Edited version of your written advice

Authorisation Number: 1012924500221

Ruling

Subject: Effective Life or write off period of depreciating asset

Question 1

Is the depreciable asset as described (and any subsequent brand names or iterations of the same technology and product offering) eligible to be granted a Z year depreciation write off period or effective life.

Answer

Yes.

An effective life determination of Z years has been recommended subject to the approval of effective life review panel meeting, occurring in early May 20XX.

This ruling applies for the following periods:

1 July 20YY onwards, though can be relied upon from issue date of this ruling.

The scheme commences on:

1 July 20YY.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The facts and circumstances include facts obtained during the visit by the ATO Effective Life Team to the Entity's business premises and facts and circumstances provided for the application for private ruling.

The asset subject to this ruling

The asset subject to this ruling aims to reduce low-voltage power consumption for certain target savings in commercial applications. The system is designed to automatically regulate incoming supply of voltage to a nominal output set point below the supply input.

The system actually monitors the voltage required from electrical items and provides the matching voltage for all those items. As appliances/items are switched off or on, the voltage required moves up and down. The system automatically adjusts the power output required and only draws the amount needed from the electrical grid. As a result power savings are in the order of %, as there is no loss of power through the electrical system with higher voltages.

In respect of the electronic versions of this asset which exist, the entity stated:

Instead of having a moving part they have electronic switches. They change voltage settings in blocks, like a tap changer. The stories we have heard is that they are not great, the products are not robust and they break down within a year.

Parts making up the asset

The Entity states the asset is made of several components that support its argument for a Z year effective life.

The asset is made up of distinct parts.

When the asset is split into its constituent parts most of the parts are quite robust. The ventilation system makes up only less than 5% of the total cost of the asset. This is a forced ventilation system that is a short life expectancy component, and it has a Z year life. The ventilation fans need total replacement after Z years.

Of the parts mentioned there is one that seems to fail more than the others and this has been identified. This part has moving parts and also constitutes just over % of the cost of the asset. The parts wear out at a rate of % in over 12 months, indicating that at current failure rates, all of these would need to be replaced in a period of over 200 months, or over 15 years. However, it is common sense to expect a greater failure rate as the asset gets older. It could be entirely possible that in year 4, 10 might fail and in year 10, all of them might fail.

For each machine there are numerous parts. These fail because they are a mechanical moving part with cogs and wheels which are attached to a drive system, and they also bear the brunt of the electricity that passes through them. It is unknown how many will fail on the system over its Effective Life. The Entity states:

Being mechanical the disadvantage of that is that it has moving parts. Subsequently you have wear involved. The core of the technology is the power module. These things are constantly moving. Bearings and brushes all wear out, that is purely a friction component there.

The Entity is not expecting the asset to last any length of time because they are confident that the next model or the one after that will be completely different, designed differently and will be able to produce greater options for the user. They believe this technology could be completely useless in Z years as per clause 27 of TR 2015/2.

Leasing period

The Entity wants the longest lease time possible as profits increase with using the same asset to deliver the service, however clients are wanting the best value for money and look at the useful life of the asset in their eyes without expending more capital than is absolutely necessary. The lease periods for the products already in the marketplace do not exceed Z years. Client demand is driving the leasing period for the machine. The Entity states:

Our customers have that Z year time frame in mind when deciding the value-add of the product to see if they wish to purchase the product. They want to know that they will make savings within Z years in case they need to pull it out for whatever reason.

If they lease or finance, they look at Z years. Customers don't want to commit to the X years; they want Z years because they don't know where they will be in Z years. They are thinking that there could be something better in V years, so they want the flexibility of going with that.

Warranty period

The client demand is driving a Z year effective life for the asset. Warranty options for the product sold by the Entity, also do not extend past Z years. The standard warranty for the product is less than 5 years, but can be extended to Z years. A less than five year term is the minimum offered to entice a sale, but the customer can pay for an extra year or two on the warranty for peace of mind. The entity does not offer a warranty past this period because even they are not sure on the technologies ability to last.

The power generating industry

The Entity explains that the industry is changing rapidly, especially in the energy sphere, and any product wouldn't be the same as it is these days:

Clients demands are changing all the time, and they are looking to install additional energy efficiency products, which reduces the efficiency of this, for example LED lighting, Z years ago no one wanted it as it was expensive but now it is almost everywhere. 10 years from now that product cannot look the same. The energy space is developing rapidly and is one of the most developing industries.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 40-100.

Reasons for decision

Taxation Ruling 2015/2 Income Tax: effective life of depreciating assets (applicable from 1 July 2015) (TR 2015/2) discusses the methodology used by the Commissioner in making a determination of the effective life of depreciating assets under section 40-100 of the Income Tax Assessment Act 1997. As specified in paragraphs 22 and 23 of TR 2015/2 the Commissioner will take into account various factors to determine effective life, including but not limited to: physical life, use of the asset, repairs and maintenance, obsolescence, market value and lease periods.

To try and garner a life for the asset we asked questions regarding the individual parts that make up the asset, the type of technology involved in the asset, the industry itself, issues faced by participants, how long the asset is leased for, and any warranty periods that apply to the asset.

Repairs and Maintenance

One of the determining factors of effective life is repairs and maintenance. Paragraph 33 of TR 2015/2 states:

An asset can be subject to such a level of repairs and maintenance that the point of time arrives when it has been wholly or substantially physically replaced. In those circumstances, the effective
life of the asset would be considered to have ended and a new asset to have come into place.

When the asset is split into its constituent parts most the parts are quite robust. We were informed that two parts wear out the most. In combination they make up % of the total assets' cost, which would constitute the 'substantially physically replaced' clause of TR 2015/2. It is too subjective because the asset is new. So whilst this gives us a guide it is not conclusive and cannot be relied upon with any conviction.

Obsolescence

In our experience technological obsolescence, as discussed in paragraphs 35 to 40 of TR 2015/2, is a huge determining factor in the energy industry. Technological advancements are meaning older technology is being replaced as the capital costs are not as expensive as they once were, and the monetary savings that are being taken up by using the new technology easily negates the purchase of the newer technology.

We agree with this point of view. Technological advancement is very much accelerated in the energy industry, and we are finding keeping older technologies is no longer occurring as the savings being created with newer technologies far outweigh the cost of keeping the older technology. We agree the market value, paragraph 45 of TR 2015/2, for this asset will almost be,
if not totally, exhausted after Z years.

Use of the asset in a particular industry

Paragraph 28 of TR 2015/2 considers the use of the asset in the particular industry, stating that 'how intensively an asset is used in an industry would have a direct impact on the asset's effective life.'

With such a high demand for consumers to save on running costs, and hence electricity being right at the forefront of cost saving, the industry itself is moving very quickly with new inventions and technologies replacing old infrastructure. Classic examples are renewable energy and battery technology, which has moved very quickly with new products released yearly which improve on the product in existence markedly. In our experience, we see the energy industry as one of the fastest moving industries in relation to change. Very few assets in the regulation of electricity are lasting for more than 3 years, and of those almost none are reaching 7-8 years in age. The Entity assumes a life of Z years for the system. We again think this is a reasonable assumption, and this life sits in the middle of the range of other regulating assets.

Lease and warranty periods

Paragraph 43 of TR 2015/2 states that '…it is unlikely that an asset will be leased for a period greater than its effective life…'.

The Entity want the longest lease time possible as profits increase with using the same asset to deliver the service, however clients are wanting the best value for money and look at the useful life of the asset in their eyes without expending more capital than is absolutely necessary. The lease periods for the products already in the marketplace do not exceed Z years. No company wants to commit to a longer timeframe in case they want to abandon the asset for a new one (paragraphs 41 and 42 of TR 2015/2).Warranty options for the product sold by the entity also do not extend past Z years. The standard warranty for the product is less than 5 years, but can be extended to Z years.
The entity does not offer a warranty past this period because even they are not sure on the technologies ability to last.

Conclusion

Most of the determining factors taken in to account point to a Z year life for the asset, which is a best guess. The repairs and maintenance for the asset point to a longer timeframe but this is untested over time and cannot be relied upon with any confidence. We think a reasonable life is either Z or W years, with the W years taking in to account the untested repairs and maintenance factor. We recommend a life of Z years, however because the technology is new and because we are confident we will be reviewing more of these types of assets in the future, we plan on revisiting this assessed life in a few years' time to see if it is still relevant and accurate.

If the review panel does not agree with this assessment, the Entity will be notified of the outcome.