Edited version of your private ruling

Authorisation Number: 1012517071464

Ruling

Subject: Environmental protection activities and repairs

Issue 1

Question

Will the expenditure incurred for the removal of the asbestos roofing be deductible under section 40-755?

Answer

Yes

Issue 2

Question

Will the expenditure for replacing the asbestos roofing material with aluminium be deductible as repairs under section 25-10 of the ITAA 1997?

Answer

No. It is deductible under the capital works provisions in Division 43

This ruling applies for the following periods:

1 July 2012 to 30 June 2022

The scheme commences on:

The 2012-13 income year

Relevant facts and circumstances

The company owns several buildings various locations.

The roofs of the buildings were constructed many years ago with a galvanised steel sheet metal product coated with an asbestos material designed to provide insulation and protection against corrosion in marine and industrial environments.

The company has recently commenced a program to remove and replace the roofs from the buildings, with priority given to those roofs with the greatest degree of deterioration and asbestos flaking. This program will continue over a number of years. In the meantime the risk on the other sheds is being managed until they can be replaced.

The program was carried out following an extensive assessment report completed a few years ago by a firm of consulting engineers which recommended that the buildings with the asbestos roofs be replaced progressively on a specified schedule.

The topside of the roofs has been recoated in the past to mitigate the asbestos flaking, however, the consulting engineers have determined there is no further option to recoat the topside surfaces.

The engineers have also found substantial underside flaking from the surface in several of the sheds and that replacement of the roofs is the only long term solution.

The report states that some risks associated with asbestos are currently rated medium and are being managed effectively with a risk plan.

The existing roofing is being replaced by an aluminium cladding material which provides insulation and protection against corrosion in marine and industrial environments and does not result in any improvement of that function. The project requires that the asbestos and the sheet metal be removed altogether as it is not possible to get rid of the asbestos only

Whilst maintenance costs are increasing substantially each year and the recladding program is considered a critical replacement project, the company claims that the program is not being undertaken as a cost saving measure due to the substantial cost of the overall project. It maintains that the asbestos is flaking and poses a Workplace Health and Safety risk to the users of the buildings as well as potential for possible product contamination.

Relevant legislative provisions

Section 40-755 of the ITAA1997

Section 25-10 of the ITAA 1997

Section 8-1 of the ITAA 1997

Div 43 of the ITAA 1997

Reasons for decision

Issue 1

Environmental protection activities

Section 40-755 deductions

Section 40-755 provides a deduction for expenditure that taxpayers incur for the sole or dominant purpose of carrying on environmental protection activities.

Environmental protection activities

Environmental protection activities are listed in subsection 40-755(2). One type of environment protection activities is the:

"(a) preventing, fighting or remedying:

(i) pollution resulting, or likely to result, from your earning activity; or

(ii) pollution of or from the site of your earning activity; or

(iii) pollution of or from a site where an entity was carrying on any *business that you have acquired and carry on substantially unchanged as your earning activity; … "

The Explanatory Memorandum to the Taxation Laws Amendment Act (No.5) 1992 (the EM) which introduced former subsection 82BK(1) of the ITAA 1936, the predecessor of section 40-755, makes it clear that pollution includes contamination by harmful or potentially dangerous elements such as asbestos.

Earning activity

Subsection 40-755(3) defines what constitutes "your earning activity' and states in part:

Your earning activity is an activity you carried on, carry on, or propose to carry on:

(a) for the *purpose of producing assessable income for an income year (except a *net capital gain); …"

In defining the site of 'your earning activity', subsection 40-755(4) includes 'leasing a site you own'.

The EM interprets subsection 40-755(4) as follows:

   ...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. The taxpayer will be entitled to a deduction (or depreciation) for environment activities. So a landlord may claim deductions for expenditure on environment activities.

In this case, the work is being done on buildings owned by the company and managed by another entity under a sub-lease arrangement. Therefore, the sites are used as part of the company's existing earning activity.

Sole or dominant purpose

The term 'sole or dominant purpose' is not defined for the purpose of subsection 40-755(1). The EM, however, provides guidance in the interpretation of this provision. It states that:

Expenditure will only be for the sole or dominant purpose of carrying on an eligible environment activity if it is primarily directed to that environment protection activity. A deduction will not be available if the protection of the environment is only a residual or subsidiary purpose of the taxpayer.

The EM uses the following example to clarify this explanation:

… suppose a taxpayer who operated a dump covers it with soil and plants it with grass and trees at the end of its life. This might have the dual purposes of protecting the environment by preventing noxious substances leaching out and beautifying the site to improve its resale value. If the landscaping is primarily to improve the resale value of the site it will not be deductible as allowable environment protection expenditure.

Where environmental protection expenditure is incurred for two or more purposes (for example protecting the environment as well as improving the resale value of the site), it is necessary to establish the dominant purpose of that expenditure.

In this case the question is whether the program is being undertaken to remove the asbestos roofing and cladding due to health risk concerns or as a cost saving measure in reducing future maintenance needs. The company acknowledges that maintenance costs are increasing substantially each year but maintains that the program is not undertaken as a cost saving measure as the overall cost is estimated to be significant over an extended period.

Whilst we do not consider the magnitude of the overall cost alone is demonstrative of the dominant or sole purpose without taking into account the projected maintenance cost over the same period, the assessment report indicates that the buildings are in various degrees of deterioration. This can cause asbestos dust in the atmosphere, which is a potentially serious health risk to the users of the buildings. The topside of the roofs has been recoated in the past to mitigate the asbestos flaking but there is no further option to recoat the topside surfaces. Substantial underside flaking is also evident in some of the shed roofs. Whilst some risks associated with asbestos are currently rated medium and being managed effectively with a risk plan, the report points out that maintenance of the existing coating is difficult due to the presence of asbestos and can only be regarded as suitable for short-term life extension.

We consider the concern over rising cost in maintenance is an important contributing factor in the company embarking on the program. On the other hand, we note the finding of the professional engineering firm that the company is running out of option to have the topside of the roofs repainted to prevent the asbestos from flaking. We acknowledge that the continued exposure of the roofs to the environment could exacerbate the situation resulting in asbestos dust in the atmosphere and the consequences of potentially serious public health risk due to a lack of remedial action.

In view of these factors, we accept that the dominant purpose of undertaking the removal of the roofs is to address potential health risks to users of the sheds and the likelihood of product contamination.

Limits on section 40-755 deductions

The environmental protection provisions are provisions of last resort. Section 40-760 limits deductions on environmental protection activities. In particular, it states that you cannot deduct capital expenditure under section 40-755 to the extent that you can deduct an amount for it under a provision of the ITAA 1997 outside Subdivision 40-H (paragraph 40-760(1)(e)).

In considering the deductibility of the expenditure incurred in removing the roofs for the purposes of section 40-755 the following factors have been considered:

· the expenditure is related to environmental protection activities as defined in section 40-755;

· the expenditure is attributable to the company's earning activity under a sub-lease arrangement; and

· the dominant purpose in demolishing the roofing and cladding is to remove the source of pollution and not for a residual or subsidiary purpose;

As all the conditions of section 40-755 have been satisfied, the company would qualify for a deduction in the year in which the expenditure is incurred, provided that no amount for it can be deducted under another provision outside Subdivision 40-H.

Each of the relevant provisions is discussed below:

Section 25-10

Section 25-10 allows a deduction for the cost of repairs to premises used for income producing purposes.

Taxation Ruling TR 97/23 Income Tax: deductions for repairs (TR 97/23) outlines the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10.

Paragraph 13 of TR 97/23 states that 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.

Paragraph 27 of TR 97/23 expands on paragraph 13 and explains:

An example of expenditure that is not deductible as a repair is the cost of removing asbestos insulation from factory walls (if the insulation is not in need of repair) and replacing it with modern insulation material. This work does not constitute the rectification of a defect in a mechanical or physical sense as envisaged by section 25-10. The asbestos insulation functions efficiently as insulation. It is being replaced because of the health risk it might pose to factory occupants, not to 'repair' the factory in the ordinary sense of the word….

As the removal of asbestos directed at decontaminating the buildings involves the demolition of the entire roofs rather than remedying existing defects or damage, it does not constitute repairs under section 25-10. Accordingly, the expenditure is not an allowable deduction.

Section 8-1

Similarly, the expenditure incurred in demolishing the roofs constructed of asbestos is not deductible under the general deduction provision of section 8-1 as it is of a capital nature.

Section 43-10

Section 43-10 provides a deduction for capital expenditure incurred for the construction of certain assessable income producing capital works. However, expenditure on demolishing existing structures does not qualify for a capital work deduction under that section as it is specifically excluded from construction expenditure by paragraph 43-70(2)(b).

Conclusion

As none of the cost in removing the asbestos roofing and cladding can be deducted under any other provision, the company is entitled to claim a deduction for that amount under section 40-755.

Issue 2

Repair or capital expenditure

Section 25-10

As discussed in Issue 1, the word 'repair' in section 25-10 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. Paragraph 26 of TR 97/23 further indicates that unless these conditions are met, it makes no difference if the work is done to property in controlling health risks associated with the use of dangerous substances (such as asbestos).

The recladding program progresses over a number of years. Whilst the consulting engineers have determined that there is no further option to recoat the topside surfaces to mitigate the asbestos flaking and also reported substantial underside flaking of asbestos from the roofs, the assessment report notes that some of the buildings are in good to moderate conditions. Some risks associated with the asbestos are currently rated moderate and are being managed effectively with a risk plan.

These findings indicate that the buildings are in various degrees of condition - some are deteriorating whilst the others are of an acceptable standard. This is supported by the facts that the program is not due to complete until the end of the decade. Where the work carried out does not remedy existing defects, damage or deterioration, the expenditure is not incurred as repairs for the purposes of section 25-10.

Section 8-1

The cost incurred in replacing the roofs is capital in nature. It constitutes a once and for all expenditure for the acquisition of a structural asset that will have an enduring benefit. It is therefore not deductible under section 8-1.

Section 43-10

Division 43 provides a deduction for capital expenditure incurred for the construction of certain assessable income producing capital works.

Capital works includes buildings and structural improvements and also extensions, alterations or improvements to buildings and structural improvements: section 43-20.

The replacement of the existing roofs with new roofs is considered to be an alteration to buildings (the buildings).

Subsection 43-10(2) (ITAA 1997) states that:

You can only deduct the amount if:

(a)   the capital works have a construction expenditure area; and

(b)   there is a pool of construction expenditure for that area; and

(c)   you use your area in the income year in a way set out in Table 43-140

(Current year use).

Under subsection 43-75(1) construction expenditure area is the part of the capital works on which the construction expenditure was incurred that, at the time when it was incurred by an entity, was to be owned by the entity. 

The cost in replacing the asbestos satisfies this criterion.

Subsection 43-85(1) defines a pool of construction expenditure as so much of the construction expenditure that is incurred by an entity on capital work as is attributable to the construction expenditure area. The expenditure in replacing the roofs is included in the project cost and this condition is satisfied.

Subsection 43-140 defines 'using your area' in a deductible way. The table contained in section 43-140 sets out how a taxpayer must use the area in order to qualify for the deduction. Since the construction of the new roofs commences after 30 June 1997 and the capital works are used by the company for producing assessable income, the expenditure satisfies this condition.

As the expenditure in replacing the existing roofs satisfies the conditions set out in Div 43, the company is entitled to claim a deduction at 2.5% per year over a period of 40 years.