February | 2017 | Thompsons Australia

A taxpayer was recently denied an immediate tax deduction for roof repair and replacement of a rental property because of vermin damage. This ruling is a concise summation for all taxpayers with rental properties assessing the deductibility of large repairs to rental properties

The ATO denied the deduction in the Private Binding Ruling under ITAA 1997 s 25-10 as the repairs were considered “initial repairs”. This was the case even though the property had been owned and rented for a number of years.

This ruling is a concise summation for all taxpayers with rental properties assessing the deductibility of large repairs to rental properties, especially replacements due to structural aspects identified at purchase such as vermin damage. The decision is a good example of the application of Taxation Ruling TR 97/23, which details the ATO approach.

Edited version of ATO written advice in case of rental property “repairs” Authorisation Number: 1013123727436 Disclaimer. Do not use the Register to predict ATO policy or decisions. Date of advice: 15 November 2016

Ruling Subject: Rental repairs.

Question Are you entitled to claim a deduction for removal and replacement of your rental property’s roof as a repair?

Answer No.

Relevant facts and circumstances
You purchased property in 20VV with a settlement date in 20VV.

You have rented this property as an investment property since 20VV.

When purchasing the property you had building inspection and pest inspection reports completed in 20VV with an issue date of 20VV.

Both of these reports advised that vermin damage was identified to the property and recommended to be addressed before acquisition of the property occurred.

The building report advises structural timber pest damage was present to the roof at the time of the inspection and to refer to the pest inspection report.

The pest inspection “Vermin working and/or damage” was found to interior, roof void, trees/stumps and landscaping timbers.

You have since had a pest controller attend the property and treat the house internally for vermin after your acquisition of the property.

The pest controller has also advised that the roof will need to be removed and replaced as well as wall studs, top plates and roof trusses will be required to be replaced during the roof repair and replacement.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Further issues for you to consider

If you have previously claimed deductions for any repairs that were previously identified on the initial building and pest inspection reports, it is highly recommended that you voluntarily lodge amendments for the years claimed and remove these from your income tax returns as you risk your income tax returns being audited and penalties applied.

Reasons for decision

Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to premises used for income producing purposes. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature.

Initial repairs

Taxation Ruling TR 97/23 explains the principles and the circumstances in which expenditure incurred for repairs is an allowable deduction.

Although the word repair is not defined within the taxation legislation, paragraph 13 of TR 97/23 states that a repair means the remedying or making good of defects in, damage to, or deterioration of property.

Paragraph 15 of TR 97/23 goes further to explain that a 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.

TR 97/23 also states that expenditure to remedy defects, damage or deterioration in existence at the date of acquisition is constituted as initial repairs.

Initial repairs are of a capital nature and not deductible

59. Expenditure incurred on an initial repair after property is acquired, if the expenditure is incurred in remedying defects, damage or deterioration in existence at the date of acquisition, is capital expenditure and is not, therefore, deductible under section 25-10. This is so whether the property is purchased or obtained under lease or licence by the taxpayer. The cost of effecting an initial repair is still not deductible even if some income happens to be earned after acquisition but before the repair expenditure is incurred: but see paragraphs 63 to 66 of this Ruling in relation to dissecting or apportioning initial repair costs.

60. The main consideration in relation to initial repairs is the appearance, form, state and condition of the property and its functional efficiency when it is acquired. Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure if the defect, damage or deterioration:

(a) existed at the time of acquisition of the property; and

(b) did not arise from the operations of the person who incurs the expenditure.

61. It is immaterial whether at the time of acquisition the taxpayer was aware of the condition of the property, including its need for repair. It is also immaterial whether the purchase price (or lease rentals) reflected the need for repairs. We consider that the English Court of Appeal decision in Odeon Associated Theatres Ltd v. Jones (Inspector of Taxes) [1972] 1 All ER 681 is not authority in Australia for a contrary view. An initial repair expense is not the type of repair expenditure ordinarily incurred as a working or operating expense in producing assessable income or in carrying on a business. This is because it lacks a connection with the conduct or operations of the taxpayer that produce the taxpayer’s assessable income. It is essentially an additional cost of acquiring the property or an improvement in the quality of the property acquired. Initial repair expenditure relates to the establishment of the profit – yielding structure. It is capital expenditure and is not deductible under section 25-10.

In your case, it is considered that the vermin damage was in existence when you purchased the property. The damage did not occur at a time you held or used the property for an income producing purpose and the work being done to rectify the structural damage made by the vermin is an initial repair and the cost involved is capital expenditure.

Therefore, you are not entitled to a deduction under section 25-10 of the ITAA 1997 for the building work being done on your rental property.

ATO priority on settling cases – but not at any cost

The ATO has advised that it places a high priority on resolving tax disputes early, including through reaching settlements where appropriate, but that it will not settle disputes at any cost. It says “the sensible use of settlements” is part of its commitment to earlier and more effective dispute resolution. In this regard, the ATO has advised that in 2015–2016, it settled 1,362 cases (31% more than in the previous year) and that the increased number of settlements can be attributed entirely to settlements finalised as part of Project DO IT (Disclose Offshore Income Today).
TIP: The ATO’s stated policy of “placing a high priority on resolving disputes early, including through settlements where appropriate” is something that should be kept in mind in any dispute with the Commissioner, whether large or small. A settlement may provide a great opportunity to finalise a difficult or long-running dispute.

ATO develops work-related expenses risk profiles

The ATO has developed work-related expenses risk profiles to help it identify how work-related expense deduction amounts compare for similar taxpayers. The ATO said improvements in data analytics and modelling have allowed it to create a risk profile for tax agents’ practices based on comparing their clients’ work-related expenses claims with those made by similar taxpayers.
The ATO has said it will share these risk profiles with some tax professionals where their clients’ claims appear higher than expected.
TIP: The ATO’s increasing capacity to monitor the often difficult issue of work-related expenses claims means taxpayers and tax professionals need to take care when preparing returns.

Onus on taxpayers to show no fraud or evasion: Full Federal Court

Several taxpayers have been unsuccessful in their appeals to the Full Federal Court in which they challenged tax assessments that dramatically increased their assessable income for certain income years. In each case, the Court confirmed that where the Commissioner of Taxation has issued an amended or default assessment out of time on the grounds of taxpayer “fraud or evasion”, the taxpayer bears the responsibility of proving that such fraud or evasion does not exist.

No disclaimer of trust interest: unsuccessful appeal

A beneficiary of two trusts whose assessable income was increased from some $70,000 to some $13 million in light of her entitlement to distributions from the trusts has been unsuccessful in claiming on appeal that she had “disclaimed her interests” in the trusts. Instead, the AAT found that she could not argue she had disclaimed her interests in the distributions. This finding was on the basis that she did not bring up having made “disclaimers” when she originally objected to amended assessments that the Commissioner of Taxation issued in 2013. Additionally, in any event, the AAT found that the disclaimers were legally ineffective because of the significant period of time between the distributions being made (in 2006 and 2007) and the disclaimers being made (in 2015).
TIP: Any attempt to disclaim an interest in a trust for tax purposes must be legally valid first – and the key consideration is that there must not have been behaviour that indicates implied acceptance of the interest. In this case, the taxpayer’s behaviour was problematic because she did not act until well after she received the distributions and they were assessed as part of her income.

Admin penalties of 75% for failing to lodge FBT returns

The AAT has confirmed that 75% administrative penalties were rightfully imposed on several companies for their failure to lodge FBT returns over a four-year period. The AAT found that the Commissioner of Taxation was obliged to impose a 75% administrative penalty because the FBT returns were not lodged, and that the “safe harbour” provisions did not apply to such an administrative penalty.
The AAT also found that it was not appropriate to exercise its discretion to remit the penalties in part or whole under the circumstances. The AAT relied on the criteria in Practice Statement Law Administration PS LA 2014/4 in arriving at its decision.

New ATO data-matching program: ride-sourcing

The ATO has announced a new data-matching program involving ride-sourcing providers. Under the program, the ATO will acquire data to identify individuals who may be engaged in providing ride-sourcing services during the 2016–2017 and 2017–2018 financial years. Details of all payments made to ride-sourcing providers from accounts held by a ride-sourcing facilitator will be requested from the facilitator’s financial institution for the 2016–2017 and 2017–2018 financial years. The ATO estimates that up to 74,000 individuals (ride-sourcing drivers) offer, or have offered, the services.
TIP: If you work as a driver for Uber or a similar ride-sourcing facilitator, the money you make is assessable income that needs to be included in your tax return. Contact us for more information about how the ATO’s data-matching program may apply to your circumstances.

Taxation ruling on commercial website deductibility

A new taxation ruling from the ATO sets out the tax deductibility of expenditure incurred in acquiring, developing, maintaining or modifying a commercial website for use in carrying on a business.
Broadly, the ruling explains that acquiring or developing a commercial website for a new or existing business is considered to be a capital expense, and is therefore not deductible. On the other hand, maintaining a website, including remedying software faults, is generally a revenue expense, so may be deductible.

Taxation determination on deductions for bad debts: trust beneficiaries and UPEs

In a new tax determination, the ATO states that a beneficiary is not entitled to a bad debt deduction for an amount of unpaid present entitlement (UPE) that the beneficiary purports to write off as a bad debt.
It says this is because the amount of UPE is not included in the beneficiary’s assessable income. Instead, the entitlement is used to determine how much net income of the trust is included in the beneficiary’s assessable income. This means that the the debt amount cannot be included in the taxpayer’s income in that year or in an earlier income year, which is a requirement for writing off a bad debt.

Taxpayer failed to prove that payments were “loans”

In a recent case, the Full Federal Court has found that several taxpayer companies had not discharged the onus of proving that assessments the Commissioner of Taxation issued to them were excessive. The amended assessments took into account income of some $4 million that the Australian companies received from overseas sources. The taxpayers had claimed that the payments were loans.
In allowing the Commissioner’s appeal, the Court majority held that it would not be appropriate to find that the taxpayers had provided the required proof that the payments were genuine loans; in fact, they had made inconsistent or “alternative” arguments about the nature of the payments.

Monthly Archives: February 2017

Large rental repairs determined not deductible to rental property owner