Edited version of private advice

Authorisation Number: 1052305387922

Date of advice: 13 September 2024

Ruling

Subject: Deductions - special levy

Question

Can you claim a deduction in the income year ended 30 June 2024 for the full amount of the special levy paid to the body corporate for expenses following the loss of the specific proceedings?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

You have an ownership interest in an investment lot under XXXX.

In 20XX one of the owners commenced action with the XXXX (XX) regarding delay to remedial work to common property by the owners' corporation (OC) and sought the appointment of a compulsory strata manager and damages for the loss of rental income as a result of water damage.

In XX 20XX XX determined the complainant was entitled to compensation for lost rent and the complainant's legal costs.

In XX 20XX, on appeal, XX concluded the complainant had a right to claim damages in consequence of a continuing breach of obligation by the OC in its duty to repair and maintain the common property and ordered the OC to pay the complainant damages and legal costs of the proceedings and the appeal from levied contributions on all lots in the strata scheme (other than the complainant's).

In XX 20XX the Owners of the strata plan agreed on a special levy to fund costs awarded by XX.

You paid an amount of $XXXX as a once off instalment to the special levy in the income year ending 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 section 26-5

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 Division 43

Reasons for decision

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

Common Property

Subsection 25-10(1) states that repair expenditure can be claimed for repair to the premises or part of the premises that you used for the purpose of producing assessable income.

Repairs to other units is a repair to the part of the property held by the particular lot owner.

Common property is that part of a strata plan not comprised in any owner's lot, and includes stairways, lifts, passages, common garden areas, common laundries and other facilities intended for common use.

Generally, owners can claim deductions relating to common property (where used for an income producing purpose) and return any income derived from the common property.

The ownership of the common property varies according to the relevant state strata title legislation. However, in all states, the income derived from the use of the common property is income of lot owners, and accordingly, you can claim deductions for capital works and, in some cases, the decline in value of depreciating assets that form part of the common property in proportion to your lot entitlement.

Body corporate fees and charges

Strata title body corporates are constituted under the strata title legislation of the various states and territories.

Body corporate fees and charges may be incurred to cover the cost of day-to-day administration and maintenance or for a special purpose.

Under section 8-1 of the ITAA 1997 body corporate fee and charges may be claimed as a deduction for rental properties.

Payments you make to body corporate administration funds and general purpose sinking funds are considered to be payments for the provision of services by the body corporate and can be claimed as a deduction for these levies at the time they are incurred. However, if the body corporate requires payments to be made to special purpose funds to pay for particular capital expenditure, these levies are not deductible.

An owner of a lot in a strata scheme may recover from the owners' corporation, such as damages for breach of statutory duty, any reasonably foreseeable loss suffered by the owner as a result of a contravention by the owners' corporation.

The obligation arises as a consequence of being an owner and is in a sense part of the estimate of the amount which is required to meet the owner's proportion of their mutual liabilities. Such a receipt is a contribution by that owner for the common benefit of all the owners.

Having regard to these principles, the Commissioner considers that the principle of mutuality applies to the amounts paid by owners to the strata title body; which is directed to for example, an administrative fund, or a sinking, reserve or special purpose fund.

Legal and other expenses

Legal and other expenses will be deductible under section 8-1 to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

For legal expenses to be an allowable deduction under section 8-1, it must be shown that they are incidental or relevant to the income earning activity.

In determining whether a deduction for legal expenses is allowable, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Application to your circumstances

The payment of contributions and levies represent the owner's share in the mutual liabilities of the strata title body and, as explained above, they are a contribution to a common fund.

You incurred the liability to pay the special levy expense in your capacity as a property owner as part of XXXX.

In your case, it is the tribunal, who is a third party, that made the determination on whether compensation and costs apply, the amount of the compensation and costs, and who receives it.

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenses must be considered, as explained in Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634. The nature of the legal expense follows the advantage that is sought to be gained by incurring the expenses.

If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. Expenditure is capital in nature where it is made with a view to bring into existence an asset or advantage that is of an enduring benefit. Capital expenditure is characterised by the fact that it is usually a one-off payment and establishes, replaces or enlarges an income producing asset.

The following are examples of expenses which are capital or of a capital nature:

•         replacement of an entire structure or unit of property (such as a complete fence or building, a stove, kitchen cupboards or a refrigerator);

•         improvements, renovations, extensions and alterations, and

•         initial repairs, for example, remedying defects, damage or deterioration that existed at the date you acquired the property.

There is no connection between the expenses incurred in the payment of compensation and costs to your rental income such that the expenses are incidental and relevant to the generation of your assessable rental income.

The expenses relate to the loss in legal proceedings following a complaint from one of the lot owners and are not directly in respect of the repairs themselves with regard to the common property remedial works.

They were not incurred for repairs to the common property, and therefore are not deductible under section 25-10 of the ITA 1997.

Nor is there an enduring benefit produced by the expenditure. The special levy is not a common fund for construction or capital works expenditure.

The purpose of the special levy was to compensate one of the lot owners for an issue raised regarding remedial repairs to common property and the failure in the OC's duty as obligated under the Strata Scheme Management Act 2015.

The special levy amount is not a capital expense that satisfies any of the capital gains tax provisions under section 110-25 of the ITAA 1997.

The amount paid to the special levy is considered payment for a penalty for contravention of a by-law and is your individual legal obligation. Under section 26-5(1) you cannot deduct an amount (however described) payable by way of a penalty under an Australian law.

Further, section 26-5(1) of the ITAA 1997 specifically denies a deduction for expenditure where a deduction has been prevented under section 8-1. The special levy amount in no way relates to management of your tax affairs.

The expense is a fine for not completing your duties as the OC and therefore, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for expenses incurred in defending the damages claim.

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