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Senate

New Business Tax System (Capital Allowances) Bill 1999

Explanatory Memorandum

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

Glossary

The following abbreviations and acronyms are used throughout this Explanatory Memorandum.

Abbreviation Definition
11.45 am AEST on 21 September 1999 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999
A Platform for Consultation Review of Business Taxation: A Platform for Consultation
A Strong Foundation Review of Business Taxation: A Strong Foundation
AEST Australian Eastern Standard Time
ANTS Government's Tax Reform Document: Tax Reform: not a new tax, a new tax system
ATO Australian Taxation Office
CGT capital gains tax
Commissioner Commissioner of Taxation
CPI Consumer Price Index
GST goods and services tax
GST Act A New Tax System (Goods and Services Tax) Act 1999
IRU indefeasible right to use a portion of an international telecommunications submarine cable system
ITAA 1936 Income Tax Assessment Act 1936
ITAA 1997 Income Tax Assessment Act 1997
RSA retirement savings account
the Recommendations Review of Business Taxation: A Tax System Redesigned
the Review Review of Business Taxation

General outline and financial impact

Full balancing adjustments on disposal of plant

This Bill amends the ITAA 1997 to:

remove plant and equipment from the CGT regime; and
include in assessable income the excess of disposal proceeds over the cost base of the plant or equipment, indexed to 30September 1999.

Date of effect: The amendments apply to balancing adjustment events (such as the disposal of plant or equipment) occurring after 11.45 am AEST on 21 September 1999.

Proposal announced: The proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 (in particular, refer to Attachment B to that Press Release).

Financial impact: The financial impact of this measure is part of the estimate for the balancing adjustment offset measures included in this Bill, but is not separately identifiable.

Compliance cost impact: This measure will reduce compliance costs, as it will reduce the need for calculations and record keeping.

Balancing adjustment offsetting

This Bill amends the ITAA 1997 to:

remove the balancing charge offset for disposals of plant, other than for small business taxpayers; and
provide for a balancing charge offset for involuntary disposals of plant to replace the current CGT roll-over relief for such disposals.

Date of effect: The amendments apply to balancing adjustment events (such as the disposal of plant or equipment) occurring after 11.45 am AEST on 21 September 1999.

Proposal announced: The proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 (in particular, refer to Attachment B to that Press Release).

Financial impact: The financial impact of this measure is set out in the table below:

1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005
$20m $400m $360m $170m $80m $0m

Compliance cost impact: This measure will reduce compliance costs, as it will reduce the need for calculations.

Small business taxpayers

This Bill amends the ITAA 1997 to provide a test to determine who is a small business taxpayer for the purposes of working out eligibility to accelerated depreciation, balancing adjustment offsets and immediate deductions for particular advance business expenditure.

Date of effect: The amendments apply to the income year in which 21September 1999 occurs and later income years.

Proposal announced: The proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 (in particular, refer to Attachment I to that Press Release).

Financial impact: This measure does not have any financial impact by itself. However, to the extent that it provides an exemption for small business taxpayers from certain measures, the revenue impact is affected. The affected measures are:

Balancing adjustment offsetting in this Bill;
Accelerated depreciation in this Bill;
Deducting prepayments in the New Business Tax System (Integrity and Other Measures) Bill 1999; and
Replacing the $300 limit with a low-value pool for assets costing less than $1,000 (to be introduced at a later date).

The financial impact cited for the prepayments measure incorporates the effect of the small business exemption. The financial impact of the small business exemption for the depreciation measures is set out in the table below:

1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005
- -$219m -$474m -$257m -$88m -$56m

Compliance cost impact: This measure involves no additional compliance costs.

Accelerated depreciation

This Bill amends the income tax law to:

remove accelerated depreciation of plant and equipment, other than for small business taxpayers satisfying certain conditions; and
where accelerated depreciation is removed, replace it with a system under which depreciation rates are determined by reference to the effective life of the plant or equipment.

Date of effect: The amendments apply to plant:

acquired under a contract entered into;
the construction of which started; or
acquired in some other way;

After 11.45 am AEST on 21September 1999.

Proposal announced: The proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 (in particular, refer to Attachment B to that Press Release).

Financial impact: The financial impact of this measure is set out in the table below:

1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005
$30m $1050m $2260m $2300m $2610m $2550m

Compliance cost impact: This measure is expected to reduce compliance costs, as it will reduce the need for depreciation rate calculations.

Submarine cables and indefeasible rights to use them

This Bill amends the ITAA 1997 to:

allow depreciation deductions for the cost of an indefeasible right to use capacity in an international telecommunications submarine cable system (IRU) over the effective life of the submarine cable; and
treat the granting of an IRU as a disposal by the grantor of an ownership interest.

Date of effect: The amendments will apply to IRUs granted over cable systems which are used for telecommunication purposes after 11.45 am AEST on 21 September 1999. Depreciation deductions will be allowed for expenditure incurred after that time.

Proposal announced: The proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 (in particular, refer to AttachmentC of that Press Release).

Financial impact: The financial impact of this measure is set out in the table below:

1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005
$11m $51m $37m $36m $30 $29

Compliance cost impact: The compliance cost impact will be minimal.

Working out new effective life

This Bill amends the ITAA 1997 to provide for rules allowing taxpayers, other than small business taxpayers, to re-estimate the effective life of plant where market, technological or other factors associated with the use of the plant have impacted on the previous estimate of effective life.

Date of effect: The amendments apply to plant:

acquired under a contract entered into;
the construction of which started; or
acquired in some other way,

After 11.45 am AEST on 21September 1999.

Proposal announced: The proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 (in particular, refer to Attachment B of that Press Release).

Financial impact: The financial impact of this measure is part of the estimate for the measure dealing with accelerated depreciation in this Bill, but is not separately identifiable.

Compliance cost impact: Where taxpayers choose to take advantage of this measure, the compliance costs are expected to be minimal.

Summary of Regulation Impact Statement

Regulation impact on business

Impact: The measures contained in this Bill are part of the Government's broad ranging reforms which will give Australia a New Business Tax System. These reforms are based on the Recommendations of the Review that the Government established to consider reforms to Australia's business tax system.

The New Business Tax System will be a simpler and sounder tax system with lower compliance costs.

Main points:

The potential compliance, administrative and economic impacts of the measures contained in this Bill have been carefully considered, both by the Review and the business sector. The business sector was involved in the substantial consultation process associated with the Review.
The measures in this Bill impact on taxpayers that undertake a particular transaction. More specifically, most of the measures in this Bill impact on taxpayers that acquire plant and equipment after 11.45 am AEST on 21 September 1999.
Ongoing compliance costs will fall as a result of the Government's business tax reforms (e.g. the measure removing depreciable assets from the CGT regime will significantly reduce the number of calculations taxpayers need to perform, as well as reduce record keeping requirements).
Small business taxpayers will retain the benefits arising from accelerated depreciation and the balancing charge offset.
The administrative costs of implementing the measures in this Bill are expected to be minimal.

Chapter 1 - Full balancing adjustments on disposal of plant

Outline of Chapter

1.1 This Chapter explains amendments that will exempt any gains or losses on the disposal of plant from the CGT provisions and will instead treat those amounts as an additional form of balancing adjustment under Division 42 of the ITAA 1997. This change will apply to balancing adjustment events for plant which occur after 11.45 am AEST on 21September 1999 (time of announcement). [Schedule 1 to this Bill]

Context of Reform

1.2 Division 42 of the ITAA 1997 (depreciation of plant) currently requires the disposal of plant to be accounted for by way of a balancing adjustment. This can result in an amount being included in assessable income or a further deduction being available. Subject to rules about double taxation, there can also be CGT implications resulting in a further amount being included in assessable income or a further capital loss being allowed.

1.3 Both the depreciation and the CGT provisions require separate records to be kept for calculating any gain or loss upon the disposal of plant. Removing plant from the CGT provisions will both simplify the law and reduce compliance costs for taxpayers.

Summary of new law

1.4 For disposals of plant after the time of announcement, the new law will exempt any capital gains and losses from the CGT provisions and will instead treat those amounts as an additional balancing adjustment under the depreciation provisions contained in Division 42 of the ITAA 1997.

1.5 Where plant purchased before the time of announcement is disposed of for more than its cost, the benefit that would have been available by way of indexation had the amount continued to be assessable as a capital gain will be retained. This will reduce the assessable amount calculated under the balancing adjustment provisions.

Comparison of key features of new law and current law

New Law Current Law
The CGT provisions will cease to apply to plant. Instead the balancing adjustment provisions will apply to take account of the difference between disposal price and cost. Plant disposed of is subject to both the balancing adjustment provisions and the CGT provisions.
For plant purchased before the time of announcement the benefit of indexation will be preserved. To the extent that an amount is included in assessable income or a further deduction is allowed under the balancing adjustment provisions, any capital gain or loss is reduced by that amount.
Any capital gain is limited to the difference between the disposal amount and the indexed cost base of the plant.

Detailed explanation of new law

Including an additional amount in assessable income on disposal of plant

1.6 This Bill includes in assessable income the excess of a plant's termination value (effectively, its sale proceeds) over its cost. For plant purchased before the time of announcement, the benefit of indexing its cost base is to be preserved. In those cases the excess will be limited to the difference between the termination value over the cost base (for CGT purposes) indexed until 30 September 1999.(Indexation is not available for plant purchased after the time of the announcement). [Item 10, section 42-192]

1.7 An example of how section 42-192 will operate is as follows:

Example 1.1 Suppose you acquired an item of plant in 1996. The plant's cost was $10,000 and its termination value in 2000 is $12,000. At the time of disposal the plant's written down value was $4,000 and the indexed cost base as at 30/9/99 was $11,000.The amount included as assessable income under subsection 42-192(1) is $2,000 that is, the amount by which the termination value ($12,000) exceeds the sum of the plant's written down value ($4,000) and balancing adjustment ($6,000). Under subsection 42-192(2), the $2,000 is reduced by $1,000 which is the difference between the plant's cost base ($11,000) and the sum of the plant's written down value ($4,000) and balancing adjustment ($6,000).Therefore, the net amount included under section 42-192 is $1,000 ($2,000 $1,000).

1.8 As this assessable amount is to be treated as a balancing adjustment amount, it will be available for amended balancing adjustment relief under Subdivision 42-H of the ITAA 1997, details of which are contained in Chapter 2 of this Explanatory Memorandum.

Allowing an additional deduction on disposal of plant

1.9 A further balancing adjustment deduction will be allowed where an item of plant's undeducted cost is less than the reduced cost base. The deduction will equal the difference between the 2amounts. Circumstances where this situation could arise are considered to be rare but nevertheless the existing CGT treatment is being preserved. [Item 11, section 42-197]

Application of additional balancing adjustments where no depreciation has been claimed or where there is an incomplete unit of plant

1.10 New Subdivision 42-GA is inserted into Division 42 to calculate an additional balancing adjustment where no depreciation deductions have been claimed or where there is a disposal of an incomplete item of plant.

1.11 This additional balancing calculation could arise where an item of plant is completed and disposed of before it is used in the income producing process. It could arise where the plant is destroyed before completion.

1.12 The additional balancing adjustment calculation must be made in the year in which the balancing adjustment event occurs. [Item 12, section 42-222]

1.13 The amount to be included in assessable income under this Subdivision will be the excess of a plant's termination value (effectively, its sale proceeds) over its cost. For plant purchased before 11.45 am on 21September 1999, the benefit of cost base indexation is to be preserved. The inclusion of this amount ensures the existing CGT treatment is preserved. [Item 12, section 42-223]

1.14 A deduction will be allowed under this Subdivision where the plant's termination value is less than the reduced cost base. The deduction will equal the difference between the 2amounts. This deduction equates to any capital loss that would have arisen under the CGT provisions ensuring that the existing CGT treatment is being preserved. [Item 12, section 42-224]

1.15 Because of the insertion of new Subdivision 42-GA, section 42-30 is amended to include the additional balancing adjustment made under new Subdivision 42-GA. [Items 6 and 7]

Circumstances where the new balancing adjustment provisions do not apply

1.16 Some items of plant will be excluded from the new balancing adjustment provisions. The exceptions cover cars, collectables, personal use assets, plant used to produce exempt income and plant acquired before 20 September 1985. As any capital gain or loss arising upon their disposal is disregarded in calculating net capital gains, they are likewise to be excluded from these balancing adjustment provisions. [Item 11, subsections 42-198(1) and (2)]

1.17 The new balancing adjustment provisions will also not apply to any profit made on plant as a result of a balancing adjustment event that is assessable under another provision of the ITAA 1997. For example, if the profit is assessable under section 6-5 then it is not included under Division 42. [Item 11, subsection 42-198(3)]

New balancing adjustment provisions where pooling is used

1.18 New balancing adjustment provisions are included for those taxpayers who use the pooling provisions contained in Subdivision 42-L. The balancing adjustment amount will equate with the capital gain that would previously have been calculated for that plant. [Item 13, subsections 42-390(2A) and (2B)]

Cutting off the operation of CGT

1.19 Any capital gain or loss arising upon the disposal of plant after 11.45 am AEST on 21 September 1999 is to be disregarded for CGT purposes [item 14] . Even though the capital gain or loss will be disregarded, the other CGT provisions for plant will continue to apply. For example, balancing adjustment relief under Common rule 1 in Subdivision 41-A of the ITAA 1997 can continue to apply where the appropriate CGT roll-over is applicable.

Changes to recognise new balancing adjustment provisions

1.20 This Bill makes changes to other depreciation provisions of the ITAA 1997to recognise the introduction of the additional balancing adjustment provisions. [Items 1 to 5, 8 and 9]

Application and transitional provisions

1.21 The amendments that disregard any capital gain or loss on disposal of plant (refer to paragraph 1.13) apply to:

a CGT event that happens after 11.45 am AEST on 21September 1999 [subitem 15(2)] ; or
disposal of a CGT asset (CGT event A1) that happens at or before 11.45 am AEST on 21 September 1999 where a contract was entered into when the event happened, but the change of ownership occurred after that time [subitem 15(3)] .

1.22 Disregarding the gain or loss on the post-announcement disposal of a CGT asset under a pre-announcement contract ensures an amount cannot be assessed under both the new balancing adjustment provisions and the CGT provisions.

1.23 The other amendments in this Schedule apply to a balancing adjustment event (such as the disposal of plant) that happens after 11.45am AEST on 21September 1999. [Subitem 15(1)]

Chapter 2 - Balancing adjustment offsetting

Outline of Chapter

2.1 This Chapter explains amendments that will:

remove the option to offset any assessable balancing adjustment amount against replacement plant for balancing adjustment events occurring after 11.45 am AEST on 21September 1999 for all taxpayers, with the exception of small business taxpayers; and
provide a new balancing adjustment offset which is to be made available for certain involuntary disposals of plant occurring after 11.45 am AEST on 21 September 1999, broadly where CGT roll-over relief for involuntary disposals is currently available.

[Schedule 2 to this Bill]

Context of Reform

2.2 Division 42 of the ITAA 1997 (depreciation of plant) currently permits a taxpayer who has disposed of depreciable plant for an amount that exceeds its depreciated value to elect to offset any assessable balancing adjustment amount against the cost or written down value of replacement or other plant.

2.3 The balancing adjustment offset applies unevenly because it gives greatest benefit to taxpayers holding plant for which depreciation allowances are significantly accelerated, and for which there is an active second-hand market. Such taxpayers can obtain a significant benefit from the further tax deferral inherent in the offset mechanism. Taxpayers with assets where there is less acceleration of depreciation or no ready second-hand market obtain little advantage comparatively.

2.4 Maintaining the balancing adjustment offset for small business taxpayers is an interim measure pending the introduction of a Simplified Tax System for these taxpayers with effect from 1 July 2001.

2.5 The new balancing adjustment offset for involuntary disposals ensures taxpayers who are forced to dispose of plant will not be disadvantaged. This is in line with the Review recommendation that a general no-detriment approach be adopted for involuntary receipts.

Summary of new law

2.6 Other than for involuntary disposals (refer to paragraph 2.7) the new law will remove the option that allows an assessable balancing adjustment to be offset against replacement or other plant. It is to be removed for balancing adjustment events (such as the disposal of plant) occurring after 11.45 am AEST on 21 September 1999. However, small business taxpayers whose average turnover is less than $1 million, will retain full access to the balancing adjustment offset.

2.7 The new law will allow an assessable balancing adjustment to be offset against replacement plant for certain involuntary disposals of plant occurring after 11.45 am AEST on 21 September 1999. It replaces the current CGT roll-over relief for involuntary disposals.

Comparison of key features of new law and current law

New Law Current Law
Other than for involuntary disposals, a balancing adjustment offset is only available for:

small business taxpayers; and
taxpayers who disposed of plant on or before 11.45am AEST on 21September 1999.

A balancing adjustment offset is available for all taxpayers.
A balancing adjustment offset will be available under the depreciation provisions for plant compulsorily acquired, lost or destroyed after 11.45 am AEST on 21 September 1999. Roll-over relief is available under the CGT provisions for assets compulsorily acquired, lost or destroyed.
Roll-over relief under the CGT provisions will cease.

Detailed explanation of new law

Removing balancing adjustment offsetting other than for small business taxpayers

2.8 Section 42-285 of the ITAA 1997 currently permits an otherwise taxable balancing adjustment to instead reduce the cost or written down value of replacement or other plant. Section 42-290 currently provides for a balancing adjustment which has been included in taxable income to be excluded (by amended assessment) and instead applied to reduce the cost of replacement plant acquired subsequently.

2.9 This Bill removes the balancing adjustment offset for plant except for small business taxpayers and for certain involuntary disposals of plant.

2.10 This Bill amends section 42-285 so that balancing adjustment offset is not available in respect of a balancing adjustment event that occurs after 11.45 am AEST on 21 September 1999. Effectively, the offset will not apply to plant disposals after that time. [Item 7, subsection 42-285(5)]

2.11 However, the offset will continue to apply to plant disposals after that time where the taxpayer is a small business taxpayer for the income year in which the balancing adjustment event occurred. [Item 7, subsection 42-285(6)]

2.12 The rules that set out who qualifies as a small business taxpayer are to be contained in the new Subdivision 960-Q, which is to be inserted by this Bill (refer to Chapter 3 of this Explanatory Memorandum).

2.13 Broadly, a taxpayer will qualify as a small business taxpayer for an income year if they carry on a business and their average turnover from that business is less than $1 million in that income year.

2.14 This Bill amends section 42-290 in the same way to remove the offset option relating to replacement plant acquired within 2years after a balancing adjustment has been included in assessable income [item 9, subsection 42-290(4)] . Again, this offset will continue to be available for small business taxpayers [item 9, subsection 42-290(5)] .

Providing a balancing adjustment offset for certain involuntary disposals

2.15 This Bill allows a new balancing adjustment offset provision for certain involuntary disposals of plant. The effect of the amendment is to allow any assessable balancing adjustment that might arise from the disposal to be offset against the cost of replacement plant. This means a lesser amount is available as a deduction for the replacement plant. [Item 10, subsection 42-293(1)]

2.16 The offset will only be available for balancing adjustment events occurring after 11.45 am AEST on 21 September 1999. These balancing adjustment events must arise because the plant is lost or destroyed, or an Australian government acquires it compulsorily or by forced negotiation. [Item 10, subsection 42-293(2)]

2.17 There are time limits imposed on when the replacement plant must be obtained. It can be obtained no earlier than one year before the time of the balancing adjustment event and no later than one year after the end of the income year in which the event occurred. The Commissioner can agree to extend the time limit. [Item 10, subsection 42-293(3)]

2.18 The existing balancing adjustment offset provisions require replacement plant to be used wholly for assessable purposes. That condition is also to apply for this type of offset. Small business taxpayers can only opt for the relief provided by this measure if they have not chosen from one of the alternatives contained in the existing law for offset relief that is, under sections 42-285 or 42-290. [Item 10, subsection 42-293(4)]

2.19 The requirement to treat the offset amount as if it were a deduction for depreciation purposes on the first day of the income year in which the replacement plant is acquired, ensures that:

under the diminishing value method that amount will be taken into account in working out opening undeducted cost which is the basis of the depreciation calculation; and
the offset amount can be recouped when there is a disposal of the replacement plant.

[Item 10, subsection 42-293(5)]

2.20 Where there are 2 or more items of replacement plant, the offset amounts are to be apportioned between those items on the basis of their cost for depreciation purposes. [Item 10, subsection 42-293(6)]

Application and transitional provisions

2.21 Most of the amendments apply to assessments for the income year in which 21 September 1999 occurred and later income years. [Subitem 23(1)] .

2.22 Two consequential amendments (items 17 and 18) deal with proposed provisions in the ITAA 1997 that apply to:

certain hire purchase arrangements entered into after 27 February 1998, which are to be treated as sale and loan transactions [subitem 23(2)] ; and
limited recourse debt arrangements that are terminated after that date [subitem 23(3)] .

2.23 These provisions refer to an assessable balancing adjustment amount that has been offset against replacement or other plant. The consequential amendments to the provisions require a different application because they rely on the Taxation Laws Amendment Bill (No.5) 1999 receiving Royal Assent, which had not occurred before the date of introduction of this Bill.

Consequential amendments

2.24 This Bill also makes other consequential amendments to the ITAA 1997 as a result of the introduction of the new balancing adjustment offset for involuntary disposals. [Items 1 to 6, 8 and 11 to 20]

Chapter 3 - Small business taxpayers

Outline of Chapter

3.1 This Chapter introduces the concept of 'small business taxpayer'. Small business taxpayers retain access to the following features of the current law that generally are being repealed for other taxpayers:

accelerated depreciation for plant and equipment;
balancing adjustment offsetting; and
immediate deductions for certain advance business expenditure.

3.2 The test to determine who is a small business taxpayer is set out in new Subdivision 960-Q of the ITAA 1997, inserted by item 22 of Schedule 2 to this Bill.

Context of Reform

3.3 The Government's announcement of the New Business Tax System foreshadowed the introduction of the Simplified Tax System for small business taxpayers to ease their compliance burden. The principal features of the Simplified Tax System are:

A cash accounting regime under which income and expenditure will generally be recognised only as they are received and paid.
A simplified depreciation arrangement under which depreciating assets costing less than $1,000 each will be written-off immediately and other depreciating assets with an effective life of less than 25 years will be pooled and depreciated at the diminishing value rate of 30%. Depreciating assets with an effective life of 25 years or more will be written-off at their effective life rates.
A simplified treatment of trading stock which will mean that small business taxpayers will need to account only for significant changes in the levels of their trading stock.

3.4 The Simplified Tax System will commence on 1 July 2001. Pending that, small business taxpayers are to retain access to the following features of the current law:

accelerated depreciation for plant and equipment used in their business activities other than predominantly in leasing activities;
balancing adjustment offsetting; and
immediate deductions for advance expenditure on the provision of services in relation to their business activities if those services are to be rendered within 13 months.

3.5 This Chapter deals only with the meaning of 'small business taxpayer'. The explanation of the changes to the current law mentioned above and the implications for small business taxpayers is contained in the following chapters:

Chapter 2 - Balancing adjustment offsetting.
Chapter 4 - Accelerated depreciation.
Chapter 9 of the Explanatory Memorandum to the New Business Tax System (Integrity and Other Measures) Bill 1999 Deducting prepayments.

Summary of new law

Meaning of small business taxpayer

3.6 A taxpayer is a small business taxpayer for an income year if the taxpayer carried on a business during that year and the taxpayer's average turnover for the year is less than $1 million.

3.7 Generally, average turnover is based on the turnover for the income year and the preceding 2 income years. If a business was not carried on in one or both of the 2 years preceding the income year, it will be the average of the turnover of those years in which a business was carried on. So, for example, the average turnover of a taxpayer commencing a business for the first time in a year of income will be the same as the turnover for that year.

3.8 For the income years before the proposed commencement of the Simplified Tax System (i.e. 1 July 2001), taxpayers have the option of basing their average turnover on their actual turnover for the year plus their estimated turnover for the following 2 years. This will ensure that the greatest number of taxpayers will qualify as small business taxpayers.

Turnover grouped with that of controlled entities

3.9 To prevent taxpayers splitting their businesses to be treated as small business taxpayers, a taxpayer's turnover will be grouped with that of entities it controls or is controlled by. These grouping measures are based on those that apply under the current CGT roll-over relief for small business.

Meaning of group turnover

3.10 Broadly, a taxpayer's group turnover for an income year means the sum of the values of all supplies of goods and services that the taxpayer and its controlled or controlling entities made during the year to third parties in the ordinary course of carrying on of a business, exclusive of GST payable on the supplies.

3.11 Turnover does not include supplies that are not made in the ordinary course of carrying on of a business. So, the sale of assets not acquired or used for trading purposes would not count as turnover. Examples of such assets include a manufacturer's plant and goods taken for private use by a retailer.

3.12 Turnover does not include things that are not supplies, such as dividend receipts, and non-business supplies as is usually the case for interest and rent received by an individual.

Application

3.13 The definition of small business taxpayer applies to the income year in which the date of announcement (i.e. 21 September 1999) occurred and later years.

Comparison of key features of new law and current law

3.14 There is no equivalent 'small business taxpayer' concept in the current income tax law. There is a small business test for CGT purposes, but it is based on net assets.

Detailed explanation of new law

3.15 The meaning of small business taxpayer is contained in new Subdivision960-Q, which is to be inserted into the ITAA 1997.

Meaning of small business taxpayer

3.16 A taxpayer is a small business taxpayer for an income year if the taxpayer carried on a business in that year and the taxpayer's 'average turnover' for the year is less than $1 million. A taxpayer's average turnover will generally be based on actual turnover for the current year and the preceding 2 years. However, taxpayers have the option of recalculating their average turnover for any of the income years before the 2001-2002 income year based on actual turnover for the year and their estimated turnover for the following 2 years. [Item 22, Schedule 2, section 960-335; item 6, Schedule 6, definition of 'small business taxpayer' inserted into subsection 995-1(1)]

Can a partnership be a small business taxpayer?

3.17 The threshold will apply to partnerships in the same manner as for other entities such as companies, trusts and individuals. That is consistent with the general treatment of partnerships under income tax law. Although partnerships are not liable to income tax, they are treated as entities for the purposes of calculating their net income and loss for an income year. Accordingly, a partnership will be a small business taxpayer in an income year if its average turnover for the year is less than $1million.

Meaning of average turnover

3.18 A taxpayer's average turnover for an income year is the average of the taxpayer's 'group turnovers' for the year and the preceding 2 years, if any. Taxpayers can only average the years in which they carry on a business, except where they are winding up a business. So, for example, if a taxpayer has carried on a business for the current and previous year only, the taxpayer would average only those 2 years. [Item 22, Schedule 2, section960-340; item 1, Schedule 6, definition of 'average turnover' inserted into subsection 995-1(1))]

Winding up a business

3.19 A taxpayer is taken to be carrying on a business in a year if:

the taxpayer is winding up a business they formerly carried on; and
the taxpayer was a small business taxpayer at the time that they stopped carrying on the business.

3.20 This avoids the need to decide whether winding up a business constitutes the carrying on of a business. This rule ensures that taxpayers are not forced to change their method of tax accounting during the winding up phase. [Item 22, Schedule 2, section960-355]

Meaning of group turnover

3.21 A taxpayer's group turnover for an income year is the sum of the 'value of the business supplies' made by the taxpayer and entities connected with the taxpayer during the year. However, this does not include any supplies made between the taxpayer and its connected entities or between those connected entities when they were both connected with the taxpayer [item 22, Schedule 2, subsection960-345(1); item 2, Schedule 6, definition of 'group turnover' inserted into subsection 995-1(1)] . Example 3.1 shows how to calculate group turnover.

Meaning of 'value of business supplies'

3.22 The concept of 'value of business supplies' is based on terms defined in the GST Act.

3.23 The value of business supplies an entity makes during an income year is the sum of the values of the supplies the entity made during the year in the ordinary course of carrying on a business [subsection960-345(2); item 8, Schedule 6, definition of 'value of business supplies' inserted into subsection 995-1(1))] . The method of working out the value of a supply depends on whether or not the supply is a 'taxable supply'.

If the supply is a taxable supply (i.e. one on which the GST is payable), its value is worked out as 10/11 of the price of the supply, so excluding the GST payable on the supply [paragraph 960-345(2)(a)] .
If the supply is not a taxable supply, its value is the same as the price of the supply [paragraph 960-345(2)(b)] . These supplies include those that are GST-free and input taxed for the purposes of the GST Act.

3.24 The term 'price' has the same meaning as in the GST Act (refer to section 9-75 of that Act). A definition of 'taxable supply', referring to the GST Act, is inserted into the ITAA 1997 [item 7, Schedule 6, definition of 'taxable supply' inserted into subsection 995-1(1))] .

3.25 Group turnover does not include:

supplies not made in the ordinary course of carrying on a business for example, the proceeds of sale of a capital asset, goods taken for own use and rental and interest receipts (unless the rental or lending activities constitute business activities); and
things that do not constitute the making of a supply for example, dividend receipts.

Linkage with CGT small business roll-over relief

3.26 The concept of group turnover draws on the existing concept of 'connected with' employed in the CGT roll-over relief provisions for small business taxpayers. These CGT provisions are contained in Division 123 of the ITAA 1997. The following provides an explanation of the term 'connected with'.

Meaning of 'connected with'

3.27 An entity is connected with another entity if it 'controls' that other entity, is controlled by that other entity or it and that other entity are controlled by the same entity (subsection 123-60(1)).

Meaning of control

The 50% or more test

3.28 An entity controls another entity if it and/or its 'small business CGT affiliates':

beneficially own interests in the other entity[F1] that carry between them the right to receive 50% or more of any distribution of income or capital by the other entity, or have the right to acquire the beneficial ownership of such interests (paragraph 123-60(2)(a)); or
if the other entity is a company beneficially own shares in the company that carry between them the right to exercise, or control the exercise of, 50% or more of the voting power in the company, or have the right to acquire beneficial ownership of such shares (paragraph 123-60(2)(b)).

3.29 The meaning of 'small business CGT affiliate' is discussed in paragraph 3.39 to 3.41.

The 40% to less than 50% test

3.30 An entity also controls another entity if it and/or its 'small business CGT affiliates':

beneficially own interests in the other entity that carry between them the right to receive 40% or more, but less than 50%, of any distribution of income or capital by the other entity, or have the right to acquire the beneficial ownership of such interests (paragraph 123-60(4)(a)); or
if the other entity is a company beneficially own shares in the company that carry between them the right to exercise, or control the exercise of, 40% or more, but less than 50%, of the voting power in the company, or have the right to acquire beneficial ownership of such shares (paragraph 123-60(4)(b)).

3.31 The rules in paragraph 3.30 do not apply if the Commissioner is satisfied, or thinks it reasonable to assume, that a third party controls that other entity.

Discretionary trusts

3.32 An entity is taken to control a discretionary trust if the entity and/or its 'small business CGT affiliates':

are the trustee or trustees of the trust and are not the public trustee of a State or Territory; or
have the power to determine the manner in which the trustee or trustees exercise the power to make any payment of income or capital to, or for the benefit of, beneficiaries of the trust (paragraph 123-60(2)(c)).

3.33 As well, a beneficiary of a discretionary trust is taken to beneficially own interests in any distribution of income or capital of the trust equal to the maximum percentage of the income or capital of the trust that the trustee of the trust has the power to pay to, or apply for the benefit of, the beneficiary (subsection 123-60(5)). However, that rule does not apply to certain public entities that could benefit from a discretionary trust because another beneficiary of the trust has an interest in the public entity (subsection 123-60(6)).

3.34 Subsection 123-60(5) links with paragraphs 123-60(2)(a) and (4)(a) above. So, for example, if a beneficiary of a discretionary trust could receive 50% or more of the income or capital of the trust, the beneficiary would be taken to control the trust under paragraph 123-60(2)(a).

3.35 A special rule applies in cases where the entity working out its group turnover is a discretionary trust. As described in paragraph 3.32, paragraph 123-60(2)(c) treats the trustee of a discretionary trust, or a person who has the power to determine the manner in which the trustee distributes the income or capital of the trust, as controlling the trust.

3.36 However, that rule does not apply if a beneficiary which section 123-60 treats as controlling the trust (e.g. by reason of their potential entitlement to a distribution of trust income or capital) is neither a 'small business CGT affiliate' of the trustee of the trust nor of the person who has that power of determination.

3.37 This Bill is amending subsection 123-60(3) so that it will apply appropriately when a discretionary trust is working out its group turnover. [Item 16 of Schedule 2]

Indirect control of entity

3.38 An entity that controls a second entity is taken to also control any entity that the second entity directly or indirectly controls. However, that generally is not the case if the second entity is a public entity (subsections123-60(7) and (8)).

Meaning of small business CGT affiliate

3.39 The concept of 'small business CGT affiliate' is defined in section 123-55. For the purposes of these small business taxpayer measures, it is relevant only to the process of working out whether an entity controls another entity, as described above. If a taxpayer controls an entity, it needs to take the value of the business supplies made by that entity into account in working out whether it is a small business taxpayer.

3.40 A person is a small business CGT affiliate of a taxpayer if:

the taxpayer is an individual and the person is their spouse or child under the age of 18 years; or
the person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer.

3.41 However, partners are not taken to be affiliates of each other simply by reason of the fact that they are in partnership with each other. The nature of partnership arrangements is that the partners usually act in concert, and in accordance with each other's wishes. Accordingly, that alone is not enough to make them affiliates of each other (subsection 123-55(2)).

Recalculating average turnover for the opening years

3.42 In working out whether they are small business taxpayers for an income year before the 2001-2002 income year, taxpayers have the option of recalculating their average turnover using their group turnover for the year plus a reasonable estimate of their group turnover, if any, for the following 2 years. [Item 22, Schedule 2, section 960-350]

Example 3.1: How to work out group turnover

A and B, who are unrelated to each other, own 50% each of the issued capital of Company C. As well, A owns 100% of D. Diagram 3.1 illustrates the structure of A and B's business affairs.

Diagram 3.1 - How to work out group turnover

The following are the values of the business supplies made by those entities in an income year.

  A ($) B (4) C (4) D (4)
Value of all business supplies 600,000 500,000 400,000 200,000
Value of those business supplies made to a connected entity 80,000 to C Nil 40,000 to A, 60,000 to B 90,000 to C

The following are the calculations of those entities group turnovers for the income year.

A's group turnover

A is connected with both C and D. It therefore needs to find the sum of the value of business supplies made by the 3 of them reduced by any supplies made between the 3 of them.

    $ $
Value of supplies made by: A 600,000
C 400,000
D 200,000
1,200,000
Less
Value of supplies made by: A to C 80,000
C to A 40,000
D to C 90,000
210,000
Group turnover 990,000
B's group turnover
B is connected with C only.
Value of supplies made by: B 500,000
C 400,000
900,000
Less
Value of supplies made by C to B 60,000
Group turnover 840,000
C's group turnover
C is connected with A, B and D.
Value of supplies made by: C 400,000
A 600,000
B 500,000
D 200,000
1,700,000
Less
Value of supplies made by: A to C 80,000
C to A 40,000
C to B 60,000
D to C 90,000
270,000
Group turnover 1,430,000
D's group turnover
D is connected with both A and C.
Value of supplies made by: D. 200,000
A 600,000
C 400,000
1,200,000
Less
Value of supplies made by: A to C 80,000
C to A 40,000
D to C 90,000
210,000
Group turnover 990,000

Application and transitional provisions

3.43 The small business taxpayer measures apply to the income year in which 21 September 1999 occurs and later years [subitem 28(1), Schedule2] . That year will normally be the 1999-2000 income year, but for some late balancers, it could be the 1998-1999 income year.

Chapter 4 - Accelerated depreciation

Outline of Chapter

4.1 This Chapter explains amendments made to the income tax law that will remove accelerated write-off rates for plant for all taxpayers except small business taxpayers who satisfy certain qualifying conditions. [Schedule 3 to this Bill]

Context of Reform

4.2 Division 42 of the ITAA 1997 (depreciation of plant) currently permits a taxpayer to deduct depreciation at accelerated rates. The depreciation rate is calculated as a percentage based on the effective life of the asset. A 20% loading is added to these rates. The rates are then broadbanded into one of 6 common rates. The 20% loading on the effective life rate, together with the broadbanding, provide accelerated rates of deductions for depreciation.

4.3 In accordance with recommendations of the Review, the current arrangements for accelerated depreciation are being replaced with a system under which the depreciation rates for plant are determined only by reference to the plant's effective life.

4.4 Removing accelerated depreciation will:

provide revenue to finance a significant reduction in the company tax rate;
improve investment decision making by removing tax-induced distortions; and
improve the structure and integrity of the tax law.

4.5 Accelerated depreciation rates will be maintained for small business taxpayers. This is an interim measure pending the introduction of a Simplified Tax System for these taxpayers with effect from 1 July 2001.

Summary of new law

4.6 The new law will remove accelerated depreciation rates for plant acquired after 11.45 am AEST on 21 September 1999. The rate for plant acquired after that time will be determined only by its effective life. The immediate deduction for plant costing less than $300 is to be retained.

4.7 Accelerated rates are to be retained for certain plant acquired by small business taxpayers after 11.45 am AEST on 21 September 1999. The intended use of the plant must be predominantly business related. However, the plant cannot be part of a major business expansion and cannot be used predominantly for leasing.

Comparison of key features of new law and current law

New Law Current Law
Depreciation rates will be determined by reference only to the basic effective life of an item of plant. Depreciation rates are determined by reference to the basic effective life adjusted by a 20% loading. This increased rate is broadbanded into one of 6 rates to provide an accelerated rate.

Detailed explanation of the new law

Removing accelerated depreciation

4.8 Subdivision 42-D of the ITAA 1997 currently contains the rules about depreciation rates. As mentioned in paragraph 4.2 the general rate is based on the effective life of the plant. The general rate is accelerated by a loading of 20%, and further accelerated by arrangements which broadband assets within 6 write-off rates.

4.9 Accelerated depreciation rates will not apply to plant:

acquired under a contract;
a taxpayer commenced to construct; or
acquired in some other way,

after 11.45am AEST on 21 September 1999 (time of announcement). For that plant, depreciation rates will be based on effective life. [Item 2, subsection 42-118(1)] .

4.10 However, accelerated depreciation rates will continue to be available to small business taxpayers for plant acquired after that time, provided certain qualifying conditions are satisfied [item2, subsection 42-118(2)] . These conditions are discussed later at paragraphs 4.17 to 4.25.

4.11 The diminishing value and prime cost formula for working out depreciation deductions will be amended so that accelerated depreciation will not apply after the time of announcement. The new calculation formulae using depreciation rates based on effective life will apply thereafter. [Item 4, subsections 42-160(2) and(3), item 5, subsections 42-165(2) and (2A)] .

Other changes to depreciation provisions to take account of accelerated depreciation being removed

4.12 As a result of these changes, subsection 42-25(2) is removed because it refers to law providing for accelerated rates. [Item 1]

4.13 Despite the removal of accelerated depreciation, items of plant that cost $300 or less will continue to be available for immediate write-off under Division42. [Item 6, section42-167]

4.14 Section 42-130, which currently deals with immediate write-off for items of plant that cost $300 or less has been removed because of section 42-167. [Item 3]

4.15 Amendments are made to section 42-175 to ensure that undeducted cost is calculated correctly for plant. In calculating that amount the current law requires a taxpayer to subtract from a plant's cost not only the actual deductions taken, but also any further amounts that were not available because of some disqualifying event, such as private usage. The current law works out these non-deductible amounts by applying the rate first used by a taxpayer to obtain an actual deduction. For plant acquired after the time of announcement the depreciation calculation provisions refer to a calculation formula rather than a rate. The amendments to section 42-175 ensure that the same result is achieved regardless of the acquisition time. [Item 7]

4.16 Where balancing adjustment roll-over relief is available for plant acquired at or before the time of announcement, the transferee is taken to have acquired the plant before that time [item 8, subsection 42-280(6)] . This ensures the transferee is not affected by the removal of accelerated rates of depreciation.

Maintaining accelerated depreciation for small business taxpayers

4.17 A new Subdivision is inserted to set out the 3 conditions that must be met in order to retain access to accelerated depreciation rates. [Item 9, Subdivision 42-K]

Condition 1: Owner or quasi-owner must be a small business taxpayer

4.18 The first condition requires the owner or quasi-owner of the plant to be a small business taxpayer in the income year in which the plant is first used or installed ready for use. [Item 9, subsection 42-345(1), item 1 of the table]

4.19 Broadly, a taxpayer will qualify as a small business taxpayer for an income year if they carry on a business and their average turnover from that business is less than $1 million in that income year refer to Chapter 3 of this Explanatory Memorandum.

Condition 2: 50% of the plant's intended use must be in an assessable income producing business

4.20 The second condition is that at least 50% of the intended use of the plant must be in carrying on a business for the purposes of producing assessable income [item 9, subsection 42-345(1), item 2 of the table] . The intended use of an item of plant could be demonstrated by the actual use it was put to during the period from the time it was first used until the end of the income year in which it was first used.

Example 4.1 Assume a person is receiving salary and wages as an employee as well as operating a small business outside employment hours. The person acquires a new computer which is partly for use in the small business and partly for use in the person's employment. In this case, the computer would only be eligible for accelerated depreciation if the computer was used at least 50% in the business.

4.21 For the purposes of this condition, a partner in a partnership will not be carrying on a business in relation to that partnership unless the partner is connected with the partnership as explained in paragraph 3.27. [Item 9, subsection 42-345(5)]

Condition 3: Reasonable expectation of maintaining small business status and plant not used for leasing

4.22 The third condition is that, at the time the plant is first used or installed ready for use, neither of the following applies:

it could be reasonably expected that because of the plant's use, whether or not in connection with another asset, the taxpayer would not be a small business taxpayer within 3 years of the end of the income year in which that time occurred; or
the plant is being, or is intended to be predominantly used for leasing as a 'plant lease'.

[Item 9, subsection 42-345(1), item 3 of the table]

4.23 This condition ensures that accelerated depreciation for an item of plant will not be available to a small business taxpayer if:

that item is part of the start-up of a major business or major expansion of an existing business; or
that item is to be used predominantly for leasing.

4.24 A plant lease covers an agreement which grants the right to use an asset. However, it does not include a hire purchase agreement or a short-term hire agreement [item 9, subsection 42-345(2)] . A reference to this definition is inserted into the dictionary in section 995-1 of the ITAA 1997 [Schedule 6, item 4] .

4.25 A short - term hire agreement is an agreement for the intermittent use of an asset, but excludes arrangements which involve a series of agreements which taken together would amount to the lease being over a period longer than a short-term basis [item 9, subsections 42 - 345(2) to(4)] . A reference to this provision is inserted into the dictionary in section 995-1 of the ITAA 1997 [Schedule 6, item 5] .

Application and transitional provisions

4.26 The changes made by Schedule 3 apply to plant:

acquired under a contract;
commenced to be constructed by a taxpayer; or
acquired in some other way,

after 11.45 am AEST on 21 September 1999 [item 14] . The changes apply to owners as well as quasi-owners.

Consequential amendments

4.27 Consequential amendments are made to both the ITAA 1936 and the ITAA 1997 so that references are made to section 42-167, which will deal with the immediate write-off of plant that cost less than $300 [items 10 to 13] . Section 42-167 replaces existing section 42-130, which this Bill proposes to remove (refer to paragraphs 4.13 and 4.14).

Chapter 5 - Submarine cables and indefeasible rights to use them

Outline of Chapter

5.1 This Chapter explains the amendments contained in Schedule 4 to this Bill which insert new Division 44 into the ITAA 1997. New Division 44 will:

modify the depreciation provisions in Division 42 of the ITAA 1997 to allow depreciation deductions for the cost of an indefeasible right to use a portion of an international telecommunications submarine cable system. The depreciation deductions will be allowed over the effective life of the submarine cable; and
treat the granting of an IRU as a disposal by the grantor of an ownership interest.

Context of Reform

5.2 Under the current law, a resident taxpayer who purchases an IRU cannot amortise the capital expenditure incurred upon entering into the IRU. Instead, the expenditure can only be written off as a capital loss when the right expires; generally at the end of the useful life of the cable.

Summary of new law

5.3 New Division 44 will modify the depreciation provisions in Division 42 so that a grantee of an IRU is able to deduct the cost of the IRU over the effective life of the cable.

5.4 The IRU will be treated as plant for the purposes of Division 42 of the ITAA 1997. The IRU holder will therefore have the choice of using either the prime cost or diminishing value methods of calculating depreciation deductions.

5.5 The deductions will commence when the taxpayer first exercises the right to use the allocated capacity of the cable for income producing purposes.

Comparison of key features of new law and current law

New Law Current Law
Depreciation deduction available over life of underlying cable No deduction. Possible capital loss when IRU disposed of, lost or destroyed.

Detailed explanation of new law

What is an IRU?

5.6 An IRU is a legal interest created by contractual agreement that confers a permanent indefeasible and exclusive right of access to some or all of the capacity in a telecommunications submarine cable system to another party. The term IRU is widely used and accepted in the telecommunications industry. The expressions 'indefeasible right of use' and 'indefeasible right of user' and 'capacity use' and 'right of use' are also used interchangeably with 'indefeasible right to use'. However described, an IRU must provide indefeasible permanent access to raw capacity in a cable system.

5.7 IRU holders in traditional consortium cable arrangements have basically the same rights and obligations as owners of the cable system except for voting and membership rights regarding cable system committees and the ability to act as a principal in claims arising in relation to the cable system. Capacity access in privately owned cable arrangements is usually only obtainable on an IRU basis.

5.8 A submarine cable system comprises not only the submarine cable itself but may also include the land based portions of the cable system including plant, testing equipment, land and buildings.

5.9 An IRU is broadly equivalent to ownership of the cable system in terms of cable operation. An IRU contract generally contains the following elements:

in consortium cable arrangements, the IRU holder uses the applicable cable system capacity to which it is entitled on the same terms and conditions as the cable system owners;
the IRU holder is generally required to contribute an upfront capital payment and to pay on-going amounts for the operation and maintenance of the cable;
the IRU holder is usually required to contribute to its proportional share of any costs which arise from the liquidation of the cable system or from claims by third parties. In addition, the IRU holder may also be entitled to any proportional share of proceeds which arise from liquidation of the cable system or from claims against third parties in respect of it; and
the IRU holder is not entitled to any compensation for the failure in or breakdown of the cable system or for any interruption of the use of the cable system.

5.10 An IRU is specifically called 'indefeasible' as it cannot be defeated or terminated by the unilateral action of one party to the IRU agreement.

An IRU as plant

5.11 IRUs will not be given a separate amortisation regime. Instead, the depreciation provisions in Division 42 will apply to IRUs as if they were units of plant [subsection 44-5(1)] . This treatment will only apply for the purposes of Division 42 and Parts 3-1 and 3-3. Application of Parts 3-1 and 3-3 is necessary to ensure that the measures removing plant from CGT (contained in Schedule 1 to this Bill) operate correctly. The treatment does not alter the nature of the contractual arrangement [subsection 44-5(3)] . The capital expenditure incurred by the purchaser of the IRU is still consideration paid for the right to use a cable system.

The cost of an IRU

5.12 When a taxpayer enters into an IRU contract it generally agrees to pay an up-front amount and also agrees to pay on-going amounts for operation and maintenance of the cable system. The former amount is the cost of the IRU for the purposes of Division 42. The latter expenses would not form part of the cost but may be deductible as normal revenue expenditure.

Commencement of deductions

5.13 A purchaser of an IRU will be able to commence claiming deductions for the year that the IRU commences to be used to produce assessable income [section 44-10] . The deduction will be apportioned if the use commences other than on the first day of the year.

Depreciation rate

5.14 The rate of depreciation for plant is generally determined in Subdivision 42-D. However, new Division 44 substitutes a rate which is based on the effective life of the cable over which the IRU is granted [section 44-15] . When calculating depreciation deductions for an IRU, as for any item of plant, a taxpayer will be able to choose between the diminishing value and prime cost methods. If the prime cost method is used the rate (expressed as a percentage) will be one divided by the number of years in the effective life of the cable [subsection 44-15(3)] . For the diminishing value method the rate will be 1 times the prime cost rate [subsection 44-15(2)] .

5.15 An IRU owner will not necessarily know what the cable owner has calculated as the effective life of the cable. Indeed, if the cable is owned by a non-resident, the cable may not have an effective life for Australian taxation purposes. Therefore, the IRU holder must place itself in the position of the cable owner and calculate the cable's effective life.

5.16 Treasurer's Press Release No. 58 of 1999 announced that, effective from 11.45 am AEST on 21 September 1999, taxpayers can elect to reassess the effective life of plant acquired after that time. This will mean for example, that if some years after the IRU is issued, technological developments mean that the cable will become obsolete in a shorter time than originally expected, an IRU holder will be able to reassess the effective life of the cable, and consequently, of the IRU.

Disposal of an IRU

5.17 A holder of an IRU generally has the right to assign their interest (whether in part or in its entirety) to a third party. The assignment of the whole IRU is a balancing adjustment event in terms of section 42-30 of the ITAA and, as such, is subject to the provisions of Subdivision 42-F, that calculate balancing adjustments.

5.18 The disposal of only part of an IRU will trigger the operation of new section 44-20. That section treats such a disposal as creating 2 new items of plant; the part that the taxpayer is disposing of and the part that it continues to own [subsection 44-20(2)] . Because of these new rules, the part disposal will no longer be a balancing adjustment event. Rather, it is the disposal of the new item of plant that will be a balancing adjustment event. Subdivision 42-J, which deals with partial changes of ownership in plant will have no application to partial disposals of IRUs or cable systems [subsection 44-20(5)] .

5.19 The undeducted cost (defined in section 42-175) of the IRU before the part disposal occurs must be apportioned on a reasonable basis between the 2 new items of plant. [Subsection 44-25(1)]

5.20 The plant that is disposed of is subject to a balancing adjustment calculation under Subdivision 42-F. Its written down value for the purposes of that calculation is the amount of written down value that is reasonably attributable to it. If the IRU has not been depreciated at the time of the part disposal it is necessary to calculate the cost and/or the reduced cost base of the part disposed of. This is because of the operation of new Subdivision 42-GA, which is inserted by Schedule 1 to this Bill. [Subsection 44-20(4)]

5.21 An IRU holder may grant more than one IRU at the same time. It is still taken to have split the plant into only 2 items of plant under new subsection 44-20(2). The calculation of the balancing adjustment is still done as if only one item of plant is disposed of.

5.22 The part that continues to be owned (the new plant) will continue to be depreciated on the following basis:

it will be treated as if it is a new item of plant [subsection 44-20(3)] ;
its cost for the purposes of calculating future depreciation deductions will be the amount of the undeducted cost of the original plant as is reasonably apportioned to it [subsections 44-25(2)] ;
the method of calculation of depreciation deductions for the original plant will be the method used for the new plant [subsections 44-25(3)] ; and
where prime cost is used, the rate is adjusted to ensure that the appropriate deductions are calculated based on the remaining effective life of the cable [subsections 44-25(5)] .

Example 5.1 Disposal of a portion of an IRUOn 31 December 2000 JW Telco Ltd enters into a contract to purchase an IRU for 10% of the capacity of a submarine cable system between Australia and New Zealand for $40 million. JW Telco Ltd assesses the effective life of the cable to be 10 years and elects to use the prime cost method to calculate deductions. The depreciation rate is 10%.For the next 2 years JW Telco Ltd calculates deductions in the following manner:

Year ended Depreciation Written Down Value (WDV)
30 June 2001 $2 million $38 million
30 June 2002 $4 million $34 million
On 30 June 2002, JW Telco Ltd disposes of 40% of its capacity for $15 million.Due to the operation of section 44-20 the IRU is split into 2 assets. JWTelco Ltd apportions the WDV of $34 million in the following manner:New plant

60% * $34 million = $20.4 million

Part it stopped owning

40% x $34 million = $13.6 million

The balancing adjustment on the part it stopped owning is calculated under section 42-190 as follows:
Termination value $15 million
WDV $13.6 million
Amount included in assessable income under section 42-192[F2] $1.4 million
Calculating later deductions for the new plantThe effective life of the IRU was originally 10 years. The disposal of 40% of the IRU had taken place in the second year. The remaining effective life of the IRU is 9 years.The prime cost method was used for the IRU and due to the operation of new subsection 44-25(3) JW Telco Ltd cannot elect to change to the diminishing value method.Using the formula in new subsection 44-25(5) the new depreciation rate for JW Telco Ltd is calculated in the following way:

(100% / Remaining effective life) = (100% / 9) = 11.11%

JW Telco Ltd calculates depreciation deductions at a rate of 11.11% on a cost of $20.4 million over 9 years.

Grant of an IRU as disposal of an ownership interest in the cable

5.23 The owner of a submarine cable system that disposes of all or part of the capacity in the cable system is treated the same way as an IRU holder who assigns part of their interest in an IRU. [Subsection 44-30(1)]

5.24 The disposal of a portion of the cable system is subject to the rules in new sections 44-20 and 44-25. That is, the disposal of a portion of the cable system creates 2 new items of plant; the part of the cable system the taxpayer is disposing of (that is applicable to the IRU granted) and the part it continues to own [subsection 44-30(2)] . Also, the undeducted cost of the original cable system is apportioned on a reasonable basis between each of the assets into which it was split.

Increase in the capacity of cable

5.25 With improvements in technology, a cable may have its capacity increased. If the cable's capacity is increased an IRU holder may be offered an increase in capacity. The increased capacity may be taken either through:

a new IRU; or
an increase in capacity of the existing IRU.

5.26 If the additional capacity is added to the existing IRU, the additional amount paid is a further addition to the cost of the IRU. The amendments will ensure that, where the IRU holder is calculating depreciation deductions using the prime cost method, the additional capital amount is added to the cost. If the diminishing value method is used then the additional capital amount is added to the opening undeducted cost for the income year in which the amount is paid. [Subsection 44-35(1)]

Recalculation of depreciation rate

5.27 Where an IRU is being depreciated using the prime cost method the amendments will require the rate to be recalculated. This recalculation will ensure that the extra cost will be written off over the remaining effective life. [Subsection 44-35(2)]

Example 5.2 Increase in the capacity of cableOn 1 July 2000, KT Communications enters into a contract to purchase an IRU over 10% of the capacity of a submarine cable system for $40million. The effective life of the cable system is 15 years.KT Communications elects to use the diminishing value method to calculate deductions and determines that the rate is 10% pa. The deductions are calculated as follows:

Year ended Depreciation Undeducted Cost (UC)
30 June 2001 $4.0 million $36 million
30 June 2002 $3.6 million $32.4 million
Due to software improvements the capacity of the cable is increased and on 31 March 2003, the cable owner offers KT Communications additional cable capacity for $15 million. KT Communications accepts the offer and this extra capacity is added to the existing IRU. The new undeducted cost is calculated as follows:
Undeducted Cost $32.4 million
Cost of additional capacity $15 million
New openining undeducted cost $47.4 million

Application of Division 41 common rules

5.28 Common rule 1 of Division 41 will apply to provide for roll-over in cases of full disposals to related entities. Common rule 2, which deals with market value substitution in situations where taxpayers do not deal with each other at arm's length, will also apply. [Subsection 44-40(1)]

5.29 Common rule 1 also allows for a joint election for roll-over relief under subsection 42-335(3). Because that section will not operate in cases of partial disposals of IRUs and cables, the opportunity will not be available to use this joint election. [Subsection 44-40(2)]

Application and transitional provisions

5.30 The amendments made by Schedule 4 relating to IRUs apply to expenditure on IRUs incurred after 11.45 am AEST on 21 September 1999. [Subitem 12(1)]

5.31 The amendments made by Schedule 4 relating to the part disposal of a cable system apply to contractual arrangements entered into after 11.45 am AEST on 21 September 1999. [Subitems 12(2)]

5.32 The amendments have no application to a submarine cable or an IRU over the submarine cable system if the cable system has been used for telecommunications purposes before 11.45 am AEST on 21 September 1999. [Subitem 12(3)]

5.33 These provisions ensure that only new cables and IRUs issued over new cables obtain the benefit of new Division 44.

Consequential amendments

5.34 Schedule 4 to this Bill also contains amendments to the ITAA 1997 which are necessary because of the introduction of a new capital allowance. These include insertion of new items in tables in:

section 12-5 (dealing with deductions [item 1] ;
section 20-30 (dealing with assessable recoupments) [item 2] ;
section 40-30 (dealing with capital allowances) [item 3] ; and
section 41-5 (dealing with common rules) [item 4] .

5.35 Other consequential amendments include insertion of notes, signposts, the removal of link notes, and an amendment to the dictionary. [Items 5 to 9]

5.36 Finally, the dictionary of the ITAA 1997 is amended to include a definition of 'IRU'. [Schedule 6, item 3]

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:

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.
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:

acquired by an owner or quasi-owner under a contract entered into;
for which construction commences; or
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.

Chapter 7 - Regulation Impact Statement

Policy objective

7.1 The measures contained in this Bill are part of the Government's broad ranging reforms which will give Australia a New Business Tax System. These reforms are based on the Recommendations of the Review that the Government established to consider reforms to Australia's business tax system.

7.2 The Government established the Review to consult on its plan to comprehensively reform the business income tax system (as outlined in ANTS). The Review made 280 recommendations to Government towards achieving a more simple, stable and durable business tax system (as set out in the Recommendations).

7.3 The New Business Tax System is designed to provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs, and improved savings as well as providing a sustainable revenue base so the Government can continue to deliver services for the community.

7.4 The New Business Tax System promotes that end by providing a basis for more robust investment decisions. This is achieved by:

using consistent and clearly articulated principles, for example;

-
taxing business entities and investments on the basis of their economic substance or equivalence rather than their legal form; and
-
aligning the tax value of business investments more closely with their commercial value, using accounting principles where appropriate;

improving simplicity and transparency;
reducing the costs of compliance through principled tax laws that are easier to understand and comply with; and
providing fairer, more equitable outcomes, and less scope for tax avoidance.

7.5 Each of the measures in this Bill is consistent with the objectives and approaches set out above. For example:

depreciating indefeasible rights to use is consistent with the tax treatment that tangible depreciating assets receive;
replacing accelerated depreciation with effective life is consistent with the move to more closely align the tax value of assets with their commercial value; and
allowing taxpayers to reassess the effective life of plant and equipment is consistent with the use of accounting principles.

Implementation options

7.6 The Review's recommendations, including those on which the measures of this Bill are based, have been the subject of extensive consultation. Discussion of each measure, including the options for implementation, are to be found in the Review's A Platform for Consultation (APFC) and A Tax System Redesigned (ATSR). Table 7.1 shows where each of the measures in this Bill (or the principles underlying the measure) is discussed.

Table 7.1 Options for implementing the measures in this Bill
Measure APFC ATSR
Removing depreciable assets from the CGT regime. Chapter 12, pp. 303-307. Recommendation 8.2, pp. 308.
Recommendation 4.10, pp. 177-180.
Depreciating the cost of indefeasible rights of use. Chapter 8, pp. 216, 227-228. Recommendation 8.2, pp. 308.
Chapter 10, pp. 268-277. Recommendation 10.1, pp. 371-372.
Replacing accelerated depreciation with effective life depreciation except for small business taxpayers. Chapter 2, pp. 116-123. Recommendation 8.1, pp. 305-308.
Removing the option to offset the balancing charge except for small business taxpayers and involuntary disposals. Chapter 1, pp. 78 and 98-99. Recommendation 8.11, pp. 318-320.
Allowing taxpayers to reassess effective life. Chapter 1, pp. 78 and 90-92. Recommendation 8.6, p. 313.

Assessment of impacts

Impact group identification

7.7 The Review has considered the impacts of the recommended New Business Tax System in A Tax System Redesigned (refer to pages 28-34). There the focus was on the economy as a whole, business, small business and investors. The Review concluded that there would be net gains to business, Government and the community generally.

7.8 Most of the measures in this Bill specifically impact on a taxpayer that conducts a type of transaction or event as shown in Table7.2.

Table 7.2: Taxpayers affected by the measures in this Bill
Measure Affected taxpayer(s)
Removing depreciable assets from the CGT regime. Taxpayers that acquire plant and equipment after 21 September 1999.
Depreciating the cost of indefeasible rights of use. Taxpayers that acquire indefeasible rights to use over new cable after 21 September 1999.
Replacing accelerated depreciation with effective life depreciation except for small business taxpayers. Taxpayers that acquire plant and equipment after 21 September 1999.
Removing the option to offset the balancing charge except for small business taxpayers and involuntary disposals. Taxpayers that dispose of plant and equipment after 21 September 1999.
Allowing taxpayers to reassess effective life. Taxpayers that acquire plant and equipment after 21 September 1999.

Analysis of costs and benefits

Compliance costs

7.9 The New Business Tax System will reduce compliance costs as it will provide a more consistent and easily understood business tax system:

Removing depreciable assets from the CGT regime will reduce the calculations that taxpayers need to perform, to one (i.e. working out any balancing charge); currently, taxpayers also need to work out if disposing the asset has resulted in a capital gain or loss, with a capital gain involving the calculation of an indexed cost base.
Replacing accelerated depreciation with effective life depreciation means the taxpayers can generally use their accounting depreciation without any adjustments.
Removing the option to offset a balancing charge involves less tax calculations.

Administration costs

7.10 The costs of implementing the measures in this Bill are not expected to give rise to any significant increase in administration costs.

Government revenue

7.11 The revenue impact of each measure is dealt with in the general outline for this Explanatory Memorandum.

Economic benefits

7.12 The New Business Tax System will provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings.

Consultation

7.13 The consultation process commenced with the release of the ANTS in August 1998. The Government established the Review in August 1998 and since that time the Review has published 4 documents on business tax reform, in particular A Platform for Consultation and A Tax System Redesigned in which the Review canvassed options and issues and sought public comment.

7.14 Also during this period, the Review has held numerous public seminars and focus group meetings with stakeholders in the taxation system. It received and analysed 376 submissions from the public on reform options. Further details are contained in paragraphs 12 to 16 of the Overview of A Tax System Redesigned.

7.15 In analysing options, the published documents frequently referred to, and often were guided by, views expressed during the consultation process.

Conclusion and recommended option

7.16 The measures contained in this Bill should be adopted to support a more efficient, innovative and internationally competitive Australian business sector, ensure a sound revenue base, reduce compliance costs and establish a simpler and sounder tax system.

The term 'entity' is defined in Subdivision 960-E of the ITAA 1997, and includes a partnership.

Treasurer's Press Release No. 58 of 21 September 1999 announced that, effective from 11.45am AEST, plant and equipment would be removed from the capital gains regime. New section 42-192, contained in Schedule 1 to this Bill, will ensure that the $1.4 million is included in JW Telco Ltd's assessable income.


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