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Ruling

Subject: Depreciation deduction

Question 1

Can roll-over relief be chosen pursuant to subsection 328-243(1) of the Income Tax Assessment Act 1997 (ITAA 1997) if all the assets that were allocated to the partnership's general small business pool are disposed of to the former partners and, just after the disposals, no former partner has an interest in each of the assets that were allocated to the pool?

Answer

No. Roll-over relief cannot be chosen pursuant to subsection 328-243(1) of the ITAA 1997 if all the assets that were allocated to the partnership's general small business pool are disposed of to the former partners and, just after the disposals, no former partner has an interest in each of the assets that were allocated to the pool, as the condition at paragraph 328-243(1)(c) of the ITAA 1997 is not met.

Question 2

Is any deduction available with respect to the remaining pool balance after subtracting the market values of the pool assets that were disposed of to the former partners?

Answer

No.

Question 3

Are you entitled to a deduction under either Division 328 or Division 40 of the ITAA 1997 with respect to the assets that were disposed of to you by the former partnership?

Answer

Yes, with the cost of each of these assets in your hands being their market value.

This ruling applies for the following periods:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

A partnership, consisting of individual partners, which conducted a business, was a small business entity (SBE) which allocated all its depreciating assets to its general small business pool.

The partners dissolved the partnership and each started to carry on business as a sole trader. As a result all of the assets held by the partnership were disposed of to the former partners. The disposal of each asset by the partnership is a balancing adjustment event for that asset of the kind mentioned in subsection 40-295(2) of the ITAA 1997.

Just after the disposals, neither partner had an interest in each of the assets that were allocated to the pool. At that time one former partner exclusively held some of the assets and the other exclusively held the balance of the assets.

Relevant legislative provisions

Acts Interpretation Act 1901

Section 15AA

Income Tax Assessment Act 1997

Subsection 40-295(2)

Subsection 40-340(3)

Subdivision 328-D

Section 328-175

Section 328-180

Section 328-185

Section 328-215

Subsection 328-220(3)

Section 328-243

Subsection 328-243(1)

Paragraph 328-243(1)(c)

Paragraph 328-245(1)(a)

Section 328-247

Reasons for decision

*All legislative references in the following analysis are to the Income Tax Assessment Act 1997, unless otherwise stated.

Broadly, a small business entity that chooses to use Subdivision 328-D (SBE taxpayer) must use a general small business pool or long life small business pool (collectively, SBE pool) to calculate deductions for all depreciating assets they hold unless the assets are specifically excluded, or are low cost assets (sections 328-175, 328-180 and 328-185). An SBE taxpayer deducts amounts for their depreciating assets allocated to an SBE pool as if they were a single asset (Subsection 328-185(1)).

Roll-over relief under subsection 40-340(3) can be chosen pursuant to subsection 328-243(1) if, amongst other things, the transferor and the transferee jointly choose the roll-over relief. Specifically, for the roll-over relief to be chosen paragraph 328-243(1)(c) requires a joint choice by the entity or entities that have the requisite interest in the assets for which the balancing adjustment events occurred.

It provides that:

(c) the entity or entities that had an interest in the assets just before the balancing adjustment events occurred (the transferor) and the entity or entities that have an interest in the assets just after the events occurred (the transferee) jointly choose the roll-over relief;

In determining whether the condition in paragraph 328-243(1)(c) is met, the interpretative issue that arises is whether or not, for the purpose of that paragraph, the requirement that the transferee 'have an interest in the assets' just after the events occurred is only met if the transferee has, at that time, an interest in each of the assets for which the events occurred. Had the Legislature intended that the requirement that the transferee 'have an interest in the assets' be met if the interests that the transferees have between them in the assets, just after the balancing adjustment events occurred, collectively represent interests in each of the assets for which the events occurred, it could be expected that the reference in the legislation to the transferee's interest would be a reference to the entity or entities that have an interest in any of the assets.

In reaching the correct interpretation of paragraph 328-243(1)(c) regard may be had to the purpose of elective roll-over relief under subsection 328-243(1) in order to verify that the interpretation of the paragraph promotes the purpose of the Act (Section 15AA of the Acts Interpretation Act 1901). The purpose of subsection 328-243(1) in making available roll-over relief can be ascertained from the Explanatory Memorandum (EM) to the Tax Laws Amendment (2004 Measures No 7) Bill 2005, which substituted that subsection in its current form, supported by a statutory construction of the consequences of its application. The primary object of statutory construction is to construe the relevant provision so that it is consistent with the language and purpose of all the provisions of the statute (Project Blue Sky Inc v. Australian Broadcasting Authority [1998] HCA 28; (1998) 194 CLR 355).

Paragraph 7.13 of the EM stated:

7.13 The extended roll-over relief will benefit STS taxpayers by removing the balancing adjustment, or taxing point, that would otherwise arise in relation to depreciating assets at the time the ownership change occurs. This will ensure that a taxable gain or loss will only arise upon disposal of the depreciating assets. This amendment ensures that consistent treatment applies to depreciating assets under the STS regime compared with the uniform capital allowances regime.

If a taxpayer has used the uniform capital allowances regime to calculate deductions for decline in value of the depreciating assets they hold and has chosen roll-over relief under subsection 40-340(3) in respect of a change in interest in one or more of those assets which satisfies the requirements of subsection 40-295(2), the principle consequence of the roll-over relief is that a 'balancing adjustment' is deferred until there is a balancing adjustment event to which no roll-over relief is applied.

For roll-over relief to be available under section 328-243(1), all of the assets that were held by the transferor and allocated to the transferor's SBE pool must stop being held by the transferor and instead all be held by the transferee (subsection 328-243(2)). A consequence of choosing the roll-over relief is that the transferor does not subtract the taxable purpose proportions of the termination values of depreciating assets allocated to the SBE pool and for which a balancing adjustment event occurred (paragraph 328-245(1)(a)).

Accordingly, the choice of the roll-over relief in these circumstances can ensure that the closing pool balance would not be reduced to an amount less than zero and consequently that no amount is included in the transferor's assessable income under section 328-215. In other words, a taxing point will not arise as a result of the balancing adjustment events occurring for each of the assets transferred.

Another consequence of roll-over relief is that the amount that could be deducted for the transferor's SBE pool for the income year (BAE year) in which the balancing adjustment events occurred is to be split equally between the transferor and transferee (subsection 328-247(1). After the BAE year, the transferor cannot deduct any amount for the SBE pool (subsection 328-247(2)) and the transferee deducts amounts for the assets transferred and allocated to the SBE pool using Subdivision 328-D (subsection 328-220(3)). In that circumstance, the practical effect is that it is the transferee that treats the pool as a single depreciating asset, with deductions being based on the closing pool balance of the SBE pool for the BAE year.

The legislative design of Subdivision 328-D ensures a small business entity deducts amounts for all the assets allocated to an SBE pool as if they were a single asset. If roll-over relief is chosen, the transfer of all of the depreciating assets to the transferee amounts, in practical effect, to a transfer to the transferee of the undeducted balance of the SBE pool as if it were a single asset. The transferee uses this amount worked out under the Subdivision as the closing pool balance to calculate whether a taxing point will arise as a result of the balancing adjustment events occurring for each of the assets transferred and allocated to the SBE pool. In this way, a choice of roll-over relief can effectively defer the taxing point (that would have otherwise arise as a result of the balancing adjustment events occurring for each of the assets) until all of the pool of assets are disposed of by the transferee.

Accordingly, consistency of roll-over relief between Division 40 and Division 328 is achieved by ensuring that the assets allocated to an SBE pool and for which balancing adjustment events satisfying subsection 40-295(2) have occurred are treated as a single asset.

In this context, the requirement at paragraph 328-243(1)(c) that the transferee must have an interest in the assets just after the balancing adjustment events occurred is a requirement that the transferee have an interest in each of the assets for which the events occurred. This requirement is met if each of the assets that were allocated to the SBE pool are held, just after the events occurred, by a single entity, for example a reconstituted partnership as transferee or a former partner. It cannot be met if the assets that were allocated to the pool are, just after the events occurred, held by more than one entity.

In this case, the disposal of all of the assets that were allocated to the general small business pool to the former partners resulted in some of those assets being held exclusively by one former partner and the balance being held exclusively by the other. In other words, just after the balancing adjustment events occurred each former partner holds the assets disposed of to it, and does not hold, nor have an interest in, the assets disposed of to the other former partner.

In that circumstance, there is no entity or entities that have an interest in each of the assets for which balancing adjustment events occurred (that is, an interest in each of the assets that were held by the partnership before its dissolution). Accordingly, there is no transferee that can choose, jointly with the transferor, the roll-over relief. It follows that the condition at paragraph 328-243(1)(c) cannot be met and that the roll-over relief cannot be chosen pursuant to subsection 328-243(1).

Consequences for you as a former partner (and now sole trader)

As stated previously, the principle consequence of the roll-over relief is that a 'balancing adjustment' is deferred until there is a balancing adjustment event to which no roll-over relief is applied. As outlined above, roll-over relief is not available in the partnership's case.

A balancing adjustment event has occurred with all the assets in the SBE pool of the partnership when it dissolved as outlined under subsection 40-295(2).

The termination value of individual assets which were distributed to the individual partners is the market value of the asset when the balancing adjustment event occurred as outlined under item 5 of the table under subsection 40-300(2).

You received assets at their market value from the dissolved partnership. As a sole trader you have the choice of using the SBE pool regime under Division 328 or using the Uniform Capital Allowances regime under Division 40.

As roll-over relief is not available, the remaining pool balance, after subtracting the market values of the pool assets that were disposed of to the former partners, is 'lost'.