Capital allowances: granting a right of use - other than a taxable purpose

Did the taxpayer use their depreciating asset for a 'taxable purpose', within the meaning of that phrase in paragraph 40-25(7)(a) of the Income Tax Assessment Act 1997 (ITAA 1997), by reason only that they made a capital gain from granting another entity a right to use the asset?

No. The taxpayer did not use their depreciating asset for a taxable purpose, within the meaning of that phrase in paragraph 40-25(7)(a) of the ITAA 1997, because the making of a statutory capital gain is too remote to constitute something done for the purpose of gaining or producing assessable income or in carrying on a business for that purpose.

The taxpayer is the only holder of a depreciating asset. The taxpayer does not use the asset, directly or indirectly, for the purpose of gaining or producing ordinary income or in carrying on a business for that purpose and the taxpayer does not hold the asset for either purpose.

The taxpayer granted to an unrelated entity, on an arms length basis, a right to use the asset. The consideration received for the grant is not ordinary income of the taxpayer.

CGT event D1 (see section 104-35 of the ITAA 1997) happened as a result of the taxpayer granting the right to the other entity. The capital gain the taxpayer made from this CGT event was taken into account in working out the net capital gain that was included in the taxpayer's assessable income for the income year in which the right was granted.

(All legislative references are to the ITAA 1997)

Subsection 40-25(1) 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. A depreciating asset declines in value with its use (or installation ready for use) for any purpose.

Subsection 40-25(2) provides a reduction in the annual deduction by the part of the asset's decline in value that is attributable to the holder's use of the asset during the income year for a purpose other than a taxable purpose.

It is accepted that the granting of a right to use the depreciating asset to the other entity for valuable consideration represents a use, albeit an indirect use, of the asset by the taxpayer. The issue in the present case is whether this use by the taxpayer constitutes a use for a taxable purpose when that use results only in the taxpayer making a statutory capital gain.

For present purposes, a 'taxable purpose' is defined in paragraph 40-25(7)(a) as the purpose of producing assessable income.

Pursuant to subsection 995-1 (1), 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.

As stated in the facts, the taxpayer does not use (or hold) the depreciating asset, directly or indirectly, for the purpose of gaining or producing ordinary income or in carrying on a business for that purpose. The taxpayer's indirect use of the asset by granting a right of use to another entity results only in the taxpayer making a statutory capital gain. The making of a capital gain is the result of a statutory process and is independent of any purpose the taxpayer may have had of gain from granting the right. While it so happens in this case that the taxpayer's capital gain was taken into account in calculating a net capital gain that was included in their assessable income for the relevant income year (see section 102-5), this will depend entirely on the particular taxpayer's taxation circumstances in the relevant income year.

In a CGT context, the capital gain does not arise from the asset but from the grant of the right to use the asset. The fact that no part of the cost base of an asset is taken into account in working out the amount of a capital gain or capital loss when a right is granted or created in relation to an underlying asset is based on the principle that no part of the underlying asset is used to generate the capital gain.

It follows that the taxpayer did not use their depreciating asset for a taxable purpose within the meaning of that phrase in paragraph 40-25(7)(a) because the making of a statutory capital gain is too remote to constitute something done for the purpose of gaining or producing assessable income or in carrying on a business for that purpose.