Capital works: balancing deduction - treatment of insurance proceeds for destroyed capital works where proceeds received in later year

Under Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997), if a taxpayer receives insurance proceeds in respect of the destruction of capital works that occurred in a previous year, can the taxpayer choose to offset the proceeds against the construction cost of the replacement capital works?

No. Under Division 43 of the ITAA 1997, section 43-250 of the ITAA 1997 provides that amounts received for the destruction of capital works are taken into account in working out any balancing deduction for those destroyed capital works. This does not change if the proceeds are received in a later year and applied towards the construction of replacement capital works.

The taxpayer purchased a residential rental property in 2001. They carried out extensive renovations during a period of three months from the purchase date to the time the property was first rented out.

Capital works deductions were claimed for the renovation expenditure under section 43-10 of the ITAA 1997. The taxpayer had entered into a contract of insurance over the property.

In the income year ended 30 June 2003, the property was completely destroyed as a result of an arson attack. Fire was a specified event in the insurance policy, but the fact of arson meant that payment of a claim by the insurance company was not certain.

At the time of preparing the income tax return for that income year, the taxpayer had not received any amount of insurance proceeds and the insurer had not determined any amount due to the taxpayer. At that time it was expected that, if the taxpayer received any insurance payout, it would not be until the income year ended 30 June 2005. The taxpayer's return was lodged prior to determination of the payout.

The taxpayer intended to use any insurance proceeds received for the destruction of the original capital works to build new capital works on the site.

Section 43-40 of the ITAA 1997 allows a deduction up to the amount of undeducted construction expenditure at the time of destruction of capital works. This amount is calculated as set out in the formula in section 43-250 of the ITAA 1997, and is reduced by the amount of any insurance proceeds received in respect of the destruction of those capital works, or any right to receive such proceeds. If the proceeds are received at a later time, under section 43-250, this amount reduces the deduction for the destroyed capital works. The taxpayer may need to adjust the amount previously claimed as calculated under section 43-250.

The receipt of the insurance proceeds in a year after destruction of the capital works is in respect of the original capital works. The subsequent expenditure of those proceeds is in respect of the new capital works. Because section 43-250 of the ITAA applies, there is no basis in Division 43 of the ITAA 1997 on which the taxpayer can reduce a pool of construction expenditure for replacement capital works, by any portion of the insurance proceeds they received for the destruction of the original capital works, even though the insurance proceeds were used to finance the construction of the replacement capital works.