House of Representatives

Explanatory Memorandum

(Circulated By Authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 2 - Increase to the small business instant asset write-off threshold and simplified depreciation

Outline of chapter

2.1 Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) by:

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increasing the small business instant asset write-off threshold from $1,000 to $6,500; and

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consolidating the long life small business pool and the general small business pool into a single pool to be written off at one rate.

2.2 All legislative references in this chapter are to the ITAA 1997 unless otherwise specified.

Context of amendments

2.3 Small businesses can choose to use the capital allowance arrangements in Subdivision 328-D to depreciate assets.

2.4 The existing capital allowance arrangements for small businesses allow low cost assets to be written off in the year the small business first started to use the asset or had it installed ready for use. A low cost asset (except a horticultural plant) is defined in section 40-425 as one which has a cost of less than $1,000 at the end of the income year in which the asset started to be used or is installed ready for use, for a taxable purpose.

2.5 Other depreciating assets, generally those costing $1,000 or more, are allocated to one of two depreciation pools, depending on the effective life of the asset: the long life small business pool or the general small business pool. The pools are depreciated at different rates (5 per cent or 30 per cent).

2.6 Recommendation 29 of the Australia's Future Tax System Review (December 2009) proposed that the capital allowance arrangements for small business be streamlined and simplified by allowing:

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depreciating assets costing less than $10,000 to be immediately written off; and

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all other depreciating assets (except buildings) to be pooled together, with the value of the pool depreciated at a single declining balance rate.

2.7 In response to this review, the Government announced on 2 May 2010 that from the 2012-13 income year small businesses would be allowed to write off assets costing less than $5,000, and that simplified pooling arrangements would be provided for other assets.

2.8 On 10 July 2011, the Government announced that as part of the Clean Energy Future Plan the small business instant asset write-off threshold would be further increased from $5,000 to $6,500.

2.9 These changes increase cash flow, reduce compliance costs, expand the existing small business capital allowance concessions and simplify the depreciation calculations for small businesses.

Summary of new law

2.10 From the 2012-13 income year, these amendments enable small businesses that choose to use the capital allowance provisions in Subdivision 328-D to:

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write off depreciating assets costing less than $6,500 in the income year in which they start to use the asset or have it installed ready for use for a taxable purpose during or before that income year; and

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allocate depreciating assets costing $6,500 or more to the general small business pool and depreciated at a rate of 15 per cent in the year of allocation and 30 per cent in following years.

Comparison of key features of new law and current law

Detailed explanation of new law

2.11 These amendments increase the threshold used to identify assets that can be written off by a small business in the year in which they start to use the asset or have it installed ready for use, for a taxable purpose. [Schedule 2, items 8 to 13, 68 and 69]

2.12 These amendments apply to small business entities as defined in section 328-110 that have an aggregated turnover of less than $2 million for an income year. Aggregated turnover is defined in section 328-115 and includes the turnover of the small business entity and certain connected and affiliated entities. A depreciating asset is defined in section 40-30 as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used.

2.13 A small business can write off (that is, claim a deduction for) a depreciating asset which has a cost of less than $6,500 at the end of an income year in which the business starts to use it, or has it installed ready for use, for a taxable purpose. [Schedule 2, items 4, 8, 9 and 67 to 69]

Example 2.1 : Claiming a deduction for an asset under the instant asset write-off threshold

Kylie's Flowers is a small business entity. During the 2012-13 income year it buys a new refrigeration unit for $3,000. As the refrigeration unit is a depreciating asset and costs less than $6,500, the business can claim an immediate $3,000 deduction for the 2012-13 income year.

2.14 The instant asset write-off for depreciating assets costing under $6,500 is available on an asset by asset basis. It is not necessary for small businesses to aggregate the cost of assets that are identical, substantially identical or form part of a set.

2.15 The existing capital allowance rules about the taxable purpose proportion of the depreciating asset still apply, and affect the amount of the deduction that can be claimed.

2.16 If the cost of an asset is less than $6,500 but the small business entity uses the asset only part of the time for a taxable purpose, the deduction available would be less than the cost the asset.

Example 2.2 : Writing off an asset that is used partly for a taxable purpose and partly for a non-taxable purpose

Pablo's Newsagency is a small business entity. During the 2013-14 income year, Pablo purchases a laptop for $3,000. He uses the laptop 80 per cent of the time for business purposes and 20 per cent of the time for personal purposes.

As the laptop cost less than $6,500 it can be written off immediately. However, as the taxable purpose proportion is 80 per cent, the business can claim a deduction of $2,400 (80 per cent of $3,000) for the 2013-14 income year.

2.17 If the cost of an asset is $6,500 or more, and the taxable purpose use determines that the amount to be depreciated is less than $6,500, the asset must be allocated to the general small business pool.

Example 2.3 : Taxable purpose proportion below the instant asset write-off threshold

Owen's Graphic Designs is a small business entity. During the 2012-13 income year it buys a new powerful computer for $6,800 that Owen uses 80 per cent of the time for business purposes and 20 per cent of the time for personal purposes. Although the taxable purpose proportion of the computer is $5,440 (80 per cent of $6,800) the business cannot claim an immediate deduction for this asset. To depreciate this asset Owen allocates $5,440 to the general small business pool for the 2012-13 income year.

2.18 Small businesses that choose to use the capital allowance provisions in Subdivision 328-D may also claim an immediate deduction for the taxable purpose proportion of additions to existing assets (that cost less than $6,500) if the addition also costs less than $6,500. [Schedule 2, items 10 to 13 and 69]

Example 2.4 : Deduction of cost additions below the instant asset write-off threshold

Martin's Printing buys a new industrial printer for $6,000. Martin's Printing claims an immediate deduction of $6,000 for the printer.

Martin's Printing later spends $1,000 on a new component for the industrial printer. The $1,000 component is a second element cost of the printer.

As the second element cost of the printer is under $6,500, Martin's Printing may claim an immediate deduction of the cost of the component.

In the next income year, Martin's Printing spends $2,000 on another new component for the industrial printer. As Martin's Printing has already claimed a deduction for the cost addition to the printer (the first new component), this addition must be allocated to the general small business pool.

2.19 Existing rules for the disposal of assets that have been totally written off continue to apply. [Schedule 2, items 45 and 72]

Simplified depreciation pooling arrangements

2.20 Depreciating assets costing $6,500 or more are depreciated using a pooling arrangement. A pool is treated as a single depreciating asset although it is made up of the individual costs of the depreciating assets that are allocated to it. Pool deductions are calculated on a diminishing value basis at a set rate. [Schedule 2, item 14]

2.21 To simplify and streamline depreciation arrangements for small business, the long life small business pool ceases to exist after the 2011-12 income year. The closing balance of a small business' long life pool and general small business pool for the 2011-12 income year is to be added together to calculate the opening balance of the general small business pool for the 2012-13 income year. [Schedule 2, items 15 and 65, section 328-200 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A 1997)]

Example 2.5 : Consolidation of the depreciation pools for 2012-13 income year

Chantal's Cafe is a small business entity and at the end of the 2011-12 income year the closing balance of its long life pool was $8,000 and the closing balance of its general small business pool was $10,000. For the 2012-13 income year, Chantal's Cafe's long life pool no longer exists, but her general small business pool opening balance is now $18,000 (that is, $8,000 + $10,000).

2.22 The calculation of the opening balance of the general small business pool for the 2012-13 income year is also adjusted by changes in the proportion of the taxable purpose use of the assets allocated to the depreciation pools.

2.23 From the 2012-13 income year the deduction for an asset acquired during an income year and then allocated to the general small business pool is 15 per cent of the taxable purpose proportion of its adjustable value. The general small business pool is written off at a rate of 30 per cent per income year thereafter. [Schedule 2, items 25, 28 and 29]

Example 2.6 : Depreciation of assets acquired during the income year and allocated to the general small business pool

Following on from Example 2.5, the opening balance of Chantal's Cafe's general small business pool for the 2012-13 income year is $18,000. During the year it purchased a new large oven for $7,500. The business can deduct 15 per cent of the cost of the oven ($1,125) in the 2012-13 income year. To calculate the deduction for the general small business pool for the 2012-13 income year, Chantal uses a rate of 30 per cent ($18,000 × 30% = $5,400). Chantal's Cafe's total deduction for the 2012-13 income year is $6,525

(that is, $1,125 + $5,400).

Writing off the balance of the pool

2.24 The threshold at which a small business is allowed to write off the total balance of the general small business pool is aligned with the instant asset write-off threshold of $6,500. [Schedule 2, items 41 to 43, 70 and 71]

Example 2.7 : Writing off the balance of the general small business pool

Justin's Gardening Pty Ltd is a small business entity and the opening balance of its general small business pool for the 2012-13 income year is $7,200. During the year Justin's Gardening sold a ride-on lawn mower for $1,000. No other assets were acquired during the year. The pool balance is adjusted ($7,200 - $1,000 = $6,200) and as it is less than $6,500, Justin's Gardening can deduct the full pool balance of $6,200 for the 2012-13 income year.

2.25 All other existing rules relating to depreciation pools, including the calculation of opening and closing pool balances, and estimates of taxable purpose proportion continue to operate.

2.26 The consolidation of the long life pool into the general small business pool occurs regardless of whether an entity has chosen to use the Subdivision 328-D capital allowance provisions for the 2012-13 income year.

2.27 If the general small business pool balance (and the long life small business pool closing balance for the 2011-12 income year) is less than zero, the amount by which the balance is less than zero is to be added to the taxpayer's assessable income for that income year. The closing pool balance for that income year is then taken to be zero.

Roll-overs

2.28 Existing section 328-250 addresses roll-over relief for certain balancing adjustment events by working out the amounts that a small business entity (a transferor or a transferee) can deduct for a depreciating asset that the transferor or transferee started to use or have installed ready for use for a taxable purpose in an income year in which the balancing adjustment event occurred. Section 328-250 applies to deductions for assets costing less than $6,500 and assets that are pooled. [Schedule 2, items 55 to 60 and 72 to 74]

Application and transitional provisions

2.29 These amendments apply to assets that small businesses first use or have installed ready for use in the 2012-13 and later income years. [Schedule 2, items 66 and 75]

2.30 The increase in the instant asset write-off threshold from $1,000 to $5,000 will commence on the later day of Royal Assent of the Bills giving effect to the Minerals Resource Rent Tax and of Royal Assent of this Tax Laws Amendment (Stronger, Fairer, Simpler and Other Measures) Bill 2011.

2.31 The increase in the instant asset write-off threshold from $5,000 to $6,500 will commence after the commencement of Part 1 of Schedule 2 to this Bill and Royal Assent of the Clean Energy Bill 2011.

Consequential amendments

2.32 Consequential amendments are made to the ITAA 1997 to consolidate the depreciation pools by removing the small business long life pool so that the general small business pool is the only available pool for use. [Schedule 2, items 1 to 3, 5 to 7, 16 to 24, 26, 27, 30 to 39, 40, 44, 46 to 54 and 61 to 64]

2.33 The consequential amendments made to the IT(TP)A 1997 clarify the treatment of the general small business pooling arrangements for the 2012-13 income year. [Schedule 2, item 65]