Revised Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
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:
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- 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
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- 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.
| New law | Current law |
|---|---|
| Taxpayers, other than small business taxpayers who choose to enter the STS, may choose to allocate to a low-value pool, all assets costing less than $1,000 (low-cost assets) or assets that have declined in value under the diminishing value method to less than $1,000 (low-value assets). Broadly, the decline for assets in the low-value pool is worked out on a diminishing value basis as if all the pooled assets had an effective life of 4 years. | Items of plant costing less than $1,000, or items of plant that have been depreciated under the diminishing value method to less than $1,000, may be pooled over an effective life of 4 years using the diminishing value method. |
| Taxpayers may choose to allocate expenditure on developing software to a software development pool. The expenditure is deductible over 2 years commencing in the next year. | Not different. |
Detailed explanation of new law
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:
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- 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:
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- for which the taxpayer has deducted, or can deduct, amounts worked out using the diminishing value method;
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- that has an opening adjustable value for the current year of less than $1,000; and
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- 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:
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- 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)] ;
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- 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
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- 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)]
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.
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.
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:
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- the pool closing balance of the pool for the previous income year; plus
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- the taxable use percentage of the costs of low-cost assets allocated to the pool for that year; plus
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- 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
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- 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
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- 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)]
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:
| Asset | Calculation | Amount |
|---|---|---|
| Low-cost asset allocated to the pool for the 2002-2003 income year. | 18.75% * ($800 * 80%) | $120.00 |
| Pool closing balance from previous year ($2,500) plus low-value assets allocated to the pool for that year ($990). | 37.5% * ($2,500 + $990) | $1,308.75 |
| Total decline in value | $1,428.75 |
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.
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.
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:
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- the disposal or part disposal of software;
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- the granting of a licence in relation to software; and
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- 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:
| Date | Project | Expenditure |
|---|---|---|
| June 2002 | Project A commenced | $10,000 |
| July 2002 | Acquires and installs off the shelf software* | $2,000 |
| October 2002 | Project B (software completed and installed on 1 January 1999) | $1,500 |
| January 2003 | Project A and other new projects | $2,000 |
| May 2003 | Project A and other new projects | $3,000 |
Deductions can be claimed as follows:
| Year ended | Class | Expenditure | Rate | Amount |
|---|---|---|---|---|
| 30 June 2002 | Pool 1 | $10,000 | 0% | $0.00 |
| 30 June 2003 | Pool 1 | $10,000 | 40% | $4,000.00 |
| Pool 2 | **$6,500 | 0% | $0.00 | |
| 30 June 2004 | Pool 1 | $10,000 | 40% | $4,000.00 |
| Pool 2 | $6,500 | 40% | $2,600.00 | |
| 30 June 2005 | Pool 1 | $10,000 | 20% | $2,000.00 |
| Pool 2 | $6,500 | 40% | $2,600.00 | |
| 30 June 2006 | Pool 2 | $6,500 | 20% | $1,300.00 |
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