House of Representatives

Tax Laws Amendment (Shipping Reform) Bill 2012

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 3 Statutory capped life

Outline of chapter

3.1 Part 1 of Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to insert a capped life of 10 years for the decline in value of a shipping vessel, where a certificate has been obtained under the Shipping Reform (Tax Incentives) Bill 2012 (SR(TI) Bill) in relation to the vessel. This capped life will be the effective life of the shipping vessel where certain conditions are met.

Context of amendments

Operation of existing law

3.2 The capital allowances provisions allow a taxpayer a deduction equal to the decline in value of a depreciating asset during an income year, in recognition that the asset loses value over the time it is used or held. That decline in value is calculated with reference to the 'effective life' of the asset. Broadly, the effective life of an asset is the length of time over which a taxpayer could reasonably be expected to use the particular asset for taxable purposes or for the purpose of producing exempt income. Currently, a taxpayer may choose to use a 'safe harbour' effective life determined by the Commissioner of Taxation (Commissioner) under section 40-100, where there is one in force. Where a taxpayer chooses not to use a 'safe harbour' effective life, or where there is none in force, the taxpayer must self-assess the effective life of the asset.

3.3 Under the current capital allowances system, the Commissioner progressively reviews and updates determinations under section 40-100 of the 'safe harbour' effective lives used to calculate deductions for depreciating assets. The Commissioner's Determinations are based on an estimate of the period the asset can be used by any entity for a taxable purpose or for the purpose of producing exempt income. The Commissioner cannot take into account national economic implications and the impact on affected industries. The Commissioner has determined the effective life of various shipping vessels to be between 15 and 30 years as set out in the Schedule to Taxation Ruling TR 2011/2 . For the purpose of this explanatory memorandum, we have referred to the Commissioner's Determination as being 20 years.

3.4 For some assets, the law provides a statutory cap on the effective life. Where a statutory cap applying to an asset is shorter than the effective life determined by the Commissioner, the capped life will prevail. In the case of shipping vessels, there is currently no statutory cap for their decline in value.

Rationale for changes

3.5 A key goal of the statutory capped life arrangements is to support owners of older vessels to reinvest in newer vessels.

3.6 Prior to 1996, an amendment to section 57AM of the Income Tax Assessment Act 1936 provided for accelerated depreciation of vessels over five years commencing in the year prior to the vessels' commissioning. During this time the average age of vessels in the Australian fleet was around 14 years. Since the scheme was withdrawn, the average age of the Australian coastal trading fleet has increased to 20 years, while the international average has fallen from 15 years to 12 years.

3.7 Introducing a statutory capped life of 10 years provides an incentive similar to that previously provided under section 57AM, for a younger fleet, which would have the additional benefit of incorporating new enhancements in technology and a reduced environmental impact.

Summary of new law

3.8 The new law inserts a statutory capped life of 10 years for shipping vessels to the table of assets in subsection 40-102(4), that are currently subject to a capped effective life.

3.9 In principle, taxpayers will continue either to use the 'safe harbour' effective life that the Commissioner has determined for shipping vessels or to self-assess their vessel's effective life. However, where the taxpayer chooses to apply the Commissioner's determination, and that determination provides for a life longer than the applicable statutory cap (as it currently does), the effective life of the vessel will be the capped life, that is, 10 years.

Comparison of key features of new law and current law

New law Current law
To determine the effective life of a shipping vessel, qualifying Australian shipping companies may choose to either self-assess the effective life or use the Commissioner's Determination. However, where the shipping company chooses to apply the Commissioner's Determination - as a statutory cap now applies to the shipping vessel and it is shorter than the effective life determined by the Commissioner - the capped life will prevail. In that case, qualifying Australian shipping companies will apply the 10 year capped life. To determine the effective life of a shipping vessel, a company can choose to self-assess the effective life of the asset or use the effective life as determined by the Commissioner. The effective life of most vessels is 20 years as set out in the Schedule to Taxation Ruling TR 2011/2 .

Detailed explanation of new law

Introduction of a statutory capped life for certain vessels

3.10 The effective life of eligible vessels is capped at 10 years for companies that have been issued with a certificate under the SR(TI) Bill in respect of their eligible vessels [ Schedule 2, item 4, item 10 in the table in subsection 40-102(4 )]. The decline in value of the depreciating asset (the vessel) will therefore be calculated over a shorter period of time, providing companies with a greater deduction in the earlier income years than is currently the case.

3.11 The effective life of a shipping vessel will be the capped life of 10 years if the following conditions are satisfied.

3.12 In accordance with the existing law, the taxpayer will follow the following steps.

3.13 Firstly, the taxpayer must choose, under existing paragraph 40-95(1)(a), to use an effective life determined by the Commissioner for the vessel.

3.14 The capped life will not apply where the taxpayer has chosen to self-assess the effective life of the vessel under paragraph 40-95(1)(b). This ensures that a taxpayer is still able to self-assess the vessel's effective life if that provides an effective life more appropriate to their circumstances of use.

3.15 Secondly, the taxpayer's choice to use an effective life determined by the Commissioner is limited to the effective life determination that was in force at the time mentioned in paragraph 40-95(2)(a) or (c).

3.16 Thirdly, there must be a capped life that applies to the depreciating asset which is in force at the relevant time.

Relevant time

3.17 Once a taxpayer has worked out that there is a capped life for an asset, it is necessary for them to establish that it is in force at the relevant time. The 'relevant time' is generally the asset's start time (that is, when the asset is first used or installed ready for use for any purpose). However, the relevant time will be the time specified in section 40-95 where paragraph 40-95(2)(a) is met and the other conditions are satisfied.

3.18 Fourthly, the capped life must be shorter than the Commissioner's determined effective life chosen by the company. The capped life of 10 years is added to the existing table for the capped life of certain depreciating assets in subsection 40-102(4). This capped life is shorter than the Commissioner's determined effective life for various shipping vessels. [ Schedule 2, item 4, item 10 in the table in subsection 40-102(4 )]

3.19 The Commissioner's Determination for the effective lives for trading ships is as follows:

bulk carriers, cargo ships, container ships, roll on/roll off ships and oil and chemical tankers - 20 years;
LNG and LPG tankers - 30 years;
coastal supply boats not longer than 10 metres - 15 years; and
coastal supply boats of longer than 10 metres - 20 years.

Example 3.7 OceanSky, an Australian company, purchased a shipping vessel on 1 July 2012 and started using it immediately in their business. OceanSky chose to use the effective life determined by the Commissioner. The effective life as determined by the Commissioner is 20 years. As the capped effective life of the shipping vessel is shorter than the Commissioner's effective life, OceanSky must use the capped effective life of 10 years.

3.20 A taxpayer who receives a certificate under the SR(TI) Bill is eligible to apply for the capped life provision.

3.21 A taxpayer will not be able to apply a capped life in relation to a vessel if some of the income in relation to the vessel is exempt from income tax for the income year. The exempt income tax provisions are described in Chapter 2 of this explanatory memorandum. [ Schedule 2, item 5, subsection 40-102(4A )]

3.22 However, where the taxpayer uses the vessel for a taxable purpose in addition to being used for the purposes attracting the income tax exemption, the taxpayer may be entitled to decline in value deductions under the normal depreciation rules for the portion that relates to that taxable purpose.

Example 3.8 Bluewater Pty Ltd, an Australian company, is the owner and operator of the Titanic. It can apply for a certificate under Part 2 of the SR(TI) Bill in respect of the capped life or in respect of a shipping exempt income certificate. However Bluewater Pty Ltd cannot apply for both in respect of the same period.Bluewater Pty Ltd decides that it would like to benefit from the income tax exemption, as the vessel is 15 years old, and most of the decline in value deductions have already been claimed. Therefore Bluewater cannot also apply the capped life in relation to the Titanic.

3.23 A taxpayer cannot apply the capped life in relation to the vessel if the taxpayer's associate/s derive ordinary income or have statutory income which is exempt under section 51-100 in relation to the vessel.

3.24 This is to ensure that a related entity cannot receive the benefit of the income tax exemption at the same time as their associate is receiving the benefit of the capped life.

3.25 However, where an owner of a vessel has obtained a certificate in respect of the vessel in accordance with section 8 of the SR(TI) Bill and the operator, other than an associate of the owner, who has obtained a shipping exempt income certificate for the same vessel also in accordance with the SR(TI) Bill, then the owner can choose to apply the statutory capped life. The operator can also seek to apply the income tax exemption under section 51-100.

Determining the remaining effective life for shipping vessels

3.26 Certain provisions are needed to deal with a company's entry or exit from the statutory capped life provisions. There are no existing transitional rules in the ITAA 1997 allowing for companies to continue to depreciate an asset, but at a different effective life.

3.27 This Schedule sets out the mechanics for taking depreciation expenses either out of, or into, the 10 year statutory effective life regime. When a company starts or ceases to apply the statutory capped life to a particular vessel, the effective life of the vessel changes accordingly; that is, a new effective life will apply. Whether or not the statutory cap has previously applied to the vessel or subsequently applies to the vessel does not matter. [ Schedule 2, item 6, subsection 40-103(1 )]

3.28 The new effective life is the 'remaining effective life', and is calculated by applying the following formula:

unadjusted remaining effective life x (alternative effective life / unadjusted effective life)

[ Schedule 2, item 6, subsection 40-103(2 )]

3.29 This formula calculates the decline in value of a depreciating asset for an income year using the prime cost method and must be adjusted for an income year in which the remaining effective life is calculated as outlined in paragraph 3.26. [ Schedule 2, item 3, paragraph 40-75(2 )( d )]

Choice of methods to work out the decline in value

3.30 There are two methods of calculating the decline in value of a depreciating asset: the prime cost (or straight line) method and the diminishing value (or reducing balance) method.

3.31 If the company calculated the decline in value based on the diminishing value method, they do not need to apply the formula in paragraph 3.28. Using the prime cost method, the annual decline in value of a depreciating asset is calculated by allocating the cost of the asset evenly over its effective life. It assumes that an asset declines in value uniformly throughout its life. The cost includes the first and second element of the cost of the asset.

3.32 Under the diminishing value method, the decline in value of a depreciating asset is assumed to be greatest in the first year and progressively smaller in each succeeding year. Unlike the prime cost method, the decline in value is calculated on a base value, which is the sum of the opening adjustable value for that year plus any second element cost. As the diminishing value is based on the actual written down value or opening adjustable value of the asset, there is no need to calculate the remaining effective life. However, the prime cost deductions are still based on the cost of the asset, and therefore the remaining effective life needs to be calculated.

3.33 The unadjusted effective life is the effective life that the company used prior to the transition to a different rate, that is, it is the effective life that the company is currently applying. [ Schedule 2, item 6, subsection 40-103(2 )]

3.34 The unadjusted remaining effective life is the residual effective life just before the company transitions between the capped life provision and normal capital allowance rules. [ Schedule 2, item 6, subsection 40-103(2 )]

3.35 Broadly, the alternative effective life is forward looking. It is the new effective life which is applied by the company as it transitions into either the capped life provision or normal capital allowance rules. It is also the effective life a company would be applying had they not been applying the current effective life. [ Schedule 2, item 6, paragraphs 40-103(2 )( a ) and ( b )]

3.36 For example, if a company receives a certificate under the SR(TI) Bill and starts to apply the capped life, the alternative effective life is the new effective life that the company will begin to apply to its shipping vessel. This will be the 10 year statutory cap. The unadjusted effective life would be the former effective life applied by the company just before it started to apply the capped life provision. This is the safe harbour effective life determined by the Commissioner, which is currently 20 years.

3.37 Example 3.3 clarifies the definition of 'unadjusted remaining effective life' and illustrates how to calculate the 'remaining effective life.

Example 3.9 BlueQueen, an Australian company, recently purchased a new shipping vessel on 1 July 2012, called the Australian Liberty. BlueQueen also operates the Australian Liberty. BlueQueen applies and receives a certificate from the relevant Minister for the vessel. After eight years, BlueQueen decides that it no longer wishes to claim the capped life, and instead it would like to apply for a shipping exempt income certificate to the relevant Minister. BlueQueen needs to revert to the normal capital allowance rules and in order to do this; it will need to calculate the 'remaining effective life' available on the Australian Liberty. BlueQueen applies the following formula to calculate the 'remaining effective life':

unadjusted remaining effective life x (alternative effective life / unadjusted effective life)

The 'alternative effective life' is the effective life had the BlueQueen not applied the capped life. We assume that the 'alternative effective life' of a vessel, such as the Australian Liberty has been determined by the Commissioner to be 20 years, under section 40-100. The 'unadjusted effective life' is the effective life applied by the BlueQueen just before the BlueQueen decided that it no longer desired the benefit of the capped life provision. This is 10 years.The 'unadjusted remaining effective life' is two years, as the BlueQueen ceased to apply the capped life for the Australian Liberty on the 8th year. From this time on there are still two out of the 10 years remaining in the capped life provision.

Thus, the remaining effective life is: 2 years x (20 years / 10 years) = 4 years

Therefore the 'remaining effective life' on the Australian Liberty, for the purpose of calculating decline in value deduction under the normal capital allowance rules, is four years. BlueQueen applies and receives a shipping exempt income certificate. Example 3.10 Following from Example 3.3, BlueQueen decides to re-enter the statutory capped life provisions. After two years of claiming the benefit of an exemption for its qualifying shipping income, the BlueQueen decides that it would like to re-apply to the relevant Minister for a certificate in order to again apply the statutory capped life provisions. As the BlueQueen applied the prime cost method whilst in the income tax exemption, they will need to apply the following formula to calculate the remaining effective life:

unadjusted remaining effective life x (alternative effective life / unadjusted effective life)

At this time, the 'alternative effective life' of the Australian Liberty is 10 years and the 'unadjusted effective life' is 20 years. The 'unadjusted remaining effective life' is two years, as the BlueQueen only applied two of the four effective life years.

Thus, the remaining effective life is: 2 years x (10 years / 20 years) = 1 year

Therefore the Australian Liberty's remaining effective life would be one year.

3.38 Provision is made to enable the Australian Taxation Office to share taxpayer information with the relevant Department in certain circumstances - refer to paragraphs 2.53 to 2.55 in Chapter 2 of this explanatory memorandum.

3.39 A minor change is made to subsection 40-70(1) (which describes the diminishing value method) to add a note to state that the effective life of a vessel can change in some cases. [ Schedule 2, items 1 and 2, subsection 40-70(1 )]

Application provisions

3.40 The amendments to give effect to the statutory cap apply to a vessel that a taxpayer holds on or after 1 July 2012, and started to hold before that day, as if they started to hold the vessel on that date. [ Schedule 2, subitems 9(1 ) and ( 2 )]

3.41 These amendments will also apply to a vessel that the taxpayer commences to hold on or after 1 July 2012. [ Schedule 2, subitem 9(1 )]

Consequential amendments

3.42 The definition of 'effective life' in subsection 995-1(1) is amended to include the effective life of certain vessels. This amendment ensures that an effective life can be recalculated when an owner of a shipping vessel transitions between the capped life and normal capital allowances provisions. [ Schedule 2, item 7, definition of ' effective life' in subsection 995-1(1 )]

3.43 VThe definition of 'remaining effective life' in subsection 995-1(1) is amended to allow for an owner of a shipping vessel to calculate the remaining effective life of their shipping vessel when they choose to apply the capped life provision or when they cease to apply the capped life provision. [ Schedule 2, item 8, definition of ' remaining effective life' in subsection 995-1(1 )]


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