Private ruling: Development approval costs
Date of advice: 8 December 2016
Published: May 2017
Ruling period: Year ending 30 June 201X | Year ending 30 June 201X | Year ending 30 June 201X
Date scheme commenced: I July 201X

Ruling: Q1: Are you entitled to a deduction for the improvements on council land to the front boundary of the property? | A1: No. | Q2: Do the costs for improvements on council land to the front boundary of the property form part of the fourth element of the cost base? | A2: Yes.

Relevant facts and circumstances: Entity A purchased a property a few years ago. The Council granted a Development Approval (DA) in respect of the property. Part of the property is being resumed by the Council. When approving the DA the Council imposed a number of conditions. One of the conditions was to construct road works and stormwater drainage works in accordance with approved drawings on the land resumed by the Council.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 110-25

Reasons for decision: Summary: Allowable deductions 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 or are necessarily incurred in carrying on a business for the purpose of 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, or a provision of the ITAA 1997 prevents it. A number of significant court decisions have determined that, for an expense to satisfy the tests in section 8-1 of the ITAA 1997: ● it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income producing expense ( Lunney and Hayley v. Federal Commissioner of Taxation (1958) 100 CLR 478; (1958) 7 AITR 166; (1958) 11 ATD 404) ● there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income ( Ronpibon Tin NL and Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; [1949] HCA 15;(1949) 4 AITR 236; (1949) 8 ATD 431); and ● it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income ( Charles Moore and Co (WA) Pty Ltd v. Federal Commissioner of Taxation (1956) 95 CLR 344; (1956) 11 ATD 147 (1956); 6 AITR 379; FC of T v. Cooper (1991) 29 FCR 177; 91 ATC 4396; (1991) 21 ATR 1616; Roads and Traffic Authority of NSW v. FC of T (1993) 43 FCR 223; 93 ATC 4508; (1993) 26 ATR 76; Federal Commissioner of Taxation v. Hatchett (1971) 125 CLR 494; 71 ATC 4184; (1971) 2 ATR 557). The question of whether or not an expense is of a capital or revenue nature depends upon a consideration of the facts and circumstances of each case. The following guidelines for determining whether a loss or outgoing is of a capital nature have been set down by the High Court in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 5 ATD 23; 5 ATD 87; 61 CLR 337: ● the expenditure is related to the business structure itself, that is, the establishment, replacement or enlargement of the profit yielding structure rather than the money earning process, or ● the nature of the advantage has lasting and enduring benefit, or ● the payment is 'once and for all' for the future use of the asset or advantage rather than being recurrent and ongoing. In this case, entity A is incurring costs for road works, drainage and other works done. Such costs are designed to have a lasting benefit and are one off payments. It is considered that the associated expenditure is capital in nature and therefore no deduction is allowable under section 8-1 of the ITAA 1997. Cost base Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset. The property is a CGT asset under section 108-5 of the ITAA 1997. Section 110-25 of the ITAA 1997 provides general rules about cost base. Subsection 110-25(5) of the ITAA 1997 provides that the fourth element of a CGT asset's cost base is capital expenditure incurred: a) the purpose or the expected effect of which is to increase or preserve the asset's value; or b) that relates to installing or moving the asset. ATO Interpretative Decision ATO ID 2012/46 Income Tax Capital Gains Tax: cost base: fourth element of cost base considers the issue of whether an underground power levy paid by a taxpayer forms part of the cost base of the taxpayer's property under subsection 110-25(5) of the ITAA 1997. Whilst the factual situation outlined in ATO ID 2012/46 is different to entity A's case, it is considered that the principles are relevant. As highlighted in ATO ID 2012/46, expenditure incurred for capital improvements to post-CGT land will not be included in the cost base of the land if the capital improvement is considered to be a separate CGT asset. Section 108-70 of the ITAA 1997 outlines when a capital improvement is a separate asset. However the expenditure for road works and other works is not regarded as a separate asset for CGT purposes. For expenditure to be included in the fourth element of the cost base of an asset under subsection 110-25(5) of the ITAA 1997, it must be incurred to enhance the value of the asset, that is, for the purpose of enhancing the value of an asset. It is immaterial whether or not the expenditure in fact enhances the value of the asset. The Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.1) Bill 2006 (the EM), which expanded the scope of subsection 110-25(5) states at paragraph 2.141: The first change is that it is no longer necessary that the purpose of the expenditure be to increase the asset's value. Instead, it is now sufficient that the purpose or expected effect be to increase or preserve the asset's value. An example of expenditure that would now qualify for inclusion in the fourth element would be legal and other expenses incurred to preserve the value of a rental property by opposing a nearby development that would adversely affect the rental property's value. Another example would be the costs incurred in unsuccessfully applying for zoning changes. The costs for the drainage and road works will enhance the overall appearance to the front of the property as well as provide improved drainage to the property. After reviewing the full circumstances surrounding the costs, it is considered that the purpose or expected effect of the expenditure is to increase or preserve the property's value. As such, the expenditure will form part of the cost base of the property under subsection 110-25(5) of the ITAA 1997.