Edited version of private advice

Authorisation Number: 1052102813272

Date of advice: 17 April 2023

Ruling

Subject: Repairs

Issues

Question 1

Is the Taxpayer entitled to a deduction under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) for expenditure incurred in replacing the asbestos reinforced sheeting roof with Colorbond and Fibreglass Trim-dek for Warehouse 1 and Warehouse 2?

Answer

Yes.

Question 2

To the extent the Taxpayer is not entitled to a deduction under section 25-10 of the ITAA, is the Taxpayer entitled to a deduction under section 40-755 of the ITAA 1997 for expenditure incurred in replacing removing and disposing asbestos for Warehouse 1 and Warehouse 2?

Answer

Yes.

Question 3

Is the Taxpayer entitled to a deduction under Division 43 of ITAA 1997 for expenditure incurred in installing sisalation paper for Warehouse 1 and Warehouse 2?

Answer

Yes.

This ruling applies for the following periods:

1 July XXXX to 30 June XXXX

Relevant facts and circumstances

The Taxpayer owns a commercial rental property.

The Taxpayer acquired the Property around XXXX.

The Property was built in the XXXX.

The Property comprises 2 buildings - Warehouse 1 (the total square meterage of the roof is XXXXm²⁾ and Warehouse 2 (the total square meterage of the roof is XXXm²).

The roofs for both buildings were not in need of repair at the time the Property was acquired and when the Taxpayer commencing holding it as a commercial rental property.

The roofing material for the roofs at the time the property was acquired was asbestos reinforced sheeting.

The roofing material has remained the same from the time of acquisition of the Property.

Warehouse 1 was rented to a related entity on commercial terms since the acquisition of the Property, until it was rented out to an unrelated entity about X years ago. The related entity conducted a wholesale business, and the warehouse was used for the storage of materials associated with the entity's business activities. Warehouse 2 has been rented out to an unrelated party since the acquisition of the Property.

The Roof is in poor condition with multiple leaks during heavy rains.

The asbestos reinforced sheeting is being replaced with Colorbond and Fibreglass Trim-dek.

Sisalation is the brand name for a special type of sarking material.

The Fibreglass Trim-dek roofing will comprise 10% of the total square meterage of the roof for each building. The purpose of the Fibreglass Trim-dek is to allow light through the roof.

The work:

•         does not entail the re-designing of the roof; and

•         involves merely replacing existing flashings/cappings/barges/ridges.

The choice of material for the replacement roof was based on cost (being the least expensive option).

The supply and installation of the sisalation paper is discrete from the cost of the supply and installation of the Colorbond and Fibreglass Trim-dek. (i.e. it can be separately segregated and its cost accurately quantified independently from the cost of the supply and installation of the Colorbond and Fibreglass Trim-dek).

The Taxpayer will incur expenses for the removal and disposal of asbestos. The removal and disposal of asbestos is discrete from the cost of the supply and installation of the Colorbond/ Fibreglass Trim-dek and sisalation paper (i.e. it can be separately segregated and its cost accurately quantified independently from the cost of the supply and installation of the Colorbond/Fibreglass Trim-dek and the sisalation paper).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 section 40-755

Income Tax Assessment Act 1997 Division 43

Reasons for decision

Questions 1 and 2

Summary

Colorbond and Fibreglass Trim-dek would not enhance the essential function of the roof in these circumstances such that the work may be considered an improvement rather than repairs for the purposes of section 25-10 of the ITAA 1997. Consequently, the expenses incurred in replacing the asbestos reinforced sheeting of the roof with Colorbond and Fibreglass Trim-dek is deductible in the year in which the expenditure was incurred.

To the extent the removal and diposal of asbestos would not qualify as a repair, the Taxpayer will be entitled to a deduction for the total cost of removing asbestos from the Property under section 40-755 of the ITAA 1997.

Detailed reasoning

Repairs

Section 25-10 of the ITAA 1997 provides that expenditure incurred for repairs to premises held or used solely for the purpose of producing assessable income are deductible in the year in which the expenditure was incurred.

The meaning of 'repairs' and the circumstances under which repairs are deductible, as set out in Taxation Ruling TR 97/23 Income tax: deductions for repairs, are applicable.

'Repairs' for the purposes of section 25-10 of the ITAA 1997 relates to the making good of defects, damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes, to restore the efficiency of function of the premises (or part of premises), without changing its character.

Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal or reconstruction, as distinguished from repair, is restoration of the entirety.

Relevantly, the Commissioner accepts, as determined in W Thomas and Co Pty Ltd v. FC of T 155 CLR 58, the roof of a building is not considered an entirety:

117. In the W Thomas & Co case, where the High Court considered deductions claimed for repairs to guttering, the roof, walls and two floors of a building, the view was taken that the whole building was the entirety. Windeyer J said (at 115 CLR 66; 14 ATD 83) that the relevant question is not:

' ... whether the roof or the floor or some other part of the building, looked at by itself, was repaired as distinct from being reconstructed or replaced. It is whether what was done to the roof or the floor or some other part was a repair of the building.'

Repair vs improvement

Whether the work undertaken constitutes repair is a question of fact and degree and an exercise of judgement. This involves a process of evaluating and weighing a range of factors for the particular circumstance.

Factors that may be relevant in determining whether the work is repair include:

(a)  The condition of the building at the time of acquisition.

(b)  The purpose of the work - for example:

(i)    whether it is to restore the building to its former appearance, form, state or condition;

(ii)   whether it is to prevent future defects in, damage to, or deterioration of a building; or

(iii)  whether it is to remedy or make good a defect in, damage to, or deterioration of a building that existed at the time of acquisition.

(c)   The outcome of the work - for example:

(i)    whether the work changes the character of the building; or

(ii)   whether the work affects the efficiency of function of the building.

The key consideration is whether the work does more that restore the character or function of the building - the use of different materials and improved technology will not in themselves cause the work to be considered an improvement:

Restoration of efficiency of function of the property

88. The High Court of Australia (Windeyer J) said in W Thomas & Co Pty Ltd v. FC of T (1965) 115 CLR 58 at 72; (1965) 14 ATD 78 at 87:

'The words "repair" and "improvement" may for some purposes connote contrasting concepts; but obviously repairing a thing improves the condition it was in immediately before repair. It may sometimes be convenient for some purposes to contrast a "repair" with a "replacement" or a "renewal". But repairs to a whole are often made by the replacement of worn-out parts by new parts. Repair involves a restoration of a thing to a condition it formerly had without changing its character. But in the case of a thing considered from the point of view of its use as distinct from its appearance, it is restoration of efficiency of function rather than exact repetition of form or material that is significant. Whether or not work done upon a thing is aptly described as a repair of that thing is thus a question of fact and degree.' (emphasis added)

89. It is therefore more significant in applying the word 'repairs' in its context in section 25-10, to consider whether the work restores the efficiency of function of the property for income purposes (without changing its character) than it is to consider whether the appearance, form, state or condition of the property is exactly restored.

Use of different materials

48. If expenditure is incurred in replacing or renewing a part of property with a material of a different type from the original, the work done may either repair the property, or be an improvement to it. The use of different materials is not in itself determinative of the issue.

49. 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.

50. 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 material enables the property to perform its function marginally more efficiently, the work may still constitute a deductible repair. However, the greater the work enhances the efficient functioning of the property, the more likely it is that the work constitutes an improvement.

51. The test is whether there is a sufficient degree of improvement to justify characterising the expenditure as capital and therefore excluding it from deductibility under section 25-10.

52. If the work produces a new and different function, or an additional function, it is likely to constitute a capital improvement.

Technological advances or enhancements

53. As a general proposition, the greater the degree of technological advancement involved in work done to property, the more it is likely the work goes beyond a 'repair'. This is so because it is more likely the work does more than restore the property to its original efficiency of function. If it does, the cost of the work is not deductible under section 25-10. (It might be deductible under section 8-1 if the cost is a working or operating expense and it is not of a capital nature.)

54. If, however:

a)    the work done to property involves:

(i)    a degree of technological advancement that results in only a minor and incidental improvement to the property; or

(ii)   an enhancement arising from the use of more modern materials and component parts (often where original materials and parts are no longer available) that adds in only a minor and incidental way to the overall efficiency of function of the property; and

b)    the work done does not change the property's character;

this does not in itself preclude the expenditure from being characterised as repair expenditure deductible under section 25-10.

The Commissioner accepts that 'repair' in this context contemplates a minor and incidental, and not a substantial, degree of improvement - in the sense that the improvement happens in fortuitous or subordinate conjunction with the repair work and it is inconsequential:

Functionality of the property on which the work is done

90. In considering whether work does more than restore property to its original efficiency of function, what is determinative is the functionality of the property on which the work is being done and not the functionality of the defective component or part. That is not to say, however, that the effect of the work on the functionality of the defective component or part is not relevant. It is a relevant factor to take into account in considering the extent of change made to the functionality of the property.

91. To illustrate, if cast-iron pistons in an engine are replaced with aluminium-alloy pistons, being a more modern material for the construction of pistons, the determining question is whether the functionality of the engine has been restored or has only been enhanced in a minor and incidental way. However, any greater efficiency of function of the pistons is a relevant consideration in deciding that question. Expenditure in replacing the pistons is deductible under section 25-10. The engine's essential efficiency of function has not changed. Nor has the character of the engine changed by the use of marginally more efficient pistons. The aluminium-alloy pistons are marginally more efficient because they are lighter, hardier and are machined differently to produce less friction.

FC of T v. Western Suburbs Cinemas Ltd (1952) 86 CLR 102 (Western Suburbs Cinema) illustrates the circumstances in which the work to the subsidiary can be taken to be an improvement that is capital in nature:

110. In the Western Suburbs Cinemas case, the ceiling of a motion picture theatre was in a state of disrepair. To restore the ceiling to its original condition would have cost #603. The company instead replaced the ceiling with a new one of a different design and better material for a cost of more than #3,000. The High Court (Kitto J) concluded that the new ceiling was an improvement to a fixed capital asset and that its cost was a capital charge. His Honour said at 86 CLR 105; 9 ATD 454:

... In this case, the work done consisted of the replacement of the entire ceiling, a major and important part of the structure of the theatre, with a new and better ceiling. The operation seems to me different, not only in degree, but in kind, from the type of repairs which are properly allowed for in the working expenses of a theatre business. It did much more than meet a need for restoration; it provided a ceiling having considerable advantages over the old one, including the advantage that it reduced the likelihood of repair bills in the future ... . The truth is, I think, that the new ceiling was an improvement to a fixed capital asset and that its cost was a capital charge.'

In making this finding, the court observed that the nature of the work involved more than merely replacing the ceiling material:

The architect came to the conclusion that it was really impossible to repair the ceiling at all. Ten Test was not available, but it does not appear that celotex, which was the Australian rival to Ten Test, or another material of a similar kind, caneite, was unobtainable. However, the architect would not use any material of this type for the ceiling, because experience had satisfied him that it was unsatisfactory for that kind of work. He employed, not fibro, but fibrous plaster, and with that he covered the whole area formerly covered by Ten Test and lattice. The fibrous plaster was affixed to new battens, which in turn were fixed to new ceiling joists: and the result was an entirely new ceiling. Fibrous plaster has a much longer life than the celotex type of material; it is harder, and it also lends itself better to decorative treatment and can be moulded. The new ceiling cost more than 3,000 pounds.

The advantage of reducing the likelihood of future repair bills is to be viewed in the context of only part of the ceiling was in need of repair but the taxpayer chose to replace the entirety. The new battens, joists and material significantly enhanced the performance of the ceiling and reduced the likelihood of repairs being required

Asbestos removal

In TR 97/23, the Commissioner explains that work done to property in controlling health risks associated with the use of dangerous substances (such as asbestos, chloroflurocarbons ('CFCs'), chromium, dioxin, cyanide, pesticides and arsenic) does not qualify as a 'repair' for the purposes of section 25-10 unless the work remedies or makes good defects in, damage to, or deterioration (in a mechanical or physical sense) of, the property.

Interaction between sections 25-10 and 40-755 of the ITAA 1997

Section 40-755 allows a deduction in the year of income for expenditure incurred for the 'sole or dominant purpose' of carrying on environmental protection activities.

Relevantly, environmental protection activities is defined in subsection 40-755(2) of the ITAA 1997 to mean 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; or
• of or from a site where an entity was carrying on a business that you have acquired and carry on substantially unchanged as your earning activity.

Environmental protection activities must be 'carried on by or for you'. An activity is 'carried on by or for you' if it is carried on directly by you or your agent or performed by another to your benefit or in place of you.

The term 'pollution' is not defined and takes its ordinary meaning, namely contamination by a harmful or potentially dangerous substance which is detrimental to living things, such as explosive chemicals, greenhouse gases and includes noise pollution. Asbestos is considered a pollutant in this context.

Relevantly, a deduction may be available when the pollution is of or from the site of your earning activity, even where the pollution has not arisen as a result of your earning activity.

Where your earning activity is the leasing of a site, the granting of rights to use a site or a similar activity in respect of a site, that site is the site of your earning activity. That is, you do not need to occupy the site to qualify for a deduction for environmental protection activities related to that site.

The deduction provision for environmental protection activities is a provision of last resort. You cannot claim expenditure to the extent that it is deductible under another provision outside Subdivision 40-H of the ITAA 1997.

Where pollutant material, such as asbestos, has been used in the construction of a building and action is taken to remove and replace this material, you may only claim an environmental protection deduction to the extent that it is not deductible under another provision outside

The removal and replacement work will be deductible under section 25-10 of the ITAA 1997 for repairs if:

•         the installed pollutant products are defective, damaged or deteriorated; and

•         the defect, damage or deterioration arose as a result of you using the property to gain or produce assessable income; and

•         the work is undertaken to restore them to their original condition.

If the replacement with the non-pollutant material results in a minor or incidental degree of improvement, the expenditure will not be precluded from deductibility under section 40-755 of the ITAA 1997. As explained above, a minor or incidental degree of improvement may result if the new material is essentially the modern day equivalent of the pollutant material, where, due to technological advancement, the new material possesses some enhanced properties.

Application in these circumstances.

The Taxpayer will incur expenses in replacing the asbestos reinforced sheeting roof of Warehouse 1 and Warehouse 2 with Colorbond and Fibreglass Trim-dek.

The Commissioner accepts that 'repair' in this context contemplates a minor and incidental, and not a substantial, degree of improvement.

The replacement of asbestos reinforced sheeting with Colorbond and Fibreglass Trim-dek (different material and technology), may result in some improvements over the asbestos reinforced sheeting roof. However, there is an insufficient degree of improvement to justify the characterisation of the expenditure as capital. Any improvement happens in a fortuitous or subordinate conjunction with the repair work and it is inconsequential. Colorbond and Fibreglass Trim-dek would not enhance the essential function of the roof in these circumstances (which is to prevent damage to the interior caused by exposure to the elements and animals) to such a degree over and above that which may be expected of an asbestos reinforced sheeting roof such that the work may be considered an improvement rather than repairs for the purposes of section 25-10 of the ITAA 1997.

The work will not amount to an improvement:

•         The entire asbestos reinforced sheeting roof is in a dilapidated state.

•         Colorbond, being very light, would not require the installation of new supporting structural components (beams etc.)

•         Colorbond does not require any significant changes to the roof's structure/design.

•         Whilst the purpose of the Fibreglass Trim-dek is also to allow some light through the roof, it comprises 10% of the total roof area for each building.

The work will also entail the removal and disposal of asbestos.

It can be said that work done to remove and dispose of asbestos in conjunction with work done to remedy or make good defects in, damage to, or deterioration of, the property (i.e. to replace the deteriorated asbestos reinforced sheeting with Colorbond and Fibreglass Trim-dek), qualifies as a repair for the purposes of section 25-10 of the ITAA 1997.

The Taxpayer's sole or dominant purpose in carrying out the work would be to rid the Property of asbestos. Whilst the replacement (of the asbestos reinforced sheeting) with the non-pollutant material (Colorbond and Fibreglass Trim-dek) may result in a minor or incidental degree of improvement because the non-pollutant is essentially the modern day equivalent of the pollutant material, where, due to technological advancement, the new material possesses some enhanced properties, the expenditure will not be precluded from deductibility under section 40-755 of the ITAA 1997.

To the extent the removal and disposal of asbestos is not a repair for the purposes of section 25-10 of the ITAA 1997, it will qualify as an environmental protection activity for the purposes of section 40-755 of the ITAA 1997, and the Taxpayer will be entitled to a deduction for the total cost of removing and disposing of asbestos from the Property under section 40-755 of the ITAA 1997.

Consequently, the Taxpayer is either:

a)    entitled to a deduction under section 25-10 if the ITAA 1997 for expenses incurred in replacing the asbestos reinforced sheeting roof with Colorbond and Fibreglass Trim-dek, including the cost of removing and disposing of asbestos; or

b)    entitled to a deduction under section 25-10 if the ITAA 1997 for expenses incurred in replacing the asbestos reinforced sheeting roof with Colorbond and Fibreglass Trim-dek, and a deduction under section 40-755 of the ITAA 1997 for the cost of removing and disposing of asbestos.

Question 3

Summary

The installation of the sisalation paper qualifies as construction expenditure for the purposes of Division 43 of the ITAA 1997.

Detailed reasoning

Division 43 of the ITAA 1997 provides a deduction for construction expenditure on capital works.

Capital works include extensions, alterations or improvements to buildings (subsection 43-20(1) of the ITAA 1997).

Building' has its ordinary meaning and refers to a substantial structure with a roof and walls, such as a shed, house, department store, etc. Warehouse 1 and Warehouse 2 are buildings to which Division 43 of the ITAA 1997 apply.

Construction expenditure is capital expenditure incurred in respect of the construction of capital works (subsection 43-70(1) of the ITAA 1997). Subsection 43-70(2) of the ITAA 1997 lists a number of expenditures that are excluded from the definition of construction expenditure. None of those exclusions apply in this case.

Having regard to the ordinary meaning, the phrase 'extension, alteration or improvement' encompasses disparate but overlapping concepts. Broadly:

•         an alteration is a change or modification;

•         an extension is a thing added to the main structure; and

•         an improvement is a betterment.

What constitutes 'extension, alteration, or improvement' is context-dependent -it can encompass the pursuit of a thing (that is, the process of extending, altering or improving) as well as the thing itself. Relevantly, the phrase 'extension, alteration, or improvement' for the purposes of section 43-20 of the ITAA 1997 refers to a change, addition or betterment to an existing building.

Section 43 -50 of the ITAA 1997 provides that where expenditure qualifies for a deduction under Division 43 a deduction cannot be claimed for that expenditure under any other provision of ITAA 1997 or ITAA 1936 - that is, Division 43 has priority over any other provision of income tax legislation. But because the definition of 'construction expenditure' excludes many other things that are dealt with elsewhere in the Act, such as repairs, it is necessary to consider other provisions in order to determine entitlement under Division 43.

Interaction between sections 25-10 and Division 43 of the ITAA 1997

To the extent your 'extension, alteration, or improvement' to a building, a structural improvement or environment protection earthworks is capital works for the purposes of section 43-20 of the ITAA 1997 and your expenditure on that capital works is 'construction expenditure' for the purposes of section 43-70, no part of that expenditure is deductible under any other provision. Relevantly, it cannot be deducted as a 'repair' under section 25-10 of the ITAA 1997.

The Commissioner considers that 'extension, alteration, or improvement' in the context of Division 43 of the ITAA 1997 does not contemplate a change or betterment that is more properly regarded as repairs. As discussed above, the Commissioner accepts that 'repair' for the purposes of section 25-10 contemplates a minor and incidental, and not a substantial, degree of improvement, addition or alteration - in the sense that the improvement, addition or alteration happens in fortuitous or subordinate conjunction with the repair work and it is inconsequential.

Broadly, sarking may improve performance and comfort through the following benefits:

• protecting the building from mould growth, ceiling staining or permanent damage which can result from the entry of storm driven rain into the roof cavity;
• limiting dust entering the building through gaps around downlights and vents by reducing draughts that blow dust into the roof space;
• improving thermal performance by reducing heat flow through the roof;
• managing the risk of condensation by allowing moisture to escape whilst preventing the entry of water;
• providing a secondary form of ember protection for the roof space.

(see e.g. https://www.bradfordinsulation.com.au/home-insulation/roof-sarking).

To the extent the installation of the sisalation paper is capital works for the purposes of section 43-20 of the ITAA 1997 and your expenditure on that capital works is 'construction expenditure' for the purposes of section 43-70, no part of that expenditure is deductible under any other provision.

The installation of the sisalation paper qualifies as construction expenditure for the purposes of Division 43 of the ITAA 1997: it is an alteration or improvement to Warehouse 1 and Warehouse 2.

The sisalation paper does not replace existing sisalation paper (either in existence at the time the Property was acquired nor installed during the period of ownership of the Property). It cannot be said that it is a minor and incidental alteration or improvement. Whilst it may happen in conjunction with the replacement of the asbestos reinforced sheeting with Colorbond and Fibreglass Trim-dek, it is not inconsequential.

Consequently, the Taxpayer is entitled to a deduction under Division 43 of the ITAA 1997 for the cost of installing the sisalation paper.

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