The Treasury Laws Amendment (2019 Tax Integrity and Other Measures No. 1) Bill 2019 was introduced to Parliament on 24 July 2019. One significant measure of the Bill is the introduction of proposed legislation to limit deductions for losses or outgoings incurred in relation to holding vacant land.
The Bill was passed by the House of Representatives on 31 July 2019 and is now before the Senate.
In the Minister’s second reading speech, Assistant Treasurer Michael Sukkar indicated that the proposal was an integrity measure which would deny deductions for expenses for some taxpayers who hold vacant land.
Mr. Sukkar indicated the purpose of the legislation was to tighten the link between claiming deductions and earning assessable income. The catalyst for the change being that historically, some taxpayers were claiming deductions for expenses incurred in holding vacant land on the basis they were holding the land for a taxable purpose (e.g. future development of rental property) when there was no substantive evidence the taxpayer had an intention to use the land to generate assessable income.
On scrutiny, the proposed legislation will deny deductions for expenses incurred in holding vacant land unless:
- The land is used or held ready for use by the taxpayer in the course of a business, the taxpayer holding the land carries on for the purpose of gaining or producing assessable income; or is
- Used or held available for use in carrying on a business by
- An affiliate, spouse or child (under the age of 18 years) of the taxpayer holding the land; or
- An entity that is connected with the taxpayer or of which the taxpayer is an affiliate in carrying on a business.
Essentially, the proposed legislation will limit deductions for expenses incurred in holding vacant land unless the land is used or held for use in carrying on a business, either by the taxpayer or a closely related entity.
If the taxpayer uses or holds ready for use, the land for the derivation of passive income, then the legislation in its current form will deny the taxpayer a deduction for any expenses incurred in earning that assessable income.
These changes will apply to any losses or outgoings incurred on or after 1 July 2019 (regardless of whether the applicable land was acquired before 1 July 2019).
Exemptions for Negative Gearing of Vacant Lands
There are limited exemptions to the proposed change, we note the amendments will not apply to corporate tax entities, superannuation plans (other than self-managed superannuation funds), managed investment trust or public unit trusts. The amendments will also not apply to unit trusts or partnerships of which the members are entities of the aforementioned types.
In the Explanatory Memorandum (EM) to the Bill, Treasury acknowledged that leasing of land to related parties in the agricultural sector was common and stated the inclusion of a special rule for related parties would ensure the amendments would not adversely impact primary producers.
However, the special rule does not appear to adequately cover all common leasing arrangements within farming families. Many primary producers or holders of farmland may find they will be denied a deduction for expenses incurred in holding the land (and earning assessable leasing income) purely because the particulars of their family structure do not fall within the special rule.
The EM is also silent on situations where a primary producer or other landholder leases vacant land for a taxable purpose to an unrelated party. In this scenario, taxpayers who lease vacant land for a taxable purpose, say to a neighbouring farmer to use for crops or agistment, may be denied a deduction for any expenses incurred in earning the assessable lease income, unless they can demonstrate they are carrying on a business of leasing land. If the land is held purely for derivation of passive income, the taxpayer will be denied a deduction for losses or outgoings incurred in earning that income.
Common negative gearing of vacant land scenarios that may fall outside the ‘special rule’ include:
The scenarios highlighted above are very common in the agricultural sector and as demonstrated in the table above, a deduction for expenses incurred in earning assessable lease income in each of these scenarios would be denied under the proposed change.
More complex family structures, for example where multiple family members carry on a primary production business as a partnership, will add an even greater layer of complexity where individuals or entities within the family group enter into separate lease agreements for the use of vacant farmland by the partnership.
This could result in a situation where some taxpayers who lease land to the partnership for use in the farming business are eligible for a deduction and others are denied the deduction, despite the land being used for the same purpose.
Vacant Land - Residential Property
Under the proposed legislation, a special rule will also apply for land that contains residential premises.
The special rule will deny a deduction for any expenses incurred in relation to holding land containing residential premises until the premises can be legally rented and the taxpayer is actively seeking to derive income from the property as residential premises.
So, irrespective of how soon the taxpayer commences the construction of the residential premises, the proposed legislation will deny any deductions for holding costs until such time the construction is complete and the property is on the market for rent.
A property developer who carries on a business of property development, however, will not be denied a deduction for expenses incurred in carrying on a business of property development. This contrasts with the application of the proposed legislation to an individual taxpayer who undertakes a one-off project; for example, of subdividing a block and building a property on the vacant land for rent or resale. In this scenario, the individual taxpayer will be denied a deduction for similar costs incurred unless the taxpayer can demonstrate they are carrying on a business of property development, rather than the mere realisation of a capital asset.
Oversight or Intention
We question whether proposed legislation has been drafted with the intention of denying deductions for expenses incurred in holding assets that earn passive income or whether this is simply incorrect drafting. We hope the Federal Government will acknowledge the above-mentioned scenarios are unintended and take immediate steps to rectify the proposed legislation.
If it is the Federal Government’s intent to deny taxpayers deductions incurred in earning assessable income related to vacant land, will there be more to come? The true intent to deny deductions incurred in relation to passive investment assets is questionable and could spell the beginning of the end for negative gearing.
For more information
We strongly recommend taxpayers who may be impacted by the proposed change contact their local RSM office for further information. Alternatively, they may wish to seek clarification on the impact of the proposed change from their local Member of Parliament or Senate Representative.