Capital allowances: business related costs - exclusion of costs of restoration of leased premises

Does paragraph 40-880(3)(d) of the Income Tax Assessment Act 1997 (ITAA 1997) deny a deduction for capital expenditure incurred in restoring leased premises to the condition they were in at the beginning of a lease, because the expenditure is related to a lease?

No. Paragraph 40-880(3)(d) of the ITAA 1997 does not deny a deduction for expenditure incurred in the restoration of leased premises as it is not capital expenditure that is incurred in relation to a lease to which the exclusion applies.

A partnership operated a shop out of leased premises. Expenditure was incurred to fit out the shop and included the tiling of the floor and walls.

At the end of the lease period the taxpayer incurred further expenditure to demolish the fit out, including the removal of the tiling. This was done to return the premises to their original state as required under the lease agreement.

The termination of the lease was an integral element of the cessation of the business and occurred contemporaneously with the cessation.

Broadly, paragraph 40-880(1)(g) of the ITAA 1997 allows a deduction for an amount of capital expenditure you incur that is a cost to stop carrying on your business, to the extent it was conducted for a taxable purpose. The expenditure incurred in the restoration of the premises would be deductible under this paragraph (see ATO ID 2003/787).

However paragraph 40-880(3)(d) of the ITAA 1997 does not allow a taxpayer to deduct anything under section 40-880 of the ITAA 1997 for an amount of capital expenditure that has been incurred to the extent that it is in relation to a lease or other legal or equitable right.

The Explanatory Memorandum to Taxation Law Amendment Act (No. 5) 2002 explains that the Government is reviewing the treatment of expenditure incurred in relation to leases or other legal or equitable rights. A deduction for that type of expenditure is not available under section 40-880 of the ITAA 1997 as the appropriate income tax treatment will be determined in that review. Expenditure representing lease surrender payments incurred in closing down your business is given as an example of expenditure incurred in relation to a lease which is excluded by the paragraph.

The capital expenditure excluded by paragraph 40-880(3)(d) of the ITAA 1997 does not extend to capital expenditure incurred for the restoration of leased premises even though the premises are leased and the work was required under a condition of a lease agreement.

Provided all other conditions in subsection 40-880(3) of the ITAA 1997 are met, a deduction is allowed under paragraph 40-880(1)(g) of the ITAA 1997 for expenditure incurred in restoring leased premises to the condition they were in at the beginning of a lease.