Taxation - Case Law of Water Jet Ferries

Continuous decrease in profit can make company out from market, for sustain in market company have make modification in their engines. Now Water Jet has decided to reduce cost by making repairs and modifications in engines. These repairs and modifications done for low consumption of fuels speedily travels of vessels and making eco-friendly engine i.e. technological advancement or up gradation. Engine Manu
facture of the company advises to the company to make repairs and modifications in engines and treat it as revenue expenditure and claim deduction in under sec 25-10 of Income Tax Assessment Act 1997 for expenditure incurred on modification of engines.

Treatment of Cost of Repairs and Modification

Continues of any assets requires day to day repairs or modifications of parts wholly or partially. Cost of day to day repairs generally includes cost of parts, consumable and labour etc. For an illustration, Owner of a car requires regular change or repairs of tires, lubricants, engine etc. When company incurs any expenditure on repair and modification of assets than expenditure should be charged according to nature of expenditure. Expenses are to be classified in two types, revenue expenditure and capital expenditure according to nature of expenses. Let us understand concept of Revenue expenditure, and capital expenditure. 

Revenue Expenditure: - Revenue Expenditure is expenses incurred on maintaining assets and generating revenue. Revenue expenditure includes repair cost, maintains charges, repainting and renewal cost. Revenue nature expenses are related to the generation of Income. 

Capital Expenditure: - Capital Expenditures are all expenses incurred on any assets to make it usable or expenses up to use. If any expenses incurred assets after put to use but results in efficiency and effective use of assets, i.e. without those expenses output from assets is not possible: should be capitalized and depreciate at appropriate rates.  

Now it clarified that those expense to be considered as repairs which generates revenue, all other expenses incurred on modification or repairs of assets should be capitalized. 

Repairs: - Repair means restoration, renovations, and modification of assets by renewal of defective parts, fixing loose parts and lubricating the parts. Repair includes restoration of something lost or damaged. Repair for the purpose of sec 25-10 of the Income Tax Assignment Act 1997 is renewal or replacement of parts to some modification and minor or incidental improvement. Repair involves modification of assets without changing its original nature and with little technological advancement.  

Case Law: -

In case W Thomas & Co v FC of T (1965) 115 CLR 58, W Thomas & Co incurred expenditure on repairs to guttering, roof, walls and two floor building and treated as revenue and claimed deduction under sec 36 of Income Tax Assessment Act 1936. In this case High Court considered as capital expenditure not repairs judgement was passed against the company stating that these expenses not of repairs but to be capitalized. 

In Case of Jet Ferries, the company had incurred cost on modification of engines to results low fuel consumption, high speed vessel traveling and eco-friendly engines. Engine manufacturer suggests the company that all expenses incurred on modification by company able to treat as repairs and claim deduction in tax under sec 25-10 of Income Tax Assessment Act 1997. In this case there is greater degree of technological advancement and change in its character. If any non-capital modification work is not repair than it may deductible under Income Tax Assessment Act 1997.  

No Deduction for ‘notional’ repairs

When repair and modification work is totally capital expenditure than no amount is allowable as deduction under Sec 25-10 of Income Tax Assessment Act 1997 for these as these are notional repairs. When tax payer have two alternatives, one involving expenditure on repairs and modification to involve in allowable deduction Tax and another alternative to involve non-allowable deduction from Tax. In that condition no deduction is allowed under sec 25-10 of Income Tax Assessment Act 1997. 

Opinion:-       

Our Opinion in this case is against the advice of engine manufacturer after applying the facts of W Thomas & Co v FC of T (1965) 115 CLR 58. All expenses done by company on modification of engine are capital nature and to be capitalized. Sec 25-10 of Income Tax Assessment Act 1997 and Sec 53 of Income Tax Assessment Act 1936 explains the which type of expenditure incurred by tax payer for repairs is an allowable deduction in Tax and which type of expenses are not deductable. Repairs involve restoration, renovation and modification of assets without changing its original nature. But in case of Water Jet Ferries modification process involves greater degree of technological advancement resultants to change its original nature of enignes. As per our opinion it advisable to company to capitalize all expenses incurred on modification as it is of capital nature. Assets of Tax payer should be depreciated according to the use life assets as per the Income Tax Assessment Act 1997. Use full life of Car is 8 Years as per Income Tax Assessment Act 1997, so rate of depreciation for car is 12.5%. While Use full life of Truck is 15 years as per Income Tax Assessment Act, 1997, so rate of depreciation is 6.67%. 

References: 

ANON, N.D., “Repairs, Maintenance and replacement expenses”, Accessed on 29 January 2015, <https://www.ato.gov.au/Business/Deductions-for-business/Repairs,-maintenance-and-replacement-expenses/> 

ANON, N.D., “What you can claim and when”, Accessed on 29 January 2015, <https://www.ato.gov.au/Business/Deductions-for-business/What-you-can-claim-and-when/> 

ANON, N.D., “Repairs and maintenance expenses”, Accessed on 29 January 2015, <https://www.accountingcoach.com/terms/R/repairs-and-maintenance-expense> 

ANON, N.D., “Income Tax: Deduction for repairs”, Accessed on 29 January 2015, <https://law.ato.gov.au/atolaw/view.htm?DocID=TXR/TR9723/NAT/ATO/00001> 

ANON, N.D., “What is a capital expenditure versus a revenue expenditure?”, Accessed on 29 January 2015, <https://www.accountingcoach.com/blog/capital-expenditure-revenue-expenditure> 

ANON, N.D., “Capital and Revenue Expenditure”, Accessed on 29 January 2015, <https://accounting-simplified.com/financial/fixed-assets/capital-and-revenue-expenditure.html> 

ANON, N.D., “Revenue Expenditure”, Accessed on 29 January 2015, <https://www.accountingtools.com/revenue-expenditure-definition>