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Ruling

Subject: Deduction-decline in value

Question 1

Are the items purchased in bulk considered to be separate low-cost assets?

Answer: Yes.

Question 2

Are the items eligible for an immediate deduction within the meaning of Practice Statement PSLA 2003/8 (PSLA 2003/8)?

Answer: No.

Question 3

Are the items which may be purchased in bulk, eligible for an immediate deduction as low cost assets where the items are hired for extended periods of time?

Answer: Yes

Question 4

Are the items eligible for pooling as low value assets where the hiring period exceeds a short term hire period?

Answer: Yes.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commenced on:

1 July 2009

Relevant facts

You operate a business of hiring items.

You are a small business entity (SBE).

You provide items to commercial industry.

Each individual item or component has a cost of less than $XXX.

Due to ongoing business development you often purchase equipment in large quantities.

You hire items to an unrelated entity (the customer) for a period of a number of weeks for a set hire fee for a particular project.

Under the hire agreement the parties agree to the following additional periods of hire:

(a) an additional number of weeks hire at a set hire fee, commencing immediately after the initial term ended; and

(b) a further period of a number of weeks of hire at a set hire fee, commencing immediately after the second term ended.

There was no further agreement for hire of the same items to the customer or a related entity of the customer.

You do not lease or hire items to any associated entities.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 328-110.
Income Tax Assessment Act 1997 section 328-115.
Income Tax Assessment Act 1997 section 328-180.
Income Tax Assessment Act 1997 subsection 328-175(6)
Income Tax Assessment Act 1997 section 40-425.
Income Tax Assessment Act 1997 subsection 40-425(2).
Income Tax Assessment Act 1997 section 40-30.
Income Tax Assessment Act 1997 subsection 995-1.

Reasons for decision

Decline in value of your hiring items

Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the capital allowance provisions.

Taxation Ruling TR 94/11 Income tax: general investment allowance -what is a unit of property contains general guidelines about the functionality test and explains how it is applied to the particular factual circumstances of each case.

Whether a particular collection of components is itself a depreciating asset or whether its components are separate depreciating assets is a question of fact and degree.

The items are intended to be dismantled and relocated regularly. The size and shape of the items are governed by the size and stage of rental requirement. The items are made up of a number of individual articles each of which are considered to be a separate depreciating asset.

Depreciating assets costing $XXX or less for business taxpayers

An immediate deduction for low cost items used in carrying on a business. This applies to expenditure of $XXX or less (inclusive of GST) incurred by a taxpayer to acquire a tangible asset in the ordinary course of carrying on a business. There are however, various restrictions to this rule.

The $XXX threshold rule is subject to the conditions set out in Law Administration Practice Statement PSLA 2003/8. The immediate deduction is not available for expenditure incurred on certain items, such as new business establishment costs, certain specified assets and items that are part of a composite asset.

An immediate deduction is not available for expenditure incurred by businesses that have entered the simplified tax system prior to 1 July 2007, or to businesses that satisfy the definition of a small business entity from 1 July 2007, as these businesses are able to claim an immediate deduction for expenditure on depreciating assets costing less than $1,000.

It is noted in PSLA 2003/8 at paragraph 4 that this practice statement does not apply to assets held by a taxpayer for lease or hire or that would otherwise be used by another entity.

In your case, you are a small business entity and PSLA 2003/8 has no application to your business as the items are held for hire. Therefore, the $100 immediate deduction for low cost items purchased in bulk is not available under either Divisions 40 or 328 of the ITAA 1997. However, immediate deduction for expenditure on low cost depreciating assets costing less than $1,000 is available under Division 328 of the ITAA 1997 for small business entities.

Small Business Entity

From the 2007-08 income year the simplified tax system provisions have been replaced by the small business entity (SBE) provisions.

You are a small business entity if you are an individual, partnership, company or trust that:

· carries on a business for all or part of the income year, and

· has less than $2 million aggregated turnover.

The aggregated turnover is your annual turnover plus the annual turnover of any business you are connected with or affiliated with during the income year (section 328-115 of the ITAA 1997). This calculation excludes amounts derived from dealings between the relevant entities (while the affiliation or connection exists). Amounts derived by entities before or after the affiliation or connection existed are also excluded.

The deductibility of the depreciating assets purchased by the business will only be potentially subject to these provisions if you are a small business entity for the purposes of Division 328 of the ITAA 1997. In your case, you have stated you are a small business entity. This ruling is made on the basis of accepting this claim.

Therefore you have access to a range of tax concessions, including simplified depreciation rules as an alternative to the uniform capital allowances rules to work out deductions for most depreciating assets.

Simplified depreciation rules

Generally, a small business entity can use the following simplified depreciation rules to claim a deduction for those assets that are first used, or installed ready for use, for a taxable purpose:

· immediately write off most depreciating assets costing less than $1,000 each (low-cost assets) (section 328-180 of the ITAA 1997)

· pool in a general small business pool, and deduct at the rate of 30% most other depreciating assets with an effective life of less than 25 years (such as motor vehicles and computers) (paragraph 328-185(2)(a) of the ITAA 1997)

· pool in a long-life small business pool, and deduct at the rate of 5% most depreciating assets with an effective life of 25 years or more (such as wharves and cement silos) (paragraph 328-185(2)(b) of the ITAA 1997))

· deduct most newly acquired assets at either 15% or 2.5% in the first year, regardless of when they were acquired during that year.

Low cost asset immediate write off
Where an entity chooses to use the simplified depreciation rules under Subdivision 328D of the ITAA 1997 an immediate write off of most depreciating assets costing less than $1,000 each (low-cost assets) is available under section 328-180 of the ITAA 1997.

A low-cost asset is one where the cost at the end of the year in which it was first used or installed ready for use for a taxable purpose is less than $1,000 (excluding horticultural plants).

One exclusion is where a depreciating asset is being let, or might reasonably be expected to be let predominantly on a 'depreciating asset lease' (subsection 328-175(6)).

A 'depreciating asset lease' is defined in subsection 995-1(1) and it does not include a 'short-term hire agreement'.

Accordingly, if a depreciating asset is hired out under a short-term hire agreement, subsection 328-175(6) does not operate to exclude you from choosing to apply Subdivision 328-D in respect of that asset.

The term 'short-term hire agreement' is defined in subsection 995-1(1) as follows:

A short-term hire agreement is an agreement for the intermittent hire of an asset on an hourly, daily, weekly or monthly basis. However, an agreement for the hire of an asset is not a short-term hire agreement if, having regard to any other agreements for the hire of the same asset to the same entity or an associate of that entity, there is a substantial continuity of hiring so that the agreements together are for longer than a short-term basis.

In your case, there is an agreement for the intermittent hire of items on a weekly basis for an initial period of a number of weeks. However, an additional number of weeks of hire were agreed to in succession.

The definition of the term 'short-term hire agreement' excludes an agreement where, having regard to any other agreements for the hire of the same asset to the same entity or an associate of that entity, there is a substantial continuity of hiring so that the agreements together are for longer than a short-term basis.

As it is not sufficiently clear what is a short-term basis or a substantial continuity of hiring, extrinsic materials may be referred to. The Explanatory Memorandum to the New Business Tax System (Simplified Tax System) Act 2001 (the Explanatory Memorandum) introduced Division 328 in respect of the simplified tax system. While Division 328 has been updated to refer to SBE taxpayers, the Explanatory Memorandum is still relevant in considering the interpretation of the exclusion to a 'short-term hire agreement'. The Explanatory Memorandum states:

5.26…Short-term hirings of the same asset to the same entity, or associates of that entity, will not be regarded as a short-term hire agreement if they are reasonably continuous and total a period longer than a few months.

The defined term, 'short-term hire agreement', is also used in Division 242 in respect of leases of luxury cars. Schedule 2E of the Income Tax Assessment Act 1936 (ITAA 1936) was the predecessor to Division 242 and it specifically stated in section 42A-125 of Schedule 2E of the ITAA 1936 that consecutive short-term hire agreements should not exceed 6 months. When Division 242 replaced Schedule 2E of the ITAA 1936, section 42A-125 was removed. However, paragraph 4.41 of the Explanatory Memorandum to the Tax Laws Amendment (Transfer of Provisions) Act 2010 which introduced Division 242 states:

4.41 The Schedule 2E definition of 'short-term hire agreement' relies, in part, on the rule in section 42A-125 about treating consecutive short-term hiring agreements as leases. The existing definition of 'short-term hire agreement' in the ITAA 1997 already broadly captures that idea, so section 42A-125 is omitted. A small difference is that section 42A-125 applies to consecutive periods totalling over six months, while the ITAA 1997 definition refers to agreements that add up to 'longer than a short term basis'. The explanatory memorandum that added that definition referred to that period as being 'longer than a few months' (see paragraph 5.26 of the explanatory memorandum to the New Business Tax System (Simplified Tax System) Bill 2000), so the two ideas are substantially the same.

As such, it will be accepted that a 'short-term hire agreement' as defined in subsection 995-1(1) should not exceed six months in total.

In your case, you and your customers agree to a weekly hire for an initial weekly period followed by an additional weekly periods. Having regard to these agreements, it is considered that the hiring out of the items for less than six months does not amount to a substantial continuity of hiring and therefore will be a short-term hire agreement.

In these circumstances, the hiring out of the items by you is not a 'depreciating asset lease' for the purposes of subsection 328-175(6).

Therefore, you can claim an immediate deduction for items you hire out under section 328-180 of the ITAA 1997.

Depreciating assets lease

Where the period of hire of the same asset to the same entity, or associates of that entity, exceeds a six months period, the hiring of the assets will not be regarded as a short-term hire agreement.

Therefore, you cannot claim a deduction for the items under section 328-180(1) nor allocate the items to a pool and claim a deduction under section 328-185 of the ITAA 1997 as the hiring out of the items is considered a 'depreciating asset lease' for the purposes of subsection 328-175(6).

Accordingly, you will have to work out any deduction for a decline in value for the items under Subdivision 40-E of the ITAA 1997 as noted below.

Low value pool
Subdivision 40-E of the ITAA 1997 allows for a taxpayer to calculate the decline in value of low-cost assets (assets costing less than $1,000) and certain other depreciating assets through a low-value pool.

Subsection 40-425(1) of the ITAA 1997 gives taxpayers the choice to allocate low-cost assets to a low-value pool for the income year in which they start to use them, or have them installed ready for use, for a taxable purpose.

A low-cost asset is defined in subsection 40-425(2) of the ITAA 1997. It is a depreciating asset, except a horticultural plant whose cost as at the end of the income year in which you start to use it, or have installed ready for use, for a taxable purpose is less than $1,000.

Subsection 40-425(5) of the ITAA 1997 defines a low-value asset as a depreciating asset, except a horticultural plant, you hold:

· if you have deducted or can deduct amounts for it under Division 40 of the ITAA 1997 for a previous income year, for which you used the diminishing value method (paragraph 40-425(5)(a) of the ITAA 1997), and

· the opening adjustable value for the current year is less than $1,000, worked out using the diminishing value method (paragraph 40-425(5)(b) of the ITAA 1997), and

· it is not a low-cost asset (paragraph 40-425(5)(c) of the ITAA 1997).

Once assets are allocated to a low-value pool, an item must remain in the pool.

Once you allocate an asset to a low-value pool, it is not necessary to work out its adjustable value or decline in value separately. Only one calculation for the decline in value for all of the depreciating assets in the pool is required.

You work out the deduction for the decline in value of depreciating assets in a low-value pool using a diminishing value rate of 37.5%.

For the income year you allocate a low-cost asset to the pool you work out its decline in value at a rate of 18.75% or half the pool rate. Halving the rate recognises that assets may be allocated to the pool throughout the income year. This eliminates the need to make separate calculations for each asset based on the date it was allocated to the pool.

Certain assets are excluded from the low-value pooling arrangements from 1 July 2007, depreciating assets for which amounts have been deducted under Subdivision 328-D (about capital allowances for small business entities) subsection 40-425(7) of the ITAA 1997.