Edited version of your written advice

Authorisation Number: 1012664880508

Ruling

Subject: Treatment of capital expenditure on abandoned plans for a development

Question 1

Are you entitled to a deduction for architect fees, drafting fees and engineering fees in customising the floor plan for a major tenant, which was subsequently abandoned, under Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Are you entitled to a deduction for architect fees, drafting fees and engineering fees in customising the floor plan for a major tenant, which was subsequently abandoned, under section 8-1 of the ITAA 1997?

Answer

No.

Question 3

Can the abandonment of plans relating to this expenditure be claimed as a capital loss pursuant to any CGT event, in any financial year?

Answer

No.

Question 4

Can the abandoned expenditure for architect fees, drafting fees and engineering fees in customising the floor plan for a major tenant, which was subsequently abandoned, be included in the cost base of the property for CGT purposes?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2008

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on

1 July 2004

Relevant facts

The entity purchased land to carry on a proposed commercial development .

An amount of total construction expenditure had been incurred by the entity in constructing a large commercial building.

The entity directly engaged its own subcontractors to carry out all of the construction work. The total amount expended by the entity comprised such things as architectural fees, engineering fees, drafting fees, earthmoving fees, builders progress payments, local council fees, water corporation fees and fees payable to main roads department and trade contractors and building material suppliers.

A quantity surveyor was engaged to determine the amounts that could be claimed under depreciation and capital works write off. An amount of capital was excluded from these deductible amounts.

The building was first designed and planned by an architect, for a major tenant. The entity expended monies in customising the original layout and design for this proposed tenant. The amount expended was on architects fees, drafting fees and engineering fees in customising the floor plan and layout to accommodate the exact requirements of its proposed tenant.

In the meantime the entity was approached by another potential tenant to lease space to them instead of the other proposed tenant, so the entity did not proceed to lease the space to the original tenant. There was no formal agreement with the original tenant and accordingly all work done and costs incurred relating to customising the design and layout of the building for the original tenant became completely redundant and worthless expenditure. All of this work was abandoned.

The entity then entered into an agreement with the new tenant and they became the major tenant of the building which was then planned, designed and built according to those new plans for the tenant. The entity went to a new architect and a completely different design was completed for a building of about twice the size.

Relevant legislative provisions

Income Tax assessment Act 1997 section 8-1

Income Tax assessment Act 1997 section 40-880

Income Tax assessment Act 1997 section Division 43

Income Tax assessment Act 1997 section 43-70

Income Tax assessment Act 1997 section 43-75

Income Tax assessment Act 1997 section 108-5

Income Tax assessment Act 1997 section 110-25

Reasons for decision

Division 43 Capital works

A deduction for capital works under Division 43 of the ITAA 1997 is based on the amount of construction expenditure, that is, capital expenditure incurred in respect of the construction of those capital works.

Before a deduction can be claimed in relation to the capital cost of constructing capital works, there must first be a "construction expenditure area" in relation to those capital works. Subsection 43-75(1) of the ITAA 1997 explains what the construction expenditure area is for capital works started after 30 June 1997. It is simply that part of the capital works on which 'construction expenditure' (s 43-70) has been incurred.

Subsection 43-75(4) says that the construction expenditure area for capital works can only be determined after the construction of the capital works has been completed. This ensures that no deduction is available in respect of capital expenditure on capital works until all construction work on the capital works is completed.

Subsection 43-75(5) ensures that each time a taxpayer constructs capital works there can only be one construction expenditure area in respect of those capital works. Subsection 43-75(6) explains that whenever an entity undertakes to construct new capital works, then a separate construction expenditure area is created in respect of those capital works.

Taxation Ruling TR 97/25 does include preliminary expenses such as architect fees and engineering fees in construction expenditure, but the capital expenditure has to be incurred 'in respect' of the construction of a particular capital works. Your expenditure on architect fees and drafting fees in customising the floor plan and layout of the building to accommodate the exact requirements of the proposed tenant is not in respect of a construction expenditure area. These plans were abandoned, they were not implemented in any particular construction of capital works. The capital expenditure on these items is not deductible under Division 43 of the ITAA 1997.

Deductibility under section 8-1 of the ITAA 1997

You can deduct from your assessable income any losses or outgoings to the extent to which they are incurred in gaining or producing your assessable income or necessarily incurred in carrying on your business for the purposes of gaining or producing assessable income. No deduction is allowed under section 8-1 for expenses to the extent to which they are capital, private or domestic nature, or incurred in gaining or producing exempt or non-assessable non-exempt income, or otherwise prevented from being deductible by a specific provision of the ITAA 1997 or the ITAA 1936.

The expenditure is in relation to the potential development of the property to be used as an asset in a business of renting out a building. You are not in the business of being a property developer and the potential asset to be developed from the plans would not be trading stock, but would have been a capital asset. Therefore this expenditure would be seen as capital expenditure and not deductible under section 8-1 of the ITAA 1997.

Capital loss on abandonment of plans

A CGT asset is any kind of property, or a legal or equitable right that is not property. Property is generally something that is capable of assignment or transmission. Mere information is not a CGT asset because it is neither property nor a right.

Examples of assets include: land, shares in a company, rights and options, leases, units in a unit trust, goodwill, licences, convertible notes, contractual rights and any major capital improvements made to certain land or pre-CGT assets.

A building, structure or other capital improvement on land that you acquired on or after 20 September 1985 is only a separate asset, if a balancing adjustment provision applies to it.

The plans that were drawn up related to the potential development of the particular block of land that the entity held. The plans are not seen as property in their own right. They are attached to the land and may have increased the value of the land.

There was no contract or agreement with the proposed major tenant of the building. This expenditure did not relate to any contractual right.

The expenditure to develop the plans to the proposed tenant's requirements has not created a separate CGT asset for income tax purposes. Therefore, as there is no separate CGT asset, there cannot be a loss at the time the plans were abandoned.

Inclusion of the expenditure in the cost base of the property

The cost base of a CGT asset is generally the cost of the asset when you bought it. However, it also includes certain other costs associated with acquiring, holding and disposing of the asset.

The cost base of a CGT asset is made up of five elements. The fourth element is capital costs you incurred for the purpose or the expected effect of increasing or preserving the asset's value - for example, costs incurred in applying (successfully or unsuccessfully) for zoning changes.

The initial plans were drawn up on the basis of the proposed tenant being the potential main tenant in a proposed building on this area of land. This expenditure is seen as potentially increasing the value of the land that could ultimately be developed into a building. The expenditure can be included in the cost base of the property as a fourth element cost.

Section 40-880 Business capital costs

This is a section of last resort. Where an amount is taken into account in working out a capital gain or capital loss it will be excluded from a deduction under section 40-880 of the ITAA 1997. Section 40-880 is not applicable to this expenditure.