RSM Australia

Farmers set to lose tax deductions for vacant land

Farmers are set to lose tax deductions for vacant land – despite calls to Government to change the proposed legislation.

The Government provided assurances “…farmers will be fully protected from any unintended consequences of the bill”
RSM has reviewed the amendment to the Treasury Laws Amendment (2019 Tax Integrity and Other Measures) Bill 2019 and say otherwise!

The Treasury Laws Amendment
(2019 Tax Integrity and Other Measures) Bill 2019

On Tuesday, 16 October 2019, the Senate passed the Treasury Laws Amendment (2019 Tax Integrity and Other Measures) Bill 2019 with an amendment.  As the Bill has been passed with amendments introduced in the Senate, the Bill will return to the House of Representatives for the amendments to be accepted before the Bill can pass and receive Royal Assent. 

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One of the significant amendments to the Bill related to Schedule 3, the amendment was introduced in response to concerns raised by tax experts and the Senate Economics Legislation Committee. 

Schedule 3 of the original Bill introduced measures to limit deductions relating to vacant land, the purpose of the legislation was to prevent taxpayers from claiming deductions, where there was no real intention to use the property to generate assessable income. 

Unfortunately, drafting issues in the original Bill had the effect certain taxpayers, primary producers, in particular, would be denied deductions against assessable income, even where the land was used for a taxable purpose


A greater layer of complexity

Despite the best intentions of the Government, the amendments have added an even greater layer of complexity to the legislation.

As a result, it introduces yet another hurdle for primary producers -the residential premises requirement. 

Under the bill passed by the Senate, an entity that holds land available for use in a primary production (or other) business,  will be denied a deduction for losses and outgoings incurred in holding the land (e.g. interest, land tax, shire rates, water rates) against assessable income earned relating to that property unless one of the following ‘special rules’ are satisfied:

  • Section 26-102 (2) ‘special rule’ for affiliates, connected entities and children under the age of 18;
  • The special rule for land held by primary producers (includes residential property exclusion);
  • The special rule for land leased at arms-length (includes residential property exclusion). 

For typical farming families, passing the criteria under the section 26-102 (2) ‘special rule’ will pose a significant challenge, particularly where the land is owned by parents (or an entity controlled by them), and leased to an adult child (or an entity controlled by them) as the terms affiliate and connected entity do not take on their ordinary and natural meaning. In the context of this legislation, typical structures used in farming families are unlikely to satisfy the affiliate or connected entity test​. 

However, under this provision, deductions will be denied if a residential property either exists on the land or is being constructed on the land.  This additional requirement was not part of the original Bill, it was introduced in the Senate as part of the amendment and completely ignores the fact, farmers and their staff, may live on the land. 

Whilst we understand what the Government may have set out to achieve, they have fallen well short as the ‘residential property’ requirement ignores the fact the property may be leased as part of the overall agreement, that is, the taxpayer who leases the land receives lease income in relation to the land as a whole, including the residential property. 


Applying the Provision

It is our understanding the intention of this provision it is to prevent a deduction for costs incurred in holding land, where the land is used for a private or domestic purpose, but the amendment does not take into account, residential premises on farmland may be vacant, may be provided to a farm manager or where the land is leased or the lessee may live in one of the properties situated on the land. 

These scenarios are very common in the rural sector and appear to have been ignored by the amendments to the legislation. 

Residential property situated on farmland can have a very different use to residential property located in a suburban area.

As mentioned previously, the inclusion of the residential property exclusion where land is leased to an arms-length party appears to ignore the fact the lessee is receiving rental income for the property.

So we potentially have an absurd result where a taxpayer who owns residential property on a suburban lot (say 380 sqm) is able to claim a deduction for losses and outgoings incurred against income earned from renting the property, yet on strict reading of the legislation, a farmer who owns say, a 100 ha lot of land, which happens to contain a residential property, may be denied a deduction for ANY costs incurred in holding the land purely because there is a residential property located on the land.

This can not be the intention of the legislation as it clearly puts primary producers at a disadvantage, in fact, it has the result of treating primary producers as a special class of taxpayer who potentially, may be specifically denied deductions against assessable income, even where the lease arrangement is arms-length and the land is held for a taxable purpose.  

Tax practitioners will need guidance from the Australian Taxation Office (‘ATO’) in order to determine exactly how the ‘residential property’ exclusion will apply, particularly where the property is leased as part of the overall arrangement for the lease for vacant farmland. 

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According to the supplementary Explanatory Memorandum released with the amendment to the Bill, the reason for denying a deduction where land including a residential property is leased to an arm’s length party, or is held by a primary producer for use in a primary production business,

land being used for residential purposes is distinct from land that is usually held in connection with a primary production business.  It also presents particularly integrity risks as residential premises can readily be used for private purposes in addition to being available for rent…”

...this statement demonstrates a clear lack of understanding of how land in primary production businesses is used.  More often than not, the ‘house block’ will be a substantial area of land used primarily for grazing or crops, it will not be a distinct and separate ‘residential’ area of land, similar to a town block.


The amendment to the Bill

Vacant land

The amendment to the Bill also ignores the scenario where a taxpayer is unable to lease farmland, either at arms-length or to a related party, because of natural disaster or exceptional circumstances. 

The amendment provides for a situation where a ‘substantial structure’ is destroyed due to natural disasters (beyond the reasonable control of the taxpayer). However, where there was no substantial structure, deductions will not be allowed where vacant land is unable to be used because of drought or flood. 

Whilst this is unlikely to have an impact where the land is held by a primary producer, it may have an impact where: 

  • The land is owned by a retired farmer (or entity they control) and they are unable to lease the land.
  • The land is leased to a related party who does not satisfy the special rule under s 26-102 (2) and the land is no longer able to be leased under an arm’s length lease arrangement. (e.g. where a ‘lease’ holiday is provided, or commercial terms waived due to financial difficulty).

For more information

To demonstrate the impact of this legislation on farmers, we summarise below common scenarios where farmers may be denied deductions for losses and outgoings incurred in earning assessable income relating to vacant land.

 

This Bill, and the amendment introduced in the Senate, should never have been passed in its current form and taxpayers and their advisers will face uncertainty until, at the very minimum, the ATO releases guidance on how the legislation is to be interpreted and applied. 

Even then, some taxpayers may find themselves in a very difficult situation if the ATO interpretation of the legislation does not extend to the taxpayers individual set of facts and circumstances, keeping in mind the ATO can only interpret and advise on how they will apply the legislation, errors in drafting must be corrected by Parliament.

RSM will continue their efforts to have the legislation changed.  If you are unsure of how the legislation will impact you, please contact your local RSM office or trusted tax adviser.

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