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The Taxpayer
31 January 2011 www.taxpayer.com.au Issue 14 • 2010/2011
Capital allowances:
Companion guide
By Andy Nguyen and Roger Timms
The Uniform Capital Allowance provisions are contained in Division 40 of the
Income Tax Assessment Act 1997 (ITAA97) with capital allowance provisions
for small business entities (SBEs) being contained in Division 328 ITAA97.
This guide provides an overview of the capital allowance rules and outlines
circumstances where certain capital expenditure may be immediately deductible.
Note: All legislative references herein are to ITAA97 unless otherwise specified.
Operative provisions • the lessee of a luxury car – item 1
Broadly, the operative provisions • the lessee, where a depreciating
state that a taxpayer can deduct an asset is fixed to the land but the
amount for the ‘decline in value’ of a lessee has a right to remove the
‘depreciating asset’ that is ‘held’ for a asset – item 2
taxable purpose at any time during the • the lessee, where an improvement
year (s40-25(1)). to land by the lessee is for the
The taxpayer entitled to claim lessees own use (even though no
a deduction is the ‘holder’, a term right to remove the asset exists) –
defined in s40-40. Whilst the holder item 3, and
will commonly be the legal owner of • the economic owner of an asset
the asset, that is not always the case. under an agreement with the
The ten categories of ‘holder’ in s40-40 characteristics of a hire purchase
include: agreement – item 6.
Continued – page 210
inside…
Editorial: Is there a Tax Summit on the horizon?
Taxation of liquidator’s distributions
see overleaf for the full listing
pages 209-224
Capital allowances: Companion guide (continued from page 209)
The decline in value is determined from the asset’s
‘start time’, which simply put, is when the asset is
first ‘used’ or ‘installed ready for use’ for any purpose
(s40-60).
The Taxpayer contents
Decision diagram Capital allowances:
Companion guide . . . . . . . . . . . . . . . . . . . .209
This guide will focus primarily on the rules and
available options in calculating the decline in value Editorial: Is there a Tax Summit on the
for a depreciating asset and the tax implications horizon? . . . . . . . . . . . . . . . . . . . . . . . . . . . . .211
when a balancing adjustment event is triggered in
relation to that asset. Taxation of liquidator’s distributions . .221
The Decision diagram on page 212 outlines the
relevant steps and key considerations.
Capital allowance schedule 1. Capital expenditure incurred
It is important that taxpayers and practitioners are Division 40 primarily outlines the methodology for
aware of the operation and terminology in relation taxpayers (other than SBE taxpayers) to determine
capital allowances provisions as a Capital Allowances the decline in value available to the holder of
Schedule may be required to be lodged with the depreciating assets.
taxpayer’s annual income tax return. Pursuant to s40-45, the Division will not apply
The Capital Allowances Schedule requires specific where the capital expenditure relates to:
disclosures to be made. The Tax Office may use such • eligible work related items (such as portable
disclosures for audit purposes. electronic devices, tools of trade) under s58X
Taxpayers who are individuals satisfying the SBE of the Fringe Benefits Tax Assessment Act 1986,
test pursuant to Division 328 are not required to which have been provided to an employee as
either an expense payment or property fringe
lodge a schedule.
benefit
For other taxpayers, a capital allowances schedule
• capital works expenditure incurred pursuant to
is normally required to be completed and lodged
Division 43, and
where either:
• certain film copyright.
• the accounting depreciation for the income
year is more than $100,000 (this applies to Note: There is an anti-overlap provision under s118-
company, partnership and trust tax returns 24 which exempts a capital gain or loss arising
only), or where an asset is a ‘depreciating asset’.
• the deduction for decline in value (ie. tax Under certain circumstances, a deduction under
depreciation) is more than $100,000 (this Division 40 may be claimed for:
applies to company, fund and self-managed • business-related capital expenditure pursuant
superfund returns only). to s40-880 over a five year period
Continued – page 212
All information provided in this publication is of a general nature only and is not personal financial or investment advice. It does not take into account your particular objectives
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210 | The Taxpayer | 31 January 2011
editorial
Is there a Tax Summit on the horizon?
Two weeks can be a long recommendations addressed issues which are
time in the world of tax! In the fundamental to the operation of the Australian
first edition of The Taxpayer economy, including:
for 2011 we noted with • the corporate tax rate – the Henry Review
enthusiasm the announcement recommended a rate of 25%; this contrasts
of a review of the tax regime with calls from the federal opposition for
which deals with trusts and the corporate tax rate and the top rate
beneficiaries. However, recent of personal tax to be aligned in order to
indicators do not bode well for the proposed tax minimise avoidance techniques – a healthy
summit announced by Julia Gillard following her debate to have
negotiations with the independent members of
• the difficulties posed by the fact that almost
parliament elected at the last federal election. A
two-thirds of revenue is attributable to
commitment to convene such a summit by mid-
income taxes, and
2011 was apparently crucial to at least two of the
independent members agreeing to support the • an arguably unsustainable tax model which
government. results in 10 of the 125 taxes levied at federal,
state and local levels accounting for 90% of
We are now approaching the end of January
total tax revenue.
2011 and therefore it is pertinent to ask what we
know of the proposed summit? It seems, very The elephant in the room would appear to be
little. For example, we do not have: the much debated new tax to be levied on some
participants in the minerals industries. Whilst
• a date for the summit
this will only directly affect a small number of
• an agenda corporations the indirect effect will be felt by most
• the format under which the summit would taxpayers because of the impact on the budget
be conducted, and bottom line.
• a list of invitees. It is incumbent on the government to urgently
What we do know is that the government advise details of the summit format and agenda,
has ruled out inclusion of the GST in matters to to revise their position as to the inclusion of GST
be considered by the summit. This is a curious in discussions and to issue invitations to attend to
decision which will hopefully be revisited in interested stakeholders. n
the near future. Representatives of the business
Roger Timms - Head of Tax & Superannuation
community have rightly questioned how a
meaningful tax summit can be held without
such a key element as the GST being included.
It seems obvious that questions such as whether
the indirect tax base should be expanded and
the rate at which GST is levied should be on the
agenda.
A 2011 year summit should provide an
opportunity to revisit the array of Henry Tax
Review recommendations which were shelved
by the Rudd government. Many of those
31 January 2011 | The Taxpayer | 211
Capital allowances: Companion guide (continued from page 210)
Capital allowances decision diagram
If not a depreciating asset, the capital expenditure may:
Is the capital expenditure • form part of cost base of a CGT asset
incurred in relation to • relate to the capital works provisions (Div 43)
holding a ‘depreciating • be deductible under ‘black-hole’ expenditure rules (s40-880)
asset’? • be deductible under subdivisions 40-F, 40-G and 40-I (mining
and primary producers)
Apply Division 328:
Capital allowance rules
Yes • immediate write-off adjustable value
triggered in relation to the • Deductible balancing adjustment amount if
depreciating asset? termination value < adjustable value
212 | The Taxpayer | 31 January 2011
• certain exploration and prospecting 2. Cost of a depreciating asset
expenditure on exploration and prospecting, The ‘cost’ of a depreciating asset is relevant to
mining site rehabilitation and environmental working out the amount of the decline in value
protection activities (subdivision 40-H) which may be claimed by the taxpayer in respect of
• certain depreciating assets relating to primary that asset.
producers (subdivision 40-F), and Pursuant to subdivision 40-C, the cost of a
• certain capital expenditure relating to primary depreciating asset comprises two elements:
producers and other landholders (subdivision • first element of cost, and
40-G).
• second element of cost.
Other matters to consider (i) First element of cost
A potentially contentious issue is the treatment of The cost of a depreciating asset consists of the
the wage cost of employees who construct assets for amount that the taxpayer has paid or is taken to
use in the business of their employer. have paid in relation to the taxpayer starting to
For some time the generally accepted view hold the asset (s40-180(1)(b)).
seemed to be that expenditure of this type was In most cases, this would be the amount that
on revenue account and therefore immediately the taxpayer paid for the asset. Travel costs in
deductible. However, the Tax Office issued a locating an asset may also be included as first
discussion paper on the subject on 17 December element cost.
2008 which cast doubt on that approach. The
discussion paper puts forward the proposition that (ii) Second element of cost
employee wages can represent a capital outlay and The second element of cost is determined after
that each case must be decided on its own facts. the taxpayer starts holding the asset.
Where expenditure in the circumstances described Pursuant to s40-190, second element costs
was on capital account it would form part of the comprise:
cost of a depreciating asset to which the capital
• expenses which have contributed to bringing
allowance provisions would apply.
the asset to its present condition and location.
The circumstances where the Tax Office are An example of such costs would be the costs of
most likely to argue that wages costs are on installing a canopy and tray on a ute (refer s40-
capital account would be where the relevant 190 example), and
employee’s primary responsibilities involved asset
• expenses which are reasonably attributable to
construction. a ‘balancing adjustment event’ such as disposal
The issue has not progressed, at least publicly, of the asset (discussed below). Demolition
beyond the discussion paper stage. However, it costs in removing an old depreciating asset is
should not be assumed that the Tax Office will an example of such a cost.
continue to accept the proposition that wages costs
are always on revenue account. 3. Effective life of a depreciating asset
Practice Statement PS LA 2003/8 sets out the Having established the cost of a depreciating asset,
circumstances in which a business taxpayer may it is necessary to determine the ‘effective life’ of the
write-off capital expenditure up to $100 (GST- asset.
inclusive), where such expenditure is periodically According to s40-95(1), a taxpayer must choose to
incurred to acquire tangible assets. The practice either:
statement offers items of office equipment and tools • use the effective life determined by the
used by primary producers as examples. Commissioner (s40-100), or
This concession would not be necessary for a • self-assess the effective life (s40-105), for each
taxpayer utilising the small business concessions. depreciating asset held.
31 January 2011 | The Taxpayer | 213
Capital allowances: Companion guide (continued)
Once the choice is made, it applies for all income The Commissioner has considered factors which
years (s40-130(2)) unless a choice is made to may be relevant to the determination of the effective
recalculate the asset’s effective life. life of a depreciating asset in Tax Ruling TR 2010/2.
However, there are circumstances where the The factors identified include:
effective life of an asset is prescribed by law (ie. a • the way the asset will be used
statutory rate).
• the relevant industry standards
These choices and other rules relating to
• past experiences of users of the asset type, and
determining an asset’s effective life are explained
below: • obsolescence and scrapping policies of the
taxpayer.
(i) Commissioner’s effective life
If a taxpayer makes this choice for a depreciating (iii) Statutory rates
asset, they are required to use the rates prescribed in There are certain depreciating assets, such
public rulings issued annually by the Commissioner as intangible assets and mining, quarrying and
(Taxation Ruling: TR 2010/2: effective life of prospecting rights, where taxpayers must use the
depreciating assets is applicable from 1 July 2010). effective lives prescribed by law.
The Tax Ruling details the effective lives of assets For selected intangible assets, the prescribed
in particular industry groups and asset classes. The
effective lives (s40-95(7)) are as follows:
ruling also details the application date for which the
effective life can be used for the asset. Intangible asset Effective life (years)
Notwithstanding that a taxpayer has relied on Standard patent 20
the Commissioner’s rates, certain assets may also
have their effective lives capped under law including Innovation patent 8
certain light commercial vehicles, trailers and trucks Petty patent 6
and assets used in specified industries. Refer to s40-
102(40) and (5). Registered design 15
The shorter of:
(ii) Self assessment of effective life of asset (a) 25 years from
If a taxpayer chooses to self-assess effective life, Copyright (except when you acquire the
under s40-105(1), the taxpayer is required to estimate copyright in film) copyright, or
the period (in years and fractions of years) that the (b) the period until the
asset can be used for income producing purposes, copyright ends
taking into account:
A license (except one
• the wear and tear that would be reasonably relating to a copyright The term of the licence
expected from its use, and or in-house software)
• assuming that it will be maintained in
The shorter of:
reasonably good order and condition. (a) 25 years from
A licence relating to
When estimating the effective life of an asset, the when you become the
a copyright (except
taxpayer must consider the total life of the asset ie. an licensee, or
copyright in a film)
intention to dispose of the asset before the end of its (b) the period until the
useful life is ignored (unless the intended disposal is licence ends
by way of scrapping or abandonment).
In-house software 4
The self-assessed effective life may be shortened if
the taxpayer concludes that the asset would be likely The law does not permit a taxpayer to self-assess
to be scrapped, sold for no more than scrap value or the effective life of an asset for which an effective life
abandoned at an earlier time (s40-105(2)). is prescribed.
214 | The Taxpayer | 31 January 2011
(iv) Other rules in determining effective life 4. Methods for claiming a deduction for
Assets acquired from associates decline in value
• Where an asset has been acquired from an Section 40-65 prescribes the prime cost and
‘associate’, the taxpayer is required to assume diminishing value methods by which a taxpayer
the remaining effective life of the asset that may claim a deduction for the decline in value for
would have applied to the associate (s40- depreciating assets held during an income year.
95(4)). The term ‘associate’ is widely defined The following rules should be noted in respect of
under s318 of the Income Tax Assessment Act these methods.
1936. • Once a choice has been made by a taxpayer to
• A taxpayer may give a written notice to the use a particular method, the taxpayer cannot
associate to request information on the change methods (unless a choice is made to
effective life adopted for the asset (s40-140). recalculate the effective life under s40-110)
(s40-130).
Recalculating effective life
• For certain assets, such as intangible assets,
• Taxpayers may choose to recalculate the
only the prime cost method can be used in
effective life of a depreciating asset in a
calculating the decline in value amount.
later income year if the current effective life
is no longer accurate due to a change in • Taxpayers who are individuals (or a partnership
circumstances (s40-110(1)). which includes at least one individual) are
not allowed to claim a deduction for the
Such circumstances may include the use of
decline in value in respect of a car where the
the asset being more or less rigorous than
‘cents per kilometre’ or ‘12% of original value’
anticipated or there have been changes
methods are used for an income year (s40-
in technology which will make the asset
55). A deduction for the decline in value of a
redundant.
car is only allowed for the ‘one third of actual
• However, taxpayers must recalculate the expenses’ and ‘log book’ method.
effective life of a depreciating asset in a later
income year, if its cost in that year is increased Immediate deduction for assets costing
by at least 10% (s40-110(2)). This applies $300 or less
irrespective of whether the Commissioner’s As a general rule, a taxpayer who is deriving non-
rates or the self assessment option has been business income is entitled to claim an outright
chosen. deduction for depreciating assets with a cost of $300
An example is expenditure incurred to or less (excluding GST) (s40-80(2). Further, the asset
increase the reproduction quality of a acquired must also not be part of a set of assets that:
photocopier.
• the taxpayer acquired during the year that cost
• After re-evaluating the asset’s effective life, the more than $300, and
taxpayer may conclude that the effective life
• it was not one of a number of identical
remains the same.
or substantially identical assets that were
• A taxpayer is not allowed to recalculate the acquired during the year that cost more than
effective life of an intangible depreciating asset $300.
as listed under s40-95(7).
Note: Where a taxpayer chooses to self-assess the 5. Depreciation pools
effective life of an asset, documentary evidence Instead of choosing either the prime cost method
would need to be maintained to demonstrate the or diminishing value method, provided certain
reasons for the period of effective life estimated, conditions are met, taxpayers may opt to use a
taking into account the above conditions. This depreciation pool.
applies similarly for re-calculating the effective In general, such depreciation pools have the
life. following potential benefits:
31 January 2011 | The Taxpayer | 215
Capital allowances: Companion guide (continued)
• simplify compliance (ie. maintain a single pool to a low value pool. Deductions for the decline in
instead of multiple assets), and value continue to be claimed using the prime cost
• provide an opportunity to maximise method.
deductions for decline in value Rules for maintaining a low value pool
Subdivision 40-E allows taxpayers to make the The rules which must be observed when
choice of establishing two types of pools: maintaining a low value pool include:
• a low value pool, or • For low cost assets, there is an ‘all in’ principle.
• a software development pool That is, where a choice is made to establish
Where a taxpayer is a ‘small business entity’ (SBE), a low value pool, all low cost assets that
they may take advantage of concessional capital are acquired during the income year or in
allowance treatment. subsequent income years must be allocated to
the pool (s40-430(1))).
For completeness, taxpayers may choose
to establish a ‘project pool’ for mining capital or • Unlike low cost assets, a taxpayer may choose
transport capital expenditure under subdivision 40-I. which low value assets can be allocated to the
pool.
The operation of these pools are as follows:
• Taxpayers who allocate a depreciating asset
(i) Low value pool to a low value pool must make a reasonable
estimate of the percentage of use of the asset
A taxpayer may allocate ‘low cost’ and ‘low value’
that will be for a taxable purpose.
assets to a low value pool for the purposes of working
out the decline in value of depreciating assets. • Once a depreciating asset is allocated to the
pool, it must remain in the pool unless it is
Pursuant to s40-425, the meaning of a ‘low cost
subject to a balancing adjustment event.
asset’ and ‘low value asset’ is:
• An asset for which an immediate deduction
Low cost asset
can be claimed (no more than $300) under
• A low cost asset is a depreciating asset whose 40-80(2) cannot be allocated to the pool (s40-
cost at the end of the income year in which the 425(4)).
taxpayer first uses the asset, or has it installed
• A taxpayer cannot allocate an asset to a low
ready for use, for a taxable purpose is less than
value pool to the extent that a choice is made
$1,000 (excluding GST).
to claim deductions under the SBE concessions
• A taxpayer can choose to allocate to the pool (s40-425(7)).
a low cost asset it holds for the income year
• Similarly, a depreciating asset cannot be
in which the taxpayer starts to use the asset,
allocated to the pool where an additional
or have it installed ready for use, for a taxable
deduction can be claimed under the research
purpose.
and development provisions pursuant to
Low value asset s73BA ITAA36.
• A low value asset is a depreciating asset that Calculating the decline in value
the taxpayer holds:
A method statement under s40-440 prescribes the
-- in-which-a-deduction-for-the-decline- manner in which a deduction for the decline in value
in-value-has-been-claimed-under-the- should be calculated for a low value pool.
diminishing-value-method
In short, the rules for calculating the deduction are:
-- which-has-an-opening-adjustable-value-for-
• Low cost assets which are allocated to the pool
the-current-year-of-less-than-$1,000,-and
in their first year are depreciated at an effective
-- is-not-a-‘low-cost-asset’. tax rate of 18.75%.
Important: A depreciating asset which has an Note: There is no need to apportion for
adjustable value of less than $1,000 which has the number of days the asset is held by the
used the prime cost method cannot be allocated taxpayer.
216 | The Taxpayer | 31 January 2011
• Existing assets, which have been allocated to computer software which is either acquired or
the pool in prior income years and low value developed (either by the taxpayer or a third party)
assets allocated during the income year, are for the taxpayer’s use to perform the functions for
depreciated at an effective tax rate of 37.5%. which it was developed.
Calculating closing pool balance Costs paid to a contractor for undertaking software
The closing pool balance (s40-440(2)) is calculated development is a typical example. Consideration
by adding: of whether periodic costs incurred to acquire the
right to use computer software is expenditure on
• the closing pool balance from the previous
capital account (and therefore subject to the capital
income year
allowance provisions), or on revenue account is
• the cost of low cost assets allocated to the pool contained in ATO ID 2010/14.
for that year
Rules for maintaining a software development
• the ‘opening adjustable values’ of any low pool
value assets that are allocated to the pool for
The rules governing the implementation and
that year
maintenance of a software development pool are:
• any second element cost amounts for the
• there is an ‘all in’ principle whereby the choice
income year of:
to create a software development pool for
-- assets-allocated-to-the-pool-for-an-earlier-
an income year requires that all software
income-year,-and
development expenditure incurred must be
-- low-value-assets-allocated-to-the-pool-for- included in the pool (s40-450(2))
the-current-year
• appropriate expenditure can only be allocated
less: to the pool if the taxpayer intends to use the
• decline in value claimed as a deduction for the software solely for a taxable purpose (s40-450(3)).
year. • a separate software development pool must
Where applicable, low cost or low value assets be created for each income year for which
allocated to the pool are adjusted for non-taxable use. software development expenditure is incurred.
Balancing adjustment event That is, expenditure cannot be allocated to the
one pool (s40-450(4)), and
Where a balancing adjustment event is triggered
in relation to an asset in a low value pool, the closing • a taxpayer’s assessable income includes any
pool balance is reduced by the termination value (eg. amount derived as consideration for pooled
amount received) in respect of that asset (s40-445(1)). software unless a roll-over occurs (s40-460(1)
No separate balancing adjustment is recognised. and (2)) (eg. insurance proceeds).
The closing pool balance cannot fall below zero. Calculating the decline in value
Where the termination values exceed the closing The decline in value of each software development
pool balance, the excess amount is assessable to the is calculated using the following rates (s40-455):
taxpayer (s40-445(2)).
Income year Deductible expenditure
(ii) Software development pool Year 1 Nil
Year 2 40%
A software development pool allows a taxpayer to
Year 3 40%
make the choice to allocate amounts of expenditure
Year 4 20%
incurred in relation to ‘in-house software’ in an
income year to a software development pool to the Important: Where the project is abandoned,
extent that the expenditure relates to developing, or taxpayers are still required to claim deductions
having another entity develop that software. for the decline in value at the prescribed rates
Broadly, the meaning of ‘in-house software’ and cannot obtain an immediate deduction for the
includes computer software or a right to use unclaimed expenditure.
31 January 2011 | The Taxpayer | 217
Capital allowances: Companion guide (continued)
6. Capital allowances for small business (ii) Long life small business pool
entities Depreciating assets held by an SBE taxpayer which
Where a taxpayer satisfies the requirement to be have an effective life of 25 years or more are allocated
a ‘small business entity’ (SBE) for an income year to a long life small business pool. The taxpayer is
pursuant to subdivision 328-C, the taxpayer may allowed to claim a deduction of 5% of the opening
choose to apply the concessional capital allowance pool balance (s328-190(1)).
rules for all depreciating assets held during or before The rate is 2.5% where:
that year (s328-175). • the asset is first used or installed ready for use
These concessions, which are contained in during an income year (ie. new assets), and
subdivision 328-D, include:
• for any additional costs incurred for assets
• low cost asset write-off
already allocated to the pool (s328-190(2) and
• Small business asset pools consisting of: (3)).
-- the-general-small-business-pool,-and
- the long life small business pool. Opening and closing pool balance
Low cost asset write-off For the first income year the pool is implemented,
the opening pool balance is the sum of the adjustable
Broadly, an SBE is entitled to claim an immediate
values of the depreciating assets allocated to the
deduction for an asset which costs less than $1,000
pool (328-195(1)).
(excluding GST) to the extent that it is used for a
taxable purpose (s328-180). For later income years, the opening pool balance is
The taxpayer must be an SBE for the income year the closing pool balance worked out under s328-200.
in which the deduction is claimed and the year that This comprises the opening pool balance plus:
the asset is first held. • the sum of adjustable values of depreciating
Note: Second element costs which are less than assets used or installed ready for use and any
$1,000 which relate to a low cost asset for which cost addition amounts
a deduction has been already claimed can also be less:
claimed as an immediate deduction (s328-180(2)).
• termination values of depreciating assets where
Where that cost exceeds $1,000, that amount
a balancing adjustment event has occurred, and
should be allocated to a general small business
pool (s328-180(3)). • deduction for the decline in value of existing
assets, newly allocated assets and cost
Small business pools additions.
The rules relating to general and long life small The value of assets allocated must be adjusted for
business pools are: any non-taxable use.
(i) General small business pool
Other rules for small business capital
Depreciating assets held by an SBE taxpayer
allowance concessions
which have an effective life of less than 25 years are
allocated to the general small business pool. Other rules in relation to the SBE capital allowance
Using the pool, the taxpayer is allowed to claim a provisions include the following:
deduction of 30% of the opening pool balance (ie. • Once the taxpayer has elected to apply the SBE
using a diminishing value method) (s328-190(1)). capital allowance provisions, all depreciating
The rate is 15% where: assets must be allocated to either pool,
• the asset is first used or installed ready for use unless the asset is specifically excluded or an
during an income year (ie. new assets), and immediate deduction is available because it is
• for any additional costs incurred in respect a low cost asset.
of assets already allocated to the pool (s328- Under s328-175, assets excluded from these
190(2) and (3)). rules include:
218 | The Taxpayer | 31 January 2011
-- certain-assets-prescribed-under-s40-45-to- there is a receipt from a balancing adjustment
which-Division-40-does-not-apply-(s328- event (s328-215).
175(2)) • Once a depreciating asset is allocated to either
-- assets-in-a-low-value-or-software- small business pool, it cannot be re-allocated
development-pool-(s328-175(7)) (s328-185(7)).
-- assets-which-are-expected-to-be-let- • Where a taxpayer is no longer an SBE, any
predominantly-under-a-depreciating-asset- depreciating assets allocated to the small
lease-(s328-175(6)),-and business pool remains in the pool and the
-- assets-in-which-deductions-were- decline in value continues to be calculated at
previously-claimed-under-the-research- the relevant pool rates (s328-220(2)).
and-development-provisions-under-s73BA- 7. Balancing adjustment events
ITAA36.
Pursuant to s40-285, a taxpayer may be subject to
• A taxpayer cannot apply the SBE capital an assessable or deductible balancing adjustment
allowance provisions if a decision was made to amount to the extent that there is a ‘balancing
apply those concessions in one year and not adjustment event’.
in a later income year, despite the taxpayer
A balancing adjustment event would arise under
still being eligible. In these situations, a five
the following conditions:
year restriction is placed on the taxpayer
from applying the concessions effective from • the taxpayer stops holding the asset
the first income year for which the taxpayer (s40-295(1)(a)) (eg. upon disposal),
satisfied the conditions for being a small • the taxpayer stops using it, or having it
business entity but did not do so (s328- installed ready for use, for any purpose and
175(10)). expects never to use it, or have it installed
ready for use, again (s40-295(1)(b)) (eg. an asset
• Where the closing pool balance for an income
previously used is scrapped), and
year is less than $1,000, the small business
taxpayer is entitled to a deduction worked out • the taxpayer has not used it and:
in accordance with s328-210(2). -- if-the-taxpayer-has-had-it-installed-ready-for-
• An assessable amount arises if the pool use-–-they-stop-having-it-so-installed,-and-
balance is reduced to less than zero where -- decide-never-to-use-it-again-(s40-295(1)(c)).
Calculation of the decline in value deduction based on effective life of the asset (non SBE taxpayers)
Yes Asset used to produce non Yes
Cost does not exceed $300 Immediate 100% write off
business income (assessable)
No No
Yes Yes
Cost less than $1,000 Is a low value pool utilised? Allocate to the pool 1
No
No Decline in value based on
effective life 2
1: Depreciate at 18.75% in first year and 37.5% thereafter
2: Commissioners published effective life tables or self assess.
31 January 2011 | The Taxpayer | 219
Capital allowances: Companion guide (continued)
Summary of key principles
1. Small Business Entities (Division 328) using the diminishing value method and the
Capital expenditure less than $1,000 opening adjustable value of the asset for the
year is less than $1,000
Immediate write off
• Taxpayers may choose which low value
Capital expenditure $1,000 or more
assets to allocate to the pool
Allocate the asset to a pool
Certain assets cannot be allocated to a low value
• General pool (effective life of assets less than pool:
25 years) - Rate: 15% (year of acquisition)
• assets to which sub-division 328-D (small
then 30%
business entities) applies
• Long life pool (effective life of assets 25 years
• horticultural plants
or more) - Rate: 2.5% (year of acquisition)
then 5% • certain R&D assets, and
• depreciating assets with a cost not
Once the SBE concessions have been adopted
assets must be ‘pooled’ unless specifically exceeding $300 which can be written off.
precluded or an immediate deduction is available. Low value pool rates
• First year: 18.75%
2. Low value pools (non-SBE taxpayers)
• Subsequent years: 37.5%
Classes of assets which may be allocated to a low
value pool: 3. Assets not used in carrying on business
Low cost assets Cost does not exceed $300 and not part of a set of
• Depreciating assets with a cost of less than assets where the cost exceeds $300:
$1,000 • Immediate deduction available
• Once a low value pool is established, all low
cost assets must be allocated to the pool 4. Other circumstances
Low value assets Calculate the decline in value deduction based
• Depreciating assets the taxpayer already on the effective life of the asset in accordance
holds where deductions have been available with Division 40.
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Book at www.taxpayer.com.au/seminars Leonda by the Yarra, 2 Wallen Rd, Hawthorn VIC
220 | The Taxpayer | 31 January 2011
Taxation of liquidator’s distributions
By Tiffany Douglas
When a company is liquidated, it ceases to exist and its surplus assets are distributed to the shareholders by a
liquidator. Such distributions are not considered to be in the nature of income and therefore assessable under
the common law however a number of income tax and capital gains tax (CGT) consequences arise pursuant
to statute. This article considers those consequences as well as providing an example of their treatment in
practice.
Income tax treatment • an amount that can be identified as share
capital, and
Section 47(1) ITAA36 deems a liquidator’s
distribution to be a dividend, to the extent which • an amount that is transferred by a non
it represents ‘income derived by the company’ Corporations Act 2001 company to remove
(whether before or during the liquidation) other than shares with a par value
income which has been ‘properly applied to replace as well as certain amounts transferred:
a loss of paid-up share capital’. Furthermore, the • under certain debt-equity swaps
provision deems that this dividend has been paid to
• from an option premium reserve, or
shareholders by the company ‘out of profits’ derived
• in connection with the demutualisation of non-
by it thereby making it assessable in the hands of the
insurance, insurance, life insurance and health
shareholder pursuant to s44(1) ITAA36.
insurance companies.
Meaning of income derived by the The provision also contains a special rule relating to
company the calculation of net capital gains which requires that
Section 47(1A) clarifies that ‘income derived by a no reference be made to indexation or capital losses.
company’ for the purposes of s47(1) includes both Note: In TD 2001/14, the Commissioner of Taxation
the ordinary and statutory income of a company. confirms that when a liquidator distributes that part
A distribution of the retained earnings or post-CGT of a capital gain that is subject to the small business
gains will therefore constitute income so derived for 50% reduction under s152-205 ITAA97, it is not
the purposes of the provision whilst distributions income derived by the company and therefore not
of pre-CGT gains and paid up share capital (to the assessable for the purposes of s47(1).
extent that the paid up share capital account has not The following table summarises the income taxation
been tainted) will not. Other amounts distributed treatment:
by a liquidator not constituting income include
those where any small business relief has been Account Income tax treatment
obtained ie. the 50% reduction and/or the retirement Pre-CGT reserve Non-assessable
exemption and typically amounts attributable to
Post-CGT reserve s47(1) deemed dividend
debt forgiveness.
SB 50% reduction Non-assessable
Furthermore, liquidator’s distributions are
Debt forgiveness Generally non-assessable
frankable distributions and thus franking credits
may be allocated where available. Where however Retained earnings s47(1) deemed dividend
the paid up share capital account has been tainted,
not only will any distribution of this amount Income which has been properly applied
constitute income for the purposes of s47, it is also to replace a loss of paid-up share capital
unfrankable. A share capital account will become Section 47(1) also provides an exemption for
tainted if a company has transferred an amount income which has been properly applied to replace
to the share capital account from another account losses of paid-up share capital. Income earned during
other than: a liquidation however cannot be so properly applied
31 January 2011 | The Taxpayer | 221
Taxation of liquidator’s distributions (continued)
and accordingly, the exemption is only available this will result in a capital loss which is disregarded
where such an application has taken place prior for the purposes of s47(1A).
to the commencement of the liquidation; Glenville
Pastoral Co Pty Ltd (in liq) v Federal Commissioner of CGT considerations
Taxation (1963) 109 CLR 199. CGT consequences may exist for shareholders
where their shares in the liquidated company
The Archer Brothers principle constitute a CGT asset.
The decision of Archer Bros Pty Ltd v FCT (1953)
90 CLR 140 stands as authority for the proposition Cancellation of shares
that a distribution received by a shareholder retains The cancellation of shares upon the liquidation of
the character of the account from which it was a company results in the happening of CGT Event C2
sourced. Thus, under this principle, a liquidator is (regarding cancellation, surrender and similar endings).
free to make distributions to shareholders in the All final amounts distributed to the shareholder by
most tax-effective manner by essentially determining a liquidator, including those deemed as dividends
the order in which the funds are to be appropriated. pursuant to s47(1) form part of the capital proceeds
Whilst the Tax Office accepts that a liquidator in respect of the event and accordingly, any non-
may rely on this principle, it considers that before assessable distributions are still potentially subject to
it can be applied to a distribution (a) the company taxation. The cost base or reduced cost base is to be
accounts have been kept so that a liquidator can determined in accordance with Division 110 ITAA97
clearly identify a specific profit or fund in making a while any capital gain can be reduced by the any CGT
distribution; and (b) that the liquidator has actually concessions available to the shareholder.
appropriated the specific profit or fund in making
the distribution either in the accounts or in the
Interim liquidation distributions
statement of distribution. The Tax Office doesn’t CGT event G1 (regarding capital payments for
however consider it necessary to keep separate shares) applies where a non-assessable payment
accounts for each specific fund or profit, although is made to a shareholder in respect of a share the
maintenance of separate accounts makes it easier to shareholder owns. It is thus triggered where a non-
identify the source of a distribution. The Tax Office assessable interim distribution is made by a liquidator
also reserves the right, in appropriate circumstances, in the course of winding up a company eg. where
to look behind accounting entries and trace the there is a partial return of paid up share capital. This
actual source of the funds distributed (TD 95/10). event also applies to interim distributions comprising
in specie distributions of property.
Distributions of assets in specie The effect of the event is that the shareholder
Where the company’s constitution permits, the will realise a capital gain equal to the amount by
liquidator may distribute in specie the company which the distribution exceeds the cost base of the
assets ie. real property and choses in action (eg. shares. Furthermore, the cost base of the shares
shares) to the shareholders. An in specie distribution will be reduced by the amount of the distribution,
by a liquidator of a post-CGT asset will trigger although the event cannot create a capital loss.
CGT Event A1 on the basis that the company has Crucially, the event only applies where the company
disposed of the asset to the shareholder. The capital has not been dissolved within 18 months of making
proceeds for the event will be the deemed market the distribution. This accordingly raises a practical
value of the asset at the time of the distribution issue for shareholders seeking to lodge their income
and accordingly, where this exceeds its cost base tax returns who will be uncertain as to when the
to the company, a capital gain will result. The after- company will cease to exist and therefore whether
tax capital gain will be included in the company’s or not a capital gain has in fact been crystalised.
income for the purposes of s47 ITAA36 whilst the In response to this difficulty, the ATO considers
shareholder will be deemed to have acquired the Event G1 is only applicable where the liquidator has
asset at its market value. Where however the advised shareholders in writing that the company
market value of assets is less than its book value, will not cease to exist within 18 months; TD 2001/27.
222 | The Taxpayer | 31 January 2011
Therefore, where the company will be dissolved Application of CGT concessions
within 18 months, this event is to be disregarded Where the shares have been held for at least
with the distribution forming part of the capital twelve months, the general discount will be
proceeds for the purposes of CGT Event C2. available. Consideration should also be given to
whether or not the shareholder is eligible for any
No further distributions by liquidator
small business relief which requires satisfaction of
CGT Event G3 happens if a liquidator declares in
the basic conditions prescribed under sub-division
writing that he or she has reasonable grounds to 152-A ITAA97 including the active asset test. This test
believe (as at the time of the declaration) there is is satisfied where the shares have been active for at
no likelihood that the shareholders in the company, least half the period that they have been owned (or
or shareholders of the relevant class of shares, will active for 7.5 years if held for more than 15 years). For
receive any further distribution in the course of the shares to be active, the total market value of the
winding up a company. The time of the CGT event following must be 80% or more of the market value
is when the liquidator makes the declaration. The of all of the assets of the company:
shareholder may choose to make a capital loss at • active assets (assets used in a business carried
this time equal to the reduced cost base of his or her on by the company), and
shares and where this choice is made, the cost base • financial instruments inherently connected with
and reduced cost base of the shares are reduced to the business that the company carries on, and
nil. This also means however that any subsequent • cash of the company that is inherently
distributions will be fully assessable as a capital gain connected with such a business.
pursuant to CGT Event C2 (to the extent that they
do not constitute a s47(1) deemed dividend). In Interaction with Division 7A
the view of the Tax Office, this event cannot apply Section 109NA ITAA36 ensures that neither s109C
while the liquidator believes there is a likelihood or s109D ITAA36 deems a dividend to be paid
that some amount (regardless of its quantum) will be following a distribution or loan made by a liquidator
distributed to shareholders; TD 2000/5. in the course of winding up a company. To the
extent however that a loan has been made and not
Relief from double taxation fully repaid by the end of the following income year,
Section 118-20 ITAA97 reduces any capital gain to s109D(1A) will deem it to be a dividend. Section
the extent that it also constitutes a deemed dividend 109L ITAA36 also ensures that double taxation does
pursuant to s47(1) ITAA36. Thus, where the capital not arise by excluding s47(1) deemed dividends
gain does not exceed the deemed dividend amount, from assessability under the provision and thus most
it will be reduced to nil otherwise it is reduced by crucially ensures that any non-assessable component
the amount which is included in assessable income. remains tax-free (subject to any CGT implications).
Example
Balance sheet of XZY Pty Ltd
Assets Shareholders equity
Cash $250,000 Paid up Share Capital $100,000
Land & buildings (acquired 1991) $400,000 Pre-CGT gains reserve $125,000
Capital gain – SB 50% reduction $125,000
Post-CGT gains reserve $50,000
Retained earnings (trading) $250,000
$650,000 $650,000
Note: The market value of the land and buildings as at 30 June 2011 is $1,000,000 whilst the company’s franking account
shows a balance of $100,000.
31 January 2011 | The Taxpayer | 223
Taxation of liquidator’s distributions (continued)
Example continued
The company went into voluntary liquidation and the liquidator makes an in specie distribution of the land
and buildings.
CGT implications for the company
Capital proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,000,000
Less: cost base. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$(400,000)
Net capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$600,000
Tax payable at 30% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$(180,000)
Net capital gain (after tax) . . . . . . . . . . . . . . . . . . . . . . . . . . . $420,000
Liquidator’s distribution:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $70,000
Land and buildings – at market value . . . . . . . . . . . . . . . . . . . $1,000,000
$1,070,000
Composition of the liquidator’s distribution and associated income tax implications
Paid-up share capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 100,000 Non-assessable
Pre-CGT gains reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 125,000 Non-assessable
Post-CGT gains reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50,000 S47(1) deemed dividend
Capital gain – SB 50% reduction . . . . . . . . . . . . . . . . . . . . . . . $ 125,000 Non-assessable
Capital gain – land and buildings . . . . . . . . . . . . . . . . . . . . . . $ 420,000 S47(1) deemed dividend
Retained earnings (trading) . . . . . . . . . . . . . . . . . . . . . . . . . . $ 250,000 S47(1) deemed dividend
$ 1,070,000
Implications for shareholders
Scenario 1 – Pre-CGT shares held in XYZ Pty Ltd by resident individual shareholder
Dividend assessable s44(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . $720,000*
*Note that the imputation credits of $100,000 will attach to the distribution.
There would be no CGT implications for the shareholder.
Scenario 2 – Post-CGT shares held in XYZ Pty Ltd by resident individual shareholder
Income tax implications
Dividend assessable s44(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . $720,000*
*Note that the imputation credits of $100,000 will attach to the distribution.
CGT implications
Capital proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,070,000
Cost base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$(100,000)
$970,000
Less: s47(1) deemed dividend pursuant to s118-20 ITAA97 . . . . . .$(720,000)
$250,000
Less: discount at 50% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$(125,000)
Net capital gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,000*
*Subject to any other CGT concessions being available.
224 | The Taxpayer | 31 January 2011