Edited version of your written advice

Authorisation Number: 1012973736735

Date of advice: 21 April 2016

Ruling

Subject: Whether works done constitute repairs

Question 1

Is the entity entitled to a repairs deduction under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) for the works undertaken?

Answer:

No.

Question 2

Is the entity entitled to a capital works deduction for the works undertaken?

Answer:

Yes.

This ruling applies for the following period:

Year ended 30 June 2015

The scheme commenced on:

1 July 2014

Relevant facts

The entity owns an asset situated on land.

The entity purchased the property with the asset several years ago.

Prior to this the asset had been used for many decades while it was owned by the previous owner.

Works have been undertaken to the asset due to ongoing issues with the asset.

The issues were not immediately apparent when the entity acquired the asset.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10.

Income Tax Assessment Act 1997 Subsection 25-10(3).

Income Tax Assessment Act 1997 Section 43-10.

Income Tax Assessment Act 1997 Subsection 43-20(2)

Income Tax Assessment Act 1997 Subsection 43-20(3)

Income Tax Assessment Act 1997 Section 43-70 .

Reasons for decision

Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to property used for income producing purposes. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature.

Taxation Ruling TR 97/23 deals with the issue of deductions for repairs. The term 'repairs', is not defined in section 25-10 of the ITAA 1997. Therefore, it is necessary to look at its ordinary meaning. Paragraph 13 of TR 97/23 states the following:

The word repair has its ordinary meaning. It 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.

At paragraph 44, TR 97/23 goes on to state:

In the case of a repair, broadly speaking, 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 - usually in some existing function.

Substantial improvements, additions, alterations, and modernisations are not repairs; rather they are items of capital expenditure. Some of the factors pointing to an improvement rather than a repair are whether: there is greater efficiency of function of the property; there is an increase in its value; or the expenditure reduces the likelihood of future repairs. The first of these factors is the most important; in fact TR 97/23 states at paragraph 45 that it 'is the determinative test'.

A leading case on whether expenditure is a repair or capital in nature is Federal Commissioner of Taxation v. Western Suburbs Cinemas Ltd (1952) 86 CLR 102; (1952) 9 ATD 452 (the Western Suburbs Cinemas case) where the High Court concluded that a new ceiling was an improvement to a fixed capital asset being the cinema and that its cost was a capital expense. Kitto J said at 86 CLR 105; 9 ATD 454:

To decide whether a particular item of expenditure on business premises ought to be charged to capital or revenue account is apt to be a matter of difficulty, though the difference between the two accounts is clear enough as a matter of general statement (Sun Newspapers Ltd v. Federal Commissioner of Taxation). In this case, the work done consisted of the replacement of the entire ceiling, a major and important part of the structure of the theatre, with a new and better ceiling. The operation seems to me different, not only in degree, but in kind, from the type of repairs which are properly allowed for in the working expenses of a theatre business. It did much more than meet a need for restoration; it provided a ceiling having considerable advantages over the old one, including the advantage that it reduced the likelihood of repair bills in the future ... . The truth is, I think, that the new ceiling was an improvement to a fixed capital asset and that its cost was a capital charge.

Where property has a defect or issue at the time of acquisition, works done that remedy or alleviate that issue, are capital in nature as the works have improved the property from its condition when it was acquired. This is the case even if the taxpayer was unaware of the issue at the time of acquisition (paragraphs 61 and 128 of TR 97/23 and W Thomas and Co Pty Ltd v. FC of T (1965) 115 CLR 58 (1965) 14 ATD 78)).

Application of the above to the entity's situation

The amount spent on the works is substantial especially in comparison to the market value of the entire property. However, it is noted that the works have not increased the market value of the property as it is unlikely that the property could be sold for the purpose that the asset on the property is used in relation to; the property's value on the market only lies in the land.

Although the property was purchased some time ago and the issues with the asset were not immediately apparent at that time, the information supplied indicates that the issues existed when the asset was acquired rather than being caused by use since acquisition.

The works undertaken have removed the issues that had been causing problems. As the issues existed at the time of acquisition, the works have done significantly more than simply return the asset to the condition it was in when it was acquired. There has been a substantial increase in the efficiency of function of the asset as the issues have now been removed.

Therefore, the works are considered to represent an improvement and are capital in nature. Consequently, a repairs deduction under section 8-1 of the ITAA 1997 is not allowable.

Capital works

Division 43 of the ITAA 1997 provides an income tax deduction for capital works attributable to a construction expenditure area that is owned or leased by the taxpayer and used during the income year for the purposes of producing assessable income.

Construction expenditure is capital expenditure incurred in respect of the construction of capital works (section 43-70 of the ITAA 1997).

Capital works include structural improvements, such as sealed roads, driveways, car parks, and airport runways begun after 26 February 1992 and earthworks that are integral to the construction of a structural improvement (subsections 43-20(2) and 43-20(3) of the ITAA 1997).

The works undertaken by the entity qualify as capital works and therefore a deduction is allowed under Division 43 of the ITAA 1997 for the construction expenditure. The deduction will be 2.5% of the construction expenditure over 40 years.