Division 43 of the ITAA 1997 provides for a system of deducting capital expenditure incurred in the construction of buildings and other capital works used to produce assessable income.
Capital works
You can deduct construction costs for the following capital works:
- buildings or extensions, alterations or improvements to a building
- structural improvements or extensions, alterations or improvements to structural improvements
- environmental protection earthworks; see Appendix 6.
Deductions for construction costs and structural improvements must be based on actual costs incurred. If it is not possible to genuinely determine the actual costs, obtain an estimate by a quantity surveyor or other independent qualified person. The costs incurred by the company for the provision of this estimate are deductible as a tax-related expense, not as an expense in gaining or producing assessable income.
Different deduction rates apply (2.5% or 4%) depending on the date on which construction began, the type of capital works, and the manner of use.
Who can claim?
The company can claim a deduction under Division 43 for an income year only if it:
- owns, leases or holds part of a construction expenditure area of capital works (‘your area’)
- incurred the construction expenditure or is an assignee of the lessee or holder who incurred the expense, and
- uses ‘your area’ to produce assessable income or in some cases for carrying on R&D activities.
In calculating the company’s deductions, identify ‘your area’ for each construction expenditure area of the capital works. Your area may comprise the whole of the construction area or part of it.
There are special rules that qualify the use of the capital works for R&D activities. The R&D activities must be conducted in connection with a business carried on for the purposes of producing assessable income and be registered under section 27A of the Industry Research and Development Act 1986 for an income year.
Lessee or holder of capital works
A lessee or holder can claim a deduction for an area leased or held under a quasi-ownership right. To claim a deduction the lessee or holder must have:
- incurred the construction expenditure or be an assignee of the lessee or holder who incurred the expenditure
- continuously leased or held the capital works area itself, or leased or held the area that had been so held by previous lessees, holders or assignees since completion of construction, and
- used the area to produce assessable income, or in some cases for carrying on R&D activities.
If there is a lapse in the lease, the entitlement to the deduction reverts to the building owner.
Requirement for deductibility
The company can deduct an amount for capital works in an income year if:
- the capital works have a ‘construction expenditure area’
- there is a ‘pool of construction expenditure’ for that area, and
- the company uses the area in the income year to produce assessable income or for carrying on R&D activities in the way set out in section 43-140 of the ITAA 1997.
No deduction until construction is complete
The company cannot claim a deduction for any period before the completion of construction of the capital works even though the company used them, or part of them, before completion. Additionally, the deduction cannot exceed the undeducted construction expenditure for your area.
Capital works are taken to have begun when the first step in the construction phase starts; for example, pouring foundations or sinking pilings for a building.
Establishing the deduction base
You can deduct expenditure for the construction of capital works if there is a construction expenditure area for the capital works. Whether there is a construction expenditure area for the capital works and how it is identified depends on the following factors:
- the type of expenditure incurred
- the time the capital works commenced
- the area of the capital works to be owned, leased or held by the entity that incurred the expenditure
- for capital works begun before 1 July 1997, the area of the capital works that was used in a particular manner, see section 43-90 of the ITAA 1997.
Construction expenditure
Expenses incurred on construction include:
- preliminary expenses, such as an architect’s fees, engineering fees, foundation excavation expenses and costs of building permits
- costs of structural features that are an integral part of the income-producing building or income-producing structural improvements; for example, lift wells and atriums
- some portion of indirect costs.
For an owner/builder entitled to a deduction under Division 43 of the ITAA 1997, the value of the owner/builder’s contributions to the works (labour or expertise and any notional profit element) do not form part of construction expenditure.
See also:
- Taxation Ruling TR 97/25 and 97/25A Addendum – Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements.
Construction expenditure does not include expenditure on:
- acquiring land
- demolishing existing structures
- clearing, levelling, filling, draining or otherwise preparing the construction site before carrying out excavation work
- landscaping
- plant
- property or expenditure for which a deduction is allowable, or would be allowable if the property were for use for the purpose of producing assessable income, under another specified provision of the ITAA 1936 or the ITAA 1997.
Construction expenditure area
The construction of the capital works must be complete before the construction expenditure area is determined. A separate construction expenditure area is created each time an entity undertakes the construction of capital works.
For construction expenditure incurred before 1 July 1997, the capital works must have been constructed for a specified use at the time of completion, depending on the time when the capital works commenced. The first specified use construction time was 22 August 1979; see section 43-90 and section 43-75(2) of the ITAA 1997.
Pool of construction expenditure
The pool of construction expenditure is the portion of the construction expenditure incurred by an entity on capital works, which is attributable to the construction expenditure area.
Deductible use
The company can only obtain a deduction under Division 43 if it uses your area in a way described in table 43-140 or 43-145 of Subdivision 43-D of the ITAA 1997.
Special rules about uses
Your area is taken to be used for a particular purpose or manner if:
- it is maintained ready for that use and is not used for another purpose, and its use has not been abandoned, or
- its use has temporarily ceased because of construction or repairs, or for seasonal or climatic conditions.
Your area is not accepted as being used to produce assessable income:
- if it is a building (other than a hotel or apartment building) used or for use wholly or mainly for exhibition or display in connection with the sale of all or part of any building, where construction began after 17 July 1985 but before 1 July 1997. If construction began after 30 June 1997, buildings that are used for display are eligible
- if it is a building (other than a hotel or apartment building) where construction began after 19 July 1982 and before 18 July 1985 and it is used wholly or mainly for
- or in association with, residential accommodation, and is not a hotel or apartment building, or
- exhibition or display in connection with the sale of all or part of any building, or the lease of all or any part of any building for use wholly or mainly for, or in association with, residential accommodation and is not a hotel or apartment building or an extension, alteration or improvement to such a building
- to the extent that the company or an associate uses part of it for residential accommodation and it is not a hotel or apartment building, for exceptions to this rule, see subsection 43-170(2) of the ITAA 1997.
Your area is taken to be used wholly or mainly as, or in association with residential accommodation if it is:
- part of an individual’s home, other than a hotel or apartment building
- a building (other than a hotel or apartment building) where construction began after 19 July 1982 and before 18 July 1985, and used as a hotel, motel or guest house.
Special rules for hotels and apartments are contained in section 43-180 of the ITAA 1997.
Calculation and rate of deduction
The company’s entitlement to a deduction begins on the date the building is first used to produce assessable income after construction is completed. The first and last years of use may be apportioned. The entitlement to a deduction runs for either 25 or 40 years (the limitation period) depending on the rate of deduction applicable.
The legislation contains two calculation provisions:
- section 43-210 of the ITAA 1997 deals with the deduction for capital works that began after 26 February 1992
- section 43-215 of the ITAA 1997 deals with deductions for capital works that began before 27 February 1992.
Capital works begun before 27 February 1992 and used as described in table 43-140
Calculate the deduction separately for each part that meets the description of your area.
Multiply the company’s construction expenditure by the applicable rate (either 4% if the capital works were begun after 21 August 1984 and before 16 September 1987 or 2.5% in any other case) and by the number of days in the income year for which the company owned, leased or held your area and used it in a relevant way. Divide that amount by the number of days in the year.
Apportion the amount if your area is used only partly to produce assessable income or for carrying on R&D activities.
The amount the company claims cannot exceed the undeducted construction expenditure.
Capital works begun after 26 February 1992
Calculate the deduction separately for each part of capital works that meets the description of your area.
There is a basic entitlement to a rate of 2.5% for parts used as described in table 43-140: Current year use. The rate increases to 4% for parts used as described in table 43-145: Use in the 4% manner.
Undeducted construction expenditure
The undeducted construction expenditure for your area is the part of the company’s construction expenditure it has left to write off. It is used to work out:
- the number of years in which the company can deduct amounts for the company’s construction expenditure
- the amount that the company can deduct under section 43-40 of the ITAA 1997 if your area or a part of it is destroyed.
Balancing deduction on destruction
If a building is destroyed or damaged during an income year, you can claim a deduction for the remaining amount of undeducted construction expenditure that has not yet been deducted, less any compensation received. If the destruction or demolition is voluntary, the entitlement to a deduction is unaffected.
You can claim the deduction in the income year in which the destruction occurs.
The deduction is reduced if the capital works are used in an income year only partly for the purpose of producing assessable income or for carrying on R&D activities.
For guidelines issued by the Commissioner on these measures, see Taxation Ruling TR 97/25 and 97/25A Addendum.
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