Edited version of your written advice

Authorisation Number: 1051408123663

Date of advice: 14 August 2018

Ruling

Subject: Deductions for repairs

Question

Will the expenses incurred by the trustee of the ABC Trust be an allowable deduction under section 25-10 of the Income Tax Assessment Act 1997 for the year ended 30 June 2017?

Answer

Yes

This ruling applies for the following period:

30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

You have provided the following details in relation to the Property. Further information provided via emails forms part of this ruling.

ABC Pty Ltd (Trustee) as trustee for the ABC Trust owns the property in State AA.

The Property has been used as a short term rental accommodation to the public for over twenty years.

The Property is heritage listed under various State AA legislations. Heritage properties in State AA are exempted from the requirement to seek approval for maintenance, cleaning, repairs, painting restoration and undertake minor activities with minimal impact on heritage significance.

The Property was in a state of disrepair due to its age and its location on the main through fare.

The Trustee engaged CP Pty Ltd to carry out remedial works on the Property. The works commenced on xx July 2016 and ended on xx June 2017.

The following remedial works were carried out to remedy the defects, damage and deterioration to the Property.

● Treatment and removal of lead paint

Damaged, blistered and delaminated lead paint on the entire building façade (including windows bars and fence) was removed or treated.

● Concrete spalling repairs

Spalling repairs were carried out on cracked concrete elements.

● Façade repairs

Cracked and unsealed joints on the building façade were repaired to rout out all cracks and junctions between dissimilar materials to seal them.

● Render repairs and fairing coating

Cracked drummy external render on the building facade was repaired where the concrete was stained, corroded and damaged. The façade fixtures and fittings were removed to repair the damaged render, remove spot corrosion and applied new render to the repaired areas to match adjacent finish and subsequently applied facade coating to the entire property. Subsequent to the repairs, the fixtures and fittings were reattached to the building.

● Façade column repairs

Façade columns repairs carried out encompassed the same process as above.

● Façade coating

The building façade including masonry elements of the front fence and stairs required repair due to water damage and wear and tear. Repairs included pressure cleaning, application of epoxy sealers, low build acrylic waterproof coatings, oil seal undercoats and painting.

● Paint to iron fence and security grills

The iron fencing and security grills were corroded. They were repaired by removing the existing surface corrosion and application of new protective coating. The protective coating includes Dulux Durabuild and Dulux Weathermax which prevent future damage.

● Water proofing repairs

Interim waterproofing works were carried out to limit water ingress into the lower rooms until major waterproofing works could be carried out. The work involved diagnostic testing to identify leak locations, removal of tiles in the surrounding area, cleaning and sealing the area between the junction and walls and retiling the area to match the existing finish.

● Door jamb replacements

All corroded room entry and bathroom jambs were replaced. The work involved removal of corroded jambs, painting with white base coat and installing water proof sealant between existing tiles and new doorjambs.

● Installation of new door seals

Existing door seals on external doors on the Property were removed and replaced with new seals to prevent water ingress.

● Water ingress

Walls in a room were water damaged. The work involved mould treatment, removal of tiles, installation of a water stop waterproof membrane and vapour barrier then retiling and painting the room.

● Structural repairs to balconies

Damaged and deteriorated timber decks on the balconies were replaced and reinforced with new bolts.

● General internal repairs

Render angles that were corroded were repaired and replaced with new cementitious render and then painted to match the adjacent surface finish.

You have stated that some elements of the remedial works, for example, the use of modern buildings materials represented a minor and incidental degree of improvement; nevertheless the expenses incurred were attributable to repairs as the work restored the previous efficiency of function of the property without changing its character.

Accordingly the expenses should be an allowable deduction under section 25-10 of the ITAA 1997.

Relevant legislative provisions

Section 25-10 ITAA 1997

Summary

Section 25-10 of the 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 Income tax: deductions for repairs, 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:

1. the works result in a greater efficiency of function in the property, therefore representing an improvement rather than a repair; or

2. the extent of the work carried out represents a renewal or reconstruction of the entirety, or

3. the work is an initial repair.

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.

What is a 'repair' for the purposes of section 25-10 is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property and its functional efficiency when the expenditure is incurred (per Buckley LJ in Lurcott v. Wakely & Wheeler [1911] 1 KB 905 at 924) and to the nature and extent of the work done. 'Repair' may involve renewal or replacement of subsidiary parts to some degree and may involve improvement but only to a minor and incidental extent.

The High Court of Australia (Windeyer J) said in W Thomas & Co Pty Ltd v. FC of T (1965) 115 CLR 58 at 72; (1965) 14 ATD 78 at 87:

'The words "repair" and "improvement" may for some purposes connote contrasting concepts; but obviously repairing a thing improves the condition it was in immediately before repair. It may sometimes be convenient for some purposes to contrast a "repair" with a "replacement" or a "renewal". But repairs to a whole are often made by the replacement of worn-out parts by new parts. Repair involves a restoration of a thing to a condition it formerly had without changing its character. But in the case of a thing considered from the point of view of its use as distinct from its appearance, it is restoration of efficiency of function rather than exact repetition of form or material that is significant. Whether or not work done upon a thing is aptly described as a repair of that thing is thus a question of fact and degree.' (emphasis added)

To repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. (para 16)

Maintenance, as generally understood, includes the prevention of defects, damage or deterioration; a common example is the regular re-painting of business premises. The word 'maintenance' may in some contexts be the same as 'repair', and it may in some contexts have a wider meaning that includes repairing as well as other operations..

In Day v. Harland and Wolff [1953] 2 All ER 387 Pearson J observed at 388:

'So, very broadly speaking, I think that to repair is to remedy defects, but it can also properly include an element of the "stitch in time which saves nine". Work does not cease to be repair work because it is done to a large extent in anticipation of forthcoming defects or in rectification of merely incipient defects, rather than the rectification of defects which have already become serious. Some element of anticipation is included.' (emphasis added)

Repairs may include some maintenance work but only if it is done in conjunction with work that is a repair. Repairs may not involve only maintenance work.

Some kinds of maintenance work are 'repairs' in terms of section 25-10, for example, painting plant or business premises to rectify existing deterioration and to prevent further deterioration (para 20)

If work done to property goes beyond what is a 'repair' in terms of section 25-10, any expenditure for the work is not deductible. The work may go beyond 'repairs' in terms of the section if it(para 22)

(a) changes the character of the property; or

(b) does more than restore its efficiency of function.

It is possible, for instance, that the replacement of a subsidiary part of property with a part better in some ways than the original is a repair to the property without the work being an improvement to the property.

In many a repair process, there is some improvement made to property as a result of technological advancements or more modern materials and component parts becoming available. The extent of this improvement is crucial in making a judgment about the deductibility of repair expenditure under section 25-10.

An important question in distinguishing between a repair and an improvement is whether expenditure incurred in replacing or renewing a part of property with a material of a different type from the original is a repair of the property or an improvement to it.

Whether the use of a more modern material to replace the original material qualifies as a repair is a question determined on the facts of each case. It is restoration of a thing's efficiency of function (without changing its character) rather than exact repetition of form or material that is significant.

If the work done restores a previous function to the property, or restores the efficiency of the previous function, it does not matter that a different material is used. Even if the work done using different material enables the property to perform its function marginally more efficiently, the work may still constitute a deductible repair provided that the work does not enhance the efficient functioning of the property, which constitutes an improvement.

If, however:

(a) the work done to property involves:

(i) a degree of technological advancement that results in only a minor and incidental improvement to the property; or

(ii) an enhancement arising from the use of more modern materials and component parts (often where original materials and parts are no longer available) that adds in only a minor and incidental way to the overall efficiency of function of the property; and

(b) the work done does not change the property's character;

this does not in itself preclude the expenditure from being characterised as repair expenditure deductible under section 25-10.

If, only minor and incidental improvement is made to the overall efficiency of function of property or due to the use of more modern materials and component parts in the work done to the property, the repair expenditure remains deductible under section 25-10.(para 107)

In your circumstances, there was significant wear and tear to the Property due to the passage of time and age of the Property.

In the remedial works that involved the removal of the old paint, concrete spalling repairs, façade repairs, façade column repairs, door jamb replacements, installation of new door seals, general internal repairs and painting were done to rectify the damage and deterioration to the Property and ultimately restored the efficiency of function without changing its character.

In case of the other remedial works, such as render repairs, façade coatings, painting to the external façade and accompanying fencing/grills, waterproofing repairs and balcony repairs, modern material and parts were used.

The use of modern materials such as epoxy sealers, low build acrylic waterproof coating, oil sealer undercoats gloss and paint parts represents a minor and incidental improvement in the overall efficiency of the function of the property.

Their use remedied the defects and also addressed the prevention of forthcoming defects or deterioration. As determined in BP Oil Refinery (Bulwer Island) Ltd case at 92 ATC 4039; 23 ATR 73 work done in anticipation of forthcoming defects or deterioration can be considered a 'repair' if it is done in combination with work of rectification.

The works carried out involved making good the damage and deterioration in the Property.

Additionally there was no renewal or reconstruction of the entirety, that is, all the works carried out would be considered as replacements or repairs of the subsidiary parts of the entirety- the entirety is the Property.

Accordingly, the expenses qualify as repairs under section 25-10.