Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Chapter 1 Depreciation Amendments
Clauses: 7,8,9,10,11,18,22 and 66
Provide higher rates of depreciation for depreciable property with effective lives of five or more years.
Simplify the calculation of most depreciation rates once effective life is known.
Depreciation Amendments
Summary of the proposed amendments
1.1. This Bill amends the income tax law to provide higher rates of depreciation for plant and equipment with effective lives of five or more years. It does this by providing new bands of depreciation rates applying to most items.
1.2. Taxpayers also benefit from a clearer statement of the depreciation rates available for plant or articles with effective lives of less than 5 years.
1.3. The amendments apply to items acquired or constructed after 26 February 1992.
Background to the legislation
1.4. Depreciation writes off the capital cost of plant and articles for use to produce assessable income. This background section describes how depreciation operated before the changes the legislation makes.
1.5. Taxpayers use the diminishing value method to calculate annual deductions for depreciation, unless they elect to use the prime cost method for items first depreciated in a particular year.
1.6. Under the diminishing value method, deductions are a percentage of depreciated value, which is the cost less deductions already allowed. Under the prime cost method, deductions are a percentage of the original cost.
1.7. Because prime cost rates are lower than diminishing value rates, prime cost gives lower initial deductions, but diminishing value gives deductions that reduce as the cost of the items is written off.
1.8. Rates of depreciation reduce as the effective life of property increases. Broadly, the effective life of an item is the period that it is capable of being used for income-producing purposes. Since 1 July 1991, taxpayers have had the option of either making an estimate of the effective lives of their depreciable items taking into account their particular circumstances of use or adopting the Commissioner of Taxation's published determination of effective lives.
1.9. If the cost of the property is less than $300 or the effective life is less than three years, the depreciation rate is 100%. So the cost is fully deductible when the item is first used for producing assessable income, or installed ready for use and held in reserve.
1.10. For most other property, the depreciation rate is calculated as a percentage based directly on effective life, broadbanded upward into one of seven broadbanded rates, and then increased by a loading of 20%. The rate is increased by a further 50% if the diminishing value method is adopted, because deductions under that method decline as the cost of the property is written off.
1.11. The depreciation rates for most property (ie. where both broadbanding and loading apply) are demonstrated by the following table:
| Years in effective life | Prime cost | Diminishing value |
|---|---|---|
| 3 to less than 5 | 40% | 60% |
| 5 to less than 6 2/3 | 24% | 36% |
| 6 2/3 to less than 10 | 18% | 27% |
| 10 to less than 13 1/3 | 12% | 18% |
| 13 1/3 to less than 20 | 9% | 13.5% |
| 20 to less than 40 | 6% | 9% |
| 40 or more | 3% | 4.5% |
1.12. These rates have been suggested as too low to encourage expenditure on items with lives of more than five, and certainly more than ten, years.
1.13. The following are exceptions:
- •
- "employee amenities" and "scientific research" plant are depreciable at 33 1/3% under the prime cost method and 50% under the diminishing value method, whatever their actual effective life;
- •
- passenger motor vehicles and derivatives, motor cycles, and other vehicles designed to carry less than either 1 tonne or nine people are not eligible for the 20% loading, eg. the prime cost rate for a motor vehicle with an effective life of 7 years would be 15% (22.5% diminishing value); and
- •
- "works of art" are not eligible for broadbanding but are entitled to the 20% loading, eg. a painting with an effective life of 100 years would have a prime cost rate of 1.2% and a diminishing value rate of 1.8%.
Explanation of the proposed amendments
1.14. The immediate deductibility for plant either costing less than $300 or with an effective life of 3 years remains unchanged [New subsection 55(2)] . However, a new six rate schedule is to replace the existing 7 broadbanded rates for plant with effective lives of 3 years or longer [New subsection 55(5)] . The schedule increases depreciation rates items with effective lives of 5 years or longer.
1.15. The new schedule absorbs the 20% loading and is expressed as diminishing value method rates. Prime cost rates are 2/3rds of the diminishing value rates, rounded to the nearest whole number [New paragraph 56(1)(b)] .
1.16. This simplifies the ascertainment of the depreciation rate for any particular item. Once the effective life is known for items covered by the schedule, this immediately decides the depreciation rate to be used by taxpayers who have not elected to use the prime cost method. This reduces the number of steps in any calculation.
1.17. The following table summarises the new rates:
| Years in effective life | Annual depreciation percentage | Diminishing value | Prime cost | ||
|---|---|---|---|---|---|
| 3 to less than 5 | 60% | 40% | |||
| 5 to less than 6 2/3 | 40% | 27% | |||
| 6 2/3 to less than 10 | 30% | 20% | |||
| 10 to less than 13 | 25% | 17% | |||
| 13 to less than 30 | 20% | 13% | |||
| More than 30 | 10% | 7% | |||
1.18. Consistent with the pre-27 February 1992 rates regime, the following exceptions are to apply:
Employee amenities and scientific research plant
1.19. "Employee amenities" and "scientific research plant" are depreciable at a minimum of 50% (diminishing value) or 33% (prime cost) [New subsections 55(3) & (4)] . Higher rates will apply where the cost is either less than $300 or effective life is less than 5 years, as the general depreciation rules, being more generous, would then apply. The previous law does not allow for higher rates if effective life was between 3 and 5 years.
1.20. Rates for passenger motor vehicles and derivatives, motor cycles, and other vehicles designed to carry less than either 1 tonne or nine people will be based on the pre-27 February 1992 rates regime [New subsection 55(6)] . The schedule of rates for these vehicles is as follows:
| Years in effective life | Annual depreciation percentage | Diminishing value | Prime cost | ||
|---|---|---|---|---|---|
| 3 to less than 5 | 50% | 33% | |||
| 5 to less than 6 2/3 | 30% | 20% | |||
| 6 2/3 to less than 10 | 22.5% | 15% | |||
| 10 to less than 13 | 15% | 10% | |||
| 13 to less than 20 | 11.25% | 8% | |||
| 20 to less than 40 | 7.5% | 5% | |||
| 40 or more | 3.75% | 3% | |||
1.21. Most vehicles of this sort will have effective lives less than ten years. For some vehicles, effective lives may be much less.
1.22. The pre-27 February 1992 rates regime will also continue to apply to "works of art" [New subsection 55(7)] . The annual depreciation percentage is calculated by dividing effective life into 1.8 and multiplying the result by 100. For example, a painting with an effective life of 100 years would have a depreciation rate of 1.8% (diminishing value) or 1% prime cost (rounding to the nearest whole number).
1.23. The new rate schedule represents the maximum rate at which depreciable property may be written-off - lower rates can be adopted at taxpayers' discretion [New subsection 55(8)] .
Commencement date
1.24. The amendments apply to depreciable property (whether new or not) either:
- •
- acquired under a contract entered into after 26 February 1992; or
- •
- constructed by the taxpayer and commenced to be constructed after 26 February 1992.
1.25. In some circumstances, a contract entered into after 26 February 1992 will be taken to have been entered into earlier.
Subclause 66(1) defines: amended Act, associate, post-26 February 1992 property, pre-27 February 1992 property, and use (relevant for the "modification of acquisition contract date" rules).
Subclause 66(2) extends the meaning of associate to taxpayers that section 59AA treats as having disposed of or acquired property as the result of a partial change in the ownership of that property.
Subclause 66(3) treats certain contracts entered into after 26 February 1992 as entered into before 27 February 1992. That will occur if the taxpayers using the property both before and after the change in ownership are the same taxpayers or associates of each other, and the taxpayer owning the property immediately before the change in ownership had acquired it under a pre-27 February 1992 contract, or constructed it, with construction commencing before 27 February 1992.
"Associate" is based on the definition contained in existing subsection 26AAB(14) of the Income Tax Assessment Act. This includes relatives, partners and their spouses and children, and certain companies and trusts [Subclause 66(1)] . However, its meaning is extended to include persons who owned property immediately before and after a partial change in ownership of property, eg. the members of both a partnership and its reconstituted successor [Subclause 66(2)].
The effect of that "Modification of Acquisition Contract Date" rule on property is that depreciation rates will be calculated under the pre-27 February 1992 rates regime.
The following are examples of when that rule will apply:
- •
- after 26 February 1992, a taxpayers sells and leases back pre-27 February 1992 property;
- •
- a lessee of pre-27 February 1992 property acquires it after 26 February 1992;
- •
- after 26 February 1992, pre-27 February 1992 property is transferred where there is no real change in its ownership. This includes transfers of property to wholly-owned companies, trusts, or within commonly-owned or wholly-owned company groups;
- •
- disposals of pre-27 February 1992 property that are taken to occur after 26 February 1992 as the result of partial changes in ownership of the property, eg. the reconstitution of a partnership on the retirement or entry of partners;
- •
- after 26 February 1992, relatives transfer pre-27 February 1992 property to one another. This includes such transfers as the transfer of a family business from parents to their children.
Subclause 66(4) specifies that the amendments are to apply to post-26 February 1992 property, ie. property either:
- •
- acquired under a contract entered into after 26 February 1992; or
- •
- constructed by the taxpayer and commenced to be constructed after 26 February 1992.
Subclause 66(5) is a measure to ensure that existing provisions will continue to apply to pre-27 February 1992 property despite their repeal or amendment by these amendments.
Subclause 66(6) specifies that if depreciation balancing adjustment rollover relief under section 58 applies to a disposal of pre-27 February 1992 property by a transferor to a transferee, that property will treated as pre-27 February 1992 property in the hands of the transferee. This means that the existing rates regime, and not the new rates regime, will apply to the property. This is consistent with the general rule under balancing adjustment rollover relief that the transferor and transferee be treated as if a single taxpayer.
Subclause 66(7) proscribes pooling of pre-27 February 1992 property and post-26 February 1992 property in the same pool. It is a measure to avoid complex rules needed if such pooling was to be permitted. It should have limited impact as there is little correspondence between post-26 February 1992 rates and pre-27 February 1992 rates. A precondition for pooling is that all property in a pool has the same rate of depreciation.
Clauses involved in the proposed amendments
Clause 7: Repeals existing section 55 and inserts new section 55 which contains the steps for calculating annual depreciation percentages in respect of post-26 February 1992 plant [refer paragraph xx above].
Clause 8: Amends subsection 56(1) reflecting the change from a system which expresses annual depreciation percentages as prime cost rates to one which expresses them as diminishing value rates.
Formerly, diminishing value rates were one and one-half times annual depreciation percentages. Now that annual depreciation percentages are expressed as diminishing value rates, prime cost rates will be two thirds of annual depreciation percentages, rounded off to the nearest whole number.
Clause 9: Amends paragraph 57AK(5)(a) so that the operation of section 57AK [which deals with pre-1 July 1992 basic iron and steel property] is not affected by the replacement of existing section 55 by the new section 55.
Concessional rates of depreciation are available in respect of plant used primarily and principally in the production of basic iron and steel products. The concession applies to plant acquired under a contract entered into after 18 August 1981 and before 20 July 1982. It also applies to plant constructed by a taxpayer where construction commenced within that period. A further condition is that the plant be either used or installed ready for use and held in reserve before 1 July 1992.
The concessional rates are determined by reference to the rates that would have otherwise applied under existing section 55, which is to be repealed. The amendment ensures that the reference in paragraph 57AK(5)(a) to section 55 is to section 55 as it stood before these changes and not new section 55.
Clause 10: Makes a minor consequential amendment to section 58 [which deals with depreciation balancing adjustment rollover relief] to change a reference in paragraph 58(4)(d) to step 2A [dealing with scientific research plant] in existing section 55 to the corresponding step 2 in new section 55.
The concession for scientific research plant is due to terminate on 30 June 1995. The purpose of paragraph 58(4)(d) is to ensure that transferees of eligible plant after that date will be able to continue with the concession if they qualify for rollover relief and continue the use of the plant in scientific research.
Clause 11: Removes the 1.5 multiplier from the subsection 62AAP(1) formula for calculating pool depreciation. The purpose of the multiplier is to convert prime cost rates calculated under existing section 55 into diminishing value rates needed for calculating pool depreciation. Depreciation rates calculated under proposed new section 55 are diminishing value rates and the multiplier is no longer necessary.
Clause 18: Makes a minor consequential amendment to paragraph 82AB(5B)(b) [investment allowance] reflecting an earlier repeal of section 57AG [depreciation loading]. The amendment has little practical effect as these investment allowance provisions are broadly redundant.
Clause 22: Make a minor consequential amendment to subparagraph 159GF(1)(a)(iii) (arrangements relating to property) reflecting an earlier repeal of section 57AG (depreciation loading). The amendment ensures that a reference in that subparagraph to section 57AG is a reference to that section as if it had not been replaced.
Clause 66: Contains the application provisions.