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Ruling

Subject: Environmental protection activities

Question

Is the trust entitled to a deduction for site rehabilitation costs as a result of complying with an environmental protection order between tenants?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

You are the owner and lessor of a commercial rental property used for the purpose of producing assessable income.

The previous tenant operated a business on the property for a number of years.

After the property was vacant for a period of time, an agreement was entered into with a large company to lease and develop the site. A pre-lease contract was signed making you, as landlord, responsible for all site clean up and pollution clean up costs.

The EPA issued a clean up order on the site and you incurred substantial costs in order to comply with this order. Failure to comply would result in heavy penalties.

The property was purchased with the intent to derive income and this intention has not changed throughout the ownership period.

At the time the costs were incurred, a contract had been entered into to lease the property for a period of years, generating a significant amount per month in rental income.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 40-755

Reasons for decision

Section 40-755 of the ITAA 1997 provides a deduction for expenditure incurred for the sole or dominant purpose of carrying on environmental protection activities.

Environmental protection activities (EPA) are defined in subsection 40-755(2) of the ITAA 1997. One type of environmental protection activity is treating, cleaning up, removing or storing waste resulting, or likely to result, from your earning activity (subparagraph 40-755(2)(b)(i) of the ITAA 1997).

A taxpayer who earns income from leasing a site which he or she owns will be taken to be carrying on an income-producing activity on that site. So a landlord may claim deductions for expenditure on environment activities.

The environmental protection provisions are provisions of last resort (section 40-760 of the ITAA 1997). This means that you cannot deduct capital expenditure under section 40-755 of the ITAA 1997 to the extent that you can deduct an amount for it under another provision of the ITAA 1997.

Under section 40-760 of the ITAA 1997, a deduction is also not available for:

· EPA bonds and security deposits;

· expenditure on acquiring land;

· expenditure on constructing or altering buildings, structures or structural improvements;

· expenditure which forms part of the cost of a depreciating asset if a deduction is available for the decline in value of the asset; or

· expenditure to the extent that you incur it on carrying out an activity for environmental impact assessment of a project. (However, if it is capital expenditure directly connected with a project, it could be a project amount for which a deduction would be available over the project life.)

It should also be noted that expenditure incurred on or after 19 August 1992 on certain earthworks constructed as a result of carrying out EPA can be written off at a rate of 2.5% under the provisions for capital works expenditure.

The requirement in subsection 40-755(1) of the ITAA 1997 that the expenditure be incurred for the sole or dominant purpose of carrying on environmental protection activities is an objective test about what the expenditure is calculated to effect. In your case, the environmental protection order that required you to rectify the land explains why you undertook the clean up and removal activities and the expenditure was clearly to effect this.

The material you cleaned up and removed is the residue remaining after your former tenant's business. Your business also satisfies the definition of 'your earning activity' in subsection 40-755(3) of the ITAA 1997 because it was carried on for the purpose of producing assessable income. It follows that your activities of cleaning up and removing the waste constitute the carrying on of an environmental protection activity as defined in subparagraph 40-755(2)(b)(i) of the ITAA 1997.

Accordingly, as your capital expenditure on cleaning up and removing waste material resulting from your former tenant's business was incurred for the sole or dominant purpose of carrying on environmental protection activities, you can deduct the expenditure under section 40-755 of the ITAA 1997, subject to the limitations set out in section 40-760 of the ITAA 1997.