Edited version of private advice

Authorisation Number: 1051745437604

Date of advice: 27 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 (CE) in relation to the Property?

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 premises for the fabrication and maintenance of the Equipment.

Tenant's activities

The Tenant is a maintenance repair organisation that is directly related to a primary original equipment manufacturer.

The activities undertaken by the Tenant within the Property includes overhauling, modifying, maintaining, repairing the Equipment. The Tenant may assemble various parts to build components to be installed for use in the Equipment.

Construction expenditure area

·         A 'construction expenditure area' for the purposes of subsection 43-75(3) exists in relation to the Property.

·         A 'pool of construction expenditure' is attributable to the Property for the purposes of section 43-85.

·         The Trustee's 'your area' is equivalent to the Property for the purposes of subsection 43-115(1).

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

·         The expenditure satisfies the definition of 'construction expenditure' in section 43-70.

·         The relevant capital works began after 30 June 1997.

Reasons for decision

Question 1

Summary

The activities undertaken by the Tenant in the Property are 'industrial activities' under section 43-150 of the Income Tax Assessment Act 1997 (ITAA 1997).

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)(i)

For an activity to be considered 'manufacturing', it would generally require that:

·         a thing having a new industrial use is created

·         Where new materials are supplied there would only be such a manufacture if the work done was more than a mere repair or modification of the old materials and was such as to change the old goods into new goods of a different character.

·         the process of manufacture involves the production of articles for use from raw materials which gives these materials a new form, quality and/or property which it did not possess before.

As Goods and Services Tax Ruling GSTR 2005/2 Goods and services tax: supplies of goods and services in the repair, renovation, modification or treatment of goods from outside Australia whose destination is outside Australia summarises at paragraph 40:

Manufacture commonly results in a change in the identity of the goods. Their essential character is altered in such a way that they can no longer be considered to be the same goods. The original goods being components, ingredients, raw materials or similar, are subsumed into new goods with their own identity.

The activities undertaken by the Tenant at the Property include the 'manufacture' of the Equipment components.

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

Subparagraph 43-150(a)(ii)

Other activities of the Tenant will fall under 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 s 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:

Both the Equipment and the Equipment components are 'manufactured items' contemplated by subparagraph 43-150(a)(ii) as they are either:

·         Existing manufactured goods made by someone other than the Tenant (i.e. the Equipment, and parts and components to the extent they are manufactured elsewhere and ordered in); and

·         Existing manufactured goods made by the Tenant (i.e. the components which are manufactured or built on-site).

The equipment are used in the manufacturer's business by being leased or sold to other entities, until they need to be repaired, modified or overhauled by the Tenant. After the Tenant's activities are complete, they are returned to service.

The nature of the Tenant's activities are 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):

·         The activities undertaken by the Tenant within the Property includes major overhauls, significant modifications, maintaining, repairing the Equipment.

·         Even where pre-made parts are ordered in, there can be some modification to allow the component to be used in the Equipment.

·         The Equipment and/or their components are 'in the form or condition in which they are sold or used' as they are returned to service after leaving the Property.

Where the activities are carried out in respect of goods not manufactured by the Tenant, the relationship with the original manufacturer of the goods as noted in MP Metals is also satisfied as the Equipment and/or the relevant components are returned to be used by the customers of their original manufacturers.

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

Question 2

Summary

The Trustee is entitled to a deduction under section 43-10 of the ITAA 1997 at a rate of 4% for the pool of construction expenditure.

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.

As outlined above, the activities of the Tenant qualify as industrial activities and therefore 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' from the time the Trustee acquired the Property.

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