Private ruling: Expenses - capital or revenue
Ruling period: 1 July 2007 to 30 June 2008
Date scheme commenced: 1 July 2007

Ruling: Q1: Is the cost incurred in purchasing additional water for the purpose of converting Type 2 entitlements to Type 1 entitlements claimable as an expense for taxation purposes under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Is the cost incurred in purchasing additional water for the purpose of converting Type 2 entitlements to Type 1 entitlements capital in nature? | A2: Yes.

Relevant facts and circumstances: You have a water entitlement. The irrigator has two types of water entitlements available to shareholders. Water is allocated every year depending on availability of water in the dams which provide water to this area. Type 1 holders have precedence over Type 2 holders. Type 1 holders receive 100% of their allocation before Type 2 holders receive any allocation. Type 1 holders receive 100% allocation every year but Type 2 holders have received varying allocations over the last 4 years. The irrigator offered water entitlement holders the opportunity to convert Type 2 to Type 1. You have provided a document which describes the scheme, this is to be read with and form part of these facts. As part of the scheme you were required to hand over actual water to the irrigator from your water allocation account. Because of the low allocation in the year you did not have enough water in your account to maximise the amount of entitlement you wanted to convert. It was necessary for you to purchase temporary transfer of water from other users to increase the amount of water in your water allocation account. During the year you participated in two separate conversions and purchased additional water for each conversion. After the conversion you received your new entitlement rights and an amount of actual water was credited to your water allocation account.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 Section 108-5

Reasons for decision: Summary: All legislative references are to the ITAA 1997. Section 8-1 allows a deduction for all losses or outgoings to the extent they are incurred in gaining or producing a taxpayer's assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, deductions are generally not available to the extent that expenditure is capital or private in nature. To determine whether expenditure is of an income or capital nature, the advantage for which the expenditure was incurred must be identified and the manner in which it is to be relied upon or enjoyed must be considered. If incurred to secure an enduring benefit for a taxpayer, the expenditure is generally of a capital nature and is not deductible. A water allocation is a statutory right. It falls within the definition of a CGT asset in section 108-5. The water allocation, as recorded in a taxpayer's water allocation account, is a CGT asset that is separate from the access licence to which it relates. | Detailed Reasoning - Application to your situation: You purchased a quantity of water to increase the volume of water in your water allocation account to enable you to convert your Type 2 entitlement to Type 1 entitlement. By converting your entitlement to Type 1 you would be guaranteed to receive your Type 1 water allocation each year. The advantage sought by the transaction was to provide you with a long term benefit in respect of your water allocation account. The sum paid for the purchase of the additional water allocation is considered a capital expense as it is an expenditure incurred to obtain an enduring benefit. The enduring benefit you received is the ability to convert your Type 2 entitlement to Type 1 entitlement. As the expenditure is capital in nature it is not deductible under section 8-1.

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