Case W68

Members:
PM Roach SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 21 July 1989.

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P.M. Roach (Senior Member)

In November 1980 a husband (``the applicant'') and his wife entered into a commercial partnership and contracted for the purchase of an investment property on a main road in suburban Sydney for $195,000. At street level it comprised three units: No. 39 - a medical surgery with a small flat at the rear with separate access (flat 4); No. 41 - a shop then let only for residential purposes; and No. 43 - shop premises then let as a hairdressing salon. At first floor level there were three residential flats, access to which was had from stairways to the rear of the property. Flat 1 was the largest, and was sited over shops No. 41 and No. 43; flat 2 was set over the surgery and lay to the front of No. 39; flat 3 was to the rear of No. 39 sitting over flat 4 and the rear portion of the surgery. The structure was of double brick. Each area was self-enclosed.

2. When the purchase was completed in February 1981 all properties were occupied by tenants. Within a month the owners received a direction from the local council to rectify defects in the shop at No. 43. They did so promptly at a cost of only $200. I think it probable that no income tax deduction in relation to that expenditure would have been allowable as it seems that the expenditure probably took on the character of ``initial repairs''. But that is of little moment for no question arises about any claim to deductibility in relation to repairs during the year of income ended 30 June 1981.

3. What has to be determined, according to the agent for the applicant, is whether the partnership is entitled to deductions in the sum of $10,785 for expenditure incurred on ``repairs'' during the year of income ended 30 June 1984. Unfortunately, the question is far from being so simple. The total deductions claimed comprise many quite discrete claims, each of which has to be assessed and judged separately.

4. The upper residential flats have all been let continuously since purchase and, on the whole, tenancies have been stable. In one instance the tenant of flat 2 moved to flat 1 as the larger flat. Similarly, the surgery and flat 4 have been the subject of ongoing tenancies since inception. However, there were major troubles in relation to shops 41 and 43. It is those difficulties which in large measure, but far from wholly, account for the difficulties to be addressed.

5. The following table shows the rental history of the properties from acquisition to 30 June 1984.

                39        41         43        39      41      43
              Surgery   Shop 2     Shop 3    Flat 1  Flat 2  Flat 3
               -Flat
                p.m.     p.m.       p.m.      p.m.    p.m.    p.m.
              -----------------------------------------------------
                 $        $          $         $       $       $
Feb. 1981       550      303        282        55      50      45
Aug.            550      303       Vacant      55      50      45
Oct.            550      325       Vacant      60      55      50
Dec.            599     Vacant     Vacant      60      55      50
Aug. 1982       599         -- 628* --         60      55      50
Nov.            599     Vacant     Vacant      60      55      50
Jan. 1984       804     Vacant     Vacant      60      55      50
March           804      478       Vacant      60      55      50
April           804      478       Vacant      65      60      55

*A rebate to $433 per month was to apply for the first three months
of a three-year tenancy.
      

6. From the outset the owners frequently met expenses of repair. Although the expenses were frequently met they related to relatively small and routine matters, and in so far as they may have been claimed in the income tax returns of the partnership for the years of income up to and including 30 June 1983 and allowed, there is nothing in dispute in these proceedings.

7. When the partnership purchased the property, shops 41 and 43 were occupied. Shop

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ATC 615

43 was let to a hairdresser until 7 November 1981, but it was vacated in August 1981. Shop 41 was occupied for residential purposes only by a tenant holding over from a previous term. He vacated in December 1981. The partners, through agents, sought suitable tenants and thought themselves fortunate when they found a tenant who was willing to enter into a long-term lease of both shops. A three-year lease was negotiated to commence from 1 August 1981. The tenant was to have a three-year option to renew and CPI increases were to apply annually to rent. The rental rate for the first year was $628.33 per month but with rent for the first three months of the lease to be reduced to $433 per month as an allowance to the tenant while he undertook substantial renovations at his own expense. The tenant, having paid his initial rent, took possession of the premises and set about the renovations. He paid the rent for the first three months but then decamped and could not thereafter be found. As a result the partnership found itself with a substantial part of the property in a completely unlettable condition.

8. Three problems quickly presented themselves. The first was to make good damage done by the tenant. The second was to make good damage done by white ants which damage either had been merely exposed by the work of the tenant or which, as the agent for the applicant would have it, was a consequence of the work of the tenant. The third problem was to satisfy the requirements of public authorities (the local council and the Sydney County Council) in completing the works undertaken to the standards required by those authorities. That generated a fourth problem: carrying out other works of alteration, addition, rectification or repair which were required by the council and which in the opinion of the applicant were necessary or desirable. A fifth problem was to carry out other works which in the opinion of the applicant were needed and which had not been the subject of requisitions from any public authority.

9. In its return of income for the 1984 year the partnership claimed ``repairs of maintenance'' $12,067. The Commissioner partly allowed the claim and, after later examining records of expenditure, satisfied himself that total expenditure by the partnership was greater than the claim made. He then allowed some further deductions. The hearing was conducted on the basis that the claims in dispute were those identified in the return of income as follows:

                                      $
      Walls                          400
      Ceiling                      5,635
      Electrical                   1,287
      Stairs                       2,280
      Glazing and carpentry          888
      Fire-hose reel                 120
      Plumbing                       175
                                 -------
                                 $10,785
                                 -------
      

10. It was difficult to correlate the documentary evidence as to accounts received and amounts paid, but relating it as best I can to the claims remaining in dispute and to separate issues I find the outgoings to have been as follows:

                                 $          $
      Staircases                         2,280
      Windows:
         bedroom                 53
         dining room             81        134
         aluminium double-hung  374        374
      Shower-screens            200        200
      Stoves:
         element                 45
         reconditioning         135        180
                                ---
                                888
                                ---
      Fire-hose reel            120
        plumbing                175        295
                                ---
      Electrical              1,287      1,287
      Walls                     400
      Ceiling                 5,635      6,035
                              -----    --------
                                       $10,785
                                       --------
      

11. It was argued for the Commissioner, in defence of his decision upon the objection that the amounts claimed were not allowable because they had the character of ``initial repairs''; that they involved in some cases the ``replacement'' of an entirety rather than ``repair''; and that in any event they constituted ``improvements'' and thereby took on the character of capital of expenditure.

12. The matter was largely argued as if there was only one issue to be resolved, but it was not so. There were many issues and the

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ATC 616

determination of the reference requires that separate items be the subject of separate consideration and then, to the extent to which the applicant establishes an entitlement, to consider the evidence available as to quantum. In some instances the work done is readily and precisely identifiable and the costs of doing it can be stated precisely. In other cases it is not so.

13. In support of the argument for ``initial repairs'' the Commissioner by his officer pointed to the many notices which issued from the council as of themselves establishing that the premises were in poor condition at the date of their requisition. But, with only one exception, that evidence tends to support the applicant in his assertion that, for their age and quality, the premises were in reasonable and lettable condition at acquisition. The first demand made by the council was on 3 March 1981: very soon after the purchase was completed. It was limited to No. 43 and only required the repair of a damaged ceiling and repainting. That work was done at a cost of only $200. Nothing further was required of the partnership until an abatement notice of 8 November 1982. That issued following abandonment by the tenant of the part-completed renovations. That notice related to No. 41 and No. 43 and to both floors. It came two years after the parties had contracted for the purchase and 21 months after they had completed the purchase. Its principal concern was the white ant problem, as to which it required treatment and the replacement of all white ant affected timber throughout the building. It referred to defective windows and power outlets, but not in terms suggestive of any major problem. It referred to ``unsightly and dilapidated garage and storage structures in the rear yard'', but nothing was put to the witness in regard to that. A problem with the overflow of water from the shower in flat 2 was referred to.

14. That was followed on 26 January 1983 by directions as to fire safety made, by terms of the notice, in relation to No. 43 only. I am satisfied that it was intended to relate to, and was understood to relate to, both No. 41 and No. 43. It also related to a known condition in which the flooring at ground floor level which had been taken up during renovations and which, as to what remained, was known to be infested by white ants. The notice required that the ground floor ceiling be replaced with a one hour fire resistance rated ceiling system; that all timber-framed walls and partitions between areas of separate occupancy be blocked with solid 225mm masonry construction; that the external stairs to the flat be replaced; and that a fire-hose reel be installed. A further notice issued to the applicant on 15 August 1983 in relation to No. 41 and No. 43 but, upon my reading of it, it raised nothing that had not already been provided for.

15. However, of all the notices, the one which I find most significant is that of 22 September 1983, a notice which issued nearly three years after the partners had contracted to purchase. It related only to the surgery premises and the flats above and behind. It dealt with two problems. One was a choked sewerage system as to which the problem was quite speedily and economically rectified to the satisfaction of the council. The other problem was in relation to the allegedly defective floor to the flats above. The partners were required to engage the services of a consulting engineer to advise. They promptly did so. He advised that to satisfy the requirements of the relevant ordinance additional feading would be required but that the ceiling was such that it could not support the required feading. The engineer recommended replacement. However, the evidence of the applicant was, and I accept it, that the council agreed that, so long as the existing tenants continued as tenants of the premises, no such upgrading would be required.

16. I am persuaded that at acquisition, the state of the premises was such that none of the ``repairs'' now in question should have been then characterised as ``initial repairs''. That is not to say that the premises were in ``perfect'' condition as at acquisition. Few premises are, Things deteriorate and that deterioration takes place over longer or shorter periods according to the nature of the thing in question. As I said in Case V167,
88 ATC 1107 at pp. 1110-1111:

``I accept that most things commence to deteriorate from the date of their construction, and in that sense, the need for most repairs can be attributed to the totality of the period of their prior existence, even if it is not coextensive with their total period of prior use. I also accept that when an asset is acquired in a run-down condition and expense is incurred to restore it to an earlier

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ATC 617

condition, it is proper to characterise that expenditure as having the character of capital because such expense, as much as the purchase price, is an expense attributable to acquiring an asset and putting it into a condition suited for the purposes of its new owner. But that is not to say that, if the need for repair is occasioned by deterioration, and deterioration can be attributed to prolonged years of existence including use by others or use for non-income-producing purposes, that the costs of repairs are not to be properly characterised as belonging to revenue account. A matter of repair is proper to revenue account if the need for the expenditure arises out of its use while the property is being applied to income-producing purposes. If a taxpayer buys a property with the view to letting it at a rent and immediately paints it throughout before letting it, the expenditure may be fairly characterised as capital. But if he buys it two years after it has been painted throughout and in consequence needs to and does repaint it throughout two years earlier than if he had painted immediately after purchase, that does not deny the character of `repair and maintenance' to the post-tenancy painting.''

I would not deny the taxpayer any deduction on the basis of any concept of ``initial repairs''.

17. The second argument for the Commissioner is that some items were not so much ``repaired'' as replaced in their entirety. The argument was particularly directed to the provision of the staircases. Two timber staircases extended from ground level at the rear of the premises to the upper floor level to provide access to the flats. By January 1983 the partners accepted as sound the view of the council that they ought to be replaced. The argument was founded on the decision of the High Court of Australia in
Lindsay v. F.C. of T. (1961) 106 C.L.R. 377. The construction there in question was of a complete slipway at the premises of shipbuilders. The High Court held that it was not proper to consider the provision of what was, to all intents and purposes, a new slipway (p. 393) as ``a repair of portion of the entire premises''. The Court took the view that what was carried out was the construction of ``a very substantial erection'', such that it constituted a ``renewal'', rather than a ``repair'' in the sense spoken of by Buckley L.J. in
Lurcott v. Wakely & Wheeler (1911) 1 K.B. 905 at p. 924 when he said:

``Repair is restoration by renewal or replacement of subsidiary parts of the whole. Renewal, as distinguished from repair, is reconstruction of the entirety, meaning by the entirety not necessarily the whole but substantially the whole subject matter under discussion.''

18. That being so, that matter is to be resolved by addressing the question as to whether the staircases are to be considered as entireties of themselves or whether they are to be considered as merely subordinate parts of some greater whole. In my view the latter assessment is the correct one. Unlike a slipway which was quite capable of providing a useful function without regard to any other part of the premises, the staircases were not. The staircases were an integral part, but only a part, of the entire premises.

19. That being so, I am satisfied that by those standards the following claims were allowable:

                                           $
      Staircases                         2,280
      Bedroom window                        53
      Dining room window                    81
      Stove repairs ($45 and $135)         180
                                        ------
                                        $2,594
                                        ------
      

20. The third argument is based upon the concept that what was provided was an ``improvement'' on what had preceded it. That argument largely rested on the authority of the decision of the High Court of Australia in
F.C. of T. v. Western Suburbs Cinemas Limited (1952) 86 C.L.R. 102, a decision in which Kitto J. said:

``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 seemed to me different, not only in degree, but in kind, from the total repairs which properly allowed for 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.''

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ATC 618

21. That concept is one which must be applied in consideration of several of the claims remaining. I first apply it to the claims in relation to the provision of an aluminium double-hung window frame in place of a timber frame ($374); the supplying and fitting of a new shower screen ($200); and the purchase and installation of a new fire-hose reel and fittings ($295). The evidence such as was presented does not persuade me that either expenditure could be properly characterised as an expenditure on a ``repair''. I am persuaded that the works did constitute ``improvements'', the cost of which is not deductible.

22. The next claim to be considered is that relating to electrical works ($1,287). In my view this claim is allowable. The need arose out of the damage done by the tenants in the course of their renovations. The claim is allowable notwithstanding the circumstance that it was required of the partnership that its work should be carried out to current standards.

23. The more difficult claim is that which was described as ``ceilings $5,635'' and ``bricks for walls $400''. In my view they can conveniently be considered together in that the bricks were all used, or taken (by arrangement) by the builder; a set-off being allowed in the settlement of his account. I am not persuaded that the white ants only commenced their work of destruction after the partnership purchased the property. However, I am satisfied that, had it not been for the ``renovations'' of the departed tenant, the infestation and the fact of the damage it was causing would have remained unknown for quite some time longer. That being so, I am satisfied that no question of ``initial repairs'' arises. Nor, in so far as the carpenters replaced the infested timber, was there any question of ``improvement''. However, there was improvement in that the carpenters had to install a ceiling with one hour fire-resistance rated system having two layers of 16mm fire rated plasterboard. That constituted an ``improvement'' and, accordingly, the cost of its installation is not deductible.

24. The second element of the carpenter's work was to make good the walls: downstairs closing up sections which had been opened by the departed tenant; and upstairs closing with bricks openings which had existed between flats 1 and 2. As to the making good of that brick-work, and the filling in with masonry of openings in existing walls, I am satisfied that there was no ``improvement'' at the lower level. But in relation to the upper level one must acknowledge that although the standard of construction remained the same, the filling up of the openings altered the condition of the premises to one better than that which had existed at the time of their purchase.

25. Over and above all of those difficulties there is yet another: how to effect an apportionment of an undissected account relating to these items. Effecting such an apportionment calls for a finding of fact such as was directed in
Ronpibon Tin N.L. v. F.C. of T. (1949) 78 C.L.R. 345 by the High Court of Australia. But in this instance I find myself in such a state of uncertainty as to what works were done, by whom and at what cost; and further as to the relativities between what was merely repair and reinstatement and what was work of a capital nature. The result is that I am not persuaded that any particular amount should be allowed.

26. For the foregoing reasons I am persuaded that a further $3,881 and no more was allowable to the partnership. That being so the assessment of the applicant was excessive and his taxable income should be reduced by $1,941. An order will issue accordingly.