Week 9 Capital Deduction Provisions

8/19/2019 Week 9 Capital Deduction Provisions

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Capital Deduction ProvisioCapital Allowances And Capital Works Allowances


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Relationship Between Capital DeductProvisions And Repair Deductions

•

Conceptual classification of provisions:• Provisions Confirming The Operation Of s8-1

• Repairs s25-10

• Provisions Extending The Operation Of s8-1

• Div 40 Uniform Capital Allowances

• Div 43 Capital Works Allowances

• Rationale for a Repair deduction

• Wear and tear during income producing use a cost of obtaining the income – lobackwards perspective – deduction this year for wear and tear arising from pas

• Rationale for Capital Allowance deductions

• Current outlay on a capital item – no immediate diminution in wealth – lastingcapital item will be subject to wear and tear in producing future income – henceach year as the capital item declines in value – decline in value a cost of the fu


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Main Capital Allowance Regimes

•

Uniform Capital Allowances – ITAA 1997 Division 40• Deduction each year of part of the cost of the asset over the useful life o

• Like depreciation in accounting but different terminology and some diffemethods

• Division 43 Capital Works Allowances• Fixed rate of deduction for construction expenditure eg on buildings

• Deduction is of part of the original construction expenditure not what a paid for the building component

• Generally rate is 2.5% per year from 1992 onwards

• Where possible taxpayer will usually prefer Div 40 deductions ovdeductions


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Uniform Capital Allowance Regim

•

Basic capital allowance provision s40-25(1):• “You can deduct an amount equal to the decline in value for an in

… of a depreciating asset that you held for any time during the yea• s40-25(2): Deduction reduced where asset’s decline in value attrib

use for a purpose other than a taxable purpose.

• Scope of regime•

Does not apply depreciating assets where:• Used in R&D activities

• Associated with investments in Oz films

• Associate with certain International Telecommunications Submarine Cable (IRUs)

• Cars – where certain substantiation methods have been used

• Capital works under Div 43


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The Div 40 Div 43 Boundary

•

The boundary between Div 40 and Div 43• s40-45(2) Div 40 does not apply to Div 43 capital works

• s43-70(2)(d) capital works allowances not available under Div 43 foexpenditure on ‘plant’

• Hence – if building is ‘plant’ deduction is under Div 40 otherwise dunder Div 43

• Therefore, in the case of buildings, Div 40 allowance only available whis plant – even though doesn’t have to be ‘plant’ to be a depreciating


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The Div 40 Div 43 Boundary

Div 43

Buildings &

Structures

Div 40

Depreciating

Assets

Buildings that are ‘plant’


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Meaning Of ‘Plant’

•

Defined in s45-40 as including, among other things, ‘articlesmachinery, tools and rolling stock’

• Yarmouth v France, per Lindley LJ:“ in its ordinary sense includes whatever apparatus is used by a b

for carrying on his business – not his stock in trade which he bufor sale; but all goods and chattels, fixed or moveable, live or deakeeps for permanent employment in his business.”

• Buildings and structures: to be ‘plant’, need to play an afunction in business rather than being merely a ‘convensetting’:

• Wangaretta Woollen Mills

• Imperial Chemical Industries


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When buildings can be ‘plant’

•

Buildings and structures:• Wangaretta Woollen Mills (plant)

• More than a convenient setting

• In nature of a tool – plays a functional role

• Useless to anyone except a dyer

• http://www.abc.net.au/landline/content/2013/s3892527.htm

• Imperial Chemical Industries (not plant)• Ceilings there for the sake of the building not the building for the ce

• Sound absorbing qualities – no more useful to this taxpayer than to merely a comfortable setting

http://www.abc.net.au/landline/content/2013/s3892527.htmhttp://www.abc.net.au/landline/content/2013/s3892527.htm


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Meaning of ‘Plant’

•

Articles that are not fixtures = ‘plant’ even if do not playfunctional role in business – • Quarries Ltd

• Current law articles not fixtures don’t need to be plant to getdeductions

• Once articles become fixtures = only ‘plant’ if they play a

functional role in business• Imperial Chemical Industries

• Machinery that is affixed is still machinery and does neeplay a functional role to be ‘plant’

• Carpentaria Transport


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Key Concepts In Basic Capital AllowaProvision

•

Basic capital allowance provision s40-25(1):• “You can deduct an amount equal to the decline in value for an in

… of a depreciating asset that you held for any time during the ye

• s40-25(2): Deduction reduced where asset’s decline in value attribuse for a purpose other than a taxable purpose.

• Key concepts• Depreciating Asset

• Hold a depreciating asset

• Decline in value

• Taxable purpose


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Meaning of ‘Depreciating Asset’

•

Depreciating Asset• s40-30 “an asset that has a limited effective life and can reasonab

expected to decline in value over time”

• Exceptions

• Land

• Trading stock

•

Most intangible assets• Exceptions include: intellectual property; in-house software

• Note: purchased goodwill = not a depreciating asset


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Hold A Depreciating Asset

•

Can only claim deduction under Div 40 if you hold a depreciasset

• Concept of ‘economic ownership’ • Ability to access economic benefits of asset while preventing othe

doing so

• Will not always coincide with legal ownership

• ‘Competing owners’ (e.g. legal owner and economic owner)• Table in s40-40 to choose between competing owners

• Where still more than one – eg joint ownership treat individual interedepreciating asset


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Decline In Value

• s40-25: You can deduct an amount equal to the decline in v

• Calculate from time you first used asset or had it installed reuse (for any purpose)

• Two methods for calculating decline in value:• Prime cost

• Diminishing value

• Assets not used in business costing < $300: decline in value cost. - s40-80(2) – note ‘set’ rule – important when purchasseveral assets and once eg hotel purchase

• Low-value pools


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Choice Of Methods

•

Prime cost or diminishing value?• In most cases, taxpayer can choose: s40-65(1)

• Must make choice by time of lodging tax return that includecalculation: s40-130(1)(a).

• Once choice made for an asset, cannot be changed: s40-130

• Acquire from associate: must use same method: s40-65(2)

• Acquire from former holder: must use same method: s40-65

• Cannot use diminishing value for in-house software, intellecproperty, spectrum licence, datacasting transmission licence


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The Prime Cost Method

•

Formula s40-75(1)

• Asset’s cost x Days held/365 x 100%/ Effective Life

• Note – does not have to be held for a ‘taxable purpose’- but dedureduced where not for taxable purpose

• Generally – cost less decline in value to date = ‘opening adjustable

• Decline in value cannot exceed ‘opening adjustable value’ plus add2nd element of cost


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The Diminishing Value Method

•

Formula s40-70 – Pre 9 May 2006 assets• Formula s40-72 – Post 9 May 2006 assets

• Base value x Days held/365 x 200%/Effective life

• Note – for pre 9 May 2006 assets multiply by 150% not 200%

• Note – does not have to be held for a taxable purpose but deduction reducheld for a taxable purpose

•

Base value = Cost in Y1• Base value = Opening adjustable value + additions to 2nd element of cost in

years


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Prime cost v. Diminishing value

Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8

Primecost $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,5

DV $5,000 $3,750 $2,813 $2,109 $1,582 $1,187 $890 $667

(Based on UTL Examples 10.1 and 10.2, and Activity 10.3)

Assume purchase after 1 May 2006.

Asset’s Cost: $20,000

Held: 365 days (purchased on 1 July)

Effective life: 8 years

Copyright School of Taxation & Business Law UNSW and KathrinBain


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0

1,000

2,000

3,000

4,000

5,000

6,000

1 2 3 4 5 6 7 8 9 10 11 12

Prime cost

Diminishing

value



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0

5,000

10,000

15,000

20,000

25,000

1 2 3 4 5 6 7 8 9 10 11 12

Base value

Opening

adjustable valu



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Key Concepts In Calculating Decline In

• Cost

• Adjustable value

• Opening adjustable value

• Base value (used only in Diminishing Value method)

• Effective Life


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Meaning of ‘Cost’

• Specific rules for certain situations s40-180 eg non-arm’s length transact

value substitution• GST input tax credits and decreasing adjustments excluded

• Where specific rules do not apply

• First element of cost s40-185• s40-185(1) first element of cost = usually what you pay for the depreciating ass

• Whether cost is specific to the depreciating asset• Broken Hill Proprietary Company Ltd (1969) 120 CLR 240

• Mt Isa Mines Ltd (1992) 176 CLR 141

• BP Refinery (Kwinana) Ltd (1960) 12 ATD 204

• Second element of cost• s40-190 amounts paid for economic benefits that have contributed to b

asset to its present condition and location


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Meaning Of ‘Cost’

• Special rules re Cost• s40-195 apportionment rule – eg where buy depreciating asset an

something else with one expenditure

• s40-215 cost reduced by any part deducted under another part ofor 97 – see also s40-220

• Car discount provisions s40-225 & car limit provisions s40-230


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Meaning of ‘Adjustable Value’ ‘OpenAdjustable Value’ and ‘Base Value

• Meaning Of ‘Base Value’ ‘Adjustable Value’ And ‘Opening AdValue’

• Adjustable value at beginning of Y1 = cost

• Adjustable value during Y1 = cost less decline in value to date

• Adjustable value subsequent years = opening adjustable value lesvalue for that year

•Opening adjustable value = adjustable value at end of previous inc

• Base value = opening adjustable value + inclusions in 2nd element that year


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Meaning of ‘Effective Life’

• s40-95: Choose either:• Effective life determined by Commissioner s40-100

• Effective life determined by you s40-105

• Certain assets have capped lives: s40-102

• Assumptions in determining effective life:• Asset subject to wear and tear at reasonable rate

• Asset maintained in reasonably good order and condition• Have regard to period in which likely to be scrapped etc (ie takes i

technical obsolescence)

• Effective life can be recalculated due to changed circumstan110


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Meaning of ‘Taxable Purpose’

• Meaning Of ‘Taxable Purpose’• s40 –25(7) core meaning

• Purpose of producing assessable income – s995-1 links across to s8-1 term

Other taxable purposes

• Purpose of exploration or prospecting;

• Purpose of mining site rehabilitation;

• Environmental protection activities

• Used or held in reserve ready for use

• AAT cases on previous provisions- had to be held in reserve for use in an exbusiness

• Capital allowance reduced under s40-25(2) where partially for a pother than a taxable purpose


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Balancing Adjustments – Or What HapWhen You Dispose Of A Div 40 Ass

• Rationale for balancing adjustments• Capital Allowances only estimates

• Actual decline in value may be more or less

• Balancing adjustments reconcile estimated decline with actual decline wheholding depreciating asset

• Balancing adj events s40-295(1)• Stop holding the asset (including if becomes trading stock)

• Stop using it for any purpose

• Decide never to use it

s40-295(2) formation, dissolution, change in composition of partn


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Balancing Adjustments

• s40-285(1) If termination value exceeds adjustable value atbalancing adjustment event, excess included in income

• s40-285(2) If adjustable value exceeds termination value at balancing adjustment event, excess is deduction.

• IE: Balancing adjustment = Termination value - Adjustable va• Positive figure = assessable

• Negative figure = deductible

• Concept of termination value is relevant to balancing adjust


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Termination Value

• Normal situation

• s40-305 Amount you receive but be aware of variations (similar to cproceeds modification rules in CGT, eg. You terminate a liability, rececash benefit)

• s40-310 apportionment where receipt only partly relates to depreci

• Special situations – s40-300(2)

• Eg non-arm’s length = market value substitution

• Eg change in composition of partnership = market value substitution• s40-230 proportion of termination value recognised where car limit

acquisition


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Basic Balancing adjustment example

• Refer back to Prime Cost v. Diminishing value example

• Assume at the beginning of Year 5, asset is sold for $8,500

Prime cost Diminishing

Value

Depreciation claimed $10,000 $13,672

Opening adjustable value (PC)/ base value (DV)

$10,000 $6,328

Termination value $8,500 $8,500

Balancing adjustment $1,500

deductible

$2,172

assessable

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain


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Balancing Adjustments

• Where use only partly for taxable purpose• Deductions reduced s40-25(2)

• Balancing adjustment reduced s40-290(2)• Example

• s104-240 possible capital gain under CGT event K7

• Example


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Black Hole Expenditure

• s40-880: Business related costs deductible over 5 years

• Temporal connection: Business can be one you currently carused to carry on, propose to carry on.

• Business needs to have a taxable purpose

• ‘Provision of last resort’: •

Does not apply if expenditure deductible under any other provisioexpenditure that forms part of cost of depreciating asset)

• Does apply if there a provision denies deduction


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Capital works – Division 43

• Provides deductions for ‘construction expenditure’ on buildother ‘capital works’ that are used to produce assessable inc

• Not deductible under s8-1 (capital)

• Not deductible under Div 40 (s 40-45(2))

• See TR 97/25


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Capital works deductions

• s43-10 – deductions for capital works

(1) You can deduct an Amount for Capital Works for an incom

(2) You can only deduct the amount if:

(a) The Capital Works have a Construction Expenditure Area;

(b) There is a Pool of Construction Expenditure for the Area; a

(c) You Use Your Area in the Income Year in the Way Set Out 43-140


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Capital works – Key terms

• Capital works: s43-20• Buildings begun post 21/08/79 (in Australia) or 21/08/90 (outside

• Structural improvements / extensions / alterations etc begun post

• Examples of Structural Improvements are set out in s 43-20(3) (e.groads, sealed driveways, sealed car parks, bridges, retaining walls,

• Commencement of construction occurs when the first step in the

construction phase starts (e.g. pouring of foundations for a buildin


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Capital works – key terms

• Construction expenditure: s43-70• Capital expenditure incurred in respect of construction of capital w

• Exclusions: e.g. Land, demolishing existing structures

• Construction expenditure area: s43-75• Part of capital works that was to be owned, leased or held under a

ownership right by the entity that incurred the expenditure

• Each time construction capital works are completed, a separate coexpenditure area is created.


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• Pool of construction expenditure: s43-85• so much of the construction expenditure incurred by an entity on

works as is attributable to the construction expenditure area

• Your area: s43-115/s43-120• the part of the Construction Expenditure Area that you Own (or if

conditions are met, lease)

•NB: the taxpayer/entity need not have incurred the construction e


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• Using your area in a deductible way:• Refer s43-140

• In broad terms – are you using your Construction Expenditufor the purpose of producing assessable income

• However, be aware that the table is divided up into differenperiods and different types of capital works


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Calculating the deduction

• Your CE x Days Used x Applicable Rate / 365

• Rates:• Rate for post 26/02/1992 commencement: 2.5%

• 4% rate available for hotels, motels, guest houses, industrial activis43-145

• No deduction until construction is completed: s43-30

• Deduction cannot exceed amount of undeducted constructiexpenditure: s43-15


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Capital works – consequences of disposal

• No balancing adjustments on sale

• Purchaser takes over deductions for undeductedcapital works expenditure

• Balancing adjustment if capital works lost ordestroyed: s43-40


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Documents

Week 9 Capital Deduction Provisions