Explanatory Memorandum(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)
Technical Amendments To Capital Allowances
- the depreciation broadbanding measures are to be amended to make it clear the rates of depreciation determined on an effective life basis that match a broadbanded rate cannot be increased to the next highest broadbanded rate.
Date of effect: The amendment is to apply from the same time as the broadbanding measures; that is, in relation to the 1991/92 and later years of income.
One of the changes arising from the March 1991 Industry Statement reduced ("broadbanded") the number of basic depreciation rate classes from eighteen to seven - 33 1/3%, 20%. 15%, 10%, 7 1/2%, 5% and 2 1/2%.
If the basic rate of depreciation for an asset was not one of those broadbanded rates, the asset could be depreciated at the next highest rate. For example, if the basic rate for an asset was 8%, the rate could be increased to 10%.
A rate was to remain unchanged if it was one of the broadbanded rates. For instance, if a basic rate for an asset was 15%, one of the broadbanded rates, it was to remain unchanged.
A literal interpretation of the relevant amending legislation [contained in Taxation Laws Amendment Act 1992] would suggest that, contrary to the principle stated in the previous paragraph, a basic rate that is one of the broadbanded rates can be increased to the next highest rate.
The relevant provision, the former subsection 55(5) [repealed by Taxation Laws Amendments Act (No.3) 1992] is expressed so that if "the raw percentage (ie. basic rate) is below one of the following (percentages)......the raw percentage is re-calculated as the next highest of those percentages".
On a literal reading of that subsection, if a basic rate for a particular asset was, say, 10% (a broadbanded rate), it could be increased to 15% (the next highest broadbanded rate) because it is not below 10%.
The application of repealed subsection 55(5) is being changed to make it clear that a raw percentage that is one of the broadbanded rates is to remain unchanged and cannot be increased to the next highest broadbanded percentage. That is achieved by having the former paragraph 55(5)(b) apply as if it read: "(b) the raw percentage is not one of the following: ..." [Clause 40]
The amendment is to apply from the same time as the original measure; that is, in calculating depreciation deductions in the 1991/92, and subsequent, years of income. [Clause 40]
- to amend the plant depreciation Crown lease provisions in relation to disposals of pre-27 February 1992 plant for which the prime cost method of calculating depreciation deductions has applied in order to prevent balancing loss deductions being allowed for that portion of the cost of such plant which was only notionally depreciated before 27 February 1992 and ensure tax is imposed, as appropriate, on recoupments of previously allowed deductions.
Date of effect: the amendment is to apply to disposals occurring after 26 February 1992.
Under the plant depreciation Crown lease provisions, taxpayers who hold Crown leases of land are treated as owners and so entitled to depreciation deductions for income-producing plant they install on the land if the law would otherwise treat them as not being the owners.
This measure applies to plant installed after 26 February 1992. It also applies to plant installed on Crown leases on or before that date, based on notional depreciated values on that date [section 38 of Act No.98 of 1992].
A technical deficiency exists in these Crown lease provisions in relation to plant installed before 27 February 1992 where the prime cost method of calculating depreciation is used. As things stand, taxpayers in those circumstances could either inappropriately obtain balancing loss deductions for that portion of the cost of plant which was only notionally depreciated before 27 February 1992, or escape tax on the recoupment of previously allowed deductions.
Taxpayers may adopt one of two methods of calculating depreciation deductions - the prime cost method or the diminishing value method - for all assets first becoming depreciable in a particular year.
Deductions under the prime cost method are calculated as a percentage of original cost so that the cost of plant is evenly written-off. Under the diminishing value method, deductions are calculated as a percentage of depreciated value at the beginning of each year so that the size of deductions reduces over time.
Because the prime cost and diminishing value methods operate in a different manner, the Crown lease provisions contain separate rules for each method in relation to plant installed before 27 February 1992.
Under the diminishing value method, taxpayers are treated as acquiring the plant on 27 February 1992 for an amount equal to its notional depreciated value at that date. The notional depreciated value of an asset is the amount that would have been its depreciated value if depreciation deductions had been available from the time it was installed [paragraph 38(3)(d) of Taxation Laws Amendment Act (No.3) 1992].
Under the prime cost method, deductions are based on the original cost of the asset but depreciation deductions are not available for that portion of the cost that would have been allowed as deductions before 27 February 1992 if the plant had been eligible for depreciation deductions from the time it was installed [paragraph 38(3)(e)].
In effect, both methods limit aggregate post-26 February 1992 depreciation deductions for plant installed before 27 February 1992 to an amount equal to notional depreciated value on that date.
Although depreciated value is not relevant for calculating depreciation deductions under the prime cost method, it is relevant for calculating balancing losses and gains on the disposal, loss or destruction of plant.
A deductible balancing loss accrues where the consideration for a disposal, loss or destruction of an asset is less than its depreciated value. An assessable balancing gain accrues if the relevant consideration exceeds an asset's depreciated value, but the assessable amount is limited to the amount of depreciation deductions allowed in relation to the asset.
Balancing adjustments are calculated in this way irrespective of which of the two methods was used to calculate depreciation deductions [subsection 59(1) and (2)].
This is where a problem occurs. The transitional rules for pre-27 February 1992 plant to which the diminishing value method has applied [paragraph 38(3)(d)] specify a modified meaning of depreciated value for balancing adjustment purposes whereas the corresponding prime cost method rules do not contain a modified meaning of depreciated value for those purposes.
Without such a specification, depreciated value would have to be calculated without reducing the cost of an asset by the notional depreciation deductions for the period prior to 27 February 1992. This means that depreciated values would be higher than is appropriate and, on the disposal, loss or destruction of an asset, deductions would be available for that portion of the cost of an asset which had notionally depreciated before 27 February 1992 or the amount of assessable recoupments of previously allowed deductions would be understated, depending on the amount of consideration received.
This defect is to be remedied by inserting, in the transitional rules for pre-27 February 1992 prime cost plant, the requirement that depreciated value be calculated by reference to depreciation deductions notionally allowed before 27 February 1992. [Clause 65]
The amendment is, in effect, to apply to disposals occurring after 26 February 1992. [Clause 2(3) specifies that the above amendments are to have effect immediately after the commencement of section 38 of Taxation Laws Amendment Act (No.3)1992]
- to replace an existing option whereby taxpayers each year may adopt lesser rates of depreciation for individual plant items with a once-only option to adopt, at the time an asset first becomes depreciable, a lesser rate of depreciation that is not less than the rate based on the asset's effective life.
Date of effect: the change is to apply to the current and subsequent years of income.
The current depreciation rates regime [section 55] applies, broadly speaking, to plant acquired after 26 February 1992. It specifies the rates of depreciation applicable to assets according to their estimated effective life.
Taxpayers are able to adopt rates of depreciation that are less than the applicable rates [subsection 55(8)]. That option, which is similar to an option under the former "5/3" measures, is available in the event that some taxpayers might be disadvantaged by the higher rates available under the existing measures.
This option is flexible enough to allow taxpayers to adopt any rate each year as long as that rate does not exceed the highest rate allowable. By comparison, taxpayers who elected out of the former "5/3" measures would adopt standard rates which, at that time, broadly reflected effective life.
The existing option to specify a rate each year that does not exceed the allowable maximum is to be withdrawn because it allows excessive manipulation of taxable incomes. Instead, taxpayers are to have a once-only option to adopt a lower rate of depreciation for an asset, exercisable only in the year of income in which the asset first becomes depreciable under income tax law. Once a lesser rate has been selected, it is not to be changed.
Further, the minimum rate a taxpayer can select for an asset is to be the rate determined by reference to the asset's effective life. So, if the estimated effective life of an asset was 10 years, the minimum allowable diminishing value rate would be 15% and the corresponding prime cost rate would be 10%. [New subsections 55(8) & (8A)]
The amendment is to apply to plant first becoming depreciable to a taxpayer for income tax purposes in the year of income in which 16 December 1992occurs ("current year of income") and subsequent years of income. [Clause 24(1)]
Taxpayers who have exercised a subsection 55(8) choice in relation to plant which was first depreciable in a year of income preceding the current year of income can make an irrevocable choice in relation to such plant for the current and later years [Clause 24(2)]. If no choice is made in those circumstances, the asset will be depreciable at the maximum allowable rate.
For example, if a taxpayer's current year of income is the 1992/93 year of income and the taxpayer had specified a rate for an asset in the 1991/92 year of income that was less than the maximum rate allowable for that asset, the taxpayer may specify a rate for the asset in relation to 1992/93 and succeeding years of income that is not less than the minimum effective life rate (and, of course, not greater than the maximum allowable rate).
- to ensure that pre-18 September 1974 expenditure in relation to property used in petroleum mining activities is covered by the existing petroleum mining rollover relief provisions.
Date of effect: the amendment applies to disposals of mining property occurring after 6 December 1990.
Under petroleum mining rollover relief [section 124AMAA], a taxpayer acquiring relevant property "inherits" the deduction entitlements in relation to the property, and their characteristics, in the hands of the taxpayer disposing of the property. For example, if the amount of unclaimed expenditure in relation to the property at the time of the disposal was deductible over a particular period, that amount will remain deductible over the same period event though the deduction period for current expenditure may be different.
Relevant expenditure on mining activities is described in the legislation as "allowable capital expenditure". The rollover provisions focus on both the amount of unclaimed allowable capital expenditure in relation to property to ascertain the amount to be rolled-over [paragraph 124AMAA(4)(a)] and on the threshold conditions satisfied in relation to that expenditure by the person transferring the property so that it continues to be treated in the same manner in the hands of the person acquiring the property [subsections 124AMAA(8) and (9)].
The existing provisions in relation to petroleum mining activities apply, broadly speaking, to expenditure incurred after 17 September 1974. Expenditure incurred before 18 September 1974 was covered by provisions which have been repealed.
Under those former provisions, relevant expenditure was immediately deductible to the extent that it was absorbed by net assessable income from petroleum (broadly, income from the sale of petroleum less all other allowable deductions). Unabsorbed expenditure was carried forward for immediate deduction in subsequent years, subject to the same limitations, until fully absorbed.
The current provisions preserve pre-18 September 1974 expenditure so that it remains immediately deductible to the extent of net income from petroleum [sections 124AE and 124AF]. However, such expenditure is defined as "unrecouped previous capital expenditure" and not as "allowable capital expenditure". Because pre-18 September 1974 expenditure is not allowable capital expenditure, the rollover provisions do not apply to it.
The requirement that pre-18 September 1974 expenditure be deductible only to the extent of net income from petroleum is restrictive compared to the treatment of current expenditure which is deductible against assessable income from any source. This explains why such "vintage" expenditure still remains undeducted. Such undeducted expenditure ought to qualify for rollover relief in the same way as more recent expenditure.
Section 124AMAA is being amended so that such expenditure is eligible for rollover relief. The effect of the amendment is that the amount of any unrecouped previous capital expenditure in relation to property, at the end of the year of income preceding the year in which a rollover disposal occurs, is to be treated as unrecouped previous capital expenditure in the hands of the person acquiring the property so that it remains immediately deductible to the extent of net income from petroleum.
The person disposing of the property will not be entitled to any deduction in relation to such expenditure in the disposal year. Instead, the person acquiring the property will be entitled to any deduction that is available in the year of disposal. [New paragraph 124AMAA(4)(aa) and related technical amendments to existing provisions]
The amendment is to apply:
- to disposals within wholly-owned company groups occurring after 6 December 1990 and before 20 December 1991 where an election for rollover relief has been made [Clause 35]; and
- to disposals occurring after 19 December 1991 where a relevant capital gains tax rollover relief provision applies to the disposal [Clause 34] .
- to ensure that section 51AD and Division 16D can apply to property used in relevant arrangements where the taxpayer's entitlement to deductions is not based on ownership.
Date of effect: the amendment is to apply to arrangements entered into after 16 December 1992.
Income tax law contains several measures to deal with arrangements relating to the use of property by tax-exempt bodies whereby taxable entities, usually financiers, would obtain deductions as owners of property [section 51AD and Division 16D].
The financier is the nominal owner of the property and so entitled to relevant income tax deductions, such as plant depreciation or the capital allowance for buildings, even though, under the arrangement, beneficial ownership, or long term use, of the property rests with the non-taxable entity.
These arrangements can cause a significant loss of revenue because the tax deductions obtained by the financiers enable them to defer income tax.
In cases to which section 51AD applies (i.e. where the property has been financed predominately by non-recourse borrowings), the legal owner is denied the relevant property deductions. Where Division 16D applies (in other than non-recourse financing cases), the arrangement is treated as if it were a loan.
The application of section 51AD and Division 16D both turn on the ownership of property by one person and the use or effective control of that property by another person in specified circumstances [subsections 51AD(4) and 159GG(1) respectively].
However, taxpayers need not necessarily be owners of property to obtain deductions under the capital allowances for property. For instance, deductions for the cost of income-producing buildings [Divisions 10C and 10D] are available to "eligible lessees". Broadly, eligible lessee means a person who either holds a lease or a Crown lease over a building.
Similarly, deductions under the capital allowances for general mining, quarrying and petroleum mining are available to persons who hold mining leases, permits and so on.
An argument has been put that section 51AD and Division 16D cannot apply to arrangements involving taxpayers who are entitled to capital allowances for property but who do not own the relevant property. The argument is that, as the term "owner" is not defined for purposes of section 51AD and Division 16D, it therefore takes its ordinary meaning and thus excludes persons who are not owners at law.
While such reasoning is open to dispute, it is nevertheless desirable that the issue be free from doubt. Accordingly, the following capital allowance provisions are to be amended so that taxpayers, entitled to deductions under those allowances for property which they do not own, are to be treated as if the owners of that property for the purposes of section 51AD and Division 16D:
- Division 10A - Mining and Quarrying [New section 122U]
- Division 10AAA - Mineral and Quarry Materials Transport [New section 123G]
- Division 10AA - Petroleum Mining [New section 124AR]
- Division 10A - Access roads and buildings in timber operations [New section 124JF]
- Division 10C - Short-Term Traveller Accommodation [New section 124ZEA]
- Division 10D - Income-Producing Buildings & Structural Improvements [New section 124ZLA]
The amendment is to apply to arrangements entered into after 16 December 1992 . [Clause 32]