Capital allowances: depreciating assets - capital works - deductions for decline in value

Does Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to a structural improvement constructed by the taxpayer if an amount cannot be deducted under Division 43 of the ITAA 1997 for reasons other than those in paragraphs 40-45(2)(a) and 40-45(2)(b) of the ITAA 1997?

Yes. Division 40 applies to the structural improvement constructed by the taxpayer if a deduction is not available under Division 43 of the ITAA 1997 for reasons other than those in paragraphs 40-45(2)(a) and 40-45(2)(b) of the ITAA 1997.

A taxpayer enters into a contract with a company to provide specialised equipment and services.

As part of conducting these activities, the taxpayer incurs expenditure on the construction of a set down area that allows the taxpayer to park the equipment, and a concrete wash down pad consisting of a rectangular cement slab that allows the taxpayer to wash down the equipment.

Both the set down area and the concrete wash down pad are constructed on land subject to a lease which is held by the company engaging the services of the taxpayer. That company has agreed to allow the taxpayer to construct the set down area and the concrete wash down pad on the land it leases.

The taxpayer has a right to exclusive possession of the set down area and the concrete wash down pad for the duration of the contract. The taxpayer has no rights or obligations in respect of the assets after the contract has expired.

The set down area and the concrete wash down pad are structural improvements and capital works to which Division 43 of the ITAA 1997 could apply provided the relevant conditions are met.

The set down area and the concrete wash down pad are also depreciating assets within the meaning of section 40-30 of the ITAA 1997.

Broadly speaking, section 40-25 of the ITAA 1997 allows to a holder of a depreciating asset, an annual deduction for the decline in value of the asset.

Both the set down area and concrete wash down pad are improvements to land to which Division 40 of the ITAA 1997 applies as if they were assets separate from the land (subsection 40-30(3) of the ITAA 1997). They are also depreciating assets, as set out in subsection 40-30(1) of the ITAA 1997, because they are assets that have a limited effective life and can reasonably be expected to decline in value over the time they are used.

The table in section 40-40 of the ITAA 1997 identifies a holder of a depreciating asset in any particular circumstance. Item 3 of that table specifies that where there is: An improvement to land (whether a fixture or not) subject to a quasi-ownership right (including any extension or renewal of such a right) made, or itself improved, by any owner of the right for the owner's own use where the owner of the right has no right to remove the asset.

the owner of the quasi-ownership right (while it exists) will be a holder of the depreciating asset.

Under subsection 995-1(1) of the ITAA 1997, a quasi-ownership right over land includes any right in connection with the land. The right of the taxpayer to exclusive possession of the assets during the term of the contract is a quasi-ownership right over the land. The taxpayer has also made the improvements for their own use and has no right to remove them. Therefore, the taxpayer holds the assets under item 3 of the table in section 40-40 of the ITAA 1997.

However, subsection 40-45(2) of the ITAA 1997 provides that Division 40 of the ITAA 1997 does not apply to depreciating assets if they are capital works for which the taxpayer can, or could in certain circumstances, deduct amounts under Division 43 of the ITAA 1997: (a) but for expenditure being incurred, or capital works being started, before a particular day; or (b) had they used the capital works for a purpose relevant to those capital works under section 43-140 of the ITAA 1997.

This means there is no deduction available for the set down area and the concrete wash down pad under Division 40 of the ITAA 1997 if amounts are able to be deducted under Division 43 of the ITAA 1997 for them. Division 40 also does not apply to the assets if there is no deduction available under Division 43, if the only reason that such deduction is not available is because either or both of the requirements referred to in paragraphs 40-45(2)(a) and 40-45(2)(b) of the ITAA 1997 have not been met. Therefore, it is necessary to determine whether the set down area and concrete wash down pad are capital works for which a deduction is available under Division 43.

The limestone set down area and concrete wash down pad fall within the type of structural improvements described in subsection 43-20(3) of the ITAA 1997. They are therefore structural improvements for the purposes of subsection 43-20(2).

Section 43-10 of the ITAA 1997 provides that an amount may be deducted for capital works for an income year if: (a) the capital works have a construction expenditure area; and (b) there is a pool of construction expenditure for that area, and (c) you use your area in the income year in the way set out in Table 43-140.

Note 2 to section 43-10 of the ITAA 1997 states that: Amongst other things, the definition of your area ensures that only owners and certain lessees of capital works, and certain holders of quasi-ownership rights over land on which capital works are constructed, can deduct an amount under this Division.

Subdivision 43-C of the ITAA 1997 defines the terms 'your area' and 'your construction expenditure'. Section 43-110 of the ITAA 1997 provides that: 'You can only get a deduction under this Division for an income year if you own, lease or hold part of a construction expenditure area of capital works. The area you own, lease or hold is called your area .'

Section 43-120 of the ITAA 1997 clarifies the terms 'your area' and your construction expenditure' with regard to lessees and quasi-ownership right holders. The section requires that a quasi-ownership right over land be granted by an exempt government agency. The taxpayer does not lease the land on which the capital works are constructed, nor does the taxpayer hold the land on which the capital works are constructed under a quasi-ownership right granted by an exempt government agency. Therefore, there is no 'your area' in relation to the taxpayer. No deduction is allowable under Division 43 for capital expenditure incurred on the construction of capital works because the expenditure does not meet the requirements of section 43-10.

The requirement that there be 'your area' is not one of those referred to under either paragraph 40-45(2)(a) or paragraph 40-45(2)(b) of the ITAA 1997. Therefore, the set down area and the concrete wash down pad are not excluded from Division 40 of the ITAA 1997and it will apply to these depreciating assets where the necessary conditions are otherwise met.