Private ruling: Division 250 of the Income Tax Assessment Act 1997 (ITAA 1997)
Date of advice: 19 December 2018
Published: April 2019
Ruling period: 1 October XXXX to 30 June XXXX
Date scheme commenced: 1 October XXXX

Ruling: Q1: Will Division 250 of the ITAA 1997 apply to Entity A and the Building which forms part of the land (Property) that will be leased to a member of the tax preferred sector Entity B? | A1: No. | Q2: Would the Commissioner make a determination under section 250-45 of the ITAA 1997 that it would be unreasonable for Division 250 of the ITAA 1997 to apply to Entity A and the Division 40 of the ITAA 1997 depreciating assets that form part of the Property that will be leased to Entity B? | A2: Yes.

Relevant facts and circumstances: 1. Entity A is an investment trust. Entity A is not a small business entity. 2. Entity A invests in commercial real estate assets. 3. Entity A acquired an office building, the Property for $X in 20XX. A reference to the Property refers to the land, the Building, and all of its components. A reference to the Building refers only to the physical structure of the building and not the land on which it sits. 4. The Property is currently leased by Entity A in its entirety to a third party and receives rental income from the third party. The third party will vacate the Property when the lease expires. 5. Entity A has agreed to lease the Property to Entity B. Entity B is an exempt entity for the purposes of the ITAA 1997. 6. The key terms of the agreement to lease are as follows: a. Entity B will lease the Property for a X year term commencing from 20XX. b. As a lease incentive, prior to handing over possession to Entity B, Entity A will spend $X in fitting out the premises and incur other costs as a result of the proposed lease. The fitout will be owned by Entity A. c. Entity B will have the option to extend its lease by up to X years (being two separate X year options) at the prevailing market rent following a market review. d. The rental payments due under the lease will increase over the term of the lease in accordance with a pre-agreed X% escalation each year. The rent for the first year of the lease is approximately $X. e. The lease is a quasi-triple-net lease structure where Entity B is responsible for: i. All occupancy related outgoings associated with the Property during the term of its occupation. ii. The repair, maintenance, and replacement of all services, plant and equipment. iii. Any capital expenditure required that is over and above what Entity A has agreed to contribute to Entity B for capital expenditure on pre-agreed items. f. Entity A will be responsible for maintaining the building structure and façade. g. At the end of the lease term, Entity B has no right, option or power to acquire the Property from Entity A. h. Entity B will have no make-good obligations at the end of the lease. i. There is no guaranteed residual value in respect of the Property at the end of the lease. 7. The rent and incentives agreed with Entity B are consistent with prevailing market rents for the given term of the lease. 8. Entity A has the full right, title and interest in the Property. 9. Entity A remains subject to all ownership risks that relate to the Property, including tenant default and building damage. Entity A remains fully exposed to any changes in the Property’s market value, any changes in the commercial office building rental market, and any other structural/disruptive forces that may emerge over the life of the Property. 10. At the commencement of the lease, the market value of the Property will be $X. This is based on the following assumptions and taking into account the following factors: a. X% capital growth to the start of the lease from a starting value of $X, being the fair value of the Property in Entity A’s accounts as at 30 June 20XX. b. A boost in value resulting from the confirmation of a new long-term tenant. c. The new fitout and lessor capital works. 11. The market value of the Property at the commencement of the lease has been attributed to different classes of assets by Entity A as follows, based on a number of commercial assumptions: Asset type Value (AUD million) Land X Building X Division 40 of the ITAA 1997 assets – remaining effective life X years or less (short term Division 40 depreciating assets) X Division 40 of the ITAA 1997 assets – remaining effective life greater than X years (long term Division 40 depreciating assets) X Total X 12. No part of the acquisition of the Property has been funded by ‘limited recourse debt’ as defined in subsection 995-1(1) and section 243-20 of the ITAA 1997. 13. The Building was built in 20XX. 14. Disregarding the operation of Division 250 of the ITAA 1997, Entity A (as owner of the Building and the entity that ‘holds’ the depreciating assets under Division 40 of the ITAA 1997) will be entitled to capital allowances under Division 43 of the ITAA 1997 in relation to expenditure on the Building and Division 40 of the ITAA 1997 in relation to the decline in value of the depreciating assets. 15. The present value of the rental payments that will be received over the course of the lease of the Property is only marginally greater than 70% of the market value of the Property at the commencement of the lease. 16. The present value of the rental payments that will be received over the course of the lease that are attributable to the Building is less than 70% of the market value of the Property attributable to the Building at the commencement of the lease. 17. The present value of the rental payments that will be received over the course of the lease that are attributable to Division 40 of the ITAA 1997 depreciating assets is greater than 70% of the market value of the Division 40 of the ITAA 1997 depreciating assets at the commencement of the lease. 18. Of the total market value of the Property at the commencement of the lease, X% of the market value is attributable to short term Division 40 depreciating assets. 19. Of the total market value of the Property at the commencement of the lease, X% of the value is attributable to long term Division 40 depreciating assets. 20. The Division 250 assessable amount with respect to Entity A’s lease of the Property to Entity B is greater than the alternative assessable amount under subsection 250-40(3) of the ITAA 1997.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 250-5 | Income Tax Assessment Act 1997 section 250-10 | Income Tax Assessment Act 1997 section 250-15 | Income Tax Assessment Act 1997 section 250-20 | Income Tax Assessment Act 1997 section 250-25 | Income Tax Assessment Act 1997 section 250-30 | Income Tax Assessment Act 1997 section 250-40 | Income Tax Assessment Act 1997 section 250-45 | Income Tax Assessment Act 1997 section 250-50 | Income Tax Assessment Act 1997 section 250-55 | Income Tax Assessment Act 1997 section 250-60 | Income Tax Assessment Act 1997 section 250-65 | Income Tax Assessment Act 1997 section 250-75 | Income Tax Assessment Act 1997 subsection 250-105(2) | Income Tax Assessment Act 1997 section 250-110 | Income Tax Assessment Act 1997 section 250-115 | Income Tax Assessment Act 1997 section 250-120 | Income Tax Assessment Act 1997 section 250-125 | Income Tax Assessment Act 1997 section 250-130 | Income Tax Assessment Act 1997 section 250-135 Question 1 | Will Division 250 of the ITAA 1997 apply to Entity A and the Building which forms part of the Property that will be leased to Entity B? | Detailed reasoning | Division 250 of the ITAA 1997 – the general test | Division 250 of the ITAA 1997 applies to you and the asset if the general test in section 250-15 of the ITAA 1997 is satisfied. | Section 250-15 of the ITAA 1997 states: | This Division applies to you and an asset at a particular time if: | a) the asset is being put to a tax preferred use; and | b) the arrangement period for the tax preferred use of the asset is greater than 12 months; and | c) the financial benefits in relation to the tax preferred use of the asset have been, will be, or can reasonably be expected to be, provided to you (or a connected entity) by: | (i) a tax preferred end user (or a connected entity); or | (ii) any tax preferred entity (or a connected entity); or | (iii) any entity that is a foreign resident; and | d) disregarding this Division, you would be entitled to a capital allowance in relation to: | (i) a decline in the value of the asset; or | (ii) expenditure in relation the asset; and | e) you lack a predominant economic interest in the asset at that time. | Division 250 of the ITAA 1997 applies on an asset by asset basis, and only to assets for which capital allowance deductions can be claimed. As such, the first step is to identify the relevant assets that form the Property being leased. | The Property is a composite asset. Composite assets may either themselves be an asset, or their separate components may be separate assets. Subsection 250-75(2) of the ITAA 1997 states that this is a question of fact and degree and can only be determined in light of all the circumstances of a particular case. Example 2 under subsection 250-75(2) of the ITAA 1997 notes that a floating restaurant consists of many separate components that are all treated as separate assets. | Similarly a large commercial office building is a composite asset that has a number of clearly separable components. It consists of a number of separate assets, primarily the Land, the Building, and the Division 40 of the ITAA 1997 depreciating assets in the Building, such as carpet, fans, air conditioning equipment etc. Each of these is a separate asset for the purposes of Division 250 of the ITAA 1997. The Building is considered a separate asset to the land itself by virtue of subsection 250-75(1) of the ITAA 1997. | Paragraph 250-15(a) of the ITAA 1997 | Section 250-60 of the ITAA 1997 provides that an asset is ‘put to a tax preferred use’ at a particular time if an end user holds at that time rights as lessee under a lease of the asset and the asset is used by, or on behalf of, an end user who is a ‘tax preferred end user’ because of paragraph 250-55(a) of the ITAA 1997. | Paragraph 250-55(a) of the ITAA 1997 provides that an ‘end user’ of an asset is a ‘tax preferred end user’ if the end user is a ‘tax preferred entity’. Subsection 995-1(1) of the ITAA 1997 defines a ‘tax preferred entity’ to include an ‘exempt entity’. An ‘exempt entity’ is defined in subsection 995-1(1) of the ITAA 1997 as an entity all of whose ordinary income and statutory income is exempt from income tax because of the Income Tax Assessment Act 1936 , ITAA 1997 or another Commonwealth law. Subsection 250-50(1) of the ITAA 1997 provides that an entity is an ‘end user’ of an asset if the entity uses, or effectively controls the use of, the asset. Subsection 250-50(4) of the ITAA 1997 provides that an entity is taken to be an end user of an asset if the entity holds rights as a lessee under a lease of the asset. | Paragraph 250-15(a) of the ITAA 1997 will be satisfied as Entity B (being an ‘exempt entity’) will be a ‘tax preferred end user’ and will lease the Property, which will include the Building, Land and Division 40 of the ITAA 1997 depreciating assets. This means that the Building, Land and Division 40 of the ITAA 1997 depreciating assets will be ‘put to a tax preferred use’. | Paragraph 250-15(b) of the ITAA 1997 | Paragraph 250-15(b) of the ITAA 1997 will be satisfied as the ‘arrangement period’ (as defined in section 250-65 of the ITAA 1997) is the X year term of the lease, which exceeds 12 months. | Paragraph 250-15(c) of the ITAA 1997 | Paragraph 250-15(c) of the ITAA 1997 will be satisfied as financial benefits, being rent payments, in relation to the tax preferred use of the assets will be provided to Entity A by a tax preferred end user (Entity B). | Paragraph 250-15(d) of the ITAA 1997 | Paragraph 250-15(d) of the ITAA 1997 will be satisfied as, disregarding Division 250 of the ITAA 1997, Entity A will be entitled to capital allowances for expenditure in relation to the Building and a decline in value of the Division 40 of the ITAA 1997 depreciating assets that form part of the Property. Paragraph 250-15(d) of the ITAA 1997 will not be satisfied with respect to the unimproved land, as land is not an asset for which capital allowances can be claimed under Division 40 or Division 43 of the ITAA 1997. | Paragraph 250-15(e) of the ITAA 1997 – predominant economic interest | A taxpayer will lack a predominant economic interest in an asset at a particular time if it satisfies one of the tests listed in section 250-110 of the ITAA 1997. | Paragraph 250-15(e) of the ITAA 1997 will not be satisfied as Entity A will not lack a predominant economic interest in the Building. | Specifically: | ● The limited recourse debt test in section 250-115 of the ITAA 1997 will not be satisfied as limited recourse debt has not been used to acquire the Building. | ● The right to acquire asset test in section 250-120 of the ITAA 1997 will not be satisfied as the lessee (Entity B) will not have the right to acquire the Building at the end of the lease, or at any other time. | ● The effectively non-cancellable, long term arrangement test in section 250-125 of the ITAA 1997 will not be satisfied in respect of the Building. Although the lease will constitute an ‘effectively non-cancellable arrangement’ as defined in section 250-130 of the ITAA 1997, section 250-125 of the ITAA 1997 states: | 1) You lack a predominant economic interest in an asset at a particular time if: | a) any arrangement that relates to: | (i) the tax preferred use of the asset; or | (ii) the financial benefits to be provided by the members of the tax preferred sector in relation to the tax preferred use of the asset | is effectively non-cancellable (see section 250-130); and | b) the arrangement period for the tax preferred use of the asset is: | (i) greater than 30 years; or | (ii) if the arrangement is less than or equal to 30 years – 75% or more of that part of the asset’s effective life that remains when the tax preferred use of the asset starts. | 2) Disregard section 40-102 in working out the asset’s effective life for the purposes of subparagraph 1(b)(ii). | Section 250-65 of the ITAA 1997 states that the ‘arrangement period’ starts when the tax preferred use of the asset starts, and is taken to end when the tax preferred use of an asset is likely or has ended. Under paragraph 250-65(4)(b) of the ITAA 1997, in determining when a particular tax preferred use of an asset is likely to end, it must be assumed that any right that an entity has to renew or extend such an arrangement will not be exercised (unless it is reasonable to assume that the right will be exercised because of the commercial consequences for the entity of not exercising the right). | The arrangement period in this case would be X years, being the period of the lease. The two options to renew would not be included as part of the arrangement period because, for the purposes of subsection 250-65(4) of the ITAA 1997, it cannot be concluded that the options to renew are likely to be exercised given the absence of any commercial consequences for Entity B of non-exercise (other than the normal inconvenience and disruption of moving premises on the expiry of a lease). | The Building (not being a depreciating asset) would not have an effective life. This means that it would be tested under subparagraph 250-125(1)(b)(i) of the ITAA 1997. | As the lease and the arrangement period is for X years, which is less than the 30 years in subparagraph 250-125(1)(b)(i) of the ITAA 1997, the test in section 250-125 of the ITAA 1997 is not satisfied for expenditure in relation to the Building. | ● The level of expected financial benefits test in subparagraph 250-135(2)(b)(ii) of the ITAA 1997 is not satisfied in respect of the Building. Section 250-135 of the ITAA 1997 states: | 1) You lack a predominant economic interest in an asset at a particular time if the asset has a guaranteed residual value at that time. | 2) You also lack a predominant economic interest in an asset at a particular time if, at that time | (a) the arrangement under which the asset is put to the tax preferred use (either alone or together with any other arrangement in relation to the tax preferred use of the asset or the provision of financial benefits in relation to the tax preferred use of the asset) is a debt interest; or | (b) the sum of the present values of the expected financial benefits that members of the tax preferred sector have provided, or are reasonably likely to provide, to you (or a connected entity) in relation to the tax preferred use of the asset exceeds 70% of: | (i) the market value of the asset if subparagraph 250-15(d)(i) applies; or | (ii) so much of the market value of the asset as is attributable to the expenditure referred to subparagraph 250-15(d)(ii) if that subparagraph applies. | The discount rate to be used in calculating the present value of the expected financial benefits is determined under subsection 250-105(2) of the ITAA 1997, which states: | For the purposes of section 250-135 and Subdivisions 250-C and 250-D, the discount rate to be used in working out the present value of a future amount is a rate that reflects a constant period rate of return (worked out on a compounding basis) on the investment in | (a) the asset referred to in subparagraph 250-15(d)(i) if that subparagraph applies; or | (b) the expenditure referred to in paragraph 2501-5(d)(ii) if that subparagraph applies; | that is implicit in the arrangements under which the asset is put to a tax preferred use and financial benefits are provided in relation to that tax preferred use. | Section 250-135 of the ITAA 1997 is a point in time test, and the test is applied at the start of the tax preferred use, being the start of the lease. Section 250-140 provides the limited circumstances that a retest of the level of expected financial benefits may be required. | The present value of the rent payments that Entity B is reasonably likely to provide to Entity A that will be attributable to the Building is less than 70% of the market value of the Building at the start of the lease. Therefore, the test in section 250-135 of the ITAA 1997 is not satisfied for expenditure in relation to the Building. | As Entity A does not lack a predominant economic interest in the Building, paragraph 250-15(e) of the ITAA 1997 is not satisfied. | Therefore, Division 250 of the ITAA 1997 will not apply to Entity A and the Building. | Question 2 | Would the Commissioner make a determination under section 250-45 of the ITAA 1997 that it would be unreasonable for Division 250 of the ITAA 1997 to apply to Entity A and the Division 40 of the ITAA 1997 depreciating assets that form part of the Property that will be leased to Entity B? | Detailed reasoning | For the same reasons outlined in Question 1, the first four requirements of the general test in section 250-15 of the ITAA 1997 are satisfied with respect to the Division 40 of the ITAA 1997 depreciating assets that form part of the Property that will be leased to Entity B. | Paragraph 250-15(e) of the ITAA 1997 will also be satisfied with respect to the Division 40 of the ITAA 1997 depreciating assets as Entity A will lack a predominant economic interest in the Division 40 of the ITAA 1997 depreciating assets that form part of the Building. Specifically: | ● The limited recourse debt test in section 250-115 of the ITAA 1997 will not be satisfied as limited recourse debt has not been used to acquire any of the Division 40 of the ITAA 1997 depreciating assets. | ● The right to acquire asset test in section 250-120 of the ITAA 1997 will not be satisfied as the lessee (Entity B) will not have the right to acquire the Division 40 of the ITAA 1997 depreciating assets that form part of the Building at the end of the lease, or at any other time. | ● The effectively non-cancellable, long term arrangement test in section 250-125 of the ITAA 1997 will be satisfied in respect of the short term Division 40 assets. As the lease to Entity B is an effectively non-cancellable arrangement as defined in section 250-130 of the ITAA 1997, and is for X years, any Division 40 of the ITAA 1997 depreciating asset with an effective life of X years or less will satisfy the test in subparagraph 250-125(1)(b)(ii) of the ITAA 1997. | ● The level of expected financial benefits test in subparagraph 250-135(2)(b)(ii) of the ITAA 1997 is satisfied with respect to the Division 40 of the ITAA 1997 depreciating assets as a class. The present value of the financial benefits (rent) that Entity B is reasonably likely to provide to Entity A that are attributable to the Division 40 of the ITAA 1997 depreciating assets is greater than 70% of the market value of the Division 40 of the ITAA 1997 depreciating assets at the start of the lease. | As such, Entity A lacks a predominant economic interest in the Division 40 of the ITAA 1997 depreciating assets that form part of the Building that will be leased to Entity B. In the absence of an exclusion applying, Division 250 of the ITAA 1997 will apply to Entity A and the Division 40 of the ITAA 1997 depreciating assets that form part of the Building. | Division 250 of the ITAA 1997 – exclusions | With respect to the exclusions in sections 250-20, 250-25, 250-30, and 250-40 of the ITAA 1997, none of these four exclusions apply. This is because: | ● Entity A is not a small business entity for the income year in which the arrangement period for the tax preferred use of the Property starts (section 250-20 of the ITAA 1997). | ● The financial benefits that can reasonably be expected to be provided to Entity A under the arrangement (the arrangement being the lease of the Property to Entity B) is in excess of $5 million (section 250-25 of the ITAA 1997). | ● The arrangement period for the tax preferred use of the Property is a lease of real property for longer than 5 years, the total value of the financial benefits expected to be received by Entity A from Entity B is in excess of $50 million, and the value of the Property being leased exceeds $40 million (section 250-30 of the ITAA 1997). | ● The Division 250 of the ITAA 1997 assessable amount with respect to Entity A’s lease of the Property to Entity B is greater than the alternative assessable amount (section 250-40 of the ITAA 1997). | Division 250 of the ITAA 1997 – fifth exclusion – Commissioner’s determination | Section 250-45 of the ITAA 1997 is the fifth and final exclusion to Division 250 applying. It states: | This Division does not apply to you and an asset at a particular time if: | a) You request the Commissioner to make a determination under this subsection; and | b) The Commissioner determines that it is unreasonable that the Division should apply to you and the asset at that time, having regard to: | i. The circumstances because of which this Division would apply to you and the asset; and | ii. Any other relevant circumstances. | The Revised Explanatory Memorandum to the Tax Laws Amendment (2007 Measures No. 5) Bill 2007 provides limited guidance with respect to when the Commissioner should make a determination: | 1.136 In making the determination, the Commissioner should give consideration to the objects of the Division set out in section 250-5. | 1.137 It is expected that the Commissioner would consider applying the discretion, for example, to prevent an arrangement from coming within the scope of Division 250 due to: | ● an unintended or marginal breach of one of the safe harbour tests; or | ● an unintended or marginal breach of one of the tests that need to be satisfied to qualify for the specific exclusion for certain operating and service arrangements. | Example 1.17 | BF Co owns a 30 storey office building. Ten floors of the building are leased by BF Co to a Australian government department. Another four floors are leased to a state government public authority. The Australian government department temporarily enters into a short term lease for an additional two floors of the building. | The building is financed by limited recourse debt. If the limited recourse debt test in section 250-115 did not apply, the lease arrangement would be outside the scope of Division 250. | Even though the members of the tax preferred sector occupy as tenants more than half of the area within the building that is occupied or available to be occupied by tenants, the Commissioner may exercise his discretion not to apply the limited recourse debt test because of the temporary nature of the short term lease for an additional two floors of the building. | Example 1.18 | RP Co, a cleaning contractor, enters into an arrangement with a local government council to provide office cleaning services. Under the contract, the total financial benefits expected to be payable to RP Co are $5.1 million. | The arrangement does not qualify for the exclusion under section 250-25 because the total financial benefits expected to be payable under the arrangement marginally exceed the $5 million threshold. | However, bearing in mind the compliance cost implications of applying Division 250 to the arrangement and that the threshold for the exclusion in section 250-25 was only marginally exceeded, the Commissioner may exercise his discretion to exclude the arrangement from the scope of Division 250 | Entity A has requested, as required under subsection 250-45(a) of the ITAA 1997 that the Commissioner exercise the discretion in section 250-45 of the ITAA 1997 to make a determination that it would be unreasonable for Division 250 of the ITAA 1997 to apply to the Division 40 of the ITAA 1997 depreciating assets that are part of the lease of the Property. | The short term Division 40 depreciating assets satisfy two tests for lacking a predominant economic interest, being the effectively non-cancellable, long term arrangement test in section 250-125 of the ITAA 1997 and the level of expected financial benefits test in paragraph 250-135(2)(b) of the ITAA 1997. | The long term Division 40 depreciating assets satisfy the level of expected financial benefits test in paragraph 250-135(2)(b) of the ITAA 1997. | Factors supporting a conclusion that it would be unreasonable for Division 250 of the ITAA 1997 to apply to the Division 40 of the ITAA 1997 depreciating assets include: | ● The short term Division 40 depreciating assets constitute X% of the total value of the Property, and the long term Division 40 depreciating assets constitute X% of the total value of the Property, at the commencement of the lease. The leasing of Division 40 of the ITAA 1997 depreciating assets therefore consists of only X% of the total value of the Property at the commencement of the lease. | ● The dominant purpose of the arrangement is to lease the Building to the lessee, and not the Division 40 of the ITAA 1997 depreciating assets which form an ordinary part of any building and are merely incidental to the overall lease arrangement. The lease of the Property is an ordinary commercial operating lease negotiated at arm’s length. The pricing is comparable to rent previously charged for the Building to members of the tax-paying sector. | ● The impact of Division 250 of the ITAA 1997 on the Division 40 of the ITAA 1997 assets is marginal in comparison to the tax consequences for the balance of, and the overall, arrangement. That is, Division 250 of the ITAA 1997 would impact only a minor portion of the assets and arrangement. For this reason, it should have no significant impact on the tax profile of the investment given the X year duration of the intended tax preferred use of the Property. | ● If the Commissioner does not make a determination under section 250-45 of the ITAA 1997, Entity A would need to apply Division 250 of the ITAA 1997 to the income attributable to the Division 40 of the ITAA 1997 depreciating assets but not to the majority of the rental and other income attributable to the Building and the land component on which the Building sits. This would result in the taxpayer having to apply Division 250 of the ITAA 1997 on a minority portion of its total income with respect to the lease arrangement, which would be a significant compliance burden, as the deemed loan treatment prescribed under Division 250 of the ITAA 1997 would have to be applied on an asset by asset basis with respect to all depreciating assets on the fixed asset register. Financial benefits (being the rent payments for the Property) would have to be allocated to each individual asset, and new deemed loans would have to be created on the replacement of any assets over the lease term. | ● When applying the test in subsection 250-135(2) of the ITAA 1997 to Entity A and the entire Property rather than the individual assets, there is only a marginal breach of the 70% threshold. | Taking these factors into account, the Commissioner considers that Entity A’s circumstances in relation to the Division 40 of the ITAA 1997 depreciating assets are not in the nature of those arrangements which Division 250 of the ITAA 1997 was intended to apply to. | Therefore, the Commissioner would, under section 250-45 of the ITAA 1997, make a determination that it would be unreasonable for Division 250 of the ITAA 1997 to apply to Entity A and the Division 40 of the ITAA 1997 depreciating assets that form part of the Property that will be leased to Entity B.