Income tax: substantiation rules: calculation of balancing adjustment for cars

The Tax Law Improvement Project is restructuring, renumbering and rewriting the income tax law in plain language. The Parliament is amending the income tax law progressively to reflect these aims. As new laws come into effect, Taxation Rulings about old laws are being brought into line with them.

This Ruling provides guidance on the application of Subdivisions 42-F and 42-G of Part 2-10 of the Income Tax Assessment Act 1997 ('the ITAA 1997').

Subdivision 42-F of the ITAA 1997 sets out the rules for calculating a balancing adjustment for a car, in respect of which a taxpayer has: (a) deducted or can deduct an amount for depreciation of the car in one or more years of income using the 'log book' or '1/3 of actual expenses' methods; and has not (b) chosen the 'cents per kilometre' method or the '12% of original value' method for deducting their car expenses for one or more other income years.

Subdivision 42-G of the ITAA 1997 sets out the rules for calculating a balancing adjustment for a car, in respect of which a taxpayer has: • (a) deducted or can deduct an amount for depreciation of the car using the 'logbook' or the '1/3 of actual expenses' methods, in one or more years of income; and has also • (b) chosen the 'cents per kilometre' method or the '12% of original value' method for deducting their car expenses for one or more other income years.

Neither Subdivision 42-F nor 42-G applies where a taxpayer has, since the use of the car began, only used the 'cents per kilometre' method or the '12% of original value' method for calculating the amount of deduction claimed for car expenses, in respect of that car. In these situations no balancing adjustment is made.

Taxation Ruling IT 2493 deals with subsection 82KY(6) of the Income Tax Assessment Act 1936 ('the ITAA 1936'). That section was rewritten as section 59AAA, which was introduced into the ITAA 1936 with effect from 1 July 1994. Section 59AAA has since been restructured, renumbered and rewritten in the ITAA 1997. Subdivision 42-G now expresses the same ideas in the ITAA 1997 as subsection 82KY(6) and section 59AAA did in the ITAA 1936. The following table cross-refers provisions in the ITAA 1997 to the corresponding provision in the ITAA 1936. 1997 Act 1936 Act Years 1998 and later 1995, 1996 and 1997 1994 and earlier Statute Income Tax Assessment Act 1997 Income Tax Assessment Act 1936 Income Tax Assessment Act 1936 Ruling This Ruling IT 2493 IT 2493 on subsection 82KY(6) Balancing adjustment for certain cars Subdivision 42-G Section 59AAA Subsection 82KY(6) Cents per kilometre method Subdivision 28-C Division 3 of Schedule 2A Subsection 82KX(1) 12% of cost method Subdivision 28-D Division 4 of Schedule 2A Subsection 82KW(3) 1/3 of actual expenses method Subdivision 28-E Division 5 of Schedule 2A Subsection 82KW(2) Log book method Subdivision 28-F Division 6 of schedule 2A Section 82KUD

This Ruling applies to years commencing before and after its date of issue.

This draft Ruling rewrites and replaces Taxation Ruling IT 2493, which will be withdrawn on finalisation of the draft Ruling.

There is no change in the policy stated in IT 2493. However, this Ruling is broader in that it covers circumstances not covered in IT 2493.

Some of the terms used in this Ruling are explained below: • Balancing adjustment event - such an event occurs when the owner* of depreciable plant (in this Ruling, a car): (i) disposes of the plant; or (ii) is taken to have ceased to be the owner of the plant; or (iii) is taken to have disposed of the plant; or (iv) the plant is lost or destroyed; or (v) there is a change in ownership of the car, or in the interests of entities in the car, and one of the entities that owned the car before the change retained some interest after the change. * Note that the term 'owner' here can include situations where a person or entity has some right or interest in the car, other than sole ownership. See subsection 42-30(3) of the ITAA 1997. • Cost - this generally means the cost incurred by a taxpayer in acquiring the car, unless: (i) the taxpayer acquired the car with other assets, without a specific value being allocated to the car; or (ii) rollover relief applies; or (iii) the taxpayer previously held the car as trading stock; or (iv) it is a luxury car. Note that this cost may be adjusted where car discount, non arm's length, car limit, double deduction or previous depreciation limit rules apply. See section 42-65 of the ITAA 1997. • Depreciation days - this means the total number of days that a taxpayer owned a car in each income year for which an amount of depreciation was deducted or can be deducted for that car. See section 42-250 of the ITAA 1997. • Non-depreciation days - this means the total number of days that a taxpayer owned a car in each income year for which the 'cents per kilometre' method or the '12% of original value' method for deducting car expenses was chosen. See section 42-250 of the ITAA 1997. • Notional depreciation amount - this is the sum of the amounts that you could have deducted for depreciation of the car for the income years for which you chose the 'cents per kilometre' method or the '12% of original value' method for the car assuming that: (i) neither the 'cents per kilometre' method or '12% of original value' method were chosen; and (ii) Division 28 (Car expenses) of the ITAA 1997 had not applied to the car; and (iii) the car was used for the purpose of producing assessable income: (a) to the extent of 20% if you used the 'cents per kilometre' method; or (b) to the extent of one-third if you used the '12% of original value' method. See section 42-255 of the ITAA 1997. • Notional written down value - this is the car's written down value less its notional depreciation amount . See section 42-260 of the ITAA 1997. • Reduction rule - this is the requirement for the amounts calculated in subsections 42-240(2) and 42-245(3) of the ITAA 1997 to be multiplied by the fraction: Depreciation days/(Depreciation days + Non-depreciation days) • Termination value - in the following situations, this means: (i) where the car has been sold for a specific price - the sale price less the reasonably attributable expenses of sale; (ii) where the car has been disposed of other than by sale - the market value of the car immediately before its disposal; (iii) where the car is lost or destroyed - the amount or value received or receivable under an insurance policy or otherwise for the loss or destruction. Note that these values may be adjusted where the 'car limit' applies (see section 42-215). Situation (i), above, may also be adjusted where the sale is not an arm's length transaction (see section 42-210). A different termination value may also be applicable where the disposal event varies from those described above. See section 42-205 of the ITAA 1997. • Undeducted cost - in respect of a car means the cost of the car less the sum of the amounts that could have been deducted for depreciation for any period that you were its owner and used it, or had it installed ready for use, assuming that: (i) it was used wholly for the purpose of producing assessable income during that period; and (ii) the same rate and method was used for that period as was used for the income year in which a depreciation deduction was first allowable to you for the car; and (iii) no provision of the ITAA 1997 denied a depreciation deduction for it; and (iv) Division 28 (Car expenses) of the ITAA 1997 did not apply. See paragraph 42-175(c) of the ITAA 1997. • written down value - this is the cost of the car less the sum of the amounts that have been deducted or can be deducted for depreciation in respect of that car. If the rules regarding 'roll-over relief' for related entities applied to your acquisition of the car, the written down value is the sum of the amounts that the transferor and earlier successive transferors deducted or can deduct for depreciation of the car. See section 42-200 of the ITAA 1997.

In these situations a balancing adjustment may be required.

An amount is assessable where the termination value of the car exceeds its written down value . Compare the amount by which the termination value exceeds the written down value , to the sum of the amounts that you have deducted or can deduct for depreciation of the car. The lesser of these two amounts is the amount that must be included in your assessable income.

An amount is deductible where the termination value of the car is less than its undeducted cost. The deductible amount is the amount by which the undeducted cost of the car exceeds its termination value , reduced to reflect the extent to which the car was used, or installed ready for use, other than for the purpose of producing assessable income.

Where the termination value of the car is less than written down value but equal to or more than its undeducted cost , no balancing adjustment is made. Also, where the termination value of the car is equal to its written down value , no balancing adjustment is made.

In these situations a balancing adjustment may be required.

An amount is assessable where the termination value of the car exceeds its notional written down value . To calculate the assessable amount compare: (i) the amount by which the termination value of the car exceeds its notional written down value to (ii) the sum of the notional depreciation amount and the amounts that have been deducted or can be deducted for depreciation of the car. The lesser of these amounts is then reduced by applying the reduction rule in section 42-250, i.e., multiply by the fraction: Depreciation days/(Depreciation days + Non-depreciation days)

An amount is deductible where the termination value of the car is less than notional written down value and also less than its undeducted cost . Two steps must be taken to calculate the deductible amount: Step 1 Determine the difference between the termination value and the undeducted cost of the car, then reduce that difference to reflect the extent to which the car was used, or installed ready for use, other than for the purpose of producing assessable income. The Commissioner accepts any reasonable basis for the calculation of this reduction that is based upon the following two assumptions: (i) that you used the car for income producing purposes to the extent of 20%, for years where you calculated deductions using the 'cents per kilometre' method; and (ii) that you used the car for income producing purposes to the extent of 1/3, for years where you calculated deductions using the '12% of original value' method. A simple method for calculating this reduction is to multiply the difference by the following fraction: (A + B)/C Where: A is the notional depreciation amount B is the amounts that have been deducted or can be deducted for depreciation of the car C is the car's cost less its undeducted cost . Step 2 Apply the reduction rule in section 42-250 to the amount calculated in Step 1 , i.e., multiply by the fraction: Depreciation days/(Depreciation days + Non-depreciation days)

Where the termination value of the car is less than its notional written down value but equal to or more than its undeducted cost , no adjustment is made. Similarly, where the termination value of the car is equal to its notional written down value , no adjustment is made.

No balancing adjustments are made.

Depreciation allows taxpayers to obtain deductions for the cost of an asset over the period it is used in income producing activities. Depreciation is only allowed to the extent that the asset is used for income producing purposes. Consequently, if a car is used partly for business purposes and partly for private purposes, only a partial depreciation deduction, based on the percentage of business use, is allowed. However, depreciation based on effective life of the asset is only an estimate which is used to spread the cost of the asset over time.

When an asset for which you have claimed depreciation is sold, lost or destroyed, you must compare its termination value on the sale, loss or destruction with its undeducted cost and its written down value at the time. This comparison shows whether you have recovered some or all of the depreciation you have claimed, or whether you have suffered a loss.

If the termination value for an asset is more than its written down value , then you have recovered some of the depreciation previously claimed. In that case, the excess, up to the total amount of depreciation deductions you have claimed, is treated as assessable income. Conversely, if the termination value of the asset is less than its undeducted cost , you have suffered a loss, and may claim a deduction for the difference less the proportion for private use. These income or deduction amounts are referred to as balancing adjustments.

Subsection 42-30(2) of the ITAA 1997 requires balancing adjustment calculations to be performed in accordance with the rules set out in Subdivision 42-F or Subdivision 42-G where the balancing adjustment event occurs in respect to certain cars.

Subdivision 42-F sets out the standard rules for calculating balancing adjustments. These rules apply to a car, in respect of which a taxpayer has: (a) deducted or can deduct an amount for depreciation of the car in one or more years of income (using the 'log book' or '1/3 of actual expenses' method); and has not (b) chosen the 'cents per kilometre' method or the '12% of original value' method for deducting their car expenses for one or more other income years.

To avoid distortion of the balancing adjustments calculated for cars, allowance must be made for years where depreciation was not claimed in respect of the car, because you instead chose to calculate the car expenses by using the 'cents per kilometre' or the '12% of original value' method.

Subdivision 42-G sets out the special rules for calculating a balancing adjustment for a car, in respect of which a taxpayer has: (a) deducted or can deduct an amount for depreciation of the car using the 'logbook' or the '1/3 of actual expenses' method, in one or more years of income; and has also (b) chosen the 'cents per kilometre' method or the '12% of original value' method for deducting their car expenses for one or more other income years.

The rules in Subdivision 42-G make allowance for the income years when actual depreciation was not claimed. The effect of these special rules is that any balancing adjustment (assessable or deductible) relates only to the actual depreciation allowed.

No balancing adjustments are made where a taxpayer has, since the use of a car began, only used the 'cents per kilometre' method or the '12% of original value' method for calculating the amount of deduction claimed for car expenses, in respect of that car. This is because no depreciation is claimed when these methods are used, and balancing adjustments only apply where depreciation has been claimed.

This example illustrates the method used to calculate balancing adjustments for a depreciated asset. In the case of a car, this example would apply where depreciation has been claimed using only the 'logbook' or '1/3 actual expenses' method, and no deductions have been claimed for the car using the 'cents per kilometre' or '12% of original value' method. (See also ATO publication: 'Guide to depreciation' for further information on these rules.)

Assume that Shelley: (i) purchases an asset on 1 July 1996 for $1,000; and (ii) sells it on 30 June 1998; and (iii) used the 'log book' method to determine that she used the asset evenly for both business and private purposes for both years; and (iv) elected to use the prime cost method to work out her depreciation; and (v) the relevant prime cost depreciation rate is 24%.

The relevant calculations are: undeducted cost ($) written down values ($) Cost on 1.7.96 1,000 1,000 Less: Depreciation (24%) to 30.6.97 240 (50% business) 120 760 880 Less: Depreciation to 30.6.98 240 (50% business) 120 520 760 Closing Balance 520 760

If the termination value on disposal is more than the written down value , the difference is to be included in assessable income. However, the assessable amount cannot be more than the sum of deductions actually allowed for depreciation on the asset.

Therefore, if Shelley sold the asset for $800, she would recover $40 - the amount by which the termination value is more than the written down value of $760. The amount of $40 is treated as assessable income.

Where the termination value is less than both the written down value and undeducted cost , the difference between termination value and the undeducted cost represents a loss. However, you are only eligible for a deduction for the business or other income producing percentage of that loss.

Therefore, if Shelley sold the asset for $400, she would show a loss of $120 - the amount by which the undeducted cost of $520 exceeds the termination value . Shelley could claim a deduction of $60 - that is, 50% of the loss.

Where the termination value is between the written down value and undeducted cost , no adjustment is made.

Thus, if Shelley sold the asset for $700, there would be no adjustment because the termination value is less than the written down value of $760 but greater than the undeducted cost of $520.

This example illustrates the method used to calculate balancing adjustments for a car where depreciation has been claimed using the 'logbook' or '1/3 actual expenses' method for one or more years, and deductions have been claimed for the car using the 'cents per kilometre' or '12% of original value' method in one or more other years.

Assume that Carol: (i) purchases a car on 1 August 1994 for $13,898; and (ii) sells it on 30 April 1998; and (iii) uses the 'log book' method to claim car expenses for the years ended 30 June 1995 and 30 June 1996. During those years 20% of the car's use was for income producing use; and (iv) for the years ended 30 June 1997 and 30 June 1998 elected to claim car expenses under the '12% of original value' method.

The relevant calculations are: undeducted cost ($) written down values ($) Cost on 1.8.94 13,898 13,898 Less: Depreciation (22 1/2 %) to 30.6.95 2,866 (20% business) 573 11,032 13,325 Less: Depreciation (22 1/2 %) to 30.6.96 2,482 (20% business) 496 8,550 12,829 Less: Depreciation (22 1/2 %) to 30.6.97 1,924 (deemed 33 1/3% business) 641 6,626 12,188 Less: Depreciation (22 1/2 %) to 30.4.98 1,242 (deemed 33 1/3% business) 414 Closing Balance 5,384 11,774

The following values are derived from the above calculations: Item Amount ($) Calculation ($) written down value 12,829 13,898 - 573 - 496 notional depreciation amount 1,055 641 + 414 The amounts that have been, or could have been, deducted for depreciation of the car 1,069 573 + 496 notional written down value 11,774 12,829 - 1,055 undeducted cost 5,384 13,898 - 2,866 - 2,482 - 1,924 - 1,242 Cost less undeducted cost 8,514 13,898 - 5,384

Assuming Carol sold her car for $13,000 then an assessable amount would be calculated as follows: $ termination value 13,000 Less notional written down value 11,774 1,226

As the amount of $1,226 is less than the sum of the notional depreciation amount and the amounts that have been deducted or could have been deducted for the car ($1,055 + $1,069 = $2,124) then the amount of $1,226 is taken and reduced by applying the reduction rule in section 42-250.

Carol claimed depreciation in respect of the car for 700 days, and chose to use the '12% of original value' method to calculate her deduction claim in respect of the car for another 669 days. Therefore, the calculation for the section 42-250 reduction is: $1,226 x 700 / (700 + 669) i.e., $626 The amount to be included in assessable income is $626.

Assuming Carol sold her car for $15,000 then an assessable amount would be calculated as follows: $ termination value 15,000 Less notional written down value 11,774 3,226

As the amount of $3,226 is more than the sum of the notional depreciation amount and the amounts that have been deducted or could have been deducted for the car ($1,055 + $1,069 = $2,124) then the amount of $2,124 is taken and reduced by applying the reduction rule in section 42-250. $2,124 x 700 / (700 + 669) i.e., $1,086 The amount to be included in assessable income is $1,086.

Any excess of the sale price over the original cost (i.e., $1,102) would usually constitute a capital gain but for the specific exclusion of most motor vehicles from the definition of 'asset' for capital gains tax purposes. Hence, the excess of the sale price over the original cost, in the case of most motor vehicles, is usually not assessable as a capital gain or as ordinary income.

Assuming Carol sold her car for $4,000 then, as the termination value ($4,000) is less than the notional written down value ($11,774) and the undeducted cost ($5,384), a deductible amount would be calculated as follows: $ undeducted cost 5,384 Less termination value 4,000 1,384 The amount of $1,384 must now be reduced to reflect the extent to which the car was used, or installed ready for use, other than the purpose of producing assessable income, as required by subsection 42-245(3). $1,384 x ($1,055 + $1,069) / $8,514 i.e., $345 The reduction rule in section 42-250 is then applied. $345 x 700 / (700 + 669) = $176 The amount to be included as a deduction is $176.

Assuming Carol sold her car for $9,500 then no adjustment would be made as the termination value exceeds the undeducted cost ($5,384) but is less than the notional written down value ($11,774).

Below is a detailed contents list for this draft Ruling: Paragraph What this Ruling is about 1 Class of person/arrangement 2 Cross-references 6 Date of effect 7 Previous Rulings 8 Definitions 10 Ruling 11 Situations where depreciation has been claimed in respect of the car using either the 'log book' method or the '1/3 of actual expenses' method to calculate the deduction claim in one or more years, and no claims have been made in respect of that car using either the 'cents per kilometre' method or the '12% of original value' method in respect of one or more other years. 11 Calculating an assessable amount 12 Calculating a deductible amount 13 Situations where no adjustment is made 14 Situations where depreciation has been claimed in respect of a car using either the 'log book' method or the '1/3 of actual expenses' method to calculate the deduction claim in one or more years, and deduction claims have also been made in respect of that car using either the 'cents per kilometre' method or the '12% of original value' method in one or more other years 15 Calculating an assessable amount 16 Calculating a deductible amount 17 Situations where no adjustment is made 18 Situations where car expenses have only been claimed in respect of the car using either the 'cents per kilometre' method, or the '12% of original value' method 19 Explanations 20 Examples 29 Example 1 29 Calculations to reflect use of an asset only partly for business purposes 30 Example 1A - calculating an assessable amount 32 Example 1B - calculating a deductible amount 34 Example 1C - situations where no adjustment is made 36 Example 2 38 Example 2A - calculating an assessable amount where termination value is less than cost 42 Example 2B - calculating an assessable amount where termination value is less than cost 45 Example 2C - calculating a deductible amount 48 Example 2D - situation where no adjustment is made 49 Your Comments 51

We invite you to comment on this Draft Taxation Ruling. We are allowing 6 weeks for comments before we finalise the Ruling. If you want your comments to be considered, please provide them to us within this period. Comments by Date: 27 October 1999 Contact officer details have been removed following publication of the final ruling.