ap_rnt03

Accepted accounting practice allowed depreciation to be reflected in the accounts, but no deduction was allowed for such 'depreciation' under income tax law.

Chapter 2, Part 2, (Chapter 2—Liability rules of general application) Division 43 allows for a deduction similar to depreciation for capital expenditure incurred on

constructing

extending

altering

improving ...

certain buildings, including ...

hotels and apartment buildings use as short-term traveller accommodation

residential income producing buildings

buildings used for research and development

buildings used generally in income producing activities

A bit of history....

The deduction is similar to depreciation and the possible rates allowed are either 2.5% or 4%, depending upon

the intended use for the building and

the date construction commenced.

This reflects the way in which they have been introduced as incentives to encourage investors to support the building industry in times of recession.

Here is how it all unfolded originally...

21/08/79	2.5%	Annual deduction for construction cost of short term traveller accommodation - old Division 10C
20/07/82	2.5%	Annual deduction for construction cost of non residential, income producing buildings - old Division 10D
21/08/84	4%	Annual rate increased to 4%
17/07/85	4%	Residential income producing buildings added to old Division 10C
15/09/87	2.5%	Rate dropped to 2.5%
21/11/87	2.5%	Buildings for research and development included
21/08/90	2.5%	buildings outside Australia included
26/02/92	4%	rate allowed for , traveller accommodation buildings (old Division 10C), buildings for defined industrial/manufacturing operations and structural improvements (bridges, etc) old Division 10D
19/08/92		environment protection earthworks added

Got all that?

We can summarise it by saying...

Residential buildings attract write off rates according to the date when construction commenced:

*Date commenced*	write off rates
After 18/07/85 and before 16/09/87	4%
after 15/07/87	2.5%

Non-Residential buildings attract write off rates according to the date when construction commenced:

*Date commenced*	write off rates
After 19/07/82 and before 22/08/84	2.5%
After 21/08/84 and before 16/09/87	4%
after 26/02/92 if used for 'eligible industrial activities'	4%
After 26/02/92 structural improvements	2.5%

The key provision is section 43-1, which says you can deduct certain capital expenditure on income producing buildings.

How much can you claim?

Section 43-5 is the operative provision. It allows you to deduct

a portion of a pool of construction expenditure

for a building or an extension, alteration or improvement to a building

in each income year in which you use your part of the building in the way that applies to that part under Table 43-140

Section 43-15 sends you to section 43-210 or 43-215 to see how deduction is calculated. It does let you know that the rate will be either 2.5% (43-210) or 4% (43-215) .

So if we can work out what the pool of construction expenditure is, you can deduct either 2.5% or 4% of it each year if the building is used for producing income in the ways set out in table 43-140.

So what is a pool of construction expenditure?

Section 43-85 says, a pool of construction expenditure is that part of an amount of construction expenditure that is attributable to a particular construction expenditure area.

And what is a construction expenditure area?

Section 43-75 says it all depends on when work on the building started. It all boils down to whether it was

started after 30/6/97

or before 1/7/97

There is a reason for breaking it up that way. As you have read in the introductory part of this topic, the deductions allowed under this section are an amalgamation of the different deductions that have been allowed over the years at the whims of successive governments. Often, the sole reason for their introduction, reduction or withdrawal, has been the desire to kick start the building sector of the economy, or to slow it down.

All those deductions had their own complicated rules and requirements, the most important of which was the intention of the owner or lessee at the time the building was completed.

By breaking the deductions into different construction expenditure areas, it is possible to retain those rules for each different amount of expenditure, whether it was for

The original building or an

extension, alteration or improvement to that original building

What is a construction expenditure area for a building that starts being constructed after 30/06/97?

Section 43-75 (1) says the construction expenditure area is,

the part of the capital works on which the construction expenditure was incurred that, at the time when it was incurred by an entity, was to be to be owned or leased or held under a quasi-ownership right by the taxpayer.(If you are worried about what quasi-ownership rights are you can read about them in the topic on depreciation - think of it as land leased from the government and you will have the general idea)

So, from the date that the improved Assessment Act starts to operate, everything is simplified. The pool will contain the amount of expenditure on the construction, extension, alteration or improvement of the building.

However, in order retain the rules for buildings, etc completed before this date, the different construction expenditure areas (types of deductions) are set out in a table - read on…

What is a construction expenditure area for a building that starts being constructed before 01/07/97?

It all depends on the intended use of the building!

Get out the chrystal ball - we have to work out what the owner or lessee intended to use the building for, at the time the building was completed!

Section 43-75 (2) says the construction expenditure area is,

the part of the capital works on which the construction expenditure was incurred that, at the time when it was incurred by an entity, was to be to be owned or leased or held under a quasi-ownership right by the taxpayer.

That was to be used, at the time of completion, in one of the ways set out in the table, which has been provided at 43-90. It lists

the intended use which was acceptable

for each type of building

for each possible construction commencement date

If your intended use at the time the expenditure was incurred is listed, then that expenditure is part of your pool of construction expenditure area, and so becomes part of the pool of construction area for which you can have either 2.5% or 4% deduction.

You can see why the law was simplified by the 1997 Assessment Act to make it reflect the actual use, rather than some historic intention on the part of the owner or lessee at the time construction was commenced.

What is construction expenditure?

Section 43-70 (1) defines construction expenditure as capital expenditure

incurred in respect of the construction of capital works.

But not any of the following (section 43-70 (2) ):

(a) acquiring land; or

(b) demolishing existing structures; or

the construction site prior to carrying out excavation works; or

(d) landscaping; or

(e) plant; or

(f) property for which a deduction is allowable, or would be allowable if the property were for use for the purpose of producing assessable income, under section

73A (scientific research),

75B (conserving or conveying water),

75D (preventing land degradation),

124F (timber operations) or

124JA (timber mill buildings) ,or

Division 10 (mining and quarrying),

10AAA (transport of minerals and quarry materials) or

10AA (prospecting for and mining petroleum) of Part III, of the Income Tax Assessment Act 1936 or

Division 330 (mining and quarrying) of the Income Tax Assessment Act 1997; or

(g) property for which a deduction is allowable, or would be allowable if the property were for use for carrying on research and development activities, under section 73B of the Income Tax Assessment Act 1936; or

(h) eligible heritage conservation expenditure within the meaning of Subdivision AAD of Division 17 of Part III of the Income Tax Assessment Act 1936.

The Commissioner will accept the original cost estimate of building work supplied by a quantity surveyor or other qualified person.(IT 2640)

Clerks of work, supervising architects and experienced builders are deemed to be qualified to provide estimates of the original cost of building work.

Valuers, real estate agents solicitors and accountants are not (TD 94/83),

Of course no deduction is allowed for any period during which the building is used for your own residential accommodation of that of an associated person - spouse, parent, or child.

Section 43-110 explains what is meant by:

your area - that's just the part that you own (section 43-115) or of which you are the lessee (section 43-120)

your construction expenditure - that's the portion of the pool of construction expenditure that is attributable to your part of the building

So who can claim a deduction?

Section 43-10 is the operative provision. It says you can only deduct an amount if:

(a) the capital works have a construction expenditure area; and

(b) there is a pool of construction expenditure for that area ; and

You can simplify that by saying if you owned or leased or held under a quasi-ownership right part of a capital work (eg a building), some part of the cost of which has not yet been deducted, you qualify for the deduction

Which capital works attract the deduction?

We have already noted that you must use your part of the structure to produce income.

A table setting out the acceptable uses, etc is found in section 43-140

It sets out ...

the date construction of the building started

the type of building

the way in which it must be used for you to qualify for a deduction.

So now we know if we qualify for the deduction, but will it be 4% or 2.5%?

The answer to this question is found just a few pages on, in section 43-140.

This list is set out in exactly the same way as that in section 43-145, but this time it lists those uses, etc, which qualify for the 4% deduction.

All the other acceptable uses attract the 2.5% rate

Calculating the deduction

The calculation is outlined in section 43-205.

In fact there are 2 formulae,

one for capital works, construction of which commenced before 26/2/92, (section 43-210 (2.5% rate),

the other for capital works constructed after 26/2/92 (section 43-215 (4% rate)

The key calculation requires you to work out:

your construction expenditure

multiply it by either 4% or 2.5%

then multiply that by days used divided by days in the year

If the building was used only partly to produce assessable income, you must then reduce the result of this calculation to reflect this

Remember, if you are not using the building in a 4% manner, then you are using it in a 2.5% manner.

Answer this question….

What is the maximum number of years a building will attract the deduction under THE 4% MANNER of use?

answer = 25

Answer this question….

What is the maximum number of years a building will attract the deduction if construction commenced between 19/7/82 and 21/8/84?

2.5% Manner of use - answer = 40

The amount of deduction is accumulated over the years it is allowed, so that in the last year, if the remaining 'undeducted construction expenditure' is LESS than the amount worked out under the formula, this lesser amount is the deduction.

What happens if the capital asset is disposed of or destroyed?

This UNDEDUCTED construction expenditure can be allowed as a deduction under section 43-250, if the building is destroyed - the deduction is actually allowed under section 43-40.

The answer is yes

That means there is no balancing adjustment made to the assessable income of the seller, as there might be under the depreciation provisions.

A balancing deduction is allowed for construction costs not yet deducted.

The write off deduction runs from the day on which the building is first used for any purpose after completion of construction. A deduction of 2.5% of the construction costs will be allowed on a pro rata basis in the first income year in which it is used for producing income, and for the next 39 years, 2.5% of construction costs will be allowed

Answer this question….

An uninsured office building is destroyed by fire after 4 years use.

What deduction would be allowed if it cost $100,000 and was built between 19/7/82 and 21/8/84.

Residual capital expenditure = 90000 2.5% X 100,000 for 4 years = 10000

Built between 19/7/82 and 21/8/84

Answer this question….

An uninsured office building is destroyed by fire after 4 years use.

What deduction would be allowed if ...

1. It cost $100,000 and was built between 19/7/82 and 21/8/84.

2. The sum of $50000 was received for salvage rights?

Residual capital value - salvage. 90000 Less 50000 = 40000