Issue
Does the taxpayer have the right to immediately possess the depreciating assets, contained in a property if the taxpayer subleases the property to another entity, pursuant to item 6 of the table in section 40-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
Yes. The taxpayer has the right to immediately possess the depreciating assets, contained in a property that the taxpayer subleases to another entity, pursuant to item 6 of the table in section 40-40 of the ITAA 1997.
Facts
The taxpayer nominates a commercial property to be purchased by an unrelated entity (Entity A). Once purchase of the property is settled, Entity A enters into a five year lease with the taxpayer and the taxpayer immediately subleases the property. The sublease is on substantially the same terms as the head lease except the sublessee has no option to purchase the property. The taxpayer can assign their interest in the lease and the option to purchase the property to another party.
Reasons for Decision
Section 40-25 of the ITAA 1997 provides to a holder of a depreciating asset an annual deduction for the decline in value of the asset as worked out under Division 40 of the ITAA 1997.
The table in section 40-40 of the ITAA 1997 identifies a holder of a depreciating asset in any particular circumstance. The default rule is that the holder of a depreciating asset is the asset's owner (item 10 of the table in section 40-40).
However, there are items that identify a holder in various other circumstances even though they are not the asset's owner. One of these circumstances is contained in item 6 of the table in section 40-40 of the ITAA 1997 which specifies that where one entity otherwise holds a depreciating asset but: • a second entity possesses, or has an immediate right to possess, the asset • the second entity has a right, the exercise of which would make them the holder of the asset, and • it is reasonable to expect the second entity will become the holder of the asset by exercising their right or that the asset will be disposed of at the direction and for the benefit of the second entity
the second entity is the holder of the depreciating asset to the exclusion of the first entity.
As the taxpayer subleases the property immediately after entering into a lease with Entity A, the taxpayer does not have possession of the depreciating assets. Therefore, it is necessary to consider whether the taxpayer has the right to immediate possession of the depreciating assets.
What is meant by an immediate right to possess is explained by paragraph 1.33 of the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 which states: Where the economic holder does not have actual possession but only a right against the apparent holder to possession, that right must be immediate, unconditional and non-contingent. That is, there must not be any thing to be done before that economic owner has the right to gain actual possession of the asset. For example, a taxpayer may have a call option over a depreciating asset the taxpayer does not hold but until that option is exercised there is no immediate right to possession and the option-holder will not hold the asset.
A lease creates a contract under which the lessor grants to a lessee the right to possess a defined interest in the premises for a fixed term. It creates both rights and obligations, principally the lessor's right to receive rent and obligation to grant the lessee quiet enjoyment of the premises, and the lessee's right to possession of the premises and corresponding obligation to pay rent (per Thomas J. in Wattie and Anor v. Commissioner of Inland Revenue 18 NZTC 13 297 at 13 316).
A sublease is a transfer of less than the whole of the tenant's interest in the lease; for example, a transfer of the unexpired term of the lease less one month or less one day. The sublessor will retain a reversion in the lease; that is, the property will return to them at the end of the lease.
Accordingly, the lease agreement between the taxpayer and the Entity A gives the taxpayer an immediate, unconditional and non-contingent right to possess the assets as against the Entity A, namely the legal owner. Although the taxpayer subleases the property and the depreciating assets to a third party, the taxpayer transfers less than their whole interest in the lease and right to exclusive possession reverts to the taxpayer at the end of that sublease.
Therefore the taxpayer has the right to immediately possess the depreciating assets in the property, that it leases and has the option to purchase, pursuant to item 6 of the table in section 40-40 of the ITAA 1997.