• The impact of this case on ATO policy is discussed in Decision Impact Statement: Alcoa of Australia Ltd (Published 21 May 2009).

ALCOA OF AUSTRALIA LTD v FC of T

Members:
A Sweidan SM

Tribunal:
Administrative Appeals Tribunal, Perth

MEDIA NEUTRAL CITATION: [2008] AATA 1128

Decision date: 16 December 2008

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A Sweidan (Senior Member)

1. The applicant operates an aluminium smelter at Point Henry, Victoria. The process of producing aluminium requires the use of carbon anodes. The applicant manufactures its own carbon anodes in an anode bake furnace on the site. In about 2006 the applicant began the Baked Anode Sustainability Project (the project) at its works at Point Henry. The project had several components including the demolition and rebuild of the refractory in the anode bake furnace, and refurbishment and upgrade of the fume scrubber in the furnace. The respondent has made a private ruling that part only of the costs incurred in the project would be deductible as incurred for repairs under s 25-10 of the Income Tax Assessment Act 1997.

RELEVANT LEGISLATION

INCOME TAX ASSESSMENT ACT 1997, SECTION 25-10

2. Section 25-10 of the Income Tax Assessment Act 1997 provides:

• (1) You can deduct expenditure you incur for repairs to premises (or part of premises) or a depreciating asset that you held or used solely for the purpose of producing assessable income.
• (2) If you held or used the property only partly for that purpose, you can deduct so much of the expenditure as is reasonable in the circumstances.
• (3) You cannot deduct capital expenditure under this section.

3. The section replaced s 53 of the 1936 Income Tax Assessment Act. The wording of s 25-10 is generally a restatement of the same ideas expressed in s 53 of the 1936 Act, and authorities on the earlier section are relevant.

4. Section 25-10 when enacted referred to expenditure incurred for repairs to "plant, machinery, tools or articles." In 1998 it was amended to refer only to plant. In 2001, as part of the new tax system amendments, "depreciating asset" was substituted for "plant." A depreciating asset is "an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used" (s 40-30).

HISTORY

THE POINT HENRY BAKE FURNACE

5. On the basis of the respondent's analysis of the material provided by the applicant, the respondent says the following background facts emerge. There is no dispute in this regard.

6. The bake furnace was constructed in 1990. There were repairs in 1995, 1997 and 2003: see at T 207-208. The general working of the bake furnace is summarised in the statement of relevant facts in the objection decision at T2, 3-5, paragraphs 1 to 12 and further reference to this is made below.

7. In 2006, the bake furnace was "reaching the end of its operating life and …unable to meet baked anode supply requirements, both quantity and quality, to satisfy the current Potroom demand" with "critical status" reached by the end of 2007 (at T16, 235.4). The typical practice for a furnace of this design is to rebuild it every 15 years. The Pt Henry furnace was 17 years old by the end of 2007 (at 235.6).

8. The fume scrubber (including the waste gas ductwork) was assessed in 2006 as requiring "complete refurbishment and upgrade" with the most efficient method "to replace the majority of the fume scrubber and to allow sufficient spare capacity to perform the majority of maintenance while on line…" (at 235.9).

THE BAKED ANODE SUSTAINABILITY PROJECT

9. The project had several components that were the subject of separate tender specifications. They include:

• 9.1 Furnace Tub Remediation and extension;
• 9.2 Decommissioning, demolition and removal of existing furnace refractory;
• 9.3 Rebuild of furnace refractory;
• 9.4 Civil, road works and underground services - including furnace tub extension and building extension; and
• 9.5 Supply of a new starter burner ramp;

THE REBUILD OF THE REFRACTORY

10. The applicant described the project in internal documents as to "rebuild the sole anode baking furnace in Building 262 at the Pt Henry Smelter." (Pt Henry Bakes Rebuild, Request for Authorisation - Executive Summary at 219.1 - emphasis added). The furnace refractory was described as "at the end of its useful life," with the fume scrubbing system in need of "major overhaul."

11. The applicant compared the cost of continuing to produce at Pt Henry (i.e. cost of overhaul and capital works, including extension of the existing furnace tubs) with purchase of anodes from an external supplier. The extension of the furnace tubs was to allow the furnace to operate sustainably on a 24 hour firing cycle. Otherwise the applicant estimated that the baking furnace's efficient operating life was to the end of 2007 (at 220.7). The improvements to the scrubbing system and the addition of the extra sections in the extended tub would ensure that a 24 hour firing cycle could be maintained (at 220.9). The improvements also offered benefits for future maintenance programs (at 221.1).

12. Through 2006, the applicant issued tender specifications for various components of the project. These included:

• 12.1 In May 2006, the applicant issued a tender specification for "Furnace Tub Remediation Works Building 262, Bakes Sustainability Project" (see T3 at 17). The Introduction to the specification document states that the Furnace "has reached the end of its serviceable life and requires a rebuild to extend the life of the facility." The applicant sought tenders for the supply, fabrication, delivery and installation of items for work including the carrying out of remediation works to the reinforced concrete furnace tub structure (T3 at 22). The tender specifications did not include decommissioning, demolition and removal of the existing furnace refractory. That work was to take place prior to the work required under the contract. The applicant was to directly undertake refractory demolition and removal and installation of new refractory materials in the furnace tub (T3 at 21 and 33).
• 12.2 In about June 2006, the applicant issued specifications for tender for refractory installation (T4 at 64). The applicant stated that it was "undertaking a project to rebuild the existing anode baking furnace in building 262. The rebuild involves the complete demolition of the furnace refractory to the concrete tub and installation of new refractory" (at 68, see also at 86, 87). Part 2 of the Specifications is headed "Works Included" and includes that the contractor will:
  • 12.2.1 determine if the installation methodology will involve pre-building of fluewalls and top sections of headwalls;
  • 12.2.2. install tub floor mortar as a base for laying floor insulation bricks;
  • 12.2.3 lay floor insulation bricks;
  • 12.2.4 install side wall insulation;
  • 12.2.5 install cross over headwalls;
  • 12.2.6 construct centre headwalls;
  • 12.2.7 construct fluewalls;
  • 12.2.8 lay pit floors;
  • 12.2.9 place precast burner blocks;
  • 12.2.10 cast flue caps;
  • 12.2.11 cap headwalls;
  • 12.2.12 seal walls and clean up

  The works did not include demolition of the existing refractory.

• 12.3 The applicant issued a further tender specification, "Specification for Point Henry Carbon Bakes Dense Refractory Bricks" (T28 at 353). Again it states in its introduction that the Anode Baking Furnace is intended to be rebuilt in entirety (at 358.1).

13. The rebuild of the refractory was to be conducted at about the same time as patching of the concrete tubs, and extension of the concrete tubs at the north end of the furnace (see at 86). The overall works are described (at 86.9) as "within a definite sequence of events to progressively rebuild the furnace/equipment and star[t]-up of furnace operations."

14. The applicant:

• 14.1 entered a contract in December 2006 for the manufacture and supply of Dense Refractory Brick for Carbon Bake. The contract amount was varied in January 2007 to $9,616,092.72 (at T6-T8, 144-148, 149-153); and
• 14.2 entered a contract in December 2006 for the installation of refractory items as set out in the tender specification (at 154-174). The contract amount was $18,673,200.

THE FUME SCRUBBER SYSTEM

15. The scrubber works were described as "a complete overhaul and upgrade". It was intended to produce energy saving from improved fan design and also meet EPA requirements (see at T16, 223, 224).

16. The applicant describes the works to the scrubber and ductwork at T31, 417. There are several items described as capital expenses. Among those treated as expense items are:

• 16.1 replacement of 3 induced fan drafts with 3 fans - two of which replace the capacity of the current 3 fans. A third standby fan to allow for system maintainability is treated as capital;
• 16.2 replacement of 3 existing filter cells. An additional cell is treated as capital;
• 16.3 waste gas ductwork refurbishment, although there is again an upgrade component treated as capital.

DEPRECIATION

17. The applicant does not treat the Bake Furnace as a single item for depreciation for accounting purposes. It breaks the components down and depreciates them on a "line by line" basis. There is no single line item for the refractory. The various components of the refractory are classed under the heading "furnace2."

ISSUE

18. The issue for the Tribunal is whether the respondent has correctly ruled that two categories of proposed expenditure are not deductible under s 25-10 of the 1997 Act. Section 25-10 of the 1997 Act.

19. The two categories of expenditure are for:

• (a) the replacement/repair of brickwork, known as "refractory", which comprises the flue walls, head walls, side and floor insulation, and some other insulation in the applicant's Bake Furnace at its Point Henry Smelter; and
• (b) the replacement of waste gas ductwork.

20. The two categories of expenditure in question were to be incurred at a time when the applicant intended to incur other expenditure in connection with its Bake Furnace. Some of this further expenditure was considered by the applicant to be of a capital nature and therefore not to be deductible (in particular that concerning an extension of 4 sections to the 60 section Bake Furnace and the addition of a new filter cell to the scrubber - see below). The respondent has ruled that other items of the proposed expenditure, namely that to be incurred in the replacement of filter cells and fans in the scrubber, and in the replacement of the coke bin and the intercooler on the crane trolley, would be deductible. The characterisation of this further expenditure is not before the Tribunal.

THE NATURE OF THE REVIEW

21. The current dispute arises from an objection by the applicant to a Private Ruling given by the respondent on 31 July 2007. The objection was disallowed on 21 December 2007. As the decision which has been referred to the Tribunal for review is one disallowing an objection to a Private Ruling the Tribunal is concerned solely with the scheme as specified by the respondent. Although the respondent is entitled to consider additional information on objection; see s 359-65 of Schedule 1 to the Taxation Administration Act 1953 ("TAA"), the scheme in respect of the ruling remains unaltered. The Full Federal Court in
FC of T v McMahon (1997) 97ATC 4986 stressed that the role of the Tribunal is not a fact finding role. "The Tribunal must be limited to the facts as identified by the Commissioner in his ruling as constituting the arrangement". The process of reviewing an objection decision in respect of a Private Ruling is therefore not a process in which the Tribunal makes findings of fact. The facts are assumed by reference to the identified scheme.

22. The scheme in the present case is set out at pp 4-7 of the Ruling and at pp 1-5 of the Reasons for the Decision disallowing the objection. Of particular relevance are paras 13 and 14 of the specified scheme:

"13.The high temperatures used in the baking process have caused deterioration in the condition of the pits and the scrubber system over time. This deterioration has resulted in reduced thermal efficiency in the baking process thereby lowering the anode quality and reducing anode output due to the need for re-baking and increased scrap rates;

14. This has necessitated the proposed works expenditure to the Bake Furnace as follows:

• The replacement of the flue walls, head walls, side and floor insulation, pre-cast shapes, castable insulation and an insulating blanket. The flue walls and head walls have become bowed and deformed as a result of the high temperatures used during the baking process. This has caused increased scrap rates, poor efficiency and production rates;

• The replacement of the waste gas ductwork which connects the pits to the scrubber as it has become deformed due to fires inside the ducting; ..".

23. A further element of the scheme on which the ruling is based is that:

"The applicant has stated that the replacements for the items at paragraph 14 above will not be significantly different from the existing items and they consider that the replacement items will result in only minor and incidental improvements".

THE ROLE OF THE BAKE FURNACE

24. In order to understand whether the expenditure in question should be deductible under s 25-10 it is useful to have a general understanding of the nature and role of the applicant's Bake Furnace as explained in the applicant's submissions and the applicant's contentions that the expenditure is not capital.

25. The smelting process by which aluminium metal is produced is one of electrolytic extraction which converts alumina (Al₂O₃) into aluminium metal by separating the oxygen from the alumina.

26. The alumina is dissolved in a liquid salt bath through which an electrical current is passed via carbon anodes. As a consequence of the electrolysis the carbon bonds with the oxygen in the alumina to form CO₂, leaving aluminium (Al). The chemical equation for the reaction is:

2Al₂O₃ + 3C → 4Al + 3CO₂.

27. The carbon which bonds with the oxygen comes from the carbon anodes which are progressively used up in the process. After about 22 days some 85% of each anode has been consumed in the process. The anodes are then taken out of the bath and replaced with new ones. They are manufactured at Point Henry by mixing pitch with carbon, including the 15% left on the used anodes, which is recycled. The green anodes are then baked in the Bake Furnace.

28. The main item of proposed expenditure in dispute between the parties relates to the cost of replacing bricks, known as "refractory", which line the inside of the Bake Furnace in which the anodes are baked. The respondent claims that the bricks when used to replace the worn refractory constitute a separate principal capital asset, so the cost of replacing them is a capital outlay. The applicant asserts that the respondent may have misunderstood the nature of the refractory, which the applicant says is simply a name for a type of material (the bricks) that are an integral part of the furnace. Reference to the relevant materials before the Tribunal and particularly the photographs seems to the Tribunal to support this assertion. The expenditure incurred in relation to the refractory was incurred in replacing the bowed and deformed brickwork and is therefore according to the applicant a repair to the Bake Furnace which is on revenue account.

29. The second category of expenditure is in respect of replacing gas ductwork through which waste gases are removed for treatment before release to the atmosphere. The ducts are also essential to the operation of the furnace as they enable the scrubber to draw the hot gases through the furnace.

30. There appears to be no dispute that the Works (see below) were necessary because of normal wear and tear of the Bake Furnace.

31. On the authorities the position seems clear that expenditure such as that presently under consideration will be on revenue account, and deductible, if it involves the periodic repair or replacement of defective components where the defects are a result of normal wear and tear in operation of an income-producing capital asset. The expenditure does not cease to be a repair or on revenue account if it involves the "replacement of worn-out parts by new parts". Nor does it matter if there is not precise repetition of the former material.

SUMMARY OF FURTHER FACTS ASSERTED BY APPLICANT AND NOT IN DISPUTE

32. The Point Henry site is extensive and houses a smelter, a port facility, a storage facility and the carbon bake furnace that is the subject of this proceeding, including the bake furnace scrubbing system ("the Bake Furnace").

33. The Bake Furnace comprises:

• (a) A long rectangular shaped building with support structures for two types of cranes - a General Purpose ("GP") crane and a Vacuum crane.
• (b) Two large underground pits (or tubs) which are separated by a centre wall. These pits are built so that the tops of the pits are level with the floor of the building.
• (c) Each of these two tubs is divided into smaller pits by the use of refractory bricks. When the Bake Furnace is operational it is into these smaller pits that the anodes are placed for baking. The side walls to these pits are hollow and are known as "flue walls". The walls at the end of the pits are solid and known as "head walls".
• (d) There is half a metre of insulation around the inside of the two large below ground tubs (adjacent to the outside flue walls) and on the base of the pits to prevent the concrete that forms the tub from crumbling under the high temperatures. This insulation and refractory material is contained within concrete casing, which is referred to as the tub.
• (e) Firing systems and fans are located over the top of the pits to bake and cool the anodes.
• (f) A ducting system within the foundation connects the pits to the scrubber. The scrubber eliminates the particulates and unwanted gases generated through the baking process from being released into the atmosphere and creates the draw for the fires to bake the anodes.

34. The anode baking process involves gas fired heating of the pits to bake the anodes. A GP crane runs on overhead rails that run the length of the building and at a sufficient height above ground level and is used to place the anodes into the smaller refractory pits. Coke is packed around and on top of the anodes for sealing and insulation purposes.

35. There are four "fires" in the Bake Furnace. A "fire" consists of the following:

• (a) two cooling manifolds which supply air for cooling the newly baked anodes and preheated combustion air for the burning of gas and pitch volatiles;
• (b) four firing frames which inject natural gas into the flues where it burns using oxygen from the induced draft from the scrubber fans and the preheated combustion air from the cooling manifolds;
• (c) an exhaust manifold which directs the draft from the scrubber fans to the fire and extracts the waste gases from the fire and directs them to the scrubber;
• (d) a TOD (temperature, oxygen and draft controller) which controls the temperatures and flow rates in the flues by adjusting valves on the exhaust manifold.

36. The pits are heated with natural gas for a period of approximately seven days. Approximately every 24 hours the "fire equipment" is moved forward one section. This starts the preheating of a freshly loaded group of anodes and frees up one baked section of anodes ready for removal from the carbon bake.

37. Essentially, hot gas from the pits being fired is drawn through the next few sections of the pits to preheat the next batch of anodes before they are directly fired with natural gas. Air for combustion of the gas travels through the flues of previously fired sections, cooling these anodes whilst reheating the air. As the anodes are baking, volatile materials released from the anodes during the baking cycle are drawn into the flues. Once in the flues they burn, providing additional heat.

38. At the end of the baking process a vacuum crane, which travels the length of the building on overhead crane rails, removes the coke from the pits where the anodes have completed baking and cooling, and deposits the coke into a newly packed pit ready for baking. A GP crane then removes the baked anodes and replaces them with green or unbaked anodes to start the whole firing process again. The baked anodes are transferred by conveyors to the rodding area to be made up into rodded anode assemblies to be used in the electrolysis process.

OVERVIEW OF THE EFFECT OF THE OPERATIONS ON THE BAKE FURNACE

39. The high temperatures used in the baking process have caused the pits and the scrubber system to deteriorate over time. This deterioration has resulted in reduced thermal efficiency in the baking process, which has lowered the anode quality and reduced anode output due to the need for re-baking and increased scrap rates. The photo which is Appendix D to the application for a ruling clearly shows the warped and deformed flue walls and the deterioration of the head walls. The applicant asserts that the information in possession of the Commissioner demonstrated that the refractory within the Bake Furnace would as a consequence of ordinary wear and tear be subject to periodic replacement. Each pit is subject to about 25 heats per annum. The refractory in the flue walls needs replacing after about 150 heats while the refractory in the head walls need relacing after about 370 heats.The headwalls which were to be replaced had been subject to some 380 heats.

40. The repairs in respect of which the ruling was sought consisted of the following elements:

• (a) The replacement of the flue walls, head walls, side and floor insulation, pre-cast shapes, castable insulation and insulating blankets which have become bowed and deformed as a result of the high temperatures and sodium absorption used during the baking process. This has caused increased scrap rates, poor efficiency and production rates.
• (b) The replacement of the waste gas ductwork which connects the pits to the scrubber as it has become deformed due to fires inside the ducting.
• (c) The filter cells and fans in the scrubber were worn, which impacted the reliability of the scrubber and its capacity to extract fumes and particulates.
• (d) The coke bins on the vacuum cranes and part of the vacuum system components are warped and eroded therefore requiring replacement.

41. Items (a) and (b) in the preceding paragraph are collectively referred to in these Reasons as the "Works" and are the subject of dispute in this proceeding. The respondent has ruled that the expenditure in items (c) and (d) is deductible.

42. The applicant took photographs of the Bake Furnace on a daily basis while the repairs were being carried out. Ten of those photographs were provided to the respondent with the notice of objection to the Private Ruling and were tendered to the Tribunal.

43. The Tribunal notes in particular that photo 4 in Appendix B to the objection shows the old refractory material used to line the furnace being removed from the large pits which constitute the outer walls of the furnace. All of the furnace lining was removed and replaced with new refractory blocks. Photo 5 shows the two large pits which constitute the outer walls of the furnace with all the internal refractory walls removed. Photos 8, 9 and 10 show the new refractory blocks being installed in the two large pits to form the many smaller pits.

CONCRETE TUBS WERE TO BE SUBJECT TO ONLY MINOR REPAIRS

44. To understand the nature of the repairs and their relationship to the Bake Furnace it is important to note that the two large pits, or tubs, are constructed of hardened steel reinforced concrete. The walls are 380mm thick and about 5m deep. The floor of the tub is 800mm thick and constructed on a compacted crushed rock layer varying in depth from 0.5m to 1m. The tub floor and walls sit upon some 700 concrete piles which go to a depth of about 5m below the tub floor, ie about 11 metres below ground level. This shows the significance of the tubs which, subject to some minor repairs and an extension in length, remain unaltered by the work carried out. The repair work in large part involved the relining of these tubs with refractory material.

45. The Specifications for the work highlight this point. Paragraph 5.4 of Section 3 of the Specifications for the work provides as follows:

"The installation methods used by the Contractor shall not involve any damage or modification to the condition or integrity of the furnace concrete tub, centre walls or building infrastructure. The existing centre walls are constructed of pre-cast concrete that are bolted to the concrete foundation. The Contractor shall take care to ensure that the centre wall concrete panels are not knocked or damaged during installation."

Hence, the contractors were forbidden from altering the condition or integrity of the concrete tubs, which were merely subject to some relatively minor repairs.

46. The pits have also been extended by four sections, which required the building to be extended. The applicant acknowledged from the outset that this expenditure was capital in nature. The expenditure on the extension was not the subject of the ruling.

NATURE AND RELATIVE SIZE OF THE WORKS

47. The Works and the extension do not affect the capacity of the Bake Furnace. Upon completion of the work the Bake Furnace still processes the same number of anodes on a cyclical basis. While the expenditure on the extension and the additional filter cell in the scrubber was expected to allow for more regular maintenance to occur without disrupting the anode baking process, this expenditure is acknowledged as being on capital account. The scheme on which the ruling was given makes it clear that the replacement of the refractory and the duct work would simply restore the pits to their original condition and "will result in only minor and incidental improvements".

48. The estimated costs of the Works as outlined in the Private Ruling application were as follows:

49. 

Proposed expenditure	Cost
	$	$
Replacement of the flue walls, head walls and insulation
(i) Material cost:
• Dense bricks	$8.6m
• Insulation	$0.8m
• Transport & delivery	$1.9m
• Castables	$0.5m
• Blankets & ancillaries	$0.3m
• Pre-cast shapes
• Other bricks	$0.2m
	$1.7m
		$14m
Replacement of waste gas ductwork
• Replacement parts	$1.5m
• Replace gas mains and support supply	$1m
• Labour	$1m
		$3.5m
Filter cells and fan repairs
• Remove fans, parts and installation	$0.6m
• Cooling tower repairs	$3m
•Labour	$0.9m
		$4.5m
Repairs to cranes		$0.9m
Total		$47.1m*

* The estimate did not include ancillary costs (being overhead, storage costs etc), which were to be apportioned between capital expenditure and deductible repairs. There were also operational spares and pack material handling costs of $1m which related to the above repairs but were not specifically allocated at the time the private ruling application was made.

50. The estimated cost of reconstructing the Bake Furnace and all its components was approximately $204 million. This fact was part of the additional information obtained by the respondent before the objection was disallowed. The cost of the Works so far as they relate to the refractory (not including the extension) was $36.6 million. Therefore, as a proportion of the total estimated cost of rebuilding the Bake Furnace, the Works only comprise 18%.

51. From a tonnage perspective, the tub and the works referred to in paragraph 40(a) are constructed from 30,900 tonnes of materials, with the latter comprising only 11,500 tonnes of that material. This means that from a physical perspective, less than 38% of the mass of the material is being replaced. That is, more than 60% of the tub and structure materials remain untouched and this does not include the Bake Furnace building, waste gas ductwork, scrubber and other components. The waste gas ductwork is a relatively minor component.

RULING, OBJECTION AND DECISION ON OBJECTION

52. In the Private Ruling issued 31 July 2007 the respondent ruled that "the demolition and replacement of the flue walls, head walls side and floor insulation, pre-cast shapes, castable insulation and insulating blanket that are positioned within the concrete tub walls and floor is the reconstruction of the entirety". But the respondent also noted that an alternative view -

"is that the entirety consists of the flue walls, head walls, side and floor insulation, pre-cast shapes, castable insulation and insulating blanket, the centre wall and the concrete tub walls and floor. Under this view, the work to be undertaken is so substantial that it will represent a substantial reconstruction of the entirety."

53. By Notice of Objection dated 23 October 2007 the applicant objected to the Private Ruling. In the objection the applicant contended that the Bake Furnace is the entirety but also argued that if the respondent's alternative identification of the entirety is correct, the Works, to the extent they relate to refractory, would only represent less than 47% of the cost of the entirety.

54. By Notice of Decision dated 21 December 2007 the respondent disallowed the objection. The reasons given for disallowing the objection were again that the Works were capital in nature, on the basis that they involved the reconstruction of the entirety. The respondent again adopted the position that "the Refractory is an entirety" because it:

• "• Provides a useful function without regard to any other parts of the premises
• • Is separately identifiable as a principal item of capital equipment, and
• • Is not physically or functionally an inseparable part of the concrete tubs.

  The function of the pits formed by the Refractory is to be the receptacle for the baking process."

The respondent rejected the applicant's argument that the relevant entirety was either the Bake Furnace or the refractory in combination with the foundations, the pilings and the tub (even though the latter alternative was originally the respondent's suggestion).

55. One further matter the respondent relied on is that in its depreciation schedule the applicant calculated depreciation by applying different rates to a number of items within the refractory (which is designated "Furnace 2" in the depreciation schedule). Therefore, according to the respondent, the applicant considered that different depreciating assets exist not only within the Bake Furnace but also within the refractory.

56. In relation to the waste gas ductwork the respondent's position was that it is an entirety because it:

"1. Provides the useful function of transporting gases to the scrubber system without regard to any other parts of the premises, and

2. Is separately identifiable as a principal item of capital equipment".

TRIBUNAL'S FINDINGS

57. The only real issue in dispute between the parties is whether the expenditure on the Works is capital. The respondent contends that the expenditure on the Works is capital because the expenditure relates to the acquisition of a principal item of capital equipment rather than a genuine repair.

THE WORKS INVOLVED THE REPLACEMENT OF SUBSIDIARY PARTS OF THE ENTIRETY

58. In
Lurcott v Wakely & Wheeler [1911] 1 KB 905 Buckley LJ explained that a repair is the replacement of subsidiary parts of an entirety rather than the entirety:

"Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal, as distinguished from repair, is reconstruction of the entirety, meaning by the entirety not necessarily the whole but substantially the whole subject matter under discussion. … the question of repair is in every case one of degree, and the test is whether the act to be done is one which in substance is the renewal or replacement of defective parts, or the renewal or replacement of substantially the whole".

The task in applying this test is distinguishing the "entirety" from the "subsidiary parts" of any subject matter. A good illustration of the issue may be found in
Rhodesia Railways Ltd v Income Tax Collector (Bechuanaland) [1933] AC 368, where the cost of replacing rails and sleepers over 33 miles of a railway line, and sleepers over a further 40 miles, was held to be a repair. The total length of the line was 394 miles, and the effect of the work was to bring the track as a whole back to normal condition. The whole railway track was considered to be the entirety and the part of the track replaced was regarded as merely a subsidiary part of the entirety. It would also seem clear that the repair to the railway would not cease to be a repair because the quality of the sleepers and rail available to be used for the repair was superior to that of the original rail and sleepers.

LINDSAY'S CASE

59. The leading Australian authority on this issue is
Lindsay v FCT (1961) 106 CLR 377, in which the High Court at first instance and on appeal held that the reconstruction of a slipway constituted the replacement of the entirety, and was not a repair. Kitto J, who heard the matter at first instance, described the slipway as follows:

"On the partnership's premises there are two slipways, each extending, from a building which houses powerful hauling machinery and is well up the gently-sloping bank of the river, down to the water and sufficiently far out into the stream to reach a depth which will allow for the draft of vessels of the kind for which the slips are intended. The premises are bounded at the sides and the rear by retaining walls. Each of the slips is provided with longitudinal girders or runways (called longitudinals), carrying iron rails upon which a large wooden cradle fitted with wheels may be moved. In each case there are two outside rails, and a double centre rail enclosing a rack. For the operation of a slip there is attached to the landward end of the cradle a series of steel traction rods connected to the hauling machinery; the cradle is allowed to slide down the runway and far enough into the water to enable it to take the vessel; the vessel is manoeuvred onto the cradle by the use of dolphins (each consisting of three piles, standing out in the stream) and warping winches, which form part of the equipment of the premises; the cradle with the vessel on it is then hauled up the slip onto dry land, and is held at the desired point by use of the rack; and when the intended work has been done to the vessel, the catch on the rack is released, the cradle is allowed to slide down into the water, and the vessel is floated off. The movement of the cradle up and down the runways is achieved by a series of movements, each the length of a traction bar. When the cradle has moved that distance, one traction bar is taken out of the line or added to it (as the case may be), with the aid of overhead handling gear, and the next movement then takes place".

60. During the war years the No 1 slipway showed signs of deterioration, particularly in the area between high-water mark and the mudline. In 1955-56 the slipway was reconstructed using reinforced concrete. Apart from the piles, which had supported the headstocks below the water, the original slipway was entirely replaced, but the work did not extend to the hauling machinery and the cradle was also repaired and retained. Reinforced concrete was used to carry out the repairs because suitable timber was unobtainable. Kitto J was satisfied that reinforced concrete offered no advantage over timber and that in some respects it was not suitable. The new slipway was 30 or 40 feet longer than the original, but otherwise of the same dimensions and capacity as it, and possessing no practical advantages over it.

61. The taxpayer argued that the "entirety" was either the whole of the premises on which the No 1 slipway existed or, alternatively, the whole No. 1 slip comprising the slipway, the hauling machinery, the cradle and the dolphins and warping winches. Kitto J rejected this argument, saying that -

"upon consideration of the evidence in the present case, assisted as I have been by a view, I am of opinion that the No. 1 slipway ought to be considered, for the purposes of the question I have to decide, as an entirety by itself, and not as a subsidiary part of anything else. It is separately identifiable as a principal, and indeed the principal, item of capital equipment, so that in a discussion as to whether work done in relation to it constitutes a repair or a renewal in the opposed senses abovementioned, the subject matter in relation to which the choice of description is to be made is the slipway itself, and not any larger thing or aggregation of things of which it may be suggested to form part".

His Honour considered that the taxpayer acquired a whole new slipway. On appeal the Full Court agreed with Kitto J.

NEITHER THE REFRACTORY NOR THE HEAD WALLS OR FLUE WALLS ARE A SEPARATE PRINCIPAL ITEM OF CAPITAL EQUIPMENT

62. Whether the cost of the Works is deductible depends on how the "entirety" is defined. The respondent asserts in paras 17 and 18 of his Statement of Facts Issues and Contentions that the refractory is a separate identifiable principal item of capital equipment, on the basis that it provides the following useful functions without regard to any other parts of the premises:

• (a) the containment of the anodes and insulating coke while the anodes are being baked;
• (b) the containment and direction of the flow of heat and gases around the anodes in the baking process so that anodes can be baked with an even and consistent temperature; and
• (c) in relation to the side and floor insulation, pre-cast shapes castable insulation and insulating blanket, the insulation and protection of the concrete tubs from excessive heat.

63. It appears to the Tribunal that, as asserted by the applicant, a major flaw in this contention is that the refractory cannot contain the anodes and insulating coke for the purpose of baking in the furnace without the tubs and foundations. The refractory lining is useless on its own without the tubs which are to be lined and the heating system including the ducting which helps draw the gases through the flues, and which together form part of the Bake Furnace. It is therefore difficult to see how the relining of the tubs with new refractory material could be regarded as giving rise to a "separately identifiable … principal item of capital equipment", to use the words of Kitto J in Lindsay's case. In the Tribunal's opinion there is nothing in the scheme as identified by the respondent, from which one could conclude that the refractory was not an integral part of the Bake Furnace.

64. The Tribunal is of the view that the facts show that the refractory material used to line the tubs and form the smaller pits in the tubs is clearly not an entirety because it exists to insulate the tub from the heat generated when baking the anodes. The smaller pits do not form a separately identifiable, principal item of capital equipment. They are clearly in the opinion of the Tribunal functionally an integral part of the Bake Furnace.

65. Insulating material whether in situ or not is unlikely generally in the Tribunal's opinion to constitute a separate principal item of capital equipment, as the Taxation Board of Review found in (1967) 18 CTBR (NS) Case 13, which concerned repairs by a butcher to a cool-room. The cool-room had stopped functioning efficiently because the sawdust used to pack the cavity walls of the cool-room, and which was used as insulating material, had become saturated with moisture. The cool-room was repaired by removing the sawdust, adding a false ceiling and fixing foam insulation to the interior of the room, including the floor and the ceiling. The interior was then cement rendered and wooden meat rails and tracks were replaced with steel substitutes. The work also involved electrical rewiring and resulted in an increase in the internal dimensions of the room.

66. The Board of Review treated the "entirety" as the outer walls, the cement floor and the wooden ceiling, together with the sawdust packing and the timber lining. The Board therefore held that the replacement of the sawdust with foam insulation and the timber lining with cement constituted repairs of the entirety, and not a reconstruction of it.

THE BAKE FURNACE SHOULD BE REGARDED AS THE "ENTIRETY"

67. The Tribunal is of the view that the Bake Furnace should be regarded as the relevant "entirety". The circumstances here are similar to those in
Samuel Jones & Co (Devonvale) Ltd v IRC (1951) 32 TC 513, in which a taxpayer who carried on a business of processing paper claimed as a deduction the cost of replacing an old chimney in its factory with a new one. The taxpayer contended that the factory as a whole was the relevant entirety, of which the chimney formed an integral and subsidiary part. The Court of Sessions accepted the argument, the Lord President stating -

"so far as this case is concerned the facts seem to me to demonstrate beyond a doubt that the chimney with which we are concerned is physically, commercially and functionally an inseparable part of an 'entirety', which is the factory. … It is doubtless an indispensable part of the factory, doubtless an integral part; but none the less a subsidiary part, and one of many subsidiary parts, of a single industrial profit-earning undertaking".

The Tribunal notes that in para 115 of Taxation Ruling TR 97/23 the respondent relies on the decision in Samuel Jones & Co (Devonvale) Ltd as authority for the criteria adopted in that ruling for identifying the entirety.

68. The facts here clearly show that the different elements of the Bake Furnace operate together in one integrated process to produce anodes. Each of those elements is essential to the efficient production of anodes. The Bake Furnace should therefore be regarded as the entirety. As was the case in Samuel Jones & Co (Devonvale) Ltd with the chimney, the refractory is physically, commercially and functionally an integral part of the entirety.

69. As the Bake Furnace is the entirety it follows in the Tribunal's opinion that the cost of replacing the refractory, which is a subsidiary but essential element of the Bake Furnace, should be on revenue account and therefore allowable under s 25-10.

ALTERNATIVELY, THE "ENTIRETY" CONSISTS OF THE CONCRETE TUBS, THE WALLS AND REFRACTORY INSIDE THE TUBS AND THE FLOOR AND THE FOUNDATIONS

70. An alternative description of the entirety is that it consists of the flue walls, head walls, side and floor insulation, pre-cast shapes, castable insulation and insulating blanket, the centre wall and the concrete tub walls, the floor and the foundations. This broadly corresponds to the alternative description of the entirety that the respondent considered in the Private Ruling. These parts of the Bake Furnace are each essential elements of the housing in which the anodes are baked. They work together to contain the anodes and to insulate the rest of the Bake Furnace from the heat generated by the baking process.

71. If this description of the entirety is adopted then the expenditure should also be of a revenue nature. The replacement is a periodic requirement. The information before the respondent showed that flue walls have an average life of 120 heats while the head walls have an average life of 370 heats. Further, the tubs and their foundations were left intact and subject to only minor repairs.

THE WASTE GAS DUCTWORK

72. In his Statement of Facts Issues and Contentions the respondent acknowledges that the waste gas ductwork is an integral part of the Bake Furnace but contends that it provides the useful function of directing waste gases from the furnace to the scrubber "without regard to any other part of the premises" and it should therefore be regarded as a separate entirety. In view of the findings by the Tribunal that the Bake Furnace is the relevant entirety it follows from the respondent's acknowledgement that the replacement of the waste gas ductwork should be a deductible repair.

73. If the alternative view set out above is correct i.e. that the relevant entirety for the purposes of determining the deductibility of expenditure on the refractory is a subset of the elements of the Bake Furnace that includes the refractory, then in the opinion of the Tribunal the waste gas ductwork should be treated as a component of that entirety. The gas ductwork together with the scrubber and the induced draft fan system is integral to enabling the hot gases to be drawn from one section of the pits to the other section in order to bake the anodes. In the Tribunal's view it is apparent from photo 6 that the gas ductwork is merely a pipe and cannot be said by itself to serve a useful function. It must be connected to the pits in which the refractory sits in order to contribute to the baking process.

74. It follows that on any view the replacement of the waste gas ductwork is the replacement of a subsidiary part of the relevant entirety and therefore of a revenue nature.

THE APPLICANT'S DEPRECIATION SCHEDULE IS IRRELEVANT TO IDENTIFYING THE ENTIRETY

75. One of the matters the respondent relied on in the reasons for decision to disallow the applicant's objection is that the applicant's relevant depreciation schedule shows a number of different tax classes of asset which are components of the Bake Furnace. In relation to the refractory there are over 30 different items, some of which have different rates of depreciation. The respondent seeks to treat the depreciation schedule as acknowledging that the Bake Furnace consists of numerous components each of which qualify as an entirety.

76. As the applicant explained in a letter from Deloitte to the Commissioner dated 30 November 2007, this is factually incorrect. Many of the separate items in the depreciation schedule are no more than entries made when capital work has been performed on some part of the Bake Furnace. The Tribunal is of the view that the classifications in the depreciation schedule clearly only reflect classifications adopted in the applicant's project management system, rather than the applicant's considered opinion about whether each item is functionally complete. Quite clearly the applicant has not, on each occasion it made an entry in the depreciation schedule, determined that it has acquired a new asset.

77. The Tribunal notes that the respondent has not cited any authority that requires a unit of depreciable property to be treated as an entirety for the purpose of determining whether repairs are deductible. The manner in which the applicant has prepared its depreciation schedule cannot in the Tribunal's opinion be determinative of whether the Bake Furnace is or is not an entirety.

78. Further, the Tribunal notes that the scheme as identified includes the fact that the replacement items referrable to the four categories of expenditure on which the Ruling was given, will result in only "minor and incidental improvements". It is on this hypothesis that the ruling is to be considered.

79. The Tribunal also rejects the respondent's assertion that the Works constitute an improvement and are therefore of a capital nature. The Tribunal notes that in
W Thomas & Co Pty Ltd v FC of T (1965) 115 CLR 58 Windeyer J made several important observations concerning the nature of a repair and whether it was on revenue account:

"The words 'repair' and 'improvement' may for some purposes connote contrasting concepts; but obviously repairing a thing improves the condition it was in immediately before repair. It may sometimes be convenient for some purposes to contrast a 'repair' with a 'replacement' or a 'renewal'. But repairs to a whole are often made by the replacement of worn-out parts by new parts. Repair involves a restoration of a thing to a condition it formerly had without changing its character. But in the case of a thing considered from the point of view of its use as distinct from its appearance, it is restoration of efficiency in function rather than exact repetition of form or material that is significant. Whether or not work done upon a thing is aptly described as a repair of that thing is thus a question of fact and degree. But the answer to that question does not of itself decide whether the expenditure on the work is properly to be considered as an outgoing upon capital account or upon revenue account. And that is what must be decided when the question is whether that expenditure is an allowable deduction in the ascertainment of taxable income.

Expenditure upon repairs is properly attributed to revenue account when the repairs are for the maintenance of an income-producing capital asset. Maintenance involves the periodic repair of defects that are the result of normal wear and tear in operation. It is an expense of a revenue nature when it is to repair defects arising from the operations of the person who incurs it. But if when a thing is bought for use as a capital asset in the buyer's business it is not in good order and suitable for use in the way intended, the cost of putting it in order suitable for use is part of the cost of its acquisition, not a cost of its maintenance".

80. It is clear therefore that the periodic repair of defects that are the result of normal wear and tear in operation is on revenue account. Such repairs ordinarily improve the function of the item repaired. In that sense every repair results in an improvement. However the issue is not whether there is an improvement but whether the expenditure in question results in a new and distinct asset. Further, a repair may also involve the use of different materials, provided it does not result in a change in the character of the item repaired. For example, in (1960) 11 CTBR (NS) Case 13 the Board of Review allowed as a deduction the cost of replacing a galvanised iron roof with concrete tiles, on the basis of evidence that the cost of the concrete tiles was only slightly in excess of the cost of replacing the roof with galvanised iron and by using tiles the taxpayer avoided the need to paint the roof.

81. In the Tribunal's view it is clear that the need for the Works arose as a result of the normal wear and tear of operating the Bake Furnace. The Tribunal notes that the applicant took the opportunity presented by the need to carry out the Works to also extend the Bake Furnace by four new sections. It did this under a separate contract and while the furnace was operating. It treated the expenditure on work relating to the extension as non-deductible capital expenditure undertaken at the same time as the Work.

82. Finally, the Tribunal notes that after carrying out the Works the Bake Furnace would have the same capacity with only minor and incidental improvements. The Tribunal therefore finds on this ground also that the Works did not constitute an improvement, and that they are not of a capital nature.

DECISION

83. The Tribunal:

• (a) sets aside the decision under review; and
• (b) remits the matter to the respondent for reconsideration with a direction to allow the applicant's objection dated 23 October 2007 to the respondent's Private Ruling dated 31 July 2007.