Capital Works: your area - assignee of that lessee's lease

Is the taxpayer who enters into the novation of a lease 'an assignee' of the earlier lessee's lease for the purposes of paragraph 43-120(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The taxpayer who enters into the novation of a lease is not 'an assignee' of the earlier lessee's lease for the purposes of paragraph 43-120(2)(b) of the ITAA 1997 because the novated lease is a new lease, not the assignment of an existing lease.

The taxpayer entered into a deed of novation for a lease of property which included capital works. The earlier lessee incurred the construction expenditure on the capital works and was entitled to deduct that expenditure under Division 43 of the ITAA 1997. The earlier lessee continuously leased the property since construction of the capital works was completed until the date the lease was novated. At the time of the novation there was an amount of undeducted construction expenditure in relation to the capital works.

All legislative references are to the ITAA 1997 unless otherwise stated.

Broadly, Division 43 allows you to deduct an amount for construction expenditure on certain income producing capital works for an income year. A deduction is dependent, among other things, on whether you have a construction expenditure area that is 'your area' for the capital works.

'Your area' has the meaning given in sections 43-115 and 43-120. Section 43-115 applies if you own the construction expenditure area. If you lease the area, section 43-120 applies. Subsection 43-120(2) applies where you lease all or part of the construction expenditure area but the construction expenditure was incurred by an earlier lessee. That subsection requires the part of the construction expenditure area you lease to be continuously leased since the construction was completed by the lessee who incurred the expenditure or an assignee of that lessee's lease.

'Assignee' is not defined in the ITAA 1997.

The Explanatory Memorandum to the Income Tax Assessment Bill 1996 that inserted section 43-120 in the ITAA 1997 offers the following limited guidance: Your area - lessees and holders of quasi-ownership rights If you lease (or hold quasi-ownership rights) your area is: • the part of the area you lease (or hold) on which you have incurred construction expenditure ; or • the area you acquired by assignment from the lessee or holder who incurred the expenditure (or one of their successors). However, the area must have been leased or held continuously since the construction was completed. You would have continuously leased an area even if your original lease had expired provided you have renewed the lease in a timely manner, for example under an option in the lease or by negotiation with the building owner.

The explanatory memorandum does not expand further on the meaning of the word 'assignee'.

Subsection 43-120(2) is the Tax Law Improvement rewrite of the former subsections 124ZA(8) and 124ZF(8) of the Income Tax Assessment Act 1936 (ITAA 1936). Although the former provisions used the word 'assignment' instead of 'assignee', in accordance with the rule in section 1-3, the different form of the words is not taken to have a different meaning. Reference to the former provisions and the associated explanatory memoranda, provides no additional guidance about the meaning of 'assignee'.

The word 'assignee' is a legal technical word and in the absence of a contrary intention it should be interpreted accordingly. This approach is confirmed by O'Connor J in Attorney-General (New South Wales) v. Brewery Employees Union of New South Wales (1908) 6 CLR 469 at 531: Where words have been used which have acquired a legal meaning it will be taken, prima facie, that the legislature has intended to use them with that meaning unless a contrary intention clearly appears from the context. To use the words of Denman J in R v. Slator (1881) 8 QBD 267 at 272: 'but it always requires the strong compulsion of other words in an Act to induce the Court to alter the ordinary meaning of a well known legal term'.

LexisNexis Butterworths, Halsbury's Laws of Australia , Volume 16 (at 11 November 2011) explains an assignment at paragraph 245-1530: An assignment is the transfer by agreement of the interest held by one person (the assignor) to another person (the assignee) and includes another party taking over the residue of the term of a lease, or where possession is given up for the remainder of the term...An assignment does not constitute the creation of a new lease.

Paragraphs 245-1550 and 245-1555 note the consequences to the lessor and the lessee (the assignor) upon assignment do not alter the contract between the lessor and the assignor.

An assignment can be distinguished from a novation. The essential feature distinguishing novation from assignment, as observed by the High Court in Olsson v. Dyson (1969) 120 CLR 365, is that in the case of novation the parties to the contract mutually agree to discharge that contract and a new contract is formed in substitution for the old contract.

In this case the taxpayer entered into a deed of novation. This means that the earlier lessee's lease was terminated.

The Commissioner considers that the expression 'assignee of that lessee's lease' means the entity to whom the rights under the existing lease are transferred. Where the earlier lessee's lease is terminated the new lessee is not an assignee of that lessee's lease. An entity that holds a lease as the result of the novation of a lease (which necessarily requires the termination of the earlier lessee's lease) is therefore not an assignee of that earlier lessee's lease.

This interpretation accords with the intended operation of Division 43. A lessee's right to deduct construction expenditure is dependent on the area being continuously leased since construction was completed. If an existing lease is assigned, the right to the deduction passes on to the assignee. However, if that lease terminates, the right to the deduction vests in the owner of the capital works (subsection 43-125(2)).

The Commissioner's preferred interpretation is also supported by the following extract from Second Reading Speech to the Income Tax Assessment Amendment Bill (No. 2) 1980 which introduced the former section 124ZA of the ITAA 1936: Where a person constructs a building on leasehold land, or otherwise incurs building costs as a lessee, that person will, subject to other requirements being met, qualify for the allowance while remaining the lessee. If the lease is assigned, entitlement to the deduction will pass to the assignee. If the lease terminates, any residual entitlement will pass to the owner to whom the building reverts.

In this case, the taxpayer entered into a deed of novation for a lease of property which included capital works. The novation resulted in the termination of the former lease between the lessor and the earlier lessee and the creation of a new lease. The novation is not an assignment of the earlier lessee's lease. Therefore, the taxpayer is not 'an assignee' of the earlier lessee's lease.