Edited version of private advice

Authorisation Number: 1052190995990

Date of advice: 9 November 2023

Ruling

Subject: Extension of time to replace a CGT asset destroyed by fire

Question:

Will the Commissioner extend the period allowed to DD MM YYYY for expenditure to be incurred on a replacement asset under paragraph 40-365(3)(b) of the Income Tax Assessment Act 1997 (ITAA 1997), in relation to the replacement of an asset destroyed by fire on DD MM YYYY?

Answer:

Yes

This ruling applies for the following periods:

DD MM YYYY to DD MM YYYY

The Scheme commences on:

DD MM YYYY

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect, and you cannot rely on it.

Background Information

The Partnership operates a business at XXX.

The property is located XX kms north of XXX.

Asset destroyed by fire

The property's improvements included an asset, which was destroyed by fire on DD MM YYYY.

The Partnership received $XXX insurance proceeds for the asset on DD MM YYYY.

Due to the remote location of the property, it took some time for the insurance company's assessor to inspect the damage and complete their report (the claim was lodged on DD MM YYYY). This delayed approval of the claim and payment of the insurance claim.

As soon as the Partnership obtained approval of its claim (a successful claim was essential to fund the reconstruction), the Partnership undertook to engage a firm to design and build a replacement asset. After discussions and negotiations, the Partnership contracted Company X of ZZZ to build the replacement asset.

Construction of replacement asset

Company X advised that they were unable to commence construction of the asset until MM YYYY. This timeline was due to a backlog of building projects which were caused by logistics associated with distance, wet weather (which can close roads for months), high demand for assets due to rural prosperity and problems with workforce availability (due to the impacts of COVID restrictions and high labour demand).

A letter and updated quote from Company X dated DD MM YYYY was received by the Partnership, which referred to the delay in the manufacture of the asset and their hope to deliver the asset within a few months.

If construction is completed on schedule, the new asset is expected to be completed by DD MM YYYY.

The Partnership engaged Company X as they had built several assets in the district so were familiar with the distances involved and requirements for freighting of materials to remote areas. Several other builders, when approached, did not wish to undertake the project due to its remote location.

The Partnership was therefore unable to engage an alternative builder who had the experience and resources required to work in a remote area that could commence construction sooner.

No costs were incurred in connection with the replacement asset by XX XXXX XXXX.

Information provided

You have provided a number of documents containing detailed information in relation to the Partnership's application including:

Private Binding Ruling ('PBR') Application, dated DD MM YYYY

We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

Relevant legislative provisions

Income Tax Assessment Act 1997subsection 40-365(1)

Income Tax Assessment Act 1997 paragraph 40-365-(3)(b)

Reasons for decision

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

Summary

The Commissioner will extend the period allowed to DD MM YYYY for expenditure to be incurred on a replacement asset under paragraph 40-365(3)(b) of the ITAA 1997, in relation to the replacement of an asset destroyed by fire.

Detailed reasoning

Section 40-365 of the ITAA 1997 allows a taxpayer to choose (the choice) whether or not to include a balancing adjustment amount in their assessable income where they cease to hold a depreciating asset because it is destroyed.

Subsection 40-365(1) of the ITAA 1997 states that:

...a taxpayer may exclude some or all of an amount that has been included in their assessable income for a depreciating asset (the original asset) as a result of a balancing adjustment event to the extent that they choose to treat it as an amount to be applied under subsection (5) for one or more replacement assets.

Paragraph 40-365(2)(a) of the ITAA 1997 states that:

...a taxpayer can only make this choice if they stop holding the asset because the original asset is lost or destroyed.

Subsection 40-365(3) of the ITAA 1997 states that:

A taxpayer can only make this choice for a replacement asset if they incur the expenditure on the replacement asset, or they start to hold it:

(a)          no earlier than one year, or within a further period the Commissioner allows, before the balancing adjustment event occurred; and

(b)          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 event occurred.

The taxpayer can choose to use 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 or assets is reduced by the otherwise assessable amount.

One of the requirements for the taxpayer to be able to make this choice is that they incur the expenditure on a replacement asset, or start to hold it, 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 (paragraph 40-365(3)(b) of the ITAA 1997).

In looking at the circumstances in which the Commissioner allows a further period, the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Act 2001 (the EM) states at paragraph 3.82:

Examples of when the Commissioner may allow a further period under paragraph 40-365(3)(b) include:

•                     in the event of a destruction of large infrastructure assets it will be likely to take... 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.

In looking at the above examples in which the Commissioner allows further time, the factors that the Commissioner uses to make a favourable decision are delays outside the control of the taxpayer or situations where construction time makes it difficult (or impossible) to replace the asset within the required time.

Application to your circumstances

In this matter, the depreciating asset was destroyed by fire on DD MM YYYY. Therefore, under paragraph 40-365(3)(b) of the ITAA 1997, unless an extension is allowed, the Partnership had until one year after the end of the income year in which the balancing adjustment occurred (that is, DD MM YYYY) to incur the expenditure on the replacement asset.

The Partnership is seeking an extension of time to DD MM YYYY to incur expenditure on the replacement asset.

In this matter, the asset owned by the Partnership was destroyed by fire on DD MM YYYY, making the balancing adjustment year, the year ending DD MM YYYY. The Partnership had until DD MM YYYY to incur expenditure on the replacement assets. As expenditure was not incurred by DD MM YYYY, the Commissioner can consider whether to allow further time to incur expenditure on replacement assets.

The Partnership engaged Company X as they had built several assets in the district so were familiar with the distances involved and requirements for freighting of materials to remote areas. Several other builders, when approached, did not wish to undertake the project due to its remote location.

The Partnership was therefore unable to engage an alternative builder who had the experience and resources required to work in a remote area that could commence construction sooner.

There were considerable delays outside the control of the Partnership and situations where construction time made it difficult to replace the asset within the required time.

Given the remote location, size of the project, delays in receiving the insurance proceeds and difficulty both in accessing contractors and contractors in accessing the site, it would be fair and equitable for the purposes of paragraph 40-365(3)(b) of the ITAA 1997 to extend the replacement asset period from DD MM YYYY to DD MM YYYY.

On consideration of the facts and circumstances in this matter, and consistent with the principles and guidance in the EM, the Commissioner will exercise his power under paragraph 40-365(3)(b) of the ITAA 1997 to allow a further period of time until DD MM YYYY to incur the expenditure on the replacement asset.

Failure to incur expenditure within the extended replacement period will result in the Partnership being assessed on the balancing adjustment in the YYYY income year.

Conclusion

The Commissioner will extend the period allowed to DD MM YYYY for expenditure to be incurred on a replacement asset under paragraph 40-365(3)(b) of the ITAA 1997, in relation to the replacement of an asset destroyed by fire.

ATO view documents

Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Act 2001

Key words

Capital Gains Tax (CGT)

Discretional power

Replacement asset