ATO ID 2011/44: Deductibility of vehicle running costs to the extent that vehicles are used in the self-construction of depreciating assets
Date of decision: 12 May 2011
Year of income: Year ended 30 June 2011
Business line: Private Groups and High Wealth Individuals

Issue
Is expenditure incurred by a taxpayer on vehicle running costs an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), to the extent that the vehicles are used on projects to construct and upgrade depreciating assets of the taxpayer?

Decision
No. Expenditure incurred by a taxpayer on vehicle running costs is not an allowable deduction under section 8-1 of the ITAA 1997, to the extent that the vehicles are used on projects to construct and upgrade depreciating assets of the taxpayer as it is capital or capital in nature.

Facts
The taxpayer is a public utility that owns and operates a large distribution network consisting of depreciating assets. The taxpayer employs a large workforce split into business units. A key responsibility of two of its business units (comprising approximately 80% of the taxpayer's total employees) involves the design, planning and co-ordination and on-site construction work of projects to expand and upgrade the taxpayer's distribution network. The construction projects involve the construction and upgrading of assets which are depreciating assets within the meaning of that term in section 40-30 of the ITAA 1997. The same business units are also responsible for the operation and maintenance of the taxpayer's network. The taxpayer has a large annual construction budget and prepares an annual capital works plan detailing the various construction projects to be undertaken each year. The taxpayer employs a large fleet of commercial vehicles. All vehicles used by employees in the relevant business units are used, to varying degrees, in undertaking some construction work as part of their normal regular usage. Further, the vehicles may be used on multiple construction projects (either concurrently or successively) as part of their normal regular usage. Whilst the usage of individual vehicles varies, on average, 60% of the overall usage of all commercial vehicles in these two business units is on construction projects and 40% of their overall usage is on operational and maintenance activities. The taxpayer incurs expenditure on various running costs for the relevant commercial vehicles. These running costs include fuel, repairs, maintenance, registration and insurance. For accounting purposes, the taxpayer uses a full absorption costing system (which capitalises the vehicle running costs that relate to the amount of time that the vehicles are used on construction projects) to determine the cost of its self-constructed depreciating assets.

Reasons for decision
Summary: A deduction is allowed under section 8-1 of the ITAA 1997 for losses or outgoings incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, a deduction is not allowed under section 8-1 of the ITAA 1997 to the extent that the loss or outgoing is of a capital nature. The words 'to the extent that' indicate that an expense may be apportioned if it is partly deductible and partly non-deductible: Ronpibon Tin NL & Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; 4 AITR 236 ( Ronpibon ); Ure v. Federal Commissioner of Taxation (1981) 50 FLR 219; 81 ATC 4100; (1981) 11 ATR 484. However, where apportionment is necessary, the method adopted must be 'fair and reasonable' in all the circumstances: Ronpibon . In the present case, the expenditure incurred on vehicle running costs for periods when the relevant vehicles were used on the relevant project is expenditure incurred in gaining or producing assessable income. However, the expenditure will not be deductible to the extent that it is a loss or outgoing of capital or of a capital nature. The decision of the High Court in Sun Newspapers Ltd and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87; (1938) 1 AITR 403 ( Sun Newspapers ) is the leading authority on the distinction between revenue and capital expenditure. The general rule is found in the frequently quoted statement of Dixon J where he said: The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay ... As general conceptions it may not be difficult to distinguish between the profit yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue. In Sun Newspapers , Dixon J stated that there are three matters to be considered when deciding whether expenditure is revenue or capital in nature. These are: The character of the advantage sought by making the outgoing is the chief, if not the critical, factor that distinguishes revenue from capital outgoings: GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1. To a similar end, in Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436, Dixon J said that the distinction between an outgoing of capital and one on account of revenue 'depends upon what it is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured'. When considering the character of expenditure on vehicle running costs, it is appropriate to consider the taxpayer's actual use of the relevant vehicle. For example, expenditure on vehicle running costs may be capital to the extent that the vehicle is used to inspect blocks of land as potential factory sites: Case Q19 83 ATC 68; (1983) 26 CTBR (NS) 545. The fact that expenditure on vehicle running costs is incurred periodically is not determinative. Recurrence is not a test; it is not more than a consideration, the weight of which depends upon the nature of the expenditure: Broken Hill Theatres Pty Ltd v. Federal Commissioner of Taxation (1952) 85 CLR 423; 9 ATD 423; 5 AITR 296; Sun Newspapers . As Pincus and Ryan JJ said in Commissioner of Taxation v. Mount Isa Mines Ltd (1991) 28 FCR 269; (1991) 21 ATR 1294; (1991) 91 ATC 4154 '[i]t happens in many businesses, particularly large ones, that the making of capital expenditure of one sort or another is almost continual'. In the present case, the taxpayer employs a large fleet of commercial vehicles to enable it to undertake construction projects in the continual expansion and upgrade of its distribution network. The vehicles are used, in a systematic manner and as part of their normal regular usage, to construct and upgrade the taxpayer's depreciating assets. The depreciating assets constructed and upgraded when using the relevant vehicles form part of the taxpayer's distribution network (that is, the taxpayer's profit-yielding structure) and result in a benefit of an enduring kind to the taxpayer. For these reasons, to the extent that the expenditure incurred on vehicle running costs for periods when the relevant vehicles were used on the relevant project relates to work undertaken to upgrade or expand the taxpayer's distribution network, the expenditure incurred by the taxpayer on vehicle running costs will be capital in nature. Accordingly, the taxpayer will not be entitled to a deduction under section 8-1 of the ITAA 1997 for this expenditure. As the taxpayer identifies the amount of time each vehicle is used in carrying out activities that relate to the expansion and upgrading of the taxpayer's distribution network for accounting purposes, we consider that, in all the circumstances, it is fair and reasonable to apportion the expenditure incurred on vehicle running costs on a similar basis for the purposes of section 8-1 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 8-1 Subdivision 40-C section 40-30
Case references: Broken Hill Theatres Pty Ltd v. Federal Commissioner of Taxation (1952) 85 CLR 423 9 ATD 306 5 AITR 296
Related ATO interpretative decisions: ATO ID 2011/42 | ATO ID 2011/43
Subject references: Deductions & expenses Capital expenditure Motor vehicle expenses