Edited version of your written advice

Authorisation Number: 1012938944384

Date of advice: 20 January 2016

Ruling

Subject: Income Tax ~ Decline in value calculation

Question 1

Is the expenditure that the entity will incur on drip irrigation systems, dam, gutters and condensation collectors expenditure on a water facility pursuant to section 40-520 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Can the entity claim a deduction equal to the decline in value for an income year for expenditure incurred on a water facility pursuant to section 40-515 of the ITAA 1997 which is calculated in accordance with section 40-540 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 20WW - 30 June 20XX

1 July 20XX - 30 June 20YY

The scheme commences on:

1 April 20XX

Relevant facts and circumstances

The entity acquired all assets, including land and assumed liabilities pertaining to a primary production business in Australia.

The entity is expanding its primary production activities. To date, the entity's construction and development project is not practically complete in accordance with the agreement with a relevant party.

The entity anticipates that in the beginning of 20YY calendar year and before 30 June 20YY, the practical completion of its construction and development project will be achieved. Consequently, the full amount of expenditure will incur in the period ending 30 June 20YY, after 12 May 20XX. The entity did not previously deduct this expenditure. There is no other entity that has deducted or can deduct this expenditure for any income year.

The entity will incur expenditure on surface drip irrigation systems, dam, gutters and condensation collectors.

Surface drip irrigation system

The drip irrigation is an irrigation method that saves water and fertilizer. The system is able to deliver a minimum amount of water by supplying just the right amount of water at the right frequency to ensure a maximum absorption by roots, hence ensuring water is conserved.

The drip irrigation system provides the mechanism for which water can be conveyed and used in a particular way such as water is delivered with minimum wastage but still meeting the demands of the plants.

Gutters

Gutters collect the rain water and connect the collected rain water through the system to the rain water storage dam. The gutters provide the means to collect rainwater for later use.

Water storage dams

Water storage dams comprise of large evaporation pond and rainwater dam. The rainwater dam collects water for later use in irrigation system.

Condensation collectors

The condensation collectors comprise of glass planes, collection gutters, collection down pipes, collection pipes and tanks. The water is cleaned from chemicals and pollutants through a variety of filters and re-used as required.

Relevant legislative provisions

Income Tax Assessment Act 1997 - paragraph 40-515(1)(a)

Income Tax Assessment Act 1997 - section 40-540

Income Tax Assessment Act 1997 - subsection 40-520(1)

Income Tax Assessment Act 1997 - subsection 40-525(1)

Income Tax Assessment Act 1997 - subsection 40-530(1)

Income Tax Assessment Act 1997 - subsection 40-555(1)

Income Tax Assessment Act 1997 - section 45-40

Income Tax Assessment Act 1997 - subsection 45-40(1)

Income Tax Assessment Act 1936 - section 75B

Reasons for decision

Summary

The expenditure that the entity will incur on drip irrigation systems, dam, gutters and condensation collectors is considered to be expenditure on a water facility pursuant to subsection 40-520(1) of the ITAA 1997.

Detailed reasoning

A 'water facility' is defined under subsection 40-520(1) of the ITAA 1997 as:

(a) ^*plant or a structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to plant or a structural improvement, that is primarily and principally for the purpose of conserving or conveying water; or

(b) a structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to a structural improvement, that is reasonably incidental to conserving or conveying water.

Example:

Examples of a water facility include a dam, tank, tank stand, bore, well, irrigation channel, pipe, pump, water tower and windmill. Examples of things reasonably incidental to conserving or conveying water include a culvert, a fence to prevent livestock entering an irrigation channel and a bridge over an irrigation channel.

Under subsection 45-40(1) of the ITAA 1997 'plant' is defined to include:

(a) articles, machinery, tools and rolling stock; and

(b)  …….; and

(c) fences, dams and other structural improvements, other than those used for domestic or residential purposes, on land that is used for agricultural or pastoral operations; ….

In Taxation Ruling No. IT 2394 Income tax: Expenditure on irrigation and water and land the meaning of 'plant or structural improvement' was discussed in relation to section 75B of the Income Tax Assessment Act 1936 (ITAA 1936) which is the predecessor to paragraph 40-520(1)(a) of the ITAA 1997. However, the test remains the same. In IT 2394 at paragraph 3, the term 'plant or a structural improvement' included a 'dam, earth, tank, underground tank, concrete tank, metal tank, stand for a tank, bore, well, irrigation channel or similar improvement, pipe, pump, water tower and windmill'.

The Explanatory Memorandum to Tax Laws Amendment (2004 Measures No. 6) Bill 2004 extended the meaning of a 'water facility' in subsection 40-520(1) of the ITAA 1997 by including a 'structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to a structural improvement that is reasonably incidental to conserving or conveying water'. The question of whether an item of capital expenditure is reasonably incidental to conserving or conveying water depends on the facts and circumstances. To clarify, examples were included in subsection 40-520(1). The examples of things listed as being reasonably incidental to conserving or conveying water included a culvert, a fence to prevent livestock entering an irrigation channel and a bridge over an irrigation channel.

Each of the stated items that the entity will incur expenditure on will be examined to determine whether they are a water facility pursuant to subsection 40-520(1) of the ITAA 1997.

Drip irrigation system

The drip irrigation system is used in the entity's primary production business and is an item of 'plant' as defined in section 45-40 of the ITAA 1997. It is also specifically provided as an example in subsection 40-520(1) of the ITAA 1997.

To determine whether the drip irrigation system is a water facility, the test in paragraph 40-520(1)(a) requires it to be primarily and principally for the purpose of conserving or conveying water.

Tax Determination TD 94/9 Income tax: whether a fruit grower is entitled to a tax deduction under section 75B or section 75D for the cost of changing to a different watering system which has a secondary purpose of preventing or combating land degradation? states that the test requires an examination of the primary and principal function or purpose of the result produced by incurring the expenditure. Although, TD 94/9 deals with former section 75B of the ITAA 1936, there have been no changes to the test.

The drip irrigation system is an irrigation method that saves water and fertiliser by allowing water to drip slowly directly onto the roots of plants. The system is able to deliver a minimum amount of water by supplying just the right amount of water at the right frequency to ensure a maximum absorption by roots, ensuring water is conserved.

It is considered that the primary and principal function of the drip irrigation system is to deliver water from the holding tanks and dam directly to the roots of the plants in an efficient way that minimises water wastage.

Therefore, the expenditure on the drip irrigation system is considered to be expenditure on a water facility under paragraph 40-520(1)(a) of the ITAA 1997 as it is primarily and principally to be used for the purpose of conserving or conveying water.

Water storage dam

The water storage dam is used in the entity's business of primary production and is an item of 'plant' as defined in section 45-40 of the ITAA 1997. A 'dam' is also specifically included as an example in subsection 40-520(1) of the ITAA 1997.

It is considered that the primary and principal function or purpose of the dam is to conserve water.

Therefore the expenditure on the water storage dam is considered to be expenditure on a water facility under paragraph 40-520(1)(a) of the ITAA 1997 as it is primarily and principally to be used for the purpose of conserving water.

Gutters

The gutters are used to collect run-off water from the roof of the glasshouse and delivers water through the system of drains and pipes. It is considered that the gutters are a 'plant or structural improvement' consistent with the examples provided in subsection 40-520(1) of the ITAA 1997.

It is considered that the primary or principal function or purpose of the gutters is to collect run-off water and direct it through the system of downpipes to the water storage tanks and dam. It is therefore evident that the gutters are to be used to conserve water for later use.

Consequently, the expenditure incurred on the gutters is considered to be expenditure on a water facility under paragraph 40-520(1)(a) of the ITAA 1997 as it is primarily and principally to be used for the purpose of conserving water.

Condensation collectors

The condensation collectors comprise of glass planes, and various collection pipes and tanks that are specifically designed and constructed to utilise condensation to collect water for re-use. The evaporated water is transformed from the vapour stage through condensation which is collected in special gutters built under the lowest connection point.

The condensed water is then delivered through a variety of pipes to condensed water holding tanks. The water is cleaned from chemicals and pollutants through filters and re-used in the irrigation system as required.

The expression 'reasonably incidental to' is discussed in ATO Interpretive Decision ATO ID 2009/32 Income Tax Capital Allowances: water facility- reasonably incidental to conserving or conveying water and examines its meaning according to case law. ATO ID 2009/32 states:

… in the view of the courts whether something is 'reasonably incidental to' another thing is a question of fact and degree. The use of the expression 'reasonably incidental to' suggests that the incidental thing must be reasonably capable of being seen as appropriate and adapted to achieving the purpose of, and to aid the function of, the other, and that the interaction between the two must be more than a general facilitation or minor effect. In other words, in the view of the courts, there must be a clear and generally accepted connection between the two things; and that this connection must be one of some substance, and not a general facilitation or minor effect of one on the other.

It is considered that the condensation collection system is primarily to be used to transform evaporated water so that it can be re-used in the irrigation system. It is clear there is a substantial connection between the condensation collectors and conserving and conveying water. The water collected through the condensation collectors is collected in condensed water holding tanks and later delivered through the irrigation system to convey and conserve water to be used in the entity's primary production business.

Therefore, it is considered that the condensation collectors and its components are reasonably incidental to conserving and conveying water pursuant to paragraph 40-520(1)(b) of the ITAA 1997.

Question 2

Summary

The entity can claim a deduction equal to the decline in value for an income year for expenditure incurred on a water facility pursuant to paragraph 40-515(1)(a) of the ITAA 1997, calculated in accordance with section 40-540 of the ITAA 1997.

Detailed reasoning

Paragraph 40-515(1)(a) of the ITAA 1997 allows a deduction for an income year equal to the decline in value of a primary production depreciating asset that is a water facility. Section 40-540 of the ITAA 1997 states the deduction for the decline in value of a water facility is worked out for the income year in which the expenditure is incurred and is the amount of capital expenditure on the construction, manufacture, installation or acquisition of the water facility. The deduction is only available if the asset has started to decline in value as specified in subsection 40-530(1) which states:

A *water facility, *fodder storage asset or *fencing asset starts to decline in value in the income year in which you first incur expenditure on the facility or asset.

The Explanatory Memorandum to Tax Laws Amendment (Small Business Measures No.2) Bill 2015 (EM to TLA-SB Measures 2 Bill 2015) provides an explanation for the recent measures announced by the government with respect to section 40-540 of the ITAA 1997 which allows primary producers to claim an immediate deduction for capital expenditure on water facilities. The EM to TLA-SB Measures 2 Bill 2015 states the following:

Water facilities

2.27 Primary producers and irrigation water providers will be able to deduct expenditure on water facilities immediately in the year in which the expenditure is incurred.

2.28 Previously, primary producers and irrigation water providers could deduct capital expenditure on water facilities over three years.

2.29 Water facility is already defined in section 40-520, and means:

• plant or a structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to plant or a structural improvement, that is primarily or principally for the purpose of conserving or conveying water; or

• a structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to a structural improvement, that is reasonably incidental to conserving or conveying water.

2.30 Immediate deduction of expenditure is achieved by providing that a water facility is taken to decline in value by the full amount of the expenditure incurred. The decline in value starts in the income year in which the expenditure is first incurred, allowing full deduction of the expenditure in that income year.

The EM to TLA-SB Measures 2 Bill 2015 also states that this measure applies to assets that an entity starts to hold, or to expenditure an entity incurs, at or after 7.30pm, by legal time in the relevant state, on 12 May 20XX.

However, in order to claim a deduction for the decline in value of a water facility, the conditions in subsection 40-525(1) of the ITAA 1997 must be satisfied:

The capital expenditure you incurred on the construction, manufacture, installation or acquisition of the water facility must have been incurred:

(a) primarily and principally for the purpose of conserving or conveying water for use in a primary production business that you conduct on land in Australia; or

(b) ...

In addition, subsection 40-555(1) of the ITAA 1997 states:

You cannot deduct an amount for any income year for capital expenditure on the acquisition of a ^*water facility if any entity has deducted or can deduct an amount under this Subdivision for any income year for earlier capital expenditure on:

(a) the construction or manufacture of the facility; or

(b) a previous acquisition of the facility.

In this regard, the EM to TLA-SB Measures 2 Bill 2015 provides the following explanation:

2.32 Under the existing provisions, expenditure cannot be deducted for the acquisition of a water facility if any person has deducted or can deduct an amount under Subdivision 40-F for any income year for earlier capital expenditure on the construction or manufacture of the facility or a previous acquisition of the facility.

2.33 These amendments extend this condition to prevent deductions for the acquisition of a water facility if any entity has deducted, or can deduct, an amount under Subdivision 40-F for any income year for earlier capital expenditure on the construction or maintenance of the facility or a previous acquisition of the facility. This will ensure the provision operates as intended.

The entity is wholly in the business of primary production. As discussed earlier, the expenditure that will be incurred on the drip irrigation system is considered to be expenditure on a water facility according to subsection 40-520(1) of the ITAA 1997.

It is considered that paragraph 40-525(1)(a) of the ITAA 1997 will be satisfied, as the water facility will be primarily and principally used for the purpose of conserving or conveying water for use in the primary production business on land in Australia.

The entity did not previously deduct this expenditure and there is no other entity that has deducted or can deduct this expenditure for any income year, satisfying subsection 40-555(1) of the ITAA 1997.

As specified by subsection 40-530(1) of the ITAA 1997 the decline in value starts in the income year in which the expenditure is first incurred by the entity allowing a full deduction of the expenditure in that income year.

Consequently, a deduction equal to the decline in value of the water facility, calculated in accordance with section 40-540 of the ITAA 1997 is available to the entity under paragraph 40-515(1)(a) of the ITAA 1997.