Edited version of private advice

Authorisation Number: 1052117474723

Date of advice: 25 May 2023

Ruling

Subject: Deductions - repairs

Question

Is the expenditure incurred by XYZB in relation to the façade remediation project, as outlined in Table A, deductible under either section 25-10 or section 8-1 of the Income Tax Assessment Act 1997 ('ITAA 1997') in the years in which the relevant expenditure was incurred, subject to any other provision of the 'Act' (as defined in subsection 995-1(1) of the ITAA 1997) preventing it from being deductible?

Answer

Yes.

This ruling applies for the following periods:

1 January 20XX to 31 December 20XX

The scheme commenced on:

1 January 20XX

Relevant facts and circumstances

Table A

Table 1: Description of costs incurred

XYZ

1.    XYZ is a multinational corporation with its headquarters located in XX. XYZ is not a resident of Australia within the meaning of subsection 6(1) of the Income Tax Assessment Act 1936 ('ITAA 1936').

2.    XYZ provides a range of services globally through approximately XX branches and offices in XX countries.

XYZB

3.    XYZ - Branch ('XYZB') provides services for customers in Australia though a permanent establishment (within the meaning of subsection 6(1) of the ITAA 1936).

4.    The registered office of XYZ is located at XXX (the 'Property').

5.    XYZ purchased the Property in 19XX for a total purchase price of approximately $XXX million. The purchase price allocated to the building (Building) was approximately $XXX million.

6.    Since the time the Property was purchased, XYZB has, and continues to, use the Building solely for the purpose of producing assessable income (within the meaning of section 6-5 of the ITAA 1997) in the form of rental income (in respect of the space it leases), and for the purpose of carrying on its business for the purpose of deriving assessable income (in respect of the space it occupies).

Identification of Building defects

7.    In 20XX a façade inspection of the Building was conducted by CCC. The inspection report highlighted a number of repairs and remedial works for the short term (0 - 2 years) and medium term (2 - 5 years). However, no works were undertaken to the defect areas identified due to budget restraints.

8.    In 20XX, the roof top membrane of the Building was found to have various water leaks and required repair or replacement to comply with commercial property lease requirements. Due to the passage of time since the 20XX façade inspection, BBB, the Building property managing agent, recommended an updated inspection report be conducted. An updated inspection was conducted by CCC in 20XX.

9.    On XX 20XX, CCC released the Façade & Roof Condition Audit report ('Audit Report').

10.  The Audit Report identified building defects at four locations of the Building, classified as immediate short term priority (with recommended time frame immediately) or short term priority (with recommended time frame 0-2 years) works. The main recommended and priority works were:

a.    North Elevations (short term priority)

                                  i.    Spall repairs, panel joint repairs, and window sealant repairs.

The North Elevations repair works were to address the following defects:

•         Spalling identified in the precast concrete panels which was believed to have caused the joints in between the precast concrete panels to have closed resulting in the extrusion of the joint sealant from the joints.

•         Cracked joints at the abutment of elements as a result from the use of rigid jointing.

•         The dilapidated glazing seal believed to be a potential point of water ingress.

b.    South Elevations (short term priority)

                                  i.    Minor repairs to glazing seals and parapet cappings etc.

The South Elevations repair works were to address water ingress from the cracked and degraded glazing seals.

c.     West Elevations (immediate short term priority)

                                  i.    Remediation of full façade brickwork adjacent to all slab levels.

The West Elevations repair works were to address the bulging brickwork and detached brick elements which were considered to be a serious safety risk and likely to result in structural failure of the wall if left unattended.

d.    Roof Area (short term priority)

                                  i.    Miscellaneous repairs e.g., spall repairs and joint repairs

The Roof Area repair works were to address cracked parapet walls, spalling concrete and degraded expansion joints.

e.    Roof membrane (short term priority)

                                  i.    Replacement of the roof waterproofing membrane

Replacement of the roof waterproofing membrane was to address the extensive degradation of surfaces, debonding and bulging of the membrane causing water penetration issues. (Note: the replacement of the roof waterproofing membrane was assessed by XYZB as non-critical hence this scope was not covered in the Project).

11.  Following review of the Audit Report, XYZB commenced a tender process (assisted by BBB and CCC) for a contractor to undertake the necessary works. The tender process concluded in late 20XX.

12.  The tender was awarded to AAA.

Medium Works Agreement

13.  In 20XX, XYZB and AAA executed a Medium Works Agreement to address the recommended works in the Audit Report (the Project).

14.  Schedule 2 of the Medium Works Agreement provides for the nature of the works undertaken to the Building, being predominantly:

a.    North Elevation works: joint repairs, spalling concrete repairs, crack repairs, window fenestration joint repair, metal capping joint repairs, and glazing gasket repairs, including making good all defective window gaskets and window trimmings as required.

b.    South Elevation works: window fenestration joint repairs, and glazing gasket repairs including making good all defective window gaskets and window trimmings as required.

c.     West Elevation works: joint repairs, masonry repairs, brick repointing repairs, brick tie investigations/repairs, and slab edge modification works. The masonry repairs included individually removing isolated bricks determined to be unsound and replacing with new bricks to match as close as possible; replacing missing, soft and friable brickwork joint mortar with a new pointing mix to match the existing colour, texture and profile as close as possible.

d.    Roof Area works: joint repairs, spalling concrete repairs, render repairs, masonry repairs, Fibre Cement sheeting repairs, painting works, and corroded element repairs/replacement.

15.  The Medium Works Agreement provides the Contract Sum totalling $XXX (excluding GST), comprising:

a.    $XXX (excluding GST) for the North Elevation works

b.    $XXX (excluding GST) for the South Elevation works

c.     $XXX (excluding GST) for the West Elevation works

d.    $XXX (excluding GST) for the Roof Area works

e.    $XXX (excluding GST) for the replacement of the plant room louvres on the rooftop which required repair due to bad corrosion.

16.  Clause 14 of the Medium Works Agreement provides for regular periodic payments of amounts due for work undertaken.

Timeline of works

17.  The building repair works were scheduled to commence on XX 20XX in accordance with Schedule 4 - Works Program in the Medium Works Agreement.

18.  However, due to delays in obtaining Council approval for a hoarding permit, the Project commenced in XX 20XX.

19.  The final inspection report was issued by CCC in 20XX, concluding the Project.

Other matters

20.  During the Project, additional works were undertaken due to unforeseen site conditions, including:

•         Removal of asbestos materials in the sealants of North and West Elevations,

•         Leveling of concrete slab of West Elevation,

•         Installation of additional brick ties to West Elevation,

•         Installation of additional pins and L-bar to North Elevation,

•         Replacement of roof louvre flashing,

•         Additional concrete spalling repairs,

•         Additional gasket and roof render repairs.

The cost of additional works undertaken totalled $XXX (excluding GST) and are included in Table A.

21.  CCC was retained as the façade specialist consultant to provide services such as site quality control inspections and assessments in the Project.

22.  BBB managed the Project, including the tender process through to completion of the Project. The project management fee paid to BBB consisted of a fixed component and variable component being a percentage of the Project costs.

23.  During the Project, XYZB continued to receive assessable rental income (with respect to the space it leases) and to occupy the same space it uses for the purpose of carrying out its business. There were no significant changes to XYZB's rental income earning capacity, nor the space it occupies for its business as a result of the Project.

24.  Only damaged parts of the Building's façade were replaced, and only damaged parts of the Building's roof were repaired/replaced and re-painted as part of the Project.

25.  Works of the nature undertaken in the Project have not previously been undertaken on the Building during the period XYZ owned the Building.

26.  The expenditure outlined in Table A was not incurred by XYZB in relation to gaining or producing exempt income (within the meaning of section 6-20 of the ITAA 1997) nor non-assessable non-exempt income (within the meaning of section 6-23 of the ITAA 1997).

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-20

Income Tax Assessment Act 1997 Section 6-23

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 8-1(1)

Income Tax Assessment Act 1997 Subsection 8-1(2)

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Subsection 25-10(3)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Repairs

You can deduct expenditure incurred for repairs to premises or a depreciating asset that is held or used solely for the purpose of producing assessable income, provided that it is not capital expenditure (section 25-10).

The building at XXX (Building) is a 'premises' within the ordinary meaning of the word and has been used solely by XYZ for the purpose of producing assessable income. Therefore, any expenditure incurred by XYZB that is considered 'repairs' to the Building, and is not capital expenditure, may be deductible under section 25-10.

Meaning of 'repair'

Taxation Ruling TR 97/23: Income Tax: deductions for repairs (TR 97/23) explains the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10.

'Repairs' is defined by The Commissioner as having its ordinary meaning, that is, the remedying or making good of defects in, damage to, or deterioration of property to be repaired, and contemplates the continued existence of the property.[1] Repair for the most part is occasional and partial, and involves restoration of the efficiency of function of the property being repaired without changing its character.[2] A substantial improvement is not a repair and is not deductible under section 25-10.[3]

Work done to prevent or anticipate defects, damage or deterioration in a property is not in itself a 'repair' unless it is done in conjunction with remedying or making good defects in, damage to, or deterioration of, the property.[4]

What is considered a 'repair' for the purposes of section 25-10 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.[5]

Work undertaken that changes the character of the property, or does more than restore its efficiency of function goes beyond the meaning of 'repair'.[6]

Based on the facts, the expenditure paid to AAA for the Project is for work done to remedy defects, damage and/or deterioration of the Building identified in the Audit report and during the course of the Project in order to restore the Building's efficiency of function. Replacement of parts including joints, window fenestrations, and rooftop louvres, and the removal of asbestos during the course of repairing joints are considered to be a 'repairs' as this work was done in conjunction with repairs to the Building.[7] There is no evidence that the works were undertaken to change the character of the Building nor substantially improve the efficiency of function of the Building. Therefore, the expenditure paid to AAA is incurred for 'repairs' done to the Building.

Work of a capital nature

You cannot deduct expenditure for repairs that is capital expenditure (subsection 25-10(3)). Expenditure for repairs to property is capital expenditure if:[8]

• it establishes, replaces or enlarges the profit-yielding structure
• it is a reconstruction of the entirety; or
• is incurred in putting an asset acquired that was not in good order into good order.

The Project works were undertaken to remedy damage and deterioration of the Building. During the Project, XYZB continued to receive assessable rental income (with respect to the space it leases) and to occupy the same space it uses for the purpose of carrying out its business. There were no significant changes to XYZB's rental income earning capacity, nor the space it occupies as a result of the Project. Therefore, the expenditure has not established, replaced or enlarged the profit-yielding structure.

In respect of the term 'entirety', where something is part of a building, the building is the entirety.[9] Parts of the Building have been repaired and replaced, including damaged bricks, joints, seals, window fenestrations, and elements of the façade and the roof of the Building. Only damaged parts of the Building's façade were replaced, and only damaged parts of the Building's roof were repaired/replaced and re-painted as part of the Project. Therefore, the works undertaken does not amount to a reconstruction of the entirety.

The expenditure was incurred many years after XYZ acquired and used or held the Building for the purpose of producing assessable income. Therefore, the expenditure is not incurred in putting the Building into good order for its intended use after acquisition.

Accordingly, the expenditure is not capital expenditure.

Therefore, the expenditure paid to AAA for the Project work is deductible as repairs under section 25-10 in the years in which the relevant expenditure was incurred.

General deductions

In addition to expenditure paid to AAA, XYZB incurred the following fees in relation to the Project (included in Table A):

•         Project management fees paid to BBB; and

•         Consulting fees paid to CCC.

You can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing assessable income or it is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income (subsection 8-1(1)).

XYZB incurred the project management fees and consulting fees in relation to the Project in the course of gaining assessable rental income (in respect of the space it leases) and for the purpose of carrying on its business for the purpose of deriving assessable income (in respect of the space it occupies).

Therefore, the project management fees paid to BBB and consulting fees paid to CCC are deductible under section 8-1, subject to subsection 8-1(2).

You cannot deduct a loss or outgoing to the extent that:[10]

a)    it is of a capital nature; or

b)    it is of a private or domestic nature; or

c)    it is incurred in relation to gaining or producing your exempt income or your non-assessable, non-exempt income; or

d)    another provision of the Act prevents you from deducting it.

As outlined above, the expenditure paid to AAA to carry-out the Project building works is for 'repairs' and is not capital expenditure. The project management and consulting fees incurred to support the Project were to facilitate the repair expenditure and are likewise not of a capital nature.

Expenditure for the Project was incurred in the course of leasing part of the Building and carrying on XYZB's business and is not of a private or domestic nature.

XYZB uses the Building solely for the purpose of producing assessable income in the form of rental income (in respect of the space it leases) or for the purpose of carrying on its business for the purpose of deriving assessable income (in respect of the space it occupies). The expenditure outlined in Table A was not incurred by XYZB in relation to gaining or producing exempt income (within the meaning of section 6-20 of the ITAA 1997) nor non-assessable non-exempt income (within the meaning of section 6-23 of the ITAA 1997).

This ruling is made on the basis that another provision of the 'Act' (as defined in subsection 995-1(1)) does not prevent the expenditure in relation to the Project from being deductible. Subsection 995-1(1) defines the [this] 'Act' to include:

(a) the Income Tax Assessment Act 1936; and

(b) Part IVC of the Taxation Administration Act 1953, so far as that Part relates to:

(i) this Act or the Income Tax Assessment Act 1936; or

(ii) Schedule 1 to the Taxation Administration Act 1953; and

(c) Schedule 1 to the Taxation Administration Act 1953;

except in Division 950 (Rules for interpreting this Act)

Accordingly, the project management fees paid to BBB and the consulting fees paid to CCC in relation to the Project are deductible under section 8-1 in the years in which the relevant expenditure was incurred, subject to any other provision of the Act preventing it from being deductible.

[1] Paragraph 13 of TR 97/23.

[2] Paragraph 15 of TR 97/23.

[3] Paragraph 16 of TR 97/23.

[4] Paragraph 14 of TR 97/23.

[5] Paragraph 21 of TR 97/23.

[6] Paragraph 22 of TR 97/23.

[7] Paragraph 14 (in respect of the replacement of joints, window fenestrations and rooftop louvres) and Paragraph 26 (in respect of the removal of asbestos) of TR 97/23.

[8] Paragraph 32 of TR 97/23.

[9] Paragraph 40 of TR 97/23.

[10] Subsection 8-1(2).

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).