Edited version of your written advice

Authorisation Number: 1051343203993

Date of advice: 1 March 2018

Ruling

Subject: Capital gains tax – Roll-overs – Crown lease

Question

Is Company Q entitled to roll-over relief under subdivision 124-J of the Income Tax Assessment Act 1997 (ITAA 1997) when it surrenders its current lease agreement and enters into a new lease agreement?

Answer

No. As the conditions in section 124-575 of the ITAA 1997 are not satisfied, the taxpayer is not entitled to rollover relief under subdivision 124-J.

This ruling applies for the following period:

1 July 2017 to 30 June 2020.

Relevant facts and circumstances

Facts as per ruling application

Company Q is the lessee of land from a Statutory Body. The Lease has a 50 year term and was granted to Company Q in 19XX by the Crown in the right of the State of State A.

In 20xx, the Crown transferred the title to the land subject to the lease to a Statutory Body which manages property on behalf of the State.

Under the Lease:

● Company Q pays an annual rental

● The rent is adjusted for movement in the CPI

● No premium was paid by Company Q on entering into the lease

● Under the lease, Company Q is required, at its own cost to maintain the leased premises in good repair and condition.

● The lease grants Company Q a right of first refusal to acquire the land if the lessor decides to sell all or part of its reversionary interest. The right of first refusal does not give Company Q a call option over the land.

The State wishes to redevelop the land over which Company Q holds the lease and to move the premises to a new site proximate to the current site.

The current premises are beyond their economic life and the cost of maintenance has become prohibitive. Relocation to new, purpose built premises has been determined to offer a more practical space for Company Q to operate, while allowing the State Government to better utilise the current site for its highest and best use.

The State Government has agreed to enter into exclusive negotiations with Company Q, to seek to agree transaction terms whereby:

● Company Q will agree to surrender its lease over the current premises (including the right of first refusal) prior to the end of the lease term.

● New fully fitted out premises will be built on land owned by a Statutory Authority. The new site is adjacent and proximate to the existing site.

● Company Q will be offered a premises lease with a term of up to 50 years over the new premises with a permitted use replicating the provisions of the existing lease.

● The New Lease will be granted by a Statutory Authority in right of the State of NSW which will take a ground lease of the site.

● The New Lease will be a premises lease because State Government policy prevents a subdivision, which would be necessary if a ground lease was to have been granted.

Relevant legislative provisions

Income Tax Assessment Act 1997

Part 3-1

Subsection102-25(1)

Section 104-10

Section 104-25

Section 104-125

Part 3-3

Subdivision 124-J

Section 124-575

Section 124-580

Section 124-585

Section 124-590

Section 124-595

Section 124-600

Reasons for decision

Division 124 – Replacement-asset roll-overs

A replacement asset roll-over allows a taxpayer, in special cases, to defer the making of a capital gain or loss from one CGT event until a later CGT event happens.

A roll-over may be available under Division 124 when a taxpayer who owns a CGT asset gives up, surrenders or relinquishes that asset and as part of the same transaction or circumstances the taxpayer receives another CGT asset to replace the original asset.

Under subdivision 124-J compulsory roll-over relief is available in situations in which the holder of a crown lease over land obtains a replacement asset when the lease is renewed, extended or converted into an estate in fee simple.

If a taxpayer fulfils all of the requirements of subdivision 124-J, the roll-over will occur automatically. The consequences are those set out in subdivision 124-A (general rules for replacement asset rollovers). For the purposes of applying the rules in subdivision 124-A, the “original asset” is the taxpayer’s original Crown lease(s), and the “new asset” is the estate(s) in fee simple and /or new Crown leases granted to the taxpayer.

Subdivision 124-J – Basic conditions for relief

Subdivision 124-J of the ITAA 1997 sets out the situations in which the holder of a Crown lease over land obtains a replacement asset roll-over when the lease is, among other things, renewed, extended or converted to an estate in fee simple. A Crown lease is defined in section 124-580 of the ITAA 1997 as a lease of land granted by the Crown under an Australian law (other than the common law) or a similar lease granted under a foreign law.

Section 124-575 of the ITAA 1997 is the central operative provision of Subdivision 124-J of the ITAA 1997. It provides an automatic roll-over where:

● a taxpayer holds one or more Crown leases over land (the "original right");

● the taxpayer surrenders the Crown leases or they expire;

● the taxpayer is granted one or more estates in fee simple or one or more new Crown leases over land (or both) (the "new right"); and

● the new estates in fee simple and/or the new leases relate to the same land as the original Crown leases(s).

For the roll-over to happen, the new right must be granted by:

● renewing or extending the term of the original Crown lease, mainly because the taxpayer held the original Crown lease;

● changing the purpose for which the land to which the original Crown lease related can be used;

● converting the original Crown lease to a Crown lease in perpetuity;

● converting the original Crown lease to an estate in fee simple;

● consolidating, or consolidating and dividing, the original Crown lease;

● subdividing the original Crown lease;

● excising or relinquishing a part of the land to which the Crown lease related; or

● expanding the area of the land.

Subsection 124-575(1) of the ITAA 1997 sets out the conditions for a roll-over of a Crown lease:

124-575(1)

There is a roll-over if:

(a) you hold one or more *CGT assets that are *Crown leases over land (the original right); and

(b) the original right expires or you surrender it; and

(c) you are granted one or more new Crown leases over land or one or more estates in fee simple in land, or both (the new right); and

(d) the new right relates to the same land as the original right.

It should be noted that the use of the conjunction “and” at the end of each condition means that paragraphs (a), (b), (c) and (d) must all be satisfied if there is to be a roll-over.

Meaning of crown lease

A lease of Crown land enables exclusive use over a particular piece of land for a specified term and purpose. Generally, leases are sought over Crown land where longer-term security of tenure is an important factor to the user of the land – such as where commercial uses are proposed and major financial outlay is required. Examples include extensive agricultural initiatives, long term extractive industries, irrigation, commercial and trading purposes, marina sites and caravan parks.

All Crown leases are issued for specified terms and are recorded on the title of that land. Unless the terms of the lease specify otherwise, there is no inherent right of purchase of the leased land. In NSW leases may be granted by:

● public tender

● invitations for expression of interest: or

● direct negotiation

A Crown lease may also be transferred or assigned to another party with the consent of the Minister responsible for administering the Crown Lease Act 1989 (NSW).

Meaning of Crown

Section 124-580 of the ITAA 1997 provides the definition of ‘Crown lease’ for the purposes of the replacement asset roll-over provisions under Subdivision 124-J of the ITAA 1997:

124-580 A Crown lease is:

(a) a lease of land granted by the Crown under an *Australian law (other than the common law); or

(b) a similar lease granted under a *foreign law.

The term ‘Crown’ is not defined for the purposes of the ITAA 1997 and therefore takes its meaning from ordinary usage and understanding. In some instances, government authorities may not, by the nature of their functions, fall within the definition of Crown.

The term ‘Crown’ is defined by the Macquarie Dictionary, 2009, rev. 5^th edn, The Macquarie Library Pty Ltd, NSW to mean:

a. The sovereign as head of the state; the monarch.

b. The imperial or regal power; sovereignty.

c. The government, or governments above local government level, of a country with a constitutional monarch.

In the context of NSW, the ‘Crown’ is referred to as the Crown in right of NSW. Section 13 of the Interpretation Act 1987 (NSW) (Interpretation Act) provides that a reference to the Crown for the purposes of any Act or Instrument is a reference to the Crown in right of the State of NSW:

13 Sovereign and Crown

In any Act or instrument:

(a) a reference to the Sovereign (whether the words “Her Majesty” or “His Majesty” or any other words are used) is a reference to the Sovereign for the time being, and

(b) a reference to the Crown is a reference to the Crown in right of State A.

Section 13A of the Interpretation Act provides guidance as to when a NSW Government agency or statutory body is representing the Crown. Specifically, subsections 13A(4) and 13A(5) of the Interpretation Act provide the following:

(4) In any Act or Instrument:

(a) a reference to a NSW Government agency includes a reference to a body that is declared to be a statutory body representing the Crown, or

(b) a reference to a statutory body representing the Crown includes a reference to a body that is declared to be a NSW Government agency.

(5) In this section, the “Crown” includes the State and the Government of the State.

The definition of ‘Australian law’ for the purposes of paragraph 124-580(a) of the ITAA 1997 can be found in subsection 995-1(1) of the ITAA 1997 and means a Commonwealth law, a State law or a Territory law.

At the present time Company Q operates from land which is under a lease from a Statutory Authority which is a statutory body representing the Crown and has the status, privileges and immunities of the Crown.

Schedule 3 to the existing lease specifies the particulars of the land over which the lease is held. It is accepted that the current lease is a Crown lease over land for the purposes of subdivision 124-J of the ITAA 1997.

The replacement asset – the new lease

One of the conditions for roll-over relief under subdivision 124-J is that:

“you are granted one or more new Crown leases over land or more estates in fee simple in land, or both” (paragraph 124-575(1)(c) ITAA 1997)

According to the facts, “Company Q will be offered a premises lease”. The premises lease will be between Company Q and the building owner (the Statutory Authority), which represents the Crown in the Right of the State of State A.

Company Q also confirms:

“The New Lease will be a premises lease because State Government policy prevents a subdivision which would be necessary if a ground lease was to have been granted.”

As the new lease is a ‘premises lease’, it does not meet the definition of “Crown lease” in section 124-580 of the ITAA 1997, which refers to “a lease over land”. Accordingly, roll-over relief would not be available under subdivision 124-J.

CGT events

Subsection 102-25(1) of the ITAA 1997 provides that where more than one CGT event may apply to a situation, you must use the one that is most specific to your situation. There are a number of CGT events which may apply when a lease is terminated. The application of these events is outlined below.

CGT event C2 – cancellation, surrender and similar endings

Under section 104-25 of the ITAA 1997 a CGT event C2 happens if a taxpayer's ownership of an intangible CGT asset ends because it is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered, forfeited or expired.

CGT event F4 – lessee receives payment for changing lease

Under section 104-125 of the ITAA 1997, a CGT event F4 happens if a lessee receives a payment from the lessor for agreeing to vary or waive a term of the lease. The payment can include the giving of property.

CGT event A1 – disposal of a CGT asset

Under section 104-10 of the ITAA 1997, a CGT event A1 happens if you dispose of a CGT asset. A CGT asset can be either tangible or intangible. The rights created under a lease constitute legal or equitable rights which are a CGT asset as defined in section 108-50 of the ITAA 1997.

Paragraph 42 of Taxation Ruling TR 2005/6 (Income tax: lease surrender receipts and payments) states that:

A CGT event happens when a lessee surrenders a lease (CGT event A1 section 104-10) about the disposal of a CGT asset rather than CGT event C2 (section 104-25) about the ownership of an asset ending by the asset being surrendered.

The footnote relating to that paragraph states:

Although we accept that CGT event C2 appears to apply on its terms, we consider that CGT event A1 is the more relevant event, as there is a change of ownership of the lease term from the lessee to the lessor, as explained at paragraphs 85-95 (addressing the implications for the lessor)

Paragraph 86 of the Ruling goes on to say:

A surrender of a lease may be either express or by operation of law. An express surrender must be by deed or in writing. A surrender by operation of law can be effected where a lessee delivers possession of the leased land that is accepted by the lessor. In both cases the surrender consists of the yielding up of the term to the person who has the immediate estate in reversion. The lease term will then, by mutual agreement, merge in the reversion.

(See Halsbury’s Laws of England (3^rd ed) Volume 23 at paragraphs 1412 to 1414; (4^th ed) Volume 27 at paragraph 444)

It is considered that the most specific CGT event that is relevant to your circumstances is CGT event A1 as explained in TR 2005/6.

Will the taxpayer make a capital gain or loss under the proposed scheme?

As explained above, a CGT event A1 will happen when the existing lease is surrendered / terminated (as per TR 2005/6). The Statutory Authority will not pay Company Q for the surrender of the lease. Therefore there will be no capital proceeds in relation to this CGT event.

According to the facts provided Company Q did not pay a premium to enter into the existing lease. However, there may have been some incidental capital costs incurred in relation to the

maintenance of the lease, as well as some incidental costs under section 110-35 of the ITAA 1997. This expenditure would then form the cost base for the old lease. Any amount that you have deducted or can deduct does not qualify as an incidental cost of acquisition or disposal of an asset and is not included in the cost base of the current lease.

As there will be no capital proceeds in relation to the surrender of the current lease, Company Q may incur a capital loss equivalent to the capital expenditure in relation to that lease.

If there was no capital expenditure in relation to the current lease there would be neither a capital loss nor a capital gain – in which case it would not be necessary to consider the roll-over provisions.

Under the proposed arrangement Company Q will be granted a lease over the new premises. Company Q will not receive any money or property as an inducement to enter into the lease. Company Q is not required to incur any expenditure to enter into the new lease.

The inherent rights under the new lease (the right to occupy the new premises) are contingent upon the regular payment of rent under the new lease agreement. The rights do not constitute capital proceeds for the surrender of the old lease.

CGT event F1 happens (for a lessor) if a lessor grants, renews or extends a lease – section 104-110 of the ITAA 1997. However there are no CGT consequences for the lessee who enters into a lease.

However, as the new lease will not be crown lease over land there can be no roll-over under subdivision 124-J of the ITAA 1997. Therefore Company Q may have a carry forward capital loss equivalent to any capital expenditure in relation to the existing lease.