Capital works deductions
Division 43 of the ITAA 1997 provides for a system of deducting capital expenditure incurred in the construction of 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, including leasehold improvements such as shop fit-outs
- structural improvements (such as bridges, retaining walls and sealed roads) or extensions, alterations or improvements to structural improvements
- environmental protection earthworks, see also Appendix 6.
You must base your deductions for construction costs on actual costs incurred. If it is not possible to genuinely determine the actual costs, provide an estimate from a quantity surveyor or other independent qualified person. The costs incurred by the partnership for providing this estimate are deductible as a tax-related expense, not as an expense in gaining or producing assessable income.
Who can claim?
A partnership can only claim a deduction under Division 43 for an income year if the partnership:
- owned, leased or held part of a construction expenditure area of capital works (‘your area’)
- incurred the expense, or was an assignee of the lease or holder who incurred the expense, and
- used your area to produce assessable income, or in some cases for carrying on R&D activities.
There are special rules that qualify the use of the capital works in relation to 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.
In calculating the partnership’s deduction, identify your area for each construction expenditure area of the capital works. Your area may comprise the whole or part of the construction area.
Lessee or holder of capital works
A lessee or holder can claim a deduction for an area of capital works leased or held under a quasi-ownership right by the lessee or holder. 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 your 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.
This deduction must not be claimed as capital allowances costs using an effective life equal to the term of the lease.
Requirement for deductibility
A partnership can deduct an amount for capital works in an income year if:
- the capital works had a ‘construction expenditure area’
- there was a ‘pool of construction expenditure’ for that area, and
- the partnership used the area in the income year to produce assessable income or for carrying on R&D activities as set out in section 43-140 of the ITAA 1997.
No deduction until construction is complete
A partnership can't claim a deduction for any period before the construction of the capital works is complete even though the partnership used them, or part of them, before completion. Additionally, the deduction can't exceed the undeducted construction expenditure for your area.
Capital works are taken to have started when the first step in the construction phase starts, for example, the pouring of foundations or sinking of pilings for a building.
Establishing the deduction base
Expenditure for the construction of capital works is deductible if there is a construction expenditure area for the capital works. Whether there is such an area and how it is identified depends on:
- the type of expenditure incurred; only construction expenditure (see below) is deductible under Division 43 of the ITAA 1997
- the time the capital works started
- the area of the capital works to be owned, leased or held by the entity that incurred the expenditure, and
- for capital works begun before 1 July 1997, the area of the capital works that was at the time of completion intended to be used in a particular manner, see section 43–90 of the ITAA 1997.
Construction expenditure
Construction expenditure includes:
- preliminary expenses, such as 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 their contributions to the work (that is, labour or expertise and any notional profit element) don't form part of construction expenditure. See Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements and addendum.
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 to be used for 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 before 1 July 1997, the capital works must have been constructed for a specified use at the time of completion, depending upon the time when the capital works started.
The first specified use construction time was 22 August 1979; see the table in section 43-90 and subsection 43-75(2) of the ITAA 1997. No deduction is available under Division 43 of the ITAA 1997 for capital works which were begun on 21 August 1979 or earlier, see subsection 43-20(1) 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
You can only claim a deduction under this Division if you use 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 in a particular manner if:
- it is maintained ready for that use, is not used for another purpose or in any other manner, and its use has not been abandoned
- its use has temporarily ceased because of, for example, construction or repairs, or 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 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 started after 30 June 1997, buildings that are used for display are eligible
- if it is a building where the construction began after 19 July 1982 and before 18 July 1985 and which is used or available for use wholly or mainly
- for, or in association with, residential accommodation, and it is not a hotel or apartment building
- for exhibition or display in connection with the sale of all or part of any building, or the lease of all or 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 partnership 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.
A hotel, motel or guest house, where construction began during the specified time, and doesn't qualify as a hotel or apartment building (for example, because it has less than 10 bedrooms or apartments) doesn't qualify for a deduction under Division 43.
Special rules for hotels and apartments are contained in section 43-180 of the ITAA 1997.
Calculation and rate of deduction
The entitlement to a deduction begins on the date your area 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 upon the rate of deduction applicable.
The legislation contains 2 calculation provisions:
- section 43-210 of the ITAA 1997 deals with the deduction for capital works which began after 26 February 1992
- section 43-215 of the ITAA 1997 deals with deductions for capital works which 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 of capital works that meets the description of 'your area'.
The applicable rate is either 4% if the capital works began after 21 August 1984 and before 16 September 1987, or 2.5% in any other case.
The amount of the deduction may be reduced in certain circumstances. This includes where your area was used only partly for the purpose of producing assessable income.
The amount claimed can't exceed the undeducted construction expenditure.
You can also work out your capital works deductions by using the Depreciation and capital allowances tool.
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 43-14.: Current year the rate increases to 4% for parts used as described in table 43-145: Use in the 4% manner.
The amount of the deduction may be reduced in certain circumstances. This includes where your area was used only partly for the purpose of producing assessable income.
The amount the company claims can't exceed the undeducted construction expenditure.
You can also work out your capital works deductions by using the Depreciation and capital allowances tool.
Undeducted construction expenditure
The undeducted construction expenditure for your area is the part of the construction expenditure the partnership has left to write off. Use it to work out the:
- number of years in which the partnership can deduct amounts for its construction expenditure, and
- amount that the partnership 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 the remaining amount of undeducted construction expenditure that has not yet been deducted, minus any compensation received. This applies even if the destruction or demolition is voluntary.
You can claim the deduction in the income year in which the destruction occurs.
The deduction is reduced where 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 on these measures, see Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements.
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