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Ruling

Subject: Replacement roof - repair or capital expenditure

Question 1

Is the cost of a replacement roof on a property owned by the entity a deductible repair under section 25-10 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

Financial year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The entity carries on a business activity at a property it purchased.

The current state of the property's roof is as follows:

The roof has deteriorated to the extent that there are small holes throughout the roof.

The plaster ceiling within the property is discoloured due to the leaking roof.

The plaster ceiling may eventually collapse if the leaks are left unattended.

There were no leaks in the roof at the time when the entity purchased the property.

The entity arranged for the entire roof to be pulled down and refitted with a new roof (the replacement roof).

The replacement roof serves the same function as the old roof.

The replacement roof is in the same design and structure as the old roof.

The material used in the replacement roof is the same as the material in the old roof. However, the replacement roof is baked in a different paint colour. The new paint colour was not available at the time when the old roof was fitted.

The replacement roof stopped any further deterioration to the building, and reduced the likelihood of future repairs.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10.

Reasons for decision

Summary

Is the cost of a replacement roof on a property owned by the entity a deductible repair under section 25-10 of the Income Tax Assessment Act 1997?

The replacement roof is in the same design and structure as the old roof, and serves the same function as the old roof. The majority of the material used in the replacement roof is the same as the material used in the old roof. The only new material being used on the replacement roof is a different paint. The roof was in good working order when the entity acquired the property. The damage was caused by wear and tear during the time the property was used to earn assessable business income.

The replacement roof is a repair to a part of the property, and is not a capital expenditure. This means the entity is entitled to a deduction for the cost of the replacement roof.

Detailed reasoning

Subsection 25-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to premises, or a part of the premises, used solely for income-producing purposes. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature.

The entity used the property solely for the purpose of earning assessable income from carrying on a business activity.

The property has a number of small holes throughout the roof. This has resulted in water leaking into the roof. The leaks have damaged the plaster ceiling in the property. The entity arranged to have a replacement roof fitted.

A deduction will only be allowable if the expenditure on the replacement roof is not a capital expenditure.

Repairs

Taxation Ruling TR 97/23 Income tax: deduction for repairs explains the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10 of the ITAA 1997 (TR 97/23).

The word 'repair' is not defined within the taxation legislation.  Accordingly, it takes its ordinary meaning. Paragraph 13 of TR 97/23 states the word 'repair' 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.

In W Thomas & Co v. FC of T (1965) 115 CLR 58, it was held that a 'repair' involves a restoration of a thing to a condition it formerly had without changing its character. It is the restoration of efficiency in function rather than the exact repetition of form or material that is significant.

Capital expenditure

TR 97/23 indicates that expenditure for work completed on a property is capital in nature where:

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

· the work represent an 'improvement' rather than a repair, or

· the work is an initial repair.

Paragraphs 113 and 114 of TR 97/23 explain the difference between a repair and a renewal or reconstruction of the entirety:

113. Repairs to property may involve renewal or replacement of a subordinate part of the property.

114. Renewal, replacement or reconstruction of the entirety (i.e., the whole or substantially the whole) of a thing or structure is an improvement rather than a deductible repair.

An 'entirety' is defined as something 'separately identifiable as a principal item of capital equipment' (Lindsay v. FC of T (1961) 106 CLR 377 at 385). Paragraph 40 of TR 97/23 specifically states a roof is only a part of a building. The building itself is the entirety.

Expenditure will also be capital in nature if it represents an improvement. Paragraph 44 of TR 97/23 explains that an improvement provides a greater efficiency of function in the property:

In the case of a 'repair', broadly speaking, the work restores the efficiency of function of the property without changing its character. An 'improvement', on the other hand, provides a greater efficiency of function in the property - usually in some existing function. It involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. Some factors that point to work done to property being an improvement include whether the work will extend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life.

Paragraphs 48 and 49 of TR 97/23 identifies that the use of different or more modern material to replace the original material does not necessarily prevent the work from being a repair. It is the restoration of an item's efficiency of function (without changing its character) rather than exact repetition of form or material that is significant.

Paragraph 4 of TR 97/23 explains that an 'initial repair' is work which remedies a defect in the property, or makes good deteriorations to the property, which existed at the time when the property was acquired from another person or entity.

Paragraph 59 of TR 97/23 states that expenditure incurred on an initial repair after a property is acquired is a capital expenditure which is not deductible under section 25-10 of the ITAA 1997.

Application

In this case, the property's original roof has deteriorated, such that a number of holes have formed throughout the roof. As a result, water has been leaking into the roof and damaging the property.

The entity arranged for the entire roof to be pulled down and refitted with a replacement roof. The replacement roof is in the same design and structure as the old roof, and serves the same function as the old roof. In addition, the majority of the material used in the replacement roof is the same as the material used in the old roof.

The replacement roof is a repair to a part of the property, and not the entirety of the property. The replacement roof did not provide a greater efficiency of function of the property. It did not bring the property into a more valuable or desirable form, state or condition. In addition, the replacement roof ensured the continued existence of the property.

The only new material being used on the replacement roof is a different paint. The use of different or more modern paint to replace the original paint does not constitute an improvement. This is because it does not provide a greater efficiency of function to the roof.

The roof was in good working order when the entity acquired the property. The damage was caused by wear and tear during the time the property was used to earn assessable business income. On this basis, the replacement roof is not an initial repair.

Based on the above discussion, the replacement roof is a repair to a part of the property, and is not a capital expenditure. This means the entity is entitled to a deduction for the cost of the replacement roof under subsection 25-10(1) of the ITAA 1997.