Capital Allowances: water facility - reasonably incidental to conserving or conveying water

Is the sealing of a road on a property that is used in a primary production business reasonably incidental to conserving or conveying water in the context of paragraph 40-520(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The sealing of a road on a property that is used in a primary production business is not reasonably incidental to conserving or conveying water in the context of paragraph 40-520(1)(b) of the ITAA 1997 because: • it cannot be said that there is a likely and generally accepted connection between the sealing of road surfaces and the conservation or conveyance of water, nor is the former liable to occur in connection with nor does it naturally appertain to the other, nor is there a substantial connection between the two things, and • the reduced water permeability of a sealed road surface as compared to a gravel surface is a characteristic that only generally and indirectly facilitates rain water run-off and is minor compared to a sealed road's improved resistance to trafficking effects, dust control and smooth riding surface.

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.

The sealing of the road significantly improves its resistance to trafficking effects, durability, dust control and smooth riding surface. As a consequence of the sealing, the water permeability of the road surface is reduced. This reduction in water permeability results in an increase in the amount of water that runs off the road surface when rain falls on it.

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 the present case, the sealing of the road is an alteration to a structural improvement. In order to determine whether the sealing of the road is reasonably incidental to conserving or conveying water, and therefore, a 'water facility' within the meaning in paragraph 40-520(1)(b), it is necessary to consider the meaning of the expression 'reasonably incidental to' in this context.

There is no definition of the words 'reasonably' or 'incidental' nor the expression 'reasonably incidental to' for the purposes of Subdivision 40-F. It is appropriate, if they are not defined, that words take their ordinary meaning shaped by the context in which they are found.

In The Macquarie Dictionary, 2001, rev. 3rd edn, The Macquarie Library Pty Ltd, NSW, 'reasonable' relevantly means 'agreeable to reason or sound judgment'.

In The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne, 'reasonable' relevantly means 'in accordance with reason, not absurd'.

In The Macquarie Dictionary, 2001, rev. 3rd edn, The Macquarie Library Pty Ltd, NSW, 'incidental to' relevantly means 'liable to happen in connection with; naturally appertaining to'.

In The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne, 'incidental to' relevantly means 'liable to happen'.

These dictionary meanings indicate that in order for a thing to be 'reasonably incidental to' another thing, the thing must be reasonably expected to happen in connection with, and be seen as naturally appertaining to that other thing. In other words, there must be a likely and generally accepted connection or relationship between the two things; and that connection must be generally accepted as one thing naturally appertaining to or liable to happen in connection with the other.

The meaning of the expression 'reasonably incidental to conserving or conveying water' has not been judicially considered, however, the meaning of the expression 'reasonably incidental to' has been judicially considered in cases dealing with other legislation. The meaning of the expression 'reasonably incidental to' which has been developed by the courts in those cases is discussed below.

In Gazzo v. Comptroller of Stamps (Vic) (1981) 149 CLR 227; [1981] HCA 73; 81 ATC 4699, Gibbs C.J. in considering whether a provision relating to stamp duty was 'reasonably incidental to' the power to make laws related to marriages granted to the Commonwealth under the Constitution said, at paragraph 11: The question whether a law is reasonably incidental to the subject matter of the power is always one of degree, and it depends to some extent on the nature of the power.

and, at paragraph 12: ... a provision cannot be said to be incidental to the subject matter of a power simply because in a general way it facilitates the execution of the power.

In AA Pty Ltd v. Australian Crime Commission [2005] FCA 1178; (2005) 60 ATR 440, Finkelstein J, in considering the extent of powers conferred on the Australian Crime Commission by section 19 of the Australian Crime Commission Act 2002 (Cth) , said, at paragraph 26: It will be incidental if it is in aid of, or procedural to, the function to which it is attached.

In Re Director of Public Prosecutions; Ex parte Lawler (1994) 179 CLR 270; [1994] HCA 10, Deane and Gaudron JJ, in considering whether a law relating to forfeiture of property is 'reasonably incidental to' a power said, at paragraph 13: And that will usually involve a consideration of whether it is reasonably capable of being seen as appropriate and adapted to achieving, or, as reasonably proportionate to some object or purpose within power.

Finally, in Re Mercantile Mutual Life Insurance Co Limited and Roy Moore v. Australian Securities Commission; Michael John Braham, Regional Commissioner of New South Wales; John William Murphy and Peter Bernard Allen [1993] FCA 61; (1993) 40 FCR 409, Gummow J. outlined the meaning of a power that is incidental to a function, at paragraph 63, as: ... a power may be incidental to a function if it naturally appertains and attaches to it ...

These passages indicate that in the view of the courts whether something is 'reasonably incidental to' another thing is a question of fact and degree. The use of the expression 'reasonably incidental to' suggests that the incidental thing must be reasonably capable of being seen as appropriate and adapted to achieving the purpose of, and to aid the function of, the other, and that the interaction between the two must be more than a general facilitation or minor effect. In other words, in the view of the courts, there must be a clear and generally accepted connection between the two things; and that this connection must be one of some substance, and not a general facilitation or minor effect of one on the other.

Tax Laws Amendment (2004 Measures No. 6) Act 2005 extended the meaning of a 'water facility' in subsection 40-520(1) by including a structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to a structural improvement that is reasonably incidental to conserving or conveying water. To clarify the meaning of 'water facility', an example was also included in subsection 40-520(1). The examples of things listed as being reasonably incidental to conserving or conveying water include a culvert, a fence to prevent livestock entering an irrigation channel and a bridge over an irrigation channel.

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: Another amendment will be made to subsection 40-520(1) to clarify the term 'water facility'. This is because of uncertainty with the interpretation of the current provision in respect of whether the test of conserving or conveying water applies to capital expenditure on each individual component of a water facility or to the water facility as whole. Consequently, the term 'water facility' will be amended to include a structural improvement, or repair of a capital nature, or alteration, addition or extension to a structural improvement that is reasonably incidental to the purpose of conserving or conveying water ...

Paragraph 6.15 of the EM goes on to state that whether an item of capital expenditure is reasonably incidental to conserving or conveying water will depend on the facts and circumstances of the case.

In the present case, the taxpayer incurs capital expenditure in sealing a road that runs through their property. The sealing of a road is generally accepted as having the direct result or objective of significantly improving its function of facilitating the conduct of traffic through improved resistance to trafficking effects, durability, dust control and smooth riding surface. There is no reason to accept that these are not the chief benefits of the fact that the road has been sealed to the taxpayer in this case. It is also probable that there will be an increase in the amount of water that enters the farm drainage system as a result of the sealing of the road - a sealed road is less permeable to moisture and thus more moisture will run-off the surface because of reduced absorption. However, this increase is nothing more than a by product of the sealing of the road brought about by the changes in the characteristics of the road surface that sealing produces.

In these circumstances, examining the results produced by the sealing of the road: • there is no natural and generally accepted connection of any substance between the sealing of a road and the conservation or conveyance of water. In the present case, the natural and liable connection which does exist is between the sealing of the road, which must reduce the surface permeability to moisture, and its function as a road through the improvement to its resistance to trafficking effects, durability and smooth riding surface - reduced permeability to moisture being essential to the stability of the surface and thereby its longevity in providing these benefits, rather than the conservation or conveyance of water. • any connection that does exist (as a result of the reduction in permeability to moisture of the road surface) is no more than a characteristic by-product that can be utilised to have a general facilitation or minor effect on water conservation or conveyance, and • the sealing of the road cannot be said to be naturally appertaining to or liable to happen in connection with the purpose of conserving or conveying water.

Accordingly, the sealing of the road is not 'reasonably incidental to conserving or conveying water' in the context of paragraph 40-520(1)(b).