A peek into your tax break package

Finally there are some details of the new temporary investment allowance for SMEs. We dissect the nitty-gritty.

The Federal Government’s announcement of a temporary investment allowance, primarily for SMEs, was always welcome news (provided SMEs want to spend the money in the first place), but as I have warned previously, the devil would be in the detail.

Well, that detail has finally arrived with Treasury’s release of draft legislation on the measure. We’re not home yet, as the legislation is only in draft form, and comments are due back to Treasury by 10 March 2009, but I expect the Government will be keen to see it progress quickly.

As I noted before in my Long time between tax drinks column, the legislation is not in addition to the proposed temporary investment allowance, which was announced by the Government in December 2008, but rather sub-sumes that allowance.

I’ll go through some of the details of the new deduction, but, as always with tax, they are somewhat technical. But this might at least arm you with a few questions for your adviser.

Broadly, the new tax break will amend the income tax law to provide a temporary bonus deduction for new, tangible depreciating assets and new expenditure on existing assets.

Businesses will be able to claim a bonus a deduction at either a rate of 10% or 30%, provided the conditions of the deduction are satisfied. The conditions are:

• The investment must occur between 13 December 2008 and 31 December 2009 (inclusive).
• The investment must be for eligible assets (see below).
• The expenditure on the investment must meet the “new investment threshold” (see below).
• The assets must be used in Australia.
• The time at which the assets start to be used, and/or the economic benefit of the improvement to an asset, must be realised before 31 December 2010.

The tax break is in addition to the depreciation deductions available under the existing capital allowance provisions of the tax law.

Timing

One of the eligibility requirements is that the investment must occur between 13 December 2008 and 31 December 2009 (inclusive). To this extent, the draft legislation introduces the concept of an “investment time”, which is when an investment is considered to have been made.

If an amount is included in an asset’s first element of cost (worked out at the time the taxpayer begins to hold the asset), the investment time will be the point the taxpayer has:

• Entered into a contract to start or hold the asset; or
• Started to construct the asset; or
• Started to hold the asset in some other way.

If an amount is included in an asset’s second element of cost (because the amount relates to an economic benefit that contributes to bringing the asset to its new condition and/or location), the investment time will be the point in time the taxpayer has entered into a contract for that economic benefit or commenced construction of that economic benefit.

Beware that a so-called “integrity rule” will be introduced to ensure that businesses cannot circumvent the investment time requirement by “refreshing” a contract entered into on or before 12 December 2008.

Small business entities

Small business entities will be eligible for the bonus deduction notwithstanding that the entities elect to use the existing capital allowance concessions contained in the tax law.

Eligible assets

The bonus deduction is available for new investment in tangible depreciating assets for which a deduction is available under the tax law. Alternatively, the bonus deduction is also available on new expenditure on existing assets.

An asset is “new” for the purposes of the bonus deduction if the asset has never been installed ready for use before, either by a taxpayer or another entity for any purposes, anywhere before 12 December 2008. Therefore, second-hand assets are not eligible for the bonus deduction.

However, an asset will still be considered to be “new” if it has only been used for the purposes of reasonable testing and trialling (by any entity). Consider the following example.

On 20 March 2009, James acquires a car to use in his mobile computer repair business. He uses the “12% of original cost” method to work out his car expense deductions for the 2008-09 income year. The car was a “demonstrator” vehicle. Providing any prior use of the car only amounted to reasonable testing and trialling, the car will still be considered to be “new” for the purposes of the bonus deduction.

Note that land, trading stock and intangibles are excluded from the definition of a depreciating asset, and therefore not eligible for the bonus deduction.

Businesses claiming deductions for assets under the following provisions of the Income Tax Assessment Act 1997 will not be entitled to claim the bonus deduction:

• Subdiv 40-F – depreciating assets involved in primary production such as water conservation facilities and horticultural plants.
• Subdiv 40-G – capital expenditure of primary producers and other landlords.
• Subdiv 40-J – capital expenditure for the establishment of carbon sink forests.

Cars

Cars will be eligible for the tax break, provided businesses are using the following methods in determining their car expenses:

• “One-third of actual expenses” method.
• “12% of original value” method.
• Log book method.

Businesses that use the “cents per kilometre” method cannot claim the bonus deduction. The amount of bonus deduction will be limited to the car cost limit (that is, $57,180 for 2008-09).

Leased assets

Eligible assets held under a lease will still qualify for the bonus deduction. The deduction will be claimed by the entity that is entitled to claim a capital allowance deduction on an eligible asset.

New investment threshold

The “new investment threshold” will depend on whether a taxpayer is a small business entity or a general business:

• For a small business entity, the threshold is $1000 or more.
• For a general business, the threshold is $10,000 or more.

The investment threshold operates on a per asset basis. That is, investments in different assets cannot be amalgamated for the purpose of meeting the threshold. However, multiple amounts (which are referred to as “recognised new investment amounts”) in relation to a same asset can be combined for the purposes of meeting the threshold.

For an amount to be a “recognised new investment amount” in an income year, the amount needs to be included in an asset’s cost base between 13 December 2008 and 31 December 2009 (inclusive). The asset’s cost base is defined and consists of two elements:

1. The first element is worked out at the time a business begins to hold the asset which is generally the amounts that the taxpayer has paid.
2. The second element is amounts that the business has paid to bring the asset to its present condition.

The following example explains how a taxpayer calculates the “recognised new investment amount”.

Kathryn, who owns and runs a cafe, decides to purchase a new oven to improve the energy efficiency of her cafe’s kitchen. She enters into a contract with the supplier of the oven on 10 August 2009 for $4500, which does not include installation. The $4500 is included in the asset’s first element of cost.

An electrician charges Kathryn $500 to install the oven on 17 August 2009. Because she has already started to hold the asset, the installation cost is included in the asset’s second element of cost. Once installed, the oven has a total cost of $5000.

New expenditure on existing assets

The bonus deduction also applies to new expenditure on assets acquired before 13 December 2008, provided that expenditure is of a capital nature. New expenditure incurred on existing assets is treated in the same manner as amounts relating to investment in new assets.

However, if new expenditure on an existing asset results in a new asset being created (for example, the asset is split into two or more assets), an amount included in the first element of cost for the new asset created will not be eligible for the bonus deduction where the amount was for an investment made before 13 December 2008 or where the bonus deduction had already been claimed on that amount.

Rate of tax bonus

The income year in which the bonus deduction can be claimed, and the rate to be used in calculating a taxpayer’s deduction, will depend on when the new investment is undertaken and when the new or modified asset is put to use.

The bonus deduction is to be claimed by the holder of the asset.

The table below summarises the key dates relating to the different rates at which the tax break could be claimed, if all conditions are met.

A business will not be required to apportion the bonus deduction between the business and non-business uses of an eligible asset. However, the business must be able to demonstrate that at the time it started to use the asset, or had it installed ready for use, the asset was to be used in Australia and for the principal purpose of carrying on its business (the “purpose test”).

Talk to your adviser

This new tax deduction can be a very useful one for many SMEs, but they really need to talk to their advisers about the mechanics of how it will work for them.

The draft legislation now released will help with that, but the final picture will only emerge when the legislation is passed by the Parliament.

Another step forward, but not over the line yet!