The Australian Taxation Office (ATO) has released draft taxation ruling TR 2021/D5 which considers the ATO’s view on non-deductible expenses associated with vacant land. From 1 July 2019, certain taxpayers are denied a tax deduction for outgoings in relation to vacant land unless the land is used in a business, or another exclusion applies. Deductions which are denied by the operation of these provisions include interest expenses, council rates, land taxes and maintenance costs. Importantly, certain entities are not impacted by these provisions including (but not being limited to) companies and managed investment trusts.
What’s vacant land?
Vacant land is land on which there is no substantial or permanent structure. TR 2021/D5 provides the ATO’s view on when there is a substantial structure on land, and it appears their view is fairly generous based on the following example:
12. Jamilla owns a 100-hectare block of farmland on a single title that includes an established house previously used as a manager's residence. The house is currently vacant but is capable of being occupied.
13. The house is a substantial and permanent structure with an independent purpose that is not incidental to the purpose of any other structure. It enables someone to live on the land and oversee farming activities.
14. Subsection 26-102(1) does not apply to deny a deduction for the holding costs in relation to the land as the land is not vacant. This is the case, even though the area that contains the home is minimal compared with the farming land. |
The example above is simplistic because the land in on one title and issues may arise in case there are multiple titles. The ruling states that where land is held under separate multiple titles, you need to determine whether the land under each title is vacant. If we were to vary some of the facts in the example above - if the house and the surrounding 10 hectares were on one title but the remaining 90 hectares were on separate titles, it is likely that the remaining 90 hectares may be considered vacant if there are no other substantial structures and therefore the individual would miss out on the deductions associated with those 90 hectares.
Residential property owners beware
For residential properties:
- The premises are deemed not to be a substantial and permanent structure if the premises are not legally available for occupation; or
- Whilst the premises can lawfully be occupied, they are not rented or otherwise available for rent.
Accordingly, care must be taken where a property is demolished or substantially renovated as it is likely that deductions will be denied until the property is available for occupation and made available for rent. This is highlighted in the following examples of the ruling:
Example 3 - demolishing an established house
19. Arun purchased an established house which he has used as a rental property for several years. On 1 July 2019, he decides to demolish the existing house to build a townhouse. The tenants vacate the property in October 2019. The house is demolished in December 2019. The property was in use or available for use until the date of demolition. Any holding costs that Arun may otherwise be entitled to deduct until the property was demolished would not be limited by section 26-102.
Example 4 - existing residential premises that are not in use or available for use are demolished
20. Continuing on from Example 3 of this Ruling, the tenants vacate the property in October 2019 because the residential premises has been declared by the local council as being structurally unsafe to occupy. Arun demolishes the property in December 2019. Any holding costs that Arun would otherwise be entitled to deduct from October 2019 when the residential premises were not legally able to be occupied would be limited by section 26-102 as the house is not 'in use or available for use'. |
Costs associated with constructing a rental property are not impacted by these provisions. For example, if an individual borrows money to buy land and build the rental property, they will be allowed to claim interest on the build component of the loan in the year incurred. Whereas interest on the land component would only be deductible when the property can lawfully be occupied and is made available for rent.
Business exclusions
Vacant land used to carry on business activities are not denied deductions under these provisions. This may be the case where the landowner is:
- using the land to carry on a business in their own right (e.g. property development); or
- using the land to carry on a business in an entity they are connected or affiliated with under tax law; or
- leasing the land under an arm's length to another entity and that land is used or available for use by that entity in carrying on a business or for primary production.
Where the land is leased under an arm’s length arrangement to another entity, the ATO expect the landowner to consider the following in determining whether the other entity carries on a business:
- whether the lessee has an active Australian business number
- whether the lessee is registered for goods and services tax
- whether the lessee requires a tax invoice or receipt for lease payments
- the lessee's stated intention regarding use of the land - using the land for primary production is likely to indicate that the lessee is carrying on a business
- the amount of the lease payments - nominal or sub-commercial rates may indicate that the lessee is not in business
- the terms of a formal lease agreement may be an indicator that the lease is commercial in nature, and therefore more likely that the lessee is carrying on a business, and
- where the lessee is an entity of the type that is referenced in subsection 26-102(5), this may indicate that the lessee is in business.
Concluding remarks
The denial of deductions has had a major impact on how taxpayers structure land acquisitions and taxpayers are now having to weigh up the pros and cons of owning property in their own names or through another structure such as a company. Certain taxpayers (e.g. individuals and trusts) may have access to the 50% CGT discount but may lose a deduction for the ongoing costs of owning vacant land. Whereas companies owning the same land may be entitled to tax deductions for the costs of ownership but will not have access to the 50% CGT discount.
With corporate tax rates reducing to 25% for some companies, the impact of not having access to the 50% CGT discount may be negligible but nevertheless, this is a number crunching exercise. Furthermore, any funds extracted from a company via dividend would lead to taxation at the shareholder level at their relevant marginal tax rates. Other issues such as asset protection, transfer duty, land taxes and compliance costs would also have a bearing on the ultimate choice of ownership structures.
More information
If you would like further information or assistance in understanding vacant land deductions, contact your local Moore Australia advisor today.
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