Edited version of private advice

Authorisation Number: 1051834909360

Date of advice: 26 May 2021

Ruling

Subject: Income tax - CGT - CGT Events - Pre-CGT assets

Question 1

Is the land a pre-CGT asset?

Answer

Yes

Question2

Is the building a separate CGT asset?

Answer

Yes

Question3

Is the building an active asset for the purposes of paragraph 152-10(1)(d) of the Income Tax Assessment Act 1997?

Answer

No

Question4

Can the valuation provided by P be used to apportion capital proceeds to the separate assets for the purposes of subsection 116-40(1) of the Income Tax Assessment Act 1997?

Answer

Yes

Question5

Can the capital proceeds attributed to the improvements be apportioned between the building and associated depreciating assets on the basis of cost for the purposes of section 40-310 and subsection 116-40(1) of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

1 July 2019 - 30 June 2020

The scheme commences on:

1 July 2019

Relevant facts and circumstances

1.    X is a private company incorporated on BB August B9GG.

2.    Clause III in X Memorandum and Articles of Association provides the following in relation to the distribution of income and property by X:

III. THE income and property of X whencesoever derived shall be applied solely towards the promotion of the objects of X as set forth in this Memorandum and no portion thereof shall be paid or transferred directly or indirectly by way of income, bonus or otherwise howsoever by way of profit to members of X. [our emphasis]

3.    X is the owner of the land and building (named 'Y') located at H.

Crown Lease

4.    The land was originally acquired by X under a 99-year Crown Lease (Crown Lease). The Crown Lease was granted to X on BD June B9GI (with the Crown Lease commencing on H June B9GH), under the City Area Leases Ordinance 1936-1967.

5.    The land was acquired for its unimproved value of $C0,000 and a rent of $B,000 per annum was applied for the first C0 years of the lease, after which a C0-year review period was to apply.

6.    This Crown Lease included the following provision in relation to how the land (over which this Crown Lease was granted) could be used:

Purpose

Clause 1(g) To use the said land for the purpose only of constructing and conducting the building aforesaid (or such other buildings as may be approved) as offices and conference rooms for the use of the N and until the whole of the building or buildings is required solely for the purposes of the N for the purpose of offices and conference rooms for organisations not engaged in trading and any other purpose approved by M except Insurance Banking or businesses necessitating the sale of goods on the premises; [our emphasis]

7.    The land rent for the above Crown Lease was altered by a legislative instrument to F cents per annum (if or when demanded), effective from B January 1JHB.

8.    The Crown Lease was varied on F May B9IG in accordance with following section 11A of the City Area Leases Ordinance 1936 (CALO), which allows a lease to be varied if there is a change in purpose for which the leased land is used:

Variation of provision, covenant or condition of a lease

11A (1) Notwithstanding anything contained in this Ordinance, the Supreme Court of the Australian Capital Territory may, subject to this section, on the application of the lessee (in this section referred to as the "application for variation"), vary any provision, covenant or condition of a lease in relation to the purpose for which the land subject to the lease may be used. [our emphasis]

9.    This variation to the Crown lease was carried out by surrender and re-grant (of the Crown Lease over the same land) on F May B9IG. The variation was to permit additional development rights in accordance with section 11A of the CALO. A betterment charge of $BC,F00 was also paid for these additional development rights.

10.  The re-granted Crown Lease included the following provision in relation to how the land and building could be used:

Purpose:

Clause 3(a) To use the premises only for the purpose of the National Headquarters of the N and/or for one or more of the following purposes only namely offices professional suites bank co-operative society and carparking -

PROVIDED ALWAYS THAT

The maximum gross floor area of the building shall not exceed DHBB square metres and the maximum gross floor area for use as a bank and co-operative society shall not exceed F00 square metres; ...

11.  The re-granted Crown Lease was varied again on BH February B99H to include car parking rights. A betterment charge of $B0,000 was also paid for these additional car parking rights.

X building

12.  The original X building was built on the land at a cost of $CGB,000. It was subsequently demolished and a new X building was constructed on the same land.

13.  The construction of the new X building was completed in November B99G at a cost of $D,HIE,JFG.

14.  In the C0B6 and C0B7 income years, an additional $GDH,HJD of capital expenditure was incurred on the new X building in relation to air-conditioning and carpeting.

15.  According to the relevant X Fixed Asset Register, the total cost of the new X building and other assets (which includes air-conditioning and carpeting) was $E,EDB,JDE and the proportion of cost allocated to the new X building and these other assets was:

• Building - IG.B0%
• Air-conditioning - BD.FH%
• Other assets (including carpeting) - 0.DD%.

16.  The new X building is a CGT asset, and the other assets (which includes the air-conditioning and carpeting) are depreciating assets.

Use of the X building

17.  The Xbuilding was used for the following activities:

              i.        for the provision of secretariat services to N on a pro-bono basis;

             ii.        for the provision of commercial leasing and rental operations to unrelated third parties;

            iii.        as an office for X.

18.  The table below shows the income that X derived from its commercial leasing and rental operations, as compared with income X earned from its other activities:

19.  The new X building has C,zzz square metres of commercial office space, with B,zzz square metres of this space being available for commercial rental operations. This represents J0% of the total building area being available for generating rental income. The remaining B0% of the total building area is used for providing secretariat services to the N and as an office for X.

20.  Clause II in the X Memorandum and Articles of Association relevantly outlines the following 'objects' of X:

(1) To honour X., by

(a) Erecting and maintaining a building in K to be called "X building":

(aa) Providing in "X building" and /or such other places in L, determined by N, such secretarial, administrative and research facilities and services as may be required by N.

(b) Carrying on in "X building"...the promotion and development in the public interest of primary and secondary industry in L including the promotion and development of the agricultural, pastoral, horticultural, viticultural, manufacturing and industrial resources of L and including the promotion of advanced, efficient, safe and scientific methods for such agricultural, pastoral, horticultural, viticultural, manufacturing and industrial development and for those purposes to receive and undertake the custody and management of moneys or donations which heretofore or hereafter be made for the erection and maintenance of "X building" and to apply the income and accretions arising there from or thereto in or towards the establishment and maintenance of X.

...

(4) To carry out such other objects directly or indirectly relating to or affecting the development of primary and secondary industry as X may from time to time or at any time determine

...

(13) To grant, sell, convey, assign, transfer, exchange, mortgage, lease, licence, let, hire or dispose of in any manner whatever and either absolutely or for any term any real or personal property or any estate or interest therein for such consideration and upon and subject to any terms, conditions, stipulations and restrictions.

...

(23) To do all such other things as are incidental to or conducive to the attainment of these objects.

...

Sale of property

21.  On 1J October Czzz, P issued a valuation dated 3B March Czzz (Valuation) for the land and building located at H (Property). The Valuation was undertaken on a market value basis, with values of $BB.B million and $D.D million being apportioned to the land and improvements (including the building) respectively.

22.  The Property was sold on 1G April Czzz for $BE.F million.

23.  The contract for the sale of the Property did not allocate this consideration of $BE.F million against the land and specific assets which were sold as part of this transaction.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 40-30(1)

Income Tax Assessment Act 1997 subsection 40-295(1)

Income Tax Assessment Act 1997 subsection 40-300(1)

Income Tax Assessment Act 1997 section 40-310

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 108-55(2)

Income Tax Assessment Act 1997 section 108-75

Income Tax Assessment Act 1997 section 109-55

Income Tax Assessment Act 1997 subsection 116-20(1)

Income Tax Assessment Act 1997 subsection 116-40(1)

Income Tax Assessment Act 1997 section 116-25

Income Tax Assessment Act 1997 section 124-10

Income Tax Assessment Act 1997 section 124-570

Income Tax Assessment Act 1997 section 124-575

Income Tax Assessment Act 1997 section 124-580

Income Tax Assessment Act 1997 section 149-10

Income Tax Assessment Act 1997 subsection 149-30(1)

Income Tax Assessment Act 1997 section 149-15

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Reasons for decision

Question 1

Summary

The land is a pre-CGT asset as the majority underlying interests in the land have not changed and have always been held by X.

Detailed reasoning

CGT asset

1.    According to subsection 108-5(1) of the ITAA 1997, the land and building/s (at H) are both CGT assets.

Crown Lease rollover

2.    X had a Crown Lease which was surrendered and re-granted over the same land (being the land at H). This occurred because the purpose for which this land was originally used under the Crown Lease changed (because of the need for additional development rights and the introduction of car parking).

3.    Therefore, as the re-granted Crown Lease is over the same land and it was only regranted upon surrender, subsection 124-575(1) of the ITAA 1997 is satisfied. Further, as the re-granted Crown Lease was granted due to a change in purpose for which the land could be used, paragraph 124-575(2)(a) of the ITAA 1997 is also satisfied and the Crown lease rollover in Subdivision 124-J of the ITAA 1997 will apply in full.

4.    Applying the general acquisition rule for CGT assets in item 6 of the table in section 109-55 of the ITAA 1997 and according to subsection 124-10(4) of the ITAA 1997, where a replacement asset rollover applies to an asset that was acquired before 20 September 1985, the new asset is also taken to have been acquired before that day. This means that upon surrender and re-grant of the Crown Lease, the re-granted Crown Lease is taken to have been acquired before 20 September 1985.

Pre-CGT asset

5.    To determine if the majority underlying interests in a CGT asset have been maintained, the identity of the ultimate owners must first be determined.

6.    Subsection 149-15(3) of the ITAA 1997 defines an ultimate owner (amongst other things) to be 'a company whose constitution prevents it from making any distribution, whether in money, property or otherwise, to its members'.

7.    The land at H (being a CGT asset) is owned by X as lessee, via a Crown Lease. As stated above in paragraph 2 (in the 'Relevant facts and circumstances'), Article III of the X Memorandum and Articles of Association states that the income and property of X shall not be paid or transferred to X members (shareholders) and can only be applied towards the promotion of X's objects.

8.    Therefore, as the X Memorandum and Articles of Association prevents X from making any distribution to its members, X is an ultimate owner within the definition in subsection 149-15(3) of the ITAA 1997.

9.    As the land has always been (and is currently) owned by X, it has an entitlement to more than 50% of the beneficial interest in the income and capital that may be derived from the land. Therefore, the majority underlying interest test in subsection 149-15(1) of the ITAA 1997 is satisfied by X.

10.  As such, the land is a pre-CGT asset of X.

Question 2

Summary

The X building is a separate CGT asset from the land.

Detailed reasoning

11.  According to subsection 108-55(2) of the ITAA 1997, a building which is constructed on pre-CGT land is a separate CGT asset if construction of the building started on or after 20 September 1985.

12.  In this situation, as the construction of the new X building was completed in November 1996, the new building is a separate CGT asset according to subsection 108-55(2) of the ITAA 1997.

13.  Further, this new building is a capital improvement to pre-CGT Crown Lease which has been the subject of a rollover under Subdivision 124-J of the ITAA 1997.

14.  The cost base of the new X building is $D,zzz,zzz. This is more than the improvement threshold of $Czz,zzz for the financial year ending 30 June Czzz, when the Property was sold (which is the relevant CGT event that happened).

15.  5% of the capital proceeds from the Property Sale (being the relevant CGT event) is $Hzz,000. The cost base of the new X building ($D,zzz,zzz) is more than this amount.

16.  Therefore, as both paragraph 108-75(3)(a) and 108-75(3)(b) of the ITAA 1997 are satisfied, the X building will be a separate CGT asset under these capital improvement provisions.

Question 3

Summary

The ATO considers that X building is not an active asset for the purposes of paragraph 152-10(1)(d) of the ITAA 1997.

Detailed reasoning

17.  The X building is used for multiple purposes by X, one of which is renting out space to unrelated third parties for commercial use (such as for office suites).

18.  As such, we do not consider TD 2021/2 to be informative in the present context, as it only considers the situation of when a company's only activity is renting out a property.

19.  According to paragraph 26 of TD 2006/78, whether an assets main use is to derive rent is dependent on a range of circumstances and depends on the facts pertaining to each case. One factor to consider is a comparison of the area of premises used between deriving rent and other uses (percentage of floor space). Another factor to consider is the comparative levels of income derived from the different uses of the asset.

20.  Paragraph 27 of TD 2006/78 states that many arrangements will not satisfy the active asset test where activities do not amount to the carrying on of a business. Further, Paragraph 21 of TD 2006/78 provides that if the activities carried on do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent.

Floor space percentage

21.  Comparing the physical area of the X building that is used to derive rental income (J0%) versus income derived from other uses (B0%), it is apparent to the ATO that deriving rent needs to be considered at least one of the main uses of the building.

Income percentage

22.  We then need to consider whether the rental income derived is from a business and would enable the X building to be considered an active asset.

23.  When reviewing the amount/s of income actually derived from rental operations, it is noted that a substantial portion of the income derived is from activities other than renting out the X building to third parties.

Non-rental income - is this from carrying on a business?

24.  As mentioned above, we note that income derived from the 'other activities' forms a substantial portion of income generated by the X building.

25.  However, we also need to consider if this is non-rental income is derived from carrying on a business - to determine if X is an active asset.

26.  In regard to the objects set out in Clause II of the X Memorandum and Articles of Association, this indicates that the main use of the X building should be for 'the promotion and development in the public interest of primary and secondary industry...in L' and for providing secretariat services to the N.

27.  Additionally, Clause III in the X Memorandum and Articles of Association provides that any income and property derived by X cannot be distributed back to the members (shareholders) of X, casting doubt over whether renting out of the X building to third parties can be considered a 'business'.

28.  It has already been established (at paragraph 17 in the 'Relevant facts and circumstances' above) that the X building is in fact used for providing secretarial services to the N. As the provision of these secretariat services is on a "pro-bono basis" (again, refer to paragraph 17 in the 'Relevant facts and circumstances'), we do not consider that this activity can be considered to be carrying on a 'business'.

29.  Therefore, paragraph 21 of TD 2006/78 becomes relevant - since the activities carried on to derive 'other (non-rental) income' do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent (even though in this case, J0% of the building's floor area is rented to third-parties, meaning that the main use of the X building by floor space is to derive rent).

30.  Therefore, the ATO does not consider that X building is an active asset for the purposes of paragraph 152-10(1)(d) of the ITAA 1997.

Question 4

Summary

The valuation provided by P can be used to apportion capital proceeds between the separate assets (being the land and building) for the purposes of subsection 116-40(1) of the ITAA 1997

Detailed reasoning

31.  Section 116-25 of the ITAA 1997 outlines the modifications to the general rules about capital proceeds (that are stated in section 116-20 of the ITAA 1997), and provides that section 116-40 of the ITAA 1997 applies in the current situation to modify the capital proceeds that are received upon the disposal of a CGT asset (land).

32.  Subsection 116-40(1) of the ITAA 1997 provides that capital proceeds from a transaction must be 'reasonably' apportioned where the transaction relates to more than one CGT event.

33.  The current transaction where the Property was sold involved (1) the sale of land and (2) the sale of a building, which are separate CGT events. As such the capital proceeds of $BE.F million for this transaction must be apportioned between the land and building, as stipulated by subsection 116-40(1) of the ITAA 1997.

34.  As the Property sale documents did not specifically apportion the capital proceeds between the land and building, each party to the transaction must make their own reasonable apportionment.

35.  Paragraph 5 in TD 98/24 provides guidance in relation to the apportionment of capital proceeds and states that each party to the Property sale should be able to justify their 'reasonable apportionment' based on the relevant market values of the separate assets, at the time of the making the contract.

36.  According to well established case authorities such as Spencer and Excellar, the sale price of a property is the best evidence of its market value. As such, the $BE.F million sale price can be taken to be the market value of the Property. This sale price was arrived at using the P valuation (which was done one month prior to the Property sale), which apportioned values of $BB.E million and $D.B million to the land and building (respectively).

37.  As such, it is reasonable to use the P valuation to apportion the capital proceeds (totalling $BE.F million) between the land ($BB.E million) and building ($D.B million).

Question 5

Summary

The capital proceeds from the sale of the Property can be apportioned between the building and depreciating assets (being air-conditioning and carpeting) on the basis of cost for the purposes of section 40-310 and subsection 116-40(1) of the ITAA 1997.

Detailed reasoning

38.  Section 40-310 of the ITAA 1997 provides that if you received an amount for the sale of several items that include a depreciating asset, you need to apportion the amount received between the termination value of the depreciating asset and the other items.

39.  In the current situation, the air-conditioning and carpets are depreciating assets in accordance with section 40-30 of the ITAA 1997. A balancing adjustment has occurred to these depreciating assets (as they were sold as part of the Property sale) on 1G April Czzz and their termination value needs to be calculated as per subsection 40-300(1) of the ITAA 1997.

40.  Paragraph 5 of TD 98/24 states that 'In the absence of an agreed allocation, each party needs to make their own reasonable apportionment of the capital proceeds to the separate assets' and that 'written down values of depreciable assets are not necessarily their market values.'

41.  The proportional cost allocated to the land and other depreciating assets (which includes air-conditioning and carpeting) is outlined in the X Fixed Asset Register (see paragraph 15 in the 'Relevant facts and circumstances' above). Noting that a fixed asset register shows the actual value of separate assets at any given point in time and that a market valuation of improvements was done by P one month prior to the Property sale, we consider that using the costs in the X Fixed Asset Register is a reasonable basis for apportioning the capital proceeds from the sale of the Property against the separate depreciating assets (air-conditioning and carpeting) pursuant to subsection 116-40(1) of the ITAA 1997.