Claire’s Column – Repairs and Improvements – Capital or Expense?

It is critical to understand the difference between repairs and improvements to get your tax deductions right.

The general principle is that if your expenditure is for ongoing asset maintenance it is an expense and is deductible when incurred.  In contrast, if the outgoing causes a substantial improvement in your asset compared with when you initially bought the asset it is a capital item and is depreciated over time.

Repairs

A repair restores an asset’s operating ability and function without changing its character, in order to maintain it in the state in which you originally acquired it. In practical terms this is fixing defects and renewing parts but the character of the asset remains the same.

Examples of expenditure that are repairs include:

• servicing plant or machinery
• replacing tracks on the dozer
• general maintenance of watering systems
• repairing damaged sheds
• mending leaks to troughs
• restraining or mending broken fences
• replacing old guttering
• desilting a dam

When it comes to initial repairs following acquisition of a second-hand asset, the ATO takes a different view.  In these circumstances, your initial expenditure to fix the asset is considered to be an improvement and not a repair.  This is because the amount you paid for the asset was discounted to reflect the state of the asset and any work undertaken subsequent to acquisition represents an improvement over what you paid for.

Improvements

Where the expenditure is for enlarging or improving an asset within the business this is capital in nature.  The expenditure forms part of the asset’s cost base and may be eligible for a tax deduction over the life of the asset as it is depreciated.
Examples of expenditure on improvements that are capital include:

• upgrading an existing watering system
• creating a firebreak
• changing single fencing to double fence a laneway
• replacing an asbestos shed roof with corrugated iron
• upgrading an internal dirt track to a gravel surfaced roadway
• purchasing additional implements for a piece of machinery
• installing air-conditioning in worker’s cottage
• building or extending a dam (i.e. increasing a dam’s water capacity)

While the general rule is that items of capital expenditure do not qualify for an immediate write-off, the Government has made various tax allowances, especially as they apply to small business and the rural sector.

Under these allowances, businesses with a turnover less than $50 million may be eligible for the instant asset write-off which enables you to claim the full cost of the asset at the time of purchase (up to $30,000).

In addition, where primary producers spend money on water facilities, fencing or fodder storage assets they are allowed:

• an immediate tax deduction for the cost of fencing assets incurred on or after 12^th May 2015. While it includes cost of posts, rails, wire, gates, fittings and labour it excludes expenditure related to stockyards and portable fences or yards
• an immediate tax deduction for the cost of water facilities incurred on or after 12^th May 2015 including tanks, bores, irrigation channels, pumps, water towers, windmills and dams
• an immediate tax deduction for the cost of fodder storage assets incurred on or after 19^th August 2018 including silos and grain and stockfeed storage tanks, construction of a fodder storage shed

While the above information aims to guide you to categorise repairs and capital expenses correctly, this area is often not black and white. If you are not sure which category an expenditure should fall under, please let us know. We are happy to discuss this with you.

To read the rest of our February 2020 Newsletter click here.

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