Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Capital Expenditure on Industrial Buildings
Summary of proposed amendments
8.1. The capital cost of buildings, or extensions, alterations or improvements to buildings, used in industrial activities is to be deductible at the rate of 4 per cent per annum.
8.2. The amendment will apply where construction commenced after 26 February 1992.
Background to the legislation
8.3. The effect of the amendment is to modify Division 10D to allow deductions at the higher rate of 4 per cent per annum when a building is used for certain industrial purposes. The following summarises how Division 10D operated before the changes made by this amendment.
8.4. Capital expenditure on constructing buildings, or extensions, alterations or improvements to buildings, for use in producing assessable income, is evenly deductible over 40 years at the rate of 2.5 per cent per annum under Division 10D of the Act. The concession also applies to income-producing residential buildings and buildings for use in research and development activities.
8.5. Division 10D first applied to non-residential buildings commenced to be constructed after 19 July 1982. The concession was subsequently extended to residential buildings commenced to be constructed after 17 July 1985 and then to buildings for use in research and development activities commenced to be constructed after 21 November 1987.
8.6. The present rate of deduction is 2.5 per cent per annum.
8.7. However certain buildings commenced to be constructed after 21 August 1984 and before 15 September 1987 are deductible at the rate of 4 per cent per annum.
8.8. Entitlement to deductions rests with owners, including certain lessees, of buildings, or parts of buildings, for which there is an amount of qualifying expenditure. Qualifying expenditure represents the capital cost of constructing a building, or extension, alteration or improvement to a building, but does not include the cost of property for which deductions are available under another provision of the Act (for example, plant depreciation).
8.9. The cost of a building includes certain preliminary costs such as architects fees, engineering fees, buildings permits, etc. and the cost of excavating foundations. It does not include the cost of land and site clearing and levelling, nor landscaping.
8.10. Associated facilities such as carparks, driveways, fences, etc. do not qualify as they are not part of a building. However, they may qualify for deduction at the rate of 2.5 per cent per annum if constructed after 26 February 1992. [See chapter 9 on amendments relating to structural improvements, contained in this Bill].
8.11. An entitlement to deductions commences on the date of first use of the building for any purpose after completion of construction and terminates 40 years later. On a change in ownership of a building, the residual entitlement passes to the new owner.
8.12. Deductions are only available for periods during which the building is used in the prescribed manner (that is, used in either producing assessable income or research and development activities) and are calculated as 2.5 per cent per annum of the amount of qualifying expenditure. Deductions may be reduced when only part of a building is used in the prescribed manner.
8.13. In the event of the destruction of a building, a deduction is available to the extent that any compensation received for the destruction is less than the amount of qualifying expenditure remaining for deduction. A precondition for a deduction is that, if the building was not used in producing assessable income at the time of destruction, its last use was in that manner. Similar rules apply on a partial destruction of a building.
Explanation of proposed amendments
8.14. As mentioned above, the effect of the amendment is to modify Division 10D so that the higher rate of 4 per cent per annum will be available to the extent that buildings are used in eligible industrial activities. Generally speaking, the existing rules under Division 10D will continue to apply. The following explains how those rules are to be modified to give effect to the measure.
Eligible industrial activities
8.15. The higher rate will apply to the extent that the income-producing use of a building, whether by the owner or another person, is in an eligible industrial manner. [New section 124ZFA]
8.16. Use in an eligible industrial manner means use that is wholly or principally for eligible industrial activities and in the provision of certain facilities for use by persons wholly or principally employed in such activities. [New subsection 124ZFA(2)]
8.17. Eligible industrial activities encompass manufacturing operations and a number of other activities which might not otherwise be considered manufacturing. [New subsection 124ZFA(3)]
8.18. The concept of eligible industrial activities begins with manufacturing processes. These are processes involving the manufacture of goods including processes necessary to the manufacture of goods provided as a service to a manufacturer by another person. For example, an upholsterer who receives car seats from a vehicle manufacturer for upholstering and return would be involved in eligible industrial activities. [New sub-subparagraph 124ZFA(3)(a)(i)(A)]
8.19. Similarly, processes involved in finishing or maintaining manufactured goods for sale, whether by the person who manufactured those goods or another person, are eligible. So a taxpayer who receives manufactured goods for painting or some other finishing process would be involved in eligible industrial activities, as would a taxpayer providing cold storage for perishable products. [New sub-subparagraph 124ZFA(3)(a)(i)(B)]
8.20. The meaning of eligible industrial activities extends to operations involving the processing of primary products, such as metals, petroleum, wool, timber, meat and fish, milk and other foodstuffs. Printing and similar activities are also included as is the production of energy either for sale or for use in manufacturing and related activities. [New subparagraphs 124ZFA(3)(a)(ii) to (xiii)]
8.21. A number of other activities also qualify when conducted by taxpayers in connection with their eligible industrial activities: packing, placing in containers, or labelling of goods; disposal of waste substances from operations; cleansing or sterilising storage facilities for raw materials and processed goods; assembly, maintenance, cleansing, sterilising or repair of property used in operations; and storage of raw materials, work-in-progress and finished goods at or next to the place of manufacture. [New paragraph 124ZFA(3)(b)]
8.22. Excluded is the preparation of food and drink in hotels, restaurants, and similar retail outlets [New paragraphs 124ZFA(3)(c) to (h)]. However food and drink preparation in factories and breweries, respectively, will qualify.
8.23. The higher rate will apply to the extent to which a building is used in an eligible industrial manner. If a building is only partly used in the prescribed manner at a particular time, the higher rate will only apply in relation to the portion of the qualifying expenditure in respect of the building that is attributable to the part used in the prescribed manner. [New subsection 124ZH(2A)]
8.24. For example, a taxpayer conducting both manufacturing and retailing activities in a single building would be entitled to the higher rate in respect of the part used in manufacturing. That would require an apportionment of the qualifying expenditure in relation the building between the two uses. No deduction is available for any part of a building that is not used in producing assessable income.
8.25. In instances where eligible industrial activities and other activities are conducted in the same area, the dominant activity will determine whether the higher rate will apply. For example, an upholstery business may be involved in both finishing off manufactured goods (which is an eligible industrial activity) and repair work (which is not). Unless those activities were performed in discrete areas of the workshop, the use of the workshop as a whole would be determined by the dominant activity. [New paragraph 124ZFA(2)(b)]
8.26. If there are two or more owners of separate parts of a building, any qualifying expenditure in relation to the building is apportioned to the various parts. Deductions in respect of each share are separately calculated according the respective circumstances of use, in the manner described above.
8.27. The total amount of deductions allowable cannot exceed the amount of qualifying expenditure in relation to that building. That is achieved by specifying that a deduction in a year in relation to an amount of qualifying expenditure must not exceed the amount of residual capital expenditure in relation to the amount of qualifying expenditure at the beginning of the year or, if the building was acquired during the year, immediately after the time of acquisition. [New subsection 124ZH(3A)]
8.28. That method of setting the limit on deductions is a change from the existing rules which specify a fixed period for which deductions are available; for example 40 years at 2.5 per cent per annum. That is not appropriate now that the rate of deduction can vary according to circumstances of use and so vary the time over which deductions ought to be available.
8.29. As described above, residual capital expenditure is relevant for determining the total amount of available deductions. It is also relevant for calculating any deductible loss on the destruction of a building - see paragraph 8.13 above.
8.30. In essence, the amount of residual capital expenditure in relation to an amount of qualifying expenditure at a particular point in time is the excess of the amount of qualifying expenditure over the sum of deductions allowed or that would have been otherwise allowable during periods when the relevant building was not used for income-producing purposes [New subsection 124ZF(11A)].
8.31. Reflecting that the rate of deduction may vary according to the circumstances of use of a building, the calculation of residual capital expenditure requires a determination of the periods of time during which a building was used in an eligible industrial manner and periods when not so used, commencing from the time when the building was first used for any purpose.
8.32. For periods during which a building is used in an eligible industrial manner, the relevant amount of qualifying expenditure is reduced at the rate of 4 per cent per annum of that amount, reflecting that deductions have been allowed at that rate.
8.33. During periods in which a building is not used in an eligible industrial manner, whether it is used for another income-producing purpose or not, the relevant amount of qualifying expenditure will be reduced at the rate of 2.5 per cent per annum of the amount of qualifying expenditure.
8.34. Where a building is only partly used in an eligible industrial manner at a particular time, the portion of the qualifying expenditure that relates to the part of the part used in the prescribed manner will be reduced at the rate of at 4 per cent per annum and the balance at 2.5 per cent per annum.
8.35. In instances where different parts of a building are owned by different taxpayers, a separate calculation is to be made of the amount of residual capital expenditure applicable to each part. That is to be done by apportioning the amount of qualifying expenditure in relation to the building between the various parts and then applying the above rules.
8.36. A person selling a building, or a lease of a building, to which this amendment applies needs to pass on sufficient information to the purchaser which will enable the purchaser to know how Division 10D will apply to the purchaser's holding of the building. The same rule applies to disposals of a part of a building.
8.37. That requirement would be satisfied by specifying the amount of qualifying expenditure and residual capital expenditure in relation to the building or part of the building. Without that information, a purchaser would not know what deductions were available.
8.38. That information must be given within 6 months of the end of the year of income in which the disposal occurs. The purchaser must retain that information for 5 years after the earlier of the purchaser ceasing to be the owner of the building or the destruction of the building. So a purchaser will be able to pass on the necessary information if they in turn dispose of the building. [New subsections 262A(4AH) and (4AJ)]
Commencement date
8.39. The amendment applies to buildings, or extensions, alterations or improvements to a building, commenced to be constructed after 26 February 1992.
Construction of a new building or an extension is taken to commence at the time of commencement of work on the foundations; for example, the excavation of foundations or sinking of pilings.
Clauses involved in proposed amendment
Clause 47(a): inserts a number of definitions into subsection 124ZF(1) which facilitate the principal amendments to be made.
Clause 47(b): amends the existing definition of residual capital expenditure, subsection 124ZF(11), so that it only applies where construction commenced before 27 February 1992.
Clause 47(c): inserts new subsection 124ZF(11A) which specifies how residual capital expenditure is to be calculated where construction commenced after 26 February 1992.
Clause 48: inserts new section 124ZFA which defines the meaning of "eligible industrial manner" and "eligible industrial activities".
Clause 49(a): amends subsections 124ZH(1) and (2) so that the existing method of calculating deductions applies only where construction commenced before 27 February 1992.
Clause 49(b): inserts new subsection 124ZH(2A) which specifies how deductions are to be calculated where construction commences after 26 February 1992.
Clause 49(c): amends subsection 124ZH(3) so that the existing rules for limits on deductions only apply where construction commenced before 27 February 1992.
Clause 49(d): inserts new subsection 124ZH(3A) containing the new rule regarding limits on deductions.
Clause 50(a) & (b): amend paragraph 124ZJ(2)(a) (dealing with reductions of deductions on destruction of buildings) to reflect the new requirement that residual capital expenditure is to be calculated separately in respect of each part of a building that is owned by different persons. The amendment does not change the effect of that provision.
Clause 51(a) & (b): make minor consequential amendments to section 124ZK (which deals with deductions on the destruction of buildings) to reflect the new method of calculating residual capital expenditure. The effect of that provision is not changed by the amendments.
Clause 52: inserts new subsections 262A(4AH) and (4AJ) containing the record keeping requirements.