Edited version of private ruling

Authorisation Number: 1011648845651

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Deduction- demolition expenses

1. Are you entitled to a deduction for the costs of demolition incurred in order to remove contaminated materials from your rental property?

Yes.

2. Are you entitled to a deduction for the interest expenses on a loan taken out to pay for demolition and removal of contaminated materials from your rental property?

Yes.

3. Are you entitled to a deduction for legal expenses incurred to recover the cost of demolition and removal of contaminated materials of your rental property?

Yes.

4. Are you entitled to a deduction for the costs of cleaning and the removal of contaminated materials from a neighbour's property where you incur the expense?

Yes.

This ruling applies for the following period:

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

The scheme commenced on:

1 July 2007

Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· a private ruling application lodged

· a quote from a contractor

· a letter from a contractor

· tax invoices from a contractor

· an email from a solicitor

· trust account statements from your solicitor

· letters from your solicitor

· letters from a number of government departments

· an order issued by a government department

· a bank statement.

You own an investment property.

You purchased the property a number of decades ago. It has been tenanted ever since apart from a short period soon after purchase when it was used for private purposes.

The property is of a timber frame construction with brick veneer exterior walls, the internal walls and roof are lined with sheeting made of contaminated materials.

Work was undertaken to the property and as a result of this work contaminated materials were accidentally exposed.

The government department issued an order requiring that contaminated materials on the property be cleaned up by a person that holds an A class removal licence or be supervised by a person who holds an A class removal licence.

You engaged the services of a contractor to demolish and remove the contaminated materials from your property.

You engaged the services of your solicitor to undertake legal action against your insurance company (the insurer) to recover the cost of eliminating the contaminated materials on your property.

You incurred legal fees for the services your solicitor provided.

Your legal action against the insurer was unsuccessful.

You have taken out a loan with a bank to pay for the expenses incurred to demolish your rental property and to eradicate contaminated materials.

You were requested to pay an amount to a government department for the cleaning up of contaminated materials from a neighbour's property.

You have taken legal action against your insurer in relation to the dispute for the cleaning up of contaminated materials on a neighbour's property.

You did not receive any proceeds for the demolition of the property.

No capital works expenditure is available as a deduction for the property.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 82BM(2)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 section 20-20

Income Tax Assessment Act 1997 subsection 20-20(2)

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 section 40-1

Income Tax Assessment Act 1997 section 40-755

Income Tax Assessment Act 1997 section 40-760

Income Tax Assessment Act 1997 section 43-40

Reasons for decision

Environmental protection activities

Section 40-755 of the Income Tax Assessment Act 1997 (ITAA 1997) allows you to claim deductions for expenses that are incurred for the sole or dominant purpose of environmental protection activities.

The Explanatory Memorandum to the Taxation Laws Amendment Act (No. 5)1992 (the EM), which introduced former subsection 82BM(2) of the Income Tax Assessment Act 1936 (ITAA 1936), provides guidance in the interpretation of section 40-755 of the ITAA 1997. The EM states:

Expenditure will only be for the sole or dominant purpose of carrying on an eligible environment activity if it is primarily directed to that environment protection activity. A deduction will not be available if the protection of the environment is only a residual or subsidiary purpose of the taxpayer.

Environmental protection activities are activities that include, but are not limited to:

· preventing, fighting or remedying pollution from your earning activity, or

· treating, cleaning up, removing or storing waste that is on or from the site of your earning activity.

The pollution or waste must have been on a site of an earning activity that was carried on, is currently carried on or is proposed to be carried on by the taxpayer, in order to be eligible for the deduction. The term earning activity includes an activity carried on for the purpose of producing assessable income (except a net capital gain). 

Section 40-760 of the ITAA 1997 states that a deduction is not allowable under section 40-755 of the ITAA 1997 for an income year for:

· land acquisition costs

· capital expenditure associated with various construction activities

· bonds/securities for performing environmental protection activities, or

· expenditure to the extent that it is deductible under another provision of the Act.

The environmental protection provisions are provisions of a last resort. Hence, expenditure cannot be deducted under section 40-755 of the ITAA 1997 to the extent that an amount can be deducted for it under a provision of the ITAA 1997 outside Subdivision 40-I of the ITAA 1997.

Demolition costs and the removal of electricity meter.

In your case, an order was issued by a government department to remove contaminated materials from your rental property. To achieve this you engaged the services of a contractor to demolish and remove contaminated materials from the property. This resulted in the demolition of the entire property.

The expenditure incurred on the demolition and removal of the contaminated materials were not incurred by you for the purpose of improving the resale value of the site, nor was it incurred for the purpose of upgrading the property, as the costs relate to removing contaminated materials identified on the site in accordance with regulatory requirements relating to the treatment of contaminated materials.

You incurred the expenditure for the sole or dominant purpose of removing contamination to the environment which would qualify as environmental protection activities.

The property was used by you for a number of years for income earning activities as a rental property.

The expenses incurred in demolishing the property and removing the contaminated materials from the site are not non-deductible expenses listed in section 40-760 of the ITAA 1997.

The expenditure incurred in remedying pollution from the rental property would be considered capital in nature as it is a one-off cost that results in an enduring advantage, being the removal of the pollution risk. Therefore, a deduction would not be allowed under section 8-1 of the ITAA 1997.

Accordingly, section 25-10 of the ITAA 1997 regarding non-capital expenditure incurred on repairs to plant or premises held or used for the production of assessable income would also not be applicable.

In addition, section 43-40 of the ITAA 1997 regarding a deduction for capital works for the undeducted construction expenditure on a property that has been destroyed in an income year, is also not applicable in your situation.

As such, the expenditure incurred on the removal of the contaminated materials is not deductible under any other provision of the ITAA 1997 outside Subdivision 40-I of the ITAA 1997. Therefore, the environmental protection provisions will apply to the demolition and removal of the contaminated materials from the property.

Interest

Interest expenses are generally deductible under section 8-1 of the ITAA 1997 to the extent they are incurred in relation to funds used for an income producing purpose.

The character of interest is determined by the purpose of the borrowing. Generally, the purpose of a borrowing can be determined from the use of the borrowed funds, and outgoings of interest ordinarily draw their character from that use: Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613; Kidston Goldmines Ltd v. Federal Commissioner of Taxation (1991) 30 FCR 77; 91 ATC 4538; (1991) 22 ATR 168.

Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest will be deductible to the extent that the property is used to produce assessable income.

In your case, your rental property was used for income producing purposes up until it was demolished. You had taken out a loan to pay for the demolition of the property and removal of contaminated materials. Therefore, the interest expense is considered capital in nature and not deductible under section 8-1 of the ITAA 1997.

However, in taking out the loan, you have incurred the interest expenditure for the sole or dominant purpose of removing contaminated materials from the environment for environmental protection activities. As the interest expense is not considered an expense listed in section 40-760 of the ITAA 1997, you are entitled to a deduction for the interest expenses on the loan under section 40-755 of the ITAA 1997.

Legal expenses home insurance claim

You incurred legal expenses in relation to a dispute with your insurer regarding the cost of the demolition and removal of contaminated materials. In order to determine if legal expenses are deductible, we must first look at the cause or purpose for which the legal expenses were incurred. In your case, legal expenses were incurred in the pursuit of insurance proceeds relating to your former rental property.

Assessability of insurance proceeds

Sections 6-5 and 6-10 of the ITAA 1997 includes in a taxpayer's income amounts of ordinary income and statutory income. A receipt being insurance for damages to property will not be ordinary income as the receipt does not have the characteristics of such income. For example, the income is not periodic, relied upon, not attributable to employment or services rendered.

Statutory income is assessable income in accordance with section 6-10 of the ITAA 1997 which states: Your assessable income also includes some amounts that are not ordinary income.

Some recoupments for insurance or indemnity are assessable income pursuant to Subdivision 20-A of the ITAA 1997.

Section 20-20 of the ITAA 1997 concerns assessable recoupments. Subsection 20-20(2) of the ITAA 1997 provides that an amount you have received as recoupment of a loss or outgoing is an assessable recoupment if you received the amount by way of insurance or indemnity and the amount can be deducted as a loss or outgoing in the current or previous years and are deductible under any provision of the ITAA 1997.

In your case, you sought the reimbursement of the costs of demolishing and removal of contaminated materials from your rental property. As already noted above, the amount expended in demolishing the property to remove the contaminated materials is an allowable deduction under Division 40 of the ITAA 1997. Therefore, had you received an insurance payout to cover these costs, it would have been considered to be an assessable recoupment under subsection 20-20(2) of the ITAA 1997. Accordingly, your legal expenses attributable to this claim are of a revenue nature and are deductible under section 8-1 of the ITAA 1997.

The removal and cleaning up of contaminated materials from a neighbour's property

For the reason outlined above you are entitled to a deduction for the cleaning up of contaminated materials for your neighbour's property under section 40-755 of the ITAA 1997. However, for an expense to be deductible in a particular year of income, it must have been incurred in that income year.

Taxation Ruling TR 97/7 sets out the Commissioner's views on when an expense is incurred. There is no statutory definition of the term 'incurred'; however, the ruling outlines general rules, settled by case law, which will assist in most cases in defining when an outgoing is incurred.

Paragraph 6 of TR 97/7 provides as follows: 

For a taxpayer to have incurred an outgoing they must be 'definitely committed' or 'completely subjected' to the outgoing. It is not sufficient if the liability is merely contingent or no more than impending, threatened or expected. There must be a presently existing liability to pay a pecuniary sum.

In Softwood Pulp and Paper Ltd v. FC of T 76 ATC 4439; (1976) 7 ATR 101, the Supreme Court of Victoria held that a taxpayer company was not entitled to a deduction for expenses relating to the conduct of feasibility studies into establishing a paper production industry in South Australia. In reaching this decision, Menhennitt J considered that the taxpayer company had not incurred the expenses because it had denied liability for the alleged debts. Consequently, the taxpayer company had not subjected itself either completely or at all to the debts and at most the debts were no more than impending, threatened or expected.

Similarly, in your case, you are currently in dispute with your insurer over a liability to pay for the cleaning up of contaminated materials at your neighbour's property. It appears from your actions that you have not sufficiently committed yourself to pay this debt for it to be said that you had incurred this expense. Therefore, any deduction for the payment to the government department to pay for the cleaning up of contaminated materials at your neighbour's property is allowable when you have definitely committed yourself to pay this debt.