Edited version of private advice

Authorisation Number: 1052194164419

Date of advice: 20 November 2023

Ruling

Subject: Deduction for water facility

Question 1

Is the partnership considered to be carrying on a primary production business as per subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the partnership able to claim in full a deduction in the 20XX-XX financial year for the total capital expenditure for installation of a new water pipeline that began in the 20XX-XX financial year and was completed and ready for use in the 20XX-XX financial year?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You have a family run wholesale export and mail order business. You are primary producers of horticultural nursery stock.

You breed, harvest and sow seed and propagate from cuttings and as such produce all stock you sell.

As collectors of these plants yourselves, prior to starting your business and their limited availability and variety, you saw the scope and demand for these unique plants and the potential for hybridising and breeding them to supply the burgeoning collector's market and a household pot plant market.

You believe the results of your business have proven the existence of a market for your particular product. You now have the reputation of being the world leaders in your chosen plant and the demand for your plants has grown exponentially over the years.

You have your packing shed registered with the Department of Agriculture, Fisheries and Forestry so as to carry out export inspections. This is renewable and audited annually.

As these plants are a protected genus you have to annually apply and renew an export license (CITES) with the Department of Agriculture, Water and the Environment. Water Allocation license and fees are paid annually.

A typical day starts by responding to email correspondence, pollinating plants, sowing seed, potting, propagating cuttings, packing orders, export order inspections to maintenance.

You have distributors across numerous continents and resellers in Australia and also supply collectors by mail order to most states in Australia.

After decades in business, you are respected by many for your quality and breeding. You are the largest breeder of your chosen plant in the world and your catalogue updates are awaited by many constantly. You advertise mainly on your social media site and catalogue updates are both advertised there and also by email. Your distributors are contacted by email when stock is available.

Breeding is a constant endeavour as the plants flower at different times of the year. Seed ripening takes 3-5 months and germination up to 3 months. Small plants are sold at around 18 months from germination. Large specimen plants can take at least 12 more months from then. Cuttings are taken in Spring over a 3 month period and these take at least 6 months to sale. Having been in business for decades, the entire process is ongoing.

Your business uses up a total of a portion of your land. This incorporates your greenhouses, packing shed, machinery shed, garage, amenities, water tanks and walkways. All the plants are grown in greenhouses. You have multiple climate-controlled greenhouses/propagation structures covering a quarter of the business percentage of the land.

Apart from your distributors, the catalogue is updated on the website for collectors on average, twice per year.

The businesses existing water supply pipeline attachment was terminated due to a nearby unrelated land/farm sale.

You needed to urgently install a new pipeline and infrastructure to obtain the water supply from your relevant water allocation to supply critical water to your business.

Without the water supply your business viability would be greatly impacted.

The installation included an engineered underground pipeline in the Council road reserve and adjoining private land and an under road crossing which received official Council approval.

There was the requirement to setup legal easement agreements with neighbouring landholders.

All of this was to allow attachment to your existing water provider infrastructure.

You supplied an email from your engineer confirming the Council had approved the works.

You supplied a sample of some of the invoices paid.

The projected costs were provided.

The Water from the Pipeline was turned on finally in the 20XX-2XX financial year. Everything being all installed and ready for use (a delay was experienced due to school holidays and other issues from hitting unforeseen rock).

The actual total overall Pipeline Project Costs over the multiple financial years was provided.

For the final financial year there was also an estimate of expenses that had been yet to be billed, but will be paid when the invoices are issued, resulting in an increased amount for the financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Assessment Act 1997 section 40-520

Income Tax Assessment Act 1997 section 40-530

Income Tax Assessment Act 1997 section 40-540

Income Tax Assessment Act 1997 section 40-570

Income Tax Assessment Act 1997 subdivision 40-F

Reasons for decision

Answer 1

The definition of primary production business from subsection 995-1(1)(a) of the ITAA 1997 states that you carry on a primary production business if you carry on a business of:

(a)  cultivating or propagating plants, fungi or their products or parts (including seeds, spores, bulbs and similar things), in any physical environment; or ...

As your business is involved in the cultivating or propagating of plants and you meet the criteria for carrying on a business under Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? you are seen as carrying on a business of primary production.

Answer 2

To determine whether a deduction is allowed in a single financial year or to be spread over multiple financial years, consideration is required into the nature of the expenditure and when it was incurred.

Section 40-520 of the ITAA 1997 defines a water facility as:

(a)  plant or a structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to plant or a structural improvement, that is primarily and principally for the purpose of conserving or conveying water; or

(b)  a structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to a structural improvement, that is reasonably incidental to conserving or conveying water.

Example:

Examples of a water facility include a dam, tank, tank stand, bore, well, irrigation channel, pipe, pump, water tower and windmill. Examples of things reasonably incidental to conserving or conveying water include a culvert, a fence to prevent live stock entering an irrigation channel and a bridge over an irrigation channel.

Your installation of the water pipeline meets the definition of a water facility under section 40-520 of the ITAA 1997 as it was installed for conveying water for a primary production business.

The water facility starts to decline in the income year in which the first expenditure was incurred on the facility or asset as per section 40-530 of the ITAA 1997. Therefore, this will be in the X financial year for your water pipeline.

The expenses would be deducted over the X years as legislation states it is when they are incurred, not when the asset was installed and ready for use.

Section 40-540 of the ITAA 1997 states:

The decline in value of a water facility for the income year in which you incurred the expenditure is the amount of capital expenditure you incurred on the construction, manufacture, installation or acquisition of the water facility.

Based on this, the decline in value is based on the year in which the capital expenditure was incurred.

Fully claiming the capital expenditure once the water pipeline is completed and ready for use is a term used for temporary full expensing. Paragraph 49 of Law Companion Ruling LCR 2021/3 Temporary full expensing advises that primary production assets which can be claimed under Subdivision 40-F of the ITAA 1997 are ineligible for temporary full expensing and advises that Subdivision 40-F applies to a depreciating asset that is a water facility, horticultural plant, fodder storage asset or a fencing asset.

You are therefore unable to claim the entire cost of the water pipeline in the X financial year due to the water facility being able to be deducted under Subdivision 40-F and the relevant costs would be claimed in each of the respective financial years in which they were incurred.

Further, under section 40-570 of the ITAA 1997, the expenditure is not taken into account by the partnership when calculating its net income. Instead, each partner is deemed to incur the expenditure proportionate to their respective interest in the net income of the partnership or otherwise by agreement. As such each partner will return their portion of the expenditure in their individual income tax return.