Explanatory Memorandum
(Circulated by the authority of the Treasurer,the Hon. J. Kerin, M.P.)Chapter 8 Deduction of Environmental Impact Studies Expenditure
Overview
Allows a deduction for expenditure incurred on environmental impact studies on or after 12 March 1991.
The cost will be written off over the lesser of 10 years or the life of the project to which the study relates.
The cost of plant or articles in the studies will not qualify for the deduction, but will be eligible for deduction under the ordinary depreciation provisions.
Summary of proposed amendments
8.1. Under the existing law the cost of studies undertaken to determine the impact a project may have on the environment may not qualify for deduction. This Bill will amend the income tax law to allow a deduction for the cost of such studies where the cost is incurred on or after 12 March 1991.
8.2. In most cases the cost of the environmental impact study will be deducted over 10 years. However, if the study relates to a project which has a life of less than 10 years, then the cost of the study will be deducted over that lesser period.
8.3. This deduction will not apply to expenditure on environmental impact studies that is deductible under some other provision of the Act.
8.4. The cost of any plant used in environmental impact studies will be depreciable, like other plant, rather than deductible on the same basis as other environmental impact study expenditure.
Background to the legislation
8.5. Expenditure on environmental impact studies is generally incurred prior to the start of the income earning activities studied or is otherwise capital in nature. The expenditure is therefore not deductible under subsection 51(1). Occasionally, the cost of an environmental impact study is deductible under other specific deduction provisions (such as Divisions 10 or 10AA, the mining and quarrying provisions) but generally the cost of such a study will not be deductible at all.
8.6. In many cases, the law requires that an environment impact study be undertaken for any new project. Even if it is not required by law, many businesses will undertaken such a study to ensure that any possible community concerns are addressed. As the projects would generally not go ahead without this assessment, the expenditure can be regarded as a necessary business expense.
8.7. The amendments proposed by this Bill will ensure that environmental impact study expenses are taken into account in determining taxable income.
Explanation of the proposed amendments
8.8. A new Subdivision will be inserted in Division 3 of the Income Tax Assessment Act 1936 to allow a deduction for expenditure undertaken on certain environmental impact activities. [Clause 39]
8.9. The deduction will be allowed against income from any source and may be carried forward indefinitely in the normal way. However, the deduction cannot be transferred to another taxpayer if the project to which the study relates is sold or ceases. The deduction remains with the taxpayer who incurs the expense.
8.10. If the expenditure is incurred in more than one income year, the proposed Subdivision will apply to each year's expenditure separately. The deductions are not deferred until all environmental impact activities are completed.
8.11. The Subdivision also ensure that the cost of plant or articles used for environmental impact activities will be depreciated like other plant.
Definitions: What expenditure qualifies for the deduction?
8.12. Allowable environmental impact expenditure qualifies for the deduction. Very simply, that expenditure includes any current or capital expenditure incurred on or after 12 March 1991 on eligible environmental impact activities in relation to an income producing project of the taxpayer. [New Subsections 82BB(1) and 82BC(1)]
8.13. Several points in the definition of allowable environmental impact expenditure require further clarification.
8.14. Eligible environmental impact activities include any acts undertaken for the sole or dominant purpose of evaluating or reporting on the impact of an income producing project on the environment. This includes both acts undertaken in the study itself and acts done in documenting the results of the study. Such activities will often examine only some aspects of a project's environmental impact. There is no implied requirement that all aspects of a project's impact be studied before any studies will count. The expensive definition of the environment means that few projects will have every aspect of the impact studied. [New Section 82BD]
8.15. The sole or dominant purpose test is used here to ensure that the expenditure is primarily directed to evaluating the impact of the project on the environment. For instance, if a study is directed primarily to the economic feasibility of the project, the cost of the study will not qualify for the deduction. Projects may commonly be the subject of studies of economic feasibility, and studies of environmental impact. Only studies that are predominantly on environmental impact will qualify.
8.16. This purpose test may also affect the deductibility of expenditure on items such as housing or welfare facilities set up for the benefit of the people undertaking the study. If those facilities will be a part of the income producing project which is being studied, the cost of erecting the facilities would be unlikely to qualify for the deduction. An example would be accommodation for people undertaking environmental impact work that is intended to be used as accommodation for those people who subsequently work in the project itself. [New Section 82BD]
8.17. Environment is defined in very broad terms similar to those used in the Environmental Protection (Impact of Proposals) Act 1974 . The definition is not limited to the natural environment, but also includes all aspects of the environment including the demographics of a community. [New Section 82BA]
8.18. An income producing project in relation to a taxpayer is one which is carried out to produce assessable income, other than a capital gain, of the taxpayer. The income producing purpose may be only one of several purposes and project includes a proposed project. But, if the taxpayer's intention is only to derive a capital gain, the expenditure will not qualify for the deduction.
8.19. A project may last longer than the time for which the taxpayer expects to derive assessable income from it. This would occur when the taxpayer expects to sell the project to another taxpayer. [New Section 82BA]
Examples of income producing project
8.20. The following examples will help to identify the income producing project of a taxpayer.
Example 1: Where the study relates to the impact of an income producing asset on the environment
8.21. Offices Incorporated, which derives its income from letting office space in the buildings it owns, intends to develop a new office block near a suburban shopping centre. Offices Inc. undertakes a study to determine the impact the building will have on the local community. For example, it may need to study the impact of increased traffic flows, disturbance to existing homes, effects on public transport and so on.
8.22. The income producing project of Offices Inc. is the construction of the building and the subsequent leasing of floor space. Therefore the cost of the study into the impact of the building would be in relation to an income producing project of the taxpayer.
8.23. It is important to note that Offices Inc. has only one income producing project in this example. It doesn't have separate projects of constructing the block and letting it, or for that matter, letting of particular rooms or suites.
Example 2: Where the study relates to the impact of the construction of an income producing asset of another
8.24. This example is an important variation on the first.
8.25 . Offices Incorporated derives its assessable income from the leasing of floor space but it generally has its buildings constructed by others. It has contracted with Constructor Company to build its new suburban office block.
8.26. Offices Inc. undertakes a study to determine the impact of the building on the local community. Once again, this study would relate to an income producing project, that project being the leasing of floor space in the building.
8.27. But suppose that the local government authority is very concerned about the impact of the actual construction of the building on the local area. Large vehicles will be using small suburban streets, cranes will overhang nearby houses, and some streets may need to be closed to local traffic. The Authority requires Constructor Co. to undertake a study to determine the impact of the construction of the building on the local community before final approval of the building is given or before work on the site can be started.
8.28 . In this case, the cost of undertaking the study may not normally be deductible to Constructor Co. because it is incurred prior to the commencement of its new income earning activity, that is, the construction of the building. But Constructor Co. does have an income producing project in relation to which the study is undertaken. Its income producing project is the construction of the building for which it will be paid by Offices Inc.
Example 3: A study undertaken by a concerned citizen or business into the impact of Constructor Co's building project
8.29. Bryan Provost, an ardent petitioner against change in the local community, is very suspicious of the study undertaken by Constructor Co. He believes that the building will permanently reduce the value of his home and is very concerned about the dangers posed by overhanging cranes which are known to drop heavy objects on occasions, and the many large vehicles which will be using his street. Mr Provost undertakes his own study into the environmental impact of the building and its construction.
8.30. Mr Provost will not be able to deduct the cost of this study under this proposed Subdivision. He has no income producing project to which the study relates.
8.31. The same result applies for the local restaurateurs who undertake a study to determine the impact of the construction. They are concerned that a number of their frequent diners may take their patronage elsewhere because parking and access to the restaurants will be reduced by the building works.
8.32. Although the restaurateurs could argue a relationship exists between their income producing activities and the study, the study itself does not related to an income producing project of their own. Therefore, they are not entitled to claim a deduction for the cost of the study.
Example 4: Where the study relates to the impact of an item of plant or a process used in a business
8.33. Manufacturer Pty Ltd undertakes a study to determine the impact of introducing a new item of processing plant or a new process on the environment. The plant will discharge certain pollutants into the atmosphere.
8.34. An item of plant, or a process, is not an income producing project. A separate income earning activity is a project. Therefore, the project to which a study of new plant or new processes relates is the income earning activity for which the new plant or process is contemplated.
8.35. Sometimes that will be a new project. For instance, Manufacturer may be considering a new area of production. On other occasions the project will already exist. For instance Manufacturer may be improving one of its existing income producing activities.
Procedure: How is the deduction calculated?
8.36. Environmental impact expenditure will be deductible over 10 years or the life of the relevant project if that is shorter. [New Subsection 82BB(1)]
8.37. The amount deducted each year depends upon the life of the relevant income producing project. At the end of the income year in which allowable environmental impact expenditure is incurred, the life of the project is to be estimated. It is measured from the year in which the expenditure is incurred, that year being called the current year of income , to the year in which it is estimated that the project will end, that year being called the final year of income . [New Subsection 82BB(1)]
8.38. In most cases, the allowable environmental impact expenditure will be deductible over 10 income years because the life of an income producing project is generally expected to exceed 10 years. Ten per cent of the expenditure will be allowable as a deduction in the income year in which the expenditure is incurred and each of the succeeding 9 income years. [New Paragraph 82BB(1)(e)]
* 8.39. The allowable environmental impact expenditure will also be deductible over 10 years if the project is abandoned in the year in which the expenditure is incurred, or if it is not practicable at the end of that year to estimate when the project will end. [New Paragraphs 82BB(1)(a) and (c) respectively]*
* Amendment - Paragraph 82BB(1)(a) - to allow deduction of all expenditure in first year. (Introduced during passage through Parliament - See Hansard Debates)*
8.40. However, there are two situations where allowable environmental impact expenditure will be deductible over a period shorter than 10 years.
8.41. If, at the end of the year in which the expenditure is incurred, it is estimated that the project will end within one of the nine income years subsequent to the year in which the expenditure is incurred, the taxpayer is entitled to write off the allowable environmental impact expenditure over that shorter period. The expenditure is divided into equal parts and is deducted in the year the expenditure is incurred, the year in which it is estimated that the project will end and each of the intervening years. [New Paragraph 82BB(1)(d)]
8.42. If the income producing project actually ends before the end of the year in which the expenditure is incurred, the full amount of the allowable environmental impact expenditure is deductible in that year. In effect, this is simply a special example of a situation where the life of the project is less than 10 years. It is a separate provision because no estimate of the year in which the project will end is needed at the end of the year in which the expenditure is incurred. [New Paragraph 82BB(1)(b)]
8.43. The following examples will help to identify when an income producing project ends.
Examples of the life of income producing projects
Example 1: Offices Incorporated develops a new office block for use in its business
8.44. Remember that the income producing project was identified as the construction and subsequent leasing of the building for income producing purposes. Offices Inc. expects the building to produce rental income for at least the next fifty years, but it is unlikely to retain the building itself for so long. Even though Offices Inc. may expect to realise its investment in the building in 8 years, the life of the income producing project is the fifty years for which the office block is expected to produce rental income. The cost of the environmental impact study will therefore be deductible over 10 years.
8.45. The reason is that, even though an income producing project is identified by reference to a project which produces assessable income of the taxpayer, the life of the project itself is not. An activity may be an income producing project of a particular taxpayer even though it may only produce assessable income for that taxpayer in one income year.
8.46. The life of an income producing project is determined by estimating the time the project will produce income, irrespective of who will derive that income. Thus, the life of Offices Inc's office block is the fifty years for which the office block is expected to derive rental income.
8.47. Note that in this example, the construction of the building is not a separate income producing project of Offices Inc. That is because Offices Inc. does not derive any income from constructing the building.
Example 2: Constructor Company contracts with Offices Inc. to build an office block
8.48. Instead of handling the construction if its latest building itself, Offices Inc. contracts with Contractor Company to build the office block. The local government authority requires Constructor Co. to undertake a study into the impact of the construction project on the local community.
8.49. Remember that the building of the block is Constructor Co's income producing project. At the end of the current year of income, Constructor Co estimates that the building project will take a further 18 months. The allowable environmental impact expenditure (which relates only to the construction project) will therefore be deductible in equal portions over 3 income years, the current, the final and the intervening year of income.
8.50. Constructor Co. will not be able to claim deductions under the proposed Subdivision for environmental impact studies relating to the operation of the completed building. Those studies wouldn't relate to its income-producing project. (After all, the letting of the completed building will generate no income for Constructor.) But Constructor Co. may have to carry out such studies under its contract with Offices Inc. Then Constructor Co. should be entitled to deduct its expenditure immediately under subsection 51(1) of the Act.
Example 3: Manufacturer Pty Ltd studies the impact of a new item of plant or a new process
8.51. Manufacturer Pty Ltd undertakes a study to determine the impact of new processing technology or plant on the environment. The plant or process will be used in a new income earning activity, in which a new product will be manufactured.
8.52. Manufacturer expects to be able to market the new product for at least the next fifteen years. The life of the project will be the period for which the new income earning activity is expected to last. The life of the project is not determined by the life of the plant used to manufacture the product, or necessarily the use of a particular process to manufacture the product. The fact that the item of plant used to make the new product will last only eight years before it is replaced is irrelevant. The expenditure incurred on the study will be deductible over 10 years.
8.53. Remember that if the study relates to plant or a process which are to be used in the existing income earning activities rather than any new income producing activities, the relevant project is the existing activity. Again, the life of the project will be the period for which it is estimated that that activity will produce assessable income. The effective life of the particular plant is irrelevant.
8.54. For instance, suppose Manufacturer's plant discharges a pollutant at a level which complies with current environmental regulations. However, that plant is nearing the end of its effective life and Manufacturer knows that in five years' time the regulations are to be changed to reduce the level of pollutant which can be discharged. Despite this, Manufacturer decides, for economic reasons, to adopt a new kind of plant that will reduce the level of pollutant, but not enough to comply with the new regulations. Manufacturer spends money on an environmental impact study of the stopgap plant, and seeks to write off that expenditure.
8.55. Even though the plant will only have an effective life of five years, the life of Manufacturer's project will be the period Manufacturer expects to continue the income earning activity. As it expects to continue on indefinitely past the tightening of the regulations, the cost of the study will be deductible over 10 years.
Limits on the Deduction for Allowable Environmental Impact Expenditure
8.56. The deduction that is to be allowed under this new Subdivision is a provision of last resort. If the cost of an environmental impact study is allowable under any other provision of the Act, that other provision will take precedence over this Subdivision. For example, mining and quarrying companies can claim an outright deduction for many environmental impact studies under the exploration or prospecting provisions of Division 10 and 10AA. [New Subsection 82BC(2)]
Expenditure on plant or articles
8.57. The cost of plant or articles used in undertaking an environmental impact study will be excluded from allowable environmental impact expenditure. A deduction will be allowed for depreciation of such plant or articles in accordance with the general depreciation provisions. [New Subsection 82BC(3)]
8.58. The deduction for depreciation will be allowed because the use of property for eligible environmental impact activities will be treated as a use for the purpose of producing assessable income. [New Subsection 82BG(1)]
Provisions which limit deductibility
8.59. Where a provision of the Act limits the operation of section 51, the provision will also apply to limit the operation of proposed Subdivision C. For example, where allowable environmental impact expenditure is also entertainment expenditure within section 51AE of the Act, it will not qualify for deduction because subsection 51AE(4) will also operate to limit the deductions allowed under this new Subdivision. [New Subsection 82BB(2)]
8.60. Similarly, where a provision of the Act states that a particular use of property is not an income producing use, the provision will also apply to limit the operation of proposed Subdivision C. For example, where an item of plant or equipment is used for environmental impact activities but is also a leisure facility under section 51AB, it will only qualify for depreciation if it is an excepted facility under section 51AB. [New Subsection 82BG(2)]
A recoupment may affect the amount of the deduction
8.61. The amount of allowable environmental impact expenditure available for deduction will be reduced by any grant the taxpayer receives for the environmental impact study or any recoupment the taxpayer receives for the expenses incurred in the study, so far as the grant or recoupment is not included in the taxpayer's assessable income. The reduction will also be made if the taxpayer becomes entitled to such a grant or recoupment. [New Subsection 82BE(1)]
8.62. In this regard, the test as to the extent to which a payment constitutes a recoupment or grant in respect of an environmental impact study is an objective test. [New Subsection 82BE(2)]
8.63. An amendment can be made at any time to disallow a deduction previously allowed to the taxpayer where a grant or recoupment is made. [New Subsection 82BE(3)]
8.64. Where a deduction under new Subdivision C arises from a transaction under which the taxpayer and another party are not dealing at arm's length, and the amount of the expenditure incurred is not reasonable, the deduction is limited to the amount which would have been incurred had the parties been dealing at arm's length.
8.65. For example, if a manufacturing company engages a related company to undertake eligible environmental impact activities, the deduction that the company may claim is limited to the amount which would be reasonable had the parties been trading at arm's length. [New Section 82BF]
Commencement date
8.66. Any allowable environmental impact expenditure incurred on or after 12 March 1991 will qualify for deduction.
Consequential amendments
8.67. An amendment will be made to section 50G (part of the current year loss provisions) to treat the deductions allowed for environmental impact expenditure as divisible deductions. [Clause 32]
8.68. The current year loss provisions are anti-avoidance measures which were introduced into the Act in 1978 to discourage trading in companies which were in tax loss-making positions. In simple terms, they are triggered on a substantial change in the ownership or control of a company. Such a change is referred to as a disqualifying event.
8.69. If the current year loss provisions apply to a company, one part of the method used to calculate the taxable income of the company for the income year divides the income derived and the deductions allowed to the company into what are referred to as full year and divisible amounts. Therefore, it is necessary to specify whether the amounts for environmental impact activities are full year or divisible deductions.
8.70. Divisible deductions are essentially those deductions which are spread over the whole of an income year. They are not attributed to a particular part of the income year. Examples include depreciation (section 54) and capital expenditure on mains electricity connections (section 70A).
8.71. The deductions allowable under the proposed Subdivision C are to be treated as divisible deductions. [Subclause 32(a)]
8.72. Under the current year loss provisions the income year is divided into the periods before and after the disqualifying event. These periods are called relevant periods. A notional taxable income is then calculated for each relevant period by reference to the amounts of divisible income and divisible deductions.
8.73. This calculation of the notional income requires a mechanism that apportions the divisible deduction between the relevant periods. A mechanism for apportioning deductions for environmental impact expenditure is to be inserted by this Bill. [Subclause 32(b)]
8.74. In the year in which allowable environmental impact expenditure is incurred, the deduction will be apportioned according to a formula. This formula apportions the amount of the deduction by taking into account the time when the expenditure is actually incurred. It compares the number of days in the relevant period which occur after the day the expenditure is incurred with the number of days in the income year after the expenditure is incurred. [New paragraph 50G(2)(jb)]
8.75. For all subsequent income years the amount of the deduction for allowable environmental impact activities is also apportioned according to a formula. This formula simply apportions the deduction by comparing the number of days in the relevant period with the number days in the income year. [New paragraph 50G(2)(jc)]
Clauses involved in the proposed amendments
Clause 32: Consequential amendment of section 50G
Clause 39: Insertion of new Subdivision C in Division 3