Case V2

Members:
KL Beddoe SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 11 December 1987.

---

K.L. Beddoe (Senior Member)

The question at issue in this application is whether an amount of $7,040 incurred by the applicant during the year of income ended 30 June 1985 is an allowable deduction within the terms of sec. 53 of the Income Tax Assessment Act 1936.

2. So far as it is relevant sec. 53 reads as follows:

``53(1) 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,... held, occupied or used by him for the purpose of producing assessable income,... shall be an allowable deduction.''

It will be apparent that the following tests must be satisfied in the context of this application before a deduction is allowable under sec. 53:

• (a) expenditure must be incurred by the taxpayer in the year of income;
• (b) the expenditure must be for repairs;
• (c) the expenditure must not be expenditure of a capital nature;
• (d) the expenditure must relate to premises or part of premises; and
• (e) those premises must be used for the purpose of producing assessable income.

3. The facts of this application are relatively straightforward but will require a somewhat lengthy discussion. In her return of income for the year ended 30 June 1985, which is the year in dispute before the Tribunal, the applicant described herself as an investor. She derives income from various sources including a block of flats located at M which is a suburb of a capital city. This particular block of flats was purchased by the applicant in July 1980 although not without some hesitation on her part. She first took an interest in these flats in 1979 when she inspected the property accompanied by her husband. The husband is a retired engineer, the relevance of his former

---

ATC 109

occupation will become apparent in the course of these reasons. At the time of the 1979 inspection the applicant and her husband noted that there was some cracking in the masonry of the flats on the north-western corner. However, they took no further interest because they formed the view that the price being asked by the vendor was too high for the applicant.

4. During 1980 the applicant became aware that the flats were still on the market and made further contact with the selling agent. A further inspection was then made by the applicant and her husband of the subject block of flats and it was even more apparent that there was a problem in relation to the foundations at the north-western corner of the building. Negotiations followed with the vendor and the result was that the vendor agreed to have the problem in the foundations rectified as a condition of the sale to the applicant. The sale eventually took place and from 1980 onwards the applicant has derived rental income from the flats.

5. Work was undertaken under the control of a structural engineer at the expense of the vendor. The structural engineer gave evidence before the Tribunal as to the nature of the work that he carried out. In essence his evidence was to the effect that the existing foundations were barely capable of supporting the building, the engineer stating that the pressure exerted by the foundations on the soil, although not beyond normal specifications, was at the limit of those specifications; he described that pressure as being moderately high. He went on to say that in this situation, where the ground is soft, movement in the structure is likely. He arranged for work to be done which had the effect of increasing the size of the footings thereby reducing the pressure on the subsoil and also resulting in the foundations being at a lower level in the subsoil and less likely to be affected by shrinking caused by drying out of the clay. At the time he was concerned that there was fill on the site but the work carried out under his supervision had, in his opinion, corrected the problem so that there was no latent defect in the foundations so far as the north-western corner was concerned. He was surprised to learn that there was a recurrence of the problem five years later and it is with the events surrounding that recurrence that the Tribunal is now concerned.

6. In early 1985 it became apparent to the applicant and her husband that the north-western corner of the block of flats had once again suffered damage due to movement of the foundations. The damage appears to have been relatively severe because a different consulting engineer engaged by the applicant to look at the building took immediate steps to shore up the north-western corner of the building to guard against further damage to the property. This shoring up consisted of putting a heavy beam in the corner of the building supported on temporary foundations. This engineer then designed remedial work to be carried out on the building and a contractor was engaged to carry out that work after soil testing by a firm of experts had determined that there had been excessive drying out of the subsoil caused by a combination of dry seasons and the proximity of a number of mango trees.

7. The building having been shorn up in its north-western corner the footing in that corner was then removed and replaced by three columns which in turn stood on solid wall foundations constructed so as to form one unit in that corner of the building. Before undertaking this construction it was necessary for the work previously done in 1980 to be removed from the site.

8. The effect of the new work was to place the load of the north-western corner on to three columns rather than one as had been the case previously. This was designed to spread the load over a wider area and this was achieved by having the solid wall foundations to an even greater depth than the old foundations had been. To further buttress these three columns a brick wall of masonry blocks and reinforced with concrete and steel was constructed between the columns around the corner of the building so that the columns were effectively prevented from moving outward. This change to the building had the effect of enclosing the back corner of a carport area under the flats but, as was pointed out in the course of evidence of the applicant's husband, it was only the corner where the three columns had been constructed that these blocks enclosed the open carport and masonry blocks were not used to enclose the rest of the carport. It is apparent from the plans of the construction (Exhibit A) that the masonry wall occupied only a short distance on one corner of the building and I have no hesitation in accepting the husband's evidence that its

---

ATC 110

only function was to buttress the columns. The expenditure in question is made up of an amount of $1,450 paid to the consulting engineer and an amount of $5,590 paid to the builder to carry out the work. Expenditure amounting to $410 in respect of the soil test has already been allowed by the respondent Commissioner. There is no dissection of these amounts before the Tribunal although there was evidence as to the estimated cost of having the masonry blocks laid.

9. There is no doubt on the evidence before the Tribunal that the amount of $7,040 was incurred by the applicant in the year of income, that it was incurred in respect of premises or part of premises used by her for the purpose of producing assessable income.

10. Two questions remain to be answered. Was the expenditure incurred in making repairs to the premises? If that question is answered in the affirmative then the question is whether the cost of the work carried out on the foundations was expenditure of a capital nature?

11. Firstly, it is well settled that the block of flats is the entirety to be considered for the purpose of deciding whether the work on the foundations was or was not a repair. See
Lindsay v. F.C. of T. (1961) 106 C.L.R. 377; (1961) 12 A.T.D. 197 and
W. Thomas & Co. Pty. Ltd. v. F.C. of T. (1965) 115 C.L.R. 58; (1965) 14 A.T.D. 78. The question is whether the work carried out constituted a repair of the building - not some part of the building.

12. The general principles to be applied in deciding whether expenditure was incurred for repairs were set out by Windeyer J. in Thomas' case and may be summarised as follows:

• (a) whether the work was done to make good a deterioration that had occurred by ordinary wear to tear or by the operation of natural causes during the passage of time;
• (b) ``repair'' involved a restoration of a thing to a condition it formerly had without changing its character;
• (c) 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 or form or material that is significant; and
• (d) whether or not work done on a thing is a repair is a question of fact.

13. In Lindsay v. F.C. of T., Kitto J. posed the question to be answered as follows (his Honour relied on dicta of Buckley L.J. in
Lurcott v. Wakely & Wheeler (1911) 1 K.B. 905 at pp. 923-924):

``The problem is to characterize the expenditure according to the familiar distinction between repair, in the sense of restoration by renewal or replacement of subsidiary parts of a whole, and renewal in the sense of reconstruction of the entirety, meaning by the entirety not necessarily the whole but substantially the whole of the subject matter under discussion.''

(C.L.R. pp. 383-384; A.T.D. p. 200.)

The dicta of Buckley L.J. relied upon by his Honour was cited with approval by Lord
MacMillan in Rhodesia Railways Ltd. v. Collector of Income Tax, Bechuanaland Protectorate (1933) A.C. 368 at p. 374.

14. Applying the tests to the facts of this case it is clear enough that the work on the foundations became necessary because of extraordinary drying out of the subsoil caused by the abnormally dry seasons and exacerbated by the mango trees in the vicinity of the building. The work carried out, although quite extensive, merely had the purpose of putting the foundations under the north-west corner back into a condition whereby they would support the building. The building itself was not altered but the foundations in the north-west corner must now be quite different in design to the original foundations supporting the remainder of the building. What happened was that the foundations were put back into a condition, albeit a different design, whereby they would support the building as intended and thereby avoid further damage to the building. At all relevant times the new works (except for the masonry buttress walls) performed the function of foundations to the existing building. It was therefore a case of the foundations being restored to their former efficiency in function without changing their essential character as foundations and without changing in any way the characteristics of the building.

15. I am therefore satisfied that the work carried out on the foundations was in the nature of repairs.

16. However, applying the criteria laid down by Windeyer J. to the buttress walls does lead me to the opposite conclusion. These

---

ATC 111

buttress walls changed the outward appearance of the building and, what is more important, were installed to perform a function not previously performed. The applicant's husband gave evidence which established that the masonry walls were erected:

• (a) to strengthen the foundations to the north-west corner of the building and thereby make them more rigid;
• (b) to prevent the new columns moving away from each other; and
• (c) at an estimated cost of $291.

17. The respondent's representative sought to establish by cross-examination that the masonry walls served a decorative or protective function in that they enclosed portion of the carport area. While erection of the walls would have that effect the evidence as to construction of the masonry walls supports the contention that their intended function was to buttress the columns in the foundations - a function not previously performed by the demolished foundations.

18. In my view the masonry walls were not repairs to the building but an addition thereto.

19. I turn then to consider whether the balance of the claim was expenditure of a capital nature. In Thomas' case, Windeyer J. stated the law at C.L.R. pp. 72-74; A.T.D. pp. 87-88 as follows:

``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. The decision of the Court of Session in
Law Shipping Co. Ltd. v. I.R. Commrs (1924) S.C. 74; 12 Tax Cas. 621, is commonly cited as authority for that proposition. The principle is obvious without the need for any supporting authority. I may nevertheless quote as a clear exposition a passage from the judgment of Woodhouse J. in the
New Zealand case of Collector of Inland Revenue, Cook Islands v. A.B. Donald Limited (1965) 9 A.I.T.R. 501, at p. 506. That case, like the Law Shipping Company's case, was concerned with the acquisition of a vessel. His Honour said:

• `When this general principle is applied to the present case the issue becomes one of deciding whether the expenditure upon the vessel is part of the company's organization of capital in order to earn profits with her, or whether it arises from causes associated with the course of operations embarked upon for that purpose. In this regard nobody would doubt that to maintain such an asset which otherwise would deteriorate by its use in operations directed to produce income is a revenue charge. Work of this sort is done to preserve the asset, and following the work the character of the asset is left unchanged. But equally clearly the initial purchase of the asset involves an outlay of capital - it is a part of the organization of capital by the taxpayer to enable income-producing activity to be carried out. How then must one label an expenditure which remedies some flaw in the asset existing at the time of purchase? To me there can be only one answer. To the extent that such initial defects are restored, the result is an improvement in the quality of the asset purchased, and, in my opinion, there has been an outlay of capital. To treat this outlay as a revenue loss is no more justified, in my opinion, than to treat the value of the improvement as an income gain. Defects may arise gradually over an extended period or develop from unexpected or sudden causes, but in so far as they have matured by the time of purchase by the new owner, they affect the quality of the asset he has acquired. Any subsequent need to remove them must be regarded as a legacy inherited by him as part of his bargain. It follows, therefore, that I take the view that the restoration of defects in an asset cannot be classed as a revenue charge unless the defects have arisen out of the taxpayer's application

  ---

  ATC 112

  of that asset in his search for income and unless the work is limited to those defects and does not become enlarged into such a reconstruction that a permanent improvement in quality has been effected.'

Applying the principle to the present case it seems to me that the expenditure of £5,082 upon repairs upon the Berry Building in the year ended 31st October 1961 was of a capital nature. It seems to me immaterial that when the taxpayer acquired the building it did not know of some of its defects, those in the basement floor for example. That means only that the cost of obtaining an asset suitable for its purpose was greater than had been expected.''

20. The point that distinguishes the present case from Thomas' case is the fact that the applicant recognised the defect in the foundations before she acquired the building. Consequently the vendor had a consulting engineer supervise the restoration of the foundations in the north-west corner before the property passed to the applicant and at the vendor's expense. This case is not therefore a latent defect case. The building was put in good order before the sale took place. It was the dry season and the mango trees which caused the problem to recur. The facts here are not the same as Case 28
(1950) 1 T.B.R.D. 82; Case 70
(1950) 1 T.B.R.D. 264 and many others where the Taxation Boards of Review have disallowed claims because of the Law Shipping principle.

21. Neither is this case the same as cases such as
Sotheby v. Grundy (1947) 2 All E.R. 761, and
Lister v. Lane and Nesham (1893) 2 Q.B. 212, cases dealing with a tenant's covenant to repair.

22. There is, however, some similarity with the V.A.T. case
ACT Construction Ltd. v. Customs & Excise Commrs (1979) S.T.C. 358. There the question was whether extensive work carried out on the foundations of a number of buildings was repair or maintenance and thereby subject to tax or whether it was outside the provision and therefore zero-rated for tax purposes. The work involved underpinning of the foundations of a number of houses. The question to be answered by the Court was whether the V.A.T. Tribunal had been correct in holding that the work carried out was in the nature of maintenance. In the course of his reasons Drake J. stated the test to be applied as follows (at p. 363):

``In the present case I think the Tribunal erred in not asking themselves the question whether this work had changed the character and nature of these buildings. Because they did not do so the decision does not contain their express answer. However, on the basis that all of these houses had defective foundations, too shallow to comply with modern building regulations and which had already resulted in subsidence, I have no hesitation in taking the view that the character and nature of these premises were altered by the work done, and that the work cannot be termed repair or maintenance so as to fall within note 2 to Group 8 of Sch. 4.''

23. That is the test that should be applied here to determine whether the outgoings incurred were of a capital nature. If the applicant had found it necessary to have all of the foundations replaced or upgraded as in ACT Construction I would be of the view that the work had changed the character and nature of the building. However, that was not the case and it was only necessary to repair the north-west corner and that became necessary because of outside influences (the unusually dry season and the mango trees) rather than an inherent defect in the structure. There was no change in the character and nature of the building.

24. I am satisfied that the expenditure on repairs to the foundations was not of a capital nature.

25. The Tribunal will set aside the objection decision under review and allow the objection in part by allowing a deduction amounting to $6,749.