Edited version of private advice

Authorisation Number: 1051802528680

Date of advice: 11 February 2021

Ruling

Subject: Capital gains tax - separate assets

Question 1

Does the open pit constitute a capital improvement to the Land for the purpose of section 108-70 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is the open pit a separate capital gains tax (CGT) asset from the Land pursuant to section 108-70 of the ITAA 1997?

Answer

Yes

Question 3

Is the open pit a depreciable asset pursuant to section 40-30 of the ITAA 1997?

Answer

Yes

Question 4

Is Company B the holder of the open pit for the purposes of Division 40 pursuant to section 40-40 of the ITAA 1997?

Answer

No

Question 5

Do the Landfill Improvements constitute an improvement to the Land such that they are a depreciable asset pursuant to section 40-30 of the ITAA 1997?

Answer

Yes

Question 6

Are the Landfill Improvements a separate depreciable asset from the open pit for the purposes of Division 40 of the ITAA 1997?

Answer

Yes

Question 7

Is Company B the holder of the landfill improvements for the purposes of Division 40 pursuant to section 40-40 of the ITAA 1997?

Answer

Yes

Question 8

With respect to the Landfill Improvements, does a balancing adjustment under Subdivision 40-D of the ITAA 1997 arise to Company B on the disposal of the Land?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Company A owns the land (Company Land).

Trust A (the Trustee) owns the land adjacent to the Company A Land (Trust Land).

The Company A Land and Trust Land are held on capital account and have been used in generating assessable income by the respective owners.

The Company A Land and the Trust Land are referred to collectively as the Land.

During 19xx, the Trustee commenced a quarry business and incurred costs for capital works relating to excavations for an open pit.

The open pit was developed over the Land, including both the Company Land and the Trust Land, and the quarry operations have been carried out on the Land.

The Trustee operates the quarry business. It also holds plant and machinery, intangible assets such as goodwill and intellectual properties in respect to the quarry operations.

The Trustee has an informal agreement with Company A to operate the quarry business on the Company A Land in exchange for rental payments.

As the life of the quarry was coming to an end, Company B was incorporated for the purpose of investigating the opportunity to operate a landfill business on the Land.

On nn Month 20xx, Company B was issued a licence to operate the landfill business.

Company B has an agreement with the Trustee and Company A to operate the landfill business on the Land in return for rental payments since the commencement of Company B's preparatory activities for the landfill operations.

Company B undertook significant activities and incurred related costs to satisfy the requirements imposed by the relevant regulatory authorities in order to obtain the landfill licence.

The costs incurred included costs for capital works for the installation of a clay cell on the floor of the open pit, including high density polyethylene (HDPE) plastic liner, associated geotextile layers, pipework and aggregated drainage layers, as well as similar clay lining on the walls of the open pit (collectively referred to as the Landfill Improvements), and upgrading access road.

At the time of the ruling application the Landfill Improvements cover approximately 10% of the open pit.

Neither the Trustee nor Company A have incurred any costs nor claimed any deductions for any costs relating to the Landfill Improvements or associated with the landfill operations.

Company B will enter into contracts with customers for the acceptance of waste that has been previously sorted for recyclable material.

Relevant legislative provisions

Income Tax Assessment Act 1997

Division 40

Subdivision 40-B

Subdivision 40-D

Section 40-30

Subsection 40-30(1)

Paragraph 40-30(1)(a)

Subsection 40-30(2)

Subsection 40-30(3)

Section 40-40

Section 40-285

Subsection 40-285(1)

Subsection 40-285(2)

Paragraph 40-295(1)(a)

Section 108-55(1)

Section 108-70

Subsection 108-70(1)

Subsection 108-70(2)

Subsection 108-70(3)

Section 355-15

Section 355-525

Reasons for decision

Questions 1 to 4

Summary

The open pit constitutes a capital improvement to the Land and is a separate CGT asset from the Land pursuant to section 108-70 of the ITAA 1997.

Detailed reasoning

Section 108-70 of the ITAA 1997 is the relevant provision to consider when a capital improvement is a separate asset from the land to which it is attached. Subsection 108-70(1) of the ITAA 1997 provides that a capital improvement to land is taken to be a separate CGT asset from the land if one of the balancing adjustment provisions set out in subsection 108-55(1) of the ITAA 1997 applies to the improvement; that is, if a balancing adjustment under Subdivision 40-D of the ITAA 1997 or sections 355-15 or 355-525 of the ITAA 1997 applies to the building or structure.

Relevant for the purpose of this ruling is a balancing adjustment under Subdivision 40-D of the ITAA 1997.

Taxation Ruling TR 2012/7 Income Tax: capital allowances: treatment of open pit mine site improvements (TR 2012/7) considers the operation of the capital allowance rules in Division 40 of the ITAA 1997 as they apply to an open pit mine site improvement that comes into being through the conduct of an open pit mining operation.

Asset separate from land and a depreciating asset

The Commissioner considers that an open pit is an improvement to land for the purposes of subsection 40-30(3) of the ITAA 1997 where it enhances the usefulness of the land to a user of the pit. An open pit mine site improvement encompasses all of the various structural elements of a typical pit, as they exist from time to time. It is a single mine site improvement to the land and is the asset to be tested against the definition of a depreciating asset.

Under subsection 40-30(1) of the ITAA 1997 a depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is in use, and cannot be land, trading stock or an intangible asset that is not mentioned in subsection 40-30(2) of the ITAA 1997.

Paragraph 16 of TR 2012/7 states that an open pit mine site improvement is considered an asset for the purpose of Division 40 of the ITAA 1997 as it is something recognised in the mining industry as having commercial and economic value to the miner and subsection 40-30(3) of the ITAA 1997 requires that it is considered to be an asset separate to the land. Paragraph 17 and 18 further state that the pit has a finite income producing life and is expected to decline in value over the period it is used.

Therefore, the open pit in this case is a single asset separate from the land and is a depreciating asset.

Subdivision 40-D - balancing adjustment

Under paragraph 40-295(1)(a) of the ITAA 1997, a balancing adjustment event occurs for a depreciating asset if the holder of the asset ceases to hold it.

Subsections 40-285(1) and (2) of the ITAA 1997 state that a balancing adjustment will arise to the holder of a depreciating asset if a balancing adjustment event occurs for the asset and relevantly, the asset's decline in value was worked out under Subdivision 40-B of the ITAA 1997.

The Trustee holds a permit to operate the quarry business, and incurred costs in developing the open pit over its own land as well as over the Company Land that it leases from Company A.

The Trustee owns the Trust Land in which the open pit emerged as a result of an open pit mining operation and is the holder under item 10 of the table in section 40-40 of the ITAA 1997.

The Trustee also has a quasi-ownership right over the Company Land as it holds a lease over this land. It has the right to operate the quarry business and has incurred costs in establishing and improving the open pit on the Land over which the right exists. The Trustee is, therefore, treated as the holder under item 3 of the table in section 40-40 of the ITA 1997, notwithstanding that it does not own the Company Land to which that part of the open pit improvement has emerged.

The Trustee has deducted the cost of the open pit as operating cost and as a result, the cost of the open pit has been reduced to nil. Paragraph 44 of TR 2012/7 considers that a decline in value is worked out for a depreciating asset under Subdivision 40-B of the ITAA 1997 even where the cost of the asset has been reduced to nil.

Accordingly, a balancing adjustment will arise to the Trustee on the disposal of the open pit as the Trustee is the holder of a depreciating asset whose decline in value was worked out under Subdivision 40-B of the ITAA 1997.

Question 5

Summary

The Landfill Improvements is an improvement to the Land and a depreciating asset pursuant to section 40-30 of the ITAA 1997.

Detailed reasoning

In the context of Division 40 of the ITAA 1997, the term 'land' as used in paragraph 40-30(1)(a) of the ITAA 1997 means land as generally understood as being the soil. 'Land' as used in paragraph 40-30(1)(a) of the ITAA 1997 was intended to draw in concepts developed by the common law and equity in relation to land, hence the need to treat fixtures as being separate to the land.

Therefore, subsection 40-30(3) of the ITAA 1997 treats improvements to land and fixtures on land as being separate to land to prevent land from being a depreciating asset.

An 'improvement' to land is something that enhances the value of the land on which it is made, or an alteration that improves the land to the user (Commonwealth of Australia v. Oldfield (1976) 133 CLR 612).

The Landfill Improvements are an asset of Company B because it is used by Company B to conduct its business and are of commercial value to Company B and subsection 40-30(3) of the ITAA 1997 requires that it is treated as if it were an asset separate from the land.

The Landfill Improvements are a depreciating asset because:

•         it is being put to use in the landfill business,

•         it has a limited effective life and will decline in value over the period it is in use as landfill materials are progressively deposited over time,

•         it is not land, an item of trading stock or an intangible asset that is not mentioned in subsection 40-30(2) of the ITAA 1997.

Question 6

Summary

The open pit and the Landfill Improvements are separate assets

Detailed reasoning

Draft Taxation Ruling TR 2017/D1 Income tax: composite items and identifying the depreciating asset for the purposes of working out capital allowances sets out the Commissioner's views on how to determine whether a composite item is itself a depreciating asset or whether its components are separate depreciating assets for the purpose of Division 40 of the ITAA 1997.

A particular composite item can be a depreciating asset itself or one or more of its components are separate depreciating assets. For a component to be considered a depreciating asset, it is necessary that the component is capable of being separately identified or recognised as having commercial and economic value. Purpose and function are generally taken into account in determining whether a composite item is a single depreciating asset or more than one depreciating asset.

In the current circumstances, the open pit and the Landfill Improvements perform separate identifiable functions. The open pit has the purpose of providing access to the quarry material located within the open pit, whilst the Landfill Improvements are to prevent contamination of groundwater by the landfill. It is not necessary that they must be self-contained or able to be used on a stand alone basis.

Therefore, the open pit and the Landfill Improvements are separate depreciating assets for the purpose of Division 40 of the ITAA 1997.

Question 7 & 8

Summary

A balancing adjustment under Division 40-D of the ITAA 1997 arises to Company B on the disposal of the Land.

Detailed reasoning

The holder of a depreciating asset is determined by the table in section 40-40 of the ITAA 1997. Item 3 in that table provides that 'an improvement to land (whether a fixture or not) subject to a quasi-ownership right ... where the owner of the right has no right to remove the asset' is held by the owner of the quasi-ownership right.

Quasi-ownership right over land is defined to include both a lease of the land or any other right in connection to the land.

Company B has a quasi-ownership right over the Land as it holds a lease with the Trustee and Company A. It has the right to operate the landfill business and has incurred costs in installing the Landfill Improvements for the purpose of the landfill business on the Land over which the right exists. Company B is, therefore, treated as the holder of the Landfill Improvements under item 3 of the table in section 40-40 of the ITAA 1997.