Edited version of your written advice

Authorisation Number: 1012849766289

Date of advice: 3 August 2015

Advice

Subject: Division 43 of the Income Tax Assessment Act 1997

Question 1

Does section 43-55 of the Income Tax Assessment Act 1997 (ITAA 1997) have any application to the proposed transaction?

Advice

No

Question 2

Is the capital works deduction base established by a purchaser under Division 43 of the ITAA 1997 by acquiring the property?

Advice

Yes

Question 3

Is the undeducted construction expenditure, calculated under Subdivision 43-G of the ITAA 1997 written off during the period that the capital works deduction is not available to Entity A during Entity A's notional tax equivalent claim period?

Advice

Yes

Question 4

Is the capital gains tax cost base worked out under Division 110 of the ITAA 1997 for the purchaser?

Advice

Yes

Question 5

Is Division 43 of the ITAA 1997 modified by Division 58 of the ITAA 1997 due to the purchaser acquiring the property from Entity A?

Advice

No

This advice applies for the following period:

Income year ending 30 June 20xx

The arrangement commences on:

X 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). Entity A is subject to the National Tax Equivalent Regime (NTER).

The transaction

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

The disposal transaction between Entity A and the purchaser will not be negotiated on the basis of the tax deduction available to the purchaser. The capital works deduction base established by the purchaser will be no more favourable than those directly between federal taxpayers and be established on the basis of original construction expenditure.

Assumption

That the future purchaser of the building/s 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 43

Income Tax Assessment Act 1997 Section 43-55

Income Tax Assessment Act 1997 Subdivision 43-B

Income Tax Assessment Act 1997 Subdivision 43-C

Income Tax Assessment Act 1997 Subdivision 43-G

Income Tax Assessment Act 1997 Division 110

Income Tax Assessment Act 1997 Subdivision 110-A

Income Tax Assessment Act 1997 Subdivision 110-B

Income Tax Assessment Act 1997 Subsection 110-45(1A)

Income Tax Assessment Act 1997 Subsection 110-45(1B)

Income Tax Assessment Act 1997 Subsection 110-45(3)

Income Tax Assessment Act 1997 Subsection 110-45(4)

Income Tax Assessment Act 1997 Subsection 110-55(4)

Anti-avoidance rules

Part IVA of the ITAA 1997 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 decision

All legislative references are to the Income Tax Assessment Act 1997

Question 1

Summary

Section 43-55 will not apply where the proposed disposal transaction between Entity A and the purchaser is not negotiated on the basis of the tax deduction available to the purchaser, and the capital works deduction base established by the purchaser will be no more favourable than those directly between federal taxpayers and be established on the basis of original construction expenditure.

Detailed reasoning

Section 43-55 contains an anti-avoidance rule to disallow deductions under Division 43 if certain arrangements with a tax-exempt entity have been entered into.

The section is directed at arrangements whereby a taxpayer would otherwise get a capital works deduction in relation to property and the benefit of that deduction is passed on to the tax-exempt entity by the payment of an amount of money, or by the transfer of property, to the tax-exempt entity equivalent to the value of the deduction.

In the present case, section 43-55 would only apply if:

(a) the purchaser nominally entitled to a Division 43 deduction is to pay an amount or transfer property, whether directly or indirectly, to Entity A;

(b) the amount of the payment or the value of the transfer is calculated having regard to the amount of the Division 43 deduction to which the purchaser is nominally entitled; and

(c) a purpose of the arrangement is to ensure that the benefit of the deduction would pass wholly or substantially to Entity A. This purpose must not be a merely incidental purpose.

The proposed disposal transaction between Entity A and the purchaser is not negotiated on the basis of the tax deduction available to the purchaser, and the capital works deduction base established by the purchaser will be no more favourable than those directly between federal taxpayers and be established on the basis of original construction expenditure. As such section 43-55 will not apply.

Question 2

Summary

The purchaser will have correctly established the capital works deduction base where all the relevant requirements in Subdivision 43-B and Subdivision 43-C have been satisfied.

Detailed reasoning

Division 43 allows the capital cost of constructing capital works to be written-off.

Capital works are:

• buildings, structural improvements and environment protection earthworks; and

• extensions, alterations or improvements to these.

One can deduct an amount for capital works in an income year if:

• the works have a construction expenditure area ;

• there is a pool of construction expenditure for that area; and

• you use your area in the year to produce assessable income.

Subdivision 43-B is about establishing the deduction base. This Subdivision explains the meaning of the terms construction expenditure, construction expenditure area and pool of construction expenditure. These are elements central to working out what deductions are available for capital works.

Subdivision 43-C sets out the relevant area to enable a taxpayer to claim a deduction. It explains the meaning of the terms your area and your construction expenditure.

Subdivision 43-D sets out the required use of your area required for there to be a deductible use of the capital works.

The concepts of Subdivision 43-B, Subdivision 43-C, and Subdivision 43-D taken together determine if you have deductible capital works and establish the basis on which your deduction is calculated.

Where the capital works deduction base established by the purchaser satisfies all relevant requirements in Subdivision 43-B, Subdivision 43-C, and Subdivision 43-D then the purchaser has correctly established the capital works deduction base.

Question 3

Summary

The taxpayer will calculate the undeducted construction expenditure amount, calculated under Subdivision 43-G of the ITAA 1997 as having been written off during the period that the capital works deduction is not available to Entity A. The fact that no capital works deductions were available to Entity A during its notional tax equivalent claim period does not affect the taxpayer's calculation of the undeducted construction expenditure.

Detailed reasoning

Subdivision 43-G explains how to calculate the undeducted construction expenditure. In relation to capital works, it is the part of the construction expenditure that remains to be written off.

Broadly, the undeducted construction expenditure is the original construction expenditure less the aggregate of amounts calculated at the relevant rate per annum of that expenditure, from the time the capital works, or a part of it, was first used by any entity for any purpose after completion of the relevant construction.

For capital works begun:

• after 26 February 1992, the rate of deduction is 2.5%, or 4% for certain purposes;

• between 22 August 1984 and 15 September 1987, the rate of deduction is 4%;

• for other periods the rate of deduction is 2.5%.

The undeducted construction expenditure is not affected by the period that capital works deductions are not available to the taxpayer, see ATO Interpretative Decision ATO ID 2014/38 Capital Works: undeducted construction expenditure - period where no capital works deduction is available.

No capital works deductions were available to Entity A during its notional tax equivalent claim period. However, this period does not affect the taxpayer's calculation of the undeducted construction expenditure. The taxpayer will calculate the undeducted construction expenditure amount, calculated under Subdivision 43-G of the ITAA 1997 as having been written off during this period.

Question 4

Summary

Division 110 will be used to determine the capital gains tax cost base and reduced cost base.

Detailed reasoning

Division 110 explains how to work out the cost base and reduced cost base of a CGT asset. The cost base and reduced cost base of CGT assets are relevant for most CGT events when working out if a capital gain or loss has been made.

Subdivision 110-A - Cost base

Subdivision 110-A contains the rules for working out the cost base of a CGT asset.

The cost base of a CGT asset to a taxpayer consists of five elements:

• first element - the amount of any money or the market value of any property the taxpayer paid or gave, or was required to pay or give, in respect of the acquisition of the asset.

• second element - the incidental costs the taxpayer incurred to acquire the asset or that relate to a CGT event that happens in relation to the asset.

• third element - the amount of costs of owning the asset provided the asset was acquired on or after 21 August 1991.

• fourth element - the capital expenditure incurred, the purpose or expected effect of which is to increase or preserve the asset's value, or that relates to installing or removing the asset. The expenditure does not apply to capital expenditure incurred in relation to goodwill. Expenditure can include giving property.

• fifth element - the capital expenditure incurred by the taxpayer to establish, preserve or defend the taxpayer's title to, or a right over, the asset. The expenditure can include giving property.

Exclusions from the cost base

For assets acquired at or after 7.30 pm on 13 May 1997, deductible expenditure is (for the first, fourth and fifth elements of the cost base) initially included in the asset's cost base and is excluded when the CGT event happens.

Expenditure does not form part of the second or third element of the cost base of a CGT asset to the extent that the taxpayer has deducted or can deduct it (subsection 110-45(1B)).

Expenditure does not form part of any element of the cost base of a CGT asset to the extent that a taxpayer has recouped it except where the recouped amount is included in the taxpayer's assessable income (subsection 110-45(3)).

Section 110-45 also operates to prevent expenditure from forming part of the cost base of land or a building acquired before 7.30 pm (ACT legal time) on 13 May 1997 if the expenditure was incurred by the taxpayer after 30 June 1999 and forms part of the fourth element of the cost base of the property (subsection 110-45(1A)).

Section 110-45(4) works to reduce the cost base to the extent that you have deducted, or can deduct for an income year, capital expenditure incurred by another entity in respect of the CGT asset. However, this rule does not apply so far as the deduction is covered by paragraph (2)(a) or (b).

Subdivision 110-B - Reduced cost base

Subdivision 110-B contains the rules for working out the reduced cost base of a CGT asset.

The reduced cost base of a CGT asset to a taxpayer at the time CGT event occurs is the amount that is compared with the capital proceeds from the event to determine whether the taxpayer has made a capital loss from the CGT event and, if so, the amount of the capital loss.

As with the cost base of a CGT asset, the reduced cost base of a CGT asset consists of five elements and all of the elements (except the third element) of the reduced cost base of the CGT asset are the same as those for the cost base (subsection 110-55(2)).

In broad terms, the reduced cost base of a CGT asset consists of the various amounts (with one exception below) that comprise the cost base of the asset reduced by any of the amounts that have been deductible or are deductible to the extent they are not subject to an assessable balancing charge (section 110-55).

The exception is that costs of owning the asset (or non-capital costs of ownership for CGT events that happened before 1 July 2005) do not form part of the asset's reduced cost base. Instead of this element, the reduced cost base includes any balancing adjustment for the disposal of the asset and any amount that would have been a balancing adjustment apart from the operation of certain depreciation provisions (subsections 110-55(3) and (4)).

Exclusions from the reduced cost base

Sections 110-55(4)-(10) contains the rules for amounts that are excluded from the reduced cost base. For example, the reduced cost base does not include an amount to the extent that the taxpayer has deducted or can deduct it (including because of a balancing adjustment) or could have deducted it apart from paragraph 43-70(2)(h)(subsection 110-55(4)). Further, as in the case of cost base, expenditure does not form part of the reduced cost base to the extent of any amounts the taxpayer has recouped and which are not included in the taxpayer's assessable income (subsection 110-55(6)).

Question 5

Summary

The capital works deduction base is not modified by the application of Division 58.

Detailed reasoning

Division 58 sets out special rules that apply in calculating deductions for the decline in value of depreciating assets and balancing adjustments for assets previously owned by an exempt entity, including assets acquired from that entity, in connection with the acquisition of a business, by a purchaser that is a taxable entity.

Division 58 does not have any application to the Division 43 Capital works deduction base.