Issues in classification
Scenario:
My company is in the business of providing fibre-optic internet and high-speed ethernet services to commercial customers. For a number of our clients in newly developed industrial estates, we are required to install the internet fibre underground before providing the internet services to them. We contract the services to civil engineers to complete the digging and installation of the fibre. Once the fibre is installed, they remain the property of our company, who then provides the internet services to the end-users based on a monthly payment plan. We have advised that the fibre has a useful life of approximately 20 years. We noticed that the digging and installation costs have been treated as blackhole expenditure in the past. However, we believe that the costs should, in fact, fall under Div. 40 and that blackhole expenditure can only apply as a matter of last resort.
Should the costs be classified as blackhole expenditure or should they be part of Div. 40? Would they be classified as revenue as opposed to capital?
Explanation:
The asset (the digging and installation costs) would certainly not to be classified as revenue since the economic benefit arising from the asset arises over many years. So, the expenditure is capital in nature and the only question is whether it qualifies for capital allowances under Div. 40 or it is blackhole expenditure. It seems clear that the expenditure would qualify for capital allowances under s 40-190 as a second element of cost. Section 40-190 contains the rules for calculating the second element of cost of a depreciating asset held by the taxpayer.
The second element is worked out after the taxpayer starts to hold the asset and is generally the amount paid to bring the depreciating asset to its present condition and location. For example, a taxpayer holding manufacturing equipment as a depreciating asset may incur installation costs in one year and upgrading costs in a subsequent year. Both would be included in the second element of the cost of the equipment for the purposes of calculating the deduction for the decline in value of the equipment.
In this case, the costs of digging, and installation are necessarily incurred in order to bring the cable into a condition where it is fit for use and accordingly they are second element costs.