Private ruling: Deductions - business and professional expenses
Date of advice: 23 April 2024
Published: 3 June 2024
Ruling period: 1 July 2021 to 30 June 2022 | 1 July 2022 to 30 June 2023 | 1 July 2023 to 30 June 2024
Date scheme commenced: 1 July 2021

Ruling: Q1: Are the expenses deductible under section 25-10 of the Income Tax Assessment Act 1997 ? | A1: Yes.

Relevant facts and circumstances: 1. The Landlords are the owners of the Property. 2. The Landlords have leased the Property to the Tenant. 3. The lease of the Property is governed by the Lease Agreement. 4. On XX February 2022, the Property was flooded and suffered substantial damages. 5. The expenses incurred to bring the Property back to its former state were substantial. Assumptions 6. The Tenant has legal responsibility to replace or repair the items damaged by the flood.

Relevant legislative provisions: Section 25-10 of the Income Tax Assessment Act 1997

Reasons for decision: Detailed Reasoning - Repairs: 7. Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to the property used for income producing purposes. However, expenses which are capital, or of a capital nature are not deductible as repairs or maintenance. 1. Taxation Ruling 97/23 Income tax: deductions for repairs (TR 97/23) highlights the Commissioner's view on the deductibility of repairs. 2. TR 97/23 at paragraph 13 states: The word 'repair' has its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property. 3. TR 97/23 at paragraph 15 and 16 states: 15. Repair for the most part is occasional and partial. It involves restoration of the efficiency of function of the property being repaired without changing its character and may include restoration to its former appearance, form, state or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. Works can fairly be described as 'repairs' if they are done to make good damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes (whether expected or unexpected) during the passage of time. 16. To repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10. 4. TR 97/23 at paragraph 17 states: ... in determining whether work done to property constitutes 'repairs', it is more significant to consider whether the work restores the efficiency of function of the property without changing its character than it is to consider whether the appearance, form, state or condition of the property is exactly restored. 5. A minor degree of improvement, addition or alteration can be a repair, however, if substantial, it is not a repair (rather it is an improvement) and not immediately deductible under section 25-10 of ITAA 1997. 6. TR 97/23 at paragraph 35 states: If work done goes beyond 'repair' and the whole cost is capital expenditure, no amount is allowable as a deduction under section 25-10 for 'notional' repairs, i.e., an amount it is estimated that repair work would have cost the taxpayer if the property had in fact merely been repaired... 7. TR 97/23 at paragraph 36 states: Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal or reconstruction, as distinguished from repair, is restoration of the entirety. | Detailed Reasoning - Entirety: 8. Property is more likely to be an entirety, as distinct from a subsidiary part, if as stated in TR 97/23 paragraph 38: • the property is separately identifiable as a principal item of capital equipment; or • the thing or structure is an integral part, but only a part, of entire premises and is capable of providing a useful function without regard to any other part of the premises; or • the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves; or • the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law. 9. Property is more likely to be a subsidiary part rather than an entirety if, as stated in TR 97/23 paragraph 39: • it is an integral part of some larger item of plant; or • the property is physically, commercially and functionally an inseparable part of something else. | Detailed Reasoning - Improvements: 10. Paragraph 44 of TR 97/23 highlights the difference between a repair and an improvement. An improvement is any works that improve something beyond its original state, in providing greater efficiency of function, significantly improving the value of the property or equipment, extend its expected working life, and/or enhancing its income-producing ability. 11. Paragraph 89 states that: It is therefore more significant in applying the word 'repairs' in its context in section 25-10 of the ITAA 1997, to consider whether the work restores the efficiency of function of the property for income purposes (without changing its character) than it is to consider whether the appearance, form, state or condition of the property is exactly restored. 12. Paragraph 123 states that: What is determinative of deductibility under section 25-10 of the ITAA 1997, if different material is used, is whether the work done restores the efficiency of function of the property (without changing its character), not whether the same material as the original is used. We accept that use of different material may result in a minor and incidental degree of improvement in the property but still only restore the efficiency of function of the property. If the degree of improvement is more than minor and incidental, the expenditure is of a capital nature and not deductible under section 25-10 of the ITAA 1997. 13. Paragraph 144 states that: Section 25-10 of the ITAA 1997 requires that you 'incur' expenditure for repairs for it to be deductible. For this purpose, the word 'incur' in section 25-10 of the ITAA 1997 has the same meaning as that given by the courts to the word 'incurred' in subsection 51(1) of the ITAA 1936, as evidenced in Case Q48 (1965) 15 TBRD 229. Broadly stated, to be 'incurred' there needs to be a presently existing pecuniary obligation in relation to the repairs that has become due, but not necessarily payable, at that time. The taxpayer must be definitively committed to the expenditure. | Detailed Reasoning - Application to your circumstances: 14. You have advised the Tenant holds the legal obligation to make good the damage caused by the flood and has incurred the expenditure for the listed items. 15. The expenditure was incurred to bring the Property back to its former state and does not improve the assets. 16. The Commissioner accepts that a deduction would be allowed for repairs for the listed items under section 25-10 of the ITAA 1997.