House of Representatives

Explanatory Memorandum

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

Chapter 7 - Simplified tax system roll-over

Outline of chapter

7.1 Schedule 7 to this Bill amends Division 328 of the Income Tax Assessment Act 1997 (ITAA 1997) to ensure that the roll-over relief available for partnerships under the uniform capital allowances regime is also available in relation to depreciating assets allocated to simplified tax system (STS) pools.

7.2 All references to legislative provisions in this chapter are to the ITAA 1997 unless stated otherwise. Context of amendments

7.3 The STS, which commenced on 1 July 2001, was introduced as a result of recommendations in the Ralph Review of Business Taxation to reduce the disproportionate tax compliance burden that falls on small business. This aim is achieved by providing eligible small businesses with simpler depreciation rules than under the uniform capital allowances regime, a cash basis for recognising income and deductible expenses (see Chapter 2 for changes to this component), and simple trading stock rules.

7.4 Subdivision 328-D provides the rules for capital allowances for STS taxpayers. Broadly, an STS taxpayer allocates depreciating assets to either a general STS pool or a long life STS pool and treats each pool as a single asset. The rates of depreciation are 30 per cent for the general STS pool and 5 per cent for the long life STS pool. Assets with effective lives of less than 25 years are allocated to the general STS pool while those having effective lives of 25 years or more are allocated to the long life STS pool. There is also an immediate deduction for low-cost assets; that is, assets whose costs are less than $1,000.

7.5 Under Division 40, the uniform capital allowances regime allows deductions for the decline in value of a depreciating asset over the asset's effective life. The Division provides a set of general rules to calculate the deduction to taxpayers for the notional decline in value of most depreciating assets. It also provides pooling mechanisms under which small expenditures are pooled and taxpayers are given deductions for the decline in value of the pool.

7.6 Adjustments may be made to assessable income under the uniform capital allowances (balancing adjustments - section 40-285) when a balancing adjustment event occurs; for example, when a taxpayer stops holding an asset (section 40-295). Subsection 40-295(2), specifically, provides that a balancing adjustment event occurs for a depreciating asset if:

•

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

•

at least one of the entities that had an interest in the asset before the change has an interest in it after the change; and

•

the asset was held by a partnership either before or as a result of the change.

7.7 Balancing adjustments are usually based on the difference between the actual value of the asset at the time of the balancing adjustment event and its adjusted value (Subdivision 40-D). Under certain circumstances, either automatic roll-over relief (subsection 40-340(1)) or optional roll-over relief (subsection 40-340(3)) is available to defer the adjustment to assessable income until actual disposal of the asset.

7.8 Amendments made to Subdivision 328-D by Taxation Laws Amendment Act (No. 2) 2004 (Act No. 20 of 2004) provide optional roll-over relief in relation to depreciating assets where there is a partial change in the ownership of an asset held by a partnership operating in the STS (section 328-240). Roll-over relief is only available where the entities both before and after the change are partnerships. Roll-over relief for partnerships in the STS ensures that the transferor taxpayer ignores the balancing adjustment amount at the time of the partnership change so that no amount is included in its assessable income.

7.9 This measure extends roll-over relief under the STS regime by removing the requirement that both entities, before and after the ownership change, must be partnerships. This will ensure that consistent roll-over relief is available for depreciating assets under both the uniform capital allowances and STS regimes.

7.10 This measure was announced by the Treasurer and the Minister for Small Business in Press Release No. 36 of 11 May 2004. Summary of new law

7.11 Amendments will be made to Subdivision 328-D to ensure that the optional roll-over relief available under subsection 40-340(3) is available for depreciating assets held in STS pools.

7.12 The roll-over relief currently provided under section 328-240 will be extended from balancing adjustment events occurring only as a result of a change in the constitution of a partnership or in the interests of the partners to all balancing adjustment events occurring under subsection 40-295(2); that is:

•

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

•

at least one of the entities that had an interest in the asset before the change has an interest in it after the change; and

•

the asset was a partnership asset either before the change or becomes one as a result of the change.

7.13 The extended roll-over relief will benefit STS taxpayers by removing the balancing adjustment, or taxing point, that would otherwise arise in relation to depreciating assets at the time the ownership change occurs. This will ensure that a taxable gain or loss will only arise upon disposal of the depreciating assets. This amendment ensures that consistent treatment applies to depreciating assets under the STS regime compared with the uniform capital allowances regime.

7.14 The depreciation deductions for the decline in value of depreciating assets will be split equally between the taxpayers who jointly choose roll-over relief.

Comparison of key features of new law and current law

Detailed explanation of new law

Extension of roll-over relief

7.15 Amendments are made to Subdivision 328-D to extend the availability of optional roll-over relief under subsection 40-340(3) to balancing adjustment events occurring in relation to depreciating assets in an STS pool under subsection 40-295(2); that is, when:

•

a change occurs in the holding of, or in interests of entities in, the asset;

•

at least one of the entities that had an interest in the asset before the change has an interest in the asset after the change; and

•

the asset was a partnership asset either before or as a result of the change.

[Schedule 7, item 11, paragraph 328-243(1)(a)]

7.16 This amendment ensures that roll-over relief is available if there is a change in business structure involving a partnership. For example, if a sole trader takes on a new partner, roll-over relief will be available to defer any adjustment to taxable income resulting from that balancing adjustment event. Likewise, if a partner leaves a partnership and the remaining partner carries on as a sole trader, roll-over relief will be available. Roll-over relief continues to be available for changes in the constitution of a partnership.

7.17 An amendment is made to paragraph 40-340(4)(b) which specifies the notification procedures when roll-over relief is chosen. The amendment ensures that the requirements for making a valid choice apply to roll-over relief for assets depreciated under Subdivision 328-D as well as under Division 40 [Schedule 7, item 2, paragraph 40-340(4)(b)]. These notification requirements were previously contained in section 328-240; however, this section has been repealed as a result of the extension of roll-over relief [Schedule 7, item 9].

Conditions

7.18 To be eligible for the roll-over relief, deductions for the depreciating assets must be calculated under Subdivision 328-D. Therefore, the assets subject to the roll-over relief must be allocated to the general STS pool or the long life STS pool at the time of the balancing adjustment event. [Schedule 7, item 11, paragraph 328-243(1)(b)]

7.19 It should be noted that when a taxpayer leaves the STS, depreciating assets that have been allocated to a general STS pool and a long life STS pool continue to be depreciated under Subdivision 328-D (section 328-220). This means that former STS taxpayers may choose roll-over relief for depreciating assets allocated to an STS pool when a balancing adjustment event occurs under subsection 40-295(2).

7.20 An amendment is also made to section 328-220 to clarify that Subdivision 328-D applies to a transferee who is either not eligible to enter the STS or chooses not to. The transferee is treated as if they had been an STS taxpayer and then ceased to be one. This is regardless of whether roll-over relief is chosen. Therefore, the assets eligible for roll-over relief continue to be allocated to an STS pool and depreciated under Subdivision 328-D even though the transferee is not an STS taxpayer. [Schedule 7, item 7, subsection 328-220(3)]

7.21 Roll-over relief is only available if the entity or entities that had an interest in the assets just before the balancing adjustment event (the transferor) and those that have an interest in the assets just after the balancing adjustment event occurred (the transferee) jointly choose the roll-over relief. [Schedule 7, item 11, paragraph 328-243(1)(c)]

7.22 The condition contained in subsection 328-243(2) must also be met for roll-over relief to apply [Schedule 7, item 11, paragraph 328-243(1)(d)]. Subsection 328-243(2) provides that all of the assets held by the transferor and allocated to an STS pool immediately before the balancing adjustment event occurred must be held by the transferee just after the balancing adjustment event. In other words, roll-over relief cannot be used for some of the assets in an STS pool and not others, but must apply to all assets in an STS pool.

7.23 The consequences of choosing roll-over relief are set out in section 328-245.

Deductions for pooled assets

7.24 Deductions for pooled assets are calculated under subsection 328-190(1) for general and long life STS pools and section 328-210 for low pool values of less than $1,000. If roll-over relief has been chosen, these deductions are apportioned between the transferor and the transferee under section 328-247. Amendments are made to this section to reflect the extension of the roll-over relief.

7.25 Section 328-247 applies in relation to deductions for the income year in which the balancing adjustment event occurred. This year is referred to as the balancing adjustment event year. [Schedule 7, item 12, subsection 328-247(1)]

7.26 If there has been only one balancing adjustment event in the balancing adjustment event year, the amount of the deduction available under subsection 328-190(1) or section 328-210 is split equally between the transferor and the transferee. However, if there are two or more balancing adjustment events occurring for the entities in the balancing adjustment event year and roll-over is chosen for each event, the amount of the deduction is split equally between each of the entities concerned. [Schedule 7, item 13, paragraph 328-247(1)(b)]

Deductions for assets first used in the balancing adjustment event year

7.27 Deductions for low-cost assets in the income year in which the asset is first used or installed ready for use are calculated under subsection 328-180(1). Deductions for pooled assets in the income year in which the asset is first used or installed ready for use are calculated under subsection 328-190(2). If roll-over relief has been chosen, these deductions are split equally between the transferor and the transferee under section 328-250. Amendments are made to this section to reflect the extension of the roll-over relief.

7.28 If the asset was first used or installed ready for use by the transferor, the deduction available under either subsection 328-180(1) or subsection 328-190(2) is split equally between the transferor and the transferee if there has been only one balancing adjustment event in the balancing adjustment event year. However, if there are two or more balancing adjustment events occurring for the entities in the balancing adjustment event year and roll-over is chosen for each event, the amount of the deduction is split equally between each of the entities concerned. [Schedule 7, item 14, paragraph 328-250(2)(b)]

7.29 If the asset is first used or installed ready for use by the transferee, the transferor is not entitled to a deduction for the balancing adjustment event year. However, if there are two or more balancing adjustment events occurring for the entities in the balancing adjustment event year and roll-over is chosen for each event, the amount of the deduction available under either subsection 328-180(1) or subsection 328-190(2) is split equally between each of the entities that used the asset or had it installed ready for use. [Schedule 7, item 15, subparagraph 328-250(3)(b)(ii)]

Deductions for cost addition amounts

7.30 Deductions are calculated under subsection 328-180(2) for the second element (cost addition amounts) of the cost of low-cost assets. If an STS taxpayer claimed a deduction for a low-cost asset in one income year, and in a later income year included an amount of less than $1,000 in the second element of the cost of the asset, an immediate deduction is available for that amount. Deductions for cost addition amounts for pooled assets are calculated under subsection 328-190(3). If roll-over relief has been chosen, these deductions are split equally between the transferor and the transferee under section 328-253. Amendments are made to this section to reflect the extension of the roll-over relief.

7.31 If the expenditure was incurred by the transferor, the deduction available under either subsection 328-180(2) or 328-190(3) for the balancing adjustment event year is split equally between the transferor and the transferee. However, if there are two or more balancing adjustment events occurring for the entities in the balancing adjustment event year and roll-over is chosen for each event, the amount of the deduction is split equally between each of the entities concerned. [Schedule 7, item 16, paragraph 328-253(2)(b)]

7.32 If the expenditure was incurred by the transferee, the transferor cannot deduct any amount for the expenditure in the balancing adjustment event year. Instead, the transferee can claim the deduction for the expenditure incurred in the balancing adjustment event year under either subsection 328-180(2) or 328-190(3). However, if there are two or more balancing adjustment events occurring for the entities in the balancing adjustment event year and roll-over is chosen for each event, the amount of the deduction is split equally between each of the entities concerned. [Schedule 7, item 18, subparagraph 328-253(3)(b)(ii)]

Closing pool balance below zero

7.33 Subsection 328-215(2) includes an amount in assessable income for a balancing adjustment event under certain circumstances. If a depreciating asset is allocated to an STS pool and either:

•

the closing balance of the pool is less than zero; or

•

the low pool value deduction calculated under subsection 328-210(2) is less than zero,

an amount is included in assessable income equal to the amount by which the balance is less than zero. Under section 328-255, this amount is split equally between the entities that have chosen roll-over relief. Amendment is required to section 328-255 to reflect the extension of the roll-over relief.

7.34 The amount included in assessable income under subsection 328-215(2) is split equally between the transferor and the transferee. However, if two or more balancing adjustment events have occurred and roll-over relief has been chosen for each event, the amount included in assessable income is split equally between each of the entities concerned. [Schedule 7, item 19, paragraph 328-255(2)(b)]

Minor technical amendment

7.35 An amendment is made to paragraph 328-253(3)(b) to correct a minor technical error. Paragraph 328-253(3)(b) refers incorrectly to 'subsection 328-180(1) or 328-190(2)'. This reference is removed and replaced with the correct reference to 'subsection 328-180(2) or 328-190(3)'. [Schedule 7, item 17, paragraph 328-253(3)(b)]

Application and transitional provisions

7.36 The amendments made by this Schedule will apply to assessments for the income year following the income year in which this Bill receives Royal Assent and later income years. [Schedule 7, item 20]

Consequential amendments

7.37 A number of consequential amendments are made to update references to the extended roll-over relief provisions. These amendments are to:

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note 2 to subsection 40-340(3) [Schedule 7, item 1] ;

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note to subsection 328-175(3) [Schedule 7, item 3] ;

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note to subsection 328-190(4) [Schedule 7, item 4] ;

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note to section 328-200 [Schedule 7, item 5] ;

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note 3 to subsection 328-205(1) [Schedule 7, item 6] ;

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note to subsection 328-225(1) [Schedule 7, item 8] ; and

•

heading to section 328-243 [Schedule 7, item 10].