110-25 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the cost base of a capital gains tax (CGT) asset consists of five elements.

The first element of the cost base, being the acquisition costs, is the total of the money paid, or required to be paid, and the market value of the property given, in respect of the acquisition.

The second element of the cost base are the incidental costs that the taxpayer incurs in acquiring the asset which relate to a CGT event that happens in relation to the asset (subsection 110-25(3) of the ITAA 1997).

The third element is the non-capital costs of ownership of an asset (subsection 110-25(4) of the ITAA 1997). A non-capital cost of ownership of an asset is any expenditure in connection with the continuing ownership of the asset. These costs include interest on money borrowed to acquire an asset, costs of maintaining, repairing and insuring an asset, rates and land tax, interest on money borrowed to refinance the money borrowed to acquire an asset, and interest on any money borrowed to finance capital expenditure incurred to increase an asset's value.

The fourth element is capital expenditure incurred to increase or preserve the value of the CGT asset (subsection 110-25(5) of the ITAA 1997).

The fifth element is capital expenditure that you incur to establish, preserve or defend your title to the asset, or a right over the asset (subsection 110-25(6) of the ITAA 1997).

Application to your circumstances

The capital expenditure incurred in engaging a town planner and other consultants, an architect to prepare conceptual plans and the expenses in obtaining development approval would be considered capital expenses under the fourth element of the cost base aimed at increasing the asset’s value.

The fourth element of the cost base would also include capital improvements made to your land such as the driveway cross over and drainage works.

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