Edited version of private advice

Authorisation Number: 1052111044156

Date of advice: 25 May 2023

Ruling

Subject: Income tax - CGT - rollover

Question 1

Is the Taxpayer entitled to choose to apply roll-over relief under Subdivision 124-B of the Income Tax Assessment Act 1997 (ITAA 1997) to reduce the capital gains that may otherwise arise with respect to its destroyed CGT assets?

Answer

Yes

Question 2

In respect of the destroyed CGT assets, is there any net capital gain that should be included in the assessable income of The Taxpayer in the year ended 30 June 20XX?

Answer

No

Question 3

Is The Taxpayer entitled to apply section 40-365 of the ITAA 1997 to exclude an amount from its assessable income for the year ended 30 June 20XX that would otherwise arise as a result of a balancing adjustment event occurring to its destroyed Division 40 assets?

Answer

Yes

Question 4

Will the Commissioner exercise his discretion under paragraph 40-365(3)(b) of the ITAA 1997 to allow The Taxpayer further time to incur expenditure on replacement assets to 30 June 20XX?

Answer

Yes

This ruling applies for the following periods:

Income Tax Year Ended 30 June 20XX

Income Tax Year Ended 30 June 20XX

Income Tax Year Ended 30 June 20XX

Income Tax Year Ended 30 June 20XX

Income Tax Year Ended 30 June 20XX

The scheme commenced on:

DD MMM 20XX

Relevant facts and circumstances

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

The Taxpayer

A fire significantly impacted its principal operations with the loss and complete destruction of a substantial number of assets.

The extent of the damage to these assets was such that there was no commercially feasible option of repairing or restoring those assets.

This loss has meant a loss in operational function.

For tax purposes, The Taxpayer's assets that were destroyed have been classified into two broad categories.

•         'CGT assets': Comprising destroyed assets that are CGT assets within the meaning of Division 108 and the taxation of which are governed by Part 3-1 ofthe Income Tax Assessment Act 1936. These assets include assets where construction commenced prior to the application of Division 43 or its predecessors, and CGT assets with respect to which capital works deductions have been claimed in prior years under Division 43.

•         'Division 40 assets': Assets to which Division 40 applies, and with respect to which deductions under Division 40 have been claimed by The Taxpayer.

The CGT assets acquired are not identical to The Taxpayer's destroyed assets (particularly given the age of the assets). However, the new assets are acquired for the same purpose as the destroyed assets.

The nature of replacement Division 40 assets and the use to which they are put, compared with the attributes of the original asset, the replacement assets are substantially similar (if not identical), even though the new depreciating assets acquired will not replace the destroyed Division 40 assets on a one-to-one basis.

Insurance Claim - Destroyed Assets

Following the damage and destruction to its assets, The Taxpayer prepared and lodged an insurance claim through its brokers.

The relevant insurance proceeds were received during the year ended 30 June 20XX.

The insurance proceeds were apportioned to the two classes of assets in the ratios of their tax cost (e.g. their adjustable value and cost base) by The Taxpayer.

Following the destruction of assets, The Taxpayer immediately began works.

The Taxpayer has stated that due to the age of the destroyed assets, a like-for-like reconstruction was neither possible nor desirable. The Taxpayer made the decision to build a more appropriately fit for purpose assets that meet short and long-term business needs, improving functionality, useability, safety, etc.

The Taxpayer has a high-level schedule of proposed construction stages, and detailed designs.

It is proposed to be delivered in three main stages, over a period of 5-6 years (or potentially longer), with each stage subject to separate business case decisions and internal and external approvals.

As at 30 June 20XX, Stage 1 had received full project planning funding and project construction funding approval via the relevant governance processes within The Taxpayer's business.

The completion of the reconstruction project will take a number of years and may finish in the 20XX - 20XX calendar year.

A total of $XX million in capital costs had been incurred for the reconstruction as at 30 June 20XX.

Based on the progress of the project to January 20XX, the project's timelines indicate that Stage 1 of the Plan should be completed in late calendar year 20XX, with total expenditure to complete this project being approximately $XX million.

The completion of Stage 1 will be the trigger to enable the replacement Division 40 assets to be placed within the completed assets. By aligning the acquisition of the replacement Division 40 assets around this completion date, The Taxpayer will avoid the impracticalities and extra expenses associated with storing those assets before they can be installed.

Reasons for decision

Question 1

Detailed reasoning

Requirements for roll-over

Division 124 provides that under certain circumstances you can make a choice to apply 'replacement asset roll-over relief' when calculating your capital gain (or loss) in a particular year.

Subdivision 124-B provides 'replacement asset roll-over relief' where a CGT asset you own is lost or destroyed (paragraph 124-70(1)(b)). The loss or destruction of a CGT asset would ordinarily result in CGT event C1 happening (section 104-20).

For roll-over relief to be available in such a circumstance you must receive money (or other CGT assets) under an insurance policy you hold covering the risk of loss or destruction to the asset (original asset) (paragraph 124-70(2))(b)).

Section 124-75 sets out additional requirements to be satisfied where you receive money, these are:

•         you can only choose roll-over if section 124-75 is satisfied (subsection 124-75(1))

•         you must incur expenditure on acquiring, repairing or restoring the CGT asset (or damaged parts thereof) (subsection 124-75(2))

•         you cannot have incurred the expenditure any earlier than 12 months before the CGT event happens (paragraph 124-75(3)(a))

•         you cannot incur the expenditure any later than 12 months after the end of the income year in which the CGT event happens (subject to the Commissioner allowing additional time) (paragraph 124-75(3)(b))

•         if just before the loss or destruction of the original asset, it was used or installed ready for use (or in the process of being installed) in your business then the replacement asset must be used or installed ready for use in the business for a reasonable time after you acquired it; and if not, then you must use the other asset (replacement) for the same or similar purpose for which you acquired the original asset (subsection 124-75(4)), and

•         the other asset (replacement) cannot have its decline in value calculated under Division 40 (subsection 124-75(5))

The time at which CGT event C1 happens is determined by subsection 104-20(2). For The Taxpayer this will be the time it first receives compensation for the loss (paragraph 104-20(2)(a)).

Application to The Taxpayer

Property comprising CGT assets (other than Division 40 assets) were destroyed. The Taxpayer received confirmation that its insurer would indemnify it, which resulted in CGT event C1 happening on that date.

The Taxpayer became eligible to choose roll-over under Division 124 as of that date (paragraph 124-70(1)(b)).

Whilst the Settlement and Release Agreement was signed on that date, the proceeds of the insurance claim were received during the year ended 30 June 20XX.

It is not expressly stated that some of the expenditure incurred on the property comprising the insured CGT assets took place no earlier than one year prior to when CGT event C1 happened. The Commissioner will extend the period such that it commences 1 January 20XX.

The Taxpayer has incurred at least some of the expenditure in acquiring another CGT asset after the CGT event, however, this has not all been incurred prior to 30 June 20XX (which is the 12 month period ending after the end of the income year in which CGT event C1 happened).

Whilst The Taxpayer has incurred some of the expenditure in acquiring another CGT asset prior to the year ending 30 June 20XX, it has not incurred all of that expenditure by that date. The Taxpayer is asking the Commissioner to extend that time to 30 June 20XX.

The Commissioner accepts that the replacement assets, being constructed meet the similar purpose requirement detailed in subsection 124-75(4).

As the requirements for roll-over relief under Subdivision 124 are otherwise met, The Taxpayer will be eligible to choose roll-over relief for these CGT Assets for all expenditure incurred up until 30 June 20XX.

Question 2

Detailed reasoning

As discussed in Question 1, The Taxpayer is allowed to choose to apply roll-over relief under Subdivision 124-B where a CGT asset is lost or destroyed, and CGT event C1 happens (section 104-20).

Section 124-85 sets out the consequences of choosing to obtain roll-over relief under section 124-70, where money is received for the event happening.

Item 3 of the table in subsection 124-85(2) provides that where the money received for the destruction of the CGT asset does not exceed the expenditure that is incurred to acquire another CGT asset, the capital gain on the destruction of the original asset is disregarded in working out the net capital gain or net capital loss of the income year. The expenditure on the replacement CGT asset is reduced by the amount of the capital gain on the destruction of the original CGT asset.

Application to The Taxpayer

The gain made on the destruction of the CGT assets is less than the expenditure already incurred on the replacement CGT assets that are intended to replace the CGT assets. Therefore, on the assumption that The Taxpayer chooses roll-over relief, the capital gain arising when CGT event C1 happens will be disregarded when calculating The Taxpayer's net capital gain for the year ended 30 June 20XX.

Question 3

Detailed reasoning

Under section 40-295, a balancing adjustment event occurs for a depreciating asset if you stop holding the asset (paragraph 40-295(1)(a)), or you stop using it for any purpose and you expect never to use it again (paragraph 40-295(1)(b)). This means when The Taxpayer's Division 40 assets were destroyed, a balancing adjustment event occurred.

Subsection 40-285(1) provides when you include a balancing adjustment amount in your assessable income. Specifically, paragraph 40-285(1)(b) provides that if the termination value of the depreciating asset is more than its adjustable value, the difference is included in your assessable income for the income year in which the balancing adjustment event occurs.

Subsection 40-285(2) provides when you deduct a balancing adjustment amount from your assessable income. Specifically, paragraph 40-285(2)(b) provides that you can deduct an amount if the termination value of the depreciating asset is less than its adjustable value. This difference is deductible for the income year in which the balancing adjustment event occurs.

The balancing adjustment amount is calculated by comparing the asset's termination value with its adjustable value outlined in paragraphs 40-285(1)(a) and (b); 40-285(2)(a) and (b).

Where a depreciating asset is lost or destroyed, the termination value is the amount or value received or receivable under an insurance policy or otherwise for the loss or destruction (item 8 in the table in subsection 40-300(2)).

The adjustable value of an asset is the opening adjustable value for that year and any amount included in the second element costs for the year, less its decline in value for the year up to that time (paragraph 40-85(1)(c)).

The opening adjustable value of a depreciating asset for an income year is its adjustable value to you at the end of the previous income year (subsection 40-85(2)).

Section 40-365 allows you to choose whether to include a balancing adjustment amount in your assessable income where you cease to hold a depreciating asset because it is lost or destroyed.

You can choose to utilise some or the entire amount that would otherwise be a balancing adjustment as a reduction in the cost and/or opening adjustable value of one or more replacement assets. The cost of the replacement asset is reduced by the otherwise assessable amount.

To make this choice, the following conditions must be satisfied:

• There is an involuntary disposal of an asset as set out in subsection 40-365(2);
• The expenditure on the replacement asset must be incurred, or you must start to hold the replacement asset:

−     no earlier than one year (or any further period the Commissioner allows) before the involuntary disposal occurred; and

−     no later than one year (or any further period the Commissioner allows) after the end of the income year in which the involuntary disposal occurred (subsection 40-365(3)); and

• You must:

−     have used the replacement asset, or have it installed ready for use, wholly for a taxable purpose by the end of the income year in which you incurred the expenditure on the asset, or started to hold it; and

−     be able to deduct an amount for it (subsection 40-365(4)).

Application to The Taxpayer

The destroyed Division 40 assets are those which The Taxpayer has claimed deductions under Division 40, and they are depreciating assets for the purposes of that Division.

A balancing adjustment event under section 40-295 occurs to the Division 40 assets in the 30 June 20XX income year, The Taxpayer stopped holding the assets due to their loss and destruction.

Further, the loss and destruction triggers section 40-365 (Involuntary disposals) which allows you the choice to exclude some or all of an amount that would otherwise be included in your assessable income as the result of a balancing adjustment as a reduction in the cost or opening adjustable values of qualifying replacement assets.

The Taxpayer is able to exclude this amount from being included in its assessable income for that income year, as it satisfies the requirements of section 40-365:

• The Division 40 assets were lost or destroyed as required by paragraph 40-365(2)(a)
• Expenditure will be incurred by The Taxpayer on replacement depreciating assets as part of construction and development of under Stage 1 of the Plan, and this expenditure will be incurred within the further period of time to 30 June 20XX that is allowed by the Commissioner (as discussed in question 4 of this ruling, below)
• The replacement assets will be held by The Taxpayer for a taxable purpose, and The Taxpayer will be entitled to claim a deduction for the decline in value of the replacement assets as required by subsection 40-365(4); and
• The Taxpayer will reduce the cost of its replacement depreciating assets by the amount of the assessable balancing adjustment it would have otherwise included in its assessable income for the year ended 30 June 20XX.

Furthermore, as set out by subsection 40-365(6), The Taxpayer will apportion the amount covered by the choice under section 40-365 between all the new replacement depreciating assets acquired as part of Stage 1 of the Plan in proportion to their cost.

Therefore, The Taxpayer should not have to include an amount in its assessable income for the year ended 30 June 20XX in respect of the balancing adjustment event that occurs to the destroyed Division 40 assets, as The Taxpayer can choose to apply this amount for the purposes described by subsection 40-365(5).

Question 4

Detailed reasoning

Section 40-365 allows you to choose to utilise some or the entire amount that would otherwise be a balancing adjustment as a reduction in the cost and/or opening adjustable value of one or more replacement assets.

Under paragraph 40-365(3)(b) the exclusion can only be made where you incur the expenditure on the replacement assets no later than one year, or within a further period the Commissioner allows, after the end of the income year in which the balancing adjustment occurred.

As the destruction occurred in the income year ending 30 June 20XX, the balancing adjustment event referred to in paragraph 40-365(3)(b) happened in the same income year. This means absent the Commissioner granting further time, the expenditure to acquire the replacement assets needs to take place before 1 July 20XX.

The Taxpayer has asked the Commissioner to extend the period it has to incur the relevant expenditure on the replacement assets until 30 June 20XX.

There are no legislative provisions which provide guidance as to what specific factors the Commissioner may take into account when determining whether it is appropriate to grant a further period of time to start holding, or to incur expenditure on a replacement asset for the purposes of subsection 40-365(3).

Chapter 3.82 of the Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 and New Business Tax System (Capital Allowances - Transitional and Consequential) Bill 2001 provide examples of when the Commissioner may allow a further period under paragraph 40-365(3)(b) which include:

• in the event of a destruction of large infrastructure assets it will be likely to take than more than 12 months to rebuild those assets, and there are no suitable corresponding assets acquired within 12 months before or after the destruction, or
• in the event of the replacement asset being acquired from overseas it will be likely to take more than 12 months to deliver such assets, and there are no suitable corresponding assets acquired within 12 months before or after the destruction.

Application to The Taxpayer

The Division 40 assets used by the entity were destroyed. The Taxpayer is in the process of replacing both the CGT Assets and Division 40 assets. The Commissioner accepts that this is a major project.

The nature of the Division 40 assets that have been destroyed means that acquisition of assets to replace the destroyed Division 40 assets is only practical when the CGT assets have been replaced.

The delivery for Stage 1 of the Plan will be the trigger to enable the replacement assets to be installed. While this is planned to be completed by October 20XX, it is reasonable to conclude that this date may be delayed due to reasons outside the control of The Taxpayer.

Based on the above factors, the Commissioner concludes it is reasonable to allow a further period of time until 30 June 20XX to allow The Taxpayer to incur the expenditure on the replacement Division 40 assets for the purposes of section 40-365.