Edited version of private advice

Authorisation Number: 1052358451100

Date of advice: 28 March 2025

Ruling

Subject: Work-related deductions

Question 1

Are you entitled to a deduction under Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997) for the expenditure incurred by you in the renovation of the office that is leased by you?

Answer 1

No, you are only entitled to a deduction under Division 40 for any depreciating assets installed in the renovation.

This ruling applies for the following period:

XX June 20XX

The scheme commenced on:

XX April 20XX

Relevant facts and circumstances

You are a small business that recently leased a shop which was empty at the time of commencing your lease.

Your intention was to use the premises as an office location and to meet clients.

You signed the lease and shortly after undertook renovations on the premises as approved by the landlord.

You made the renovations of the premises with the intention of creating a professional and welcoming atmosphere to reflex excellence services.

Renovations were completed and your business operating from the premises began to generate assessable income shortly after.

Your leased office is central to the business' daily operations with 70% of customer base attending the site.

The renovation consisted of:

•                     List of renovations supplied

You provide a breakdown of expenses involved in the renovations as well as cost of building permits and construction drawings.

You provided a copy of your lease agreement. The lease agreement defines tenant's works as the works specified in the plans to fit out the premises and other works which the tenant has the landlord's approval to carry out in the premises during the term of the lease. It states tenant's works are the property of the tenant.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 subsection 40-25(1)

Income Tax Assessment Act 1997 subsection 40-25(2)

Income Tax Assessment Act 1997 subsection 40-25(7)

Income Tax Assessment Act 1997 section 40-40

Income Tax Assessment Act 1997 section 40-100

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 section 43-70

Income Tax Assessment Act 1997 subsection 43-75(1)

Income Tax Assessment Act 1997 section 43-110

Income Tax Assessment Act 1997 subsection 43-120(1)

Reasons for decision

Decline in value deduction under Division 40

Division 40 of the ITAA 1997 provides a deduction for the decline in value of depreciating assets. These assets are defined as those with a limited effective life that are expected to decrease in value over time. The division ensures that taxpayers can account for the depreciation of their assets in their tax returns, thereby reflecting the wear and tear or obsolescence of these assets.

Section 40-25(1) allows taxpayers to deduct an amount equal to the decline in value of a depreciating asset for an income year, provided they held the asset at any time during that year. The decline in value is calculated using methods specified in sections 40-70, 40-72, and 40-75.

A depreciating asset is defined in subsection 40-30(1) as one that has a limited effective life and can reasonably be expected to decline in value over time, excluding land, trading stock, and certain intangible assets unless specified otherwise.

Subsection 40-25(2) requires that the deduction for a depreciating asset be reduced by the portion of its decline in value attributable to its use for a purpose other than a taxable purpose. A taxable purpose is defined in subsection 40-25(7) to include the purpose of producing assessable income.

Section 40-40 provides a table to determine who holds a depreciating asset. In broad terms, a holder of a depreciating asset is its economic owner. In most cases, the legal owner is also the economic owner and therefore, the holder. Item 2 and Item 3 of the table state the following:

Table 1: Depreciating assets

Item 2 applies to those cases where the quasi-owner has a right to remove the depreciating asset from the land, whereas Item 3 applies to those cases where the quasi-owner does not have a right to remove the depreciating asset at the termination of the quasi-ownership right.

'Quasi-ownership right' over land is defined in subsection 995-1(1) of the ITAA 1997 to mean:

(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.

The term lease is not defined in the ITAA 1997 and takes on its ordinary meaning.

Taxation Ruling TR 2022/1 - Income tax: effective life of depreciating assets provides guidance on the effective life of depreciating assets for income tax purposes, applicable from 1 July 2022. This ruling explains the methodology used by the Commissioner of Taxation to determine the effective life of depreciating assets under section 40-100 of the ITAA 1997. The effective life of an asset is used to calculate its decline in value (depreciation). Taxpayers can choose to use the Commissioner's determination or make their own estimate of the effective life of a depreciating asset. The ruling includes Tables A and B, which list the effective life determinations made to date.

Capital works deduction under Division 43

Division 43 of the ITAA 1997 provides a deduction for capital works attributable to a construction expenditure area that is owned or leased by the taxpayer and used during the income year for the purposes of producing assessable income. Capital works include a building, or an extension, alteration or improvement to a building (subsection 43-20(1)). Capital works also include structural improvements, or extensions, alterations or improvements to structural improvements (subsection 43-20(2)). The basic rate of deduction is 2.5% per year for capital works used for the purpose of producing assessable income.

Section 43-110 provides that a taxpayer can only get a capital works deduction under Division 43 for an income year if the taxpayer owns, leases or holds part of a construction expenditure area of capital works.

Subsection 43-75(1) explains what the construction expenditure area is for capital works started after 30 June 1997. In general, it is the part of capital works on which the construction expenditure was incurred by an entity that, at that time, was to own or lease the capital works, or hold them as a quasi-owner.

Section 43-70 defines construction expenditure as capital expenditure incurred in respect of the construction of capital works. Taxation Ruling TR 97/25 states that construction expenditure includes preliminary expenses such as architect fees, engineering fees, foundation excavation expenses and costs of building permits.

Under subsection 43-120(1), a lessee or holder can claim a deduction for capital works in respect of an area leased or held under a quasi-ownership right. To claim deduction, the lessee or holder must have:

•                     incurred the construction expenditure or been an assignee of the lessee or holder who incurred the expenditure;

•                     continuously leased or held the capital works area itself, or leased or held the area that had been so held by previous lessee, holder or assignee since completion of construction, and

•                     used the area to produce assessable income.

If there is a lapse in the lease, the entitlement to the deduction reverts to the building owner.

Application to your circumstances

The lease agreement defines tenant's works as the works specified in the plans to fit out the premises and other works which the tenant has the landlord's approval to carry out in the premises. In the present case, these works include:

•                     Installed X flooring, lighting, and X air conditioner units

•                     Repainted the entire premises

•                     Constructed internal facilities

•                     Installed cabinetry and signage

In accordance with your lease agreement, you hold ownership of the tenant's works specified in the approved plans that are carried out in the premises during the term of your lease. Consequently, the renovations you have undertaken on the premises soon after you entered the lease agreement are considered to be held by the you as the tenant of the premises. As a result, you are regarded as the legal and economic holder of the assets brought in as part of the renovation.

Depreciating assets

Under Division 40 of the ITAA 1997, the following items are considered depreciating assets, allowing for a deduction for the decline in value of the assets based on their effective life:

•                     X flooring

•                     Installation of X air conditioner units

•                     Installation of a logo

Tables A and B in Taxation Ruling TR 2022/1 provide effective life determinations for assets depreciable under Division 40.

As per section 40-25 of the ITAA 1997, consideration must be given to the proportion of business use and whether the asset is acquired for the purpose of producing assessable income.

Capital works

The remaining expenditure incurred in the renovation of your leased office includes:

•                     Installation of lighing

•                     Repaint of the entire premise

•                     Construction of a facilities

•                     XX meeting room

•                     Installation of cabinetry

All the above items are permanently attached to the building and form part of the building. Downlights are hard wired and fixed to the ceiling. Installation of lights, repainting of the premise, construction of facilities and installation of carpentry are considered construction expenditure for the purposes of Division 43.

According to TR 97/25 your preliminary expenses such as building permits and construction drawings incurred in the renovation are also considered to be construction expenditure.

As you incurred the construction expenditure for an area that is leased by you for the purpose of producing assessable income, section 43-120 enables you to claim deductions while you lease or hold ownership of the capital works area.

Conclusion

You are entitled to a deduction for the decline in value of depreciating assets, as listed above, installed in the renovation under Division 40 of the 1997; the effective life of these depreciating assets is available in Taxation Ruling TR 2022/1. The expenditure relating to capital works incurred in the renovation is deductible under Division 43 at a rate of 2.5% per year.

Other information

In your application, you referenced Taxation Ruling TR 2007/9 - Income tax: circumstances when an item used to create a particular atmosphere or ambience for premises used in a cafe, restaurant, licensed club, hotel, motel or retail shopping business. You stated that the renovation of your leased office was done with the purpose of creating a professional and welcoming atmosphere to reflex excellence services and that you considered several items from the renovation as potentially qualifying as 'plant' under TR 2007/9.

TR 2007/9 considers circumstances when an item used to create a particular atmosphere or ambience for premises used in a cafe, restaurant, licensed club, hotel, motel or retail shopping business, constitutes an item of plant. Such an item must be more than mere decor, and the atmosphere must form a definable element in the service which the business of these types provides and for which customers are prepared to pay. Your business is not one of the types of business covered in this ruling.

Further, as stated in TR 2007/9, as a basic rule, an item that forms part of the premises does not come within the ordinary meaning of plant, except in the rare case where the premises are themselves plant.

The primary factor in determining whether an item qualifies as plant is its function. If the function is to provide the setting or environment within which income-producing activities are conducted (e.g. an office building), the item does not qualify as plant. Therefore, the X door for the meeting room and other items installed during the renovation of your leased office (as listed under Capital works above) are not plant.