1 Is the Trust eligible for a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the loan interest payments and holding costs (such as council rates) for the Property during the renovation when the Property was not operational?
1 Yes. Question 2 Will section 26-102 of the of the ITAA 1997 apply to deny the deductions referred to in question 1? Answer 2 No. This ruling applies for the following period : Income year ending 30 June 20XX The scheme commenced on: 1 July 20XX
1. The Trust is a property trust that owns and manages property assets. 2. For asset protection purposes, the day to day operation of the property assets is owned and operated by separate companies which form part of their corporate group. 3. The Trust has an active involvement in the property assets. 4. The Trust charges rent to the entities operating the property assets for use of the properties/businesses and also management fees for the services it provides to the businesses. 5. The Trust is in the business of property leasing and management. 6. The Trust undertook a major renovation project on one of the property assets (the Property). The existing building was partially demolished and a new structure was built. 7. The Property was actively trading from the time it was acquired to the date the renovation started. 8. During the renovation the Property was not operational. It was intended that the Property would be rented and operated following the renovation. 9. The Property commenced again as soon as the renovation was completed.
10. There is a loan associated with the Property. The loan was initially used to fund the acquisition of the Property. It was also used to fund the renovation of the Property.
Income Tax Assessment Act 1997 section 8-1 Income Tax Assessment Act 1997 section 26-102
Question 1 Detailed reasoning Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income, or is necessarily incurred in carrying on a business for that purpose. Generally, an expense incurred for income producing purposes is deductible under section 8-1 of the ITAA 1997 to the extent that it is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances. Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. The character of interest on a loan is generally ascertained by reference to the purpose of the loan ( Fletcher & Ors v. Federal Commissioner of Taxation
(1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 (Fletcher's Case)) and the use to which the loan is put ( Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153 (Munro's Case)). Taxation Ruling TR 2004/4 Income Tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities provides that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances: • the interest is not incurred 'too soon', is not preliminary to the income earning activities, and is not a prelude to those activities; • the interest is not private or domestic; • the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost; • the interest is incurred with one end in view, the gaining or producing of assessable income; and
• continuing efforts are undertaken in pursuit of that end (paragraph 9). The Trust is part of a corporate group. The Trust owns property assets and carries on a business of property leasing and management. The Trust acquired the Property using a loan to fund the purchase. From the time of purchase, the Trust leased the Property to a separate company within the corporate group who operated the Property. The Trust undertook a major renovation on the Property which involved part of the existing building being demolished and rebuilt. The renovation was funded using a loan. The Property was not operational during the renovation, but it was intended that the Property would be leased and operated following the renovation, and the Property recommenced following the completion of the renovation. The holding expenses (such as council rates) in relation to the Property were necessarily incurred as part of the business of the Trust (property leasing and management) and are deductable under section 8-1 of the ITAA 1997.
The loan was originally used to acquire the Property which the Trust used to derive business income. The loan was also used to fund the renovation. During the renovation the Property ceased operations, but it was intended that the Property would be used to derive business income for the Trust after the renovation was completed. Following the renovation the Property recommenced and derives business income for the Trust. The Property was used to derive business income for the Trust from the time it was acquired. Although the Property did not operate during the renovation, there is a connection between the interest expense and the business activities of the Trust during the renovation. The interest paid under the loan is deductible under section 8-1 of the ITAA 1997. Conclusion The loan interest payments and other holding expenses (such as council rates) of the Trust in relation to the Property during the renovation are deductible under section 8-1 of the ITAA 1997. Question 2 Detailed reasoning Relevantly, section 26-102 of the ITAA 1997 states: 1. If:
(a) at a particular time, you incur a loss or outgoing relating to holding land (including interest or any other ongoing costs of borrowing to acquire the land); and (b) at the earlier of the following (the critical time ): (i) that time; (ii) if you have ceased to hold the land - the time just before you ceased to hold the land; there is no substantial and permanent structure in use or available for use on the land having a purpose that is independent of, and not incidental to, the purpose of any other structure or proposed structure; you can only deduct under this Act the loss or outgoing to the extent that the land is in use, or available for use, in carrying on a business covered by subsection (2) at the time applying under subsection (3). 2. A business is covered by this subsection if the business is carried on for the purpose of gaining or producing the assessable income of one or more of the following entities: (a) you; (b) your affiliate; (c) if you are an individual - your spouse or any of your children who is under 18 years of age; (d) an entity connected with you.
3. The time applying under this subsection is the critical time... Taxation Ruling TR 2023/3 Income tax: expenses associated with holding vacant land explains the Commissioner's view of the application of section 26-102 of the ITAA 1997, and states the following on when land is in use or available for use in carrying on a business: 35. Subsection 26-102(1) does not limit deductions for holding costs of vacant land to the extent that the land is in use, or available for use, in carrying on a business for the purpose of gaining assessable income of you, your affiliate, an entity of which you are an affiliate, your spouse, your child under the age of 18 or an entity connected with you... 37. whether the activities on the land amount to carrying on a business is a question of fact determined by reference to the indicia of carrying on a business as set out in the case law...
39. Property developers will generally not be affected by subsection 26-102(1) provided they are carrying on a business satisfying the requirements outlined in paragraph 37 of this Ruling. There is no requirement for the land to be in active use in the business. Land held by a developer for future development would be considered 'available for use'. The Trust is carrying on a business of property leasing and management. Prior to the renovation the Property was used in the business of the Trust, but the Property was not operational during the renovation (it was partially demolished). Although the Property was not in active use during the renovation, the Property was held by the Trust and available for use in the business of the Trust (it was intended that the Property would be rented and used after the renovation, and the Property recommenced following the renovation). As the Property was available for use in the business of the Trust, section 26-102 of the ITAA 1997 will not apply to limit the deductions of the Trust in relation to the holding costs (such as council rates) and loan interest payments for the Property during the renovation.