Edited version of private advice

Authorisation Number: 1052125761713

Date of advice: 22 June 2023

Ruling

Subject: Apportionment of initial repairs

Question

For the purposes of determining the amount of capital expenditure that is not deductible under subsection 25-10(3) of the Income Tax Assessment Act 1997 (ITAA 1997), will the Commissioner accept the time-based apportionment methodology as proposed by the trustee of Trust A?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2022

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

1.         Trust A purchased an investment property the Premises) on Date P and has been continually leased out to tenants since it was acquired.

2.         The building that forms part of the Premises was constructed on Date A which was a number of years before Date C.

3.         As a result of water ingress (i.e. water from outside makes its way into the building), which commenced after Date P, Trust A commissioned an investigation into the cause of the ingress. The results of the investigation concluded that the metal roof had corroded to the point where it would need replacing.

4.         The trustee for Trust A applied for a private ruling on the application of section 25-10 of the ITAA 1997 in respect of expenditure they were considering incurring to replace the roof. and the Commissioner ruled that the full amount incurred to replace the roof could not be deducted under section 25-10 as part of the expense would be capital expenditure excluded under subsection 25-10(3).

5.         The work to replace the roof was completed on Date R.

6.         Paragraph 64 of Taxation Ruling TR 97/23[1] provides for a time-based apportionment methodology for initial repairs, which compares construction date, acquisition date and the date repairs are completed and apportions the total repair costs between pre-acquisition and post-acquisition periods.

7.         Rather than use Date A as the start date from which to apply a time-based apportionment, the Trustee of Trust A is proposing to use the date that is the half-way point between the construction date and replacement date (Date H).

8.         The basis for this approach is that the trustee believes rusting would not have commenced from the moment the building was completed but was more likely to have commenced in the later years of the roof's life. To support the basis for this approach, the trustee provided documents and articles that discuss the effective list of a metal roof and what factors impact that effective life.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 subsection 25-10(3)

Reasons for decision

Issue 1

All legislative references are to the ITAA 1997 unless otherwise indicated.

Question 1

For the purposes of determining the amount of capital expenditure that is not deductible under subsection 25-10(3) will the Commissioner accept the time-based apportionment methodology as proposed by the trustee of Trust A?

Summary

Yes, the Commissioner accepts that this proposed methodology is fair and reasonable in the circumstances of this case.

Detailed reasoning

9.         Section 25-10 states:

25-10(1)

You can deduct expenditure you incur for repairs to premises (or part of premises) or a *depreciating asset that you held or used solely for the *purpose of producing assessable income.

25-10(2)

If you held or used the property only partly for that purpose, you can deduct so much of the expenditure as is reasonable in the circumstances.

25-10(3)

You cannot deduct capital expenditure under this section.

10.      As explained in paragraphs 59 to 60 and 125 to 134 of TR 97/23, initial repairs[2] are capital expenditure and are not deductible under section 25-10.

11.      As the roof had been in place since Date C and Trust A acquired the property on Date P, the Commissioner formed the view that the replacement of the roof would remedy defects, damage or deterioration to the roof that was in existence on Date P. As a result, the Commissioner ruled that an unspecified portion of the cost of the roof repairs was capital expenditure.

12.      Section 8-1 allows a deduction for losses or outgoings incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, a deduction is not allowed under section 8-1 to the extent that the loss or outgoing is of a capital nature.

13.      The words 'to the extent that' indicate that an expense may be apportioned if it is partly deductible and partly non-deductible: Ronpibon Tin NL & Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; 4 AITR 236 (Ronpibon); Ure v. Federal Commissioner of Taxation (1981) 50 FLR 219; 81 ATC 4100; (1981) 11 ATR 484. However, as explained in Ronpibon, where apportionment is necessary, the method adopted must be 'fair and reasonable' in all the circumstances.

14.      In respect of apportionment of initial repair costs, paragraphs 138 to 140 of TR 97/23 state:

138. Initial repair expenses can be dissected or apportioned under section 25-10 to allow a deduction to the extent to which the repair work remedies defects, damage or deterioration arising from the taxpayer's holding, etc., of the property for income purposes after it is acquired: see the Law Shipping case where the Special Commissioners allowed a deduction of £pound;12,000 (out of a sum of £pound;51,558 incurred on repairs) as being applicable to the period during which the company owned the ship. See also (1962) 10 CTBR (NS) Case 84; (1963) 11 CTBR (NS) Case 63; (1950) 1 CTBR (NS) Case 18 and (1959) 8 CTBR (NS) Case 137 in which purchased properties were repaired and Taxation Boards of Review allowed a portion of repair expenditure; contrast the views of Senior Member, Mr PM Roach, in Case V167 88 ATC 1107; AAT Case 12 (1986) 18 ATR 3056 and Case W7 89 ATC 161; AAT Case 4845 (1988) 20 ATR 3170.

139. We accept that Windeyer J in the Thomas case (at 115 CLR 74; 14 ATD 88) was saying nothing more than that there was insufficient evidence in relation to the items of expenditure he was considering in that particular case to permit him a basis of apportionment. Windeyer J was not saying categorically that apportionment is never possible. This approach is also suggested by his Honour citing with approval the decision in the Law Shipping case.

140. We accept, for example, that a court might agree to apportionment if a taxpayer is able to identify the extent to which repair expenditure is necessitated by deterioration arising after property is acquired and is attributable to the taxpayer's holding, etc., of the property for income purposes.

15.      Although Ronpibon was dealing with section 8-1, costs under section 25-10 are also capable of being apportioned in a similar way to account for capital costs under section 8-1,and the requirement under section 8-1 that any apportionment be fair and reasonable would equally apply when apportioning initial repair costs under section 25-10.

16.      An apportionment methodology that is acceptable to the Commissioner is detailed in paragraph 64 of TR 97/23:

64. Dissection or apportionment on a time basis is appropriate if repair costs are incurred either due to defects (whether expected or unexpected) that arise gradually over an extended period or due to wear and tear or deterioration that occurs:

(a) in part before the property is acquired by a taxpayer; and

(b) in part in the course of the taxpayer's holding, etc., of the property for income purposes.

17.      In this case the roof of the building corroded to the point where there was water ingress, which corrosion is gradual deterioration rather than a specific event that resulted in repairs having to be made. Therefore, the methodology set down in paragraph 64 would be appropriate to allow for gradual deterioration that would have occurred both before and after a building was acquired by a taxpayer.

18.      If Trust A was to follow the methodology using the date construction of the building was completed as the start date, the apportionment would result in a greater percentage the roof replacement costs being treated as capital expenditure which is excluded under subsection 25-10(3) than the percentage that is deductible under section 25-10.

19.      If Date H was used instead of Date C, the percentage of the total costs that is treated as capital expenditure would be reduced but would be still greater than the percentage that otherwise would be deductible under section 25-10.

20.      The report on water ingress did not comment as to when the gradual deterioration commenced or how long it would have taken for the roof to corrode to the point that it allowed water ingress. In effect, Date H is offered as the commencement date because the date on which corrosion of the roof in fact commenced is unknown. For this date to be used, the Commissioner has to be satisfied that it is fair and reasonable in the circumstances of this case.

21.      The roof in this case was replaced earlier than would generally be expected and indicates that the corrosion occurred earlier than normal. Although the point in time at which corrosion commenced is unknown, it is accepted that the corrosion would not have commenced on Date C.

22.      In looking at the proposed choice of Date H in the actual life of the roof, the corrosion may have started at any time during the life of the roof. In the absence of knowledge as to the actual date the roof began to rust, it is accepted that treating Date H as the point at which the roof started to rust is fair and reasonable based on the circumstances in this case.

[1] Income tax: deductions for repairs

[2] expenditure incurred in remedying defects, damage or deterioration in existence at the date of acquisition,