• Appendix 5: Capital works deductions and other tax offsets

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    Capital works deductions

    Division 43External Link of the ITAA 1997 provides for a system of deducting capital expenditure incurred in the construction of capital works used to produce assessable income.

    Capital works

    You can deduct construction costs for the following capital works:

    • buildings or extensions, alterations or improvements to a building
    • structural improvements (such as bridges, retaining walls and sealed roads) or extensions, alterations or improvements to structural improvements
    • environmental protection earthworks - see also appendix 6.

    You must base deductions for construction costs and structural improvements on actual costs incurred. If it is not possible to genuinely determine the actual costs, provide an estimate by a quantity surveyor or other independent qualified person. The costs incurred by the trust for providing this estimate are deductible as a tax-related expense, not as an expense in gaining or producing assessable income.

    Who can claim?

    You can only claim a deduction under Division 43 for an income year if the trust:

    • owns, leases or holds part of a construction expenditure area of capital works ('your area')
    • incurred the expense, or is an assignee of the lease or holder who incurred the expense, and
    • uses your area to produce income.

    In calculating the trust's deduction, identify your area for each construction expenditure area of the capital works. Your area may comprise the whole or part of the construction area.

    Lessee or holder of capital works

    You can claim a deduction for an area leased or held under a quasi-ownership right by the lessee or holder. To claim a deduction, the lessee or holder must have:

    • incurred the construction expenditure or be an assignee of the lessee or holder who incurred the expenditure
    • continuously leased or held the capital works area itself, or leased or held the area that had been so held by previous lessees, holders or assignees since completion of construction, and
    • used the area to produce assessable income.

    If there is a lapse in the lease, the entitlement to the deduction reverts to the building owner.

    Requirement for deductibility

    A trust can deduct an amount for capital works in an income year if:

    • the capital works have a 'construction expenditure area'
    • there is a 'pool of construction expenditure' for that area, and
    • it uses the area in the income year to produce assessable income in the way set out in section 43-140External Link of the ITAA 1997.
    No deduction until construction is complete

    You cannot claim a deduction for any period before the construction of capital works is complete even though the trust used them, or part of them, before completion. Additionally, the deduction cannot exceed the undeducted construction expenditure for your area.

    Capital works are taken to have started when the first step in the construction phase starts, for example, the pouring of foundations or sinking of pilings for a building.

    Establishing the deduction base

    Expenditure for the construction of capital works is deductible if there is a construction expenditure area for the capital works. Whether there is such an area and how it is identified depends on:

    • the type of expenditure incurred (only construction expenditure, see below, is deductible under Division 43External Link of the ITAA 1997)
    • the time the capital works started
    • the area of the capital works to be owned, leased or held by the entity that incurred the expenditure, and
    • for capital works begun before 1 July 1997, the area of the capital works that was at the time of completion intended to be used in a particular manner, see section 43-90External Link of the ITAA 1997.
    Construction expenditure

    Construction expenditure includes:

    • preliminary expenses, such as architect's fees, engineering fees, foundation excavation expenses and costs of building permits
    • costs of structural features that are an integral part of the income-producing building or income producing structural improvements, such as lift wells and atriums
    • some portion of indirect costs.

    For an owner/builder entitled to a deduction under Division 43 of the ITAA 1997, the value of their contributions to the work (labour or expertise and any notional profit element) do not form part of construction expenditure - see TR 97/25External Link Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements and addendum.

    Construction expenditure does not include expenditure on:

    • acquiring land
    • demolishing existing structures
    • clearing, levelling, filling, draining or otherwise preparing the construction site before carrying out excavation work
    • landscaping
    • plant
    • property or expenditure for which a deduction is allowable or would be allowable if the property were to be used for producing assessable income under another specified provision of the ITAA 1936 or the ITAA 1997.
    Construction expenditure area

    The construction of the capital works must be complete before the construction expenditure area is determined. A separate construction expenditure area is created each time an entity undertakes the construction of capital works.

    For construction expenditure before 1 July 1997, the capital works must have been constructed for a specified use at the time of completion, depending upon the time when the capital works started.

    The first specified use construction time was 22 August 1979, see table 43-90External Link and subsection 43-75(2)External Link of the ITAA 1997. No deduction is available under Division 43 of the ITAA 1997 for capital works which were begun on 21 August 1979 or earlier - see subsection 43-20(1)External Link of the ITAA 1997.

    Pool of construction expenditure

    The pool of construction expenditure is the portion of the construction expenditure incurred by an entity on capital works which is attributable to the construction expenditure area.

    Deductible use

    You can only claim a deduction under this Division if the trust uses your area in a way described in table 43-140External Link or 43-145External Link of Subdivision 43-D of the ITAA 1997.

    Special rules about uses

    Your area is taken to be used for a particular purpose or manner if:

    • it is maintained ready for that use, is not used for another purpose, and its use has not been abandoned
    • its use has temporarily ceased, for example, because of construction or repairs, or seasonal or climatic conditions.

    Your area is not accepted as being used to produce assessable income:

    • if it is a building (other than a hotel or apartment building) used for exhibition or display in connection with the sale of all or part of any building, where construction began after 17 July 1985 but before 1 July 1997. If construction started after 30 June 1997, buildings that are used for display are eligible
    • if it is a building (other than a hotel or apartment building) where the construction began after 19 July 1982 and before 18 July 1985 and which is used or available for use wholly or mainly:  
      • for, or in association with, residential accommodation, and it is not a hotel or apartment building
      • for, exhibition or display in connection with the sale of all or part of any building, or the lease of all or any part of any building for use wholly or mainly for, or in association with, residential accommodation and is not a hotel or apartment building or an extension, alteration or improvement to such a building
       
    • to the extent that the trust or an associate uses part of it for residential accommodation and it is not a hotel or apartment building, for exceptions to this rule, see subsection 43-170(2)External Link of the ITAA 1997.

    Your area is taken to be used wholly or mainly as, or in association with residential accommodation, if it is:

    • part of an individual's home (other than a hotel or apartment building)
    • a building (other than a hotel or apartment building) where construction began after 19 July 1982 and before 18 July 1985, and used as a hotel, motel or guest house.

    Special rules for hotels and apartments are contained in section 43-180External Link of the ITAA 1997.

    Calculation and rate of deduction

    The entitlement to a deduction begins on the date your area is first used to produce assessable income after construction is completed. The first and last years of use may be apportioned. The entitlement to a deduction runs for either 25 or 40 years (the limitation period) depending upon the rate of deduction applicable.

    The legislation contains two calculation provisions:

    Capital works begun before 27 February 1992 and used as described in table 43-140

    Calculate the deduction separately for each part that meets the description of your area.

    Multiply the construction expenditure by the applicable rate (either 4% if the capital works began after 21 August 1984 and before 16 September 1987 or 2.5% in any other case) and by the number of days in the income year in which the trust owned, leased or held your area and used it in a relevant way. Divide that amount by the number of days in the year.

    Apportion the amount if your area is used only partly to produce assessable income.

    The amount claimed cannot exceed the undeducted construction expenditure.

    Capital works begun after 26 February 1992

    Calculate the deduction separately for each part of capital works that meets the description of your area.

    There is a basic entitlement to a rate of 2.5% for parts used as described in table 43-140External Link (current year use). The rate increases to 4% for parts used as described in table 43-145External Link (use in the 4% manner).

    Undeducted construction expenditure

    The undeducted construction expenditure for your area is the part of the construction expenditure the trust has left to write off. Use it to work out the:

    • number of years in which the trust can deduct amounts for its construction expenditure, and
    • amount that the trust can deduct under section 43-40External Link of the ITAA 1997 if your area or a part of it is destroyed.
    Balancing deduction on destruction

    If a building is destroyed or damaged during an income year, you can claim the remaining amount of undeducted construction expenditure that has not yet been deducted, less any compensation received. This applies even if the destruction or demolition is voluntary.

    You can claim the deduction in the income year in which the destruction occurs.

    The deduction is reduced where the capital works are used in an income year only partly for the purpose of producing assessable income.

    For guidelines on these measures, see TR 97/25External Link and addendum.

    Infrastructure borrowings

    The previous infrastructure borrowings tax concession, which was introduced in 1992 to facilitate private sector investment in certain publicly accessible infrastructure projects, was closed to new projects from 14 February 1997. The provisions relating to the concession are contained in Division16LExternal Link of the ITAA 1936, and Chapter 3 of the Development Allowance Authority Act 1992External Link.

    The lender's interest and amounts in the nature of interest on infrastructure borrowings are not assessable. Alternatively, the lender may choose to be assessed on the amounts and to claim a tax offset of 30%. The borrower's interest and amounts in the nature of interest on the infrastructure borrowings are not deductible. In addition, any profit on the disposal of an infrastructure borrowings instrument is non-assessable and any loss is non-deductible.

    The replacement land transport infrastructure tax offset in Division 396External Link of the ITAA 1997 is a more restricted concession, it is a tax offset on the taxable interest of a resident lender to an approved infrastructure project. The offset is calculated by applying the general company tax rate to the lender's assessable interest, but may be subject to an upper limit set by the Minister for Infrastructure and Transport.

    If the lender's interest is subject to a tax offset, the project borrower cannot claim a deduction for a comparable amount of interest.

    Last modified: 13 Aug 2014QC 28037