Private ruling: Deductibility of expenditure
Published: October 2013

Ruling: Q1: Will the expenditure incurred on refurbishing the asset form part of the cost of a depreciating asset for the purposes of Subdivision 40-C? | A1: Under Division 40, a deduction may be allowable over time for the cost of a depreciating asset that a taxpayer holds. Key elements of the operation of Division 40 are the identification of a 'depreciating asset' and the holder of the asset. Is the asset a depreciating asset? Whether or not the asset is a depreciating asset depends on whether it falls within the definition in subsection 40-30(1) (Note 1 to subsection 40-30(3)). Subsection 40-30(1) defines a depreciating asset as an asset that has a limited effective life and can reasonably 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 40-30(2). Therefore, the asset will be a depreciating asset if it satisfies all of the following conditions: · it is an asset; · it has a limited effective life; · it can reasonably be expected to decline in value over the time it is used; and · it is not land, an item of trading stock or an intangible asset that is not mentioned in subsection 40-30(2). In the present case it is considered that the asset satisfies all of the above conditions. Does the taxpayer hold the asset? Broadly, section 40-25 provides a deduction for the decline in value of a depreciating asset a taxpayer holds to the extent the asset is used for a taxable purpose. The table in section 40-40 identifies a holder of a depreciating asset in any particular circumstance. Item 3 of the table identifies the holder of a depreciating asset that is an improvement to land subject to a quasi-ownership right. Item 3 provides that for: An improvement to land (whether a fixture or not) subject to a quasi-ownership right (including any extension or renewal of such a right) made, or itself improved, by any owner of the right for the owner's own use where the owner of the right has no right to remove the asset The owner of the quasi-ownership right holds the depreciating asset while the right exists. Further, paragraph 1.42 of the revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 explains that: Where the owner of the quasi-ownership right improves the land with a depreciating asset, or improves a depreciating asset that is itself an improvement to land, and where that improvement is for their own use but they cannot remove that asset from the land, they are nonetheless the holder while their quasi-ownership right exists. A quasi-ownership right over land is defined in subsection 995-1(1) to include any right, power or privilege over the land, or in connection with the land. The right owned by the taxpayer (the mining lease) to extract the mineral deposit is a quasi-ownership right over the land. The asset, which is an improvement to land, cannot be removed from the land by the taxpayer. Therefore, the taxpayer satisfies the requirements in item 3 of the table in section 40-40 and is, therefore, the holder of the asset for the purposes of Division 40. Does the expenditure form part of the cost of the asset? The cost of a depreciating asset consists of both the first and second elements (section 40-175). The first element of cost is worked out as at the time when the taxpayer began to hold the depreciating asset. Generally, the first element of cost is the amount paid, or taken to have been paid, to hold the asset (sections 40-180 and 40-185). As the expenditure incurred on refurbishing the asset was incurred after the taxpayer started to hold the asset, the expenditure cannot form part of the first element of the cost of the asset. Therefore, it is necessary to consider whether the expenditure forms part of the second element of the cost of the asset. The second element of cost is worked out after the taxpayer has started to hold the depreciating asset. This element includes economic benefits which contribute to bringing the asset to its present condition and location (section 40-190). Paragraphs 2.71 to 2.74 of the Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 ('the EM') provide guidance on what is included in the second element of the cost of a depreciating asset: 2.71 The second element of a depreciating asset's cost is essentially what was paid for economic benefits that contribute to its present condition and location from time to time. This is worked out at any time after the taxpayer began to hold the asset [Schedule 1, item 1, subsections 40-190(1) and (2)]. When taxpayers need to know the asset's cost, they work out what it has cost them to that point to bring the asset to its current condition and location from time to time - that may include costs of bringing the asset to a condition or location which has since been changed. (Emphasis added) What is an 'economic benefit'? 2.72 An economic benefit is a thing of value that can be measured in money. However, the benefit does not need to be capable of being converted into money. Economic benefits can be assets, services or some combination of both. They are the things added or used up to bring the asset to its location or condition from time to time. Second element expenses need not increase the actual market value of a depreciating asset, but ordinarily will (because they will generally be improvements). (Emphasis added) What is present condition and location? 2.73 An asset's 'condition' refers to its general form, state or order. This condition is represented by all of the economic benefits embodied in the asset. The second element of cost for depreciating assets includes all payments for economic benefits that are embodied in a depreciating asset (e.g. improvements but not repairs deductible under section 25-10 of the ITAA 1997 and refer also to paragraph 2.88). (Emphasis added) 2.74 The second element of cost will also include transportation costs that bring the asset to its present location (from time to time). These paragraphs indicate that the second element of the cost of a depreciating asset is the amount a taxpayer is taken to have paid for economic benefits which contribute to bringing the asset to its present condition or location. That is, it is only necessary for one of these requirements to be met. This view is supported by Example 1 to section 40-190 which provides that payments made for economic benefits which contribute to the present condition of a depreciating asset are included in the second element of the cost of that asset. Example 1 to section 40-190 relevantly states: Example 1: Andrew adds a new tray and canopy to his ute. The materials and labour that go into the addition are economic benefits that Andrew received and that contribute to the ute's present condition. The payments he makes for those economic benefits are included in the second element of the ute's cost. At the time the asset started to be held by the taxpayer it was in a state of disrepair and significant work was required to make the asset safe and compliant with current legislative safety requirements. The expenditure incurred on refurbishing the asset contributed to the improved condition of the asset. Therefore, the expenditure incurred on refurbishing the asset will form part of the second element of the cost of the asset. Accordingly, the expenditure forms part of the cost of the depreciating asset for the purposes of Subdivision 40-C. | Q2: Will the decline in value of the asset be the cost of the asset under subsection 40-80(1)? | A2: Subsection 40-25(1) provides a deduction for the decline in value of a depreciating asset a taxpayer holds during an income year. Relevantly, subsection 40-80(1) provides that the decline in value of a depreciating asset is the asset's cost if, among other things: · the taxpayer first uses the asset for 'exploration or prospecting' for minerals obtainable by mining operations (paragraph 40-80(1)(a)); and · when the taxpayer first uses the asset, they do not use it for operations in the course of working a mining property (subparagraph 40-80(1)(b)(ii)). In the Commissioner's view the taxpayer's first use of the asset would not only be considered to be not for 'exploration or prospecting' for the purposes of paragraph 40-80(1)(a) but also would be considered to be 'operations in the course of working a mining property' for the purposes of subparagraph 40-80(1)(b)(ii). The set of factual circumstances would at best give the totality of the refurbishment of the asset a dual purpose. If such dual purposes are present, a deduction calculated by reference to subsection 40-80(1) is not available. Therefore, the expenditure on refurbishing the asset, as periodic additions to the second element of cost of that depreciating asset, would not be available for immediate deduction under subsection 40-25(1) by applying subsection 40-80(1). | Q3: Will the refurbishing expenditure be deductible under section 40-730? | A3: Relevantly, section 40-730 allows an immediate deduction for certain capital expenditure incurred on exploration or prospecting for minerals obtainable by mining operations. Subsection 40-730(4) provides an inclusive definition of 'exploration or prospecting'. Subsection 40-730(3) excludes expenditure from deduction under section 40-730 to the extent that it forms part of the cost of a depreciating asset. As the expenditure incurred on refurbishing the asset forms part of the second element of the cost of the depreciating asset, the expenditure is excluded from deduction under section 40-730 by subsection 40-730(3). The refurbishment expenditure is also not incurred on activities of the type or akin to those described in subsection 40-730(4). | Q4: Will the refurbishing expenditure be deductible under section 40-830? | A4: Section 40-830 provides a deduction for certain capital expenditure associated with projects. Qualifying 'project amounts' are allocated to a project pool and are deducted over the life of the project from the first income year when the project starts to operate. The meaning of 'project amount' is contained in section 40-840. Under paragraphs 40-840(1)(a) and 40-840(2)(a) expenditure which forms part of the cost of a depreciating asset cannot be a project amount for the purposes of section 40-840. As the expenditure incurred on refurbishing the asset forms part of the second element of the cost of the asset it cannot be a project amount within the meaning in section 40-840 and is not deductible under section 40-830. | Q5: Will the refurbishing expenditure be deductible under section 40-880? | A5: Section 40-880 allows certain business capital expenditure to be deducted in equal proportions over five income years if the expenditure is not otherwise taken into account or denied a deduction under another provision. Paragraph 40-880(5)(a) provides that you cannot deduct anything under section 40-880 for an amount of expenditure you incur to the extent that it forms part of the cost of a depreciating asset that you hold, used to hold or will hold. The expenditure incurred on refurbishing the asset forms part of the second element of the cost of the depreciating asset. Therefore, the expenditure is excluded from deduction under section 40-880 by paragraph 40-880(5)(a). Issue 2: Initial and on-going expenditure | Q6: Will the expenditure (initial and on-going) be deductible under section 8-1? | A6: A deduction is allowed under section 8-1 for losses or outgoings to the extent that the loss or outgoing is incurred in gaining or producing assessable income, or is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, a deduction is not allowed under the section where the loss or outgoing is of a capital, private or domestic nature, it is incurred in producing exempt income, or where another provision prevents a deduction. In the present circumstances the initial expenditure is considered to be of a capital nature and is therefore excluded from deduction under section 8-1 by paragraph 8-1(2)(a). However, the on-going expenditure is considered to be on revenue account and is therefore deductible under section 8-1. | Q7: Will the expenditure form part of the cost of the depreciating asset for the purposes of Subdivision 40-C? | A7: As discussed at Question 1 in Issue 1, the cost of a depreciating asset consists of both the first and second elements (section 40-175). Under section 40-220 the cost of a depreciating asset is reduced by any portion of it that consists of an amount that is not of a capital nature. As the on-going expenditure is not capital expenditure it will not form part of the cost of the asset. However, the question arises as to whether the initial expenditure incurred, which is considered capital expenditure, forms part of the cost of the asset. The initial expenditure incurred by the taxpayer was incurred after it started to hold the asset. As the first element of cost is worked out as at the time when the taxpayer began to hold the depreciating asset, it follows that in this case the initial expenditure incurred by the taxpayer cannot form part of the first element of the cost of the asset. Therefore, it is necessary to consider whether the initial expenditure forms part of the second element of the cost of the asset. The second element of cost is worked out after the taxpayer has started to hold the depreciating asset. This element includes economic benefits which contribute to bringing the asset to its present condition and location (section 40-190). Based on the information provided to the Commissioner it is considered that the initial expenditure does not form part of the cost of the depreciating asset for the purposes of Subdivision 40-C. | Q8: Will the expenditure be deductible under section 40-730? | A8: As section 40-730 only applies to capital expenditure, the on-going expenditure is not deductible under this provision. Therefore, only the initial expenditure, which is considered capital expenditure, needs to be considered under section 40-730. Under paragraph 40-730(2)(b) expenditure on operations in the course of working a mining property, quarrying property or petroleum field is not deductible under section 40-730. It is considered that that taxpayer's initial expenditure is 'expenditure on operations in the course of working a mining property' for the purposes of paragraph 40-730(2)(b) and not expenditure on activities of the type or akin to those described in subsection 40-730(4). Therefore, the initial expenditure is not deductible under section 40-730. | Q9: Will the expenditure be deductible under section 40-830? | A9: Relevantly, under subparagraph 40-840(1)(c)(i) an amount of 'mining capital expenditure' is a project amount if it is directly connected with carrying on the mining and quarrying operations in relation to which the expenditure is incurred. The meaning of 'mining capital expenditure' is contained in section 40-860. It includes capital expenditure a taxpayer incurs in carrying on mining and quarrying operations and in preparing a site for those operations. Under paragraph 40-840(1)(b) expenditure which is deductible under another provision outside of Subdivision 40-I cannot be a project amount. As the on-going expenditure is deductible under section 8-1, that expenditure is not a project amount and is not deductible under section 40-830. However it is considered that the initial expenditure is a project amount under subparagraph 40-840(1)(c)(i) and is therefore deductible under section 40-830. | Q10: Will the expenditure be deductible under section 40-880? | A10: Paragraph 40-880(5)(b) provides that you cannot deduct anything under section 40-880 for an amount of expenditure you incur to the extent that you can deduct an amount for it under a provision other than section 40-880. As the on-going expenditure and initial expenditure are both deductible under other provisions of the ITAA 1997 they are excluded from deduction under section 40-880 by paragraph 40-880(5)(b).


Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1. | Income Tax Assessment Act 1997 Division 40. | Income Tax Assessment Act 1997 Subdivision 40-C. | Income Tax Assessment Act 1997 Subdivision 40-I. | Income Tax Assessment Act 1997 section 40-25. | Income Tax Assessment Act 1997 subsection 40-25(1). | Income Tax Assessment Act 1997 subsection 40-30(1). | Income Tax Assessment Act 1997 subsection 40-30(2). | Income Tax Assessment Act 1997 subsection 40-30(3). | Income Tax Assessment Act 1997 section 40-40. | Income Tax Assessment Act 1997 subsection 40-80(1). | Income Tax Assessment Act 1997 paragraph 40-80(1)(a). | Income Tax Assessment Act 1997 subparagraph 40-80(1)(b)(ii). | Income Tax Assessment Act 1997 section 40-175. | Income Tax Assessment Act 1997 section 40-180. | Income Tax Assessment Act 1997 section 40-185. | Income Tax Assessment Act 1997 section 40-190. | Income Tax Assessment Act 1997 section 40-220. | Income Tax Assessment Act 1997 section 40-730. | Income Tax Assessment Act 1997 paragraph 40-730(2)(b). | Income Tax Assessment Act 1997 subsection 40-730(3). | Income Tax Assessment Act 1997 subsection 40-730(4). | Income Tax Assessment Act 1997 section 40-830. | Income Tax Assessment Act 1997 section 40-840. | Income Tax Assessment Act 1997 paragraph 40-840(1)(a). | Income Tax Assessment Act 1997 paragraph 40-840(1)(b). | Income Tax Assessment Act 1997 subparagraph 40-840(1)(c)(i). | Income Tax Assessment Act 1997 paragraph 40-840(2)(a). | Income Tax Assessment Act 1997 section 40-860. | Income Tax Assessment Act 1997 section 40-880. | Income Tax Assessment Act 1997 paragraph 40-880(5)(a). | Income Tax Assessment Act 1997 paragraph 40-880(5)(b). | Income Tax Assessment Act 1997 subsection 995-1(1).


Ruling: All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.