Edited version of private advice

Authorisation Number: 1051745429260

Date of advice: 26 August 2020

Ruling

Subject: Capital works deductions

Question 1

Are the activities undertaken by the Tenant at the Property considered to be 'industrial activities' under section 43-150 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If the answer to Question 1 is yes, is the Trustee entitled to a deduction under section 43-10 of the ITAA 1997 at a rate of 4% in respect of construction expenditure area 1 (CE 1) (the Property) and construction expenditure area 2 (CE 2) (the hardstand)?

Answer

Yes.

Relevant facts and circumstances

Background

The Trustee owns the Property. The Property is leased by the Trustee to the Tenant who uses the Property as the service centre.

Tenant's activities

The Tenant supplies a range of Products.

The Tenant uses the Property to repair and maintain the Products. The Tenant has a number of processes to repair and maintain the Products which encompasses some automatic and some manual processes. The Products will then be stacked ready for transport to a client or another site.

The Tenant recently installed new machinery which improves the efficiency, prompting the Tenant's request for construction of a hardstand which can be used to store the Products which are either in-bound or out-bound.

The Trustee acquired a parcel of adjoining land and constructed hardstand along with a range of site upgrades to meet the Tenant's request.

The Tenant has undertaken the activities described above within the Property since the Property was acquired by the Trustee.

Construction expenditure area

A 'construction expenditure area' for the purposes of subsection 43-75(3) exists in relation to the Property, in respect of capital works completed prior to the Trustee's acquisition of the Property (CE Area 1).

A separate 'construction expenditure area' for the purposes of subsection 43-75(1) exists in relation to the Property, in respect of capital works completed during the relevant income year (CE Area 2).

In respect of CE Area 1:

(i)    There is a 'pool of construction expenditure' is attributable to CE Area 1 for the purposes of section 43-85;

(ii)   The Trustee's 'your area' is the equivalent of CE Area 1 for the purposes of subsection 43-115(1);

(iii)  Amounts attributable to the Trustee's 'your area' satisfy the definition of 'your construction expenditure' for the purposes of subsection 43-115(2); and

(iv)  The relevant capital works began after 30 June 1997 and completed prior to the Trustee's acquisition of the Property.

In respect of CE Area 2:

(i)    There is a 'pool of construction expenditure' is attributable to CE Area 2 for the purposes of section 43-85;

(ii)   The Trustee's 'your area' is the equivalent of CE Area 2 for the purposes of subsection 43-115(1);

(iii)  Amounts attributable to the Trustee's 'your area' satisfy the definition of 'your construction expenditure' for the purposes of subsection 43-115(2); and

(iv)  The relevant capital works began and completed in the relevant income year.

Reasons for decision

Question 1

Summary

The activities undertaken by the Tenant in the Property are 'industrial activities' under section 43-150.

Detailed reasoning

Section 43-150 relevantly provides the definition of 'industrial activities' as:

(a)  any of the following activities (core activities):

(i)    operations where manufactured items are derived from other goods even if those manufactured items are themselves used as parts or materials in the manufacture of other items;

(ii)   operations (other than packing, placing in containers or labelling) by which manufactured items are brought into or maintained in the form or condition in which they are sold or used, even if they are for sale or use as parts or materials in the manufacture of other items;

...

Subparagraphs 43-150(a)(i) and (ii) are distinguished in that the former refers to the activity of manufacturing itself, and the latter to the ancillary procedures of bringing items which are already manufactured into or maintaining them in the form or condition in which they are to be sold or used.

Subparagraph 43-150(a)(ii)

MP Metals Pty Ltd v Federal Commissioner of Taxation (1968) 117 CLR 631(MP Metals) considered the meaning of 'manufactured goods' in the context of sub-paragraph 62AA(2)(a)(ii) of the Income Tax Assessment Act 1936 (ITAA 1936) (the predecessor to subparagraph 43-150(a)(ii), which is similar in wording). Menzies J noted:

The provision has, I think, been carefully framed to ensure that the operation of bringing or keeping goods already manufactured into or in the form or condition required for sale or use as the case may be, is covered only when that operation is auxiliary to the operation of manufacturing the goods. Two cases are covered; the first when a taxpayer works upon goods of his own manufacture; the second when a taxpayer works upon the goods of another manufacturer in order that the other manufacturer may sell or use his goods.

Windeyer J, also in MP Metals, similarly explained that sub-paragraph 62AA(2)(a)(ii) of the ITAA 1936 'deals with the preservation or finishing of goods for the purpose of use by the manufacture or sale':

... the two paragraphs (paragraph (a)(ii) and (a)(ii)) deal with two different aspects of manufacturing. The first deals with the actual making of goods: the second with what I may call finishing or preserving processes to which the goods after being made must be subjected to bring them into, or maintain them in, a condition for sale or use... I read it (paragraph (a)) as applying in either of two kinds of cases: one where the taxpayer who is himself a manufacturer has plant for brin[g]ing his manufactured goods into (or maintaining them in) a form or condition in which he will either sell them, or use them (eg in the production of other goods): the other where a taxpayer who is not himself a manufacturer has plant used by him for bringing goods manufactured by someone else into (or maintaining them in) a condition or form in which they are sold or used by their manufacturer. ...

Applying this to the activities of the Tenant:

·         The Products are the 'manufactured items' as per subparagraph 43-150(a)(ii) as they are existing manufactured goods made by someone other than the Tenant.

·         The Products are used as part of the Tenant's business in that they are supplied to its customers until the Products need to be serviced, at which point they are taken to the Property. After the repairs/maintenance activities are complete, the Products are returned to be used in the Tenant's business.

·         The nature of the Tenant's activities is within the scope of 'brought into or maintained in the form or condition in which they are sold or used' contemplated by subparagraph 43-150(a)(ii).

Therefore, the activities of the Tenant satisfy subparagraph 43-150(a)(ii).

Subparagraph 43-150(b)(v)

In addition to the core activity as listed paragraph 43-150(a), if one or more activities as listed in paragraph 43-150(b) is carried out in association with any one or more of those core activities such as storage, packaging, cleansing and waste disposal they will qualify as being an industrial activity.

Subparagraph 43-150(b)(v) states:

43-150(b)(v) the storage, within premises in which core activities are carried on, or premises contiguous to those premises, of goods in carrying on core activities, goods in relation to which core activities have commenced but not finally been completed or goods resulting from core activities;

The Tenant's use of the hardstand to store the Products is done at premises (CE2) which are contiguous to the premises at which the core activities of repairing and maintenance of the Products are carried on. As the purpose of the hardstand is for storage, pursuant to subparagraph 43-150(b)(v), the storage activity of the Tenant undertaken at the hardstand also satisfies the definition of 'industry activities'.

Question 2

Summary

The Trustee is entitled to a deduction under section 43-10 of the ITAA 1997 at a rate of 4% in respect of CE 1 (the Property) and CE 2 (the hardstand).

Detailed reasoning

Under section 43-10, a taxpayer can deduct an amount for capital works if:

a)    The capital works have a construction expenditure area; and

b)    There is a pool of construction expenditure for that area; and

c)     You use your area in the income year in the way set out in Table 43-140 (Current year use).

The Trustee's construction expenditure on the relevant capital works is a construction expenditure area as defined in subsection 43-75(1). There is a pool of construction expenditure for that area.

Construction expenditure is capital expenditure incurred in respect of the construction of capital works (subsection 43-70(1)) but does not include the cost of acquiring land, expenditure on demolishing existing structures; or expenditure on clearing, levelling, filling, draining or otherwise preparing the construction site prior to carrying out excavation works; or expenditure on landscaping (subsection 43-70(2)).

The Trustee is using its 'area' for the purpose of producing assessable income as it is deriving rental income from the Tenant, which is assessable. Therefore, the Trustee satisfies the requirements of section 43-140.

As a result, the Trustee can claim capital works deductions as all of the section 43-10 requirements have been satisfied.

Pursuant to sections 43-25 and 43-145, the Trustee can get a deduction at a rate of 4% if:

·         The Trustee uses the relevant 'area' for producing assessable income; and

·         The Property is used 'wholly or mainly' by any entity (the Tenant) whose activities qualify as 'industrial activities' under section 43-150.

The Trustee is using its 'area' for the purpose of producing assessable income as it is deriving rental income from the Tenant, which is assessable and as explained above the Tenant is using both CE Areas for industrial activities.

Hence, the Trustee is considered to use the relevant part of its area 'in the 4% manner' under section 43-145.

The Trustee is therefore entitled to claim a deduction under section 43-10 at a rate of 4% in respect of its 'portion of your construction expenditure' attributable to:

·         CE Area 1 from the time the Trustee acquired the Property; and

·         CE Area 2 from the time of completion of construction of the relevant capital works in relation to the hardstand.

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