ATO ID 2007/170: Investment Product: reasonable to expect - holder of depreciating assets
Date of decision: 14 August 2007
Year of income: Year ended 30 June 2007 Year ended 30 June 2008 Year ended 30 June 2009
Business line: Public Groups and International

Issue
In the circumstances described in the facts below is it 'reasonable to expect' that the taxpayer will become the holder of depreciating assets under item 6 of the table in section 40-40 of the Income Tax Assessment Act 1997 (ITAA 1997) by exercising their right as against the legal owner or that the assets will be disposed of at their direction and for their benefit?

Decision
Yes. It is 'reasonable to expect' that the taxpayer will become the holder of the depreciating assets by exercising its right as against the legal owner or that the depreciating assets will be disposed of at their direction and for their benefit in accordance with 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). Entity A obtains the finance to purchase the property by borrowing a percentage of the purchase price from a funding trustee and by using funds raised through the issue of debentures to the taxpayer. Once the purchase of the property is settled, Entity A enters into a five year lease with the taxpayer. 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 rent from subleasing the property is used firstly to meet outgoings in relation to the property and secondly to meet the interest on the principal outstanding on Entity A's loan. The balance is then applied to repay the principal on Entity A's loan. At the end of the five year lease period the taxpayer may renew the lease for another five years (subject to there being only 3 additional renewal periods); exercise their option to purchase the property; find a buyer to purchase the property and direct Entity A to sell the property to that buyer; or they may arrange for Entity A to sell the property on their behalf. The taxpayer can assign, to another party, their interest in the lease and the option to purchase the property. If the taxpayer exercises the option to purchase the property the taxpayer pays the initial purchase price paid by Entity A plus transaction costs. The taxpayer cannot borrow funds in order to purchase the property. The return the taxpayer receives on the debentures depends entirely on the net sale proceeds and the rental performance of the property as amounts are only paid on the debentures after Entity A's secured loan in relation to the property has been repaid. The property contains assets which are depreciating assets subject to Division 40 of the ITAA 1997.

Reasons for decision
Summary: In broad terms, the holder of a depreciating asset is its economic owner. There may be several economic owners of a depreciating asset. The economic owners are the entities that are able to access the asset's economic benefits while stopping other entities from doing the same. Under item 6 of the table in section 40-40 of the ITAA 1997, the economic owner of a depreciating asset is an entity other than its apparent holder (for example, the legal owner) where the other entity possesses, or has a right against the apparent holder to possess, the asset immediately and has a right to become the holder of the asset and it is reasonable to expect that the right will be exercised, or that the asset will be disposed of at the direction and for the benefit of the economic owner. The taxpayer satisfies the requirement of it being reasonable to expect that they will become the holder of the existing assets by exercising their right for reasons directly associated with the taxpayer's specific obligations under the lease and economic considerations relating to the arrangement. This is because the taxpayer must, at the end of the last lease period, either: Further, under the terms of the arrangement: An objective analysis of the economic factors related to the arrangement indicate that: As the taxpayer has an immediate right to possess the depreciating assets, has the option to purchase the property and the depreciating assets and it is reasonable to expect that the taxpayer will become the holder of the depreciating assets or that the depreciating assets will be disposed of at the direction and for the benefit of the taxpayer, the taxpayer is regarded as the holder of the depreciating assets under item 6 of the table in section 40-40 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 40-25 section 40-40
Related ATO interpretative decisions: ATO ID 2007/171
Subject references: Decline in value Deduction for depreciating assets Economic owner Hold a depreciating asset Legal owner