Effective life of depreciating asset - choice of Commissioner's determination

If a taxpayer chooses to use the Commissioner's determination of effective life for a depreciating asset, which effective life should be used under subsection 40-95(2) of the Income Tax Assessment Act 1997 if the taxpayer enters into a contract before 1 July 2001 for the construction of the asset and the construction commences after 30 June 2001?

Under subsection 40-95(2) of the ITAA 1997 the effective life that should be used is the one in force at the time when the taxpayer entered into the contract to acquire the depreciating asset provided the asset is used, or installed ready for use, for any purpose within 5 years of the time the contract was entered into. Otherwise, the taxpayer must use the Commissioner's determination that is in force at the time the depreciating asset is first used, or installed ready for use, for any purpose.

The taxpayer entered into a contract before 1 July 2001 (but after 21 September 1999) for the construction by another taxpayer of particular items of plant. Construction of the items is to commence after 30 June 2001.

The contract represents, in effect, an end to end process consisting of all design, engineering, procurement, construction management, project management, commissioning, start-up and performance testing activities necessary to deliver a final working product within two income years.

Because of the taxpayer's practical expertise, some of its personnel may be required, from time to time and to varying extents, to assist the contractor. If this does occur, the contractor is to assume full responsibility for the supervision, direction and work product of the taxpayer's personnel and the taxpayer is to remain responsible for its employment obligations to the personnel.

Division 40 of the ITAA 1997 generally applies to depreciating assets you start to hold under a contract entered into after 30 June 2001 (see Item 2 of Schedule 1 to the New Business Tax System (Capital Allowances) Act 2001 ). However, section 40-12 of the Income Tax (Transitional Provisions) Act 1997 also brings into the application of Division 40 of the ITAA 1997 plant acquired under a contract entered into before 1 July 2001 but which you start to hold after 30 June 2001.

Paragraph 40-95(2)(a) of the ITAA 1997 provides that a taxpayer's choice of an effective life determined by the Commissioner is limited to one in force at the time when the taxpayer enters into the contract to acquire the asset, the time when the taxpayer otherwise acquires it or the time when the taxpayer starts to construct the asset provided the asset's start time occurs within 5 years of the respective time.

Utah Development Co v. Federal Commissioner of Taxation 14 ATR 601; 83 ATC 4545 and Tully Co-op Sugar Milling Assoc Ltd v. Federal Commissioner of Taxation 13 ATR 410 and 14 ATR 495; 82 ATC 4454 and 83 ATC 4495 both involved the question of whether, in the circumstances of those cases, a unit of property had been acquired or constructed for the purposes of the former investment allowance provisions (see sections 82AA - AQ of the Income Tax Assessment Act 1936 ).

These cases are reviewed in Taxation Ruling IT 2142 which provides some principles to be applied in relation to the meaning of the words 'acquisition' and 'construction'. It specifies that the intent of the legislation being considered in these cases is that the concepts of acquisition and construction should between them cover all cases though they may well apply at different times in the development of a project. The conclusion is drawn that the construction test would apply if construction is wholly by or under the control of the taxpayer, whether using the taxpayer's employees or sub-contactors. On the other hand, if the work of an independent contractor is neither under the control of the taxpayer nor integrated into the taxpayer's business, the taxpayer could not usually be said to have constructed the unit himself. Broadly, then, the construction test would apply provided the taxpayer plays the predominant role in construction. In other cases, the acquisition test will apply.

It is considered that the observations are equally applicable to those same words in the context of Division 40 of the ITAA 1997.

The facts support the view that construction is not under the control of the taxpayer, is not integrated into its business and that the taxpayer is not playing a dominant role in the construction process. This remains so even though the taxpayer will sometimes assist the contractor by providing the services of some of its personnel. The essence of the contract is to deliver to the taxpayer a finished operating product according to its negotiated requirements. In these circumstances, it is considered that the taxpayer has entered into a contract to acquire the plant.

This means that paragraph 40-95(2)(a) of the ITAA 1997 would apply to limit the taxpayer's choice of Commissioner's determination to the one in force at the time of entering into the contract, provided the assets are used, or installed ready for use, for any purpose within 5 years of that time. If the assets are not used, or installed ready for use, within that period, paragraph 40-95(2)(c) of the ITAA 1997 will apply to limit the taxpayer's choice to the Commissioner's determination that is in force at the time the assets are first used, or installed ready for use, for any purpose.