Capital Allowances: water facility - the repair or the asset?

When a taxpayer incurs capital expenditure to seal a road on their property, must the road itself be reasonably incidental to conserving or conveying water in order for the sealing of the road to qualify as a water facility under paragraph 40-520(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. In order for the sealing of the road to qualify as a water facility under paragraph 40-520(1)(b) of the ITAA 1997, it is the objective result of the road having been sealed, and not the road itself, that must be reasonably incidental to conserving or conveying water.

The taxpayer operates a primary production business on land in Australia.

The taxpayer uses a road that runs through their property in their daily business activities. The road does not qualify as a water facility under subsection 40-520(1) of the ITAA 1997.

Rain water run-off from the road is collected via agricultural piping and directed into the main dam on the property.

The taxpayer incurs expenditure to have the road, previously gravel surfaced, sealed with asphalt.

The taxpayer states that their main reason for sealing the road is to increase the collection of rain water run-off.

The sealing of the road is an alteration to a structural improvement, being the road, and is not a structural improvement in its own right.

All references to legislation in this Interpretative Decision are to the ITAA 1997 unless otherwise stated.

Paragraph 40-515(1)(a) allows a deduction for an income year equal to the decline in value of a depreciating asset that is a water facility. The deduction for the decline in value of a water facility is worked out in equal instalments over three income years under section 40-540.

Under paragraph 40-520(1)(b), a structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to a structural improvement is a water facility if it is 'reasonably incidental to conserving or conveying water'.

In considering the application of the provision, a question has arisen as to whether in order for a repair of a capital nature, or an alteration, addition or extension, to a structural improvement to qualify as a 'water facility' under paragraph 40-520(1)(b), it is the structural improvement itself, or the repair of a capital nature, or the alteration, addition or extension, to the structural improvement that must be reasonably incidental to conserving or conveying water.

In discussing the extended meaning of the term 'water facility' in subsection 40-520(1), paragraph 6.14 of the Explanatory Memorandum to the Tax Laws Amendment (2004 Measures No. 6) Bill 2004 (the EM) states: The test 'primarily and principally for the purpose of conserving or conveying water' is intended to apply to the expenditure itself rather than the purpose of the asset that may be modified to convey or conserve water.

Although paragraph 6.14 of the EM refers to 'primarily and principally for the purpose of conveying or conserving water', in the context in which it is found (a discussion of the extended definition of 'water facility' in subsection 40-520(1)) it is reasonable to conclude that the same principle is intended to apply in determining whether an item of capital expenditure is 'reasonably incidental to conserving or conveying water' for the purposes of paragraph 40-520(1)(b).

Given the context in which it is found, it is apparent that the expenditure referred to in paragraph 6.14 of the EM is the expenditure incurred to effect the repair of a capital nature, or the alteration, addition or extension to a structural improvement. It follows that the purpose of the expenditure is reflected in the objective result of the repair, alteration, addition or extension on which it is incurred. The test outlined in paragraph 6.14 of the EM is therefore to be applied in considering the objective result of the repair of a capital nature, the alteration, addition or extension to the structural improvement on which the expenditure is incurred.

Accordingly, when considering whether the sealing of the road in question is an alteration to a structural improvement that qualifies as a 'water facility' under paragraph 40-520(1)(b), the test 'reasonably incidental to conserving or conveying water' is to be applied to the objective result of the road having been sealed and not to the road itself.