House of Representatives

Taxation Laws Amendment Bill (No. 2) 1998

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 9 - Depreciation

Overview

9.1 The amendments contained in Schedule 10 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to insert new section 61A to clarify the operation of the depreciation provisions in circumstances when an entity the income of which is exempt becomes, for any reason, subject to tax on any part of its income under the provisions of the Act.

Summary of the amendments

Purpose of the amendments

9.2 The amendments will ensure that the depreciable assets of tax exempt entities which become taxable are brought into the tax system, for the purposes of the depreciation provisions, at their notional written down values as if they had always been used wholly for the purposes of producing assessable income. The provisions will apply to Government exempt entities which are privatised either by legislation or by sale to private interests and non-Government exempt entities which cease to be exempt.

Date of effect

9.3 The amendments will apply to entities which became taxable earlier than 3 July 1995 but not earlier than the start of the year of income in which 1 July 1988 occurred. The amendment is required to provide certainty with respect to entities which became subject to taxation before 3 July 1995.

Background to the Legislation

9.4 When an entity changes from exempt to taxable status, an important taxation issue which arises is the appropriate basis for calculating depreciation deductions and balancing charges for depreciable assets owned by the entity at the time of transition to taxable status ('transitional plant').

9.5 This taxation issue which arises is the same for both private and Government owned entities changing from exempt to taxable status. For example:

·
a privately owned entity that is exempt, under paragraph 23(g) for the promotion of sport, might lose its exempt status if it starts to be carried on for other purposes;
·
complying superannuation funds became taxable with the repeal of the exemption contained in the Act as from their year of income in which 1 July 1988 occurred;
·
a Commonwealth Government Business Enterprise (GBE) will become taxable when the Commonwealth Government legislates to make the GBE taxable even without any change of ownership, for example Telecom (now Telstra) and Australia Post as from 1 July 1990;
·
a GBE (either State or Commonwealth owned) will also cease to be exempt when it is wholly or partially transferred to private beneficial ownership.

9.6 The general scheme of the depreciation provisions of the Act is to allow annual deductions for depreciation based on the historical cost of an item of plant and spread over the effective life of that plant. This scheme is supported by a system of balancing charges when the taxpayer disposes of the plant (eg. section 59) and apportionment rules in the event that the plant is used by the taxpayer only partly for assessable purposes (eg. section 61).

9.7 The long standing, and generally accepted, view of the Commissioner of Taxation is that when an entity changes from exempt to taxable status, its transitional plant is brought into the tax system, for the purposes of the depreciation provisions, at its notional written down value (NWDV). The Commissioner has consistently administered section 61 on the basis that, in such circumstances, NWDV is calculated using effective life rates (including any applicable loadings under the former section 57AG) and on the assumption that the transitional plant was always used by the entity wholly for the purposes of producing assessable income throughout the entire period of its ownership by the entity. This basis is referred to as the 'NWDV including section 57AG loadings basis'. The High Court decision in FC of T v Anderson (1956)
11 ATD 115 provides strong support for this approach.

9.8 Prior to the enactment of Schedule 2D, Division 57 of the Act, legislation modifying the Act has been introduced on a 'case by case' approach for certain exempt entities that have become taxable. The usual practice was not to include specific provisions in such transitional legislation requiring the use of the NWDV including section 57AG loadings basis for the purposes of calculating depreciation deductions and balancing charges.

9.9 In recent years, some challenges have emerged to the Commissioner's interpretation and administration of section 61 in respect of transitional plant when a tax exempt entity becomes taxable. Division 57 has removed any doubts caused by these challenges about the use of the NWDV including section 57AG loadings basis in circumstances when an exempt entity becomes taxable on or after 3 July 1995. These amendments will make it clear that the NWDV including section 57AG loadings basis applies to transitional plant in circumstances when an exempt entity became taxable earlier than 3 July 1995 but not earlier than the start of the year of income in which 1 July 1988 occurred.

Explanation of the amendments

Entities to which the section applies

9.10 Item 1 ensures that section 61 of the Act has effect subject to new section 61A . Item 2 inserts new section 61A . New subsection 61A(1) sets out the circumstances in which new section 61A applies. New subsection 61A(1) provides a test to work out if new section 61A applies to an entity. This test is the same as the test that is used in Division 57 of the Act (see section 57-5).

9.11 New section 61A applies if at any time :

·
all of the income of an entity is fully exempt from income tax; and
·
immediately afterwards, any of its income becomes assessable to any extent.

[New paragraphs 61A(1)(a) and (b)]

9.12 An entity to which new section 61A applies because at least part of its income has become at least partly assessable, is termed the 'transition taxpayer' . The time at which at least part of its income becomes assessable to at least some extent is the 'transition time' [New paragraphs 61A(1)(c) and (d)] . Although the term 'transition taxpayer' is used, the term applies to identify the entity in relation to matters arising before, at, and after the transition time.

9.13 Under new paragraph 61A(1)(e) the year of income of the newly taxable entity in which the transition time occurs, that is, in which at least a part of its income becomes at least partly assessable, is called the 'transition year' for the entity.

9.14 The provisions apply to a taxpayer for which a transition time occurs. It is possible for a taxpayer to be wholly exempt from income tax at the end of one year of income and commence to be assessable at the beginning of the following year of income. In that case, the transition time occurs at the beginning of the year in which the taxpayer commences to be assessable, and that year is the 'transition year'. The operative provisions of new section 61A are designed so that such a transition time does not hinder their operation. There is always a transition year, because the time when at least part of an entity's income becomes at least partly assessable always occurs in a year of income.

Depreciation deductions for transitional plant

9.15 New subsection 61A(2) ensures that the NWDV including section 57AG loadings basis applies in working out the depreciation deductions allowable to a transition taxpayer after the transition time in respect of transitional plant. The elements of the NWDV including section 57AG loadings basis are contained in new subsections 61A(3) to (9) .

Notional Written Down Value - when transitional plant is not acquired from a predecessor Government entity

9.16 New subsection 61A(7) ensures that transitional plant is notionally written down to reflect the fact that it has been used by the transition taxpayer in the period before the transition time. Notional depreciation is assumed to have been allowed to the transition taxpayer on the assumption that the unit was used wholly for the purposes of producing assessable income by the transition taxpayer from the date of the unit's acquisition or construction by the transition taxpayer.

Notional Written Down Value - when transitional plant is acquired from a predecessor Government entity

9.17 Certain transition taxpayers may have acquired transitional plant from a predecessor Government entity or from a succession of such entities. For instance, an item may have been originally constructed by a Commonwealth Government department and later transferred to a corporatised Commonwealth GBE which is later made taxable by Commonwealth Government legislation. In such circumstances, the unit's NWDV at the transition time is determined by applying notional depreciation to the original construction cost of the unit to the Commonwealth Government department from the time of the unit's construction until the transition time. [New subsections 61A(3),(4) and 7] The transition taxpayer is assumed to have acquired the unit at the time, and for the cost, it was acquired or constructed by the first 'exempt government entity' . (This result is the same whether or not the transition taxpayer has provided consideration in respect of its acquisition of the unit.) The transition taxpayer is then assumed to have been allowed notional depreciation on this assumed cost from this assumed acquisition date. The term 'exempt government entity' is defined in new subsection 61A(13) .

Calculations of notional depreciation and actual depreciation deductions

9.18 New subsections 61A(3) to (9) provide for the calculation of notional depreciation assumed to have been allowed to the transition taxpayer in respect of a unit and of actual depreciation deductions allowable to the transition taxpayer after the transition time.

9.19 A transition taxpayer can choose either the prime cost or diminishing value method of depreciation. However, the amendments will ensure that the method used for notional depreciation purposes to obtain the unit's NWDV at the transition time is the method used for the remainder of the life of the unit. [New subsection 61A(8)] This ensures that the taxpayer receives the same treatment that other taxpayers receive when making an election under section 56 of the Act.

9.20 The rates of depreciation, both for the purposes of notional depreciation and actual depreciation, are determined by making a notional estimate of the unit's effective life at the time when it was acquired or constructed by the transition taxpayer, or at the time of its assumed acquisition by the transition taxpayer in circumstances when there is a predecessor Government entity. [New subsection 61A(5)] In making this notional estimate, the transition taxpayer is assumed to have made any election that would have been available under subsection 54A(1) to adopt any determination by the Commissioner of the unit's effective life. [New subsection 61A(6)] The transition taxpayer cannot make another estimate of the unit's effective life or remaining effective life at the transition time in order to determine the rate of depreciation for actual depreciation purposes.

9.21 In determining the rate of depreciation for notional depreciation purposes, any applicable loadings under former section 57AG are taken into account but any applicable accelerated rates under former section 57AL are disregarded. [New subsection 61A(9)]

9.22 The following example demonstrates the operation of new subsections 61A(2) to (9) :

Example On 1 July 1986, a Commonwealth Government department acquires a depreciable asset at a cost of $100,000. If the Commissioner had made an estimate of the unit's effective life at 1 July 1986, he would have estimated it to be 10 years. On 1 July 1989 the unit is transferred to a corporatised Commonwealth GBE for consideration of $90,000. The Commonwealth Government legislates to make the GBE taxable commencing on 1 July 1990. The GBE uses the unit wholly for the purposes of producing assessable income in the 1991 year of income. The GBE elects to use the prime cost method of depreciation for the unit and estimates the unit's remaining effective life, at 1 July 1990, to be 3 years.The GBE is a transition taxpayer. The GBE is assumed to have acquired the unit on 1 July 1986 at an assumed cost of $100,000. The GBE is assumed to have been allowed notional depreciation for the period 1 July 1986 to 30 June 1990. The rate of depreciation for notional depreciation purposes is 11.8% (base rate of 10% + section 57AG loading of 18% of base rate) using the prime cost method applied to the assumed cost of $100,000. This same rate and method applied to the assumed cost are also used for actual depreciation purposes for the 1991 year.

Assumed cost 100,000
less notional depreciation:
1987 year [100,000 x 11.8%] (11,800)
1988 year (11,800)
1989 year (11,800)
1990 year (11,800)
--------
NWDV as at 1 July 1990 52,800
less actual depreciation allowable:
1991 year 11,800
41,000

Depreciation balancing adjustments on the disposal of transitional plant

9.23 The amendments ensure that the NWDV including section 57AG loadings basis applies when working out the amount of any balancing adjustment to be made when a transition taxpayer disposes of transitional plant. Balancing adjustments in these circumstances are worked out under new subsections 61A(11) and (12) , and not under subsections 59(1) and (2). [New subsection 61A(10)]

Including an amount in assessable income

9.24 New subsection 61A(11) provides for an amount to be included in the transition taxpayer's assessable income if the consideration receivable in respect of the disposal of a unit exceeds the unit's 'depreciated value' . Depreciated value is defined in new subsection 61A(13) . In circumstances when there is a predecessor Government entity, the assumed cost of the unit to the transition taxpayer is used to calculate the unit's depreciated value.

9.25 For instance, in the Example in paragraph 22, the depreciated value of the unit owned by the GBE at 30 June 1991 is $88,200 (assumed cost of $100,000 less actual depreciation deductions allowable of $11,800). If the GBE were to dispose of the unit on 30 June 1991 for consideration receivable of $92,000, an amount of $3,800 ($92,000 - $88,200) would be included in the GBE's assessable income for the 1991 year of income.

Deducting an amount

9.26 New subsection 61A(12) provides a formula for determining the amount to be allowed as a deduction to the transition taxpayer if the consideration receivable on the disposal of a unit is less than the unit's 'notional depreciated value' . Notional depreciated value is defined in new subsection 61A(13) . The definition takes into account the amounts of notional depreciation assumed to have been allowed to the transition taxpayer before the transition time, the amount of actual depreciation deductions allowable to the transition taxpayer after the transition time, and any further amounts of notional depreciation in respect of any use of the unit for non-assessable purposes after the transition time. In circumstances when there is a predecessor Government entity, the assumed cost of the unit to the transition taxpayer is used to calculate the unit's notional depreciated value.

9.27 The formula for determining the amount of the balancing adjustment deduction under new subsection 61A(12) is as follows:

difference X actual deductions /actual deductions + notional deductions

Each of the terms 'difference', 'actual deductions' , and 'notional deductions' is defined in new subsection 61A(12) . The effect of the formula is to limit the amount of the deduction allowable to that part of the 'difference' which reflects the extent to which the unit was actually used for assessable purposes during the entire period of its ownership, or assumed ownership by the transition taxpayer.

9.28 For instance, in the Example in paragraph 22, the notional depreciated value of the unit owned by the GBE at 30 June 1991 is $41,000 (assumed cost of $100,000 less notional depreciation before the transition time of $47,200 less actual depreciation deductions allowable of $11,800). If the GBE were to dispose of the unit on 30 June 1991 for consideration receivable of $26,000, the GBE would be allowed a deduction in the 1991 year of:

($41,000 - $26,000) x $11,800 /$11,800 + $47,200 = $3,000

Making no adjustment

9.29 If the amount of consideration receivable in respect of the disposal of transitional plant is between the unit's depreciated value and the unit's notional depreciated value, a balancing adjustment on the disposal is not required.

9.30 For instance, in the Example in paragraph 22, the depreciated value is $88,200 and the notional depreciated value is $41,000. If the GBE were to dispose of the unit on 30 June 1991 for consideration receivable of $60,000, no amount would be included in the GBE's assessable income or allowable to it as a deduction.

Application

9.31 The amendments will apply to entities which became taxable earlier than 3 July 1995 but not earlier than the start of the year of income in which 1 July 1988 occurred. The amendment is required to provide certainty with respect to entities which became subject to taxation before 3 July 1995. [Item 3]


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