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WorkshopSolutionsWeek8.pdf

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ACC3TAX S1 2018 Suggested Workshop Solutions Week 8

DISCLAIMER: The solutions below represent an outline of the elements that must be present in an answer. They should be taken as a guide, not as exhaustive solutions. Please note that especially for essay questions, you must structure your answer as a proper essay, i.e., with an introduction (where you state what the issue(s) is/are), a body of text (where you will develop your arguments) and a conclusion.

ATSM Question 549: Reefer Ltd owns a factory building, erected in 1989, in which it carries on building operations. The company acquired the building in 1993. In August 2017 it became apparent that two walls were in danger of collapsing and this was caused by subsidence. Between August and October 2017, the two walls were demolished, new pile foundations were provided, and the walls were rebuilt using new bricks. At the same time all the wooden beams and battens supporting the iron roof were replaced with steel beams. One section of the iron roof, comprising one-half of the total area, was badly rusted and was replaced. The costs of $260,000 were claimed as deductible but the Commissioner had disallowed them. Advise Reefer of what deductions (if any) it might be able to claim. The issue in this question concerns the deductibility of the expenses incurred to repair the building where Reefer Ltd carries on its business. It must be determined whether the repair works carried on at the structure (the two walls, the replacement of the wooden beams which support the iron roof and half the iron roof itself) constitute repairs for the purposes of s 25-10 ITAA97 or whether they constitute capital works for the purposes of Div 43. In relation to the walls, while it is clear that there was a need for a repair in view of the fact that they were in danger of collapsing due to subsidence, the repair works actually represented a structural alteration to the building, with a full replacement of the walls and their foundations with materials which could potentially reduce the likelihood of future repairs. While it is arguable that the repaired walls constituted part of an entirety according to the principle of W THOMAS & CO, the fact that they were entirely rebuilt with better and presumably longer-lasting materials would cause the application of the principle of WESTERN SUBURBS CINEMAS, where the entire ceiling was rebuilt with better and longer-lasting materials, representing an improvement rather than just a repair. Also applicable, in the same line, are the principles of LINDSAY and CASE N61, where there had been a replacement of an entirety with a consequent improvement. In relation to the replacement of the wooden beams with steel beams, although it could be argued that the steel beams would perform essentially the same function of the wooden beams and therefore would not imply an improvement, as seen in CASE 51, the lack of information about a genuine need for a repair to the beams allows the assumption that their replacement constitutes a structural alteration (an improvement, as seen in CASE N61) rather than a repair. As such, it seems that the rebuilding of the two walls and the replacement of the wooden beams with steel beams go beyond mere repairs and actually constitute an improvement, which would be claimable under the Capital Works provisions in Div 43. However, in relation to the replacement of half of the roof which was badly rusted it is possible to argue that this was a genuine repair. Furthermore, as there was not a replacement of an entirety and nothing in the question indicates that the materials used in the new section of the roof would substantially reduce the likelihood of future repairs, it is arguable that this expense would be deductible as a repair under s 25-10, according to the principles of RHODESIA RAILWAYS, SAMUEL JONES & CO. Therefore, Reefer would be able to object to the Commissioner’s position in relation to the repair done to the roof, however that would not apply to the rebuilding of the walls and to the replacement of the roof supporting beams.

ACC3TAX S1 2018 Suggested Workshop Solutions Week 8

ATSM Question 550: On 1 October 2017, Chapman & Co, a firm of chartered accountants, moved from its leased Richmond premises to its own premises in Malvern. The Malvern office was built on land which Chapman & Co had acquired in March 1984. Construction of the building commenced on 1 February 2017 and it was completed on 10 September 2017 at a total cost of $850,000. To obtain a permit of occupancy, Chapman & Co had to modify the driveway to allow off-street parking for six cars. The cost of this modification was $40,000. Due to the change in the driveway, additional landscaping work was required, and this cost $12,000. In March 2018, Chapman & Co’s $50,000 air-conditioning system broke-down. Chapman & Co received a quote of $25,000 to repair it. Instead, Chapman & Co accepted another quote on 14 March 2018 to trade in the old air conditioner for $30,000; at a cost of $75,000 it was replaced by a new air conditioner which had an effective life of 15 years. The new system was installed on 31 March 2018. Advise Chapman & Co on what deductions (if any) it might be able to claim. New building: A deduction can be claimed under the Division 43 capital works provisions in respect of the capital expenditure of $850,000 on the new office building for the year ended 30 June 2018 to the extent it was used for an income producing purpose from the date that construction was completed on 10 September 2017. Section 43-10 allows construction expenditure to be written off over a period of 40 years on a 2.5% straight- line basis to the extent that the building was used for an income producing purpose, which would appear to be the case as Chapman & Co constructed the building for use as its own office premises. The 2.5% rate applies as construction of the new non-residential building commenced after 27 February 1992, and the office premises does not constitute an industrial building. However, the deduction for the write-off of the building’s construction costs from the year ended 30 June 2018 will only commence from the date that construction of the building was completed being 10 September 2017. The deduction for the write-off is calculated according to following formula:

Construction expenditure x Days used/365 x Applicable Rate Construction expenditure = claimant’s share of eligible building costs Days used = number of days in year which capital works were used in an income year $850,000 x 294/365 x 2.5% = $17,116 Sealed driveway: The $40,000 cost of constructing the sealed driveway would be regarded as a structural improvement for Division 43 purposes under section 43-20 which actually lists a sealed driveway as being an example of a structural improvement under section 43-20(3). Such a cost can be written off over 40 years on a straight-line basis of 2.5%. It is not possible to determine the amount of the write-off that relates to the year ended 30 June 2018 as there are no details as to the date on which construction was completed. Landscaping: The landscaping costs will not be regarded as eligible construction expenditure as it does not appear to constitute a structural improvement or earthworks that are integral to the installation or construction of a structure. Nor would it be included in the cost base of the land which would be regarded as being a pre-CGT acquired asset since the land was acquired in March 1984. Accordingly, it would appear to constitute building capital expenditure that could be written off over 5 years in equal instalments under the black hole capital expenditure rules under section 40-880 of the ITAA

ACC3TAX S1 2018 Suggested Workshop Solutions Week 8

(1997) in which case the deduction claimed for the year ended 30 June 2018 would be $2,400 (i.e. $12,500 X 0.2). Old Air conditioning trade in: balancing adjustment event as the air conditioner is a depreciating asset for Chapman.

 Termination value: $30,000.

 Original cost of Asset: $50,000

 Adjusted value of old air conditioner just before balancing adjustment event: $50,000 (not

enough info to calculate depreciation, therefore assume $50,000)

As the termination value (sale price) $30,000 was less than the adjusted value $50,000, there will be a deductible balancing charge of $20,000 – this will be claimed by Chapman as a deduction under s 40-285(2), and no capital gain or loss arises (s 118-24). New air conditioning – depreciation Cost of new air-con: $75,000 Effective life: 15 years Date when first installed: 31 March 2018 Considering the values provided in the question it is reasonable to assume that Chapman would likely be an SBE and would elect to apply the small business capital allowance provisions. This being the case, the air conditioner could be included in the SBE pool (Div 328-D) and would depreciate at a rate of 15% in the first year when it is included in the pool, and 30% thereafter. Accordingly, the decline in value of the new air conditioner would be $11,250 (i.e. $75,000 X 15%) If Chapman were not a SBE, it would have to calculate depreciation under the general rules of Div 40. In this case, the Diminishing Value would provide the best result in the first year. Asset’s cost x (Days held/365) x (200%/Asset’s effective life) $75,000 x 92/365 x 200%/15 = $2,521 in the first year Under the Prime Cost method the deduction would be Asset’s Cost x (Days held/365) x (100%/Asset’s effective life) $75,000 x (92/365) x (100%/15) = $1,260 in the first year.

ACC3TAX S1 2018 Suggested Workshop Solutions Week 8

Extra review question For the year ended 30 June 2018, Emma Watts incurred the following costs to the hairdressing salon premises she acquired in December 2017:

 Painting of the external façade in January 2018 – cost $2,600.

 Installation of new wash basins – cost $5,000.

 Repairs costing $2,895 to the mirrors, which were stained and cracked.

 Payment of $450 to “Jim’s Cleaning” for professional cleaning.

 Erection of new signs for the business premises – cost $1,450.

Advise Emma what deductions may be claimed in respect of the above expenditure for the year ended 30 June 2018.

1. Painting of the external façade in January 2018 – cost $2,600. Knowing that Emma acquired the business in December 2017, the painting of the exterior of the building ($2,600) would likely represent initial repairs, as in LAW SHIPPING CO. This is because if there was a genuine need to repaint the external façade it would likely have been caused by the previous owner, as these are maintenance works which are expected to have a long-lasting benefit. Therefore these expenses would not be claimable as repairs under s 25-10, but could qualify for depreciation/capital allowances under Division 40 for plant or Division 43 for buildings.

2. Installation of new wash basins – cost $5,000. The new wash basins would be depreciating assets and therefore the amount would be claimable under the Capital Allowances provisions (Div 40). Considering the amounts involved, it is reasonable to assume that Emma’s hairdressing salon is a SBE, therefore the $5,000 spent on the new wash basins could be claimed immediately under the SBE Concessions Div 328, as this amount is within the annual limit of less than $20,000.

3. Repairs costing $2,895 to the mirrors, which were stained and cracked. In general a deduction for repairs is allowed where the expenditure is to restore the asset (due to normal wear and tear) and does not improve or alter the asset – s 25-10. In this case there was a genuine need for repair (mirrors were stained and cracked), therefore the deduction will come under s 25-10, according to the principles established in SAMUEL JONES & CO (DEVONDALE) (1951) repair – deductible (where the replacement of a chimney in a factory premises was held to be a repair as the chimney was regarded as merely the subsidiary part of the entirety) and RHODESIA RAILWAYS (where the replacement of a section of a railway was considered a repair).

4. Payment of $450 to “Jim’s Cleaning” for professional cleaning. Allowable deduction under s 8(1) as cleaning expenses are normal recurring business expenses, sitting in the same category as utility bills.

5. Erection of new signs for the business premises – cost $1,450. Capital expenditure (new signs are a capital asset that will improve the business capacity to earn more assessable income by increasing their visibility to customers) to be declined in value as per Commissioner’s specifications. Again the SBE Concessions would likely allow an immediate deduction as the cost of $1,450 is within the limit of less than $20,000 which applies for the year ended 30 June 2018.