Edited version of private ruling

Authorisation Number: 1011846431268

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Ruling

Subject: CGT discount and interest on loan

Questions and answers:

1. Is the capital gain made on the disposal of your dwelling a discount capital gain?

Yes

2. Are you entitled to a deduction for your share of the interest expense on a block of land purchased in the last financial year on which you do not intend to commence the construction of an investment dwelling for at least 12 months?

No

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commences on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Dwelling

You and your spouse purchased a vacant block of land in City X on date A after mid 19XX.

You and your spouse began building a dwelling on the land on date B, a few months later.

You and your spouse do not intend to reside in the dwelling.

You and your spouse intend to sell the dwelling for a capital gain in the next few years, but not before 12 months from date A.

No agreement to sell the dwelling will be entered into to sell the dwelling before 12 months after date A.

Vacant land

You and your spouse purchased a vacant block of land in City Y for investment purposes on date C in the last financial year.

You and your spouse took out a loan to purchase the property.

You and your spouse do not intend to begin any building plans for at least another 12 months and not before date D.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 8-1.

Income Tax Assessment Act 1997 Subsection 102-5.

Income Tax Assessment Act 1997 Subsection 102-20.

Income Tax Assessment Act 1997 Subsection 115-5.

Income Tax Assessment Act 1997 Subsection 115-40.

Income Tax Assessment Act 1997 Subsection 115-100.

Reasons for decision

Sale of dwelling

You make a capital gain if a capital gains tax (CGT) event occurs to a CGT asset.

Separate asset

Under common law principles, anything that is attached to land becomes part of the land. However, the exception to this principle provides that a building will be treated as a separate asset from the land to which it is affixed if the building is a depreciating asset for which a balancing adjustment must be worked out on sale or the building is a post CGT asset and the land to which it is attached is a pre CGT asset (acquired before September 19XX).

Your dwelling is not covered by the balancing adjustment provisions and the land was acquired after September 19XX. Therefore the dwelling will not be treated as a separate asset from the land. Thus the dwelling is taken to be acquired on the date you acquired the land (date A).

CGT discount

To be eligible to use the 50% discount method to calculate your net capital gain, the capital gain must result from a CGT event happening to a CGT asset that you acquired at least 12 months before the CGT event.

The time of the event is when you enter into the contract to dispose of the asset.  

You are taken to have acquired your interest in the City X dwelling when the purchase contract was entered into on date A.

You will be taken to have disposed of your interest in the dwelling when the contract for sale is entered into. In your case, you intend to sell the dwelling in the next few years, however no agreement to sell the dwelling will be entered into before 12 months after date A.

On disposal of your interest in the dwelling, CGT event A1 will happen. As you will have owned the land for at least 12 months (even though you may not have constructed the dwelling more than 12 months before the sale of the dwelling), you can use the discount method to work out your capital gain as:

· you are an individual

· a CGT event happens to an asset you own after 21 September 1999

· you will have owned the CGT asset for more than 12 months, and

· the cost base will not be indexed.

The discount percentage for individuals is 50%. The discount is applied to the discount capital gain only after any applicable reductions are made (if any) and all current and prior year capital losses are applied.

Interest expense on vacant block of land

A deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature.

It is not necessary that the expenditure in question should produce assessable income in the same year in which the expenditure is incurred. In Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steeles Case), the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production.

Taxation Ruling TR 2004/4, in considering the above decision, concludes 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.

Whilst this does not require constant on-site development activity, the requirement is not satisfied if the holding of the asset is passive, even if there is an intention to build some time in the future.

In your case, you and your spouse purchased vacant land on date C with the intention of building a dwelling for rental purposes. You do not have any intention to begin planning its construction for at least 12 months, and not before date D.

It is considered that the interest expense is incurred at a point too soon and is preliminary to the commencement of the income producing activity. The period prior to the derivation of income (date C to date D) is considered to be so long that the required connection between the outgoing and income is lost. It cannot be said that at this stage, continuing efforts are being undertaken in pursuit of an end, such as submitting plans for approval to the Council.

In conclusion a deduction is not allowable for the interest expense on your loan for the City B land until you seriously begin to undertake action to commence the construction of your rental dwelling.

Summary

The capital gain made on the disposal of your City A dwelling will be a discount capital gain. No deduction is allowed at this stage for the interest expense on your vacant land in City B.