Edited version of private advice

Authorisation Number: 1012677488914

Ruling

Subject: Bathroom works

Question 1

Are you entitled to a deduction for repairs?

Answer

No.

Question 2

Are you entitled to a capital works deduction for the portion of the refurbishments expenditure you incurred?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

Entity A leases a property and runs a business.

Entity A and the landlord agreed to update and refurbish specified areas as they were outdated.

The landlord reimbursed entity A for a portion of the costs.

Under the lease, entity A must keep the landlords property in good and substantial repair.

Entity A uses the property for the purpose of producing assessable income.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 Section 43-110

Income Tax Assessment Act 1997 Section 43-120

Reasons for decision

Repairs and maintenance

Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to premises used for income producing purposes, to the extent that the expenditure is not capital in nature.

Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the circumstances in which deductions for repairs are allowable. TR 97/23 states that what is a repair for the purposes of section 25-10 of the ITAA 1997 is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property. The ruling further states that repairs mean the remedying or making good of defects in, damage to, or deterioration of, property. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated.

TR 97/23 indicates that expenditure for repairs to property is of a capital nature where:

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

• the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than 'repair', or

• the work is an initial repair. 

Repair costs are deductible where they are incurred during the period the property is held for income producing purposes and are attributable either to damage that occurs during your income producing use of the property or to defects that emerge suddenly during that time.

According to paragraph 125 of the TR 97/23, a repair after acquisition of property is an 'initial repair' if the repair was due when the property was acquired, in the sense that there was a need for repair to restore or maintain the property's efficiency of function. In other words, the property was neither in good order when it was acquired nor suitable for use for income purposes in the way intended.

TR 97/23 states that with a repair, 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. It involves bringing a thing or structure into a more valuable or desirable state or condition than a mere repair would do.

To repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. However, if the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10 of the ITAA 1997.

In this case the costs of the refurbishments are regarded as an improvement and therefore capital in nature. Even though the areas were outdated they were still functional and the expenses in relation to the areas are not deductible as repairs.

Where repairs are capital in nature, the capital works provisions in Division 43 of the ITAA 1997 are relevant.

Capital works

Division 43 of the ITAA 1997 provides a deduction for certain capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to buildings and structural improvements where a property is used for income producing purposes.

The capital works deduction is only available for taxpayers with certain proprietary rights to the capital works. Section 43-110 of the ITAA 1997 explains that a capital works deduction is only available if you own, lease or hold the capital works. No more than one entity may be entitled to the deduction in relation to that part of the capital works.

Capital expenditure on capital works by the owner of those capital works can only be deductible to that owner or a subsequent owner, that is, entitlement cannot be transferred to a lessee of those capital works.

However, in your case the capital expenditure was not fully incurred by the owner of the property, therefore we need to consider the situation where a lessee incurs the capital expenditure on the capital works.

The capital works deduction in relation to lessees is considered in two ways: firstly, on the basis that the taxpayer's construction expenditure was incurred by the lessee and secondly, on the basis that the taxpayer's construction expenditure was incurred by an earlier lessee.

As entity A incurred the construction expenditure, it is necessary to consider subsection 43-120(1) of the ITAA 1997 which explains the capital works area for construction expenditure by lessees. To qualify as a capital works deduction under subsection 43-120(1) of the ITAA 1997, you must have continuously leased or held the area since construction of the capital works was completed.

Entity A has satisfied the requirements of subsection 43-120(1) of the ITAA 1997 and as entity A is using the property for the purpose of producing assessable income, a deduction under Division 43 of the ITAA 1997 is allowed.

Please note a deduction for capital works is only allowed after the completion of the work.