ATO ID 2009/36: Capital Allowances: business related costs - limitation of deduction - in relation to a lease or other legal or equitable right
Date of decision: 24 April 2009
Year of income: Year ended 30 June 2006 Year ended 30 June 2007 Year ended 30 June 2008 Year ended 30 June 2009 Year ended 30 June 2010
Business line: Public Groups and International

Issue
Is the taxpayer's capital expenditure on landscaping land, that it leases from one party and subleases to other parties, incurred in relation to a lease or other legal or equitable right for the purpose of paragraph 40-880(5)(d) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. The taxpayer's capital expenditure on landscaping land, that it leases from one party and subleases to other parties, is not incurred in relation to a lease or other legal or equitable right for the purpose of paragraph 40-880(5)(d) of the ITAA 1997 because there is not a sufficient and relevant connection between the taxpayer's expenditure and any of the leases.

Facts
The taxpayer carries on businesses on land they lease (head lease) from the land owner. The taxpayer does not have any right or option to purchase the land during the course of or at the end of the lease. The land is not treated as a capital gains tax (CGT) asset of the taxpayer. One of those businesses, not the taxpayer's core business, is a business of sub-leasing premises to third parties (sub-leases). The taxpayer constructed on the land that they lease a new building from which they carry on their core business. The construction included landscaping works annexed to the land on the new building site. The capital expenditure incurred by the taxpayer on landscaping works includes the cost of purchasing and planting trees and shrubs and the cost of purchasing and laying turf and mulch. The new building is not sited within the proximity of any of the premises sub-leased by the taxpayer. The expenditure on landscaping works does not have any impact on the market value of the sub-leases. The sub-leased premises have no connection with the taxpayer's core business of which the new building is part other than being sited on the land covered by the head lease. In respect of the head lease, the expenditure incurred on the landscaping works in insignificant when compared with the original outlay for the head lease. Also, the land area of the landscaping works is insignificant when compared with the total area covered by the head lease. The expenditure incurred on the landscaping works does not have any impact on the market value of the head lease The taxpayer's capital expenditure was incurred 'in relation to your business' for the purpose of paragraph 40-880(2)(a) of the ITAA 1997 and the taxpayer's deduction for that expenditure under section 40-880 of the ITAA 1997 is not limited under subsection 40-880(3) of the ITAA 1997. The expenditure was incurred on or after 1 July 2005.

Reasons for decision
Summary: Section 40-880 of the ITAA 1997 provides a deduction over five income years for certain business related capital expenditure. Paragraph 40-880(5)(d) of the ITAA 1997 provides that you cannot deduct anything under section 40-880 of the ITAA 1997 for an amount of expenditure you incur to the extent that it is in relation to a lease or other legal or equitable right. In respect of paragraph 40-880(5)(d) of the ITAA 1997, paragraph 2.68 of the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 1) Bill 2006 (the EM) states: This exclusion replicates that found in the repealed section 40-880, having been added in 2002 in the context of the Government's review of the treatment of expenditure incurred on leases or other legal or equitable rights. The 2005-06 Budget announced that the Government would take a case-by-case approach in relation to the taxation of rights. Since that paragraph states that the exclusion contained in paragraph 40-880(5)(d) of the ITAA 1997 replicates that found in the repealed section 40-880 of the ITAA 1997, it is relevant to consider the repealed paragraph 40-880(3)(d) of the ITAA 1997. In discussing that exclusion, paragraph 3.67 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 2002 stated: The Government is reviewing the treatment of expenditure incurred in relation to leases or other legal or equitable rights as part of the consideration of the recommendations of the Review of Business Taxation. The appropriate income tax treatment of capital expenditure incurred in relation to these leases and rights will be determined as part of that review. Consequently, capital expenditure on leases or other legal or equitable rights will be excluded from deduction under section 40-880. For example, expenditure representing lease surrender payments incurred in closing down your business will not be deductible under section 40-880. It is therefore relevant to consider what 'leases and rights' were considered in the recommendations of the Review of Business Taxation in order to determine the intended scope of the phrase 'in relation to a lease or other legal or equitable right' in paragraph 40-880(5)(d) of the ITAA 1997 and former paragraph 40-880(3)(d) of the ITAA 1997. Section 10 of the Review of Business Taxation, A Tax System Redesigned, Report, July 1999, made recommendations in relation to the taxation of leases and rights. While that report did not explain what was encompassed by the expression 'leases and rights', it can reasonably be inferred that it was referring to the sorts of 'leases and rights' outlined in the Review of Business Taxation, A Platform for Consultation, Discussion Paper 2 Volume 1, February 1999, which included 'leases and similar contracts which provide rights over physical assets'. On the facts, the sub-leases and the head lease are of the type considered by the Review of Business Taxation (in the context of its review of the taxation of leases and rights) to be leases that would be covered by paragraph 40-880(5)(d) of the ITAA 1997. However, for paragraph 40-880(5)(d) of the ITAA 1997 to apply in this case, the capital expenditure incurred by the taxpayer on landscaping works must be 'in relation to' to the sub-leases or the head lease. The phrase 'in relation to' was considered by the High Court in PMT Partners Pty Ltd (In Liquidation) v. Australian National Parks & Wildlife Service (1995) 184 CLR 301. Brennan CJ, Gaudron and McHugh JJ observed, in considering the application of the Commercial Arbitration Act 1985 (NT), at 313: Inevitably, the closeness of the relation required by the expression 'in or in relation to' in s 48 of the Act, indeed, in any instrument - must be ascertained by reference to the nature and purpose of the provision in question and the context in which it appears. In that case, Toohey and Gummow JJ also observed: It is apparent that the words 'in or in relation to' are particularly wide. ... Cases concerning the interpretation of this phrase in other statutory contexts are of limited assistance. However, the cases do show that the words are prima facie broad and designed to catch things which have sufficient nexus to the subject. The question of sufficiency of nexus is, of course, dependent on the statutory context. (at 330) ... The connection which is required by the phrase 'in relation to' is a question of degree. There must be some 'association' which is 'relevant' or 'appropriate'. The question of the relevance or appropriateness of the connection is a question which cannot be divorced from the particular statutory context. (at 331) In First Provincial Building Society Limited v. Federal Commissioner of Taxation (1995) 56 FCR 320; 95 ATC 4145; (1995) 30 ATR 207, Hill J considered the phrase 'in relation to' within the context of paragraph 26(g) of the Income Tax Assessment Act 1936. He considered the words 'in relation to' in that context included a relationship that may either be direct or indirect, provided that the relationship consisted of a real connection, but that a merely remote relationship is insufficient. Thus, whether capital expenditure is incurred to any extent 'in relation to' a lease or other legal or equitable right will depend on whether there is a sufficient and relevant connection between the incurrence of the expenditure and in this case, the sub-leases or the head lease. On the facts of this case, the sub-leases do not form part of the core business being carried on by the taxpayer. Instead, the sub-leases relate to another separately identifiable business that the taxpayer carries on. The expenditure incurred by the taxpayer on landscaping works is in relation to the new building, which forms part of the taxpayer's core business. The expenditure on landscaping works was not incurred for the purpose or expected effect of increasing or preserving the value of the rights in relation to the sub-leases. In addition, the sub-leased properties are not within proximity of the new building site. In these circumstances, there is not a sufficient and relevant connection between the capital expenditure incurred by the taxpayer on the landscaping works and the sub-leases. Although the head lease relates to the entire land leased by the taxpayer and includes the land on which the new building is situated, the expenditure incurred by the taxpayer on landscaping works is insignificant when compared with the original outlay for the head lease and the land area of those works is insignificant when compared with the total area covered by the head lease. In addition, the expenditure on the landscaping works will not have any impact on the market value of the head lease. In these circumstances, there is not a sufficient and relevant connection between the capital expenditure incurred by the taxpayer on the landscaping works and the head lease. Accordingly, the taxpayer's capital expenditure on landscaping land that it leases from one party and subleases to other parties is not incurred in relation to a lease or other legal or equitable right for the purpose of paragraph 40-880(5)(d) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 40-880 subsection 40-880(2) subsection 40-880(2)(a) subsection 40-880(3) subsection 40-880(5)(d) former paragraph 40-880(3)(d)
Case references: PMT Partners Pty Ltd (in liq) v Australian National Parks and Wildlife Service (1995) 184 CLR 301
Related ATO interpretative decisions: ATO ID 2009/35 | ATO ID 2009/37
Other references: Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 1) Bill 2006 Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 2002 Review of Business Taxation, A Tax System Redesigned, Report, July 1999 Review of Business Taxation, A Platform for Consultation, Discussion Paper 2 Volume 1, February 1999
Subject references: Australian Taxation Office Blackhole expenditure Capital Allowances CoE Capital Works Deductions Centres of Expertise Deductions & expenses