Edited version of private advice

Authorisation Number: 1051526149714

Date of advice: 12 June 2019

Ruling

Subject: Tax Treatment of building plans (not proceeded with)

Question 1

Is the Entity entitled to claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for amounts expended on plans for an extension to a retail store, as detailed in the circumstances describing the scheme?

Answer

No.

Question 2

Is the Entity entitled to claim a deduction under section 40-25 of the ITAA 1997 for amounts expended on plans for an extension to a retail store, as detailed in the circumstances describing the scheme?

Answer

No.

Question 3

Is the Entity entitled to claim a deduction under section 43-10 of the ITAA 1997 for amounts expended on plans for an extension to a retail store, as detailed in the circumstances describing the scheme?

Answer

No.

Question 4

Are the amounts expended on plans for an extension to a retail store, as detailed in in the circumstances describing the scheme, included in the calculation of the cost base of the retail store under section 110-25 of the ITAA 1997?

Answer

Yes.

Question 5

Is the Entity entitled to claim a deduction under section 40-880 of the ITAA 1997 for amounts expended on plans for an extension to a retail store, as detailed in the circumstances describing the scheme?

Answer

No.

This ruling applies for the following period:

1 July 20xx to 30 June 20zz

Relevant facts and circumstances

The Entity owns several commercial rental properties in a shopping complex. During the income year ended 30 June xx, the Entity spent $xxx on plans to do a major extension to one of the retail stores. The store was to be extended by several hundred square metres.

The majority of this expenditure was paid to a building firm. Payments totalling $yyy which was paid to this building firm included payments for survey fees, architect fees, consultant fees and certain building reports and fees. The remaining amount was paid to another firm for consultant's fees.

The intention of the store extension, for which plans were drawn up for, was to increase the future lease income from its current tenant.

Due to the decline in the retail sector, and increased competition from other retail stores a decision was made during the income year ended 30 June 20zz to not undertake the extension of the retail store, notwithstanding that $xxx had been spent drawing up the plans.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 8-1(2)

Income Tax Assessment Act 1997 subsection 40-25

Income Tax Assessment Act 1997 subsection 40-30

Income Tax Assessment Act 1997 subsection 40-30 (1)

Income Tax Assessment Act 1997 subsection 40-30 (2)

Income Tax Assessment Act 1997 subdivision 40-B

Income Tax Assessment Act 1997 subdivision 40-D

Income Tax Assessment Act 1997 section 40-880

Income Tax Assessment Act 1997 paragraph 40-800(5)(f)

Income Tax Assessment Act 1997 section 43-10

Income Tax Assessment Act 1997 paragraph 43-10(2)(c)

Income Tax Assessment Act 1997 subsection 43-70(1)

Income Tax Assessment Act 1997 subsection 43-75(6)

Income Tax Assessment Act 1997 subsection 108-5

Income Tax Assessment Act 1997 section 108-55

Income Tax Assessment Act 1997 section 108-70

Income Tax Assessment Act 1997 subdivision 108-D

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 subsection 110-25(5)

Reasons for decision

All future legislative references contained in this document are references to the Income Tax Assessment Act 1997.

Question 1

Section 8-1 provides that a loss or an outgoing is an allowable deduction if it is incurred in producing assessable income or in carrying on a *business for the production of assessable income except where the outgoings are of a capital, private or domestic nature, or relate the earning of exempt income.

Capital expenses

Under subsection 8-1(2), expenses of a capital, or of a capital nature are excluded from a deduction under section 8-1.

An expense will usually be capital in nature where it is incurred with the intention to create an asset or advantage of a lasting and enduring nature (British Insulated & Helsby Cables Ltd v. Atherton (1926) AC 205; (1926) 10 TC 155).

In Sun Newspapers Ltd and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 23; (1938) 1 AITR 403 (Sun Newspapers), the taxpayer was denied a deduction for an amount paid to prevent a rival publisher from producing a newspaper in the area for a period of three years. The expenditure was held to be capital in nature.

In this regard, Dixon J in Sun Newpapers said at pp 359 to 360:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity structure or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss...As general conceptions it may not be difficult to distinguish between the profit yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue.

Dixon J at p 363 outlined three matters to consider when making the distinction between capital and revenue:

(a) The character of the advantage sought, and in this its lasting qualities may play a part;

(b) The manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part; and

(c) The means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

The authorities have also indicated that the character of expenditure is not determined by whether it succeeded or failed in its object. As a matter of principle, expenditure which, if successful, would produce a capital asset or an asset or advantage of an enduring nature, and which is of a capital nature, is equally a capital expenditure if it is unsuccessful (Southwell v Savill Brothers Ltd (1901) 4 TC 430; Foley Brothers Pty Ltd v FC of T (1965) 13 ATD 562).

Likewise, in Case J50 77 ATC 440 a taxpayer's claim for a deduction for architect's fees for a construction project i.e a parking station was disallowed. The project did not proceed as the taxpayer's land was resumed by a state government.

The Board of Review found that the expenditure was an outgoing of a capital nature as it was clearly incurred in establishing the 'profit yielding subject' (Sun Newpapers). The fact that the taxpayer did not obtain any benefit because the project did not succeed did not determine its deductibility. The object of the expenditure was part of a plan designed to bring into existence a parking station which represented an enduring benefit to the taxpayer.

In the present circumstances, the character of the advantage sought by the Entity in incurring the planning expenses was that as part and parcel of constructing the store extension, it would enable the Entity to generate additional income from leasing the store. As the Entity is in the business of leasing commercial properties, it is considered that this expenditure was directed to enlarging or improving the Entity's profit-yielding structure.

Further, it is considered that the Entity would also secure benefits which are long lasting or enduring in the form of increased lease payments from its tenant. The payments made for the planning expenses are not recurrent expenses and were made 'once and for all' to secure future use or enjoyment.

The fact that the construction of the store extension did not ultimately proceed would not change the nature of the planning expense as a capital expense.

Consequently, it is considered that the planning expense payments are of capital nature. Accordingly, subsection 8-1(2) will operate to deny the Entity a deduction for the planning costs under section 8-1.

Question 2

Under Subdivision 40-B, a taxpayer is entitled to a deduction for the decline in value of a depreciating asset that the taxpayer held during the particular year - see section 40-25.

A 'depreciating asset' is defined in subsection 40-30(1) as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is in use.

Generally, the effective life of a depreciating asset is how long it can be used by any entity to produce assessable income, exempt income or non-assessable non-exempt income.

Certain assets are excluded from being depreciating assets for the purposes of ITAA 1997, and include land, items of trading stock and intangible assets unless they are specifically mentioned in the legislation in subsection 40-30(2).

Assets specifically mentioned in subsection 40-30(2) which are treated as depreciating assets, include software and certain items of intellectually property. The items of intellectual property are rights that an entity has under a Commonwealth law as the owner, or licensee of a copyright or registered design or as the patentee or licensee of a patent (see section 995-1).

The word 'asset' in the definition of the term 'depreciating asset' is not defined in the income tax provisions. Guidance about the meaning of the word 'asset' for the purposes of Division 40 is provided in Taxation Ruling TR 2012/7 Income tax: capital allowances: treatment of open pit mine site improvements

In TR 2012/7 the Commissioner states that in the context of Division 40, an 'asset' is considered something that is capable of being put to use in the taxpayer's business.

In the present circumstances, it is considered that the plans drawn up for the store extension are not a 'depreciating asset' within the meaning of that term under section 40-30.

In this regard, the building plans were one of the components of developing the store extension. They are integral and cannot be separated from the development of the store extension (which has since been abandoned). They represent no value or use to the Entity in carrying on its business of leasing commercial properties. As such, the plans are not an 'asset'' for the purposes of Division 40 as they are not something that can be put to use by the Entity in the conduct of its leasing business.

Additionally, the building plans drawn up do not have a 'limited effective life' within the meaning of that term i.e they do not have a finite life in which they are used to produce income for the Entity.

Consequently, as the plans do not qualify as a depreciating asset under section 40-30, no deduction is allowable under section 40-25 for the amounts expended by the Entity.

Question 3

Section 43-10 of the ITAA 1997 provides that a taxpayer can only claim a capital works deduction if:

(a) the capital works have a construction expenditure area

(b) there is a pool of construction expenditure for that area, and

(c) the taxpayer uses the area in the income year in the way set out in the table in section 43-140 of the ITAA 1997. Broadly, this requires the area to be used to produce assessable income.

The term 'capital works' includes buildings and structural improvements and also extensions, alterations or improvements to buildings and structural improvements (see section 43-20).

To be eligible for a deduction under section 43-10 there is a requirement that there be a 'construction expenditure area' in relation to those capital works. For works that commenced after 1 July 1997, the 'construction expenditure area' is the part of the capital works on which 'construction expenditure' was incurred.

When an entity undertakes to construct new capital works, then a separate construction expenditure area is created in respect of those capital works (subsection 43-75(6)). The example in subsection 43-75(6) illustrates this principle. In that example the original construction of the building, a subsequent extension to the building and a later renovation of the entire building (i.e the original building, extension and renovation) gives rise to three separate construction expenditure areas.

'Construction expenditure' is broadly defined as capital expenditure incurred on the construction of capital works (subsection 43-70(1)). It includes preliminary expenses such as architect fees, engineering fees, foundation excavation expenses and costs of building permits (see paragraph 9 of Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements).

A taxpayer is required to have completed the construction of the capital works before claiming a deduction under Division 43. Under section 43-30 a taxpayer is denied a deduction for capital works until construction of the capital works is completed. This is notwithstanding that a taxpayer may use the capital works or part of them before completion.

In this case, the Entity has expended amounts for plans for an extension to the store including payments for architect and consultant fees, licences, and surveyor fees. In light of the views expressed in TR 97/25 about preliminary expenditure, these amounts would qualify as construction expenditure for the purpose of Division 43.

The construction of an extension to the store building meets the definition of 'capital works' under subsection 43-20. Further, the store extension is considered to be a 'construction expenditure area' in its own right for the purposes of section 43-10. Under section 43-75(6), the store extension is treated as a separate construction expenditure area to that of the original store.

However, as the Entity has decided not to implement the plans and construct the extension to the store, it will not be entitled to a deduction under section 43-30 for the cost of the plans.

This is for the reason that the Entity does not meet the requirement in paragraph (c) of section 43-10 about the area i.e store extension being used to produce assessable income. Moreover, section 43-70 will operate to deny a deduction for the cost of plans as the building of the store extension was never completed.

Question 4

Section 110-25 sets out the five elements that can be included in the cost base of a CGT asset.

A CGT asset is defined to mean any kind of property, or a legal or equitable right that is not property - see section 108-5. Examples of CGT assets are land and buildings, shares in a company, rights and options, leases, licences, goodwill.

Mere information is not a CGT asset because it is neither property nor a right. For example, knowledge, however valuable, is not property and not a CGT asset. Knowledge is neither real nor personal property - see FC of T v United Aircraft Corporation (1943) 68 CLR 525. 'Know-how' is also not a CGT asset because it is not a form of property nor a legal or equitable right - see Taxation Determination TD 2000/33 Income tax: capital gains: is know-how a CGT asset?

Likewise, the plans drawn up for the Entity regarding the store extension is considered not to be a CGT asset as it is neither property nor a legal or equitable right.

A building, structure or other capital improvements on land that a taxpayer acquired after 20 September 1985 is a separate CGT asset from land, if amongst others, a balancing adjustment in Subdivision 40-D applies (see section 108-70 and section 108-55 in Subdivision 108-D).

Subdivision 40-D applies to assets that are depreciated under Subdivision 40-B. The provisions in Subdivision 40-B were considered previously in Question 2 of this Private Ruling. It was considered that the planning expenses were not a depreciating asset under Subdivision 40-B. Consequently, the rules in Subdivision 108-D about separate CGT assets have no application here.

The plans that were drawn up relate to the potential development of the existing retail store. The issue that then arises is whether the cost of the plans could fall within any of the five cost base elements for the purposes of calculating the retail store's cost base.

The cost base element that is relevant to this case is the fourth cost base element in subsection 110-25(5). The fourth element includes capital expenditure that is incurred by a taxpayer for the purpose or the expected effect of increasing or preserving the assets' value or that relates to installing or removing the asset. For example, costs incurred in applying unsuccessfully for zoning changes would be included in a taxpayer's cost base under the fourth element provisions.

Therefore, for expenditure to fall within the fourth element, it is required that:

·        the expenditure must be of a "capital" nature; and

·        the expenditure must have been incurred for the specified purpose or expected effect.

It was considered previously in Question 1 of this Private Ruling in the discussion about the application of section 8-1 that the amounts paid by the taxpayer for the plans were capital amounts. Therefore, the requirement about the expenditure for the plans being capital expenditure is met.

In relation to the requirement about the expenditure's purpose or its expected effect, the Entity drew up the plans for the store on the basis that the store extension would increase the future lease income from the retail store. It is considered that this expenditure is directed or expected to increase or preserve the value of the store. Therefore, the expenditure for the cost of the plans can be included in the fourth element of the Entity's cost base.

Accordingly, the amounts expended on plans by the Entity are included in the cost base calculation of the retail store under section 110-25.

Question 5

Broadly, under section 40-880 a taxpayer is allowed a deduction for capital expenditure over 5 years if:

·        it is not taken into account in some way elsewhere in the income tax law;

·        it is not expressly made non-deductible (other than because the expenditure is of a capital nature); and

·        relates to a business that is, was or is proposed to be carried on for a taxable purpose.

The ways in which an amount of expenditure can be taken into account elsewhere in the income tax law are listed in subsections 40-880(5) to (8). One of those ways is where the amount of expenditure could be taken into account in working out the amount of a capital gain or capital loss from a CGT event - see paragraph 40-880(5)(f).

In this case, paragraph 40-880(5)(f) excludes the expenditure for amounts expended on drawing up the plans from deductibility under section 40-880. These amounts will be included in the cost base calculation of the retail store (as concluded in Question 4 of this Private Ruling) and thus taken into account in calculating the capital gain/ loss upon a CGT event happening to the retail store.

Accordingly, no deduction is allowed for a deduction under section 40-880 for the cost of the planning expenses.