Issue
Where parts of a cable system that link two places are owned by different entities, are the parts separate depreciating assets pursuant to the definition of that term in section 40-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No, the separate ownership of parts of the cable system that link two places does not make those parts into separate depreciating assets pursuant to the definition of that term in section 40-30 of the ITAA 1997. The cable system includes depreciating assets according to the relevant functionality achieved which requires the entities combining or linking their parts in a particular integrated or interdependent way.
Facts
A cable system was constructed to transmit data between three places A, B and C. The system was constructed with two major functional segments; the segments that transmits data from A to B and the segment that transmits data from B to C.
Each segment of the system consists of fibre optic cables and transmission and receiving equipment. Different but associated entities own the fibre optic cables, and the transmission and receiving equipment.
The different entities have contractual relationships between each other to facilitate a venture that brings the complete cable system together to enable the carrying of traffic on the system (from A to B, from B to C, and from A to C). The amount of income the system produces for the various entities is based on their contribution to the cost of the system.
Reasons for Decision
A depreciating asset is broadly defined as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used (subsection 40-30(1) of the ITAA 1997).
For composite items, however, subsection 40-30(4) of the ITAA 1997 provides that whether the composite item itself is a depreciating asset or whether its components are separate depreciating assets is a matter of fact and degree to be objectively determined in light of all the circumstances of the particular case.
Subsection 40-30(4) of the ITAA 1997 is followed by examples, one in which a composite item is a single depreciating asset, the other in which a composite item does not make a single depreciating asset.
Subsection 40-30(4) of the ITAA 1997 is not a provision that applies or operates to mandate or deem a single particular factual outcome. Its purpose is to require the consideration, in an objective way, of a composite item as to whether the composite item or its separate components are or are not depreciating assets for the purposes of Division 40 of the ITAA 1997.
In accepted principles of statutory interpretation, ascertaining the meaning of words of a provision takes account of the context in which they appear and the purpose which the words were meant to serve. The legislative history can indicate the intention to which a particular provision has been directed.
Some relevant explanation is provided by paragraph 1.15 of the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001. This Bill introduced section 40-30 of the ITAA 1997.
The paragraph states that judgement is required to be exercised in the objective identification of the depreciating asset where the asset in question is a composite item. The paragraph further suggests that the 'functionality test' that was used as a basis of identifying a unit of plant in the then existing plant depreciation rules can be used in the identification process in a modified manner taking into account the differences in the basis to the definitions of plant and depreciating asset. The purpose of such examination then, is not to test components of a composite asset as separate 'units' but to test the components for definable, separately identifiable and discrete function and then completeness in that function but not necessarily self-containment or isolation in that function.
In the context of a provision that seeks to define what a depreciating asset is, it is apparent that the determination or question intended to be addressed by subsection 40-30(4) of the ITAA 1997 is identification of the relevant item or thing to be tested as to its standing as a depreciating asset.
In particular, the operative purpose of subsection 40-30(4) of the ITAA 1997 is to provide practical guidance about how the determination as to whether a particular composite item is itself a single depreciating asset is to be made.
In that sense, subsection 40-30(4) of the ITAA 1997 does not change the law as it relates to the identification of a component that is a depreciating asset. Subsection 40-30(4) does mandate an objective consideration of the relevant things that might be considered to be a composite item and its components in order to identify either the (single) thing that is a depreciating asset, or the separate (multiple) things that might themselves be depreciating assets.
A cable system can be formed by combining or linking a number of components in a particular integrated or interdependent way. In this case, there are two 'segments' of the system, each 'segment' being composed on a number of components. The components include the fibre optic cable and transmission and receiving equipment. Each 'segment' by which, as a whole, communications are carried between two places can be said to be, in the words of Lockhart J in Overseas Telecommunications Commission (Australia) v. Federal Commissioner of Taxation [1989] FCA 447; 89 ATC 5200; (1989) 20 ATR 1482 ( OTC ), 'capable of a separate existence and which could be operated as a functionally distinct unit.'
While each component of each segment contributes to the system, the relevant function of all components within a segment is to transmit data from one place to another. This is the function the various entities have achieved by making available their part of the cable system for the effective use of the system to produce income. It is this effective use that identifies the life of the depreciating asset. Each of the two major segments of the system is capable of achieving that function and can be identified by an effective life in that use.
This function can only be derived from the integration of the components in a particular way in each 'segment' of the system. For example, the cable on its own can not generate and transmit data from one place to another. It is, in essence, a conduit through which the data once generated and transmitted can pass. Without the generation and transmission of the data, the relevant function of the system can not be achieved. Similarly, without the cable, the generation and transmission of the data from one place to another could not occur.
Taken as a whole, each 'segment', being composed of both the fibre optic cable between two places and the necessary equipment at either end is capable of achieving the network function of transmitting data from one place to another. The components within each segment are not separately capable of achieving the network function of a cable system.
Based on this functionality, each 'segment' of the system, rather than the components of each segment, is considered to be the depreciating asset in these circumstances. This conclusion is supported by the finding in the OTC case where the whole of each segment between two countries, including its on-shore, territorial waters, and international waters elements, was found to be a eligible unit of property by Lockhart J (at FCA paragraphs 55-61). Although the decision in the OTC case related to the availability of deductions under the former Investment Allowance provisions, the Commissioner considers that the principles established in that case as to what constituted the eligible unit of property can be applied equally to the identification of a depreciating asset for the purposes of section 40-30 of the ITAA 1997. The 'segment' is identifiable as having its own life in effective use in transmitting data from one place to another and can reasonably be expected to decline in value over that life. Accordingly, the segment is itself the depreciating asset within the meaning of that term in section 40-30.