In some cases, expenses incurred by a lessee on capital works expenditure or depreciating assets in leased premises may not be capital in nature, and therefore not regarded as leasehold improvements. Instead, an immediate deduction may be available for these expenses provided the premises have been used by the lessee in their business (or in gaining their assessable income). For example, the lessee may claim a deduction for repairs under S.25-10, and other maintenance costs may be deductible under S.8-1.
TAX WARNING – Repairs are not automatically ‘revenue’ in nature
It is important that taxpayers do not operate on the assumption that repairs automatically have a revenue character as this is not always the case. Repairs that are capital in nature are not immediately deductible under S.25-10. Instead, they are generally considered to be leasehold improvements and subject to the relevant rules (which vary depending on whether they relate to depreciating assets or capital works).
The ATO broadly considers (in Taxation Ruling (‘TR’) 97/23) repairs to be capital in nature in the following scenarios:
- The ‘repairs’ result in an ‘entirety’ being replaced (rather than a ‘subsidiary’ part of an entirety). This broadly applies to the replacement of something considered to be a separate and distinct item in its own right for these purposes (e.g., a house), but not the replacement of something merely regarded to be an integral part of something larger or an inseparable part of something else (e.g., walls of a house).
- The ‘repairs’ change the character of the item being repaired, and provide a greater efficiency of function.
- The ‘repairs’ constitute ‘initial repairs’, being repairs to remedy defects, damage or deterioration in the item that were already in existence at the date of acquistion.