Topic 13 Captial Allowances PDF

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Topic 13: Capital allowances Content _1386070_1

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Learning Outcomes At the end of this topic, you should be able to: understand the tax treatment of capital expenditure explain the terms depreciating asset, effective life, decline in value, cost and balancing adjustment understand the treatment of low value and software development pools

Readings Text Read the following sections of Sadiq: Chapter 14 Introduction   

Depreciation deductions Scan the following sections of Sadiq: Chapter 14 Black hole expenses

Recommended 

Jorgensen, R. Uniform capital allowances.

This reading is important in order to group the relationship between the UCA system (Uniform Capital Allowances) with other regimes such as the STS system. Available via ereserve http://primo.unilinc.edu.au/primo_library/libweb/action/dlSearch.do? institution=CSU&vid=CSU&onCampus=false&group=GUEST&search_scope=CSU&query=lsr04,contains,LAW301 Legislation ITAA 1997 or ITAA 1936 Part 2-10. Divisions 40 to 43

Intro Video and Mind Map An overview video is provided here. Click below for the mind maps related to this topic. Capital Allowances

Capital Allowances First, note how long-term (capital) outgoings to earn income are treated under ITAA.

1. ITAA 1997 section 8-1 denies a deduction for capital expenses. A deduction would allow a claim for the whole amount of the outgoing to be deducted from assessable income in the year in which it is incurred. No such deduction is permitted. 2. Capital losses under Part IIIA ITAA 1936 can be set off only against capital gains, not against other assessable income.

System overview Uniform capital allowance system The uniform capital allowance system (Division 40) commenced on 1 July 2001 and broadly collapsed at least 27 capital allowance regimes into a single system that generates deductions based on the effective life of assets. 

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A taxpayer who incurs the loss in value of a depreciating asset is entitled to deduct the cost of the asset (this is not restricted to the legal owner of the asset). Taxpayers can choose to use the Commissioner’s effective life schedule or self-assess the effective life of their assets. Some black hole expenditure including the costs of establishing an entity and all forms of capital raising expenses can be written-off over a 5-year period.

Certain types of depreciating assets are excluded from the system, including assets:   

used in Research and Development activities; capital works under Division 43 of the ITAA 1997 (buildings and structural improvements); cars where deductions are substantiated using the cents per kilometre method or the 12% of original value method to calculate their car expenses (these methods already take into account the decline in value (or depreciation) of the car - therefore, no separate deduction for decline in value is necessary).

Précis and key terms The following commentary is based on Paragraph 1.5 of the Explanatory Memorandum accompanying The New Business Tax System (Capital Allowances) Act 2001 which summarises the operation of the system: What Division 40 does

Division 40 provides a set of general rules (in Subdivision 40-B) to calculate the deduction to taxpayers for the notional decline in value of most depreciating assets they hold. It also provides pooling mechanisms, under which some expenditures are pooled and taxpayers are given deductions for the decline in value of the pool. Further, it allows immediate deductions for certain other capital expenditure. What is a depreciating asset? A depreciating asset is an asset with a limited effective life that loses value over that life because it is effectively used up (section 40-30). This definition captures the meaning of plant (such as machinery). Land, trading stock and most intangible assets are not depreciating assets. Who is the holder of a depreciating asset? This does not limit depreciating assets to things that lose value steadily over their effective lives. Nor are depreciating assets limited to things that only ever decline in value. Depreciating assets may hold their value for a time, or even increase it for a time. The test of a depreciating asset requires only that the asset lose its value overall (or down to no more than scrap value) by the end of its effective life. A holder of a depreciating asset is its economic owner (section 40-40). The economic owners are the entities that are able to access the asset’s economic benefits while stopping other entities from doing the same. Generally, this will be its legal owners. In specific circumstances, entities other than legal owners may hold an asset. For example, the economic owner of a depreciating asset may lack legal title to that asset because it is subject to a legal mortgage or a hire-purchase agreement. When does the decline in value start? Usually, once you first use the depreciating asset or install it ready for use for any purpose (section 40-60). The deduction for the decline will be adjusted if the asset is not used for a taxable purpose (e.g. if the asset is for private use). How is the decline in value calculated? You choose between one of 2 formulas: the prime cost method and the diminishing value method for all depreciating assets except intangibles. Particular intangibles must use the prime cost method. Both methods rely on the effective life of the asset, and generate a decline writing the asset off regardless of changes to the actual market value of the asset. Both produce an adjustable value, that is, the amount remaining after the decline. What is the asset’s effective life?

It is the period that the asset can be used for income producing purposes, assuming it will be subject to wear and tear at a reasonable rate and that it will be maintained in reasonably good order and condition. You choose between your reasonable assessment of the effective life and any applicable safe harbour determination of effective life by the Commissioner of Taxation. Low value items Pursuant to section 40-80, an immediate deduction for depreciating assets costing $300 or less is available to taxpayers broadly who: 1. use the asset predominantly for the purpose of producing assessable income that is not from carrying on a business; and 2. do not acquire the asset as part of a set of assets costing more than $300; and 3. do not acquire the asset with one or more assets that are either identical or substantially identical where the total cost of these acquisitions is more than $300. The second criterion ensures that taxpayers cannot disaggregate a set of assets by buying individual items from the set (each costing $300 or less) rather than buying the set itself (which costs more than $300 and claiming the immediate deduction. In addition, the third criterion ensures that taxpayers cannot claim an immediate deduction for identical (or substantially identical) assets acquired in an income year where the individual item costs $300 or less but collectively they cost more than $300. Where an asset costing less than < $1,000 is used in carrying on a business, it may be depreciated as part of a low cost asset pool. If a pool is used, it must be used for all low value assets. Taxpayers can also choose to add to the pool any assets that have declined in value to less than...