Tracey Dunn, Associate Director – Tax Services at RSM Australia Pty Ltd, explores the changing landscape in vacant land deductions after 1 July 2019. She will delve further into this topic in her presentation at the upcoming Property Taxes: Post-Budget Insights on Thursday 26 November 2020.
The Treasury Laws Amendment (2019 Tax Integrity and Other Measures) Bill 2019 was passed in October 2019 and introduced amending legislation to limit deductions relating to vacant land.
The intent of the legislation was to prevent taxpayers from claiming tax deductions where there was no real intention to use the property to generate assessable income.
The legislation which took effect from 1 July 2019 and is found under s 26-102 Income Tax Assessment Act 1997 (ITAA 1997) acts to deny tax deductions relating to holding vacant land unless you satisfy one of the following exceptions:
- There is a substantial and permanent structure in use or available for use on the land; or
- The land or part of the land is used or is available for use, in carrying on a business; or
- The loss or outgoing in relation to holding the land was incurred by an excepted entity (e.g. a company); or
- One of the exceptions applies (e.g. primary producer, natural disaster, exceptional circumstances, use in carrying on a business).
It is important to note that residential properties are excluded from the definition of a ‘substantial and permanent structure’ unless, the residential premises are lawfully able to be occupied and are either leased or available for lease.
The vacant land provisions under s 26-102 ITAA 1997 have presented practical difficulties, particularly surrounding the interpretation of what constitutes a ‘substantial and permanent structure’ and the circumstances under which a taxpayer can access one of the exceptions.
Substantial and permanent structure
‘Substantial and permanent structure’ is not defined under s 26-102 ITAA 1997 and while some guidance is provided by the Australian Taxation Office (ATO), determining whether a structure has the necessary degree of permanency, size, value or purpose to satisfy the requirements is not an easy task and one that is open to interpretation.
The question of whether a substantial and permanent structure is incidental to the purpose of another structure or proposed structure on the land opens a pandora’s box of issues for taxpayers who use land for a mixed purpose.
Primary producers for example may hold multiple lots of land on different land titles, typically members of the family who are actively engaged in the farming business may live in a residence on one of the land titles. As an example, there may also be a large shed located on the property which is used both to store farm equipment and personal use vehicles. If the shed is located adjacent to the private residence, the question is raised, is the shed incidental and part of the private residence or is it a substantial and permanent structure for the purposes of the vacant land provisions?
Under the legislation, an entity that holds land available for use in a primary production (or other) business, will be denied a deduction for losses and outgoings incurred in holding the land (e.g. interest, land tax, shire rates, water rates) against assessable income earned relating to that property unless one of the following ‘special rules’ are satisfied:
- Section 26-102 (2) ‘special rule’ for affiliates, connected entities and children under the age of 18;
- The special rule for land held by primary producers;
- The special rule for land leased at arms-length.
For typical farming families, passing the criteria under the section 26-102 (2) ‘special rule’ will pose a significant challenge, particularly where the land is owned by parents (or an entity controlled by them), and leased to an adult child (or an entity controlled by them) as the terms affiliate and connected entity do not take on their ordinary and natural meaning. In the context of this legislation, typical structures used in farming families are unlikely to satisfy the affiliate or connected entity test.
Where the affiliate or connected entity rules are not satisfied, primary producers may need to enter into commercial lease agreements to lease land at market value from a related party. Determining market value in respect of the lease of farm land presents its own challenges, particularly where the parties to the lease agreement are related. Guidance is required from the ATO as to whether a market valuation of the proposed lease is required by a suitably qualified valuer, or whether an appraisal from a real estate agent would suffice.
In certain circumstances, the entry into commercial lease agreements in relation to land used in a primary production business may have an unintended consequence of impacting on primary production averaging provisions and farm management deposits.
Arm’s length lease – land used in carrying on a business
Another of the exceptions to the provisions under s 26-102 ITAA 1997 is where vacant land is leased under an arm’s length dealing and the land is used or is available for use in carrying on a business.
We note, this arm’s length dealing exception applies where the land is used or available for use where the lessee uses the land (or holds it available for use) in carrying on a business. This raises the question as to how the lessor determines whether the lessee is carrying on a business. The lessee may hold an ABN and be registered for GST, however the requirements for ABN and GST registration are tied to the concept of carrying on an enterprise, not carrying on a business. Whether a taxpayer is carrying on a business is a similar, but different concept to that of carrying on an enterprise.
This raises the question of what steps must a lessor take to determine whether the land they are leasing to an arm’s length party will be used or held ready for use in carrying on a business. Will it be sufficient that the lessee provides an ABN? What are the consequences if, in the event of an ATO review of the lessee’s taxation affairs, the lessee is found not to be carrying on a business?
The ‘carrying on a business’ exception applies where the land holder leases the land to a taxpayer who uses, or holds ready for use, the land in carrying on a business – it is not tied to assessable income. This means that there will be circumstances where a taxpayer will lease land to taxpayers who are not carrying on a business, will be assessed on the income derived under the lease agreement but will be denied a deduction for any losses or outgoings incurred in holding the land, merely because the lessee is not carrying on a business.
The ATO have commenced consultation into the application and interpretation of the vacant land provisions under s 26-102 ITAA 1997. We are hopeful the consultation planned for November 2020 will highlight some of the practical issues identified in the application of the legislation and result in either clear guidance being provided by the ATO or further legislative change by Treasury.
Tracey Dunn is an Associate Director in the Tax Services division of RSM in Perth.
Tracey has worked in senior roles in public practice for over sixteen years. Prior to commencing a career in public practice, Tracey worked in commerce in various roles including banking, logistics management, and international trade.
Tracey has experience in assisting clients with ATO high wealth reviews, ATO audits, the preparation of private binding ruling applications, and objections to notices of assessments.
Tracey’s expertise lies in providing simple and complex tax advice to high net worth individuals, small and medium-sized businesses with multiple structures and corporate entities. She has significant experience in advising on the application of fringe benefits tax, Division 7A, and trusts. Tracey regularly presents on taxation topics.
Tracey has provided litigation support in a number of family tax law matters involving high wealth individuals and groups. She is a regular presenter to legal firms that specialise in family law. She has also presented at the Family Law Practitioners Association (WA) Conference in 2017. Tracey writes extensively on the interpretation of tax legislation for businesses and has been published in the Ex Curia magazine.