Deductions: capital allowances - correction of cost

If an understatement in the first element of cost of a depreciating asset is discovered, is the opening adjustable value of the asset recalculated under section 40-85 of the Income Tax Assessment Act 1997 (ITAA 1997) for all affected income years using the correct cost of the asset?

Yes. The opening adjustable value of the asset is recalculated for all affected income years because the cost of the asset is corrected for the understatement and the adjustable value of a depreciating asset at a particular time, worked out under section 40-85 of the ITAA 1997, is ultimately based on the cost of the asset.

The taxpayer purchases a depreciating asset and uses it wholly to produce assessable income.

The acquisition cost of the asset is understated in the taxpayer's accounts.

The taxpayer claims deductions for decline in value of the depreciating asset based on the understated cost for several income years.

The understatement of the cost of the depreciating asset is discovered when a balancing adjustment event occurs for the asset.

The taxpayer needs to establish the adjustable value of the asset at the time of the balancing adjustment event to work out the amount of their balancing adjustment amount.

The time allowed by section 170 of the Income Tax Assessment Act 1936 (ITAA 1936) to amend the taxpayer's assessment for the income year in which they acquired the depreciating asset and for some of the income years in which they claimed decline in value deductions has expired.

For a depreciating asset that has been used or installed ready for use for any purpose, the adjustable value of the asset at a particular time is defined in subsection 40-85(1) of the ITAA 1997 as: (b) for a time in the income year in which you first use it or have it installed ready for use, for any purpose - its cost less its decline in value up to that time; or (c) for a time in a later income year - the sum of its *opening adjustable value for that year and any amount included in the second element of its cost for that year up to that time, less its decline in value for that year up to that time.

The opening adjustable value of a depreciating asset for an income year is its adjustable value at the end of the previous income year (subsection 40-85(2) of the ITAA 1997).

The cost on which the adjustable value of the depreciating asset is based is worked out under Subdivision 40-C of the ITAA 1997.

Under subsection 40-180(1) of the ITAA 1997, the first element of cost is worked out as at the time when you begin to hold the depreciating asset. Subsection 40-180(1) of the ITAA 1997 provides that the first element of cost is the amount specified in the last applicable item in the table in subsection 40-180(2) of the ITAA 1997 or, if no item in the table applies, the amount you are taken to have paid to hold the depreciating asset under section 40-185 of the ITAA 1997. No item in the table in subsection 40-180(2) of the ITAA 1997 applies in this case.

Paragraph 40-185(1)(b) of the ITAA 1997 provides that you are taken to have paid an amount to hold a depreciating asset in the circumstances specified in the table in subsection 40-185(1) of the ITAA 1997. Item 1 of the table specifies that if you pay an amount, the amount you are taken to have paid to hold a depreciating asset is the amount so paid.

In this case, the taxpayer pays an amount to hold the depreciating asset. Despite the fact that the taxpayer incorrectly records the amount that they paid and works out deductions for decline in value based on the understated amount, the first element of cost of the asset is the amount actually paid by the taxpayer.

The formulae for working out the decline in value of an asset under the diminishing value and prime cost methods are contained in sections 40-70 and 40-72 of the ITAA 1997 (diminishing value method) and section 40-75 of the ITAA 1997 (prime cost method). In either case, the decline in value is worked out by reference to the asset's cost.

The adjustable value of a depreciating asset at a particular time, worked out under section 40-85 of the ITAA 1997, is ultimately based on the cost of the asset.

It follows that if the cost of the asset is understated, all of the decline in value and opening adjustable value figures worked out based on the incorrect cost are also understated.

Therefore, if an understatement in the first element of cost of a depreciating asset is discovered, the figures recorded as the decline in value and the opening adjustable value of the asset for each income year from the time that the asset started to be used or installed ready for use are corrected by being recalculated using the corrected cost of the asset. Note, this recalculation is done even if it is not possible to amend the assessment for an income year (or years) to reflect the recalculated decline in value of the asset because the time allowed by section 170 of the ITAA 1936 for amendment has been exceeded.