Capital Allowances: deposit paid for improvement before depreciating asset held - second element of cost

Does capital expenditure incurred by a taxpayer, before they become the holder of a depreciating asset, on a deposit paid to secure the supply of goods and services that will improve the asset once it is held, form part of the second element of cost of the asset under subsection 40-190(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. As the economic benefit (that is, the goods and services) was supplied after the taxpayer began to hold the depreciating asset and has contributed to its present condition, the expenditure incurred forms part of the second element of cost under subsection 40-190(2) of the ITAA 1997.

The taxpayer paid a deposit to secure the supply of goods and services required to modify an imported motor vehicle so it can be used in Australia. The deposit was paid before the taxpayer began to hold the asset which was to be modified. The actual modification work took place after the taxpayer had begun to hold the vehicle. The balance of the payment was paid once the modification to the motor vehicle was completed. The company that was contracted to conduct the modifications is unrelated to the taxpayer and the supplier of the vehicle.

The cost of a depreciating asset consists of both the first and second elements (section 40-175 of the ITAA 1997).

The first element of cost is worked out at the time you begin to hold the 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 of the ITAA 1997).

The fact that the expenditure on the deposit was not directed at holding the asset and was not reflected in the condition of asset at the time it was acquired, precludes it from being a first element of cost.

The second element of cost is worked out after you have begun to hold the asset and includes the amount you are taken to have paid for economic benefits that have contributed to bringing the asset to its present condition and location (section 40-190 of the ITAA 1997).

The supply of goods and services is an economic benefit. The deposit was paid to secure the performance of an economic benefit that would bring the depreciating asset to a certain condition after it was held. Although the deposit was paid before the asset was held, the economic benefit was not provided until after the asset was held.

The expenditure incurred on the deposit is included in the motor vehicle's second element of cost under subsection 40-190(2) of the ITAA 1997 as it was paid for an economic benefit that has contributed to bringing the motor vehicle to its present condition since the taxpayer began to hold it.