Ruling Compendium

We agree with the Commissioner's preliminary views that:

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in determining whether a composite item is a single depreciating asset or whether each of its component parts are separate depreciating assets, regard should be had for the five guiding principles set out in paragraph 6 of the draft Ruling, and

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an 'interest in an underlying asset' refers to both a partial interest in the entirety of a composite item and a whole interest in a particular component of a composite item.

We are pleased to see 14 practical examples that should assist users of the final Ruling once finalised.

The second sentence of paragraph 4 of the draft Ruling sets out the legislated directive determining whether a composite item is itself a depreciating asset or whether one or more components are separate depreciating assets is a question of fact and degree. While the provision (subsection 40-30(4)) has been duly referenced in the footnotes, it would be preferable to incorporate the reference into paragraph 4 itself.

This is to provide clarity to readers that the directive is legislated and it is not a view or an interpretation of the Commissioner.

We agree with the conclusion that the original computer package is one single depreciating asset.

However, paragraph 30 of the draft Ruling requires some clarity. It states that the subsequent acquisition of 'replacement' elements of the single asset will be treated as the acquisition of separate depreciating assets.

If the monitor in the computer package (composite item) is broken and replaced, the outcome of applying paragraph 30 of the draft Ruling is that the new monitor will constitute a separate depreciating asset apart from the original computer package asset.

In Example 9 of the draft Ruling, the replacement of an electricity pole which was destroyed in a storm does not create a new deprecating asset separate from the distribution line (for example, the composite asset) of which the relevant pole is a part. The ATO is of the view that there has been no substantial alteration to the function of the depreciating asset. Why would the replacement of a broken monitor, being one composite part of the overall 'desktop computer package' asset, not give rise to the same outcome?

If the above commentary in fact represents a misinterpretation of paragraph 30 of the draft Ruling, please reword the paragraph to clarify the circumstances in which the 'replacement' of one component will, and will not, constitute the acquisition of a depreciating asset separate from the original composite item.

Example 3 of the draft Ruling can be improved by incorporating pertinent facts about the 20 new terminals. In particular, their 'adaptability to work with a wide range of controllers' and any other factors that differentiate the 20 new terminals from the 50 original terminals should be stated in paragraph 33 before the analysis and conclusion. The current drafting of paragraph 33 leaves the reader with the impression that the 20 new terminals are identical to the 50 original terminals, with a reasonable expectation that the new terminals would be treated the same as the original ones, that is, included as part of the original depreciating asset (as second element of cost).

If the new terminals pass the 'identifiable' test, the features which allow them to perform a function separate to the rest of the system needs to be clearly set out in paragraph 33.

If however they have no identifiable function independent of the mainframe or other controlling device to which they are connected, please expand on the reasons why they would not simply be treated as an improvement to the original asset with the acquisition costs included in the second element of the cost of the original asset.

For completeness, Example 6 of the draft Ruling can be expanded with commentary on the Division 40 treatment in a situation where a car dashboard is modified to install an in-built global positioning system (GPS) bracket or holder, but the GPS unit itself is removable, portable and able to be used away from the car. This is distinct from the scenario contained in paragraph 47 of the draft Ruling, where presumably the portable GPS is merely used inside the car without involving any permanent modification to the car interior.

Presumably, the costs of modifying the car to install the bracket or holder and associated electrical components would be included in the second element of the cost of the car, while the removable GPS unit itself would be treated as a separate depreciating asset.

We recommend that the final Ruling includes a practical example relating to a common intangible asset that is relevant to many or most taxpayers. Even though there is commentary on intangible assets in the proposed binding section of the draft Ruling and in Appendix 1 - Explanation, all of the Examples in the draft Ruling relate to tangible items.

An ideal example is copyright in software. In the modern business environment, the sale and purchase of software is very common. ATO Interpretative Decision ATO ID 2004/982 Capital allowances: depreciating asset - copyright in computer program may be a suitable scenario on which to base the example.

However, if there is a significant issue in relation to intangible assets that we haven't appreciated that the community consider warrants guidance separate to that already provided in ATO ID 2004/982, the Commissioner would have regard to possible further public advice or guidance, subject to other priorities.

Another Ruling that must be considered in the overall analysis on repairs is Taxation Ruling TR 97/23 Income tax: deductions for repairs.

The very fabric of a major aspect of the tax system is held together by the concepts of what is the 'asset' or 'entirety', 'unit of property' or 'depreciating asset'. Once that is determined all other matters fall into place:

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replacement parts – expense

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commencement of deprecation on use, or installed ready for use

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termination of use

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spare parts deductions and Taxation Ruling IT 333 Expenditure on spare parts and consumable stores. Whether deduction allowable on usage basis or in year of purchase, and

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others.

The breadth of the implications of these concepts is very broad.

Some of these 'well understood' principles may be questioned in some of the examples contained in the draft Ruling.

Take Example 2 – desktop computer package – the inference in paragraph 30 of the draft Ruling is that the acquisition of a new keyboard to replace an existing keyboard would be capital. There are a number of factors to take into account, including the fact it is a wireless keyboard, but generally thinking, as a part of a functional whole, that replacement would be considered an expense.

This all presupposes that underlying all this is a similar concept and the linkage of 'depreciating asset' to the concept of 'unit of property'. If that is not the case then reliance on past legal principles may not be appropriate.

It is outside the scope of the draft Ruling to consider what constitutes a repair or capital improvement.