Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Depreciation of Property Installed on Leased Crown Land
Summary of proposed amendments
6.1. Income tax law is to be amended to extend depreciation deductions to taxpayers who are currently denied deductions for plant installed on Crown leases.
6.2. Under existing law, taxpayers who install property on Crown leases can be denied depreciation deductions where, owing to the degree of attachment of the plant to the land, the law treats the Crown as the owner, and not the taxpayer who actually incurred the expenditure on the plant. A precondition for depreciation deductions is that the taxpayer owns the property for which deductions are sought.
6.3. Taxpayers in those circumstances are now to be treated as owners of the property for depreciation purposes, so enabling them to obtain deductions.
6.4. The amendment applies from 27 February 1992. It applies to expenditure incurred on or after 27 February 1992 in installing property on Crown leases. It also applies to expenditure on property incurred before that date based on a notional written down value of the property on 27 February 1992.
Background to the legislation
6.5. Under income tax law, the cost of plant used in income-producing activities is a capital expense and therefore not a deductible outgoing. Depreciation is a means by which the capital cost of plant used in producing assessable income can be written off as tax deductions over a period of time. It recognises that plant will gradually wear out as it is used.
6.6. Taxpayers must own the property for which they seek depreciation deductions. This is because subsection 54(1) of the Income Tax Assessment Act gives depreciation only for property "owned" by the taxpayer.
6.7. Under existing law, taxpayers who incur capital expenditure in installing property on leased land can be denied depreciation deductions where, owing to the degree of attachment of the property to the land, the law treats the lessor as the owner, and not the taxpayer who actually incurred the expenditure.
6.8. Taxpayers in those circumstances are not always denied deductions.
6.9. For example, a lessee is entitled to claim depreciation deductions on the cost to the lessee of depreciable structural improvements and fixtures on land used in primary production because of special rights conferred under various state property laws. The lessee may have a statutory proprietary right, a right to remove property or a right to compensation from the lessor for the value of the property. Those rights are seen to confer sufficient rights to make the lessee the owner for depreciation purposes, even if not the owner in the fullest sense.
6.10. However, there are instances where holders of Crown leases cannot be viewed as the owners of depreciable property installed on the land because they have no real ownership rights. Under existing law, they would not obtain depreciation deductions.
6.11. Example of that are taxpayers who construct facilities such as power stations, roads or tollbridges on Crown land where there is no special right to compensation or removal (if that was possible) on the expiry of the lease. The intention in those cases is that the taxpayers have a fixed period during which they operate the facility; on the expiry of the lease, the property passes to the Crown for no consideration.
6.12. Because taxpayers in those situations do not have sufficient ownership rights, existing tax law denies them depreciation deductions in relation to any part of the facility which constitutes depreciable property.
6.13. The amendments apply to those sorts of situation; that is, where property is attached to Crown leases for which lessees are denied depreciation deductions under the existing law only by reason of its attachment to the land.
6.14. For convenience, a reference in the following notes to "leasehold depreciable property" will be a reference to such property.
Explanation of proposed amendments
6.15. The effect of the amendments is to treat holders of Crown leases as owners of property on the land so that the existing depreciation rules can generally apply. There are some necessary modifications. The following explains the amendments and how they will interact with existing depreciation provisions.
6.16. The amendments apply to holders of Crown leases. "Crown lease" is a term already defined in subsection 160K(1) of the Act and means either a lease of land granted by the Crown under a statutory law of the Commonwealth, a State or Territory or a similar lease granted under a statutory law of a foreign government. [New paragraph 54AA(1)(a) and subsection 54AA(8)]
6.17. Taxpayers who acquire or construct property and install it on Crown leases held by them will, if the existing law does not treat them as owners for depreciation purposes, generally be treated as the owners of that property for depreciation purposes, as will subsequent holders of the leases. [New subsection 54AA(1) and new paragraph 54AA(2)(a)]
6.18. That will then enable those lessees of Crown land to obtain depreciation deductions for the capital cost to them of leasehold depreciable property.
Lessees not owners of plant in certain situations
6.19. Taxpayers will be not treated as owners of property on Crown leases if they are involved in arrangements to obtain depreciation deductions instead of the person who is to obtain the real benefits of ownership of the property. [New subparagraphs 54AA(1)(d)(ii) and 54AA(1)(e)(iii)]
6.20. For instance, a finance company which acquired a Crown lease and installed depreciable property on the land under an arrangement where another taxpayer could acquire the lease at a later time would not be treated as the owner of that property for depreciation purposes. Such an arrangement is equivalent to a "hire purchase" agreement under which the other person effectively acquires ownership of the lease.
6.21. Similarly, a finance company would be not treated as the owner of property on a Crown lease owned by it if, in the ordinary course of business, it had granted an exclusive right to another person to use that property for the whole or a substantial portion of its effective life. The effect of such an arrangement is to pass the benefits of ownership of the property to the other person.
Cost of leasehold depreciable property
6.22. If the taxpayer installed the property on the land, the taxpayer's costs in acquiring or constructing that property will be the amount available for depreciation. (That follows under existing law and no amendment is required).
6.23. If the depreciable property was on the land at the time a taxpayer acquired a Crown lease from the earlier lessee, the taxpayer would be taken to have acquired the property for an amount equal to that portion of the purchase price of the lease that related to the property. [New paragraph 54AA(2)(b)]
Consequence of termination of leases
6.24. An expiry or surrender of a Crown lease, or termination of a Crown lease by the lessor, not followed by the grant of either a fresh lease or freehold title over the land to the lessee or an associate, will be treated as a disposal by the lessee to the lessor of any leasehold depreciable property.
6.25. The consideration for disposal will be the amount, if any, received by the lessee in respect of the expiry, termination or surrender of the Crown lease so far as that relates to leasehold depreciable property. [New paragraphs 54AA(2)(c) and (2)(e)]
6.26. The existing balancing adjustment rules governing disposals of depreciable property will then determine whether the lessee has derived an assessable recoupment of previously allowed deductions or incurred a deductible loss.
6.27. If the consideration for disposal exceeds the depreciated value of the property (broadly, cost less deductions allowed), the lessee will be assessable on the excess to the extent that it does not exceed the sum of depreciation deductions allowed.
6.28. Similarly, if the consideration for disposal is less than depreciated value, a deduction will be available for the difference.
Terminated lease followed by grant of fresh lease or freehold title
6.29. It would be inappropriate to treat an expiry, surrender or termination of a Crown lease as disposal of property on the land if followed by the grant of a fresh lease of the land to the lessee - the lessee would still have use of the property. Instead, the lessee will be taken to continue to own the property. That is achieved by specifying that the fresh lease is a continuation of the terminated lease. [New subsection 54AA(5)]
6.30. Similarly, if a termination, expiry or surrender of a lease is followed by the grant of freehold ownership of the land to the lessee, the lessee will be taken to continue to own the property. (That is considered to follow from having treated the lessee as the owner under the lease, and no further amendment is necessary).
Terminated lease followed by grant of fresh lease or freehold title to associate of lessee
6.31. If, in the above circumstances, a fresh lease or freehold title was granted to an "associate" of the lessee, the lessee would similarly be taken to have disposed of any depreciable leasehold property to the lessor.
6.32. However, that disposal will be taken to occur for consideration equal to what would have been the market value of the leasehold depreciable property immediately before the termination as if the lessee had held freehold title to the land. [New paragraphs 54AA(2)(d) and (2)(f)]
6.33. That is a measure to prevent abuses of the new arrangements. Otherwise, deductible balancing losses could arise in circumstances where there was no real change in ownership or use of property.
6.34. "Associate" has the same meaning as in existing section 26AAA [new subsection 54AA(8)] . That meaning is quite extensive and broadly applies to relatives and partners of a taxpayer or trusts or companies which a taxpayer controls.
6.35. The meaning of associate is extended to ensure that a reconstituted partnership is an associate of the former partnership [New subsection 54AA(7)] . It also ensures that authorities of the Commonwealth are treated as associates of the Commonwealth and of each other, as are authorities of a State or Territory. [New subsection 54AA(6)]
6.36. This ensures that there will not be balancing losses when, for instance, a statutory authority leasing Crown land on which plant is installed is replaced with another authority of the same government using the same Crown land and the same plant.
6.37. An assignment of a Crown lease will constitute a disposal of any leasehold depreciable property by the lessee to the assignee. The consideration is the part of the amount paid by the assignee for the lease that relates to that property. [New paragraph 54AA(2)(g)]
6.38. Under existing law, non-arm's length disposals of depreciable property are taken to occur at market value (paragraph 59(3)(d) or subsection 59(4)). In the case of non-arm's length disposals of Crown leases, market value of leasehold depreciable property will be assessed as if the lessee had a freehold interest in the land. [New paragraphs 54AA(3)(a) and (3)(b)]
Partial changes in ownership of property
6.39. A partial change in ownership of depreciable property, as can occur on the reconstitution of a partnership, is taken for depreciation purposes to constitute a disposal of the whole of the property by all of the persons who owned the property before the change to all of the persons who owned the property after the change. The consideration for disposal is deemed to be the market value of the property immediately before the partial change in ownership.
6.40. That rule will also apply on a partial change in ownership of leasehold depreciable property on Crown leases. The only modification is that the market value of the property immediately before the partial change in ownership will be worked out as if the owners had a freehold interest in the land. [New paragraph 54AA(3)(c)]
Destruction of depreciable property
6.41. Under the existing law, the destruction of depreciable property is treated as if there had been a disposal of that property for consideration equal to any amount of compensation received [subsections 59(1) and (2) and paragraph 59(3)(b)] . Assessable/deductible balancing adjustments may arise as described above at (paragraphs 6.26 to 6.28).
6.42. The same rules will apply on the destruction of depreciable property installed on Crown leases. That follows from having deemed lessees to be owners and therefore entitled to depreciation deductions, and no modification to the law is required.
6.43. As explained above (paragraph 6.41) , recoupments of deductions which accrue on the disposal of leasehold depreciable property are assessable. Recoupments arise if the consideration for disposal exceeds depreciated value.
6.44. Under existing law, taxpayers can obtain several forms of rollover relief in relation to disposals of depreciable property. Where relief is taken, assessable recoupments are offset or deferred. Those forms of relief are:
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- an option to set assessable recoupments successively against the depreciable cost of replacement property, other property acquired during the year and the depreciated values of property on hand at the beginning of the year (subsections 59(2A) and (2D)) ;
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- balancing adjustment rollover relief, which permits a deferral of balancing adjustments in a number of situations where there is no change the real ownership of property or there is there is only a partial change in ownership of property (section 58)
6.45. By the nature of these amendments, those forms of rollover relief will also be available for disposals of leasehold depreciable property in the same circumstances.
Consequential amendments to capital gains tax
6.46. A number of the changes made by these amendments to the treatment of leasehold depreciable property mean that the depreciation and capital gains tax provisions would not treat such property in a consistent manner.
6.47. For example, capital gains tax treats the termination of a lease as a disposal of the lease, including any leasehold depreciable property, irrespective of whether the lease is followed by the grant of a fresh lease or freehold title over the land.
6.48. That would be inappropriate now that the depreciation rules treat the lessee in those circumstances as continuing to the own any property on the leased land.
6.49. Accordingly, the capital gains tax provisions are to be amended so that they treat crown leases in a manner consistent with the new depreciation rules. It is expected that those amendments will be introduced during the Budget session of Parliament, and will apply from the same time as these depreciation amendments.
Commencement date
6.50. Commencing on 27 February 1992, holders of Crown leases are to be treated as owners of depreciable property installed on the land. [Subclause 38(2)]
Depreciable property installed after 26 February 1992
6.51. That means that holders of Crown leases who incur capital expenditure after 26 February 1992 in installing income-producing depreciable property on the land will be entitled to depreciation deductions. Similarly, taxpayers who acquire Crown leases from earlier holders after that date will be entitled to depreciate the cost to them of any leasehold depreciable property on the land.
Pre-27 February 1992 leasehold depreciable property
6.52. Taxpayers holding Crown leases on 27 February 1992 who were denied depreciation deductions for the cost of leasehold depreciable property because they were not the owners, will become entitled to depreciation deductions in respect of income-producing use of that property on or after that date. That follows from having treated Crown lessees to be owners of leasehold depreciable property, commencing 27 February 1992.
6.53. Deductions will be calculated under the diminishing value method unless an election is made under existing subsection 56(1AA) to adopt the prime cost method for all property, including leasehold depreciable property, first becoming depreciable in the same year.
6.54. If the prime cost method is adopted, deductions will be calculated by applying the appropriate rate of depreciation to the original cost of the property. However, deductions will not be available for so much of that cost that would have been allowable as depreciation deductions before 27 February 1992 if holders of Crown leases had always been treated as owners.
6.55. In calculating the amount of deductions notionally allowed before 27 February 1992, Crown lessees will use the relevant standard rate of depreciation applicable to their property increased by the former section 57AG loading of either 20 percent or 18 percent if that section would have applied.
6.56. Special rates of depreciation that may have otherwise applied (for example "5/3") are ignored. Also ignored is the effect of "broadbanding"; that is, taxpayers will not be required to increase standard depreciation rates to the next highest of the seven broadbanding rates that first applied for the 1991/92 income year for all property acquired before 27 February 1992. [Transitional paragraph 38(3)(e)]
6.57. However, broadbanding of depreciation rates will be available in calculating claims for deductions after 26 February 1992 if taxpayers so choose. (That follows from existing law).
6.58. If the diminishing value method applies to pre-27 February 1992 leasehold depreciable property, the cost for calculating future depreciation deductions will be equal to the notional depreciated value of the property immediately before 27 February 1992; that is, the original cost of the property less the deductions notionally allowable before 27 February.
The rules for calculating those notionally allowed deductions are the same as described above in relation to the prime cost method. [Transitional paragraph 38(3)(d) and transitional subclause 38(4)]
Clauses involved in proposed amendments
Clause 37: inserts new section 54AA.
Subsection 54AA(1): specifies the circumstances under which a lessee of Crown land is to be treated as the owner of property on the land.
Subsection 54AA(2): specifies what transactions will be treated as acquisitions and disposals of property on Crown leases for the purposes of the depreciation provisions, and the consideration taken into account for the purposes of those provisions.
Subsection 54AA(3): specifies the meaning of market value in relation to certain disposals of property on Crown leases.
The effect of subsection 54AA(4) : is to treat lessees of Crown land who are treated as owners of property for depreciation purposes as owners under section 51AD and Division 10D.
Those provisions apply to certain arrangements involving the use of property by tax exempt bodies and the like. One of their purposes is to deny depreciation deductions to owners of property used in proscribed transactions.
Subsection 54AA(4): ensures that the intended application of those provisions is not frustrated by reason that Crown lessees are not, at law, the real owners of property on the leased land.
Subsection 54AA(5): treats a renewal of a Crown lease as the continuation of the former lease.
Subsections 54AA(6) to (8): define a number of terms used in the amendments. One term defined in subsection (8) is "associate"; subsection (6) gives this an extended meaning in relation to government authorities, while subsection (7) gives it an extended application to certain partnerships.
Clause 38: contains the transitional rules.
Subsection 38(1): contains a number of definitions relevant to the transitional rules.
Subsection 38(2): specifies that taxpayers to whom these amendments apply are to be entitled to depreciation deductions for any income-producing use of their leasehold depreciable property that occurs after 26 February 1992.
Subsections 38(3) and (4): contain the rules for working out the amount of deductions to be available after 26 February 1992 in respect of property installed on Crown leases before 27 February 1992.