Edited version of your written advice

Authorisation Number: 1013061398024

Date of advice: 1 August 2016

Ruling

Subject: Deductibility of replacing outdoor tiling

Question 1

Is the cost of replacing tiling surrounding the outside of your commercial property deductible as repairs and maintenance?

Answer

No

Question 2

Is the cost of replacing the tiling surrounding the outside of your commercial property expenditure which is eligible for an annual write-off deduction under the capital works provisions?

Answer

Yes

This ruling applies for the following period:

30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

You have owned a commercial property for more than 20 years.

The property is divided into a number of leases which have been continuously rented to tenants or available for rental during the period of ownership.

The tiles on the ground surrounding the outside of the building became worn and cracked. You advised they constituted a hazard and detracted from the look of the property. You advised the location of the property means it is important to maintain a good presentation to attract customers to justify the rents paid by your tenants.

After repairing the tiles over several years you decided it was going to be more economical to completely replace the existing tiles rather than repair an increasing number of broken tiles each year.

You obtained a quote for the works required to replace the tiles. The tiles were replaced and paid for in full by the end of the applicable financial year.

You own the area of property you retiled.

The original tiles used were unavailable. You have stated that the new tiles did not increase the functionality of the existing tiles.

You did not receive an insurance payment to contribute to the cost of replacing the tiles.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Division 43

Reasons for decision

Question 1

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. However there are also provisions in the income tax law which deal with specific deductions, including repairs and capital works (section 25-10 and Division 43 of the ITAA 1997).

Section 25-10 of the ITAA 1997 states that expenditure incurred by you for repairs to any premises, or part of premises, plant, machinery, tools or articles held or used by you solely for the purpose of producing assessable income is an allowable deduction. However, a deduction is not allowable if the expenditure is of a capital nature, for example, an improvement.

The term 'repairs' is not defined in section 25-10 of the ITAA 1997. Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23) provides the Tax Office's view on expenditure that is allowable under section 25-10 of the ITAA 1997.

Paragraph 13 of Taxation Ruling TR 97/23 states the following: 

The word 'repairs' 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.

Paragraph 15 says that:

A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. Works can be fairly described as 'repairs' if they are done to make good damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes (whether expected or unexpected) during the passage of time.

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.

Consequently, what is considered to be a repair for the purposes of section 25-10 is determined by the facts of each case.

In your case the works to replace the outdoor tiled area was not an initial repair as the works completed were due to wear and tear sustained over a period of time and the outdoor tiling was not in that state at the time of acquisition. The works also were not an improvement as they were simply done to restore the normal function and the change of tile with a modern replacement did not improve the area substantially.

We have considered your circumstances in detail (below) in terms of the replacement of the outdoor tiles being the renewal or reconstruction of the entirety.

Replacement of a subsidiary part or an entirety

In Lindsay v. Federal Commissioner of Taxation (1960-1961) 106 CLR 377; (1960) 12 ATD 197; (1961) 12 ATD 505; (1960) 8 AITR 99; (1961) 8 AITR 458; it was held that expenditure incurred to renew a slipway was a renewal of an entirety and was not deductible as a repair under section 53 of the Income Tax Assessment Act 1936 (which was rewritten as section 25-10 of the ITAA 1997). This conclusion was drawn on the basis that the slipway was considered to be a separately identifiable capital item, maintaining its own function. Substantially the whole of the old slipway had been demolished and replaced by a new slipway, comprising all new components and was a renewal of a separately identifiable item and not a repair.

Determining what is the entirety is a question of fact in each case. According to TR 97/23, property is more likely to be an entirety if:

(a) the property is separately identifiable as a principal item of capital equipment; or

(b) the thing or structure is an integral part, but only a part, of entire premises and is capable of providing a useful function without regard to any other part of the premises; or

(c) the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves; or

(d) the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law (paragraph 38 of TR 97/23).

Property is more likely to be a subsidiary part rather than an entirety if:

(a) it is an integral part of some larger item of plant; or

(b) the property is physically, commercially and functionally an inseparable part of something else (paragraph 39 of TR 97/23).

In your case the tiled outside area that was completely retiled is considered to be a separately identifiable capital item, maintaining its own function and is therefore not a repair.

As the replacement of an entirety is capital in nature, it is not deductible under section 25-10 of the ITAA 1997. Also, a deduction is not available under section 8-1 of the ITAA 1997 (the general deduction provision) as this provision also excludes expenses of a capital nature.

Question 2

Capital works deduction

Division 43 of the ITAA 1997 allows a deduction for capital expenditure incurred in constructing capital works, including buildings and structural improvements that are used for income producing purposes.

The deduction is available on the cost of constructing structural improvements or extensions, alterations or improvements to structural improvements if construction started after 26 February 1992.

In your case, the works done to replace the outdoor tiling surrounding your commercial property have been classified as capital in nature and are considered to be capital works for the purposes of Division 43 of the ITAA 1997.

The amount you can deduct is a portion of your construction expenditure. In the case of structural improvements begun after 26 February 1992 the rate of deduction is 2.5%. In your case, the construction expenditure in relation to the new outdoor tiling may be written off over a 40 year period, at a rate of 2.5% per year.  

However, it should be noted that the write-off deduction is allowable only for the period your property is rented or is available for rent. It should also be noted that you cannot deduct an amount for any period before the completion of construction of the capital works.

Cost base adjustments for capital works deductions

In working out a capital gain from a rental property, you may need to reduce the cost base of the property to the extent that it includes construction expenditure for which you claimed, or were entitled to claim, a capital works deduction.