Case V83

DJ Trowse SM

Administrative Appeals Tribunal

Judgment date: 31 May 1988.

D.J. Trowse (Member)

The question for determination in this reference is whether expenditure incurred in renovating various aspects of a recently acquired suburban dwelling qualifies for deduction in terms of the provisions contained in sec. 53 of the Income Tax Assessment Act 1936. The outgoings in issue total $3,592 and the year of income is 1986. In that same year the property yielded rental income of $3,360.

2. The property had been an asset in the estate of the applicant's father who had died in July 1984 and who, by his will, had devised two undivided third parts in same to the applicant. The remaining interest was devised to the applicant's brother, who resided at the property rent free from July 1984 to October 1985. The transfer of the property to the two beneficiaries was effected in May 1985. At about that time, it was agreed that the applicant purchase his brother's one-third interest for a consideration of $17,000, and it seems that that transaction was completed on 4 November 1985. It is of interest to observe that the dwelling was built approximately 100 years ago.

3. Within a few days of that acquisition, the applicant engaged a firm of real estate agents to let the property and, in so doing, advised the agent that certain electrical and plaster work was to be carried out in the near future. At that stage it was envisaged that the work necessary would comprise:

  • - replastering due to cracking, particularly in front rooms,
  • - electrical work, the extent of which was to be determined by inspection.

Notwithstanding those faults and uncertainties, the agent quickly located a tenant who took up occupancy on 13 November 1985 at a weekly rental of $120.

4. However, it soon became apparent that the electrical system required urgent attention and this was confirmed by an electrician who reported that the wiring was very old, did not conform to the prescribed regulations and should be completely replaced. The work required to remedy those deficiencies was carried out during March and early April 1986 at a cost of $2,090, and included the rewiring of power and light points, installing new

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consumer mains for overhead connection, shifting the meter box outside and fitting a new circuit-breaker board inside. As a result of further complaints by the tenant, additional electrical work was undertaken to ensure a more controlled flow of electricity in order to overcome the problems of cut-out and fusing. Those corrections were achieved by increasing the number of power circuits and replacing the circuit-breaker board with one containing additional breaker points. That further work was carried out in May 1986 at a cost of $520. Both of these amounts are in contention.

5. Also in dispute is the expenditure associated with the plastering of the walls which commenced in May and was completed prior to the close of the financial year. That work, costing $982, related to the repair of the cracks in the walls and to the replastering of those areas affected by the electrical rewiring.

6. The tenancy arrangement previously entered into was terminated on 25 June 1986. A new tenant moved in in July with the rent being increased to $150 per week.

7. The applicant's 1986 income tax return disclosed the history of the property and also comprehensive details of rental income derived and expenditure incurred. The claim for repairs to the property totalled $4,650, and of that amount the Commissioner had denied deductibility to the extent of $3,592, i.e. the costs pertaining to the electrical and plastering works described above. The Commissioner considered that the outgoings so incurred were of a capital nature.

8. In rejecting that contention, the applicant made the following submissions in his objection:

``I do not consider the electrical rewire and plastering should be disallowed as capital expenditure. When the property came into my possession it was in a very poor state of repair. I had it inspected by both an electrician and a builder.

The electrician indicated that the property had to be rewired as the current wiring present at the time did not meet required E.T.S.A. standards (e.g. unearthed plugs, sub-standard wiring etc.).

The builder indicated that cracks and peeling plaster would make it difficult, if not impossible, to rent the property.

Therefore these repairs were necessary to bring the property up to a minimum standard for renting (i.e. producing income).

These necessary and essential basic repairs were in no way alterations, additions or improvements to the property.''

9. Turning now to the law relevant to this issue, subsec. 53(1) of the Assessment Act provides that:

``Expenditure incurred by the taxpayer in the year of income for repairs, not being expenditure of a capital nature, to any premises, or part of premises, plant, machinery, implements, utensils, rolling stock, or articles held, occupied or used by him for the purpose of producing assessable income, or in carrying on a business for that purpose shall be an allowable deduction.''

Summarily, to qualify for deduction under this subsection the expenditure must first come within the description of being a repair for income tax purposes and secondly, that the asset subject to the repair is used in the production of assessable income. Furthermore, the legislation provides that expenditure of a capital nature is excluded.

10. A determination as to whether or not a particular outgoing comes within the meaning of being a repair will be assisted by reference to various judicial decisions, see for example, comments made by Windeyer J. in
W. Thomas & Co. Pty. Ltd. v. F.C. of T. (1965) 115 C.L.R. 58 at p. 72:

``Repair involves a restoration of a thing to a condition it formerly had without changing its character.''

11. To decide whether a particular amount expended on premises ought to be charged against revenue or capital may in some circumstances present difficulties. However, it is clear that where the expenditure does substantially more than meet a need for restoration and results in an asset with considerable advantage over the old one, that expenditure is of a capital nature - see comments of Kitto J. in
F.C. of T. v. Western Suburbs Cinemas Ltd. (1952) 86 C.L.R. 102 at p. 106.

12. The decision in the case of Thomas (supra) is, in my opinion, most relevant to this

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reference, in as much that it is authority for the proposition that amounts expended to remedy faults in existence at the time of acquisition, sometimes referred to as ``initial repairs'', are to be regarded as part of the original cost. As such they are to be classified as capital expenditure. The following statement taken from the judgment of Windeyer J. at p. 72 is apposite:

``Expenditure upon repairs is properly attributed to revenue account where 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.''

(emphasis added)

13. In my view the ``initial repair'' test is no more than an application of the well-recognised principles that have been developed over the years by courts in determining what is capital. More specifically, I see it as an extension of the ``profit-yielding structure'' principle enunciated by Dixon J. (as he then was) in
Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T. (1938-1939) 61 C.L.R. 337. In terms of that reasoning, expenditure relating to the establishment, replacement or enlargement of the profit-yielding structure, as opposed to those incurred in the operation of that structure, will be of a capital nature.

14. The evidence in this matter makes it clear that the property when acquired was not in good order, nor was it suitable for letting. The carrying out of the repair work now under review made good those defects and only then did the property become suitable for leasing. The expenditure of $3,592 was part of the organisation of capital by the applicant to enable the income-producing activity to be carried out. Expressed in another form, the expenditure related to the establishment of the profit-yielding structure. Certainly it was not incurred in the operation of that structure. The Tribunal's conclusion is that the outgoings in question are of a capital nature and thus not deductible.

15. It should be acknowledged that in the case of Thomas (supra) the property was purchased, whereas in the present matter portion was acquired by testamentary disposition. Notwithstanding that factual difference, I see no reason to deviate from the principles referred to above. I am fortified by the knowledge that a similar conclusion has been reached by various members of Taxation Board of Review, see for example Case H116,
(1957) 8 T.B.R.D. 538 and Case M57
(1961-1962) 12 T.B.R.D. 283.

16. Part of the applicant's submission referred to his lack of knowledge at time of acquisition as to the extent of the defects, and by implication, that that factor should by itself produce a result in his favour. In the words of Windeyer J. in Thomas (supra), the presence of that fact is immaterial (see p. 74).

17. In conclusion, it is my view that the decisions in Thomas (supra) and Sun Newspapers (supra) are more than sufficient to dispose of this matter. I see no great purpose served in referring to the English cases of
Law Shipping Co. Ltd. v. I.R. Commr (1924) 12 T.C. 621 and
Odeon Associated Theatres Ltd. v. Jones (Inspector of Taxes) (1972) 1 All E.R. 681, nor do I regard it as rewarding to seek out an explanation for the varying decisions handed down in those matters.

18. For these reasons, the Tribunal affirms the Commissioner's decision on the objection.

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