Senate

Explanatory Memorandum

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

Chapter 4 - Accelerated depreciation

Outline of Chapter

4.1 This Chapter explains amendments made to the income tax law that will remove accelerated write-off rates for plant for all taxpayers except small business taxpayers who satisfy certain qualifying conditions. [Schedule 3 to this Bill]

Context of Reform

4.2 Division 42 of the ITAA 1997 (depreciation of plant) currently permits a taxpayer to deduct depreciation at accelerated rates. The depreciation rate is calculated as a percentage based on the effective life of the asset. A 20% loading is added to these rates. The rates are then broadbanded into one of 6 common rates. The 20% loading on the effective life rate, together with the broadbanding, provide accelerated rates of deductions for depreciation.

4.3 In accordance with recommendations of the Review, the current arrangements for accelerated depreciation are being replaced with a system under which the depreciation rates for plant are determined only by reference to the plant's effective life.

4.4 Removing accelerated depreciation will:

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provide revenue to finance a significant reduction in the company tax rate;

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improve investment decision making by removing tax-induced distortions; and

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improve the structure and integrity of the tax law.

4.5 Accelerated depreciation rates will be maintained for small business taxpayers. This is an interim measure pending the introduction of a Simplified Tax System for these taxpayers with effect from 1 July 2001.

Summary of new law

4.6 The new law will remove accelerated depreciation rates for plant acquired after 11.45 am AEST on 21 September 1999. The rate for plant acquired after that time will be determined only by its effective life. The immediate deduction for plant costing less than $300 is to be retained.

4.7 Accelerated rates are to be retained for certain plant acquired by small business taxpayers after 11.45 am AEST on 21 September 1999. The intended use of the plant must be predominantly business related. However, the plant cannot be part of a major business expansion and cannot be used predominantly for leasing.

Comparison of key features of new law and current law

Detailed explanation of the new law

Removing accelerated depreciation

4.8 Subdivision 42-D of the ITAA 1997 currently contains the rules about depreciation rates. As mentioned in paragraph 4.2 the general rate is based on the effective life of the plant. The general rate is accelerated by a loading of 20%, and further accelerated by arrangements which broadband assets within 6 write-off rates.

4.9 Accelerated depreciation rates will not apply to plant:

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acquired under a contract;

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a taxpayer commenced to construct; or

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acquired in some other way,

after 11.45am AEST on 21 September 1999 (time of announcement). For that plant, depreciation rates will be based on effective life. [Item 2, subsection 42-118(1)] .

4.10 However, accelerated depreciation rates will continue to be available to small business taxpayers for plant acquired after that time, provided certain qualifying conditions are satisfied [item2, subsection 42-118(2)] . These conditions are discussed later at paragraphs 4.17 to 4.25.

4.11 The diminishing value and prime cost formula for working out depreciation deductions will be amended so that accelerated depreciation will not apply after the time of announcement. The new calculation formulae using depreciation rates based on effective life will apply thereafter. [Item 4, subsections 42-160(2) and(3), item 5, subsections 42-165(2) and (2A)] .

Other changes to depreciation provisions to take account of accelerated depreciation being removed

4.12 As a result of these changes, subsection 42-25(2) is removed because it refers to law providing for accelerated rates. [Item 1]

4.13 Despite the removal of accelerated depreciation, items of plant that cost $300 or less will continue to be available for immediate write-off under Division42. [Item 6, section42-167]

4.14 Section 42-130, which currently deals with immediate write-off for items of plant that cost $300 or less has been removed because of section 42-167. [Item 3]

4.15 Amendments are made to section 42-175 to ensure that undeducted cost is calculated correctly for plant. In calculating that amount the current law requires a taxpayer to subtract from a plant's cost not only the actual deductions taken, but also any further amounts that were not available because of some disqualifying event, such as private usage. The current law works out these non-deductible amounts by applying the rate first used by a taxpayer to obtain an actual deduction. For plant acquired after the time of announcement the depreciation calculation provisions refer to a calculation formula rather than a rate. The amendments to section 42-175 ensure that the same result is achieved regardless of the acquisition time. [Item 7]

4.16 Where balancing adjustment roll-over relief is available for plant acquired at or before the time of announcement, the transferee is taken to have acquired the plant before that time [item 8, subsection 42-280(6)] . This ensures the transferee is not affected by the removal of accelerated rates of depreciation.

Maintaining accelerated depreciation for small business taxpayers

4.17 A new Subdivision is inserted to set out the 3 conditions that must be met in order to retain access to accelerated depreciation rates. [Item 9, Subdivision 42-K]

Condition 1: Owner or quasi-owner must be a small business taxpayer

4.18 The first condition requires the owner or quasi-owner of the plant to be a small business taxpayer in the income year in which the plant is first used or installed ready for use. [Item 9, subsection 42-345(1), item 1 of the table]

4.19 Broadly, a taxpayer will qualify as a small business taxpayer for an income year if they carry on a business and their average turnover from that business is less than $1 million in that income year refer to Chapter 3 of this Explanatory Memorandum.

Condition 2: 50% of the plant's intended use must be in an assessable income producing business

4.20 The second condition is that at least 50% of the intended use of the plant must be in carrying on a business for the purposes of producing assessable income [item 9, subsection 42-345(1), item 2 of the table] . The intended use of an item of plant could be demonstrated by the actual use it was put to during the period from the time it was first used until the end of the income year in which it was first used.

Example 4.1

Assume a person is receiving salary and wages as an employee as well as operating a small business outside employment hours. The person acquires a new computer which is partly for use in the small business and partly for use in the person's employment. In this case, the computer would only be eligible for accelerated depreciation if the computer was used at least 50% in the business.

4.21 For the purposes of this condition, a partner in a partnership will not be carrying on a business in relation to that partnership unless the partner is connected with the partnership as explained in paragraph 3.27. [Item 9, subsection 42-345(5)]

Condition 3: Reasonable expectation of maintaining small business status and plant not used for leasing

4.22 The third condition is that, at the time the plant is first used or installed ready for use, neither of the following applies:

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it could be reasonably expected that because of the plant's use, whether or not in connection with another asset, the taxpayer would not be a small business taxpayer within 3 years of the end of the income year in which that time occurred; or

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the plant is being, or is intended to be predominantly used for leasing as a 'plant lease'.

[Item 9, subsection 42-345(1), item 3 of the table]

4.23 This condition ensures that accelerated depreciation for an item of plant will not be available to a small business taxpayer if:

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that item is part of the start-up of a major business or major expansion of an existing business; or

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that item is to be used predominantly for leasing.

4.24 A plant lease covers an agreement which grants the right to use an asset. However, it does not include a hire purchase agreement or a short-term hire agreement [item 9, subsection 42-345(2)] . A reference to this definition is inserted into the dictionary in section 995-1 of the ITAA 1997 [Schedule 6, item 4] .

4.25 A short - term hire agreement is an agreement for the intermittent use of an asset, but excludes arrangements which involve a series of agreements which taken together would amount to the lease being over a period longer than a short-term basis [item 9, subsections 42 - 345(2) to(4)] . A reference to this provision is inserted into the dictionary in section 995-1 of the ITAA 1997 [Schedule 6, item 5] .

Application and transitional provisions

4.26 The changes made by Schedule 3 apply to plant:

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acquired under a contract;

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commenced to be constructed by a taxpayer; or

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acquired in some other way,

after 11.45 am AEST on 21 September 1999 [item 14] . The changes apply to owners as well as quasi-owners.

Consequential amendments

4.27 Consequential amendments are made to both the ITAA 1936 and the ITAA 1997 so that references are made to section 42-167, which will deal with the immediate write-off of plant that cost less than $300 [items 10 to 13] . Section 42-167 replaces existing section 42-130, which this Bill proposes to remove (refer to paragraphs 4.13 and 4.14).