Edited version of your private ruling

Authorisation Number: 1012101718232

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. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Investment allowance

Question 1

Will the Commissioner confirm that the investment commitment time, as defined in subsection 41-25(1) of the Income Tax Assessment Act 1997 (ITAA 1997), for the expenditure incurred by the taxpayer in the construction of an industrial plant occurred in June 2009?

Answer

Yes

Question 2

Will the Commissioner confirm that, for those components included in the identified groups of items which individually cost less than $10,000, they can be aggregated for the purpose of meeting the new investment threshold as defined in section 41-35 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 2007 to 30 June 2010

The scheme commences on:

1 July 2007

Relevant facts and circumstances

The taxpayer is the head company of a tax consolidated group.

During the 2007-08 income year, the directors of the company discussed engaging a firm for the supply of a new industrial machinery. This project also includes the construction of an industrial building.

Under the contract, the supplier would provide the design of the whole plant according to specifications and supply some of the components. Due to logistics issues, it was agreed that the taxpayer would procure or manufacture some of the equipment and materials itself.

The supplier initially issued a sale confirmation order to supply certain equipment for the project, with the remaining system to be sourced by the taxpayer. Installation was also to be carried out by the taxpayer's personnel, with supervision from the supplier during the commissioning phase.

From mid 2008, the supplier issued several sales orders for the designs and drawings of the plant and specifications were updated regularly but no contract was signed for the construction to begin. The taxpayer also made several payments during this period for the commencement of the overall design of the project.

In June 2009, the final construction specifications were prepared by the supplier based on the verbal agreements with the taxpayer. The supplier issued a final sale confirmation order which specified the correct payment dates and other commercial terms (as agreed).

This was followed by the taxpayer making a payment which represented payment for the delivery of all drawings of parts to be fabricated by the taxpayer and commencement of the construction engagement after the taxpayer's acceptance to proceed with the construction of the plant.

Construction commenced in June 2009.

During June 2009, the taxpayer began the process of sourcing pricing for all other items and materials it had to supply for the construction of the industrial plant and contracts were entered into progressively over the following 12 months until final commissioning in June 2010.

The components or areas of the plant are detailed in the supplier's June 2009 contract. It specifies the engineering process and the X groups of components and their respective cost.

The total amount payable covers the contract final value owing to the supplier as set out in the June 2009 contract. It also includes all other related acquisitions acquired both in June 2009 and between July 2009 and June 2010 that were required to be supplied by the taxpayer as part of the construction process. It excludes the industrial building itself, concrete pits and foundations as these are capital works which are not eligible for the tax break.

For ease of reference, the term 'the X items' for the X identified groups of items is used throughout this private ruling.

The industrial plant was installed ready for use before 30 June 2010.

Relevant legislative provisions

Income Tax Assessment Act 1997

paragraph 41-10(1)(d)

section 41-20

subsection 41-25(1)

paragraph 41-25(1)(a)

subparagraph 41-25(1)(a)(ii)

subsection 41-25(3A)

subsection 41-35(b)

Reasons for decision

Note that all legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated

Investment commitment time

Div 41 allows an additional deduction for certain business investment in new, tangible deprecating assets and for new expenditure on existing assets - the 'tax break'.

A business entity may be able to claim the tax break if it is committed to investing in an eligible asset within the 'investment commitment time' as defined in paragraph 41-25(1)(a). Section 41-20 specifies the investment commitment time as between 13 December 2008 and 31 December 2009.

In the case of where a taxpayer enters into a contract to have an eligible depreciating 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.

In the case of self-constructed assets, the investment commitment time is the time at which the taxpayer starts to construct the asset. For the purposes of subsection 41-25(3A), the taxpayer is treated as having started to construct an asset at a time when they first incur expenditure in respect of the construction of the asset.

In Taxation Ruling IT2142 - investment allowance - unit of property - construction and acquisition - incurring of expenditure, the Commissioner sets out the principles to be applied in relation to questions of acquisition and construction of an asset. The table at paragraph 10 states that where construction is partly carried out by the taxpayer and partly by others, the asset is considered to have been constructed provided the taxpayer plays the predominant role in construction. Paragraph 12 confirms that this is the case notwithstanding that parts incorporated into that unit of property were manufactured by and purchased from other persons.

The roles of the taxpayer and the supplier in this project are considered:

Under the arrangement, the supplier was responsible for the engineering, designing and technological aspects of the project in addition to supplying some of the components. The taxpayer's role was to project manage the new plant construction and installation carried out by its own personnel, with supervision from the supplier during the commissioning phase. The taxpayer also supplied the remaining components. The final sale confirmation order in June 2009 detailed each and every component of the plant, along with a breakdown of what items were to be supplied directly by the supplier and what items were to be supplied by the taxpayer under the design specifications provided by the supplier.

After signing the final sale confirmation order, the taxpayer began the process of sourcing prices for all other items and materials required for the construction of the plant over the following 12 months until final commissioning in June 2010.

In view of the predominant role of the taxpayer in the procurement and construction process, it is considered that the plant constitutes a self-constructed asset. As such, the applicable investment commitment time was when the taxpayer started to construct the asset, that is, when the taxpayer first incurred expenditure in respect of the construction of the asset.

The expression 'in respect of' indicates that the expenditure associated with the construction of an asset is not limited to expenditure incurred on the actual construction. Paragraph 9 of Taxation Ruling TR 97/25 - Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements confirms that 'construction expenditure' includes not just the cost of the structure itself but preliminary expenses such as architect fees and engineering fees.

IT 2142 at paragraph 13 refers to comment made by Fitzgerald J in FC of T v. Tully Co-operative Sugar Milling Association Limited (1983) 14 ATR 495, 83 ATC 4495 ('Tully's case') that expenditure in respect of construction may in appropriate cases include costs of purchase. It concludes that, as a result, 'construction' may commence before the actual physical work of assembly or the likes begins.

For the purpose of determining the investment commitment time for self-constructed assets, however, it is only expenditure which demonstrates a commitment to proceed with the construction that is covered by the expression 'in respect of' construction. Expenditure that is incurred before there is a definite decision to proceed with the construction, or expenditure that only has a remote or tenuous connection with the construction is not indicative of the investment commitment time. In the context of the investment commitment rules, this type of expenditure does not exhibit the material or relevant connection with the construction for it to qualify as being 'in respect of' the construction. Accordingly, it will not be expenditure that triggers the investment commitment time for the asset.

In the present case, the proposal to construct an industrial plant started in early 2007 when the taxpayer considered engaging the supplier in the project. In the ensuing months, discussions were held between the two parties in relation to the specifications, supply and installation of various items and equipment, specifically, the design and drawings of the plant and overall site layout.

Two payments were made to the supplier in 2008 for commencement of the overall design and the full set of definitive concrete foundations drawings. The taxpayer made another payment in May 2009 for a full set of definitive drawings of parts to be supplied by the supplier and all parts to be sourced or fabricated by the taxpayer.

No contract was entered into throughout this period. In June 2009 the supplier prepared the final construction specifications based on the verbal agreements with the taxpayer. This agreement was formalised a few days later when the supplier issued the final sale confirmation order and the taxpayer accepted the terms and conditions. The taxpayer followed by making a payment for the delivery of all drawings of parts it would fabricate and commencement of the construction engagement.

It is considered that the payments made to the supplier prior to June 2009 did not evidence a commitment to proceed with the construction of the galvanising plant. These were preparatory costs incurred towards design and drawings during the feasibility stage. The taxpayer was not bound by the payments or earlier sales orders and it was open to the taxpayer to abandon the project for any reason. As the earlier payments did not commit the taxpayer to proceed with the construction of the plant they were not expenditure that would trigger the investment commitment time for the construction.

When the taxpayer signed off the final sale confirmation order, it gave rise to an enforceable contract which it could not rescind without legal ramifications. As such, the payment in June 2009 evidenced the company's commitment to proceed with the construction of the industrial plant. Accordingly, for the purpose of subparagraph 41-25(1)(a)(ii), the investment commitment time occurred in June 2009.

New investment threshold

To be eligible for the tax break, the total amount of new investment in an asset for the income year must equal or exceed the relevant new investment threshold - paragraph 41-10(1)(d).

As the taxpayer is not a small business entity, the new investment threshold in relation to an eligible asset for the company is $10,000 under subsection 41-35(b).

Each of the X items comprises a large number of low value materials and parts such as bolts, cables and raw materials which individually cost less than $10,000. The question is whether the industrial plant is a single asset made up of the X items or whether each of these X items is a single asset in its own right with its own components that include the low value materials and parts.

The taxpayer is of the view that these X items collectively represent the components of one single depreciating asset, being the plant. As such, the asset is substantially in excess of the $10,000 threshold.

Taxation Ruling TR 94/11- Income tax: general investment allowance - what is a unit of property? provides guidelines on what represents a separate unit or item for the purposes of dealing with cases under the former investment allowance provisions.

Paragraph 3 of TR 94/11 indicates that an item is generally a unit of property if it has one or more of the following characteristics:

(a) it is an entity entire in itself, capable of being separately identified or regarded and having a separate function …

(b) the item is functionally complete in itself. However, the item need not be self contained or used in isolation. It is not necessary that the item function on its own. It should however, be capable of performing its intended discrete function …

(c) the item when attached to another unit of property having its own independent function varies the performance of that unit …

(d) the item itself performs a definable, identifiable function …

Paragraph 4 of TR 94/11 states that a unit of property can be made up of a number of components. Several components or parts of an item of plant working together with other components may be parts of a single functional item. This larger functional item, rather than the individual components, could be the relevant 'unit of property'. It draws on the function test applied in the Tully's case where the relevant items on appeal were each held to be a separate unit of property:

mixed juice pumping station (incorporating starters, pumps, motors and other components),

first and third crushing mills (incorporating turbine gear box roller crusher, gearing and other components);

juice heaters.

The plant is a collective structure covering the industrial building, the pits and foundation that form the bases of the building and the X items which carry out a series of sequential steps in the engineering process. The plant is not a single unit having its own individual function (it is the X items that perform their own respective functions), nor is it capable of being attached to another unit of property to alter the performance of that unit. Thus, the plant is not considered to be a unit of property itself.

In contrast, each of the X items (referred to as components or areas of the plant by the taxpayer) is functionally complete in itself. Working together they complete the engineering process; individually, each performs a distinct and independent function. They are analogous to the various items used in the sugar milling process in the Tully's case.

Accordingly, it is considered appropriate to take the view that each of the X items of the plant is a unit of property by itself, rather than the alternative that these items together form one unit of property, being the plant.

Whilst the total cost of each item is well above $10,000, it includes a large number of low value raw materials and part such as cables and bolts (collectively referred to as components for the purpose of this ruling), which individually cost less than the investment threshold.

The general rule under Div 41 is that the new investment threshold is applied on an asset by asset basis, meaning that it must be satisfied in relation to each individual asset. However, in the case of assets which form part of a set, subparagraph 41-10(4)(b)(i) allows the recognised new investment amounts to be aggregated to meet the new investment threshold.

Items may be regarded as a set if they are:

dependent on each other

marketed as a set

designed and intended to be used together

Guide to small business and general business tax break provides the following explanation:

The concept of a set requires more than one depreciating asset. In some cases, however, more than one item makes up a single depreciating asset. An example would be a three volume dictionary. This is a single depreciating asset, not a set of three separate depreciating assets as the three volumes have a single integrated function. Similarly, a computer - consisting of a hard drive, monitor and mouse - would not be considered to be a set, as it forms a single composite asset (with the components naturally aggregated for threshold purposes).

While the plant is made up of the X items, each one is used for a different purpose in the engineering process and is not specifically designed to be used with the others. They do not form a set. Each item is a single depreciating asset on its own. Each of these items cannot perform its designated function without the low value components which are integral to the fabrication and operation of the relevant item. As such, each item with its own low value components is considered to be one single composite asset. Accordingly, those components which individually cost less than $10,000 can be grouped with the relevant item for the purpose of determining the new investment threshold.