Edited version of private advice

Authorisation Number: 1051534807469

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise specified.

Date of advice: 01 July 2019

Ruling

Subject: Commissioner's discretion under subsection 40-365(3)

Question 1

Will the Commissioner exercise his discretion under subsection 40-365(3)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow the taxpayer further time to incur expenditure or start to hold replacement assets to 30 June 20XZ?

Answer

Yes

This ruling applies for the following periods:

·    Year ending 30 June 20XT

·    Year ending 30 June 20XU

·    Year ending 30 June 20XV

·    Year ending 30 June 20XW

·    Year ending 30 June 20XX

·    Year ending 30 June 20XY

·    Year ending 30 June 20XZ

The scheme commences on:

Year ending 30 June XT

Relevant facts and circumstances

The taxpayer is the head company of a consolidated group ('the Group') which operated a production facility.

A related trustee company of a unit trust ('Subsidiary A') owns freehold land in Australia on which the production facility, was built (the "Facility").

A subsidiary of the Group ('Subsidiary B') has been the operator of the Facility since it was acquired by Subsidiary A pursuant to an agreement between Subsidiary A and Subsidiary B (referred to as the "Lease Agreement").

Subsidiary B constructed, acquired, and held plant and equipment ("depreciating assets") for use in carrying on its business at the Facility.

Subsidiary B has been claiming deductions for the decline in value of the depreciating assets on the basis that these assets are Division 40 assets.

During the year ending 30 June XT a fire occurred at the Facility (the "Fire") which brought production at the Facility to an immediate standstill.

As a result of the Fire, the Facility sustained extensive damage. The majority of the depreciating assets at the Facility were destroyed (the "destroyed depreciating assets"), some depreciating assets were subsequently abandoned (the "abandoned depreciating assets"), and some depreciating assets remain on-hand and in use.

The Group had a comprehensive insurance policy and various related policies issued by co-insurers, covering 'Material Loss and Damages' and 'Consequential Losses' (together the "Insurance Policy"). Shortly after the Fire the Group initiated a claim under the Insurance Policy in relation to the Fire (the "Claim").

The Insurers agreed to indemnify the Group in relation to the Claim and further agreed that the Group was entitled to be indemnified for the cost of reinstatement of the destroyed depreciating assets. The Insurance Policy permitted the reinstatement of the depreciating assets to occur on an alternative site.

The Group engaged a third party to represent it during the insurance assessment process, and to assist in the evaluation of options for replacement of the Facility.

The Group received a number of partial settlements of the Company's entitlement under the Insurance Policy (Interim Payments).

Subsidiary A then settled on the purchase of a parcel of land and secured an additional adjacent property several weeks later, to support the replacement of the Facility.

The Company and its Insurers agreed to settle the Company's Claim for a final settlement payment to both Subsidiary A and Subsidiary B (net of the Policy Excess and inclusive of the Interim Payments) ("Settlement Payment").

Later the Group received the remaining instalments of the Settlement. Those monies are currently on deposit with a financial institution.

A third party was then commissioned to design a fully functional processing facility that would be implemented using a staged/modular methodology.

Subsequently the third party provided Subsidiary B with a summary letter ("Summary") which outlines the proposed final design and costings for a new facility to replace the Facility lost in the Fire.

The replacement program for the Facility will be a multi-stage, multi-faceted program expected to take at least X years. The Company management has committed substantial resources to evaluating the various options available to replace the Facility. However, factors such as the capacity of the Company's management to project manage a project of this scale, the availability of workforce, market access, and environmental and operating conditions, create an environment in which the replacement of the Facility will necessarily be undertaken over a period of years.

The Company announced a replacement of the Facility. Due to the scale and complexity of this project, the precise design, scale, and extent of the new Facility will remain under development and is subject to regulatory approval. Due to the significance of the project and the staged manner in which it will be undertaken, replacement assets will be acquired across the life of the project.

Based on insurance proceeds attributable to the destroyed depreciating assets and the written down value and associated amounts, the Company has calculated a total Balancing Adjustment Gain.

Given the scale and complexity the Company consider it is reasonable that it will incur expenditure to acquire replacement assets for the destroyed depreciating assets over the life of the project, up to and including the year ended 30 June XZ.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 40-365

Reasons for decision

Section 40-365 of the ITAA 1997 allows a taxpayer to choose ('the Choice') whether or not to include a balancing adjustment amount in their assessable income where they cease to hold a depreciating asset because it is destroyed.

The taxpayer can choose to use some or the entire amount that would otherwise be a balancing adjustment as a reduction in the cost and/or opening adjustable value of one or more replacement assets. The cost of the replacement asset or assets is reduced by the otherwise assessable amount.

One of the requirements for the taxpayer to be able to make this choice is that they incur the expenditure on a replacement asset, or start to hold it, no later than one year, or within a further period the Commissioner allows, after the end of the income year in which the balancing adjustment occurred (paragraph 40-365(3)(b) of the ITAA 1997).

In this instance the depreciating assets were destroyed by fire on during the year ending 30 June 20XT. Therefore, under paragraph 40-365(3)(b), unless an extension is granted, the Company has until the end of the year after the year ending 20XT (i.e. 30 June 201U) to incur the expenditure on the replacement assets.

The Company is seeking an extension to 30 June 20XZ to incur expenditure on replacement assets.

In looking at the circumstances in which the Commissioner allows a further period the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Act 2001 (the EM) states at paragraph 3.82:

Examples of when the Commissioner may allow a further period under paragraph 40-365(3)(b) include:

                 ·    in the event of a destruction of large infrastructure assets it will be likely to take... more than 12 months to rebuild those assets, and there are no suitable corresponding assets acquired within 12 months before or after the destruction; or

                 ·    in the event of the replacement asset being acquired from overseas it will be likely to take more than 12 months to deliver such assets, and there are no suitable corresponding assets acquired within 12 months before or after the destruction.

In looking at all the above examples in which the Commissioner allows further time the factors that the Commissioner uses to make a favourable decision are delays outside the control of the taxpayer or situations where construction time makes it difficult (or impossible) to replace the asset within the required time.

In the current case, the Facility owned by Subsidiary B was destroyed by fire during the year ending 30 June XT (making the balancing adjustment year the year ending 30 June 20XT).

On consideration of the facts and circumstances and consistent with the principles and guidance in the EM, the Commissioner will exercise his power under paragraph 40-365(3)(b) to grant a further period of time until 30 June 20XZ to incur the expenditure on the replacement assets (or start to hold the assets).

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