Edited version of your written advice

Authorisation Number: 1051257979386

Date of advice: 28 July 2017

Ruling

Subject: Repairs

Question 1

Are you entitled to claim a deduction for the repairs to the external cladding of your commercial rental property?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You purchased a commercial property in March 2000 in good working order.

The property is under a strata plan and you own X% of the total property.

The property has been available for rent since March 2000.

In early 2015 one of the external cladding modules became detached from the building and fell in to the garden below.

In March 2015 an engineer inspected the building and discovered the following faults:

● Termites had destroyed the timber grounds connecting the cladding to the building and lightweight steel framework

● The fixing screws had been corroded.

● The termite damage was not restricted to the timber grounds and was evident in other parts of the building

● The neoprene seals behind the windows in the cladding had failed and moisture was penetrating through the façade causing corrosion.

● Visible cracking in the cladding modules.

● The cladding modules contained a high proportion of asbestos and any attempt to refix these panels would have resulted in an unacceptable health risk.

The engineer compiled a report after the inspection and recommended the complete removal of all building cladding and associated fixtures and replacement with a structurally sound cladding system.

Works were undertaken in line with the engineer’s recommendation and the cladding was removed and replaced with Equitone cladding panels.

The new cladding panels do not perform any additional functions.

The total cost of the works was $Y and you were required to pay $Z which represents X% of the total cost in line with your strata title.

You have provided an itemised breakdown of this amount.

You did not receive any insurance or compensation payout in relation to the damage or repairs.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10.

Reasons for decision

Detailed reasoning

Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to premises used for income producing purposes, to the extent that the expenditure is not capital in nature.

Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the circumstances in which deductions for repairs are allowable. TR 97/23 states that what is a repair for the purposes of section 25-10 of the ITAA 1997 is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property. The ruling further states that repairs mean the remedying or making good of defects in, damage to, or deterioration of, property. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated.

TR 97/23 indicates that expenditure for repairs to property is of a capital nature where:

● the extent of the work carried out represents a renewal or reconstruction of the entirety, or

● the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than 'repair', or

● the work is an initial repair.

Repair costs are deductible where they are incurred during the period the property is held for income producing purposes and are attributable either to damage that occurs during your income producing use of the property or to defects that emerge suddenly during that time.

TR 97/23 states that with a repair, the work restores the efficiency of function of the property without changing its character. An improvement, on the other hand, provides a greater efficiency of function in the property. It involves bringing a thing or structure into a more valuable or desirable state or condition than a mere repair would do.

It is acknowledged in TR 97/23 that to repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. However, if the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10 of the ITAA 1997.

In your case, it is necessary to consider whether the use of Equitone cladding panels is considered the replacement of a subsidiary part or an entirety and whether it would actually constitute a repair or an improvement.

Replacement of a subsidiary part or an entirety

TR 97/23 at paragraph 38 considers that a property is more likely to be an entirety if:

● the property is separately identifiable as a principal item of capital equipment, or

● the thing or structure is an integral part, but only a part, of entire premises and is capable of providing a useful function without regard to any other part of the premises, or

● the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves, or

● the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law.

According to paragraph 39 of the TR 97/23, property is more likely to be a subsidiary part rather than an entirety if:

● it is an integral part of some larger item of plant, or

● the property is physically, commercially and functionally an inseparable part of something else.

In the case of W Thomas and Co Pty Ltd v. Federal Commissioner of Taxation (1965) 115 CLR 58; 14 ATD 78, which involved a claim for general repairs to a building, it was said that the question was not whether the roof or floor or some other part of the building, looked at in isolation, was repaired as distinct from wholly reconstructed, but whether what was done to the floor or the roof was a repair to the building.

In your case, the building is itself considered to be the entirety. The cladding would be considered a subsidiary part of the building.

Improvement vs Repair

Repairs generally improve the condition of the property. However substantial improvements, additions, alterations, modernisations and reconstructions are not repairs. Some of the factors which indicate an improvement as opposed to a repair include:

● the modification work has effected an improvement to the asset

● there is greater efficiency of function of the property

● there is an increase in the value of the asset

● the expenditure reduces the likelihood of future repairs.

According to TR 97/23, the Commissioner accepts that the use of a different material does not necessarily prevent the work from being a repair, provided the work merely restores a previous function to the property or restores the efficiency of the previous function. Whether the use of a more modern material to replace the original material qualifies as a repair is a question determined on the facts of each case. It is restoration of a thing's efficiency of function (without changing its character) rather than exact repetition of form or material that is significant.

In your case the same materials could not be sourced or reattached due to the dangers of the asbestos. Paragraph 26 of TR 97/23 discusses expenditure incurred in controlling health risks from dangerous substances. The ruling explains that work done to a property in controlling health risks associated with the use of dangerous substances, such as asbestos, does not qualify as a repair for the purposes of section 25-10 of the ITAA 1997 unless the work remedies or makes good defects in, or damage to, or deterioration (in a mechanical or physical sense) of, the property.

The fact that a different material had to be used due to asbestos will not automatically mean the use of the Equitone cladding panels is not a repair. To be allowable under section 25-10 of the ITAA 1997 the expense must meet the general repair requirements.

In the case of Wates v. Roland (1952) 2 QB 12, the floor of a house had rotted from dampness and a tiled floor was installed. The new floor was held not to be an improvement but a repair. It was considered that the floor had merely been replaced by its modern equivalent.

TR 97/23 provides that if the work done restores a previous function to the property, or restores the efficiency of the previous function, it does not matter that a different material is used. Even if the work done using different materials enables the property to perform its function marginally more efficiently, the work may still constitute a deductible repair. The test is whether there is a sufficient degree of improvement to justify characterising the expenditure as capital and therefore excluding it from deductibility.

In your situation the primary purpose for adding the Equitone panels was to restore the original function of the external cladding. The original cladding could not be re-attached due to the high asbestos content and the same product can no longer be sourced. The repair itself was required due to the state of the timber grounds, corrosion of the fixings and cracks in the cladding panels. The repairs were not required simply because the cladding panels contained asbestos.

It is considered that the Equitone cladding which was used in place of existing asbestos cladding will constitute a repair as the change in material will not enable the property to perform its function more efficiently than previously. It cannot be said that the installation of the Equitone cladding to the exterior walls will improve the function of efficiency of the external walls. The Equitone panels are merely the modern equivalent to the previous cladding and the original function of the cladding has been restored.

Initial repairs

Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure and not deductible, if the defect, damage or deterioration:

● existed at the time of acquisition of the property, and

● did not arise from the operations of the person who incurs the expenditure.

In your case, you purchased the rental property in the year 2000 and it was in good working condition. Therefore, the repair to the external cladding would not constitute an initial repair as the deterioration of the cladding and frames occurred during the time when you were earning income from the property.

Therefore you are entitled to a deduction if $Z for the cost of the repairs to your rental property in the year in which the expenses were incurred.

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