Edited version of private advice

Authorisation Number: 1051824408174

Date of advice: 13 April 2021

Ruling

Subject: Environmental protection activities - replacement of asbestos roof with a superior material

Question

Is the full amount for the removal of the asbestos of $XXX,XXX deductible as an environmental protection activity under section 40-755(1) of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997)?

Answer

Yes. The removal of the asbestos is deductible as it can be identified and specifically allocated to an environmental protection activity and therefore satisfies the sole or dominant purpose test.

Question 2

Is the amount for the replacement of the roof with corrugated iron zincalume of $XXX,XXX deductible as an environmental protection activity under section 40-755 of the ITAA 1997?

Answer

No. The replacement of the roof is a capital improvement and is therefore not deductible under section 40-755 of the ITAA 1997 since it is a capital improvement excluded under section 40-760.

Question 3

Is the amount for the replacement of the roof with corrugated iron zincalume deductible over time under Division 43 of the ITAA 1997?

Answer

Yes. The replacement roof is a capital improvement which is deductible over time under Division 43 of the ITAA 1997.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

13 December 20XX

Relevant facts and circumstances

On 13 December 20XX a Superannuation Fund entered into a contract to purchase a large factory with the expectation that a related entity would carry out its business of operating a knitting mill activity from that premises. The related entity has continued in business from various locations for XX years.

It was realised on XX November 20XX when planning to lease the premises to the related entity, from the original owners, prior to settlement on XX April 20XX, that remedial works in relation to asbestos in the roof would be needed. This was the result of a visual check of the building conducted, when the corrugated cement sheeting roof was first deemed suspect, as a result of observing broken sheets which exposed asbestos fibres. The lease would then, after settlement, be continued with the Superannuation Fund as landlord.

It was then proposed that the related entity would undertake the remedial work and quotes were obtained by the related entity for $XXX,XXX, with $XXX,XXX for asbestos removal and $XXX,XXX for the replacement roof.

The corrugated cement sheet roof containing asbestos will be removed and then replaced with corrugated iron zincalume.

A quote has been obtained and a deposit is to be paid by the related entity.

Relevant legislative provisions

ITAA 1997 subsection 40-755(1)

ITAA 1997 subsection 40-755(2)

ITAA 1997 subsection 40-755(3)

ITAA 1997 section 40-760

ITAA 1997Division 43

ITAA 1997 subsection 43-20(1)

ITAA 1997 section 43-40

Reasons for decision

Environmental Protection Activities Legislation

Section 40-755 of the ITAA 1997 allows deductions for environmental protection activities and subsection 40-755(1) of the ITAA 1997 states:

You can deduct expenditure you incur in an income year for the sole or dominant purpose of carrying on *environmental protection activities

Subsection 40-755(2) of the ITAA 1997 defines what constitutes environmental protection activities and states:

Environmental protection activities are any of the following activities that are carried on by or for you:

(a) preventing, fighting or remedying:

(i) pollution resulting, or likely to result, from *your earning activity; or

(ii) pollution of or from the site of your earning activity; or

(iii) pollution of or from a site where an entity was carrying on any *business that you have acquired and carry on substantially unchanged as your earning activity;

(b) treating, cleaning up, removing or storing:

(i) waste resulting, or likely to result, from your earning activity; or

(ii) waste that is on or from the site of *your earning activity; or

(iii) waste that is on or from a site where an entity was carrying on any business that you have acquired and carry on substantially unchanged as your earning activity.

No other activities are environmental protection activities.

Subsection 40-755(3) of the ITAA 1997 defines what constitutes your earning activity and states in part:

Your earning activity is an activity you carried on, carry on, or propose to carry on:

(a) for the *purpose of producing assessable income for an income year (except a *net capital gain);...

Section 40-760 of the ITAA limits deductions from environmental protection activities. Paragraph 40-760(1)(c) of the ITAA 1997 denies a deduction for expenditure that is 'capital expenditure for constructing an extension, alteration or improvement to a building, structure or structural improvement'.

In addition, subsection 40-760(2) of the ITAA 1997 states:

In particular, you cannot deduct under section 40-755 expenditure to the extent that you incur it on carrying out an activity for environmental impact assessment of your project.

Therefore, for section 40-755 of the ITAA 1997 to apply:

•         the expenditure must be in respect of environmental protection activities

•         the environmental protection activities must be connected to the entity's earning activity

•         the sole or dominant purpose is the carrying on of those environmental protection activities; and

•         section 40-760 of the ITAA 1997 does not deny the deduction.

Environmental protection activities

At paragraph 3 of TR 2020/2 Income tax: deductions for expenditure on environmental protection activities, the 'environmental protection activities' are defined as activities carried on by or for you:

• to prevent, fight or remedy pollution

- resulting, or likely to result, from your earning activity

- of or from the site of your earning activity

- of or from a site where an entity was carrying on any business that you have acquired and carry on substantially unchanged as your earning activity, and

• to treat, clean up, remove or store waste

- resulting, or likely to result, from your earning activity

- on or from the site of your earning activity

- on or from a site where an entity was carrying on any business that you have acquired and carry on substantially unchanged as your earning activity.

Paragraph 4 states that the term 'activities' is not defined and takes its ordinary, natural meaning of 'specific deeds or actions'. Paragraph 12 also states that

Such activities may include identifying and testing for actual or likely pollution. Where there may be actual or likely pollution (for example, asbestos is suspected), and testing is required to identify the existence and/or extent of the actual or likely pollution, the testing activity is considered to be integral to the undertaking of the environmental protection activity, even if pollution is not found.

Environmental protection activities must be connected to the entity's earning activity

To establish the necessary connection betweenpollution or waste and 'your earning activity', the pollution must be of be of or from the site of your earning activity according to paragraph 19 of TR 2020/2.

In this case the work being done is on the factory, paid for by the related entity. The related entity will continue to use this site to carry out its business of operating a knitting mill.

Therefore, the site will be used as part of the related entity's existing income producing activity.

Sole or dominant purpose is the carrying on of those environmental protection activities

Paragraph 32 of TR 2020/2 states that to claim a deduction, you must have incurred expenditure for the 'sole or dominant purpose of carrying on environmental protection activities'.

On XX November 20XX, a visual check of the building was conducted, where you observed broken sheets in the corrugated cement sheeting roof which exposed asbestos fibres. It was then realised that remedial works in relation to asbestos in the roof would be needed.

The question is whether or not the intended work is being undertaken simply to remove asbestos. As the work undertaken is only on the roof where the asbestos is located and it is doubtful that the work on the roof will have any impact on the knitting mill operations, the intended work is undertaken only for the removal of asbestos.

Therefore, it is accepted that the dominant purpose of undertaking the work at the roof level is the removal and replacement of the asbestos.

Section 40-760 of the ITAA 1997

This case involves the removal of the current corrugated cement sheeting roof and replacing it with corrugated iron zincalume. Because of the wording of paragraph 40-760(1)(c) of the ITAA 1997 we have to examine the impact to each of the buildings the work being undertaken may have.

In undertaking the work there are two phases the destruction followed by a reconstruction.

If this reconstruction results in an extension, alteration or improvement to any of the buildings then section 40-760 of the ITAA 1997 will deny a deduction under section 40-755 of the ITAA 1997 for that reconstruction. However, given the nature of the work we can eliminate the end result being an extension to a building and only need to look at whether the work is an alteration or an improvement.

If the work is an is an alteration or an improvement then the work will more than likely be capital expenditure to which Division 43 of the ITAA 1997 applies and if Division 43 of the ITAA 1997 applies then section 43-40 of the ITAA 1997 may also apply in respect of the destruction of the old roof.

The wording in subsection 43-20(1) of the ITAA 1997 which says 'This division applies to capital works being a building, or an extension, alteration or improvement to a building' is similar to that contained in section 40-760 of the ITAA 1997.

In respect of a building and capital expenditure paragraph 32 of TR 2020/2 states that you cannot deduct an amount under section 40-755 of the ITAA 1997 for capital expenditure for constructing a building, structure or structural improvement (including an extension, alteration or improvement to any of these), due to the operation of s 40-760 of the ITAA 1997, unless according to paragraph 43 of TR 2020/2, the replacement of a pollutant material with a non-pollutant material results in a minor or incidental degree of improvement to a building or structure.

Minor or incidental degree

Example 8 of TR 2020/2 clearly states replacing the original roof with roofing material of a superior quality is a capital improvement under section 40-760 of the ITAA 1997 and is therefore not deductible under section 40-755.

The replacement of the pollutant material, corrugated cement sheeting with a higher quality non-pollutant material of corrugated iron zincalume does not involve a minor or incidental degree of improvement and is therefore a capital improvement and not deductible under section 40-755 of the ITAA 1997.

Capital Improvement Deduction under Division 43

Division 43 of the ITAA 1997 provides a deduction for capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to buildings and structural improvements where a residential property is used for income producing purposes. In this case, the replacement of the factory's roof with a superior material is capital works. As a capital works deduction is available, a depreciation deduction is not allowable for the roof.

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