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Queensland University of Technology QUT Business School School of Accountancy AYB 219 Taxation Law Lecture 6 Semester 1, 2020

ALLOWABLE DEDUCTIONS SPECIFIC PROVISIONS 1.0

GENERAL AND SPECIFIC DEDUCTIONS 1.1

2.0

Relationship between General and Specific Deductions

DIVISION 40: DEPRECIATING ASSETS 2.1 2.2 2.3 2.4 2.5 2.6 2.7

2.8 2.9

Who is the Holder of a Depreciating Asset? What is a Depreciating Asset? Determining the Cost of a Depreciating Asset Determining the Effective Life of a Depreciating Asset Calculating the Decline in the Value of Depreciating Assets Intangible Assets that have a Statutory Life Special Rules Relating to Different Types of Taxpayers 2.7.1 Individual Taxpayers 2.7.2 Small Business Entities (SBE's) 2.7.3 Large Business Taxpayers Computer Software Disposals of Depreciated Assets

3.0

DIVISION 43: DEDUTION FOR CAPITAL WORKS EXPENDITURE

4.0

DIVISION 36: PRIOR-YEAR TAX LOSSES

5.0

DIVISION 35: NON-COMMERCIAL LOSS PROVISIONS

6.0

SUMMARY AND CONCLUSIONS

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Objectives of Lecture 6: At the end of this lecture, you should be able to: 

determine the deductibility of specific items of expenditure pursuant to the ITAA (1997), namely: -

Depreciating Assets; Capital Works Allowance; Prior-Year Tax Losses; and Non-Commercial Loss Provisions.

Lecture 6 Reading: 1.

2020 CCH Australian Master Tax Guide: Chapter 16 "Business and Employment Deductions", paragraphs 16-020, 16-880 to 16-895.

2.

2020 CCH Australian Master Tax Guide: Chapter 17 "Depreciating Assets", paragraphs 17-000 to 17-040, 17-080 to 17-200, 17-270 to 17-640, 17-810.

3.

2020 CCH Australian Master Tax Guide: Chapter 7 "Small Business Concessions", paragraph 7-250.

4.

2020 CCH Australian Master Tax Guide: Chapter 20 "R&D, Films, Capital Works and NRAS”, paragraphs 20-470 to 20-530.

5.

Taxation Ruling TR 2019/5: Effective Life of Depreciating Assets – 281 pages (available on the AYB 219 Blackboard site).

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1.0

GENERAL AND SPECIFIC DEDUCTIONS

1.1

Relationship between General and Specific Deductions As we saw in Lecture 5, deductions are governed by Division 8 of the ITAA (1997). Division 8 refers to two categories of deductions:  

Section 8-1: General Deductions; and Section 8-5: Specific Deductions.

Diagram 1 below summarises the tax equation showing the relationship between assessable income and deductions.

Diagram 1: The Tax Equation

Ordinary Income (Section 6-5) Assessable Income (Division 6)

plus Statutory Income (Section 6-10)

Taxable Income (Division 4)

=

minus General Deductions (Section 8-1) Deductions (Division 8)

Tax is paid on taxable income

plus Specific Deductions (Section 8-5)

This lecture will consider some of these deductions, including:    

Division 40: Depreciating Assets; Division 43: Capital Works Allowance; Division 36: Tax Losses; and Division 35: Non-Commercial Loss Provisions.

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2.0

DIVISION 40: DEPRECIATING ASSETS Under Section 8-1(2), a taxpayer is denied an immediate deduction for any outgoing of a capital nature. However, Division 40 allows a taxpayer a deduction for the decline in the value of a “depreciating asset” that is owned and used by a taxpayer in the course of gaining or producing assessable income. The key operative provision for depreciation is Section 40-25(1) of the ITAA (1997). It states: "You can claim an amount equal to the decline in value for an income year of a depreciating asset that you held for any time during the year.” Note the term “decline in value” means “depreciation”. In order to claim a deduction for depreciation, the taxpayer must use the asset for income-producing purposes (Section 40-25(2)).

2.1

Who is the Holder of a Depreciating Asset? A deduction for depreciation is available to the “holder” of a depreciating asset. In most cases, the legal owner is the holder of the asset. However, there are some exceptions to this rule. Section 40-40 contains a table detailing the entity that is treated as the holder of a depreciating asset.

2.2

What is a Depreciating Asset? According to Section 40-30(1), a “depreciating asset” is defined as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. This definition captures the meaning of plant (such as machinery). Virtually all non-current assets are considered depreciable assets. However, land, trading stock and most intangible assets (with some notable exceptions) are specifically excluded from the definition of a depreciating asset for tax purposes. Furthermore, buildings are not considered depreciable assets for taxation purposes under Division 40. However, a special claim for buildings can be made under Division 43 of the ITAA (1997). This section is discussed later in these lecture notes.

2.3

Determining the Cost of a Depreciating Asset The decline in value of a depreciating asset is calculated on the basis of the “cost” of the asset. According to Section 40-175, the cost of a depreciating asset comprises:  

the first element (Section 40-180) which consists of the initial purchase price; and the second element (Section 40-190) which comprises those incidental costs incurred to bring the asset to its present condition and location.

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Hence, the cost of a depreciating asset not only includes its purchase price, but also costs including customs duty, delivery costs, in-transit insurance and installation costs (see Taxation Ruling IT 2197). This is a similar concept for accounting purposes, where incidental costs are added to the cost of the asset in the Balance Sheet. 2.4

Determining the Effective Life of a Depreciating Asset (a)

Accounting

According to paragraph 50 of AASB 116 Property, Plant and Equipment, a depreciable asset must be systematically depreciated over its estimated useful life (expressed in years). The definition of useful life in paragraph 6 means the estimated period over which the future economic benefits are expected to be consumed by the entity. (b)

Taxation

For taxation purposes, the decline in value of a depreciating asset is calculated under Division 40 of the ITAA (1997) based on the asset’s effective life (expressed in years). The question is: How does one determine the effective life of an asset for taxation purposes? According to Section 40-95(1), a taxpayer has one of two choices in determining a depreciating assets effective life: (i) (ii)

self-assess and determine the effective life themselves (Section 40-105); or rely on the Commissioners determination of effective life (Section 40-100).

This choice must be made at the assets “start time” (Section 40-95(3)). This is the time that the asset is first used by the taxpayer for any purpose or is installed ready for use (Section 40-60(2)). To assist taxpayers in determining the useful (or effective) lives of depreciable assets, in January 2001, the Commissioner published his own determination of effective lives of depreciating assets. This listing is included in a taxation ruling which is updated and re-issued every year. The latest version, Taxation Ruling TR 2019/5, was issued by the Commissioner on 26 June 2019 and applies in respect of income years beginning on or after 1 July 2019. This 281-page ruling can be accessed at the ATO’s website. The effective lives of depreciating assets are incorporated in Tables A and B. Table A is an industry table which contains assets under industry headings generally derived from the Australian and New Zealand Standard Industry Classification (ANZSIC) subject categories. These include industries such as agriculture, mining, manufacturing, retail trade, accommodation and food services, arts and recreation and education and training. This table is only to be used by members of the specified industries. Taxpayers not in those industries must use Table B.

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Table B is a list of common assets (eg rental property assets, cars, computers, etc) used by a broader range of taxpayers (including salary and wage earners, landlords, small businesses, etc), whereas Table A is an industry-specific listing. If the taxpayer chooses to self-assess the effective life of a depreciating asset, they must be able to provide to the Commissioner how they have come up with their estimate of the effective life of the asset and why it differs from the Commissioner’s estimate of effective life contained in Taxation Ruling TR 2019/5. 2.5

Calculating the Decline in the Value of Depreciating Assets (a)

Accounting

According to paragraph 62 of AASB 116, there are three (3) acceptable methods of calculating depreciation. These are:   

straight-line; diminishing balance; and units-of-production method.

All methods are acceptable under AASB 116 as they progressively allocate the cost of the asset on a systematic basis to the Income Statement over the useful life of the asset.

(b)

Taxation

For taxation purposes, Section 40-65(1) permits only one of two methods in calculating the decline in the value of a depreciating asset:

(i) (ii)

the prime cost method (Section 40-75); or the diminishing value method (Section 40-70).

Table 1: Accounting and Taxation Depreciation Methods Accounting Term

Taxation Term

Straight line

Prime cost

Diminishing balance

Diminishing value

A taxpayer may choose either the prime cost or diminishing value method for each depreciating asset. However, the choice of method for a particular asset applies for that income year and all later years in which the taxpayer claims a deduction for the decline in value of that asset (Section 40-130). In other words, the taxpayer cannot change depreciation methods once a particular method is chosen.

(i)

The Prime Cost Method

The prime cost method for taxation purposes is similar to the straight-line method for ________________________________________________________________________________________________________ AYB 219 Taxation Law © Queensland University of Technology

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accounting purposes. The prime cost depreciation rate is calculated as dividing 100% by the effective life of the item.

Depreciation Expense $

No. of Years

Where a depreciating asset is acquired during the income year, the amount of depreciation is calculated on a pro-rata basis from the date of acquisition to 30 June on a daily basis. The prime cost formula under Section 40-75 is shown as follows: Asset’s cost

x

Days held 365

x

100% Effective Life

Example 1: A taxpayer purchases a photocopying machine costing $5,000 on 1 January 2019. According to TR 2019/5, the effective life of a photocopying machine is five (5) years. There are 181 days from 1 January 2019 to 30 June 2019. Calculate the decline in value of the photocopying machine for the years ended 30 June 2019 and 30 June 2020 under the prime cost depreciation method. Answer: 2019: $5,000

x

181 days 365 days

x

100% 5 years

=

$496 (rounded)

$5,000

x

365 days 365 days

x

100% 5 years

=

$1,000 (rounded)

2020:

(ii)

The Diminishing Value Method

The diminishing value method for taxation purposes equates to the diminishing balance method for accounting purposes. The diminishing value method involves applying a percentage rate initially to the original cost of the item, but subsequently to ________________________________________________________________________________________________________ AYB 219 Taxation Law © Queensland University of Technology

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the base value (ie. written down value) at the commencement of each year thereafter.

Depreciation Expense $

No. of Years

The diminishing value depreciation rate is calculated as dividing 200% by the effective life of the item. Where a depreciating asset is acquired during the income year, the amount of depreciation is calculated on a pro-rata basis from the date of acquisition to 30 June on a daily basis. The diminishing value formula under Sections 40-70 and 4072 is shown as follows: Base Value of Asset (WDV)

x

Days held 365

x 200% Effective Life

Example 2: Assume the same facts Example 1.Calculate the decline in value of the photocopying machine for the years ended 30 June 2019 and 30 June 2020 under the diminishing value depreciation method. Answer: 2019: $5,000

x

181 days 365 days

x

200% 5 years

=

$992 (rounded)

2020: Base Value (or WDV) = ($5,000 - $992) = $4,008 $4,008

x

365 days 365 days

x

200% 5 years

=

$1,603 (rounded)

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2.6

Intangible Assets that have a Statutory Life There are certain intangible assets that have been determined to have specific statutory lives for income tax purposes. These intangible assets are listed in a table contained in Section 40-95(7) of the ITAA (1997). The list of depreciable intangible assets are shown below in Table 2 below. Each of these assets other than items (6) and (7) must be depreciated using the prime cost depreciation method. These statutory effective lives override any other assessments of effective lives determined by the Commissioner of Taxation in various taxation rulings and/or by the taxpayer themselves through their own self-assessment processes.

Table 2: Selected Intangible Assets that have a Statutory Life Intangible Asset

Effective Life

1.

Standard patent

20 years

2.

Innovation patent

8 years

3.

Petty patent

6 years

4.

Registered design

15 years

5.

Copyright (except copyright in a film)

6.

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

7.

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

8.

In-house software

5 years

9.

Spectrum licence

The term of the licence

The shorter of (i) 25 years; or (ii) the period until the copyright ends The term of the licence The shorter of (i) 25 years; or (ii) the period until the licence ends

10. Datacasting transmitter licence 14. Telecommunications site access right

*

2.7

15 years The term of the right

Note that a trademark (as distinct from a patent, registered design or copyright) is not considered a depreciating asset (see Section 40-30 of the ITAA (1997)).

Special Rules Relating to Different Types of Taxpayers Special rules relating to the decline in value of depreciating assets apply to various categories of taxpayers. These taxpayers are split into:   

individual taxpayers; small business entities (SBE); and large business taxpayers.

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2.7.1

Individual Taxpayers The depreciation rules for individual taxpayers are summarised as follows: (a)

according to Section 40-80(2), an immediate 100% deduction applies in respect of depreciating assets costing $300 or less used by non-business taxpayers in deriving assessable income. (b) for depreciating assets costing more than $300 but less than $1,000, there are two options available: (i)

Firstly, the assets may be allocated to a low-value pool and depreciated at the following rates:  

18.75% DV in the first year; and 37.5% DV in the second and subsequent years.

Once a low-value pool has been created, then all depreciable capital assets costing between $300 and $1,000 must be allocated to that low-value depreciation pool and the business must continue to use the low-value pool method until all value in that pool has been diminished. In other words, once an item is allocated into this low-value pool, it must remain there. If a low-value pool has been created, then any asset with an adjustable value (ie. written down value) of less than $1,000 at the beginning of the income year must also be transferred to the low-value pool. (ii) (c)

Note:

Secondly, if the taxpayer elects not to use a low-value pool, then the normal depreciation rules as contained in (c) below apply.

depreciating assets costing $1,000 or more are depreciated over their effective lives as outlined by the Commissioner in Taxation Ruling TR 2019/5 using either the prime cost or diminishing value depreciation methods. There are three (3) advantages of pooling: Firstly, there is no need to ascertain the individual effective life of each depreciating asset. Secondly, there is no need to calculate the number of ownership days as there is no need to apportion the depreciation for the number of days in the initial ownership year ie from the date of purchase to 30 June in that first year. Thirdly, only two depreciation rates need to be used. One rate for depreciating assets purchased during the year (being 18.75%), and a second rate for assets held since the end of the prior year (ie. 37.5%).

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