Private ruling: Capital gains tax - air rights
Date of advice: 24 April 2018
Published: July 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Are the air rights a separate CGT asset, distinguishable from the freehold land? | A1: No. | Q2: Is there a value that can be apportioned to the air rights for CGT purposes in this case? | A2: No. | Q3: Is the proposed apportionment of the market value of the property as between the pre-CGT assets and the deemed post-CGT separate asset considered reasonable? | A3: Yes.

Relevant facts and circumstances: The trust, acquired a pre-CGT commercial rental property with ground level shops and land. In 19XX, another level (the first floor) was constructed above the shops, with further extension work on it in 20XX. The 19XX Capital Improvements cost around $XXXX. The 20XX Capital Improvements cost around $XXXX. The Capital Improvements are post-CGT assets. Sometime after the Capital Improvements were completed, the property was strata-titled into lots. Car parking spaces and common area rights were attached to the upstairs property. The trust vested in 20XX, and the trustee arranged for a market valuation by property valuers. They valued the property as a whole, and then valued it without the post-CGT extension, the difference to be attributed to the first floor extension. The value of the pre-CGT land was included in these valuations. The Office of State Revenue placed an unimproved value of XXX on the first floor in 20XX. A capital gain event occurred on the vesting of the trust. You provided a method that was used to calculate the capital gain.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 104-35 | Income Tax Assessment Act 1997 subdivision 108-D; | Income Tax Assessment Act 1997 paragraph 108-5(1)(a) | Income Tax Assessment Act 1997 section 108-60; | Income Tax Assessment Act 1997 section 108-70; | Income Tax Assessment Act 1997 section 110-25; | Income Tax Assessment Act 1997 section 116-40; | Income Tax Assessment Act 1997 section 118-42; | Income Tax Assessment Act 1997 subdivision 124-D; | Income Tax Assessment Act 1997 section 124-10

Reasons for decision: Detailed Reasoning - Air Rights: The concept that air rights form part of land is accepted in Australian law. The Australian Law Commission (ALRC) in its update ‘ Existing Common Law Causes of Action: Intrusions into Air Space ’, which, although dealing with privacy, states that intrusions into air space may amount to a trespass to land if the intrusion is at a height necessary for the ordinary use and enjoyment of the occupier. For trespass to occur, ownership rights need to exist. You contend that the airspace between the floor of the first floor and the roof is part of the rights attached to the land, and these rights were present when the land and buildings were originally acquired. The ALRC update states: 3.38 Intrusions into airspace may amount to trespass to land if the intrusion is at a height potentially necessary for the ordinary use and enjoyment of the occupier. 3.39 It is a question of fact in the circumstances as to whether or not a trespass has occurred on common law principles. This would depend on whether the potential use and enjoyment of the land and the airspace by the occupier has been interfered with from within the relevant height limit of the occupier’s interests. … Section 118-42 of the Income Tax Assessment Act 1997 (ITAA 1997) ensures that the CGT provisions do not apply in certain circumstances. That is, where land, building and common property is transferred to an entity that had the right to occupy it prior to a stratum title subdivision, then any capital gain or capital loss from transferring the unit is disregarded. Ordinarily, section 118-42 of the ITAA 1997 would be applicable in conjunction with roll-over relief for stratum title conversions under Subdivision 124-D of the ITAA 1997. Taxation Ruling TR 97/4: Income tax: capital gains: roll-over relief for buildings subdivided under strata title law into stratum units and common property (TR 97/4) confirms that on creating the stratum title, the pre-CGT status remains, provided that ownership interests are unchanged. This is supported in the following examples, 10. If a member acquired shares, or a lessee entered into a lease, before 20 September 1985, the relevant stratum unit held by the member or lessee is treated as having been acquired by that member or lessee before 20 September 1985 (paragraph 160ZZPG(3)(b)). 14. If a person acquired his or her interest as a tenant in common and rights before 20 September 1985, the relevant stratum unit is treated as having been acquired by the person before 20 September 1985 (paragraph 160ZZPG(3)(b)). 52. If an original asset is acquired before 20 September 1985, the Commissioner will treat an asset acquired by a taxpayer on or after 20 September 1985 as a result of a conversion as if that asset had been acquired before 20 September 1985, that is, a relevant stratum unit acquired by a taxpayer as a result of a subdivision and transfer process is treated as having been acquired before 20 September 1985. Generally, air rights may be included in the definition of ‘property’, as they are capable of assignment under paragraph 108-5(1)(a) of the ITAA 1997. The following passages provide a useful insight into the question of whether air rights are ‘property’: ‘ Traditional Rights and Freedoms—Encroachments by Commonwealth Laws ’ (ALRC Interim Report 127), published on 3 August 2015: 7.16 A ‘property right’ may take different forms depending on the type of property. Implicit in a property right, generally, are all or some of the following rights: the right to use or enjoy the property, the right to exclude others, and the right to sell or give away. Property rights also depend on the statutory framework of laws and property rights affecting the particular type of property, for example, the system of land tenure in a particular state or territory, or a scheme such as the Personal Property Securities Act 2009 (Cth), and the interaction between that statutory scheme and the common law. 7.17 For land and goods, both of which may be possessed by someone other than the lawful owner, property rights in the sense of ownership must be distinguished from mere possession of the land or goods, even though the latter may give rise to qualified legal rights, and from mere contractual rights affecting the property. The particular right may be regarded as ‘proprietary’ even though it is subject to certain rights of others in respect of the same property: a tenancy of land, for example, gives the tenant rights that are proprietary in nature as well as possessory. In conclusion, the air rights above the trust’s land are ‘property’ within the terms of paragraph 108-5(1)(a) of the ITAA 1997. The air rights are attached to the land. This attachment would only be severed by the sale or disposal of the air rights on their own, which creates CGT Event D1. In this present case, as the land and rental shops on the ground floor were acquired pre-CGT, the land, rental shops and the air rights above the land were not subject to the CGT provisions. With a stratum title, it is possible to subdivide the air space above an area of land, as in this case. This stratum title gives the sole ownership rights to each particular unit’s owner, as well as the space enclosed by it. Therefore the owner may lease, sell or legally dispose of their unit in the same way as other freehold property owners. As the land, shops and air rights on the ground floor are pre-CGT assets, the trust is treated as having acquired the strata units before 20 September 1985 (section 124-10 of the ITAA 1997). As such the land, shops on the ground floor and air rights are not subject to CGT on subsequent disposal by the trust. However the subsequent CGT event in relation to the post-CGT asset (the first floor extension) will be subject to CGT. The law does not allow for rights attached to land, such as air rights, to be allocated or apportioned any value. In this context, it is useful to examine the relevant tax laws in relation to easements. Air rights are similar to easements in this regard. CGT Event D1 happens if a taxpayer grants an easement (section 104-35 of the ITAA 1997). CGT Event D1 happens at the time the contract is made or the right is created. Payments received in return for the voluntary acquisition of an easement may be treated as capital proceeds on the part disposal of the land. The voluntary grantor receives consideration in return for granting the rights in favour of the grantee. There is no scope under section 116-40 of the ITAA 1997 for apportioning the consideration between the creation of the easement and the loss of rights of ownership of the land. Taxation Ruling TR 97/3 Income tax: capital gains: compensation received by landowners from public authorities states: 18. It has been suggested that the consideration a landowner receives in return for voluntarily granting an easement could be apportioned. The apportionment would be between the creation and vesting of the easement and the loss of rights of ownership of the land. We take the view, however, that there is no scope for section 160ZD(4) [now section 116-40] to operate to apportion the disposal consideration in these circumstances. The whole consideration is received, in terms of paragraph 160ZD(1)(a), as a result of, or in respect of, the creation of the easement and its vesting in the grantee. We do not accept, for the purposes of subsection 160ZD(4), that any part of the consideration received on the voluntary grant of an easement specifically relates to the landowner's loss of rights of ownership. This applies equally to the situation where the CGT asset has ‘changed’ in the case of a partial disposal of a CGT asset. Where the land holding is pre-CGT, the part-disposal will normally not have CGT consequences. However, there is not a part disposal where a taxpayer subdivides a block of land and then disposes of one of the subdivided lots. This is considered to be a split of the original asset - see section 112-25 of the ITAA 1997. Thus, a grant of an easement would result in a part disposal of the pre-existing right to use or exploit. The Commissioner once regarded the grant of an easement or profit à prendre by a landowner as constituting a part disposal of land, but it is now considered that the easement or profit à prendre is an asset created at the time it is granted (Taxation Ruling IT 2561). Therefore, as there was no disposal of the air rights enclosed within the first floor structure, there is no CGT event. Also, there is no basis for an allocation of any value to the air rights. Thus, the air rights have no value for CGT purposes. | Detailed Reasoning - Apportionment: Subdivision 108-D of the ITAA 1997 covers when assets become separate CGT assets. For CGT purposes there are exceptions to the common law principle that what is attached to the land is part of the land and rules about when a capital improvement to a CGT asset is treated as a separate CGT asset. Section 108-70 of the ITAA 1997 provides information on when a capital improvement is a separate asset. Subsection 108-70(3) of the ITAA 1997 states that capital improvements to a CGT asset (the original asset) that you acquired before 20 September 1985 that are related to each other are taken to be a separate CGT asset if the total of their cost bases when a CGT event happens in relation to the original asset is: ● more than the improvement threshold for the income year in which the event happened; and ● more than 5% of the capital proceeds from the event. Because you acquired the property prior to 20 September 1985 (pre-CGT) and extensions to the dwelling occurred in 19XX and 20XX (post-CGT), for the purposes of capital gains tax the property will be considered to be made up of separate CGT assets. At the time of the CGT event the property consisted of the following assets: 1) the land and pre-CGT building – the pre-CGT assets; 2) the extensions constructed in 19XX & 20XX – the post-CGT asset. While the land and pre-CGT building (the pre-CGT assets) will be exempt from capital gains, the building extensions will not. Apportionment In Taxation Determination TD 98/24 Income tax: capital gains: what are the CGT consequences of a CGT event happening to post-CGT real property if the property comprises separate CGT assets under Subdivision 108-D in Part 3-1 of the Income Tax Assessment Act 1997 (the 1997 Act) or if the property is sold with depreciable assets? (TD 98/24), the Commissioner ruled on the apportionment of consideration received on the disposal at one time of multiple CGT assets. If the property is disposed of under a contract and the parties are dealing with each other at arm's length, the agreed apportionment of the parties (whether at the time of contract or subsequently) will be accepted by the Commissioner. If there is no agreed apportionment, each party must make their own reasonable apportionment of the capital proceeds to the separate assets which have regard to the relevant market values of the assets at the time of the making of the contract. In this case CGT event E5 happened in relation to the property. The market value of the property must be apportioned on a reasonable basis between the pre-CGT assets and the post-CGT asset. In this case, the Trust has obtained an independent valuation and used rates notice valuations in order to place a value on the pre-CGT assets and the post-CGT asset to apportion the market value of the property. The Commissioner considers that the method used to calculate the capital gain is reasonable.