Capital gains and losses: exemptions - expiry of a lease - non-assessable non-exempt income

Is a capital loss made by the lessee from the expiry, surrender, forfeiture or assignment of a lease disregarded under section 118-40 of the Income Tax Assessment Act 1997 (ITAA 1997) if the lessee used the lease to produce non-assessable non-exempt income?

Yes. A capital loss made by the lessee from the expiry, surrender, forfeiture or assignment of a lease is disregarded under section 118-40 of the ITAA 1997 if the lessee used the lease to produce non-assessable non-exempt income.

An Australian resident company (the lessee) enters into a 20 year lease for property located overseas.

The lessee uses the lease to derive non-assessable non-exempt income pursuant to section 23AH of the Income Tax Assessment Act 1936 (ITAA 1936).

Five years into the term of the lease the lessee requests that the lease be terminated.

The lessor agrees to the termination of the lease if the lessee pays a lease surrender payment.

The lessee makes the payment and the lease is terminated.

Under section 118-40 of the ITAA 1997, if a lessee makes a capital loss from the expiry, surrender, forfeiture or assignment of a lease that was granted for less than 99 years, the capital loss is disregarded if the lessee did not use the lease solely or mainly for the purpose of producing assessable income.

The term 'purpose of producing assessable income' is a defined term for income tax purposes under section 995-1 of the ITAA 1997. This section states that: something is done for the purpose of producing assessable income if it is done: (a) for the purpose of gaining or producing assessable income; or (b) in carrying on a business for the purpose of gaining or producing assessable income.

Section 6-23 of the ITAA 1997 states that an amount of ordinary income or statutory income is 'non-assessable non-exempt income' if a provision of the ITAA 1997 or another Commonwealth law states that it is not assessable income and is not exempt income.

Subsection 6-1(5) of the ITAA 1997 states that an amount of ordinary income or statutory income can have only one status (that is, assessable income, exempt income or non-assessable non-exempt income) in the hands of a particular entity.

Accordingly, if a lease is used to produce 'non-assessable non-exempt income', it is not used for the purpose of producing assessable income and any capital loss made by the lessee from the expiry, surrender, forfeiture or assignment of the lease is disregarded under section 118-40 of the ITAA 1997.