Private ruling: Environmental Protection Activities and asbestos
Published: April 2012
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014.
Date scheme commenced: 1 July 2011.

Ruling: Q1: Is the taxpayer entitled to a deduction under section 40-755 of the ITAA 1997 for expenditure referenced as Item 1? | A1: Yes - but only to the extent the expense relates to replacing Areas x-z. | Q2: Is the taxpayer entitled to a deduction under section 40-755 of the ITAA 1997 for expenditure referenced as Item 2? | A2: Yes - but only to the extent the expense relates to replacing Areas x-z. | Q3: Is the taxpayer entitled to a deduction under section 40-755 of the ITAA 1997 for expenditure referenced as Item 3? | A3: No. | Q4: Is the taxpayer entitled to a deduction under section 40-755 of the ITAA 1997 for expenditure referenced as Item 4? | A4: No. | Q5: Is the taxpayer entitled to a deduction under section 40-755 of the ITAA 1997 for expenditure referenced as Item 5? | A5: Yes | Q6: Is the taxpayer entitled to a deduction under section 40-755 of the ITAA 1997 for expenditure referenced as Item 6? | A6: Yes | Q7: Is the taxpayer entitled to a deduction under section 40-755 of the ITAA 1997 for expenditure referenced as Item? | A7: No.

Relevant facts and circumstances: The taxpayer is engaged in producing product and purchased a site in which to expand its operations. On that site is a number of existing buildings. They will also be undertaking redevelopment work to allow them to use the site to produce their assessable income. In order to meet relevant environmental laws the taxpayer had to undertake an asbestos risk survey. A report was produced that detailed the asbestos risks the site posed (a copy of which was provided). The taxpayer decided to undertake work which would result in asbestos being removed from w areas within the buildings on the site. In areas d-f repairs to broken items would also be made and additional features would be added while the work is in progress. Area g would have the items containing asbestos removed and replaced Areas l and m would have all the items containing asbestos removed but they would not all be replaced. The cost of the work was broken down over a number of items, k of which are the subject of this ruling. A copy of the tender documents and contract drawings were provided.

Relevant legislative provisions: ITAA 1997 section 25-10 | ITAA 1997 subsection 40-755(1) | ITAA 1997 subsection 40-755(2) | ITAA 1997 subsection 40-755(3) | ITAA 1997 section 40-760 | ITAA 1997Division 43 | ITAA 1997 subsection 43-20(1) | ITAA 1997 section 43-40

Reasons for decision: Summary: Section 40-755 of the ITAA 1997 only applies in respect of the work being undertaken in Areas x-z As substantial work in being undertaken to parts of Areas a-f beyond the removal of asbestos section 40-755 of the ITAA 1997 will not apply to that work. | Detailed Reasoning - Legislation: Section 40-755 of the ITAA 1997 allows deductions for environmental protection activities and subsection 40-755(1) states: You can deduct expenditure you incur in an income year for the sole or dominant purpose of carrying on *environmental protection activities Subsection 40-755(2) of the ITAA 1997 defines what constitutes environmental protection activities and states: Environmental protection activities are any of the following activities that are carried on by or for you: (a) preventing, fighting or remedying: (i) pollution resulting, or likely to result, from *your earning activity; or (ii) pollution of or from the site of your earning activity; or (iii) pollution of or from a site where an entity was carrying on any *business that you have acquired and carry on substantially unchanged as your earning activity; (b) treating, cleaning up, removing or storing: (i) waste resulting, or likely to result, from your earning activity; or (ii) waste that is on or from the site of *your earning activity; or (iii) waste that is on or from a site where an entity was carrying on any business that you have acquired and carry on substantially unchanged as your earning activity. No other activities are environmental protection activities. Subsection 40-755(3) of the ITAA 1997 defines what constitutes your earning activity and states in part: Your earning activity is an activity you carried on, carry on, or propose to carry on: (a) for the *purpose of producing assessable income for an income year (except a *net capital gain); . . . Section 40-760 of the ITAA limits deductions from environmental protection activities. Paragraph 40-760(1)(c) of the ITAA 1997 denies a deduction for expenditure that is 'capital expenditure for constructing an extension, alteration or improvement to a building, structure or structural improvement'. In addition subsection 40-760(2) of the ITAA 1997 states: In particular, you cannot deduct under section 40-755 expenditure to the extent that you incur it on carrying out an activity for environmental impact assessment of your project. Therefore for section 40-755 of the ITAA 1997 to apply: · the expenditure must be in respect of environmental protection activities · the environmental protection activities must be connected to the entity's earning activity · the sole or dominant purpose is the carrying on of those environmental protection activities; and · section 40-760 of the ITAA 1997 does not deny the deduction. | Detailed Reasoning - Environmental protection activities: Paragraph 27 of Taxation Ruling TR 97/23 Income Tax: deductions for repairs states: An example of expenditure that is not deductible as a repair is the cost of removing asbestos insulation from factory walls (if the insulation is not in need of repair) and replacing it with modern insulation material. This work does not constitute the rectification of a defect in a mechanical or physical sense as envisaged by section 25-10. The asbestos insulation functions efficiently as insulation. It is being replaced because of the health risk it might pose to factory occupants, not to 'repair' the factory in the ordinary sense of the word. The costs, if incurred on or after 19 August 1992, are deductible under subsection 82BK(1) of the ITAA 1936 as allowable environmental protection expenditure. Example 2 in paragraph 163 of TR 97/3 expands on paragraph 27 and states: By January 1997, Widgets Pty Ltd has used a building for a manufacturing plant for many years. Widgets Pty Ltd discovers on testing for contaminants that insulation in the roof and walls contains dangerous levels of asbestos fibres. The contaminated insulation had been placed in the building by the previous owner. The company immediately set about removing the insulation and replacing it with a safe alternative. Expenditure incurred by Widgets Pty Ltd in removing and replacing the insulation is not a 'repair' and not deductible under section 25-10. However, because the expenditure is incurred entirely for an environment protection activity, namely, removing pollution from a site on which the company carries on its income producing activities (subparagraph 82BM(1)(a)(ii) of the ITAA 1936), it is deductible under subsection 82BK(1) of that Act. The expenditure is not in respect of constructing an improvement to the building so subsection 82BN(1) of that Act does not preclude a deduction under the environment protection provisions. Subsection 82BK(1) of the ITAA 1936 has since been replaced by section 40-755 of the ITAA 1997 but it is clear from paragraphs 27 and 163 of TR 97/23 that actions undertaken in respect of the removal of asbestos will be the preventing, fighting or remedying of pollution. | Detailed Reasoning - Environmental protection activities must be connected to the entity's earning activity: In this case the work is being done at a site the taxpayer intends to use to expand existing operations Therefore the site will be used as part of the existing income producing activity. | Detailed Reasoning - Sole or dominant purpose is the carrying on of those environmental protection activities: In respect of a sole or dominant purpose the reasons for decision in ATO Interpretative Decision ATO ID 2004/44 Income Tax Capital Allowances: environmental protection activities - septic tank system states in part: . . .The term sole or dominant purpose is not defined for the purpose of subsection 40-755(1) of the ITAA 1997. Former section 82BK of the Income Tax Assessment Act 1936 (ITAA 1936) was repealed and ultimately replaced with section 40-755 of the ITAA 1997. The Explanatory Memorandum to the Taxation Laws Amendment Act (No. 5) 1992 (the EM), which introduced former section 82BK of the ITAA 1936, provides guidance in interpretation of section 40-755 of the ITAA 1997. It stated that: Expenditure will only be for the sole or dominant purpose of carrying on an eligible environment activity if it is primarily directed to that environment protection activity. A deduction will not be available if the protection of the environment is only a residual or subsidiary purpose of the taxpayer. The EM used the following example to clarify this explanation: ...suppose a taxpayer who operated a dump covers it with soil and plants it with grass and trees at the end of its life. This might have the dual purposes of protecting the environment by preventing noxious substances leaching out and beautifying the site to improve its resale value. If the landscaping is primarily to improve the resale value of the site it will not be deductible as allowable environment protection expenditure. Where environmental protection expenditure is incurred for two or more purposes (for example protecting the environment as well as improving the resale value of the site), it is necessary to establish the dominant purpose of that expenditure. In this case in acquiring the site the taxpayer has to be compliant with numerous laws including environmental . To do this they commissioned an asbestos report and then called for tenders to carry out. However the site is also being modified for use in their business activities. The question is whether or not the intended work is being undertaken to remove asbestos or is part of the modifications . Based on the information provided the work is being done in areas of the building that would not impact on the income producing activities. Therefore it is accepted that the dominant purpose for deciding to undertake the work is the removal and replacement of the asbestos. | Detailed Reasoning - Section 40-760 of the ITAA 1997 does not deny the deduction: In this case the activities are being undertaken on six locations on buildings. Because of the wording of paragraph 40-760(1)(c) of the ITAA 1997 we have to look at the impact to the buildings the work being undertaken may have. In undertaking the work there are two phases the partial destruction followed by a reconstruction. If this reconstruction results in an extension, alteration or improvement to any of the buildings then section 40-760 if the ITAA 1997 will deny a deduction under section 40-755 of the ITAA 1997 for that reconstruction. However given the nature of the work we can eliminate the end result being an extention to a building and only need to look at whether the work is an alteration or an improvement. If the work is an is an alteration or an improvement then the work will more than likely be capital expenditure to which Division 43 of the ITAA 1997 applies and if Division 43 of the ITAA 1997 applies then section 43-40 of the ITAA 1997 may also apply in respect of the destruction of Areas 1-6 . The wording in subsection 43-20(1) of the ITAA 1997 which says 'This division applies to capital works being a building, or an extention, alteration or improvement to a building' is similar to that contained in section 40-760 of the ITAA 1997. Although it is looking at repairs versus capital expenditure TR 97/3 provides advice on the circumstances where work goes beyond a repair and become capital expenditure. The rationale contained in TR 97/3 could equally apply in the application of section 40-760 of the ITAA 1997 when determining if the work has resulted in an extension, alteration or improvement to a building. In respect of a building and capital expenditure paragraph 42 of TR 97/23 states: Work done to a part of a building, though not amounting to a replacement or reconstruction of an entirety, may still be capital expenditure and not deductible, for example, because it amounts to an improvement: see (1953) 4 CTBR (NS) Case 9 and paragraphs 44 to 57 of this Ruling for the distinction between a repair and an improvement. In this case we need to look at the work being undertaken on each area to determine if section 40-760 if the ITAA 1997 will apply to that work. The work in Areas 1 to 3 is effectively the same in all three building and can be examined together. However this is not the case in respect of the work on the other three areas so these will need to examined separately. | Detailed Reasoning - Areas a to f: As stated in the Asbestos Management Plan the material which has asbestos was present in one part of Areas a to f. As explained in both paragraphs 27 and 28 of TR 97/3 had the work been limited to the removal and replacement of the parts containing asbestos then section 40-755 of the ITAA 1997 would have applied to allow a deduction. However additional work is being undertaken on other parts of Areas a to f that does not contain asbestos and what we need to determine if that work results in an extension, alteration or improvement to the Area (and by extention to the building itself), or is deductible elsewhere within the ITAA 1997. The tender documents state that whilst replacing the parts containing asbestos other broken parts should also be replaced. However the works table suggests that all of these other parts are going to replaced not just the broken ones. Normally the replacement of broken parts is a repair deductible under section 25-10 of the ITAA 1997. However section 25-10 of the ITAA 1997 does not apply to capital expenditure and repairs undertaken when a property is acquired are considered to be capital expenditure. In respect of this paragraphs 125 to 128 of TR 97/23 states: A repair after acquisition of property is an 'initial repair' if repair was due when the property was acquired, in the sense that there was a need for repair to restore or maintain the property's efficiency of function. In other words, the property was neither in good order when it was acquired nor suitable for use for income purposes in the way intended. The leading Australian case in this area is the High Court decision in the Thomas case. There, Windeyer J held that the costs of repairing a roof, guttering, wall, basement floor and wooden floor and painting a building in the year of income it was acquired was expenditure of a capital nature. His Honour said (at 115 CLR 72; 14 ATD 87): 'Expenditure upon repairs is properly attributable to revenue account when the repairs are for the maintenance of an income-producing capital asset. Maintenance involves the periodic repair of defects that are the result of normal wear and tear in operation. It is an expense of a revenue nature when it is to repair defects arising from the operations of the person who incurs it. But if when a thing is bought for use as a capital asset in the buyer's business it is not in good order and suitable for use in the way intended, the cost of putting it in order suitable for use is part of the cost of its acquisition, not a cost of its maintenance . The decision of the Court of Session in Law Shipping Co. Ltd. v. Inland Revenue Commissioners, [(1923) 12 TC 621] is commonly cited as authority for that proposition. The principle is obvious without the need for any supporting authority.' (emphasis added) His Honour made it clear that it is immaterial whether the taxpayer knew of the defects or whether the purchase price was affected by them. Windeyer J said (at 115 CLR 74; 14 ATD 88): 'It seems to me immaterial that when the taxpayer acquired the building it did not know of some of its defects ... . That means only that the cost of obtaining an asset suitable for its purpose was greater than had been expected.' Given the fact that the taxpayer purchased the site and needs to redevelop it to use it to produce assessable work that would normally have been repairs is considered to be capital expenditure to which section 25-10 of the ITAA 1997 would not apply during that redevelopment. Although dealing with repairs, paragraphs 44 and 46 of TR 97/23 state: The meaning of 'repair' or 'repairs' is considered in paragraphs 12 to 30 of this Ruling. In the case of a 'repair', broadly speaking, the work restores the efficiency of function of the property without changing its character. An 'improvement', on the other hand, provides a greater efficiency of function in the property - usually in some existing function. It involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. Some factors that point to work done to property being an improvement include whether the work will extend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life. To distinguish between a 'repair' and an 'improvement' to property, one needs to consider the effect that the work done on the property has on its efficiency of function. This is the determinative test. If the work entails the replacement or restoration of some defective, damaged or deteriorated part of the property, one does not focus on the effect the work has on the efficiency of function of the part . That is not determinative of whether the property is repaired or improved. It is a relevant factor to take into account, however, in considering the effect of the work on the property's efficiency of function . It is possible, for instance, that the replacement of a subsidiary part of property with a part better in some ways than the original is a repair to the property without the work being an improvement to the property. Fixing the broken parts will improve the 'efficiency of function' of Areas a to f and because it is being undertaken as a result of acquiring the site and redeveloping it the repairs will be initial repairs which is capital expenditure that results in an improvement to each of the buildings. This would also extend to a decision to relace all the parts rather than just the broken ones as the end result will overall improve the 'efficiency of function' of each Area. In addition the contract drawing shows that two new features will be added. Paragraph 16 of TR 97/23 states: 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. By adding these features the work has gone beyond remedying of the asbestos pollution as detailed in the asbestos management report and has altered that part of the building. This work could not be seen as an incident of removing the asbestos it is an intentional redesign of the Areas and is an addition to what was there when the site was purchased. For section 40-760 of the ITAA 1997 to apply we need to look at the overall effect the work on the Areas have on the building and the end result of this work is an alteration and/or an improvement to the Areas. Therefore section 40-760 of the ITAA 1997 will apply in respect of the work being undertaken on Areas 1 to 3 to deny a deduction under section 40-755 of the ITAA 1997. | Detailed Reasoning - Areas x-z: Unlike Areas a-f the entirety of Areas x-z contain asbestos so the removal and replacement of these Areas with different material would be in line with the example in paragraph 27 of TR 97/3. Area g is being fully reconstructed and the functionality is being fully restored. This cannot be seen as an alteration or improvement and in line with paragraph 27 of TR 97/3 the demolition and reconstruction costs would be deductible under section 40-755 of the ITAA 1997. However in the case of Areas l and m not all of items are being replaced, so the work on these Areas needs to be examined separately to see what effect (if any) the decision not to fully reconstruct the Areas has on functionality. In respect of Area j, the nature of the work shows the functionality of the Area is returned to the level it was before the work began. It cannot be said that omission of some parts will results in an alteration or an improvement to Area j and therefore the demolition and reconstruction costs would be deductible under section 40-755 of the ITAA 1997. In Area k a large part of the area will not be replaced. This will have an effect on functionality by removing the function in that part of Area k altogether. The function has been altered but is as a result of an act of omission rather than a removal and then a substitution. The work being undertaken is the removal and replacement of the asbestos. A choice was made to not undertake a full replacement of those items that contain asbestos and there is no other 'construction' work being undertaken to the Area. Had the asbestos been replaced in its entirety then section 40-755 of the ITAA 1997 of the ITAA 1997 would apply to that expense. Although it is arguable that an alteration has been made because the loss of functionality has altered the nature of the building itself, common sense would suggest that a partial replacement of the items containing asbestos would equally be deductible under section 40-755 of the ITAA 1997. Otherwise the alternative would be for the taxpayer to incur additional expenditure in replacing all the asbestos with non-asbestos items for section 40-755 of the ITAA 1997 to apply and then incur the cost of removing the items they don't need. In this case any resulting alteration is an incident of the asbestos removal rather than the construction of an alteration in the way in which the function of Areas a-f were altered. Therefore based on the fact that the items being removed and replaced all contain asbestos section 407-55 of the ITAA 1997 will apply even though functionality has been effected. | Detailed Reasoning - Work items 1 and 2: The Explanatory Memorandum, to the Taxation Laws Amendment Act (No. 5) 1992 which introduced former subsection 82BM(2) of the ITAA 1936, provides guidance on the deductibility of associated work: Expenditure for the sole or dominant purpose of carrying on an eligible environment activity is only deductible to the extent that it is in respect of that activity. Expenditure for the dominant purpose of carrying on an eligible environment protection activity will be apportioned so that only that portion of the expenditure on the eligible environment protection activity will be deductible [New paragraph 82BL(1)(b)]. For example, a company buys a polluted site for a manufacturing plant. The company tests for contaminants across the whole site and finds one quarter of it is polluted. It removes all the contaminated soil, leaving a large hole. It then brings in fresh soil to fill in the hole and also to level the rest of the site, which is slightly uneven. The cost of testing for contaminants and removing the contaminated soil will be fully deductible. These expenditures are for the sole or dominant purpose of cleaning up waste, an eligible environment activity, and are incurred entirely for that activity. The dominant purpose of bringing in fresh soil to the site is to fill in the hole where there was contamination. This is part of the waste clean-up. However, a part of this expenditure was on soil to level the rest of the site. The expenditure on bringing in fresh soil is allowable environment expenditure only to the extent that it is for the purpose of filling the hole where there was contamination. Items 1 and 2 do not directly relate to asbestos removal, as they occur before the work begins. In looking at preliminary expenses Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements, it is the Commissioner's view (as explained in paragraph 9) that preliminary expenses are part of the construction expenditure. Therefore the preliminary costs that relate to the work on Areas a to f would not be deducible under section 40-755 of the ITAA 1997 as the work itself is not deductible under section 40-755 of the ITAA 1997. However a deduction is allowable under section 40-755 of the ITAA 1997 to the extent that the preliminary costs under item 1 and 2 apply to Areas x-z.

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