Edited version of private advice

Authorisation Number: 1052271618254

Date of advice: 8 July 2024

Ruling

Subject: Temporary full expensing - exclusions

Question

Does paragraph 40-165(2)(b) of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A) operate to deny the taxpayer a deduction for a decline in value equal to cost for a depreciating asset under Subdivision 40-BB of the IT(TP)A?

Answer

No.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

The Company is an Australian tax resident company with all direct and indirect shareholders also being Australian tax residents.

The Company carries out contract business activities for other companies.

The sum of the Company's ordinary income and statutory income for the income year ending 30 June 20ZZ was less than $X billion. The Company is not a member of a tax consolidated group. The Company's aggregated turnover is over $XX million.

The Company has a facility at their head office. This facility is used to manufacture and modify assets and carry out various research and development (R&D) activities.

The Company has developed significant technology.

The Company constructed four assets, which are critical to the Company's operations. These assets incorporate all relevant features that have resulted from the Company's R&D activities and intellectual property.

These assets were ready for use by 30 June 20XX.

The Company had to update their 'template' design in order to incorporate the new features to the assets.

The total cost of the four assets was $XXX. The Company constructed these assets by purchasing materials and components which were then used by the Company's employees to construct the assets at the head office. The cost of each asset was provided.

None of the expenditure for R&D design work up to 30 June 20YY was capitalised to the cost of the assets. R&D design costs incurred between 1 July 20YY and 30 June 20XX were capitalised to the assets on 30 June 20XX.

The Company had to develop their own systems to improve the systems that currently exist, and to integrate with their existing systems. The Company undertook an experimental and systematic process, which generated new knowledge for the Company and the industry.

All R&D expenditure incurred prior to 7.30pm AEDT on X October 20XX (20XX Budget Time) related to another R&D Project Plan. The assets were not built based on the original R&D Project Plan but based on a separate R&D Project.

The engineer and Chief Finance Officer (CFO) of the Company identified labour that was used for the original R&D Project Plan and that was for separate R&D Project Plan.

Costs for the assets were incurred after 20XX Budget Time and the separate project was created to sort out the R&D costs from the pure design costs that were capital and part of the cost of building the assets.

To separate out the R&D costs from the design costs that were capitalised, the original R&D Project Plan was used, and the costs then journalled to the capital project. This was done for simplicity for engineers coding their time.

All of the materials and components for each of the four assets were purchased after 20XX Budget Time.

The first employee costs relating to the design and construction of each of the four assets were incurred after 20XX Budget Time.

Relevant legislative provisions

Income Tax (Transitional Provisions) Act 1997 Subdivision 40-BB

Income Tax (Transitional Provisions) Act 1997 subsection 40-165(2)

Income Tax (Transitional Provisions) Act 1997 subsection 40-165(4)

Income Tax (Transitional Provisions) Act 1997 subsection 40-165(5)

Income Tax (Transitional Provisions) Act 1997 subsection 40-160(3)

Income Tax (Transitional Provisions) Act 1997 section 40-155

Income Tax Assessment Act 1997 Subdivision 40-B

Income Tax Assessment Act 1997 Subdivision 328-C

Reasons for decision

Background

Subdivision 40-BB of the IT(TP)A provides how an entity may be eligible for TFE.

The Explanatory Memorandum to the Treasury Laws Amendment (A Tax Plan for the COVID-19 Economic Recovery) Act 2020 (TFE EM) outlines the context for the amendments introducing the TFE measures. It provides that the Government is providing a temporary tax incentive to support new investment and deliver significant cash flow benefits by allowing eligible businesses to immediately deduct the full cost of eligible depreciating assets that are first held, and first used or installed ready for use for a taxable purpose between 7.30pm, by legal time in the Australian Capital territory, on X October 20XX (20XX Budget Time) and 30 June 20XX.

TFE supports businesses that invest and builds on the enhanced instant asset write-off and accelerated depreciation previously announced through the Backing Business Investment (BBI) incentive.

Subdivision 40-BB of the IT(TP)A contains the TFE provisions that allow businesses with aggregated turnover of less than $X billion to deduct the full cost of eligible depreciating assets, worked out in accordance with subsection 40-160(3) of the IT(TP)A, that are first held, and first used or installed ready for use for a taxable purpose, between 20XX Budget Time and 30 June 20XX.

Eligible entities

The Commissioner's view in respect of TFE is outlined in Law Companion Ruling LCR 2021/3 Temporary full expensing. Relevantly, LCR 2021/3 states in relation to an entity being eligible to claim TFE:

14. An entity will be eligible for TFE if it:

•         satisfies a test based on aggregated turnover, referred to in this Ruling as the eligible entity test (section 40-155 of the IT(TP)A), or

•         is a corporate tax entity and satisfies a test based on total income, referred to in this Ruling as the alternative income test (section 40-157 of the IT(TP)A).

Eligible entity test

15. Under the eligible entity test, an entity must satisfy the definition of 'small business entity' in Subdivision 328-C of the ITAA 1997 to be eligible for TFE for an income year or satisfy it on the basis that each reference to $10 million in Subdivision 328-C of the ITAA 1997 (about aggregated turnover) was instead a reference to $5 billion.

16. This requirement means that an entity will need to carry on business in the income year and determine that its aggregated turnover is under the $5 billion threshold in accordance with the provisions of Subdivision 328-C of the ITAA 1997.

Carrying on a business

LCR 2021/3 provides guidance on determining whether an entity is carrying on a business for the purposes of TFE. Relevantly it states:

18. For companies, the ATO has published guidance in Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? In line with that guidance, companies ordinarily will be considered to carry on business if they are established and maintained to make a profit for shareholders and invest assets in gainful activities that have both a purpose and prospect of profit. This will be so even if activities are relatively limited and consist of the passive receipt of returns on investments for distribution to shareholders.

The Company is an Australian resident company. The Company carries out contract drilling activities such as air core drilling, reverse circulation drilling and diamond core drilling for large resource companies.

Therefore, The Company is considered to be carrying on a business.

Aggregated turnover

An entity is eligible for TFE if it satisfies the aggregated turnover requirements in section 40-155 of the IT(TP)A.

Section 40-155 of the IT(TP)A requires an entity accessing TFE to be a 'small business entity', as follows:

40-155 Businesses with turnover under $5 billion

This section covers you for an income year if:

(a)  you are a small business entity for the income year; or

(b)  you would be a small business entity for the income year if:

(i)            each reference in Subdivision 328-C of the Income Tax Assessment Act 1997 (about what is a small business entity) to $10 million were instead a reference to $5 billion; and

(ii)           the reference in paragraph 328-110(5)(b) of that Act to a small business entity were instead a reference to an entity covered by this section.

The Company have advised that their aggregated turnover for the income year ended 30 June 202XX was more than $50 million.

On the basis that the Company is carrying on a business has an aggregated turnover which is greater than $XX million but less than $X billion, it can be concluded that the Company satisfies the small business entity criteria in section 40-155 of the IT(TP)A (where the reference to $XX million was instead a reference to $X billion).

Exclusions under section 40-165 of the IT(TP)A 1997

Subsection 40-165(2) of the ITTP Act provides an exclusion for commitments already entered into and states:

This exclusion applies in relation to the asset if, before the 20XX budget time, you:

(a)  entered into a contract under which you would hold the asset; or

(b)  started to construct the asset; or

(c)   started to hold the asset in some other way.

Subsection 40-165(4) of the IT(TP)A provides that for the purposes of subsection 40-165(2) of the IT(TP)A, treat yourself as having started to construct an asset at a time if you first incur expenditure in respect of the construction of the asset at that time.

For the avoidance of doubt, subsection 40-165(5) of the IT(TP)A provides that you do not enter into a contract under which you hold an asset merely because you acquire an option to enter into such a contract.

The TFE EM provides minimal commentary in respect of the exclusion for commitments already entered into. However, as identified in footnote 52 of LCR 2021/3, Example 1.16 in paragraph 1.104 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business and General Business Tax Break) Bill 2009 (Tax Break EM) is a reasonable illustration of when an entity would first incur expenditure in respect of an asset's construction for TFE purposes.

The extract from Example 1.16 of the Tax Break EM is as follows:

Greenfield Power is a power supply company that builds its own transmission lines. During mid-2008, the company started to contemplate building a number of new transmission lines. Over the remainder of 2008, preliminary design work was undertaken in anticipation of the project going ahead.

On 15 January 2009, the company's directors signed off a decision to proceed with construction of the lines. However, the company does not physically start to construct the transmission lines or order materials at this stage.

On 10 February 2009 the relevant division of the company started to finalise the specification of the lines and placed the first of a series of orders for the necessary materials.

The investment commitment time for each of the transmission lines is 15 January 2009 as this is when the company evidenced a clear intention to proceed with the construction.

Application to your circumstances

Prior to 20XX Budget Time, the Company took two actions:

•         incurred R&D design costs for original R&D Project Plan; and

•         placed a purchase order for a component of the assets.

The original R&D Project Plan was not used to build the assets.

The purchase order was submitted early as the supplier had a backlog of work. The Company submitted the purchase order in order to be placed into the supplier's queue, but the Company did not incur any expenditure prior to 20XX Budget Time on any materials or components for the assets.

The Company did not incur any costs and expenditure on the construction of the assets until after 20XX Budget Time.

Conclusion

The exclusion in subsection 40-165(2) of the IT(TP)A will not apply to prevent the Company from applying the TFE measures under Subdivision 40-BB of the IT(TP)A to the assets for the income year ended 30 June 20XX.