Private ruling: Special council levy
Published: October 2014
Ruling period: Income year ended 30 June 2015 | Income year ended 30 June 2016 | Income year ended 30 June 2017 | Income year ended 30 June 2018 | Income year ended 30 June 2019
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the special levy raised by the local council be deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) if at the time of incurring the expense the relevant property is used for income producing purposes? | A1: No | Q2: Will the special levy raised by the local council be deductible under section 43-10 of the ITAA 1997 if at the time of incurring the expense the relevant property is used for income producing purposes? | A2: No | Q3: Will the special levy raised by the local council be included in the fourth element of the cost base under section 110-25 of the ITAA 1997? | A3: Yes

Relevant facts and circumstances: You have a beachfront property. Your local council is constructing a rock wall on the esplanade some metres away from the boundary of your property. State legislation allows the council to raise a special levy against your property where it deems you will receive a special benefit. The council has deemed that your property will receive a special benefit from the construction of the rock wall. The rock wall will be constructed on state land. The levy is estimated to be $x per annum over 10 years, or potentially the council may allow a lump sum payment of $X. You intend to rent this property out.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 43-10 | Income Tax Assessment Act 1997 section 110-25

Reasons for decision: Summary: Section 8-1 of the ITAA 1997 allows a deduction for losses and outgoings to the extent that they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate the earning of exempt income. A deduction may be claimed under section 8-1 of the ITAA 1997 for expenses that are relevant and incidental to the production of rental income derived by a landlord or lessor ( Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 78 CLR 47 at p 56) The question of whether an outgoing is "incidental and relevant" to the gaining or producing of assessable income is resolved by asking whether the occasion of the outgoing is to be found in what is expected to provide assessable income ( Fletcher & Ors v FC of T 91 ATC 4950 at p 4957; Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431 at pp 435-436; (1949) 78 CLR 47 at pp 56-57). The expense must also have the essential character of a ``business'' or ``income-producing'' expense (Charles Moore & Co (WA) Pty Ltd v FC of T (1956) 95 CLR 344). The decision of McLennan v Federal Commissioner of Taxation 90 ATC 4047 (McLennan) considered the deductibility of a levy paid by a group of cane farmers to raise funds to construct a weir. The decision refers to the passage set out by Dixon J. in Sun Newspapers Ltd. V Federal Commissioner of Taxation (1938) 61 CLR 337: There are, I think three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future sue or enjoyment. In relation to the first of these factors, Hill J. notes at 90 ATC 4055, that: It is obvious that levies under the Primary Producers Organisation and Marketing Act 1926-1981 (Qld), whatever the particular purpose of the levy may be, form part of the ordinary or constant demands which must be answered out of the returns of the trade of a cane grower, just like rates, water levies and the like and are rather of the character of recurrent expenditure than expenditure made once and for all for the purpose of obtaining an advantage of an enduring nature… On the particular facts of McLennan, the full Federal Court held that the levy was deductible, as the character of the benefit obtained from paying the levy was not that of a new income-producing asset, and was part of the ordinary or constant demands which must be answered out of the returns of the trade of a cane grower" (at 1780-5). In addition, Hill J. notes (at 4055): …That the application of a rigid test will not necessarily provide the right solution. "It is a common sense appreciation of all the guiding features which must provide the ultimate answer. " The process is one of balancing all of the considerations looking at the matter from "a practical and business point of view". | Detailed Reasoning - Application to your circumstances: In this case, the relevant assessable income will be earned by you through rental income. The rock wall is intended to protect homes that run along the beach front from erosion caused by the ocean. It is considered that the facts of the present case can be distinguished from those in McLennan. In relation to the levy to fund the rock wall, it is considered that the character of the advantage sought and the manner, in which it is to be used, is that of a lasting benefit, that does not directly contribute to the means by which you earn the relevant assessable income (renting out the property). In terms of the means adopted to obtain the rock wall, the levy is payable by a series of annual payments plus interest or a one off payment. Even if paid in annual payments, it is considered that this would not give the payment a recurrent character, but rather that the annual payments would be instalments of the total lump sum figure. As the character of the benefit obtained from paying the levy was not part of the 'ordinary or constant demands which must be answered 'out of the returns of renting the property, the levy is not considered to be incidental and relevant to earning the relevant assessable income and will not be deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Capital Works Deductions: Section 43-10 of the ITAA 1997 provides that you can deduct an amount for capital works for an income year if: a) The capital works have a construction expenditure area; and b) There is a pool of construction expenditure for that area; and c) You use your area in the income year in the way set out in Table 43-140 (Current year use). Note 2 to section 43-10 of the ITAA 1997 provides that amongst other things, the definition of 'your area' ensures that only owners and certain lessees of capital works, and certain holders of quasi-ownership rights over land on which capital works are constructed, can deduct an amount under this Division. As a capital works deduction is only available to construction expenditure incurred on land where the person has an ownership interest, and the rock wall will be constructed entirely on State land, you are not entitled to a deduction for the levy under section 43-10 of the ITAA 1997. | Detailed Reasoning - Inclusion in the Cost Base: Section 110-25 of the ITAA 1997 deals with the cost base of a CGT asset. Subsection 110-25(5) 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 ATOID 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. The decision concludes that the levy will form part of the fourth element of the cost base of the property if the purpose or the expected effect of the expenditure is to increase or preserve the property's value. Whilst the factual situation is slightly different in the present case, it is considered that the same principles can be applied: Subsection 110-25(5) of the ITAA 1997 provides that the fourth element of the cost base of a CGT asset is that capital expenditure incurred to increase the asset's value. 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. As neither of subsection 108-70(1) or section 108-60 of the ITAA 1997 apply in relation to the cabling it is not a separate asset for CGT purposes. Subsection 108-70(1) of the ITAA 1997 does not treat the cabling as a separate asset because none of the balancing adjustments contained in section 108-55 of the ITAA 1997 apply to it. Section 108-60 of the ITAA 1997 will not apply in this case as the cabling is not a depreciating asset that is part of a building. 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. | Detailed Reasoning - Application to present case: As noted above, 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. It is therefore necessary to consider whether the rock wall in the present case is considered a separate CGT asset. Section 108-70 of the ITAA 1997 deals with when a capital improvement is considered to be a separate asset. Subsection 108-70(1) provides that a capital improvement to land is taken to be a separate CGT asset from the land if one of the balancing adjustment provisions set out in subsection 108-55(1) applies to the improvement; that is, if a balancing adjustment under Subdivision 40-D or section 355-15 or 355-525 applies to the building or structure. As none of the balancing adjustments in subsection 108-55(1) apply to the rock wall, it is not treated as a separate CGT asset. As also noted above, 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. 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 construction of the rock wall is intended to protect beachfront properties in that area from erosion and other damage from the ocean. In the present case, similar to the underground cabling in ATOID 2012/46, and in light of the examples sighted in the EM above, it is considered that the purpose or expected effect of the expenditure on the levy to fund the rock wall is to increase or preserve the property's value. As such, the levy paid by you will form part of the cost base of your property under subsection 110-25(5) of the ITAA 1997.