Wulf and Commissioner of Taxation (Taxation)
[2022] AATA 3094
•21 September 2022
Wulf and Commissioner of Taxation (Taxation) [2022] AATA 3094 (21 September 2022)
Division:TAXATION AND COMMERCIAL DIVISION
File Number: 2020/7835
Re:Peter Wulf
APPLICANT
AndCommissioner of Taxation
RESPONDENT
Decision
Tribunal:Senior Member K James
Date:21 September 2022
Place:Melbourne
The Tribunal ORDERS:
1.The Applicant is to present to the Respondent further particulars in relation to expenditure totalling $22,064.00 as set out in paragraph 63 of the Tribunal’s reasons no later than 28 days from the date of this decision.
2.Pursuant to s 43(1)(c)(ii) of the Administrative Appeals Tribunal Act 1975 (Cth) the objection decision of the Respondent dated 29 September 2020 is set aside and remitted to the Respondent for reconsideration in accordance with the following directions:
a.Expenditure totalling $28,342.54 as set out in paragraph 62(a) of the Tribunal’s reasons for decision are capital improvements and not deductable in the 2018 income year;
b.Expenditure totalling $2,819.35 as set out in paragraph 62(b) of the Tribunal’s reasons for decision are repair expenses and deductable pursuant to s 25-10 of the Income Tax Assessment Act 1997 (Cth); and
c.Subject to order 1, expenditure totalling $22,064.00 as set out in paragraph 63 is to be apportioned in accordance with TR 97/23 as set out in paragraph 42 of the Tribunal’s reasons.
................[sgd]........................................................
Senior Member K James
Catchwords
TAXATION – whether expenditure deductible as repairs – improvement to property – deductible capital works – water damage to property – degree of works completed – revenue and capital accounts – increased value of property – repairs and refittings to bathrooms, kitchen and laundry – decision set aside and remitted
Legislation
Income Tax Assessment Act 1997 (Cth) ss 25-10, 43-10
Cases
AAT Case 10/98 (1998) 39 ATR 1059
Federal Commissioner of Taxation v Western Suburbs Cinemas Ltd (1952) 86 CLR 102
Lindsay v Federal Commissioner of Taxation (1961) 106 CLR 377
NT1998/512 and Commissioner of Taxation [1999] AATA 363
NT87/4237 and Commissioner of Taxation [1989] AATA 494
Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337
W Thomas & Co Pty Ltd v Federal Commissioner of Taxation (1965) 115 CLR 58Secondary Materials
A. H Mann and K.C. Keown, The Australian Accountant (University of Queensland, 1948)
J.P Hannan, A treatise on the principles of income taxation: stated or deduced mainly from decisions and pronouncements of British and Australian courts (Law Book Co, 1946)
L. R. Dicksee, Advanced Accounting (4th edition, 1911)
Michael Kirby, ‘Kitto and the High Court of Australia’ (1999) 27(1) Federal Law Review 131
R.W. Parsons, Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (The Law Book Company Limited, 1985)Taxation Ruling 97/23: Income Tax: deductions for repairs
REASONS FOR DECISION
K James, Senior Member
21 September 2022
INTRODUCTION
On 25 November 2022 the Applicant applied to the Tribunal for review of an objection decision of the Respondent dated 29 September 2020 in respect of deductions claimed in the 2018 Income Year relating to repairs and capital improvements for a residential property owned by the Applicant used for investment purposes through residential leasing.
This matter concerns the deductibility of expenditure claimed to be deductible as repairs to a residential rental property. In Tax Ruling 97/23 (‘TR 97/23’),[1] the Commissioner states:
We recognise that in some cases practical difficulty may be involved in deciding, for the purpose of deductibility of repair expenditure under sections 25-10, whether the property is returned to its original efficiency of function by particular work done to it. We accept that there can be sound commercial and other reasons for doing work on property to improve its appearance, condition or functional efficiency. The question is necessarily one of fact and degree. It requires a careful weighing of the various factors discussed in this Ruling and exercising judgement in the light of decided case law and practical commercial experience.
[1] Taxation Ruling 97/23: Income Tax: deductions for repairs.
In a leading Tribunal case, P M Roach, Senior Member, observed the deductibility of repairs was unfortunately “far from being so simple”.[2] In TR 97/23 the Commissioner opines that ‘what is a ‘repair’…is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property”.[3]
[2] NT87/4237 and Commissioner of Taxation [1989] AATA 494, [3].
[3] Ibid [21].
The relevant expenditure in this matter is in the amount of $53,225.89 and is set out in Table A-1 of Annexure 1, contained within an Agreed Statement of Positions, as outlining the “expenditure…in dispute between the parties”. That expenditure related to work done on a rental property in a family bathroom, ensuite, toilet, laundry and kitchen.
BACKGROUND
The property was purchased by the Applicant in July 1983. It was first rented out around March 2008. It had a checked rental history. The Applicant was happy with the two families who tenanted between 2008 and August 2014.
The third family left overnight after two months in breach of the lease owing rent. The Applicant’s evidence was that:[4]
On leaving the property without notice and well before the end of their lease, the tenants deliberately blocked water drainage in the showers of the main bathroom and ensuite, plugged the bath in the main bathroom, plugged the bathroom sinks in both bathrooms and the kitchen sinks, and turned on all the taps;
the water overflowed and caused significant damage to the kitchen, ensuite, main bathroom and adjacent toilet and laundry. In the kitchen, given the way the taps were turned…the water ran across the kitchen bench top behind the sink and then down between the benchtops and the wall. The water also overtopped the sinks and flowed all over the floor. The water then infiltrated each of the cupboards along the back side of the house. The flooding to the kitchen resulted in the melamine (chip board) shelves and superstructure soaking up the water and made the shelves immediately unusable. Both bathrooms, toilet and laundry suffered extensive water damage.
…
The flooding resulted in a failure of the waterproofing between for example, the shower and the walls and wooden floors as well as the vanity and walls, wooden floor under the water proofing and structural and non-structural wall and members.
[4] Applicant’s Statement of Facts, Issues and Contentions filed 16 April 2021, paragraph 8(a)-(b) (Jones and Hewen family).
His evidence was that ‘some repair works were undertaken immediately to the bathrooms, including replacing the shelves and vanity’.[5] In the kitchen, the Applicant ‘changed the shelves within the cupboards’ and noted with hindsight that ‘given the amount of water that had been released onto the benchtops that then infiltrated into the cupboards, (and over time) the kitchen continued to deteriorate and the doors started to fall off, mould was growing and the bench tops lifted’.[6]
[5] Applicant’s Statement of Facts, Issues and Contentions filed 16 April 2021, paragraph 8(c) (Jones and Hewen family); See also the Applicant’s evidence that with hindsight ‘the flooding resulted in a failure to the waterproofing between for example, the shower and the walls and wooden floors as well as the vanity and walls, wooden floor under the water proofing and structural and non-structural wall and members’ in the Applicant’s Statement of Facts, Issues and Contentions filed 16 April 2021, paragraph 8(b) (Jones and Hewen family).
[6] Ibid.
The fourth family stayed for seven months before also breaking their lease due to a family separation.
The fifth family stayed for two years, between September 2015 to September 2017. The Applicant contended that this family ‘broke the shower head off the wall of the ensuite in August 2017’ which required replacement and ‘resulted in flooding of the ensuite’.[7] In the final month of their tenancy, the flexible water pipe at the property burst under the sink, ‘again flooding the main bathroom and adjoining toilet and laundry’.[8]
[7] Applicant’s Statement of Facts, Issues and Contentions filed 16 April 2021, paragraph 8(a) (The Stephen family).
[8] Ibid.
A further tenant occupied the property until May 2019, when they were evicted for the non-payment of rent.[9] The property remained vacant from this time until 27 January 2020, during which time the expenditure under review took place.
[9] Applicant’s Statement of Facts, Issues and Contentions filed 16 April 2021, paragraph 5.
NATURE OF THE WORKS
The works on the bathroom, ensuite, laundry and toilet were carried out in the main by a contract carpenter, Callum Elliott. Mr Elliott filed two witness statements by way of affidavit and gave oral evidence before the Tribunal. His evidence was that both bathrooms in the property ‘had suffered from significant water ingress both to the fittings within the bathrooms (for example, the vanities) as well as structural damage to the floor, walls and ceiling’.[10] He was of the opinion that the ‘only way to fix the bathrooms properly was to remove the fittings, wall sheets and ceiling’ to get access behind and underneath them respectively.[11]
[10] Affidavit of Callum David Elliott dated 25 June 2021, [15].
[11] Ibid.
Further, Mr Elliott’s evidence is as follows:[12]
[12] Affidavit of Callum David Elliott dated 25 June 2021, [16]-[18].
(a)There was cracking in the floor tiles of both bathrooms, allowing water ingress into the floor substrate;
(b)Without fully removing the tiles, tile bed, failed waterproofing and tile underlay, access to assess the damage to the floorboards and wall studs in both bathrooms is impossible;
(c)Ongoing structural degradation would have occurred, requiring extensive structural replacement, would the measures described in paragraph (b);
(d)Wall tiles in both bathrooms had become detached from the walls due to water ingress;
(e)Reattaching new tiles or replacing some tiles would be a piecemeal approach only and would not be waterproof or warrantable;
(f)Where tiles had become detached, structural damage to the rooms had resulted due to the detachment providing a path for water ingress;
(g)The tiles needed to be removed fully, re-waterproofed and new tiles laid to ensure waterproofing integrity;
(h)He discovered water damage behind the wall sheet, the extent of which would have been unknown if the tiles and wall sheets were not removed, and would have resulted in greater damage over time; and
(i)He considers it was necessary to fully waterproof the bathrooms to stop water ingress across the whole of the rooms and that to have conducted ‘piecemeal’ works would not have been consistent with good building practice.
The Tribunal accepts this evidence, that is, that the gutting of the infrastructure in the bathrooms was undertaken for the purpose of ensuring that the underlying structure and integrity of the bathrooms going forward would be sound, habitable and compliant. What was undertaken was in concept a necessary restoration of the damage to the walls and floor in the various rooms. Access to the structural stud work had to be obtained and that necessarily involved the removal of the existing wall sheeting and tiling covering that stud work. His evidence was that partly due to the access obtained by way of the removal of the bathroom wall sheeting, less action was required in other rooms of the property, such as the laundry and toilet.
His evidence was that his involvement in the kitchen was to assist in the removal of the existing cabinetry, which he was of the opinion was ‘beyond repair’,[13] and after doing so removing the wall sheets to assess the structural damage sustained in these areas as a result of water ingress, and to ensure that the kitchen area could be ‘rodent proofed’ and not be an ‘ongoing health hazard’.[14]
[13] Affidavit of Callum David Elliott dated 25 June 2021, [5].
[14] Ibid [8]-[9].
It was not in dispute that new kitchen cabinetry, which included a range hood,[15] as supplied and installed by a kitchen cabinet specialist firm.
[15] The rangehood has been treated as depreciable and its treatment is not in dispute.
RELEVANT LEGISLATION AND LEGAL PRINCIPLES
Section 25-10 of the Income Tax Assessment Act 1997 (‘ITAA 1997’) relevantly provides:
(1) You can deduct expenditure you incur for repairs to premises (or part of premises) or a depreciating asset that you held or used solely for the purpose of producing assessable income
Property held or used partly for that purpose
(2) 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.
No deduction for capital expenditure
(3) You cannot deduct capital expenditure under this section.
Section 43-10 of the ITAA 1997 provides:
(1) You can deduct an amount for capital works for an income year.
(2) You can only deduct the amount if:
(a) the capital works have a construction expenditure area; and
(b) there is a pool of construction expenditure for that area; and
(c) you use your area in the income year in the way set out in Table 43-140 (Current year use).
The Applicant’s detailed and extensive submissions (discussed later) are to the effect that the expenditure was for repairs, not of a capital nature and not an improvement.
The Commissioner’s position is that the expenditure was capital in nature because, as a matter of fact and degree, the works amounted to improvements. To assist the Tribunal and the Applicant, the Commissioner did not ‘submit the works amounted to renewals or reconstructions of entireties’, which were an added reason in the Commissioner’s decision disallowing of the Applicant’s objection.
It is clear from the wording in Section 25-10 that to be entitled to a deduction the relevant expenditure must satisfy the positive test of being a ‘repair’, and the negative test of not being ‘capital expenditure’.
In the context of ‘improvements’, this raises the question as to whether the concepts of ‘repair’ and ‘capital expenditure’ are mutually exclusive.[16] For the purposes of this decision the Tribunal is of the opinion that, applying the applicable law, the concepts are only to an extent mutually exclusive, and that both tests require proper consideration.
[16] See R.W. Parsons, Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (The Law Book Company Limited, 1985), [10.13], supported by the structure of TR 97/23.
The authorities relied upon by both parties acknowledge that a repair can involve some element of improvement. Where there is a repair with some improvement, the challenge is to find the line where such an improvement crosses that line such that it is no longer a deductible repair but a capital improvement.
The leading Australian authority is the decision of Justice Kitto in Federal Commissioner of Taxation v Western Suburbs Cinemas Ltd.[17] After finding that the expenditure was for fibrous plaster ‘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”.[18]
He continued:[19]
“Even if, on this evidence, the provision of a new ceiling for the theatre should be regarded as a repair…I should have thought that the expenditure involved was expenditure of a capital nature and therefore not allowable as a deduction…
…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”.
[17] (1952) 86 CLR 102 (‘WSC’).
[18] Ibid 105.
[19] Ibid 106-106.
In a subsequent decision in 1961,[20] dealing with repairs in the context of whether there was an ‘entirety’, Kitto J again makes reference to ‘whether an item of expenditure is to be held on general principles to be chargeable to income or capital account’, noting that it is necessary to “distinguish between “the business entity, structure or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay’.[21]
[20] Lindsay v Federal Commissioner of Taxation (1961) 106 CLR 377.
[21] Ibid 384, citing Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337, 359-360.
The accounting concept of assets being recorded in separate capital and revenue accounts was common at the turn of the last century, and still of some relevance in the middle part of that century.[22] Capital gains and capital losses, including the wasting of capital assets, were not historically recorded in the ‘revenue account’. Acquisitions of new capital assets were recorded in the ‘capital account’.[23]
[22] L. R. Dicksee, Advanced Accounting (4th edition, 1911) 142; See also A. H Mann and K.C. Keown, The Australian Accountant (University of Queensland, 1948) 347.
[23] J.P Hannan, A treatise on the principles of income taxation: stated or deduced mainly from decisions and pronouncements of British and Australian courts (Law Book Co, 1946) 280 and 355.
A separate capital account is still relevant in some areas of trust law,[24] especially for trust estates that have different capital and income beneficiaries. This is commonly the case where properties are left in testamentary trusts with a life interest for a surviving spouse and a remainder interest to children. Again, more commonly where there is a second spouse and children of an earlier marriage.
[24] Michael Kirby, ‘Kitto and the High Court of Australia’ (1999) 27(1) Federal Law Review 131, 146.
W Thomas & Co Pty Ltd v Federal Commissioner of Taxation completes the trilogy of High Court repair cases drawing a distinction between capital accounts and revenue account.[25] The case concerned expenditure on a factory/warehouse building. The building’s roof was originally slate ‘patched in part with malthoid’ and ‘in other parts the slates had been removed and galvanized iron had been fairly recently substituted…’[26] The remainder was galvanized iron ‘although there too some parts had been fairly recently renewed’.[27]
[25] W Thomas & Co Pty Ltd v Federal Commissioner of Taxation (1965) 115 CLR 58.
[26] Ibid 66.
[27] Ibid.
A new roof, including guttering was installed in place of the slate and the older galvanized iron with new iron and fibreglass Perspex. The gutters and downpipes were also replaced. There was also work on the interior walls that had ‘fretted and was fretting in part and plaster from them kept falling to the floor’.[28] The surface of the ‘walls were picked out where necessary and were replaced with concrete cemented over’.[29]
[28] Ibid 67.
[29] Ibid.
The whole of the interior had a thorough clean and was painted including areas that had not previously been painted. A basement floor had become damp. A contractor put ‘a special mastic asphalt ... on top of the existing brick and concrete floor.’ The final item related to the wooden floor on upper levels that had become worn and damaged by white ants in places. Part of the flooring was ‘replaced by new boards and some of the supporting timbers which were considered faulty were renewed to strengthen the floor and ensure it was stable’.[30]
[30] Ibid 68.
As to whether this work was a repair Windeyer J stated:[31]
The works in question can all be fairly described as repairs to the building. They were done to make good a deterioration that had occurred by ordinary wear and tear or by the operation of natural causes during the passage of time. I was referred to various definitions of the word “repair” and to a number of cases illustrative of its meaning. I need not discuss them. Cases arising between landlord and tenant are only of indirect assistance. And nothing much is to be gained by comparing the particular facts of other cases with the facts of this case. And understanding the concept of “repair” is not much aided by contrasting that word with other words that in themselves gain only by contrast whatever precision of meaning they have in this field. 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 in 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. But the answer to that question does not of itself decide whether the expenditure on the work is properly to be considered as an outgoing upon capital account or upon revenue account. And that is what must be decided when the question is whether that expenditure is an allowable deduction in the ascertainment of taxable income.
Expenditure upon repairs is properly attributes to revenue account when the repairs are for the maintenance of an income-producing capital asset. Maintenance involves the periodic repair of defects that are the result of normal wear and tear in operation. It is an expense of a revenue nature when it is to repair defects arising from the operations of the person who incurs it.
[31] Ibid 72.
These repairs were undertaken within 12 months of the purchases of the building and were held to be ‘initial repairs’ and therefore capital in nature. His finding that the expenditure was a repair was relevant to a subsequent finding that the company had made a ‘full and true disclosure’ for penalty purposes.[32]
[32] Ibid 75.
There has since been a small number of Tribunal decisions dealing with the nature of improvements in rental properties.
In the 1989 decision of Senior Member P M Roach referred to at paragraph 3 of these reasons, the supply and fitting of, a new shower screen, an aluminium double hung window frame in replacement of a timber frame window, and the purchase and installation of a new fire hose reel and fittings all constituted improvements.[33] Further, work done by carpenters to ‘install a ceiling with one hour fire-resistance rated system having two layers of 16mm fire rated plaster board…constituted an “improvement” and, accordingly, the cost of its installation [was] not deductible’.[34]
[33] NT87/4237 and Commissioner of Taxation [1989] AATA 494.
[34] Ibid [23].
In a 1999 case of Senior Member M D Allen,[35] the expenditure before the Tribunal was for the installation of ‘new cupboards and benchtops and…for removal of the old cupboards’.[36] The matter concerned work that became necessary in a kitchen due to there being damage ‘caused by tenants, including burn marks on laminated bench tops, missing handles on cupboard doors and chips and scratches to surfaces. In addition, a rat had chewed through a dishwasher hose, leading to flooding which had caused water damage to cupboards including swelling of doors and shelves’.[37]
[35] NT1998/512 and Commissioner of Taxation [1999] AATA 363.
[36] Ibid [5].
[37] Ibid [4].
After citing the quote at paragraph 30 herein of W Thomas & Co Pty Ltd v Federal Commissioner of Taxation, the Tribunal decision of Senior Member Allen continued:[38]
[38] Ibid [10], [11], [13] & [14].
…the dilemma involved in creating a test to distinguish repairs from improvements was referred to by Denning LJ (as he then was) in Morcom and Others v Campbell-Johnson and Others [1955] 3 All ER 264 at 266…
“It seems to me that the test, so far as one can give any test in these matters, is this: If the work which is done is the provision of something new for the benefit of the occupier, that is, properly speaking, an improvement; but if it is only the replacement of something already there, which has become dilapidated or won out, then, albeit that it is a replacement by its modern equivalent, it comes within the category of repairs and not improvements.”
I note however, the submissions by Ms Rands, who appeared for the Respondent, that the remarks of Denning LJ should be approached with caution as the Court of Appeal was not dealing with a taxation statute but a case under a Rent Restriction Act. Notwithstanding this caveat there is in the above remarks, like most of what fell from that learned Law Lord, eminent good sense.
Senior Member Beddoe in Case 10/98 98 ATC 171 at 177 referred to Windeyer J’s adoption in W Thomas & Co Pty Ltd supra of the remarks of Woodhouse J in Collector of Inland Revenue, Cook Islands v A.B. Donald Limited (1965 9 A.I.T.R. 501 at 506. The relevant part of Woodhouse J’s judgment for present purposes reads:
“…I take the view that the restoration defects in an asset cannot be classed as a revenue charge…unless the work is limited to those defects and does not become enlarged into such a reconstruction that a permanent improvement in quality has been effected.”
…
In this matter the Applicant, following the refurbishment of the kitchen, was able to obtain a higher rent than previous for the said premises. In addition the replacement of the kitchen cupboards was undertaken as part of a refurbishment of the whole kitchen. Whereas I can understand the good sense in replacing the existing dilapidated cupboards with new ones, the test is…where the work has gone beyond a mere remedying of defects.
In this matter I am not satisfied that the work undertaken did not enlarge itself into an improvement. It may well be that the only practical way of effecting repairs was to replace the whole. I can quite understand that, for example, cupboards or draws can become warped so that merely to replace a door does not remedy the underlying defect. Similarly, to replace water damage shelving may requiring a complete restructuring of total fabric.”
The Applicant’s position was that the work done to the bathroom, ensuite, laundry and toilet ‘was within exactly the same footprint as the original bathrooms. There was no expansion of the bathrooms and moreover, every fitting and aspect of the bathroom was in exactly the same location, except where a small bath was installed to replace a larger bath that was previously within the main bathroom to accommodate the bath. As an example, the showers were and are now in exactly the same location as the previous showers, the vanity and sinks in the ensuite is also in the same position and the toilets were not moved’.[39]
[39] Applicant’s Amended Statement of Facts, Issues and Contentions filed 16 September 2021, [39].
It was also advanced by the Applicant that: [40]
‘The only change was that more contemporary fittings etc were installed including shower heads that complied with water efficiency requirements, were gender flexible (e.g. rain head and handheld shower to replace rain heads), the replacement of the same style of lights for broken/ damages lights that were there originally installed including but not limited to three way lights which include a light, heat lamp and exhaust fan system (there was one installed in both bathrooms that were not operating effectively). All materials were done on a budget, using materials that were cheaper than could have been installed to match the previous bathroom fittings and no new fittings would be considered as being anything other than what was there originally except for the showers as described above.
None of the works changed in any way, the character of the property, nor did any of the repairs do more than restore the efficiency of the property’s functions including ensuring that the bathrooms were structural sound (sic) and operating to a standard that would be required to rent the property. None of the works were an improvement to the existing property’.
[40] Ibid [40]-[41].
The Applicant’s position in respect of the kitchen was that the work done was to make ‘good the previous kitchen that was significantly damaged as a result of the actions of the tenants…None of the repairs in the kitchen went outside the existing footprint as can be observed from the information and photos [that] are provided in the affidavits of Mr Callum David Elliott and the Applicant…None of the works changed the character of the property, nor did they do more than restore the efficiency of the property’s functions including ensuring that the kitchen was structural sound (sic) and operating to a standard that would be required to rent the property. None of the works were an improvement to the existing property’.[41]
[41] Ibid [44].
In closing written submissions, the Applicant acknowledged that the work undertaken ‘must not amount to a substantial improvement, addition or alteration’ and that ‘the leading example of this principal is found’ the WSC decision of Justice Kitto.[42]
[42] Applicant’s Closing Written Submissions filed 14 January 2022, [39].
The Applicant’s submission continued:[43]
‘While his Honour did undertake an analysis of the expenditure incurred on the footing that it was a repair and came to a conclusion that it was capital in nature, the reasoning for that is, first, strictly obiter, and secondly, directed to quite different facts given the nature of the change to the relevant construction.
The present circumstances are quite different. The deduction claimed is for the expenditure actually incurred which, it is respectfully submitted, is wholly a repair by way of reinstatement of damage caused, and on revenue account having its origin and occasion in damage caused by periodical tenant of the relevant property’.
[43] Ibid [41]-[42].
The Commissioners closing written submissions were:[44]
‘Throughout the Applicant’s written submissions, reference is made to the damage which prompted the works and the subsequent restoration of function which was achieved. The Commissioner submits that the Tribunal ought to be wary of unduly limiting the question before it to merely whether something was remedied.
Instead, as previously submitted by the Commission, regard must also be had to the degree of works done and whether they amounted to improvements.
In this respect, the Applicant relies in part on the propositions that:
a. the refurbished rooms performed the same purpose as they did before; and
b. the refurbished rooms were laid out in much the same way as they were before.
In the circumstances of a residential dwelling, the Commissioner respectfully submits that neither of these considerations can be determinative of whether the works amounted to improvements of the property.
Instead, the examination of whether the works amounted to improvements requires broader consideration of whether they brought the Property into a more valuable or desirable form such that there was a greater efficiency of function. This may be illustrated by enhancements to the Property’s income-producing ability, market value or expected life’. (footnotes omitted)
[44] Respondent’s Closing Written Submissions filed 4 February 2022, [8]-[12].
The Tribunal notes that in TR 97/23, under the heading ‘Repairs done at the same time as improvements’, the Commissioner states the following:[45]
‘The character of the repair does not necessarily change because it is carried out at the same time as an improvement. If, for example, a shopping centre is extensively renovated or restored (the project combining repairs and improvements) and if some parts of the project can be effectively separated and considered in isolation from the rest of the project, they may still be repairs. It is necessary to examine separately the individual parts of the total project to determine whether any part, if considered in isolation, is a repair. It is not appropriate to have regard only to the result of the entire work done. It is inappropriate to regard the whole project as an affair of capital. In other words, if individual parts of the total project can be separated and characterised as repairs, and if their cost can be segregated and accurately quantified, their cost is deductible. It must be possible to segregate the cost of repairs actually effected from the capital cost of the improvements.
If, however, repair work is inextricably bound up with work of an improvement nature, and the repair work cannot be separately segregated and its cost accurately quantified independently from the cost of the improvements, we regard the cost of the entire work as being of a capital nature and not deductible’.
[45] TR 97/23,[55]-[56].
The Tribunal accepts these statements as an accurate summary of the relevant authorities and notes their binding nature on both the Commissioner and the Tribunal.
FINDING OF FACTS
The Tribunal finds that significant damage had occurred to the stud walls and floor of the kitchen, bathroom, ensuite, laundry and toilet as a consequence of water ingress. In order to examine this damage, it was necessary to remove the wall coverings which included much, if not all, of the wall tiles in the bathroom and ensuite and to a lesser extent in the toilet and laundry. This work was necessary, is a repair and not in the nature of an improvement.
The Tribunal finds that the decision of the Respondent should be set aside and remitted with a direction which allows the objection for the cost of materials in respect of this work. (see paragraph 62 below). The invoices for labour do not allow the Tribunal to quantify the amount deductible in doing this work. As such, Mr Elliott’s invoices are remitted to the Commissioner to make the appropriate apportionment consistent with paragraph 42 above.
The Tribunal finds that the work done in addition to that dealt with in paragraph 45 above, in the toilet and laundry, was mainly done in reinstating the walls to a condition they were in before the work dealt with in the above paragraph was conducted. The walls and floors of a toilet and laundry are nothing special. The Tribunal notes that the toilet pan and the laundry trough was not replaced.[46] This work will have had little impact on the market or rental value of the house or have any enduring impact on future repair or maintenance expenses.
[46] Hearing Transcript, 18.
Any improvement to the property resulting from this work is ‘marginal’,[47] and is not to ‘a sufficient degree of improvement to justify characterising the expenditure as capital and therefore excluding it from deductibility under section 25-10’.[48]
[47] TR 97/23, [50].
[48] Ibid [51].
The Tribunal also finds that the decision of the Respondent must be set aside and remitted with a direction which allows the objection (see paragraph 62 below) in respect of the materials identified from the invoices supporting claims made in the schedule. Again, Mr Elliott’s invoices for labour are remitted to the Commissioner to make the appropriate apportionment consistent with paragraph 42 above.
The bathroom was completely rebuilt, and on the evidence with a new smaller bath, vanity, including a new basin and a shower with new fittings including a new shower screen. By necessity there were new tiles on the walls and floor. From the tendered photographs the Tribunal accepts that this rebuilding was done on a sensible budget, but with the outcome that the bathroom had been refurbished and modernised.
The walls were also stripped of their tiles and fittings, removed and water-proofed up to at least 200mm above the floor.[49] Mr Elliott’s evidence on affidavit and in person was that his work significantly extended the effective life of the bathroom (and ensuite).[50]
[49] Applicant’s Amended Statement of Facts, Issues and Contentions filed 16 September 2021, [8].
[50] Affidavit of Callum Elliott dated 18 April 2021, [6]-[7]; Hearing Transcript, 21.
The work in the ensuite is similar; it was completely retiled, and a new vanity was installed, with new fitting and new shower screen.
After the walls were repaired the kitchen was completely refitted with new kitchen cabinetry including a new sink and plumbing fittings. This included new overhead cupboards, which on the evidence replaced the existing ones that were not water damaged. Mr Elliott’s evidence was that new flooring behind the cupboards, new sections of wall, and new kitchen cupboards were installed, although there was no new plumbing put in.[51] The Applicant has agreed that the new oven and dishwasher supplied with these appliances in the kitchen were not part of the repair claim and subject to depreciation treatment.
[51] Hearing Transcript, 21.
The Respondent submitted that evidence that the work (in this context including all five rooms) was an improvement evidenced by the difference in the rent obtained before the work, being ‘$480 a week, an amount under the medium weekly rent for the Property’s location around that time’,[52] and $550 a week, ‘following completion of the majority of the relevant works’.[53]
[52] Respondent’s Written Outline of Argument filed 10 November 2021, [36].
[53] Ibid [37].
That tenancy was intended to extend for 5 years, with the $550 weekly rent fixed for three years with provision for it to increase to $575 for the last two years. In NT1998/512 and Commissioner of Taxation,[54] the obtaining of a higher rent after the refurbishment of a kitchen was submitted by the Respondent to support ‘a conclusion that those works increased the property’s income-producing ability’ and therefore were an improvement.[55]
[54] [1999] AATA 363
[55] Respondent’s Written Outline of Argument filed 10 November 2021, [39].
The Applicant’s counter submission was extensive and included information that the tenant refused to pay the rent seven months into that tenancy and was ultimately evicted through a Warrant of Possession issued by the Queensland Civil and Administrative Tribunal.[56] He experienced difficulties reletting the property before finally doing so in January 2020 for $510 per week.
[56] Applicant’s Amended Statement of Facts, Issues and Contentions filed 16 September 2021, [51].
The total expenditure on the property at the time the work was done on the kitchen, bathroom and ensuite was in the order of $77,351.15. The expenditure in dispute in those three rooms is in the order of $53,225.89. The Tribunal accepts that it is difficult to determine what, if any, immediate increased rent was caused by the disputed work. That said, the test formulated by Justice Kitto in WSC focuses on future benefits and, in the facts of that case, future savings in revenue outgoings. A properly waterproofed modernised kitchen, bathroom and ensuite, even when done on a prudent budget, can be expected to produce revenue savings over time and extend the useful life of the asset. Mr Elliott’s evidence was to that effect.
They can also be expected to provide enduring benefits of improved rental appeal over time and to improve the market (capital) value of the property. The fact that the work was necessary is not the major consideration. What the authorities focus on is whether, on the facts, the work/expenditure is of a nature that the property (capital) has been enhanced. That is, are there significant benefits that will be enjoyed going forward.
On the evidence, the expenditure must have improved the condition of the property from what it was before it was first let out, and/or from before the water damage first occurred.
In the accounting terminology of the time of the WSC decision, such enhancements should be recorded in a capital account. The Tribunal finds the expenditure on renewing the three rooms fails the negative capital test. That is, it is properly considered a capital expenditure.
The Tribunal notes that this accounting outcome sits comfortably in the hypothetical testamentary trust discussed in paragraph 26 above. A life tenant/income beneficiary would have grounds to feel aggrieved if the whole of the expenditure was to be charged against their entitlement.
The accounting also sits comfortably with modern accounting standards which provide that assets should be recognised if there are future economic benefits. Even on an assumption that the rent is not increased, this property could be rented in its new form for longer periods or, as Justice Kitto determined, with fewer future costs.
The Tribunal has cross-referenced the items listed in in Table A-1 of Annexure 1 of the Agreed Statement of Positions, to the relevant invoices contained within the T Documents.
(a)The following materials, totalling $28,342.54, are expenses treated as capital improvements and thus the objection decision of the Commissioner is upheld. This expenditure is eligible to be claimed in the future pursuant to Section 43-10 of the ITAA 1997.
Date
Supplier
Item
Amount
14 Sept 2017
Kitchens by Alliance
Progress payment for replacement kitchen
$1,316.76
21 Sept 2017
CNW
Replacement light fittings for bathrooms and kitchen
$460.90
21 Sept 2017
Kitchens by Alliance
Progress payment for replacement kitchen
$3,652.00
25 Sept 2017
Metro Tiles
Replacement tiles for bathrooms floors and walls
$1,380.72
28 Sept 2017
Reece
Fittings for replacement bathrooms
$374.97
3 Oct 2017
Reece
Copper fittings for replacement bathrooms
$104.10
3 Oct 2017
Reece
Fittings for replacement bathrooms
$6,982.99
4 Oct 2017
Reece
Plumbing fittings for replacement bathrooms
$164.44
4 Oct 2017
Bunnings
Sealant for replacement bathrooms
$321.19
7 Oct 2017
Reece
Plumbing fittings and parts for replacement bathrooms
$185.26
11 Oct 2017
Bunnings
Materials for replacement bathrooms
$577.62
13 Oct 2017
Kitchens by Alliance
Progress payment for replacement kitchen
$8,497.00
16 Oct 2017
Bunnings
Materials for replacement bathrooms
$95.05
18 Oct 2017
Bunnings
Materials for replacement bathrooms
$89.94
23 Oct 2017
Metro Tiles
Tiles and materials for floors and walls of replacement bathrooms
$143.00
23 Oct 2017
Metro Tiles
Floor leveller for replacement bathrooms
$448.05
23 Oct 2017
Kitchens by Alliance
Progress payment for kitchen
$560.00
23 Oct 2017
Reece
Materials for replacement bathrooms
$77.88
7 Dec 2017
Metro Tiles
Metroflex for walls of replacement bathrooms
$59.00
8 Dec 2017
Metro Tiles
Grout for replacement bathrooms
$87.86
14 Dec 2017
Metro Tiles
Grout and sealer for replacement bathrooms
$70.49
14 Dec 2017
Glass Projects
Replacement shower screens
$2,306.00
22 Jan 2018
Metro Tiles
Grout and sealer for replacement bathrooms
$295.32
24 Jan 2018
Traditional Tiles
Tiles for replacement bathroom and toilet
$92.00
(b)The following materials, totalling $2,819.35 should be allowed as deductions as they are held to be repairs and not capital improvements.
Date
Supplier
Item
Amount
5 Aug 2017
Reece
Replacement shower head pulled off wall
$114.01
6 Sept 2017
Brookfield Produce
Plumbing fittings
$39.90
23 Sept 2017
Metro Tiles
Replacement tiles for toilet
$150.00
6 Oct 2017
Beta Board
Replacement walls, floor and ceiling for bathroom
$993.91
9 Oct 2017
Bunnings
Materials for replacement bathrooms
$152.95
11 Oct 2017
Reece
Plumbing fittings for replacement bathrooms
$16.50
12 Oct 2017
Centenary Hire
Jackhammer to remove tiles from replacement bathrooms
$75.00
16 Oct 2017
Bunnings
Materials for replacement bathrooms
$44.32
16 Oct 2017
Bunnings
Materials for replacement bathrooms
$87.63
1 Nov 2017
Bretts Timber
Materials for replacement bathrooms
$384.38
4 Nov 2017
Reece
Traps for replacement bathrooms
$20.33
13 Nov 2017
Bunnings
Nails for replacement bathrooms
$51.80
27 Nov 2017
CNW
Electrical cable for replacement lights in bathrooms
$75.14
8 Dec 2017
Bunnings
Materials for replacement bathrooms and other works
$195.98
12 Dec 2017
Bretts Timber
Timber to replace rotten timber at property
$249.45
24 Jan 2018
Reece
Plumbing fittings for works at property
$168.05
63.The following invoices for labour incurred from Mr Elliott, totalling $22,064.00, are remitted back to the Commissioner to be apportioned in accordance with paragraphs 45 and 48 above.
Date
Supplier
Item
Amount
3 Oct 2017
Callum David Elliott
Construction Labour
$1,400.00
8 Oct 2017
Callum David Elliott
Construction Labour
$2,300.00
13 Oct 2017
Callum David Elliott
Construction Labour
$1,450.00
20 Oct 2017
Callum David Elliott
Construction Labour
$2,000.00
28 Oct 2017
Callum David Elliott
Construction Labour
$2,750.00
4 Nov 2017
Callum David Elliott
Construction Labour
$464.00
5 Nov 2017
Callum David Elliott
Construction Labour
$2,750.00
3 Dec 2017
Callum David Elliot
Construction Labour
$750.00
9 Dec 2017
Callum David Elliott
Construction Labour
$1,750.00
17 Dec 2017
Callum David Elliott
Construction Labour
$2,650.00
22 Dec 2017
Callum David Elliott
Construction Labour
$200.00
13 Jan 2018
Callum David Elliott
Construction Labour
$1,650.00
21 Jan 2018
Callum David Elliott
Construction Labour
$1,950.00
The Applicant has, for the most part, put forward his case on the premise that the entirety of the works and their associated expenditure should be classified as repairs. As the Tribunal has found this not to be case this impacts the taxation treatment of the labour expenditure in accordance with TR 97/23. The invoices supplied by Mr Elliot do not itemise the particular tasks undertaken. The Tribunal, sitting in the shoes of the Commissioner, has accepted his evidence that he undertook work which is properly regarded as a deductible cost of repairing the premises. The work has been ‘segregated and its cost accurately quantified independently from the costs of the improvements’.
As a matter of procedural fairness, and considering the findings the Tribunal has made with regard to the expenditure on materials the Tribunal will make orders to allow the Applicant a modest period of time to produce to the Respondent further particulars to identify which particular expenditure on labour was to give effect to the required repairs.
Accordingly, the Tribunal will make orders as follows
1.The Applicant is to present to the Respondent further particulars in relation to expenditure totalling $22,064.00 as set out in paragraph 63 of the Tribunal’s reasons no later than 28 days from the date of this decision.
2.Pursuant to s 43(1)(c)(ii) of the Administrative Appeals Tribunal Act 1975 (Cth) the objection decision of the Respondent dated 29 September 2020 is set aside and remitted to the Respondent for reconsideration in accordance with the following directions:
a.Expenditure totalling $28,342.54 as set out in paragraph 62(a) of the Tribunal’s reasons for decision are capital improvements and not deductable in the 2018 income year;
b.Expenditure totalling $2,819.35 as set out in paragraph 62(b) of the Tribunal’s reasons for decision are repair expenses and deductable pursuant to s 25-10 of the Income Tax Assessment Act 1997 (Cth); and
c.Subject to order 1, Expenditure totalling $22,064.00 as set out in paragraph 63 is to be apportioned in accordance with TR 97/23 as set out in paragraph 42 of the Tribunal’s reasons.
I certify that the preceding sixty-six (66) paragraphs are a true copy of the reasons for the decision herein of Senior Member K James
………[sgd]…………………………….
AssociateDated: 21 September 2022
Date of hearing: 12 November 2021 Advocate for the Applicant:
Mr Peter Wulf
Advocate for the Respondent: Mr Alex Dekkers Solicitors for the Respondent: Australian Taxation Office
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