Edited version of private ruling

Authorisation Number: 1011891338729

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Ruling

Subject: Repairs or capital

Question

Is adding a new skin to the external layer of strata title units to stop the roof leaking a repair under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) as distinct from a capital expenditure?

Answer

No

This ruling applies for the following period:

The 2011-12 income year

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You are adding a new skin to the external layer of a leaking roof on a set of strata title commercial units.

You do not possess a strata agreement.

The strata is a separate entity, it maintains the buildings and common areas. The strata makes no money, and holds no money. It does not lodge tax returns. When work is required, the owners pay into a strata bank account on a per unit basis.

You own a number of units in a strata title block of commercial rentals. Your company owns one unit and the other is owned by an unrelated third entity.

All of the strata units are currently tenanted. Your units and the unit owned by your company are leased to businesses on commercial terms and the other unit is owner occupied.

The units were built in two stages, being completed post-CGT.

The building is constructed with concrete floors, brick walls and a steel roof.

The roofing material is a 'composite panel', consisting of an insulation material sandwiched between two sheets of steel and was known as econodeck.

The econodeck panels are screwed to steel battens.

The underneath of the econodeck formed the ceiling of the buildings.

The existing econodeck roofing has deteriorated and now leaks water. Some of the units are leaking. Of the units that are leaking, you own some and your company owns one.

Econodeck is no longer made or available for purchase and as such cannot be used to repair the existing roof.

You engaged a firm of structural/civil engineers to provide a solution to repair the roof.

The engineers have provided a solution that whilst repairing the roof also minimises disruption to the tenants.

Given the general state of repair of the roof, it has been determined that it will need to be repaired by adding a 'skin' over the entirety of the roof.

The solution involves fixing new steel (or potentially wooden) battens to the top side of the econodeck roof and then fixing sheets of 'trimdeck' (or similar) to the steel battens and generally adding flashings and covers to watertight the roof. Essentially adding a 'skin' to the external surface of the existing roof structure.

The existing econodeck will still provide the ceiling and insulation for the buildings.

Given the existing econodeck is not being removed means minimum disruption to tenants who would have otherwise been exposed to the weather while the roof was removed.

The fix to the roof will be done by the strata entity.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1,
Income Tax Assessment Act 1997 Section 25-10 and
Income Tax Assessment Act 1997 Subsection 25-10(3).

Does Part IVA 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

Summary

It is determined that the addition of a skin to the external layer of a set of eight commercial strata title units is not a repair, and the costs are not deductable under section 25-10 of the ITAA 1997. The expense is capital in nature.

Detailed reasoning

The word 'repair' is not defined within the tax legislation. Accordingly, it takes its ordinary meaning. 'Repair' involves a restoration of a thing to a condition it formerly had without changing its character (W Thomas & Co v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) AITR 710).

Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent to which they are incurred in gaining or producing assessable income, except to the extent that they are outgoings of a capital, private or domestic nature.
Section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to premises used for income tax purposes. Subsection 25-10(3) of the ITAA 1997 precludes a deduction for repairs where the expenditure is of a capital nature.

Taxation Ruling TR 97/23 explains the circumstances in which expenditure incurred for repairs is an allowable deduction. This ruling indicates that expenditure for repairs to property is of a capital nature where:

· the work is an initial repair

· the extent of the work carried out represents a renewal or reconstruction of the 'entirety', or

· the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than a ' repair'.

In paragraph 16 of TR 97/23, a repair to a property may involve a minor and incidental degree of improvement, addition or alteration. However, if the work amounts to a substantial improvement, addition or alteration it is not a repair and not deductible under section 25-10 of the ITAA 1997.

In BP Oil Refinery (Bulwer Island) Ltd v. FC of T 92 ATC 4031; (1992) 23 ATR 65, the Federal Court of Australia (Jenkinson J) considered a repair deduction claim for the cost of encasing wooden piles on a wharf in concrete in order to stop marine organisms from further damaging the piles. The court held that neither the piles nor the wharf as a whole were repaired. Work will not be considered to be a 'repair' unless it includes some restoration of something that was lost or damaged rather than effecting an improvement.

Some factors that point to work done to property being an improvement include whether the work will extend the property's income producing ability or extend the property's expected life or reduce the likelihood of repair bills in the future.

FC of T v. Western Suburbs Cinemas Ltd (1952) 86 CLR 102; (1952) 9 ATD 452 (Western Suburbs Cinema Case) concerns whether expenditure for repairs is of a capital nature. In the Western Suburbs Cinema Case the ceiling of a motion picture theatre was in a state of disrepair. The company replaced the ceiling with a new one of a different design and better materials for a greater cost. The High Court (Kitto J) concluded that the new ceiling was an improvement to a fixed capital asset and that its cost was a capital charge.

Considerations in distinguishing between a repair and an improvement are discussed at paragraph 124 of TR 97/23. They are:

· whether or not the thing replaced or renewed was a major and important part of the structure of the property

· whether or not the work performed did more than meet the need for restoration of efficiency of function, bearing in mind that 'repair' involves a restoration of a thing to a condition it formerly had without changing its character

· whether the thing was replaced with a new and better one

· whether the new thing has considerable advantages over the old one, including the advantage that it reduces the likelihood of repair bills in the future.

It is noted that TR 97/23 explains that a roof is a subsidiary part of the whole, the building itself is the entirety (paragraph 40) and that separate buildings in a commercial complex are entireties in themselves (paragraph 41). This means that if individual parts of the total project can be separated and characterised as repairs, and if their cost can be segregated and accurately quantified, their cost is deductable. Paragraph 55 of TR 97/23 explains that it must be possible to segregate the cost of the repairs actually effected from the capital cost of the improvements. If repair work cannot be separately segregated and the cost accurately quantified independently from the cost of the improvements, then the cost of the entire work would be capital.

Other points to consider include:

· to claim a deduction under section 25-10 of the ITAA 1997 you must hold the property for income purposes

· the property must be held or used bona fide for income purposes

· work done to property not in need of repair is not repair work

· repair is restoration by renewal or replacement of subsidiary parts of a whole

· expenditure for repairs must be 'incurred'.

In your situation you own some units in a strata complex. The existing roofing is a composite panel made up of insulation sandwiched between two sheets of steel that is screwed to steel battens. The underneath of this forms the internal ceiling of the units. Some of the units you own are leaking.

To minimise disruption to the tenants, you propose not to 'fix' the existing roof, but to add a 'skin' on top by attaching battens to the top of the existing roof and then attaching a material, possibly 'Trimdeck', to those battens. You would then add flashings and covers to watertight the roof. This skin would be placed over the top of all eight units.

A repair involves restoration of a thing to a condition it formerly had without changing its character. You are not restoring the roof to its previous condition, you are adding a skin. The new skin has a different character in that you do not describe it as a roof and it does not form the ceiling of the units. Paragraph 16 of TR 97/23 explains that if the work amounts to a substantial improvement, alteration or addition, it is not a repair and not deductable under section 25-10 of the ITAA 1997. Adding a skin to the existing roof is a substantial addition to the property.

Considering the points raised in paragraph 124 of TR 97/23:

· the roof is a major and important part of the structure of the property. It is also considered that you are not replacing or renewing the leaking roof, you are adding another asset to the property

· you have not 'repaired' the roof. You have not restored the existing roof to its former condition without changing its character

· the roof has not been 'replaced', a new asset has been added

· the new skin will reduce the likelihood of repair bills in the future.

On consideration, it is determined that the addition of a skin to the external layer of a set of commercial strata title units is not a repair, and the costs are not deductable under section 25-10 of the ITAA 1997. The expense is capital in nature.