House of Representatives

Explanatory Memorandum

(Circulated by authority of the Minister for Housing and Assistant Treasurer the Hon Michael Sukkar MP)

Chapter 3 - Limiting deductions for vacant land

Outline of chapter

3.1 Schedule 3 to the Bill amends the ITAA 1997 to deny deductions for losses or outgoings incurred that relate to holding vacant land. However, the amendments do not apply to any losses or outgoings relating to holding vacant land to the extent to which the land is:

•

used or held available for use by the entity in the course of carrying on a business in order to earn assessable income; or

•

used or held available for use in carrying on a business by;

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an affiliate, spouse or child of the taxpayer; or

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an entity that is connected with the taxpayer or of which the taxpayer is an affiliate.

3.2 The amendments also do not apply to taxpayers that are:

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corporate tax entities, superannuation plans (other than self managed superannuation funds), managed investment trusts or public unit trusts; or

•

unit trusts or partnerships of which all the members are entities of the above types.

3.3 All legislative references in this Chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

3.4 The income tax law allows taxpayers to claim the costs of holding vacant land if it is held for the purpose of gaining or producing assessable income or carrying on a business for the purpose of gaining such income. However, some taxpayers have been claiming deductions for costs associated with holding vacant land when it is not genuinely held for the purpose of gaining or producing assessable income.

3.5 As the land is vacant, there is often limited evidence about the taxpayer's intent other than statements by the taxpayer. The reliance on a taxpayer's assertion about their current intention leads to compliance and administrative difficulties.

Summary of new law

3.6 Schedule 3 to the Bill amends the ITAA 1997 to deny deductions for losses or outgoings incurred to the extent they relate to a taxpayer holding vacant land.

3.7 However, the amendments do not apply to any losses or outgoings relating to holding vacant land to the extent the land was:

•

used or held available for use by the taxpayer in the course of a business the taxpayer holding the land carries on for the purpose of gaining or producing assessable income; or

•

used or held available for use in carrying on a business by:

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an affiliate, spouse or child of the taxpayer holding the land; or

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an entity that is connected with the taxpayer or of which the taxpayer is an affiliate in carrying on a business.

3.8 The amendments also do not apply to:

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corporate tax entities, superannuation plans (other than self managed superannuation funds), managed investment trusts or public unit trusts; or

•

unit trusts or partnerships of which all the members are entities of the above types.

Comparison of key features of new law and current law

Detailed explanation of new law

3.9 Schedule 3 to the Bill amends the ITAA 1997 to deny deductions for losses or outgoings incurred that relate to holding vacant land.

3.10 However, the amendments do not apply to any losses or outgoings relating to holding vacant land to the extent that the land was:

•

used or held available for use in the course of a business the taxpayer carries on for the purpose of gaining or producing assessable income; or

•

used or held available for use in carrying on a business by an affiliate, spouse or child of the taxpayer, or an entity that is connected with the taxpayer or of which the taxpayer is an affiliate.

3.11 The amendments also do not apply to the extent that the losses or outgoings relate to a period after land ceases to be vacant land.

3.12 The amendments do not prevent certain types of entities from claiming such deductions (refer to paragraphs 3.42 to 3.52).

Vacant land

3.13 Land is vacant, for the purpose of these amendments, if there is no substantial and permanent building or other structure that is in use or available for use on the land, with an independent purpose that is not incidental to the purpose of another structure or proposed structure on the land. A structure includes a building or other thing that is built or constructed on the land. [Schedule 3, item 3, subsection 26-102(1)]

Land

3.14 In this context, the relevant area of land is the land to which the loss or outgoing relates. [Schedule 3, item 3, subsection 26-102(1) and the notes to subsection 26-102(1)]

3.15 For most losses and outgoings relating to holding land, this will be the land covered by a single property title as the loss or outgoing relates to that title.

3.16 For example, if an entity becomes liable to rates in respect of a property, the relevant land is the property that is the subject of the rates notice. If this land contains a substantial and permanent structure that has an independent purpose and it is not incidental to the purpose of another structure or proposed structure then the land is not vacant and the loss or outgoing may be deductible.

3.17 In other cases a loss or outgoing may relate to only part of the land covered by a title or to land covered by multiple titles.

Substantial and permanent

Meaning of substantial

3.18 To be substantial, a building or other structure needs to be significant in size, value or some other criteria of importance in the context of the relevant property. [Schedule 3, item 3, subsection 26-102(1)]

3.19 Whatever makes the structure substantial must be a feature of that particular structure - a structure is not substantial if it only has value as an adjunct to another structure. For example, a letterbox would not be substantial and a residential garage would be unlikely to be substantial.

Meaning of permanent

3.20 To be permanent, a structure needs to be fixed and enduring. A fixed structure that is not built for a temporary purpose is a permanent structure even if it would not be expected to remain standing forever. Likewise the fact a structure may require some repairs either at the present time or at some future point does not affect its permanency. [Schedule 3, item 3, subsection 26-102(1)]

Independent rather than incidental purpose

3.21 Whether a particular structure has an independent purpose that is not incidental to the purpose of another structure or proposed structure on the land is a question of fact. It needs to be considered in the context of the structure, the land on which it is located and the other structures (if any) that have been, are in the process of being or may be expected to be constructed on that land. [Schedule 3, item 3, subsection 26-102(1)]

3.22 Structures that exist to support the use or functioning of another structure, such as pipes or powerlines, will not satisfy this requirement. Similarly, structures that have the purpose of increasing the utility of another structure will not satisfy this requirement.

3.23 For example, structures such as a residential garage or shed are constructed for the purpose of adding utility for individuals using the residence on the land. Such structures do not have an independent purpose and are incidental to the related residential premises.

3.24 On the other hand, a commercial parking garage complex, a woolshed for shearing and baling wool and a grain silo would all usually have an independent purpose, rather than being incidental to some other structure as they operate separately from and independent of any other structure on the land. In general, the separate primary use of a structure to generate income will be an indication the structure satisfies this requirement.

Example 3.1 : Vacant land

Chelsy owns a block of land. She intends to eventually build a rental property on the land. However, while the block of land is fenced and has a retaining wall, it currently does not contain any substantial and permanent building or other structure with an independent purpose that is not incidental to the purpose of another building or structure. As the block of land does not have a substantial and permanent structure on it, it is vacant land and Chelsy cannot deduct any holding costs she may incur in relation to the land.

Time at which land must contain a structure

3.25 For a loss or outgoing to be deductible, the relevant land must generally contain a structure at the time the loss or outgoing is incurred. [Schedule 3, item 3, subsection 26-102(1)]

3.26 However, in some cases a taxpayer may incur a loss or outgoing after ceasing to hold the land to which it relates (for example, they may pay interest on a loan after the land has been sold). In this case, the loss or outgoing will be deductible if the land was not vacant immediately before the taxpayer ceased to hold an interest in the land. [Schedule 3, item 3, paragraph 26-102(1)(b)]

Holding costs

3.27 The amendments apply to the costs of holding land. The amendments clarify that any ongoing borrowing costs, including interest payments on money borrowed for the acquisition of land, are considered to be costs of holding land for this purpose. Other examples of such holding costs include land taxes, council rates and maintenance costs. [Schedule 3, item 3, paragraph 26-102(1)(a)]

3.28 Holding costs can be costs incurred in the capacity of the owner of the freehold interest in the land or of a long term leasehold interest in the land. Alternatively, where the owner leases the land to another party, the amendments also apply separately to any costs incurred by the lessee in relation to their interest in the land as the lessee is also considered to hold the land under the terms of the lease.

Holding costs of vacant land incurred in carrying on a business

3.29 Even where land is vacant (i.e. does not contain any structures) these amendments do not deny deductions to the holder of the land for the costs of holding that land to the extent that they are incurred in:

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carrying on a business by the taxpayer (for example a property development or primary production business); or

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holding land that is used or made available for use in carrying on such a business by certain entities related to the taxpayer.

[Schedule 3, item 3, subsections 26-102(1) and 26-102(2)]

3.30 Whether a business is being carried on depends on the facts of the particular case. Some indicators that the courts have considered relevant are whether the activity has a significant commercial purpose or character, whether there is repetition and regularity of the activity and whether the activity is better characterised as a hobby or recreational pastime.

3.31 The exclusion applies to both land used in a business and land held available for use in a business. This would include land held by a property developer for future development of a housing estate for sale. This ensures that the exception is not limited to land that is in active use by a business but also applies to land or parts of land that are available for business purposes.

3.32 Accordingly, it is sufficient that land is held in the course of carrying on a business for future use or made available to a related entity that is carrying on a business for future use.

3.33 The reference to 'to the extent that' ensures that the amendment does not exclude the whole area of vacant land from the principle that holding costs of vacant land should not be deducted if a small part of the land is being used for carrying on a business but the rest of the land is being used for another purpose. For example, where a business is operated on one part of a property that is vacant land by an entity but the remainder of the vacant land is set aside for the construction of residential premises for rent and not held available for business use then apportionment is required. In such circumstances, the entity can only claim a deduction for the costs of holding the land that is used to carry on the business and not for that part of the land that is vacant land.

3.34 The extent to which a property is used or held available for use in carrying on a business must be determined on an apportionment basis that is fair and reasonable in the context of the particular property.

Example 3.2 : Expenditure for mixed use land

Howard owns one hectare of land in Queensland. He uses one third of the land for carrying on his firewood sales business. He stores all his firewood in the open and there are no structures on the land. Howard has set aside the remainder of the land to construct a rental property. The remaining part of the land is separately fenced off and has been subject to site work including earthworks to clear the land ready for construction.

Howard is eligible to claim losses and outgoings relating to holding the part of the land that he uses for carrying on his firewood business, to the extent that the loss or outgoing is necessarily incurred for the purpose of gaining or producing the assessable income.

The remainder of his land is not used or held available for use in carrying on his firewood business. Further, as there are no structures on Howard's land, it cannot contain a building or other structure that meets the requirements of these amendments. As a result, Howard is not entitled to claim any deductions relating to the costs of holding this part of the land even though he intended to derive income from it in the future as a rental property.

Related parties

3.35 The related entities that enable the holder of land to satisfy the test that a business is being carried on are:

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an affiliate of the holder of the land (broadly an entity controlled by the entity that holds the land - see section 328-130);

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an entity of which the holder of the land is an affiliate (see also section 328-130);

•

a spouse, or a child aged under 18 years of age, of the holder of the land (see section 152-47); or

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an entity that is connected with the holder of the land (see section 328-125).

[Schedule 3, item 3, subsection 26-102(2)]

3.36 The leasing of land to related parties is common in the agricultural sector for family enterprises and the special rule for related parties ensures that the amendments do not adversely affect primary producers using such arrangements.

Past business use

3.37 In some cases a taxpayer may incur holding costs relating to a time when land was previously used or made available for use in the course of carrying on a business. These costs can be deducted based on the use of the land at that prior time as they relate to the time at which the prior business use occurred despite being incurred after this use had ceased. [Schedule 3, item 3, subsection 26-102(3)]

3.38 For example, a taxpayer may have borrowed money to acquire land for use in carrying on a business. On ceasing to carry on that business, the taxpayer disposes of the property and repays the loan including outstanding interest. Even though this interest cost is incurred after the business ceases to be carried on, these amendments do not prevent it from being deductible. This is because it relates to (ie. is deductible because of) the prior use or availability for use of land in the period in which the land was used in carrying on the business.

Example 3.3 : Expenditure incurred in carrying on a business deductible

Albert carries on business as a property developer and owns a significant property portfolio of vacant land in Melbourne. He incurs outgoings relating to holding the vacant land including interest payments and council rates. Some of this vacant land is currently in use. Other areas are being held available for use in future developments.

As Albert incurs the expenditure to hold the land in carrying on his business for the purpose of producing assessable income it is deductible. It does not matter whether the land is currently being developed or if it is held for future use.

Example 3.4 : Expenditure incurred in carrying on a business by a related party of the holder of land

Gina owns vacant land in New South Wales which she rents to her spouse Robin for use in a farming business he carries on. Robin, as Gina's spouse, forms part of the class of related parties (spouses, children under 18 years old, affiliates and connected entities) that allow Gina to deduct her costs of holding the land. This is because Robin is carrying on a business on it to produce assessable income.

Land will be treated as vacant land until residential premises exist on the land

3.39 A special rule applies when determining if land that contains residential premises within the meaning of the GST Act is vacant. The land is treated as remaining vacant for the purposes of these amendments until the residential premises are:

•

able to be occupied under the law; and

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leased, hired or licensed or available for lease, hire or licence.

[Schedule 3, item 3, subsection 26-102(4)]

3.40 This rule means a taxpayer cannot deduct the costs of holding land containing residential premises until the premises can be legally rented and the taxpayer is actively seeking to derive income from the use of the property as residential premises. It ensures that in the context of a rental property, statements about intention are not sufficient. Instead, deductions are only available for the costs of holding land containing residential premises if the premises are available for rent and are placed on the rental market.

3.41 The special rule is only relevant once an amount would otherwise be deductible. This means that:

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the land must contain a substantial and permanent building on it with an independent purpose that is not incidental to another building or structure on the land or to be built on the land; and

•

the building must be in use or ready for use to generate income;

in order to satisfy both the general requirements for deductibility under this measure and the separate deductibility requirements in section 8-1. [Schedule 3, item 3, subsections 26-102(1) and (4)]

Example 3.5 : New residential premises available for rent

Anna purchased a block of vacant land and built new residential premises on it. Occupancy permits are issued for the residential premises once the building is considered suitable for occupation and the building is actively made available for rent.

Anna can deduct the costs of holding this block of land to the extent expenses are incurred once the property is legally available for occupation and is leased, hired or licensed or otherwise available for lease, hire or licence.

Excluded classes of entity

3.42 These amendments do not prevent an entity from deducting a loss or outgoing that relates to holding vacant land, if at any time during the income year in which the loss or outgoing is incurred, the entity is:

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a 'corporate tax entity' within the meaning of the ITAA 1997;

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a 'superannuation plan' that is not a 'self managed superannuation fund' within the meaning of the ITAA 1997;

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a public unit trust within the meaning of section 102P of the ITAA 1936;

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a managed investment trust within the meaning of section 275-10; or

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a partnership or unit trust if all of the members of the partnership or trust are entities included on this list (including this item).

[Schedule 3, item 3, subsection 26-102(5)]

3.43 Effectively this means that the amendments do not apply to deductions for institutional investors holding vacant land. Institutional investors usually operate under a corporate structure, are public unit trusts or managed investment trusts, meet the description of being a 'superannuation plan' that is not a 'self managed superannuation fund' or are unit trusts or partnerships that are ultimately held by these entities. Generally, such investors are considered to have a low risk of incorrectly claiming deductions in relation to vacant land, as these entities are either not controlled by an individual, do not receive tax concessions which flow through to individuals or both.

3.44 Corporate tax entity is defined in section 960-115. It includes entities that are companies, corporate limited partnerships, corporate unit trusts and public trading trusts at the relevant time. It does not include a trust merely because the trustee of the trust is a corporate tax entity.

3.45 'Superannuation plan' and 'self managed superannuation fund' are defined in subsection 995-1(1).

3.46 Public unit trust is defined in section 102P of the ITAA 1936. Broadly, a unit trust will be a public unit trust if the units in the trust are listed for quotation in the official list of a stock exchange, offered to the public in a public offer and held by more than 50 people or where a tax-exempt investment vehicle (such as a foreign superannuation fund) is a substantial unitholder (see subsections 102P(1) and (2) of the ITAA 1936). However, a trust will not be a public unit trust if 20 or fewer people hold the beneficial interest in 75 per cent or more of the income or property of the trust, or if other integrity rules are not satisfied (see section 102P of the ITAA 1936).

3.47 Trusts are also excluded if they are managed investment trusts within the meaning of section 275-10.

3.48 In all cases these requirements ensure that trusts must be widely held and genuinely free from the control of any one member to benefit from this exclusion.

3.49 The final exclusion for unit trusts or partnerships applies if all of the members of the entity (i.e. the unit holders or partners) are listed as excluded entities. It includes unit trusts or partnerships that have a member or members that are an excluded entity because of this amendment (ie. they are themselves a trust or partnership where all of the members are excluded entities).

3.50 This exclusion ensures that where all the benefit of deductions goes to excluded entities, the deductions continue to be available. This includes situations where the excluded entities receive the benefit of deductions through a chain of unit trusts or partnerships.

3.51 The entities to which the measure does not apply are consistent with the excluded entities for the purposes of section 26-31 concerning travel related to use of residential premises as residential accommodation and section 40-27 that relates to reduction of deductions for second-hand assets in residential property.

3.52 References to entities holding vacant land in this Chapter exclude the above entities for which this measure does not apply.

Denied deductions for cost base expenses included in the cost base

3.53 Losses and outgoings that are not deductible in an income year as a result of these amendments are not able to be deducted in later years. However, under the existing law they may be included in the cost base of the asset for CGT purposes, resulting in a corresponding reduction in any capital gain when a CGT event happens if they meet the cost base criteria.

3.54 The relevant CGT event would typically be the sale of land (CGT event A1) but could include other CGT events such as granting, renewing or extending an option to purchase land (CGT event D2) or entering into a conservation covenant over land (CGT event D4).

3.55 This CGT treatment is consistent with the tax treatment that applies for holding vacant land for private use. For instance, an individual who buys land to later build a holiday home solely for private use can include expenses, such as rates and borrowing expenses, in their CGT cost base upon sale if they have never been entitled to claim the expenses as deductions and they are ordinarily a cost base element.

Consequential amendments

3.56 Schedule 3 includes a consequential amendment to add a reference to the new rules to the guidance material in section 12-5 (which contains a list of provisions about deductions). [Schedule 3, items 1 and 2, section 12-5]

Application and transitional provisions

3.57 The amendments commence from the start of the first quarterly period commencing after the day of Royal Assent of the Bill. [Clause 2]

3.58 The measure applies to losses and outgoing incurred on or after 1 July 2019 regardless of whether the land was first held prior to this date. [Schedule 3, item 4]

3.59 This measure was announced by the Government in the 2018-19 Budget on 8 May 2018. Exposure draft legislation was released for public consultation from 15 October 2018 to 31 October 2018.

3.60 Retrospective application is necessary as the amendments are an important integrity measure to prevent deductions being claimed in relation to vacant land that may not be genuinely held for the purpose of gaining or producing assessable income. However, given taxpayers have received advance notice of over a year of the changes and the period of retrospectivity is expected to be resolved well before the end of the 2019-20 income year, in practice any disadvantage is likely to be minimal.