Edited version of private ruling

Authorisation Number: 1011750063278

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 fac 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

Repairs and capital expenditure

Question 1

Is all the expenditure to be incurred on the main structure deductible under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the expenditure to be incurred reconditioning the existing fire hydrants, fire hose reels, and fire hoses and nozzles deductible under section 25-10 of the ITAA 1997?

Answer

Yes.

Question 3

Is the expenditure in respect of installing audible alarms, installing new fire hoses and nozzles and replacing existing fire hoses and nozzles expenditure to which Division 40 of the ITAA 1997 applies?

Answer

Yes.

Question 4

Is the remaining expenditure to be incurred on the main structure expenditure to which Division 43 of the ITAA 1997 applies?

Answer

Yes.

Question 5

Is all the expenditure to be incurred on the main electrical switchboard (MSB), distribution boards and land based electrical cables deductible under section 25-10 of the ITAA 1997?

Answer

No

Question 6

If the answer to the above is no, is all the expenditure to be incurred on the MSB, distribution boards and land based electrical cables expenditure to which Division 43 of the ITAA 1997 applies?

Answer

Yes.

This ruling applies for the following periods:

Year Ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The taxpayer holds a lease over an area of land and on that land it built a structure.

The taxpayer commissioned a report on the condition of that structure and from that called for tenders to undertake work based on findings in that report.

Under the tender chosen work will be done on all parts that make up the structure. Depending on the condition this will be either repair, replacement or preventative work to mitigate damage in the future.

The existing fire system will be updated including reconditioning existing hydrants, hose reels and hoses where possible. If this is not possible the units will be replaced. Additional units will also be added. New stand pipes will be added as will audible alarms and call points will also be added.

Existing water pipes will be replaced with larger pipes to increase water pressure and flow throughout the structure.

A new MSB, distribution boards and electrical cables will be added with the existing ones retained.

Built in service facilities will also ne replaced and additional facilities added.

Relevant legislative provisions

Section 25-10 of the ITAA

Subsection 25-10(3) of the ITAA

Division 40 of the ITAA 1997

Subsection 40-45(2) of the ITAA 1997

Division 43 of the ITAA 1997

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Background

The taxpayer will be undertaking substantial work on a structure they built on land they lease and is seeking a ruling from the Commissioner on which provisions of the ITAA 1997 will apply to the expenditure incurred.

What we will be looking at is whether section 25-10 of the ITAA 1997 will apply in respect of the expenditure incurred. This section states:

25-10(1) You can deduct expenditure you incur for repairs to premises (or part of premises) or a *depreciating asset that you held or used solely for the *purpose of producing assessable income.

Property held or used partly for that purpose

25-10(2) If you held or used the property only partly for that purpose, you can deduct so much of the expenditure as is reasonable in the circumstances.

No deduction for capital expenditure

25-10(3) You cannot deduct capital expenditure under this section.

In looking at this subsection we need to look at the work being performed to determine if it is a repair and if it is a repair and whether subsection 25-10(3) of the ITAA 1997 denies a deduction .

If the work is not a repair or is a repair but is considered to be capital expenditure then either Division 40 or Division 43 of the ITAA 1997 will apply in respect of the expenditure.

In respect of the application of Division 43 and 40 of the ITAA 1997 on page 25 of the Guide for rental property owners (NAT 1729-6.2010) under the heading 'Which deductions can you claim?' it states:

You cannot claim a deduction for a depreciating asset's decline in value if you are allowed a capital works deduction for the asset.

Capital works deductions may be available for expenditure on the construction of buildings and structural improvements and extensions, alterations or improvements to either of those.

Capital works deductions are not available for expenditure on plant (see Plant).

Decline in value deductions may be available if your plant is a depreciating asset.

If your depreciating asset is not plant and it is fixed to, or otherwise part of, a building or structural improvement, your expenditure will generally be construction expenditure for capital works and only a capital works deduction may be available.

As subsection 40-45(2) of the ITAA 1997 denies a deduction under Division 40 of the ITAA 1997 for amounts an entity can claim under Division 43 of the ITAA 1997 in looking at which provision best apples to each item of expenditure we will look to see if section 25-10 of the ITAA 1997 applies. If section 25-10 of the ITAA 1997 does not apply then we will look at whether Division 43 of the ITAA 1997 applies and then whether Division 40 of the ITAA 1997 applies.

Repairs and capital expenditure

The application of section 25-10 of the ITAA 1997 is discussed in detail in Taxation Ruling TR 97/23 Income Tax: deductions for repairs. In respect of the ordinary meaning of repairs paragraphs 13 to 16 states:

The word 'repairs' has its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property.

Work done to prevent or anticipate defects, damage or deterioration (in a mechanical or physical sense) in property is not in itself a 'repair' unless it is done in conjunction with remedying or making good defects in, damage to, or deterioration of, the property.

Repair for the most part is occasional and partial. It involves restoration of the efficiency of function of the property being repaired without changing its character and may include restoration to its former appearance, form, state or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. Works can fairly be described as 'repairs' if they are done to make good damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes (whether expected or unexpected) during the passage of time.

To repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10.

In respect of capital expenditure paragraph 32 of TR 97/23 states:

Expenditure for repairs to property is capital expenditure if any of the following subparagraphs applies:

(a) The guidelines for distinguishing between capital and revenue outgoings laid down by the courts for the purposes of the forerunners of section 8-1 in such cases as Sun Newspapers Ltd v. FC of T (1938) 61 CLR 337; (1938) 5 ATD 87 and Hallstroms Pty Ltd v. FC of T (1946) 72 CLR 634; (1946) 8 ATD 190 indicate that the expenditure is incurred in establishing, replacing or enlarging the profit-yielding (i.e., business) structure rather being a working or operating expense (see also paragraphs 111 and 134 of this Ruling).

(b) The expenditure, rather than being for work done to restore the property by renewal or replacement of subsidiary parts of a whole, is for work that is a renewal in the sense of a reconstruction of the entirety (see paragraph 114 of this Ruling for what is meant by an 'entirety'). The application of this distinction depends very much on what, in the circumstances of the case, is properly considered to be the relevant entirety (see also paragraph 115 of this Ruling).

(c) If property bought for use as a capital asset in the buyer's business is not in good order and suitable for use in the way intended, expenditure incurred in putting it in order suitable for use is part of the cost of its acquisition and is of a capital nature (see also paragraphs 59 to 66 and 125 to 140 of this Ruling).

In this case given the amount of work to be undertaken we will need to consider example (b) in paragraph 32 of TR 97/23.

In looking at what is an entirety paragraphs 37 to 40 of TR 97/23 states:

The term 'entirety' is used by the courts in repair cases to refer to something 'separately identifiable as a principal item of capital equipment' (Lindsay v. FC of T (1960) 106 CLR 377 at 385; (1960) 12 ATD 197 at 201), 'a physical thing which satisfies a particular notion' (the Lindsay case at 106 CLR 384; 12 ATD 201) and 'not necessarily the whole but substantially the whole of the [property] under discussion' (the Lindsay case at 106 CLR 383-4; 12 ATD 200). There is no one correct test for what is a subsidiary part and what is an entirety. Which approach to adopt depends on the facts in each particular case and, even then, the question is one to be answered in the light of all the circumstances it is reasonable to take into account (see Regent Oil Co Ltd v. Strick Inspector of Taxes [1965] 3 All ER 174 at 179; Brown (Inspector of Taxes) v. Burnley Football and Athletic Co Ltd [1980] 3 All ER 244 at 255).

Property is more likely to be an entirety if:

· the property is separately identifiable as a principal item of capital equipment; or

· the thing or structure is an integral part, but only a part, of entire premises and is capable of providing a useful function without regard to any other part of the premises; or

· the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves; or

· the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law.

Property is more likely to be a subsidiary part rather than an entirety if:

· it is an integral part of some larger item of plant; or

· the property is physically, commercially and functionally an inseparable part of something else.

Examples of property that constitute an entirety are a slipway on the business site of a slip proprietor and ship repairer (the Lindsay case); a spectators' grandstand in a football stadium (the Burnley FC case); a bridge giving access to the driveway of a garage (Case B21 (1951) 2 TBRD 101); a substantially new race track (Case D64 72 ATC 390; (1972) 18 CTBR (NS) Case 33); and a factory drainage system comprising an underground system of concrete stormwater drains (Case G5 (1955) 7 TBRD 29). Examples of property that do not constitute an entirety are the insulation and lining for a cool room (Case T14 (1968) 18 TBRD 67) and a window in a factory (even though the window is totally restored). Something that is part of a building, e.g., a roof or wall, is just that and no more. The building itself is the entirety.

The Assets

In order to determine how the expenditure will be deductible we need to look at the assets that the expenditure is in respect of and then look to see if example (b) in paragraph 32 of TR 97/23 applies to that asset.

The need to look at the 'asset' in order to work out which provisions within the ITAA 1997 apply to that asset can be best described by looking at the reasons for decision in ATO ID 2004/579 which states:

For the purpose of applying the capital allowance provisions in Division 40 of the ITAA 1997, whether a composite item is itself a depreciating asset or whether its components are separate depreciating assets is a question of fact and degree to be determined in the light of all of the circumstances of the particular case (subsection 40-30 (4) of the ITAA 1997).

A test used in determining that outcome is a test of function, the functional test.

The Commissioner's views as to the application of the functional test are set out in Taxation Ruling TR 94/11. Some of the factors to be considered in applying the functional test include:

· being separately identifiable

· being capable of performing its own separate function, and

· the item varies the performance of another item.

Factors such as the mechanical independence of an item, physical separability and whether an item can be separately acquired, need also to be considered in deciding whether an item may be a separate depreciating asset.

It is considered that each of the water tank and piping, and the pump and hose, is a separately identifiable unit performing its own intended discrete function. Functionally, they are separate items. The piping transfers the waste water from the rental property to the water tank. The water tank captures the waste water from the rental property. The pump acts as the mechanism of getting the waste water from the tank, and the hose transfers the water to the garden.

The pump and hose are separate items that are depreciating assets for which a decline in value deduction is allowable under section 40-25 of the ITAA 1997.

The piping and tank are functionally separate from the pump and hosing, and are not part of the same depreciating asset as the pump or hosing.

Because the piping and tank are also capital works for which a deduction is available under section 43-10 of the ITAA 1997, subsection 40-45(2) of the ITAA 1997 provides that no decline in value deduction is available for these assets under section 40-25 of the ITAA 1997.

This is further explained on page 26 of the Guide for rental property owners under the heading Indentify the unit which states:

Taxation Ruling TR 94/11 - Income tax: general investment allowance - what is a unit of property? provides guidelines to help you identify what is a unit. You need to consider whether a particular item is a unit, part of a larger unit, or whether its components are separate units. A unit will generally be an entity entire in itself; something that has an identifiable, separate function. However, it need not be self-contained or used in isolation and it may vary the performance of another unit. An item is not a unit simply because it is described as a system.

An item may be made up of several components. To determine what the relevant unit is, you need to consider the function of each component and of the larger composite item. A door handle, for example, is part of the door and not a separate unit. Similarly, a freestanding spa pool that is made up of the shell, skirt, heater, pump, filter and piping is one unit.

In other cases separate units may work in conjunction with each other to achieve a common objective. For example, a fire safety system may consist of several components including, for example, an indicator board, hydrants, piping, alarms, smoke detectors and sprinklers. All these components function together to form the system. However, each component also performs its own discrete function independent of the others. In this example, each component is a separate unit.

To begin with we have the main structure which is an asset in itself.

In respect of the fire services the example on page 26 of the Guide for rental property owners clearly states that each component of the fire safety system is a separate unit and as such needs to be looked at separately.

In addition, although not mentioned specifically in Table B, electrical switching gear is mentioned throughout TR 2010/2 ( e.g. is listed in 'Construction Material Mining' table).

In addition a number of these assets are listed in Table 3 Guide for rental property owners as separate assets (this table also indicates when a capital works deduction can be claimed). This table includes:

· Fire detectors (which includes addressable manual call points)

· Fire hydrants

· Hose cabinets and reels (excluding hoses and nozzles)

· Fire hoses and nozzles

· Water piping

· electrical assets (including conduits, distribution boards, power points, safety switches, switchboards, switches and wiring)

In effect we need to look at the following units to determine which provision of the ITAA 1997 applies.

· Main structure

· Service points

· Water pipes/line

· Fire hydrants

· stand pipes

· Fire hose reels

· Fire hoses and nozzles

· Audible alarm

· break glass/ Manual Call points

· Main electrical switch board

· Electrical distribution boards

· Electrical wiring

Main Structure

As stated in paragraph 47 of TR 97/23 the 'Replacement or substantial reconstruction of the entirety, as distinct from the subsidiary parts of the whole, is an improvement'.

Given the extensive nature of the work that will be undertaken what needs to be determined is the extent to which that work results in a reconstruction of the entirety. To do this we need to examine the decision in Lindsay v. FC of T (1960) 106 CLR 377 at 385; (1960) 12 ATD 197 (the Lindsay case) in which a slipway which could not function on its own was still considered to be an entirety.

In the Lindsay case for the slipway to function it needed to be used in conjunction with heavy machinery but could still be separately identifiable as a principal item of capital equipment and as such was an entirety.

In this case each structure could be seen as separately identifiable. Therefore based on the decision in the Lindsay case it can be concluded that each structure is an entirety in its own right. Once again this is comparable with the Lindsay case in which there were two slipways and only one being worked on and this one was considered to be an entirety.

Looking at the Lindsay case the work on the slipway did not involve replacing every part of the slipway but was comprehensive enough over the entirety to amount to a demolition of the old slipway and amounted to a new rather than a repaired slipway.

In making his finding in the Lindsay case Kitto J contrasted the facts in his case with those in Rhodesia Railways v. Collector of Income Tax, Bechuanaland [1933] AC 368 (Rhodesia Railways Case). In the Rhodesia Railways Case the replacement of rails and sleepers over thirty-three miles of a railway line, and of sleepers over a further forty miles, was held to be a repair. The total length of the line was three hundred and ninety-four miles and the work performed was to repair parts of the track (the whole three hundred and ninety-four miles was considered the entirety) as they became worn out from use.

The report looked at the condition of the structure as a whole and made recommendations on what work needed to be done on all the components that make up the structure.

Depending on the item and the component, the work will where possible involve reusing of existing items, repairing items, replacement of items and preventative work on items. As a result the work being undertaken will result in each part that makes up the entirety being renewed in some form or other which will have the effect of renewing the structure in its entirety.

Therefore following the decision in the Lindsay case the work to be completed will result in a renewal of the entirety and as such is capital expenditure.

As the expenditure is capital subsection 25-10(3) of the ITAA will apply to deny a deduction as a repair under section 25-10 of the ITAA 1997.

ATO Interpretative Decision ATO ID 2004/410 Income Tax Capital Works: your area - earlier lessee's expenditure, states in part:

Broadly speaking, Division 43 of the ITAA 1997 allows you to deduct an amount for construction expenditure on certain income producing capital works for an income year.

More specifically, section 43-10 of the ITAA 1997 provides that an amount may be deducted for capital works for an income year if there is a construction expenditure area, a pool of construction expenditure for that area and you use 'your area' in a required way (including to produce assessable income; section 43-140 of the ITAA 1997). The first two conditions are satisfied in this case.

'Your area' has the meaning given in sections 43-115 and 43-120 of the ITAA 1997. How 'your area' is determined under those sections depends on whether you are an owner or lessee (or holder of a quasi-ownership right) of the part of the capital work on which the construction expenditure is incurred.

For a lessee 'your area' is the part of the construction expenditure area that has been continuously leased from the time of completion by the lessee who incurred the expenditure. Subsection 43-120(2) of the ITAA 1997 provides that if an earlier lessee incurred the expenditure, 'your area' is that part of the construction expenditure area that has been continuously leased from the time of completion by that lessee or an assignee of that lessee's lease. It is only the original lessee who incurred the construction expenditure or an assignee of that lessee's lease that can have a 'your area'. . .

The taxpayer did not obtain their lease by way of assignment from the sublessor who incurred the expenditure. The taxpayer is a sublessee, not an assignee of the sublessor's lease. Therefore, the acquisition of a sublease does not give the taxpayer an interest in a construction expenditure area that meets the definition of 'your area' contained in subsection 43-120(2) of the ITAA 1997.

The 'your area' of the construction expenditure area of the taxpayer is the entire construction expenditure area. This is because the taxpayer is the lessee over the entity of the land.

Given the structures are used by the taxpayer to produce its assessable income any construction expenditure incurred within their area is capital works to which Division 43 of the ITAA 1997 applies.

Service points

The work on this falls into two categories.

To begin with additional points will be added. As these are in addition to those currently in place they cannot be a repair. What they do is increase functionality of the structure.

The existing points are all being replaced in their entirety and as they are being replaced in their entirety the work cannot be considered to be a repair of an existing asset.

As the service points are a part of the main structure allowing access to the services provided (electricity/water) the work will be capital works to which Division 43 of the ITAA 1997 applies.

Water Pipes/line

These pipes are used to provide both potable and fire service water throughout the structure.

The work being done to the pipes is to replace them with larger pipes to increase water flow and volume from current levels.

This work is not a repair to which section 25-10 of the ITAA 1997 would apply. This is because all of the old water pipes are being removed and new larger pipes being installed in their place. As a result the work has the effect of replacing the entirety.

As explained in ATO ID 2004/579 expenditure on the installation of water pipes is capital works to which Division 43 of the ITAA 1997 applies.

Fire hydrants

The work on the fire hydrants fall into three categories.

To begin with four additional hydrants will be installed. As these are unrelated to those hydrants already installed the work to install these cannot be a repair. Division 43 of the ITAA 1997 applies in respect of the cost of installing these four hydrants.

The second is some of hydrants are not serviceable and need to be replaced. This would not be a repair as these hydrants are being replaced in their entirety. Division 43 of the ITAA 1997 applies in respect of replacing these four hydrants.

This leaves the remaining hydrants which will be reconditioned and reused. To determine if the work on these hydrants are repairs we must once again look at the Lindsay case and the Rhodesia Railways case.

In this case the work on the hydrant is being undertaken on the defective or damaged parts within the hydrant which will have the effect of returning them to full working order.

This can be differentiated from that of the main structure where the work was done over the entire structure to renew the structure in its entirety (including preventative work to reduce further damage).

In respect of these hydrants the entirety is not being renewed only the worn out subsidiary parts are being replaced and this is more akin to the decision in the Rhodesia Railways case than the Lindsay case.

Therefore the work being done to reuse the hydrant is a repair and deductible under section 25-10 of the ITAA 1997.

Stainless Steel stand pipes

These are either new items or they will be replacing existing stand pipes and as a result they would not be considered to be a repair.

As explained above water pipes are capital works to which Division 43 of the ITAA 1997 applies.

Audible alarm

Regulations require that an audible alarm be installed at every fire hose reel position.

This was not a requirement in the past and as a result these will be new items not previously installed and the work cannot be considered to be a repair.

As per table 3 of the Guide for rental property owners the cost of installing audible alarms are not capital works to which Division 43 would apply but are items to which Division 40 of the ITAA 1997 would apply.

Break glass/ Manual Call points

Regulations require that a break glass point be installed at every fire hose reel position. The ones being installed are non-addressable.

This was not a requirement in the past and as a result these will be new items not previously installed and the work cannot be considered to be a repair.

As per table 3 of the Guide for rental property owners the cost of installing non-addressable manual call points are capital works to which Division 43 would apply.

Main electrical switch board distribution boards and wiring

All of these items are listed under the heading 'electrical assets' in table 3 of the Guide for rental property owners) to which Division 43 of the ITAA 1997 applies

As this work is brand new with the existing units being retained the cost of installing the new units cannot be considered to be a repair.

Therefore Division 43 of the ITAA 1997 will apply in respect of this work.