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Edited version of your written advice
Authorisation Number: 1013024914475
Date of advice: 1 June 2016
Ruling
Subject: Capital works deduction
Question 1
Can you claim a capital works deduction for the construction costs at the time of surrender of the lease?
Answer
Yes.
This ruling applies for the following periods:
Year ended 30 June 20xx
The scheme commences on:
1 July 20xx
Relevant facts and circumstances
The R family trust (You), is the owner and lessor of a commercial property at X (your property).
The lease was entered into on a specific date with Y Company (the lessee).
The lessee with your consent incurred construction expenditure by constructing a substantial showroom and other building works on your property.
Construction was completed around the 20aa/20bb years.
The estimated cost of construction was approximately $2,000,000.
The Lessee surrendered the lease on or about April 20cc.
In April 20cc you entered into a new lease with a new tenant/lessee, ABC Investments Pty Ltd (new lessee).
Relevant legislative provisions
Income Tax Assessment Act 1997 Subsection 43-10(1)
Income Tax Assessment Act 1997 Subsection 43-15(1)
Income Tax Assessment Act 1997 Subsection 43-120(1)
Income Tax Assessment Act 1997 Subsection 43-120(2)
Income Tax Assessment Act 1997 Subsection 43-125(1)
Income Tax Assessment Act 1997 Subsection 43-125(2)
Reasons for decision
Question 1
Can you claim a capital works deduction for the construction costs at the time of surrender of the lease?
Summary
Yes. At the time of surrender of the lease, the right to claim capital works deduction reverts back to you.
Detailed reasoning
Subsection 43-10(1) of the ITAA 1997 states that you can deduct an amount for capital works for an income year.
Subsection 43-15(1) of the ITAA 1997 states that the amount you can deduct is a portion of your construction expenditure. However, it cannot exceed the amount of undeducted construction expenditure for your area.
Subsection 43-125(1) of the ITAA 1997 states that an amount that relates to a pool of construction expenditure that arises as a result of expenditure incurred by a lessee can only be deducted by a lessee who satisfies subsections 43-120(1) or (2) of the ITAA 1997.
Subsection 43-125(1) of the ITAA 1997 also states that an amount cannot be deducted by the owner of the capital works while there is a lessee who satisfies that subsection.
Subsection 43-125(2) of the ITAA 1997 states that the owner of the capital works may deduct an amount that relates to that pool if there is no longer a lessee who satisfies subsections 43-120(1) or (2).
Subsection 43-120(1) of the ITAA 1997 states that your area is the part of the construction expenditure area that you lease and that is attributable to a pool of construction expenditure that you incurred; and you have continuously leased or held since the construction was completed.
Subsection 43-120(2) of the ITAA 1997 states that your area is the part of the construction expenditure area that you lease and that is attributable to a pool of construction expenditure incurred by another lessee and has been continuously leased or held since the construction was completed by the lessee who incurred the expenditure or an assignee of that lessee's lease.
ATO Interpretative Decision ATO ID 2012/4 Income Tax - Capital Works: your area - assignee of that lessee's lease interprets subsection 43-120(2) of the ITAA 1997 and distinguishes between an assignment of a lease from a novation of a lease. Where the previous lessee has 'assigned' the existing lease to a new lessee/assignee then subsection 43-120(2) will be satisfied. If however, the previous lease terminates then the right to any residual deductions will vest in the owner of the capital works.
In your case, you are the owner of the capital works.
Prior to April 20cc the lessee satisfied subsection 43-125(1) of the ITAA 1997 as they met the test under subsection 43-120(1) of the ITAA 1997, namely that they incurred construction expenditure by constructing a showroom and other works within a construction expenditure area and which is attributable to a pool of construction expenditure incurred by the lessee until their lease ended at approximately April 20cc.
After April 20cc, the lessee no longer satisfied subsections 43-120(1) or (2) of the ITAA 1997 as the lease was no longer held, and the lease was not assigned to the new lessee. Instead, the lease was terminated and a new lease agreement was entered into with the new lessee (novation of a lease).
The new lessee also does not satisfy subsections 43-120(1) or (2) of the ITAA 1997 as they did not incur the construction expenditure, nor was the lease assigned to the new lessee.
Therefore, pursuant to subsection 43-125(2) of the ITAA 1997 and ATO ID 2012/4, when the lessee's lease ended at around April 20cc the right to claim any residual capital works deduction for works incurred by the lessee vests in you.