Edited version of private advice

Authorisation Number: 1052234767332

NOTICE

This edited version has been found to be misleading or incorrect. It does not represent the ATO’s view of the relevant law.

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Edited versions cannot be relied upon as precedent or used for determining how the ATO will apply the law in other cases.

Date of advice: 26 March 2024

Ruling

Subject: Depreciating asset - decline in value deduction

Question 1

Will a dwelling being constructed the Taxpayer constitute a depreciating asset as defined in section 40-30 of the Income Tax Assessment Act 1997 (ITAA 1997), so that the decline in value is deductible pursuant to section 40-25 of the ITAA 1997?

Answer

No.

Question 2

Will the use of the dwelling by associates of a shareholder of a company constitutes a 'payment' for the purpose of Division 7A of the ITAA 1936?

Answer

No.

This ruling applies for the following period:

1 July 202X to 30 June 202X

The scheme commences on:

XX/XX/20XX

Relevant facts and circumstances

1.            The Taxpayer commenced carrying on a business in 20XX. The Taxpayer is controlled by X individuals (the individuals). The individuals are directors and manages the business. The Taxpayer and the individuals are part of the connected and affiliated entities associated with the farming business. The business is being conducted on land owned by a company that is an associate of the Taxpayer, ABC Pty Ltd. The Taxpayer has exclusive use of the land which is subject to a lease agreement.

2.            Prior to 20XX, the land was used in the primary production business operated by a partnership. The partners in the partnership include the individuals, other members of their family and an associate entity XYZ that is also controlled by the individuals. Following a restructure, the Taxpayer took over the operation of the business with individuals in control.

3.            The primary production business conducted by the Taxpayer employs X staff, compromised of full-time, part-time and casual staff.

4.            In 202X, the Taxpayer signed a contract for a single storey dwelling to be constructed on the land (the dwelling). The dwelling comprises X bedrooms, situated on a solid concrete foundation with rendered brick walls and colour bond steel roof. The Taxpayer will be responsible for payment of the construction cost as well as rates, insurance and utilities. The landowner, ABC Pty Ltd, will not be responsible for any part of the construction cost.

5.            The dwelling will be on the main homestead farm where most of the machinery of the farming business is located, including the farm workshop. It is expected that the construction of the dwelling will be completed during the 202X income year.

6.            Only the individuals and their young children (individuals' family) will be occupying the dwelling as their private family residence. The individuals will have all the rights, power, or privileges in relation to the dwelling.

7.            The individuals together are responsible for managing all aspects of the primary production business.

8.            The individuals are not employees of the Taxpayer.

9.            The dwelling will provide the individuals more opportunities to spend more time working on the business, like dealing with deliveries outside of normal working hours.

10.          There will be no formal lease agreement between the individuals and the Taxpayer. The individuals will have exclusive right to use and occupy the dwelling. The Taxpayer and the individuals are part of the connected and affiliated entities associated with the farming business.

11.          The dwelling will be XX kilometres from another property where the individuals' family currently reside. This property was purchased by XYZ in 20XX. The property is located on one of the parcels of land on which the Taxpayer is conducting its primary production business. There is no lease agreement on the property between XYZ and the individuals, and no rent is being paid for using the dwelling on the land. The individuals' control XYZ and the entities are affiliated entities associated with the farming business.

12.          The primary production business does not have enough accommodation to accommodate all the staff working on the farm. The construction of the dwelling is to free up the current dwelling being used by the individuals to assist to accommodate all the staff and the individuals working and managing the farm.

13.          The main business facilities are located nearby where the dwelling will be located. Most business activities take place at this address and due to current Occupational Health and Safety laws and recent changes to Industrial Manslaughter laws, the individuals have made the decision that they do not want any full-time employees and families residing at this location.

14.          The farm office will be located in the dwelling. This will allow the individuals to be able to hold business meetings on site and other benefits like attending to other business activities outside business hours.

15.          The Taxpayer employs a number of staff who are required to live on farm. There is no housing for sale or rent in the nearby townsite. The decision to purchase a property off site was decided against due to the requirement for late night shifts during seeding and harvest and therefore staff safety.

16.          The Taxpayer currently owns a number of properties around the nearby areas to the farm. These properties are being provided as housing to the employees. However, these properties are in poor conditions and require repairs. The decision to construct a new larger dwelling on the farm was made due to the size and condition of current housing available. There is a great labour shortage in the agricultural industry and keeping quality staff is a challenge for the business. Therefore, providing a reasonable standard of accommodation is essential.

Relevant legislative provisions

Income Tax Assessment Act 1936 former subsection 51(1)

Income Tax Assessment Act 1936 former section 54

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 Subdivision B of Division 7A

Income Tax Assessment Act 1936 Subdivision D of Division 7A

Income Tax Assessment Act 1936 subsection 109C(1)

Income Tax Assessment Act 1936 subsection 109C(3)

Income Tax Assessment Act 1936 paragraph 109C(3)(c)

Income Tax Assessment Act 1936 section 109CA

Income Tax Assessment Act 1936 subsection 109CA(1)

Income Tax Assessment Act 1936 subsection 109CA(2)

Income Tax Assessment Act 1936 subsection 109CA(5)

Income Tax Assessment Act 1936 subsection 109CA(6)

Income Tax Assessment Act 1936 subsection 109CA(7)

Income Tax Assessment Act 1936 subsection 109ZB(3)

Income Tax Assessment Act 1936 section 109ZD

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1936 paragraph 318(1)(a)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 subsection 40-25(1)

Income Tax Assessment Act 1997 subsection 40-25(2)

Income Tax Assessment Act 1997 subsection 40-25(7)

Income Tax Assessment Act 1997 subsection 40-30(1)

Income Tax Assessment Act 1997 subsection 40-30(3)

Income Tax Assessment Act 1997 section 40-40

Income Tax Assessment Act 1997 subsection 40-45(2)

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 section 43-10

Income Tax Assessment Act 1997 section 43-20

Income Tax Assessment Act 1997 subsection 43-20(3)

Income Tax Assessment Act 1997 subsection 43-70(1)

Income Tax Assessment Act 1997 subsection 43-70(2)

Income Tax Assessment Act 1997 paragraph 43-70(2)(e)

Income Tax Assessment Act 1997 section 43-110

Income Tax Assessment Act 1997 section 43-115

Income Tax Assessment Act 1997 section 43-120

Income Tax Assessment Act 1997 section 43-140

Income Tax Assessment Act 1936 Subdivision 43-E

Income Tax Assessment Act 1997 section 43-160

Income Tax Assessment Act 1997 subsection 43-170(1)

Income Tax Assessment Act 1997 subsection 43-170(3)

Income Tax Assessment Act 1997 subsection 118-115(1)

Income Tax Assessment Act 1936 Subdivision 328-D

Income Tax Assessment Act 1997 subsection 960-100(1)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

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

Question 1

Will the dwelling being constructed by the Taxpayer constitute a depreciating asset as defined in section 40-30, so that the decline in value is deductible pursuant to section 40-25?

Summary

The dwelling is capital works under Division 43. However, as the dwelling will mainly be used as residential accommodation, a deduction cannot be claimed for capital works under Division 43 as it is not used in producing assessable income. A deduction for decline in value is also not available under Division 40 to the extent that it is not used for taxable purposes. However, if part of the dwelling is established as an area used, or installed ready for use, for a taxable purpose, a deduction may be claimed for decline in value subject to the reduction set out in subsection 40-25(2).

Detailed reasoning

1.            The cost associated with the construction of the dwelling on the farm is considered to be capital in nature and no deduction will be allowed under section 8-1.

2.            Under Division 40 a taxpayer may claim deductions for the decline in value of depreciating assets that are held by the taxpayer, to the extent to which the assets were used for a taxable purpose. However, under subsection 40-45(2), Division 40 does not apply to capital works for which you can deduct amounts under Division 43, or for which you could deduct amounts under that Division. It is therefore necessary to first determine whether an amount can be deducted under Division 43.

Division 43

3.            Division 43 provides a deduction for certain construction expenditure incurred in respect of the construction of 'capital works' such as buildings (including any extensions, alterations, or improvements to buildings, other than buildings used for residential accommodation) or structural improvements (other than buildings) that are located in Australia and the capital works are used to produce assessable income.

4.            Division 43 applies to capital works that are:[1]

•         buildings

•         structural improvements (other than buildings), and

•         environmental protection earthworks.

5.            Some examples of 'structural improvements' are:[2]

(a) roads, sealed driveways, sealed car parks, sealed airport runways, bridges, pipelines, lined sealed road tunnels, retaining walls, fences, concrete or rock dams and artificial sports fields; and

(b) earthworks that are integral to the construction of a structural improvement (other than a structural improvement described in subsection (4)), for example, embankments, culverts and tunnels associated with a runway, road or railway.

6.            The extension of the statutory definition of capital works to include structural improvements makes it clear a building is not included in the meaning of structural improvements and includes other things that are not buildings.

Buildings

7.            The term 'building' is not a defined term in either of the Income Tax Assessment Acts and will take its ordinary meaning. Dictionary definitions commonly defines a 'building' to mean a substantial and permanent structure with roof and walls such as a shed, house, department stores etc.[3]

8.            It is without controversy that the dwelling to be built on the land is considered a building. Moreover, the construction of the building is to be used mainly by the individuals' family as residential accommodation will fall within the meaning of a 'dwelling'.[4]

9.            Whether a building falls within the meaning of 'plant' needs to be established as subsection 43-70(2) excludes, amongst other things, a deduction under Division 43 with respect to capital expenditure incurred in respect of the construction of capital works that relates to plant.[5]

10.          As a basic rule, an item that forms part of the building does not come within the ordinary meaning of plant, except in the rare case where the building are themselves plant.[6] It is a question of fact and degree as to whether an item forms part of the building. Where an item on the building does not form part of the building and also does not fall within the extended meaning of plant (for example, as an article or machinery), it will come within the ordinary meaning of plant where the function performed by the item is so related to the particular taxpayer's income producing activities or special that it warrants the item being held to be plant.

11.          To the extent that parts of a building may be identified as plant, those parts should be excluded from deduction under Division 43 and deductions considered under Division 40.[7]

12.          The Taxpayer operates a primary production business. While the dwelling will include a farm office that will allow the individuals to attend to certain business activities outside of normal business hours, the main purpose for constructing the dwelling is to provide residential accommodation for the individuals' family. The dwelling is designed in the character of a family home featuring bedrooms, kitchen and family room which together gives function and purpose of a residential accommodation. As the dwelling will be mainly used for residential accommodation, it cannot come within the ordinary meaning of plant as the function to be performed by the dwelling is not considered to be so related to the income earning activities or special to the primary production business of the Taxpayer.

Capital works deduction

13.          Division 43 allows you to deduct an amount for construction expenditure on certain income producing capital works for an income year.

14.          Specifically, section 43-10 provides that an amount may be deducted for capital works for an income year if there is a construction expenditure area, a pool of construction expenditure for that area and you use 'your area' in the income year in a way set out in section 43-140.

15.          For capital works begun after 30 June 1997, the 'construction expenditure area' of capital works means the part of the capital works on which the construction expenditure was incurred that, at the time it was incurred by an entity, was to be owned or leased by the entity or held by the entity under certain quasi-ownership rights. Accordingly, a threshold requirement for a taxpayer to deduct an amount for an income year under section 43-10 is that it incurs 'construction expenditure'.

16.          A pool of construction expenditure is that part of an amount of construction expenditure that is attributable to a particular construction expenditure area.

17.          'Construction expenditure' is defined in subsection 43-70(1) as capital expenditure incurred in respect of the construction of capital works, subject to the exclusions listed at subsection 43-70(2).

18.          Section 43-110 also provides that 'you can only get a deduction under this Division for an income year if you own, lease or hold part of a construction expenditure area of capital works. The area you own, lease or hold is called your area.'

19.          'Your area' has the meaning given in sections 43-115 and 43-120. How 'your area' is determined under those sections depends on whether you are an owner, lessee or holder of a quasi-ownership right of the part of the capital work on which the construction expenditure is incurred.

20.          The Taxpayer signed a contract to construct a dwelling (the capital works) on land that it had leased from ABC Pty Ltd. The Taxpayer will be responsible for payment of the construction cost as well as rates, insurance and utilities. The landowner will not be responsible for any part of the construction cost.

21.          The expenditure incurred in respect to the construction of the dwelling is the construction expenditure. Therefore, the capital works have a construction expenditure area and there is a pool of construction expenditure for that area as required under section 43-10. Accordingly, the first 2 conditions in section 43-10 will be satisfied.

Deductible uses of capital works

22.          The table in section 43-140 sets out the way you must use your area in an income year for a deduction to be allowed under section 43-10. Where the capital works begins after 30 June 1997, requires the Taxpayer to use the area for the purpose of producing assessable income.

23.          Something is done for the purpose of producing assessable income 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.[8]

24.          'Purpose of producing assessable income' has been considered in relation to the use of plant and depreciating assets in Pettigrew v. FC of T 90 ATC 4124; (1990) 20 ATR 1833 (Pettigrew) and Reef Networks Pty Ltd v. DFC of T 2004 ATC 4001; (2003) 54 ATR 509 (Reef). Those cases recognised that considering whether plant or a depreciating asset was used for the 'purpose of' was different to considering whether a loss or outgoing is 'incurred in gaining or producing' assessable income under either the former subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) or section 8-1.

25.          Justice Hill in Pettigrew said that in contrast with former subsection 51(1) of the ITAA 1936 the purpose of which former section 54 of the ITAA 1936 speaks is the purpose of the use to which the plant is put in the year of income. It is clear that in the former subsection 51(1), purpose is not a criterion of deductibility, however it will not necessarily be irrelevant. Hely J in Reef stated that the determination of the purpose for which the asset under consideration in that case was used was a matter of objective characterisation. These statements are also relevant in the application of section 43-140.

26.          The purpose referred to in section 43-140 is an objective characterisation and will normally be apparent from the use to which the capital works are put.

Special rules for uses

27.          Subdivision 43-E contains special rules about uses of 'your area'.

28.          Section 43-160 provides that a capital works is taken to be used for a particular purpose (i.e., the purpose of producing assessable income) if it is maintained ready for use for that purpose, has not been used for another purpose, and its use for that purpose has not been abandoned.

29.          However, if any part of the capital works is used mainly for, or in association with, residential accommodation, including where it constitutes the whole or part of an individual's home, subsection

30.          43-170(1) provides that such capital works are not taken to be used for the purpose of producing assessable income.

31.          Subsection 43-170(3) further provides that, if a property is the whole or a part of capital works (other than a hotel or apartment building) and is part of an individual's home, then the property is taken to be used, or for use, wholly or mainly for or in association with providing residential accommodation, e.g., if a house is mainly used by a taxpayer and his family as a residence, then no capital works deduction is available at all in respect of that house. Accordingly, if another part of the house is used for income-producing purposes, e.g., as a home office, then a deduction for capital works is not available in respect of that part of the house unless the area use for business is separately identifiable as being used for business.

32.          The Taxpayer advised that the dwelling is on the main homestead where most of the main business machinery and facilities are. While it may be said that the dwelling on the farm will allow the individuals to attend to business activities outside of normal business hours, the main use of the dwelling is to provide residential accommodation for the individuals' family. Further, no formal lease agreement will be entered into between the individuals and the Taxpayer for the use of the dwelling. That is, no rent will be received by the Taxpayer for the use of the dwelling by the individuals.

33.          Accordingly, no amount for capital works can be deducted under Division 43 for construction expenditure relating to the dwelling will be taken to be used, or for use, wholly or mainly for or in association with residential accommodation under subsection 43-170(3).

Division 40

34.          As expenditures incurred in constructing the dwelling will not qualify for deduction under Division 43, it is necessary to consider whether you can deduct amounts for decline in value of the dwelling under Division 40.

35.          Division 40 contains rules for claiming a deduction for the decline in value of depreciating assets. Subsection 40-25(1) provides:

You can deduct an amount equal to the decline in value for an income year (as worked out under this Division) of a *depreciating asset that you *held for any time during the year.

Is the dwelling a depreciating asset?

36.          A 'depreciating asset' is defined in subsection 40-30(1) as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. However, land, trading stock and certain intangible assets are specifically excluded from the definition of a depreciating asset for tax purposes.

37.          Although land is excluded from being depreciating asset, improvements to land or fixtures on land, whether removable or not, are treated as assets separate from land and therefore a deduction may be available for the decline in their value under Division 40.[9]

38.          As with any permanent fixture and building such as a house, the dwelling is subject to wear caused by exposure to the elements. It will therefore have a limited effective life and is expected to decline in value over the time. The dwelling will fall within the definition of a depreciating asset in subsection 40-30(1).

Who can claim deductions for the decline in value of a depreciating asset?

39.          Only the entity that holds the depreciating asset can claim a deduction for its decline in value. In certain circumstances there may be more than one holder of the asset. The table in section 40-40 is used to work out who holds a depreciating asset.

40.          Specifically, the table in section 40-40 refers to cases where a depreciating asset is fixed to land which is itself subject to a 'quasi-ownership right'. Item 3 of the table in section 40-40 is the most relevant item and refers to:

An improvement to land (whether a fixture or not) subject to a *quasi ownership right (including any extension or renewal of such a right) made or, itself improved, by any owner of the right for the owner's own use where the owner of the right has no right to remove the asset.

41.          A 'quasi-ownership right' is defined in subsection 995-1(1) as a lease over land, an easement in connection with land, or any other right, power or privilege over the land, or in connection with the land. An entity has a quasi-ownership right if it is the successive owner of such a right, e.g., a sublessee will have a quasi-ownership right. For Division 40 purposes, the quasi-ownership right need not be held from an Australian government or government agency.[10]

42.          Paragraph 1.42 of the Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 (the EM) explains the policy intent of item 3 of the table in section 40-40:

Where the owner of the quasi-ownership right improves the land with a depreciating asset, or improves a depreciating asset that is itself an improvement to the land, and where that improvement is for their own use but they cannot remove that asset from the land, they are nonetheless the holder while their quasi-ownership right exists.

Example 1.4

Jerry is leasing land and building from Cantrell Nominees Pty Ltd, on which he carries on business. Jerry installs an in-ground watering system on the land, at his own expense and for the benefit of the business he carries on. Under the lease agreement, Jerry is not permitted to remove fixtures from the property.

Even though Cantrell Nominees has become the owner of the watering system under the law of fixtures, Jerry is recognised as a holder while the lease exists under item 3 in the table in section 40-40.

43.          The Taxpayer commenced carrying on a primary production business in 202X on land that it leased from ABC Pty Ltd. Under the lease agreement, the Taxpayer has exclusive right to use the land to conduct its business.

44.          The Taxpayer signed a contract to construct the dwelling which will be provided to the individuals' family for their exclusive use as their private residential accommodation while living and working on the farm.

45.          The dwelling is designed to be permanently fixed to the land and cannot be removed. This means that ABC Pty Ltd as the landowner will become the owner of the dwelling. However, so long as the lease over the land exist (the quasi ownership right), the Taxpayer will be recognised as the holder of the depreciating asset being the dwelling pursuant to Item 3 of the table in section 40-40.

Taxable purpose

46.             Subsection 40-25(2) provides that the deduction for decline in value is reduced by the part that is attributable to the use of the asset, or having it ready installed for use, for a purpose other than a taxable purpose. Paragraph 1.10 of the EM states:

The adjustment ensures that the amount deducted reflects the extent to which the depreciating asset was used for a taxable purpose, that is for producing assessable income, for exploration or prospecting, or for mining site rehabilitation or for environmental protection activities (essentially, pollution control and waste management).

47.          Taxable purpose' is defined in subsection 40-25(7) to mean:

(a) the *purpose of producing assessable income, or

(b) the purpose of *exploration or prospecting, or

(c) the purpose of *mining site rehabilitation, or

(d) *environmental protection activities.

48.          Subsection 995-1(1) states that something is done for the 'purpose of producing assessable income' 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.

49.          The term 'for the purpose of producing assessable income' has been considered in a number of authorities that looked at deduction for decline in value for expenditures relating to employment and self-education.

50.          For example, in Lunney v C of T (1958) HCA (Lunney) the Court looked at whether expenditure incurred by the taxpayer in travelling between home and the workplace qualifies for a deduction under the Income Tax and Social Services Contribution Assessment Act 1936-1956. The Court found that travel to work was not deductible notwithstanding that the taxpayer could not derive assessable income without incurring expense to get to work. It was found that the essential character of the travel expenditure was private in nature. Williams, Kitto and Taylor JJ addressed the issue as one principle. Their Honours said:

...It is, of course, beyond question that unless an employee attends at his place of employment he will not derive assessable income and, in one sense, he makes the journey to his place of employment in order that he may earn his income. But to say that expenditure on fares is a prerequisite to the earning of a taxpayer's income is not to say that such expenditure is incurred in or in the course of gaining or producing his income. Whether or not it should be so characterised depends upon considerations which are concerned more with the essential character of the expenditure itself than with the fact that unless it is incurred an employee or a person pursuing a professional practice will not even begin to engage in those activities from which their respective incomes are derived.

51.          The joint judgment pointed out that the purpose of the journeys under consideration was as much to enable the taxpayer to reside at his home, as to attend his place of work or business. Their Honours concluded as follows:

... Expenditure of this character is not by any process of reasoning a business expense; indeed, it possesses no attribute whatever capable of giving it the colour of a business expense. Nor can it be said to be incurred in gaining or producing a taxpayer's assessable income or incurred in carrying on a business for the purpose of gaining or producing his income; at the most, it may be said to be a necessary consequence of living in one place and working in another. And even if it were possible - and we think it is not - to say that its essential purpose is to enable a taxpayer to derive his assessable income there would still be no warrant for saying, in the language of s 51, that it was 'incurred in gaining or producing the assessable income' or 'necessarily incurred in carrying on a business for the purpose of gaining or producing such income'.

52.          In FC of T v Faichney 72 ATC 4245, the taxpayer was a CSIRO research scientist, the nature of whose work, and the inadequate facilities provided by his employer, required him to spend an appreciable amount of time after hours in a converted bedroom working on matters which directly related to his employment. He claimed deductions for a proportion of the mortgage interest and electricity expenses as being referable to the home office and for depreciation on the office furniture. The issue was whether carpet, curtains, bookshelves and a desk in the taxpayer's home office were depreciable. The Commissioner argued that the use of plant for the purpose of producing assessable income must be a predominant, or at least significant, use. Mason J, in rejecting this argument, said that where there is only partial use for an income-producing purpose, then apportionment may be necessary but there is no basis for rejecting the claim altogether. Mason J made it clear that former section 54 of the ITAA 1936 (the ITAA 1936 equivalent of section 40-25) does not exclude plant of a private or domestic nature from being eligible for depreciation deductions but only requires that the plant be used for an income-producing purpose. The carpet and curtains were used for such an income-producing purpose and were therefore eligible for depreciation deductions. However, Mason J rejected the deduction for mortgage interest on the basis that it was an outgoing of a capital, or of a private or domestic nature.

53.          In Thomas v FC of T 72 ATC 4094 (Thomas), the taxpayer was a barrister who has a chamber in Brisbane. He resides at Moggill, about 15 miles from the City of Brisbane. He later purchased three adjoining blocks of land at Moggill having a total area of 7½ acres on which he built a house that was to become his family home. Subsequently, some further bedrooms were added to the house. One room was used by him as a study in which he does some of the work required in the carrying on of his practice. The taxpayer sought to deduct a proportion of the interest payable under a loan which had been raised and expended partly for the purpose of adding additional bedrooms to the existing house. The court found that the taxpayer was carrying on a primary production business. However, in rejecting the taxpayer's claim to deduct a portion of the interest, Walsh J said:[11]

... the house should not be regarded ... as including part of the business premises of the appellant and the loan should not be regarded as having been raised for the purpose of providing him with business premises. Payment of the interest, in so far as it was an outgoing connected with the cost of extensions to the house was ... an outgoing 'of a capital, private or domestic nature'... it did not lose that character merely because the appellant, like most professional men, did some of his work at home, or because he used one of the added rooms for that purpose. The appellant did not spend money in erecting premises suitable only for use as business premises. He added rooms to his house.

54.          The cases indicate that, to be deductible, a loss or outgoing must be incurred in the course of gaining or producing assessable income or in carrying on a business for that purpose. This requires that the loss or outgoing be incidental and relevant to the taxpayer's income/business operation and have the essential character of an income producing/business expense. Expenses which relate to the use or ownership of a home normally have a private or domestic character and are not allowable deductions (Thomas).

55.          Taxation Ruling TR 93/30 'Income tax: deductions for home office expenses' discusses the circumstances where a deduction is allowable for expenses associated with a home office. At paragraph 2, a deduction is generally not allowable for the costs associated with a person's home as they are private or domestic in nature. An exception to this general rule is where part of the home is used for income producing activities and has the character of a place of business.

56.          Paragraph 11 of TR 93/30 outlines the factors that indicate whether or not a home office has the character of a place of business. This is likely to be the case where part of a residence is set aside exclusively for the carrying on of a business by a self-employed person, such as a doctor or dentist with a surgery or consulting rooms at home or a tradesperson with a workshop at home.

57.          The existence of any of the factors or a combination of them will not necessarily be conclusive in determining whether the home constitutes a place of business in the ordinary and common sense meaning of the term. The determination will depend on a balanced consideration of the essential character of the area, the nature of the taxpayer's business and any other relevant factors. It is not sufficient that a room in the home is used in association with a business. The fact that no other accommodation is available is not of itself sufficient to render a house as a place of business.

58.          Based on the case authorities above and the distinctions outlined in TR93/30, the dwelling on the farm is more readily identifiable as a private home and not a place of business. Whilst it is acknowledged that part of the dwelling will be used as a home office to conduct activities associated with the management of the farming business, this does not characterise the whole of the dwelling as a place of business (see Thomas). Once constructed, the dwelling will be occupied by the individuals' family as their residential home. This is to allow the individuals more opportunities to spend more time working on the business and to attend to certain business activities outside of normal business hours.

59.          Prior to taking up occupancy of the dwelling, the individuals have been living at another property which is located on another parcel of land where the Taxpayer is also conducting a farming business. Living at this property required the individuals to travel to work on the farm (see Lunney). There is insufficient nexus to show that the cost incurred in constructing the dwelling is incidental and relevant to the business operation or have the essential character of an expense incurred in producing assessable income. The contention that it allows more time for individuals to attend and manage the business of the farm by living on the farm does not change the private nature and use of the dwelling. Based on the information provided, the dwelling will not be considered to be used for a 'taxable purpose' as defined in subsection 40-25(7). Therefore, the Taxpayer would not be entitled to a deduction for the decline in value of the dwelling under section 40-25.

60.          If a part of the dwelling is set aside solely for use as a place of business, i.e., for a 'taxable purpose', a deduction may be allowable for decline in value subject to the reduction requirement outlined in subsection 40-25(2).

Question 2

Will the use of the dwelling by associates of a shareholder of a company constitutes a 'payment' for the purpose of Division 7A of the ITAA 1936?

Summary

The provision of the dwelling for use by the individuals and their family is a payment under subsection 109CA(1) of the ITAA 1936. However, the use of the dwelling is connected to the use of the land to carry on a primary production business. As such, the use of the dwelling falls within the exception relating to the use of certain dwellings in subsection 109CA(6) of the ITAA 1936. Therefore, the provision of the dwelling is connected with the use of the land owned by JWO is disregarded for the purposes of subsection 109CA(1) of the ITAA 1936.

Detailed reasoning

61.          Subdivision B of Division 7A of the ITAA 1936 treats certain payments, loans and debt forgiveness made by a private company to a shareholder (or their associate) as a dividend paid by the company.

62.          Subsection 109C(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either:

(a)          the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder, or

(b)          a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time.

63.          Subdivision D of Division 7A of the ITAA 1936 sets out payments and loans that are not treated as dividends under subsection 109C(1) of the ITAA 1936, none of which apply in this case.

64.          'Entity' is defined in section 109ZD of the ITAA 1936 and has the meaning given by subsection 960-100(1). An entity includes an individual.

65.          'Associate' is defined in subsection 109ZD of the ITAA 1936 and has the meaning given by section 318 of the ITAA 1936. An 'associate' of a natural person (other than in the capacity of trustee) includes a relative of the natural person under paragraph 318(1)(a) of the ITAA 1936.

66.          A 'payment' to an entity is defined in subsection 109C(3) of the ITAA 1936 and includes a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity. However, Division 7A of the ITAA 1936 does not apply to a payment made to a shareholder or their associate, in the capacity as an employee.[12]

67.          The statutory definition of payment does not cover arrangements where the private company provides an asset to a shareholder or an associate of a shareholder for use. As part of a number of amendments introduced by Tax Law Amendment (2010 Measures No.2) Bill 2010 (the Bill), the definition of payment was extended with effect from 1 July 2009 to include the provision of an asset for use by the entity under subsection 109CA(1) of the ITAA 1936. The Explanatory Memorandum to the Bill (the EM) states at paragraph 1.18 that 'this extension ensures that arrangements aimed at circumventing the operation of Division 7A, through the provision of an asset under a licence or other right to use, are now within the scope of Division 7A'.

68.          Under subsection 109CA(2) of the ITAA 1936, a payment occurs when use of the asset occurs. A payment may also occur when the asset is available for use to the exclusion of the company and it does not matter when the right to use the asset is granted.

69.          In addition, an asset may be available for the shareholder's use without a formal agreement or whether the asset is actually being used.

70.          If the use or right to use a company asset continues into another income year, then the provision of the asset for use in the subsequent year is treated as being a separate payment made at the start of that year.

Exclusion from use of asset

71.          The use of an asset will not be a payment under section 109CA of the ITAA 1936 if it is covered by one of the exceptions which include the minor use of certain company assets and certain payments that would otherwise be allowable as a once-only deduction.

72.          There are also specific exclusions in respect of the provision of certain kinds of dwellings contained in subsections 109CA(6) and (7) of the ITAA 1936. The use of an asset will not be a payment under section 109CA if it is covered by one of the exceptions.

73.          Paragraph 1.10 of the EM states:

These exceptions only apply to payments that arise because of the operation of section 109CA. That is, the exception applies to the use of certain dwellings, but not where there is a transfer of property within the meaning of paragraph 109C(3)(c).

74.          In relation to a dwelling owned by a private company, subsection 109CA(6) of the ITAA 1936 provides an exception for the provision of a dwelling for use by a shareholder or their associate (the entity) where that provision would not meet the otherwise deductible rule (that is, because the use is for private purposes). In order to qualify for the exception certain conditions must be met. These are that:

(a)          the entity or their associate is carrying on a business,

(b)          the entity or their associate

                                                (i)            uses, or

                                               (ii)            is granted or has a lease, licence or other right to use;

land, water or a building for the purpose of carrying on the business; and

(c)          the provision of the dwelling to the entity is connected with that use or with that lease, licence or other right to use the land, water or building to carry on the business.

75.          Paragraph 1.34 of the EM states:

It is also necessary for there to be a connection between the provision of the dwelling and that use, lease, licence or other right to use land, water or building in carrying on a business, even if the business is being carried on by an entity other than the entity living in the dwelling.

Example 1.10

Aaron and Liz Jones are shareholders in a private company called Farm Pty Ltd and beneficiaries of the Jones Family Trust. Farm Pty Ltd owns a property called Greenacre on which the Jones Family Trust runs a farming business.

For the 2009-10 income year Aaron and Liz live in a dwelling on Greenacre. Aaron and Liz do not make payments to Farm Pty Ltd for the use of this dwelling.

As this use is for private purposes, it does not come within the otherwise deductible exception in subsection 109CA(5).

However, as their use of the dwelling is in connection with the Jones Family Trust using Greenacre to carry on a business, the provision of the dwelling by Farm Pty Ltd is disregarded for the purposes of subsection 109CA(1).

Liz's brother Tom who is also a shareholder of Farm Pty Ltd does the accounts for the Jones Family Trust from his harbour side dwelling in Sydney. Farm Pty Ltd also owns this dwelling. Tom's use of the harbour side dwelling is not connected to the use of the land, water or building on Greenacre and therefore is not eligible for this exception.

Application to your circumstances

76.          The Taxpayer commenced carrying on a primary production business in 202X on land that it leased from ABC Pty Ltd. ABC Pty Ltd is a private company with X shareholders, who are immediately family members of the individuals.

77.          The land is an asset of the private company which the Taxpayer have exclusive use under a lease agreement.

78.          The individuals are beneficiaries of the Taxpayer and they are also the controllers of the Taxpayer.

79.          The Taxpayer signed a contract for a single level dwelling to be constructed on the land. The Taxpayer will be responsible for payment of the construction cost. The landowner, ABC Pty Ltd, will not be responsible for any part of the construction cost.

80.          Once completed, the dwelling will be provided to, and used by, the individuals' family as their main residence while living and working on the farm. The use of the dwelling is not subject to a formal lease agreement with the Taxpayer, i.e., the individuals are not required to make any payment to the Taxpayer or ABC Pty Ltd for the use of the dwelling.

81.          For the purpose of Division 7A, the individuals are the entities being provided with the use of the company's asset. The individuals are associates of the shareholders of the company (ABC Pty Ltd) that provide the use of the land and the dwelling.

82.          As the use of the dwelling is for private purposes, it does not come within the otherwise deductible exception in subsection 109CA(5) of the ITAA 1936.

83.          However, the use of the dwelling is in connection with the Taxpayer using the land owned by ABC Pty Ltd to carry on its primary production business. Therefore, the provision of the proposed dwelling by the Taxpayer is disregarded for the purposes of subsection 109CA(1) of the ITAA 1936.

[1] Section 43-20.

[2] Subsection 43-20(3).

[3] Macquarie Dictionary online (2022) at https://www.macquariedictionary.com.au; Australian Oxford Dictionary, 2nd edition (2004) at https://www.oxfordreference.com.

[4] Subsection 118-115(1).

[5] Paragraph 43-70(2)(e).

[6] Taxation Ruling TR 2007/9.

[7] Subsection 40-45(2) and section 45-40.

[8] Subsection 995-1(1).

[9] Subsection 40-30(3).

[10] Paragraph 1.41 of the EM.

[11] Thomas v FC of T 72 ATC 4094 at 4097.

[12] Subsection 109ZB(3) of the ITAA 1936.

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