Capital allowances: 'tax break' - used principally in Australia

At the first use time is it reasonable to conclude that the taxpayer will use the depreciating asset principally in Australia for the purpose of paragraph 41-20(1)(d) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. At the first use time it is not reasonable to conclude that the taxpayer will use the depreciating asset principally in Australia for the purpose of paragraph 41-20(1)(d) of the ITAA 1997. It is not expected that the taxpayer will use the asset in Australia more than 50 per cent of the total time the asset is in operation.

The taxpayer purchased a tangible depreciating asset and installed the asset in an aircraft.

When the taxpayer installed the depreciating asset ready for use, it was expected that, of the total time the asset is in operation, not more than 50 per cent will be in Australia. This is based on the expected use of the aircraft at the time the asset was installed in the aircraft ready for use.

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

Division 41 allows an additional deduction for certain business investment in new, tangible depreciating assets and for new investment in existing assets - the 'tax break'.

One of the conditions that must be met for a depreciating asset to be eligible for the tax break is, at the time the asset is first used by the taxpayer or installed ready for use (the 'first use time'), it must be reasonable to conclude that the taxpayer will use the asset principally in Australia (paragraph 41-20(1)(d)).

The expression 'use the asset principally in Australia' is not defined in the legislation and the explanatory memorandum to the Tax Laws Amendment (Small Business and General Business Tax Break) Bill 2009 (the EM to the Bill) provides limited guidance as to its meaning.

The EM to the Bill explains that the tax break will not be reduced for any non-taxable use or apportioned based on the actual taxable use of the asset. At paragraphs 1.69 to 1.70 and 1.117 to 1.119 it contemplates active use of an asset as well as passive use by the lessor of an asset.

Justice Taylor in Council of the City of Newcastle v. Royal Newcastle Hospital (1956) 96 CLR 493 at 515 states that the 'word "used" is ....a word of wide import and its meaning in any particular case will depend to a great extent upon the context in which it is employed' and 'the purpose for which it has been acquired or created'.

The Macquarie Dictionary relevantly defines 'use' to mean 'to employ for some purpose; put into service; turn to account' and 'to operate or put into effect'.

Division 41 applies to certain depreciating assets for which a taxpayer can deduct an amount for decline in value under section 40-25. Broadly, a 'depreciating asset' is defined in subsection 40-30(1) to mean an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used.

Taxation Determination TD 2007/5 explains that, in the context of Division 40, a depreciating asset is 'used' when it is employed in such a way that it can reasonably be expected to decline in value over the time it is so employed. For a tangible depreciating asset to be employed in such a way, an actual use or employment of the asset is required. Depending on the nature of the depreciating asset, this actual use or employment may be active (for example, physical use by the holder) or passive (for example, the holder allowing others to physically use).

Similarly, in the context of Division 41, the use of a tangible depreciating asset requires actual use or employment of the asset - such that it can reasonably be expected to decline in value over the time it is used.

In the present case, the depreciating asset is a tangible asset actively used by the taxpayer. Therefore, for the purpose of paragraph 41-20(1)(d), the actual physical use of the asset in Australia by the taxpayer is relevant.

The term 'principally' is not defined in the ITAA 1997. However, The Macquarie Dictionary defines the adverb 'principally' as 'chiefly' or 'mainly'. Therefore, for the depreciating asset in this case to be used principally in Australia, it must be used chiefly or mainly, but not necessarily solely, in Australia.

In the present case, the depreciating asset will be used both in and outside Australia. It is necessary to establish the appropriate basis to measure the use in order to determine whether the taxpayer will use the asset principally in Australia.

In Federal Commissioner of Taxation v. FH Faulding & Co Ltd (1950) 83 CLR 594; 9 ATD 201, the High Court examined whether two cordials produced by the taxpayer were 'essences, concentrates and cordials, consisting wholly or principally of juices of Australian fruits'. In doing so, the court noted that whether the phrase 'principally' was referring to a quantitative or other measure was determined by the context in which it was used. In this case the High Court took a quantitative approach to its meaning; at page 602 Fullager J. concluded that: The natural meaning of the words 'consist ... principally' is emphasised in item 36(3) by the presence of the words 'wholly or'. The reference must be to quantity.

At page 597 Latham C.J. concluded: ... the words 'consisting principally of' must be read as referring to quantity expressed in terms of either volume or weight of substance of the cordial...

Taxation Ruling TR 2003/4 considers whether a boat owner uses or holds a boat 'mainly' for letting it on hire in the ordinary course of business. Paragraph 103 of that ruling concludes that a quantitative approach may be appropriate to measure how an asset is 'mainly used' because how it is actually used is readily quantifiable based on time.

In the present case, the period of time for which the depreciating asset will be used can be measured across both its use in Australia and outside Australia and it is considered that time is the most appropriate measure of use in this context.

If a taxpayer will use an asset for more than 50 per cent of the time in Australia, it is accepted that the taxpayer will use the asset principally in Australia.

At the first use time, it is not expected that the taxpayer will use the depreciating asset in Australia more than 50 per cent of the total time the asset is in operation. Therefore, it is reasonable to conclude, at the first use time, that the taxpayer will not use the depreciating asset principally in Australia for the purpose of paragraph 41-20(1)(d).