From 1 July 2019, a tax deduction will not be allowed for expenses associated with holding vacant land. These denied deductions will not be allowed to carry forward for a later income year. Also, the expenses will not be allowed to be included in the cost base for capital gains tax purposes. 

Current treatment

The deductibility of interest expenses under the general deduction provision in ITAA 1997 s 8-1 has been the subject of much litigation. A majority of the High Court concluded in Steele v DFCT 99 ATC 4242 that interest incurred during the construction phase of a development when no income is being derived is of a revenue (not capital) nature, and so potentially deductible. This means that an income tax deduction may be allowable for interest borrowed to construct an income-producing asset, such as a block of flats or a factory, even where the interest is paid during the construction period when no income is being derived from the project.

Also, the third element of the cost base of an asset is the costs of owning the asset, as long as the asset was acquired after 20 August 1991.

Costs of owning an asset consist of any expenditure incurred by a taxpayer to the extent to which it is incurred in connection with the continuing ownership of the asset. These costs include interest on money borrowed to acquire an asset, costs of maintaining, repairing and insuring an asset, rates and land tax, interest on money borrowed to refinance the money borrowed to acquire an asset, and interest on any money borrowed to finance capital expenditure incurred to increase an asset's value.

Proposed new treatment

The 2018 Budget announcement states that any expenses relating to vacant land are not deductible and cannot be added to the asset's cost base. This measure will apply to land held for residential or commercial purposes. However, the "carrying on a business" test will generally exclude land held for commercial development.

Under the proposal, the expenses relating to holding costs will only become deductible where:

·         a property has been constructed on the land, it has received approval to be occupied and is available for rent, or

·         the land is being used by the owner to carrying on a business, including a business of primary production.

Risk mitigation steps

This announcement shows the intention of the government to stimulate the construction of buildings in a timely manner. Also, it significantly reduces the tax incentives for "land banking", which is an investment strategy to purchase and hold land until such time as it is re-zoned for construction purposes.

For clients who are holding land in this manner, or are preparing to commence a construction project, timing is of crucial importance. As the measure is only intended to commence from 1 July 2019, a window of 13 months exists for construction to get underway and completed.

Despite these future detriments to constructing buildings for rent or sale, it should not be a complete deterrent where large gains could be made. However, adjustments to investment calculations should be factored into future decision making.

Information sourced using CCH iknow