Capital Deduction Provisions

Capital Allowances And Capital Works Allowances

Relationship Between Capital Deduction

Provisions 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 looking
backwards perspective deduction this year for wear and tear arising from past use

Rationale for Capital Allowance deductions

Current outlay on a capital item no immediate diminution in wealth lasting benefit but
capital item will be subject to wear and tear in producing future income hence deduction
each year as the capital item declines in value decline in value a cost of the future income

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 of the asset
Like depreciation in accounting but different terminology and some different
methods

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 purchaser
paid for the building component
Generally rate is 2.5% per year from 1992 onwards

Where possible taxpayer will usually prefer Div 40 deductions over Div 43
deductions

Uniform Capital Allowance Regime

Basic capital allowance provision s40-25(1):
You can deduct an amount equal to the decline in value for an income year
of a depreciating asset that you held for any time during the year.
s40-25(2): Deduction reduced where assets decline in value attributable to its
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 Systems
(IRUs)
Cars where certain substantiation methods have been used
Capital works under Div 43

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 for
expenditure on plant
Hence if building is plant deduction is under Div 40 otherwise deduction is
under Div 43

Therefore, in the case of buildings, Div 40 allowance only available where building
is plant even though doesnt have to be plant to be a depreciating asset

The Div 40 Div 43 Boundary

Buildings that are plant

Div 43
Buildings &
Structures

Div 40
Depreciating
Assets

Meaning Of Plant
Defined in s45-40 as including, among other things, articles,
machinery, tools and rolling stock
Yarmouth v France, per Lindley LJ:
in its ordinary sense includes whatever apparatus is used by a business man
for carrying on his business not his stock in trade which he buys or makes
for sale; but all goods and chattels, fixed or moveable, live or dead, which he
keeps for permanent employment in his business.

Buildings and structures: to be plant, need to play an active

function in business rather than being merely a convenient
setting:
Wangaretta Woollen Mills

Imperial Chemical Industries

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 ceilings
Sound absorbing qualities no more useful to this taxpayer than to others
merely a comfortable setting

Meaning of Plant
Articles that are not fixtures = plant even if do not play a
functional role in business
Quarries Ltd

Current law articles not fixtures dont need to be plant to get Div 40
deductions

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 need not

play a functional role to be plant
Carpentaria Transport

Key Concepts In Basic Capital Allowance

Provision
Basic capital allowance provision s40-25(1):
You can deduct an amount equal to the decline in value for an income year
of a depreciating asset that you held for any time during the year.
s40-25(2): Deduction reduced where assets decline in value attributable to its
use for a purpose other than a taxable purpose.

Key concepts

Depreciating Asset
Hold a depreciating asset
Decline in value
Taxable purpose

Meaning of Depreciating Asset

Depreciating Asset
s40-30 an asset that has a limited effective life and can reasonably be
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

Hold A Depreciating Asset

Can only claim deduction under Div 40 if you hold a depreciating
asset
Concept of economic ownership
Ability to access economic benefits of asset while preventing others from
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 interests as the
depreciating asset

Decline In Value
s40-25: You can deduct an amount equal to the decline in value
Calculate from time you first used asset or had it installed ready for
use (for any purpose)
Two methods for calculating decline in value:
Prime cost
Diminishing value

Assets not used in business costing < $300: decline in value is total
cost. - s40-80(2) note set rule important when purchasing
several assets and once eg hotel purchase
Low-value pools

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 includes the
calculation: s40-130(1)(a).
Once choice made for an asset, cannot be changed: s40-130(2)
Acquire from associate: must use same method: s40-65(2)
Acquire from former holder: must use same method: s40-65(3)
Cannot use diminishing value for in-house software, intellectual
property, spectrum licence, datacasting transmission licence

The Prime Cost Method

Formula s40-75(1)
Assets cost x Days held/365 x 100%/ Effective Life
Note does not have to be held for a taxable purpose- but deduction
reduced where not for taxable purpose
Generally cost less decline in value to date = opening adjustable value
Decline in value cannot exceed opening adjustable value plus additions to
2nd element of cost

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 reduced where not
held for a taxable purpose
Base value = Cost in Y1
Base value = Opening adjustable value + additions to 2nd element of cost in subsequent
years

Prime cost v. Diminishing value

Y1

Y2

Y3

Y4

Y5

Y6

Y7

Y8

Prime
cost

$2,500

$2,500

$2,500

$2,500

$2,500

$2,500

$2,500

$2,500

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.
Assets Cost: $20,000
Held: 365 days (purchased on 1 July)
Effective life: 8 years

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

17

Prime cost v. Diminishing value

6,000
5,000
4,000
3,000

Prime cost

2,000

Diminishing
value

1,000
0
1

10 11 12

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

18

Prime cost v. Diminishing value

25,000

20,000

15,000
Base value
10,000

Opening
adjustable value

5,000

0
1

10 11 12

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

19

Key Concepts In Calculating Decline In Value

Cost
Adjustable value
Opening adjustable value
Base value (used only in Diminishing Value method)
Effective Life

Meaning of Cost
Specific rules for certain situations s40-180 eg non-arms length transaction = market
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 asset
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 bringing the
asset to its present condition and location

Meaning Of Cost
Special rules re Cost
s40-195 apportionment rule eg where buy depreciating asset and
something else with one expenditure
s40-215 cost reduced by any part deducted under another part of the ITAA36
or 97 see also s40-220
Car discount provisions s40-225 & car limit provisions s40-230

Meaning of Adjustable Value Opening

Adjustable Value and Base Value
Meaning Of Base Value Adjustable Value And Opening Adjustable
Value
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 less decline in
value for that year
Opening adjustable value = adjustable value at end of previous income year
Base value = opening adjustable value + inclusions in 2nd element of cost for
that year

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 into account
technical obsolescence)

Effective life can be recalculated due to changed circumstances: s40110

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 terminology
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 existing
business

Capital allowance reduced under s40-25(2) where partially for a purpose

other than a taxable purpose

Balancing Adjustments Or What Happens

When You Dispose Of A Div 40 Asset
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 when you stop
holding 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 partnership

Balancing Adjustments
s40-285(1) If termination value exceeds adjustable value at time of
balancing adjustment event, excess included in income
s40-285(2) If adjustable value exceeds termination value at time of
balancing adjustment event, excess is deduction.
IE: Balancing adjustment = Termination value - Adjustable value.
Positive figure = assessable
Negative figure = deductible

Concept of termination value is relevant to balancing adjustments

Termination Value
Normal situation
s40-305 Amount you receive but be aware of variations (similar to capital
proceeds modification rules in CGT, eg. You terminate a liability, receive a noncash benefit)
s40-310 apportionment where receipt only partly relates to depreciating asset

Special situations s40-300(2)

Eg non-arms length = market value substitution
Eg change in composition of partnership = market value substitution
s40-230 proportion of termination value recognised where car limit applied on
acquisition

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

29

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

Black Hole Expenditure

s40-880: Business related costs deductible over 5 years
Temporal connection: Business can be one you currently carry on,
used 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 provision (including
expenditure that forms part of cost of depreciating asset)
Does apply if there a provision denies deduction

Capital works Division 43

Provides deductions for construction expenditure on buildings and
other capital works that are used to produce assessable income
Not deductible under s8-1 (capital)
Not deductible under Div 40 (s 40-45(2))

See TR 97/25

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

32

Capital works deductions

s43-10 deductions for capital works
(1) You can deduct an Amount for Capital Works for an income year.
(2) You can only deduct the amount if:
(a) The Capital Works have a Construction Expenditure Area; and
(b) There is a Pool of Construction Expenditure for the Area; and
(c) You Use Your Area in the Income Year in the Way Set Out in Table
43-140

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

33

Capital works Key terms

Capital works: s43-20
Buildings begun post 21/08/79 (in Australia) or 21/08/90 (outside Australia)
Structural improvements / extensions / alterations etc begun post 26/02/92
Examples of Structural Improvements are set out in s 43-20(3) (e.g. sealed
roads, sealed driveways, sealed car parks, bridges, retaining walls, fences).
Commencement of construction occurs when the first step in the
construction phase starts (e.g. pouring of foundations for a building): s 43-80.

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

34

Capital works key terms

Construction expenditure: s43-70
Capital expenditure incurred in respect of construction of capital works.
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 quasiownership right by the entity that incurred the expenditure
Each time construction capital works are completed, a separate construction
expenditure area is created.

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

35

Capital works key terms

Pool of construction expenditure: s43-85
so much of the construction expenditure incurred by an entity on capital
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 certain
conditions are met, lease)
NB: the taxpayer/entity need not have incurred the construction expenditure.

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

36

Capital works key terms

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

In broad terms are you using your Construction Expenditure Area

for the purpose of producing assessable income
However, be aware that the table is divided up into different time
periods and different types of capital works

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

37

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 activities: see
s43-145

No deduction until construction is completed: s43-30

Deduction cannot exceed amount of undeducted construction
expenditure: s43-15

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

38

Capital works consequences of disposal

No balancing adjustments on sale
Purchaser takes over deductions for undeducted
capital works expenditure
Balancing adjustment if capital works lost or
destroyed: s43-40

Copyright School of Taxation & Business Law UNSW and Kathrin

Bain

39