Private ruling: Deduction for repairs or capital works
Published: September 2011
Ruling period: Financial year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q4: Is the taxpayer entitled to a deduction under section 8-1 of the ITAA 1997 for each item of work listed as immediately deductible in Attachment C? Yes

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. The hotel was originally built in the late 1800's. Sometime in 20XX, there was extensive flooding in the area where the hotel is located and was subject to significant flooding. As a consequence, significant work has been done so the hotel can re-open and continue with its operations. The taxpayer provided some photographs of the damage to the hotel. The taxpayer provided a quote from a lifts company to repair water damage to the lift. The taxpayer advised that the work to be undertaken in respect of the lift will only repair the water damage to the lift and is not the equivalent of a new lift being installed. The taxpayer engaged the services of a firm of quantity surveyors and construction cost consultants (consultant), to provide an itemised estimate of the cost of work to be done to the hotel to restore it to a similar condition prior to the flood. The consultant provided a detailed breakdown of the work required and an estimated cost. The taxpayer advised that the estimated costs provided by the consultant does not represent the cost of any future renovations or change of use of any component of the hotel, but is limited to the extent of damage to the main hotel and the adjacent restaurant. The taxpayer provided a list of items for consideration as repairs under section 25-10 of the ITAA 1997. The taxpayer provided a list of items for consideration as capital works under Division 43 of the ITAA 1997. The taxpayer provided a list of items for consideration as replacement assets, which will be capitalised and depreciated under Division 40 of the ITAA 1997; and items which are immediately deductible under section 8-1 of the ITAA 1997.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 25-10 | Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 Division 40 | Income Tax Assessment Act 1997 Division 43

Reasons for decision: Summary: Section 8-1 of the ITAA 1997 allows a deduction for a loss or outgoing to the extent that it is incurred in gaining or producing the assessable income. Section 25-10 of the ITAA 1997 allows a deduction for expenditure on repairs to premises or depreciating assets that are held or used solely for the purpose of producing assessable income. Section 8-10 of the ITAA 1997 provides a rule against double deductions. If expenditure on repairs is potentially deductible under both sections 25-10 and 8-1 of the ITAA 1997, section 8-10 of the ITAA 1997 provides that you can deduct only under the legislative provision that is most appropriate. Expenditure on capital assets will not be deductible under section 8-1 of the ITAA 1997 because such capital expenditure is excluded from deductibility under paragraph 8-1(2)(a). Often, capital expenditure on an existing asset will reach beyond the concept of a repair for the purposes of section 25-10 of the ITAA 1997 because it constitutes an improvement or entails the replacement of an entirety. In such cases, the expenditure will often comprise an extension, alteration or improvement to a capital work, and hence, give rise to a construction expenditure area for the owner. In general terms, a deduction can be claimed in respect of an amount of capital expenditure on capital works: section 43-10 of the ITAA 1997. The relevant kinds of capital works are broadly categorised under three headings in section 43-20 of the ITAA 1997 as follows: · Buildings; · Structural improvements; and · Environment protection earthworks. A deduction is allowable under Division 40 of the ITAA 1997 for the decline in value of depreciating assets. Taxation Ruling TR 97/23 Income Tax: deduction for repairs provides the following: Paragraph 12 states that: In its context in section 25-10 of the ITAA 1997, the word 'repairs' relates to work done to 'premises (or part of premises), plant, machinery, tools or articles'. The word 'repairs' appeared in a similar context in the old law. While the things specified in the section cover a wide range of property, they do not extend to all classes of property, e.g., intangible property. Paragraph 13 states that: 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. Paragraph 15 states that: 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. Paragraph 16 states that: 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 of the ITAA 1997. Paragraph 17 states that: 'Repairs', in its context in section 25-10 of the ITAA 1997, is directed to the holding or use of property for income purposes. Under the old law, the property had to be 'held, occupied or used' for income purposes. Holding or use of property for this purpose indicates that, 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. Paragraph 21 states that: What is a 'repair' for the purposes of section 25-10 of the ITAA 1997 is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property. Paragraph 25 states that: The expenditure must not be of a capital nature, e.g., an improvement. Paragraph 33 states that: The cost of replacing things such as free-standing stoves, refrigerators and furniture in premises used for income purposes is capital expenditure and is not deductible under section 25-10 of the ITAA 1997. Note, however, that these items, if they are not permanent fixtures, are plant on which depreciation is allowable. Paragraph 34 states that: The cost of replacing items such as locks and exhaust fans, which are permanent fixtures installed in premises used for income purposes, is deductible as a repair under section 25-10 of the ITAA 1997, provided it is a replacement of a worn out unit by a new unit of a similar design that simply restores its efficiency of function and is not an improvement, as set out in Case S27 (1966) 17 TBRD 163; (1966) 13 CTBR (NS) Case 56 . 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. 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. 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. Paragraph 164 provides an example and states that: Elle Bashful uses her truck for income producing purposes. She replaces the truck's worn out petrol engine with a diesel engine with a much greater economy of operation. The engine is not an entirety but a subsidiary part of truck. However, the costs relate to an improvement of the truck because the replacement of the engine involved a significantly greater efficiency in the truck's function. The engine is a major and important part of the truck and is a new and better engine with considerable advantages over the old one, including the advantage that it reduces the likelihood of future repair bills. The costs are of a capital nature and are not deductible under section 25-10 of the ITAA 1997. A deduction for depreciation under section 42-15 of the ITAA 1997 may be allowable. Paragraphs 165, 166 and 167 provide an example and state that: Mr Fermier and Mr Agricola are neighbouring farmers affected by a severe bushfire. Mr Fermier restores his existing fencing to good condition by mending it and replacing damaged sections, e.g., the fence on the northern boundary. Mr Agricola replaces the entire fencing surrounding his property. Mr Fermier is entitled to claim a deduction for the cost of repairing his fencing under section 25-10 of the ITAA 1997. The entirety is the total fencing so replacing the fences on the northern boundary is a replacement of a subsidiary part of the whole fencing. However, Mr Agricola's expenditure is not deductible under section 25-10 of the ITAA 1997 because the whole fencing was replaced, making it a reconstruction of the entirety. The total fencing is not a subsidiary part of the rural property or of anything else. To replace entire fencing with new fencing is to replace one capital asset with another capital asset. The cost is therefore of a capital nature. Mr Agricola's fences are depreciable 'plant' under paragraph 42-18(1)(c) of the ITAA 1997 or the former subparagraph 54(2)(b)(i) of the ITAA 1936, and are deductible under section 42-15 of the ITAA 1997. Paragraph 170 provides an example and states that: Mr P Bowser owns a service station that is not connected to mains power supply. He has meters and a pumping plant to supply power to the service station. He has to replace both the meters and the pumping plant due to their old age. The meters and the pumping plant are entireties in their own right, separate and distinct from the service station. Their replacement is not a repair and the cost is not deductible under section 25-10 of the ITAA 1997. | Detailed Reasoning - Conclusion: A deduction for repairs for each item of work listed in Attachment A, submitted by the taxpayer for consideration under section 25-10 of the ITAA 1997 is allowed. A deduction for capital works for each item of work listed in Attachment B, submitted by the taxpayer for consideration under Division 43 of the ITAA 1997 is allowed. A deduction for the decline in value of the replacement assets listed in Attachment C, submitted by the taxpayer for consideration under Division 40 of the ITAA 1997 is allowed. A deduction for the items listed as immediately deductible in Attachment C, submitted by the taxpayer for consideration under section 8-1 of the ITAA 1997 is allowed.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Question 1: Is the taxpayer entitled to a deduction for repairs under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) for each item of work listed in Attachment A? | Question 2: Is the taxpayer entitled to a deduction for capital works under Division 43 of the ITAA 1997 for each item of work listed in Attachment B? | Question 3: Is the taxpayer entitled to a deduction for the decline in value of the replacement assets listed in Attachment C under Division 40 of the ITAA 1997? | Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. | If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. | For more information on Part IVA, go to our website www.ato.gov.au and enter 'Part IVA general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.