Senate

Revised Explanatory Memorandum

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

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Uniform capital allowance system

There are currently over 37 separate capital allowance regimes in the income tax law that are not consistent. The Capital Allowances Bill proposes to remedy this by introducing a uniform capital allowance system that will offer significant simplification benefits as well as improve neutrality. The uniform capital allowance system is based on the following principles:

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a set of general rules to calculate the deduction for the notional decline in value of most depreciating assets;

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a pooling mechanism under which some expenditures are pooled and given deductions for the decline in the pool; and

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deductions, immediate or over a period of time, for certain capital expenditure used in the primary production and the mining industries.

Certain types of depreciating assets are to be excluded from the uniform capital allowance system. These are assets that are:

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used in R&D activities;

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associated with investments in Australian films;

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capital works under Division 43 of the ITAA 1997;

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associated with certain IRUs; and

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cars where the deductions on these cars have been substantiated using certain methods.

Transitional and consequential amendments

The New Business Tax System (Capital Allowances - Transitional and Consequential) Bill 2001 will ensure that assets and expenditures subject to the current law move into the uniform capital allowance system smoothly. This is required as existing regimes may use differing terms and concepts. Further, various provisions of the income tax law as well as other Commonwealth legislation require amending so as to align the terminology used in the generalised regime with that used in these Acts.

Date of effect : 1 July 2001 for the uniform capital allowance system. In relation to the transitional and consequential amendments, they generally apply from 1 July 2001. Proposal announced : The proposal was announced in Treasurers Press Release No. 58 of 21 September 1999 and No. 74 of 11 November 1999. In particular, refer to Attachment L of Treasurers Press Release No. 74.

Financial impact : These Bills are based on the recommendations of the Review of Business Taxation. Section 24 of A Tax System Redesigned provides a comprehensive assessment of the revenue impact of all measures recommended by the Review of Business Taxation. However, because some recommendations have already been adopted, for example the removal of accelerated depreciation, while other recommendations in relation to capital allowances have not been included in these Bills, the financial impact cannot be accurately ascertained.

Compliance cost impact : Because the uniform capital allowance system is based on interdependent topics, the compliance costs for these Bills have been considered collectively. The compliance costs for businesses affected by the uniform capital allowance system are expected to be reduced due to:

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a uniform treatment of depreciation for capital items rather than the current taxation treatments. This will lead to a reduction in record keeping and administration expenses; and

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recurrent savings over the life of the system relative to the previous system due to simplification.

However, these compliance cost savings may be offset initially by:

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training and education costs associated with taxpayers and agents gaining an understanding of the new legislation; and

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expenses associated with updating record keeping systems.

Summary of regulation impact statement

Regulation impact on business

Impact : Low.

Main points :

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The uniform capital allowance system will collapse at least 27 of the capital allowance regimes that currently exist in the income tax law into a single system that generates deductions based on the effective life of assets.

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A taxpayer who incurs the loss in value of a depreciating asset will be entitled to deduct their cost of the asset. This may not be the legal owner of the asset.

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Taxpayers can choose to use the Commissioners effective life schedule or self-assess the effective life of their assets. Further, they can recalculate the effective life of the asset if the circumstances surrounding the use of the asset change.

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Project development costs will be eligible for depreciation through pooling arrangements.

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Some blackhole expenditure including the costs of establishing an entity and all forms of capital raising expenses can be written-off over a 5-year period.

Chapter 1 - Capital allowances - core rules

Outline of chapter

1.1 This chapter explains amendments made in Schedule 1 to this Bill. The amendments implement the Governments decision to introduce a uniform capital allowance system. This system will consolidate within a single Division of the ITAA 1997 (Division 40) most of the different capital allowances of the current law. This Division will allow taxpayers deductions for the decline in value of a depreciating asset over that assets effective life.

1.2 This chapter also explains amendments that will allow taxpayers deductions as they write off certain other capital expenditure that does not attract a deduction under the current law.

Context of reform

1.3 The introduction of the uniform capital allowance system for depreciating assets and its general application, giving deductions for some previously non-deductible capital expenditure, are key components of the New Business Tax System announced in Treasurers Press Release No. 74 of 11 November 1999 (refer to Attachment L).

1.4 The uniform capital allowance system will offer significant simplification benefits, because it is based on a common set of principles. The existing capital allowance regimes are complex, inconsistent and involve significant replication of parallel but not identical provisions and concepts in the current law. Consolidation of these regimes will overcome these deficiencies. It will also provide a more neutral tax treatment for capital expenditure on depreciating assets and therefore should improve the quality of investment and economic efficiency.

Summary of new law

1.5 The following summarises the key elements of the uniform capital allowance system that is to be included in Division 40.

Comparison of key features of new law and current law

1.6 The following table sets out the important differences between the various capital allowances in the existing law and the basic rules in Subdivision 40-B. Some of the key features of the new law are subject to exceptions and details as explained under later headings.

Detailed explanation of new law

Deducting amounts for depreciating assets

1.7 Subdivision 40-B contains the core provisions for working out the deduction for the decline in value of most depreciating assets. The rules are based on similar principles to those used in calculating depreciation deductions for plant currently allowed under Division 42 of the ITAA 1997. The calculation process has been restructured to deal better with those further costs of a depreciating asset that can arise after taxpayers begin to hold the asset, and to make other improvements to the process.

1.8 The core provisions will not apply to depreciating assets which are water facilities, horticultural plants or grapevines, or to depreciating assets used in landcare operations. Subdivisions 40-F and 40-G maintain the concessional write-off rules provided under the existing law for these depreciating assets used in primary production activities (see Chapters 5 and 6). [Schedule 1, item 1, subsection 40-50(1)]

1.9 A taxpayer will be entitled to a deduction for the decline in value of a depreciating asset that they hold in an income year. This decline in value is a statutory decline; it does not depend on a measure of actual decline in market value in the income year. [Schedule 1, item 1, subsection 40-25(1)]

1.10 The deduction allowable for the amount of a depreciating assets decline in value is reduced where the asset was used for a private or domestic purpose, or to produce exempt income. The adjustment ensures that the amount deducted reflects the extent to which the depreciating asset was used for a taxable purpose, that is for producing assessable income, for exploration or prospecting, or for mining site rehabilitation or for environmental protection activities (essentially, pollution control and waste management). [Schedule 1, item 1, subsections 40-25(2) and (7)]

1.11 The deduction may be further reduced if the depreciating asset is a boat or a leisure facility. Broadly, the deduction for the decline in value of a boat or leisure facility will be further reduced to the extent that the asset is not integral to the taxpayers income producing activities, although used or installed ready for use for a taxable purpose. For example, the deduction will be further reduced if it is not held as trading stock or its use did not give rise to a fringe benefit. [Schedule 1, item 1, subsections 40-25(3) and (4)]

1.12 The general and further reduction rules do not apply to:

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depreciating assets allocated to a low-value pool (the amount allocated to the pool is reduced instead); and

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cars whose expenses have been substantiated using the one-third of actual expenses method (the deduction is reduced to one third of the decline instead).

[Schedule 1, item 1, subsections 40-25(5) and (6)]

What is a depreciating asset?

1.13 A depreciating asset is broadly defined in subsection 40-30(1) as being an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. The fact that an asset is not being used does not mean it does not satisfy this definition. Rather it will satisfy the definition if the asset can reasonably be expected to decline in value had it been used. This definition captures the meaning of plant (such as machinery) under the current Division 42 of the ITAA 1997 as well as other assets that are wasting in nature.

1.14 This does not limit depreciating assets to things that lose value steadily over their effective lives. Nor are depreciating assets limited to things that only ever decline in value. Depreciating assets may hold their value for a time, or even increase it for a time. The test of a depreciating asset requires only that the asset lose its value overall (or down to no more than scrap value) by the end of its effective life. From that effective life, the statutory methods produce a statutory decline from time to time, which is not required to be correlated to an expected decline in market value with the same timing. The balancing adjustment rules bring the adjustable value, that is the cost as declined by statute from time to time, back into line with value when a balancing adjustment event occurs - essentially when a taxpayer stops holding the asset.

1.15 Taxpayers will be required to exercise judgement in identifying the depreciating asset where the asset itself is made up of different parts and components. In doing this, the functionality test that is used as a basis of identifying a unit of plant in the existing plant depreciation rules can be used. (Specific reference to a unit or an item is not necessary to attract the test, as the definition of a depreciating asset is based on a life in effective use, and the depreciating asset must be identifiable as having its own life in such use.) [Schedule 1, item 1, subsection 40-30(4)]

1.16 Land is excluded from the definition of depreciating asset as it is not generally considered to have a limited effective life [Schedule 1, item 1, paragraph 40-30(1)(a)] . However improvements to land or fixtures on land may still qualify as depreciating assets. For the purposes of Division 40, these improvements or fixtures are treated as separate assets, not as part of the land, regardless of whether they can be removed from the land or are permanently attached [Schedule 1, item 1, subsection 40-30(3)] . This ensures that all the specific inclusions in the definition of plant under the current section 42-18 of the ITAA 1997 are depreciating assets, so those inclusions are not replicated in the new provisions.

1.17 Other assets that are specifically excluded from the definition of depreciating asset are items of trading stock and any intangible assets not specifically included [Schedule 1, item 1, paragraphs 40-30(1)(b) and (c)] . However, the following types of intangible assets will be depreciating assets to the extent they are not trading stock:

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mining, quarrying or prospecting rights;

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mining, quarrying or prospecting information;

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in-house software;

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items of intellectual property - for example, patents;

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an IRU;

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spectrum licences; and

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datacasting transmitter licences.

The inclusion of these intangible assets maintains a capital allowance deduction like the write-off they receive under the existing law and includes the new write-off for datacasting transmitter licences, announced by the Government since it publicly exposed a version of this Bill. [Schedule 1, item 1, subsection 40-30(2)]

1.18 With the exception of in-house software and datacasting transmitter licences, these intangibles retain their current tax law definitions. In relation to in-house software, Division 46 of the ITAA 1997 contained a definition of expenditure on software and treated units of software on which you incur expenditure as if they were units of plant that you own. The treatment of in-house software in this Bill does not however, represent an in-substance change in the way in which software is treated. Previously software on which you incur expenditure was treated as if it were plant and now in-house software that satisfies the definition is a depreciating asset. In relation to datacasting transmitter licences, a new definition has been inserted into subsection 995-1(1) of the ITAA 1997.

Depreciating assets excluded from Division 40

1.19 Certain types of depreciating assets are specifically excluded from the uniform capital allowance system. These are:

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certain depreciating assets used in R&D activities;

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depreciating assets associated with investments in Australian films;

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depreciating assets that are capital works under Division 43 of the ITAA 1997;

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depreciating assets that are associated with certain IRUs; and

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depreciating assets that are cars where the deductions on those cars have been substantiated using certain methods.

Depreciating assets associated with R&D or with investments in Australian films

1.20 This exclusion from the uniform capital allowance system preserves the concessional tax treatment available under the existing law for capital expenditure incurred in carrying on R&D activities and investments in Australian films. In particular:

•

the proposed capital allowances provisions will only apply where the plant is not installed ready for use exclusively for carrying on R&D activities or where the taxpayer has elected under subsection 73B(18) of the ITAA 1936 that the R&D provisions will not apply [Schedule 1, item 1, subsection 40-45(1)] ; and

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any taxpayer that has previously deducted or is entitled to deduct an amount under the existing law in respect of Australian films or copyrights acquired over those films will continue to deduct under the existing law and not under Division 40 [Schedule 1, item 1, subsection 40-45(5)] .

Depreciating assets that are capital works under Division 43 of the ITAA 1997

1.21 Expenditure incurred on capital works to which Division 43 of the ITAA 1997 applies is also excluded from the uniform capital allowance system. Those buildings and structural improvements which would be deductible only under Division 43 but which are ineligible because expenditure was incurred or work was started too early to qualify for a deduction will also be excluded from the uniform capital allowance system. As Division 43 only applies where other regimes do not, the buildings and structural improvements currently dealt with in other parts of the taxation law other than Division 43 will be included in the uniform capital allowance system. However, Division 43 will continue to apply to other capital works. [Schedule 1, item 1, subsection 40-45(2)]

Depreciating assets that are associated with certain IRUs

1.22 Also excluded from the uniform capital allowance system are:

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IRUs to the extent that the expenditure on the IRU was incurred at or before 110 am, by legal time in the Australian Capital Territory, on 21 September 1999 [Schedule 1, item 1, subsection 40-45(3)] ;

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any international telecommunications submarine cable system, or an IRU over the system, if the system has been used for telecommunications purposes at or before 110 am, by legal time in the Australian Capital Territory, on 21 September 1999 [Schedule 1, item 1, subsection 40-45(4)] .

These exclusions maintain the effect of the existing law.

Depreciating assets that are cars where the deductions on those cars have been substantiated using certain methods

1.23 Taxpayers can choose to use the cents per kilometre method or the 12% of original value method to calculate their car expenses. These methods already take into account the decline in value (or depreciation) of the car. Therefore, no separate deduction for decline in value is necessary. The decline continues, providing the basis of balancing adjustments if applicable. [Schedule 1, item 1, section 40-55]

Who holds a depreciating asset?

1.24 Under subsection 40-25(1), an entity can deduct an amount equal to the decline in value for an income year of a depreciating asset that they held during the year. Working out whether an entity holds an asset is therefore an important step in determining whether the entity can deduct amounts for its cost of a depreciating asset under Division 40.

1.25 In broad terms, a holder of a depreciating asset will be its economic owner. The economic owners are the entities that are able to access the assets economic benefits while stopping other entities from doing the same. [Schedule 1, item 1, section 40-40]

1.26 Entities may be the economic owners of depreciating assets in any of several ways. There may also be several economic owners, each with its own cost of the asset. These may each be holders of the asset, so joint holding of depreciating assets is generally recognised. However, in some cases, for an entity to hold an asset in a particular way excludes another entity from being an economic owner of the asset. In those cases, the entity for whom holding is excluded is specifically identified.

Ownership

1.27 In most cases, the legal owner of a depreciating asset is also its economic owner. This is because a legal owners ability to use or exchange the asset and deny others the same is protected by the courts. On this basis, the legal owner of an asset is treated as holding the asset in most cases. [Schedule 1, item 1, section 40-40, item 10 in the table]

1.28 Where a depreciating asset has both a legal and equitable owner, the legal owner will be regarded as a holder of that asset under this item, unless excluded by another item (such as item 5 or 6).

Economic ownership

1.29 In some cases, however, an economic owner of an asset is not its legal owner. Such an economic owner is a holder of the depreciating asset. Sometimes, also, a legal owner of an asset is not its economic owner. Such a legal owner is not a holder of the depreciating asset. For example, the economic owner of a depreciating asset may lack legal title to that asset merely because it is subject to:

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a legal mortgage;

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a hire-purchase agreement;

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a product financing or product sponsor agreement (see Example 1.1);

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a reservation of title arrangement; or

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a bare trust.

1.30 There are 2 general cases in which the economic owner of an asset is someone other than its legal owner, to the exclusion of the legal owner. These cases are dealt with separately because of the need to address both tangible and intangible depreciating assets; but the purpose of both items in the table is the same in principle. There are also a number of other specific cases.

First general case: economic ownership of a tangible depreciating asset

1.31 The first situation is where an asset is apparently held by one entity (perhaps a legal owner), but another entity possesses, or has the right against the apparent holder to possess that asset immediately, in circumstances in which that other entity has a right to become the holder, and it is reasonable to expect:

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that the other entity will become the holder; or

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that the asset will be disposed of at the direction and for the benefit of that other entity.

1.32 In this situation, the other entity is the economic owner, and they are the holder of the depreciating asset to the exclusion of the apparent holder. [Schedule 1, item 1, section 40-40, item 6 in the table]

1.33 Where the economic owner does not have actual possession but only a right against the apparent holder to possession, that right must be immediate, unconditional and non-contingent. That is, there must not be any thing to be done before that economic owner has the right to gain actual possession of the asset. For example, a taxpayer may have a call option over a depreciating asset the taxpayer does not hold but until that option is exercised there is no immediate right to possession and the option-holder will not hold that asset.

1.34 This item has to deal with cases where the apparent holder is not the legal owner, as for tangible assets in a range of circumstances there may be an apparent holder who is not the legal owner and against whom the economic owner has both possession (or a right to immediate possession) and rights, the exercise of which will make them a holder. For example, a tenant of land to which a depreciating asset is fixed may give both possession and a right to a transfer of the tenancy to a new economic owner.

Example 1.1

Emma wants to acquire additional finance for her business. In order to do this, she enters into a product financing arrangement with Republic Pty Ltd. Under the arrangement, she sells an item of plant to Republic, but contracts to repurchase it for a price equal to the original sale price plus a finance charge. Emma remains in possession of the item, and continues to use it, even though Republic has been given temporary ownership of it. In this situation, Emma is the holder of the plant under item 6 in the table in section 40-40, because she has the right to possess the plant, the right to again become its legal owner (and therefore its holder), and it is reasonable to expect that this will happen.

Second general case: economic ownership of an intangible depreciating asset

1.35 The second situation occurs where a depreciating asset that is a right is legally owned by one entity, but another entity exercises the subject matter of that right, or has the right to exercise it immediately, in circumstances in which that other entity has a right to become the legal owner, and it is reasonable to expect:

•

that the other entity will become the legal owner; or

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that the right will be disposed of at the direction and for the benefit of that other entity.

1.36 In this situation, the other entity is the economic owner, and they are the holder of the depreciating asset to the exclusion of the legal owner. Again, where the taxpayer has a right to possession, rather than actual possession, it must be an immediate right of possession (not a right to possession that will become immediate only on exercising an option, for example). [Schedule 1, item 1, section 40-40, item 5 in the table]

Example 1.2

The trustees of Tritech Unit Trust want to raise additional finance. They do this by borrowing money from Apricon Pty Ltd, securing the loan by granting a mortgage over one of the Trusts patents. Under the mortgage agreement, legal title to the patent is assigned to Apricon Pty Ltd, but Apricon grants Tritech a licence to continue to exploit the subject matter of the patent in its business. Thus, Tritech continues to enjoy the subject matter of the patent even though Apricon has been given temporary ownership of it. In this situation, Tritech is the holder of the patent under item 5 in the table in section 40-40, because it exercises the rights over the subject matter of the patent, has the right to again become legal owner of the patent, and it is reasonable to expect that Tritech will become the legal owner.

Specific cases

1.37 There are also a number of more specific cases which recognise that an economic owner of a depreciating asset is its holder. These cases fall into 3 categories:

•

depreciating assets which are leased;

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depreciating assets which improve, or are fixed to, land over which an entity owns quasi-ownership rights; and

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depreciating assets held by partnerships.

Depreciating assets which are leased

1.38 The table in section 40-40 contains specific rules relating to depreciating assets which are leased.

1.39 A depreciating asset that is itself subject to a lease may be fixed to land. Assets which become fixtures at common law are regarded as part of the land, and are therefore owned by the lands legal owner. However, in circumstances where the lessor of a depreciating asset has a right to recover that asset, the lessor is still an economic owner. The lessor is recognised as a holder, while their right to recover the asset exists. [Schedule 1, item 1, section 40-40, item 4 in the table]

Example 1.3

Damian leases an ammonia plant to Simon, which Simon attaches to land that he owns. Under the plant lease agreement, Damian has a right to recover the asset upon completion of the plant lease.

Damian is a holder of the plant under item 4 in the table in section 40-40 while his right to recover the plant exists, as he is the lessor of the plant.

Simon is a holder of the plant under item 10; this will be important if he has costs of the plant (for instance, in modifying or extending it after installation).

1.40 Further, consistent with the current law, where a depreciating asset is a luxury car that is subject to a lease, the lessee is regarded as a holder, and the lessor is not a holder, while the lessees right of use continues. [Schedule 1, item 1, section 40-40, item 1 in the table]

Depreciating assets which improve, or are fixed to, land over which an entity has quasi-ownership rights

1.41 The table in section 40-40 addresses specific cases where a depreciating asset is fixed to land which is itself subject to a quasi-ownership right. A quasi-ownership right is defined in subsection 995-1(1) of the ITAA 1997 as a lease over land, an easement in connection with land, or any other right, power or privilege over the land, or in connection with the land. An entity has a quasi-ownership right if it is the successive owner of such a right. For example, a sublessee will have a quasi-ownership right. The quasi-ownership right need not be held from an Australian government or government agency, a requirement for depreciation under the current law.

1.42 Where the owner of the quasi-ownership right improves the land with a depreciating asset, or improves a depreciating asset that is itself an improvement to the land, and where that improvement is for their own use but they cannot remove that asset from the land, they are nonetheless the holder while their quasi-ownership right exists. [Schedule 1, item 1, section 40-40, item 3 in the table]

Example 1.4

Jerry is leasing land and building from Cantrell Nominees Pty Ltd, on which he carries on business. Jerry installs an in-ground watering system on the land, at his own expense and for the benefit of the business he carries on. Under the lease agreement, Jerry is not permitted to remove fixtures from the property.

Even though Cantrell Nominees has become the owner of the watering system under the law of fixtures, Jerry is recognised as a holder while the lease exists under item 3 in the table in section 40-40.

1.43 Where, on the other hand, a depreciating asset is fixed to land where the owner of the quasi-ownership right has a right to remove the asset, the uniform capital allowance system recognises them as the holder while the right of removal exists. Right of removal is consistent with the established legal concept, connoting a right to remove the asset for the benefit of the holder of the right, with the removed item being for their rather than the landowners benefit. Often the right of removal will extend beyond the term of the quasi-ownership right, allowing the quasi-owner reasonable time to remove the asset; they will remain a holder of the asset until that right ends, as until then they might exercise the right and remove the asset, and so continue to hold the asset. [Schedule 1, item 1, section 40-40, item 2 in the table]

Example 1.5

Ben affixes an item of plant to land which he is leasing from Sally. Under the law of fixtures, Sally legally owns the plant. However, under the law of tenants fixtures, Ben has the right to remove fixtures while the lease subsists and for a reasonable time afterwards. While his right of removal remains, Ben is a holder of the plant under item 2 in the table in section 40-40, because he owns a quasi-ownership right over the land.

1.44 The entity with the quasi-ownership right need not be the only holder. For instance, a landlord may agree with a tenant to share the cost of a depreciating asset which is a fixture. The landlord will be a holder of the asset too. Under the joint holding rule, discussed below, each holder will calculate their own decline and will calculate for themselves any reduction in their own deduction.

Depreciating assets held by partnerships

1.45 Property which has become partnership property or a partnership asset at general law is beneficially owned by all of the partners, even if only one partner is the legal owner. Where a depreciating asset is or becomes a partnership asset, it is appropriate to identify the partnership as being the economic owner of the asset. Thus, the partnership, and not any individual partner, is regarded as holding the asset. This is consistent with the structure of the income tax law, under which the partnership is a notional taxpayer arriving at a tax position which is then allocated out between the partners. [Schedule 1, item 1, section 40-40, item 7 in the table]

1.46 Whether a particular depreciating asset is a partnership asset is determined in accordance with partnership law. This is a question of fact that can only be determined from the terms of the partnership agreement and/or inferences drawn from the conduct of the partners towards the asset.

Depreciating assets which are mining information

1.47 To avoid doubt, mining, quarrying or prospecting information that an entity has will be specifically stated as being held by an entity. This will ensure, amongst other things, that the disposal of such information will give rise to a balancing adjustment. Mining information is something that can be held in either of 2 ways. First, taxpayers hold mining information that is relevant to mining operations they carry on, or propose to carry on, or that is relevant to an exploration or prospecting business they carry on. In that case, the taxpayer holds the information even if the information is generally available, because the information is still of special value to the taxpayer. So deductions for the decline of the cost are appropriate. Second, taxpayers hold mining information that is not generally available, because others may want it and not have it, and so the information is of special value to the taxpayer. [Schedule 1, item 1, section 40-40, items 8 and 9 in the table]

1.48 If information becomes generally available, and is not relevant to a mining or exploration business of the taxpayer, the taxpayer stops holding the information. That triggers a balancing adjustment for the taxpayer. This is appropriate, as the information must lose its value to the taxpayer at that point. The hold table helps to ensure this result, even though information is generally something that taxpayers still have however widely they may pass it on.

Extension or renewal of a right

1.49 Extensions or renewals of a depreciating asset that is a right will be taken to be a continuation of that right thus ensuring that a balancing adjustment event will not be triggered merely because the right terminates and is immediately followed by an extension or renewal of that right. This provision is related to the effective life rule, that intangible depreciating assets will have effective lives no greater than their term, but that the term must include any reasonably assured extensions or renewals of the term (see paragraphs 10 to 10 for discussion of that rule). [Schedule 1, item 1, subsection 40-30(5)]

Jointly held depreciating assets

1.50 In applying the table in section 40-40, it is important to note that, in some circumstances, there can be more than one holder of a depreciating asset. The most common situation in which this would be the case is where there are multiple holders under the same item. For example, joint legal owners of a depreciating asset are all holders of that asset.

1.51 This does not necessarily mean that there will be multiple claims for the deduction for decline in value, however, as an entity can only deduct an amount for the decline of the cost of the asset to them. If a depreciating asset cost nothing to an entity, they will generally have no cost to write-off.

1.52 It is also important to note that some of the items in the table in section 40-40 preclude the recognition of some kinds of joint holding under 2 or more different items. The exclusions contained in column 3 of items 1, 5, 6 and 7 effectively prevent some entities from being a holder under one of those items or any other item. Other joint holdings can still arise.

Example 1.6

Gossard Pty Ltd let a bulldozer to Edward under a hire purchase agreement under which Edward paid rental instalments and could exercise an option to purchase the bulldozer after paying the final instalment. Edward is reasonably expected to exercise the option, because the final payment will be well below the expected market value of the bulldozer at the end of the agreement. Edward is therefore the holder under item 6. The legal owner, Gossard Pty Ltd, is not the holder under item 10, because item 6 specifies that the legal owner is not the holder where item 6 applies.

1.53 In addition, it is important to note that partners do not hold partnership assets either alone or jointly with the other partners. Partnership assets are held by the partnership not partners. [Schedule 1, item 1, section 40-40, item 7 in the table]

Common joint holding situations

1.54 Three situations in which the application of the joint holding rule will commonly be significant are:

•

cases of joint ownership;

•

cases where there are multiple interests in the same land or depreciating asset, and more than one holder of an interest contributes to the cost of a depreciating asset; and

•

cases where both lessee and lessor contribute to the cost of a depreciating asset.

1.55 The first of these cases occurs, for example, where there are multiple legal owners [Schedule 1, item 1, section 40-40, item 10 in the table] . Consistently with current practice, where depreciating assets are jointly owned, they may be depreciated by each individual owner according to the use made of the asset by that owner.

1.56 The second case would occur, for example, if 2 or more entities were joint signatories to a lease, and contributed to the cost of acquiring a depreciating asset and affixing it to land. In this situation, both entities would be holders under item 2 or 3 in the table, and each would be able to work out the decline in value of their interest by reference to that portion of the underlying assets cost which they contributed.

1.57 Finally, the third case would typically occur where a lessee attaches a depreciating asset to land, such that it becomes a fixture. The lessee would be regarded as the holder under items 2 or 3, whilst the lessor would be regarded as the holder under item 10. If there is a sharing of costs between lessor and lessee, both parties will be able to deduct the decline in value of their interest in the underlying asset by reference to their contribution to the assets cost.

Decline in value of an interest in a depreciating asset

1.58 Where there is more than one holder of a depreciating asset, it is the decline in value of an entitys cost ofthat asset which is taken into account [Schedule 1, item 1, subsection 40-35(1)] . The interest in the underlying asset is dealt with as if it were the depreciating asset itself. This rule looks to whether, under the table in section 40-40, there is more than one entity which holds the same depreciating asset; it is not necessarily concerned with whether there is joint tenancy or co-ownership at general law.

1.59 When subsection 40-35(1) applies, the decline in value of the actual underlying asset is otherwise disregarded by the entity holding the interest [Schedule 1, item 1, subsection 40-35(2)] . This rule is necessary to ensure that there is no double-counting or miscounting of the decline in value, which would otherwise result if the decline in value of the underlying asset were taken into account and deductions adjusted according to all the holders uses of the asset, with the resulting amount shared out in some way.

1.60 The term interest in the underlying asset is intended to be interpreted broadly, and is not limited to rights which create a proprietary interest in the underlying asset. Rather, an entitys interest is simply a reference to their holding of the underlying asset and the circumstances which bring that about.

1.61 The interest specified in subsection 40-35(1) arises from, and therefore takes on the characteristics of, the underlying asset. This means that the effective life of the interest is that of the underlying asset. However, because each holders interest is dealt with as if it were the asset, changes to one holders interest do not have to affect another holder. For example, if there are 3 joint owners of an asset, and one sells all or part of an interest in the underlying asset to a new co-owner, the other original owners have no change to their asset; no balancing adjustment event occurs for them. Joint ventures that are not partnerships provide a common illustration of the practical application of this rule, as they are joint owners who are each holders of a separate asset under this Bill. Partners do not illustrate the point, as partnership assets are held only by the partnership (and not by the partners).

Example 1.7

Claude purchases a gas furnace, which he affixes to land that he leases from Lonsdale Pty Ltd. The total cost to him of the asset is $10,000. The effective life of the furnace is 10 years, and Claude has only 6 years left on his lease when he installs it.

Claude has a right to remove the furnace, while the lease subsists, under the law of tenants fixtures. Claude would be a holder of the unit under item 2 in the table in section 40-40, while his right to remove exists.

Lonsdale Pty Ltd is also the holder under item 10 in the table, as the legal owner of the furnace, which has become a fixture. Legal title to a fixture remains with the lessor unless and until the tenant chooses to exercise their right of removal and sever it.

As there is more than one holder, the relevant asset for both Lonsdale and Claude is their interest in the furnace (as if that interest were itself the furnace).

Lonsdale did not pay anything for its interest. Therefore, its cost is nil, and it is not entitled to deduct amounts for the decline in value of the asset.

Claude accounts for the decline in the value of his interest in the furnace under subsection 40-35(1); as a result, he is not otherwise entitled to deduct amounts for the decline in value of the furnace itself. Claude may claim deductions for the decline in value of his interest by reference to his cost of $10,000. He deducts amounts according to an effective life of 10 years. It does not matter that the balance of his lease is of a shorter duration.

Jointly held interests and balancing adjustments

1.62 A balancing adjustment event does not happen in relation to an underlying asset or interest in that asset merely because the underlying asset starts to be, or ceases to be, jointly held. In such a case, the effect of the joint holding rules is that the asset is split, and splitting an asset is not itself a balancing adjustment event. To the extent that a new joint holder then takes one of the assets resulting from the split from the original holder, there will be a balancing adjustment event, but not in any other respect. The balancing adjustment rules are concerned to cover cases only so far as an entity ceases to hold an asset, not where they otherwise begin or cease to hold the asset jointly with others. For further discussion on balancing adjustments, see Chapter 3. For further discussion on splitting or merging assets, see paragraphs 10 to 10 and 10 to 1.153.

When does a depreciating asset start to decline in value?

1.63 The decline in value of a depreciating asset held by a taxpayer is triggered by the earlier of the following events:

•

the taxpayer first uses the asset; or

•

the taxpayer has the asset installed ready for use and held in reserve.

[Schedule 1, item 1, section 40-60]

1.64 The point at which the earliest of these events occurs is referred to as the assets start time . It is irrelevant that the depreciating asset may first be used for a non-taxable purpose. The current law expressly refers to assets installed ready for use and held in reserve, but the express words are not reproduced here, as an unused asset is not installed ready for use unless it is held in reserve. Conversely, an asset which begins to be used must be installed ready for use. There are some assets which by their nature cannot be installed. Their start time will occur once they begin to be used [Schedule 1, item 1, subsection 40-60(2)] . However, there is a further start time when taxpayers start using the asset again after a balancing adjustment event has occurred for that asset. That start time is when the taxpayer begins using that asset again [Schedule 1, item 1, subsection 40-60(3)] .

1.65 The effect of section 40-60 may bring forward the time at which a taxpayer starts to calculate the decline in value of a depreciating asset. Under the existing capital allowances rules, a taxpayer generally will not start to calculate the amount which can be deducted until the asset is first used for income producing purposes or is installed ready to be used for this purpose. So if initial use is private, under the current law, calculations do not start, even though the use by which the assets useful life (and, overall, its value) is absorbed has begun.

Example 1.8: Establishing start time

Roy acquires a car on 5 June 2002 and commences private use of the vehicle from this date. The car is used jointly for business and private purposes from 1 August 2002 when Roy begins a fast food delivery run. In accordance with subsection 40-60(2), the start time for the car is 5 June 2002 - this is the time at which Roy will start to calculate the assets decline in value under the new law.

Under the existing income tax law Roy would not start to calculate the cars depreciation deduction until the 2002-2003 income year, that is, the calculation starts from 1 August 2002.

1.66 The proposed timing rule is an improved way of calculating the decline in value of a depreciating asset (and any deduction allowable) to the current rules in Division 42 of the ITAA 1997. As a whole, the rules under Subdivision 40-B ensure that the results achieved under the uniform capital allowance system are consistent with what would otherwise be obtained using the existing rules.

Example 1.9

To continue with Example 1.8, Roys entitlement to a deduction for the 2001-2002 income year is reduced to nil in accordance with subsection 40-25(2) as the asset was only used for private purposes. In the following income year, Roy will be entitled to deduct that portion of the assets decline in value that relates to business use.

Under the existing law, the calculation of decline in value is delayed by an income year. In the 2002-2003 income year, Roy would be required to apportion the deduction allowed for the decline in value of the asset so that it reflects the income producing use of the asset.

The total deduction allowed over the 2 year period using the proposed capital allowance regime will equal the result that is obtained under the existing law.

1.67 In reality taxpayers will not generally bother to calculate the decline of depreciating assets that they use totally for private purposes. However, if those assets are used in later years for a taxable purpose, the decline for the private purposes must be reconstructed.

Calculating the decline in value

1.68 Sections 40-70 and 40-75 contain the general rules for working out the decline in value ofdepreciating assets. However, where the depreciating asset forms part of a low-value pool or a software development pool, the taxpayer must calculate the decline in value using the rules provided under Subdivision 40-E (see Chapter 4). [Schedule 1, item 1, subsection 40-65(5)]

1.69 The application of the general rules vary, depending on whether it is the first income year in which the decline in value is being calculated for a particular depreciating asset, or a later income year. There is a limit on the decline in value of a depreciating asset. By limiting each years decline to its base value this ensures that the total decline in value of an asset cannot be greater than the assets total cost. [Schedule 1, item 1, subsections 40-70(3) and 40-75(5)]

Immediate decline in value for assets used in exploration and prospecting

1.70 The decline for a depreciating asset you hold will be the assets cost, if the asset is for exploration and prospecting. This means you must first use the asset for exploration and prospecting for things you can get by mining operations. But you must not use the asset for petroleum development drilling, or for operations in the course of working a mining or quarrying operation; and when you start to use the asset you must carry on mining operations, or objectively you must be going to do so, or you must carry on a business including exploration and prospecting for which the cost of the asset was necessarily incurred. These restrictions mirror the current law; see the former section 330-15 and subsection 330-20(2). [Schedule 1, item 1, subsection 40-80(1)]

1.71 It is thought that much expenditure on exploration or prospecting will be a cost of a depreciating asset, and so be fully deductible in an income year under new subsection 40-80(1). Nevertheless, the new law retains the current rules for deducting expenditure on exploration or prospecting in the event there are some expenditures that currently qualify for immediate deduction and that are not a cost of a depreciating asset [Schedule 1, item 1, section 40-730] . The rules regarding this immediate deduction are explained in full in Chapter 7.

Immediate decline in value for assets costing $300 or less

1.72 An immediate deduction for depreciating assets costing $300 or less will be available to taxpayers who:

•

use the asset predominantly for the purpose of producing assessable income that is not from carrying on a business;

•

do not acquire the asset as part of a set of assets costing more than $300 and acquired in an income year; and

•

do not acquire with one or more assets that are either identical or substantially identical in an income year where the total cost of these acquisitions is more than $300.

The second criterion ensures that taxpayers cannot disaggregate a set of assets by buying individual items from the set (each costing $300 or less) rather than buying the set itself (which costs more than $300) and claiming the immediate deduction. In addition, the third criterion ensures that taxpayers cannot claim an immediate deduction for identical (or substantially identical) assets acquired in an income year where the individual item costs $300 or less but collectively they cost more than $300. For example, a landlord with a furnished rental property cannot claim the immediate deduction in an income year for buying 2 identical lamps which individually cost $280. [Schedule 1, item 1, subsection 40-80(2)]

1.73 It should be noted that subsection 40-80(2) merely works out the deduction. It does not govern the income year in which the deduction is allowed. Rather this is governed by section 40-60, with decline starting from start time.

General rules

Calculating the decline in value for the first income year

Method of calculation

1.74 For each depreciating asset, the taxpayer must decide whether to apply the prime cost or diminishing value method for working out the decline in value. [Schedule 1, item 1, subsection 40-65(1)]

1.75 However, taxpayers can only use the prime cost method to work out the decline in value of in-house software expenditure, intellectual property, spectrum licences and datacasting transmitter licences. [Schedule 1, item 1, subsection 40-70(2)]

1.76 Further, taxpayers must use the same method that their associate was using when they acquire a depreciating asset from that associate. [Schedule 1, item 1, subsection 40-65(2)]

1.77 Also, taxpayers must use the same method that the previous holder of the depreciating asset was using where the end-user of the depreciating asset does not change. Examples of where this could occur are under sale and leaseback arrangements and by a lessee purchasing an asset after the lease of the asset has ended. [Schedule 1, item 1, subsection 40-65(3)]

1.78 Where taxpayers cannot readily ascertain the method that the former holder was using, they must use the diminishing value method. This overcomes any difficulties in obtaining the necessary information to ascertain the method. [Schedule 1, item 1, subsection 40-65(4)]

1.79 For both methods, the decline is limited to the part of the cost that has not already been declined. Under diminishing value, the decline in any year is limited to the base value for the year. Under prime cost, for any year after the first (in which the prime cost formula ensures no more than cost can be claimed), the decline is limited to the opening adjustable value (the cost remaining after the previous years decline) and any second-element costs of the year. [Schedule 1, item 1, subsections 40-70(3) and 40-75(7)]

1.80 The main difference between the prime cost and diminishing value methods of calculation is the way in which the value of a depreciating asset will be written-off. Under the prime cost method, the value of an asset is assumed to decrease uniformly over its effective life, that is, the period the asset is used. The decline each year for the cost of the asset from time to time therefore allocates the remaining cost over the remaining effective life, and produces essentially a straight line write-off. In contrast, the diminishing value method assumes that the decline each year is a constant proportion of the remaining cost, and produces a progressively smaller decline as the remaining cost reduces; the constant rate is based on 1 times the effective life rate, as under the current law, giving larger deductions at first and smaller deductions later in the life compared to the prime cost method.

1.81 There is a separate formula that is used to work out the decline in value of an asset for each method. However, both the prime cost and diminishing value formulas consist of 3 elements, these being:

•

cost or base value;

•

days held; and

•

effective life or remaining effective life.

1.82 A more detailed explanation of the 2 formulas and the individual components is provided in paragraphs 10 to 1.107.

Base value

1.83 This is only relevant for the diminishing value formula. The base value of a depreciating asset represents the value of the asset that can be further declined. For the first income year in which a decline occurs, the base value is the assets first and second element costs at the end of that income year (see Chapter 2). For later years, the base value is the opening adjustable value for the year and any second element costs for the year. [Schedule 1, item 1, subsection 40-70(1)]

1.84 It should be noted that the assets base value may be reduced by an amount of commercial debt that has been forgiven during the income year for which the assets decline in value is calculated. The assets cost is reduced in that income year by the debt forgiveness amount. Where the debt forgiveness occurs in an income year after which the start time occurs, the assets opening adjustable value is also reduced by the debt forgiveness amount, as in those years decline on a prime cost or diminishing value basis includes that amount rather than cost in the formula. [Schedule 1, item 1, section 40-90]

Example 1.10

Chris buys an asset on 1 July 2002 for $2,000 financed through instalment payments. The opening adjustable value as at 10 July 2005 is $1,500. On 1 July 2005 Chris has $300 of the debt forgiven in relation to this asset. The opening adjustable value for the 2005-2006 income year will be $1,200 (i.e. $1,500 - $300). Further, the cost of this asset is now $1,700 rather than $2,000. This is relevant only in calculating a balancing adjustment after a balancing adjustment event has occurred and the asset has a non-taxable use component that will be subject to CGT.

1.85 This provision reflects the general policy for dealing with cost reductions and offsets where they occur. Practically, no other general provision is considered necessary.

1.86 Further, the base value includes costs added during the year. So the costs of any improvements made to a depreciating asset during an income year are to be taken into account when calculating the assets decline in value for that year. Because these costs are simply added to base value, they are (in effect) given the benefit of a whole years decline rather than being apportioned in some way.

Cost

1.87 The assets cost is the basis upon which the decline is calculated using the prime cost formula. For every income year in which a decline occurs and for which one of 6 circumstances do not occur, the cost is the total of the assets first and second elements of cost at the end of the income year in which the start time occurs (see Chapter 2). This maintains the existing prime cost formula. [Schedule 1, item 1, subsection 40-75(1)]

1.88 However, when one or more of 6 circumstances occur in an income year, instead of the cost being first element cost, it becomes the assets opening adjustable value for that income year plus any second element costs for that income year. That then becomes the assets cost for that income year and all later years until one of those 6 circumstances occurs again. [Schedule 1, item 1, paragraph 40-75(3)(a)]

1.89 The 6 circumstances referred to in paragraphs 10 and 10 are:

•

the recalculation of the assets effective life;

•

the incurring of second element costs in an income year after the start time occurs;

•

the application of the debt forgiveness provisions in section 40-90;

•

the obtaining of rollover relief under section 40-340;

•

the obtaining of rollover relief for certain involuntary disposals; and

•

the making of certain GST adjustments under Subdivision 27-B.

[Schedule 1, item 1, subsection 40-75(2)]

Number of days you held the asset

1.90 The days held component of the prime cost and diminishing value formulas refers to the number of days during the income year that the taxpayer held the depreciating asset up until the time a balancing adjustment event occurs in respect of that asset (see Chapter 3 for an explanation of balancing adjustment events). This component ensures that the total amount by which an assets value can be written-off for an income year is reduced where, for example, the asset is acquired or disposed of during the year, or where the taxpayer permanently stops using the asset but continues to hold it. These are events that end or suspend the decline of the asset, because it is neither being used nor held ready for use when they occur. The kind of use a taxpayer makes of an asset affects deductions, but not decline, and is discussed in paragraph 1.10.

1.91 The days held component is calculated from the assets start time. The reason for this is that the value of a depreciating asset cannot begin to decline until the relevant start time has occurred, which may not necessarily coincide with the time the taxpayer actually started to hold the asset. [Schedule 1, item 1, subsections 40-70(1) and 40-75(1)]

Effective life

1.92 The term effective life is used to describe the length of time over which any entity could reasonably expect to use the particular asset for any productive purpose, whether for taxable purposes or for the purpose of producing exempt income. For the first income year the effective life component used under the diminishing value or prime cost methods represents the effective life of the asset calculated as from its start time, that is, the time the asset is first used by the holder for any purpose.

1.93 The rules for working out the assets effective life are discussed in paragraphs 10 to 1.127.

Example 1.11: Diminishing value method

Sonja is a tourist operator in the Whitsunday Islands. Sonja decides to expand her operations and acquires a new helicopter on 13 August 2001 at a cost of $1 million. Sonja self assesses the effective life of the asset to be 7 years and decides to work out its decline in value in accordance with the diminishing value formula. Assuming that the asset is first used on 5 September 2001, the assets decline in value for Sonjas income year ended 30 June 2002 is calculated in the following way:

$1,000,000 * (365 - 66)/365 * 150%/7 = $20,479


Example 1.12: Prime cost method

During the 2001-2002 income year, Jimmy purchases a piece of machinery for use in his landscaping business. The cost of the asset is $65,000 and Jimmy estimates the effective life to be 8 years. The machinery is first used on 22 October 2001. Using the prime cost method, the decline in value of the asset for the income year ending 30 June 2002 would be calculated as:

$65,000 * (365 - 113)/365 * 100%/8 = $5,609


Calculating decline in value for later income years

Method

1.94 A taxpayer must continue to calculate a depreciating assets decline in value for later income years in accordance with whichever of the prime cost or diminishing value methods was chosen to apply for the first income year. [Schedule 1, item 1, subsections 40-65(1) and 40-130(2)]

Base value

1.95 Broadly, the base value component used under the diminishing value method formula is calculated in a later year of income by adding:

•

the opening adjustable value (essentially the reduced value of the asset at the start of the income year); to

•

the cost of any improvements made to the asset during that year [Schedule 1, item 1, subsection 40-70(1)] . This may require the taxpayer to recalculate the effective life of the depreciating asset (this is discussed in paragraph 10 to 1.133).

Adjustable value

1.96 Section 40-85 introduces the concept of adjustable value for a depreciating asset. The adjustable value of a depreciating asset broadly represents so much of the cost of the asset at a particular time as is not yet declined, and so provides the starting point for further decline calculations and for balancing adjustments. This term essentially replaces the concept of undeducted cost used within the existing depreciation provisions under Division 42 of the ITAA 1997.

1.97 A taxpayer will need to know the adjustable value of an asset:

•

when there is a balancing adjustment event;

•

when there is a splitting or merging of a depreciating asset; or

•

at the end of the income year.

1.98 Where the asset has yet to be used or installed ready for use for any purpose, the adjustable value is the assets cost. Such a rule allows a balancing adjustment calculation to be carried out for such assets. For example, an asset maybe destroyed before it is used. [Schedule 1, item 1, paragraph 40-85(1)(a)]

1.99 For the first income year after which the decline in value is being worked out for a particular asset, the adjustable value is determined in the following way:

adjustable value = assets cost - assets decline in value for the income year


[Schedule 1, item 1, paragraph 40-85(1)(b)]

1.100 Where a taxpayer continues to hold the depreciating asset at the end of the first calculation year, the adjustable value will be carried forward to the start of the following income year as the assets opening adjustable value . [Schedule 1, item 1, subsection 40-85(2)]

Example 1.13: Calculating adjustable value

Following from Example 1.12, the adjustable value of the machinery is obtained by subtracting the $5,609 decline in value over the 2001-2002 income year from the original cost of the asset, that is:

$65,000 - $5,609 = $59,391


The amount of $59,391 will be carried forward as the opening adjustable value for the 2002-2003 income year.

1.101 To calculate the adjustable value of a depreciating asset at a particular time in a later income year, the opening adjustable value at the start of that income year is added to the second element costs, such as the cost of any improvements made to the asset, during the year up until that particular time, reduced by the assets decline in value up to that particular time. [Schedule 1, item 1, paragraph 40-85(1)(c)]

1.102 The assets adjustable value will be reduced to take into account any debt forgiveness amount [Schedule 1, item 1, subsection 40-90(3)] . This reduction ensures the amount is taken into account for balancing adjustment purposes and to arrive at the correct opening adjustable value for the following income year.

Number of days held during the income year

1.103 The number of days that a taxpayer held a depreciating asset in a later income year is worked out from the start of the income year for which the decline in value is being calculated. This period is reduced by the number of days that the taxpayer continued to hold the depreciating asset for which the asset was neither used nor installed ready for use (for instance, because it was mothballed). [Schedule 1, item 1, subsections 40-70(1) and 40-75(1)]

Effective Life

1.104 The assets effective life for a later income year will be worked out on the basis of the most recent calculation of the assets whole effective life for the holder. This will be the assets effective life used in calculating the initial decline in value, unless the assets effective life has been recalculated in a later income year. [Schedule 1, item 1, subsection 40-95(1)]

1.105 If the taxpayer recalculates the effective life of a depreciating asset the recalculated life must be used (see paragraphs 10 to 1.133).

1.106 Under the prime cost method formula, the remaining effective life of an asset can be calculated in a later income year in the following way:

remaining effective life = original calculation of effective life - period of time that has elapsed from the assets start time, up until the beginning of the income year for which the decline in value is being calculated


[Schedule 1, item 1, subsection 40-75(4)]

1.107 However, where the effective life of a depreciating asset has been recalculated, the remaining effective life of the asset under the prime cost method formula is calculated as:

remaining effective life = most recent calculation of effective life - period of time that has elapsed from the assets start time, up until the beginning of the income year for which the decline in value is being calculated


Working out effective life of a depreciating asset

Choice of effective life

1.108 For the income year in which the depreciating assets start time occurs a taxpayer will need to decide whether the assets effective life will be worked out by:

•

adopting the Commissioners determination of effective life applicable to that depreciating asset (if there is such a determination) [Schedule 1, item 1, paragraph 40-95(1)(a) and subsection 40-95(3)] ; or

•

self-assessing the assets effective life [Schedule 1, item 1, paragraph 40-95(1)(b) and subsection 40-95(3)] .

1.109 However the choice is not available in 3 situations. First, where the taxpayer acquired the asset from an associate. In this case the effective life is the effective life of the asset that the associate was using, if the taxpayer is using the diminishing value method. If the taxpayer is using the prime cost method then they must use the remaining effective life. [Schedule 1, item 1, subsection 40-95(4)]

1.110 Second, where the end-user of the depreciating asset does not change. In this case the effective life is the effective life of the asset that was used by the previous holder of the depreciating asset, if the taxpayer is using the diminishing value method. If the taxpayer is using the prime cost method then they must use the remaining effective life. Examples of where this could occur are under sale and leaseback arrangements and by a lessee purchasing the asset after the lease has ended. If the Commissioner later finds that the previous holder was using an incorrect effective life and amends the previous holders tax returns to reflect the use of a correct effective life, the effective life as reset by the Commissioner applicable to the previous holder will apply to the new holder. [Schedule 1, item 1, subsection 40-95(5)]

1.111 Where taxpayers cannot readily ascertain the effective life that the former holder was using, they must use the effective life of the asset as determined by the Commissioner. [Schedule 1, item 1, subsection 40-95(6)]

1.112 Third, this choice is also not available for certain intangible assets that qualify for write-off under Division 40. For those assets their effective life is the statutory effective life they had under their existing write-off regime [Schedule 1, item 1, subsections 40-95(7) and 40-105(4)] . However, where those assets are acquired from a former holder, as the taxpayer must use the prime cost method, their effective life is the number of years remaining in that assets effective life at the start of the income year in which the acquisition occurred. This ensures that those intangible assets are written-off in accordance with the statutory period. This does not apply where those intangible assets are copyright, licences over copyright and in-house software. This exclusion ensures taxpayers are required to write-off these 3 types of intangible assets over the statutory effective life from the time they acquire the asset [Schedule 1, item 1, subsections 40-75(5) and (6)] .

1.113 For other intangible assets that are not IRUs and that qualify for write-off under Division 40 the effective life cannot be longer than the term of that intangible asset as extended by any reasonably assured extension or renewal of that term. Together with subsection 40-30(5) this ensures that the effective life of these intangibles that are rights cannot be shortened by a term that excludes any renewal or extension of those rights. [Schedule 1, item 1, subsection 40-95(8)]

What is the effective life of other rights?

1.114 The effective life of an intangible asset that is not covered by the table in new subsection 40-95(7) and is not an IRU, for example, a mining quarrying or prospecting right for use in extracting a resource, is to be worked out under section 40-105 (see paragraphs 10 to 1.127). Under that section, the effective life of a right would have to be worked out taking into account renewals or extensions. [Schedule 1, item 1, subsection 40-30(5)]

1.115 Under relevant Crown laws, mining, quarrying or prospecting rights often are issued for a fixed term, for example 21 years, but can be extended or renewed on an indefinite basis subject to any relevant conditions being meant. This could lead to a conclusion that the effective life of such rights is indeterminate with the consequences that no deduction would be allowable for the cost of the right.

1.116 That would not be appropriate for those rights. Rather, their effective life is the period of time over which the right, including any reasonably assured extensions or renewals, is likely to be used by any person for the purposes of extracting the resource.

1.117 Accordingly, the effective life of such rights is not to be longer that the term of the right, including any reasonably assured extension or renewal of that term [Schedule 1, item 1, subsection 40-95(8)] . In effect, that ensures that the effective life of mining or prospecting rights would generally be the same as the effective life of mining, quarrying or prospecting information in relation to the resource.

1.118 Examples 10 and 10 show how the effective life of mining, quarrying or prospecting rights would be worked out where used for the purpose of extracting a resource.

Example 1.14

Global Resources Limited obtains a right to extract a mineral for an initial term of 21 years. The right can be renewed or extended indefinitely on a 21 year basis while mining continues. Global estimates that, based on its anticipated level of production, the resource will be fully exhausted after 30 years. It could be concluded that the right, together with any reasonably assured extensions or renewals, will exist for 42 years. However, based on Globals plans, Global or any other person is likely to use the right for 30 years only. Accordingly, Global could reasonably adopt an effective life of 30 years for the right.

Example 1.15

Global Resources Limited identifies a major uranium deposit that could last for up to 100 years. For political reasons, the Government is prepared to allow Global to mine the uranium for 10 years only. There is no reasonable expectation of the right being extended or renewed. Under those circumstances, Global could reasonably conclude that the effective life of the right is 10 years.

What is the effective life of IRUs?

1.119 For IRUs, the effective life is the effective life of the international telecommunications submarine cable over which the IRU is granted. This maintains the existing law. By excluding IRUs from subsection 40-95(7), it allows the effective life of IRUs to be determined by the Commissioner or it allows taxpayers to self-assess the effective life. Further, the effective life can be recalculated if in fact the effective life of the international telecommunications submarine cable over which the IRU is granted can be recalculated. [Schedule 1, item 1, subsection 40-95(9)]

Commissioners determination of effective life

1.120 Subsection 40-100(1) maintains the Commissioners existing powers to make a written determination of the effective life of a depreciating asset [Schedule 1, item 1, subsection 40-100(1)] . That determination may specify its date of effect and it may also operate retrospectively to that date but only in 2 circumstances. First, where there was no determination at the date for that particular asset. Second, where the determination specifies a shorter effective life [Schedule 1, item 1, subsections 40-100(2) and (3)] .

1.121 In making a determination, the Commissioner works out the estimated period such a depreciating asset can be used by any entity for income producing purposes assuming:

•

it will be subject to wear and tear at a rate that is reasonable for the Commissioner to assume; and

•

it will be maintained in reasonably good order and condition.

In estimating this period the Commissioner has regard to the likelihood of the asset being scrapped, sold for scrap or abandoned, as the effective life ends when these events happen even if otherwise the life would be longer. [Schedule 1, item 1, subsection 40-100(4)]

1.122 The appropriate determination to be applied in establishing the effective life of the asset is that which is in force at the earlier of the following times:

•

the time the taxpayer enters into a contract to acquire the asset;

•

the time the taxpayer acquires the asset; and

•

the time the taxpayer begins construction of the asset,

provided that the assets start time is within 5 years of the appropriate time. Otherwise the appropriate determination is the one in force at the assets start time. This does not mean the asset must be used within 5 years to attract the earlier determination, provided it is installed ready for use within that time. The 5-year rule helps to ensure that the taxpayer was really committed at the time from which an earlier determination would apply. [Schedule 1, item 1, paragraph 40-95(2)(a)]

1.123 However, where the depreciating asset that is plant was acquired under a contract or otherwise acquired or construction of it commenced before 110 am, by legal time in the Australian Capital Territory on 21 September 1999 the appropriate determination to be applied is that which was in force at that time. There is no restriction on the period within which this plant must be first used or held ready for use. [Schedule 1, item 1, paragraph 40-95(2)(b)]

Self-assessing effective life

1.124 An alternative option to relying on the Commissioners effective life determination is for the asset holder to self-assess the assets effective life [Schedule 1, item 1, paragraph 40-95(1)(b)] . Diagram 10 illustrates how the effective life of a depreciating asset is worked out by a taxpayer, for the first income year that the decline in value is to be calculated.

Diagram 1.1: Determining the effective life of a depreciating asset for the first calculation year

1.125 The initial estimate of an assets effective life must be worked out from the depreciating assets start time, that is, when the asset is first used, or first installed ready for use, for any purpose. However, the choice need not be made at that time. The choice only needs to be made for the income year in which the start time occurs. [Schedule 1, item 1, subsection 40-95(3)]

1.126 A reasonableness test applies when estimating the wear and tear of the asset and the condition in which the asset will be maintained. A reasonable estimate will depend on the circumstances in which the asset is to be used by the taxpayer (or any other expected user).

Example 1.16: Effective life

Andre runs a tennis-coaching clinic. During the income year, Andre purchases a new ball launching machine for use during training sessions. According to the machines specifications, the maximum number of tennis balls that can be launched from the machine is 1 million. From previous coaching experience, Andre estimates that the machine will be used to fire an average of 10,000 tennis balls per month. The effective life of the machine, based on Andres anticipated level of usage, is therefore 8 1/3 years.

1.127 The estimated effective life of an asset is to be expressed in terms of years, including parts of years - it is not estimated and then rounded to the nearest whole year. Therefore, if the effective life of a particular asset is estimated to be 4 years and 7 months, the effective life component in the formulas would be expressed as 4 and 7/12 years. Of course, for many assets, the actual effective life will be estimated to be a number of whole years.

Recalculating effective life

1.128 A taxpayer may choose, and in some cases is required, to recalculate the effective life of a depreciating asset. The methodology used for recalculating the effective life of a depreciating asset is based on the same principles that apply when self-assessing the original effective life of a depreciating asset: see section 40-105. [Schedule 1, item 1, subsection 40-110(4)]

1.129 For each income year in which improvements have been made to a depreciating asset, a taxpayer must consider the effect of these additions on the assets effective life. This allows for an appropriate allocation of the cost of these improvements over the effective life of the asset. In consequence, a taxpayer must recalculate the effective life of a depreciating asset in the following circumstances:

•

the taxpayer has self assessed the effective life and its cost increased by at least 10% in that year;

•

the taxpayer uses the Commissioners determination of effective life, uses the prime cost method and the depreciating assets cost increased by at least 10% in that year; or

•

the taxpayer uses an effective life because of subsection 40-95(4) and (5) and the depreciating assets cost increased by at least 10% in that year.

[Schedule 1, item 1, subsections 40-110(2) and (3)]

1.130 Without the requirement to reassess when using the Commissioners determination and the prime cost method, second element costs incurred late in the assets effective life could be deducted almost immediately even though these costs relate to future activities over a substantial period. The requirement to reassess is not necessarily burdensome, however, for example, if expenditure has not altered a previously estimated effective life, its reasonable simply to decide accordingly.

1.131 A taxpayer may choose to determine a new effective life for a depreciating asset where the way the asset is used or other circumstances relating to the nature of its use have changed, and the change means the effective life the taxpayer is using is no longer accurate. [Schedule 1, item 1, subsection 40-110(1)]

1.132 The application of subsection 40-110(1) is limited to cases where the basis used by the taxpayer in most recently estimating the effective life of the asset has changed. It does not extend to situations where the basis of the effective life estimate used in the calculations is incorrect due to a mistake of fact or error made by the taxpayer. In these cases, the taxpayer may apply to the Commissioner for an amendment of prior assessments.

1.133 The ability to reassess effective life applies regardless of whether the taxpayer has chosen to self-assess the effective life of the asset, has adopted the Commissioners determination of effective life or has reassessed under section 40-110. The general requirements for choices made under Division 40 do not apply in respect of recalculations of effective life. So taxpayers can reassess again if circumstances change again, and taxpayers can reassess effective life if circumstances change even if they were previously relying on a determination by the Commissioner [Schedule 1, item 1, subsection 40-130(3)] . Taxpayers cannot reassess the effective life of an intangible depreciating asset listed in subsection 40-95(7) [Schedule 1, item 1, subsection 40-110(5)] .

Splitting a depreciating asset

1.134 A taxpayer can split a depreciating asset into 2 or more assets. When a depreciating asset is split, the taxpayer no longer holds the original depreciating asset, instead the taxpayer now holds a number of different assets. The granting of a licence over an item of intellectual property will also be treated as a part disposal of that item of intellectual property. This will apply to allocate a portion of the cost to the split item of intellectual property disposed of as a result of the granting of the licence. This is done for the purposes of making any balancing adjustment or CGT calculation. [Schedule 1, item 1, section 40-115]

1.135 A balancing adjustment event does not occur when a depreciating asset is split (although generally a balancing adjustment event occurs when, amongst other things, a taxpayer either stops holding a depreciating asset or stops using the depreciating asset). Because there is no balancing adjustment event when a depreciating asset is split, there will not be an adjustment to the taxpayers taxable income for any difference between the actual value of the asset when the taxpayer stopped holding the depreciating asset (i.e. when it was split) and its adjustable value. Balancing adjustment events and affiliated rules are discussed in Chapter 3. [Schedule 1, item 1, subsection 40-295(3)]

1.136 In determining whether the split assets can be declined, each asset must individually be identified and must satisfy the requirements in Subdivision 40-B. Depreciating assets are practically unlikely to be split into assets that are not depreciating assets, however.

1.137 The first element of the cost for each of the split assets is a reasonable proportion of the sum of the adjustable value of the original asset just before it was split and the same proportion of the amount the taxpayer is taken to have paid under section 40-185 to receive the economic benefit involved in splitting the original asset (i.e. essentially, the cost of the split) - cost is discussed in Chapter 2. [Schedule 1, item 1, section 40-205]

1.138 If a balancing adjustment event occurs to one of the new depreciating assets, the amount to be included in the taxpayers assessable income or the amount that can be deducted is reduced by:

•

the amount that is attributable to the use of the asset other than for a taxable purposes; and

•

the amount that can reasonably be attributed to the use of the original depreciating asset (before it was split) for non-taxable purposes.

[Schedule 1, item 1, subsection 40-290(3)]

Example 1.17: Splitting depreciating assets

Hamish is an owner-driver of a transport truck. 90% of the trucks use can be attributed to a taxable purpose. In August 2001 Hamish removes the CB radio that is attached to his truck and installs it at home. Assuming that the CB radio is part of the whole truck, there has been a splitting of a depreciating asset. There will be no balancing adjustment event when the CB radio is split from the truck. The first element of the cost of the CB radio will be determined in accordance with section 40-205.

One year later Hamish sells the CB radio that he and his family have been using from home. The use of the radio that can be attributed to non-taxable purposes is 40%, the remaining use has been for a taxable purpose. In determining the amount that is either to be included in Hamishs assessable income or that can be deducted, the use that can be attributed to non-taxable purposes must be calculated not only when the radio was used at home (at 40% for that period) but also when it was a part of the truck (at 10% for that period).

1.139 An asset that has been split may be merged with other depreciating assets in accordance with section 40-115 (these rules are discussed in paragraphs 10 to 1.153).

1.140 If a taxpayer holds a depreciating asset jointly, section 40-35 provides that each taxpayers holding of the underlying asset is treated as a separate depreciating asset (these rules are discussed in paragraphs 10 to 1.62). [Schedule 1, item 1, section 40-35]

1.141 When a taxpayer stops holding part of a depreciating asset because it is now held jointly they are considered to have split the original depreciating asset into an asset that is kept by the taxpayer and an asset that the taxpayer ceases to hold. In other words, when a taxpayer becomes a joint holder, because they give up an interest in a depreciating asset, they are taken to have split the underlying asset into new assets, that is, the interest retained and the interest given up. The normal balancing adjustment rules apply to the new asset that the taxpayer is taken to have stopped holding. The same principles that are discussed in paragraphs 10 and 10 in relation to balancing adjustments and cost applies to the new assets that have been created by the split. [Schedule 1, item 1, subsection 40-115(2)]

Example 1.18: Splitting part of a depreciating asset

PJ Ltd holds a 50% interest in a depreciating asset with another joint venturer. Pursuant to section 40-35, PJ Ltds 50% interest in the depreciating asset is considered to be a separate depreciating asset. Two years later, PJ Ltd decides to sell 15% of the underlying depreciating asset. In accordance with subsection 40-115(2), PJ Ltd is treated as having split the depreciating asset it holds into 2 separate assets. The first of these new assets is the asset that is to be sold. The second asset is the asset that PJ Ltd is to retain. PJ Ltd will need to choose between self-assessing the effective life for the depreciating asset and using the Commissioners safe harbour determination of effective life if there is one. As the underlying asset does not change and neither do the circumstances of use, the actual effective life will not change. PJ Ltd must also choose a method for calculating the assets decline in value.

Spectrum licences

1.142 A spectrum licence is issued by the ACA pursuant to the Radcom Act for a period of up to 15 years. Spectrum licences allow the licence holders access to specified parts of the radio frequency spectrum in order to provide telecommunications services such as mobile telephone services.

1.143 An objective of the ACAs spectrum licensing process is to allow the market to play a part in the allocation of spectrum between users, not only in the auction process (the initial allocation of spectrum by the ACA), but also by the creation of a legislative environment that allows for a secondary market in spectrum licences. Licensees are able to trade licences, or parts of licences, provided that they follow the rules about trading which are found in sections 85 to 88 of the Radcom Act. The Radcom Act defines part of a licence to include both geographic area and radio frequency (Radcom Act at section 5).

1.144 Taxpayers are able to acquire licences or parts of licences from each other in the market place and aggregate them to form licences covering, for example, a larger area or more bandwidth. Taxpayers are also capable of dividing their licences into smaller parts and disposing of any or all of these parts.

1.145 The ACA has the authority to vary existing spectrum licences, or to issue one or more new licences, to give effect to an assignment of part of a licence, under Division 5 of Part 30 of the Radcom Act, or the partial resumption of a licence under Division 6 of Part 30 of that Act. The ACA may:

•

vary the original licence by reducing the spectrum specified in the licence;

•

vary the original licence to reflect part of the remaining spectrum and issue one or more new licences (to the same entity) to reflect the remaining spectrum; or

•

issue one or more new licences which reflect all of the reduced spectrum.

1.146 In these circumstances the modified original licence or the new licence(s) will not be the same depreciating asset as the original licence. Therefore a balancing adjustment would be triggered. However, the reality is that the taxpayer still holds the same spectrum. A legislative fiction has been created to treat the whole process as a splitting of the original licence (just after the assignment has taken place) into the replacement licences. [Schedule 1, item 1, subsection 40-120(1)]

1.147 The provisions in this Bill relating to merging depreciating assets, splitting depreciating assets and replacement spectrum licences are all capable of operating on spectrum licences in some way.

Example 1.19: Disposal of spectrum

Consider the example in section 40-120. The assignment of the spectrum relating to area C triggers the operation of subsection 40-115(2) because MGP has stopped holding part of a depreciating asset (the spectrum relating to area C). The spectrum relating to area C is now taken to be a different depreciating asset. The adjustable value of $1 million that is allocated to that asset is compared to the amount received from the assignee in order to calculate the balancing adjustment under section 40-285.

Example 1.20: Replacement spectrum licences

To carry the previous example further, the ACA decides to modify the licence that MGP holds in order to reflect the fact that it now only specifies areas A and B (because they are adjoining areas) and issues a new licence to MGP that specifies only area D. The 2 licences together specify the same rights that were covered by the original licence just after the assignment of the spectrum relating to area C (i.e. areas A, B and D). Therefore, subsection 40-120(1) operates to split the original licence into the 2 new licences.

1.148 Because of the trading market that has been set up in spectrum, a taxpayer may eventually acquire several licences over adjoining areas. In such cases the ACA may resume all of those licences and replace them with one licence specifying all of the areas. Such a scenario would trigger the operation of section 40-120. The adjustable values of all of the separate spectrum licences would be added together and become the adjustable value of the replacement licence.

Merging a depreciating asset

1.149 A taxpayer can merge a depreciating asset he or she holds into another asset. When this occurs the taxpayer no longer holds the original depreciating asset, but holds the merged asset. [Schedule 1, item 1, section 40-125]

1.150 A balancing adjustment event does not occur to depreciating assets that are merged into one or more other depreciating assets. [Schedule 1, item 1, subsection 40-295(3)]

1.151 In determining whether the merged asset or assets can be written-off, the requirements in Subdivision 40-B must be satisfied. The first element of the cost of each of the merged depreciating assets is the reasonable proportion of the sum of the adjustable values of the original assets just before they were merged, and the amount the taxpayer is taken to have paid under section 40-185 to receive the economic benefit involved in merging the original assets (i.e. essentially, the cost of the merger). [Schedule 1, item 1, section 40-210]

1.152 If a balancing adjustment event occurs to one of the new merged depreciating assets, the amount to be included in the taxpayers assessable income or the amount that can be deducted is reduced by:

•

the amount that is attributable to the use of the asset other than for a taxable purpose; and

•

the amount that can be reasonably attributed to the use of the original depreciating assets prior to the merger for non taxable purposes (these rules are discussed in Chapter 3).

[Schedule 1, item 1, section 40-290]

1.153 An asset that has been merged may itself then be split into separate depreciating assets in accordance with section 40-115 (these rules are discussed in paragraphs 10 to 1.141). Similarly, an asset that has been split from another asset may then be merged. The rules are designed to work together in such cases to give the same outcome as if a succession of separate splits and mergers had taken place.

Choices under Division 40

1.154 The general rules relating to when a taxpayer must exercise a choice provided under Division 40, and the effect of this decision, are contained in section 40-130. For the income year that the decline in value is first calculated, a taxpayer will need to decide:

•

whether the prime cost or diminishing value method will be used in calculating the decline in value of the asset; and

•

whether the effective life of the depreciating asset will be self-assessed or whether the taxpayer will rely on the Commissioners determination of effective life.

1.155 The decisions must generally be made by the time the taxpayer actually lodges the income tax return for the first income year that the decline in value is being calculated for [Schedule 1, item 1, paragraph 40-130(1)(a)] . Further, a taxpayer cannot revoke a decision once it has been made [Schedule 1, item 1, subsection 40-130(2)] . This rule prevents taxpayers from swapping between the prime cost and diminishing value methods, or varying the effective life of an asset, without the necessary changes in circumstances occurring, when it would be advantageous to do so.

1.156 However, in certain cases a taxpayer may be allowed additional time for making these decisions [Schedule 1, item 1, paragraph 40-130(1)(b)] . An example of where the Commissioner might grant such an extension is where a taxpayer has sought a determination of the effective life of an asset and has asked for an extension of time to make a choice.

1.157 There is no requirement for the taxpayer to formally notify the Commissioner of the method chosen for calculating the decline in value of a depreciating asset. The Commissioner might, however, require notification of a taxpayers choice to self-assess the effective life of a depreciating asset on an income tax return.

Anti-avoidance rules

1.158 Where a taxpayer is entitled to receive a deduction under Division 40 in respect of a depreciating asset, section 40-135 treats the taxpayer as the owner of the asset for the purposes of applying certain anti-avoidance provisions. This rule replicates Common Rule 3 of the existing capital allowances anti-avoidance provisions. [Schedule 1, item 1, section 40-135]

1.159 The relevant anti-avoidance provisions are those relating to disallowable deductions in respect of property held under certain leveraged arrangements, and certain non-leveraged finance arrangements relating to the use of property. These are presently section 51AD and Division 16D of the ITAA 1936. [Schedule 1, item 1, section 40-135]

Obtaining information from associates

1.160 To assist associates with the implementation of the rules, section 40-140 authorises a taxpayer to issue to the associate from whom they acquired a depreciating asset a written notice within 60 days of acquisition requesting the associate to provide information on:

•

whether the prime cost or diminishing value method was applied in determining the assets decline in value for the period that the associate held the asset; and

•

the period of effective life the associate attributed to the asset.

[Schedule 1, item 1, subsection 40-140(1) and paragraph 40-140(2)(a)]

1.161 A notice issued to an associate must also address the following matters in order for the taxpayers request to be valid:

•

the period within which the associate must provide the information being sought. The taxpayer must give at least 60 days for enabling an associate to respond; and

•

the implications of failing to comply with the request (i.e. that a penalty of 10 penalty units applies).

[Schedule 1, item 1, paragraphs 40-140(2)(b) and (c)]

1.162 In the case where an associate of the taxpayer is a partnership, the obligation to provide the information requested by the taxpayer is imposed on each of the partners. Any one of the partners may respond to the request. [Schedule 1, item 1, paragraph 40-140(4)(b)]

1.163 It is an offence for an associate to fail or intentionally refuse to provide the information requested by the taxpayer [Schedule 1, item 1, subsections 40-140(3) and (5)] . In order to avoid the imposition of a penalty an associate will have only one opportunity to discharge the obligations arising from a notice issued in accordance with subsection 40-140(1). This is because the associate cannot be issued with more than one notice in respect of each depreciating asset [Schedule 1, item 1, subsection 40-140(6)] . If charged for an offence under Subdivision 40-B, a taxpayer can rely on the relevant defences available under the Criminal Code Act 1995 [Schedule 1, item 1, section 40-145] .

1.164 A penalty of 10 penalty units applies for failing to comply with a notice issued pursuant to section 40-115. [Schedule 1, item 1, subsections 40-140(3) and (5)]

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:

•

the 2 elements of cost;

•

which amounts are included in cost;

•

which amounts are not included in cost; and

•

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:

•

achieving standardisation; and

•

providing a more robust framework.

2.4 The cost rules introduce concepts that recognise payments made:

•

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

•

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:

•

first element costs;

-

expenses in order to hold the asset; and

•

second element costs;

-

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:

•

GST input credits and decreasing adjustments;

•

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

•

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

•

amounts deductible outside Division 40; and

•

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:

•

the car limit; and

•

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:

•

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

•

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:

•

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

-

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

•

a specified amount in particular cases:

-

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:

•

consideration given:being the sum of the following:

-

money paid or non-cash benefits provided;

-

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

-

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

•

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

-

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

-

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:

•

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

•

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

•

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:

•

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

•

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

•

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

•

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:

•

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

•

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:

•

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

•

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:

•

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

•

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:

•

the market value of the chainsaw she provided; and

•

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:

•

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

•

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:

•

the truck to be $50,000; and

•

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:

•

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

•

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:

•

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

•

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

•

$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:

•

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

•

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

Example 2.10

Mary owns 3 spectrum licenses covering:

•

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

•

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

•

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)]

Chapter 3 - Balancing adjustments

Outline of chapter

3.1 This chapter explains amendments to be made to the income tax law that will provide certain adjustments to a taxpayers assessable income or deductions. These adjustments must be made when:

•

a taxpayer stops holding a depreciating asset;

•

a taxpayer stops using a depreciating asset for any purpose and expects never to use it again;

•

a taxpayer has not used a depreciating asset and expects never to use it; or

•

there is a change in the holding of, or in the interest of entities in the asset, and one of the entities that have an interest after the change, held the asset before the change.

3.2 In these cases, the adjustable value of the asset is compared with its termination value. If the termination value is higher, the adjustable value (which reflects past decline and original cost) is below the actual value, and the difference generates a balancing charge for inclusion in income. (If a depreciating asset has actually increased in value while it was held, the gain is fully assessable: corresponding to the immediate deductions available in relation to the statutory decline.) If the termination value is lower, the adjustable value is above the actual value, and the difference generates a balancing deduction against income.

Context of reform

3.3 Division 42 of the ITAA 1997 (depreciation of plant) currently provides for the calculation of a balancing adjustment when a balancing adjustment event occurs. By incorporating these parallel but not identical provisions and concepts into the uniform capital allowance system in accordance with the recommendations in A Tax System Redesigned, a more neutral tax treatment can be achieved for all the depreciating assets subject to the uniform capital allowance system.

Summary of new law

3.4 An amount is included in assessable income when the termination value of a depreciating asset is more than its adjustable value. An amount is deducted when the termination value of a depreciating asset is less than its adjustable value. There is a reduction in the amount included in assessable income, or the amount deducted, in proportion to the extent of use of the depreciating asset for purposes other than a taxable purpose. There is also a further reduction for leisure facilities and boats.

3.5 The termination value of a depreciating asset is worked out using the table in section 40-300. The termination value of a car may be adjusted where the cost of the car is affected by the car limit. The termination value is reduced by expenses that are reasonably attributed to the balancing adjustment event occurring for that asset. Where an amount is received for 2 or more things that include a balancing adjustment event occurring for a depreciating asset, only that part of what is received that is reasonably attributable to the asset is taken into account as its termination value.

3.6 The adjustable value of a depreciating asset is decreased in applying the balancing adjustment provisions if a taxpayer had deducted or can deduct an amount for the asset under section 73B of the ITAA 1936 relating to expenditure on R&D.

3.7 Where a taxpayer abandons in-house software prior to use or installation, he or she can deduct any expenditure incurred on such software where he or she incurred the expenditure and the software was intended to be used or installed ready for use for a taxable purpose.

3.8 A taxpayer may exclude some or all of an amount that has been included in assessable income for a depreciating asset as a result of a balancing adjustment event that constitutes an involuntary disposal of the asset to the extent that the taxpayer chooses to treat that amount as an amount he or she has deducted for one or more replacement assets.

3.9 Adjustments are worked out differently for a car where different car expense methods have been used.

Detailed explanation of new law

Balancing adjustments

3.10 Subdivision 40-D to this Bill provides for balancing adjustments to be either added to a taxpayers assessable income or deducted when a balancing adjustment event occurs [Schedule 1, item 1, Subdivision 40-D] . The most common balancing adjustment event is where a depreciating asset is sold. The balancing adjustment is generally based on the difference between the termination value of the asset when a taxpayer stops holding it and its adjustable value. There are special rules about private use of assets, in-house software expenditure, involuntary disposals and cars.

Balancing adjustment included in assessable income

3.11 An amount is included in a taxpayers assessable income if a balancing adjustment event occurred for a depreciating asset he or she held and the assets termination value is more than its adjustable value just before the event occurred. The amount included is the difference between those amounts, and it is included for the income year in which the balancing adjustment event occurred. [Schedule 1, item 1, subsection 40-285(1)]

3.12 However, an amount is only included under subsection 40-285(1) if the decline in value has been worked out under Subdivision 40-B or would have been worked out under this Subdivision had the taxpayer used the asset. This will ensure that an amount is only included for this balancing adjustment event if Subdivision 40-B has been or could be used. Other Subdivisions in Division 40 have their own balancing adjustment mechanisms, for example, Subdivision 40-E. Further, amounts will be included in assessable income for balancing adjustments on depreciating assets that have not been used, for example, where an asset is destroyed prior to it being used.

Example 3.1

Kris is a house painter and is painting a house for a client. Every afternoon Kris leaves her trestles and ladders neatly stored in a corner of the garden, there being no other storage available. One morning Kris arrives at work to discover that one of her ladders has been vandalised and has been rendered useless.

Kris makes a claim on her insurance policy and receives $5,000. This amount is the termination value because it satisfies item 8 in the table in subsection 40-300(2). The adjustable value of the ladder at the beginning of the income year was $2,800 and its decline in value up to the date the ladder was destroyed was $800. Thus the adjustable value of the ladder when it was destroyed was $2,000. The amount that Kris will include in her assessable income as a balancing adjustment is $3,000, being $5,000 - $2,000.

3.13 A different calculation is used if the depreciating asset is a car and the taxpayer had also been using the cents per kilometre method and/or the 12% of original value method of substantiation. This rule is discussed in paragraphs 30 to 3.97. [Schedule 1, item 1, section 40-370]

Balancing adjustment that can be deducted

3.14 A taxpayer can deduct an amount if a balancing adjustment event occurred for a depreciating asset he or she held and the assets termination value is less than its adjustable value just before the event occurred. The amount is the difference between those values, and the taxpayer can deduct it for the income year in which the balancing adjustment event occurred. [Schedule 1, item 1, subsection 40-285(2)]

3.15 However, an amount is only deducted under subsection 40-285(2) if the decline in value has been worked out under Subdivision 40-B or would have been worked out under this Subdivision had the taxpayer used the asset. This will ensure that an amount is only deducted for this balancing adjustment event if Subdivision 40-B has been or could be used. Other Subdivisions in Division 40 have their own balancing adjustment mechanisms, for example, Subdivision 40-E. Further, amounts will be deducted from a taxpayers assessable income for balancing adjustments on depreciating assets that have not been used, for example, where an asset is destroyed prior to it being used.

3.16 Once a balancing adjustment has occurred the adjustable value of the depreciating asset held by the taxpayer is then zero [Schedule 1, item 1, subsection 40-285(3)] . This rule has the general effect that an amount cannot be later included in assessable income or deducted, in respect of a depreciating asset, where it has already been taken into account on an earlier balancing adjustment event. As you would expect, where a depreciating asset continues to be held, or is reacquired, there may be further amounts of cost; these will be included in cost by the operation of the usual cost rule.

3.17 However, if after the balancing adjustment event occurs the depreciating asset is held in accordance with items 3 or 4 of the cost table in subsection 40-180(2), the adjustable value of this asset will not be zero. Instead, the adjustable value will be its cost as stated in items 3 or 4 of subsection 40-180(2) (i.e. its termination value). In effect, in these cases, the termination value on which the earlier balancing adjustment was calculated becomes the cost once reuse arises. This is appropriate, because that termination value was treated as the remaining value of the asset when reconciling the deductions so far allowed to the actual loss of value of the asset. As that value remained, it is the starting point for any further decline and further deductions for decline in the value of the asset. Where the taxpayer begins to reuse the asset after a balancing adjustment event occurs in which they continue to hold the depreciating asset, they must continue to use the same method to work out the decline in value of their asset as they had used before the balancing adjustment event occurred. The taxpayer is however entitled to re-exercise their choice in determining the effective life of the asset. [Schedule 1, item 1, subsection 40-285(4)]

Example 3.2

Greta writes novels and due to the success of her last book she felt that she could afford to buy a computer for word processing rather than continue to use her typewriter. The typewriters adjustable value at the start of that income year was $1,000. At the date that Greta installed her new computer ready for use there had been a $200 decline in value in the typewriter. Greta was unable to find a buyer for her typewriter and determined its market value was about $20 (its termination value). Assuming the typewriter was used solely for a taxable purpose, the balancing adjustment for the typewriter was $780. This amount was a deduction.

Two years later Gretas computer is ruined by a virus, so in order for her to complete her latest novel Greta starts using her typewriter again. Because item 3 in the table in subsection 40-180(2) is satisfied the adjustable value of the typewriter is $20, it will not be zero.

Capital gains tax

3.18 Section 118-24 of the ITAA 1997 is to be amended . This amendment will remove depreciating assets from the CGT provisions unless CGT event K7 applies. Generally, these assets will now fall under Division 40. The consequence of this is that, where a balancing adjustment event has occurred, a balancing adjustment must be made. However, if any part of the balancing adjustment for a depreciating asset is reduced because a proportion of the deductions for decline were not allowable (for instance because the asset was also used for purposes other than taxable purposes) and the balancing adjustment is proportionately reduced under section 40-290, there may still be that proportion of the CGT gain or loss available. The CGT consequences are dealt with in Chapter 12.

Balancing adjustment event

3.19 A balancing adjustment event occurs in one of 4 ways:

•

a taxpayer stops holding a depreciating asset;

•

a taxpayer stops using a depreciating asset or holding it ready for use for any purpose, never expecting to do so again;

•

a taxpayer has not used a depreciating asset and expects never to use it and if it was installed ready for use the taxpayer ceases to have it installed ready for such use; or

•

if a change occurs in the holding of, or in the interests in an asset and at least one of the entities that have an interest after the change held the asset before the change and that asset was a partnership asset before the change or became one as a result of the change.

[Schedule 1, item 1, subsections 40-295(1) and (2)]

3.20 However, due to subsection 40-30(5), a balancing adjustment event will not occur where, upon the expiry of a right that is a depreciating asset, that right is renewed or extended.

3.21 A balancing adjustment event occurs under paragraph 40-295(1)(a) when deductions for a depreciating asset stop because the taxpayer no longer holds it. This covers, amongst other things:

•

the disposal, sale, loss or theft of a depreciating asset;

•

the situation when a taxpayer converts a depreciating asset to trading stock, as referred to in section 70-30 of the ITAA 1997 [Schedule 1, item 1, subsection 40-295(1), note] ;

•

a taxpayer lessee ceases to be taken to be the owner of a luxury car as mentioned in subsections 42A-15(3) or 42A-80(3) in Division 42A of Schedule 2E to the ITAA 1936;

•

a taxpayer lessor or lessee is taken to have disposed of a luxury car as mentioned in subsections 42A-15(1), 42A-90(2) or 42A-105(2) in Division 42A of Schedule 2E to the ITAA 1936; or

•

the taxpayer dies.

3.22 A balancing adjustment event occurs under paragraph 40-295(1)(b) when deductions for a depreciating asset stop because the asset will no longer be used for any purpose. This includes in-house software where a taxpayer:

•

permanently stops using the asset;

•

permanently stops having it installed ready for use; and

•

to the extent that the expenditure is on a right to use software it is reasonable to expect that the taxpayer will never obtain a subsequent right to use the underlying software.

3.23 Further examples of where a balancing adjustment event may occur under paragraph 40-295(1)(b) include:

•

the cessation of activity in one mine on a multiple mine property;

•

the cessation of activity in a particular mining seam or area within a mine;

•

the cessation of use of a particular mining asset (such as a decline, haul road or shaft) within a mine as the mining operations evolve over time; or

•

the holding of a mining right after all potential mining activities have ceased.

3.24 If a taxpayer who has not yet used a depreciating asset decides never to use it, that is a balancing adjustment event too. The circumstances in which it is available are similar. [Schedule 1, item 1, paragraph 40-295(1)(c)]

Splitting and merging assets

3.25 Splitting a depreciating asset into 2 or more depreciating assets or merging it with another depreciating asset is not a balancing adjustment event [Schedule 1, item 1, subsection 40-295(3)] . However, a balancing adjustment event will occur if a taxpayer stops holding a split or a merged depreciating asset, for example, when the taxpayer sells a merged asset or one of the assets into which an asset was split (splitting and merging assets are discussed in paragraphs 10 to 10 and 10 to 1.153).

How is a depreciating assets termination value worked out?

Which amounts are included in termination value?

3.26 Generally, the termination value of a depreciating asset consists of amounts a taxpayer has received, or is taken to have received, in relation to the asset under a balancing adjustment event. These amounts will include non-cash benefits that a taxpayer has received. However, in certain circumstances the termination value will be a particular amount attributed under the termination value rules rather than the amount actually received.

3.27 In addition, where a taxpayer receives a payment for several things that include a depreciating asset, that payment will be apportioned between the termination value of the depreciating asset and those other things.

Which amounts are not included in termination value?

3.28 Generally, the termination value of a depreciating asset will be reduced by the expenses of a balancing adjustment event.

What adjustments are made to termination value?

3.29 The termination value of a depreciating asset will be adjusted for the following:

•

the car limit; and

•

acquiring a car at a discount.

How is a depreciating assets termination value worked out?

3.30 The termination value of a depreciating asset (essentially, what was received under a balancing adjustment event) is either:

•

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

-

generally, a balancing adjustment event occurs because a taxpayer receives money (or something other than money) to stop holding an asset or because the taxpayer has stopped holding the asset. Examples include selling the asset and an insurance payout for the destruction of the asset. The sum of these amounts will be the termination value in all cases except the special cases listed in paragraphs 30 to 30 [Schedule 1, item 1, subsection 40-300(1)] ; or

•

a specified amount in particular cases:

-

for a number of special cases the termination value is attributed directly, regardless of the amount the taxpayer actually received [Schedule 1, item 1, subsection 40-300(2)] .

Amounts a taxpayer has received or is taken to have received

3.31 Generally, the termination value of a depreciating asset is simply the amount a taxpayer has received or is taken to have received, or the value of non-cash benefits a taxpayer has received or is taken to have received, under a balancing adjustment event. This includes receipts such as the sale price of an asset. This will be the case in all circumstances other than the special situations listed in paragraphs 30 to 3.65. [Schedule 1, item 1, subsection 40-300(1)]

3.32 That is the greater of:

•

consideration received: being the sum of the following:

-

money or non-cash benefits received;

-

a right to be paid money or receive non-cash benefits; and

-

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

•

deductible amounts: being the sum of the following:

-

the amounts that form the basis on which the taxpayer is entitled to deduct because the taxpayer stopped holding the asset; and

-

any amount by which the amounts that form the basis for deductions were reduced because of any consideration received.

3.33 This reflects the view that all applicable deductions will generally represent the full value of the asset on termination, and that all actual receipts of amounts (including non-cash benefits) will offset the applicable deductions. [Schedule 1, item 1, subsection 40-305(1)]

Consideration received

Money received

3.34 The main case is simply receiving money under a balancing adjustment event, in which case the termination value is that amount [Schedule 1, item 1, subsection 40-305(1), item 1 in the table] . This would cover the most common case where money is received on the sale of an asset.

3.35 In addition, a taxpayer will be taken to have received amounts under notional transactions that are deemed to have occurred under the tax law. These amounts include:

•

the price of the notional sale when a depreciating asset is converted to trading stock under section 70-30 of the ITAA 1997;

•

the consideration for an asset held under a hire purchase arrangement under section 240-25 of the ITAA 1997^[F2];and

•

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

3.36 In addition, when a taxpayer reduces (or terminates) a liability to pay an amount measured in money, under a balancing adjustment event, that reduction will be included in the assets termination value. [Schedule 1, item 1, subsection 40-305(1), item 2 in the table]

3.37 Also, where a taxpayer is granted a right to receive an amount measured in money (or increasing an existing right to receive) under a balancing adjustment event, the termination value is the amount of the right (or the increase in the right) when the event occurred. [Schedule 1, item 1, subsection 40-305(1), item 3 in the table]

Non-cash benefits received

3.38 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 receive non-cash benefits under a balancing adjustment event mirror those for taxpayers who receive money.

3.39 Where a taxpayer received non-cash benefits under a balancing adjustment event the market value of those benefits at that time will be included in the termination value. [Schedule 1, item 1, subsection 40-305(1), item 4 in the table]

3.40 Similarly, where a taxpayer is granted a right to receive non-cash benefits under a balancing adjustment event, the termination value includes the market value of those non-cash benefits at that time. Also, the termination value will include the market value at that time of any increase in an existing right to receive property or services. [Schedule 1, item 1, subsection 40-305(1), item 6 in the table]

3.41 Finally, when a taxpayer reduces (or terminates) a liability to provide non-cash benefits under a balancing adjustment event, the market value at that time of the non-cash benefits retained will be included in the assets termination value. [Schedule 1, item 1, subsection 40-305(1), item 5 in the table]

Example 3.3

Andrew sells a panel-van (a depreciating asset) to Fiona, a house painter, in exchange for Fiona:

•

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

•

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

•

undertaking to re-paint Andrews home again in 10 years, the painting services are a non-cash benefit with a market value of $1,500; and

•

incurring a liability to pay Andrew $1,000.

His termination value for the panel-van is the sum of these amounts, that is, $7,500.

Only include outstanding rights to receive amounts

3.42 Termination value does not include any part of the right to receive an amount or non-cash benefits that has already been satisfied. Only outstanding rights to be paid money or to be provided non-cash benefits (or an increase in such rights) are included in the cost. [Schedule 1, item 1, subsection 40-305(2)]

Example 3.4

Brian enters into an agreement to sell a tractor in 4 months time on monthly instalments starting immediately totalling $10,000. By the time the balancing adjustment event occurs, he has already received $2,000. The termination value of the tractor is $10,000, being the $2,000 he has received plus the outstanding right to receive $8,000.

Deductible amounts

3.43 Alternatively, the termination value may consist of:

•

an amount a taxpayer may deduct; and

•

any amount by which that deductible amount is reduced because of an amount of consideration received,

where this total exceeds the amount of consideration received. [Schedule 1, item 1, paragraph 40-305(1)(a)]

Example 3.5

Splinko Pty Ltd gives a depreciating asset to one of its customers. This is not a private or domestic arrangement and so item 7 in the table in subsection 40-300(2) does not apply. The market value of the asset is a deductible outgoing under section 8-1 of the ITAA 1997.

Splinkos termination value for the asset will include the market value of the asset.

Specified termination value in particular cases

3.44 There are a number of special balancing adjustment events in which the termination value for a depreciating asset will be attributed specifically. This is a limited departure from the general principle that the termination value of a depreciating asset is the amount that is received under a balancing adjustment event. [Schedule 1, item 1, paragraph 40-300(1)(a)]

3.45 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 40-300(2)]

Expectation of permanent non-use

3.46 Where a taxpayer expects that they will never use a depreciating asset (for any purpose) there is a balancing adjustment event even though they continue to hold the asset. This will occur whenever a taxpayer:

•

stops using an asset and expects never to use it again [Schedule 1, item 1, paragraph 40-295(1)(b)] ; or

•

has not used an asset and decides to never use it [Schedule 1, item 1, paragraph 40-295(1)(c)] .

3.47 Generally, the termination value under those balancing adjustment events is the market value of the depreciating asset at the time of the event. [Schedule 1, item 1, subsection 40-300(2), items 1 and 2 in the table]

Example 3.6

Zinco Ltd operates an zinc mine. Due to falling prices for zinc, it closes its mine and stops using a conveyor belt it holds (a depreciating asset). It expects that the zinc prices will never recover sufficiently, so it does not keep holding the conveyor ready for use as it believes it will never use this asset again. This is a balancing adjustment event. The termination value of the conveyor belt is its market value just before Zinco formed the expectation that they would never use it again, $100,000.

Exception: In-house software

3.48 Where a taxpayer expects that they will never use, or will not use, in-house software ever again (for any purpose) there is also a balancing adjustment event even though they continue to hold the asset. However, the termination value for this kind of balancing adjustment is zero. [Schedule 1, item 1, subsection 40-300(2), items 3 and 4 in the table]

Partnership assets

3.49 In the simple case where a partner sells an asset, the termination value is the amount the partner received. [Schedule 1, item 1, section 40-305]

3.50 However, partners may contribute assets that they own individually for the use of the partnership. The partnership will often not pay an amount to become the holder of the asset. In these circumstances, a special rule is required to attribute the termination value of that asset for the partner.

3.51 Where an individual partner was the holder of the depreciating asset immediately before it became a partnership asset or a balancing adjustment event occurs because there is a change in the interest of the asset under subsection 40-295(2), the termination value for the partner is the market value of the asset when the partnership started to hold it or when that balancing adjustment event occurred. [Schedule 1, item 1, subsection 40-300(2), item 5 in the table]

Ceasing to be the holder under a non-arms length arrangement

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

3.53 Existing Common Rule 2 of Subdivision 41-B of the ITAA 1997 prevents a taxpayer from being able to manipulate the balancing adjustment based on an artificially understated purchase price and is subsumed within the proposed cost rules.

3.54 The rule provides that where a taxpayer stops holding 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

•

received (or are taken to have received) less than the market value of the asset,

the termination value is the market value of the asset when they stopped holding it. [Schedule 1, item 1, subsection 40-300(2), item 6 in the table]

3.55 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 outcome of their dealing is a result of real bargaining.

Example 3.7

Moe buys a car from his friend Barney. They agree that Moe will pay $10,000 for the car, which has a market value of $20,000. On the basis of the facts of the case, Moe did not deal at arms length with Barney and Barney got less than the market value. Barneys termination value for the car is the market value of that car, $20,000 rather than the $10,000 he received.

Ceasing to hold under a private or domestic arrangement

3.56 Where a taxpayer stops holding a depreciating asset under a private or domestic arrangement the termination value will be the market value of the asset, rather than the amount that the taxpayer has received to stop holding it. [Schedule 1, item 1, subsection 40-300(2), item 7 in the table]

3.57 The concepts of private or domestic are explained in paragraphs 20 to 2.64.

Example 3.8

Edna gives Seymour a typewriter (a depreciating asset) for his birthday. This is a private arrangement. The typewriter has a market value of $800.

Ednas termination value for the asset is therefore $800, notwithstanding that he has received nothing to stop holding the asset.

Lost or destroyed depreciating assets

3.58 The termination value of an asset that is lost or destroyed is the amount that a taxpayer receives as compensation for that loss or destruction. This will include amounts that a taxpayer has either received or has a right to receive under an insurance policy. [Schedule 1, item 1, subsection 40-300(2), item 8 in the table]

Death of a taxpayer

3.59 The termination value of a depreciating asset a taxpayer ceases to hold because of their death is the assets adjustable value at the date of death. This is only the case if the asset has passed to their legal personal representative. This codifies the current administrative practice. [Schedule 1, item 1, subsection 40-300(2), item 9 in the table]

3.60 The termination value of a depreciating asset that a taxpayer ceases to hold because of their death is the assets market value just before the taxpayer dies. This is only the case if the asset has passed to a joint tenant or directly to a beneficiary (i.e. it has not passed firstly to the legal personal representative). [Schedule 1, item 1, subsection 40-300(2), item 10 in the table]

3.61 The termination value of a depreciating asset that a legal personal representative ceases to hold because it has been passed to a beneficiary is the assets market value just before the legal personal representative ceased to hold the asset. [Schedule 1, item 1, subsection 40-300(2), item 9 in the table]

Leasing airports

3.62 The termination value table also deals with the special case where depreciating assets are transferred pursuant to the Airports (Transitional) Act 1996 which forms the framework for the leasing of federal airports by private companies.

3.63 That Act gives the Minister for Finance the power to determine the consideration receivable by the FAC for the transfer of assets as part of the scheme to lease the airports to private companies.

3.64 In such a case, the termination value for the FAC is the amount determined by the Minister. [Schedule 1, item 1, subsection 40-300(2), item 11 in the table]

Apportionment of termination value

3.65 If a payment is for several things that include a balancing adjustment event that occurs for a depreciating asset, only the reasonable part of it is treated as being for that event it covers. That is, the termination value will be apportioned between the balancing adjustment event for the asset and those other things. [Schedule 1, item 1, section 40-310]

Example 3.9

Luke receives $100,000 for the sale of both a chainsaw (a depreciating asset) and a block of land (not a depreciating asset). The $100,000 will be apportioned between:

•

the termination value of the chainsaw; and

•

the proceeds of sale for the land,

based on the relative market values of the chainsaw and the land.

What is not part of termination value

Expenses of a balancing adjustment event

3.66 Termination value is reduced by expenses a taxpayer incurs as a result of a balancing adjustment. Most commonly this reduction will consist of the expenses that are reasonably attributable to the sale of a depreciating asset, such as advertising expenses etc. However, this reduction will not include any amounts that a taxpayer has deducted or can deduct. [Schedule 1, item 1, subsection 40-315(1)]

Example 3.10

Stanley sells a motorcycle (a depreciating asset) for $10,000. He paid $100 to advertise the sale of the motorcycle in a newspaper, and this is not a deductible amount to him. His termination value is $9,900, being the amount he received ($10,000) less the expenses reasonably attributable to the balancing adjustment event ($100).

3.67 This adjustment to termination value does not apply to taxpayers that:

•

cease to be the holder under a non-arms length arrangement; or

•

transfer assets as part of a privatisation scheme to lease an airport.

[Schedule 1, item 1, subsection 40-315(2)]

Adjustments to termination value

Car limit

3.68 Where the first element of 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 that element of cost is reduced to the car limit for that financial year (see paragraphs 20 to 2.93). [Schedule 1, item 1, subsection 40-230(1)]

3.69 The termination value of the car is adjusted to account for this reduction in cost. This adjustment recognises that the car limit has restricted the proportion of the cars cost that has been available to be declined, and recognises only that same proportion of the assets termination value for the purposes of a balancing adjustment. The adjustment is made by multiplying the termination value by:

car limit + any second element of cost / total cost of the car (ignoring the car limit)


[Schedule 1, item 1, section 40-325]

Example 3.11

Ben acquires a car for $90,000. The first element of cost of a car to him is $90,000. This is then adjusted so that the final adjusted first element of cost is $55,134.

He incurs $10,000 of second element costs over the next year he holds the car.

He sells the car for $85,000. The termination value is:

$85,000 * ($55,134 + $10,000) / $100,000) = $55,364


Acquiring a car at a discount

3.70 The first element of cost of a car is increased when a car is acquired at a discount (see paragraphs 20 to 2.98). The termination value for the taxpayer who is disposing of the car under that transaction will also be increased by the amount of the discount portion. [Schedule 1, item 1, section 40-320]

Example 3.12

Geoff arranges to buy a $40,000 car from Tom, a car dealer, and at the same time trade in an old ute worth $10,000. The changeover price is therefore $30,000. Tom agrees to reduce the price of the car to $35,000 but only if Geoff accepts $5,000 for the trade-in of the ute. There is a discount portion of $5,000 in this arrangement.

The cost of the car is adjusted to $40,000, being the discount portion ($5,000) plus the amount paid by Geoff ($35,000).

For Tom, the balancing adjustment is worked out on the basis of a termination value of $40,000 for his car, being the amount he has received ($35,000) plus the discount portion ($5,000).

Adjustable value

3.71 As mentioned in paragraph 3.10, the amount of a balancing adjustment is worked out by comparing the assets termination value and its adjustable value [Schedule 1, item 1, section 40-285] . The general adjustable value rules are discussed in paragraphs 10 to 1.102.

Reduction for undeductible decline

3.72 The amount of the balancing adjustment to be included in assessable income, or the amount to be deducted, is reduced by the amount that is attributable to the use of the asset other than for a taxable purpose, for example, using the depreciating asset for private purposes or for gaining exempt income. Further, there are other reductions in deductions for the decline of depreciating assets that are mentioned in section 40-25 that may also reduce the amount that is to be included in assessable income or that can be deducted. [Schedule 1, item 1, subsection 40-290(1)]

3.73 The formula to use that will reduce the amount of the balancing adjustment is:

sum of reductions for an asset under section 40-25 / total decline in the value of the depreciating asset since it was held by the taxpayer * balancing adjustment amount


This means the balancing adjustment (whether a deduction or an income amount) is reduced simply according to the extent to which deductions for the decline of the asset were reduced. There is no regard taken to when or why the deductions were reduced, and no attempt to work out to what period the difference between the decline and the actual change in value of the asset are attributable. Further, the formula ensures that in the event of rollover relief under section 40-340 or a legal personal representative holding the asset, the use of the asset for purposes other than taxable purposes by any earlier transferor or the deceased can be taken into account in working out the reduction. [Schedule 1, item 1, subsection 40-290(2)]

Split and merged assets

3.74 Where a balancing adjustment event occurs to a merged depreciating asset (or assets) or a split depreciating asset, the amount to be included in the taxpayers assessable income or the amount that can be deducted is reduced by:

•

the proportion of the decline for the new asset or assets that was not deductible, for instance, because an amount was attributable to the use of the asset other than for a taxable purposes [Schedule 1, item 1, subsection 40-290(1)] ; and

•

the further amount that can reasonably be attributed to the use of the original depreciating asset prior to it being split or merged for non-taxable purposes. This means that although the asset took over a cost based on the adjustable value of the source assets at the time they were split or merged, the earlier history of those assets can be taken into account so far as their deductions were less than their decline [Schedule 1, item 1, subsections 40-290(3) and (4)] .

These rules are discussed in paragraphs 10 to 10 and 10 to 1.153.

3.75 However, there is no reduction required where the depreciating asset is mining, quarrying or prospecting information. This reflects the exclusion of such information from any residual capital gains consideration, as it is not a CGT asset. [Schedule 1, item 1, subsection 40-290(5)]

Deduction for in-house software expenditure

3.76 A taxpayer can deduct certain in-house software expenditure he or she has incurred. In-house software is not just software developed in-house; it includes software for use in-house. It is computer software, or a right to use such software that the taxpayer has acquired, developed or has had another entity develop:

•

that will be used mainly by the taxpayer in performing the functions for which the software was developed; and

•

the taxpayer cannot deduct the expenditure in acquiring or developing this software expenditure under a provision outside Division 40.

[Schedule 2, item 394 of the New Business Tax System (Capital Allowances - Transitional and Consequential) Bill 2001, subsection 995-1(1)]

3.77 A taxpayer can deduct the cost of in-house software if the expenditure was incurred with the intention of using the software for a taxable purpose, but before being able to use the software, or before installing it ready for use, the taxpayer decides they will never use it or will never install it ready for use. Further, in order to obtain this deduction, the expenditure must not be allocated to a software pool (that treatment is inconsistent with the use of these balancing adjustment provisions). [Schedule 1, item 1, subsection 40-335(1)]

3.78 The amount a taxpayer can deduct in the current year is determined in accordance with the following formula:

This amount is then reduced to the proportion of the intended use (or installation ready for use) of the software that was a taxable purpose. [Schedule 1, item 1, subsection 40-335(2)]

3.79 If an amount of the expenditure is recouped, that amount may be included in the taxpayers assessable income pursuant to Subdivision 20-A of the ITAA 1997.

Involuntary disposals

3.80 Where a depreciating asset ceases to be held by a taxpayer because it is:

•

lost or destroyed;

•

compulsorily acquired by an Australian government agency; or

•

disposed of to an Australian government agency after compulsory negotiations,

the taxpayer can choose whether or not he or she will include a balancing adjustment in assessable income. The taxpayer may instead decide to use some or all of the amount that would otherwise be a balancing adjustment as a reduction in the cost, or in the base value, of one or more replacement assets [Schedule 1, item 1, subsections 40-365(1) and (2)] . This provision replicates section 42-293 of the ITAA 1997.

3.81 To make this choice the taxpayer must satisfy the following conditions:

•

have an involuntary disposal of a depreciating asset as mentioned in paragraph 30 [Schedule 1, item 1, subsection 40-365(2)] ;

•

the taxpayer must incur the cost of the replacement asset, or the taxpayer must start to hold it:

-

no earlier than one year (or any further period the Commissioner allows) before the involuntary disposal occurred; and

-

no later than one year (or any further period the Commissioner allows) after the end of the income year in which the involuntary disposal occurred [Schedule 1, item 1, subsection 40-365(3)] ; and

•

the taxpayer must:

-

have used the replacement asset, or have it installed ready for use, wholly for a taxable purpose by the end of the income year in which he or she incurred the expenditure on the asset, or started to hold it; and

-

be able to deduct an amount for it [Schedule 1, item 1, subsection 40-365(4)] .

3.82 Examples of when the Commissioner may allow a further period under paragraph 40-365(3)(b) include:

•

in the event of a destruction of large infrastructure assets it will be likely to take than more than 12 months to rebuild those assets, and there are no suitable corresponding assets acquired within 12 months before or after the destruction; or

•

in the event of the replacement asset being acquired from overseas it will be likely to take more than 12 months to deliver such assets, and there are no suitable corresponding assets acquired within 12 months before or after the destruction.

3.83 The amount covered by the choice is applied in reduction of:

•

the cost of the replacement asset, for the income year in which its start time occurs; or

•

the base value of the replacement asset, for a later year - that is, in reduction of the sum of its opening adjustable value for that year and any amount included in the second element of its cost for that year.

[Schedule 1, item 1, subsection 40-365(5)]

3.84 If a taxpayer is making the choice for 2 or more replacement assets, he or she must apportion the amount covered by the choice between those items in proportion to their cost. This limits arbitrage from, for instance, choosing replacement asset treatment for as much of the amount as can be allocated to very long effective assets. [Schedule 1, item 1, subsection 40-365(6)]

Balancing adjustments where different car expense methods used

3.85 The method for calculating car expense deductions chosen under Division 28 of the ITAA 1997 will affect its treatment under the uniform capital allowance system.

3.86 If a taxpayer has used only the cents per kilometre or the 12% of original value methods for deducting car expenses, there will not be a balancing adjustment for the purposes of Division 40 (because there has been no deduction for decline in relation to the car). Nor will the balancing adjustment produce a CGT gain or loss, because cars are excluded from having such gains and losses. There will be a balancing adjustment pursuant to section 40-285 if the one-third of actual expenses method or the log book method has been used (calculated normally, but with two-thirds of the balancing adjustment excluded by apportionment where the one-third of actual expenses method was used). Where, however, there has been a mix of methods between the cents per kilometre or the 12% of original value methods on the one hand with the one-third of actual expenses method or the log book method on the other hand the formula found in subsection 40-370(2) for calculating the balancing adjustment must be used. Section 40-285 has no application in such a situation. [Schedule 1, item 1, section 40-370]

3.87 In summary, the tax treatment under the proposed uniform capital allowance system for car expenses is shown in Table 3.1.

Using the cents per kilometre and/or the 12% of original value methods

3.88 If a taxpayer has used only the cents per kilometre or the 12% of original value method (or both of them) for car expense deductions there will not be a balancing adjustment included in income, or deducted, under Division 40. This is because section 40-55 provides that a taxpayer is unable to deduct any amount for a decline in value where the taxpayer has used either of these methods for calculating car expenses deductions. Therefore, the whole amount otherwise included in income, or deducted, is excluded by the apportionment rule in section 40-290.

3.89 Because the taxpayer is unable to deduct any amount for a decline in value, he or she will not reduce the cost of the car in determining its adjustable value under section 40-85. The balancing adjustment is, pursuant to section 40-285, the difference between the termination value of the car and its adjustable value. Cars are excluded from having capital gains or losses, so none of this amount will have a tax effect.

3.90 Further, the balancing adjustment formula provided in section 40-370 cannot be used because the taxpayer has not deducted any amount for the decline in value of the car. This is pursuant to paragraph 40-370(1)(b).

3.91 Because the balancing adjustment is wholly apportioned away, there is no tax consequence under Division 40 when the car is subject to a balancing adjustment event.

Using the one-third of actual expenses method and/or the log book method

3.92 If a taxpayer uses only the one-third of actual expenses method or the log book method (or both of them) for calculating car expense deductions and a balancing adjustment event occurs, the taxpayer must calculate the balancing adjustment in accordance with section 40-285. Where the one-third of actual expenses method was used, only one-third of the balancing adjustment will be income or a deduction under Division 40, because of the apportionment rule in section 40-290.

Using a mixture of methods

3.93 If a taxpayer has used the cents per kilometre or the 12% of original value methods for some years and used the one-third of actual expenses method or the log book method for other years in calculating car expense deductions the formula that must be used to calculate the balancing adjustment at the occurrence of a balancing adjustment event is provided in subsection 40-370(2). A taxpayer who has combined methods in this way is not able to use the formula for determining balancing adjustments in section 40-285.

3.94 The amount that the taxpayer must include in his or her assessable income or that is a deduction is calculated as follows:

Step 1:

termination value - car's adjustable value just before the balancing adjustment event occurred


Step 2:

Reduce from the balance of step 1, the amount attributable to the use of the asset for non-taxable purposes. The formula that must be used is:

sum of reductions for an asset under section 40-25 / total decline in the value of the depreciating asset since it was held by the taxpayer * balancing adjustment amount


In working out the amount that is attributable for non-taxable purposes, for years for which the cents per kilometre or the 12% of original value methods for calculating car expense deductions were used the taxpayer must instead use the following as being for a taxable purpose:

•

to the extent of 20% if the cents per kilometre method has been used; or

•

to the extent of one-third if the 12% of original value method has been used.

[Schedule 1, item 1, subsection 40-370(4)]

Step 3:

balance from step 2 * total number of days for which the taxpayer deducted the decline in value of the car under Division 40 (i.e. you used the 'log book' or 'one-third of actual expenses' methods


Step 4:

result from step 3 / total number of days the car was held by the taxpayer


Step 5:

If the result from step 4 is a negative number it is a deduction for the taxpayer. However, if the result is a positive number the amount must be included in the taxpayers assessable income.

3.95 In order to work out the balancing adjustment under subsection 40-370(2), because there has been a mixture of methods used for calculating car expense deductions, there is a need to counter the effect of section 40-55. This is achieved by assuming that the decline in value for years in which the cents per kilometre and the 12% of original value methods applied was calculated on the same basis as when the one-third of actual expenses and/or the log book methods were used. [Schedule 1, item 1, subsection 40-370(3)]

Rollover relief

3.96 Rollover relief under the uniform capital allowance system is available where there has been a disposal of a depreciating asset from a transferor to a transferee and certain CGT rollover relief is available in respect of that balancing adjustment event. Rollover relief defers balancing adjustments on the transfer of property between related entities until the next balancing adjustment event occurs. It attributes to the final transferor certain characteristics of previous transferors. The capital allowance rollover provisions replicate Common Rule 1 of the existing rules contained in Subdivision 41-A of the ITAA 1997.

3.97 The general effect of the capital allowance rollover provisions is to allow the transferee of the depreciating asset to claim deductions for its decline in value as if there had been no change in ownership. There will not be a balancing adjustment event when the transferor disposes of the depreciating asset to the transferee. The transferee will use the same method of calculating the decline in value and effective life that the transferor used. Where that method of calculating the decline was the prime cost method, the transferee must use the remaining effective life of the asset. Further, the cost to the transferee will be the adjustable value of the depreciating asset when it was in the hands of the transferor just before the balancing adjustment event occurred. [Schedule 1, item 1, section 40-345 and subsection 40-180(2), item 5 in the table]

3.98 The capital allowance rollover provisions do not apply if Subdivision 170-D of the ITAA 1997 applies to the disposal of the depreciating asset or the change in interests in it. (The Subdivision covers certain transactions by companies within linked groups.) This provision is a replication of section 41-14 of the ITAA 1997. [Schedule 1, item 1, subsection 40-340(8)]

3.99 The capital allowance rollover provisions can occur automatically or by choice.

Automatic rollover relief

3.100 If the following criteria are satisfied automatic capital allowance rollover relief is available to the transferor and the transferee:

•

the transferor disposed of a depreciating asset to a transferee (so there is a balancing adjustment event);

•

the disposal involves a CGT event;

•

the transferor deducted or could deduct amounts for the assets decline in value; and

•

the depreciating asset that is disposed of is one that qualifies for certain CGT rollover relief. This includes the disposal of assets to a wholly-owned company and the disposal of assets because of a marriage breakdown.

[Schedule 1, item 1, subsection 40-340(1)]

3.101 In order to ensure there is no tension between the CGT rollover provisions and the capital allowance rollover provisions, subsection 40-340(2) provides that in working out whether the CGT rollover provisions apply to the items listed in the subsection 40-340(1) table, a taxpayer can ignore the fact that certain depreciating assets are excluded from the CGT regime pursuant to Division 118 and subsection 122-25(3) of the ITAA 1997. [Schedule 1, item 1, subsection 40-340(2)]

Information that must be provided to the transferee

3.102 The transferor must give the transferee enough information about his or her holding of the property to enable the transferee to work out how Division 40 applies to the transferees holding of the depreciating asset. [Schedule 1, item 1, subsection 40-360(2)]

3.103 The transferor must give a notice containing the information to the transferee within 6 months after the end of the transferees income year in which the balancing adjustment event occurred (or a longer period that is allowed by the Commissioner). As the rollovers concerned are between associated parties, the transferee will generally be able to determine when that is, and can seek an extension of time from the Commissioner as a practical solution in other cases. [Schedule 1, item 1, subsection 40-360(3)]

3.104 The transferee must keep the notice until the end of the 5 years after the first balancing adjustment event following the rollover - that is, the earliest of either disposing of the property or where the property is lost, abandoned or destroyed. Failure to comply with this requirement may attract a penalty of 30 penalty units. [Schedule 1, item 1, subsection 40-360(4)]

Choosing rollover relief

3.105 The rollover relief provisions can also be taken advantage of in some cases when, amongst other things, the transferor and the transferee agree. Commonly, an agreement will occur when there are variations in the constitution of a partnership or in the interests of the partners. An agreement may also occur when a partner allows an asset they hold to become a partnership asset, or when a partnership allows a partnership asset to become an asset of a partner. [Schedule 1, item 1, subsection 40-340(3)]

3.106 In order to choose the rollover relief provisions the following conditions must be satisfied:

•

there is a change in the holding of, or in the interests of entities in, a depreciating asset;

•

the transferor retains an interest in the depreciating asset after the change in holding;

•

the transferor and the transferee jointly agree to use the rollover relief;

•

the decision to use the rollover relief must be in writing and must contain sufficient information about the transferors holding of the property to enable the transferee to work out the application of Division 40 on his or her holding of the depreciating asset; and

•

the decision to use the rollover relief must be made within 6 months after the end of the transferees income year in which the balancing adjustment event occurred (or longer period allowed by the Commissioner).

[Schedule 1, item 1, subsections 40-340(3) and (4)]

3.107 If either the transferor or the transferee dies before the end of the 6 month period commencing at the end of their income year in which the balancing adjustment event occurred (or longer period that is allowed by the Commissioner), the trustee of the deceased estate may join in making the choice. [Schedule 1, item 1, subsection 40-340(5)]

The keeping of documentation

3.108 The transferor must keep a copy of the agreement to use the rollover relief or the agreement itself for 5 years after the balancing adjustment event occurred. Failure to keep this documentation may lead to a penalty of 30 units being imposed on the transferor. [Schedule 1, item 1, subsection 40-340(6)]

3.109 Likewise, the transferee must keep a copy of the agreement to use the rollover relief or the agreement itself until the end of 5 years after the next balancing adjustment event occurs for the depreciating asset. Failure to keep this documentation may lead to a penalty of 30 units being imposed on the transferee. [Schedule 1, item 1, subsection 40-340(7)]

Disposal of leases pursuant to Division 45 of the ITAA 1997

3.110 There are further consequences for the rollover if the transferee satisfies the following:

•

if the transferor leased the depreciating asset on or after 22 February 1999, the transferee is also taken to have done so;

•

if the transferor primarily used the depreciating asset for leasing to others, then the transferee is taken to have done so too; and

•

if the transferors main business was to lease assets to others then the transferees main business is taken to have been leasing assets.

[Schedule 1, item 1, subsection 40-350(1)]

3.111 However, these additional consequences do not apply where there is a disposal of a lease pursuant to Division 45 of the ITAA 1997, but the sum of all the disposal benefits is at least equal to, or greater than, the market value of the plant or interest concerned [Schedule 1, item 1, subsection 40-350(2)] . These rules are a replication of subsections 41-40(4) and (5) of the ITAA 1997.

Chapter 4 - Low-value and software development pools

Outline of chapter

4.1 This chapter explains amendments made to the income tax law that will:

•

provide taxpayers, except small business taxpayers who have chosen to enter the STS, with the choice of a low-value pool to which to allocate all assets costing less than $1,000, as well as the choice to allocate assets that have declined in value to less than $1,000 under the diminishing value method to the pool; and

•

provide taxpayers that incur expenditure on developing, or having someone develop software, with the option of deducting that expenditure under a pooling method.

Context of reform

4.2 Taxpayers will be provided with a choice of working out the decline in value of all depreciating assets costing less than $1,000, and any assets they choose that have been depreciated to less than $1,000 under the diminishing value method, through a pooling mechanism. Such a mechanism will reduce compliance costs for taxpayers. The mechanism is not available to small business taxpayers while they have chosen to enter the STS, which has its own simplified treatment of depreciating assets.

4.3 Taxpayers using the diminishing value method have to calculate their deduction based on an ever-declining balance of assets. This requires an ascertainment of this balance every year. A pooling mechanism available for these items when that balance is less than $1,000 will simplify the calculation process and thus reduce compliance costs.

4.4 Taxpayers currently are allowed the option of deducting expenditure on developing software on a pooled basis. This policy is being retained.

Summary of new law

4.5 There will be a choice to set up a pool for all assets costing less than $1,000 that you start to hold, whether in the year you set up the pool, or in a later year. So if taxpayers start to pool such low cost assets they must do so for all such assets of that or any later year. Taxpayers can also choose to add to the pool any assets that have declined in value to less than $1,000 under the diminishing value method. The decline in value of assets in the pool will be worked out by working out a decline in value for the pool, each income year. Broadly, the decline for the pool is worked out on a diminishing value basis as if all assets allocated to the pool had an effective life of 4 years. Where the choice to pool assets is not exercised, the decline in value for the assets will be determined only by their individual effective life.

4.6 The current law allows taxpayers the option of deducting expenditure on developing software on a pooled basis. The expenditure for the year is deductible over 2 years commencing in the following year.

Detailed explanation of new law

Low-value pools

4.7 Taxpayers will have the choice to set up a low-value pool for all assets they start to hold, in or after the year they set up the pool, that cost less than $1,000, and can choose to allocate to the pool depreciating assets that have declined in value below $1,000 under the diminishing value method [Schedule 1, item 1, subsections 40-425(1) and (3)] . The mechanism is not available to small business taxpayers who have chosen to enter the STS, as it has its own simplified rules for depreciating assets.

4.8 Such a mechanism will reduce compliance costs for taxpayers. Taxpayers using the diminishing value method have to calculate their deductions based on an ever-declining balance for each asset. This requires an ascertainment of each balance every year. A pooling mechanism for items which cost less than $1,000, and to which other assets can be allocated when their balance is less than $1,000, will simplify the calculation process and thus reduce compliance costs.

Assets allocated to a low-value pool

4.9 Taxpayers may choose to set up a low-value pool for 2 classes of assets:

•

low-cost assets - a low-cost asset is a depreciating asset (except horticultural plants and grapevines) whose cost as at the end of the income year in which a taxpayer starts to use it for a taxable purpose is less than $1,000 [Schedule 1, item 1, subsections 40-425(1) and (2)] . The $1,000 threshold is applied on an item by item basis. If a taxpayer sets up a pool, they must allocate to it all low-cost items they start to hold in or after the year the pool is set up; and

•

low-value assets - a low-value asset is a depreciating asset (except horticultural plants and grapevines) a taxpayer holds:

-

for which the taxpayer has deducted, or can deduct, amounts worked out using the diminishing value method;

-

that has an opening adjustable value for the current year of less than $1,000; and

-

that is not a low-cost asset [Schedule 1, item 1, subsection 40-425(5)] .

4.10 However, for Division 58 taxpayers in an entity sale situation, a low-value asset is a depreciating asset (except horticultural plants and grapevines) whose adjustable value at the end of the income year is less than $1,000 for which the taxpayer used the diminishing value method. [Schedule 1, item 1, subsection 40-425(6)]

4.11 Horticultural plants and grapevines have been excluded from the definition of both low-cost assets and low-value assets. If not excluded very large investments could be written-off on a highly accelerated basis, because horticultural investments commonly involve substantial numbers of horticultural plants with individual costs under $300 but which may have long effective lives.

4.12 Low-value assets and low-cost assets are mutually exclusive. This overcomes an ability for taxpayers to allocate assets that otherwise would be low-cost assets as low-value assets and thereby circumventing the once and for all choice rule for low-cost assets.

Assets that cannot be allocated to low-value pools

4.13 The following assets cannot be allocated to a low-value pool:

•

a horticultural plant, including a grapevine (excluded by the definitions of low-cost asset and low-value asset) [Schedule 1, item 1, subsections 40-425(2) and (5)] ;

•

depreciating assets that will be subject to Subdivision 328-D (which is about capital allowances for STS taxpayers), because of the special rules for depreciating assets which the Subdivision provides. STS taxpayers who are excluded from claiming capital allowances under the STS provisions, for certain assets can allocate those assets to the pool, providing they meet the relevant requirements to allocate the asset to the pool [Schedule 1, item 1, subsection 40-425(7)] ; and

•

those depreciating assets costing $300 or less that allow the taxpayer to claim an immediate deduction [Schedule 1, item 1, subsection 40-425(4)] . This deduction is further discussed in paragraph 1.72.

Effect of using the low-value pool

4.14 Once a choice is made to allocate a low-cost asset to a low-value pool for an income year, all low-cost assets the taxpayer starts to hold in that income year or in a later income year must be allocated to that pool [Schedule 1, item 1, subsection 40-430(1)] . This rule does not apply to low-value assets.

4.15 Any depreciating asset that has been allocated to the low-value pool must remain in the pool [Schedule 1, item 1, subsection 40-430(3)] . Assets allocated to the pool will then have their decline in value worked out under section 40-440.

Example 4.1

In the 2002-2003 income year, Max holds 3 low-cost assets, Assets A, B and C. In August 2003, Max decides to put Asset B into a low-value pool. Pursuant to subsection 40-425(1), Max must put into this low-value pool all low-cost assets that he started to hold on or after the income year commencing 1 July 2003. He is not required to put Assets A or C into the low-value pool. This is because he started to hold these assets before 1 July 2003. He can, however, put these assets into the low-value pool if he so wishes.

As at 1 July 2003 Max held 2 low-value assets. He is not required to (but can) put these assets into the low-value pool. For any assets that become low-value assets on or after 1 July 2003, Max can decide on an asset by asset basis whether they will be put into the low-value pool.

4.16 Where a taxpayer using a low-value pool needs to separate their deductions (e.g. primary production expenditure from their non-primary production expenditure), he or she should apportion their deduction from the low-value pool on a reasonable basis. In practice, one way to do this is to keep records as if the deductions needing to be separated, and the assets to which the deductions relate, were in separate pools.

Effect of not using the low-value pool

4.17 Taxpayers who do not choose to allocate low-cost assets or low-value assets to a low-value pool must work out the decline in value of each of these assets according to their effective life.

Working out the decline in value of the low-value pool

4.18 Taxpayers who allocate a depreciating asset to a low-value pool are required to make a reasonable estimate of the percentage of their use of the asset that will be for a taxable purpose over either its effective life (for a low-cost asset) or its remaining effective life (for a low-value asset). This percentage is called the taxable use percentage . This makes it unnecessary, and inappropriate, to reduce the deduction for the decline in the pool in the way that the deduction for the decline in relation to other depreciating assets is reduced each year by reference to taxable purpose. [Schedule 1, item 1, section 40-435]

Example 4.2

John buys a printer for $990. He allocates the printer to a low-value pool. Over its effective life of 3 years, John reasonably estimates that he will use the printer for taxable purposes 40% in the first year, 80% in the second year and 60% in the third year. Thus, the taxable use percentage for the printer is 60% (i.e. 180%/3).

4.19 The decline in value of assets in low-value pools is worked out as follows. [Schedule 1, item 1, subsection 40-440(1)]

Step 1

4.20 Take 18.75% of the taxable use percentage of the costs of low-cost assets allocated to the pool for that year.

4.21 The 18.75% rate represents half of the 37.5% which is the diminishing value rate on an effective life of 4 years. Halving this rate is in recognition that assets may be allocated to the pool throughout the income year.

Step 2

4.22 Add to the result from step 1, 18.75% of the taxable use percentage of any amounts included in the second element of the cost for that year of assets allocated to the pool for an earlier income year and low-value assets allocated to the pool for the current year. Again, the halved rate is in recognition that such further costs may be incurred at any time throughout the income year.

Step 3

4.23 Take 37.5% of the sum of the pool closing balance for the previous income year and the taxable use percentage of the opening adjustable values of low-value assets, at the start of the income year, that were allocated to the pool for that year and add this amount to the amount worked out in step 2. These amounts get the full 4-year diminishing value rate, because they are amounts either in the pool from the start of the year, or in relation to items which existed from the start of the year and get no other write-off for the year.

4.24 The pool closing balance for an income year is the sum of:

•

the pool closing balance of the pool for the previous income year; plus

•

the taxable use percentage of the costs of low-cost assets allocated to the pool for that year; plus

•

the taxable use percentage of the opening adjustable values of any low-value assets allocated to the pool for that year as at the start of that year; plus

•

the taxable use percentage of any amounts included in the second element of the cost for the income year of assets allocated to the pool for an earlier income year and low-value assets allocated to the pool for the current year; less

•

the decline in value of the depreciating assets in the pool worked out under subsection 40-440(1).

[Schedule 1, item 1, subsection 40-440(2)]

Step 4

4.25 The result from step 3 is the decline in value of the depreciating assets in the pool.

Example 4.3

EasyCo Pty Ltds pool closing balance for the year ended 30 June 2002 was $2,500. During the 2002-2003 income year EasyCo Pty Ltd acquired a depreciating asset for $800. Its taxable use percentage is 80%. Also in the 2002-2003 income year, EasyCo Pty Ltd chose to allocate to the low-value pool a low-value asset. The opening adjustable value of this depreciating asset as at 1 July 2002 was $990.

The decline in value of the depreciating assets in the low-value pool for the 2002-2003 income year is as follows:

Balancing adjustment events

4.26 If a balancing adjustment event happens to a depreciating asset in a low-value pool in an income year, the pool closing balance for that year is reduced (but not below zero) by the taxable use percentage of the assets termination value instead of the usual balancing adjustment rules, and the apportionment rule, applying. [Schedule 1, item 1, subsection 40-445(1)]

4.27 This reduction of the pool closing balance has 2 consequences. First, the depreciating asset that is disposed of effectively attracts a full years pool decline in the income year of disposal. Secondly, there is a lesser amount available for the decline of the assets allocated to the pool in the following income years. This is the equivalent of including an amount in assessable income.

Example 4.4

John sold the printer referred to in Example 40 for $440. The pool closing balance will be reduced by $264 (i.e. $440 60%).

4.28 Any excess of that termination value over the pool closing balance is included in the taxpayers assessable income [Schedule 1, item 1, subsection 40-445(2)] . Further, where a taxpayer sells a business and there is a remaining pool balance, that balance can continue to be written-off notwithstanding the taxpayer is no longer in business. Consequently, once a low-value pool is established it remains in existence notwithstanding the circumstances of the taxpayer may change.

Software development pools

4.29Taxpayers may have many software development projects in train at any one time. If they chose to recognise the depreciating asset that is created by the project, taxpayers will capitalise all expenditure that relates to the particular application that is being developed. Once the project is completed and the software begins to be used (or held ready for use) in the business, those taxpayers will begin to claim deductions for the decline in value.

4.30 However, it may be that the compliance costs of tracking all of that expenditure and allocating it to each particular item of software is seen as too onerous. There may also be some possibility that no actual software ever arises from the project, or that the software will not exist for some time after the expenditure is incurred. In that event taxpayers may choose to pool the expenditure on all projects in each year [Schedule 1, item 1, subsection 40-450(1)] . There will be a pool for each year with a maximum of 4 pools at any one time (because of the fixed schedule of decline used) [Schedule 1, item 1, subsection 40-450(4)] .

4.31 If a taxpayer chooses the pooling option over recognising the depreciating assets that are being created, all expenditure on development of software (including payments to a third party who does the development work on the taxpayers behalf) incurred in that year and subsequent years is to be pooled. That is, once the choice is made to pool, it is irrevocable [Schedule 1, item 1, subsection 40-450(2)] . Further, the pooled expenditure must be incurred in relation to software that is intended solely for a taxable purpose [Schedule 1, item 1, subsection 40-450(3)] .

4.32 The expenditure incurred on software development projects commenced before the income year in which the choice to pool is made must continue to be capitalised until the particular item of software is used or installed for use. So must expenditure incurred on software development projects that are not intended solely for a taxable purpose. Because the software is still in development, it would be too difficult to expect taxpayers to set a discount for such expenditure and pool it.

4.33 Once a choice is made to pool, software development expenditure in relation to a project that is abandoned cannot be written-off at that time but must continue to be written-off as part of the pool.

Rate of deduction

4.34 Under the software pooling method, deductions will be allowed at the rate of 40% for each of the following 2 years after the expenditure is incurred and the remaining 20% in the next year. No deduction will be allowed for the income year in which the expenditure is incurred. [Schedule 1, item 1, section 40-455]

Consideration included in assessable income

4.35 Taxpayers have to include in their assessable income any consideration they receive for software in relation to which they pooled the development expenditure [Schedule 1, item 1, subsection 40-460(1)] . This would include, for example, consideration received for:

•

the disposal or part disposal of software;

•

the granting of a licence in relation to software; and

•

the loss or destruction of software (insurance proceeds).

4.36 However, if rollover relief applies under subsection 40-340(3), no amount will be included in assessable income. [Schedule 1, item 1, subsection 40-460(2)]

Example 4.5: Application of pooling method

Blitz Pty Ltd chooses on 30 June 1999 to apply the pooling method (from 11 May 1998) to software development expenditure for the 1997-1998 (from 11 May 1998 to 30 June 1998) and 1998-1999 income years. It commenced several software development projects, none of which are in relation to Y2K compliance, and incurred the following expenditure:

Deductions can be claimed as follows:

Chapter 5 - Primary production depreciating assets

Outline of chapter

5.1 Subdivision 40-F contains the rules for calculating deductions for the decline in value of capital expenditure on depreciating assets that are water facilities, horticultural plants or grapevines. It explains when a taxpayer starts deducting amounts for these assets and provides the methods of calculation for each.

Context of reform

5.2 The introduction of the uniform capital allowance system and the allowing of previously non-deductible capital expenditure are key components of the New Business Tax System announced in Treasurers Press Release No. 74 of 11 November 1999 (refer to Attachment L).

5.3 That press release also mentioned that the uniform capital allowance system was not to apply to depreciating assets used in primary production. Instead, the existing rules that allow a write-off for expenditure on these assets are to be maintained, notwithstanding the introduction of a uniform regime.

Summary of new law

5.4 Division 387 of the ITAA 1997 currently contains the provisions for capital allowances for primary producers and some land holders. However, the rules dealing with the different expenditures are dealt with in different Subdivisions within Division 387. For example, grapevines are dealt with in Subdivision 387-D while horticultural plants are dealt with in Subdivision 387-C.

5.5 Subdivision 40-F groups together depreciating assets used in primary production business and standardises the method of calculating the decline in value each year for these assets whilst maintaining the existing rates of decline. It also recasts in a condensed form, and withminimal alteration, the concepts contained in Division 387 of the ITAA 1997. STS taxpayers have a choice of using this Subdivision or Division 328.

Detailed explanation of new law

5.6 This Subdivision allows taxpayers to deduct the decline in value from:

•

water facilities;

•

horticultural plants; and

•

grapevines,

provided that certain conditions are met [Schedule 1, item 1, subsections 40-515(1) and (2)] . These conditions vary depending upon the type of depreciating asset.

5.7 There are 2 general rules that apply to the deductions:

•

the deduction cannot exceed the total capital expenditure incurred [Schedule 1, item 1, subsection 40-515(3)] ; and

•

the amount of capital expenditure on which any of these deductions is based, cannot exceed the market value of what the expenditure was for if any of the parties to an arrangement under which the expenditure is incurred, are not dealing at arms length. The non-arms length provision will operate automatically without the need for the Commissioner to exercise any discretion [Schedule 1, item 1, section 40-560] .

Deduction for water facilities

What is a water facility?

5.8 A water facility is plant (as defined for the purposes of the ITAA 1997) or a structural improvement, or an alteration, addition or extension to plant or a structural improvement, that is primarily and principally for the purpose of conserving or conveying water. [Schedule 1, item 1, subsection 40-520(1)]

Conditions for the deduction of a water facility

5.9 In order to obtain this deduction, taxpayers must incur capital expenditure on the construction, manufacture, installation or acquisition of the water facility. Further, the capital expenditure must be incurred primarily and principally to conserve or convey water for use in a primary production business that you conduct on land in Australia. [Schedule 1, item 1, subsection 40-525(1)]

When does the decline in value for a water facility start?

5.10 A water facility starts to decline in value in the income year in which the capital expenditure is first incurred on the facility. [Schedule 1, item 1, section 40-530, item 1 in the table]

How to work out the decline in value of a water facility

5.11 The decline in value of a water facility is 33 1/3% of the capital expenditure incurred on the construction, manufacture, installation or acquisition of the water facility. The decline in value starts in the income year the expenditure was incurred and continues for the 2 following years. [Schedule 1, item 1, section 40-540]

Example 50

Horace is engaged full-time in the business of farming. He spends $100,000 on building a dam on his dairy cattle farm. In the income year in which he incurs the expenditure (and each of the subsequent 2 income years) Horace will be entitled to deduct $33,333.

Amounts you cannot deduct

5.12 Apart from the general rules that apply to deductions (discussed in paragraph 5.7), the following amounts cannot be deducted by a taxpayer as a decline in value:

•

the decline in value that is attributable to the period (if any) in the income year for usage other than for a primary production business on land in Australia or that was not wholly used for a taxable purpose [Schedule 1, item 1, subsection 40-515(4)] ; and

•

an amount for any income year for capital expenditure on the acquisition of a water facility, if any person has deducted or can deduct an amount under this Subdivision, for any income year for earlier capital expenditure on the construction or manufacture of the facility, or a previous acquisition of the facility [Schedule 1, item 1, subsection 40-555(1)] . A water facility and an alteration, addition or extension to that facility are not the same water facility for these purposes [Schedule 1, item 1, subsection 40-555(2)] .

Deductions for horticultural plant

What is a horticultural plant, horticulture and commercial horticulture?

5.13 A horticultural plant is a live plant or fungus that is cultivated or propagated for any of its products or parts. The definition differs from the ITAA 1997 by being generic in scope but does not alter the meaning. The definition of horticultural plant must take its meaning from the context of the conditions imposed upon horticultural plant within the Subdivision. [Schedule 1, item 1, subsection 40-520(2)]

5.14 Horticulture has the same meaning as the definition of that term in subsection 387-170(3) of the ITAA 1997. It is widely defined to include both the cultivation and the propagation of plants or fungi, and of seeds, bulbs, spores or the like in any environment whether that environment is natural or artificial. [Schedule 1, item 1, subsection 40-535(1)]

5.15 Horticulture encompasses an activity that can precede the planting of trees or plants. It includes the propagation or cultivation of plants and their products such as fruit, flowers and vegetables. Where trees are not planted for felling, then the activity for which they are planted will fall within the definition of horticulture; for example, planting and tending of tea-trees for the production of oil. The definition of horticulture is sufficiently wide to cover the growing of plants, etc. in pots or by hydroponic means and will allow other means of growing plants to come within the definition when those means are developed.

5.16 Commercial horticulture requires that the horticultural plant be used for income producing purposes in a business of horticulture. [Schedule 1, item 1, subsection 40-535(2)]

Conditions for the deduction of a horticultural plant

5.17 A taxpayer can deduct the decline in value of the horticultural plant if one of the following conditions is satisfied:

•

the taxpayer owns the horticultural plant. Where the taxpayer owns the plant, no holder of a lease, lesser interest or licence relating to the land of which the plant is a part can carry on a business of horticulture using the plant [Schedule 1, item 1, subsection 40-525(2), item 1 in the table] ;

•

the horticultural plant is attached to land that the taxpayer leases (from anyone), or holds under a quasi-ownership right granted by an exempt Australian government agency, and the lease or quasi-ownership right entitles the taxpayer to carry on a business of horticulture on the land. Further, if there is another entity that holds a lesser interest or licence relating to the land, that entity must not carry on a horticulture business on the land [Schedule 1, item 1, subsection 40-525(2), item 2 in the table] ; or

•

the taxpayer is the licensee relating to the land to which the horticultural plant is attached and carries on a business of horticulture on the land as a result of holding the licence [Schedule 1, item 1, subsection 40-525(2), item 3 in the table] .

Together, these rules ensure that the taxpayer who can claim is the taxpayer with the least interest in the land who carries on a business of horticulture using the plants.

When does the decline in value commence for horticultural plants?

The taxpayer is the first owner, etc.

5.18 If the taxpayer is the first owner, lessee, holder of a quasi-ownership right or licensee and satisfies one of the conditions relating to horticultural plant in subsection 40-525(2), the horticultural plant starts to decline in value in the income year in which its first commercial season starts. [Schedule 1, item 1, section 40-530, item 2 in the table, paragraph (a)]

Example 5.2

In February 2002, Astri plants 2,000 avocado trees on her farm which she plans to harvest for commercial use. Four years later the first avocados from these trees are able to be harvested and sold commercially. Therefore, the decline in value commences in 2006 when the avocados are ready for picking, this being when the first commercial season starts.

If the avocados are ready for picking, but Astri has not yet picked them, and a hail storm destroys all the avocados, Astri will still be entitled to deduct an amount that is the decline in value of the plants for that income year.

The taxpayer is not the first owner, etc.

5.19 Where the taxpayer is not the first entity to satisfy one of the conditions in subsection 40-525(2), a horticultural plant starts to decline in value in the income year when the taxpayer first satisfies the conditions mentioned in this subsection and the first commercial season has commenced. [Schedule 1, item 1, section 40-530, item 2 in the table, paragraph (b)]

How to work out the decline in value of a horticultural plant

5.20 The decline in value of a horticultural plant is worked out from its effective life. Because a horticultural plant is a depreciating asset, the effective life is determined in accordance with sections 40-70, 40-75 and 40-80. These rules are in keeping with the current income tax law.

Horticultural plants effective life is less than 3 years

5.21 All of the capital expenditure incurred in the establishment of a horticultural plant may be deducted for the income year in which the plant starts to decline if the effective life of the horticultural plant is less than 3 years. There are several kinds of horticultural plants with effective lives of one, 2 or 3 years, and for several of these there was an established practice of treating their establishment costs as immediately deductible before the first horticultural plant provisions were enacted. This concession is maintained by the provisions, rather than bringing such plants with short lives into line with other depreciating assets. [Schedule 1, item 1, subsection 40-545(1)]

Horticultural plants effective life is 3 years or more

5.22 If the effective life of the horticultural plant is 3 years or more, the deduction is worked out by reference to the write-off rate appropriate to its effective life, its establishment expenditure and period during which the plant is used in the horticulture business [Schedule 1, item 1, subsection 40-545(2)] . That is:

5.23 Establishment expenditure is capital expenditure attributable to the establishment of a horticultural plant, no matter by whom it was incurred [Schedule 1, item 1, subsection 40-545(2)] . It is analogous to the cost of plant and equipment or the original cost of building work or structural improvements.

5.24 The costs of establishing horticultural plants may include the following:

•

the cost of acquiring the plants or seeds;

•

the cost of planting the plants or seeds;

•

any costs incurred preparing to plant. These do not include the initial clearing of the land, but may in some cases include part of the costs of ploughing, contouring, top dressing, fertilising, stone removal, top soil enhancement and so on, that is attributable to the establishment of the plant;

•

the costs of pots and potting mixtures (for potted plants);

•

the costs incurred in grafting trees; and

•

the costs of replacing existing plants and trees, because of loss of fair economic return or because of declining popularity of a particular existing variety.

5.25 Establishment expenditure incurred on establishing horticultural plants does not include expenditure on other plants. However, where plants are used for associated purposes, such as demonstration purposes or for companion planting, in a business of horticulture, then expenditure incurred in establishing those plants will fall within the operation of this subsection. Plants used for the purpose of producing assessable income in a business of horticulture may be accepted as horticulture plants in their own right, rather than as establishment expenditure on other plants.

5.26 Establishment expenditure does not include expenditure incurred in draining swamp, low-lying land or on clearing land. [Schedule 1, item 1, subsection 40-555(3)]

5.27 The write-off days in income year are the number of days in the income year in which the taxpayer satisfied a condition of ownership in subsection 40-525(2) for the horticultural plant and used it either for commercial horticulture or held it ready for use. [Schedule 1, item 1, subsection 40-545(2)]

5.28 The write-off rate is a percentage worked out by reference to the effective life of the particular plant. The relevant rates are set out in the table that is contained in the definition of write-off rate in subsection 40-545(2).

Example 5.3

XYZ Pty Ltd grows lemons for the domestic market. On 1 March 2002, XYZ Pty Ltd spent $400,000 establishing a lemon farm by planting lemon trees. The first lemons are ready for picking on 1 March 2006. The plants have an effective life of 20 years.

The decline in value for these plants is:

2005-2006 income year

establishment expenditure * write-off days in income year/365 * write-off rate
$400,000 * 122/365 * 13% = $17,380.82


2006-2007 income year

establishment expenditure * write-off days in income year/365 * write-off rate

$400,000 * 365/365 * 13% = $52,000


Because the decline in value over the 20 year effective life of the lemon trees would exceed the $400,000 capital expenditure, section 40-515 provides a cap on the amount that can be deducted ensuring that a taxpayer cannot deduct more than the amount of capital expenditure incurred on the depreciating asset.

5.29 There is a special rule that limits the period of the horticultural plant deduction. This is achieved by imposing a limit on the write-off days. The limit ensures that a taxpayers write-off days in the income year can only include the period which starts when the horticultural plant can first be used for commercial horticulture and ends at the specified time as shown in the table in subsection 40-545(3) [Schedule 1, item 1, subsection 40-545(3)] . This is in keeping with the current income tax law and ensures that no more than the full amount of the establishment costs can be deducted, and that amounts which could not be deducted (e.g. because of periods in which the plants were not used for a horticultural business) cannot be carried forward and deducted later.

Example 5.4

Following on from Example 5.3, because it was decided that the lemon trees have an effective life of 20 years, XYZ Pty Ltd must deduct the capital expenditure in 7 years and 253 days (subsection 40-545(3), item 5 in the table). By deducting the capital expenditure over this period, XYZ Pty Ltd will not be able to deduct more than the amount of capital expenditure incurred on the depreciating asset.

It is important to note that the time periods in the table in subsection 40-545(3) cannot be extended. If XYZ Pty Ltd, for example, did not use the lemon trees for commercial horticulture and did not hold them ready for that use in the 2008-2009 income year, XYZ Pty Ltd will not be able to deduct an amount for the decline in value of the lemon trees for that income year. Thus, at the end of the 7 years and 253 days, XYZ Pty Ltd may still have an amount that could be deducted, but it will not be entitled to deduct this amount in the following income year because it is outside the 7 years and 253 days time frame.

Extra deduction for destruction of a horticultural plant

5.30 An additional deduction will be allowed if a horticultural plant, with an effective life of 3 years or more, is destroyed during the income year while it is owned and used for commercial horticulture [Schedule 1, item 1, paragraph 40-565(1)(a)] . This would cover plants destroyed by disease as well as healthy plants that are removed from the ground because the produce from the removed plants are no longer marketable.

5.31 The formula to use to work out the deduction is the same as that for grapevines. This is discussed in paragraphs 50 to 5.47.

Obtaining tax information after acquiring a horticultural plant or grapevine

5.32 The deduction for a horticultural plant or a grapevine can be transferred from one taxpayer to another. When a taxpayer acquires a horticultural plant or grapevine from another entity in circumstances that makes the taxpayer eligible to claim the deduction, section 40-575 assists with the implementation of these rules by ensuring sufficient information is given to a taxpayer who acquired a horticultural plant or a grapevine from the last entity in the chain who satisfied a condition in subsection 40-525(2) in relation to that horticultural plant or grapevine. [Schedule 1, item 1, subsection 40-575(1)]

5.33 The inclusion of amounts of establishment expenditure used by the entity in calculating the assets decline in value, as well as the period of effective life used in the calculations for horticultural plants, must continue to be applied by the taxpayer who acquired the horticultural plant or grapevine.

5.34 The taxpayer who acquired the horticultural plant or grapevine must, within 60 days of satisfying a condition in subsection 40-525(2), give a written notice to the other entity seeking certain information [Schedule 1, item 1, paragraph 40-575(2)(a)] . Only one notice can be served on the other entity [Schedule 1, item 1, subsection 40-575(6)] . The written notice must address the following matters:

•

a request that the other entity provide information as to the amount of establishment expenditure for the plant or grapevine, the effective life of the plant and the day on which the plant could first be used for commercial horticulture, the day on which the grapevine was established [Schedule 1, item 1, subsection 40-575(1)] ;

•

the other entity has at least 60 days in which to reply to the taxpayer who acquired the horticultural plant or grapevine [Schedule 1, item 1, paragraph 40-575(2)(b)] ; and

•

the notice must advise the other entity that failure to comply with the request will subject the entity to a penalty of 10 penalty units if the entity does not have a reasonable excuse and fails or intentionally refuses to comply with the notice [Schedule 1, item 1, subsection 40-575(3)] .

5.35 Where the other entity is a partnership, the notice is properly served where the taxpayer gives the notice to any one of the partners of the partnership. [Schedule 1, item 1, paragraph 40-575(4)(a)]

5.36 The obligation to provide the information requested by the taxpayer is imposed on each of the partners, not the partnership. In order to discharge the obligation any one of the partners may respond to the request. [Schedule 1, item 1, paragraph 40-575(4)(b)]

5.37 There is a penalty of 10 penalty units if a partner without reasonable excuse, fails or intentionally refuses to comply with the request for information from the taxpayer. [Schedule 1, item 1, subsection 40-575(5)]

Deductions for grapevine

Conditions for the deduction of grapevines

5.38 The decline in value for an income year of a grapevine can be deducted provided:

•

the taxpayer owns it [Schedule 1, item 1, subsection 40-525(3), item 1 in the table] ; or

•

it is attached to land that the taxpayer holds under a quasi-ownership right granted by an exempt government or exempt government agency and:

-

was planted by the taxpayer or a previous holder of the land under such a right; and

-

the grapevine is used in a primary production business [Schedule 1, item 1, subsection 40-525(3), item 2 in the table] .

When does the deduction for a grapevine start?

5.39 A grapevine starts to decline in value in the income year when it is first used in a primary production business for the purpose of producing assessable income. [Schedule 1, item 1, section 40-530, item 3 in the table]

How you work out the decline in value of grapevines?

5.40 Grapevines are written-off over a 4 year period at a rate of 25% per annum. The 4 years will be spread over 5 income years if the grapevine was not established on the first day of the income year [Schedule 1, item 1, subsection 40-550(2)] . This rule is in keeping with the current law. If the decline in value for a grapevine is worked out pursuant to section 40-545, that is, as a horticultural plant, a decline in value cannot be worked out under section 40-550 [Schedule 1, item 1, subsection 40-550(3)] .

5.41 The following formula must be used to work out the decline in value :

establishment expenditure * write-off days in income year/365 * write-off rate


[Schedule 1, item 1, subsection 40-550(1)]

5.42 The establishment expenditure of a grapevine is the capitalexpenditure attributable to the establishment of the grapevine [Schedule 1, item 1, subsection 40-550(1)] . It does not include expenditure that is incurred on draining swamp, low-lying land or on clearing land [Schedule 1, item 1, subsection 40-555(3)] .

5.43 The write-off days in income year are the number of days in the income year in which the taxpayer satisfied a condition of ownership in subsection 40-525(3) for the grapevine and used it in a primary production business for the purpose of producing assessable income. [Schedule 1, item 1, subsection 40-550(1)]

Example 5.5

In August 2002, Albert plants $200,000 worth of grapevines on a farm that he owns. The vines will be used for the purpose of producing assessable income as Albert intends to produce raisins.

Alberts decline in value of the grapevines is as follows:

2002-2003 income year

establishment expenditure * write-off days in income year/365 * 25%


2003-2004 income year (and the 2004-2005 and 2005-2006 income years)

$200,000 * 365/365 * 25% = $50,000


2005-2006 income year

$200,000 * 31/365 * 25% = $4,246.58


Deduction for destroyed grapevines

5.44 An additional deduction will be allowed for an income year if a grapevine is destroyed at any time up to 4 years after the day it was established. [Schedule 1, item 1, paragraph 40-565(1)(b)]

5.45 To work out the deduction, first calculate the total amounts the taxpayer could have deducted for the grapevine for the period that starts when the grapevine was established and ends when it was destroyed. Ignore any use of the grapevine for a purpose other than producing assessable income. [Schedule 1, item 1, subsection 40-565(2), paragraphs (a) and (b) of step 1]

5.46 Secondly, subtract from the capital expenditure attributable to the establishment of the grapevine, the result from step 1 as well as any amount received for the destruction (whether under an insurance policy or otherwise). The remaining amount is the deduction allowed for the destruction. [Schedule 1, item 1, subsection 40-565(2), step 2]

Example 5.6

Agnes grapevines are destroyed on 30 June 2005. The grapevines, established on her own farmland, were cultivated for selling as table grapes in her primary production business. The grapevines were established on 1 July 2003. Agnes recovered $75,000 from her insurance company.

The establishment capital expenditure was $250,000.

Agnes deduction is worked out as follows:

Step 1

2003-2004 income year: $250,000 * 365/365 * 25% = $62,500Z
2004-2005 income year: $250,000 * 365/365 * 25% = $62,500
Total amount that could have been deducted = $125,000


Step 2

5.47 This deduction for destruction is in addition to any other write-off for the grape vines for the income year under these provisions. [Schedule 1, item 1, subsection 40-565(3)]

Obtaining tax information after acquiring a grapevine

5.48 The mechanism to obtain information comes under the same provisions as for horticultural plants and is discussed in paragraphs 50 to 5.37. This maintains the effect of the current law for grapevines.

How Subdivision 40-F applies to partners and partnerships

5.49 Subdivision 40-F allocates expenditure incurred by a partnership to each of the partners of the partnership. That is, the deduction is available to the partner and is not a deduction against the partnership income. [Schedule 1, item 1, subsection 40-570(1)]

5.50 Each partner is taken to have incurred, during an income year:

•

the amount of the expenditure incurred by the partnership that the partners agree each partner should bear; or

•

if there was no such agreement, the proportion of the partnership expenditure equal to each partners individual interest in the partnership net income or partnership loss for that income year.

[Schedule 1, item 1, subsection 40-570(2)]

5.51 The partnership must disregard Subdivision 40-F when working out the net income or partnership loss of the partnership under section 90 of the ITAA 1936. (Otherwise there could be a double deduction effect, with expenditure being taken into account both at individual partner and at partnership level.) [Schedule 1, item 1, subsection 40-570(3)]

Chapter 6 - Capital expenditure of primary producers and other landholders

Outline of chapter

6.1 Subdivision 40-G contains the rules for writing-off capital expenditure incurred by primary producers or rural businesses on landcare operations and on electricity connections or telephone lines.

Context of reform

6.2 The introduction of the uniform capital allowance system and the allowing of previously non-deductible capital expenditure are key components of the New Business Tax System announced in the Treasurers Press Release No. 74 of 11 November 1999 (refer to Attachment L).

6.3 However, the uniform capital allowance system is not to apply to change the effect of the special primary producer provisions.

Summary of new law

6.4 Subdivision 40-G maintains the write-off for capital expenditure incurred on landcare operations, electricity connections or telephone lines, currently provided for in Division 387 of the ITAA 1997.

Comparison of key features of new law and current law

Detailed explanation of new law

6.5 Subdivision 40-G will allow taxpayers to deduct capital expenditure incurred on:

•

landcare operations;

•

connection of a mains electricity cable to a metering point or the upgrading of a connection, provided the electricity is used for a taxable purpose; and

•

a telephone line brought onto land the taxpayer uses in a primary production business.

6.6 A taxpayer does not work out a decline in value of these assets. This is not because, in general, these assets are not depreciating assets. For example, fences or drainage works for landcare are depreciating assets. The connection of power or telephone is generally accomplished by installing or constructing depreciating assets, too, although this can also involve contribution to assets being jointly installed or constructed. These deductions could have been dealt with under the general immediate deduction provisions, but instead, have been dealt with under Subdivision 40-G, as part of the treatment of depreciating assets generally, to which they most closely relate. This is also because it was considered that landcare operations, electricity and telephone connection are the concern of rural and primary producers only and as such should be dealt with in a provision that deals with them specifically.

What cannot be deducted

6.7 Capital expenditure on plant is not generally deducted immediately under this Subdivision. However, plant that can be deducted under this Subdivision are:

•

certain fences erected for the purpose of:

-

separating different land classes; or

-

excluding animals from an area affected by land degradation [Schedule 1, item 1, paragraph 40-630(2)(a)] ; or

•

dams or structural improvements, including drains, covered by paragraphs (1)(c) to (f) of the definition of plant in section 45-40 of the ITAA 1997 [Schedule 1, item 1, paragraph 40-630(2)(b)] .

6.8 The deduction must be reduced by a reasonable amount if the land upon which the operations are carried on is used for other things as well as for a primary production business or a business for the purpose of producing assessable income from the use of rural land (that is not a business of mining operations). [Schedule 1, item 1, subsection 40-630(3)]

Expenditure on landcare operations

6.9 Capital expenditure on a landcare operationis deducted in the income year it is incurred provided that operation is either for:

•

Australian land used in a primary production business; or

•

rural Australian land used in a business to produce assessable income, except a business of mining operations.

[Schedule 1, item 1, subsection 40-630(1)]

What is a landcare operation?

6.10 Landcare operation has the same meaning as the former section 387-60 of the ITAA 1997 and means:

•

erecting fences (including any extension, alteration or addition to a fence) to separate different land classes in accordance with an approved management plan for the land [Schedule 1, item 1, paragraph 40-635(1)(a)] . An approved management plan is a plan prepared or approved in writing by an officer of an Australian government agency that is responsible for land conservation or an approved farm consultant that shows the different classes within the land, the location of and the type of fence required, to separate these classes [Schedule 1, item 1, section 40-640] . This term has the same meanings as former section 387-80 of the ITAA 1997;

•

erecting fences (including any extension, alteration or addition to a fence) to stop animals coming onto the land so that land degradation will be prevented or limited as well as to help reclaim the area [Schedule 1, item 1, paragraph 40-635(1)(b)] ;

•

constructing a levee or similar improvement to the land [Schedule 1, item 1, paragraph 40-635(1)(c)] ;

•

constructing drainage works on the land primarily and principally to control salinity or to assist in drainage control [Schedule 1, item 1, paragraph 40-635(1)(d)] ,so long as the works are not an operation draining swamp or low-lying land [Schedule 1, item 1, subsection 40-635(2)] ;

•

operations to eradicate animal pests, to eradicate detrimental plant growth or to prevent or fight land degradation (other than by fencing the land) [Schedule 1, item 1, paragraph 40-635(1)(e)] ; or

•

a change to such an asset or an extension to such an operation [Schedule 1, item 1, paragraph 40-635(1)(f)] .

Farm consultants

6.11 This Bill recognises the approval of persons as farm consultants for the purposes of the preparation of approved management plans in similar terms to Division 387 of the ITAA 1997 [Schedule 1, item 1, sections 40-640 and 40-670 ] . The Secretary to the Department of Agriculture, Fisheries and Forestry as well as authorised officers from that Department can approve people to act as farm consultants. Revocation of this approval by the Department of Agriculture, Fisheries and Forestry is implied pursuant to subsection 33(3) of the Acts Interpretation Act 1901 [Schedule 1, item 1, subsection 40-670(1), note] .

6.12 As in Division 387 of the ITAA 1997, provision is made in this Bill for a person to apply to the Administrative Appeals Tribunal for review of a decision to refuse to approve the person as a farm consultant or to revoke the approval of the person as a farm consultant. [Schedule 1, item 1, section 40-675]

Expenditure on electricity and telephone lines

Electricity lines

6.13 Taxpayers can deduct amounts for capital expenditure they incur on connecting power to land or upgrading the connection if, when they incur the expenditure:

•

they have an interest in the land or are a share-farmer carrying on a business on the land; and

•

they or another entity intends to use some or all of the electricity to be supplied as a result of the expenditure in carrying on a business on the land for a taxable purpose at a time when they have an interest in the land or are a share-farmer carrying on a business on the land.

[Schedule 1, item 1, subsection 40-645(1)]

Meaning of connecting power to the land or upgrading the connection

6.14 Connecting power to the land or upgrading the connection is defined as any of the following:

•

connecting a mains electricity cable to a metering point on the land (whether or not the point from which the cable is connected is on the land);

•

providing or installing equipment designed to measure the amount of electricity supplied through a mains electricity cable to a metering point on the land;

•

providing or installing equipment for use directly in connection with the supply of electricity through a mains electricity cable to a metering point on the land;

•

work to increase the amount of electricity that can be supplied through a mains electricity cable to a metering point on the land;

•

work to modify or replace equipment designed to measure the amount of electricity supplied through a mains electricity cable to a metering point on the land, if the modification or replacement results from increasing the amount of electricity to the land;

•

work to modify or replace equipment for use directly in connection with the supply of electricity through a mains electricity cable to the land, if the modification or replacement results from increasing the amount of electricity supplied to the land; or

•

work carried out as a result of a contribution to the cost of a project consisting of the connection of mains electricity facilities to that land and other land.

[Schedule 1, item 1, subsection 40-655(1)]

6.15 However, an operation described in subsection 40-655(1) done in the course of replacing or relocating mains electricity cable or equipment is connecting power to the land or upgrading the connectiononly if done to increase the amount of electricity that can be supplied to a metering point on the land. [Schedule 1, item 1, subsection 40-655(2)]

6.16 A metering point on land is a point where consumption of electricity supplied to the land through a mains electricity cable is measured. [Schedule 1, item 1, subsection 40-655(3)]

Telephone lines

6.17 Taxpayers can deduct amounts for capital expenditure they incur on a telephone line on, or extending to, land if, when they incurred the expenditure:

•

a primary production business was carried out on the land; and

•

they had an interest in the land or they were a share-farmer carrying on a primary production business on the land.

[Schedule 1, item 1, subsection 40-645(2)]

Amounts that cannot be deducted for electricity connections and telephone lines

Electricity connections

6.18 Taxpayers cannot deduct amounts for capital expenditure they incur on connecting power to land or upgrading the connection if, during the 12 months after electricity is first supplied to the land as a result of the expenditure, no electricity supplied as a result of the expenditure is used in carrying on a business on the land for a taxable purpose. [Schedule 1, item 1, subsection 40-650(1)]

6.19 If taxpayers deducted an amount for any income year under Subdivision 40-G for the expenditure, their assessment for that income year may be amended under section 170 of the ITAA 1936 to disallow the deduction. [Schedule 1, item 1, subsection 40-650(2)]

6.20 Taxpayers cannot deduct an amount they incur on connecting power to land or upgrading the connection for:

•

capital expenditure in providing water, light or power for use on, access to or communication with the site of mining operations; or

•

a contribution to the cost of providing water, light or power for those operations.

[Schedule 1, item 1, subsection 40-650(3)]

Telephone lines

6.21 Taxpayers cannot deduct an amount for any income year for their capital expenditure on a part of a telephone line if:

•

any entity has deducted, or can deduct, an amount for any income year for the cost of that part under a provision of the ITAA 1936 or the ITAA 1997 except Subdivision 40-G; or

•

the cost of that part has been, or must be, taken into account in working out:

-

the amount of any entitys deduction (including a deduction for a depreciating asset) for any income year under a provision of the ITAA 1936 or the ITAA 1997 except Subdivision 40-G; or

-

the net income, or partnership loss, of a partnership under section 90 of the ITAA 1936.

[Schedule 1, item 1, subsection 40-650(4)]

6.22 However, taxpayers can deduct an amount under Subdivision 40-G for their expenditure on a part of a telephone line even if:

•

an entity that worked on installing that part has deducted, or can deduct, an amount relating to that part for any income year under the ITAA 1936 or the ITAA 1997 except Subdivision 40-G; or

•

the cost of that part has been, or must be, taken into account:

-

in working out the amount of such an entitys deduction for any income year under a provision of the ITAA 1936 or the ITAA 1997 except Subdivision 40-G; or

-

under section 90 of the ITAA 1936 in working out the net income, or partnership loss, of a partnership that worked on installing that part.

[Schedule 1, item 1, subsection 40-650(5)]

6.23 That rule has effect whether the entity did the work itself or through one or more employees or agents. [Schedule 1, item 1, subsection 40-650(6)]

Both electricity connections and telephone lines

6.24 If a taxpayer can deduct, or has deducted, an amount for any income year under section 40-645 for their expenditure on electricity connections or telephone lines:

•

another entity cannot deduct an amount for the expenditure for any income year under a provision of the ITAA 1936 or the ITAA 1997, except Subdivision 40-G; and

•

the expenditure cannot be taken into account to work out the amount of an entitys deduction for any income year under a provision of the ITAA 1936 or the ITAA 1997, except Subdivision 40-G.

[Schedule 1, item 1, subsection 40-650(7)]

6.25 That rule also applies in working out the net income, or partnership loss, of a partnership under section 90 of the ITAA 1936. [Schedule 1, item 1, subsection 40-650(8)]

How much can be deducted?

6.26 The amount taxpayers can deduct is 10% of the expenditure:

•

for the income year in which they incur it; and

•

for each of the next 9 income years.

[Schedule 1, item 1, subsection 40-645(3)]

6.27 Various provisions may reduce the amount taxpayers can deduct or stop them deducting, for example:

•

Division 26 of the ITAA 1997 (limiting deductions generally);

•

section 40-650 of the ITAA 1997 (specifying expenditure taxpayers cannot deduct under this Subdivision); and

•

Division 245 of Schedule 2C to the ITAA 1936 (which may affect taxpayers entitlement to a deduction if their debts are forgiven).

[Schedule 1, item 1, subsection 40-645(3), note 1]

Recoupment of expenditure

6.28 If taxpayers recoup an amount of the expenditure incurred on electricity or telephone lines, the amount will be included in their assessable income in accordance with Subdivision 20-A of the ITAA 1997. [Schedule 1, item 1, subsection 40-645(3), note 2]

Non-arms length transactions

6.29 The amount of capital expenditure on which any of these deductions is based cannot exceed the market value of what the expenditure was for, if any of the parties to an arrangement under which the expenditure is incurred are not dealing at arms length. The non-arms length provision will operate automatically without the need for the Commissioner to exercise any discretion. [Schedule 1, item 1, section 40-660]

Partners and partnerships

6.30 Subdivision 40-G allocates expenditure incurred by a partnership to the partners of the partnership. That is, the deduction is available to the partner and is not a deduction against the partnership income. [Schedule 1, item 1, subsection 40-665(1)]

6.31 Each partner is taken to have incurred, during the income year:

•

the amount of the expenditure incurred by the partnership that the partners agree each partner should bear; or

•

if there was no such agreement - the proportion of the partnership expenditure equal to each partners individual interest in the partnership net income or partnership loss of the partnership for that income year.

[Schedule 1, item 1, subsection 40-665(2)]

6.32 The partnership must disregard Subdivision 40-G when working out the net income or partnership loss of the partnership under section 90 of the ITAA 1936. [Schedule 1, item 1, subsection 40-665(3)

Chapter 7 - Capital expenditure that is immediately deductible

Outline of chapter

7.1 Subdivision 40-H contains the rules that allow certain capital expenditure under the uniform capital allowance system to be immediately deductible.

Context of reform

7.2 The introduction of the uniform capital allowance system and the allowing of previously non-deductible capital expenditure are a key component of the New Business Tax System announced in Treasurers Press Release No. 74 of 11 November 1999 (refer to Attachment L).

7.3 However, certain expenditure that is now immediately deductible is to remain so.

Summary of new law

7.4 This Subdivision broadly replicates the treatment under the current law to allow an immediate deduction for expenditure on the following:

•

exploration or prospecting;

•

rehabilitation of mining or quarrying sites;

•

petroleum rent resource tax; and

•

environmental protection.

7.5 The cost of depreciating assets (including mining information) used in exploration or prospecting will continue to be immediately deductible, rather than being deductible over the effective life of the asset.

Detailed explanation of new law

7.6 This Subdivision deals with capital expenditure (other than certain expenditure incurred by primary producers on landcare operations) that is to be given immediate deductibility. The types of expenditure dealt within this Subdivision are:

•

exploration and prospecting;

•

expenditure on the rehabilitation of mining sites;

•

payments of certain petroleum taxes; and

•

expenditure on certain environmental protection activities.

Deduction for expenditure on exploration or prospecting

What is the current treatment of expenditure on exploration and prospecting activities?

7.7 Subject to a number of conditions, expenditure, whether capital or not, on exploration or prospecting for minerals (including petroleum) and quarry materials, is immediately deductible. Therefore, expenditure on things like salaries and wages, contract drilling, travel and accommodation, and consumables can qualify, irrespective of whether the expenditure is capital and so ordinarily not immediately deductible. Also, the cost of depreciating assets used directly in the activities can qualify for immediate deduction. In the case of plant, taxpayers can elect to deduct its cost over its effective life.

7.8 There are 2 conditions for the deduction. The first is that the minerals, petroleum or quarry materials are obtainable by eligible operations in respect of the resource. Broadly, that requires that the minerals, petroleum or quarry materials are in their natural site and any income derived as a result of their extraction would be assessable.

7.9 The second condition is essentially that the taxpayer carried on eligible operations, proposed to carry on such operations, or was carrying on a business of exploration or prospecting for minerals, petroleum or quarry materials obtainable by eligible operations in relation to the resource.

What is exploration or prospecting?

7.10 The meaning of exploration or prospecting is not defined exhaustively and so takes its ordinary meaning. However, it is defined to include a number of things that commonly are undertaken in performing activities, such as geological mapping, geophysical surveys, exploratory drilling, studies to evaluate the economic feasibility of mining or quarrying, and so on. It does not, however, include expenditure on developing or operating a mining or quarrying field or site. The point at which a decision to proceed to actual mining operations has been made, is the dividing line between exploration and prospecting on the one hand, and development and operation on the other.

What is to be the new treatment of exploration or prospecting?

7.11 The new law retains the full deduction in an income year for expenditure on exploration or prospecting for minerals, including petroleum, and quarry materials. However, the method of claiming deductions and the timing of those deductions has changed. As well, full deductions are now available for expenditure on acquiring mining, quarrying or prospecting rights and/or information for use in exploration or prospecting activities. Currently such expenditure either is deductible over time or is not deductible at all.

Full deduction for the cost of depreciating assets first used in exploration or prospecting

7.12 Subject to a number of conditions, the decline in value of a depreciating asset of a taxpayer is the assets cost if the taxpayer first uses the asset for exploration or prospecting for minerals, which includes petroleum, or quarry materials. [Schedule 1, item 1, paragraph 40-80(1)(a)]

7.13 The first condition is that the asset is not used for development drilling for petroleum, or operations in the course of working a mining property, petroleum field or quarrying property. [Schedule 1, item 1, paragraph 40-80(1)(b)]

7.14 The second is that the taxpayer satisfies at least one of the following:

•

the taxpayer carries on mining operations;

•

it would be reasonable to conclude that the taxpayer proposed to carry on mining operations; or

•

the taxpayer carries on a business of exploration or prospecting for minerals or quarry materials obtainable by mining operations, and the expenditure on the asset was necessarily incurred in carrying on that business.

[Schedule 1, item 1, paragraph 40-80(1)(c)]

7.15 This new treatment represents 3 changes to the current law. Firstly, expenditure on depreciating assets, such as drilling rigs, can still qualify for full deduction in an income year but under the general provisions of Subdivision 40-B, attracting the general provisions of that Subdivision such as balancing adjustments and so on rather than having unique provisions.

7.16 To that end, the use of depreciating assets for exploration or prospecting will constitute a taxable use, ensuring that deductions are allowable in cases where the exploration or prospecting activities are not for the purpose of producing assessable income (e.g. because they are preliminary). [Schedule 1, item 1, paragraph 40-25(7)(b)]

7.17 Secondly, expenditure on acquiring mining, quarrying or prospecting information or mining, quarrying or prospecting rights will be fully deductible if the asset is first used in exploration or prospecting. Currently, such expenditure is either deductible over time (from when a decision is taken to extract) or not all.

7.18 The current requirement for the vendor and purchaser to agree on the amount that can be deductible to the purchaser of a mining, quarrying or prospecting information or right is removed. In principle, the purchase price is to be deductible, in full in the case where the asset is first used in exploration or prospecting, or over time where used in connection with the extractive process.

7.19 To those ends, mining, quarrying or prospecting information and rights are defined to be depreciating assets [Schedule 1, item 1, paragraphs 40-30(2)(a) and (b)] . As well, the current meaning of exploration or prospecting has been extended to include obtaining mining, quarrying or prospecting information associated with the search for, and evaluation of, areas containing minerals or quarry materials [Schedule 1, item 1, paragraph 40-730(4)(d)] .

7.20 Thirdly, section 40-60 which determines when a depreciating asset starts to decline in value applies equally to assets used for exploration or prospecting including mining, quarrying or prospecting rights and information. Section 40-60 states that the decline in value starts when the asset is first used or installed ready for use. This means for exploration or prospecting assets the full deduction is given when they are first used or installed ready for use. This is a departure from the current regime which allows immediate deductions for expenditure on exploration or prospecting at the time when the expenditure is incurred. For example, expenditure on the construction of plant that is to be first used for exploration or prospecting is deductible when the plant is first used, or installed ready for use, rather than when the expenditure is incurred.

7.21 Expenditure on creating mining, quarrying or prospecting information is considered to be a cost of the information. Accordingly, expenditure, such as salaries and wages, contractors fees, travel and accommodation, fuels and consumables, will be a cost of the information and will be deductible according to the use to which the information is put and at the time when the information is first used, as described in paragraph 7.17.

7.22 It is envisaged that much expenditure on exploration or prospecting will be a cost of a depreciating asset. The new law nevertheless retains the current method of deducting expenditure on exploration or prospecting in the event there are some expenditures that currently qualify for immediate deduction and that are not a cost of a depreciating asset. [Schedule 1, item 1, paragraphs 40-730(1)(b) and (c)]

What is the meaning of exploration or prospecting?

7.23 The definition of exploration or prospecting replicates the definition under the current law. [Schedule 1, item 1, subsection 40-730(4)]

7.24 This definition is intended to reflect the definition contained in the existing Division 330 of the ITAA 1997 under the current law.

What is the meaning of minerals, petroleum or quarry materials?

7.25 The meaning of these terms remain unchanged. Minerals takes its ordinary meaning and retains the inclusion of petroleum [Schedule 1, item 1, subsection 40-730(5)] . The new law retains the current meaning of petroleum [Schedule 1, item 1, subsection 40-730(6)] . Quarry materials remain undefined and so takes its ordinary meaning.

What is the meaning of mining operations?

7.26 This expression has the same meaning as the current law definition of eligible mining or quarrying operations. [Schedule 1, item 1, subsection 40-730(7)]

What is the meaning of mining, quarrying or prospecting information?

7.27 This expression retains its meaning under the current law. [Schedule 1, item 1, subsection 40-730(8)]

Deduction for expenditure on mining site rehabilitation

7.28 An immediate deduction is allowable for expenditure, whether capital or not, on rehabilitating mining or quarrying sites, sites of exploration or prospecting activities, and sites of ancillary activities [Schedule 1, item 1, subsection 40-735(1)] . In determining the availability of the immediate deduction, regard must be had to other provisions of the Act apart from Division 8 [Schedule 1, item 1, subsection 40-735(2)] .

7.29 Mining site rehabilitation means the restoration, in whole or in part, of the site to a reasonable approximation of its condition prior to the commencement of the mining, quarrying, exploration or prospecting activity [Schedule 1, item 1, subsections 40-735(4) and (5)] . There is a timing rule that states when ancillary activities were first started on a mining building site; this rule ensures that the objective is not taken to be restoration of the building, but of the site, before any building works began on it [Schedule 1, item 1, subsection 40-735(6)] .

7.30 The scope of those activities and the meaning of the site upon which those activities can be carried on remain unchanged from the existing law. [Schedule 1, item 1, section 40-740]

7.31 The immediate deduction is not available for depreciating assets used in rehabilitation [Schedule 1, item 1, subsection 40-735(3)] . However, the cost of such assets may be deductible over time under Subdivision 40-B or under Division 43 as appropriate. That is achieved by specifying that property used in rehabilitation is taken to be used for a taxable purpose, just like the purpose of producing assessable income [Schedule 1, item 1, paragraph 40-25(7)(c)] .

7.32 The immediate deduction is also not available for expenditure on acquiring land, an interest in the land, or any right, power or privilege to do with the land, a bond or security, or on housing and welfare. [Schedule 1, item 1, section 40-745]

7.33 The new law is intended to reflect the current law. The opportunity has been taken to somewhat simplify the legislation and make it more logical. As well, it has been necessary to adopt a number of new terms, such as depreciating asset, to reflect the new concepts under Division 40.

Deduction for payments of petroleum resource rent tax

7.34 An immediate deduction is allowable for petroleum resource rent tax, imposed by the Petroleum Resource Rent Tax Act 1987 other than under paragraph 99(c) of that Act (i.e. other than certain penalties) [Schedule 1, item 1, subsections 40-750(1) and (2)] . Included in assessable income are refunds, credits, amounts paid and applied of the tax [Schedule 1, item 1, subsection 40-750(3)] . Division 20 of the ITAA 1997 will be amended to include any recoupment of this deduction.

7.35 The provisions are intended to reflect the current law and have been largely reproduced, unchanged. The only change of particular note is the omission of current subsection 330-350(4), which deals with the various capacities in which taxpayers can act, because it is an unnecessary repetition of the effect of the law.

Expenditure on certain environmental protection activities

7.36 An immediate deduction is allowable for expenditure incurred for the sole or dominant purpose of carrying out environmental protection activities [Schedule 1, item 1, subsection 40-755(1)] . As to what constitutes those activities, the definition is the same as in the existing law [Schedule 1, item 1, subsections 40-755(2) to (4)] .

7.37 The exceptions to this immediate deduction are also the same as the existing law [Schedule 1, item 1, subsection 40-760(1)] . Further, an immediate deduction is also not available if the expenditure is deductible as part of a project pool (see Chapter 8) [Schedule 1, item 1, subsection 40-760(2)] . This ensures such expenditure is not deducted twice, and is consistent with the effect of the current law.

7.38 As a consequence of the introduction of the uniform capital allowance system, the rules for non-arms length transactions apply across the whole Subdivision. [Schedule 1, item 1, section 40-765]

7.39 The provisions are intended to follow the provisions contained in the existing Subdivision 400-B of the ITAA 1997 in the current law and have been largely reproduced unchanged.

Chapter 8 - Capital expenditure that is deductible over time

Outline of chapter

8.1 Subdivision 40-I contains the rules that allow certain capital expenditure associated with a project but that is not a cost of a depreciating asset under the uniform capital allowance system to be written-off over a period of time. This type of expenditure is pooled and written-off over project life. Some other expenditures are written-off over 5 years: or, for some expenditures, the life of an underlying depreciating asset.

Context of reform

8.2 The introduction of the uniform capital allowance system and the allowing of previously non-deductible capital expenditure, are a key component of the New Business Tax System announced in Treasurers Press Release No. 74 of 11 November 1999 (refer to Attachment L).

8.3 However, certain expenditure that is not a cost of a depreciating asset and that is deductible under the current law over different statutory periods will now be deductible over the project life or, for some expenditures, the life of an underlying depreciating asset.

Summary of new law

8.4 Subdivision 40-I allows certain expenditure in relation to a project to be pooled and written-off on the basis of the effective life of the project. It also allows certain other expenditure in relation to certain kinds of underlying depreciating assets to be written-off on the basis of the effective life of the asset. Some other expenditures are written-off over 5 years.

Detailed explanation of new law

8.5 This Subdivision deals with capital expenditure (other than certain expenditure incurred by primary producers) that does not form part of a depreciating asset, but nonetheless is allowed to be amortised over a period of time. That period can either be in relation to the life of a project ( project life ) or the life of an underlying asset or over a statutory life.

Relationship with the mining provisions under Division 330 of the current law

8.6 This Subdivision also ensures that any expenditure associated with the mining, petroleum and quarrying sector that was previously deductible under Division 330 and not captured by previous Subdivisions in Division 40 will be captured. In this regard, all expenditure previously deductible under Division 330 would have been captured under the uniform capital allowance system in the following ways:

•

by ensuring allowable capital expenditureand transport capital expenditureunder Division 330 that forms part of the cost of a depreciating asset you hold, is deducted under Subdivision 40-B;

•

by specifically including mining, quarrying or prospecting rights and information as depreciating assets, thereby ensuring the cash bidding payments in Subdivision 330-D are captured;

•

by replicating Subdivisions 330-A, 330-G and 330-I in Subdivision 40-H; and

•

by including any other allowable capital expenditureand transport capital expenditureunder Division 330 that is not captured by Subdivision 40-B as part of a project pool and deductible under Subdivision 40-I over the project life or the effective life of the depreciating asset as appropriate.

Expenditure to be written-off over project life

Allocation of expenditure to a project pool

8.7 Taxpayers can deduct certain expenditure (a project amount ) through a project pool by allocating that amount to the pool [Schedule 1, item 1, subsection 40-830(1)] . Having allocated the project amount to the pool, you can deduct an amount of the project pool each year [Schedule 1, item 1, subsection 40-830(2)] .

What is a project amount?

8.8 A project amount may consist of 2 types of expenditure. First, it consists of mining capital expenditure and transport capital expenditure (described in paragraph 80 and 8.25) incurred by taxpayers that:

•

does not form part of the cost of a depreciating asset that you hold or are taken to have held;

•

is not deductible under another provision of the income tax law; and

•

is directly connected with carrying on the mining operations in relation to mining capital expenditure or with the business in relation to which the transport capital expenditure is incurred.

[Schedule 1, item 1, subsection 40-840(1)]

8.9 The inclusions of this first type of expenditure as a project amount ensures that all allowable capital expenditure and transport capital expenditure that would have been deductible under Division 330 of the ITAA 1997 is now deductible under the new Division 40. Where this expenditure forms part of the cost of a depreciating asset that the taxpayer holds, it is deductible under section 40-25. In that case it is not deductible under Subdivision 40-I.

8.10 Second, it includes specific types of expenditure that also do not form part of a depreciating asset that is held by a taxpayer and is not deductible under another provision of the income tax law [Schedule 1, item 1, paragraphs 40-840(2)(a) and (b)] . These types of expenditure must be directlyconnected with a project the taxpayer carries on for a taxable purpose, thus ensuring expenditure that is essentially of a private or domestic nature is not deductible under the pool treatment [Schedule 1, item 1, paragraph 40-840(2)(c)] .

8.11 Having satisfied the requirements in the preceding paragraph, the following amounts of capital expenditure will be project amounts:

•

amounts to create or upgrade community infrastructure;

•

amounts for site preparation costs for a depreciating asset other than, for horticultural plants and grapevines, expenditure in draining swamp or low-lying land or expenditure in clearing land;

•

amounts for feasibility studies for the project;

•

amounts for environmental assessments of the project;

•

amounts for information associated with the project;

•

amounts to obtain a right to intellectual property; and

•

amounts for ornamental trees or shrubs.

[Schedule 1, item 1, paragraph 40-840(2)(d)]

8.12 Including amounts for environmental assessments as a project amount ensures that expenditure that would have been deductible under Subdivision 400-A of the ITAA 1997 is now deductible under Division 40.

Calculating the deduction for a project pool

8.13 The deduction for a project pool commences for the income year when the construction or preparatory stage of the project is sufficiently completed that the project begins to operate [Schedule 1, item 1, section 40-855] . Because a project is something you carry on (or propose to carry on) for a taxable purpose, it does not begin to operate until you start to do the things that themselves will support that purpose. Generally, your taxable purpose is the purpose of producing assessable income; a project with that purpose will start to operate when you start to do the things which themselves will produce assessable income. For example, suppose the project is carrying on a mining operation to produce assessable income. The project will start to operate when you start the extraction activities.

8.14 The deduction is calculated using the diminishing value method by multiplying the pool value by the fraction that represents 150% divided by DV project pool life . For the first year in which an amount is allocated to the pool, the pool value is the total of those amounts so allocated. For any subsequent year, it is the closing pool value plus any further amounts allocated in that year. This rule does not discount the deduction for the possibility that pool expenditures may be incurred after the start of the income year. [Schedule 1, item 1, subsection 40-830(3)]

8.15 The deduction is to be reduced by a reasonable amount to any extent to which the project does not operate for a taxable purpose. [Schedule 1, item 1, section 40-835]

8.16 For the first year in which an amount is allocated to the pool, the closing pool value is the total of those amounts so allocated, less any amounts deducted for the pool or that could have been deducted had it been wholly used for a taxable purpose [Schedule 1, item 1, paragraph 40-830(7)(a)] . For any subsequent year, it is the closing pool valuefor the previous income year, plus any further amounts allocated in that year, less any amounts deducted for the pool or that could have been deducted had it been wholly used for a taxable purpose [Schedule 1, item 1, paragraph 40-830(7)(b)] .

8.17 The calculation of the closing pool value ensures any additional amounts allocated to the pool are included in the formula for calculating the deduction. Further, it ensures the value of the pool will decline to its fullest extent each year notwithstanding there has been some private or domestic use associated with the project.

8.18 Where the project is abandoned, sold or otherwise disposed of in an income year, there is a deduction available in that income year for an amount equal to the closing pool valuefor the previous income yearplus any further amounts allocated in that year. This deduction is available regardless of whether the project has started to operate, and so regardless of whether section 40-855 has been satisfied. Consequently, taxpayers can deduct the remaining balance of the pool even though they have not commenced to deduct amounts for the project pool under section 40-855. For example, a deduction is available if a project does not in fact commence because it is abandoned. Further, a deduction would also be available for unsuccessful feasibility project expenditure. In both cases, the deduction is to be an immediate deduction. [Schedule 1, item 1, subsections 40-830(4) and (7)]

8.19 Taxpayers who receive proceeds from the abandonment, sale or from any other disposal of the project must include those proceeds in their assessable income in the income year they receive those proceeds. [Schedule 1, item 1, subsection 40-830(5)]

8.20 Taxpayers must also include in their assessable income any amounts they derive in relation either to a project amount they have allocated to their project pool or in relation to something on which such a project amount was expended. This rule and the previous rule together ensure that all receipts in relation to pooled amounts have been included in assessable income, and so the closing deduction can be allowed in full without carrying out the equivalent of a balancing adjustment calculation. As the project pool does not relate to depreciating assets held by the taxpayer, this approach is intended to simplify the application of the project pool rules. [Schedule 1, item 1, subsection 40-830(6)]

8.21 There is a limit on the deductions for the project pool. By limiting each years deduction to the pool value for that year, this ensures that the total decline in value of the pool cannot be more than the total of the project amounts allocated to the pool. [Schedule 1, item 1, subsection 40-830(8)]

What is DV project life?

8.22 Generally, this will be the project life, or if that project life has been recalculated (which may happen if the circumstances of the project change in a way which make the project life already being used incorrect), it is the most recently recalculated project life. In determining the project for these purposes, it is the taxpayers project and not the other parties asset or project that is the relevant project.

What is project life?

8.23 The project life is the effective life of the project or its most recently recalculated effective life. The effective life of the project is worked out from when the project starts to operate until it stops operating. It must be recalculated each year, as it is freshly applied in the formula each year. [Schedule 1, item 1, section 40-845]

What is mining capital expenditure and transport capital expenditure?

8.24 These terms replicate the current concepts of allowable capital expenditure and transport capital expenditureunder the current law. [Schedule 1, item 1, sections 40-860 to 40-875]

8.25 These definitions and related terms are intended to reflect the definitions contained in the existing Division 330 of the ITAA 1997 under the current law.

Expenditure to be written-off over a statutory life

8.26 Taxpayers will be able to deduct the following 7 types of expenditure to the extent the relevant business is carried on for a taxable purpose:

•

business establishment costs;

•

business restructuring costs;

•

business equity raising costs;

•

costs of defending their business against a takeover;

•

costs to the business of unsuccessfully attempting a takeover;

•

costs of liquidating a company that carried on a business and of which you are a shareholder; and

•

costs of ceasing to carry on the business.

[Schedule 1, item 1, subsection 40-880(1)]

8.27 Examples of business establishment costs include the costs of incorporating a company, costs of setting up a partnership or trust and costs of obtaining relevant information in connection with the business.

8.28 This expenditure will be deducted over a 5-year period on a straight line basis with no apportionment required for expenditure incurred part way through the year. [Schedule 1, item 1, subsection 40-880(2)]

8.29 Expenditure will only be deductible under section 40-880 to the extent that:

•

it is not included in the cost of either a depreciating asset held by the taxpayer or land; or

•

it is not deductible under another provision of the income tax law apart from section 40-880.

[Schedule 1, item 1, subsection 40-880(3)]

8.30 As a consequence of the introduction of the uniform capital allowance system, the rules for non-arms length transactions apply across the whole Subdivision. [Schedule 1, item 1, section 40-885]

Chapter 9 - Effective life and low-cost plant

Outline of chapter

9.1 This chapter explains 3 amendments that are being made to Division 42 of the ITAA 1997. These are in consequence of the introduction of the uniform capital allowance system.

9.2 Firstly, the effective life specified by the Commissioner that is to be available for plant will be made certain.

9.3 Secondly, an immediate deduction for plant costing $300 or less to certain taxpayers will be reintroduced as from 1 July 2000.

9.4 Thirdly, the effective life and the method of calculating deductions will be stipulated in certain circumstances.

Context of reform

9.5 In order to provide certainty to taxpayers, the effective life specified by the Commissioner that is to be available for plant, will be made certain.

9.6 The reintroduction of the immediate deduction for plant costing $300 or less to certain taxpayers will simplify the tax consequences of such assets, as well as reduce compliance costs to these taxpayers. Further, because the immediate deduction of plant costing $300 or less is currently available to small business taxpayers only, it will provide greater equity between taxpayers.

9.7 The stipulation of effective life and method in certain circumstances is an integrity measure.

Summary of new law

9.8 Three major amendments will be made to Division 42 of the ITAA 1997 in Schedules 2 and 3 to this Bill:

•

what effective life specified by the Commissioner is to be available for plant;

•

the reintroduction of the immediate deduction for plant costing $300 or less to certain taxpayers as from 1 July 2000; and

•

what effective life and calculation method is to be used in certain circumstances.

Detailed explanation of new law

Effective life specified by the Commissioner

9.9 The Commissioner can determine the effective life of plant pursuant to section 42-110 of the ITAA 1997. However, due to a number of reasons including technological advances, the effective life of plant may periodically change. As a consequence the Commissioner may need to change the determination of the effective life of plant.

9.10 In order to ensure taxpayers can conduct their affairs with certainty, section 42-100 of the ITAA 1997 will be amended so that they will know what effective life determination made by the Commissioner will apply to their specific circumstances. This is achieved by using the effective life specified by the Commissioner for plant that is in force as at:

•

the time when the taxpayer entered into a contract to acquire the plant, or otherwise acquired it, or started to construct the plant, so long as it was first used or installed ready for use for the purpose of producing assessable income within 5 years of that time;

•

the time that the taxpayer entered into a contract to acquire or otherwise acquired the plant, or construction of the plant, commenced before 110 am, by legal time in the Australian Capital Territory, on 21 September 1999; or

•

when the taxpayer first used the plant or had it installed ready for use for the purpose of producing assessable income.

[Schedule 2, item 1]

Example 9.1

Oilco Ltd signs a contract on 21 February 2000 for the building of 3 new oilrigs for the extraction of oil in the Timor gap. The rigs take 2 years to build, construction commencing 1 April 2000. Although Oilco Ltd know that there may be an effective life review for oilrigs, it currently uses the safe harbour rate of 10 years. Oilco Ltds analysis has shown that the project will be viable at this level of investment and at the rate of deduction based on this effective life. Without further information it continues to factor this safe harbour rate into its financial analysis. At the end of year one, the Commissioner completes a review of effective lives and releases a new Determination showing a life of 30 years for oilrigs.

Under the proposed law the safe harbour effective life that Oilco Ltd can choose is the one that applied when it signs the contract to commence construction. This is because the criteria in paragraph 42-100(2)(a) have been satisfied as Oilco Ltd will start to use the asset within a 5-year period.

Low-cost assets

9.11 Currently, except for small business taxpayers, there is no immediate deduction for plant costing $300 or less. The immediate deduction was removed by the New Business Tax System (Miscellaneous) Act (No. 1) 2000 as from 1 July 2000. Instead, items of plant costing less than $300 are now pooled and depreciated over an effective life of 4 years using the diminishing value method.

9.12 In order to bring the current law in line with the uniform capital allowance system, an immediate deduction for plant costing $300 or less will be available to the owners or quasi-owners of such plant who are either small business taxpayers or taxpayers who:

•

use the plant predominantly for the purpose of producing assessable income that is not from carrying on a business;

•

do not acquire a set of assets on an item by item basis rather than as a set; and

•

do not acquire one or more items of plant that are either identical or substantially identical in an income year where the total cost of these acquisitions is more than $300.

9.13 The second criterion ensures that taxpayers cannot disaggregate a set of assets by buying individual items from the set (each costing $300 or less) rather than buying the set itself (which costs more than $300) and claiming the immediate deduction. In addition, the third criterion ensures that taxpayers cannot claim immediate deduction for identical (or substantially identical) items of plant acquired in an income year where the individual item costs $300 or less but collectively they cost more than $300. For example, a landlord with a rental house cannot claim the immediate deduction in an income year for buying 2 identical lamps which individually cost $280. [Schedule 2, item 2]

9.14 This deduction has been made retrospective, with effect as from 1 July 2000. [Schedule 2, item 4]

9.15 Taxpayers who satisfy the criteria in paragraphs 90 and 90 cannot allocate this plant to a low-value pool. [Schedule 2, item 3]

Effective life and method

Method of calculation

9.16 For each unit of plant, a taxpayer must decide whether to apply the prime cost or diminishing value method for working out their deduction.

9.17 However, taxpayers must use the same method that their associate was using when they acquire plant from that associate.

9.18 Also, taxpayers must use the same method that the previous owner or quasi-owner of the plant was using where the end-user of the plant does not change. Examples of where this could occur are under sale and leaseback arrangements and by a lessee purchasing plant after the lease of the plant has ended.

9.19 Where taxpayers cannot readily ascertain the method that the former owner or quasi-owner was using, they must use the diminishing value method. This overcomes any difficulties in obtaining the necessary information to ascertain the method. [Schedule 3, item 1]

Effective life

9.20 Taxpayers have a choice of using the Commissioners determination of effective life or self-assessing. However the choice is not available in 2 situations. First, where the taxpayer acquired the plant from an associate. In this case the effective life is the effective life of the plant that the associate was using if the taxpayer is using the diminishing value method. If the taxpayer is using the prime cost method then they must use the remaining effective life.

9.21 Second, where the end-user of the plant does not change. In this case the effective life is the effective life of the plant that was used by the previous owner or quasi-owner of the plant, if the taxpayer is using the diminishing value method. If the taxpayer is using the prime cost method then they must use the remaining effective life. Examples of where this could occur are under sale and leaseback arrangements and by a lessee purchasing the plant after the lease has ended. If the Commissioner later finds that the previous holder was using an incorrect effective life and amends the previous holders tax returns to reflect the use of a correct effective life, the effective life as reset by the Commissioner applicable to the previous holder will apply to the new holder.

9.22 Where taxpayers cannot readily ascertain the effective life that the former owner or quasi-owner was using, they must use the effective life of the asset as determined by the Commissioner. [Schedule 3, item 2]

9.23 The changes made by Schedule 3 apply to plant:

•

acquired under a contract;

•

commenced to be constructed by a taxpayer; or

•

acquired in some other way,

on or after 100 am, by legal time in the Australian Capital Territory, on 9 May 2001. The changes apply to owners as well as quasi-owners.

Chapter 10 - Capital allowances - finding tables

Outline of chapter

10.1 This chapter contains finding tables to enable you to locate quickly the provisions in Division 40 that correspond to a particular provision in the existing law and vice versa.

Finding table - old law to new law

10.2 In the finding table:

•

omitted means that the provision of the old law has not been included in the new law; and

•

transitional means that effect of the provision of the old law has been picked up by a provision in the New Business Tax System (Capital Allowances - Transitional and Consequential) Bill 2001.

Finding table - new law to old law

10.3 In this finding table no equivalent means that this is a new provision that has no equivalent in the existing law. Typically, these would be guide materials.

Chapter 11 - Transitional provisions

Outline of chapter

11.1 This chapter explains the amendments to the Income Tax (Transitional Provisions) Act 1997 to facilitate the transition from the various separate existing capital allowance regimes into the uniform capital allowance system.

11.2 The application of the uniform capital allowance system (contained in the Capital Allowances Bill) is to depreciating assets:

•

that taxpayers start to hold under a contract entered into after 30 June 2001;

•

that are constructed where construction started after that day; or

•

that start to be held in some other way after that day.

The transitional provisions will allow taxpayers to apply the new system to existing depreciating assets and certain capital expenditures. That is, these provisions generally apply the new law to assets and capital expenditures that are not directly subject to the new law but are or would be subject to the existing law if it had continued to have application. Effectively, Division 40 will apply to the depreciating assets created, acquired, etc. after 30 June and depreciating assets subject to the transitional provisions that are created, acquired, etc. before that date. Division 40 will also apply to pools of unrecouped mining related expenditure that are deemed to be depreciating assets.

Context of reform

11.3 The introduction of the uniform capital allowance system for depreciating assets and its general application, giving deductions for some previously non-deductible capital expenditure, are key components of the New Business Tax System announced in Treasurers Press Release No. 74 of 11 November 1999 (refer to Attachment L).

11.4 Because it is based on a common set of principles the uniform capital allowance system will offer significant simplification benefits. The existing capital allowance regimes are complex, inconsistent and involve significant replication of parallel but not identical provisions and concepts. Therefore, transitional provisions will be needed so that the assets and expenditures currently subject to the separate system can be transferred to the general regime.

Summary of new law

11.5 These provisions will provide for the transition from the following regimes into the uniform capital allowance system:

•

Division 42 - Plant;

•

Division 44 - IRUs;

•

Division 46 - Software;

•

Division 330 - Mining and quarrying;

•

Division 373 - Intellectual property;

•

Division 380 - Spectrum licences;

•

Division 387 - Capital allowances for primary production;

•

Division 388 - Landcare and water facilities; and

•

Division 400 - Environmental assessments and protection.

11.6 The purpose of the transitional provisions is to ensure that taxpayers who are currently deducting amounts under the existing law can continue their deductions under the uniform capital allowance system. Broadly, taxpayers will continue to deduct the same amount under the uniform capital allowance system as they would under the existing law.

Detailed explanation of new law

11.7 The transitional provisions transfer existing assets into the uniform capital allowance system whilst preserving a taxpayers existing entitlements to deductions in relation to their capital expenditure.

11.8 Explained in paragraphs 110 to 110 are how the provisions that allow for the transition of assets and capital expenditures under the existing Divisions (that are to be repealed) are to be dealt with under the new law. Taxpayers with a substituted accounting period have special rules for their transition into the unified regime.

Actual amounts deducted under old law

11.9 Amounts deducted as a capital allowance relating to an asset under the existing law will be treated as deductions taken for the decline in value of a depreciating asset under the uniform capital allowance system. [Schedule 1, item 1, subsection 40-70(1)]

11.10 The purpose of subsection 40-70(1) of the New Business Tax System (Capital Allowances - Transitional and Consequential) Bill 2001, amongst other things, is to ensure that:

•

balancing adjustments under the uniform capital allowance system will apply where plant for which there have been deductions under existing law is disposed of after the new law starts. Amounts deducted under the existing law will be taken into account in a balancing adjustment calculation required under the uniform capital allowance system;

-

balancing adjustments under the new law will also take into account non-taxable use under the existing law [Schedule 1, item 1, section 40-290] ;

•

plant as well as other assets held before the commencement of the uniform capital allowance system will be eligible to be allocated to the low-value pool if they meet the relevant criteria, without requiring a further year of diminishing value decline under the uniform capital allowance system; and

•

the anti-avoidance rules in respect of transfers to associates and the purchase of assets under certain finance contracts apply to assets transferred into the uniform capital allowance system from the existing law.

Division 42 - Depreciation of plant

11.11 The transitional provisions will explain how taxpayers, who are eligible to depreciate plant under the existing law, can continue to depreciate it under the uniform capital allowance system. The provisions will ensure that taxpayers who are eligible and claiming depreciation deductions at a certain rate under the current law, will maintain that level of depreciation (to be known as the decline in value of their depreciating asset) provided no change in circumstances occurs in relation to that asset.

11.12 In broad terms, taxpayers will continue to depreciate existing plant under the new law on the same basis as they do under the existing provisions (i.e. using the same calculation method, cost and effective life). [Schedule 1, item 1, paragraph 40-10(2)(b)]

11.13 A taxpayer may be claiming depreciation deductions as an owner or quasi-owner under Division 42 but may not be a holder under the uniform capital allowance system. For instance, a taxpayer may be a lessee of an item of plant for the entire effective life of the plant and be claiming depreciation deductions as an owner or quasi-owner in reliance upon a binding ruling. The transitional provisions will not prevent that taxpayer from continuing to rely upon that binding ruling and, consequently, claiming deductions for decline under the uniform capital allowance system [Schedule 1, item 1, paragraph 40-10(1)(b)] . Nor will the transitional provisions protect that taxpayer if that reliance was later found to be ill-founded. Any risk associated with a position taken before the commencement of the uniform capital allowance system will neither be increased nor decreased for the taxpayer.

11.14 However, taxpayers will continue to be able to claim deductions for decline only while the circumstances under which they claimed depreciation deductions continue to exist [Schedule 1, item 1, paragraph 40-10(2)(d)] . If those circumstances change they will cease to be a holder under the uniform capital allowance system.

11.15 Generally, plant that has had its depreciation calculated under the existing law will have its decline in value calculated under the uniform capital allowance system. The transitional provisions will substitute the adjustable value of the plant (as calculated under the uniform capital allowance system) for the undeducted cost of the item of plant (calculated under the old law) as at the end of the 2000-2001 income year. The uniform capital allowance system would then apply to that asset (in its entirety) from the end of the 2001-2002 income year onwards [Schedule 1, item 1, section 40-10] . Further, taxpayers may have entered into a contract before 1 July 2001 to acquire plant but the actual acquisition of that plant may occur on or after 1 July 2001. That plant will also have its decline in value calculated under the uniform capital allowance system and the taxpayer will retain accelerated depreciation on that item of plant where applicable [Schedule 1, item 1, section 40-12] .

Example 11.1

Kristen bought a helicopter on 16 April 2000 for use in her protective services business. As at 1 July 2001 she continues to hold and use this property in her business. The cost of the helicopter is $100,000 and it has an effective life of 8 years. Kristen has chosen to depreciate the item using the diminishing value method. The item of plant is depreciable under the existing law and has an undeducted cost as at 30 June 2001 of $78,162.

From 1 July 2001, Kristen must use the uniform capital allowance system to calculate the decline in value of her deprecating asset (the helicopter). The opening adjustable value of the helicopter is $78,162 and its cost is $100,000. Kristen must use the diminishing value method to calculate the decline in value of the asset and must also use an effective life of 8 years.

If the circumstances surrounding the use of the helicopter have not changed between income years 2000-2001 and 2001-2002, the depreciation deduction under the new law will be equivalent to the deduction she would have received if the existing law continued to apply.

11.16 There is an exception where either a taxpayer became the owner or quasi-owner of the items of plant under a contract entered into before 110 am, by legal time in the Australian Capital Territory, on 21 September 1999, or the taxpayer is a small business taxpayer. If this exception applies then a modification is required to certain components of the diminishing value and prime cost formulas under the new law. This ensures that the taxpayer retains accelerated depreciation on that item of plant. [Schedule 1, item 1, subsections 40-10(3) and 40-12(3)]

Example 11.2

Millie's Farmhouse Pty Ltd (Millies Farmhouse) bought a tractor on 10 March 1998. The tractor has a cost of $75,000 and an effective life of 62/3 years. Because the tractor was acquired before 110 am, by legal time in the Australian Capital Territory, on 21 September 1999 accelerated deprecation still applies to this asset.

Millie's Farmhouse decided to use the prime cost method to depreciate this tractor. As at 1 July 2001, the undeducted cost of the tractor is $25,357. In order to maintain the accelerated depreciation on the tractor, Millies Farmhouse must modify the prime cost formula in section 40-75 of the Capital Allowances Bill. Millies Farmhouse will do this by replacing the effective life component of the formula with the prime cost rate used under the existing law (i.e. 20%).

11.17 Where the exception applies (i.e. plant was subject to accelerated depreciation) taxpayers are unable to recalculate the effective lives of those items of plant. This is because recalculation would provide an opportunity to extend the benefits of the grandfathered accelerated depreciation regime which would be inconsistent with the uniform capital allowance system. Also, the intention of this grandfathering provision is to preserve a treatment already being received. [Schedule 1, item 1, section 40-15]

Car limit

11.18 The reference to car limit in the uniform capital allowance system is equivalent to the car depreciation limit as used in the old law. The concept of car limit will incorporate the concept of car depreciation limit for cars currently depreciable under existing law. [Schedule 1, item 1, subsection 40-230(1)]

11.19 Taxpayers with a substituted accounting period must use the car limit provisions in the uniform capital allowance system for their 2001-2002 income year. However, if their 2001-2002 income year begins before 1 July 2001, the car depreciation limit in the existing law must be used. [Schedule 1, item 1, subsection 40-230(2)]

Pooling under Subdivision 42-L

11.20 Taxpayers who have allocated items of plant to the general elective pools under Subdivision 42-L of the ITAA 1997 will be entitled to continue to claim deductions under the new law as if the pool was a single depreciating asset. [Schedule 1, item 1, subsection 40-60(1)]

11.21 The pool is treated as a depreciating asset and the decline in value of that asset is calculated on the following basis:

•

the taxpayer must use the diminishing value method for calculating the decline in value of the asset;

•

the opening adjustable value and cost of the asset upon entering into the new regime will be equal to the closing value of the pool under the existing law as at the end of the 2000-2001 income year; and

•

the component of the formula under the uniform capital allowance system that contains the effective life must be replaced with the pool percentage used in the existing law. The base value in the income year for which the uniform capital allowance system is effective is equal to the opening adjustable value.

[Schedule 1, item 1, subsection 40-60(2)]

11.22 If a balancing adjustment event occurs to an item of plant that was allocated to the pool (despite the depreciating asset being the pool and not the item of plant) the depreciating asset (the pool) is treated as having been split under the new law (into the item of plant and the remaining pooled items). The newly created asset (item of plant) will be subject to the balancing adjustment rules under the uniform capital allowance system when it is disposed of. [Schedule 1, item 1, paragraph 40-60(2)(e)]

Example 11.3

John created a general elective pool on 29 November 1998 that contained assets relating to the operation of his video rental business. As the video recorders that are hired out are depreciated using the same diminishing value rate, John has pooled these items and now depreciates the balance of the pool. At 30 June 2001 the closing value of the pool is $12,570 and the pool percentage is 25%.

As at 1 July 2001, John moves into the new uniform system for capital allowances. The transitional rules state that the pool created by John is now treated as a depreciating asset and the pool closing balance of $12,570 becomes the depreciating assets adjustable value and the effective life component of the diminishing value method is replaced with the pool percentage (i.e. 25%).

If John subsequently sells a video recorder that has been allocated to the pool to Julia and Paul on 7 December 2002, John must split his asset into the asset being disposed of and the remaining pool. John reasonably apportions the adjustable value of the original asset into its split components and calculates the balancing adjustment on the asset disposed of. John continues to calculate the decline on value of the remaining asset based on the previous pool percentage.

11.23 If the taxpayer incurs an amount that would have been in the second element of cost for a single asset that had been allocated to the pool, the amount will be included as the second element of cost of the created depreciating asset (i.e. the pool). [Schedule 1, item 1, paragraph 40-60(2)(f)]

Later year relief

Non-small business taxpayers

11.24 This provision applies to a taxpayer who has had a balancing adjustment event occur to an item of plant before 110 am, by legal time in the Australian Capital Territory, on 21 September 1999 and the taxpayer has chosen to exclude an amount from their assessable income and instead reduces the allowable deductions from an item of replacement plant.

11.25 Where the replacement plant started to be held in the 2000-2001 income year, the replacement asset is taken to have declined in value by the amount excluded from assessable income under the existing law. [Schedule 1, item 1, section 40-295]

Example 11.4

HND Mining Ltd disposed of an ore truck on 20 September 1999 and the balancing adjustment event that resulted required HND Mining Ltd to include $10,000 in its assessable income.

On 14 July 2001, HND Mining Ltd purchased a replacement asset for $150,000. It opted for later year relief pursuant to section 42-290 of the existing law. Consequently, the $10,000 will be excluded from HND Mining Ltds assessable income for the 1999-2000 income year (assuming it does not use a substituted accounting period). Therefore, HND Mining Ltd is required to base the decline in value of the replacement asset on $140,000 and not $150,000.

Small business taxpayers

11.26 This provision applies to a taxpayer who has had a balancing adjustment event occur to an item of plant before the commencement of the uniform capital allowance system and the taxpayer has chosen to exclude an amount from their assessable income and to instead reduce the allowable deductions from an item of replacement plant.

11.27 Where the replacement plant started to be held in the 2000-2001 income year, the replacement asset is taken to have declined in value by the amount excluded from assessable income under the existing law. [Schedule 1, item 1, section 40-295]

Rollovers

11.28 If the taxpayer has rolled over a depreciating asset under the rollover provisions of the uniform capital allowance system and the asset being rolled over was subject to accelerated depreciation, the taxpayer acquiring that asset will continue to be able to access accelerated deductions provided that either the:

•

plant was acquired before 110 am, by legal time in the Australian Capital Territory, on 21 September 1999 by the transferor; or

•

the taxpayer receiving the asset is a small business taxpayer (subject to meeting certain requirements).

11.29 If the taxpayer is entitled to accelerated depreciation then the formulas that work out decline in value of the asset require modification (see paragraphs 110 and 11.16). [Schedule 1, item 1, section 40-340]

Plant acquired before 21 September 1999

11.30 Where a balancing adjustment event occurs to an item of plant on or after 1 July 2001 and that plant was acquired before 110 am, by legal time in the Australian Capital Territory, on 21 September 1999, an amount is to be included in assessable income as a capital gain (CGT event K7). This will only occur where the plant was used partly for income producing purposes. However, the capital gain is reduced by an amount calculated under subsection 42-192(2) of the existing law. This ensures that the benefits of indexation of cost base for CGT purposes is maintained for plant acquired before 21 September 1999. This indexation is also maintained where there has been a rollover of a depreciating asset under the rollover provisions of the uniform capital allowance system. [Schedule 1, item 1, section 40-345]

Low-value pools

11.31 If a taxpayer has created a low-value pool under the existing law and the pool has a closing balance at the end of the 2000-2001 income year, the taxpayer can work out the decline in the value of this pool under the uniform capital allowance system. In working out the decline in value for the 2001-2002 income year, the taxpayer must use the closing balance (worked out under the existing law) as at the end of the 2000-2001 income year for the purposes of step 3 of the method statement in subsection 40-440(1) of the Capital Allowances Bill. [Schedule 1, item 1, section 40-420]

11.32 A taxpayer can allocate an item of plant (held before the commencement of the new law) to the low-value pool under that new law if they were eligible to allocate that item of plant to the low-value pool under the existing law. [Schedule 1, item 1, section 40-425]

Division 44 - IRUs

11.33 A taxpayer who is currently claiming a deduction under the current law for an IRU they own, can continue to claim a deduction for the decline in value of the IRU under the uniform capital allowance system.

11.34 The taxpayer must use the same method to calculate the decline in value of their IRU as that used to calculate the rate of depreciation under the existing law. The taxpayer must also substitute the adjustable value under the new law with the undeducted cost from the current law as at the end of the 2000-2001 income year. The new law will then apply (in its entirety) to IRUs depreciable under the existing law from the 2002-2003 income year. [Schedule 1, item 1, section 40-20]

Division 46 - Software

11.35 Expenditure on software that was allocated to a software pool under the existing law will continue to be deductible under the existing legislation. While the existing provisions will be repealed the transitional provisions will maintain the existing provisions operation for this expenditure. [Schedule 1, item 1, subsection 40-25(1)]

11.36 Software that has been depreciated as if it was plant will become subject to the new law on the following basis:

•

the taxpayer must use the prime cost method for calculating the decline in value of the software;

•

the opening adjustable value of the software upon entering into the new regime will be equal to the undeducted cost of the software under the existing law as at the end of the 2000-2001 income year;

•

the taxpayer must use the same effective life under the new law as they had been using under the existing law; and

•

the cost is equal to the amount of expenditure incurred by the taxpayer in relation to that unit of plant.

[Schedule 1, item 1, subsection 40-25(2)]

Software development pools

11.37 If a taxpayer had a software development pool created under the existing law and incurs expenditure on software development after 1 July 2001, the taxpayer must allocate that expenditure to a software development pool under the uniform capital allowance system. The taxpayers choice to pool that expenditure under the existing law is taken to be a choice made under the new law. [Schedule 1, item 1, section 40-450]

Example 11.5

Carmen, the proprietor of a bed and breakfast chain, commenced developing a computerised booking system. Carmen created a software development pool under the existing law to which she allocated expenditure on developing this system.

As at 1 July 2001, the software is still in its developmental stages. The existing law will continue to apply to expenditure already allocated to the pool. On 5 October 2001 Carmen incurs further expenditure in relation to the development of software. Carmen is required to create a software development pool under the uniform capital allowance system and allocate any further expenditure to that pool. This requirement comes about because Carmen had previously decided to pool this expenditure under the existing law.

Division 330 - Mining and quarrying

11.38 Expenditure incurred before 1 July 2001 that is deductible under the special provisions for mining and quarrying is generally to retain its current treatment. That is to be achieved by bringing such expenditure into Division 40 and modifying the ordinary application of the Division to ensure that the expenditure retains its current treatment. Accordingly, the current provisions will cease to apply from 1 July 2001.

11.39 There are 3 categories of expenditure covered by these transitional rules:

•

mining unrecouped expenditure;

•

transport expenditure; and

•

mining expenditure incurred after 1 July 2001 in respect of assets acquired, etc. before that day.

Mining unrecouped expenditure

11.40 Broadly, capital expenditure other than on plant incurred on developing and operating a mine site, petroleum field or quarry (allowable capital expenditure) is deductible over the shorter of 10 years (20 years for quarrying) and the life of the project. The amount of such expenditure remaining to be deducted is unrecouped expenditure.

11.41 If a taxpayer has an amount of unrecouped expenditure at the end of 30 June 2001, the taxpayer will work out the decline in the value of that amount under Division 40 using the prime cost method, and as if it were a depreciating asset held by the taxpayer. The amount of unrecouped expenditure that is taken to be an asset is taken to be an asset for all purposes of Division 40, including balancing adjustments. [Schedule 1, item 1, section 40-35]

11.42 The decline in value of that asset is calculated on the following basis:

•

the adjustable value of the expenditure upon entering into the new regime will be equal to the amount of unrecouped expenditure at the end of 30 June 2001 (i.e. after taking into account any deductions up to the end of that day) [Schedule 1, item 1, paragraph 40-35(2)(a)] ;

•

the asset comprising the unrecouped expenditure had a cost equal to the total amount of allowable capital expenditure under Division 330 [Schedule 1, item 1, paragraph 40-35(2)(b)] ;

•

the decline under the prime cost formula is calculated using the adjustments to the formula found in the new law for the year in which the transition occurs. The basis for calculating the decline in the transition year will be on remaining effective life and adjustable value (to ensure that deductions are calculated in the same manner as under the current law) [Schedule 1, item 1, paragraph 40-35(2)(c)] ;

•

the asset was used for a taxable purpose at the start of the 2001-2002 income year (to reflect that unrecouped expenditure literally cannot have a start time and that deductions under the current law are allowable before the underlying asset is used) [Schedule 1, item 1, paragraph 40-35(2)(d)] ; and

•

the asset had a remaining effective life equal to the shorter of the remaining number of years in the 10 year period for deduction (20 years for quarrying) and the life of the project [Schedule 1, item 1, paragraph 40-35(2)(e) and subsections 40-35(3) and (4)] .

Disposal, etc. of property to which unrecouped expenditure relates

11.43 If underlying property to which the unrecouped expenditure relates is disposed of, lost or destroyed, or it ceases to be used for a taxable purpose, there is an additional decline in value of the notional asset that includes this expenditure. If the underlying property is a depreciating asset, that additional decline in value is that part of the notional assets adjustable value that relates to the underlying property and that was not taken into account in working out the balancing adjustment for the disposal of the depreciating asset. [Schedule 1, item 1, subsection 40-35(5)]

11.44 A similar additional decline in value of the notional asset occurs if the underlying property is not a depreciating asset. Further, where that underlying property is not a depreciating asset and the taxpayer disposes of the asset by sale, those sale proceeds are to be included in the taxpayers assessable income. If the disposal is otherwise than by sale and the taxpayer owns the asset, an amount equivalent to the market value of the asset is included in the assessable income of the taxpayer. If the taxpayer does not own the asset, the amount included in assessable income is a reasonable amount (see the former Division 330 for the comparable existing rule). However, in each case, the amount to be included in assessable income is to be reduced so far as it is already included in assessable income under the rules that relate to a project pool (to avoid double-counting the income). In effect, therefore, the deductions given indirectly for underlying property that is not a depreciating asset, through the expenditure previously deducted or included in mining unrecouped expenditure, are reconciled to the actual loss in value of the property. [Schedule 1, item 1, subsection 40-35(6)]

Transport capital expenditure

11.45 Broadly, capital expenditure on certain facilities used primarily and principally in the transport of minerals, including petroleum, and quarry materials, away from the place of extraction, is evenly deductible over 10 years (20 years for quarry materials). The deduction commences in the year the facility is so used.

11.46 A taxpayer who has deducted or is entitled to deduct an amount for transport capital expenditure in respect of a transport facility can continue to deduct that expenditure under the new law. [Schedule 1, item 1, subsection 40-40(1)]

11.47 The capital expenditure is treated as a depreciating asset and the decline in value of that asset is calculated using the prime cost method on the following basis:

•

the opening adjustable value of the expenditure upon entering into the new regime will be equal to the total amount of transport capital expenditure determined under the existing law (less amounts deducted or able to be deducted) as at the end of the 2000-2001 income year;

•

the cost of this asset is equal to the total amount of transport capital expenditure calculated under the existing law;

•

the decline under the prime cost formula is calculated using the adjustments to the formula found in the new law for the year in which the transition occurs. The basis for calculating the decline in the transition year will be on remaining effective life and adjustable value (to ensure that deductions are calculated in the same manner as under the current law); and

•

the asset had an opening effective life equal to the years remaining in the 10 year period for deduction (20 years for quarrying).

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

Disposal, etc. of property to which transport expenditure relates

11.48 If the underlying property to which the transport expenditure relates is disposed of, lost or destroyed, or it ceases to be used for a taxable purpose, there is an additional decline in value of the notional asset that represents this expenditure. That decline in value is that part of the notional assets adjustable value that relates to the underlying property and was not taken into account in working out the balancing adjustment for the disposal of the depreciating asset, if the property happens to be a depreciating asset. [Schedule 1, item 1, subsection 40-40(4)]

11.49 A similar additional decline in value of the notional asset occurs if the underlying property is not a depreciating asset. Further, where that underlying property is not a depreciating asset and the taxpayer disposes of the asset by sale, those sale proceeds are to be included in the taxpayers assessable income. If the disposal is otherwise than by sale and the taxpayer owns the asset, an amount equivalent to the market value of the asset is included in the assessable income of the taxpayer. If the taxpayer does not own the asset, the amount included in assessable income is a reasonable amount (see the former Division 330). However, in each case, the amount to be included in assessable income is to be reduced so far as it is already included in assessable income by the rules that relate to a project pool. In effect, therefore, the deductions given indirectly for underlying property that is not a depreciating asset, through the expenditure previously deducted or included in transport expenditure, are reconciled to the actual loss in value of the property. [Schedule 1, item 1, subsection 40-40(5)]

Mining expenditure incurred after 1 July 2001 in respect of assets acquired, etc. before that day

11.50 Division 40 does not apply to depreciating assets started to be held under contracts entered into, or commenced to be constructed, or started to be held in some other way, on or before 30 June 2001. Expenditure incurred after that day that is a cost of such an asset and that would have been covered by the special provisions for mining and quarrying under the former law will be deductible under the new law. [Schedule 1, item 1, subsection 40-75(1)]

11.51 The expenditure is immediately deductible if it is expenditure on exploration or prospecting. [Schedule 1, item 1, subsection 40-75(2)]

11.52 Otherwise, the expenditure is treated as a cost of the depreciating asset to which Division 40 applies on the basis that it has a cost, and adjustable value, of zero at the start of the 2001-2002 income year [Schedule 1, item 1, subsection 40-75(3)] . The effect is that such expenditure will be deductible over time based on the effective life of the asset, in the same way as if the asset were one to which Division 40 had always applied. If that effective life is longer than the period over which the taxpayer would have deducted the expenditure under Division 330, then the effective life is the shorter period [Schedule 1, item 1, subsection 40-75(4)] .

11.53 Division 40 will apply to all mining, quarrying and prospecting depreciating assets that are held before 1 July 2001 on the basis that they have a cost, and adjustable value, of zero at the start of the 2001-2002 income year unless another transitional rule provides for a different outcome. This is to ensure that these assets will be subject to the balancing adjustment rules under Division 40 on an appropriate basis. [Schedule 1, item 1, subsections 40-75(1) and (3)]

Mining, quarrying or prospecting rights or information held before 1 July 2001

11.54 The transitional rules provide for mining, quarrying and prospecting rights that the taxpayer held before 1 July 2001 to remain subject to the CGT provisions contained in the ITAA 1997 instead of being subject to the balancing adjustments in the uniform capital allowance system. This change will mean that the uniform capital allowance system will not apply to a mining, quarrying and prospecting right that the taxpayer held before 1 July 2001 and the taxpayer will not be able to claim deductions for costs incurred on those rights after the introduction of the new system. These amounts can only be used in the calculation of the taxpayers capital gain or loss under the CGT provisions. [Schedule 1, item 1, paragraph 40-75(1)(b) and subsection 40-77(1)]

11.55 The transitional rules also allow for non-deductible costs (which cannot have been included in allowable capital expenditure under the former law) associated with mining, quarrying and prospecting information the taxpayer started to hold before 1 July 2001 to reduce amounts included in assessable income from the realisation of such information. [Schedule 1, item 1, subsection 40-77(3)]

11.56 If a taxpayer disposes of the mining, quarrying and prospecting right that they held before 1 July 2001 to an associate, or enters into arrangements where in-substance ownership or use is retained, the cost of the asset to the purchaser is capped at the amount that would have been deductible under the repealed Division 330 of the ITAA 1997. [Schedule 1, item 1, subsection 40-77(2)]

Example 11.6

Melissa Iron Ore Pty Ltd (Melissa Iron Ore) holds a mining right and mining information relating to their iron ore mining operation as at 30 June 2001. Melissa Iron Ore has $100,000 of undeductible costs associated with the mining right and $1,000 worth of undeductible costs associated with the mining information.

On 12 August 2001, Melissa Iron Ore incurred further costs ($5,000) in relation to the mining right that it holds. Those costs will form part of the cost base of the mining right and cannot be subject to a deduction under the uniform capital allowance system.

Further on 4 September 2001, Melissa Iron Ore received $10,000 for the sale of mining information that it holds. Melissa Iron Ore continues to hold that information after the sale so generally, the entire $10,000 would be included in assessable income. However, Melissa Iron Ore held mining information before 1 July 2001 and has undeductible cost associated with that information. Therefore, Melissa Iron Ore can reduce the $10,000 included in assessable income by $1,000 (amount included in assessable income is now $9,000). The $1,000 cannot be used to reduce any further amounts included in assessable income from the further realisation of Melissa Iron Ores mining information.

On 15 January 2002, Melissa Iron Ore disposes of its iron ore operation including the associated mining right and mining information. The reasonable consideration allocated to the mining right is $150,000 and the mining information is $5,000.

Melissa Iron Ore would have the $5,000 included in its assessable income from the disposal of the mining information. There is no reduction of this amount as all undeductible cost associated with this mining information has been previously utilised. There would be a capital gain of $45,000 ($150,000 - ($100,000 + $5,000)) from the disposal of the mining right.

Excess deductions

11.57 Excess deductions under the mining provisions in subsections 122J(4) and 124AH(4) of the ITAA 1936 are to be immediately deductible in the 2001-2002 income year. [Schedule 1, item 1, section 40-85]

Genuine prospectors

11.58 The exemption provided for ordinary income derived from the sale, transfer or assignment of your rights to mine for certain specified metals and minerals will continue to apply until 20 August 2001. This is despite the repealing of the relevant provisions. [Schedule 1, item 1, section 40-825]

Division 373 - Intellectual property

11.59 A taxpayer who holds the following intellectual property:

•

standard patent;

•

petty patent;

•

innovation patent;

•

registered design;

•

copyright; or

•

a licence to an item listed above,

and can claim or has claimed a deduction under the existing law for amortisation of that item, will be entitled to a deduction for the decline in value of that property under the uniform capital allowance system. [Schedule 1, item 1, subsection 40-45(1)]

11.60 An item of intellectual property that has been amortised under the existing law will become subject to the new law on the following basis:

•

the taxpayer must use the prime cost method for calculating the decline in value of the intellectual property;

•

the opening adjustable value of the property upon entering into the new regime will be equal to the unrecouped expenditure of the property under the existing law as at the end of the 2000-2001 income year;

•

the taxpayer must use the same effective life under the new law as they had been using under the existing law; and

•

the cost of the property is equal to the expenditure that the taxpayer incurred in obtaining that property.

[Schedule 1, item 1, subsection 40-45(2)]

Division 380 - Spectrum licences

11.61 A taxpayer who currently is entitled to claim deductions for the amortisation of a spectrum licence under the existing law will be entitled to a deduction for the decline in value of the licence under the uniform capital allowance system if there is expenditure yet undeducted. [Schedule 1, item 1, subsection 40-30(1)]

11.62 A spectrum licence that has been amortised under the existing law will become subject to the new law on the following basis:

•

the taxpayer must use the prime cost method for calculating the decline in value of the licence;

•

the opening adjustable value of the licence upon entering into the new regime will be equal to the unrecouped expenditure of the licence under the existing law as at the end of the 2000-2001 income year;

•

the taxpayer must use the same effective life under the new law as they had been using under the existing law; and

•

the cost of the licence is equal to the expenditure that the taxpayer has incurred in obtaining the licence.

[Schedule 1, item 1, subsection 40-30(2)]

Division 387 - Capital allowances for primary production

11.63 In line with recommendations made by A Tax System Redesigned, specific primary production concessions continue to apply where they depart from the uniform capital allowance system. As such, these provisions provide rules for the smooth transition into the new regime for these assets and capital expenditures.

11.64 The new law provides equivalent treatment for those primary production capital expenditures. These provisions ensure that those capital expenditures currently subject to existing primary production concessions will have that treatment maintained under the uniform capital allowance system.

Water facilities, grapevines and horticultural plants

11.65 A taxpayer who is entitled to deductions or has made deductions under the existing law in relation to:

•

a water facility;

•

horticultural plants; or

•

grapevines (under the special grapevine rules),

and continues to hold these assets at the commencement of the new system, will be entitled to continue to receive these deductions under the new law. [Schedule 1, item 1, subsection 40-515(1)]

11.66 The transitional provisions provide that the taxpayer must set the expenditure or establishment expenditure (as calculated under the new law) as equal to the capital expenditure incurred in construction or establishment of these assets. [Schedule 1, item 1, paragraph 40-515(2)(a)]

11.67 A taxpayer, when calculating the decline in value of a horticultural plant under the uniform capital allowance system, must use the effective life that the taxpayer was using under the existing law. [Schedule 1, item 1, paragraph 40-515(2)(b)]

11.68 Deductions that a taxpayer has claimed for primary production assets under the existing law are taken to have been deducted under the uniform capital allowance system (i.e. the asset is taken to have declined in value by the amount of the deductions taken or eligible to be taken under the existing law). [Schedule 1, item 1, paragraph 40-515(2)(c) and section 40-525]

Example 11.7

Jan currently receives deductions for the capital expenditure on the establishment of mango trees in her fruit export business. The establishment expenditure incurred was $20,000. If the existing law had continued to apply, Jan would still be entitled to deductions in relation to the establishment of her mango trees.

In calculating her deduction as from 1 July 2001, Jan must substitute the establishment expenditure in the new law with the establishment expenditure calculated under the existing law (i.e. the establishment expenditure to be used is $20,000).

Jan must also carry over the write-off rate calculated under the existing law. The new law will then apply to Jan as if it had always applied, so the time restrictions for claiming deductions continue into the new law. Jan cannot claim more than the total establishment expenditure incurred.

Special rule for water facilities

11.69 A taxpayer who no longer holds a water facility at the commencement of the uniform capital allowance system and who is nevertheless entitled to a deduction for that facility under the existing law, can continue to claim that deduction under the new law on the basis specified in paragraphs 110 to 11.68. No other taxpayer is eligible to claim a deduction for that water facility under the new law. [Schedule 1, item 1, section 40-520]

Electricity and telephone lines

11.70 If a taxpayer is currently deducting or is entitled to deduct an amount for the capital expenditure on connecting or upgrading the supply of mains electricity or a telephone line on land the taxpayer holds, the taxpayer can continue to deduct that amount under the new law. [Schedule 1, item 1, subsections 40-645(1) and (2)]

Special rule where a taxpayer no longer holds the land

11.71 At the commencement of the uniform capital allowance system, taxpayers who no longer hold land to which the expenditure relates and who are nevertheless entitled to a deduction for that expenditure under the existing law, can continue to claim that deduction under the uniform capital allowance system. No other taxpayer is eligible to claim a deduction for that expenditure under the new law. [Schedule 1, item 1, section 40-650]

11.72 Deductions taken under the existing law, or the law that proceeded the existing law, are taken to be deductions that have been made under the appropriate Subdivision of the new law. [Schedule 1, item 1, subsection 40-645(3)]

Forestry roads and timber mill buildings

11.73 Taxpayers who currently deduct or are entitled to deduct an amount for the capital expenditure on a forestry road or building can continue to deduct that amount under the uniform capital allowance system in accordance with the transitional rules. [Schedule 1, item 1, subsection 40-50(1)]

11.74 A forestry road or building that has been depreciated under the existing law will become subject to the uniform capital allowance system on the following basis:

•

the taxpayer must use the prime cost formula for calculating the decline in value of the road or building;

•

the opening adjustable value and cost of the road or building upon entering into the new regime will be equal to the expenditure incurred on the forestry road or building (less amounts deducted or able to be deducted) under the existing law as at the end of the 2000-2001 income year;

•

the taxpayer must use the remaining effective life under the new law as they had last estimated under the existing law; and

•

the taxpayer must apply the adjustments to the prime cost formula contained in the new law for the year in which the transition occurs.

[Schedule 1, item 1, subsection 40-50(2)]

11.75 Upon having moved into the uniform capital allowance system a taxpayer is entitled to recalculate the effective life of the road or building if he or she believes their estimate is no longer accurate because of changed circumstances. The recalculated effective life cannot exceed 25 years. [Schedule 1, item 1, paragraph 40-50(2)(e)]

Farm consultant

11.76 If a person was approved to be a farm consultant under the existing law, they will continue to be a farm consultant under the new law. [Schedule 1, item 1, section 40-670]

Division 400 - Environmental impact assessment

11.77 A taxpayer who is currently claiming a deduction or is entitled to claim a deduction for expenditure incurred on evaluating the impact on the environment of a project under the existing law can continue to claim a deduction for that expenditure under the new law as if that expenditure was incurred in relation to a depreciating asset the taxpayer holds. [Schedule 1, item 1, section 40-55]

11.78 The capital expenditure is treated as a depreciating asset on the following basis:

•

the taxpayer must use the prime cost method for calculating the decline in value of the expenditure;

•

the opening adjustable value of the environmental expenditure upon entering into the new regime will be equal to the expenditure incurred on evaluating the impact on the environment of a project under the existing law (less amounts deducted or able to be deducted) as at the end of the 2000-2001 income year;

•

the taxpayer must use an effective life equal to the period the expenditure was to be deducted over under the existing law; and

•

the cost of this asset is equal to the expenditure incurred on evaluating the impact on the environment of a project calculated under the existing law.

[Schedule 1, item 1, subsection 40-55(2)]

Substituted accounting periods

11.79 Special transitional rules will allow taxpayers with a substituted accounting period to work out the decline in value of either a depreciating asset or for capital expenditure that is to be treated as a depreciating asset. [Schedule 1, item 1, subsection 40-65(1)]

11.80 A taxpayer with a substituted accounting period must work out their deductions from the beginning of their income year until 30 June 2001 under the existing law. As from 1 July 2001, the taxpayer must work out their deduction using the uniform capital allowance system provisions [Schedule 1, item 1, subsection 40-65(2)] . Use of the diminishing value method in both of these periods can result in an amount of depreciation that is less than that which would have been calculated if the diminishing value method had been used for the entire substituted accounting period. Therefore, in those circumstances a taxpayer can increase the deduction by the difference between the 2 amounts [Schedule 1, item 1, subsection 40-65(10)] .

[Schedule 1, item 1, subsection 40-65(3)]

11.81 Taxpayers using the diminishing value method under the existing law must continue to use that method under the uniform capital allowance system. In doing so, they must alter the base value component of that formula under that method so that it is equal to the opening adjustable value set out in Table 11.1. [Schedule 1, item 1, subsection 40-65(4)]

11.82 Taxpayers using the prime cost method under the existing law must continue to use that method under the uniform capital allowance system. In doing so, adjustment rules to the prime cost method in subsection 40-75(3) of the Capital Allowances Bill will apply to some depreciating assets upon transition into the uniform capital allowance system. The transitional rules that apply to taxpayers that do not have a substituted accounting period will indicate whether those adjustment rules are applicable to the depreciating asset. [Schedule 1, item 1, subsections 40-65(5) and (6)]

11.83 These adjustment rules require that taxpayers substitute the cost component of the prime cost formula with the amount that is the adjustable value of the asset. Further, the effective life component becomes the remaining effective life component. The adjustable values that are to be substituted for a taxpayer with a substituted accounting period are listed in Table 11.1.

11.84 Taxpayers that have expenditure treated as a depreciating asset under the uniform capital allowance system, will need to refer to the general transitional rules to determine whether these adjustment rules will apply to that depreciating asset upon transition into the uniform capital allowance system.

11.85 If the special rules for taxpayers using a substituted accounting period do not contain all the necessary rules required for that taxpayer to move the assets and expenditures into the uniform capital allowance system, then the general rules for taxpayers that do not have a substituted accounting period apply to provide the remaining information. The transitional rules for taxpayers with a substituted accounting period only apply to override the general transitional rules where and to the extent that those rules are inconsistent.

Example 11.8

Shirley Fashions Pty Ltd (Shirley Fashions) is the subsidiary of an American fashion design company operating in Australia and has a substituted accounting period. Shirley Fashions has numerous industrial sewing machines for which it claims deductions for depreciation under the existing law.

Shirley Fashions purchased a new industrial sewing machine on 29 February 2000 at a cost of $2,000. The machine has an effective life of 10 years and the diminishing value method is to be used to work out the machines depreciation deductions. The undeducted cost of the asset at 31 March 2001 is $1,678.

Shirley Fashions must make 2 calculations for the 2001-2002 income year:

•

first, it must calculate the portion that is subject to the current law (i.e. the period between 1 April 2001 and 30 June 2001) as follows:

depreciation = 1678 * 91/365 * 150&/10 = 63


The undeducted cost at 30 June 2001 for the sewing machine is $1,615 (i.e. $1,678 - $63). This amount will also be the opening adjustable value that is subject to the uniform capital allowance system.

•

second, it must calculate the portion that is subject to the uniform capital allowance system (i.e. the period between 1 July 2001 and 31 March 2002) as follows:

decline in value = 1615 * 274/365 * 150%/10 =182


Shirley Fashions must continue to use the diminishing value method and effective life of 10 years. Also it must now use the uniform capital allowance system for future income years.

Other deductions

11.86 A taxpayer must apportion their deduction in relation to:

•

a water facility;

•

expenditure on connecting power to land;

•

expenditure on a telephone;

•

transport capital expenditure; or

•

allowable capital expenditure,

to the days of the 2001-2002 income year where the existing law was used and to the days where the uniform capital allowance system has application.

11.87 This is done by calculating the number of days from the beginning of the taxpayers income year until and including 30 June 2001 (the deduction will be calculated under the existing law) and for the number of days from 1 July 2001 until the end of their income year (the deduction will be worked out by using the provisions in the uniform capital allowance system). These days calculated should be divided by 365 and multiplied against the deductions calculated under the respective laws. [Schedule 1, item 1, subsection 40-65(6)]

Example 11.9

Stephanie Pty Ltd owns a mineral quarrying business that has incurred expenditure on establishing a railway line between its mine site and the nearest port (transport capital expenditure). It has a substituted accounting period that begins on 1 June and ends on 31 May.

Stephanie Pty Ltd must calculate its deduction as allowed under the existing law. In doing this, the deduction must be reduced so that the deduction only reflects the portion of its income year between 1 June 2001 and 30 June 2001. This is despite the fact that the existing law does not provide for apportioning this type of deduction.

Stephanie Pty Ltd must then calculate the remaining deduction for this income year under the uniform capital allowance system from 1 July 2001. That expenditure is treated as if it was a depreciating asset with an adjustable value equal to the amount of the transport capital expenditure incurred less amounts that it had deducted under the existing law. It must also use the prime cost method as if as at 1 July 2001 the adjustment rules applied replacing the effective life component with a remaining effective life and cost with adjustable value. Remaining effective life is equal to the period for which it would continue to have received deductions under the existing law.

Miscellaneous

Expenditure incurred from 1 July 2001 on assets acquired before that day

01 A taxpayer may incur expenditure from 1 July 2001 that is the cost of an asset which they started to hold before that day or for which deductions had not yet commenced. Where that expenditure would have been deductible under the repealed law if it had satisfied the relevant deductibility requirements, it can be deducted under Division 40. The relevant repealed law is Division 44 (IRUs), Subdivision 46-B (software), Division 373 (intellectual property), Division 380 (spectrum licences) and Subdivision 387-G (forestry roads and timber mill buildings). However, no cost or adjustable value will carry into that year from previous years. [Schedule 1, item 1, section 40-80]

Balancing adjustments

11.89 Depreciating assets held on 1 July 2001 will be subject to the balancing adjustment provisions under the uniform capital allowance system. [Schedule 1, item 1, subsections 40-285(1) and (4)]

11.90 Taxpayers who would have been entitled to a deduction under section 42-197 of the ITAA 1997, will retain the entitlement to that deduction providing that the depreciating assets were brought into the tax system from exempt usage under Division 58 of the ITAA 1997 or under either section 61A of the ITAA 1936 or Division 57 of Schedule 2D of the ITAA 1936. [Schedule 1, item 1, subsections 40-285(2) and (3)]

11.91 A taxpayer may have a balancing adjustment event occur to an item of plant acquired at or before 110 am, by legal time in the Australian Capital Territory, on 21 September 1999 or to another depreciating asset held before 1 July 2001. Where the balancing adjustment includes an amount in assessable income the amount must be reduced to preserve the benefit of indexation, various CGT exemptions and applicable pre-CGT asset rules [Schedule 1, item 1, subsections 40-285(5) and (6) and section 40-345] . The relevant CGT exemptions are for cars, collectables, personal use assets and plant used to produce exempt income.

11.92 Further, a taxpayer may have a CGT disposal occur to an item of plant before 21 September 1999 or to another depreciating asset before 1 July 2001 but there is no change in ownership of that asset until on or after those relevant times. In these circumstances, the capital gain or loss will be disregarded to prevent the potential for a disposal occurring after the uniform capital allowance system commences to be dealt with, both under the uniform capital allowance system and as a CGT event under the CGT provisions. This ensures the same amount cannot be assessed under both the uniform capital allowance system and the former CGT provisions. [Schedule 1, item 1, subsection 40-285(7)]

Chapter 12 - General consequential amendments

Outline of chapter

12.1 This chapter explains amendments to various provisions of the ITAA 1997, the ITAA 1936 and other Commonwealth legislation as a consequence of the introduction of a uniform capital allowance system.

12.2 The amendments are necessary to facilitate the introduction of the uniform capital allowance system.

Context of reform

12.3 The introduction of the uniform capital allowance system for depreciating assets and its general application, giving deductions for some previously non-deductible capital expenditure, are key components of the New Business Tax System announced in Treasurers Press Release No. 74 of 11 November 1999 (refer to Attachment L).

12.4 Because it is based on a common set of principles the general capital allowance regime will offer significant simplification benefits. The existing capital allowance regimes are complex, inconsistent and involve significant replication of parallel but not identical provisions and concepts in the current law. Consequently, consolidating these regimes into a single regime will require a number of amendments to the ITAA 1997, the ITAA 1936 and other Commonwealth statutes.

Summary of new law

12.5 The more significant of these amendments will:

•

amend some Commonwealth statutes;

•

repeal those Divisions that are being consolidated into the single regime;

•

ensure the interaction between the GST and the capital allowance provisions operates as intended;

•

ensure the interaction between the capital works provisions and the capital allowance provisions operates as intended;

•

ensure the interaction between the CGT provisions and the capital allowance provisions operates as intended;

•

streamline the existing Division 58 of the ITAA 1997;

•

relocate definitions;

•

repeal redundant definitions;

•

give new labels to existing definitions that will remain unchanged;

•

insert additional definitions; and

•

update references.

Detailed explanation of new law

Amending the Airports (Transitional) Act 1996

12.6 Amendments to the Airports (Transitional) Act 1996 have been made so that the terms used in this Act are aligned with the uniform capital allowance system.

Amendment to section 48A definitions

12.7 The definition of depreciating asset has been added to section 48A of the Airports (Transitional) Act 1996 and has the meaning given by subsection 995-1(1) of the ITAA 1997 [Schedule 2, item 1] . Likewise, the term hold has also been defined in section 48A and has the meaning given by subsection 995-1(1) of the ITAA 1997 [Schedule 2, item 2] .

12.8 The Capital Allowances Bill provides for the term quasi-owner as defined in section 42-310 of the ITAA 1997 to be repealed. However, the term is still required in the Airports (Transitional) Act 1996 and cannot be replaced with the Division 40 term holder. Consequently, the definition of quasi-owner in section 48A of the Airports (Transitional) Act 1996 will be amended so it will retain its current definition in section 42-310 of the ITAA 1997. [Schedule 2, item 3]

Section 49B - special rules for fixtures that are depreciating assets - ITAA 1997

12.9 It is proposed that section 49B be inserted after section 49A of the Airports (Transitional) Act 1996 [Schedule 2, item 4] . The new section is to have the same effect as section 49A but will be based on the rules in Division 40 of the Capital Allowances Bill. This course is recommended because sections 49 and 49A of the Airports (Transitional) Act 1996 deem the depreciation provisions to apply to some entities.

12.10 Subsection 49B (1) of the Airports (Transitional) Act 1996 provides that section 49B applies if a company obtains a lease relating to particular land under section 21, 22 or 23 and at the time the lease was obtained, a depreciating asset is attached to the land.

12.11 Subsection 49B(2) provides that if, just before the land vested in the Commonwealth under Part 2 of the Airports (Transitional) Act 1996, the part of the land to which the depreciating asset was attached was held by another entity under a quasi-ownership right over land granted by an exempt Australian government agency, and the other entity was the holder of the asset and on the grant of the lease referred to in subsection 49B(1) the other entity became a sub-lessee of the company, then, so long as the other entity continues to hold the sub-lease of that part of the land from the company or a successor, the other entity is taken to hold the asset.

12.12 Subsection 49B(3) provides that if subsection 49B(2) does not apply to the depreciating asset and the FAC was the owner of the depreciating asset for the purposes of Division 40 of the ITAA 1997 immediately before the land vested in the Commonwealth under Part 2, Division 40 applies to the depreciating asset as if the company held the asset and the amount paid by the company for the grant of the lease were an amount paid for the acquisition of the right.

12.13 Subsection 49B(4) provides that the Minister for Finance may make a written determination of the cost of the depreciating asset referred to in subsection 49B(3) for the purposes of Division 40 of the ITAA 1997. The note to subsection 49B(4) points out that if a determination is made, the cost of the asset will be determined under item 10 in the table in section 40-180 of the ITAA 1997.

12.14 Subsection 49B(5) provides that the FAC must give the Minister for Finance such information as the Minister for Finance requires about the application of Subdivision 40-D of the ITAA 1997 to the asset and to the FAC.

12.15 Subsection 49B(6) provides that section 49B does not affect the operation of section 19 of the Civil Aviation Legislation Amendment Act 1995.

12.16 Subsection 49B(7) provides that in section 49B entity has the same meaning as in section 49A of the Airports (Transitional) Act 1996. [Schedule 2, item 4]

Section 50B - Acquisition of depreciating asset from the Commonwealth - Division 40 of the ITAA 1997

12.17 It is proposed that a section 50B be inserted after section 50A of the Airports (Transitional) Act 1996 [Schedule 2, item 5] . The section is to have the same effect as section 50A but will be based on the rules in Division 40 of the Capital Allowances Bill. The same reasoning as discussed in paragraph 120 in relation to sections 49 and 49A applies to sections 50 and 50A.

12.18 Subsection 50B(1) of the Airports (Transitional) Act 1996 provides that section 50B applies to a depreciating asset that was transferred from the Commonwealth to a company under section 23 of the Airports (Transitional) Act 1996 and, at the time of transfer, was not attached to land.

12.19 Subsection 50B(2) of the Airports (Transitional) Act 1996 provides that the Minister for Finance may make a written determination of the cost of the depreciating asset for the purposes of Division 40 of the ITAA 1997. The note to subsection 50B(2) states that if a determination is made, the cost of the depreciating asset will be determined under item 10 in the table in section 40-180 of the ITAA 1997.

12.20 Subsection 50B(3) provides that the FAC must give the Minister for Finance such information as the Minister for Finance requires about the application of Subdivision 40-D of the ITAA 1997 to the asset and to the FAC. [Schedule 2, item 5]

Section 51B - Acquisition of depreciating asset from the FAC - Division 40 of the ITAA 1997

12.21 It is proposed that section 51B be inserted after section 51A of the Airports (Transitional) Act 1996. The new section is to have the same effect as section 51A but will be based on the rules in the proposed Division 40 of the ITAA 1997. The same reasoning as discussed in paragraph 120 in relation to sections 49 and 49A applies to sections 51 and 51A.

12.22 Subsection 51B(1) applies to a depreciating asset that was transferred from the FAC to a company under section 30 of the Airports (Transitional) Act 1996.

12.23 Subsection 51B(2) provides that the Minister for Finance may make a written determination of the cost of the asset for the purposes of Division 40 of the ITAA 1997. The note to subsection 51B(2) provides that if a determination is made, the cost of the depreciating asset will be determined under item 10 in the table in section 40-180 of the ITAA 1997.

12.24 Subsection 51B(3) provides that the FAC must give the Minister for Finance such information as the Minister for Finance requires about the application of Subdivision 40-D of the ITAA 1997 to the asset and to the FAC. [Schedule 2, item 6]

Amendments to section 52A

12.25 The note to subsection 52A(2) of the Airports (Transitional) Act 1996 states that if such a determination is relevant to working out a balancing adjustment, the termination value of the plant will be determined under item 13 or 14 in the table in former section 42-205 of the ITAA 1997 or item 11 in the table in subsection 40-300(2) of that Act. [Schedule 2, item 7]

12.26 Subsection 52A(3) provides that the FAC must give the Minister for Finance such information as the Minister for Finance requires about the application of Subdivision 42-F of the ITAA 1997, or Subdivision 40-D of that Act, to the asset and to the FAC. [Schedule 2, item 8]

Amendment to section 55 - Modification of capital allowances and CGT provisions

12.27 It is proposed that paragraph 55(2)(a) of the Airports (Transitional) Act 1996 be amended by inserting after the word depreciation the words or capital allowances. The heading to the section is correspondingly altered. [Schedule 2, item 9]

Interaction with the A New Tax System (Goods and Services Tax) Act 1999

12.28 The references to car depreciation limit in the GST Act will be replaced with the new term car limit which has exactly the same meaning. Consequently, there is no effect on the operation of the law [Schedule 2, items 10 to 13] . The definition of minerals will have an updated reference. Again, there is no effect on the operation of the law [Schedule 2, item 14] .

Interaction with the A New Tax System (Luxury Car Tax) Act 1999

12.28 Subsection 25-1(3) of A New Tax System (Luxury Car Tax) Act 1999 is to have updated references to refer to the new term car limit which has the same meaning as car depreciation limit. There is no effect on the operation of the law. [Schedule 2, item 15]

Interaction with the Bounty and Capitalisation Grants (Textile Yarns) Act 1981

12.30 It is proposed that paragraph 3(3)(p) of the Bounty and Capitalisation Grants (Textile Yarns) Act 1981 be repealed and replaced with a new paragraph 3(3)(p) that reflects the income tax law relating to claiming deductions for the decline in value of depreciating assets under Division 40 of the ITAA 1997.

12.31 Subparagraph 3(3)(p)(i) replicates the current provisions found in paragraph 3(3)(p) while subparagraph 3(3)(p)(ii) ensures that the decline in value of machinery, plant or equipment for which the producer can deduct amounts under Division 40 of the ITAA 1997 cannot be included in the factory costs incurred by a producer of bountiable yarn in connection with processes in the production of that yarn. [Schedule 2, item 16]

Interaction with the Bounty (Computers) Act 1984

12.32 It is proposed that paragraph 6(5)(t) of the Bounty (Computers) Act 1984 be repealed and replaced with a new paragraph 6(5)(t) that more clearly reflects the income tax law relating to the uniform capital allowance system.

12.33 Subparagraph 6(5)(t)(i) replicates the current provisions found in paragraph 6(5)(t), while subparagraph 6(5)(t)(ii) provides that the factory cost incurred by a manufacturer in connection with processes in the manufacture of bountiable equipment does not include any amount being the decline in value depreciation of machinery, plant or equipment, other than depreciation of machinery, plant or equipment owned by the manufacturer that is depreciation for which the producer can deduct amounts under Division 40 of the ITAA 1997. [Schedule 2, item 17]

Interaction with the Bounty (Machine Tools and Robots) Act 1985

12.34 It is proposed that paragraph 12(6)(p) of the Bounty (Machine Tools and Robots) Act 1985 be repealed and replaced with a new paragraph 12(6)(p) that reflects the income tax law relating to the uniform capital allowance system.

12.35 Paragraph 12(6)(p) will provide that the factory cost incurred by a producer in connection with processes in the manufacture of bountiable equipment A or in the modification of bountiable equipment B does not include depreciation of machinery, plant or equipment, other than depreciation of machinery, plant or equipment owned by the producer that is depreciation allowed by the Commissioner for the purposes of a law of the Commonwealth relating to taxation or depreciation for which the producer can deduct amounts under Division 40 of the ITAA 1997. [Schedule 2, item 18]

Interaction with the Defence Act 1903

12.36 It is proposed that a new subsection 122AA(4) of the Defence Act 1903 be inserted that reflects the income tax law relating to the uniform capital allowance system.

12.37 Subsection 122AA(4) will provide that, in calculating the deductions (if any) allowable to Australian Defence Industries Pty Ltd or to Aerospace Technologies of Australia Pty Ltd (the companies referred to in subsection 122AA(1)) under Subdivision 40-B of the ITAA 1997 in respect of the asset referred to in subsection 122AA(1), the adjustable value of the asset to the company at the time of the acquisition of the asset is the amount that would have been its adjustable value to the Commonwealth just before that time if the Commonwealth had been a taxpayer and the asset had been used by the Commonwealth exclusively for the purpose of producing assessable income. [Schedule 2, item 19]

Amendments to the ITAA 1936

Inserting the definition of depreciating asset

12.38 The definition of depreciating asset will be inserted into subsection 6(1) of the ITAA 1936. This is to facilitate amendments to other provisions of the ITAA 1936 that will refer to this term. [Schedule 2, item 20]

Exemption of foreign branch profits

12.39 Section 23AH of the ITAA 1936 exempts certain foreign branch profits. To ensure these provisions continue to operate correctly with the introduction of Division 40, various amendments have been made to the section. [Schedule 2, items 21 to 24]

References to table in section 51AAA

12.40 The references in the table in subsection 51AAA(2) of the ITAA 1936 have been updated as a result of the introduction of Division 40. For convenience, the revised table has been substituted. [Schedule 2, item 25]

Anti-avoidance provisions

12.41 Amendments are required to both section 51AD and Division 16D of the ITAA 1936 to ensure they continue to operate effectively with the introduction of Division 40. [Schedule 2, items 26, 27 and 63 to 89]

Research and development provisions

12.42 The existing R&D provisions that interact with the various capital allowance provisions have been amended to reflect the incorporation of those provisions into Division 40. [Schedule 2, items 28 to 42]

Development allowance

12.43 In order for taxpayers to continue to be entitled to the development allowance, various amendments have been made to these provisions. [Schedule 2, items 43 to 51]

Updating references

12.44 Various references have been updated with the equivalent reference or term used in Division 40. [Schedule 2, items 52, 53, 58, 62, 90 to 96, 106 to 141 and 145 to 148]

Anti-avoidance schemes

12.45 The provisions which apply to losses and outgoings incurred under certain tax avoidance schemes have also been amended as a result of the introduction of Division 40. [Schedule 2, items 54 to 57]

Foreign income measures

12.46 The foreign income measures that interact with some capital allowances have been updated with the corresponding references in Division 40. [Schedule 2, items 59 to 61 and 97 to 103]

Debt forgiveness provisions

12.47 In order that the debt forgiveness provisions can apply to the cost of a depreciating asset under Division 40, amendments have been made to ensure that they can apply. [Schedule 2, items 104 and 105]

Leases of luxury cars

12.48 The rules regarding leases of luxury cars use many depreciation concepts contained in the former Division 42 of the ITAA 1997. Amendments are required to maintain the equivalent concepts that are now contained in Division 40. [Schedule 2, items 142 to 144]

Amendments to the ITAA 1997

Updating table lists

12.49 The tables in sections 10-5, 11-15, 12-5 and 13-1 have been updated because of the repeal of the various capital allowance provisions and the introduction of Division 40. [Schedule 2, items 149 to 193]

Assessing mining information

12.50 Division 15 of the ITAA 1997 is to be amended to ensure an amount taxpayers receive for providing mining quarrying or prospecting information to another entity will be assessable income providing they continue to hold that information. [Schedule 2, item 194]

Recoupment provisions

12.51 The recoupment provisions in Subdivision 20-A will be amended to ensure they can apply to capital allowances allowed under Division 40. [Schedule 2, items 196 to 205]

Updating references

12.52 Various references have been updated with the equivalent reference or term used in Division 40. [Schedule 2, items 206 to 213, 217 to 222, 229 to 242, 245 to 254, 303 to 318, 322, 325, 326, 328 to 336]

Interaction with GST

12.53 Subdivision 27-B of the ITAA 1997 predominantly deals with the interrelationship between Divisions 40 and 328 and the GST Act [Schedule 2, item 195, section 17-35 and item 216, section 27-35] . This Subdivision will ensure that where necessary, the effect of GST is taken into account when calculating a deduction under Division 40 or Division 328.

Acquiring or importing a depreciating asset

12.54 When a taxpayer makes a creditable acquisition of a depreciating asset, the cost of the asset is reduced by any input tax credit the taxpayer is entitled to (or becomes entitled to) claim in relation to this acquisition [Schedule 2, item 216, subsection 27-80(1)] . A creditable acquisition is a GST concept and is defined in section 11-5 of the GST Act. In effect it means an acquisition by a taxpayer of a taxable supply that is used either partly or solely for a creditable purpose. Further, the taxpayer must have paid consideration for the acquisition and must be registered or required to be registered for GST.

Example 12.1

Usha registers for GST on 31 December 2001. This registration has been made retrospective, effective 1 July 2001. On 1 August 2001 Usha buys a ladder for $550 that will be used for 80% of the time in her plumbing business. The remaining 20% usage is for non-taxable purposes. Consequently, the cost of this asset will be $510 (i.e. $550 - [(1/11 $550) 80%] = $510).

12.55 The same principle applies to creditable importations. When a taxpayer makes a creditable importation of a depreciating asset, the cost of the importation is reduced by any input tax credit the taxpayer is entitled or becomes entitled to claim in relation to this importation [Schedule 2, item 216, subsection 27-80(1)] . A creditable importation has the meaning provided in section 15-5 of the GST Act and covers the situation where a taxpayer, who is registered or required to be registered for GST, makes a taxable importation of goods that are to be used solely or partly for a creditable purpose [Schedule 2, item 370, subsection 995-1(1)] .

12.56 Where a taxpayer incurs second element costs in relation to a depreciating asset that are the creditable acquisition or creditable importation in the income year the asset is first held, the assets cost is reduced by any input tax credit the taxpayer is entitled or becomes entitled to claim [Schedule 2, item 216, subsection 27-80(2)] . Where the second element costs are incurred in an income year after the one in which the assets start time occurs, the assets opening adjustable value in the income year in which the second element costs are incurred is reduced by the input tax credits claimed [Schedule 2, item 216, subsection 27-80(4)] . If, however, either of these reductions is greater than the depreciating assets cost for the first income year or opening adjustable value in a later income year, the excess is included in the taxpayers assessable income (unless the taxpayer is an exempt entity) [Schedule 2, item 216, subsection 27-80(5)] .

12.57 Where the cost of the depreciating asset is its market value no reduction for GST payable is required [Schedule 2, item 216, subsection 27-80(3)] . This is because the term market value as defined in section 995-1 of the ITAA 1997 is its GST-exclusive price. However, where the term is not preceded by an asterisk it may mean that the market value is the GST-inclusive price.

12.58 These provisions do not apply to a depreciating asset that has been allocated to a low-value pool, an STS pool (see Division 328), to expenditure allocated to a software development pool or to a project pool [Schedule 2, item 216, subsection 27-80(6)] . This is because these pools are dealt with specifically under section 27-100 of the ITAA 1997 and are discussed in paragraphs 120 to 12.84.

Decreasing adjustments

12.59 Under the GST Act adjustments can be made for any GST paid or input tax credits claimed. These adjustments can occur for a number of reasons including change of creditable purpose and change of consideration. These situations will affect the amount of GST that a taxpayer is required to remit to the ATO or can claim as an input tax credit.

12.60 Where too much GST has been paid by a taxpayer or where they have claimed too few input tax credits, the taxpayer can make a decreasing adjustment.

12.61 Where the decreasing adjustment arises under Divisions 129 or 132 of the GST Act as a result of a change in creditable purpose, the amount of the adjustment is included in the taxpayers assessable income for the income year the adjustment arose [Schedule 2, item 216, subsection 27-85(1A) and section 27-87] . The treatment of all other decreasing adjustments under the GST Act are discussed in paragraphs 120 to 12.65.

12.62 Where a taxpayer holds a depreciating asset and a decreasing adjustment (other than one mentioned in paragraph 12.61) that relates either directly or indirectly to that asset occurs in the income year in which the assets start time commences, the taxpayer must reduce the assets cost by an amount equal to the decreasing adjustment [Schedule 2, item 216, subsections 27-85(1) and (2)] . However, if the decreasing adjustment occurs in an income year that is after the one in which the assets start time commenced, the assets opening adjustable value is reduced by an amount equal to the decreasing adjustment [Schedule 2, item 216, subsection 27-85(3)] .

12.63 In order to make an adjustment to the depreciating assets cost or opening adjustable value, the decreasing adjustment must relate either directly or indirectly to the depreciating asset. The use of the words directly or indirectly ensures that, irrespective of the type of decreasing adjustment that has occurred, there is a sufficient nexus with the adjustment and the depreciating asset. All decreasing adjustments, except for those under Divisions 129 or 132 of the GST Act, to the extent that they relate to the depreciating asset whether it be a change in consideration or the cancellation of a contract for the asset, must be accounted for.

Example 12.2

Joan buys a depreciating asset for $110,000. If the depreciating asset is to be used 60% for taxable purposes and 40% for non-taxable purposes, the input tax credit Joan can claim is $6,000. Consequently, the cost of the depreciating asset at acquisition is $104,000 (i.e. $110,000 - $6,000 (input tax credit)).

If the decline in value of the depreciating asset is $24,000 over 2 years, the opening adjustable value at the commencement of year 3 will be $80,000 (i.e. $104,000 - $24,000). If the taxable purpose changes at the commencement of year 3 to a 100% taxable purpose, the input tax credit that was claimed by Joan will need to be adjusted because of the change in usage. As the actual application of the asset since purchase is now around 74%, Joan will have a Division 129 decreasing adjustment of around $1,400 (as too few input tax credits have been claimed in relation to this creditable acquisition). This decreasing adjustment does not effect the cost or the opening adjustable value of the depreciating asset but instead will be included in Joans assessable income for that income year.

12.64 If the reduction for a decreasing adjustment is greater than the depreciating assets cost or opening adjustable value the excess must be included in the taxpayers assessable income (unless the taxpayer is an exempt entity). [Schedule 2, item 216, subsection 27-85(4)]

12.65 These provisions do not apply to a depreciating asset that has been allocated to a low-value pool or to expenditure allocated to a software development pool or to a project pool [Schedule 2, item 216, subsection 27-85(5)] . This is because these pools are dealt with specifically under section 27-100 of the ITAA 1997 and are discussed in paragraphs 120 to 12.84.

Increasing adjustments

12.66 Where the increasing adjustment arises under Divisions 129 or 132 of the GST Act as a result of a change in creditable purpose, the taxpayer can deduct the amount of the adjustment in the income year the adjustment arose. However, taxpayers cannot deduct the amount to the extent the adjustment arises from an increase of activity of a private or domestic nature [Schedule 2, item 216, subsection 27-90(1A) and section 27-92] . The treatment of all other decreasing adjustments under the GST Act are discussed in paragraphs 120 and 12.68.

12.67 Where a taxpayer has paid too little GST to the ATO or claimed too many input tax credits, an increasing adjustment must be made by the taxpayer. If an increasing adjustment (other than one mentioned in paragraph 12.66) that relates either directly or indirectly to that asset occurs in the income year in which the assets start time commences, the taxpayer must increase the assets cost by an amount equal to the increasing adjustment [Schedule 2, item 216, subsections 27-90(1) and (2)] . However, if the increasing adjustment occurs in an income year that is after the one in which the assets start time commences the assets opening adjustable value must be increased by an amount equal to the increasing adjustment [Schedule 2, item 216, subsection 27-90(3)] . Like decreasing adjustments mentioned in paragraph 12.62, all increasing adjustments, except for those under Division 129 or 132 of the GST Act, that relate directly or indirectly to the depreciating asset must be accounted for.

Example 12.3

Egil buys a depreciating asset for $110,000. As the asset is used 100% for taxable purposes, Egil can claim an input tax credit of $10,000. Thus, the cost of the asset is $100,000. If the asset declines in value by $20,000 over 2 years, the opening adjustable value of the depreciating asset will be $80,000 at the commencement of the third year.

If at the commencement of the third year the usage of the depreciating asset alters from a 100% taxable purpose to a 80% taxable purpose and a 20% non-taxable purpose, an increasing adjustment will need to be made under Division 129 of the GST Act since too many input tax credits have been claimed. As the actual application of the asset since purchase is now around 94%, Egil will have an increasing adjustment for the asset of about $600. This increasing adjustment does not effect the cost or the opening adjustable value of the depreciating asset. Since the increasing adjustment arises from an increase in the extent to which the asset is used for a private or domestic purpose, Egil is unable to deduct the amount of the increasing adjustment.

12.68 These provisions do not apply to a depreciating asset that has been allocated to a low-value pool or to expenditure allocated to a software development pool or to a project pool [Schedule 2, item 216, subsection 27-90(4)] . This is because these pools are dealt with specifically under section 27-100 of the ITAA 1997 and are discussed in paragraphs 120 to 12.84.

Balancing adjustment events

12.69 When a balancing adjustment event occurs in relation to a depreciating asset, its termination value will be reduced if the relevant balancing adjustment event is a taxable supply. The reduction is an amount equal to the GST payable on the supply [Schedule 2, item 216, subsection 27-95(1)] . However where the termination value of the depreciating asset is its market value no reduction for GST payable is required [Schedule 2, item 216, subsection 27-95(2)] .

Example 12.4

Astri sells a depreciating asset for $88. Assuming she is making a taxable supply, she is required to remit $8 as GST to the ATO. If the adjustable value of the depreciating asset just before the asset was sold was $90, the balancing adjustment for the purposes of section 40-285 of the Capital Allowances Bill is $10 (i.e. $90 - $80 = $10, as the termination value of the asset is $80 and not $88).

12.70 If an increasing or a decreasing adjustment that either directly or indirectly relates to a depreciating asset occurs after a balancing adjustment event, the income tax consequences will depend on when the increasing or decreasing adjustment occurred. The consequences are shown in Table 12.1.

Example 12.5

In August 2002 Max makes a taxable supply by selling a depreciating asset for $99. Of this $99, $9 is remitted to the ATO as GST. In October 2002 it is discovered that the purchaser of the asset was entitled to a discount of $10. This means that after taking into account the discount, Max only received $88 for the asset. Therefore the termination value of the asset is $80 (i.e. $88 - $8 GST).

However, if Max only discovers in the next income year that the buyer of Maxs asset was entitled to a discount, Max must include an amount equal to the decreasing adjustment (i.e. $1) in his assessable income in the 2003-2004 income year.

Pooled depreciating assets

12.71 Special provisions are required to deal with the following types of pooled assets:

•

low-value pools;

•

STS pools (i.e. assets that are pooled under Division 328 of the ITAA 1997);

•

software development pools; and

•

project pools.

[Schedule 2, item 216, subsection 27-100(1)]

Input tax credits and low value pools

12.72 Where a taxpayer makes a creditable acquisition or a creditable importation of a depreciating asset and that asset is put into a low-value pool, and the income year in which the taxpayer becomes entitled to the input tax credit is the same as the income year in which the acquisition or importation occurred, the cost of the asset is reduced by any input tax credit the taxpayer is entitled (or becomes entitled) to claim in relation to this acquisition or importation. [Schedule 2, item 216, subsection 27-100(2B)]

12.73 Where a taxpayer makes a creditable acquisition or a creditable importation of a depreciating asset and that asset is put into a low-value pool, and the income year in which the taxpayer becomes entitled to the input tax credit occurs after the income year in which the acquisition or importation occurred, the closing pool balance will be reduced as follows:

•

in the first income year in which the assets are allocated to the low-value pool, the closing pool balance at the end of that income year. The reduction is an amount equal to any input tax credit that the taxpayer can claim or is entitled to claim;

•

in a later income year, the prior years closing pool balance. The reduction is an amount equal to any input tax credit that the taxpayer can claim or is entitled to claim.

[Schedule 2, item 216, subsections 27-100(2) and (3)]

12.74 If a taxpayer incurs second element costs in relation to a depreciating asset that has been put into a low-value pool and the income year in which the taxpayer becomes entitled to the input tax credit in relation to those costs occurs is the same in which the acquisition or importation occurred, the expenditure included in the assets second element of cost is reduced by any input tax credit the taxpayer is entitled or becomes entitled to claim. [Schedule 2, item 216, subsection 27-100(7A)]

12.75 If a taxpayer incurs second element costs in relation to a depreciating asset that has been put into a low-value pool and the income year in which the taxpayer becomes entitled to the input tax credit in relation to those costs occurs after the income year in which the acquisition or importation occurred, an amount equal to the input tax credit is reduced from the low-value pool (and not the depreciating asset in question) as follows:

•

in the first income year in which the assets are allocated to the low-value pool, the closing pool balance at the end of that income year. The reduction is an amount equal to any input tax credit that the taxpayer can claim or is entitled to claim; and

•

in a later income year, the prior years closing pool balance. The reduction is an amount equal to any input tax credit that the taxpayer can claim or is entitled to claim.

[Schedule 2, item 216, subsection 27-100(6) and paragraph 27-100(7)(a)]

12.76 Where the cost of the depreciating asset is its market value, no reduction for GST payable is required [Schedule 2, item 216, subsection 27-100(5A)] . This is because the term market value as defined in section 995-1 of the ITAA 1997, is its GST-exclusive price. However, where the term is not preceded by an asterisk it may mean that the market value is the GST-inclusive price.

Input tax credits and STS pools

12.77 Where a taxpayer makes a creditable acquisition or a creditable importation of a depreciating asset and that asset is put into an STS pool under Division 328 of the ITAA 1997, and the income year in which the taxpayer becomes entitled to the input tax credit is the same as the income year in which the acquisition or importation occurred, the cost of the asset is reduced by any input tax credit the taxpayer is entitled (or becomes entitled) to claim in relation to this acquisition or importation. [Schedule 2, item 216, subsection 27-100(2B)]

12.78 Where a taxpayer makes a creditable acquisition or a creditable importation of a depreciating asset and that asset is put into an STS pool under Division 328 of the ITAA 1997, and the income year in which the taxpayer becomes entitled to the input tax credit occurs after the income year in which the acquisition or importation occurred, the opening pool balance is reduced by the amount equal to the input tax credit. [Schedule 2, item 216, subsections 27-100(2) and (5)]

12.79 If a taxpayer incurs second element costs on a depreciating asset in an STS pool, and the income year in which the taxpayer becomes entitled to the input tax credit for those costs is the same in which the acquisition or importation occurred, the expenditure included in the assets second element of cost is reduced by any input tax credit the taxpayer is entitled or becomes entitled to claim. [Schedule 2, item 216, subsection 27-100(7A)]

12.80 If a taxpayer incurs second element costs on a depreciating asset in an STS pool, and the income year in which the taxpayer becomes entitled to the input tax credit for those costs occurs after the income year in which the acquisition or importation occurred, the opening pool balance will be reduced by an amount equal to the input tax credit the taxpayer is entitled to claim. [Schedule 2, item 216, subsection 27-100(6) and paragraph 27-100(7)(b)]

12.81 Where the cost of the depreciating asset is its market value, no reduction for GST payable is required [Schedule 2, item 216, subsection 27-100(5A)] . This is because the term market value as defined in section 995-1 of the ITAA 1997 is its GST-exclusive price. However, where the term is not preceded by an asterisk it may mean that the market value is the GST-inclusive price.

Software and project pools

12.82 If a taxpayer incurs expenditure that has been allocated to either a software development pool or a project pool on a creditable acquisition or a creditable importation and is entitled to claim an input tax credit for that acquisition or importation, the taxpayer must reduce the pool value in the income year in which the taxpayer is or becomes entitled to the input tax credit by an amount equal to that input tax credit. [Schedule 2, item 216, subsections 27-100(2A) and (4)]

Increasing and decreasing adjustments

12.83 If an increasing adjustment, except an adjustment arising under Division 129 or 132 of the GST Act, occurs that relates directly or indirectly to a creditable acquisition or a creditable importation to which the pooled expenditure relates, an amount equal to the increasing adjustment must be added to, as the case may be:

•

the closing pool balance at the end of the first income year, if it is the first year depreciating assets are allocated to the low-value pool;

•

the prior years closing pool balance of a low-value pool if it is not the first income year in which depreciating assets have been put into the low-value pool;

•

the opening pool balance of the pool of the adjustment year if the pool is an STS pool;

•

the amount of the expenditure that has been allocated to the software development pool for the adjustment year; or

•

the pool value for the adjustment year if the expenditure has been allocated to a project pool.

[Schedule 2, item 216, subsections 27-100(8) and (9)]

12.84 Likewise, decreasing adjustments, except an adjustment arising under Division 129 or 132 of the GST Act, are treated in a similar manner. [Schedule 2, item 216, subsections 27-100(10) to (12)]

12.85 Increasing and decreasing adjustments that arise under Divisions 129 or 132 of the GST Act are discussed in paragraphs 120 and 120 respectively.

Other Division 40 expenditure

12.86 Certain expenditure incurred by a taxpayer can be deducted pursuant to Division 40. For example expenditure incurred on the construction, manufacture, installation or acquisition of water facilities, expenditure incurred on landcare operation or expenditure incurred on connecting power to land is deductible. However, the effect of GST must be taken into account when calculating any deduction for such expenditure. The following provisions do not, however, apply to exempt entities. [Schedule 2, item 216, subsection 27-105(6)]

12.87 The amount of the expenditure is reduced when a taxpayer is or becomes entitled to an input tax credit for a creditable acquisition or creditable importation to which the expenditure relates either indirectly or directly. The reduction is the amount of the input tax credit that relates to that expenditure. [Schedule 2, item 216, subsection 27-105(2)]

12.88 If a taxpayer has a decreasing adjustment in an income year that relates indirectly or directly to the expenditure, he or she can include in his or her assessable income an amount equal to the decreasing adjustment that relates to the expenditure [Schedule 2, item 216, subsection 27-105(3)] . Likewise where a taxpayer has an increasing adjustment in an income year that relates indirectly or directly to the expenditure, he or she can deduct an amount equal to the increasing adjustment that relates to the expenditure [Schedule 2, item 216, subsection 27-105(4)] . However, neither of these provisions apply to an exempt entity [Schedule 2, item 216, subsection 27-105(6)] .

Input tax credit, etc. relating to 2 or more things

12.89 Where an input tax credit can be claimed by a taxpayer or where an increasing or decreasing adjustment occurs and these relate directly or indirectly to 2 or more things, one of which is a depreciating asset, the taxpayer must reasonably apportion the input tax credit or the increasing or decreasing adjustment to each of the assets and each of the things. [Schedule 2, item 216, section 27-110]

Example 12.6

Owen buys 20 power saws for his employees and pays $2,000 for an expert to give his employees instructions on workplace health and safety issues regarding the use of these saws. Three months later Owen receives a discount from the supplier of the saws and instructor for the above creditable acquisitions. Because the increasing adjustment relates to both the depreciating assets and the service (the thing), Owen must apportion the increasing adjustment to each depreciating asset as well as the service on a reasonable basis.

Interaction with Division 43

12.90 Division 43 will continue to allow deductions for those capital works as specified in section 43-20. Capital works that are currently written-off under other specific existing capital allowance provisions (e.g. Divisions 42, 330 and 387) are excluded from Division 43. Amendments will be made to Division 43 to ensure that the effect of those exclusions is maintained. Capital works that come within those exclusions will be written-off under Division 40 rather than under Division 43. [Schedule 2, items 223 to 227]

12.91 Division 43 will exclude buildings and structures that are plant (the concept of plant still exists for the purposes of other provisions of the ITAA 1997 and so the definition has been retained). It will also exclude from its operations, buildings and structures that fall within the definition of mining capital expenditure and transport capital expenditure. All of these buildings and structures are treated as depreciating assets under Division 40.

Repealing redundant Divisions

12.92 The single regime will replace many of the existing capital allowances in the ITAA 1997. This replacement requires the repeal of the following Divisions under the ITAA 1997:

•

Division 40 - Overview of capital allowances;

•

Division 41 - Common rules for capital allowances;

•

Division 42 - Plant depreciation;

•

Division 44 - IRUs and submarine cable systems;

•

Division 46 - Software depreciation;

•

Division 330 - Mining and quarrying;

•

Division 373 - Intellectual property;

•

Division 380 - Spectrum licences;

•

Division 387 - Capital allowances for primary producers;

•

Division 388 - Landcare and water facility tax offset; and

•

Division 400 - Environmental assessments and protection.

[Schedule 2, items 228, 243, 331 to 333, 335, 336 and 339]

12.93 As a result of the repeal of these Divisions, transitional provisions will allow taxpayers who are currently deducting amounts under the existing law to continue their deductions under the uniform capital allowance system. Broadly, taxpayers will continue to deduct on the same basis under the uniform capital allowance system as they would under the existing law. These rules are discussed in Chapter 1.

Streamlining Division 58

12.94 The existing Division 58 will be repealed and replaced with a new Division 58. The new Division 58 sets out special rules that will affect the way Division 40 applies to depreciating assets previously owned by an exempt entity in much the same way as the existing Division 58 affects the way Division 42 applies to plant entering the tax net.

12.95 However, the calculation rules in the new Division 58 have been streamlined to make them simpler and easier to comply with than the current rules in existing Division 58.

12.96 Many of the current calculation rules require taxpayers to look back and notionally apply various old depreciation regimes that have existed in the past, based on the assumed acquisition date of each unit of privatised plant to the exempt entity, for example, the calculation of notional depreciation under both the notional written-down value method and the undeducted pre-existing audited book value method.

12.97 Under the new Division 58 calculation rules, taxpayers will simply use the ordinary Division 40 rules with some minor modifications for all privatised depreciating assets. (This is favourable to taxpayers, as the Division 40 rules are not accelerated, and so the largest possible amount will remain as the notional written-down value available as the basis of further deductions.) Taxpayers will no longer be required to apply rules contained in superseded depreciation regimes. Transition entities will now work out actual deductions for decline in value (after the transition time) of a privatised depreciating asset in the same way as a purchaser does in an asset sale situation, but subject to the requirement that a transition entity cannot change methods of depreciation for an asset. [Schedule 2, item 244]

Interaction with the CGT provisions

12.98 When a balancing adjustment event happens to a depreciating asset, a balancing adjustment calculation and/or a capital gain or loss calculation must be made. This is in contrast to the current position under Division 42 where only a balancing adjustment calculation is made when a balancing adjustment event happens to an item of plant.

12.99 A capital gain or loss from a depreciating asset may now arise if new CGT event K7 happens to the asset [Schedule 2, item 259, section 104-235] . That event can only happen if a balancing adjustment event has happened to a depreciating asset that has been used either wholly or partly for non-taxable (generally for private) purposes. A capital gain from CGT event K7 happening may qualify for the CGT discount if the conditions in Division 115 of the ITAA 1997 are satisfied.

12.100 Broadly, the calculations that are required to be made can be summarised in Table 12.2.

12.101 A capital gain or loss under CGT event K7 is calculated by reference to Division 40 concepts (e.g. cost and termination value), and not those found in the CGT provisions (e.g. cost base and capital proceeds) [Schedule 2, item 255, section 100-15 and items 269 to 279] . The use of Division 40 concepts is consistent with the Governments original decision to remove plant from the CGT regime to reduce record keeping costs.

12.102 A capital gain or loss from CGT event K7 happening to a depreciating asset arises in the same income year as any balancing adjustment calculated under Subdivision 40-D. This is in contrast to the treatment that existed prior to the removal of plant from the CGT regime. Because capital gains or losses generally arise in the year a contract is entered into, it was sometimes the case that a capital gain or loss from plant was included in an earlier year of income than a related balancing adjustment.

12.103 A capital gain from a depreciating asset will be disregarded if the asset was acquired prior to 20 September 1985. If the depreciating asset is a personal use asset (i.e. one used or kept mainly for personal use and enjoyment) any capital loss from it is disregarded under section 108-20 of the ITAA 1997. Similarly, a capital gain from a collectable that cost $500 or less or a personal use asset that cost $10,000 or less may be disregarded under section 118-10 of the ITAA 1997.

12.104 Subsections 118-10(1) and (3) of the ITAA 1997 have been amended so it is now clear that Division 40 concepts are being used consistently when dealing with depreciating assets.

Depreciating asset used 100% for taxable purposes

12.105 If a balancing adjustment event happens to a depreciating asset that has been used 100% for taxable purposes, the taxpayer will not make any capital gain or loss. The relevant gain or loss will be accounted for under section 40-285 of the Capital Allowances Bill as either assessable income or as a deduction.

Example 12.7

Anna buys a depreciating asset that cost $100. The effective life of this asset is 5 years and the prime cost method of calculating the decline in value is used. Two years after its acquisition Anna sells the asset. The adjustable value of this asset at this time is $60 while its termination value is $130. Anna has used the asset 100% for taxable purposes.

The amount that will be included in Annas assessable income under subsection 40-285(1) of the Capital Allowances Bill is:

termination value - adjustable value
= $130 - $60
= $70


The $70 represents a recoupment of the $40 Anna has deducted for the decline in value of the asset and the $30 profit.

There will not be any capital gain or loss.

Depreciating asset used partly for taxable purposes and partly for non-taxable purposes

12.106 The tax consequences will depend on the termination value of the depreciating asset, its cost and its adjustable value. The consequences are outlined in Table 12.3.

Example 12.8

Fiona buys a depreciating asset for $1,000. Its effective life is 5 years and the decline in value is worked out using the prime cost method. Two years later Fiona sells the asset for $700. Its adjustable value at this time is $600. Fiona has used the asset 30% for non-taxable purposes. The amount included in Fionas assessable income will be worked out according to the requirements of subsection 40-285(1) and section 40-290 of the Capital Allowances Bill, that is:

amount included in assessable income

= (termination value - adjustable value) - non-taxable use amount


= ($700 - $600) - [30% * (termination value - adjustable value)]


= $100 - ($100 * 30%)


= $100 - $30


= $70


The capital loss is worked out using the following formula:

capital loss = (cost - termination value) * sum of reductions/total decline


= ($1,000 - $700) * $120 (30% * $400)/$400


= $300 * 0.3


= $90 capital loss.


Depreciating asset used 100% for non-taxable purposes

12.107 If a balancing adjustment event happens to a depreciating asset that was used 100% for non-taxable purposes, there will not be any balancing adjustment. Section 40-290 of the Capital Allowances Bill provides that a balancing adjustment amount must be reduced to the extent that (in this case 100%) it is attributable to any non-taxable use of the depreciating asset.

12.108 Instead, the difference between the assets termination value and its cost will be a capital gain or loss [Schedule 2, item 259, section 104-240] . As mentioned in paragraph 12.103, the capital gain or loss may be disregarded.

Section 118-24

12.109 Section 118-24 will ensure that no capital gain or capital loss will arise from any CGT event happening to a depreciating asset that is the equivalent of a balancing adjustment event except as provided by CGT event K7 (also see paragraph 11.92).

12.110 Thus, for example, if a trust is created over an asset that is used 100% for taxable purposes, a balancing adjustment event happens to the asset because it ceases to be held by the first owner. Section 118-24 will ensure that any capital gain or capital loss that may otherwise arise under CGT event E1 is disregarded. [Schedule 2, item 292, section 118-24]

12.111 Section 118-24 will not exempt capital gains and losses from CGT events that are not equivalent to balancing adjustment events. For example if rights are created over a depreciating asset any gain from CGT event D1 will not be disregarded.

Partnership assets

12.112 Subsection 106-5(1) of the ITAA 1997 provides that any capital gain or loss from a CGT event happening to a partnership asset is made by the partners individually and not the partnership. However, this rule will not apply where a CGT event happens to a depreciating asset. [Schedule 2, item 260, subsection 106-5(5)]

12.113 The existing rule would not operate appropriately in context of partnership depreciating assets because Division 40 treats the partnership as owning the asset.

Pooling of assets

12.114 Separate rules are required for depreciating assets that have been allocated to a low-value pool.

12.115 When a balancing adjustment event happens in relation to a depreciating asset in a low-value pool, the taxable use portion of the assets termination value is taken into account in working out the pools closing balance for the income year.

12.116 Whether a capital gain or loss is made will depend on, amongst other things, the assets termination value, its cost and the estimated non-taxable use of the asset at the time it was allocated to the pool. Section 40-435 of the Capital Allowances Bill makes it clear that when a depreciating asset is allocated to a low-value pool regard must be had to its past as well as anticipated future use in determining its estimated taxable/non-taxable use.

12.117 The consequences are summarised in Table 12.4.

12.118 No capital gain or loss will arise in respect of depreciating assets in a software development pool because these assets must be used only for a taxable purpose. Similarly no capital gain or loss will arise in respect of project pools as only expenditure (and not depreciating assets) can be allocated to them.

Partial realisation of intellectual property

12.119 Intellectual property is a depreciating asset for the purposes of the Capital Allowances Bill.

12.120 The introduction of a uniform capital allowance system means that it is no longer appropriate to continue the special treatment for partial realisations of intellectual property that exists in the ITAA 1997 (Division 373 and section 104-205). [Schedule 2, item 256, section 104-5; item 258, section 104-205; item 280, section 112-45; item 285, section 116-25 and item 287, subsection 116-30(4)]

12.121 If a part interest in an item of intellectual property is disposed of, the splitting rule in subsection 40-115(2) of the Capital Allowances Bill will apply. This means that an appropriate share of the cost (or acquired value) is attributed to that part of the asset for the purposes of making any balancing adjustment or CGT calculation.

12.122 The granting of a licence over an item of intellectual property will also be treated as a part disposal of that item of intellectual property. Subsection 40-115(3) of the Capital Allowances Bill will apply to allocate a portion of the cost base of the item of intellectual property for the purposes of making any balancing adjustment or CGT calculation from the grant of the licence.

Small business CGT concessions

12.123 None of the small business CGT concessions in Division 152 of the ITAA 1997 will apply to a capital gain that arises from CGT event K7 happening. Essentially those concessions relate to the use of an asset in a small business. A capital gain from CGT event K7 on the other hand arises only from the private use of an asset. To the extent that an asset is used in small business, CGT event K7 never applies and so the small business concessions cannot apply to that event. [Schedule 2, item 314, subsection 152-10(1)]

Discount capital gains

12.124 Where a taxpayer makes a capital gain as a result of CGT event K7, that taxpayer, where eligible, can choose to use the CGT discount provisions available in Division 115 of the ITAA 1997.

Minor technical corrections

12.125 Depreciating assets will be treated as precluded assets for the purposes of rollover under Division 122. [Schedule 2, item 294, subsection 122-25(3)]

12.126 When an asset is compulsorily acquired, lost or destroyed, CGT rollover under Subdivision 124-B will not be available if the replacement asset is a depreciating asset. This is consistent with the treatment that applies if a replacement asset is trading stock and ensures that a capital gain from the original asset is appropriately taxed [Schedule 2, items 295 to 298] . Because of the different way in which the small business rollover in Subdivision 152-E operates, it is not necessary to deny rollover where a depreciating asset is acquired to replace another small business asset. Amendments have also been made to the value shifting rules in Division 138 to ensure that they continue to operate with the introduction of the uniform capital allowance system [Schedule 2, items 305 to 313] .

Amendments to the dictionary

12.127 There are several amendments to the dictionary contained in subsection 995-1(1) of the ITAA 1997 due to the following:

•

relocating definitions;

•

repealing some redundant definitions;

•

giving a new label to some definitions;

•

inserting new definitions; and

•

updating references to existing definitions.

[Schedule 2, items 242, 349 to 476]

Interaction with the Income Tax Rates Act 1986

12.130 Due to the repeal of sections 42-295 and 42-300 of the ITAA 1997 as a result of the introduction of the uniform capital allowance system, there will no longer be the concept of abnormal income. As a result, the provisions of the Income Tax Rates Act 1986 that refer to the concept of abnormal income have been amended accordingly. [Schedule 2, items 477 to 479]

Interaction with the Social Security Act 1991

12.129 Paragraph 1075(1)(b), sub-paragraph 1185K(3)(d)(ii), paragraph 1208B(1)(b) and paragraph 1209C(1)(b) of the Social Security Act 1991 all require amendment in similar terms. Under these provisions income is reduced by depreciation that relates to the business, farming, investment or primary production enterprise where the depreciation is an allowable deduction under subsection 54(1) of the ITAA 1936 or Division 42 of the ITAA 1997.

12.130 Paragraph 1075(1)(ba), subparagraph 1185K(3)(d)(iia), paragraph 1208B(1)(ba) and paragraph 1209C(1)(ba) of the Social Security Act 1991 refer to amounts that relate to the business, relevant farm asset, business or investment or primary production enterprise, respectively. Under these provisions the decline in value of the depreciating assets in question can be deducted under Subdivision 40-B of the ITAA 1997. This will allow that where applicable, the relevant income of the entity can be reduced by these amounts. [Schedule 2, items 480 to 483]

Interaction with the Veterans Entitlements Act 1986

12.131 Paragraph 46C(1)(b), subparagraph 49J(3)(f)(ii), paragraph 52ZZO(1)(b) and paragraph 52ZZZO(1)(b) of the Veterans Entitlements Act 1986 all require amendment in similar terms. Under these provisions income is reduced by depreciation that relates to the business, farming, investment or primary production enterprise where the depreciation is an allowable deduction for the purposes of subsection 54(1) of the ITAA 1936 or Division 42 of the ITAA 1997.

12.132 Paragraph 46C(1)(ba), subparagraph 49J(3)(f)(iia), paragraph 52ZZO(1)(ba) and paragraph 52ZZZ0(1)(ba) of the Veterans Entitlements Act 1986 refer to amounts that relate to the business, relevant farm asset, business or investment or primary production enterprise, respectively, and that can be deducted for the decline in value of the depreciating assets under Subdivision 40-B of the ITAA 1997. [Schedule 2, items 484 to 487]

Interaction with the proposed Divisions 240 and 243

12.133 Amendments are to be made to proposed Divisions 240 and 243 contained in Taxation Laws Amendment Act (No. 1) 2001 to ensure that these proposed Divisions will interact in the appropriate manner with the uniform capital allowance system. [Schedule 3, items 1 to 6]

Chapter 13 - Regulation impact statement

Policy objective

The objectives of the New Business Tax System

13.1 These Bills establish the uniform capital allowance system that is a part of the Governments broad-ranging reforms which will give Australia a New Business TaxSystem. The reforms are based on the recommendations of the Review of Business Taxation, established by the Government to consider reform of Australias business tax system.

13.2 The Government established the Review of Business Taxation in August 1998 to consult on its plan to comprehensively reform the business tax system (as outlined in ANTS). The Review of Business Taxation made 280 recommendations to the Government that were designed to achieve a more simple, stable and durable business tax system.

13.3 The New Business TaxSystem is designed to provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings, as well as a sustainable revenue base so that the Government can continue to deliver services for the community.

13.4 The New Business TaxSystem also seeks to provide a basis for more robust investment decisions by:

•

improving simplicity and transparency;

•

reducing the cost of compliance; and

•

providing fairer, more equitable outcomes.

13.5 These Bills are part of the legislative program implementing the New Business TaxSystem. Other Bills have been introduced and passed already and are summarised in Table 13.1.

13.6 A number of exposure drafts have recently been released. These include:

•

the New Business Tax System (Entity Taxation) Bill 2000 - Exposure Draft (released in October 2000);

•

the New Business Tax System (Simplified Tax System) Bill 2000 - Exposure Draft (released in October 2000);

•

the New Business Tax System (Consolidation) Bill 2000 - Exposure Draft (released in December 2000); and

•

the New Business Tax System (Thin Capitalisation and Other Measures) Bill 2001 - Exposure Draft (released in February 2001).

This Bill was released as an exposure draft in December 2000 and in May 2001; these exposure drafts were titled the New Business Tax System (Capital Allowances) Bill 2000 - Exposure Draft and the New Business Tax System (Capital Allowances) Bill 2001 - Exposure Draft.

The objectives of measures in this Bill

13.7 The New Business Tax System will enhance Australias competitiveness by removing many of the direct or indirect impediments to desirable investment.

13.8 The uniform capital allowance system based on a common set of principles will offer significant simplification benefits. The existing law contains over 37 separate capital allowances regimes that are complex, inconsistent and involve significant replication. The collapse of the majority of these separate regimes into a single comprehensive regime has the objectives of providing:

•

consistent taxation treatment of depreciating assets by reference to the effective life of these assets;

•

a framework under which blackhole expenditure on depreciating assets can be recognised; and

•

more neutral tax treatment for some other specific capital expenditures that should improve investment and economic efficiency.

13.9 A new measure included in the Capital Allowances Bill has the objective of including datacasting transmitter licences purchased by entities as depreciating assets under the uniform capital allowance system. This measure was announced on 24 January 2001.

Implementation options

13.10 The uniform capital allowance system arises from recommendations of the Review of Business Taxation. Those recommendations were the subject of extensive consultation. The implementation options for those measures can be found in the Review of Business Taxations A Platform for Consultation and A Tax System Redesigned. Table 130 shows where the measures (or the principles underlying them) are discussed in these publications.

Assessment of impacts

13.11 The potential compliance, administrative and economic impacts of most of the measures in these Bills have been carefully considered, both by the Review of Business Taxation and by the business sector. The Review of Business Taxation focused on the economy as a whole in assessing the impacts of its recommendations (including those relating to the measures in these Bills) and concluded that there would be net gains to business, government and the community generally from business tax reform.

Impact group identification

13.12 The measures in these Bills specifically impact on those taxpayers identified in Table 13.3.

Analysis of costs / benefits

Compliance costs

13.13 One of the key objectives of the Review of Business Taxation is to reduce the cost of compliance by business taxpayers.

13.14 The changes under the uniform capital allowance system are expected to affect approximately 170,000 business entities of all types. This number does not include those entities that may be eligible for the STS for small business.

13.15 Because the uniform capital allowance system is based on interdependent topics, the compliance costs of the introduction of this Bill have been considered collectively. The compliance costs for businesses affected by the uniform capital allowance system are expected to be reduced due to:

•

a uniform treatment of depreciation for capital items rather than the current taxation treatments. This will lead to a reduction in record keeping and administration expenses; and

•

recurrent savings over the life of the system relative to the previous system due to simplification.

13.16 However, these compliance cost savings may be offset initially by:

•

training and education costs associated with taxpayers and agents understanding of the new legislation; and

•

expenses associated with updating record keeping systems.

13.17 These transitional and ongoing compliance costs are discussed in more detail in paragraphs 130 to 13.23.

13.18 The cost of compliance impacts for the entire Review of Business Taxation reforms are outlined in pages 31-34 of A Tax System Redesigned.

Capital allowance rewrite - effective life to stay

13.19 The effective life provisions will not have a compliance cost impact for the majority of taxpayers, as the effective life concepts are used in the existing legislation including:

•

the same choice between the Commissioners effective life and your own calculation of effective life of an asset;

•

similar methods for working out the effective life of an asset; and

•

same choice to work out a new effective life of an asset.

13.20 This measure will provide more consistency across the range of different types of depreciating assets. Generally, there are expected to be significant compliance cost savings from the rationalisation of rules and treatments of depreciating assets. In particular this will ensure reduced compliance costs for taxpayers who are using more than one of the existing amortisation regimes. These taxpayers will benefit from dealing with the one system instead of different systems for different assets.

13.21 For example, a large business with a number of assets will need knowledge of a number of different amortisation regimes. There are different amortisation regimes for a wide variety of depreciating assets including plant, buildings and forestry roads. A business having assets within all of these classes would mean that the business owner, staff and/or a tax agent would be required to perform separate calculations, using different depreciation rules and keep separate records for each regime. This difference could be expected to add significant time and must be done annually, each time a tax return is prepared. In addition, the depreciation schedule and other records relating to depreciation must be kept for 5 years.

Entitlement to write-off

13.22 The measure where an entitlement to write-off is given to the taxpayer who incurs the loss in value of the asset, should reduce compliance costs once taxpayers become familiar with the measure. There should be fewer compliance costs because the doubt that currently exists with the legal ownership test in the current law will be removed. The change will ensure that each appropriate eligible person will be entitled to depreciation with respect to holding of an asset or an interest in an asset.

Cost of asset to include all relevant costs

13.23 The cost of assets are to include all relevant costs of acquiring and installing the asset. These costs should currently be accounted for and therefore should not affect compliance costs.

Option of methods

13.24 The option of writing off depreciating assets on the basis of prime cost or diminishing value may cause a small compliance cost increase for some taxpayers in relation to assets for which no option presently applies. This increase can be attributed to the extra cost in taxpayers having to work out the new formulas, the removal of the general rates for some types of depreciating assets and that for a number of assets taxpayers have to make a decision between methods.

Administration costs

13.25 Most of the measures in this Bill are not expected to impose ongoing administration costs. There will be a small initial administration cost involved in updating systems, return forms and other ATO publications and in providing education.

Government revenue

13.26 A comprehensive assessment of the revenue impact of all measures recommended by the Review of Business Taxation is provided in the Overview and Section 24 of A Tax System Redesigned. The revenue impact provided in Section 24 was based on implementing all recommendations in A Tax System Redesigned. However, some recommendations have already been adopted, for example the removal of accelerated depreciation, while other recommendations in relation to capital allowances have not been included in Division 40.

13.27 The revenue impact of these particular changes adopted in this Bill cannot be accurately ascertained or separated from the collated revenue impacts in Section 24 of A Tax System Redesigned.

Economic benefits

13.28 The New Business TaxSystem will provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings. The economic benefits of these measures are explained in more detail in the publications of the Review of Business Taxation, particularly A Platform for Consultation and A Tax System Redesigned.

Other issues - consultation

13.29 The consultation process began with the release of ANTS in August 1998. The Government established the Review of Business Taxation in that month. Since then, the Review of Business Taxation has published 4 documents about business tax reform; in particular A Platform for Consultation in which it canvassed options, discussed issues and sought public input.

13.30 Throughout that period, the Review of Business Taxation held numerous public seminars and focus group meetings with key stakeholders in the tax system. It received and analysed 376 submissions from the public about reform options. Further details are contained in paragraphs 11 to 16 of the Overview to A Tax System Redesigned.

13.31 In analysing options, the published documents frequently referred to, and were guided by, views expressed during the consultation process.

13.32 After the production of a draft version of the Capital Allowances Bill, several capital allowance workshops were held with key stakeholders in the tax system, to obtain their thoughts on the draft Bill produced for these measures. Many comments were received through this process, and were taken into account before the release of the Bill for public consultation.

13.33 After the release of the exposure draft in December 2000 on Capital Allowances, 19 submissions were received from stakeholders. These submissions have been considered prior to the release of these Bills.

13.34 Through this process a number of concerns have been raised and in some cases changes were made to the draft legislation, some of which are described in paragraphs 130 to 13.38.

13.35 Removal of an item in the hold table about depreciating assets connected with mining capital expenditure and transport capital expenditure is one such change. This was removed as it was considered that it did not work structurally and that it would be better dealt with in the project pool provisions. The effect of that item has been placed into the project pool mechanism and called an asset contribution amount.

13.36 A concern was also raised that a mandatory recalculation of project life would result in high compliance costs. This requirement has been removed from the legislation.

13.37 Further, a change was made to the draft to ensure a deduction is allowable when a project is abandoned, sold or otherwise disposed of. This change arose due to the consultation process.

13.38 Other changes made as a result of the consultations include:

•

the removal of complex rules about partially completed assets;

•

guidance included in this explanatory memorandum on the identification of a depreciating asset; and

•

the relationship with the mining provisions under the existing law and the inclusion of finding tables.

Conclusion and recommended option

13.39 The measures in these Bills should be adopted to support a more efficient, innovative and internationally competitive Australian business sector, to reduce compliance costs and to establish a simpler and more structurally sound business tax system.

Index

New Business Tax System (Capital Allowances) Bill 2001

Schedule 1: Capital allowances

New Business Tax System (Capital Allowances - Transitional and Consequential) Bill 2001