Capital Allowances: termination value - assigning depreciating assets to terminate a liability

Is the termination value of a depreciating asset assigned in satisfaction of liabilities arising from defaults under, and early termination of, a lease agreement ,the amount of those liabilities under section 40-305 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. Item 2 in the table in section 40-305 of the ITAA 1997 provides that the termination value of a depreciating asset, where all or part of a liability is terminated, is the amount of the liability or part when it is terminated.

The taxpayer entered into a three year lease of a commercial property. The lease agreement set a minimum amount of annual rent to be paid and contained provisions which required the lessee to pay interest on overdue rent, expenses incurred by the lessor in curing defaults and also damages in respect of repudiation or breach of covenant. Damages could include a charge for rent for the balance of the lease term, but the lessor was required to mitigate the amount of damages by obtaining a replacement lessee.

The taxpayer's business was unprofitable and the premises were vacated. At that time rent was in arrears and the unexpired term of the lease was two years.

The taxpayer and lessor formally agreed to a settlement whereby the lessor accepted a depreciating asset in complete satisfaction of any and all of the taxpayer's liabilities arising from any default, and the early termination of the lease agreement.

Section 40-300 of the ITAA 1997 provides that the termination value of a depreciating asset is worked out as at the time when a balancing adjustment event occurs. The termination value is, in certain circumstances, an amount specified in the table in subsection 40-300(2) of the ITAA 1997. Otherwise, the termination value is the amount taken to have been received under section 40-305 of the ITAA 1997.

As no item in the table in subsection 40-300(2) of the ITAA 1997 applies, the termination value is worked out under section 40-305 of the ITAA 1997. Item 2 in the table in section 40-305 of the ITAA 1997 provides that the termination value of a depreciating asset, where all or part of a liability is terminated, is the amount of the liability or part when it is terminated.

The taxpayer has assigned the legal title of a depreciating asset to the lessor in order to terminate all liabilities arising under the lease agreement. The termination value of the depreciating asset under item 2 in the table in section 40-305 of the ITAA 1997 is therefore the amount of those liabilities when terminated.

The amount of the lessee's liability under the lease is not specified in the settlement agreement. It cannot be easily quantified as the amount of any damages is unknown. However the value of the asset assigned by the taxpayer can be determined.

Goods and Services Tax Ruling (GSTR) 2001/6 expresses a view that where parties are dealing at arm's length, the goods, services or other things exchanged are of equal GST inclusive market value.

Consistent with that principle, we accept that, in the absence of other evidence, the market value of the depreciating asset the taxpayer assigned is a fair indicator of the amount of the liability terminated and may, in these circumstances, be used for the purposes of item 2 in the table in section 40-305 of the ITAA 1997.