Edited version of private ruling

Authorisation Number: 1011481339594

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Tax break - do materials used to construct a rental property qualify as depreciating assets

Question:

Do the expenses incurred on building materials qualify as new investment in tangible, depreciating assets under Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No.

This ruling applies for the following period:

1 July 2009 to 30 June 2010.

The scheme commences on:

1 July 2009.

Relevant facts and circumstances

You and your spouse commenced to purchase rental properties a number of years ago. Some time later a trust deed was signed.

The trust currently owns less than 10 rental properties.

You and your spouse own a number of rental properties jointly.

You have a business plan in place.

You spend a large number of hours per week on the rental properties.

Some of the rental properties are managed by agents (those that are some distance from your home) and you manage the others yourself.

After 13 December 2008 the trust purchased building materials. Residential units were commenced before 31 December 2009 and completed prior to 30 June 2010 and are available for rent.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 40-25.

Income Tax Assessment Act 1997 Paragraph 41-10(1)(b).

Income Tax Assessment Act 1997 Section 43-10.

Income Tax Assessment Act 1997 Section 43-70.

Income Tax Assessment Act 1997 Section 43-110

Income Tax Assessment Act 1997 Section 43-140.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Small business tax break

Under the Tax Laws Amendment (Small Business and General Business Tax Break) Act 2009 a deduction is available for eligible expenditure on new investment in tangible, depreciating assets.

Small business entities are able to claim a 50% bonus tax deduction (the tax break) for eligible assets costing $1,000 or more that they:

- commit to investing in between 13 December 2008 and 31 December 2009, and

- start to use or have installed ready for use by 31 December 2010.

To qualify for the 50% rate you need to meet the definition of a small business entity in section 328-110 of the ITAA 1997. This generally means that the taxpayer is carrying on a business and has an annual turnover of less than $2 million.

Businesses can commit to investing in an asset by:

- entering into a contract under which they will hold the asset, or

- starting to construct the asset.

Eligible assets

The tax break is available for new investment in tangible depreciating assets for which a capital allowance deduction is available under Subdivision 40-B (specifically, section 40-25) of the ITAA 1997.

To be eligible for the tax break, the asset must be a tangible 'depreciating asset' for which a capital allowance deduction is available under section 40-25 of the ITAA 1997 as per paragraph 41-10(1)(b) of the ITAA 1997.

A depreciating asset is an asset with a limited effective life that can reasonably be expected to decline in value over time.

Buildings and capital works

You cannot claim deductions under Division 40 of the ITAA 1997 if you can claim deductions for capital works under Division 43 of the ITAA 1997. As such, if a capital works deduction under Division 43 of the ITAA 1997 is available to you, you will not be able to apply the tax break.

Deductions for capital works

Division 43 of the ITAA 1997 provides deductions for capital works for buildings, structural improvements and environment protection works.

Under section 43-10 of the ITAA 1997 you can claim deductions for capital works if:

- the capital works have a construction expenditure area

- there is a pool of construction expenditure for that area, and

- you use your area in the income year in the way set out in the table in section 43-140 of the ITAA 1997.

For capital works commenced after 30 June 1997, the construction expenditure area is the part of the capital works on which the construction expenditure was incurred, that at the time it was incurred by you, was to be owned, leased or held under a quasi-ownership right.

Construction expenditure is defined under section 43-70 of the ITAA 1997. It is the capital expenditure incurred in the construction of capital works that is deductible under Division 43 of the ITAA 1997.

Under section 43-110 of the ITAA 1997 you can only claim deductions under Division 43 if you own, lease or hold part of a construction expenditure area of capital works. This area is called 'your area'.

In order to establish whether your situation is subject to the provisions of Division 43 of the ITAA 1997 it must be determined whether the residential units that you have constructed will fall into the definition of buildings or structural improvements.

Rental properties 2009 (NAT 1729-6.2009) details that expenditure on the construction of residential properties is capital works and deductions are available if the properties are used to derive rent.

The construction of the residential properties will qualify as capital works under section 43-10 of the ITAA 1997.

As you can claim a deduction for the residential properties under Division 43 of the ITAA 1997 you are not able to consider a deduction under Division 40 of the ITAA 1997.

You are therefore not entitled to a deduction under the small business tax break for the materials used in the construction of the rental properties.

Additional information

We have not provided a ruling on whether or not the trust is a small business entity, but will provide the following information.

Carrying on a business

Whether a business is being carried on depends on the large or general impression gained (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; 5 AITR 548) from looking at all the indicators of carrying on a business, and no one indicator will be decisive (Evans v. Federal Commissioner of Taxation 89 ATC 4540; (1989) 20 ATR 922). These indicators are described in Taxation Ruling TR 97/11. The indicators to establish whether a taxpayer is carrying on a business are contained in TR 97/11and include the following:

- significant commercial purpose or character

- purpose and intention to engage in business and nature of the activities

- intention to make a profit and prospect of profits

- repetition and regularity

- activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business

- organisation, systematic, business like manner

- the size and scale of the activity

Other factors that can be taken into account are:

- whether the taxpayer is operating to a plan, setting budgets and targets, keeping records

- whether the taxpayer is engaged in another full time occupation.

We would also consider whether the rental activities of the trust were better described as the management of a passive investment

In this case the trust is the entity that has incurred expenditure. The trust owns less than 10 rental properties and has to be seen to be carrying on a business independently to be a small business entity.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).