Edited version of private ruling

Authorisation Number: 1011494523793

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Ruling

Subject: Income Tax: Deduction - Investment allowance (Tax Break)

Question 1

Are the construction costs associated with:

a. the floating marina berths;

b. septic pump out system; and

c. timber board walk

an eligible spend for Investment Allowance purposes and thus, eligible for depreciation deductions under Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

a. Yes

b. Yes

c. No

Question 2

Are additional consultancy costs incurred in receiving approval from the relevant government departments (a critical perquisite in order for the construction of the floating berths to commence and be completed) considered to be an eligible spend for Investment Allowance purposes under Division 41 of the ITAA 1997?

Answer

Yes

Question 3

Further to Question 2, are the consultancy costs considered as second element of the costs base for part of the eligible spend for investment allowance deduction under Division 41 of the ITAA 1997?

Answer

No

Question 4

Can the taxpayer reasonably apportion the eligible costs between costs relating to Division 40 of the ITAA 1997 and Division 43 of the ITAA 1997 using a conservative percentage allocation?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commences on:

1 July 2008

Relevant facts and circumstances

The taxpayer operates a marina business in Australia. The taxpayer is finalising the construction of new floating berths. This construction was part of a larger redevelopment of the marina site, including sea walls, boardwalks, car parking, landscaping works, and pump-out facility. The marina carries on the business of rental of the floating marina berths.

The floating marina berths are effectively floating pontoons attached to piles driven into the lake bed that boats attach too.

For this redevelopment, the taxpayer has engaged the services of several consultants, during various stages of the development in order to satisfy the conditions of the development application and ultimately finalise the construction of the floating berths and the greater development. These costs were incurred before and during the construction of the marina berths.

The taxpayer is not a small business taxpayer for income tax purposes under section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997),as the taxpayer's aggregated annual turn over is more 2 million.

The taxpayer wishes to claim the investment allowance -Tax break of 30% for the following assets:

the floating marina berths;

sewer pump out system

the timber board walk

any specialist consultant costs that were incurred between 13 December 2008 and 30 June 2009 related to a, b and c above.

The taxpayer wish to claim the 10% investment allowance on any specialist consultant costs incurred between 1 July 2009 and 31 December 2009.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 sub section 40-30(1)

Income Tax Assessment Act 1997 section 40-95

Income Tax Assessment Act 1997 section 40-105

Income Tax Assessment Act 1997 section 40-180

Income Tax Assessment Act 1997 subsection 40-190(2)

Income Tax Assessment Act 1997 Division 41

Income Tax Assessment Act 1997 section 41-10

Income Tax Assessment Act 1997 section 41-25

Income Tax Assessment Act 1997 subsection 41-25(3A)

Does Part IVA or any other anti-avoidance provision apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1

Summary

The marina berths and the septic pump out system are considered as depreciating assets for the purpose of investment allowance (tax break) under Division 41 of the ITAA 1997.

However, the timber board walk is not considered as a depreciating asset for the purpose of Investment allowance - Tax break deduction under Division 41 of the ITAA 1997. Also, the demolition cost of existing marina arms is not an eligible expense for the purpose of Investment Allowance - Tax break deduction.

Detailed reasoning

Division 41 of the ITAA 1997 allows an additional deduction for certain business investment in new, tangible depreciating assets and for new expenditure on existing assets - the 'tax break'.

To be eligible for the tax break, a taxpayer must evidence a commitment to invest in a qualifying asset within the legislated time frames. This requirement is an element of the definition of recognised new investment amount in paragraph 41-20(1)(b) of the ITAA 1997 which provides that the 'investment commitment time' for the amount must occur in the period starting on 13 December 2008 and ending on 31 December 2009.

The expression 'investment commitment time' is defined in section 41-25 of the ITAA 1997. For purchased assets, subparagraph 41-25(1)(a)(i) of the ITAA 1997 provides that the time of entering into the contract under which the asset is, or will be, held is the investment commitment time. In the case of self-constructed assets, the investment commitment time under subparagraph 41-25(1)(a)(ii) of the ITAA 1997 for an amount that is included in the first element of the asset's cost is the time at which you start to construct the asset.

For the purposes of subsection 41-25(3A) of the ITAA 1997, you are treated as having started to construct an asset at a time when you first incur expenditure in respect of the construction of the asset.

In this case the documentary evidence indicates that the taxpayer entered into a contract for the construction of marina berths before 30 June 2009.

As mentioned above the investment allowance is limited to new tangible depreciating assets and new expenditure on existing assets used in Australia.

Further, to be eligible for the tax break, the new investment threshold is $1,000 for small business entities and $10,000 for all other taxpayers. In this case the taxpayer is not a small business entity.

The general rule is that the new investment threshold is applied on an asset by asset basis, meaning that it must be met in relation to each individual asset. However, in meeting the new investment threshold, taxpayers are permitted to aggregate their investments in assets that are identical or substantially identical under subparagraph 41-10(4)(b)(ii) of the ITAA 1997.

For the purpose of aggregation, assets will be considered identical if they are same in all respects and are substantially identical if they are the same in most respects, despite the existence of minor or incidental differences. Factors which need to be considered include colour, shape function, texture, composition, brand and design. In this case the marina berths an identical in their shapes and function therefore, for the threshold the taxpayer is eligible to aggregate the construction cost of the marina berths.

In this case the aggregate cost of certain number of marina berths exceeds the investment allowance threshold of $10,000, the taxpayer is eligible to claim the deduction.

The taxpayer wish to claim deduction for the construction cost associated with the marina berths under Division 41 of the ITAA 1997 for the following assets.

a. The floating marina berths; and

b. Septic pump out system; and

c. Timber board walk

In order to be eligible for the investment allowance deduction the asset should be a tangible depreciating asset.

Depreciating assets

A depreciating asset is defined in subsection 40-30(1) of ITAA 1997 to be an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used but excludes land, trading stock, and intangible assets except for those listed in subsection 40-30(2) of the ITAA 1997.

The effective life of a depreciating asset is used to work out the asset's decline in value. To the extent the asset is used for taxable purposes, deduction may be available, under Division 40 of the ITAA 1997, for its decline in value. However some depreciating assets, depending on the circumstances of use, may qualify for capital works deductions under division 43 of the ITAA 1997.

The Commissioner's determination of effective life is explained in section 40-100 of the ITAA 1997 and in section 40-105 of the ITAA 1997 explains for self assessment.

The decline in value of a depreciating asset is calculated on the basis of the effective life of the asset. Taxpayers can work out their own estimate of the effective life of a depreciating asset or rely on the Commissioner's determination. The choice must be made for the year in which the asset is first used, or installed ready for use, by the taxpayer for any purpose.

The Commissioner publishes recommended periods of effective life which taxpayers may optionally adopt as a safe harbour estimate for a depreciating asset. The Commissioner's latest determinations of effective life are incorporated in Taxation Ruling TR 2010/2. The determination specifies its date of effect and may only operate retrospectively in limited circumstances.

The Commissioner has made a determination specifying the effective life of the following assets as per TR 2010/2 is as follows:

Marina-wet berths (incorporating piling decking and floating pontoons category 91110-92009 is for 20 years from 1 July 2002.

Sewer Pump out system category 28120 is for 25 years from 1 January 2005

The appropriate determination to be applied to determine the effective life of a depreciating asset is that in force under section 40-95 of the ITAA 1997:

· when the taxpayer entered into a contract to acquire the asset;

· when the taxpayer otherwise acquired the asset; or

· when the taxpayer started to construct the asset;

· provided the asset started to be used (or was installed ready for use) for any purpose within five years of that time. Otherwise, it is the determination in force when the asset starts being used (or is installed ready for use) for any purpose. The marina berths are ready for use before 30 June 2010

Accordingly, the marina berths and the septic pump out system are considered as depreciating assets for the purpose of 30% investment allowance -tax break under Division 41 of the ITAA 1997.

(c) Timber board walk:

The timber board walk is attached to the land and removable. In applying Division 40 of the ITAA 1997, improvements to land and fixtures on land are treated as if they were assets separate from the land. This is regardless of whether the improvement or fixture is removable or not. Therefore, in determining whether the improvement or fixture satisfies the definition of depreciating asset in subsection 40-30(1) of the ITAA 1997 (whether it is an asset with a limited effective life that can reasonably be expected to decline in value and which is not trading stock), the improvement or fixture is to be treated as separate from the land. If the improvement or fixture satisfies the definition, a deduction may be available for its decline in value under Division 40 of the ITAA 1997.

However, Division 40 of the ITAA 1997 does not apply to capital works for which a deduction is available under Division 43 of the ITAA 1997.

The general rule is that the new investment threshold is applied on an asset by asset basis, meaning that it must be met in relation to each individual asset. However, in the case of assets which form part of a set, there is an exception that allows the recognised new investment amounts to be aggregated to meet the new investment threshold subparagraph 41-10(4)(b)(i) of the ITAA 1997.

The meaning of the word 'set' is further clarified in the Revised Explanatory Memorandum to the Tax Laws Amendment (Small Business and General Business Tax Break) Bill 2009 (the EM) by the use of two examples:

· a lawn mower, brush cutter and leaf blower used in a landscaping business do not constitute a set, even if purchased at the same time from the same supplier or manufacturer (Example 1.11)

· a two way radio base station and mobile handsets used in a delivery business do constitute a set as they were intended to function together (Example 1.12).

The guidance provided by the EM reflects the ordinary usage of the word 'set' and the examples outline the parameters of what is considered to be a set for the purposes of Division 41 of the ITAA 1997.

In this case the timber board walk is a separate item from the marina berths and the functions are also separate from the marina berth.

Accordingly, the timber board walk is not considered as depreciable asset under Division 40 of the ITAA 1997. It is considered as an improvement on the land for the purpose of Division 43 of the ITAA 1997.

Therefore, the construction cost on timber board walk is not considered as an eligible expense for the purpose of Investment allowance (Tax break) under Division 41 of the ITAA 1997.

Demolition Cost

Subsection 40-180(3) of the ITAA 1997 includes in the first element of cost of a depreciating asset amounts the holder of the asset is taken to have paid in relation to starting to hold the asset if those amounts are directly connected with holding the asset.

Further, in paragraph 7 of the Taxation Ruling IT2197 the Commissioner states that:-

Costs incurred in the demolition of existing plant and generally clearing a site for the installation or erection of new plant and equipment is of a capital nature and no income tax deduction will be allowable either to an owner or to lessee.

Accordingly, the cost of demolition of old plant and the clearing of a site to make way for the installation of new plant is not part of the cost of new plant for depreciation purposes

As mentioned above the demolition cost of existing marina arms are not directly connected with holding the new marina arms and therefore, the demolition cost is not be included in the cost of construction of the marina berths for the purpose of investment allowance - tax break under Division 41 of the ITAA 1997.

Question 2

Summary

The additional consultation cost incurred in receiving approval from the relevant government departments are considered as an eligible expense for investment allowance purposes and the taxpayer is eligible to claim investment allowance - tax break deduction for the consultation cost incurred in connection with the construction of the marina berths and the septic pump out system under Division 41 of the ITAA 1997.

Detailed reasoning

An amount is only a recognised new investment amount and so eligible for a Division 41 of the ITAA 997 deduction if it is included:

· in the first element of the asset's cost; or

· in the second element of the asset's cost .

This covers only capital expenditure and amounts that are not deductible under provisions outside Divisions 40 and 41 of the ITAA 1997. The cost of an asset does not include any input tax credits that can be claimed for the expenditure.

The first element of a depreciable asset's cost is worked out at the time the taxpayer begins to hold the asset, and is generally the amounts paid by the taxpayer in order to start to hold the asset. As the first element of cost of a luxury car is, for capital allowance purposes, reduced to the car limit for the financial year in which a taxpayer starts to hold the car, the first element of cost of a luxury car for Division 41 of the ITAA 1997 is similarly reduced to the car limit. If an amount is included in the first element of cost, it must be in respect of a new asset, not a second hand one.

The second element of an asset's cost under paragraph 40-190(2)(a) of the ITAA 1997 is amounts that the taxpayer has paid to bring the asset to its present condition and location. This could include, for example, installation costs and expenditure on an upgrade to equipment, but not expenditure to replace worn out parts as this would ordinarily be deductible as a repair.

The expression 'investment commitment time' is defined in section 41-25 of the ITAA 1997. For purchased assets, subparagraph 41-25(1)(a)(i) of the ITAA 1997 provides that the time of entering into the contract under which the asset is, or will be, held is the investment commitment time. In the case of self-constructed assets, the investment commitment time under subparagraph 41-25(1)(a)(ii) of the ITAA 1997 for an amount that is included in the first element of the asset's cost is the time at which you start to construct the asset.

For the purposes of subsection 41-25(3A) of the ITAA 1997, you are treated as having started to construct an asset at a time when you first incur expenditure 'in respect' of the construction of the asset.

The use of the expression 'in respect of' indicates that the expenditure in question is not limited to expenditure incurred on the actual construction of the asset. The words expand or enlarge the range of expenditure that will be counted for the purposes of determining the investment commitment time for an amount.

This interpretation is consistent with the ATO's interpretation of subsection 43-70(1) of the ITAA 1997 which uses the same expression to define 'construction expenditure' as 'capital expenditure incurred in respect of the construction of capital works'. Taxation Ruling TR 97/25 at paragraph 9 confirms that 'construction expenditure' includes not just the cost of the structure itself but preliminary expenses such as architect fees and engineering fees.

Although the statutory phrase 'in respect of' uses wide words of connection, the closeness of the connection or relation that is required between expenditure incurred and construction turns on an examination of the legislative context.

In Workers Compensation Board (Q) v. Technical Products Pty. Ltd . (1988) 165 CLR 642; [1988] HCA 49 and Technical Products v. State Government Insurance Office (Qld ) (1989) 167 CLR 45; [1989] HCA 24, the High Court considered the context of the particular legislative provisions as an indicator of whether the connection between two subjects was both material and relevant and so capable of being described as 'in respect of' each other. In these cases, the court found that the context constrained or narrowed the connection that was required between the two subject matters identified. The expression was not so wide as to include any distant relationship or remote nexus between the connected subjects.

The legislative context in which the expression 'in respect of' appears is therefore an important indicator of its intended scope. The purpose of the tax break is highlighted in paragraph 1.5 of the EM which states: 'The role of the Tax Break is to stimulate new investment by Australian businesses. The temporary nature of the measure provides an incentive for businesses to bring forward and sustain new capital investment in the current economic climate.'

To be eligible for the tax break a taxpayer must make a commitment to invest within the legislated time frames. For assets that are purchased, this commitment is evidenced at the time of entering into the relevant contract. For assets that are self-constructed, the analogous commitment occurs when expenditure in respect of the construction is first incurred.

This interpretation of the intended reach of the expression 'in respect of' is confirmed by examples 1.16 and 1.18 of the EM. In example 1.16 the company's directors sign off a decision to proceed with the construction of new transmission power lines and the company then incurs expenditure by ordering materials required for the construction. In example 1.18 the company starts to order some of the materials it needs to construct a new conveyor belt although work on the physical construction of the asset does not commence for a few weeks.

The examples show that 'expenditure in respect of construction' is intended to cover not just the expenditure incurred directly on the actual construction activities, but also expenditure incurred at an earlier time that evidences a commitment to future construction. They highlight that incurring expenditure on the materials has the necessary material and relevant connection with the construction of the asset. In both situations, it can be seen that there was a decision to construct the new asset and the incurrence of the expenditure on materials objectively verifies the making of the commitment. Accordingly, the expenditure signifies the investment commitment time in relation to the particular assets. As the EM notes at paragraph 1.108, the test for self-constructed assets in requiring the incurrence of expenditure in respect of the construction, is both 'objective and verifiable'. In this sense it is analogous to entering into a contract to purchase an asset.

In this case the facts indicate the consultation costs were incurred before and during the construction of the marina berths. Therefore, it is considered as first element of the cost base of a depreciating asset for the purpose of investment allowance - tax break deduction under Division 41 of the ITAA 1997.

Accordingly, the additional consultation costs that are incurred in respect of the construction of the new marina berths are considered as an eligible expense for the investment allowance - tax break deduction for the consultation cost that is incurred in connection with the marina berths and septic pump out system.

The taxpayer is eligible to claim 30% deduction for the consultation cost incurred during 13 December 2008 to 30 June 2009 and 10% deduction during 1 July 2009 to 31 December 2009.

Question 3

Summary

The consultation cost is not considered as second element of the cost base of a depreciation asset under subsection 40-190(2) of the ITAA 1997. It is considered as first element of the cost base under section 40-180 of the ITAA 1997.

Detailed reasoning

Where a deprecating asset is constructed, the construction starts when the taxpayer first incurs expenditure in respect of the construction of the asset under section 41-25(3A) of the ITAA 1997

For new assets, the "recognised new investment amount" is the amount included in the first element of the asset's cost (worked out in accordance with Subdivision 40-C of the ITAA 1997.

For existing assets, this is the amount included in the second element of the asset's cost under subsection 40-190(2) of the ITAA 1997. The second element is the amount the taxpayer is taken to have paid to bring the asset to its present condition and location from time to time. For example, the second element of cost would include the cost of modifications, alterations or improvements made to the asset by the taxpayer during the relevant income year as well as the cost of transporting the asset to its current location such as freight, import duties, installation charges and legal costs. It does not include registration and insurance costs of a car.

In this case the tax agent argued that the consultation cost that incurred for the construction of marina berths is second element of the cost base of a depreciating asset. However, the facts indicate that the consultation costs were incurred before and during the construction of the marina berths.

Therefore, the consultation costs are not considered as second element of the cost base of a depreciating asset under subsection 40-190 of the ITAA 1997. It is considered as first element of the cost base of marina berths under section 40-180 of the ITAA 1997.

Question 4

Detailed reasoning

If you pay a single undissected amount for two or more things that include at least one depreciating asset, section 40-195 of the ITAA 1997 requires you to take into account as part of the asset's cost only that part of what you paid that is reasonably attributable to the asset. What is reasonable will often depend on the particular circumstances.

If property, including depreciating assets, is acquired under a contract and parties dealing with each other at arm's length allocate the overall contract price to the separate assets in the contract, the Commissioner will accept such an allocation for the purpose of working out the cost of the depreciating assets under Subdivision 40-C of the ITAA 1997. An allocation in these circumstances to only a class of assets will also be acceptable but, in the case of depreciating assets, the purchaser will then need to make their own reasonable apportionment of the amount so allocated to the class of assets to each of the assets in that class.

In making their apportionment, it is expected that the purchaser will generally have regard to and be able to justify their reasonable apportionment based on the relevant market values of the separate depreciating assets at the time of the making of the contract.

The Commissioner does not accept that the adjustable value of a depreciating asset necessarily represents the market value of the asset.