Edited version of private advice

Authorisation Number: 1052040201418

Date of advice: 11 October 2022

Ruling

Subject: Capital works - continuously leased or held construction expenditure area

Question

When Company A surrenders the Original Lease and enters into the Revised Lease immediately after the surrender, will Company A be taken, for the purposes of paragraph 43-120(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) to have continuously leased or held the construction expenditure area on which the Project was completed on and from the date of the Original Lease?

Answer

Yes.

This ruling applies for the following period:

The relevant income year.

The scheme commences on:

The commencement date

Relevant facts and circumstances

The entity entered into an agreement that granted various rights and imposed various obligations in relation to land.

The entity subsequently entered into a Development Agreement which required a Lease (the Original Lease) over the land to be entered into prior to the release of detailed plans.

The Original Lease provided for variations as the detailed plans became available with approval from the Lessor.

The Lessor is an exempt Australian government agency.

The Original Lease required a Revised Lease be created once the Project was completed, incorporating the 'as-built' area of the Project.

Reasons for decision

Summary

When the Entity surrenders the Original Lease and enters into the Revised Lease immediately after the surrender, the Entity will be taken to have continuously leased or held the construction expenditure area on which the Project was completed.

Detailed reasoning

Division 43 of the ITAA 1997 operates to allow a deduction for expenditure incurred on eligible capital works.

Section 43-10 of the ITAA 1997 provides that an entity can only deduct an amount if the capital works have a 'construction expenditure area', there is a 'pool of construction expenditure' for that area, and it uses its 'your area' in the income year in a way set out in the table in section 43-140 of the ITAA 1997. 'Your area' must be identified for each different construction expenditure area of capital works. It may comprise the whole of the construction area, or part of it.

Subdivision 43-C of the ITAA 1997 contains the key provisions for identifying your area of your construction expenditure. Subsection 43-120 is contained within Subdivision 43-C and is the key provision for defining what is 'your area' and the construction expenditure for lessees and quasi-ownership right holders. Subsection 43-120(1) provides that:

Your area is the part of the *construction expenditure area that you lease, or hold under a *quasi-ownership right over the land granted by an *exempt Australian government agency or an *exempt foreign government agency, and that:

a)    is attributable to a *pool of construction expenditure that you incurred; and

b)    you have continuously leased or held since the construction was completed.

Before determining for the purposes of paragraph 43-120(1)(b) whether 'your area', being a construction expenditure area, has been continuously leased or held since the construction was completed, it is necessary to firstly determine that there is 'construction expenditure area', that is

• leased or held under a quasi-ownership right over land granted by an exempt Australian or foreign government agency, and
• attributable to a 'pool of construction expenditure' for that area that was incurred.

Construction expenditure area

The term 'construction expenditure area' is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 43-75 of the ITAA 1997. Section 43-75 differentiates capital works that began before 1 July 1997 and capital works that began after 30 June 1997. The Entity incurred the construction expenditure after the Entity entered into the Original Lease.

For capital works that began after 30 June 1997, subsection 43-75(1) relevantly states -

The construction expenditure area of capital works begun after 30 June1997 is the part of the capital works on which the construction expenditure was incurred that, at the time when it was incurred by an entity, was to be owned or leased by the entity or held by the entity under a quasi-ownership right over land granted by an exempt Australian government agency or an exempt foreign government agency.

Pursuant to subsection 43-75(4), it is not until the construction of capital works is complete that the construction expenditure area is determined. One construction expenditure area is created each time an entity constructs capital works (subsection 43-75(5)). Subsequent undertakings for the construction of capital works create a separate construction expenditure area.

The Project will form part of the one construction expenditure area if at the time the expenditure was incurred, the area covered by the Project satisfies the requirements of subsection 43-75(1).

Capital works on which construction expenditure was incurred

'Construction expenditure' is defined in subsection 43-70(1) as capital expenditure incurred in respect of the construction of capital works (subject to exclusions listed in subsection 43-70(2)).

'Capital works' to which Division 43 applies are described in subsections 43-20(1) and (2) of the ITAA 1997 to include a building, an extension, alteration or improvement to a building after the times noted in those sections. Subsections 43-20(4) and (5) also describe structural improvements that are, and are not, capital works for the purposes of Division 43.

The Entity incurred expenditure in connection with the construction of the Project and are considered to be capital works for the purposes of Division 43, including subsection 43-75(1) of the ITAA 1997.

The construction of the Project does not fall within the exceptions of construction expenditure listed in subsection 43-70(2).

Therefore, the expenditure incurred on the construction of the Project falls within the definition of "construction expenditure" pursuant to subsection 43-70(1).

Accordingly, the Project was capital works on which construction expenditure was incurred.

Owned, leased or held under a quasi-ownership right over the area covered by the Casino Expansion Project

Subsection 43-120(1) provides that 'Your area' is the part of the construction expenditure area that you lease or hold under a quasi-ownership right over the land granted by an exempt Australian government agency or an exempt foreign government agency.

When determining the construction expenditure area for the purposes of subsection 43-75(1), the relevant fact is that at the time that the construction expenditure was incurred, the construction expenditure area was to be owned, leased or held by the entity. If it was to be held by the entity, it must be under a quasi-ownership right over land granted by an exempt Australian or foreign government agency at the time the expenditure was incurred.

The area on which the construction expenditure was incurred was never intended to be owned by the Entity.

'Lease' is not defined for the purposes of subsection 43-120(1) and takes its ordinary meaning. The Macquarie Dictionary 2001, rev. 3^rd edition, The Macquarie Library Pty Ltd, NSW defines a "Lease" as:

an instrument conveying property to another for a definite period, or at will, usually in consideration of rent or other periodical compensation.

"Leased" is then defined as:

to grant the temporary possession or use of (lands, tenements, vehicles, etc.) to another, usually for compensation at a fixed rate; let; or to take or to hold by a lease.

A 'quasi-ownership right over land' is defined in subsection 995-1(1) of the ITAA 1997 to mean:

(a)  a lease of the land; or

(b)  an easement in connection with the land; or

The Entity and the Lessor entered into a Development Agreement for the Project. It was expected that the final plans and specifications would deviate slightly from the schematic plans attached to the Development Agreement, as allowed in the Original Lease.

Accordingly, it is considered that on the terms of the Original Lease, the Entity incurred expenditure on the Project on an area that was to be leased pursuant to the schematic drawings included in the Original Lease. The Entity also incurred expenditure on the Project on an area held under a quasi-ownership right over land for the area that is outside the boundary of the schematic drawings attached to the Original Lease. These areas form part of the completed Project capital works.

On this basis, it is considered that the area of the Project contained within the schematic drawings of the Original Lease was to be and still is leased for the purposes of subsection 43-75(1) and subsection 43-120.

For the areas of the Project that were not covered by the schematic drawings that were constructed on the basis of the operation of the Original Lease, a quasi-ownership right was and continues to be held by the Entity pursuant to the Expansion Lease and Development Agreement. To satisfy the requirements of subsection 43-75(1) and subsection 43-120(1), that right for 'your area' must have been granted by an exempt Australian or foreign government agency.

Subsection 995-1(1) of the ITAA 1997 defines exempt Australian government agency as:

(a)  the Commonwealth, a State or a Territory; or

(b)  an authority of the Commonwealth or of a State or a Territory whose ordinary income and statutory income is exempt from income tax because of Division 50; or

(c)   an STB (within the meaning of Division 1AB of Part III of the Income Tax Assessment Act 1936) whose ordinary income and statutory income is exempt from income tax under that Division of that Part.

The Lessor is an exempt Australian government agency.

As a result, the rights and obligations granted to the Entity in relation to the area of land as agreed to by the Lessors pursuant to the Original Lease, created a quasi-ownership right over that land that was created at the point in time the final plans were approved.

'Construction expenditure area' conclusion

It is considered that the requirements of subsection 43-75(1) are satisfied and that the Entity has a construction expenditure area that encompasses the area on which the as-built Project was completed. Accordingly, this area is the construction expenditure area for the purposes of subsection 43-120(1)(b).

Attributable to a 'pool of construction expenditure' for the construction expenditure area that was incurred

Paragraph 43-120(1)(b) requires that the construction expenditure area is attributable to a pool of construction expenditure that the entity claiming the deduction under Division 43 incurred.

A 'pool of construction expenditure' is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by section 43-85 of the ITAA 1997. Subsection 43-85(1) states -

A pool of construction expenditure is so much of the construction expenditure incurred by an entity on capital works as is attributable to the construction expenditure area.

As set out above, the Entity has incurred capital expenditure in the construction of capital works for the Project. That part of the construction expenditure incurred by the Entity on the capital works attributable to the area on which the as-built Project was completed (the construction expenditure area for the purposes of section 43-75) will be a pool of construction expenditure for the purposes of subsection 43-85(1) of the ITAA 1997.

Accordingly, the construction expenditure incurred for the Project's construction expenditure area is attributable to a pool of construction expenditure that the Entity has incurred as required under paragraph 43-120(1)(a).

Construction expenditure area has been continuously leased or held since construction was completed

For the purposes of satisfying paragraph 43-120(1)(b), it is necessary to determine whether the Entity has continuously leased or held the construction expenditure area since construction was completed.

The Entity entered into the Original Lease which will remain in place before being surrendered just prior to entering into the Revised Lease.

The phrase "continuously leased" is not defined in the ITAA 1997 and takes its ordinary meaning in the context of the provision. In Federal Commissioner of Taxation v Consolidated Media Holdings Ltd (2012) 250 CLR 503 the High Court stated at 519:

This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the [statutory] text.'. So must the task of statutory construction end. The statutory text must be considered in its context. That context includes legislative history and extrinsic materials. Understanding context has utility if, and in so far as, it assists in fixing the meaning of the statutory text. Legislative history and extrinsic materials cannot displace the meaning of the statutory text. Nor is their examination an end in itself.

Section 43-120 was introduced with the enactment of the ITAA 1997. The explanatory memorandum to the Income Tax Assessment Bill 1996 at page 132 confirms that land can be taken to have been continuously leased by a lessee for the purposes of section 43-130 even if the lease ceases provided that the lessee leases the land again in a "timely manner".

... the area must have been leased or held continuously since the construction was completed. You would have continuously leased an area even if your original lease had expired provided you have renewed the lease in a timely manner, for example under an option in the lease or by negotiation with the building owner.

Division 43 of the ITAA 1997 is a rewrite of former Divisions 10C and 10D of Part III of the Income Tax Assessment Act 1936 (ITAA 1936). The interpretation of "continuously leased" is consistent with how those provisions operated.

Section 1-3 of the ITAA 1997 provides that if the ITAA 1936 expressed an idea in a particular form of words and the ITAA 1997 appears to express the same idea in a different form of words in order to use a clearer or simpler style, the ideas are not to be taken to be different just because different forms of words were used. The explanatory memorandum to the Income Tax Assessment Bill 1996 confirms that Division 43 of the ITAA 1997 was intended to operate in the same manner as the former Divisions 10C and 10D of Part III of the ITAA 1936.

Section 43-120 of the ITAA 1997 is a rewrite of former subsections 124ZA(8) and 124ZF(8) of the ITAA 1936, which operated to allocate capital works deductions to lessees and eligible assignees by deeming those eligible lessees to be 'owners' for the purposes of the former capital works provisions.

Former subsections 124ZA(8) and 124ZF(8) of the ITAA 1996 relevantly required that the relevant person -

... was, at all times after the completion of the relevant construction, and before the relevant time, the lessee of the whole, or of a part, of the building.

While this phrase does not refer to 'continuously leased' it is clear from the context that it refers to the same idea and despite the change in wording section 43-120 of the ITAA 1997 was intended to operate in the same manner.

The explanatory memorandum to the Income Tax Assessment Bill 1983 which was enacted to introduce Division 10D of Part III of the ITAA 1936, and subsection 124ZF(8) relevantly states at page 78:

Where a lessee who is entitled to deductions surrenders the lease or the lease is terminated, and the lessee does not immediately secure another lease, the entitlement to deductions will pass to the owner of the building. The right to deductions will then remain with the owner of the building notwithstanding any subsequent lease arrangements. Should an eligible lessee surrender part only of the lease, he or she will remain entitled to deductions but only with respect to that part of the building that he or she continues to lease.

The Original Lease will be replaced with the Revised Lease, which will also include the land held under a quasi-ownership right. This is necessary as the final survey of the as-built footprint of the Project found that it differed from the schematic footprint attached to the Development Agreement as reflected in the area leased under the Original Lease.

The quasi-ownership rights to the land held by the Entity outside of the schematic drawings attached to the Original Lease will also be terminated and the parties will immediately enter into the Revised Lease which will expressly cover the entire Project's capital expenditure area. There will be no gap in time where the Entity will not have continuous quasi-ownership access rights or a lease covering its capital expenditure area for the period encompassing the entry into the Original Lease, construction and completion of the Project and the time just after the time which the Revised Lease will be entered into.

The Commissioner accepts that the surrender of the Original Lease and termination of the quasi-ownership rights and immediate entry into the Revised Lease does not mean that the Entity will cease to have 'continuously leased or held' its construction expenditure area since it completed the construction of the Project for the purposes of paragraph 43-120(1)(b).

Conclusion

When the Entity surrenders the Original Lease and terminates its quasi-ownership rights and enters into the Revised Lease immediately afterwards, the Entity (as the provisional head company) will be taken, for the purposes of paragraph 43-120(1)(b) of the ITAA 1997 to have 'continuously leased or held' its construction expenditure area since the construction of the Project capital works were completed.