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Has the 'demonstrator' motor vehicle purchased by the taxpayer been used merely for the purposes of reasonable testing and trialling for the purposes of subsection 41-20(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The use of the demonstrator motor vehicle does not qualify as being merely for the purposes of reasonable testing and trialling in terms of subsection 41-20(3) of the ITAA 1997. Factors including the period and extent of the vehicle's use mean that it can no longer be considered new.

The vehicle was registered and used as a 'demonstrator' model by a car dealer for almost 12 months before its sale to the taxpayer. The sale price of $30,000 represented a discount of $10,000 on the new vehicle price.

At the time of sale the odometer reading was 10,500 kilometres and two years of the original three year manufacturer's warranty remained.

(All references are to the ITAA 1997 unless otherwise stated)

Division 41 allows an additional deduction for certain new business investment in new, tangible depreciating assets and for new expenditure on existing assets.

To qualify, the asset must not have been previously used or installed ready for use for any purpose (paragraph 41-20(1)(e)). The Revised Explanatory Memorandum to Tax Laws Amendment (Small Business and General Business Tax Break) Bill 2009 notes at paragraph 1.59: Division 40 of the ITAA 1997 does not contain a concept of new or second-hand assets. However, this is an important feature of the eligibility criteria for the Tax Break. An asset is new for the purposes of the Tax Break if it has never been used or installed ready for use either by the taxpayer or another entity for any purpose...This means that second-hand assets are not eligible for the Tax Break.

Although the general rule is that the tax break is only available for investment in new assets, there is an exception in the case where the previous use of the asset 'was merely for the purposes of reasonable testing and trialling' (subsection 41-20(3)).

The Revised Explanatory Memorandum notes at paragraph 1.62: Further, 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).

This extract from the Revised Explanatory Memorandum indicates that despite the previous use of the asset which prevents it from being new, it can still be considered or treated as new if the earlier use was merely for the purposes of reasonable testing and trialling.

To come within the scope of the exception, not only must the use satisfy the description of testing or trialling, the nature and extent of that use must also be reasonable.

The policy context of the tax break is to provide an incentive in the form of a temporary bonus tax deduction for investment in new tangible assets. Once an asset has been used it can no longer be described as new. However, in the limited case of use for reasonable testing and trialling, the law provides that the asset can nevertheless be eligible for the tax break.

As the Explanatory Memorandum notes, this is because the asset can still be considered new. An asset can still be considered new despite it having been used for testing and trialling, if the nature and extent of that use is consistent with the asset retaining the essential attributes of what would be regarded as a new asset. In this sense, the adverb 'reasonable' qualifies the nature and extent of the testing and trialling which can have occurred but not prevent the asset from being eligible for the tax break. Accordingly, if the testing and trialling results in the asset losing the quality of what is essentially a new asset, then it is considered that the use will mean the asset is ineligible for the tax break.

In the case of a motor vehicle that is sold as a 'demonstrator', the duration of the period for which it has been used and the extent of the use in the sense of total kilometres travelled will be indicators of whether the vehicle can still be considered new.

This approach is consistent with the interpretation applied in the context of the old investment allowance law in determining whether an asset qualified as 'new' under former subsection 82AQ(1) of the Income Tax Assessment Act 1936 . Taxation Ruling IT 2132 (withdrawn on 9 April 1997 as it dealt with provisions which were no longer operative) examined the circumstances in which a demonstrator vehicle could be regarded as new. The Ruling notes at paragraph 3 that 'a limited amount of demonstration mileage is not regarded as affecting the newness of a particular vehicle'. Further at paragraph 4 it states: As a guide it may be accepted that a vehicle which would otherwise qualify as new will continue to be so regarded where it is used for ordinary demonstration purposes for less than three months. The term "ordinary" is used to guard against the situation where there may be excessive use of a vehicle for demonstration purposes in a three month period which would lead to the conclusion that the particular vehicle could not be regarded as new in the hands of the purchaser.

The basis upon which the Ruling distinguished between demonstrator vehicles that could be regarded as new and those that could not turned on whether the use detracted from the 'newness' of the vehicle. As a guiding principle, use over a significant period or use that exceeded the mileage that would be expected for 'ordinary' demonstration purposes was regarded as affecting the quality of 'newness' of the vehicle.

Whether the use of a demonstrator motor vehicle for the purposes of testing and trialling is 'reasonable' is a question of fact and degree. Where it can be objectively concluded that factors such as the period of use and the extent of use mean that the vehicle can no longer be considered new, then the testing and trialling will not be reasonable.

The use of the motor vehicle by the dealer supports the objective conclusion that the use did not amount to reasonable testing and trialling.

In particular the following factors indicate that at the time of purchase the motor vehicle could not be considered new: • the period over which the vehicle was used for testing and trialling. When the vehicle was sold, it had been registered and used as a 'demonstrator' model for almost 12 months; • the number of kilometres travelled. The vehicle had travelled 10,500 kilometres in the course of its use for testing and trialling; • the decline in the market value of the vehicle compared to the new price. The sale price of $30,000 represented a $10,000 discount on the new car price; and • the balance of the manufacturer's warranty remaining. One year of the warranty had expired at the time of the purchase, leaving a balance of only two years.

These factors indicate that the motor vehicle could no longer be considered new. Accordingly, the use of the vehicle by the dealer is not reasonable testing and trialling for the purposes of subsection 41-20(3).