Law

Depreciating Assets & Buildings (Capital Allowances) – Div 40

What is a depreciating asset?

A depreciating asset has a limited effective life that can be expected to decline in value as it is used. The effective life of an asset is shown in s 40-105. This excludes land, trading stock, and intangibles. 

Deductions:

Deductions for the decline in value of a depreciating asset are available under the uniform capital allowances system (ITAA97 Div 40). Section 40-25 gives a deduction for the decline in value of a depreciating asset that you hold and use for a taxable purpose. One of the largest expenses claimed by many businesses (after interest) is the cost of the equipment it uses, such as:

  • Buying machinery and equipment;
  • Buying intangible assets;
  • Leasing business equipment;
  • Constructing buildings; and
  • Repairing business assets.

Or you can get an immediate deduction for non-business use and cost ≤ $300 in s 40-80(2).

Assessment of an asset:

  1. Is this kind of asset, a depreciating asset in s 40-30?
  2. Is this taxpayer entitled to the deduction for depreciation in s 40-45?
  3. What is the cost of the asset in s 40-180 and s 40-190?
  4. At what rate in s 40-100 and s 40-105?
  5. By what method in s 40-70 and s 40-72, 40-75 is it depreciated?
  6. What if the asset is sold/lost for more or less than the amount recovered under the deprecation rules in s 40-285?

Who is entitled to claim the decline in value?

The entitled claimant is the holder/legal owner. Special rules for economic owners include: treatment of fixtures/improvements to land and leased items 

  • Luxury car leases – item 1, Div 242
  • Hire purchase agreements – item 6 

Typical lease arrangement the user claims a deduction for lease outgoing provided the asset is used to produce assessable income/carrying on business in s 8-1. The financier returns the full amount of each payment as income and claims depreciation deductions in relation to the asset.

Various regimes reconstruct leases as sales with vendor financing. Where the user claims interest and depreciation and doesn’t claim lease payment as a deduction. Where the financier reports interest component of each payment and doesn’t report gross lease receipts or claim depreciation. 

What if there are multiple holders and/or assets? P.251 Partnership Assets Item 7

See s 40-35, Jointly held depreciating assets and Buaford Corp example.

Working out the decline in value in s 40-65:

div 40.png

Effective life s 40-95 

The Commissioner’s determinations made each year in s 40-100, see TR 2019/5 for current determinations and Industry categories and asset types.

  • Self-assessing in s 40-105 
  • Recalculation in s 40-110 and By choice: sub-s(1) and Mandatory: sub-s(2)

Cost basis for Division 40

The first element of cost, see s 40-180 and s 40-185.

  • In most circumstances, simply the amount you paid to acquire/hold the asset [table item 1 at s 40-185] 

– Second element: see s 40-190 

  • Incurred after you start to hold 
  • Can pick up installation costs and improvements as well as costs in relation to the disposal 

– No double deductions: s 40-215 

– “Luxury” car limit: s 40-230 

  • $57,581 for 2019/20 year 
  • Why this limit?

Balancing Adjustments

What is a balancing adjustment event? See s 40-295 

  • Usually stop holding (ie a disposal) 
  • Also picks up when you stop using it and expect never to use it again 

Compare the “termination value” to the “adjustable value” just before the event 

  • Income if termination value > adjustable value: s 40-285(1) 
  • Deduction if termination value < adjustable value: s 40-285(2) 

– Meaning of termination value: ss 40-300 & 40-305 

– Anti-overlap of CGT: s 118-24 disregard gain or loss

Prime Cost Method

-Assume an asset with an effective life of 10 years and cost of $100,000 

-Assume it is held/used for the whole of each year for a taxable purpose

-Assume it is sold on the first day of the year for $58,000

div 40 question.png

Depreciation of intangibles – special rules

Only some intangibles can be depreciated, see definition of depreciating asset and “intellectual property” in s 995-1. A depreciated asset on a straight-line basis over an effective life. Only prime cost (straight-line) method can be used see s 40-72(2).

Grant of license over intellectual property treated as part disposal. Treat as if split assets into 2 assets, see s 40-115. Allocate cost on a reasonable basis to the 2 new assets, see s 40-205. Dispose of asset being rights granted or assigned under the license, see s 40-115(3).

Capital allowances for buildings: Div 43

In Div 43, expenses on buildings and improvements to buildings (capital works) built after 1979 used to produce assessable income, would apply to buildings that are not plant. A deduction is given to the current owner of the building (so it passes as the building is sold) who uses it to produce assessable income, in s 43-10 and s 43-15.

If not owner/builder, then can determine construction expenditure using the original builder’s documentation or quantity surveyor. The deduction is (usually) 2.5% of construction expenditure and 4% for other buildings (such as Industrial buildings and hotels). Construction expenditure is defined in s 43-70. 

Div 43 deductions reduce the cost base in the improved land, see in s 110-45. If the building is sold, there is no balancing adjustment – the new owner just takes over where the previous owner left off. If building is destroyed or demolished, the balance of construction expenditure is available as a deduction, in s 43-40.

Repairs and Improvements

Expenses incurred on “repairs” are deductible if the asset is used to produce assessable income, see in s 25-10. Meaning of repair can be difficult. Need to distinguish a repair from (the replacement of an asset – eg, is fixing the ceiling a repair of the building or replacement of the ceiling? Restoration w/o improvement? The improvement of an asset – using a better subsidiary part?)

Notice also the concept of an “initial repair” – that is, a repair done to an asset which was dilapidated when purchased. This is not deductible but viewed as part of the “cost” of acquiring the asset. See W Thomas case.

Cases

  • Philip and Morris 
  • Southern Motors case (lease equipment)
  • Wangaratta Woollen Mills case
  • Western Suburbs Cinemas 

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