Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello MP)Chapter 6 - Irrigation water providers
Outline of chapter
6.1 Schedule 6 to this bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to allow irrigation water providers in Australia who are primarily and principally in the business of supplying water to primary producers access to the water facilities tax concession. It will also amend the ITAA 1997 to allow rural land irrigation water providers in Australia who are primarily and principally in the business of supplying water to primary producers or to businesses using rural land, access to the landcare tax concession.
6.2 This chapter discusses the amendments to the water facilities provisions (in Subdivision 40-F of the ITAA 1997) and to the landcare provisions (in Subdivision 40-G of the ITAA 1997).
Context of amendments
6.3 Primary producers are allowed to deduct amounts for capital expenditure on depreciating assets that are water facilities. One-third of the expenditure on water facilities is deductible in the year in which it is incurred, and one-third in each of the following two years. Examples of a water facility include dams, tanks, wells, irrigation channels, pumps and windmills. This concession is designed to encourage primary producers to undertake expenditure on water management to increase their capacity to withstand drought and to improve their on-farm water management.
6.4 Primary producers and businesses (except mining businesses) using rural land are also allowed to have an outright deduction for capital expenditure on a landcare operation. Examples of a landcare operation include fences to exclude animals from land affected by land degradation, constructing a levee on land, constructing drainage works to control salinity and expenditure associated with eradicating pests and destroying plant growth detrimental to the land. The concession is designed to encourage primary producers and users of rural land to undertake capital expenditure that assists the long-term sustainability of their use of land.
Summary of new law
6.5 This bill will allow:
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- irrigation water providers in Australia to have access to the water facilities taxation concession, if they are primarily and principally in the business of supplying water to primary producers; and
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- rural land irrigation water providers in Australia to have access to the landcare taxation concession, if they are primarily and principally in the business of supplying water to primary producers or to businesses using rural land.
6.6 The meaning of a 'water facility' and a 'landcare operation' will also be amended to improve certainty for irrigation water providers, rural land irrigation water providers and primary producers by including repairs of a capital nature and structural items reasonably incidental to conserving or conveying water (in the case of the water facilities tax concession) and reasonably incidental to certain assets under landcare operation.
6.7 The policy rationale for the amendments is to improve equity by aligning the deductions available to primary producers and businesses using rural land with deductions available to irrigation water providers and rural land irrigation water providers which supply those primary producers and businesses with water. Therefore, extending the water facilities and landcare taxation concessions to irrigation water providers and rural land irrigation water providers respectively ensures that the tax concessions apply indirectly to work done by the water providers, as well as directly, to work done by those provided with water for their businesses.
6.8 The amendments also assist irrigation water providers and rural land irrigation water providers to renew water supply infrastructure with a view to enhancing the efficiency of water delivery to primary producers and to carry out landcare work on land affected by delivery of this water.
Comparison of key features of new law and current law
| New law | Current law |
|---|---|
| Primary producers and irrigation water providers will be eligible to claim a deduction for capital expenditure on water facilities over three years. | Primary producers are eligible to claim a deduction for capital expenditure on water facilities over three years. |
| Primary producers, businesses (other than mining) using rural land, and rural land irrigation water providers will be eligible to claim an immediate deduction on a landcare operation. | Primary producers and businesses (other than mining) using rural land are eligible to claim an immediate deduction for capital expenditure incurred on landcare operations. |
Detailed explanation of new law
6.9 An irrigation water provider is defined as an entity whose business is primarily and principally the supply of water to primary production businesses on land in Australia. The basic functions of an irrigation water provider include the storage of water in headworks, providing infrastructure (channels and pipes) through which irrigation water can flow, managing and monitoring the flow of this water, pumping water into reservoirs, controlling drainage of water from users of this water and providing access across irrigation and drainage channels and pipes.
6.10 However, an irrigation water provider does not include businesses that use a vehicle or vehicles to transport water, or a business that is not primarily and principally supplying water to primary producers because of the extent to which it supplies water to businesses using rural land or to towns and residences. [Schedule 6, item 2, subsection 40-515(6)]
6.11 Capital expenditure incurred by an irrigation water provider must be incurred primarily and principally for the purpose of conserving or conveying water for use in primary production businesses. This is consistent with the current law as it applies to primary producers. Eligible capital expenditure incurred by an irrigation water provider is deductible over three years. One-third of the expenditure is deductible in the income year in which it is incurred and one-third in each of the following two years. This is also consistent with the current law as it applies to primary producers. [Schedule 6, item 4, subsection 40-525(1)]
6.12 The term water facility is defined in subsection 40-520(1) as plant or structural improvement, or an alteration, addition or extension to plant or a structural improvement that is primarily and principally for the purpose of conserving or conveying water. It is used to determine eligible capital expenditure for the water facilities tax concession. Typical examples of eligible capital expenditure include dams, tanks, wells, irrigation channels, pumps and windmills.
6.13 An amendment will be made to ensure that the definition of a 'water facility' includes repairs of a capital nature to a water facility, as well as alterations, additions and extensions to a water facility. Repairs are, in general, immediately deductible, but 'initial' repairs may be treated as part of the cost of a depreciating asset for taxation purposes. This proposed amendment addresses an anomaly in that there is no policy reason to exclude such expenditure from the water facilities tax concession.
6.14 Another amendment will be made to subsection 40-520(1) to clarify the term 'water facility'. This is because of uncertainty with the interpretation of the current provision in respect of whether the test of conserving or conveying water applies to capital expenditure on each individual component of a water facility or to the water facility as whole. Consequently, the term 'water facility' will be amended to include a structural improvement, or repair of a capital nature, or alteration, addition or extension to a structural improvement that is reasonably incidental to the purpose of conserving or conveying water. This amendment will apply to both water irrigation providers and primary producers. The test 'primarily and principally for the purpose of conserving or conveying water' is intended to apply to the expenditure itself rather than the purpose of the asset that may be modified to convey or conserve water.
6.15 The question of whether an item of capital expenditure is reasonably incidental to conserving and conveying water depends on the facts and circumstances. However, typical examples of expenditure meeting the reasonably incidental test could include a bridge over an irrigation channel, a culvert (a length of pipe or multiple pipes (usually concrete) that are laid under a road to allow the flow of water in a channel to pass under the road), or a fence preventing livestock entering an irrigation channel. An example of capital expenditure not falling within the reasonably incidental test is a bulldozer used to dig irrigation channels. [Schedule 6, item 3, subsection 40-520(1)]
6.16 The current law (paragraph 40-515(4)(a)) indicates that the amount of the deduction is reduced where the water facility is not wholly used in carrying on a primary production business on land in Australia. An amendment will be made to the effect that this provision does not apply to water irrigation providers. This means that if the water facility is primarily and principally for the purpose of conserving or conveying water for use in primary production businesses, then the whole amount is deductible. However, if the water facility is primarily and principally for the purpose of conserving or conveying water for use in non-primary production businesses, then the whole amount is non-deductible. An example of this is a water facility used primarily and principally to supply town water.
6.17 The current law (paragraph 40-515(4)(b)) indicates that the amount of the deduction is reduced where the water facility is not wholly used for a taxable purpose. This provision applies to water irrigation providers, in the same way it applies to primary producers. [Schedule 6, item 2, subsection 40-515(5)]
6.18 After 1 July 2004 (the commencement date), certain capital expenditures undertaken by irrigation water providers will be a water facility for the purposes of Subdivision 40-F. Further, water irrigation providers may have depreciating assets created before 1 July 2004 and may incur capital expenditure that is a water facility for the purposes of Subdivision 40-F on these assets post-1 July 2004. In the case of assets created pre-1 July 2004, water irrigation providers can claim decline in value deductions under Subdivision 40-B. These decline in value deductions are over the effective live of the asset which is typically longer than the three years specified in the water facilities tax concession. If irrigation water providers incur any expenditure on or after 1 July 2004 on altering, adding, extending or repairing assets created pre-1 July 2004, this expenditure will be subject to Subdivision 40-F. However, this expenditure may also satisfy the words in section 40-50 "...amounts for it..." because the amounts would (under normal circumstances) be a second element cost (for the purposes of section 40-190) of any pre-July 2004 asset. Therefore, there is a possibility that decline in value deductions for any pre-1 July 2004 asset (which is altered, added, extended or repaired) could be disallowed by section 40-50.
6.19 For example, assume an irrigation water provider incurs capital expenditure to widen an irrigation channel (which is eligible for the water facilities tax concession). Further, assume that the original irrigation channel was constructed in 1999 (five years ago). This irrigation channel is not a 'water facility' because it was constructed prior to 1 July 2004 (which is the commencement date of this measure), making it ineligible for the water facilities tax concession. The irrigation water provider has been claiming decline in value deductions in relation to the original irrigation channel over the past five years based on an effective life of 70 years. In this case, the irrigation water provider can claim decline in value deductions over a three year period in the case of expenditure incurred widening the irrigation channel, but decline in value deductions over the next 65 years relating to the original irrigation channel may be denied.
6.20 A new subsection 40-53(1) will be inserted to ensure that decline in value deductions are not denied by the operation of section 40-50 when a water facility is altered, added to, extended or repaired. Using the example in paragraph 6.19, the amendment will ensure that decline in value deductions to the original depreciating asset (i.e. the irrigation channel) are not denied. A consequential change flowing from the proposed subsection 40-53(1) is to repeal subsection 40-555(2). [Schedule 6, item 1, section 40-53; item 5, subsection 40-555(1); item 6, subsection 40-555(2)]
Rural land irrigation provider
6.21 A rural land irrigation water provider is defined as an entity whose business is primarily and principally supplying water to primary production businesses on land in Australia and businesses using rural land in Australia for a taxable purpose. Examples of businesses using rural land in Australia may include an abattoir and a wool scour. [Schedule 6, item 7, subsection 40-630(1B)]
6.22 Capital expenditure incurred by a rural land irrigation water provider must be incurred on land used by another entity carrying on a primary production business, or rural land used by another entity carrying on a business for a taxable purpose. This is consistent with current law as it applies to primary producers and users of rural land. Eligible expenditure on a landcare operation qualifies for an outright deduction in the year the expenditure is incurred. This is also consistent with current law as it applies to primary producers and users of rural land. [Schedule 6, item 7, subsection 40-630(1A)]
6.23 The term 'landcare operation' is defined in subsection 40-635(1). It is used to determine eligible capital expenditures for the landcare tax concession. Examples of landcare operations may include the construction of a levee or a similar improvement on the land, or the construction of drainage works for the purpose of controlling salinity or assisting in drainage control.
6.24 The definition of a 'landcare operation' will be amended to include repairs of a capital nature to a landcare operation, as well as alterations, additions and extensions to a landcare operation. This is consistent with the proposed amendment to the definition of a 'water facility'. [Schedule 6, item 10, paragraph 40-635(1)(f)]
6.25 Another amendment to the definition of a 'landcare operation' will be made to include a structural improvement, repairs of a capital nature, or alteration, addition or extension that is reasonably incidental to certain assets deductible under a landcare operation. The types of landcare operations to which this amendment will apply are constructing a levee or a similar improvement on land, and constructing drainage works on land for the purpose of controlling salinity or assisting in drainage control. The amendment will apply to rural land irrigation water providers, primary producers and users of rural land. This is consistent with the proposed amendment to the definition of a 'water facility'.
6.26 The question of whether an item of capital expenditure is reasonably incidental to the relevant landcare operation depends on the facts and circumstances. However, typical examples of expenditure meeting the reasonably incidental test could include a bridge constructed over a drain that was constructed to control salinity and a fence constructed to prevent livestock entering a drain that was constructed to control salinity. An example of capital expenditure not falling within the reasonably incidental test is a bulldozer used to dig a drain to control salinity. [Schedule 6, item 11, subsection 40-635(1)]
6.27 In general, distinguishing whether a particular expenditure falls within the water facilities or landcare tax concession depends on the primary and principal purpose of the expenditure. However, there could be instances where it is difficult to determine the primary and principal purpose of a particular expenditure. Consequently, an amendment will be made to the effect that where an entity can deduct expenditure under both the water facilities and landcare tax concessions, the expenditure will be eligible for deduction under the water facilities tax concession only. The purpose of this amendment is to remove any uncertainty.
6.28 For example, a rural land irrigation water provider constructs a channel that both drains excess irrigation water or rainfall from primary producers' properties and supplies the drainage water back to the primary producers at a discounted fee. Assume that neither of these purposes can be said to be the primary and principal purpose. The channel is therefore being used both to conserve or convey water and to control salinity or assist in drainage control. The amendment will allow the eligible expenditure to be deducted under the water facilities tax concession rather than the landcare tax concession. [Schedule 6, item 8, subsection 40-630(2B)]
6.29 The current law (subsection 40-630(3)) states that the amount of the landcare deduction is reduced where the landcare operation is not used for the purpose other than a primary production business or a business for the purpose of gaining assessable income from the use of rural land. An amendment will be made to ensure that this provision does not apply in the case of rural land irrigation water providers. However, a rural land irrigation water provider will be required to reduce the amount of its landcare operation where the expenditure is incurred for a non-taxable purpose. This is consistent with the current law as it applies to primary producers and businesses using rural land. [Schedule 6, item 9, subsection 40-630(4)]
6.30 Paragraph 40-635(1)(f) allows a rural land irrigation water provider to incur expenditure for making an alteration, addition or extension to an existing landcare operation. Similar to the water facilities, a new provision will be inserted to ensure that the decline in value of deductions is not denied when the original depreciating asset is repaired, altered, added to or extended. [Schedule 6, item 10, paragraph 40-630(1)(f)]
6.31 Subsection 40-630(2) indicates that amounts cannot be deducted as a landcare operation for capital expenditure on plant except certain items of plant covered by paragraphs 40-45(1)(c) and (d). The definition of plant (paragraph 45-40(c)) includes, inter alia, fences, dams and other structural improvements which are constructed on "...land that is used for agricultural and pastoral operations.". An amendment will be made to ensure that the requirement to construct these items of plant on land that is used for agricultural and pastoral operations does not apply to rural water irrigation providers. This amendment ensures that expenditure on landcare operations (e.g. drainage works to control salinity) undertaken by a rural land water provider falls within the landcare tax concession (i.e. Subdivision 40-F). [Schedule 6, item 8, subsection 40-630(2A)]
Application and transitional provisions
6.32 The amendments will apply from 1 July 2004 for expenditure incurred on, or after, that date.
Regulation impact statement
Background
6.33 Primary producers are allowed to deduct amounts for capital expenditure on depreciating assets that are water facilities. One-third of the expenditure on water facilities is deductible in the year in which it is incurred, and one-third in each of the following two years. This concession is designed to encourage primary producers to undertake expenditure on water management to increase their capacity to withstand drought and to improve their on-farm water management.
6.34 Primary producers and businesses (except mining) using rural land are also allowed to have an outright deduction for capital expenditure on a landcare operation. The concession is designed to encourage primary producers and users of rural land to undertake capital expenditure that assists the long-term sustainability of rural industries by encouraging the development and maintenance of improved land management practices.
Policy objective
6.35 The policy objectives are to:
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- improve equity by aligning the deductions available to primary producers and businesses using rural land with deductions available to irrigation water providers and rural land irrigation water providers which supply those primary producers and businesses with water; and
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- assist irrigation water providers and rural land irrigation water providers to renew water supply infrastructure with a view to enhancing the efficiency of water delivery to primary producers and to carry out landcare work on land affected by delivery of this water.
6.36 An irrigation water provider is an entity whose business is primarily and principally the supply of water to primary production businesses on land in Australia. A rural land irrigation water provider is an entity whose business is primarily and principally supplying water to primary production businesses on land in Australia and businesses using rural land in Australia for a taxable purpose.
Implementation options
6.37 Option 1 has three key characteristics. First, this option applies to expenditure incurred on or after 1 July 2004. This date is chosen because it represents the commencement of a financial year. As is typically the case with new taxation measures, the measure applies prospectively.
6.38 Second, the tax treatment of expenditure on capital works has dual purposes - for example, supplying water to primary producers for primary production activities and to non-primary producers such as town water. In this case, expenditure on capital works either falls within or outside the water facilities and landcare taxation concessions based on whether the primary and principal purpose of such expenditure falls within the existing provisions. For example, a pipe that primarily and principally supplies water to primary producers, but provides some water for residential use would fall within the water facilities and landcare tax concessions. However, a pipe that primarily and principally supplies town water would fall outside the water facilities and landcare tax concessions.
6.39 The third characteristic of option 1 relates to the type of capital expenditures covered by the water facilities and landcare tax concessions. This option extends the type of capital expenditure to include repairs that are of a capital nature, and to include a structural improvement, or repair, alteration, addition or extension to a structural improvement that is reasonably incidental to the stated purpose of the water facilities and landcare tax concessions. This option also improves certainty and ensures that all relevant capital expenditure is included within the scope of the water facilities and landcare tax concessions.
6.40 In contrast to the second characteristic referred to in paragraph 6.38, option 2 apportions the expenditure between that relating to primary production or rural land use, and other purposes. That part of the expenditure relating to primary production or rural land use would fall within the water facilities and landcare taxation concessions and the remaining part would fall outside the concessions. The first and third characteristics referred to in paragraphs 6.37 and 6.39 remain the same.
Assessment of impacts
6.41 Any amendments to the water facilities and landcare tax concessions will directly affect irrigation water providers and rural land irrigation water providers that are subject to the ITAA 1997. This could be around 20 entities. Primary producers and businesses using rural land will also be directly and indirectly affected from the proposed amendments to the water facilities and landcare tax concessions.
Analysis of costs / benefits
Improving the efficiency of water delivery and services
6.42 Both options 1 and 2 impact positively on water irrigators because they are being provided access to the water facilities and landcare tax concessions which allow accelerated decline in value deductions for eligible capital expenditure. This in turn will facilitate the renewal of water supply infrastructure and enhance the delivery of water to primary producers and users of rural land. The exact level of benefits is unclear, but is expected to be an on-going benefit.
6.43 Irrigation water providers are currently required to claim deductions on capital expenditures over the effective life of the depreciating asset. Consequently, the amendments, in general, are likely to reduce the compliance costs incurred by irrigation water providers and rural land irrigation water providers as they are able to write-off expenditure over three years (in the case of the water facilities tax concession) and a year (in the case of the landcare tax concession), rather than over the effective life of the capital item. That is, lower compliance costs arise because the effective life of many capital items is a much longer period of time than three years under the water facilities and one year under the landcare tax concessions (perhaps 40 years or longer).
6.44 Both options identified include amending the meaning of a water facility and a landcare operation to include structural items that are reasonably incidental to conserving or conveying water. This is expected to lower compliance costs relative to the current law by providing greater certainty in the interpretation of the current water facilities and landcare provisions. However, option 2 could involve higher compliance costs relative to option 1 because it could be difficult and time consuming for taxpayers to determine the amount of apportionment. Option 2 also adds complexity to the law.
6.45 The level and extent of the compliance cost reduction from the proposed amendments are unclear, but this cost is likely to be slightly lower compared to the existing provisions.
6.46 In the context of option 1, there are likely to be no additional administrative costs for the Australian Taxation Office (ATO) relative to the costs of administering the current law. If anything, there could be lower administrative costs over the long term as the proposed law is more certain relative to the old law. However, there could be some relatively small transitional costs associated with internal training, informing taxpayers of the new law and answering taxpayer questions on interpretation of the new law.
6.47 Relative to option 1, option 2 may involve slightly higher administrative costs because it may be difficult and time consuming for the ATO to determine a methodology or approach to apportion expenditure (in the case of preparing a taxation ruling).
6.48 The level and extent of administrative costs identified in paragraphs 6.46 and 6.47 are unclear, but are likely to be negligible compared to existing administrative costs for the water facilities and landcare provisions.
6.49 The options are expected to have a minor impact on the Government's revenue. Specifically, option 1 is estimated to cost $15 million over the period 2004-2005 to 2007-2008. Option 2 is expected to have the same or slightly lower cost revenue as option 1.
Consultation
6.50 The response arises from various consultations with irrigation water providers and rural land irrigation providers over a period commencing as early as 1995. Other interested parties have also been consulted throughout the policy formulation process, including the Department of Agriculture, Fisheries and Forestry and the ATO.
Conclusion and recommended option
6.51 Both options 1 and 2 improve equity and assist irrigation water providers and rural land irrigation water providers to renew water infrastructure. For these reasons, the proposed measure is expected to provide net benefits to irrigation water providers and rural land irrigation water providers as well as to primary producers and businesses using rural land that obtain water from these entities. Further, the proposed measure assists with the renewal of water supply infrastructure in rural Australia. However, option 1 is favoured over option 2, as option 2 provides little in terms of revenue savings while increasing complexity as well as adding to compliance and administrative costs.
6.52 The Department of the Treasury and the ATO will monitor this taxation measure, as part of the whole taxation system, on an on-going basis.