Senate

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 2 - Capital allowances - cost rules

Outline of chapter

2.1 Subdivision 40-C defines the cost of a depreciating asset on which the deductions under Subdivision 40-B are based. This chapter explains that definition of cost by outlining:

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the 2 elements of cost;

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which amounts are included in cost;

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which amounts are not included in cost; and

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the adjustments to cost.

Context of reform

2.2 The cost of a depreciating asset is essential in working out the amounts a taxpayer can deduct for it under Division 40.

2.3 The cost rules contained in Subdivision 40-C adopt a new structure and new core concepts with a view to:

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achieving standardisation; and

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providing a more robust framework.

2.4 The cost rules introduce concepts that recognise payments made:

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in money and in a form other than money (i.e. recognising the appropriate value when anything of value is given in consideration for an asset); and

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when an asset is acquired and at a time after the asset is acquired (i.e. recognising all payments that add to the economic benefits embodied in the asset).

2.5 The cost rules in Subdivision 40-C are a comprehensive and principled treatment of expenditure on a depreciating asset.

Summary of new law

What will Subdivision 40-C do?

2.6 Subdivision 40-C establishes the concept of the cost of a depreciating asset. This chapter explains that concept.

2.7 The cost of a depreciating asset is the sum of expenses that the holder of that asset has incurred either in order to hold the asset or to bring it to its present condition and location. Broadly, these expenses will be deductible according to the life of that asset. Therefore, it is critical to the calculation of deductions that taxpayers can identify which expenses form part of the cost of a depreciating asset they hold (and which do not).

How is a depreciating assets cost worked out?

What are the 2 elements of cost?

2.8 The cost of a depreciating asset may consist of 2 elements:

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first element costs;

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expenses in order to hold the asset; and

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second element costs;

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expenses after the taxpayer starts to hold the asset that bring the asset to its condition and location from time to time.

Which amounts are included in cost?

2.9 Generally, the cost of a depreciating asset consists of amounts a taxpayer has paid, or is taken to have paid, in relation to the asset. These amounts will include non-cash benefits that a taxpayer has provided. However, in certain circumstances the cost will be a particular amount attributed under the cost rules rather than the amount actually paid (e.g. where a taxpayer becomes a holder under a luxury car lease).

2.10 In addition, where there is a payment for more than one thing that is partly for a depreciating asset, that payment will be apportioned between the cost of the depreciating asset and any other things.

Which amounts are not included in cost?

2.11 The cost of a depreciating asset will not include the following:

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GST input credits and decreasing adjustments;

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amounts incurred before 1 July 2001 (or under a contract entered into before that date) on a depreciating asset that is not plant;

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amounts deductible for expenditure on mining, quarrying or prospecting information;

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amounts deductible outside Division 40; and

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expenses not of a capital nature.

What adjustments are made to cost?

2.12 The cost of a depreciating asset will be adjusted for the following:

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the car limit; and

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acquiring a car at a discount.

Detailed explanation of new law

How is a depreciating assets cost worked out?

2.13 The cost of a depreciating asset may include 2 elements:

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the first element broadly deals with what it cost the taxpayer to start holding the asset. That element will be part of the cost of almost every asset; and

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the second element is about the additional cost to the taxpayer to bring the asset to its current condition and location. That element will only apply to some assets.

[Schedule 1, item 1, section 40-175]

2.14 The first element is always worked out as at the time when the taxpayer began to hold the depreciating asset. If the taxpayer has held the asset more than once (e.g. because it was sold, then repurchased later), the relevant time is when the taxpayer most recently began to hold it. [Schedule 1, item 1, subsection 40-180(1)]

2.15 The second element is worked out at a particular moment after the taxpayer began to hold the asset. When taxpayers need to know the assets cost, they work out what it has cost them to that point to bring the asset to its current condition and location from time to time. [Schedule 1, item 1, subsection 40-190(1)]

First element of cost

2.16 The first element of the depreciating assets cost (essentially, the cost to start holding it) includes expenditure such as the acquisition price of an asset and incidental expenses incurred to acquire the asset or to create a new asset. The first element of cost is either:

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amounts a taxpayer has paid or is taken to have paid:

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generally, a taxpayer becomes the holder of an asset because they pay an amount measured in money, or provide something else (a non-cash benefit, which has a market value). The sum of these amounts and values will be the first element of cost in all cases except the special cases [Schedule 1, item 1, subsection 40-180(1)] ; or

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a specified amount in particular cases:

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for a number of special cases the first element cost is attributed directly, regardless of the amount the taxpayer actually paid or the value of the benefit the taxpayer has provided [Schedule 1, item 1, subsection 40-180(2)] .

Amounts a taxpayer has paid or is taken to have paid

2.17 Generally, the first element of cost of a depreciating asset is simply the amount a taxpayer has paid or is taken to have paid to hold the asset. This will be the case in all circumstances other than the special situations listed in paragraphs 20 to 2.70. [Schedule 1, item 1, paragraph 40-180(1)(a)]

2.18 That is the greater of:

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consideration given :being the sum of the following:

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money paid or non-cash benefits provided;

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a liability to pay money or provide non-cash benefits; and

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a reduction in a right to receive money or non-cash benefits; and

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amounts included in assessable income :being the sum of the following:

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the amount included in assessable income because a taxpayer started to hold the depreciating asset, or gave something to start holding it; and

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any amount which would have been included if you ignored the value of any consideration given.

[Schedule 1, item 1, subsection 40-185(1)]

Consideration given

Money given

2.19 The usual case is simply paying money to hold the depreciating asset, in which case the first element is that amount [Schedule 1, item 1, subsection 40-185(1), item 1 in the table] . This would cover money paid to create an asset (e.g. labour and materials) as well as simple purchase prices. It would also cover payments incidental to starting to hold the asset (e.g. stamp duty). Where a taxpayer makes a prepayment to acquire an asset, the first element of cost will be that amount.

2.20 In addition, a taxpayer will be taken to have paid amounts under notional transactions that the tax law deems to have occurred. These amounts include:

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the price of the notional purchase made when trading stock is converted to a depreciating asset under section 70-110 of the ITAA 1997;

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the cost of an asset held under a hire purchase arrangement under section 240-25 of the ITAA 1997 ^[F1] ; and

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a lessors deemed purchase price when a luxury car lease is terminated under subsection 42A-105(3) of Schedule 2E to the ITAA 1936 .

2.21 Another case is incurring a liability to pay money (or increasing an existing liability to pay money) in order to hold a depreciating asset. In that case, the first element is the amount of the liability (or the increase in the liability) when the taxpayer began to hold the asset. [Schedule 1, item 1, subsection 40-185(1), item 2 in the table]

2.22 To be included in the first element of cost, a liability must be incurred in order to hold the depreciating asset. This will be the case where a liability is given in direct exchange for an asset. However, a liability incurred by one party to fund the purchase of an asset from another is not a liability incurred in order to hold the asset. Rather, this is a liability incurred in order to get finance; that finance is then used to pay for that asset. In that case, the first element of cost is the amount paid for the asset, and does not include boththe sum of the amount paid and the liability to pay a sum to the financier. Similarly, if a taxpayer incurs a liability to pay an amount so as to acquire an asset, the later payment of (or towards) the liability is not part of the cost of the asset: it was paid to meet a liability, not to hold the asset (which the taxpayer already holds).

Example 2.1

Greg takes out a loan of $100,000 from Bankco to buy a harvester from Helen. He incurs the liability to repay Bankco but also pays the amount to Helen. The liability is not incurred in order to hold the asset, rather it is incurred to receive the $100,000 that he then pays to hold the asset. The first element of cost is simply the $100,000 that he paid to Helen, not the sum of that amount and the liability he incurred.

2.23 In addition, when a taxpayer reduces (or terminates) a right to be paid money, in order to hold a depreciating asset, that reduction will be included in the first element of the assets cost. For instance, a taxpayer could waive a debt as the price of a depreciating asset from a debtor. [Schedule 1, item 1, subsection 40-185(1), item 3 in the table]

Non-cash benefits given

2.24 Non-cash benefit is the label for all property or services that are not money (subsection 995-1(1) of the ITAA 1997). The rules dealing with taxpayers who provide non-cash benefits in order to hold a depreciating asset mirror those for taxpayers who provide money.

2.25 Where a taxpayer provides non-cash benefits in order to hold a depreciating asset, the market value of those benefits will be included in the first element of cost. [Schedule 1, item 1, subsection 40-185(1), item 4 in the table]

2.26 Similarly, where a taxpayer incurs a liability to provide non-cash benefits in order to hold a depreciating asset, the first element includes the market value of those non-cash benefits (at the time the liability is incurred, not at the time the liability is met). Also, the first element will include the market value (at that time) of any increase in an existing liability to provide property or services to begin holding the asset. [Schedule 1, item 1, subsection 40-185(1), item 5 in the table]

Example 2.2

Fiona, a house painter, buys a panel van (a depreciating asset) from Andrew in exchange for:

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painting Andrews home - the painting services are a non-cash benefit with a market value of $4,000;

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terminating a $1,000 debt owed to her by Andrew;

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undertaking to re-paint Andrews home in 10 years - this is a liability owed by her to provide him with non-cash benefits with a market value of $1,500; and

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incurring a liability to pay Andrew $1,000.

Her first element of cost for the panel van is the sum of these amounts, that is, $7,500.

2.27 Finally, when a taxpayer reduces (or terminates) a liability to receive non-cash benefits (other than the depreciating asset), in order to hold a depreciating asset, the first element of the assets cost will include the market value of the non-cash benefits given up. [Schedule 1, item 1, subsection 40-185(1), item 6 in the table]

Example 2.3

Following the case in Example 2.2, Fiona undertook to provide Andrew with non-cash benefits (the materials and services involved in repainting Andrews house). Instead of providing the non-cash benefits she gives him a computer (a depreciating asset). Andrew accepts this asset in satisfaction of the liability (which is terminated). Andrews cost for the computer is the market value of the material and services when that liability is terminated.

Only include outstanding liabilities

2.28 Where part of a liability is already satisfied, that part of the liability cannot become part of the first element of cost. Only outstanding liabilities to pay money or provide non-cash benefits (or an increase in such liabilities) are included in cost. [Schedule 1, item 1, subsection 40-185(2)]

Example 2.4

Brian enters into an agreement to buy a tractor to be delivered in 4 months, on monthly instalments starting immediately and totalling $10,000. By the time he begins to hold the tractor, he has already paid off $2,000. The first element of the tractors cost is the $2,000 he has paid to hold the tractor plus the outstanding $8,000 of the liability.

Amounts included in assessable income

2.29 Alternatively, the first element of cost may consist of:

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an amount included in assessable income because a taxpayer started to hold a depreciating asset, or gave something to start holding it; and

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any amount which would have been included if you ignored the value of any consideration given,

where this total exceeds the amount of consideration given. [Schedule 1, item 1, paragraph 40-185(1)(a)]

2.30 The circumstances in which an amount may be included in the assessable income of a taxpayer include:

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where a business taxpayer started to hold a depreciating asset and this was a non-cash benefit; and

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where there is a balancing adjustment for a depreciating asset given up in order to start holding another depreciating asset.

Amount included because a business taxpayer started to hold a depreciating asset

2.31 Where a business taxpayer receives a depreciating asset as a non-cash benefit, the arms length value of those benefits, less any contribution made by the taxpayer, may be included in that taxpayers assessable income (section 21A of the ITAA 1936). In this case, the first element of cost consists of the amount included in assessable income and any amount that the taxpayer contributed to hold the asset.

Example 2.5

Sharon receives a car (a depreciating asset) as a non-cash business benefit that is income to her. The car has an arms length value of $10,000. Sharon contributes $1,000 to start holding the car.

Sharons assessable income will include $9,000, being the arms length value of the car, less the contribution she has made (section 21A of the ITAA 1936).

The first element of cost is $10,000, being the sum of the $9,000 included in her assessable income and the $1,000 that she has paid which reduced the amount included in her assessable income.

Amount included because a taxpayer gave up something to start holding a depreciating asset

2.32 Where a taxpayer exchanges one depreciating asset for another they may have an amount included in their assessable income as a result of a balancing adjustment on the asset they stop holding. In this case, the first element cost of the depreciating asset they begin to hold will be the amount that would have been included, if the value of the asset they gave up was ignored. In other words, the first element of cost of the new depreciating asset will be any amount included in assessable income under the balancing adjustment plus the adjustable value of the depreciating asset given up.

Example 2.6

Mary exchanges a tractor with an adjustable value to her of $10,000, in return for a plough with a market value of $15,000. Marys termination value for the tractor is the market value of the plough (a non-cash benefit) she receives, $15,000. As a result of disposing of the tractor, Mary has a balancing adjustment of $5,000 (termination value of $15,000 - adjustable value of $10,000) included in her assessable income.

The first element of the ploughs cost will be the greater of:

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the market value of the tractor she provided (a non-cash benefit); and

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the amount that was assessable income because she gave the tractor to start holding the plough ($5000), ignoring the value of the tractor that she gave ($10,000). The total being $15,000.

Example 2.7

Bronwyn exchanges a chainsaw with an adjustable value to her of $800 in return for a lawn mower with a market value of $500. Bronwyns termination value for the chainsaw is the market value of the lawn mower (a non-cash benefit) she receives ($500). As a result of disposing of the chainsaw, Bronwyn is entitled to a deduction of $300 under a balancing adjustment (termination value of $500 - adjustable value of $800).

The first element of the chainsaws cost will be the greater of:

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the market value of the chainsaw she provided; and

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the $500 that would have been included in her assessable income if you ignored the value of the chainsaw she gave (i.e. its adjustable value was zero).

Specified cost in particular cases

2.33 There are several special cases in which a taxpayer may begin to hold a depreciating asset. For these special cases, the first element of cost is attributed specifically. This is a limited departure from the general principle that the cost of a depreciating asset is the amount that is given up in order to hold the asset. [Schedule 1, item 1, paragraph 40-180(1)(a)]

2.34 These cases are listed in a deliberate order. If more than one case applies, only the last case that applies is used. [Schedule 1, item 1, subsection 40-180(2)]

Split assets

2.35 When a depreciating asset that a taxpayer holds is split, the taxpayer is taken to have stopped holding that original asset and to have begun to hold the new assets into which it is split (see the discussion in paragraphs 10 to 1.141). [Schedule 1, item 1, subsection 40-115(1)]

2.36 The split assets are essentially created out of the original asset and must then have a first element of cost that is based on the adjustable value of the original asset from which they are split. [Schedule 1, item 1, subsection 40-180(2), item 1 in the table]

2.37 The first element of cost for each of these newly split assets the taxpayer begins to hold is a reasonable proportion of the sum of:

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the adjustable value of the original asset just before it was split (for a discussion of adjustable value see paragraphs 10 to 1.102); and

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any expenses that the taxpayer incurred to split the original asset.

[Schedule 1, item 1, section 40-205]

Example 2.8

Larry owns a cement truck with an adjustable value of $100,000. He decides to remove the cement mixer from the truck, this costs him $10,000. Larry has split the original asset into 2 new depreciating assets, the truck and the mixer.

He works out the first element of cost for each of the 2 new assets by apportioning the total of the adjustable value of the original asset and the cost of splitting it between those assets, that is, $110,000. Larry works out the first element of cost for:

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the truck to be $50,000; and

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the cement mixer to be $60,000,

on the basis of the relative market values of those new assets.

Merged assets

2.38 When one or more depreciating assets that a taxpayer holds is or are merged into another depreciating asset, the taxpayer is taken to have stopped holding the original asset(s) and to have begun to hold the new asset(s) into which they are merged (see the discussion in paragraphs 10 to 1.153). [Schedule 1, item 1, section 40-125]

2.39 The merged asset(s) is essentially created out of the original assets and must then have a first element of cost that is based on the adjustable values of the original assets. [Schedule 1, item 1, subsection 40-180(2), item 2 in the table]

Merging a single asset into a single asset - transformation

2.40 The rules cover the case where a depreciating asset is transformed into another. When an asset changes to the extent that it takes on the character of a new depreciating asset it is taken to have merged into that new depreciating asset. The taxpayer is taken to have stopped holding the original asset and to have started holding the new one.

2.41 Nevertheless, the merging rules ensure that there is no balancing adjustment for the taxpayer on the original asset and the cost of the new asset will be based on the adjustable value of the original asset.

Merging multiple assets into a single asset

2.42 When 2 or more original assets are merged into a single asset, the first element of cost for that single merged asset is simply the sum of:

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the adjustable value of the original assets just before they were merged (for a detailed discussion of adjustable value see paragraphs 10 to 1.102); and

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any expenses that the taxpayer incurs to merge the original assets.

[Schedule 1, item 1, section 40-210]

Example 2.9

Following Example 2.8, Larry bought a new truck for $90,000 and spent $10,000 to have his cement mixer attached to it. He has merged these depreciating assets into a single depreciating asset, a new cement truck. He works out the first element of cost for the merged asset by adding:

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$60,000, being the adjustable value of the cement mixer, just before it was merged with the new truck;

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$90,000, being the adjustable value of the new truck, just before it was merged with the cement mixer; and

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$10,000, being the expense of attaching the cement mixer to the new truck.

Therefore, the first element of cost of the merged depreciating asset, being the new cement truck, is $160,000.

Merging into multiple assets

2.42 When a taxpayer holds more than 2 depreciating assets, the taxpayer may merge them so that they continue to hold 2 or more merged assets. For instance, the taxpayer may merge 3 assets into 2. In these circumstances, the first element of cost for each of the merged assets a taxpayer begins to hold is a reasonable proportion of the sum of:

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the adjustable value of the original assets just before they were merged (for a discussion of adjustable value see paragraphs 10 to 1.102); and

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any expenses that the taxpayer incurs to merge the original assets.

Example 2.10

Mary owns 3 spectrum licenses covering:

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area A, which has an adjustable value of $50,000;

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area B, which has an adjustable value of $60,000; and

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area C, which has an adjustable value of $70,000.

The ACA resumes the 3 licenses. Mary pays $10,000 for them to be replaced by 2 new licenses that together cover exactly the same rights as the 3 original licenses.

To work out the first element of cost for each of the 2 new licenses, Mary apportions the total of $190,000 between the new licenses on the basis of their relative market values.

Depreciating assets a taxpayer expected not to use ever, or ever again

2.44 Where a taxpayer expects that they will not use a depreciating asset ever, or ever again (for any purpose) there is a balancing adjustment event even though they continue to hold the asset. [Schedule 1, item 1, subsection 40-295(1)]

2.45 Paragraphs 30 and 30 explain the balancing adjustment event that occurs and the termination value attributed to a depreciating asset that a taxpayer continues to hold but expects not to use ever, or ever again, and no longer has it installed ready for use. This balancing adjustment event is necessarily based on the expectation of the holder at the time that the taxpayer stops using the asset, or decides never to use it. The termination value for such an event is the market value of the asset at that time. [Schedule 1, item 1, subsection 40-300(2), item 1 in the table]

2.46 Given that the balancing adjustment event is triggered by an expectation, rather than a determinative event, it is possible that the taxpayers expectation, that they will not use the asset ever, or ever again, will not be fulfilled.

2.47 Where the taxpayer has a balancing adjustment event occur and still holds the asset after the balancing adjustment event, the cost and adjustable value of the asset are reset to termination value. That is, the value to which the balancing adjustment rules reconciled the adjustable value when the balancing adjustment event occurred. This will allow any further gain or loss to be recognised when another balancing adjustment event occurs, for instance because the asset is subsequently disposed of, lost or destroyed. Any further costs incurred after the first balancing adjustment event will be recognised in the usual way. [Schedule 1, item 1, subsection 40-180(2), items 3 and 4 in the table]

Example 2.11

Minco Ltd operates a bauxite mine. Due to falling prices for aluminium, it closes its mine and stops using a conveyor belt it owns (a depreciating asset). It expects that prices will not recover and so that it will never use this asset again; the assets are mothballed. This is a balancing adjustment event. The termination value of the conveyor belt is its market value just before Minco formed the expectation that they would never use it again, $100,000.

However, some years later the price for aluminium soars. Minco reopens the mine and renews and recommences use of the belt. The cost and adjustable value became equal to its termination value at the time of the earlier balancing adjustment event, that is, $100,000. Any capital cost of the renewal adds to that cost, and once the belt begins to be used again there is a start time for the belt and decline begins again.

Depreciating assets for which a taxpayer has had rollover relief

2.48 In most cases, where a taxpayer transfers a depreciating asset to another they will have a balancing adjustment at the time they stop holding the asset. However, in certain circumstances that taxpayer (the transferor) will not have a balancing adjustment but will be entitled to rollover relief (discussed in greater detail in paragraphs 30 to 3.116).

2.49 Essentially the rollover relief means that the taxpayer that becomes the holder (the transferee) continues to deduct the decline in value of the depreciating asset using the same method and effective life as the transferor. In addition, the transferee will have a first element of cost that is equal to the adjustable value of the transferor just before the exchange. [Schedule 1, item 1, subsection 40-180(2), item 5 in the table]

Partnership assets

2.50 A partnership, rather than an individual partner, is the holder of a depreciating asset that is a partnership asset (see paragraphs 10 and 1.46). [Schedule 1, item 1, section 40-40, item 7 in the table]

2.51 In the simple case where a partnership buys a partnership asset from an entity other than a partner, the first element of its cost to the partnership is the amount the partnership paid. [Schedule 1, item 1, section 40-185]

2.52 However, partners may contribute assets that they own individually and often the partnership will not pay an amount to become the holder of the asset. In these circumstances, a special rule is required to attribute the first element of cost of that asset for the partnership.

2.53 Where an individual partner was the holder of the depreciating asset immediately before it became a partnership asset, the first element of cost for the partnership is the market value of the asset when it became the holder. The same rule applies where an asset becomes a partnership asset in more complex circumstances, for example, it is already a partnership asset and becomes a partnership asset of a differently constituted partnership. [Schedule 1, item 1, subsection 40-180(2), item 6 in the table]

Hire purchase agreements

2.54 The hold rules generally treat the economic owner as the holder of a depreciating asset, rather than the legal owner, where the economic owner uses that asset and has a right to become the legal owner of it (see paragraphs 10 to 1.46). [Schedule 1, item 1, section 40-40, items 5 and 6 in the table]

2.55 Hire purchase agreements are a particular example of this type of arrangement. For example, under a lease with option type hire purchase, a hirer will not be the legal owner of the asset until the option to purchase is exercised. However, the hirer will be the holder of the asset as long as they have the right to become the legal owner under the agreement. This right will end if the hirer does not become the legal owner by exercising that right under the agreement, and then the legal owner of the asset will become the holder. In this case, the first element of cost for the legal owner will be the market value of the asset when they become the holder. [Schedule 1, item 1, subsection 40-180(2), item 7 in the table]

Becoming the holder under a non-arms length arrangement

2.56 Under the current law there are a number of common rules that apply across the range of capital allowances. This Bill will collapse these separate capital allowances into a single system. The common rules can be incorporated directly into it.

2.57 Existing Common Rule 2 of Subdivision 41-B of the ITAA 1997 prevents a taxpayer from being able to claim a higher depreciation deduction based on an artificially inflated purchase price and is subsumed within the proposed cost rules.

2.58 The rule provides that where a taxpayer becomes the holder of a depreciating asset under an arrangement in which they:

•

did not deal at arms length with one or more of the other parties to that arrangement; and

•

paid (or are taken to have paid) more than the market value of the asset,

the first element of cost is the market value of the asset when they started to hold it. [Schedule 1, item 1, subsection 40-180(2), item 8 in the table]

2.59 Whether parties are dealing at arms length is an assessment of fact. It is necessary to look at the nature of the dealing between them to assess whether the cost that results from their dealing is what it would be as a result of real bargaining at arms length.

Example 2.12

Rod buys a car from his father Ned. They agree that Rod will pay $10,000 for the car, which has a market value of $5,000. On the facts of the case, Rod did not deal at arms length with Ned and the price is higher than market value. Rods first element of cost for the car is the market value of that car, $5,000 rather than the $10,000 he paid.

Becoming the holder under a private or domestic arrangement

2.60 Where a taxpayer begins to hold a depreciating asset under a private or domestic arrangement the first element of cost will be the market value of the asset, rather than any amount that the taxpayer has paid to hold it. [Schedule 1, item 1, subsection 40-180(2), item 9 in the table]

What does private and domestic mean?

2.61 Private is a word that can carry a number of shades of meaning. The meaning that it carries in the context of taxation laws is one that can be contrasted with income earning or commercial or business . A transaction of a private character is typically associated with the enjoyment or sharing of wealth in contrast to the creation or growth of wealth. In this context, private does not carry the shade of meaning that contrasts with public , being the meaning it bears in, for example, private property .

2.62 Domestic can be used to describe those things that are of, or pertaining to, the household. Its meaning is similar to, though less general than, private .

2.63 A typical example of a domestic or private arrangement is a gift. In this case the taxpayer may not have paid any consideration to become the holder of the asset. Nevertheless, in these cases the taxpayer will be entitled to deductions for the decline in value that is based on a first element of cost equal to the market value of the asset at the time the taxpayer started to hold it.

2.64 This rule will ensure that a depreciating asset given directly has the same result under depreciation as a gift of money that is used by the recipient to purchase the asset.

Example 2.13

Maude gives her son Todd a piano (a depreciating asset) for his birthday. This is a private arrangement. The piano has a market value of $8,000.

Todds first element of cost for the asset is therefore $8,000, notwithstanding that he has paid nothing to hold the asset. The result is the same as if Maude had given Todd a gift of money that he then used to buy the asset himself.

Leasing airports

2.65 A further special case is where depreciating assets are acquired pursuant to the Airports (Transitional) Act 1996 which forms the framework for the leasing of Federal airports by taxable entities.

2.66 That Act gives the Minister for Finance the power to determine the depreciable cost of assets acquired by a taxable entity in taking a lease of a Federal airport. In such a case, the first element of cost is the amount determined by the Minister. [Schedule 1, item 1, subsection 40-180(2), item 10 in the table]

Division 58 - plant previously owned by an exempt entity

2.67 Division 58 of the ITAA 1997 sets out the rules for calculating the decline in value and balancing adjustments in respect of depreciating assets owned by an exempt entity if the asset:

•

continues to be owned by that entity after the entity becomes taxable; or

•

is acquired from that entity, in connection with the acquisition of a business, by a purchaser that is a taxable entity.

2.68 The first element of cost of a depreciating asset to which Division 58 applies is the amount applicable under subsections 58-70(3) and (5). [Schedule 1, item 1, subsection 40-180(2), item 11 in the table]

Becoming the holder as the legal personal representative of a deceased

2.69 When a person holding a depreciating asset dies and the legal personal representative of the deceased becomes the holder, the first element of cost to the legal personal representative is the assets adjustable value to the deceased at the time of the death. This Bill codifies the previous administrative practice. [Schedule 1, item 1, subsection 40-180(2), item 12 in the table]

2.70 When a person holding a depreciating asset dies and the asset passes to a joint tenant or directly to the beneficiary (i.e. the asset does not pass through a legal personal representative) or the asset passes from a legal personal representative to the beneficiary, the first element of cost to the beneficiary or joint tenant is equal to the market value of the asset at the time of the deceaseds death. This amount is reduced by any capital gains that are disregarded as a result of the CGT rules dealing with death. [Schedule 1, item 1, subsection 40-180(2), item 13 in the table]

Second element of cost

2.71 The second element of a depreciating assets cost is essentially what was paid for economic benefits that contribute to its present condition and location from time to time. This is worked out at any time after the taxpayer began to hold the asset [Schedule 1, item 1, subsections 40-190(1) and (2)] . When taxpayers need to know the assets cost, they work out what it has cost them to that point to bring the asset to its current condition and location from time to time - that may include costs of bringing the asset to a condition or location which has since been changed.

What is an economic benefit?

2.72 An economic benefit is a thing of value that can be measured in money. However, the benefit does not need to be capable of being converted into money. Economic benefits can be assets, services or some combination of both. They are the things added or used up to bring the asset to its location or condition from time to time. Second element expenses need not increase the actual market value of a depreciating asset, but ordinarily will (because they will generally be improvements).

Example 2.14

Marie installs a machine that she owns into her factory. The labour and materials that are used in the installation are economic benefits that she has received. These are second element costs regardless of whether they increase the value of her asset. Indeed the market value of the asset may have fallen because she has fixed the asset to her own factory.

What is present condition and location?

2.73 An assets condition refers to its general form, state or order. This condition is represented by all of the economic benefits embodied in the asset. The second element of cost for depreciating assets includes all payments for economic benefits that are embodied in a depreciating asset (e.g. improvements but not repairs deductible under section 25-10 of the ITAA 1997 and refer also to paragraph 2.88).

2.74 The second element of cost will also include transportation costs that bring the asset to its present location (from time to time).

Example 2.15

David relocates his textile factory. At the same time, he pays to have his machinery overhauled in a way that will enhance the output.

The expenditure to overhaul and to relocate the machinery will be included in Davids second element of cost for the machinery as it contributes to the current condition and location of the assets.

What amounts are second element costs?

2.75 As with the first element (see paragraphs 20 to 2.70), the second element of the depreciating assets cost is either:

•

amounts a taxpayer has paid or is taken to have paid, or the value of non-cash benefits the taxpayer has provided or is taken to have provided [Schedule 1, item 1, subsection 40-190(2)] ; or

•

a specified amount in particular cases [Schedule 1, item 1, subsection 40-190(3)] .

Amounts a taxpayer has paid

2.76 Like the first element of cost, generally the second element of a depreciating asset simply consists of the amount a taxpayer has paid or is taken to have paid, or the non-cash benefits the taxpayer has provided or is taken to have provided (see paragraphs 20 to 2.30). This will be the case in all circumstances other than the special situations listed in paragraphs 20 to 2.78. [Schedule 1, item 1, subsection 40-190(2)]

Example 2.16

Martin has his car modified and improved. The materials and the labour involved are economic benefits that contribute to the present condition of the car. The payments he makes for those economic benefits would be included in the second element of the cars cost.

Specified amount in particular cases

Receiving benefits under a non-arms length arrangement

2.77 This parallels the first element of the cost rule discussed in paragraphs 20 to 2.59. It provides that where a taxpayer receives economic benefits that contribute to the present location and condition of a depreciating asset they hold, under an arrangement in which they:

•

did not deal at arms length with one or more of the other parties to that arrangement; and

•

paid (or are taken to have paid) more than the market value of the economic benefit,

the second element of cost is the market value of the benefit when they received it. [Schedule 1, item 1, subsection 40-190(3), item 1 in the table]

Receiving benefits under a private or domestic arrangement

2.78 This parallels the first element of cost rule discussed in paragraphs 20 to 2.64. Where a taxpayer receives economic benefits that contribute to the present condition and location of a depreciating asset under a private or domestic arrangement, the second element of cost will be the market value of the asset, rather than the amount that the taxpayer has paid to receive them. [Schedule 1, item 1, subsection 40-190(3), item 2 in the table]

Demolition costs

2.79 Demolition costs in respect of depreciating assets, other than buildings, will be second element costs only if the asset is partially demolished. Otherwise, such costs could be an expense of a balancing adjustment event and therefore reduce the assets termination value under section 40-315. Alternatively, such cost could be site preparation costs under sub-paragraph 40-840(2)(d)(ii) and therefore form part of the project pool concept that is discussed in Chapter 8.

Apportionment of cost

2.80 If a payment is for several things that include a depreciating asset, only a reasonable part of it is treated as being for the asset it covers [Schedule 1, item 1, section 40-195] . This apportionment applies to both first and second element costs.

2.81 What is reasonable will depend on the circumstances of each case. However, the market values of the various things for which the payment was made, will generally form the basis for a reasonable apportionment.

Example 2.17

Juanita pays $1,000 to both acquire a new desk and to upholster a chair she already owns. The $1,000 will be apportioned between:

•

the first element of cost of the desk; and

•

the second element of cost of the chair,

based on the relative market values of the desk and the economic benefits that contribute to the present condition and location of the chair (i.e. the labour and materials).

What is not part of cost

Pre-1 July 2001 depreciating assets (that are not plant)

2.82 The cost of a depreciating asset (other than plant) will not include any amount that was incurred either before 1 July 2001 or under a contract entered into before that time.

2.83 Any amounts incurred on plant before that time may form part of the cost of a depreciating asset. The transitional rules contained in a New Business Tax System (Capital Allowances - Transitional Provisions and Consequential Amendments) Bill 2001 explain how those expenses become the cost. [Schedule 1, item 1, section 40-200]

Double deductions - amounts deductible outside Division 40

2.84 Broadly, the cost of a depreciating asset will not include any amount that is the basis for which the taxpayer is entitled to a deduction elsewhere in the ITAA 1997. In other words, the cost of a depreciating asset (i.e. the basis for deductions generated for decline, that is, for depreciation) will not include any amount that is the basis for deductions granted elsewhere in the tax law. [Schedule 1, item 1, subsection 40-215(1)]

2.85 This will generally prevent taxpayers from being entitled to claim deductions under both Division 40 and other provisions of the tax law in respect of the same expenditure.

2.86 The kinds of amounts excluded are those that:

•

a taxpayer has deducted or is entitled to deduct outside of Division 40:

-

for instance, an amount deductible under section 8-1 of the ITAA 1997; and

-

form the basis of a calculation as to an amount a taxpayer has deducted or is entitled to deduct outside of Division 40.

Double deductions allowed in some circumstances

2.87 For special reasons, the rule against double deductions will not apply to the following provisions:

•

Section 73B of the ITAA 1936 which deals with R & D expenditure.

-

This ensures that, if the cost of plant was deductible as R & D expenditure, then the cost of plant for depreciation purposes does not have to be reduced for any R & D deductions. This is because the cost has already been reduced by the R & D expenditure.

•

Subdivisions B and BA of Division 3 of Part III of the ITAA 1936 that respectively deal with the development allowance and the general investment allowance.

-

This ensures that, if expenditure on plant is otherwise eligible for the development allowance or the general investment allowance, then that allowance is available in addition to depreciation.

•

Part XII of the ITAA 1936 that deals with the drought investment allowance.

-

This ensures that, if expenditure on plant is otherwise eligible for the drought investment allowance, then that allowance is available in addition to depreciation.

[Schedule 1, item 1, subsection 40-215(2)]

Example 2.18

Natalie buys machinery for $50 million that is eligible for the decline in value under Division 40 and also for the development allowance. She can claim a development allowance deduction of $5 million in the year it is first used and can also claim a decline in value of $50 million over the effective life of the machinery. This is because the intention of the development allowance is to provide a tax incentive in addition to the decline in value so that overall deductions of up to $55 million can be claimed even though the actual expenditure incurred was only $50 million.

Expenses not of a capital nature

2.88 The cost of a depreciating asset includes only those amounts that are of a capital nature. Any expenses that are of a revenue nature will be excluded from the cost of a depreciating asset. The cost of a depreciating asset that is obtained to be used for a taxable purpose is of a capital nature, even if a net gain or loss on realisation of the asset would be income or a deduction. [Schedule 1, item 1, section 40-220]

2.89 Broadly, revenue expenditure incurred in carrying on a business or in producing assessable income will be deductible under section 8-1 of the ITAA 1997and will therefore be excluded from the cost of a depreciating asset.

2.90 Revenue expenses that are not otherwise deductible under the tax law will nevertheless not be included in the cost of a depreciating asset.

Example 2.19

Phyllis holds a car that she uses for private purposes. She buys petrol and pays for annual registration and compulsory third party insurance in order to run her car. This is not a deductible expense to Phyllis. It could be argued, this expenditure is for an economic benefit that contributes to the assets present condition and location and would otherwise be included in the second element of cost. However, the expenditure is not capital or of a capital nature and so would be excluded from the assets cost.

Cost adjustments

Car limit

2.91 Where the cost of a car that is a depreciating asset is more than the car limit for the financial year in which the taxpayer started to hold it, then the first element of cost is reduced to the car limit for that financial year. [Schedule 1, item 1, subsection 40-230(1)]

2.92 The car limit for the 2000-2001 financial year is $55,134. This amount is indexed annually. Subdivision 960-M of the ITAA 1997 explains how this figure is indexed. [Schedule 1, item 1, subsection 40-230(3)]

Example 2.20

Martin acquires a car for $90,000. The first element of cost of the car to Martin is $90,000. This is then adjusted so that the final adjusted first element of cost is the car limit, $55,134 for the 2000-2001 financial year.

2.93 However, this adjustment does not apply to a car:

•

that was specially fitted out for transporting disabled people for profit:

-

for example, specially modified cars used as taxis for hire or by private hospitals; or

•

which has a first element of cost in excess of the limit only because of modifications made to enable an individual with a disability to use it for a taxable purpose:

-

for example, modifications made by a disabled person that allows them to drive a car in their business as a courier.

[Schedule 1, item 1, subsection 40-230(2)]

Acquiring a car at a discount

2.94 The first element of cost of a car must also be adjusted when a taxpayer acquires the car at a discount. The adjustment only applies to cars that are designed mainly for carrying passengers. This rule is an anti-avoidance provision designed to stop arrangements intended to overcome the effects of the car limit (see paragraphs 20 and 2.92).

2.95 The first element of cost of the car must be increased by the part of the discount (called the discount portion ) that relates to the disposal of another depreciating asset by the taxpayer or another entity for an amount less than the market value of that other asset when:

•

depreciation deductions were allowable to the taxpayer or another entity for the other asset for any income year; and

•

the sum of the cost of the car and the discount portion is more than the car depreciation limit in which the taxpayer first uses the car for any purpose, including non-deductible purposes.

[Schedule 1, item 1, subsections 40-225(1) and (2)]

2.96 The adjustment will be only so much of any discount that relates to the disposal of another asset by the taxpayer or another entity for below market value. Any discount arising for other reasons can be ignored for this adjustment.

2.97 The termination value of the other asset is similarly increased by the discount portion (see paragraph 3.69).

Example 2.21

Renee arranges to buy a $60,000 sedan from Greg, a car dealer, and at the same time trade in an old station wagon worth $20,000. The changeover price is therefore $40,000. Greg agrees to reduce the price of the sedan to $55,000 but only if Renee accepts $15,000 for the trade-in of the station wagon.

For Division 40 purposes the cost of the sedan to Renee is taken to be $60,000 and the amount to be deducted is limited to the car limit of $55,134 (for the 2000-2001 financial year). Similarly, the balancing adjustment on disposal of the station wagon is worked out on the basis of a termination value of $20,000.

2.98 This adjustment does not apply to a car that was specially fitted out for the use of disabled people (see paragraph 2.93). [Schedule 1, item 1, subsection 40-225(3)]