Edited version of private advice

Authorisation Number: 1052180354229

Date of advice: 17 October 2023

Ruling

Subject: Income tax - capital allowances - primary production capital expenditure

Question 1

Is the taxpayer considered to be an Irrigation Water Provider under subsection 40-515(6) of the Income Tax Assessment Act 1997 (ITAA 1997) and therefore able to claim a deduction under subsection 40-515 for the cost of the construction of the dam?

Answer

No

Question 2

If the taxpayer is not an Irrigation Water Provider is the dam considered to be a depreciating asset within the meaning of subsection 40-30(1) of the ITAA 1997 as outlined in ATO ID 2008/50?

Answer

Yes

This ruling applies for the following periods

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

X Pty Ltd as trustee for the X (X) owns a rural property and farmland, (the Property). X conducts its own farming operations on the Property. Apart from this, X is not currently carrying on any other business.

Aside from the Property, X owns other properties in its own right and in partnership with a related entity. These properties are leased to other parties.

X entered into a lease agreement, as Lessor, for some of the Property with the Lessee. The Lessee is not related to X.

Some of the stock on the Property under the terms of the Lease, remain the property of X, who has the right to continue to process these and is entitled to the income from this activity.

The Lessee is a primary producer.

Details of the Dam

At the time the Lease was entered into there were no dams on the Property.

The Dam is defined in the Lease as including all pipework and other infrastructure to connect to a pump house as reasonably required by the Lessee, but does not include a pump house.

X does not provide any other water facilities to other entities, and there is no intention at this stage to supply water to other entities besides the Lessee.

The Dam is being constructed across a gully and over a water course or creek. The dam wall is across a gully to impound water. It is being constructed of excavated clay, sourced from the excavation of the existing gully, with a compacted clay core in the centre of the dam wall.

Expert advice has been obtained in relation to the construction of the Dam. All necessary licences and permits have been obtained.

Water will be provided continuously from the Dam as required by the Lessee. The Lessee will access the water by connecting to an offtake pipe provided by X at the base of the Dam. The Lessee will pump the water from the offtake pipe location to wherever it is required.

The Dam will have a limited effective life and can reasonably be expected to deteriorate over time from erosion, water seepage and the growth of trees, which compromise the sealing of the dam. Over time it is expected that timber (trees) and the construction will cause the Dam to fail as timber growing on the embankment will compromise the sealing and water will begin to trickle through and empty the dam. Removing timber will assist to maintain the Dam.

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 40-45

Income Tax Assessment Act 1997 section 40-100

Income Tax Assessment Act 1997 section 40-105

Income Tax Assessment Act 1997 section 40-515

Income Tax Assessment Act 1997 section 40-520

Income Tax Assessment Act 1997 section 40-525

Income Tax Assessment Act 1997 section 43-20

Income Tax Assessment Act 1997 section 43-70

Income Tax Assessment Act 1997 section 45-40

Reasons for decision

Question 1

Summary

The taxpayer is not considered to be an Irrigation Water Provider under subsection 40-515(6) of the ITAA 1997 and therefore will not be able to claim a deduction under subsection 40-515 for the cost of the construction of the dam.

Detailed reasoning

Subdivision 40-F of the ITAA 1997 allows deductions for capital expenditure incurred on certain depreciating assets used in primary production. One of these depreciating assets is a 'water facility' (paragraph 40-515(1)(a) of the ITAA 1997).

Subsection 40-515(6) of the ITAA 1997 provides the meaning of irrigation water provider (underlining added):

An irrigation water provider is an entity whose *business is primarily and principally the supply (otherwise than by using a *motor vehicle) of water to entities for use in *primary production businesses on land in Australia.

Subsection 40-520(1) of the ITAA 1997 defines 'water facility' and provides examples of a water facility which include a dam.

In order to claim a deduction for the decline in value of a water facility, the conditions in subsection 40-525(1) of the ITAA 1997 must be satisfied. That is, the capital expenditure you incurred on the water facility must have been incurred:

(a) primarily and principally for the purpose of conserving or conveying water for use in a ^*primary production business that you conduct on land in Australia; or

(b) for expenditure incurred by an ^*irrigation water provider - primarily and principally for the purpose of conserving or conveying water for use in primary production businesses conducted by other entities on land in Australia, being entities supplied with water by the irrigation water provider.

In your situation the conditions in subsection 40-525(1) of the ITAA 1997 are not satisfied i.e.:

(a) is not satisfied, as the capital expenditure incurred on the water facility will not be incurred primarily and principally for the purpose of conserving or conveying water for use in a primary production business that you conduct on land in Australia

(b) is not satisfied as you do not satisfy the meaning of irrigation water provider in subsection 40-515(6) per below.

Subsection 40-515(6) meaning of irrigation water provider refers to an entity whose business involves the supply of water to entities for use in primary production businesses on land in Australia. We will consider each of these requirements as follows:

•         an entity whose business

•         supply of water to entities

•         for use in primary production businesses

• an entity whose business - the facts in this case do not support a conclusion that X is conducting a business of supplying water in the period for which the Ruling applies. Indicators of carrying on a business are contained in Taxation Ruling TR 97/11 - Income tax: am I carrying on a business of primary production? (TR 97/11)

The income referred to in the facts is primarily passive income from leasing activities i.e. the receipt of income from letting the property to a tenant does not amount to the carrying on of a business and is the passive receipt of income from granting a lease to a tenant for the right to exclusive possession of the property

• supply of water to entities

X does not provide any other water facilities to other entities, and there is no intention at this stage to supply water to other entities besides the Lessee

• for use in primary production businesses - supply will not be to primary production businesses, but instead to a single business run by the Lessee of the land, under the terms of the lease

Although the expenditure is for the construction, manufacture, installation or acquisition of a water facility, in your situation the water facility is not principally and primarily for use in a primary production business that you carry on, or for use in the carrying on of a business as an irrigation water provider in Australia. Therefore a deduction under section 40-515 of the ITAA 1997 is not available to you.

Question 2

Summary

The dam is a depreciating asset within the meaning of subsection 40-30(1) of the ITAA 1997.

Detailed reasoning

Subsection 40-30(1) of the ITAA 1997 is contained within Subdivision 40-B, the core provisions of the capital allowance rules about deductibility of capital expenditure in part 2-10 of the ITAA 1997.

Section 40-30 covers what a depreciating asset is:

40-30(1) A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used, except:

(a) land; or

(b) an item of trading stock; or

(c) an intangible asset, unless it is mentioned in subsection (2).

40-30(2) ...[intangible assets]

40-30(3) This Division applies to an improvement to land, or a fixture on land, whether the improvement or fixture is removable or not, as if it were an asset separate from the land.

Note 1: Whether such an asset is a depreciating asset depends on whether it falls within the definition in subsection (1).

Note 2: This Division does not apply to capital works for which you can deduct amounts under Division 43: see subsection 40-45(2).

40-30(4) [composite items]

40-30(5) [rights]

40-30(6) [mining, quarrying or prospecting right]

A depreciating asset is broadly defined in subsection 40-30(1) of the ITAA 1997 as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used.

Land is specifically excluded in paragraph 40-30(1)(a) of the ITAA 1997 from being a depreciating asset.

Subsection 40-30(3) of the ITAA 1997 requires Division 40 of the ITAA 1997 to be applied to an improvement to land, whether the improvement is removable or not, as if the improvement were an asset separate from land. However, for an improvement to land to also be a depreciating asset the improvement must not be 'land' for the purposes of paragraph 40-30(1)(a) of the ITAA 1997.

To determine if an improvement to land is other than land in its ordinary meaning, the improvement to land must be found to have a discrete and separately identifiable function to merely existing as the exposed surface of the earth.

This gully dam, constructed using specified materials, is performing a discrete and identifiable function of collecting, storing and stopping the flow of water. Therefore, it is considered that the gully dam is not land for the purposes of paragraph 40-30(1)(a) of the ITAA 1997, as it has a discrete and identifiable function separate to merely existing as the exposed surface of the earth.

The lessor is a holder of a depreciating asset that is subject to a lease where the asset is fixed to land and the lessor has the right to recover the asset: ITAA 1997 section 40-40, item 4 in the table.

Having established that X will hold an improvement to land, it is necessary to determine if that improvement is also a 'depreciating asset' under subsection 40-30(1) of the ITAA 1997, specifically, whether it has a limited effective life and can reasonably be expected to decline in value over the time it is used [See Note 1 at subsection 40-30(3) of the ITAA 1997].

The requirement that an asset decline in value over the time that it is used does not mean that this must occur uniformly over time. It is sufficient that it will decline in value by the end of its effective life.

As a tangible item suffering deterioration from continual use and exposure to the elements, the dam can reasonably be expected to decline in value over the time it is used. The dam will deteriorate from erosion, water seepage and the growth of trees, which compromise the sealing of the dam. It is therefore considered that the dam has a limited effective life.

The meaning of effective life is contained in section 40-100 of the ITAA 1997 (for the Commissioner's determination) and in section 40-105 of the ITAA 1997 (for self-assessment). Broadly, the effective life of the dam in this case is how long it can be used by anyone for producing assessable income, having regard to the period within which it is likely to be scrapped or abandoned.

As the dam is an improvement to land; has a discrete and identifiable function separate to merely being the exposed surface of the earth; has a limited effective life; and can reasonably be expected to decline in value over the time it is used, the dam is a depreciating asset for the purposes of subsection 40-30(1) of the ITAA 1997.

Subsection 40-45(2) of the ITAA 1997 states Division 40 does not apply to capital works for which you can deduct an amount under Division 43. As the gully dam is a structural improvement, it is capital works to which Division 43 may apply (subsection 43-20(2) of the ITAA 1997).

A capital works deduction under Division 43 of the ITAA 1997 is based on the amount of construction expenditure. Construction expenditure is defined in subsection 43-70(1) of the ITAA 1997 as capital expenditure incurred in respect of construction of capital works. However, subsection 43-70(2) of the ITAA 1997 excludes certain expenditure. Expenditure on plant is one such exclusion (paragraph 43-70(2)(e) of the ITAA 1997).

The definition of plant in section 45-40 of the ITAA 1997 includes fences, dams and other structural improvements, other than those used for domestic or residential purposes, on land that is used for agricultural or pastoral operations (paragraph 45-40(1)(c) of the ITAA 1997). As the gully dam falls within the meaning of plant at paragraph 45-40(1)(c) of the ITAA 1997, expenditure on its construction is excluded from construction expenditure by paragraph 43-70(2)(e) of the ITAA 1997.

Therefore, you would not be entitled to deduct an amount for capital works under Division 43 and subsection 40-45(2) of the ITAA 1997 will not apply.

The capital allowances provisions in Division 40 of the ITAA 1997 will apply to the dam.