ATO ID 2006/213: Capital Allowances: Capital works - construction expenditure - preliminary expense
Date of decision: 2 June 2006
Year of income: Year ended 30 June 2005
Business line: Private Groups and High Wealth Individuals

Issue
Is the expenditure incurred by a builder of a residential unit complex in South Australia on an insurance policy that insures the owner of the residential unit complex against the risk of loss from the building not being completed included in construction expenditure as defined in subsection 43-70(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. The expenditure incurred on this particular type of insurance policy is construction expenditure as defined in subsection 43-70(1) of the ITAA 1997 as the expenditure is incurred in respect of the construction of capital works.

Facts
A residential unit complex was constructed by a builder in South Australia in 2003. The builder was required, under section 34 of the Building Work Contractors Act 1995 (SA) (BWCA 1995), to obtain an insurance policy that insured the building owner against the risk of loss from the building not being completed due to the insolvency, death or disappearance of the builder. Section 34 of the BWCA 1995 prevented the builder from undertaking any building work until such an insurance policy was in place. Under the BWCA 1995, builders were required to take out this type of insurance policy on behalf of the homeowner for each and every contract that they entered into. Section 34 of the BWCA 1995 prevented the builder from undertaking any building work until such an insurance policy was in place. The residential unit complex is capital works to which Division 43 of the ITAA 1997 applies.

Reasons for decision
Summary: A deduction for capital works 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 the construction of capital works'. The Explanatory Memoranda to the Income Tax Assessment Bill (No. 2) 1980 (Cth) and Income Tax Assessment Bill 1983 (Cth) (the Explanatory Memoranda), which inserted former Division 10C and 10D into the Income Tax Assessment Act 1936 , state that construction costs include such preliminary expenses as architects' fees, engineering fees and the cost of foundation excavations. This is reflected in paragraph 9 of Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements (TR 97/25), which also considers that the costs of building permits form part of preliminary expenses. The insurance policy is required by section 34 of the BWCA 1995. The policy must be obtained to permit the building work on the capital works to commence and has a direct connection with the construction of the capital works (being the residential unit complex). It is therefore incurred in respect of the construction of the capital works and is included within construction expenditure as defined by subsection 43-70(1) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1936 Division 10C Division 10D
Related public rulings and determinations: Taxation Ruling TR 97/25
Related ATO interpretative decisions: ATO ID 2002/1098 | ATO ID 2004/137 | ATO ID 2004/138 | ATO ID 2004/822
Other references: Explanatory Memorandum to Income Tax Assessment Bill (No. 2) 1980 Explanatory Memorandum to Income Tax Assessment Bill 1983
Subject references: Buildings Capital expenditure Construction costs