Edited version of your written advice

Authorisation Number: 1012818716166

Date of advice: 11 June 2015

Ruling

Subject: Demolition of depreciating assets and capital works

Question 1

Will a balancing adjustment event occur for the Company upon destruction of the depreciating assets at the industrial site such that the Company will be entitled to an allowable deduction pursuant to section 40-285 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. A balancing adjustment event will occur for the Company upon destruction of its depreciating assets. A deduction will be allowable where the assets termination value is less than its adjustable value just before the balancing events occurs.

Question 2

Will the Company be entitled to deduct the undeducted construction expenditure of capital works at the Industrial site when those capital works are demolished pursuant to section 43-40 of the ITAA 1997?

Answer

Yes. Further, it is noted that demolition costs would not be deductible under this provision.

Question 3

Will the costs of demolishing capital works be included in the cost base of the land held by the Company pursuant to subsection 110-25(5)?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX to year ended 30 June 20YY

The scheme commences on:

During the year ended 30 June 20XX

Relevant facts and circumstances

1. The taxpayer Company is an Australian resident that owns and runs an industrial site. It also owns the land.

2. The industrial site is made up of a vast collection of assets which themselves vary between depreciating assets, capital works and CGT assets.

3. The Company has legal and beneficial ownership of the depreciating assets and the capital works assets at the industrial site.

4. The Company made the decision to permanently shut down and demolish the entire industrial site.

5. The costs incurred by the Company will be the net demolition costs charged by the demolition contractor plus other labour and decommissioning costs incurred by the Company directly.

6. At the completion of the demolition the Company intends to sell or redevelop the industrial site.

7. The Company has undeducted construction expenditure in relation to its capital works.

8. The Company does not have any CGT assets that were acquired before 20 September 1985.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 40-285

Income Tax Assessment Act 1997 Section 40-295

Income Tax Assessment Act 1997 Section 43-40

Income Tax Assessment Act 1997 Section 43-250

Income Tax Assessment Act 1997 Section 43-255

Income Tax Assessment Act 1997 Subsection 110-25(5)

Reasons for decision

Question 1

Pursuant to item 10 of the table in section 40-40 of the ITAA 1997 an entity holds a depreciating asset if it is the owner of the depreciating asset or the legal owner if there is both a legal owner and a beneficial owner.

Subsection 40-295(1)(a) of the ITAA 1997 states that a balancing adjustment event occurs for a depreciating asset when a taxpayer stops holding the asset. In this case the Company will stop holding the asset once the asset ceases to exist.

The Commissioner considers that each depreciating asset ceases to exist once it is demolished to ground level into large pieces and relocated. That is, at the completion of this process, there is no depreciating asset for the taxpayer to hold.

In these circumstances, the Company stops holding the depreciating asset causing a balancing adjustment event to occur for the asset under paragraph 40-295(1)(a) of the ITAA 1997.

Deductible balancing adjustment

Under subsection 40-285(2) of the ITAA 1997 a deduction will be allowable if the termination value of the relevant depreciating asset, is less than its adjustable value just before the balancing adjustment event occurs in the income year in which the balancing adjustment event occurs. With the deduction generally being the difference between those two amounts, unless the asset was used for a non-taxable purpose, in which case an apportionment may be required in accordance with the formula in subsection 40-290(2) of the ITAA 1997.

Question 2

Subsection 43-40(1) of the ITAA 1997 provides that you can deduct an amount if all or a part of your area is destroyed in an income year. However the deduction is subject to meeting the following conditions set out in paragraphs 43-40(1)(a) to 43-40(1)(c) of the ITAA 1997:

(a) you have been allowed, or can claim, a deduction under Division 43, or Division 10C or 10D of Part III of the Income Tax Assessment Act 1936 , for your area; and

(b) there is an amount of undeducted construction expenditure for your area; and

(c) you were using your area in the way that applies to it under Table 43-140 (Current year use) immediately before the destruction or, if not, neither you nor any other entity used your area for any purpose since it was last used by you in that way.

As at 20XX, the Company owned capital works with undeducted construction expenditure amounting to $x,xxx,xxx and a substantial portion of the capital works which represent this undeducted construction expenditure balance will be demolished as part of the demolition of the Industrial site.

On this basis the requirements of paragraphs 43-40(a) and (b) of the ITAA 1997 have been satisfied.

Paragraph 43-40(1)(c) of the ITAA 1997 has two limbs. The first limb is satisfied if 'your area' was used immediately before the destruction in the way that applies to it under Table 43-140 of the ITAA 1997 (the required use for capital works in all periods is use 'for the purpose of producing assessable income or conducting R&D activities). If not, the second limb allows a deduction if no entity has used the area for any purpose since it was last used by the taxpayer for the purpose of producing assessable income.

In the context of paragraph 43-40(1)(c) of the ITAA 1997, immediately before refers to a relatively short period of time between the last use of your area and its destruction.

In this case, the capital works at the Industrial plant fall into two categories; firstly construction expenditure areas which will be used for the purposes of producing assessable income until immediately before the destruction, and secondly construction expenditure areas which were last used to produce assessable income but are no longer in use and will not be used by the Company or any other entity for any purpose prior to destruction.

In relation to the first category these areas will satisfy the first limb of paragraph 43-40(1)(c) of the ITAA 1997 as the areas will be used immediately before the destruction in the way that applies to them under Table 43-140 of the ITAA 1997, being for the purpose of producing assessable income.

In relation to the second category these areas will satisfy the second limb of paragraph 43-40(1)(c) of the ITAA 1997 as these areas were last used prior to destruction in the way that applies to them under Table 43-140 of the ITAA 1997, being for the purpose of producing assessable income and have not since been used by the Company or any other entity for any other purpose.

As both categories of capital works meet the requirements of paragraph 43-40(1)(c) of the ITAA 1997 a deduction will be available for the Company in relation to the relevant undeducted construction expenditure following its demolition under section 43-40 of the ITAA 1997.

Any deduction under section 43-40 of the ITAA 1997 is available in the income year in which the destruction occurs and is calculated under section 43-250 of the ITAA 1997.

Expenditure on demolishing existing structures is not an amount that can contribute to a deduction for capital works under section 43-10 of the ITAA 1997. This is because it is not construction expenditure (paragraph 43-70(2)(b) of the ITAA 1997). However, such expenditure is taken into account (by way of section 43-250 with paragraph 43-255(b) of the ITAA 1997) in calculating a deduction under section 43-40 of the ITAA 1997.

The amount deductible under section 43-40 of the ITAA 1997 is calculated using the method statement set out in section 43-250 of the ITAA 1997. Step 1 in section 43-250 provides that the balancing deduction amount is the undeducted construction expenditure for the destroyed capital works that exceeds the amounts you have received, or have a right to receive, for the destruction of the capital works.

Section 43-255 of the ITAA 1997 provides that the amounts you have received or have a right to receive for the destruction of the capital works include:

(a) an amount received under an insurance policy or otherwise for the destruction of the capital works, and

(b)  an amount received for disposing of any property that was included in your area, less any demolition expenditure incurred on the property.

An example of an amount received for disposing of any property may be salvage receipts. Thus, in calculating the balancing deduction under section 43-250 of the ITAA 1997, demolition expenditure acts to offset the lessening of the deduction that occurs because of the fact that an amount has been received for disposing of the destroyed capital works.

In this case, however, the demolition costs in respect of the Industrial site will be charged to the Company on a net basis and therefore the Company itself will not have receive any direct amounts for the destruction of the capital works or from disposing of any property salvaged from the demolition. On that basis in relation to step one in the method statement in section 43-250 the undeducted construction expenditure of the Company should not be reduced on account of receipts as there will be none. For the same reason demolition costs cannot be used as an offset under paragraph 43-255(b) of the ITAA 1997.

Question 3

CGT event C1 in section 104-20 of the ITAA 1997 happens if a CGT asset you own is lost or destroyed. The industrial site capital works are not a separate CGT asset because none of the balancing adjustment provisions in subsection 108-55(1) of the ITAA 1997 applied to them. However the note to subsection 104-20(1) of the ITAA 1997 makes it clear that CGT event C1 can apply to part of a CGT asset.

Taxation Determination TD 1999/79 confirms that CGT event C1 can happen on the voluntary destruction of an asset where for example, a taxpayer might demolish a building in the course of redeveloping a property.

Therefore, on the demolition of the Industrial site capital works CGT event C1 will happen.

Subsection 104-20(3) of the ITAA 1997 provides that you make a capital gain from CGT event C1 if the capital proceeds from the loss or destruction are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

Capital proceeds

the Company will not receive any capital proceeds on the demolition of the Industrial site capital works. Further, section 116-25 of the ITAA 1997 provides that the market value substitution rule does not apply to CGT event C1.

Cost base

As a CGT event has happened to only part of the Company's asset, the Company will be required to apportion the cost base or reduced cost base between the land and the industrial site capital works using the apportionment rules in subsections 112-30(2), (3) and (4) of the ITAA 1997. Because the taxpayer received no capital proceeds, the combined effect of these provisions is that no amount is apportioned to the cost base /reduced cost base of the industrial site capital works.

Subsection 112-30(5) of the ITAA 1997 is an exception to the application of these apportionment rules. It provides that an amount that forms part of the cost base or reduced cost base of an asset is not apportioned if, on the facts, that amount is 'wholly attributable' to the part to which the CGT event happened or to the remaining part. In this case no amount of the demolition costs is wholly attributable to the demolition of the industrial site capital works.

The capital proceeds from the demolition are nil and the cost base attributed to the industrial site capital works is nil.

The Company will not make a capital gain or capital loss from CGT event C1 in section 104-20 of the ITAA 1997 on the demolition of the Industrial site capital works.

Expenditure to increase or preserve value

Under section 110-25(5) of the ITAA 1997 the fourth element of the cost base of a CGT asset is capital expenditure the taxpayer incurred:

(a) the purpose or the expected effect of which is to increase or preserve the assets' value, or

(b) that relates to installing or removing the asset.

In some circumstances the demolition of some structure on land or the clearing or levelling of land could increase the value of the land within the meaning of section 110-25(5) of the ITAA 1997. It has been held, in some contexts at least, that the clearing of land may constitute an improvement to land (Dampier Mining Co Ltd v FC of T 81 ATC 4329 at p 4331).

In this case the Commissioner finds it reasonable to accept that the demolition of the capital works and equipment on the Industrial site are required to enable to land to be sold and therefore the expected effect of the demolition is taken to be to increase or preserve the value of the land within the meaning of section 110-25(5) of the ITAA 1997.

Therefore under section 110-25(5) of the ITAA 1997 the entire net demolition costs of the capital works should be included in the fourth element of the cost base or the reduced cost base of the land on which the industrial site capital works are located.