Capital write off and allowance PDF

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CHAPTER16

Capital Write-Offs and Allowances Introduction Capital allowance regime Business-related ‘blackhole’ capital expenditure Capital works regime Study questions References and further reading

¶16.1 ¶16.2 ¶16.3 ¶16.4 ¶16.5 ¶16.6

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[¶16.1] Introduction Capital expenditure is not deductible under the general deduction provision in s 8-1 ITAA97 as it falls within the first negative limb of the section [¶13.4]. This means that capital expenditure can only be deductible if it satisfies the requirements of a specific deduction provision. The tax legislation contains a number of provisions that provide deductions for particular kinds of capital expenditure. Some of these provisions allow immediate deductions for capital expenditure, while others require capital expenditure to be written off over a number of years. Amortisation of capital expenditure is justified on the basis that the expenditure usually provides taxpayers with benefits that extend beyond a single income year. It is therefore appropriate to spread their deductions over more than one year to align the expenditure with the benefits received. This chapter focuses on two regimes that provide deductions for capital expenditure. The first regime is the capital allowance regime in Div 40 ITAA97. This regime allows taxpayers to deduct the cost of depreciating assets over what is broadly the period of time they expect to use those assets in their income-producing activities [¶16.2]. It also contains a special rule that allows certain kinds of otherwise non-deductible businessrelated capital expenditure to be written off over five years [¶16.3]. The second regime is the capital works regime in Div 43 ITAA97. This regime provides deductions over a period of 25 or 40years for construction expenditure on buildings and structural improvements used for income-producing and other eligible purposes [¶16.4].

Barkoczy, S. (2018). Foundations of taxation law 2019 ebook. Retrieved from http://ebookcentral.proquest.com Created from csuau on 2020-05-20 21:24:07.

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[¶16.2] Capital allowance regime The capital allowance regime in Div 40 ITAA97 was introduced on 1 July 2001 to replace a number of former regimes. The central provision in Div 40 is s 40-25(1), which provides that an entity can deduct an amount equal to the ‘decline in value’ for an income year of a ‘depreciating asset’ that it ‘held’ during the year. The deduction is reduced by that part of a depreciating asset’s decline in value attributable to the entity’s use of the asset, or installation ready for use, for a purpose other than a ‘taxable purpose’ (s 40-25(2)). An asset is applied for a ‘taxable purpose’ if it is applied for the purpose of producing assessable income, exploration or prospecting, mining site rehabilitation or environmental protection activities (s 40-25(7)).

Depreciating asset A ‘depreciating asset’ is defined in s 40-30(1) as an asset that has a limited ‘effective life’ and can reasonably be expected to decline in value over the time it is used. It expressly excludes: •

land

•

trading stock, or

•

intangible assets (other than those intangible assets mentioned in s 40-30(2), namely:mining, quarrying or prospecting rights or information, intellectual property, in-house software, indefeasible rights to use international telecommunications submarine cable systems, spectrum licences and datacasting transmitter licences).

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Examples of depreciating assets include: •

fridges used in a supermarket to store frozen food

•

display cabinets used in a cake shop

•

computers and furniture used in an office

•

tools and trucks used by construction workers

•

machinery and equipment used in a factory, and

•

aircraft and ships used by an airline or shipping company.

Land and trading stock are the most commonly encountered assets that are not depreciating assets. Another frequently encountered asset that is not a depreciating asset is ‘goodwill’. Goodwill is an intangible asset that represents the price paid to acquire a business over the value of its tangible assets less liabilities. It is essentially the ‘premium’ paid to acquire the business. Goodwill is not a depreciating asset as it is an intangible asset that is not specifically mentioned in s 40-30(2). Improvements or fixtures on land, whether removable or not, are treated as separate assets from the land for the purposes of Div 40 (s 40-30(3)). Nevertheless, it is generally not possible to deduct amounts under Div 40 in relation to expenditure on items such as buildings because the division does not apply to ‘capital works’ that are deductible under Div 43 (or that would be deductible under Div 43 but for certain reasons) (s 40–45(2)) [¶16.4].

¶16.2

Barkoczy, S. (2018). Foundations of taxation law 2019 ebook. Retrieved from http://ebookcentral.proquest.com Created from csuau on 2020-05-20 21:24:07.

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Example: Dorio operates a pizza restaurant and owns the following assets: • ingredients for making pizzas (which are trading stock) • the land, restaurant premises and goodwill of the business, and • the tables, chairs, ovens, fridges and other equipment used in the business. Only the tables, chairs, ovens, fridges and other equipment are depreciating assets.

Holder The ‘holder’ of a depreciating asset is determined by reference to the table in s 40-40. In the general case, the ‘holder’ of a depreciating asset is its legal owner. In most cases, the legal owner of an asset is also its ‘economic owner’ (ie the entity able to access the asset’s economic benefits while stopping others from doing the same). However, in some cases the legal owner of an asset will not be its economic owner. In these instances, it is the economic owner who is treated as the holder of the asset. For instance, under a ‘hire purchase arrangement’ the holder of the asset is the economic owner of the asset (the lessee) rather than the legal owner of the asset (the lessor). The table also contains a variety of specific rules for determining the holder of particular kinds of depreciating assets.

Decline invalue

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The decline in value of a depreciating asset commences from the ‘start time’ (which is usually the time when the entity first uses the asset or has it installed ready for use) (s 40-60). An entity can choose to calculate the ‘decline in value’ of a depreciating asset using: •

a ‘diminishing value method’, or

•

a ‘prime cost method’ (s 40-65).

Once a taxpayer has chosen to use a particular method to calculate the decline in value of a depreciating asset, the method cannot be changed (s 40-130). Ataxpayer cannot therefore swap from one method to another in respect of the same depreciating asset. Ataxpayer can, however, choose to use different methods for different depreciating assets. There is one prime cost method formula (s 40-75) and two diminishing value method formulas—one of these applies to assets acquired before 10 May 2006 (s 40-70) and the other applies to assets acquired after 9 May 2006 (s 40-72): 150% Days held Diminishing value method × Base value × : Asset ’ s effective life 365 (pre-10 May 2006 assets) 200% Days h eld Diminishing value method × Base value × : 365 Asset ’ s effective life (post-9 May 2006 assets) Prime cost method

: Asse t’ s cost ×

100% Days held × 365 Asset ’ s effective life

The meanings of the terms used in the above formulas are outlined below: •

Asset’s effective life. Entities can choose to use the Commissioner’s determination of an asset’s effective life under s 40-100 or self-assess the asset’s effective life under s 40-105 (s 40-95). The Commissioner’s determination of the effective life of particular

Foundations of Taxation Law

Barkoczy, S. (2018). Foundations of taxation law 2019 ebook. Retrieved from http://ebookcentral.proquest.com Created from csuau on 2020-05-20 21:24:07.

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assets is published in TR 2018/4 and Income Tax (Effective Life of Depreciating Assets) Amendment Determination 2018 (No 1). In self-assessing the effective life of an asset, the entity must estimate the period that the asset can be used for a taxable purpose (or for producing exempt income) having regard to reasonable wear and tear and assuming that the asset will be maintained in reasonably good order. If the entity concludes that it would be likely to scrap or abandon the asset before the end of this period, the effective life of the asset is deemed to end at such earlier time (s 40-105(2)). An entity may recalculate the effective life of an asset where its original estimate is no longer accurate (s 40-110). Special statutory rules exist to calculate the effective lives of certain assets. The following table specifies the deemed effective lives of certain intangible depreciating assets (s 40-95(7)). The Government is proposing to allow taxpayers to self-assess the effective lives of intangible depreciating assets that they start to hold on or after 1 July 2016 (see Treasury Laws Amendment (2017 Enterprise Incentives No 1)Bill 2017). Intangible depreciating asset Standard patent

20years

Innovation patent

8years

Petty patent

6years

Registered design Copyright (except copyright in a film)

15years The shorter of:(a) 25years from when the taxpayer acquires copyright; or (b)the period until the copyright ends The term of the licence

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A licence (except one relating to copyright or in-house software)

•

Effective life

A licence relating to a copyright (except copyright in a film)

The shorter of:(a) 25years from when the taxpayer becomes licensee; or (b)the period until the licence ends

In-house software

5years (for assets first used on or after 1 July 2015)or 4years (in other cases)

Datacasting transmitter licence

15years

Telecommunications site access right

The term of the right

Asset’s cost. The cost of a depreciating asset is determined in accordance with Subdiv40-C. There are two elements that make up the cost of an asset (s 40-175). In general: – the first element (usually calculated at the time when an entity begins to hold the asset) is the amount that the entity is taken to have paid under s 40-185 to hold the asset (eg cash paid to acquire the asset), and – the second element (calculated after the entity begins to hold the asset) is the amount the entity is taken to have paid under s 40-185 for each economic benefit that has contributed to bringing the asset to its present condition and location from time to time since it commenced to hold the asset (eg cash paid to transport or modify an asset).

¶16.2

Barkoczy, S. (2018). Foundations of taxation law 2019 ebook. Retrieved from http://ebookcentral.proquest.com Created from csuau on 2020-05-20 21:24:07.

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In specified cases, the first and second elements of the cost of a depreciating asset are determined in accordance with market value and other special rules (s 40-180, s 40-190). Certain amounts are excluded from the cost of a depreciating asset. Most importantly, the cost of a depreciating asset is reduced to the extent of any ITCs available to the entity (s 27-80). The cost of an asset is also generally reduced by any portion of its elements that are deductible under a provision outside Div 40 (s 40215). Furthermore, special adjustments, such as the ‘car limit’ (see below), may reduce the cost of an asset (s 40-230). •

Base value. Base value is an asset’s cost (for the start year) or its opening adjustable value for the year and any element included in the second element of its cost for the year (for any later income year). The ‘opening adjustable value’ of an asset for an income year is its ‘adjustable value’ at the end of the previous year. The ‘adjustable value’ of a depreciating asset at a particular point of time is essentially the cost of the asset less any decline in value of the asset up until that time (s 40-85). The opening adjustable value of an asset is reduced by the entity’s relevant ITC entitlements (s 2780(3A), (4)).

•

Days held. Days held means the number of days in the income year that the entity held the asset (ignoring any days that it did not use it or have it installed ready for use).

Example: Choco Co is a chocolate manufacturer registered for GST. On 30 September 2018, Choco Co installed a new machine in its factory. It purchased the machine for $110,000 (inclusive of GST) and uses it exclusively to manufacture a new variety of chocolate. When it acquired the machine, Choco Co estimated that it would have an effective life of 10years. For depreciation purposes, the cost of the machine is deemed to be $100,000 (as Choco Co is entitled to an ITC of $10,000 in relation to the acquisition). Depending on which method of depreciation is chosen, the deduction for the decline in value of the machine over the next few years is calculated as follows:

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Year 2018/19 2019/20 2020/21 2021/22

Diminishing value method $100,000 ×

365 − 92 200% × = $14,959 365 10

($100,000 − $14,959) ×

365 200% × = $17,008 365 10

($100,000 − $14,959 − $17,008 ) ×

365 200% × = $13,607 365 10

($ 100, 00 − $ 14, 959 − $17 , 008 − $13 , 607 ) ×

365 200 % × = $10, 885 365 10

Prime cost method $100,000 ×

365 − 92 100% × = $7,479 365 10

$100,000 ×

365 100 % × = $10,000 365 10

$100,000 ×

365 100 % × = $10,000 365 10

$100,000 ×

365 100 % × = $10,000 365 10

Assuming the machine continues to be used exclusively for income-producing purposes, Choco Co can continue to deduct the decline in value of the machine over the subsequent years until its cost is totally written off.

Foundations of Taxation Law

Barkoczy, S. (2018). Foundations of taxation law 2019 ebook. Retrieved from http://ebookcentral.proquest.com Created from csuau on 2020-05-20 21:24:07.

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Immediate deduction forassets that cost upto $300 Where the cost of an asset does not exceed $300 and the asset is used predominantly for the purpose of producing assessable income that is not income from carrying on a business, the decline in value of the asset is deemed to be the asset’s cost (s 40-80(2)). This rule is designed to simplify the capital allowance regime by allowing assets costing up to $300 to be completely written off in the income year in which they start to be held. The rule does not apply to an asset that is part of a set of assets that the taxpayer starts to hold in the income year where the total cost of the set of assets exceeds $300. Furthermore, it does not apply where the total cost of the asset and any other identical asset that the taxpayer starts to hold in the income year exceeds $300. Example: Jerry is an employee that purchased a printer for work-related purposes for $290 (excluding GST). Even though the printer may have an effective life of three years, Jerry can write off its total cost in the income year in which he commenced to hold the printer. If the printer had cost $6,000 (excluding GST), Jerry would have to write off the cost of the printer under the normal capital allowance rules.

Reduction forsecond-hand assets used inresidential premises

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Section 40-27 reduces the deduction available under s 40-25 for depreciating assets acquired after 7.30 pm on 9 May 2017 by that part of the asset’s decline in value that is attributable to producing assessable income from the use of residential premises to provide residential accommodation not in the course of carrying on a business, if: •

the taxpayer did not hold the asset when it was first used or installed ready for use (other than as trading stock) by any entity

•

the asset was previously used or installed ready for use in the taxpayer’s residence, or

•

the asset was previously used or installed ready for use for a non-taxable purpose.

The reduction is designed to ensure that deductions for the decline in value of depreciating assets used to produce assessable income from residential premises are only available in respect of new assets (not second-hand assets). The reduction is aimed primarily at individuals and does not apply to specified entities, such as companies and superannuation funds that are not self-managed (s 40-27(3)). Example: Liz owns a residential apartment and furniture that she leases to tenants. She acquired the apartment and furniture on 1 July 2018 from the previous owner, who had also leased the apartment and furniture to tenants. As the furniture is second-hand, by virtue of the operation of s 40-27, Liz cannot claim any deductions for its decline in value under s 40-25. If Liz had instead acquired new furniture from a retailer, s 40-27 would not apply, and she would be able to claim deductions for the decline in value of the furniture leased to tenants.

¶16.2

Barkoczy, S. (2018). Foundations of taxation law 2019 ebook. Retrieved from http://ebookcentral.proquest.com Created from csuau on 2020-05-20 21:24:07.

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461

Car limit A special rule limits the write-off available for the cost of purchasing expensive luxury cars. According to this rule, the first element of the cost of a car is reduced to the amount of the indexed ‘car limit’ for the financial year in which it is first held by the taxpayer if its cost exceeds that limit (s 40-230). The car limit is $57,581 for 2018/19. Example: In August 2018, Herb purchased a luxury German car for $100,000 (exclusive of GST) for use in his business. As the cost of the car exceeds the car limit, its decline in value for the current and future years is based on the car costing only $57,581 (exclusive of GST).

The car limit does not apply to cars used for transporting disabled people in wheelchairs for profit (eg modified taxis) or to cars whose cost exceeds the car limit only because of modifications made to enable it to be used by a disabled person for a taxable purpose (eg carrying on a business).

Balancing adjustments Subdivision 40-D contains special ‘balancing adjustment’ rules that apply where a taxpayer disposes of a depreciating asset. The aim of these rules is to reconcile (ie ‘balance’) the deductions that have been claimed for the decline in value of an asset with any consideration received on the disposal of the asset. The rules may result in the taxpayer being required to include an amount in assessable income (where the taxpayer has ‘over-depreciated’ the asset) or ...