Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 6 - Working out new effective life
Outline of Chapter
6.1 This Chapter explains amendments made to the ITAA 1997 that will give taxpayers, other than small business taxpayers, the option to calculate a new effective life for plant acquired after 11.45 am AEST on 21 September 1999 (time of announcement). Small business taxpayers will effectively maintain access to accelerated depreciation through the Simplified Tax System. [Schedule 5 to this Bill]
Context of Reform
6.2 Division 42 of the ITAA 1997 (depreciation of plant) currently permits a taxpayer to either self-assess the effective life of plant or to use the Commissioner's published schedule of effective life. It does not allow a taxpayer to adjust that calculation for future periods if at a later time it becomes evident that the original estimate is no longer accurate.
6.3 The ability to adjust effective life is not needed if depreciation rates are accelerated because acceleration means that plant is written-off over a period shorter than its effective life.
6.4 With the removal of accelerated depreciation (refer to Chapter 4 of this Explanatory Memorandum) taxpayers (other than small business taxpayers) will now be permitted to vary, either up or down, the effective life depreciation rates of plant acquired after the time of effect. This will allow these taxpayers to have regard to changing market or technological developments, or other factors connected with usage, that will result in plant being scrapped at a different time than had previously been determined.
Summary of new law
6.5 The new law will permit taxpayers to vary, either up or down, the effective life of plant acquired after the time of announcement. This measure is designed to allow taxpayers to have regard to changing market or technological developments, or other factors connected with usage, that influence the length of time over which an asset can be used to produce income.
6.6 The ability to vary effective life will be available to taxpayers regardless of whether they have originally assessed an asset's effective life or adopted an effective life from the Commissioner's schedule.
Comparison of key features of new law and current law
| New Law | Current Law |
|---|---|
| Under the new law taxpayers will be able to adopt a new effective life if circumstances such as market development cause a previous estimate to be no longer accurate. | Taxpayers do not have the ability to adopt a new effective life if later circumstances reveal the original estimate to be no longer accurate. |
Detailed explanation of new law
Providing for recalculation of effective life
6.7 The effective life of plant acquired after the time of announcement will be able to be calculated afresh in a later income year if circumstances have arisen that make an earlier estimate no longer accurate [item 3, subsection 42-112(1)] . The adjustment can be made whether a taxpayer self-assessed effective life or used the Commissioner's schedule.
6.8 Effective lives cannot be re-estimated by taxpayers who will still be entitled to apply rates that are accelerated. This will particularly apply to small business taxpayers who will effectively retain access to accelerated depreciation under the Simplified Tax System. [Item 3, subsection 42-112(3)]
6.9 This fresh calculation of effective life may be either up or down but it must be based on market or technological developments or other changes in circumstances connected with usage. [Item 3, subsection 42-112(4)] .
6.10 An example of where a fresh calculation is appropriate would be where adverse environmental conditions have caused plant to deteriorate more rapidly than previously estimated. An example of where a fresh calculation is not appropriate would be where a taxpayer acquires the latest model computer but retains an older model for continued use and has no intention of scrapping it any earlier than had been previously determined.
6.11 A taxpayer who chooses to work out a new effective life for an item of plant does so from the start of the income year for which the choice applies. A taxpayer does this using the same assumptions they would have used had they originally self-assessed the plant's effective life. [Item 3, subsection 42-112(5)]
6.12 The new effective life is used for the future write-off of the balance of the amount yet to be deducted. [Item 3, subsections 42-112(2), (6) and (7)]
Example 6.1
A Co. purchases plant at the start of the 2000-2001 income year, for $50,000. A Co. estimates that the plant has an effective life of 10 years and uses the prime cost method.
For that year A Co. claims a depreciation deduction for $5,000. In the next year, the taxpayer realises that the plant is wearing out more quickly then expected due to greater usage. A Co. work out a new effective life for the asset of 5 years.
A Co. needs to take into account the remaining $45,000 of the asset's written down value over that 5 year period, so A Co. adjusts the rate, and uses the opening written down value as the cost.
The rate will be:
100% / 5 = 20%
Other changes to depreciation provisions to take account of effective life recalculation
6.13 This Bill removes the requirement for taxpayers to assume that all plant is new when self-assessing effective life. [Items 1 and 2]
6.14 This is being done for 2 reasons:
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- As part of the removal of accelerated depreciation (refer to Chapter 4 of this Explanatory Memorandum), plant will be written-off over its effective life. Given this, it is appropriate that a taxpayer's estimate of effective life accurately reflects the age and condition of the plant when acquired.
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- It allows taxpayers to adjust effective life of plant because its use has been more rigorous than originally expected. It would be nonsensical to assume plant is new when reassessing its effective life.
6.15 Changes are made to the provisions dealing with the calculation of undeducted cost to ensure it is worked out correctly for plant acquired after the time of announcement where a new effective life is adopted in a later income year [item 4, subsections 42-175(3) and (4)] . This amendment will require taxpayers who adopt a new effective life to use it in the formula in that income year and in future income years when calculating undeducted cost.
6.16 Entities that are exempt from taxation but which become taxable, will have the ability to reassess effective life under the same conditions that are to apply to taxpayers generally. [Item 5, subsection 58-85(3A)]
Application and transitional provisions
6.17 The changes made by Schedule 5 apply to plant:
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- acquired by an owner or quasi-owner under a contract entered into;
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- for which construction commences; or
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- acquired in some other way,
after 11.45 am AEST on 21 September 1999. [Item 6]
Consequential amendments
6.18 There are no other consequential amendments arising from this measure.