The University of Sydney-    Classic Texts in Australian and International Taxation Law

Buildings

8.82. The Act allows deductions for depreciation of ‘plant’ used for income-producing purposes but, with certain limited exceptions, not for depreciation of ‘buildings’. The exceptions are income-producing buildings forming an integral part of plant; buildings used only for scientific research related to the business of the taxpayer; structural improvements on land used for the purpose of agricultural or pastoral pursuits; and buildings erected by mining enterprises as part of the development of a mining property.

8.83. One argument that has been used to support the present situation is that land and buildings appreciate in value rather than depreciate. The Hulme Committee, in observing that the Commonwealth income tax law did not allow depreciation on buildings, stated that the reasons which appeared to have previously weighed against the granting of such an allowance were those to be found in the following extract from the Report of the Ferguson Commission (1932-34):

‘We received many requests that depreciation should be allowed in all cases. There are many buildings, however, which with repairs and maintenance, all of which are of course allowed as deductions, will last for hundreds of years. There is the further consideration that many substantial buildings in good localities have not depreciated in value—on the contrary the property as a whole has appreciated owing to an increase in values of the sites on which the buildings stand … We recommend that depreciation on buildings be restricted to buildings forming an integral part of plant …’

8.84. The Hulme Committee reported that in none of the matters which came before it had it encountered more widespread representation, or more unanimity of opinion, than that an allowance should be given for depreciation of buildings. It


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recommended that depreciation be allowed in respect of the cost of all income-producing buildings but drew attention to the practical problems of including existing buildings.

8.85. It recommended that existing buildings be included where, if depreciation using the prime cost method had been available at the time the building was constructed, there would still be some portion of the construction cost unrecouped. However, to overcome the problem of ascertaining the actual construction costs of older buildings, it devised a complex scheme for calculating the cost of existing buildings where actual construction costs were not known. Construction costs of buildings erected between 1939 and 1955 (the year in which the recommendations were made) could, it was thought, be ascertained. It was proposed that buildings erected before 1939, which tended to be more standardised than are buildings erected today, should be given a deemed cost of construction calculated by applying a standard cost for that type of building in 1939 to the building's internal floor area and then relating the result to an index of relative levels of building costs in earlier years. Since the rates of depreciation suggested for brick, stone or concrete buildings assumed a normal life of sixty-seven years, the existing buildings (in 1955) which would still have qualified for depreciation could have been constructed as long ago as 1888.

8.86. Depreciation on industrial and commercial buildings used in the production of income is allowed in many overseas countries including Belgium, Canada, Italy, Japan, Netherlands, New Zealand, South Africa, Sweden, the United States, and West Germany. The United Kingdom is an exception, the deduction being limited to industrial buildings. However, the Millard Tucker Committee on the Taxation of Trading Profits (1951) and the Royal Commission on the Taxation of Profits and Income (1955) both recommended that the depreciation allowance be extended to include commercial buildings.

8.87. In reaching this conclusion, the second of these United Kingdom inquiries reported:

‘380. No doubt commercial buildings involve an ultimate wastage of capital in the same way as industrial buildings do. From that point of view there is no reason to distinguish between them. But we recognise that there are other arguments to be considered. There is an argument that any allowance for capital that is lost in the using up of a fixed asset is anomalous in an income tax system which refrains from treating as taxable a realised capital surplus. This unbalanced treatment, for long confined to plant and machinery, has now been extended to cover other types of assets, in order to stimulate capital investment of a kind desirable in the national interest. It is only in the new context of shortages and high prices combined with a wider range of assets to which capital allowances apply that the anomaly of principle could be of any material importance. But in that context it is not impossible that what is right for industrial buildings is wrong for commercial buildings.

381. The Board are opposed to this recommendation. We summarise their reasons:

• (1) Commercial buildings last a very long time; they are not nearly as much subject to obsolescence as factories are.
• (2) Over very long periods they tend to appreciate rather than depreciate in value, so that if allowances were given they would very often have to be withdrawn when a sale took place.
• (3) At the present time there is no economic importance in stimulating the construction of commercial buildings.
• (4) The proposal would involve drawing a line between commercial buildings and dwelling-houses that would inevitably be regarded as unsatisfactory, particularly in the common case of the house over the shop. Complicated provisions would, moreover, be required to deal with changes of user.



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• (5) The proposal would add considerably to the work of the Department.

382. Although these arguments must be taken into account we do not believe that in the long run they can be decisive. So far as they are not concerned with administration they amount to saying that businesses would not find it worth while to claim the allowance, or that there would be no economic reason for a Chancellor to implement the recommendation. That may well be so, and we should agree to this extent that we do not regard a change from the present system as in any sense an urgent requirement. But we could find no fiscal justification for distinguishing between commercial and industrial buildings and we think both should get the allowance. Accordingly, we endorse the recommendation of the first Tucker Committee.’

8.88. The Institute of Chartered Accountants in Australia and the Australian Society of Accountants, in a joint statement, ‘Depreciation of Non-current Assets’, issued in April 1974, recommended as follows:

‘Buildings. For the purposes of calculating depreciation, the historical cost of a freehold property (or other value substituted for historical cost in the accounting records) should be apportioned between the land itself and the building(s) erected on the land. The resultant depreciable amount attributable to the building(s) should be written off as an expense by means of periodical depreciation charges over the estimated useful life (lives) of the building(s).’

8.89. The experience of this Committee is very similar to that reported by the Hulme Committee and referred to in paragraph 8.84. Numerous submissions have been received which are unanimous in condemning the present restriction of the allowances to buildings to the extent that they form integral parts of manufacturing plant. The representatives of various kinds of business have urged that at least their own particular class of buildings should qualify for relief.

8.90. The basic arguments in favour of allowing depreciation on buildings as a taxation deduction stem from a recognition that a material asset has a finite useful life which may be shorter than the physical life of the asset. All buildings and other structures on land are just as subject to the need for eventual replacement as is working plant, and with the rapid rate of technological change the effective working life of these items is becoming shorter. This fact is reflected in a practical manner in the continual demolition of existing buildings to make room for new ones, usually of increased capacity and more suitably designed for modern conditions.

8.91. The argument which persuaded the Ferguson Commission to recommend against an allowance for building depreciation—that any loss in value of a building tends to be offset by appreciation in the value of land—has, in general, long since been rejected. A further argument—that the imposition of a capital gains tax on profits arising from the realisation of real property is a necessary counterpart to the allowance of building depreciation—has also been rejected. The reasons for the rejection of both these arguments were stated in the Hulme Committee report and have been dealt with at some length in pronouncements by the major professional accounting bodies in Australia and overseas. The principal reason is that they overlook the fact that buildings are consumed and replaced in the course of business operations unrelated in any way to changes in the value of the underlying land. Many business activities are conducted on land owned for very long periods. Rarely is industry carried on efficiently in buildings erected more than fifty years previously. Commercial buildings of the same vintage originally used for offices or accommodation are seldom now suitable for that purpose without expenditure of a capital nature on reconstruction.

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8.92. In the Committee's view allowances for depreciation of buildings are called for. Their introduction, however, raises certain problems:

• (a) For what classes of building should depreciation be allowed?
• (b) Should all buildings be included or only those completed after a certain date or after the proposal is introduced?
• (c) How should changes in the ownership of depreciating buildings subject to depreciation be treated?
• (d) How should the demolition and destruction or damage of buildings be treated?
• (e) Is a phasing-in period necessary to cushion the effect on tax revenue?

8.93. Classes of buildings which should qualify. The Committee sees no valid reason for excluding particular classes of buildings from the allowances and therefore recommends that depreciation be allowable in respect of all income-producing buildings whether they be industrial or commercial. In this context commercial would include residential accommodation. While the case for allowances may be stronger for industrial buildings, which generally have a shorter effective life than other buildings, and possibly also for accommodation buildings such as hotels and motels for the same reason, allowances are justified whenever a building is used in producing income. Moreover, real difficulties would arise in identifying industrial buildings if the allowances were confined to such buildings, or in identifying accommodation buildings if allowances extended only to industrial and accommodation buildings.

8.94. The inclusion of existing buildings. Some restriction on the scope of buildings entitled to allowances, related to time of erection, would seem to be inescapable. The broad alternatives are to give allowances in relation to (i) all existing buildings, together with all new buildings and additions to buildings; or (ii) buildings and additions erected after a specified day (say 1960); or (iii) buildings and additions erected after a very recent date (say 1974). The problems involved in giving allowances in respect of all existing buildings are immense, especially when it is proposed that all income-producing buildings should qualify. On the other hand, the restriction of the allowance to relatively new structures must give rise to inequity: for example, a rented house finished in 1975 would qualify but one next door completed in 1973 would not. The exclusion of existing buildings would also distort the property market.

8.95. Choosing between the alternatives is not easy. The major reason why nothing has been done in this area for so long, despite the recommendations of earlier committees, is probably the administrative difficulties associated with the proposals that have been made. Hence, administrative feasibility must be the major consideration, even though some inequities may result. The Committee therefore recommends that all buildings which were completed, and were used or were available for use, in the production of assessable income after 30 June 1974 (referred to hereafter as the ‘qualifying date’) and any additions to buildings where the additions were completed and used or available for use after that date, should qualify for depreciation. The rates should be based on their estimated effective lives as determined by the Commissioner. Contractual completion date rather than cost incurred to a specified date should be more readily ascertainable in the case of most buildings and a modestly retrospective date, coinciding with the end of a fiscal year, is proposed.

8.96. There will be formidable problems in determining the apportionment of the cost of a building to individual home units, own-your-own units and strata titles to property. An official study will be needed to work out special provisions for these


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cases, and initially it may be appropriate to defer granting allowances for buildings to which the title is held in one of those forms.

8.97. There is evidence in the published reports of a number of public companies that some taxpayers hold the view that because of the purpose for which a property is held, the value attributed to a building, or some other reason, depreciation of the building does not need recognition. There could be little merit in introducing a difference between tax accounting and financial accounting in these instances. In some overseas countries certain allowances are available only to the extent that the costs concerned have been recognised in a taxpayer's financial records. A similar provision might well be appropriate in relation to allowances for building depreciation proposed by the Committee, at least in respect of companies.

8.98. Treatment on change of ownership. The segregation of the proceeds of the sale of a building from the proceeds of the sale of the land on which it is erected gives rise to special difficulty. This was recognised by the Hulme Committee in its proposal that there be no balancing charge in respect of depreciation on the sale of a building, but not, however, in its proposal that there be a balancing allowance on such a sale.

8.99. In the view of this Committee, the difficulty of ensuring a fair and realistic segregation, within the proceeds from the sale of a property, of that part of those proceeds applicable to a building dictates that there be neither a balancing charge nor a balancing allowance. Segregation within sale proceeds would give rise to added complications if it were necessary to dissect further the sum allocated to buildings, so as to identify that part of the sum applicable to a building erected prior to the qualifying date and that part applicable to additions to it made subsequently.

8.100. Accordingly, the Committee recommends that in the event of the disposal of a building, the new owner should be entitled to depreciation on the basis that he succeeds to the unrecouped amount of the original cost of the structure. His annual allowances would be in accordance with the depreciation schedule for that property applying at the date of purchase. The purchase price of the property would be irrelevant in regard to depreciation allowances, the sale proceeds of the building being deemed to be its written-down value. Where there has been non-income-producing use in any year, the written-down value will have been reduced by a ‘notional’ depreciation allowance in that year.

8.101. Implicit in these proposals is the principle that all proceeds received on the sale of a property which are in excess of the written-down value of the building must represent the value of the land on which the building stands. The total of depreciation previously allowed to the vendor will, however, diminish the cost base of property for capital gains tax purposes. Where property is sold for less than the written-down value of the building—an unlikely event, no doubt—the assumption that the building was sold for its written-down value is of course contradicted by the facts, and there may be a case in this circumstance for the application of a balancing allowance. The buyer would be treated as having acquired the building at the price he paid for the property. If this is not done, the seller will be allowed only a capital loss in respect of what should be an income deduction.

8.102. It should be noted that these proposals are not intended to vary the present treatment of depreciation of buildings under the special provisions of the Act relating to mining, petroleum, primary production and forestry operations.

8.103. Demolition and damage. There would need to be exceptions, in the case of demolition or damage to a depreciated building, to the general rule that balancing


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adjustments are not made. Problems of segregating amounts received between land and buildings would not arise here (though segregation would need to be made between a building erected prior to the qualifying date and additions made subsequently). In the case of demolition or destruction, the difference between the written-down value of the building and the salvage or insurance proceeds would be allowed as a deduction in the year of demolition. If the proceeds exceeded the written-down value, the excess, up to the sum of the depreciation deductions previously allowed to the taxpayer, would be a balancing charge. Any amount of the excess not then treated as a balancing charge would reduce the cost base of the land for purposes of capital gains tax, unless the taxpayer elected to apply it in reduction of the cost of a building erected in replacement. Where there is only partial damage, any insurance recoveries would be offset against the cost of any restoration not deductible as a repair. Any amount not so absorbed would be treated as a balancing charge to the extent of depreciation previously allowed to the taxpayer and thereafter applied to reduce the cost base of the property for purposes of capital gains tax. Insurance recoveries in respect of restoration amounting to repair are income under existing law and the repair cost deductible. Balancing deductions would not be allowed, since depreciation will continue to be available on the original schedule.

8.104. Effect on revenue. The loss of tax revenue that would result if income-producing buildings were to qualify for allowances has been a major factor in postponing the introduction of such allowances. But this factor should not be permitted to override the correction of an inequity in the form of an overstatement of net income by a large body of taxpayers. Some phasing-in of the allowances is nevertheless called for. If, contrary to the Committee's proposal, a major portion of existing buildings were to qualify, phasing-in could be achieved by commencing with a low rate which would increase to a realistic figure over a period of five to ten years. A phasing-in is automatically achieved under the Committee's proposal that the allowances be restricted to buildings completed after the qualifying date.