Capital allowances: recalculating effective life

Must the transition entity recalculate the depreciating asset's effective life from a later income year where the conditions in subsection 40-110(2) of the Income Tax Assessment Act 1997 (ITAA 1997) are satisfied?

Yes. The transition entity must recalculate the depreciating asset's effective life from a later income year where the conditions in subsection 40-110(2) of the ITAA 1997 are satisfied.

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. The transition entity must make a choice of determining the effective life of a tangible depreciating asset for the income year in which the asset's start time occurs (subsections 40-95(1) and (3) of the ITAA 1997).

Subsection 40-110(2) of the ITAA 1997 deals with circumstances in which you must recalculate a depreciating asset's effective life from a later income year. You must recalculate a depreciating asset's effective life from a later income year if one of the conditions in subparagraphs 40-110(2)(a)(i)-(iii) is met and the asset's cost is increased in that year by at least 10%. You may conclude that the effective life is the same. The recalculation required under subsection 40-110(2) must be done using section 40-105 of the ITAA 1997 (about self-assessing effective life) as required by subsection 40-110(4).

Division 58 of the ITAA 1997 applies to an entity that is a transition entity in an entity sale situation. 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 after the transition time. However, Division 58 is silent as to the requirement to recalculate a depreciating asset's effective life from a later income year where the conditions in subsection 40-110(2) of the ITAA 1997 are satisfied.

The intention that the requirement to recalculate effective life from a later income year imposed by subsection 40-110(2) apply to a transition entity, 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 of the ITAA 1997 imposes no limitation on a transition entity's requirement to recalculate the effective life of a depreciating asset after the transition time where the conditions in subsection 40-110(2) of the ITAA 1997 are satisfied. The ordinary operation of subsection 40-110(2) occurs. Accordingly, the requirement in subsection 40-110(2) that the transition entity must recalculate the effective life of the depreciating asset it holds from a later income year applies where the conditions in that subsection are satisfied.