Private ruling: Expenses - other - capital works
Published: April 2014
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2010

Ruling: Q3: Are you entitled to a deduction for legal expenses incurred? Answer No.

Relevant facts and circumstances: In 200X, you purchased a commercial property. The property was tenanted at the time of purchase. In 200X, a large company redeveloped their premises across the road which included changing the intersection on the same corner of your property. You reported safety issues caused by the intersection change and did not receive a response from either Council or Main Roads. Due to the safety issues, the larger of your two tenants relocated to another premises. You then decided to redevelop the premises which included changing the driveway accesses and car parking. This was, at the time, approved by Council as minor works. After construction was complete, the Council decided that the change to the driveway and car park was no longer minor works and considered one particular driveway did not meet safety standards. You disputed the changes at the Council's Planning committee on the basis that the plans were originally approved and that you were in fact addressing safety concerns in undertaking the works. You incurred legal and town planning fees and construction costs in closing the driveway.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1, | Income Tax Assessment Act 1997 Section 25-10 and | Income Tax Assessment Act 1997 Division 43 .

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. Section 25-10 of the ITAA 1997allows a deduction for the cost of repairs to premises used for income producing purposes, to the extent that the expenditure is not capital in nature. Taxation Ruling TR 97/23 provides guidelines on the deductibility of repairs. Generally, a repair involves a restoration of a thing to a condition it formerly had without changing its character. Works can be fairly described as repairs if they are done to make good damage or deterioration of property that has occurred by ordinary wear and tear, by accidental or deliberate damage, or by the operation of natural causes during the passage of time. TR 97/23 indicates that expenditure for repairs to property is of a capital nature where: • the extent of the work carried out represents a renewal or reconstruction of the entirety, or • the work results in a greater efficiency of function in the property, therefore representing an 'improvement' rather than a 'repair', or • the work is an initial repair. In your case, the works to the driveway are considered a reconstruction and are therefore of a capital nature. Capital works Division 43 of the ITAA 1997 provides a deduction for capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to buildings and structural improvements where a property is used for income producing purposes. Construction costs, as defined in subsection 43-70(1) of the ITAA 1997 is capital expenditure incurred in respect of the construction of capital works. Taxation Ruling TR 97/25 explains that construction expenditure includes: • preliminary expenses such as architect fees, engineering fees, foundation excavation expenses and costs of building permits • cost of structural features that are an integral part of the income producing buildings or income producing structural improvements, such as atriums and lift wells, and • some portion of indirect costs. In your case the construction cost incurred in the closing the driveway along with the town planning fees are considered to be construction expenditure for the purposes of Division 43. You are therefore entitled to a capital works deduction for these construction costs. | Detailed Reasoning - Legal expenses: For legal expenses to be considered as allowable deductions, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income ( Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431). The nature of the expenditure must also be considered ( Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436 per Dixon J). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. Expenses as a result of legal action are generally deductible if the expenses arise out of the day to day activities of the taxpayer's business ( Herald & Weekly Times v FC of T 48 CLR 113; 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer's income producing activities ( Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276). However, where the expenditure is devoted to a structural purpose or to gain an enduring benefit, rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible ( Sun Newspapers Ltd v. FC of T (1938) 61 CLR 337; (1938) 5 ATD 87; (1938) 1 AITR 403). In your case, you incurred legal expenses in disputing the Council's "change of mind" on the works you had undertaken on the basis that the works were originally approved by the Council as minor works. It is considered that the legal fees incurred were devoted to a structural purpose, and in relation to a capital asset, and therefore of a capital nature. The legal fees are not deductible under section 8-1 of the ITAA 1997. It is acknowledged that your situation is unfortunate, in that the works were forced upon you due to the Council's turnaround of your original application, however that does not alter the nature of the expenditure as capital in nature.

Question 1: Are you entitled to an outright deduction for all costs incurred? | Question 2: Are you entitled to a capital works deduction for town planning fees and construction costs incurred?