House of Representatives

Taxation Laws Amendment Bill (No. 5) 1992

Taxation Laws Amendment Act (No. 5) 1992

Income Tax (Dividends and Interest Withholding Tax) Bill 1992

Income Tax (Dividends and Interest Withholding Tax) Amendment Act 1992

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)

Environment Protection Expenditure

Summary of proposed amendments

Purpose of amendment: Environment protection expenditure incurred by a business may not qualify for deduction. This Bill will amend the Income Tax Assessment Act 1936 (the Act) to:

·
allow a deduction for certain environment protection expenditure incurred by a taxpayer carrying on an income-producing activity, where the expenditure is incurred on or after 19 August 1992; and
·
allow property used for certain environment activities to be treated as if used for producing assessable income (so that depreciation or other amortizing deductions will be available). [New section 82BH]

The deduction will be available to taxpayers for certain environment expenditure in relation to pollution or waste:

·
resulting from a taxpayer's income-producing activity or on a site used for that income-producing activity; .
produced by a taxpayer's own income-producing business, whether before the taxpayer became the owner of the business or while they own it;
·
likely to result from a proposed income-producing activity of the taxpayer or on a site that will be used for that activity.

If a deduction for the cost of environment activities is allowable under another provision of the Act, the cost will not be allowable environment expenditure.

Date of effect: 19 August 1992.

Background to the legislation

Environment protection expenditure that is necessarily incurred in the course of producing assessable income or carrying on a business for that purpose is an allowable deduction under section 51 of the Act. Depreciation on plant and equipment and amortization of buildings and structures which have an environment function and are used for the purpose of producing assessable income is also deductible under the existing law.

However, some environment expenditure of a taxpayer who carries on an income-producing activity may be incurred before the income-producing activity or business commenced or after it has ceased, or it may be of a capital nature. It is therefore not deductible.

In many cases the law requires that such environment activities be carried out. Even where not required to do so by law, many businesses will undertake environment activities. The amendments proposed by this Bill will ensure that allowable environment expenditure, whether capital or current, will be deductible.

Explanation of proposed amendments

A new Subdivision will be inserted in Division 3 of the Income Tax Assessment Act 1936 to allow a deduction for allowable environment expenditure . [Clause 25.]

This is expenditure, whether capital or current, incurred for the sole or dominant purpose of an eligible environment activity . In summary, it is expenditure incurred for the sole or dominant purpose of:

·
preventing, combating or rectifying pollution of the environment; or
·
treating, cleaning up, removing or storing waste.

In order to be eligible for the deduction, a taxpayer must have carried on, carry on or propose to carry on an income-producing activity . This includes any business or investment activity (such as leasing out a site) which is carried on by the taxpayer in order to earn assessable income.

The pollution or waste may result from the income-producing activity or be on the site or proposed site of that activity. Where the site is a source of pollution of other sites, the deduction is also allowable for expenditure to clean up those sites. A taxpayer is also eligible to clean up a site on which a predecessor of the taxpayer carried on a business activity . So, a taxpayer who buys a business and carries on the same business as the predecessor but on a new site, is eligible for a deduction for expenditure to clean up the old site of the business on which the predecessor, whether immediate or otherwise, carried on the business.

The deduction does not depend on whether expenditure is mandatory, nor does it treat expenditure as allowable environment expenditure just because it is mandatory. The deduction is only available to the extent that expenditure is for an eligible environment activity.

The deduction is not available for bonds and security deposits. Nor is it available for depreciable expenditure on plant, or the cost of acquiring land, or the capital cost of constructing or altering buildings, structures or structural improvements.

Instead, items of property which are used for eligible environment activities will be taken to be used for producing assessable income. This means that plant and equipment used for eligible environment activities will be depreciable in the usual way under section 54 of the Act. Capital costs of buildings, structures and structural improvements used for eligible environment activities will be able to be amortised under Division 10C or Division 10D of the Act.

Amendments will be made to Division 10D of the Act to enable the capital cost of environment earthworks (permanent earthworks constructed for environment purposes) to be amortised as if such earthworks were buildings [Clauses 26 and 27].

The provisions are discussed in more detail below.

Allowable environment expenditure

Allowable environment expenditure incurred on or after 19 August 1992 will qualify for deduction in the year of income in which the expenditure is incurred.

The deduction will be allowable from income derived from any source and will be a "non-loss" deduction under section 79E. So, any losses may be carried forward indefinitely in the normal way [New section 82BK]. The deduction will operate in the same way as a deduction under section 51 of the Act and will be subject to the same general limitations; see Limits on the Deduction below [New subsection 82BK(2)].

Allowable environment expenditure includes capital or current expenditure for the sole or dominant purpose of carrying on one or more eligible environment activities. [New subsection 82BL(1)]

However, it does not include depreciable expenditure [New subsection 82BN(2)] . Nor does it include the cost of land, construction, or bonds and securities for the performance of eligible environment activities [New subsection 82BN(1)]. Depreciation of plant, and amortization of the capital cost of buildings, structures and structural improvements, are allowed for these items where used for eligible environment activities; this is discussed in more detail below.

Expenditure will only be for the sole or dominant purpose of carrying on an eligible environment activity if it is primarily directed to that environment protection activity. A deduction will not be available if the protection of the environment is only a residual or subsidiary purpose of the taxpayer [New paragraph 82BL(1)(a)].

For example, suppose a taxpayer who operated a dump covers it with soil and plants it with grass and trees at the end of its life. This might have the dual purposes of protecting the environment by preventing noxious substances leaching out and beautifying the site to improve its resale value. If the landscaping is primarily to improve the resale value of the site it will not be deductible as allowable environment protection expenditure.

Expenditure for the sole or dominant purpose of carrying on an eligible environment activity is only deductible to the extent that it is in respect of that activity. Expenditure for the dominant purpose of carrying on an eligible environment protection activity will be apportioned so that only that portion of the expenditure on the eligible environment protection activity will be deductible [New paragraph 82BL(1)(b)].

For example, a company buys a polluted site for a manufacturing plant. The company tests for contaminants across the whole site and finds one quarter of it is polluted. It removes all the contaminated soil, leaving a large hole. It then brings in fresh soil to fill in the hole and also to level the rest of the site, which is slightly uneven.

The cost of testing for contaminants and removing the contaminated soil will be fully deductible. These expenditures are for the sole or dominant purpose of cleaning up waste, an eligible environment activity, and are incurred entirely for that activity. The dominant purpose of bringing in fresh soil to the site is to fill in the hole where there was contamination. This is part of the waste clean-up. However, a part of this expenditure was on soil to level the rest of the site. The expenditure on bringing in fresh soil is allowable environment expenditure only to the extent that it is for the purpose of filling the hole where there was contamination.

Eligible environment activity

An eligible environment protection activity of a taxpayer is an environment protection activity of the taxpayer that relates to an income-producing activity of the taxpayer.

Environment protection activities may prevent, combat or rectify pollution, or may treat, clean up, remove or store waste.

Income-producing activities include the carrying on of a business to earn assessable income, or investments for the same purpose.

The environment protection activities must be related to the income-producing activities in one of five possible ways:

(i)
the pollution or waste has resulted or is likely to result from the income-producing activity of the taxpayer; [New subparagraphs 82BM(1)(a)(i) and (b)(i)]
(ii)
the pollution or waste is on a site on which the taxpayer carried on, carries on or will carry on the income-producing activity; [New subparagraphs 82BM(1)(a)(ii) and (b)(ii)]
(iii)
the source of pollution or waste is a site on which the taxpayer carried on, carries on or will carry on the income-producing activity; [New subparagraphs 82BM(1)(a)(iii) and (b)(iii)]
(iv)
the pollution or waste is on a site on which the predecessor, whether immediate or otherwise, of the taxpayer carried on a business activity; [New subparagraphs 82BM(1)(a)(iv) and (b)(iv)]
(v)
the source of the pollution or waste is a site on which the predecessor, whether immediate or otherwise, of the taxpayer carried on a business activity. [New subparagraphs 82BM(1)(a)(v) and (b)(v)]

If expenditure is incurred on environment protection activities where the pollution or waste is not a result of the taxpayer's income-producing activity or linked to its site, no deduction will be allowable except in the limited situations (iv) and (v) above; see Site on which the predecessor of the taxpayer carried on a business activity below.

A deduction will be allowable for expenditure incurred on an eligible environment protection activity where the activity is only partly complete. For example, the cost of treatment of only some contaminants on a site will be deductible. Similarly, a deduction is allowable where only part of a site is the subject of eligible activity. An activity need not prevent, combat or rectify all pollution to be undertaken to prevent, combat or rectify some pollution; and an activity need not treat, clean up, remove or store all waste to be undertaken to treat, clean up, remove or store some waste.

The environment protection activity may be carried out by or on behalf of the taxpayer. [New subsection 82BM(1)]

Environment protection activity

An environment protection activity is an activity undertaken to either:

·
prevent, combat or rectify pollution of the environment; [New paragraph 82BM(1)(a)] or
·
treat, clean up, remove or store waste. [New paragraph 82BM(1)(b)]

pollution of the environment

Environment is not limited to the natural environment but includes all aspects of the environment including the demographics of a community. It has the same meaning as in the provisions relating to expenditure on environmental impact studies (section 82BA), based on the broad definition used in the environment (Impact of Proposals) Act 1974 . [New section 82BJ]

pollution has its ordinary common sense meaning. Pollution will include contamination by harmful or potentially dangerous substances such as explosive chemicals and greenhouse gases, and will include noise pollution. It will also include contamination by elements which once may not have been considered to be pollutants but which are now so considered because more is now known about their effects, for example asbestos and controlled foreign companies.

Although eyesores are sometimes loosely referred to as visual pollution, pollution does not include merely presenting an unattractive or unappealing appearance.

Preventing, combating or rectifying pollution of the environment will not include merely improving the aesthetics of a site, although eyesores are sometimes loosely referred to as visual pollution. It also will not include removing a structure no longer used by the taxpayer. The removal of a redundant structure because it is unattractive or is likely to collapse will not be an environment protection activity. However, if the structure is contaminated or it is removed to enable pollution under it to be rectified, the removal may be an environment protection activity.

Work of a preventive nature such as the removal of underground storage tanks because they may leak and cause loss or injury to a future owner or user of the site will be an environment protection activity.

Waste

Waste has its ordinary common sense meaning. The treatment, clean up, removal or storage of waste will include any operation which leads to resource recovery, recycling, reclamation, direct re-use or alternative uses of waste at any stage of an industrial process. It will also include any means of disposing of waste such as landfill, storage, chemical conversion and incineration.

income-producing activity

This is defined broadly. It will encompass all business activities that are carried on for the purpose of generating income. Investment activities undertaken for the purpose of generating assessable income will also be income-producing activities for environment protection purposes. However, an investment made for the purpose of producing a capital gain when the investment is realised will not be an income-producing activity. [New section 82BJ]

Income from a passive investment, such as leasing a site, is treated under existing law as income from property and not as an income-producing activity conducted on the site. Under the amendments, a taxpayer who earns income from leasing a site which he or she owns, or from granting a right (or anything similar) to use a site which he or she owns or controls, will be taken to be carrying on an income-producing activity on that site. The taxpayer will be entitled to a deduction (or depreciation) for environment activities. So a landlord may claim deductions for expenditure on environment activities. [New subsection 82BM(2)]

For example, a taxpayer runs a small business repairing cars from her backyard. She also owns a small block of four flats by the beach which she rents out except for one which she uses herself. Both the car repair business and the renting of the flats would be income-producing activities for environment purposes.

A taxpayer who proposes to carry on an income-producing activity must have a real intention to carry on this activity. Evidence of this intention includes actions of the taxpayer such as expenditure on buying a site for the business, advertising, establishing goodwill and developing an infrastructure. Where a taxpayer who does not go on with a venture because of a change in circumstances has incurred expenditure on eligible environment activities associated with that venture, those costs will be allowable environment expenditure. [New subparagraphs 82BM(1)(a)(i) and (b)(i)]

pollution or waste resulting from an income-producing activity

Where an income-producing activity results or has resulted in pollution or waste, eligible environment activities will not be limited to the site on which the income-producing activity was or is carried on. The deduction will be available for environment activities carried out wherever they are needed. [New subparagraphs 82BM(1)(a)(i) and (b)(i)]

For example, an industrial plant accident pollutes a lake downstream from the plant. The taxpayer who carries on the industrial activity cleans up the pollution in the lake. The pollution has resulted from the income-producing activity of the taxpayer and therefore the cost of the clean-up will be allowable environment expenditure.

Site or proposed site of an income-producing activity

The site of an income-producing activity is the site which is used for that activity. It need not be owned by the taxpayer who carries on the activity. A site which is leased out or over which a licence or other right is granted by a taxpayer for the purpose of producing assessable income is a site of an income-producing activity of the taxpayer. So more than one taxpayer may use, or propose to use, a site to carry on an income-producing activity. [New subsection 82BM(2)]

Environment protection expenditure incurred on only one part of a site which a taxpayer uses for an income-producing activity will be allowable, as the definition of site includes part of a site. [New section 82BJ]

The deduction will be allowable whether the site was used in the past for the taxpayer's income-producing activity, is presently being used, or is proposed to be used in the future. [New paragraphs 82BM(1)(a)(ii), (iii) and (b)(ii), (iii)]

The cost of acquiring a site will not be deductible as allowable environment expenditure. A taxpayer must hold an interest in a proposed site of an income-producing activity before the taxpayer can carry out an eligible environment protection activity on that site. Particular costs may be deductible under other provisions of the income tax law, however. [New subsection 82BN(1)(a)]

Pollution of or waste on a site

Tests carried out by a taxpayer to see if a site is contaminated and to discover the nature of the contaminants for the purpose of deciding what environment action to take will be environment activities. The cost of these will be deductible where the necessary link with the taxpayer's income-producing activity exists. [New subparagraphs 82BM(1)(a)(ii) and (b)(ii)]

Pollution or waste sourced on a site

Pollution or waste which is widespread may have its source on a site used by a taxpayer for an income-producing activity. For example, chemicals in the soil of the site of a taxpayer's business may have leached into other sites. The taxpayer will be entitled to a deduction for expenditure incurred in cleaning up those other affected sites. A taxpayer will also be entitled to a deduction for measures taken on the site of his or her income-producing activity to prevent pollution of other sites, for example an emergency dam wall. [New subparagraphs 82BM(1)(a)(iii) and (b)(iii)]

More than one person may be in a position to carry out an eligible environment protection activity on a particular site. Of course, a deduction will only be available to the person who actually incurs the clean-up expenditure. For example, A may earn assessable income from leasing a site. The tenant, B, may earn assessable income from a business conducted on that site. If the site is polluted already or if pollution of the site results from the business conducted by B, either A or B will be able to carry out eligible environment activities to clean up the site. [New section 82BM]

Site on which the predecessor of the taxpayer carried on a business activity

Where a taxpayer acquired his or her business from a person who carried on that business on another site, the taxpayer will be eligible for a deduction for eligible environment activities in relation to pollution of or waste on the site on which the predecessor of the taxpayer carried on the business (the "old site"). The taxpayer will be eligible for the deduction whether the old site was used by the person who sold the business to the taxpayer (the immediate predecessor), or by a predecessor of that person. [New subparagraphs 82BM(1)(a)(iv) and (b)(iv) ]

Similarly, the taxpayer will be eligible for a deduction for eligible environment activities in relation to pollution or waste sourced on the old site of the business. [New subparagraphs 82BM(1)(a)(v) and (b)(v)]

This deduction applies in strictly limited circumstances. The taxpayer must be carrying on an income-producing activity, on a new site, which consists of the carrying on of a business by the taxpayer. This is narrower than the broad meaning given to income-producing activity in the rest of the amendments. Further, the business must have been acquired by the taxpayer from another person who carried on the business on the old site, or had a predecessor in the business who did so. [New paragraphs 82BM(3)(a), (b), (c)]

Apart from the change of site, the taxpayer's business must be the same, or substantially the same, as that carried on by the predecessor (or, as the case requires, the predecessor's predecessor) - the person who carried on the business on the old site. Evidence of this will include where the taxpayer carries on the same activities as the predecessor, using assets and goodwill purchased from the predecessor, and operates under the same business name. [New paragraph 82BM(3)(d)]

For example, B acquires a textile business called Cloth Co. from A. B continues to operate Cloth Co. but on a different site from the one A used. The old site of Cloth Co. is polluted by chemicals that were used in the textile business. B is entitled to a deduction for allowable environment expenditure incurred cleaning up the old Cloth Co. site.

Suppose C then acquires Cloth Co. from B and continues to operate it on the new site. C is also eligible for a deduction for cleaning up the old Cloth Co. site.

Expenditure on plant, equipment, buildings, structures and structural improvements

Plant, equipment, buildings, structures and structural improvements used for eligible environment activities will be treated as if they had been used for the purpose of producing assessable income. [New subsection 82BR(1)]

Depreciation of plant and equipment

Expenditure incurred on plant or equipment used by a taxpayer for eligible environment activities will not be deductible as allowable environment expenditure in the year of income in which it was incurred. [New subsection 82BN(2)]

However, expenditure incurred on or after 19 August 1992 on such plant or equipment will be depreciable under section 54 of the Act as if the property was used for the purpose of producing assessable income of the taxpayer. [New subsection 82BR(1)]

Amortization of buildings and structures

Capital expenditure on constructing buildings, structures and structural improvements which are used by a taxpayer for eligible environment activities will not be deductible as allowable environment expenditure in the year of income in which it was incurred. Similarly, a deduction will not be allowed (as allowable environment expenditure) for expenditure on extensions, alterations or improvements to these items. [New paragraphs 82BN(1)(b) and (c)]

Buildings, structures and structural improvements used on or after 19 August 1992 for eligible environment activities will be taken to be used to produce assessable income of the taxpayer. Expenditure on acquiring or constructing such property on or after 19 August 1992 will qualify for amortization under section 54, Division 10C (traveller accomodation) or Division 10D (capital improvements on certain buildings and structural improvements) of the Act if the other requirements of those provisions are satisfied. [New subsection 82BR(1)]

This applies to structural improvements which are earthworks that are reasonably likely to require replacement, cannot be economically maintained for an indefinite period, or are integral to the construction of a building.

The same treatment will be accorded expenditure on extensions, alterations or improvements to a building, structure or structural improvement incurred for environment purposes. [New subsection 82BR(1)]

For example, a new, specially designed filter is added to a factory chimney to filter out solid particles to prevent pollution. The filter, as an item of plant or a structural improvement, will be depreciable in the normal way.

Deductions for depreciation and amortization are limited by any provision of the Act that expressly provides that a particular use of property is not to be taken to be for the purpose of producing assessable income. [New subsection 82BR(2)]

environment earthworks

An environment earthwork is an earthwork which is constructed as the result of carrying out an eligible environment protection activity, is permanent and is not integral to the construction of a building. [New subsection 124ZFC(1)]

Unlike the earthworks discussed above, environment protection earthworks are earthworks that are not reasonably likely to require replacement, can be economically maintained in reasonably good order and condition for an indefinite period, and are not integral to the construction of a building. They therefore do not qualify for amortization under the existing law (section 124ZFB).

An environment earthwork will be amortized under Division 10D as if it were a building. [New subsection 124ZFC(2); subsection 124ZF(1)]

Expenditure incurred on or after 19 August 1992 on the construction or extension, alteration or improvement of an environment earthwork will be eligible for amortization. [New subsection 124ZFC(3)]

For example, a permanent earth embankment constructed to prevent noise pollution from an industrial plant will be amortized over 40 years.

Where an earthwork is actually part of a process of waste treatment or clean-up, it will still be deductible in the year of income in which the expenditure was incurred.

For example, the cost of treating contaminated soil by piling it in mounds, controlling the temperature and moisture content and introducing bacteria capable of digesting the contaminant (later placing the treated soil elsewhere) will be allowable environment expenditure. This is because such work is not considered to produce a structural improvement. [New subsection 82BN(1)]

Repairs

Repairs to plant or equipment used in an eligible environment activity will be deductible in the year of income in which the cost is incurred. The cost of replacing a worn part of an item of plant or equipment with its modern, environmentally friendly equivalent will be deductible as a repair (section 53). However, where the replacement amounts to an improvement to the plant or equipment it will be depreciable at the relevant rate because the property is used for an eligible environment protection activity.

Record-keeping requirements

There are no specific record-keeping requirements in the amendments. Taxpayers will be expected to maintain the records necessary to demonstrate that expenditure is incurred for environment purposes.

Most taxpayers will maintain records for their own purposes of types and levels of pollution or waste which result from their business activities, and of the methods and costs of dealing with these emissions. These could be used to substantiate a claim for deduction of allowable environment expenditure.

Where a taxpayer proposes to carry on an income-producing activity, the taxpayer should have records of the types and quantities of pollution or waste likely to result and of the mechanisms and plant needed to control or manage this pollution or waste. These records could be used to substantiate claims for pollution prevention measures or waste management expenses incurred before commencement of the income-producing activity.

Bonds and security deposits

Environmental bonds or securities of any description deposited or paid by a taxpayer will be excluded from deduction under the amendments. [New paragraph 82BN(1)(d)]

Therefore, if a company is required by a government authority to contribute a sum of money to a fund for environmental disasters, this payment will not qualify as allowable environment protection expenditure. It may in some circumstances be deductible under another provision of the Act.

Compensation payments for environmental damage will not qualify as allowable environment expenditure under the amendments. Such payments may be deductible in certain circumstances under another provision of the Act.

Limits on the Deduction for Allowable Environment Protection Expenditure

Provision of last resort

Deductions for expenditure on environment activities that would qualify for deduction under any other provision of the Act will be allowable under that provision and not under the amendments. For example, the cost of an environment protection activity which is also expenditure necessarily incurred in carrying on a business will qualify for deduction under section 51 of the Act and not under new Subdivision CA. [New subsection 82BL(3)]

Expenditure on a study to determine, for example, the quantity and type of pollutants which will be produced from a process used in a proposed business may qualify as allowable environment expenditure. Such expenditure may also be environmental impact expenditure. In this case, it will be deductible over 10 years or the life of the project under Division 3 Subdivision C of the Act, and will be excluded from allowable environment expenditure. [New subsection 82BL(2)]

Limits on Section 51

Where a provision of the Act limits the operation of section 51, the provision will also apply to limit the operation of new Subdivision CA. [New subsection 82BK(2)]

For example, certain costs which would be deductible under the environment measures may be associated with a leveraged lease arrangement between the taxpayer and a tax-exempt body. If these costs were deductible under section 51 of the Act, the deductions would be prevented or restricted by section 51AD. This limitation will also apply to environment expenditure under the amendments.

Recoupment

Where a taxpayer receives or becomes entitled to receive:

·
a grant to carry out eligible environment activities; or
·
any recoupment for expenses incurred on eligible environment activities,

then no deduction will be allowable for the expenditure if the grant or recoupment is not included in the taxpayer's assessable income. [New subsection 82BP(1)]

The test as to the extent to which a payment constitutes a recoupment or grant in respect of allowable environment expenditure is an objective test. [New subsection 82BP(2)]

An amendment can be made at any time to disallow a deduction previously allowed to the taxpayer where a grant or recoupment is made. [New subsection 82BP(3)]

Transactions not at arm's length

Where a deduction under the amendments arises from a transaction under which the taxpayer and another party are not dealing at arm's length and the amount of the expenditure incurred is not reasonable, the deduction will be limited to the amount which would have been incurred had the parties been dealing at arm's length. [New section 82BQ]

For example, if a manufacturing company engages a related company to clean up a site polluted by the manufacturing process and pays double the usual rate because the related company is in financial difficulties, the deduction allowable to the manufacturing company will be limited to the amount which would be reasonable had the parties been trading at arm's length.


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