Capital expenditure incurred on a fixed or intangible asset will not be deductible under the general deduction provisions (section 8(1)).However, a tax deduction (usually over a number of years) may be allowed under the capital allowance rules.Most capital items decline in value over time and the tax law recognises that this decline in value represents a legitimate cost that is deductible against business or other income.
DECLINE IN VALUE
Division 40 of the Act contains the capital allowance provisions which allow tax deductions for the decline in value of depreciating assets.The amount
claimed in any given tax year is an estimation of the amount by which the asset’s value has fallen or depreciated.For tax deductions to be claimed,
the item of plant must be used to produce assessable income.
EFFECTIVE
Depreciation rates are determined by the estimated effective life of an asset.Most taxpayers opt to follow the
As the term suggests, effective life means the total estimated income-producing life of the asset, whether the asset is retained or sold at some point.When
determining effective life, assume that the item will be retained by the taxpayer until it can no longer be used economically to produce income
by any taxpayer in that industry.
It is possible to self-assess effective lives of capital items; however, you should have specific reasons for self assessing a shorter effective life.
TR 2017/2 only deals with the effective life of new plant, so it is permissible to self-assess for second-hand plant which may justify a shorter effective
life than determined under the ruling.
Taxpayers can re-estimate the effective life of plant acquired subsequent to 21 September 1999, where a change in circumstance means the original estimate
is no longer accurate (section 40-110).
Note that effective life cannot be recalculated if the plant has been subject to accelerated depreciation rates.
CHOICE OF DEPRECIATION METHOD
A taxpayer has two choices for calculating the depreciation method to be claimed, namely the prime cost method or the diminishing value method.
Under the prime cost method, a percentage rate is applied to the acquisition cost of the plant each year until the cost is fully written off.
Under the diminishing value method, depreciation is calculated on the written down value of the plant at the start of the year.In the first
year this will be equal to the cost, but in subsequent years the written down value will decrease.The percentage applied is higher than that used
under the prime cost method.
CALCULATING DEPRECIATION
For assets acquired prior to 1 July 2001, general and special depreciation rates determined by the Commissioner are used.For assets acquired after
1 July 2001, the Uniform Capital Allowance system applies, and the effective life of the asset is used.
The depreciation percentage to be used is calculated from the effective life of the asset as follows:
Prime Cost
- 100% divided by effective life (in years)
Diminishing Value
- For assets acquired prior to 10 May 2006 150% divided by effective life (in years)
- For assets acquired after 10 May 2006 200% divided by effective life (in years)
LOW VALUE ITEMS
Taxpayers such as investors or employees who derive non-business income are still able to immediately write off plant items costing less than $300.Taxpayers
who are not a Small Business Entity (SBE) may elect to write off items costing less than $1,000 through a low value pool.
Items that may be allocated include:
- New items of plant (costing less than $1000).
- Existing items of plant subject to the diminishing value method with a written down value of less than $1,000 at the start of the tax year.
The low value pool depreciation rates are:
- 18.75% of the total cost of low value items purchased in the current year.
- 37.5% of the prior year’s closing balance of the low value pool, plus the opening written down value of existing plant newly allocated to the low
value pool in commencement of the current year.
You may allocate items used partly for private purposes to the low value pool, but first be sure to deduct the private use percentage from the cost
of the item.
SBE POOLING ARRANGEMENTS
These are discussed in Chapter 13.
SALE OF DEPRECIATED PLANT
If an item of plant is sold for an amount less than the written down value, the shortfall can be claimed as a full deduction in the year of sale (assuming
the item has been used entirely for business purposes).
Similarly, if an item of plant is sold for an amount exceeding it’s written down value, the difference must be included in assessable income as a balancing
adjustment.
Note that this does not apply to items included in a low value pool or SBE pool.
REPLACEMENTS
Formerly, it was
an immediate tax deduction for the expense.As this practice has ceased, such purchases should now be allocated to the low value pool.
In summary:
- Formerly, SBE taxpayers could claim an outright deduction for items costing $6,500 or less (see Chapter 13).The Government then reduced the immediate
write off to $1,000 from 1 January 2014.In the 2015 Federal Budget the government expanded the threshold significantly for small business.SBE’s
can immediately deduct depreciating assets costing less than $20,000 for depreciable assets acquired and ready for use between 7.30pm (AEST)
12 May 2015 and 30 June 2019.
- Non-business taxpayers claim an immediate deduction for items up to $300.
- Items costing $100 or less can generally be claimed in full.
COMPUTER SOFTWARE
Since 1 July 2001, taxpayers have been able to pool expenditure on commissioning or developing software to be used solely for business purposes.Software
directly acquired cannot be pooled.
Alternatively, a claim for depreciation may be made based on the effective life, which is determined to be four years.
This was extended to 5 years from 1 July 2015. The decline in value of in-house software must be calculated using the prime cost method. If the in-house
software costs $300 or less and it is used mainly for producing non-business assessable income, an immediate deduction may be claimable. The SBE
simplified depreciation rules do not apply to computer software.
If in-house software becomes obsolete the written down value may be claimed in full.Expenditure incurred in website maintenance is fully deductible;
such expenses include content updating,
Website setup costs are capital in nature if incurred prior to the commencement of business or in establishing, replacing or extending a profit yielding
structure in an existing business. We also draw your attention to Taxation Ruling TR 2016/3 which discusses the ATO view on deductibility of expenditure
on a commercial website.
BUSINESS ‘BLACK HOLE’ EXPENDITURE
Since 2005 the Income Tax Assessment Act 1997 hasprovided tax for treatment for legitimate business expenses, known as ‘black hole’ expenditures,
for income tax purposes.
Black holes occur when business expenses are not recognised under the income tax laws.The need for an appropriate treatment for black hole expenditures
was identified in the Review of Business Taxation.
The systematic treatment comprises:
- Permitting deductions for capital expenditures incurred by businesses that are carried on for a taxable purpose;
- Providing deductions for certain pre-business expenditures incurred by existing businesses; and
- Recognising these expenditures in a new provision that will only apply where the expenditures do not have tax treatment, or are denied a deduction,
elsewhere in the tax laws.Therefore, the new provision will be a provision of last resort.
Consistent with the systematic treatment, some black hole expenditures will be recognised by increasing the range of expenditures that form the cost
base of an asset for capital gains tax purposes.
The provisions apply to expenditures incurred on or after 1 July 2005.Expenditure can be written off on a straight-line basis over five years for the
purposes of the uniform capital allowance regime.
Examples include:
- Business set-up costs, incorporation costs, costs to establish a partnership or trust.Search fees and other relevant costs used to obtain information,
- Costs of equity raising,
- Takeover defence costs, and
- Costs to restructure an existing business.
If expenditure is not eligible for depreciation or otherwise deductible, you should check if it is eligible under this provision of the uniform capital
allowance scheme.
From 1 July 2015, small businesses have been allowed to claim an immediate write-off for a range of professional expenses associated with starting
a new business, such as professional, legal and accounting service.
LUXURY
The limit on the depreciable cost of motor vehicle is $57,581 (TD 2018/6) and this figure has hardly changed since the 2002/03 tax year when it was
$57,009.
There appears to be consensus that $57,581 is too low and that the luxury car limit should be revised upwards.
If you pay say $95,000 for car, depreciation can only be claimed up to the depreciation cost limit of $57,581.
In cases where luxury vehicles are leased, the luxury car limit will be deemed to be a hire purchase agreement with depreciation allowed up to the
depreciation cost limit.This restricted depreciation claims along with interest (implicit in the lease) will be claimed in lieu of lease rentals.
The luxury car tax (LCT) was increased from 25 per cent to 33 per cent from 1 July 2008.Note that the luxury car threshold for general cars for 2018/19
is $66,631 and $65,094 for 2017/18. The fuel-efficient car limit is $75,526 for both 2018/19 and 2017/18.
Refer to Luxury Car Tax Determination LCTD 2018/1 for further details.
PRIMARY PRODUCTION
There are a number of concessions:
- Land care operations – deductible in full in the first year claimed.
- Water facilities – immediate write off.
- Telephone lines and mains electricity – may be written off in equal instalments over a period of 10 years.
- Forestry roads and timber mill buildings – deductible over 25 years or the effective life, whichever is shorter.
- Horticultural plants and grapevines – accelerated write-off.Refer to Section 40/545 of ITAA 1997 and TR2016/1.
It is recommended that further investigation regarding eligibility be undertaken before claiming any deductions for the above.
From 7.30pm (AEST) 12 May 2015, the government has allowed all primary producers to:
- Immediately deduct capital expenditure on fencing and water facilities; and
- Depreciate all capital expenditure on fodder storage assets over 3 years.
DEDUCTIONS FOR CAPITAL WORKS EXPENDITURE
A taxpayer can claim a deduction for capital expenditure incurred in constructing eligible buildings and structural improvements.Note that the deduction
is not based on the cost to the taxpayer, but on the original construction cost.
Therefore, on change of ownership the new owner is entitled to the same claims on the original cost base.
Included in the definition of construction costs are preliminary expenses such as architect’s fees, engineering fees and development approval costs
as well as the cost of foundation excavations, but not the cost of the land, clearing or demolition.
PLANT IN RENTAL PROPERTIES
The extent to which there is plant in a residential property is outlined in Taxation Ruling TR 2004/16.The outcome determines whether a deduction is
available under Div 40 for depreciable assets or Div 43 for capital works.
Significantly the ATO considers that an item that forms part of the setting of the residential property is not within the ordinary meaning of
plant.
Key considerations are:
-Whether the item appears visually to retain a separate identity
-The degree of permanence with which it has been attached
-The incompleteness of the structure without it, and
-The extent to which it was intended to be permanent or whether it was likely to be replaced within a relatively short period.
The applicable rates are:
Income producing residential
Used wholly or principally for residential accommodation, e.g. guesthouses, apartments, units, flats, rented houses.
| Construction Commenced | Per Annum |
| 18.07.85 – 15.09.87 | 4% |
| From 16.09.87 | 2.5% |
Income producing non-residential
All income producing buildings except residential buildings, including shops, offices, casinos, convention centres, shopping centres etc.
| Construction Commenced | Per Annum |
| 20.07.82 – 21.08.84 | 2.5% |
| 22.08.84 – 15.09.87 | 4% |
| From 16.09.87 | 2.5% |
Short-term traveller accommodation
Hotels, motels, resorts etc, with at least 10 bedrooms.
| Construction Commenced | Per Annum |
| 22.08.79 – 21.08.84 | 2.5% |
| 22.08.84 – 15.09.87 | 4% |
| 16.09.87 – 26.02.92 | 2.5% |
| From 27.02.92 | 4% |
Manufacturing
Used wholly or principally for manufacturing, processing of primary products, printing, energy production etc.
| Construction Commenced | Per Annum |
| From 27.02.92 | 4% |
Research and Development buildings
Research and Development carried on for the purpose of producing assessable income.
| Construction Commenced | Per Annum |
| From 20.11.87 | 2.5% |
Any capital expenditure claimed after 13 May 1997, must be deducted from the cost base of the asset when calculating the capital gain on sale. Subject
to this requirement, there is no other balancing adjustment on sale.When purchasing a building, establish the date of construction to determine
your eligibility to make a claim.
If you are unable to ascertain the construction costs, engage a qualified quantity surveyor to make an estimate.This is acceptable to the
solicitors and real estate agents are not acceptable.
Expenditure is deductible from the date the building is first used for income producing purposes after completion of construction.For a deduction to
be claimed, the building must be used or maintained ready for use for income producing or research and development purposes.
Be careful to exclude from claims depreciable plant and equipment such as air conditioning.This should be separately identified as normally much higher
depreciation rates can be claimed.
EXPANDING ACCELERATED DEPRECIATION FOR SMALL BUSINESS
In the May 2015 Federal Budget, in a major boost to small business, it was announced there would be an immediate deduction for most depreciating assets
that cost less than $20,000.
The measure was due to finish on 30 June 2018 but has been extended to 30 June 2019 as announced in the May 2018 Budget. This applies to assets acquired
and installed ready for use from 7.30pm (AEST) 12 May 2015 to 30 June 2019.
In line with this incentive, the Government has also suspended the current ‘lock out’ laws for the simplified depreciation rules (these prevent small
businesses from re-entering the simplified depreciation regime for five years if they opt out) until 30 June 2019.
In general, you can pool most depreciated assets costing more than $20,000 in the general SBP and depreciate at the diminishing value rate of 15% in
the first year and 30% thereafter.
The balance of the SBP is also immediately deductible if the closing balance is less than $20,000 at the end of an income year that ends on or after
12 May 2015 and on or before 30 June 2019.
RENTAL PROPERTIES & THE 2017 BUDGET
From 1 July 2017 deductions against rental income for travel will no longer be available in relation to travel costs to inspect or maintain the property
or collect rent.
In addition, depreciation deductions for plant and equipment in residential rental properties will be limited to outlays actually incurred by the investor.
Therefore, consequently depreciation can no longer be claimed against items in situ at the time of purchase (e.g. dishwashers, ceiling fans etc. installed
by a previous owner). Grandfathering arrangements apply to existing investments as at 9 May 2017.
PROPERTY INVESTORS TO LOSE OUT FROM BUDGET CHANGES
The ATO allows owners of income producing property to claim depreciation deductions for the wear and tear that occurs to a building’s structure and
the plant and equipment assets within.
The changes relate to the depreciation of plant and equipment assets and the eligibility to claim this deduction.
Until 30.6.2017, investors were able to claim qualifying plant and equipment depreciation on assets found in an investment property they purchase,
even if they were installed by a previous owner.
Under the new rules investors will be able to depreciate new plant and equipment assets and items they add to their property; however subsequent owners
will not be able to claim depreciation on existing plant and equipment assets.
This change could lead to investors being in a tighter financial position and may discourage future investors from purchasing a second hand residential
property.
Note that if the property is new, investors will be able to continue to depreciate plant and equipment as they had previously.
Investors will still be able to claim capital works deductions also known as building write off, including any additional capital works carried out
by a previous owner.