Edited version of your written advice

Authorisation Number: 1012845699769

Date of advice: 23 July 2015

Advice

Subject: The application of Division 40 of the Income Tax Assessment Act 1997

Question 1

Is the capital allowances tax bases established by a purchaser under Division 40 modified by Division 58 by entering into the transaction to purchase the Property from Entity A?

Advice

Yes

This advice applies for the following period:

Income year ending 30 June 20xx

The arrangement commences on:

xx xx 20xx

Relevant facts and circumstances

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

Entity A is an exempt entity within the meaning of subsection 995-1(1) of the ITAA 1997. The Property is owned by Entity A and is held as an investment property.

The transaction

Entity A is proposing to divest its interest in the Property.

Audited reports

Entity A prepared audited final accounts which were signed before 5 August 1997.

The accounts disclosed a value for the assets.

The audit report did not state that the auditor was not satisfied that the specified value fairly represented the value of the asset.

Assumption

That the future purchaser of the building will acquire the building with all current leases in place such that the purchaser at acquisition time is using the assets to carry on the business.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 subsection 40-95(2)

Income Tax Assessment Act 1997 section 40-102

Income Tax Assessment Act 1997 section 40-110

Income Tax Assessment Act 1997 subsection 40-180(2)

Income Tax Assessment Act 1997 section 40-185

Income Tax Assessment Act 1997 section 40-190

Income Tax Assessment Act 1997 Division 58

Income Tax Assessment Act 1997 Subdivision 58-B

Income Tax Assessment Act 1997 section 58-5

Income Tax Assessment Act 1997 subsection 58-5(4)

Income Tax Assessment Act 1997 subsection 58-10(1)

Income Tax Assessment Act 1997 paragraph 58-10(1)(a)

Income Tax Assessment Act 1997 paragraph 58-10(2)(b)

Income Tax Assessment Act 1997 section 58-65

Income Tax Assessment Act 1997 section 58-70

Income Tax Assessment Act 1997 subsection 58-70(1)

Income Tax Assessment Act 1997 subsection 58-70(5)

Income Tax Assessment Act 1997 paragraph 58-70(5)(a)

Income Tax Assessment Act 1997 section 58-75

Income Tax Assessment Act 1997 subsection 58-75(2)

Income Tax Assessment Act 1997 subsection 58-75(3)

Income Tax Assessment Act 1997 subsection 58-75(4)

Income Tax Assessment Act 1997 subsection 58-75(5)

Income Tax Assessment Act 1997 subsection 58-75(5A)

Income Tax Assessment Act 1997 subsection 58-75(6)

Income Tax Assessment Act 1997 section 58-80

Income Tax Assessment Act 1997 subsection 58-80(1)

Income Tax Assessment Act 1997 section 58-85

Income Tax Assessment Act 1997 subsection 58-85(1)

Income Tax Assessment Act 1997 paragraph 58-85(1)(b)

Income Tax Assessment Act 1997 subsection 58-80(2)

Income Tax Assessment Act 1997 subsection 58-80(3)

Income Tax Assessment Act 1997 subsection 58-80(4)

Income Tax Assessment Act 1997 subsection 58-80(5)

Income Tax Assessment Act 1997 subsection 58-80(6)

Income Tax Assessment Act 1997 subsection 58-80(7)

Further issues for you to consider

If the purchaser is not a taxable entity or does not use the assets to carry on the business than Division 58 of the ITAA 1997 will not apply.

We have covered this outcome under Option 2 in the detailed reasoning below so that the purchaser has guidance on the taxation outcomes in relation to the depreciating assets regardless of whether or not they use the assets to carry on the business.

Anti-avoidance rules

Part IVA is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

Reasons for advice

All legislative references are to the Income Tax Assessment Act 1997

Summary

The details of the purchasers' use of the asset will determine the taxation treatment of the capital allowances cost base.

• Option 1 - will deal with the situation where the purchaser satisfies section 58-5 meaning the direct sale of the Property will be an asset sale situation.

• Option 2 - will deal with the situation where section 58-5 does not apply meaning that the direct sale of the Property is not an asset sale situation.

Option 1

Where the direct sale of the Property is an asset sale situation under section 58-5, Subdivision 58-B will apply to modify the rules in Division 40 when calculating ongoing deductions for the decline in value of depreciating assets that were previously held by an exempt entity.

The purchaser can choose either the notional written down value (NWDV) method or the undeducted pre-existing audited book value (UPABV) method under section 58-65. This option of NWDV or UPABV is open to the purchaser as the Property has a pre-existing audited book value from before 4 August 1997.

Option 2

Where the direct sale of the Property is not an asset sale situation under section 58-5, Subdivision 58-B will not apply to modify the rules in Division 40 when calculating ongoing deductions for the decline in value of depreciating assets that were previously held by an exempt entity. That is, the standard rules in Division 40 will apply with no modification.

Detailed reasoning

Subdivision 58-B sets out the rules that affect the way in which the purchaser works out the decline in value of, and balancing adjustments for, privatised assets under Division 40 after the acquisition time.

Section 58-70 contains the rules for the application of Division 40 (capital allowances) where an asset sale situation as described in section 58-5 has occurred. The section prescribes how Division 40 is to be applied in calculating ongoing deductions for the decline in value of depreciating assets that were previously held by an exempt entity. The section also has an effect on the calculation of balancing adjustments if a balancing adjustment event subsequently occurs for the asset (e.g. the asset is disposed of).

For completeness' sake, two options will be explored in this answer. Option 1 will deal with the situation where the purchaser satisfies section 58-5 meaning the direct sale of the Property will be an asset sale situation. Option 2 will deal with the situation where section 58-5 does not apply meaning that the direct sale of the Property is not an asset sale situation.

Option 1: the Property is purchased by an entity that continues carrying on the business in which the relevant asset was used prior to the sale pursuant to paragraph 58-10(1)(a)

Under Option 1, an asset sale under subsection 58-5(4) will occur because an entity whose income is assessable acquires a depreciating asset from the exempt entity and the asset is acquired in connection with the acquisition or a business from the exempt entity. Therefore, the decline in value of the depreciating asset that was previously held by the exempt entity must be calculated under Division 40 as modified by Subdivision 58-B.

Section 58-70 considers the application of Division 40. This requires the purchaser to select either the NWDV method or the UPABV method under section 58-65. Pursuant to subsection 58-70(1), the purchaser will work out the decline in value of, and the effect of a balancing adjustment event occurring for, each privatised asset using Division 40 (capital allowances) as if the asset had been acquired under a contract entered into on or after 1 July 2001.

The purchaser will then calculate (depending on its choice) either the NWDV of the privatised asset or the UPABV under subsection 58-70(5). Once the purchaser has made that calculation, that value will form part of the first element cost of the asset (paragraph 58-70(5)(a)) for the purposes of calculating future deductions for its decline in value (i.e. after the transition time or the acquisition time) under item 11 in the table contained in subsection 40-180(2).

The calculation of the NWDV or UPABV is, in one sense, a "notional" amount, i.e. the amount of the decline in value and for which a deduction would have been allowed under Division 40, had the entity been taxable. This step produces a written-down value for the privatised asset, on which the deductible decline in value for the post-transition time or the post-acquisition time period is based.

Notional written down value

The meaning of NWDV of a privatised asset is set out in section 58-75. The NWDV of a privatised asset is its adjustable value in the hands of the tax exempt vendor just before the acquisition time worked out using the assumptions of section 58-75.

Subsection 58-75(2) requires the purchaser to assume that Division 40 had always applied to work out the decline in value of the privatised asset.

Subsection 58-75(3) requires the purchaser to assume that, in applying Division 40 to the privatised asset, it had always been used by the tax exempt vendor wholly for taxable purposes.

Subsection 58-75(4) states that if the tax exempt vendor was an exempt Australian government agency just before the transition time and had acquired the privatised asset from another exempt Australian government agency:

(a) assume that the transition entity or tax exempt vendor acquired it at the time when it was acquired or constructed by the other exempt Australian government agency and that the first element of the cost to the transition entity or tax exempt vendor is the amount that was its cost to the other exempt Australian government agency; or

(b) if it had, before its acquisition by the transition entity or tax exempt vendor, been successively held by 2 or more exempt Australian government agencies - assume that:

(i) the transition entity or tax exempt vendor acquired it at the time when it was acquired or constructed by the first of those exempt Australian government agencies that owned it; and

(ii) the first element of its cost to the transition entity or tax exempt vendor is the sum of the amount that was the first element of its cost to the first of those exempt Australian government agencies that owned it and any amount included in the second element of its cost for that first agency or a later successive agency.

Subsection 58-75(5) goes on to assume that the tax exempt vendor had chosen to use an effective life determined by the Commissioner for the privatised asset as in force at the acquisition time and that subsection 40-95(2) did not apply. In addition, subsection 58-75(5A) requires the purchaser to assume that section 40-102 did not apply to a privatised asset unless certain criteria are met. Section 40-110 will also be assumed not to apply pursuant to subsection 58-75(6).

In this case, the purchaser has the option of choosing between the NWDV and the UPABV as the assets have a pre-existing audited book value from before 4 August 1997 (paragraph 58-85(1)(b)).

Undeducted pre-existing audited book value

The meaning of UPABV of a privatised asset is set out in section 58-80. Subsection 58-80(1) states that the UPABV of a privatised asset is its adjustable value in the hands of the tax exempt vendor just before the acquisition time worked out using the assumptions in this section.

Subsection 58-80(2) assumes that Division 40 had always applied to work out the decline in value of the privatised asset.

Subsection 58-80(3) assumes that, in applying Division 40 to the privatised asset, it had always been used by the tax exempt vendor wholly for taxable purposes.

Subsection 58-80(4) assumes that:

(a) the first element of the privatised asset's cost to the tax exempt vendor is its pre-existing audited book value as at the latest time (the test time) at which it had a pre-existing audited book value; and

(b) no amount was included in the second element of the asset's cost before the test time; and

(c) any amount included in the second element of the asset's cost after the test time had been incurred by the tax exempt vendor.

Subsection 58-80(5) assumes that the tax exempt vendor had acquired the privatised asset at the test time.

Subsection 58-80(6) assumes that:

(a) the tax exempt vendor had chosen to use an effective life determined by the Commissioner for the privatised asset as in force at the transition time or the acquisition time; and

(b) subsection 40-95(2) did not apply.

Subsection 58-80(7) further assumes that section 40-110 did not apply.

For the purposes of this section, a privatised asset has a pre-existing audited book value if it satisfies the conditions in 58-85.

Subsection 58-85(1) provides that a privatised asset has a pre-existing audited book value if:

(a) a balance sheet, as at the end of an annual accounting period (the balance date), that was prepared as part of the final accounts of the Commonwealth, a State, a Territory or an exempt entity for that period showed the asset as an asset of the relevant entity and specified a value for it;

(b) a qualified independent auditor who was engaged, or was required by law, to undertake an audit of those accounts had prepared and signed, before 4 August 1997, a final audit report on those accounts; and

(c) the report did not state that the auditor was not satisfied that the specified value fairly represented the value of the asset.

In this case, Entity A prepared audited final accounts from before 4 August 1997 and it contained a value for the assets. The audit report did not state that the auditor was not satisfied that the specified value fairly represented the value of the asset.

Option 2: the Property is purchased by an entity that does not continue carrying on the business in which the relevant asset was used prior to the sale pursuant to paragraph 58-10(2)(b)

The special rules in Division 58 will not apply as the Privatisation is not an asset sale situation under section 58-5.

The standard rules in Division 40 will apply.

Because there is no modification of Division 40, the cost of the depreciating asset to the purchaser will be by reference to the following provisions:

40-185 Amount you are taken to have paid to hold a depreciating asset or to receive a benefit

(1) This Division applies to you as if you had paid, to *hold a *depreciating asset or for an economic benefit for such an asset, the greater of these amounts:

(a) the sum of the amounts that would have been included in your assessable income because you started to hold the asset or received the benefit, or because you gave something to start holding the asset or receive the benefit, if you ignored the value of anything you gave that reduced the amount actually included; or

(b) the sum of the applicable amounts set out in this table in relation to holding the asset or receiving the benefit.

(2) In applying the table in subsection (1) to a liability of yours to pay an amount or provide a *non-cash benefit, don't count any part of the liability you have already satisfied.

40-190 Second element of cost

(1) The second element is worked out after you start to *hold the *depreciating asset.

(2) The second element is:

(a) the amount you are taken to have paid under section 40-185 for each economic benefit that has contributed to bringing the asset to its present condition and location from time to time since you started to *hold the asset; and

(b) expenditure you incur that is reasonably attributable to a *balancing adjustment event occurring for the asset.

(2A) Paragraph (2)(b) does not apply to a *balancing adjustment event referred to in item 6 or 11 of the table in subsection 40-300(2).

(3) However, the second element is worked out using this table if an item in it applies. Use the last applicable item.