tax 101 depreciation - cch learning au · 1/05/2019 1 02 may 2019 tax 101 – depreciation what we...
TRANSCRIPT
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02 MAY 2019
Tax 101 – Depreciation
What we will cover
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• Capital v revenue: immediate deduction or write-off over time?
• What is depreciation?
• Effective life of an asset
• Methods of calculating depreciation
• Disposing of a depreciating asset
• Interaction between depreciation and Capital Gains Tax
• Depreciating intangible assets
• Special rules for small businesses
• Depreciating buildings and other capital works
• How are other capital costs treated?
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Capital v Revenue
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• Assets that have a longer life are called capital assets. Examples include buildings, motor vehicles, furniture, machinery and equipment.
• A capital expense is either:• the cost of an asset that has a longer life (usually more than one income year)
• an expense associated with establishing, replacing, enlarging or improving the structure of a business.
• Expenses on revenue account are those that are:• (a) incurred in gaining or producing assessable income; or
• (b) are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.
• And are NOT capital
What is depreciation?
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• The concept of depreciation is designed to match the cost of capital assets against the revenue that those assets help to generate over the period that the capital assets are in use.
• In its purest form, work out how many years a capital asset will be used to generate income in the business and write off the cost over that period.
• The depreciation rules are in many cases overwritten or exceptions provided to further the policy goals of government. For instance:
• Instant write-off for some assets held by certain businesses to boost overall economic activity
• Write-off over a shorter period than effective life for some assets by certain businesses to reduce compliance costs
• Write off for some assets that don’t depreciate, eg buildings
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General rules
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• Division 40 (Uniform Capital Allowances rules):
• To claim depreciation on an asset three conditions must be met:• The business must be the owner or quasi-owner of the asset (so assets financed under a
HP contract are included, even though the financier might have secured the loan on the asset)
• The asset must be installed and ready for use (so if the asset is purchased but not installed or the asset has been paid for but not yet delivered, a claim can’t be made)
• The asset must be used in the business.
• Where the above three requirements are satisfied, the depreciation deduction is worked out by reference to:
• the cost, and
• the effective life of each depreciating asset in a two-step process.
General rules
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• First, calculate the decline in value of the asset for the period it was used, or installed ready for use, for any purpose, including a non-taxable purpose.
• Second, reduce the depreciation of the asset by any use of the asset by the taxpayer for a non-taxable purpose. If the asset isn’t used in the business, no deduction is allowed and if it’s partially used in the business, depreciation needs to be apportioned between business and non-business use.
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Cost
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• The cost of a depreciating asset consists of two elements regardless of whether it is acquired new or second-hand. However, neither element includes the cost of structural alterations to a building to enable plant to be installed as these are subject to the rules in Div 43 (IT 2197).
• The first element of cost is the consideration paid for the acquisition of the asset.• In some specific circumstances the consideration payable is ignored and a deemed cost
amount applies, eg non-arm’s length transactions and private or domestic arrangements (eg gift of an asset).
• The second element of cost is the consideration paid subsequent to the acquisition of the asset such as:
• Delivery and installation costs
• Relocation costs
Effective life
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• The cost of an asset is written off for tax purposes over a period of several years which equates to the effective life of the asset to the business.
• Each year, the Commissioner of Taxation publishes a list of effective lives of different types of assets (the current one is TR 2018/4).
• There are two parts to the list the Commissioner produces• Table A lists assets which are specific to certain industries
• Table B lists assets which are used more generally.
• You only use Table A if you are in the particular industry listed in the context of that asset. If you are using the same asset but in a different industry, use Table B.
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Effective life
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• The effective lives of some commonly used assets (per TR 2018/4) are as follows:• Computers – 4 years
• Laptops – 2 years
• Motor vehicles – 8 years (except taxis which are 4 years)
• A taxpayer can also self-assess the effective life of an asset if the Commissioner’s estimate is believed to be incorrect or inappropriate
Decline in value methods
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• Generally, taxpayers can choose to calculate the depreciation of each depreciating asset using one of the following methods:
• prime cost (ie straight line) method, or
• diminishing value (ie reducing balance) method.
• Taxpayers indicate their choice by the way in which the income tax return for the income year in which depreciation is first eligible to be claimed is prepared. Once made the choice is irrevocable for that asset.
• The diminishing value method will allow a greater rate of deduction at the early stages of the asset’s life
• Where an asset is initially used for a non-taxable purpose the prime cost method will result in non-deductible depreciation being minimised. Also, the prime cost method may be preferable where a taxpayer is incurring tax losses.
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Prime Cost (straight line) Method
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• The prime cost (or straight line method).
• Using this method, the cost is written off equally over the assets effective life. The formula for applying the direct cost method is:
• Asset’s cost × (days held/365) × (100%/asset’s effective life)
For example, an asset purchased for $10,000 with a five year effective life, claim will be:
• $10,000 x (365/365) x (100%/5) = $2,000 depreciation each year.
Diminishing value (or reducing balance) method
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• Using this method, the base value of the asset diminishes each year as it is reduced by the amount of the previous year’s depreciation. The formula for applying the diminishing value method is:
Base value × (days held/365) × (200%/asset’s effective life)
• Applying that formula to the example above, the depreciation over five years would look like this:
•Year Opening base value Depreciation Closing base value
1 10,000 4,000 6,000
2 6,000 2,400 3,600
3 3,600 1,440 2,160
4 2,160 864 1296
5 1296 518 777
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Poll
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On 1 July 2016, a taxpayer (not a small business entity) acquired a new depreciating asset for $3,000,000. The taxpayer determines that the effective life of the asset is six years, with a residual value of $100,000. As the taxpayer wishes to maximise deductions for 2016-17, it has chosen to use the diminishing value method to calculate a deduction for decline in value of the asset?
What is the decline in value for the year ended 30 June 2017?
• $483,333
• $500,000
• $1,000,000
• $966,667
Special rules
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• Under the general depreciation rules, an immediate write-off applies to:• items costing up to $100 used to earn business income (but note the higher immediate
write-off limit for small businesses)
• items costing up to $300 used to earn income other than from a business (such as employee-provided tools and equipment).
• Special rules apply where you acquire (or develop) in-house computer software. This is written off over five years (ie, 20% per year on a prime cost basis). In-house software is expenditure on acquiring, developing or commissioning software (egsystems and application software) for use within a business. If you stop using the software within five years of acquisition, you can claim an immediate tax deduction for the unclaimed expenditure.
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Special rules
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• You can calculate the depreciation of certain low-cost and low-value assets by allocating them to a low-value pool and depreciating them at a set annual rate.
• A low-cost asset is one that costs less than $1,000 after deducting any GST credits you're entitled to claim.
• A low-value asset is an asset that has depreciated over one or more years and now has a written-down value of less than $1,000, but only if you've previously worked out deductions for it using the diminishing value method.
• You calculate the depreciation of all the assets in the low-value pool at the annual rate of 37.5%.
• If you acquire an asset and allocate it to the pool during an income year, you calculate its deduction at a rate of 18.75% (that is, half the pool rate) in that first year.
Disposing of a depreciating asset
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• When a depreciating asset is sold, lost or destroyed, a balancing adjustment may arise.
• Balancing adjustments are not made for:• depreciating assets in a low-value pool – the proceeds from the sale are instead used to
reduce the value of the pool, which in turn reduces future depreciation deductions
• buildings and other capital works, which are dealt with separately under the capital works provisions
• The balancing adjustment is calculated by comparing the asset's termination value (for example, the sale proceeds) with its adjustable value (the cost of the asset less depreciation deductions).
• If the asset’s termination value is more than its adjustable value, include the difference in assessable income.
• If the asset’s termination value is less than its adjustable value, claim a deduction for the difference.
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Small businesses (turnover < $10 million)
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• Small business entities can choose to deduct amounts for most of their depreciating assets under a special depreciation regime (“small business depreciation”).
• The simplified regime for calculating capital allowances on depreciating assets is contained in ITAA97 Subdiv 328-D. Small business entities that choose to use this regime are not subject to the provisions of ITAA97 Div 40.
Small businesses
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• Any assets (including in-house software) costing less than the small business deprecation threshold amount are written-off immediately in the year they are bought and used or installed ready for use.
• This threshold amount has varied considerably in recent years but is currently $30,000 (effective 2nd April 2019 to 30 June 2020)
• Previously $25,000 from 29th January 2019 to 2nd April 2019 and $20,000 before 29th January 2019
• Entire cost of the asset must be less than the instant asset write-off threshold, irrespective of any trade-in amount.
• In calculating the deduction, the claim is only relation to the taxable purpose proportion in producing assessable income.
• Example: an asset that is newly acquired for $8,000 is to be used 60% for business purposes, the deduction will be $4,800. If it is to be used only for business purposes, the deduction will be $8,000. While only the taxable purpose proportion is deductible, the entire cost of the asset must be less than the threshold for a claim to be made in the first place.
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Small business
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• If the cost of an asset (other than a building) is the same as or more than the instant asset write-off threshold, the asset is placed into the small business pool and is depreciated at a rate of 15% for the first year (regardless of when the asset was purchased during the year) and 30% in subsequent years.
• If the adjusted balance of the small business pool is less than the applicable instant asset write-off threshold for the year (currently $20,000) the whole pool balance must be written off.
• A “balancing adjustment event” occurs when the taxpayer disposes of a depreciating asset. If the asset is a low-value asset for which an immediate deduction was obtained, the taxable purpose proportion of the “termination value” (broadly, the disposal proceeds) is included in the taxpayer’s assessable income. If it is a pooled asset, the taxable purpose proportion of the asset’s termination value is subtracted from the pool.
Extension of the instant asset write-off to “medium” businesses
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• From 2 April 2015, medium sized businesses (those with a turnover between $10 million and $50 million) can also take advantage of the $30,000 instant asset write-off
• The other features of the small business depreciation regime do not apply and the normal Div 40 rules apply to all other aspects of depreciation for these businesses
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Depreciating intangible assets
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• Intangible assets are typically categorised as:• identifiable intangible assets (excluding intellectual property and goodwill)
• intellectual property
• goodwill.
• Broadly speaking, intangible assets cannot be depreciated. However, the depreciation of some of these assets allows for some of the cost of acquisition and use to be recouped over the life of the assets in the form of tax deductions.
• Currently, the effective life of most intangible depreciating assets is prescribed in s. 40.95(7) of the Income Tax Assessment Act 1997.
• Intangible assets with a statutory effective life can’t be self-assessed to bring their tax life in line with the economic life of the asset.
• Intangible assets such as trademarks and business goodwill cannot be depreciated
Depreciating intangible assets
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Item Asset Effective life in years
1 Standard patent 20
2 Innovative patent 8
3 Petty patent 6
4 Registered design 15
5Copyright (except copyright in a
film)
The shorter of 25 years from when
you acquire it or the period until the
copyright ends
6A licence (except one relating to a
copyright or in-house software)The term of the licence
7A licence relating to a copyright
(except copyright in a film)
The shorter of 25 years from when
you become the licensee or the
period until the licence ends
8 In-house software 5
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Poll
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A Pty Ltd (not a small business entity) acquires a depreciating asset for $60,000 on 1 October 2016 and first uses the asset on that day solely for a taxable purpose. The estimated effective life of the asset is 8 years and the company elects to use the prime cost method.
What is the decline in value for the year ended 30 June 2017?
• $7,500
• $5,625
• $5,610
• $11,250
Capital Gains Tax and Depreciating Assets
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• A capital gain or capital loss from the disposal of a depreciating asset will only arise to the extent that the asset was used for a non-taxable purpose (eg, private usage).
• Calculate a capital gain or capital loss from a depreciating asset used for a non-taxable purpose using the cost and termination value, not cost base and capital proceeds under the capital gains tax (CGT) rules.
• If a balancing adjustment event (such as sale, loss or destruction) occurs for a depreciating asset used for a non-taxable purpose, a CGT event happens.
• A capital gain happens if the termination value of the depreciating asset is greater than its cost. A capital loss happens if the asset’s cost is more than its termination value.
• Assets of small business entities: disregard any capital gain or capital loss from a depreciating asset for a small business entity
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Capital Gains Tax and Depreciating Assets
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• Bob bought a truck in August 2016 for $5,000 and sold it in June 2018 for $7,000. He used the truck 10% of the time for private purposes. The decline in value of the truck up to the date of sale was $2,000.
• The sum of his reductions relating to his private use is $200 (10% of $2,000). Bob calculates his capital gain from CGT event K7 as follows:
• ($7,000 − $5,000) × (200 ÷ 2,000)
• = $2,000 × 0.1
• = $200
• Capital gain from CGT event K7 = $200 (before applying any discount).
Depreciation of buildings and other capital works
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• Division 43 ITAA 1997
• The cost of many buildings used to earn income can be written off for tax purposes over time but the rules are different to the normal depreciation rules set out earlier.
• A tax deduction is available under Division 43 for the following capital expenditure:• buildings or extensions, alterations or improvements to a building
• structural improvements such as sealed driveways, fences and retaining walls
• earthworks for environmental protection, such as embankments
• As well as the frame of the building itself (walls, ceiling, roof, etc), the sort of things which can be included in a claim could include items as diverse as bathroom equipment, doors, windows, tiling and cupboards.
• The cost of the land is excluded.
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Depreciation of buildings and other capital works
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• Note: The distinction between items which qualify for normal depreciation and those which qualify for capital works deductions can be quite fine. For instance, air conditioning units can be depreciated as per the normal rules but the ducting for the air conditioning will qualify under the capital works rules instead.
• Different rates apply depending on when the building was constructed and what the building is used for.
• Where construction commenced after 27 February 1992, the following rates apply:• Short term traveller accommodation (such as hotels, hostels, etc) - 4%
• Industrial buildings (used for manufacturing, timber milling, printing, etc) – 4%
• All other income-producing buildings (such as offices, shops, warehouses and also rented residential properties) – 2.5%
• Structural improvements – 2.5%
• In practice, the 2.5% rate will be the most commonly applied.
Depreciation of buildings and other capital works
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• If you buy a second-hand building, you continue to make a claim at the same rate and based on the same cost as the original owner, until the claim period ends (40 years after construction was completed for buildings on the 2.5% rate).
• If you can’t obtain detailed construction information for the purposes of working out the cost, you can use an estimate, provided it was prepared by a suitably qualified person such as a quantity surveyor.
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Capital works deductions example
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• Clive Randle is a property developer and in 1995 he decided to diversify his activities by constructing hotels, and factory units for industrial activities. During 1995/96 the following contracts were entered into:
• Hotel
• Contract date: 1 October 1995
• Construction commenced: 1 February 1996
• Construction completed and hotel operating: 1 March 1997
• Construction cost: $1.5m
• Factory units
• Contract date: 1 May 1996
• Construction commenced: 1 July 1996
• Construction completed and factory units leased for industrial activities: 1 January 1997
• Construction cost: $1m
Advise Clive on the tax deductions available to him in relation to his hotel, apartment block and factory units for the 2018/19 year.
(adapted from Australian Practical Tax Examples, CCH Wolters Kluwer, 2017)
Capital works deductions example
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• Capital works deduction for hotel for 2016/17
• Construction of the hotel commenced on 1 February 1996. Construction was completed and the hotel started operation on 1 March 1997. The deduction rate is 4% and is available for the entire 2016/17 year.
• Calculation of the hotel capital works deduction
• $1,500,000 × 4% = $60,000
• Capital works deduction for factory units for 2016/17
• Construction of the factory units commenced on 1 July 1996. Construction was completed and all units were leased for industrial activities and in operation on 1 January 1997. The deduction rate is 4% (ITAA97 s 43-150) and is available for the entire 2016/17 year.
• Calculation of the factory units’ capital works deduction
• $1,000,000 × 4% = $40,000
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How are other capital costs treated?
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• Under s 40-880, taxpayers can deduct capital expenditure relating to a past, existing or proposed business. Such expenditure is sometimes called “blackhole expenditure” because, in the absence of a specific deduction provision, it would generally be non-deductible despite being a genuine business expense. The section only applies if the expenditure would not already be deductible (or specifically made non-deductible), capitalised or capped in some way under another provision.
• Expenditure may be deductible under s 40-880 to the extent that it is incurred for a taxable purpose, and could include pre-business expenditure on feasibility studies, market research or establishing a business structure. It could extend to expenditure to raise equity, to defend a business from takeover or to terminate a business.
How are other capital costs treated?
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• From the 2015/16 year, small business entities and taxpayers not yet carrying on a business may be able to immediately deduct certain start-up capital expenses on a proposed business.
• To qualify, the capital expenditure must relate to a proposed business. It needs to be incurred in obtaining advice or services for the proposed structure or operation of the business. Alternatively, it must be a fee, tax or charge paid to an Australian government agency relating to the set up or operating structure of the business.
• In addition, the taxpayer must be a small business entity for the income year the expense was incurred. Alternatively, for the year the expense was incurred, the taxpayer must neither: (i) carry on a business; nor (ii) be connected or affiliated with a non-small business entity that carries on a business
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How are other capital costs treated - example
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• After Jonah Salinger had been employed as a mathematics teacher in Queensland for 20 years, he decided to set up a coaching college business in Sydney. When he arrived in Sydney, he spent some time getting his personal affairs in order, and then set to work organising the coaching college business. Jonah engaged experts to advise him on what kind of college was needed, where it should be located, what staff should be hired and what regulations had to be complied with. After six months, Jonah’s expenditure on the venture amounted to nearly $60,000, but he was then forced to abandon the project when he was diagnosed with a severe illness.
• Is Jonah entitled to a tax deduction for the expenditure he incurred? If a tax deduction is not available, can the expenditure be taken into account in any other way?
How are other capital costs treated - example
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• A taxpayer who has incurred capital expenditure relating to a business may determine the tax treatment of the expenditure according to the following steps:
• Can the expenditure be included in the cost of a depreciating asset for the purposes of the capital allowance provisions in ITAA97 Div 40? The answer is no in this case as there is no relevant depreciating asset.
• Can the expenditure be included in construction expenditure for the purposes of the capital works provisions in ITAA97 Div 43? The answer is no in this case as there is no relevant construction expenditure.
• Is there any other specific deduction provision that applies? The answer is no in this case.
• Can the expenditure be included in the cost base of a CGT asset for the purposes of calculating the capital gain or capital loss when the CGT asset is disposed of? The answer is no in this case as there is no relevant CGT asset.
• Can the expenditure be deducted under ITAA97 s 40-880 which allows a deduction for certain business capital expenditure that would not be deductible or taken into account in any other way under the tax law? The answer may be yes.
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How are other capital costs treated - example
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• Because Jonah’s expenditure related to a business that he proposed to carry on, he would need to demonstrate that, when the expenditure was incurred: (i) he demonstrated a commitment of some substance to commence to carry on the business, (ii) there was sufficient identity about the business proposed to be carried on, and (iii) it was reasonable to conclude the business was proposed to be carried on within a reasonable time (ATO Interpretative Decision ID 2009/42).
• Provided the requirements of s 40-880 are satisfied, Jonah would be entitled to deduct the $60,000 equally over five income years at $12,000 each year beginning in the year it is incurred.
• Furthermore, assuming the expenditure was incurred during or after the 2015/16 year, he may be entitled to deduct the entire amount in the year the expenditure was incurred as qualifying start-up costs.
Questions?
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• You can type them in the “Questions” box now
• Or contact me via:
• Mark Chapman
• Director of Tax Communications, H&R Block
• 0415 844 388