Edited version of private ruling

Authorisation Number: 1011693496144

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Ruling

Subject: Capital Allowance Deductions

Relevant facts and circumstances

The applicant, as the head company of a tax consolidated group, submitted a request for a private binding ruling.

The applicant contended it acquired the depreciating assets through its agent, prior to 11:45 am on 21 September 1999.

The applicant stated in its application that the following chronology applied to the construction of the depreciating assets:

§ negotiations

§ a contract was signed by the applicant and a contractor

§ a deed of variation and a change order form were agreed with the contractor

§ execution of a change order form; and

§ the assets were commissioned and wholly owned and operated by the applicant.

Also in the application, the applicant gave the following information regarding the construction of the assets:

§ the contract came after several years of negotiations with the contractor

§ a contract for the engineering, procurement and construction was signed

§ the contract included:

earthworks

roads, fences and sewage system

marine infrastructure

buildings

process areas

§ the contract price was not at the unilateral discretion of either party

§ the applicant engaged the contractor to construct the assets according to the specifications in the contract and its appendices

§ a clause of the contract provided for the ability of either party to withdraw from it

§ none of the conditions created a condition precedent to a binding contract

§ the intended assets or facilities to be constructed and the responsibilities of the parties in that regard were stated in an appendix

§ an appendix allowed for changes in scope, which included changes in capacity, functionality, design, major equipment and materials specifications

§ during the construction works the parties became better apprised of the details of the construction works required and fine-tuned the general conditions of the contract

§ a deed of variation and a change order form were produced and signed off in order to document refinements of the construction process

§ nevertheless, the depreciating assets were contracted for under the contract; wherein

§ the applicant's role was detailed as supervising, reviewing and approving the contractor's services under the contract; and

§ the contractor was engaged for the construction, with obligations to engineer, procure and construct the assets.

The applicant and the contractor executed a change order form to vary the remuneration structure of the contract so that remuneration was directly based on scheduling and cost control in order to more efficiently close out the contract.

The assets commenced being depreciated for tax purposes on a staggered basis as various facilities were handed over and commissioned.

Issue 1 Question 1

Were the depreciating assets acquired under a contract entered into before the cut-off date?

Answer

Yes.

Detailed reasoning

The applicant contended that through its agent, it entered a contract with the contractor whereby it acquired the depreciating assets.

In Taxation Ruling IT 2158, Investment Allowance: Contract for Acquisition or Construction of Eligible Property Entered into Prior to 1 July 1985 Rulings NOS. IT 72, 76, 2142 (IT 2158) the Commissioner considered the essential elements of a contract being entered into by a cut-off date, in the context of an investment allowance deduction. The criteria were that:

§ there had been an offer and acceptance of the terms of the contract

§ the offer and acceptance corresponded in all material aspects

§ the contract related to eligible property identified for the purpose of producing assessable income; and

§ none of the conditions affected the time the contract was entered.

At paragraph 7, IT 2158 also considered 'other terms or conditions which appear in contracts which do not affect the time at which the contract becomes operative' … but which 'give the parties an opportunity to withdraw from the contract in certain circumstances'.

Offer and Acceptance

In its consideration of the initial criteria regarding offer and acceptance, IT 2158 considers whether 'a contract for the acquisition of eligible property has been entered into' and cites Tadgell J. in Kearney v Federal Commissioner of Taxation 84 ATC 4295; (1984) 15 ATR 564 (Kearney):

… offer and acceptance must express assent to one and the same thing and there must be no substantial or material variance between them.

In Kearney a taxpayer sought to take advantage of an investment allowance in relation to the construction of a catamaran. Tadgell J. stated in finding for the taxpayer:

One must bear in mind the nature of the transaction. It was one for the supply of a specifically identified kind of vessel as discussed and agreed between the taxpayer and Clifford [CEO of the boat builder], with engines and other refinements to be nominated by the taxpayer. That the make of the engines and the precise nature of the other refinements had not been specified by 30 June was, I think, of little consequence having regard to the matters that had been agreed. It was almost inevitable, having been regard to the subject matter, that incidental items would need to be dealt with in the course of construction.

The fact a formal written agreement would follow the contract and that 'incidental items' and 'other refinements' would be agreed at that time, did not prevent an earlier contract being entered.

Similarly, W&J Investments Limited v. Federal Commissioner of Taxation 89 ATC 5130; (1989) 20 ATR 1506 (W&J Investments), is a case in which a taxpayer company sought to take advantage of an investment allowance. The taxpayer company, with a business of providing finance for a parent company dealing in tractors and other heavy equipment, placed a number of orders with the latter, on 29 June 1978, to take advantage of an investment allowance deduction that reduced as of 1 July 1978.

The full Federal Court allowed the appeal and in doing so found that the contracts were evidenced by the orders and that variations in attachments to the essential orders did not affect the original contracts, nor did conditions for cancellation, in the absence of their exercise.

Burchett J. in W&J Investments cited Perri v. Coolangatta Investments Proprietary Limited (1982) 149 C.L.R. 537 (Perri):

… a court will tend to construe a condition as related to the performance, rather than the existence, of a contract.

After consideration of the cases discussed above, the contract signed by the applicant and the contractor included the specifications in the contract such that it was apparent that there was agreement for the construction of the assets and that the latter was an eligible property identified for the purpose of producing assessable income.

Also, in an appendix to the contract there was anticipation of changes in scope, which might include changes in plant capacity, functionality, design, major equipment and materials specifications. Such changes are 'almost inevitable' in work of the scope encompassed by the Contract, as was found in Kearney, (see above).

Eligible property and the Time the Contract was Entered

Eligible property

Taxation Ruling TR 1999/2 Income tax: deductibility of expenditure incurred on tailings dams or similar mining residue, waste storage or disposal facilities (TR 1999/2) provides the following ATO view of the meaning of plant:

20. [Plant] in its ordinary sense includes whatever apparatus is used by a business man for carrying on his business, - not his stock-in-trade which he buys or makes for sale; but all goods and chattels, fixed or moveable, live or dead, which he keeps for permanent employment in his business: Lindley LJ in Yarmouth v. France (1887) 19 QBD 647 at 658.

The units that comprise the assets and include those listed in the Facts and included in the contract documents, such as:

§ earthworks

§ roads, fences and sewage system

§ marine infrastructure

§ buildings

§ process areas

fall within the ATO view of plant, as described in TR 1999/2.

Time the Contract was Entered

The changes in scope were reflected in a deed of variation and a change order form which documented refinements of the construction process. Nevertheless, the depreciating assets that comprised the assets were contracted for originally. The contractor was originally engaged to engineer, procure and construct the assets, as clearly stated in the contract.

As stated above, in consideration of Perri, contracts routinely provide for agreement of additional terms or general conditions which include variation of works and as such are conditions subsequent to the entering of contracts.

Based on the information provided by the applicant, we accept that it entered into the contract for the assets.

Issue 2 Question 1

Assuming that the answer to question 1 [Issue 1] is 'yes', are the tax depreciation rates found under a former section of the Income Tax Assessment Act 1997 (ITAA 1997) the relevant rates that are applicable to those assets in calculating capital allowance deductions?

Answer

Yes.

Detailed reasoning

Construction of the asset

Having established that a contract for the construction of the assets was entered into prior to the cut-off date, it is appropriate to consider whether they were self-constructed.

Under paragraph 41-25(1)(a) of the ITAA 1997, where an amount is included in the first element of an asset's cost, the investment commitment time for recognised new investment amounts is the time at which you:

(i) enter into a contract under which you hold the asset at that time, or will hold the asset at a later time; or

(ii) start to construct the asset; or

(iii) start to hold the asset in some other way.

In this case, we accept that the applicant entered into the contract for the assets. Accordingly, subparagraph (i), above, applies as where a taxpayer enters into a contract to have an eligible asset constructed to meet their specifications, the investment commitment time is determined by when the contract was entered into and not when the physical construction of the asset occurred. However, we need to consider if subparagraphs (ii) or (iii) also apply.

In order to consider whether the applicant self-constructed the assets (subparagraph (ii) above), it is useful to refer to Taxation Ruling IT 2142 Income tax: investment allowance - unit of property - construction and acquisition - incurring of expenditure (IT 2142).

Two cases discussed in IT 2142 and in which it was held that a taxpayer could both acquire the assets under a contract and self-construct them are Federal Commissioner of Taxation v. Tully Co-operative Sugar Milling Association Limited 83 ATC 4495; (1983) 14 ATR 495 (Tully) and Utah Development Co. v. Federal Commissioner of Taxation 83 ATC 4545; (1983) 14 ATR 601 (Utah).

In Tully, the taxpayer company claimed an investment allowance for the upgrade of a sugar mill, which the trial judge found (favourably) to be work that used components acquired from a contractor but used by the taxpayer to construct a new mill which was commenced prior to the cut-off date for an investment allowance.

In Utah, a coal miner, the taxpayer company, claimed an investment allowance for plant (draglines). The taxpayer assembled components from other companies on a site it had prepared and to which it provided supervisory services and infrastructure, including roads, power, water and accommodation facilities for workers.

The applicant's role in the construction of the assets can be distinguished from the circumstances of the taxpayer companies in Tully and Utah by consideration of information provided in the application and in the contract's appendices and attachments, which establish a discrete division of roles between client and contractor, as follows:

§ the applicant's role was in supervising, reviewing and approving the contractor's services under the contract; and

§ the contractor was engaged for the construction, with obligations to engineer, procure and construct.

It is apparent in the contract and its appendices and attachments that the construction and engineering work necessary to build the assets were the responsibility and ownership of the contractor. Once units of the assets were completed they were then acquired by the applicant under the contract and therefore, not self-constructed by it. In view of this and the contract for the construction of the assets entered into before the cut-off date, subparagraphs (ii) and (iii) do not apply.

Capital Allowance

Given the existence of the contract and its chronology and the manner of the assets' construction, namely that they were constructed by the contractor and then acquired by the applicant, it is now appropriate to consider the applicable rates of depreciation.

Section 40-12 (Plant acquired after 30 June 2001) of the Income Tax (Transitional Provisions) Act 1997 (ITTPA 1997) states:

40-12(1)

This section applies to you if:

(a) you entered into a contract to acquire an item of plant before 1 July 2001 and you acquired it after 30 June 2001; or

(b) you started to construct an item of plant before 1 July 2001 and you complete its construction after 30 June 2001.

Division 40 of the new Act applies to the plant.

If you entered into the contract, or started to construct the plant, at or before 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999, you replace the component in the formula in subsection 40-70(1) or 40-75(1) of the new Act that includes the plant's effective life with the rate you would have been using if you had acquired it, or completed its construction, before 1 July 2001 and had used it, or had it installed ready for use, for the purpose of producing assessable income before that day.

Before 1 July 2001 and the introduction of Division 40 - Capital Allowances in the ITTPA 1997 the former Division 42 of the ITAA 1997 set out the basis on which plant could be depreciated. The former paragraph 42-118(a) provided that a contract to acquire plant entered into prior to 11:45 am on 21 September 1999 allowed accelerated rates of depreciation from the time of ownership of a unit or units of plant.

Division 40 of the ITTPA 1997 applies by virtue of the transitional provision in section 40-12 of the ITTPA 1997 (above) and specifically its subsection 40-12(3). It follows, therefore, that the applicable depreciation rates for the capital allowance deductions for the assets are former section 42-125 of the ITAA 1997.