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Is the transition entity obliged to make a choice, after the transition time, of determining the effective life of the depreciating asset it holds at the transition time, in accordance with subsection 40-95(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. The transition entity is obliged to make a choice, after the transition time, of determining the effective life of the depreciating asset it holds at the transition time, in accordance with subsection 40-95(1) of the ITAA 1997.

The taxpayer is a transition entity for the purposes of Division 58 of the ITAA 1997. All the shares in the taxpayer were sold under a sale process that was an entity sale situation within the meaning of that term in Division 58. The transition time for the purpose of Division 58 was the time of the sale of the shares. The transition entity owns and uses a tangible depreciating asset (within the meaning of that term in section 40-30 of the ITAA 1997) that it held just before the transition time and that is a privatised asset for the purposes of Division 58. At the transition time the transition entity holds and uses that same tangible depreciating asset.

The depreciating asset was not an asset to which any of subsections 40-95(4)-(6) inclusive applies. The transition entity did not apply section 40-102 (about the capped life of certain depreciating assets) in working out the first element of cost of the privatised asset for the purpose of Division 58.

Broadly, Division 40 of the ITAA 1997 allows you to deduct the decline in value of a depreciating asset you hold over its effective life, to the extent you use the asset for a taxable purpose. The calculation of the decline in value of a depreciating asset for an income year is based on, among other things, its effective life.

In determining the effective life of a depreciating asset, subsection 40-95(1) of the ITAA 1997 provides that you must choose either an effective life determined by the Commissioner for the asset, or to work out the effective life of the asset yourself under section 40-105 of the ITAA 1997. This choice of determining effective life must be made for the income year in which the asset's start time occurs (subsection 40-95(3)). Section 40-60 of the ITAA 1997 defines the start time of a depreciating asset to be when you first use it, or have it installed ready for use, for any purpose.

Division 58 of the ITAA 1997 applies to an entity that is a transition entity in an entity sale situation (where the income of an exempt entity becomes, to any extent, taxable). Subdivision 58-B sets out rules that affect the way in which a transition entity works out the decline in value of privatised assets under Division 40 of the ITAA 1997, after the transition time. In particular, subsection 58-70(2) provides that Division 40 applies to a privatised asset held by the transition entity as if the asset had not been used, or installed ready for use, for any purpose before the transition time.

Notwithstanding prior use of the asset before the transition time, the requirement in subsection 58-70(2) of the ITAA 1997 that in an entity sale situation the use of a depreciating asset before the transition time be ignored, means that, in conjunction with section 40-60 of the ITAA 1997, the start time of a depreciating asset held by a transition entity is effectively the time after the transition time at which the transition entity first uses the asset, or has it installed ready for use, for any purpose. The note to subsection 40-60(2) confirms that previous use by a transition entity is ignored for the purpose of that subsection. Accordingly, the start time of the depreciating asset held by the transition entity is effectively the time immediately after the transition time.

With the exception of paragraph 58-90(2)(a) of the ITAA 1997 (which deals with the circumstance where a capped effective life applied to the asset) Division 58 is silent as to determining the effective life of the depreciating asset that is to be used to calculate its decline in value after the transition time. Division 58 does not alter the ordinary operation of Division 40 in respect of either the choice about determining effective life of the depreciating asset the transition entity can make under subsection 40-95(1) of the ITAA 1997, or the requirement under that subsection that the transition entity must make that choice.

Therefore when the transition entity makes the choice in subsection 40-95(1) of the ITAA 1997 of determining the effective life of the depreciating asset, the choice is made as if the asset had not been used before the transition time.

The intention that section 40-95 of the ITAA 1997, including the choice of determining effective life required by subsection 40-95(1), apply to a transition entity for a depreciating asset it holds after the transition time, is supported by paragraph 12.97 of the Explanatory Memorandum to the New Business Tax System (Capital Allowances - Transitional and Consequential) Act 2001 , which inserted new Division 58 on introduction of Division 40, and which (to the extent it is relevant here) states: Under the new Division 58 calculation rules, taxpayers will simply use the ordinary Division 40 rules with some minor modifications for all privatised depreciating assets. Taxpayers will no longer be required to apply rules contained in superseded depreciation regimes. Transition entities will now work out actual deductions for decline in value (after the transition time) of a privatised depreciating asset in the same way as a purchaser does in an asset sale situation, but subject to the requirement that a transition entity cannot change methods of depreciation for an asset.

Division 58 imposes no restriction on or exception to a transition entity's choice of determining effective life of a depreciating asset it holds after the transition time. Accordingly, the ordinary operation of section 40-95 of the ITAA 1997 occurs and the transition entity can and must make a choice under subsection 40-95(1) of determining the effective life of the depreciating asset it holds after the transition time.

The requirement in subsection 40-95(3) of the ITAA 1997 that the transition entity's choice must be made for the income year in which the asset's start time occurs, is met if the choice is made by the transition entity for the income year in which the transition time occurs.