House of Representatives

Explanatory Memorandum

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

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 3.87 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. [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 for any purpose, never expecting to use it again;

•

a taxpayer has not used a depreciating asset and expects never to use it; 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 1.134 to 1.141 and 1.149 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 3.45 to 3.65 [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 3.45 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 2.61 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 2.91 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 2.94 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 1.96 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 of an asset under section 40-25 / total decline in the value of the depreciating asset since it was hled 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 1.134 to 1.141 and 1.149 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 1, item 1, section 995-1]

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:

amount the taxpayer can deduct = total expenditure incurred on the in-house expenditure - any consideration derived from the software; this cannot exceed the total expenditure incurred on the in-house expenditure


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.

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

•

have an involuntary disposal of a depreciating asset as mentioned in paragraph 3.82 [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 occured


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 os days for which the taxpayer deducted the deline in value of the car under Division 40 (i.e. you used the 'log book' or 'one-third of acutal 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.