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Ruling

Subject: CGT Cost Base and Capital Works Expenditure

Question 1

Will the capital works expenditure incurred by Company A, as head company of the Company A income tax consolidated group, in relation to its CGT asset (being a building) acquired before 7:30pm on 13 May 1997 not be excluded from the CGT cost base of the CGT asset by virtue of section 110-40(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the capital works expenditure incurred by Company A, as head company of the Company A income tax consolidated group, in relation to its CGT asset (being a building) acquired before 7:30pm on 13 May 1997 not be excluded from the CGT cost base of the CGT asset by virtue of section 110-40(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

Income year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Prior to 1991, Company A purchased and entered into a contract for the purchase of land and Subsidiary A began construction of a building on the premises. Subsidiary A was a wholly-owned subsidiary of Company A at the time the building was constructed.

The construction of the building was completed on 19XX and the building has since completion and up until when it was disposed of (see further details below) been used for the purpose of producing assessable income from various business operations.

Since the completion of the building, capital works deductions at a rate of 2.5% per annum have been claimed under the former Division 10D of the Income Tax Assessment Act 1936 (Cth) (the "ITAA 1936") and Division 43 of the Income Tax Assessment Act 1997 (Cth) (the "ITAA 1997") for various capital expenditure incurred in constructing and subsequently improving the building. These deductions have been claimed up to the time of disposal of the building.

Company A formed an income tax consolidated group (the "Company A Group") with its wholly-owned subsidiaries (being Subsidiary A, Subsidiary B and Unit Trust A (in respect of which Subsidiary A is the Trustee)). The election to consolidate was made in 20XX and Company A elected to apply the "stick" method in relation to the cost base of its assets brought into consolidation (i.e. the transitional method of using existing tax values of assets upon consolidation).

In 20XX, receivers and managers were appointed to Company A Group and in September 20XX the group was placed into voluntary administration. Subsequently, in December 20XX, the Company A Group was placed into liquidation.

As part of the liquidation process, the land, building and business was disposed of for a combined consideration. Settlement of the building took place in 2010 and a capital gain has arisen from the disposal of the building in December 2010 (when the contract to enter into the disposal was entered into).

Appendix 1 to the further information request reply sent by the Applicant outlines the list of capital works expenditure incurred after 1 July 1991. Only new capital works expenditure incurred prior to 30 June 1999 has been deducted under Division 43 of the ITAA 1997 by Unit Trust A or Company A and not excluded from the cost base of the building. All new capital works expenditure incurred after 30 June 1999 has been deducted under Division 43 by Unit Trust A or Company A and excluded from the cost base of the building. This has been attached to the private ruling application.

The capital works expenditure incurred by Company A can be split into two categories:

Construction of the new building

Construction work aimed at improving the building in that it substantially enhanced its market value and income producing ability. Thereby increasing the asset's value. The intent of this expenditure was neither to restore efficiency in the function of the building nor maintain the building's current functional efficiency.

Relevant legislative provisions

Income Tax assessment Act 1997

Division 20

Subsection 20-25(2)

Division 43

Section 102-5

Subsection 110-25(3)

Section 110-35

Subsection 110-40(2)

Subsection 110-40(3)

Section 110-45 of the ITAA 1997

Reasons for decision

Issue 1

Question 1

Summary

The capital works expenditure incurred by Company A, as head company of the Company A income tax consolidated group (Company A Group), in relation to its CGT asset (being a building) acquired before 7.30pm on 13 May 1997 is not excluded from the CGT cost base of the CGT asset by virtue of subsection 110-40(2) of the ITAA 1997. This is because the capital works expenditures do not form part of the second or third element of the CGT cost base. They were incurred to construct and subsequently improve the building. This type of expenditure falls within the fourth element of the CGT cost base and does not form part of the second or third element of the CGT cost base.

Detailed reasoning

Subsection 110-40(2) of the ITAA 1997 can prevent the capital works deductions made from forming part of the second or third element of the cost base to the extent that Company A have deducted or can deduct it.

Taxation Determination TD 2005/47 Income tax: what do the words 'can deduct' mean in the context of those provisions in Division 110 of the ITAA 1997 which reduce the cost base or reduced cost base of a CGT asset by amounts you have deducted or can deduct and is there a fixed point in time when this must be confirmed? provides clarification on the words 'can deduct' and whether there is a fixed point when deductibility must be determined.

It has been determined that the capital works expenditure is deductible and has been deducted by the taxpayer, as they have been incurring such expenses, prior to the sale of the building to third parties.

From the further information request, we were informed that the expenditures which were deducted for capital works were mainly for:

§ Building construction

§ Construction work for canteen

§ Air Conditioning Tower removal and installation

§ Refurbishment (post 30 June 1999)

The second element of the CGT cost base, subsection 110-25(3) of the ITAA 1997, consists of the incidental costs that you incurred, of a CGT asset acquired before 7.30pm legal time in the ACT on 13 May 1997. Incidental cost has the meaning given by section 110-35 of the ITAA 1997. This section sets out what are incidental costs. There are nine incidental costs all except the ninth are costs to acquire a CGT asset or costs in relation to a CGT event happening to a CGT asset. The capital works expenditure list Company A provided to the Taxation Office, does not include incidental costs that would form part of the second element of the CGT cost base.

The third element of the CGT cost base consists of the costs of owning the CGT asset you incurred (only if you acquired the asset after 20 August 1991). In this case, Company A acquired the land and its subsidiary completely built the building before 20 August 1991. Hence, they would not have any costs (let alone capital works expenditures) which can be attributed to the third element of the CGT cost base.

Therefore, the capital works expenditures do not form part of the second or third element of the CGT cost base. Hence, Company A would not be forced by subsection 110-40(2) of the ITAA 1997 to reduce from the CGT cost base, the capital works expenditures it has incurred for the building.

Does the consolidation provisions modify the operation of section 110-40(2) of the ITAA 1997?

The consolidations provisions do not change the entry ACA cost base of the Building when it is acquired by Company A (the head entity), being an asset of a 100% owned subsidiary. The unclaimed capital works deductions remaining at 1 January 2004 does not decrease the entry ACA. The unclaimed capital works deductions remaining at 4 August, 2010 (date that the sale contract is signed) will not increase the exit ACA of the building.

In fact according to House of Representatives Tax Laws Amendment (2010 Measures No. 1) Bill 2010 Tax Laws Amendment (2010 Measures No. 1) Act 2010 Explanatory Memorandum, chapter 5 on consolidations, Subsection 701-55(6) of the ITAA 1997 is a residual or catch all provision that operates to treat the tax cost setting amount as the cost of an asset when any provision of the income tax law not specifically mentioned in section 701-55 applies to the asset. The purpose of subsection 701-55(6) is to ensure that the tax cost setting amount of an asset (rather than its original tax cost) is used when applying a provision of the income tax law that is not specifically covered by subsections 701-55(2) to (5C). The determination of which provision in the income tax law is to apply to an asset is a question of fact that will depend on the particular circumstances of each case. The scope of the operation of subsection 701-55(6) is clarified by section 701-56, which specifies that: subsection 701-55(6) does not apply to certain capital expenditure provisions. If a joining entity is entitled to a deduction under the capital expenditure provisions, the head company of the group may be entitled to a deduction because of the operation of the single entity rule (subsection 701-1(1)) and the entry history rule (section 701-5). The amount of the deduction is based on the remaining balance of the capital expenditure, rather than the tax cost setting amount allocated to the asset.

Therefore, the consolidations provisions will operate to determine the cost setting amount for the building when it enters the consolidated group. This is not dependant on the amount of unclaimed capital works deductions left on the building. This is not dependant on the amounts of capital works already claimed on the building prior to consolidations. Due to the selection of the "stick" method by Company A for bringing in the ACA for the land and buildings, the cost base held by the trust would not be changed when it is brought in. After consolidation, the CGT cost base will be reduced by the capital works deductions claimed by Company A i.e. the consolidations legislation would not affect the CGT cost base of the building and the consolidations legislation would not change the operation of subsection 110-40(2) of the ITAA 1997.

Question 2

Summary

The capital works expenditure incurred by Company A, as head company of the Company A group, in relation to its CGT asset acquired before 7:30pm on 13 May 1997 is not excluded from the CGT cost base of the CGT asset by virtue of section 110-40(3) of the ITAA 1997. This is because any capital works deduction allowable for the capital works expenditure is not a recoupment as required by that subsection. Neither Company A nor Unit Trust A have ever been reimbursed or compensated for the capital works expenditure incurred.

Detailed reasoning

Subsection 110-40(3) of the ITAA 1997 provides that an expenditure will be excluded from the CGT cost base if it is recouped unless it has been included in the entity's assessable income.

Subdivision 20-A of the ITAA 1997 provides that certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable.

Under subsection 20-20(2) of the ITAA 1997, an amount received as recoupment of a loss or outgoing is an assessable recoupment if the taxpayer:

(a) received the amount by way of insurance or indemnity; and

(b) can deduct an amount for the loss or outgoing for the current year, or did deduct or could deduct an amount for the loss or outgoing for an earlier income year under any provision of the Act.

Subsection 20-20(1) of the ITAA 1997 provides that an amount is not an assessable recoupment to the extent that it is ordinary income, or it is statutory income because of a provision outside of Subdivision 20-A of the ITAA 1997.

Ordinarily, an amount paid to compensate for loss acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82; ATO ID 2002/175).

Subsection 20-25(1) of the ITAA 1997 provides that a recoupment of a loss or outgoing includes any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described and a grant in respect of the loss or outgoing. Subsection 20-25(2) of the ITAA 1997 also provides that if some other entity pays an amount for you in respect of a loss or outgoing that you incur, you are taken to receive the amount as recoupment of the loss or outgoing.

In this case, these capital works deductions are not recouped from other parties. They were incurred and paid for by Company A or Unit Trust A. Neither taxpayer were not ever reimbursed or compensated for the capital works expenditure incurred. Hence, subsection 110-40(3) of the ITAA 1997 does not apply.

Does the consolidation provisions modify the operation of section 110-40(3) of the ITAA 1997?

As per the explanation, in the detailed reasoning for question 1, re the consolidation provisions, the consolidations legislation would not affect the CGT cost base of the building and the consolidations legislation would not change the operation of subsection 110-40(3) of the ITAA 1997.