Edited version of private ruling

Authorisation Number: 1011612220742

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Ruling

Subject: Deductibility of expenditure

Question

Is the cost of upgrading business property to a level which satisfies statutory requirements a repair and therefore deductible under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

The taxpayers approached an authorised OH&S contractor to ascertain their adherence to OH&S standards. The contractor advised that their assets did not meet the relevant standard at that time. The standards had not previously been met.

As a result, they had to be upgraded. The taxpayer received an invoice from the supplier describing the work as repairs. In addition, an additional similar amount was spent on new items which the relevant invoice confirms as being capital in nature.

Essentially the same work was performed on all items. The adjustments involved replacing the assets with larger, higher structures. All of them are semi-portable and can be moved or removed at any time.

Relevant legislative provisions

Section 25-10 Income Tax Assessment Act 1997

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 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 of the ITAA 1936 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.

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Reasons for decision

Question

Unless otherwise stated, all references in the following Reasons for Decision are to the Income Tax Assessment Act 1997 (ITAA 1997).

Summary

In the present case, the work is not being done to restore a previously existing efficiency of function; it is not remedying a defect, damage or deterioration. It involves the replacement or substantial reconstruction of the items. Those items are a distinct asset in their own right rather than merely a part of a larger whole. Having regard to all of those factors, the expenditure incurred is held to be capital in nature and is not a repair for the purposes of section 25-10.

Detailed reasoning

Section 25-10 allows a deduction for the cost of repairs to assets used for income producing purposes. Subsection 25-10(3) precludes a deduction for repairs where the expenditure is of a capital nature.

The word repair is not defined within the tax legislation; accordingly, it takes its ordinary meaning. The word repair has been described as involving restoration of a thing to a condition which it formerly had without changing its character (W Thomas & Co v. FC of T (1965) 115 CLR 58 (the Thomas Case)).

Taxation Ruling TR 97/23 deals with the issue of deductions for repairs. TR 97/23 states that expenditure for repairs to property is of a capital nature where the extent of the work carried out represents a renewal or reconstruction of the entirety (paragraphs 36-42), or the works result in a greater efficiency of function in the property. In such cases, the work represents an improvement rather than a repair (paragraphs 44-58).

TR 97/23 states that the term repair ordinarily means remedying or making good of defects in, damage to, or deterioration of (in a mechanical and physical sense), the property to be repaired. It contemplates the continued existence of the property. If, however, the work done amounts to an improvement by way of replacement rather than a repair then the cost is a capital expense and no deduction is allowable.

In the present case, the adjustments made in respect of the assets seem to represent a significant change to them as they existed previously. The work performed would seem to have gone beyond merely augmenting the existing assets to remedy defects and is not rectifying damage or deterioration. For all practical purposes, the work amounts to effective replacement of the pre-existing items.

The legislation contemplates that an item may be completely replaced but still constitute a repair where that item represents only part of an entirety. In Lindsay v. FC of T (1960-1961) 106 CLR 377; 12 ATD 197; 12 ATD 505; (1960) 8 AITR 99; (1961) 8 AITR 458 the High Court considered whether the replacement of a slipway was a repair or replacement of an entirety. The court held that the slipway was the relevant entirety and that it was not a subsidiary part of anything else but was separately identifiable as a principal item of capital expenditure.

Whilst the items in question constitute only part of the infrastructure of the property they are a clearly identifiable distinct entity. On that basis, it could not be argued that substantial changes and improvements to their quality represent only minor or peripheral changes to some wider asset of which they are but a part.

The fact that the work is being undertaken to comply with statutory OH&S requirements does not alter the situation. TR 97/23 discusses at paragraphs 100 to 104 the argument that work undertaken purely to comply with relevant regulatory requirements is being undertaken to remedy an impediment or defect in the efficient functioning of the asset. At paragraph 101 it expressly refers to 'a requirement relating to health, safety or for some other social utilitarian purpose.' It concludes at paragraph 104:

We do not accept the correctness of this alternative view. As stated earlier, we take the view that removing an impediment to the holding, etc., of property for income purposes arising from regulatory requirements does not constitute 'repair' of a defect in, damage to, or deterioration of the property in the context required by section 25-10.

In the present case, the work is not being done to restore a previously existing efficiency of function; it is not remedying a defect, damage or deterioration. It involves the replacement or substantial reconstruction of the items. Those items are a distinct asset in their own right rather than merely a part of a larger whole. Having regard to all of those factors, the expenditure incurred is held to be capital in nature and is not a repair for the purposes of section 25-10.