Edited version of private ruling

Authorisation Number: 1011810115102

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Ruling

Subject: Income tax - deductions - vacant land

Question 1

Can the taxpayer claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for interest on a loan taken out to fund the purchase of vacant land held for future income producing purposes?

Answer

No.

Question 2

Can the taxpayer claim a deduction under section 8-1 of the ITAA 1997 for rates expenses associated with vacant land held for future income producing purposes?

Answer

No.

Question 3

Can the taxpayer claim a deduction under section 8-1 of the ITAA 1997 for borrowing costs associated with the purchase of vacant land held for future income producing purposes?

Answer

No.

This ruling applies for the following period:

Income year ended 30 June 2011

The scheme commenced on:

1 July 2009

Relevant facts and circumstances

The taxpayer purchased a vacant waterfront block of land in 200X.

The purchase was financed by an interest only investment loan from a bank.

The land was purchased with the intention of constructing a residential investment property. This intention was documented in a resolution.

On advice from a real estate agent the taxpayer decided to defer construction. Due to economic conditions the properties market has suffered; the market affects the equity and borrowing to construct the property.

The taxpayer is unsure of when construction will commence. The intention remains to construct a residential investment property.

No activities have been undertaken to develop the vacant block of land since its purchase.

The taxpayer has other residential investment properties which have been acquired as part of a strategy to provide retirement income. At no time has the taxpayer purchased land for development or resale.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-25

Income Tax Assessment Act 1997 subsection 25-25(4)

Income Tax Assessment Act 1997 subsection 25-25(6)

Reasons for decision

Question 1

Summary

In the taxpayer's circumstances the interest on a loan taken out to fund the purchase of vacant land held for future income producing purposes is not deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Interest is deductible under section 8-1 of the ITAA 1997 to the extent that it is incurred in gaining or producing assessable income.

The deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production was considered by the High Court in: Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele).

Paragraph 9 of Taxation Ruling TR 2004/4, which considers the implications of the decision in Steele, states that it follows from Steele that 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 lost;

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

· continuing efforts are undertaken in pursuit of that end.

Paragraph 35 of TR 2004/4 states:

It follows that interest on borrowed funds which have been expended upon any aspect of the development of a property which is solely intended to be employed in income earning operations would satisfy the first of the conditions at paragraph 9.

Paragraph 36 of TR 2004/4 states:

The last of those conditions requires that continuing efforts are undertaken in pursuit of assessable income. This condition received no attention from the majority, and consideration of this matter is to be found in the reasons of Callinan J. We have concluded that the concept of 'continuing efforts' should not be taken to require constant on-site development activity. The comments of Callinan J indicate that a test of 'continuing efforts' would need to be set within the context of the normal time frames of the relevant industry. 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 some time in the future.

The ATO publication Rental Properties 2009-10 (NAT 1729-6.2010) states that if you take out a loan to purchase land on which to build a rental property or to finance renovations to a property you intend to rent out, the interest on the loan will be deductible from the time you took the loan out.

Application to the taxpayer's circumstances

In the taxpayer's case the interest has been incurred on money borrowed to fund the purchase of a vacant waterfront block of land on which the taxpayer intends to construct a residential investment property.

On advice from a real estate agent, the taxpayer has deferred construction as due to economic conditions the waterfront properties market has suffered. The market affects the equity and borrowing to construct the property.

The taxpayer is unsure of when construction will commence and has not undertaken any activities to develop the vacant block of land since its purchase. The intention however remains to construct a residential investment property.

For interest incurred in a period prior to the derivation of relevant assessable income to be interest 'incurred in gaining or producing assessable income' continuing efforts in pursuit of that end are required to be undertaken.

As the taxpayer has not yet commenced construction of the residential investment property and has not undertaken any activities to develop the vacant block of land since its purchase, it is considered that the taxpayer has not made any continuing efforts to pursue the derivation of assessable income. Although the taxpayer's intention has not changed since purchasing the property the lack of activity does not support a continued intention to build an income producing property and suggests that the venture has become dormant.

Although the land has not been used for any other purpose other than to hold it for the intention for which it was purchased in these circumstances the taxpayer is not entitled to a deduction for the interest expense under section 8-1 of the ITAA 1997.

Question 2

Summary

In the taxpayer's circumstances the rates expenses associated with vacant land held for future income producing purposes are not deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income.

The deductibility under section 8-1 of the ITAA 1997 of rates and other holding costs incurred on a vacant block of land held for future income producing purposes is considered in ATO ID 2001/479.

ATO ID 2001/479 states that while Steele's case deals with the issue of interest, the principles can be applied to other types of expenditure including local council, water and sewerage rates, land taxes and emergency services levies.

It follows that the conditions set out in paragraph 9 of TR 2004/4 apply equally to rates and other holding costs.

Application to the taxpayer's circumstances

In accordance with the discussion in Question 1, it is considered that the taxpayer has not made any continuing efforts to pursue the derivation of assessable income and that the lack of activity does not support a continued intention to build an income producing property and suggests that the venture has become dormant.

Although the land has not been used for any other purpose other than to hold it for the intention for which it was purchased in these circumstances the taxpayer is not entitled to a deduction for the rates expenses associated with the vacant land under section 8-1 of the ITAA 1997.

Question 3

Summary

Borrowing expenses are normally of a capital nature and not deductible under section 8-1 of the ITAA 1997. Section 25-25 of the ITAA 1997 allows a deduction for expenditure incurred for borrowing money to the extent that the money is used for the purpose of producing assessable income. In the taxpayer's circumstances the borrowed money has not been used for the purpose of producing assessable income and the borrowing expenses are not allowable as a deduction either under section 8-1 or section 25-25 of the ITAA 1997.

Detailed reasoning

Borrowing expenses are normally of a capital nature and not deductible under section 8-1 of the ITAA 1997.

Section 25-25 of the ITAA 1997 allows a deduction for expenditure incurred for borrowing money to the extent that the money is used for the purpose of producing assessable income

Subsection 25-25(6) of the ITAA states that borrowing costs not exceeding $100 dollars are fully deductible in the year in which they are incurred. If the total borrowing costs exceed $100, the deduction is spread over the period of the loan or 5 years - whichever is the shorter period. Subsection 25-25(4) of the ITAA 1997 sets out the process for calculating the deductible amount for an income year where the borrowing expenses exceed $100 dollars.

Application to the taxpayer's circumstances

The taxpayer has incurred borrowing expenses on money borrowed to fund the purchase of a vacant waterfront block of land on which the taxpayer intends to construct a residential investment property.

On advice from a real estate agent, the taxpayer has deferred construction as due to economic conditions the waterfront properties market has suffered. The market affects the equity and borrowing to construct the property.

The taxpayer is unsure of when construction will commence and has not undertaken any activities to develop the vacant block of land since its purchase.

Borrowing expenses are normally of a capital nature and not deductible under section 8-1 of the ITAA 1997.

Section 25-25 of the ITAA 1997 requires that the borrowed money be used for the purpose of producing assessable income. In the taxpayer's circumstances the borrowing expenses relate to vacant land held for future income producing purposes and not to an income producing asset. As concluded in Questions 1 and 2 above, the lack of activity does not support a continued intention to build an income producing property and suggests that the venture has become dormant. Accordingly, the borrowing costs associated with the vacant block of land are not deductible under section 8-1 or section 25-25 of the ITAA 1997.