CHAPTER 14 – CAPITAL ALLOWANCES

Principles of Taxation Law2020

Answers to Questions

CHAPTER 14 – CAPITAL ALLOWANCES

Question 14.1

On 1 June 2018, Roganpurchased a new scooter for $6,000 for use in his business. The Commissioner has assessed the effective life of scooters as three years. Rogandecided to upgrade to a scooter and sold the old one to a reputable second-hand dealer for $3,000 on 31 August 2019. Rogan estimates that he used the scooter for business purposes 90% of the time.

Advise Roganof his income tax consequences arising on the disposal of the scooter under both the diminishing value method and the prime cost method. Assume that Rogan does not qualify as a small business entity.

Answer

Prime cost method (s 40-75):

Decline in value:

• 1 June 2018–30 June 2018: $6,000 x (30/365) x (100% / 3) = $164
• 1 July 2018–30 June 2019: $6,000 x (365/365) x (100% / 3) = $2,000
• 1 July 2019–31 August 2019: $6,000 x (62/365) x (100% / 3)= $340

See [14.70]–[14.90].

Adjustable value = $6,000 – $2,504= $3,496:ITAA97, s 40-85

Termination value = $3,000

Termination value < Adjustable value, therefore Rogan has a deduction of $496for the year:ITAA97, s 40-285(2).

However, as Rogan only used the scooter for business purposes 90% of the time, his depreciation deductions would have been reduced by 10%; therefore, his balancing adjustment deduction must also be reduced by 10%. Therefore, balancing adjustment deduction = $496x 90% = $446: ITAA97, s 40-290.

See [14.100]–[14.120].

Diminishing value method (s 40-72):

Decline in value:

• 1 June 2018–30 June 2018: $6,000 x (30/365) x (200% / 3) = $329
• 1 July 2018–30 June 2019: ($6,000 – $329) x (365/365) x (200% / 3) = $3,781
• 1 July 2019–31 August 2019: ($6,000 – $329 – $3,781) x (62/365) x (200% / 3) = $214

See [14.70]–[14.90].

Adjustable value = $6,000 – $4,324= $1,676:ITAA97, s 40-85

Termination value = $3,000

Termination value > Adjustable value; therefore Rogan has an assessable income amount of $1,324for the year:ITAA97, s40-285(1).

As Rogan only used the scooter for business purposes 90% of the time, his depreciation deductions would have been reduced by 10%; therefore, his balancing adjustment amount must also be reduced by 10%. Therefore, balancing adjustment amount= $1324x 90% = $1,192: ITAA97, s 40-290.

See [14.100]–[14.120].

Question 14.2

Jack and Jill jointly own and run a bed and breakfast business. The business is run through their partnership, J & J Bed and Breakfast. Jack and Jill also own an investment property together which they purchased in equal proportions. During the year, they undertook the following transactions:

• Purchased furniture for their bed and breakfast business for $3,000 on 21 December 2019. The furniture is expected to last for seven years.
• Purchased a printer for their bed and breakfast business for $700 on 30 April 2020. The machine is expected to last for three years.
• Purchased an air-conditioner for their investment property for $2,000 on 15 March 2020. The air-conditioner is expected to last for eight years. Jack and Jill contributed to the purchase price of the air-conditioner equally.

Advise Jack and Jill of their income tax consequences arising out of the above information under both the diminishing value method and the prime cost method (if relevant) for the year ended 30 June 2020. Assume that the business does not qualify as a small business entity.

Answer

• Purchase of furniture is by the partnership;therefore partnership includes depreciation deductions in calculating its taxable income for the year.
  • Prime cost method:
    • Depreciation = $3,000 x (193/365) x (100% / 7) = $225
      • This assumes that the partnership is choosing to self-assess the effective life of the furniture.
  • Diminishing value method:
    • Depreciation = $3,000 x (193/365) x (200% / 7) = $451
      • This assumes that the partnership is choosing to self-assess the effective life of the furniture.
      • 200% is used as the asset is acquired after 10 May 2006: ITAA97, s 40-72.
• Purchase of printer → purchased by the partnership;therefore partnership must include depreciation deductions in calculating its taxable income for the year.
  • Depreciation deductions can be calculated as above under the prime cost method or diminishing value method.
  • Alternatively, the partnership may choose to add the machine to its “low value pool” if it has one as the asset costs less than $1,000.
• Purchase of air-conditioner for investment property → Jack and Jill are joint owners of the investment property;thereforeeach has a 50% interest in the air-conditioner.
  • Prime cost method:
    • Depreciation = $2,000 x (108/365) x (100% / 8) = $74
  • Diminishing value method:
    • Depreciation = $2,000 x (108/365)x (200% / 8) = $148

Jack and Jill can each claim half of the depreciation expense as a deduction.

See [14.40]–[14.90].

Question 14.3

Gil has had a long-running dispute with his landlord regarding his tenancy agreement for his store’s premises. Although he has a 10-year lease over the premises, the landlord is trying to get him to vacate the premises early. The premises are integral to the business as Gil has a post office licence which is area specific and Gil would not be able to lease any other premises in the area due to availability and zoning.

Advise Gil of his tax consequences in relation to any legal fees incurred in defending his tenancy agreement.

Answer

The legal fees are likely to be non-deductible under s 8-1 as they are a capital expense. The fees relate to Gil’s income earning structure rather than his income earning activities (Sun Newspapers):see [12.170]–[12.210].

Consider whether the expenses are deductible under s 40-880 of ITAA97as capital business-related expenses:see [14.180]–[14.210].

Question 14.4

Acme Pty Ltd acquired a machine from its parent company for $500,000 on 1 January of this year. The market value of the machine at that time was $300,000. The parent company has owned the machine for three years and calculated its depreciation deductions using the prime cost method and an effective life of eight years. Calculate the decline in value of the machine for Acme this income year. Assume that it is not a leap year and Acme is not a small business entity.

Answer

• Depreciation = $300,000 x 181/365 x (100%/5) = $29,753
• As the asset is acquired from an associate, Acme must use the same method and remaining effective life and the “cost” is limited to market value:see [14.70]–[14.90].

Question 14.5

Following on from 14.4, Acme sold the machine to an unrelated party for $400,000 on 1 December of this year. Advise Acme of its tax consequences on disposal of the machine.

Answer

• Depreciation 1 January–30 June = $29,753 (from Question 14.4)
• Depreciation 1 July–1 Dec = $300,000 x 154/365 x (100%/5) = $25,315
• Termination value = $400,000
• Adjustable value = $300,000 – $29,753 – $25,315 = $244,932
• Termination value > adjustable value;thereforeAcme has an assessable income amount of $155,068 for the year.

See [14.70]–[14.120].

Question 14.6

An extract of the asset register of Alpha Pty Ltd (“Alpha”) for the 2018-19 income year is as follows:

All depreciable assets are for 100% business use and Alpha uses a low-value pool for all eligible assets. The closing value of the low-value pool at 30 June 2019 was $5,300. Alpha purchased a printer on 5 June 2020for $700.

Advise Alpha of the income tax consequences arising out of the above information for the 2019-20 income year assuming Alpha is not a small business entity.

Answer

• Depreciation of furniture: 1 July 2019 to 30 June 2020; prime cost method

• $5,000 x 366/365 x 100%/10 = $500

• Depreciation of filing cabinets: 1 July 2019 to 30 June 2020; prime cost method

• $1,200 x 366/365 x 100%/10 = $120

• Low value pool

• Note, only assets that have been depreciated under the diminishing value can be added to the low-value pool: s 40-425(5).  Consequently, the filing cabinets are ineligible to be added to the pool as they are being depreciated using the prime cost method.

• Decline in value of the low-value pool:

See [14.140]–[14.150].

Question 14.7

Jacaranda Pty Ltd is a new company operating in Perth, West Australia. The company signed a commercial lease for a period of several years with an option to further extend the lease at its discretion. The company incurred various expenses in making the leased premises suitable for its business. The expenses relate to the leased premises and are considered a capital expense.

Advise Jacaranda as to its income tax consequences arising out of the above information.

Answer:

The expenses are not deductible under s 8-1 or s 25-10 as they are a capital expense. They relate to leased premises therefore not related to Jacaranda’s capital asset. Therefore, the expenses should be deducted over 5 years under s 40-880.

Based on ATO PBR Authorisation Number: 1051508300142.