Edited version of private advice

Authorisation Number: 1051802779949

Date of advice: 11 February 2021

Ruling

Subject: CGT - 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 A 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

On the basis that subsection 108-70(1) is not satisfied in respect to the Company Land, are the requirements of subsection 108-70(2) or (3) satisfied in respect to the capital improvements forming the open pit such that it should be regarded as a separate CGT asset from the land held by Company A?

Answer

Not applicable

Question 6

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 7

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 8

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

Answer

No

Question 9

Does the Land continue to be pre-CGT asset pursuant to Division 149 of the ITAA 1997? (to be considered separately for each parcel of land)

Answer

Yes

Question 10

Is the Trustee considered to hold the shares in Company A that were transferred in accordance with the will of Individual B throughout the period they were held by Individual B pursuant to subsection 149-30 of the ITAA 1997?

Answer

Yes

Question 11

Should any capital gain arising to Company A on the sale of the Company Land be disregarded on the basis that it is a pre-CGT asset pursuant to Division 149 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

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.

On nn Month 20xx Company C was incorporated. Its business activities include a waste sorting business whereby it receives waste and sorts through this waste to divert recyclable materials and others (soil, timber, mattresses) and deliver the balance of non-divertible materials to Company B to deposit in the landfill cell.

Company C will enter into a licence agreement with Company A and the Trust to permit it to undertake waste management operations from the site and to make arrangements with the landfill customers for the acceptance of unsorted waste.

Company C will also facilitate the delivery of the non-recyclable sorted waste to Company B.

Company C will enter into contracts with customers for the delivery of waste that has not been sorted for recyclable material.

Company C will sort the waste for recyclable material and landfill waste.

The landfill waste will be delivered to Company B which will charge a fee for accepting the waste while recyclable material will be sold to third parties.

The Trust is a discretionary trust and was settled by a Trust Deed prior to 19 September 1985 (Trust Deed).

The Trust Deed provided that the Unnamed Family (the Family) were the beneficiaries, which included Individual A, Individual B and their issue.

The Trust Deed was amended on xx Month 20xx. This amendment sought to expand the class of eligible beneficiaries to include companies and trusts in which the existing eligible beneficiaries held an interest.

A review of all distributions made by the Trust since the amendment show that the only company to which distributions have been made is Company B which is wholly owned by an Investment Trust, the beneficiaries of which are also the Family.

As at dd Month 1979 the shares in Company A were held by Individual A and Individual B as to 2 ordinary shares each and the Trustee as to 4 ordinary shares.

Upon Individual A's death after 19 September 1985, their 2 shares were transferred to Individual B.

At a later time, Individual B transferred one share to the Trustee.

Upon Individual B's death after 19 September 1985, their 3 shares were transferred to the Trustee to be held on trust on the same terms and conditions in the Trust Deed.

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)

Division 149

Section 149-30

Paragraph 149-15(1)

Paragraph 149-30(1)

Paragraph 149-30(3)

Paragraph 149-30(4)

Section 355-15

Section 355-525

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Questions 1 to 5

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.

Detailed reasoning

Section 108-70 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) 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) applies to the improvement; that is, if a balancing adjustment under Subdivision 40-D or section 355-15 or 355-525 applies to the building or structure.

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

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 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) 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) 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).

Paragraph 16 of TR 2012/7 states that an open pit mine site improvement is considered an asset for the purpose of Division 40 as it is something recognised in the mining industry as having commercial and economic value to the miner and subsection 40-30(3) 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) a balancing adjustment event occurs for a depreciating asset if the holder of the asset ceases to hold it.

Subsection 40-285(1) and (2) 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.

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.

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, 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 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.

A balancing adjustment does not arise to Company A as it does not meet the requirements of section 40-285.

Question 6

Summary

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

Detailed reasoning

In the context of Division 40 the term 'land' as used in paragraph 40-30(1)(a) means land as generally understood as being the soil. 'Land' as used in paragraph 40-30(1)(a) 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.

Subsection 40-30(3) therefore, 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) 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).

Question 7

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.

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.

Question 8

Summary

Company A does not hold the Landfill Improvements.

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.

Although Company A may be the legal owner of some of the land upon which the Landfill Improvements sit, it does not have a right to the Landfill Improvements; that right sits with Company B. Accordingly, Company A does not hold the Landfill Improvements.

Questions 9 to 11

Summary

The Company A Land will continue to be treated as a pre-CGT asset under Division 149. Accordingly, any capital gain will be disregarded.

Detailed reasoning

Division 149 outlines the rules which govern when an asset acquired by a taxpayer before 20 September 1985 is treated as being acquired after that date for CGT purposes.

Under subsection 149-30(1), a pre-CGT asset of a non-public entity stops being a pre-CGT asset at the earliest time when the majority underlying interest in the asset were not had by the ultimate owners who had the majority underlying interests in the asset immediately before 20 September 1985.

Subsection 149-15(1) provides that majority underlying interests in a CGT asset consists of:

•         more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset; and

•         more than 50% of the beneficial interests that ultimate owners have (whether directly or indirectly) in any ordinary income that may be derived from the asset.

Taxation Ruling IT 2340 Income tax: capital gains: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date discusses the application of the former section 160ZZS of the Income Tax Assessment Act 1936 (now Division 149 of the ITAA 1997) and states that:

6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.

7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. That is consistent with the role of the section to close potential avenues for avoidance of tax in cases where there is a substantial change in underlying ownership of assets and the legislative guidance contained in Subdivision G of Division 3 of Part III of the Act. On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act.

The shares in Company A owned by Individual B were transferred to the Trustee and held on trust on the same terms and conditions in the Trust Deed. The Trust is the operating entity of the group and held the remaining shares in Company A, being greater than 50% of the total Company A shares.

Accordingly, subsections 149-30(3) and (4) have the effect that the Trustee is regarded as having held those shares throughout the period they were held by Individual B.

The 'majority underlying interests' in the Trust are taken not to have changed since 14 December 2012 and any capital gain made on the disposal of the Company Land will be disregarded under paragraph 104-25(5)(a).