ATO ID 2004/860: Capital works: balancing deduction - a right to receive an amount - future insurance proceeds
Date of decision: 17 September 2004
Year of income: Year ended 30 June 2003
Business line: Public Groups and International

Issue
Where the insured capital works were destroyed, did the owner have a right to receive an amount for the destruction of works, as described in section 43-250 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. For the purposes of applying section 43-250 of the ITAA 1997, the taxpayer had a right to receive an amount for the destruction of works, being a right to insurance proceeds.

Facts
The taxpayer purchased a residential rental property in 2001. They carried out extensive renovations during a period of three months from the purchase date to the time the property was first rented out. Capital works deductions were claimed for the renovation expenditure under section 43-10 of the ITAA 1997. The taxpayer had entered into a contract of insurance over the property. In the income year ended 30 June 2003, the property was completely destroyed as a result of an arson attack. Fire was a specified event in the insurance policy, but the fact of arson meant that payment of a claim by the insurance company was not certain. At the time of preparing the income tax return for that income year, the taxpayer had not received any amount of insurance proceeds, and the insurer had not determined any amount due to the taxpayer. At that time it was expected that, if the taxpayer received any insurance payout, it would not be until the income year ended 30 June 2005. The taxpayer's return was lodged prior to determination of the payout.

Reasons for decision
Summary: Section 43-40 of the ITAA 1997 allows a taxpayer to deduct an amount for the destruction of capital works (called a balancing deduction) if all or part of their capital works are destroyed in an income year and: The balancing deduction under section 43-40 of the ITAA 1997 is allowed in the income year in which the destruction occurs and is calculated under section 43-250 of the ITAA 1997. On the facts in this case, the deduction is equal to the undeducted construction expenditure at the date of the destruction of the capital works less the amounts the taxpayer received or has a right to receive for the destruction of the capital works. The amounts the taxpayer has received or has a right to receive for the destruction of the capital works includes an amount received under an insurance policy for the destruction of the capital works (section 43-255 of the ITAA 1997). The taxpayer's insurance policy was a contract of insurance. In Medical Defence Union Ltd v Department of Trade (1979) 2 All ER 421 Megarry V-C held that a contract of insurance provides the insured with the right to money or money's worth on the occurrence of a specified event. During the income year ended 30 June 2003, under the taxpayer's contract of insurance, a specified event occurred. By virtue of the contract between the two parties, a right to receive an amount under the insurance policy arose at the time the capital works were destroyed by fire, being the specified event. While the exact amount of the insurance proceeds was not known at that time, there was an amount that the taxpayer had a right to receive, for the purposes of the calculation needed to be made in section 43-250 of the ITAA 1997. The amount of the right could not be correctly quantified until the taxpayer either received insurance proceeds in fulfilment of the insurance contract entitlements or was notified that no amount would be paid. In preparing a tax return for the year during which the fire occurred, the taxpayer needed to make an estimate of the likely payout and include it in calculating the amount of deduction under section 43-40. If necessary, an amendment could later be made to the tax return for the income year ended 30 June 2003 where the proceeds did not equal the amount taken into account as the amount representing the right received for destruction of capital works.

Legislative references: Income Tax Assessment Act 1997 Division 43 section 43-10 section 43-40 section 43-250 section 43-255
Case references: Medical Defence Union Ltd v Department of Trade (1979) 2 All ER 421
Related ATO interpretative decisions: ATO ID 2004/861 | ATO ID 2004/862
Subject references: Building depreciation Destruction of assets Insurance