Limiting Deductions for Vacant Land
New legislation has now been enacted by the Parliament to deny deductions for losses or outgoings incurred to the extent they relate to a taxpayer holding vacant land. The measure was first announced by the Government in the 2018-19 Federal Budget to address the Government’s concerns that holdings costs (such as, interest expenses, rates, taxes and maintenance costs) for vacant land are ‘improperly claimed’ as deductions by some taxpayers.
Historically, the High Court in Steele v FC of T 99 ATC 4242 held that this type of expenditure was deductible provided the taxpayer could establish the vacant land was held for the purpose of gaining or producing assessable income. This view was subsequently formalised by the Australian Taxation Office (ATO) in the Taxation Ruling TR 2004/4.
The Government was concerned that there was often limited evidence about the taxpayer’s intent other than statements by the taxpayer and the holding costs on vacant land were claimed as deductions for many years without the taxpayer’s taking concrete steps to start deriving assessable income.
The New Legislation
In short, taxpayers can no longer claim deductions for losses or outgoings incurred on or after 1 July 2019 that relate to holding vacant land. This is regardless that the land was acquired before 1 July 2019.
The land is vacant if there is no substantial and permanent structure in use or available for use on the land. Further, the structure must have an ‘independent purpose’ that is not incidental to the purpose of another structure or proposed structure on the land. To be substantial, a building or other structure needs to be significant in size, value or some other criteria of importance in the context of the relevant property. To be permanent, a structure needs to be fixed and enduring.
Most residential premises should satisfy the definition of ‘substantial and permanent structure’. However, the land is treated as remaining vacant until the residential premise (that is constructed or substantially renovated) is able to be lawfully occupied and the residential premise is leased, hired or licensed, or available for lease, hire or licenced.
However, deductions for vacant land are still available to the extent that they are incurred in:
- carrying on a business by the taxpayer (for example a property development or primary production business); or
- holding land that is used or made available for use in carrying on such a business by the taxpayer’s affiliates, connected entities, spouse and/or children under 18 years of age.
Further, the new rule does not apply to the following entities:
- a corporate tax entity;
- a superannuation plan that is not a self-managed superannuation fund;
- a managed investment trust;
- a public unit trust; or
- unit trust or partnership where the unitholder or partner is an entity mentioned at (1)-(4) above.a
Additional exceptions were later introduced by the Senate. In addition to the exceptions above, the new rule does not apply to either of the following circumstances:
- the land becomes vacant due to the structures on the land affected by natural disasters or other exceptional and unforeseeable events beyond the reasonable control of the taxpayer resulting in;
- the land is under lease, hire or licence to another entity and either the taxpayer or the other entity carries on a primary production business; or
- the land is under lease, hire or licence to another entity on an arm’s length basis, and it is in use or available for use in carrying on a business.
Where the land becomes vacant due to a natural disaster or other exceptional circumstance, deductions can be claimed for three years from the date the exceptional circumstance first resulted in there being no relevant substantial and permanent structure on the land.
Arguably, the new legislation is not required as the ATO could have used the argument that the taxpayer did not have the requisite purpose or the expenses incurred too early before gaining any income in accordance with the principles in the Steele case or TR 2004/4. Nevertheless, the Explanatory Memorandum to the new legislation states that reliance on a taxpayer’s assertion about their current intention leads to ‘compliance and administrative difficulties’ (meaning it is all too hard for the ATO to challenge the assertion) and, as such, the new legislation is required. This, unfortunately, adds considerable complexity to an already complex rule in this area.
All are not lost for the expenses that are denied deductions under the new rule as they may be included in the cost base of the vacant land for CGT purposes.
If you would like MKT to assist you in this area, please contact Peter Hong.