Edited version of your written advice

Authorisation Number: 1051317504330

Date of advice: 9 January 2018

Ruling

Subject: Deductibility of work undertaken to a charter vessel

Question

Are you entitled to a deduction under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) for the expenses incurred in June and July 20XX relating to the replacement of engines and other work on your charter vessel?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 April 20XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

On 20XX you commenced a charter vessel business.

You purchased the vessel for $XXXX, to conduct charter cruises.

The vessel was purchased with two engines.

Between 20XX and 20XX you completed approximately XXXX charters.

The engines had become run down over time. During your first year of operation you began to encounter numerous mechanical issues.

In 20XX you replaced the engines with two new engines. Each engine cost $XXXX (or $XXXX for the pair).

You also incurred significant costs having the following additional work completed to support the new engines.

You considered the lower maintenance and fuel costs as well as the performance differences when determining which size engines to purchase, as well as the cost difference between the two models.

The total cost to replace the engines and the additional work was $XXXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Reasons for decision

Detailed reasoning

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. 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 discusses the circumstances in which expenditure incurred for repairs may or may not be an allowable deduction under section 25-10 of the ITAA 1997.

The word 'repair' is not defined within the taxation legislation. Accordingly, it takes its ordinary meaning. Works can fairly be 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 (paragraph 15 of TR 97/23).

While some works may be fairly described as repairs, the expenditure will be considered capital in nature in some situations, and therefore not deductible under section 25-10 of the ITAA 1997. Expenditure incurred for repairs to property used for income producing purposes is of a capital nature where the works result in a greater efficiency of function in the property, therefore representing an improvement rather than a repair.

An improvement

An 'improvement' involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. Some factors that point to work done to property being an improvement include whether the work will extend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life.

Paragraph 16 of TR 97/23 provides that 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.

Paragraph 18 of TR 97/23 provides that there is a need for exercise of judgment and that there can be sound commercial and other reasons for doing work on property to improve its appearance, condition or functional efficiency. The Commissioner’s view is that the question is necessarily one of fact and degree and requires a careful weighing of the various factors and exercising judgement in the light of decided case law and practical common experience.

Paragraphs 45 - 47 of TR 97/23 provide that to distinguish between what is a repair and what is an improvement to property, one must consider the effect that the work done on the property has to its efficiency of function. If the work entails the replacement or restoration of some defective part of the whole, one does not focus on the effect on the efficiency of that part, but on the whole. Replacement or substantial reconstruction of the entirety, as distinct from the subsidiary parts of the whole, is an improvement.

Application to your circumstances

The Commissioner considers that while it made commercial sense to have the additional work completed while the engines were being replaced, that this amounts to a substantial reconstruction of the entirety of the vessel. In this regard the expenditure incurred is of a capital nature and not immediately deductible under section 25-10 of the ITAA 1997 as a repair. You also took into consideration the greater efficiency of function and lower maintenance and fuel costs when deciding to purchase the larger engines to install in the vessel. The overall efficiency of the vessel has been improved, rather than repaired through the installation of larger engines, as it will require less maintenance in the future.