Senate

Explanatory Memorandum

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

Chapter 1 - Full balancing adjustments on disposal of plant

Outline of Chapter

1.1 This Chapter explains amendments that will exempt any gains or losses on the disposal of plant from the CGT provisions and will instead treat those amounts as an additional form of balancing adjustment under Division 42 of the ITAA 1997. This change will apply to balancing adjustment events for plant which occur after 11.45 am AEST on 21September 1999 (time of announcement). [Schedule 1 to this Bill]

Context of Reform

1.2 Division 42 of the ITAA 1997 (depreciation of plant) currently requires the disposal of plant to be accounted for by way of a balancing adjustment. This can result in an amount being included in assessable income or a further deduction being available. Subject to rules about double taxation, there can also be CGT implications resulting in a further amount being included in assessable income or a further capital loss being allowed.

1.3 Both the depreciation and the CGT provisions require separate records to be kept for calculating any gain or loss upon the disposal of plant. Removing plant from the CGT provisions will both simplify the law and reduce compliance costs for taxpayers.

Summary of new law

1.4 For disposals of plant after the time of announcement, the new law will exempt any capital gains and losses from the CGT provisions and will instead treat those amounts as an additional balancing adjustment under the depreciation provisions contained in Division 42 of the ITAA 1997.

1.5 Where plant purchased before the time of announcement is disposed of for more than its cost, the benefit that would have been available by way of indexation had the amount continued to be assessable as a capital gain will be retained. This will reduce the assessable amount calculated under the balancing adjustment provisions.

Comparison of key features of new law and current law

Detailed explanation of new law

Including an additional amount in assessable income on disposal of plant

1.6 This Bill includes in assessable income the excess of a plant's termination value (effectively, its sale proceeds) over its cost. For plant purchased before the time of announcement, the benefit of indexing its cost base is to be preserved. In those cases the excess will be limited to the difference between the termination value over the cost base (for CGT purposes) indexed until 30 September 1999 .(Indexation is not available for plant purchased after the time of the announcement). [Item 10, section 42-192]

1.7 An example of how section 42-192 will operate is as follows:

Example 1.1

Suppose you acquired an item of plant in 1996. The plant's cost was $10,000 and its termination value in 2000 is $12,000. At the time of disposal the plant's written down value was $4,000 and the indexed cost base as at 30/9/99 was $11,000.

The amount included as assessable income under subsection 42-192(1) is $2,000 that is, the amount by which the termination value ($12,000) exceeds the sum of the plant's written down value ($4,000) and balancing adjustment ($6,000). Under subsection 42-192(2), the $2,000 is reduced by $1,000 which is the difference between the plant's cost base ($11,000) and the sum of the plant's written down value ($4,000) and balancing adjustment ($6,000).

Therefore, the net amount included under section 42-192 is $1,000 ($2,000 $1,000).

1.8 As this assessable amount is to be treated as a balancing adjustment amount, it will be available for amended balancing adjustment relief under Subdivision 42-H of the ITAA 1997, details of which are contained in Chapter 2 of this Explanatory Memorandum.

Allowing an additional deduction on disposal of plant

1.9 A further balancing adjustment deduction will be allowed where an item of plant's undeducted cost is less than the reduced cost base. The deduction will equal the difference between the 2amounts. Circumstances where this situation could arise are considered to be rare but nevertheless the existing CGT treatment is being preserved. [Item 11, section 42-197]

Application of additional balancing adjustments where no depreciation has been claimed or where there is an incomplete unit of plant

1.10 New Subdivision 42-GA is inserted into Division 42 to calculate an additional balancing adjustment where no depreciation deductions have been claimed or where there is a disposal of an incomplete item of plant.

1.11 This additional balancing calculation could arise where an item of plant is completed and disposed of before it is used in the income producing process. It could arise where the plant is destroyed before completion.

1.12 The additional balancing adjustment calculation must be made in the year in which the balancing adjustment event occurs. [Item 12, section 42-222]

1.13 The amount to be included in assessable income under this Subdivision will be the excess of a plant's termination value (effectively, its sale proceeds) over its cost. For plant purchased before 11.45 am on 21September 1999, the benefit of cost base indexation is to be preserved. The inclusion of this amount ensures the existing CGT treatment is preserved. [Item 12, section 42-223]

1.14 A deduction will be allowed under this Subdivision where the plant's termination value is less than the reduced cost base. The deduction will equal the difference between the 2amounts. This deduction equates to any capital loss that would have arisen under the CGT provisions ensuring that the existing CGT treatment is being preserved. [Item 12, section 42-224]

1.15 Because of the insertion of new Subdivision 42-GA, section 42-30 is amended to include the additional balancing adjustment made under new Subdivision 42-GA. [Items 6 and 7]

Circumstances where the new balancing adjustment provisions do not apply

1.16 Some items of plant will be excluded from the new balancing adjustment provisions. The exceptions cover cars, collectables, personal use assets, plant used to produce exempt income and plant acquired before 20 September 1985. As any capital gain or loss arising upon their disposal is disregarded in calculating net capital gains, they are likewise to be excluded from these balancing adjustment provisions. [Item 11, subsections 42-198(1) and (2)]

1.17 The new balancing adjustment provisions will also not apply to any profit made on plant as a result of a balancing adjustment event that is assessable under another provision of the ITAA 1997. For example, if the profit is assessable under section 6-5 then it is not included under Division 42. [Item 11, subsection 42-198(3)]

New balancing adjustment provisions where pooling is used

1.18 New balancing adjustment provisions are included for those taxpayers who use the pooling provisions contained in Subdivision 42-L. The balancing adjustment amount will equate with the capital gain that would previously have been calculated for that plant. [Item 13, subsections 42-390(2A) and (2B)]

Cutting off the operation of CGT

1.19 Any capital gain or loss arising upon the disposal of plant after 11.45 am AEST on 21 September 1999 is to be disregarded for CGT purposes [item 14] . Even though the capital gain or loss will be disregarded, the other CGT provisions for plant will continue to apply. For example, balancing adjustment relief under Common rule 1 in Subdivision 41-A of the ITAA 1997 can continue to apply where the appropriate CGT roll-over is applicable.

Changes to recognise new balancing adjustment provisions

1.20 This Bill makes changes to other depreciation provisions of the ITAA 1997to recognise the introduction of the additional balancing adjustment provisions. [Items 1 to 5, 8 and 9]

Application and transitional provisions

1.21 The amendments that disregard any capital gain or loss on disposal of plant (refer to paragraph 1.13) apply to:

•

a CGT event that happens after 11.45 am AEST on 21September 1999 [subitem 15(2)] ; or

•

disposal of a CGT asset (CGT event A1) that happens at or before 11.45 am AEST on 21 September 1999 where a contract was entered into when the event happened, but the change of ownership occurred after that time [subitem 15(3)] .

1.22 Disregarding the gain or loss on the post-announcement disposal of a CGT asset under a pre-announcement contract ensures an amount cannot be assessed under both the new balancing adjustment provisions and the CGT provisions.

1.23 The other amendments in this Schedule apply to a balancing adjustment event (such as the disposal of plant) that happens after 11.45am AEST on 21September 1999. [Subitem 15(1)]