ATO ID 2007/88: Capital allowances: business related costs - limitation to deduction - cost of depreciating asset
Date of decision: 6 February 2007
Year of income: Year ended 30 June 2007
Business line: Public Groups and International

Issue
Is the taxpayer's deduction under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997) for capital expenditure they incurred in relation to their business limited to any extent by paragraph 40-880(5)(a) of the ITAA 1997?

Decision
No. The taxpayer's deduction under section 40-880 of the ITAA 1997 for capital expenditure they incurred in relation to their business is not limited to any extent by paragraph 40-880(5)(a) of the ITAA 1997 because the expenditure does not form part of the cost of a depreciating asset that they hold, used to hold or will hold.

Facts
The taxpayer conducts a bus charter business as a sole trader. They carry on that business wholly for a taxable purpose. Based on photographs and information provided by the seller, the taxpayer paid a holding deposit on a second hand-bus to replace an older bus being used in the taxpayer's business. The second-hand bus was located in another State. The taxpayer incurred capital expenditure on an airfare to travel to where that bus was located so as to take delivery of the bus and drive it back to where their business is carried on. The taxpayer also incurred capital expenditure on having new tyres fitted to the bus in anticipation of driving it back to their place of business. After inspecting the bus, the taxpayer decided not to continue with the purchase. The taxpayer subsequently purchased a return airfare back to their place of business. While the taxpayer had their deposit refunded, they decided to leave the new tyres fitted to the second-hand bus because it was not worth their time, effort and cost of removing and returning the new tyres and finding other replacement tyres. The original tyres had been discarded when the new tyres were fitted. The taxpayer's capital expenditure was incurred 'in relation to your business' for the purpose of paragraph 40-880(2)(a) of the ITAA 1997 and the taxpayer's deduction for that expenditure under section 40-880 of the ITAA 1997 is not limited under subsection 40-880(3) of the ITAA 1997. The expenditure was incurred on or after 1 July 2005.

Reasons for decision
Summary: Subsections 40-880(5) to 40-880(9) of the ITAA 1997 set out limitations and exclusions to deductibility under section 40-880 of the ITAA 1997. In particular, paragraph 40-880(5)(a) of the ITAA 1997 provides that you cannot deduct anything under section 40-880 of the ITAA 1997 for an amount of expenditure you incur to the extent that it forms part of the cost of a depreciating asset that you hold, used to hold or will hold. While the taxpayer's incurrence of capital expenditure on the airfare to inspect the bus was an integral step in the process of seeking to hold the second-hand bus, the taxpayer did not hold the bus at any stage and will never hold it. The deduction the taxpayer is otherwise entitled to under section 40-880 of the ITAA 1997 for their capital expenditure on the airfare is, therefore, not excluded by paragraph 40-880(5)(a) of the ITAA 1997. The capital expenditure on the return airfare to the taxpayer's place of business was incurred as a consequence of the taxpayer's decision on inspection not to purchase the second-hand bus. If the taxpayer had continued with the purchase of the second-hand bus the return airfare would not have been purchased. In other words, the expenditure was only incurred because the taxpayer did not hold the bus and will never hold the bus. As such, the deduction the taxpayer is otherwise entitled to under section 40-880 of the ITAA 1997 for their capital expenditure on the return airfare is, therefore, not excluded by paragraph 40-880(5)(a) of the ITAA 1997. Subsection 40-30(4) of the ITAA 1997 states that whether a particular composite item is itself a depreciating asset or whether its components are separate depreciating assets is a question of fact and degree which can only be determined in the light of all the circumstances of the particular case. How taxpayers determine that question is discussed in paragraph 1.15 of the revised explanatory memorandum for the New Business Tax System (Capital Allowances) Bill 2001. That paragraph states: Taxpayers will be required to exercise judgement in identifying the depreciating asset where the asset is made up of different parts and components. In doing this, the 'functionality' test that is used as a basis of identifying a 'unit of plant' in the existing plant depreciation rules can be used. (Specific reference to a 'unit' or an 'item' is not necessary to attract the test, as the definition of a depreciating asset is based on a life in effective use, and the depreciating asset must be identifiable as having its own life in such use.) The 'functionality' test has been applied in such cases as Ready Mixed Concrete (Vic) Pty Ltd v. FC of T 69 ATC 4038; (1969) 1 ATR 123, FC of T v. Tully Co-operative Sugar Milling Assoc Ltd 83 ATC 4495; (1983) 14 ATR 495, Monier Colourtile Pty Ltd v. FC of T 84 ATC 4846; (1984) 15 ATR 1256, Case S51 85 ATC 380; 28 CTBR (NS) Case 57 , and Case T33 86 ATC 293; 29 CTBR (NS) Case 35 . In this case it is considered that the bus is the composite item and is itself the relevant depreciating asset. The tyres which the taxpayer paid for and had fitted to the bus are a component of this depreciating asset and are not themselves separate depreciating assets in this case for the purpose of Division 40 of the ITAA 1997. The bus tyres as a set or individually are not functionally complete in themselves. They perform their function only as part of the bus. Accordingly, the taxpayer's expenditure on the bus tyres is not expenditure which forms part of the cost of a depreciating asset that they hold, used to hold or will hold because they do not hold, have not held and will not hold the bus to which the tyres were fitted. The deduction the taxpayer is otherwise entitled to under section 40-880 of the ITAA 1997 for their capital expenditure on the bus tyres is not excluded by paragraph 40-880(5)(a) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 40-880 subsection 40-30(4) subsection 40-880(5) paragraph 40-880(5)(a) subsection 40-880(6) subsection 40-880(7) subsection 40-880(8) subsection 40-880(9)
Case references: Ready Mixed Concrete (Vic) Pty Ltd v. FC of T 69 ATC 4038 (1969) 1 ATR 123
Related public rulings and determinations: Taxation Determination TD 2002/5
Related ATO interpretative decisions: ATO ID 2007/87 | ATO ID 2007/89
Other references: Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001
Subject references: Blackhole expenditure Capital Allowances CoE Capital expenditure Depreciating assets First element cost