Private ruling: Depreciating assets or cost base
Date of advice: 14 November 2017
Published: April 2018
Ruling period: 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Are you entitled to claim depreciation for the capital allowances under Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997). | A1: No | Q2: Are you entitled to claim a deduction for capital works under Division 43 of the ITAA? | A2: No | Q3: Will the cost of the works completed form part of the cost base of the land? | A3: Yes

Relevant facts and circumstances: You carry on a business of primary production. There were dams and channels on the property that supplied water. A pipeline was built and connected to the land. The dams were no longer needed and the dams were levelled and filled in. The cost to have one of the dams filled in was paid for by the business. The additional land is now available for more primary production activities to be undertaken.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 40 | Income Tax Assessment Act 1997 Division 43

Reasons for decision: Summary: The cost to claim filling and levelling the dams is not an allowable deduction under Division 40 or Division 43 of the ITAA 1997. Instead, this capital expenditure forms part of the cost base of the land. | Detailed Reasoning - Detailed reasoning: Deductions for the cost of depreciating assets Section 40-30(1) of the ITAA 1997 defines a depreciating asset is an asset that has a limited effective life and can be expected to decline in value over the time it is used, except: (a) land; or (b) an item of trading stock; or (c) an intangible asset, unless it is mentioned in subsection (2). Under income tax law, you are allowed to claim certain deductions for expenditure incurred in gaining or producing assessable income, for example, in carrying on a business. Land and items of trading stock are specifically excluded from the definition of depreciating asset. For most assets you apply the general depreciation rules unless you’re eligible to use the simplified depreciation for small business. In your case, you advised that the entity carries on a primary production business and completed works as a land improvement which is excluded from the definition of depreciating asset. Therefore the expenditure is not allowable as a deduction under Division 40 of the ITAA 1997. Capital works Division 43 of the ITAA 1997 provides for a system of deduction capital expenditure incurred in the construction of building and other capital works used to produce assessable income. Section 43-20 of the ITAA 1997 recognises three categories of capital works: (a) buildings or extensions, alterations or improvements to buildings; (b) structural improvements or extensions, alterations or improvements to structural improvements and (c) environment protection earthworks. Capital works do not include structural improvements in the form of earthworks described in subsection 43-20(4). Similarly capital expenditure on land (on which the capital works are to be constructed), including clearing, is not part of construction expenditure. These are specifically excluded under section 43-70(2): Construction expenditure does not include: (a) expenditure on acquiring land; or (b) expenditure on demolishing existing structures; or (c) expenditure on clearing, levelling, filling, draining or otherwise preparing the construction site prior to carrying out excavation works; or (d) expenditure on landscaping We consider construction expenditure to include preliminary costs such as foundation excavation expenses and cost of structural features that are an integral part of the income producing structural improvement. Paragraphs 7 - 9 of Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements discusses the expenses that are included in the construction for Division 43 of the ITAA 1997 purposes. Consequently, expenditure incurred in the cost of filling in and levelling the channels and dams does not form part of deductions for capital works for the purposes of Division 43 of the ITAA 1997 purposes. Therefore the application of Division 110 of the ITAA 1997 – cost base and reduced cost base is relevant to your circumstances. Cost base elements There are five elements to the cost base of a capital gains tax (CGT) asset. Subsection 110-25(5) of the ITAA 1997 states: The fourth element is capital expenditure you 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. In your case, the purpose of the filling in of the channels and dams has an expected effect of additional land being made available, where further primary production activities can be conducted. You have incurred capital expenditure that would form part of the cost base of the land.