Capital Works: using your area in a deductible way

Does the taxpayer use their area in a deductible way set out in the table in section 43-140 of the Income Tax Assessment Act 1997 (ITAA 1997) if capital works owned by the taxpayer are leased to a related company and the only amount received for an initial period is an amount for outgoings of the leased property?

Yes. The taxpayer does use their area in a deductible way set out in the table in section 43-140 of the ITAA 1997 if the only amount received during an initial period is for outgoings of the leased property.

The taxpayer and their spouse constructed an industrial building in 2001 and leased it to a related company. They are the sole directors and shareholders of the company. The company began its business operations in the same year.

The company has only been required to pay amounts for outgoings such as rates, insurance and land tax for the building and property during an initial period of 18 months. As the company has had inadequate cash flow and has traded at a loss, it has not been required to pay an additional amount for rent.

The sales revenue of the company has increased significantly since the company's inception. The company will be able to pay rent from the next year.

The building is a capital work to which Division 43 of the ITAA 1997 applies. The expenditure incurred by the taxpayer to construct the building is construction expenditure as defined in section 43-70 of the ITAA 1997.

The capital works have a construction expenditure area and there is a pool of construction expenditure for that area as required under section 43-10 of the ITAA 1997.

Section 43-10 of the ITAA 1997 provides that an amount may be deducted for capital works for an income year if: • there is a construction expenditure area • a pool of construction expenditure for that area, and • you use your area in the way set out in Table 43-140 of the ITAA 1997.

Table 43-140 (Current year use) in section 43-140 (Using your area in a deductible way) of the ITAA 1997 sets out the various ways that an area must be used for that income year. Capital works begun after 30 June 1997 must be used, among other things, for the purpose of producing assessable income.

Something is done for the purpose of producing assessable income if it is done for the purpose of gaining or producing assessable income; or in carrying on a business for the purpose of gaining or producing assessable income (section 995-1 of the ITAA 1997).

Generally, a mere lease of property does not constitute carrying on a business.

'Purpose of producing assessable income' has been considered in relation to the use of plant and depreciating assets in Pettigrew v. FC of T 90 ATC 4124; (1990) 20 ATR 1833 ( Pettigrew ) and Reef Networks Pty Ltd v. DFC of T 2004 ATC 4001; (2003) 54 ATR 509 ( Reef ). Those cases recognised that considering whether plant or a depreciating asset was used for the 'purpose of' was different to considering whether a loss or outgoing is 'incurred in gaining or producing' assessable income under either subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) or section 8-1 of the ITAA 1997.

In particular, Justice Hill in Pettigrew noted that in contrast with subsection 51(1) of the ITAA 1936 the purpose of which section 54 of the ITAA 1936, which incorporates 'purpose of producing assessable income' as a test, speaks is the purpose of the use to which the plant is put in the year of income. It is not concerned with motive, however subjective purpose may not be irrelevant. Hely J in Reef stated that the determination of the purpose for which the asset under consideration in that case was used was a matter of objective characterisation. These statements are also relevant in the application of section 43-140 of the ITAA 1997.

Although the requirements of subsection 51(1) of the ITAA 1936 and section 8-1 of the ITAA 1997 differ from that of section 43-140 of the ITAA 1997, the principles developed in the application of those sections may provide assistance in the application of that section. It has been well established that the assessable income referred to in section 8-1 and its predecessors is not required to be the assessable income of the year of income but it may be the assessable income of a past or future year ( Spassked Pty Ltd v. FC of T 2003 ATC 4184; (2003) 52 ATR 337). The assessable income referred to in section 43-140 may also be that of future years.

The purpose referred to in section 43-140 of the ITAA 1997 is an objective characterisation and will normally be apparent from the use to which the capital works are put. If that use is in a regular income producing activity then it will satisfy the condition. However, where lengthy periods of time pass before the production of assessable income from the use in question the possibility of other uses arises. This is consistent with the statement in FC of T v. Brand 95 ATC 4633; (1995) 31 ATR 326 that: ... The temporal hiatus may suggest that the outgoing was incurred for some purpose other than the gaining or producing of assessable income.

In this case the use of the building by the taxpayer is to lease it to the company to use as a base of operations. The taxpayer is receiving less than a commercial rent because of initial cash flow difficulties of the company. This has enabled the taxpayer to receive a commercial rent within the next year. The current use of the building is producing some assessable income now and contributing to the production of assessable income in a future period.

Taking all the circumstances together, including the period for which an amount that is lower than a commercial rent has been received, it is considered that the building is being used for the purpose of producing assessable income and not for any other purpose. If the period for which the non-commercial amount was received became significant, it could suggest that it was being used for some other purpose.