The Commissioner of Taxation (Commissioner) has released draft taxation ruling TR 2023/D2, which provides updated guidance on whether an asset made up of multiple parts or components (a composite item) is itself a depreciating asset, or whether the components are each separate depreciating assets.
The relevant inquiry is set out at subsection 40-30(4) of the Income Tax Assessment Act 1997, where the following is stated:
"Whether a particular composite item is itself a depreciating asset or whether its components are separate depreciating assets is a question of fact and degree which can only be determined in the light of all the circumstances of the particular case."
The issue is of relevance to taxpayers for numerous reasons, including:
- An asset’s ‘start time’– i.e., the time at which a depreciating asset held starts to decline in value, determined by reference to when the depreciating asset is first used or installed ready for use.. The ‘start time’ of a composite depreciating asset may be materially later than that of its components. This could be particularly relevant, for example, in the context of the R&D Tax Incentive;
- An asset’s effective life – i.e., identifying the relevant depreciating asset’s effective life and therefore the rate at which deductions for decline in value can be claimed;
- Access to ‘low value pools’ – i.e., the cost (or opening adjustable value) of the relevant ‘depreciating asset’ must be less than $1,000; and
- Instant Asset Write-Off (IAWO) – e.g., the proposed temporary increase to the IAWO threshold to $20,000 will apply on a per-asset basis.
Whilst the foregoing ostensibly represent timing differences, there will be a real and potentially material cost in net present value terms. This was particularly significant in a Temporary Full Expensing (TFE) context where eligible taxpayers were able to deduct the entire cost of eligible depreciating assets.
Comparison to TR 2017/D1
- The draft ruling has replaced the previous draft taxation ruling TR 2017/D1, which has been withdrawn. The draft ruling contains some changes from its predecessor, but largely reaffirms the Commissioner’s view with respect to the identification of composite depreciating assets. Key updates are summarised as follows:
- The new draft ruling clarifies that the test for a composite depreciating asset is not the same test for determining a ‘facility’ in the context of the non-concessional MIT income rules. Particularly, although acknowledging that these tests require similar considerations, those considerations may and are generally expected to lead to different outcomes, thereby requiring the taxpayer to consider the statutory context and purpose of the relevant inquiry;
- Consideration of jointly-held tangible assets and the meaning of ‘your interest in the underlying asset’ in the context of separate ownership of component parts of a composite depreciating asset;
- Coverage of issues specifically relevant to intangible depreciating assets – i.e., the question of whether an intangible asset is a composite depreciating asset requiring consideration of the legal character of the item and any underlying individual rights; and
- Numerous updates have been made to the examples set out in withdrawn TR 2017/D1, which are not particularly material but seek to better enunciate the application of the relevant guiding principles. The updates include simplification of the examples to focus only on the most critical guiding principle for each, clarification on how the acquisition of a replacement asset might be treated differently to an asset initially acquired as part of a system, and the inclusion of additional facts to assist in illustrating examples.
Summarise key aspects of Draft Ruling
TR 2023/D2 affirms the Commissioner’s position regarding the five guiding principles to be applied in identifying relevant depreciating assets, including his emphasis on purpose or functionality, whilst acknowledging that no single guiding principle is determinative and that ‘every enquiry requires the exercise of judgment in the prevailing factual circumstances’.
Consistent with preceding guidance in TR 2017/D1, TR 2023/D2 sets out five guiding principles which must be considered by a taxpayer in identifying the relevant depreciating asset for the purposes of the capital allowances provisions contained in Division 40 of the ITAA 1997.
The five guiding principles are summarised below:
Whilst TR 2023/D2 provides some additional clarity to taxpayers regarding the Commissioner’s view on the approach that should be taken to identifying relevant depreciating assets, as acknowledged by the Commissioner at paragraph 7, each enquiry requires the exercise of judgement in the prevailing factual circumstances and a composite item may be a single depreciating asset in one taxpayer’s circumstances but not in another’s.
It is also important to acknowledge that TR 2023/D2 represents draft administrative guidance and not law. In seeking to identify relevant depreciating assets, taxpayers should have regard to seminal case law such as Commissioner of Taxation v Tully Co-operative Sugar Milling Association Ltd 83 ATC 4495, wherein various components in a cane processing system were held to be separate units of property for income tax purposes, notwithstanding their ostensible integration as a system.
FOR MORE INFORMATION
If you would like to discuss how the TR 2023/D2 will impact you, please contact your local RSM team to discuss how the guiding principles can be applied to you.