Private ruling: Deductibility of expenses
Date of advice: 27 April 2022
Published: July 2022
Ruling period: Income year ended 30 June XXXX
Date scheme commenced: 1 July XXXX

Ruling: Q1: Are the relevant expenses incurred by the taxpayer deductible under section 8-1 of the Income Tax Assessment Act 1997 ( ITAA 1997< ) or section 25-10 of the ITAA 1997? | A1: No

Relevant facts and circumstances: 1. The taxpayer is a private company which entered into a lease agreement for a property as a lessee to use as its business premises. 2. At the beginning pf the lease, the taxpayer undertook various renovations ( the renovations ) to the property before occupying it. 3. After 7 years, the taxpayer terminated the lease and moved out of the property. 4. Under a clause of the lease agreement entitled ' Make Good' , the tenant must, by the date the tenancy ends: • remove all its chattels, fixtures, other property and all rubbish from the premises; • restore the premises alterations back to the condition upon commencement of the lease; • repair and replace floor coverings including carpets; • remove external signage and make good any damage caused by erection and subsequent removal of such signage; • restore the ceiling to open plan layout including lighting layout and air conditioning duct layout; and • leave the premises clean and tenantable. 5. Prior to the end of the tenancy, the taxpayer incurred expenses to ' make good ' the property as per the condition of the lease ( the relevant expenses ). Specifically, the relevant expenses were incurred in engaging two separate contractors to perform the following works: • strip the office kitchen partitions and washroom cupboards to the original layout at start of lease; • replace the cupboards to the original layout at the start of the lease; • remove the blinds to windows (fixtures); • reinstall glass/ timber/plaster partitions which were removed by the renovations; • replace small patches of damaged carpet due to moving of the office furniture; • remove the external signage; and • return the altered ducts and lighting panels on the ceiling from the renovations to their original positions at the start of the lease. 6. The office kitchen partitions and washroom cupboards, fixtures (blinds to windows), external signage and the ducts and lighting panels on the ceiling were not damaged, or in a state of disrepair, prior to the termination of the lease. 7. There were no requests from the owner to perform any routine repairs to the premises. With the exception of the renovations, the taxpayer did not undertake any works other than those to which the relevant expenses relate.

Relevant legislative provisions: Income Tax Assessment Act 1997I Section 8-1 | Income Tax Assessment Act 1997 Section 25-10

Reasons for decision: Summary: In determining the question of whether the relevant expenses are deductible to the taxpayer, the Commissioner has considered the application of both section 8-1 and section 25-10. In this regard, it is noted that section 8-10 of the ITAA 1997 provides a rule against double deductions. The effect of this is that, as per paragraph 7 of Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23): "... If expenditure on repairs is potentially deductible under both sections 25-10 and 8-1, section 8-10 provides that you can deduct only under the provision that is most appropriate. Which provision is the most appropriate is an objective question. In our view, if both sections 25-10 and 8-1 allow you to deduct the same amount, section 25-10, being the provision that deals specifically with repair expenditure, is the most appropriate provision." | Detailed Reasoning - Section 25-10: Section 25-10 pertains specifically to expenditure on repairs and provides as follows: 25-10(1) You can deduct expenditure you incur for repairs to premises (or part of premises) or a * depreciating asset that you held or used solely for the * purpose of producing assessable income. Property held or used partly for that purpose 25-10(2) If you held or used the property only partly for that purpose, you can deduct so much of the expenditure as is reasonable in the circumstances. No deduction for capital expenditure 25-10(3) You cannot deduct capital expenditure under this section...." TR 97/23 explains the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10 of the ITAA 1997. Paragraphs 67 and 68 of TR 97/23 provide that a taxpayer can incur expenditure on repairs to property that the taxpayer does not own: "67. A taxpayer is entitled to a deduction under section 25-10 for expenditures for repairs to property they hold for income purposes, even though the taxpayer does not own the property ... 68. A lessee of business premises, for example, is entitled to a deduction under section 25-10 for repair expenditure incurred in a year of income during the term of the lease if the lessee held etc the premises for income purposes when the expenditure is incurred." Therefore the relevant expenses may be deductible under section 25-10 notwithstanding that the taxpayer does not own the property, so long as the relevant works are in the nature of repairs. Work that is not strictly in the nature of repairs, but is more in the nature of maintenance work, may also be classed as repair work where it is done in conjunction with repair work. In this respect, paragraph 6 of TR 97/23 provides: "... Repairs may include some maintenance work but only if it is done in conjunction with work that is a repair. Repairs may not involve only maintenance work ..." Paragraph 13 to 16 of TR 97/23 explains the ordinary meaning of a repair and what it consists of: "13. The word 'repairs' 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. 14. Work done to prevent or anticipate defects, damage or deterioration (in a mechanical or physical sense) in property is not in itself a 'repair' unless it is done in conjunction with remedying or making good defects in, damage to, or deterioration of, the property. 15. ... 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. ... If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10." In respect of the distinction between repair and either renewal or reconstruction, paragraph 36 of the TR 97/23 provides as follows. 36. 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. In this case, the work undertaken was in essence a replacement in entirety of the features and conditions of the property as they existed after the renovations. This work was performed in order to restore the premises alterations back to the condition that existed upon commencement of the lease as per the terms of the lease agreement. The work involved substantial alterations to the property including the following: Viewed as a whole, the works do not amount to ' repairs '. The broader purpose for which the works were undertaken was not for ' 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)' , given that the items removed, replaced or altered were for the most part not damaged or in a state of disrepair ; but was, rather, borne directly from the obligation arising under the lease agreement to reinstate, in its entirety, the condition and appearance of the premises at the commencement of the lease and prior to the renovations conducted by the taxpayer. As such, the fundamental character of the works is that of a reconstruction or replacement of the property to restore it, as a whole , to its original condition. This is distinguishable from a repair which - whilst encompassing replacements of subsidiary parts of a whole - does not include the restoration of the entirety (see paragraph 36 of TR 97/23). It follows that section 25-10 does not apply. | Detailed Reasoning - Section 8-1: Section 8-1 provides as follows: 8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a * business for the purpose of gaining or producing your assessable income ... 8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your * exempt income or your * non-assessable non-exempt income; or (d) a provision of this Act prevents you from deducting it. It is recognised that, while not deductible as ' repairs ' under section 25-10, expenditure on work that is in the nature of maintenance alone (rather than repairs, or maintenance work that is not conducted in conjunction with repairs) may in some circumstances be deductible under section 8-1. As per paragraph 20 of TR 97/20: "20. ... Other kinds of maintenance work, such as oiling, brushing or cleaning something that is otherwise in good working condition and only requires attention to prevent the possibility of its going wrong in the future, are not 'repairs' in terms of the section. Expenditure on the latter kind of maintenance work may be an allowable deduction under section 8-1." However, the works conducted cannot be described as ' maintenance ', being more in the nature of a reconstruction in its entirety of the premises as they appeared at the beginning of the lease. Taken as a whole, the works undertaken are in the nature of capital, and the relevant expenses, being expenses to which they relate, are more appropriately classed as capital expenditure. In this respect, TR 97/20 provides as follows: 32. Expenditure for repairs to property is capital expenditure if any of the following subparagraphs applies: (a) The guidelines for distinguishing between capital and revenue outgoings laid down by the courts for the purposes of the forerunners of section 8-1 in such cases as Sun Newspapers Ltd v. FC of T (1938) 61 CLR 337; (1938) 5 ATD 87 and Hallstroms Pty Ltd v. FC of T (1946) 72 CLR 634; (1946) 8 ATD 190 indicate that the expenditure is incurred in establishing, replacing or enlarging the profit-yielding (i.e., business) structure rather being a working or operating expense (see also paragraphs 111 and 134 of this Ruling). (b) The expenditure, rather than being for work done to restore the property by renewal or replacement of subsidiary parts of a whole, is for work that is a renewal in the sense of a reconstruction of the entirety (see paragraph 114 of this Ruling for what is meant by an 'entirety'). The application of this distinction depends very much on what, in the circumstances of the case, is properly considered to be the relevant entirety (see also paragraph 115 of this Ruling). (c) If property bought for use as a capital asset in the buyer's business is not in good order and suitable for use in the way intended, expenditure incurred in putting it in order suitable for use is part of the cost of its acquisition and is of a capital nature (see also paragraphs 59 to 66 and 125 to 140 of this Ruling). As discussed above, the work done in this case is not a renewal or replacement of subsidiary parts of a whole. Rather it is a reconstruction of the entirety of the premises as they existed prior to the renovations. The relevant expenses form part of the overall cost incurred by the taxpayer to put the premises in a condition suitable for its use in the operation of its business; that is, the expenses incurred to make structural changes suitable for the business included both the costs of the renovation as well as the costs of returning the premises to its former condition. This are capital expenses within the meaning of paragraph 8-1(2)(a). Therefore, they are not deductible under section 8-1. Hence, the relevant expenses cannot be deducted by the taxpayer under section 25-10 or section 8-1 of the ITAA 1997.

The reinstatement of the glass/timber/plaster partitions which were removed at the beginning of the lease. | When the ceiling of the premises were first altered, ducts and lighting panels were moved to positions where they would suit the needs of the business. The works returned these to their original positions. | The manufacture and installation of washroom cupboards, kitchen cabinets and the kitchen bench to the original look when the property was first leased. | Blinds to the windows (which were not damaged or in a state of disrepair) were removed. | Minor patches of carpet that were damaged were replaced. | The external sign was removed.