22 Week 7 Capital Allowances, Trading Stock & Tax Accounting ...
Week 7 Capital Allowances, Trading Stock & Tax Accounting Deductions for capital expenditure However, specific provisions of the tax law provide for some types of capital expenditure to be deducted over time, roughly corresponding to the rate at which the taxpayer is expected to derive benefits from the capital expenditure; the primary provisions are contained in the capital allowances regime in Div 40 ITAA97. ‘Black hole’ expenses However, some of these expenses may be deducted over time under the capital allowances regime – these provisions, related to so-called ‘black hole’ expenses, were introduced into the tax law in 2001. The primary provision: ‘business-related’ costs in s40-880 ITAA97. Taxpayers are allowed a deduction over five years for business-related capital expenditure, for example:
Expenses incurred in starting a business, such as costs of issuing a prospectus, legal expenses or registration costs associated with formation of a company; Expenditure relating to a proposed new business including the cost of feasibility studies; Expenses incurred in ceasing a business; Expenses incurred in changing business structures.
Capital allowances regime – depreciation Section 40-25(1) ITAA97 provides that an entity can deduct an amount equal to the “decline in value” for an income year of a “depreciating asset” that is “held” during the year. Note: if the asset cost is $300 or less, and is not predominantly related to carrying on a business (e.g. related to employment income) > the full cost can be deducted immediately: s40-80(2). The deduction is reduced to the extent that it relates to a non-taxable purpose: s40-25(2). An asset is applied for a taxable purpose if it is used for the purpose of producing assessable income, exploration or prospecting, mining site rehabilitations or environmental protection activities: s4025(7).
What is a “depreciating asset” – see s40-30(1) ITAA97: An asset which has a limited effective life and can reasonably be expected to decline in value over the time that it is used. Excluded: land, trading stock, some intangible assets e.g. goodwill.
Who is the “holder” of a depreciating asset – see s40-40 ITAA97: In most cases, the legal owner of the depreciating asset will be its holder. However, in limited cases, another person may be the holder - the main example is where another person (the “economic owner”) possesses the asset and has an option to become the legal owner.
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calculating “decline in value” The decline in value of a depreciating asset commences from the “start time” (when the entity first uses the asset or has it installed ready for use): s40-60 ITAA97. Under s40-65, the decline in value of a depreciating asset can be calculated using either: The diminishing value method; or the prime cost method. Diminishing value method: There are two diminishing value method formulas:
Assets acquired before 10 May 2006 [s40-70]:= Base value * Days Held/365 * 150%/Asset’s effective life Assets acquired on or after 10 May 2006 [s40-72]:= Base value * Days Held/365 *200%/Asset’s effective life
Prime cost method [s40-75]: =Asset cost * Days Held/365 * 100%/Asset’s effective life
Taxpayers can either choose the Commissioner’s determination of an asset’s effective life or self-assess the asset’s effective life: s40-95(1). Asset cost: The cost of a depreciating asset is determined under subdivision 40-C.
Asset cost in prime cost method Two elements comprise the cost of an asset:
The first element is generally the amount paid to acquire the asset; The second element comprises costs incurred after acquisition, which contribute to bringing the asset to its present condition and location.
Capital allowances – balancing adjustments Adjustable value = asset’s cost minus the decline in value of the asset in previous years: see s40-85(1) and s40-85(2). Base Value = initially this is the asset’s cost; in later years, this is the asset’s opening adjustable value plus second element costs incurred in the current year: s40-70(1) ITAA97. Subdivision 40-D ITAA97 provides for a balancing adjustment to taxable income where you stop holding or using the depreciating asset. The balancing adjustment amount is worked out under s40285 as follows:
Where termination value> adjustable value, the difference is included in taxpayer’s AY: s40285(1) Where termination value < adjustable value, the difference is a deduction for the taxpayer that year: s40-285(2). Where the depreciating asset is used partly for non-taxable purposes: The balancing adjustment amount is reduced to the extent that the asset was used for non23
Expenses incurred in starting a business, such as costs of issuing a prospectus, legal expenses or registration costs associated with formation of a company; Expenditure relating to a proposed new business including the cost of feasibility studies; Expenses incurred in ceasing a business; Expenses incurred in changing business structures.
Capital allowances regime – depreciation Section 40-25(1) ITAA97 provides that an entity can deduct an amount equal to the “decline in value” for an income year of a “depreciating asset” that is “held” during the year. Note: if the asset cost is $300 or less, and is not predominantly related to carrying on a business (e.g. related to employment income) > the full cost can be deducted immediately: s40-80(2). The deduction is reduced to the extent that it relates to a non-taxable purpose: s40-25(2). An asset is applied for a taxable purpose if it is used for the purpose of producing assessable income, exploration or prospecting, mining site rehabilitations or environmental protection activities: s4025(7).
What is a “depreciating asset” – see s40-30(1) ITAA97: An asset which has a limited effective life and can reasonably be expected to decline in value over the time that it is used. Excluded: land, trading stock, some intangible assets e.g. goodwill.
Who is the “holder” of a depreciating asset – see s40-40 ITAA97: In most cases, the legal owner of the depreciating asset will be its holder. However, in limited cases, another person may be the holder - the main example is where another person (the “economic owner”) possesses the asset and has an option to become the legal owner.
22
calculating “decline in value” The decline in value of a depreciating asset commences from the “start time” (when the entity first uses the asset or has it installed ready for use): s40-60 ITAA97. Under s40-65, the decline in value of a depreciating asset can be calculated using either: The diminishing value method; or the prime cost method. Diminishing value method: There are two diminishing value method formulas:
Assets acquired before 10 May 2006 [s40-70]:= Base value * Days Held/365 * 150%/Asset’s effective life Assets acquired on or after 10 May 2006 [s40-72]:= Base value * Days Held/365 *200%/Asset’s effective life
Prime cost method [s40-75]: =Asset cost * Days Held/365 * 100%/Asset’s effective life
Taxpayers can either choose the Commissioner’s determination of an asset’s effective life or self-assess the asset’s effective life: s40-95(1). Asset cost: The cost of a depreciating asset is determined under subdivision 40-C.
Asset cost in prime cost method Two elements comprise the cost of an asset:
The first element is generally the amount paid to acquire the asset; The second element comprises costs incurred after acquisition, which contribute to bringing the asset to its present condition and location.
Capital allowances – balancing adjustments Adjustable value = asset’s cost minus the decline in value of the asset in previous years: see s40-85(1) and s40-85(2). Base Value = initially this is the asset’s cost; in later years, this is the asset’s opening adjustable value plus second element costs incurred in the current year: s40-70(1) ITAA97. Subdivision 40-D ITAA97 provides for a balancing adjustment to taxable income where you stop holding or using the depreciating asset. The balancing adjustment amount is worked out under s40285 as follows:
Where termination value> adjustable value, the difference is included in taxpayer’s AY: s40285(1) Where termination value < adjustable value, the difference is a deduction for the taxpayer that year: s40-285(2). Where the depreciating asset is used partly for non-taxable purposes: The balancing adjustment amount is reduced to the extent that the asset was used for non23
