Edited version of private advice

Authorisation Number: 1051909775067

Date of advice: 15 October 2021

Ruling

Subject: Deduction under section 40-880

Question

Will Company A as trustee for the ABC Trust be entitled to a deduction pursuant to section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997) for the cost it will incur of paying tax invoices that have issued to the landlord, for the acquisition and installation, at the premises, of the switchboard?

Answer

No

This ruling applies for the following period

Year ending 30 June XXXX

The scheme commences on:

30 June XXXX

Relevant facts and circumstances

Company A Pty Ltd as trustee for the ABC Trust (Company A) is the lessee of premises (the premises).

Company A wishes to have a new switchboard (the switchboard) installed at the premises that will improve the efficiency of its activities at the premises. The switchboard enables the safe reticulation of power throughout the leased premises for use by Company A in carrying on its business. The switchboard will be an improvement on the old switchboard in that it enables an increased power supply to the business.

The switchboard will become the property of the landlord. It is situated on, and will form part of, the leased premises which Company A will be entitled to use. Further, Company A will have no right to remove the switchboard.

For the purposes of Division 40 the switchboard will be treated as a depreciating asset separate from the land comprising the premises.

The landlord is prepared to install the switchboard provided that Company A meets the expense involved. The landlord will contract directly with suppliers for the supply and installation of the switchboard. The suppliers will issue invoices to the landlord for relevant materials and services. Company A will make direct payment of those invoices to the relevant supplier. The agreement between Company A and the landlord for payment of the installation of the switchboard was made verbally and is not documented.

At the time the expenditure is incurred, Company A is carrying on a business wholly for a taxable purpose.

The expenditure on the switchboard does not serve more than one purpose or object.

For the purposes of subsection 40-880(2A) of ITAA 1997 Company A is not a small business entity or an entity covered by subsection 40-880(2B) of ITAA 1997, for the income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 40-30

Income Tax Assessment Act 1997 section 40-40

Income Tax Assessment Act 1997 section 40-175

Income Tax Assessment Act 1997 section 40-180

Income Tax Assessment Act 1997 section 40-185

Income Tax Assessment Act 1997 section 40-880

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Company A will not be entitled to a deduction pursuant to section 40-880 of the ITAA 1997 for the cost it will incur of paying tax invoices that have issued to the landlord for the acquisition and installation at the premises of the switchboard.

The blackhole expenses deduction provision in section 40-880 applies to certain business-related capital expenditure that satisfies various requirements under the provision.

Subsection 40-880(5) contains exceptions to the types of expenditure to which section 40-880 applies. In particular, paragraph 40-880(5)(a) of ITAA 1997 states:

'You cannot deduct anything under this section for an amount of expenditure you incur to the extent that:

(a)         it forms part of the cost of a depreciating asset that you hold, used to hold or will hold;..'

The Commissioner considers that the expense that Company A will incur in respect of the installation of the new switchboard falls under the exception in paragraph 40-880(5)(a), as it will be considered to form part of the cost of 'a depreciating asset' that Company A will 'hold', for the reasons discussed below.

Is the switchboard a depreciating asset?

Section 40-30 of ITAA 1997 sets out what a depreciating asset is. You have stated in your application that the new switchboard will be a depreciating asset.

Will Company A 'hold' the switchboard?

In relation to whether Company A will hold the switchboard for the purposes of paragraph 40-880(5)(a), section 995-1 of ITAA 1997 defines "hold" as follows:

'(b) hold a depreciating asset has the meaning given by section 40-40...'

Item 3 of section 40-40 of ITAA 1997 provides as follows:

The Commissioner considers that the requirements of item 3 will be met in this case. The various requirements of item 3 and their application to the facts in this case are considered in further detail below.

Quasi-ownership right

Item 3 refers to an improvement to land 'subject to a quasi-ownership right'. Section 995-1 of ITAA 1997 defines a 'quasi-ownership right' over land as:

(a) a lease of the land; or

(b) an easement in connection with the land; or

(c) any other right, power or privilege over the land, or in connection with the land.

Company A has a quasi-ownership right over the land as a lessee of the premises.

Improvement to land

The Commissioner's view is that the 'improvement' in this case is captured by the terms of item 3, as 'an improvement to land (whether a fixture or not) subject to a quasi-ownership right (including any extension or renewal of such a right)' made by the owner of the right. Specifically, it is the Commissioner's view that:

•         An 'improvement to an improvement' to the land may itself be an 'improvement to land' in its own right for the purposes of item 3 of section 40-40.

In other words, while buildings affixed to the land may constitute as 'improvement to land', any asset on the land that, in effect, improves the land - whether or not affixed directly upon the land, and whether or not contained in the building - would itself be an improvement to land under item 3.

Item 3 thereby captures the breadth of items that, in this example, includes not only the building but - separately and in its own right - any individual asset within the building (whether a fixture or not), such that each such asset may in appropriate circumstances itself be considered to be an 'improvement to land' when installed.

•         'Improvement to land' is construed in broad terms and, as per Taxation Ruling TR 2012/7: Income tax: capital allowances: treatment of open pit mine site improvements (which, while relating to open pit mine site improvements, contains general principles that outline the Commissioner's view of the expression), includes any alterations that increase the usefulness of the land to the user:

90. It is apparent, therefore, that the meaning of the term 'improvement' in subsection 40-30(3) needs to be found principally in the concepts developed in land tax law and then expanded somewhat in the context of Division 40 to also capture those alterations that increase the usefulness of the land to the user.

91. The Commissioner's view is that an improvement, as that word appears in Division 40, would constitute any alteration to land that is considered an enhancement to the user even if the alteration has not, in fact, increased the value of the land.

•         In this case, it is clear that the removal of the former switchboard and the installation of a new switchboard, which has increased capacity and enables Company A to meet the increasing amount of electricity required in its growing business, is an 'alteration' that is an enhancement to Company A as a user. Note further that it is immaterial whether the switchboard is a fixture to the land (item 3 applies to an improvement to land 'whether a fixture or not').

•         The approach taken above is in accordance with the purpose of the provision, expressed in the Explanatory Memorandum to New Business Tax System (Capital Allowances) Bill 2001 as capturing, broadly, situations in which 'the owner of the quasi-ownership right improves the land with a depreciating asset, or improves a depreciating asset that is itself an improvement to the land, and where that improvement is for their own use but they cannot remove that asset from the land'.

Company A 'made' the improvement

We consider it material that:

       the installation of the new switchboard is at Company A's initiative; and

       the cost of the installation will be borne entirely by Company A.

For these reasons, we consider that Company A will have 'made' the improvement, as a matter of substance and for the purposes of item 3 in section 40-40.

Therefore, it is the Commissioner's view that Item 3 of section 40-40 of ITAA 1997 is satisfied, and Company A will be the holder of the switchboard.

Conclusion

In conclusion, any amount of expenditure that Company A incurs to the extent that it forms part of the cost of the switchboard (such 'cost' being an amount as ascertained under section 40-175), will be excluded from the operation of section 40-880 as a result of paragraph 40-880(5)(a).

Therefore, Company A will not be entitled to deduct any such expenditure under section 40-880 of ITAA 1997.