Repairs - what are theyRepairs: division 25
Initial repairs - are they capital in nature?
Section
25-10 is fairly concise, but as we will discover, the courts have devoted a lot of time to working out how to define the term 'repair'
Section
25-10 (1) allows a deduction for repairs to
premises (or part of premises),
plant,
machinery,
tools or
articles
that you held or used solely for the purpose of producing assessable income.
Did you notice the bit about used solely for the purpose of producing assessable income
Section
25-10 (2) modifies that by saying that if you held or used the property only partly for that purpose, you can deduct so much of the expenditure as is reasonable in the circumstances.
But section
25-10 (3) imposes an important exception. Can you see what it is?If you said the expenditure must not be of a
capital nature ... Well done!The precise words are, you cannot deduct capital expenditure under this section
Repairs of a capital nature
A
repair will always involve the replacement of a part of an income producing asset, but if it entailsreplacement of the entire asset or
an improvement in its functioning
it is no longer a repair - it is a capital expenditure
Answer this question….
Does section 25-10 require that the articles repaired be owned by the taxpayer?
Yes No
held or used
- not necessarily owned - section 25-10 (1)
Answer this question….
Must the owner be under some legal obligation to effect the repair before a deduction can be allowed under section 25-10?
Yes No
No mention of obligation, legal or otherwise in section
25-10
Answer this question….
A taxpayer repairs a car used 50% for business purposes.
Expenditure = $200 What deduction will be allowed?
Refer section 25-10(3) - 50% of 200 would be allowed
What is a repair?
The Oxford dictionary defines a repair as ...
Restoration of some material thing or structure by renewal of decayed or worn-out parts ... Or
by refixing what has become loose or detached
A
repair will always involve a renewal of some subsidiary part of a whole.The word
connotes the continuing existence of the thing, which is subject to repairRepairs - part claims & covenants
It doesn't have to be all or nothing
If renovations and improvements have been undertaken concurrently, the cost of repairs should be isolated from the expenditure on improvements and claimed as a deduction - see para 1.6.38 - Assessing handbook.
What if the asset is used only partly for income production?
Section
25-10(3) allows a partial deduction where the asset is used only partly for producing income.
Answer this question….
A taxpayer who holds a lease on a hotel wishes to assign (sell) the lease to another person. Under the terms of the lease he can do this, but only on 2 conditions ....
That he gain the consent of the owner (lessor) to do this
That he bears the cost of certain repairs to the hotel.
The taxpayer pays the sum required under the lease agreement, in order to obtain the lessor's consent.
Is a deduction allowed under section 25-10 as a repair?
Yes No
He has not incurred expenditure on repairs - he has just paid money under the lease agreement
Answer this question….
A taxpayer who holds a lease on a hotel wishes to assign (sell) the lease to another person. Under the terms of the lease he can do this, but only on 2 conditions....
That he gain the consent of the owner (lessor) to do this
that he bears the cost of certain repairs to the hotel.
The taxpayer pays the sum required under the lease agreement, in order to obtain the lessor's consent
Is any deduction allowable? (Hint: refer section 25-15)
Yes No
the taxpayer must hold a lease over land and use it for producing income
the lease agreement must require the taxpayer to make certain repairs to improvements on the land - eg obligation to paint a building on the land yearly
the taxpayer fails to make the repairs and thus becomes liable to pay money to have the repairs done by someone else.
If all these conditions are satisfied then a deduction will be allowed.
Note: The amount is assessable income of the entity to which you pay it: either as ordinary income under section 6-5 or because it is included by section 15-25.
Initial repairs - are they capital in nature?
Answer this question….
A shipping company purchased a ship ready to sail and with freight booked.
The purchaser was so desirous of having the ship embark on its voyage that it obtained an exemption from the insurer's periodic survey.
On its return the survey was carried out and revealed a need to effect over 500,000 pounds (sterling) worth of work to remedy the defects found.
Would the work done in remedying these defects be repairs?
Yes No
These were the facts of the Law Shipping case - refer CCH Master Tax Guide para 14-720 for details
It was held that the repairs were capital because it seemed to be fair to infer that the sellers would have demanded and obtained a higher price than they did, but for the immediate necessity for repairs to which the ship was subject when they put her in the market.
Answer this question….
A cinema proprietor acquired certain theatres during and after the period of World War II (1939-45).
During the war, prohibitions in force had barred all but essential maintenance work, so all operating cinemas were in the same run-down state with a back-log of long delayed repairs though this did not have much effect on patronage by the public.
The condition of the cinemas had no effect on the price paid for them.
Would the cost of effecting these long delayed repairs be in the nature of a capital outgoing?
Yes No
These are the facts of the Odeon Associated Theatres case - CCH Master Tax Guide - paragraph 14-720.
It was held that the repairs were revenue outgoings - not capital.
The facts were distinguished from those in the Law Shipping case because there was no evidence that the price paid for the asset had reflected its state of disrepair
The cinemas were profit earning assets at the date of acquisition whereas the ship was not in a fit state to be used for gaining income.
Initial repairs-the Australian position
Both Law Shipping and Odeon Theatres are English cases.
It should be noted that the Australian courts would not be bound by them.
It would seem from paragraphs 1.6.18 to 20 of the non-business assessing handbook
that the Commissioner inclines toward the Odeon Theatres approach.
The view there stated is that, careful consideration should be given to the state of the asset when the change of ownership occurs
Where a state of disrepair existed at the time of purchase, and expenditure is necessary to restore or maintain the asset to an income producing capacity, it is suggested that the outgoing will be capital in nature.
Paint jobs
A taxpayer purchases a house for rental purposes and repaints it immediately
Would the cost of painting be in the nature of a revenue or capital outgoing?
According to paragraph 1.6.19 - Non-business assessing handbook, it will not necessarily follow that because a building was painted shortly after acquisition that the cost was automatically part of the cost of the asset. The view is that the deduction should be allowed where ....
There is no evidence that the expenditure resulted in an increase in the capital value of the asset, and
The painting was not part of the cost of gaining the asset or associated with capital works
We have established that a
repair will always involve the renewal of something - however that thing must be a subsidiary part of something else.When the repair
ceases to be a renewal of part of an entirety and becomes a reconstruction of what amounts to substantially the whole of the subject matter, then it will no longer be allowed as a deduction.
Answer this question….
Will the following be a repair?
A new reservoir is built in place of an old one, which does not warrant rebuilding
Yes No
Refer para 1.6.24 - Assessing Handbook Margaret v Lowestoff Water & Gas Co
Answer this question….
Will the following be a repair?
A shopkeeper is ordered to reset his shop awning 2 feet inside the curb
Yes No
Refer para 1.6.25 - Assessing handbook. The awning is not being repaired. There is nothing to be restored, nothing detached to be replaced or fixed
Answer this question….
Will the following be a repair?
Instead of patching up an old roof a company built a completely new roof over the old one, raising the side walls some 5 feet in the process.
Yes No
Refer para 1.6.29 - Assessing handbook. The entirety being renewed is the roof - not the building - case K24, 10 TBRD
Answer this question….
Will the following be a repair?
A chimney into which the steam plant of a paper processing company discharges is rebuilt.
Yes No
Refer para 1.6.30 - Assessing handbook. The chimney is not an entirety, but physically, commercially and functionally an inseparable part of an 'entirety' which is the factory Samuel Jones & Co v IRC
Answer this question….
Will the following be a repair?
Meters and pumping plant used in connection with the supply of light and power to a garage and service station are replaced.
Yes No
Refer para 1.6.31 - Assessing handbook. They are distinct and separate items of plant in their own right case A55, 69 ACT
Answer this question….
Will the following be a repair?
Sawdust and timber-lining of a butcher's cool room is replaced with foam insulation.
Yes No
Refer para 1.6.32 - Assessing handbook. The cool room was the entirety - made up of outer walls, cement floor ceiling and lining-case 32, 14 CTBR(NS)
Confused?
Don't worry
! The area is a contentious one, as the number of cases of disagreements between taxing authorities and taxpayers will attest.
When is a 'repair' an improvement?
In other words when will expenditure incurred for the purpose of fixing deficiencies be disallowed as capital?
The Commissioner takes the view that a
repair merely replaces or corrects a component of an article or building which is already there, but has ceased to function in the way intended due to wear and tear.An
improvement provides something new for the benefit of the user and in doing so generally enhances the income producing ability and/or expected life of the asset - refer para 1.6.33 Of the assessing handbook.But the key concept embodied in the concept of 'repair' is that of restoration of a thing to a condition it formerly had without changing its character.
It is the facility to be used for the intended purpose that is being restored - not just the component parts-to quote justice Windeyer in W. Thomas & Co
'it is the restoration of efficiency in function rather than exact repetition in form or matter that is significant' - refer assessing handbook para 1.6.36
What if new and different materials are substituted for the old ones when the repair is effected?
Let's assume the old materials are more expensive than their modern equivalents, or even unavailable.
Would the substitution of different (and possibly better) components for the old, 'worn-out' ones amount to an improvement?
The Commissioner's
basic test for allowing the outgoing as a repair is ...Does the new or different material result in an increase in the
revenue earning capacity or
the value of the asset?
Another factor considered is the likelihood of future repairs being reduced.
If
the revenue earning capacity of the item has been enhanced or
the likelihood of future repairs has been reduced,
the expenditure will be capital and the claim for repairs will be disallowed.
Refer para 1.6.37 - Assessing handbook
The board held that since only some of the pillars were replaced with steel uprights, the life expectancy of the system of supports, as a whole, was not improved. So there was no 'improvement' as such.
Answer this question….
The floor of a factory consisted of paving stones covered with asphalt.
It had sunk and developed holes, so repairs were called for.
A concrete surface, following the same contours as the old floor, is laid.
Would the cost of replacement be a repair?
Yes No
The new floor had no advantages over old - para 1.6.37-Assessing handbook
The Commissioner did not produce evidence to show that the concrete floor had any advantages over the old one so the replacement was a 'repair'
Answer this question….
The ceiling of a cinema was in a state of disrepair.
The cost of repairing the ceiling using the same material would have been $1200 - but it was not available at the time.
The operators erected a new ceiling of different design and better material which would need less maintenance than the original material for $6,000.
Would the cost of replacement be a repair?
Yes No
Refer Western Suburbs Cinemas case - paragraph 1.6.39 - Assessing handbook.
The replacement of the ceiling was an operation different not only in degree but in kind from the type allowed for in the working expenses of a cinema. It did much more than meet a need for restoration - it provided a ceiling having considerable advantages over the old one - eg reduced likelihood of future repair bills
In this case, the operator accepted that the new ceiling was an improvement, but claimed a deduction of $1200 as a notional repair. In other words, a claim was made for the amount which would have been expended had the old ceiling been repaired.
The Court dismissed this idea that what would have been spent on repairing the old ceiling if it had not been replaced could be treated as a notional repair. A deduction can not be allowed for an expenditure that was not incurred.
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