Is the Taxpayer entitled to a deduction for the cost replacing the tiled section of the roof of the rental property with Colorbond under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Yes. This ruling applies for the following periods : 1 July XXXX to 30 June XXXX
The Taxpayer) owns a rental property (House). The House has been rented out since the Taxpayer acquired it, except during the period of renovations around 20XX/20XX. The House was built in XXXX, using terracotta tilling for the roof. The roof was not in need of repair at the time the House was acquired and when the Taxpayer commencing holding it as a rental property. Extensions were subsequently made to the house. The Taxpayer estimates that the original roof area constituted approximately 50% of the total roof area. The roof to the extensions were Colorbond, rather than terracotta tiles. In XXXX, the Taxpayer sought council approval to replace the original terracotta section of the roof with Colorbond, as the old tiles were prone to cracking and did not match the Colorbond extensions. The council rejected the Taxpayer's request, the Taxpayer was required to repair the original part of the roof using spare terracotta tiles whenever an old tile cracked.
By XXXX, the Taxpayer's collection of spare tiles had been depleted. The old terracotta tiles continued to crack (for example, from hail or from possums running over the roof). This caused moisture to penetrate the ceiling, which led to complaints from tenants. The Taxpayer was unable to acquire further spare' terracotta tiles, as modern terracotta tiles are shaped differently to the original terracotta tiles, making them incompatible with the fit and design of the original portion of the roof. This Taxpayer sought council approval to replace the original portion of the roof, and the application was approved by council. Before submitting the application to council, the Taxpayer had to decide whether to replace the original area of the roof with modern tiling or with Colorbond. The Taxpayer's primary considerations were cost and the aesthetics of each alternative. The Taxpayer sought advice from a builder who was familiar with the roof. The builder noted that Colourbond was a cost-effective replacement, having regard to the cost of materials and installation.
Based on the builder's advice, and so that the original roof area would match the extensions, the Taxpayer decided to replace the original roof area with Colorbond.
Income Tax Assessment Act 1997 section 25-10
Questions Summary Colorbond would not enhance the essential function of the roof in these circumstances such that the work may be considered an improvement rather than repairs for the purposes of section 25-10 of the ITAA 1997. Consequently, the expenses incurred in replacing the old tiled section of the roof with Colorbond is deductible in the year in which the expenditure was incurred. Detailed reasoning Section 25-10 of the ITAA 1997 provides that expenditure incurred for repairs to premises held or used solely for the purpose of producing assessable income are deductible in the year in which the expenditure was incurred. The meaning of 'repairs' and the circumstances under which repairs are deductible, as set out in Taxation Ruling TR 97/23 Income tax: deductions for repairs, are applicable. 'Repairs' for the purposes of section 25-10 of the ITAA 1997 relates to the making good of defects, damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes, to restore the efficiency of function of the premises (or part of premises), without changing its character.
Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal or reconstruction, as distinguished from repair, is restoration of the entirety. Relevantly, the Commissioner accepts, as determined in W Thomas and Co Pty Ltd v. FC of T 155 CLR 58, the roof of a building is not considered an entirety: 117. In the W Thomas & Co case , where the High Court considered deductions claimed for repairs to guttering, the roof, walls and two floors of a building, the view was taken that the whole building was the entirety. Windeyer J said (at 115 CLR 66; 14 ATD 83) that the relevant question is not: ' ... whether the roof or the floor or some other part of the building, looked at by itself, was repaired as distinct from being reconstructed or replaced. It is whether what was done to the roof or the floor or some other part was a repair of the building.' Whether the work undertaken constitutes repair is a question of fact and degree and an exercise of judgement. This involves a process of evaluating and weighing a range of factors for the particular circumstance. Factors that may be relevant in determining whether the work is repair include:
• The condition of the building at the time of acquisition. • The purpose of the work - for example: o whether it is to restore the building to its former appearance, form, state or condition; o whether it is to prevent future defects in, damage to, or deterioration of a building; or o whether it is to remedy or make good a defect in, damage to, or deterioration of a building that existed at the time of acquisition. • The outcome of the work - for example: o whether the work changes the character of the building; or o whether the work affects the efficiency of function of the building. The key consideration is whether the work does more that restore the character or function of the building - the use of different materials and improved technology will not in themselves cause the work to be considered an improvement: Restoration of efficiency of function of the property 88. The High Court of Australia (Windeyer J) said in W Thomas & Co Pty Ltd v. FC of T (1965) 115 CLR 58 at 72; (1965) 14 ATD 78 at 87:
'The words "repair" and "improvement" may for some purposes connote contrasting concepts; but obviously repairing a thing improves the condition it was in immediately before repair. It may sometimes be convenient for some purposes to contrast a "repair" with a "replacement" or a "renewal". But repairs to a whole are often made by the replacement of worn-out parts by new parts. Repair involves a restoration of a thing to a condition it formerly had without changing its character. But in the case of a thing considered from the point of view of its use as distinct from its appearance, it is restoration of efficiency of function rather than exact repetition of form or material that is significant. Whether or not work done upon a thing is aptly described as a repair of that thing is thus a question of fact and degree.' (emphasis added) 89. It is therefore more significant in applying the word 'repairs' in its context in section 25-10, to consider whether the work restores the efficiency of function of the property for income purposes (without changing its character) than it is to consider whether the appearance, form, state or condition of the property is exactly restored.
Use of different materials 48. If expenditure is incurred in replacing or renewing a part of property with a material of a different type from the original, the work done may either repair the property, or be an improvement to it. The use of different materials is not in itself determinative of the issue. 49. Whether the use of a more modern material to replace the original material qualifies as a repair is a question determined on the facts of each case. It is restoration of a thing's efficiency of function (without changing its character) rather than exact repetition of form or material that is significant. 50. If the work done restores a previous function to the property, or restores the efficiency of the previous function, it does not matter that a different material is used. Even if the work done using different material enables the property to perform its function marginally more efficiently, the work may still constitute a deductible repair. However, the greater the work enhances the efficient functioning of the property, the more likely it is that the work constitutes an improvement.
51. The test is whether there is a sufficient degree of improvement to justify characterising the expenditure as capital and therefore excluding it from deductibility under section 25-10. 52. If the work produces a new and different function, or an additional function, it is likely to constitute a capital improvement. Technological advances or enhancements 53. As a general proposition, the greater the degree of technological advancement involved in work done to property, the more it is likely the work goes beyond a 'repair'. This is so because it is more likely the work does more than restore the property to its original efficiency of function. If it does, the cost of the work is not deductible under section 25-10. (It might be deductible under section 8-1 if the cost is a working or operating expense and it is not of a capital nature.) 54. If, however: a) the work done to property involves: (i) a degree of technological advancement that results in only a minor and incidental improvement to the property; or
(ii) an enhancement arising from the use of more modern materials and component parts (often where original materials and parts are no longer available) that adds in only a minor and incidental way to the overall efficiency of function of the property; and b) the work done does not change the property's character; this does not in itself preclude the expenditure from being characterised as repair expenditure deductible under section 25-10. The Commissioner accepts that 'repair' in this context contemplates a minor and incidental, and not a substantial, degree of improvement - in the sense that the improvement happens in fortuitous or subordinate conjunction with the repair work and it is inconsequential: Functionality of the property on which the work is done
90. In considering whether work does more than restore property to its original efficiency of function, what is determinative is the functionality of the property on which the work is being done and not the functionality of the defective component or part. That is not to say, however, that the effect of the work on the functionality of the defective component or part is not relevant. It is a relevant factor to take into account in considering the extent of change made to the functionality of the property.
91. To illustrate, if cast-iron pistons in an engine are replaced with aluminium-alloy pistons, being a more modern material for the construction of pistons, the determining question is whether the functionality of the engine has been restored or has only been enhanced in a minor and incidental way. However, any greater efficiency of function of the pistons is a relevant consideration in deciding that question. Expenditure in replacing the pistons is deductible under section 25-10. The engine's essential efficiency of function has not changed. Nor has the character of the engine changed by the use of marginally more efficient pistons. The aluminium-alloy pistons are marginally more efficient because they are lighter, hardier and are machined differently to produce less friction. FC of T v. Western Suburbs Cinemas Ltd (1952) 86 CLR 102 (Western Suburbs Cinema) illustrates the circumstances in which the work to the subsidiary can be taken to be an improvement that is capital in nature: 110. In the Western Suburbs Cinemas
case, the ceiling of a motion picture theatre was in a state of disrepair. To restore the ceiling to its original condition would have cost #603. The company instead replaced the ceiling with a new one of a different design and better material for a cost of more than #3,000. The High Court (Kitto J) concluded that the new ceiling was an improvement to a fixed capital asset and that its cost was a capital charge. His Honour said at 86 CLR 105; 9 ATD 454: ... In this case, the work done consisted of the replacement of the entire ceiling, a major and important part of the structure of the theatre, with a new and better ceiling. The operation seems to me different, not only in degree, but in kind, from the type of repairs which are properly allowed for in the working expenses of a theatre business. It did much more than meet a need for restoration; it provided a ceiling having considerable advantages over the old one, including the advantage that it reduced the likelihood of repair bills in the future ... . The truth is, I think, that the new ceiling was an improvement to a fixed capital asset and that its cost was a capital charge.'
In making this finding, the court observed that the nature of the work involved more than merely replacing the ceiling material: The architect came to the conclusion that it was really impossible to repair the ceiling at all. Ten Test was not available, but it does not appear that celotex, which was the Australian rival to Ten Test, or another material of a similar kind, caneite, was unobtainable. However, the architect would not use any material of this type for the ceiling, because experience had satisfied him that it was unsatisfactory for that kind of work. He employed, not fibro, but fibrous plaster, and with that he covered the whole area formerly covered by Ten Test and lattice. The fibrous plaster was affixed to new battens, which in turn were fixed to new ceiling joists: and the result was an entirely new ceiling. Fibrous plaster has a much longer life than the celotex type of material; it is harder, and it also lends itself better to decorative treatment and can be moulded. The new ceiling cost more than 3,000 pounds.
The advantage of reducing the likelihood of future repair bills is to be viewed in the context of only part of the ceiling was in need of repair but the taxpayer chose to replace the entirety. The new battens, joists and material significantly enhanced the performance of the ceiling and reduced the likelihood of repairs being required Application in these circumstances. The Taxpayer has incurred expenses in replacing the tiled section of the roof of the House with Colorbond. The Commissioner accepts that 'repair' in this context contemplates a minor and incidental, and not a substantial, degree of improvement.
The replacement of tiles with Colorbond (a different material and technology), may result in some improvements over a tiled roof. However, there is an insufficient degree of improvement to justify the characterisation of the expenditure as capital. Any improvement happens in a fortuitous or subordinate conjunction with the repair work and it is inconsequential. Colorbond would not enhance the essential function of the roof in these circumstances (which is to prevent damage to the interior caused by exposure to the elements and animals) to such a degree over and above that which may be expected of a tiled roof such that the work may be considered an improvement rather than repairs for the purposes of section 25-10 of the ITAA 1997. Notwithstanding the reduced likelihood of repair bills may have been a consideration, unlike Western Suburbs Cinema, it is not in the context of undertaking work that amounts to an improvement: • The entire tiled section of the roof is in a dilapidated state. • Colorbond, being very light, would not require the installation of new supporting structural components (beams etc.)
• Whereas Colorbond is a minor improvement in terms of reducing repairs, it costs no more over the life of the roof and does not require any significant changes to the roof's structure/design. In these circumstances the reduced likelihood of future repair bills is not determinative and would not apply to render what is otherwise repairs capital in nature. Consequently, the Taxpayer is entitled to a deduction under section 25-10 if the ITAA 1997 for the expenses incurred in replacing the old tiled section of the roof with Colorbond.