Webb Martin Consulting - Expert Tax Advice

The investment allowance ‘tax break’ is well and truly the flavour of the last few months based on the number of calls our consultants have been receiving on the topic!!

In theory the tax break deduction is quite straightforward. However, quite a few issues relating to interpretation have arisen since its enactment and quite a few practitioners, and advisers for that matter, are still a little bit confused on these issues.

Below we look at some of the more pertinent issues that have been raised - some of which have been addressed in recent ATO Interpretative Decisions.

Used for the principal purpose of carrying on business

To claim the tax break, when an entity starts to use the asset, or have it installed ready for use, it must be reasonable to conclude that the asset will be used by the entity for the principal purpose of carrying on a business. How is this principal purpose tested??

Let’s take the example of the purchase of a laptop.

The ATO has released ATOID 2009/47 which looks at the use of a laptop computer, and addresses the issue of ‘principally’ by correctly stating that the term ‘principally’ is not defined in the income tax law. It does however adopt a quantitative approach in determining the principal use of the laptop.

ATOID 2009/47 also refers to TR 2003/4 and TR 98/6. 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, and 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. However, it is necessary to look at all the factors surrounding the use of the asset, including the pattern of use. Other factors may be present which indicate that a simple time analysis will not be the correct method to use.

TR 98/6 is concerned with the principal use of a building and uses the quantitative measure of time to establish the principal use of the building.

However, the quantitative approach adopted in ATOID 2009/47 does not seem to be the approach adopted by the ATO in ATOID 2008/127 concerning the FBT exemption in section 58X as it applies to laptops.

In order for the section 58X exemption to be available in relation to a laptop computer it must be shown that the laptop is provided ‘primarily for use in an employee’s employment’.

ATOID 2008/127 states:

There is no requirement to reach this conclusion by reference to usage which can only be ascertained retrospectively. Rather this conclusion is determined by reference to the available evidence at the time the benefit is provided.

Let’s also look at the example of a motor vehicle.

The ATO’s ‘Guide to small business and general business tax break’ (hereafter the ‘Guide’) makes the following statement in respect to cars:

The one-third of actual expenses and 12% of original value methods are only available where there is substantial business use (that is, a minimum of 5,000 business kilometres applies). However, the use of these methods does not necessarily mean that the car will be used for the principal purpose of carrying on a business. The purpose test needs to be satisfied independently of the calculation of deductions for car expenses.

Which approach is correct?

The bottom line appears to be that both a quantitative and/or qualitative approach may be appropriate in determining the principal use of an asset. Whichever method is chosen, or whether a combination of the two is chosen, the taxpayer should take care to ensure that the measurement is done on a reasonable basis taking into account the facts of the particular case. Further, the taxpayer should also ensure that it substantiates its use.

At a minimum, and as a safeguard measure, taxpayers should at least adopt a quantitative approach (as this appears to be the favoured method based on the ATOID’s issued to date regarding claiming the tax break).

Assets subject to sale and leaseback arrangements

We are slightly uncomfortable with sale and leaseback arrangements occurring within a short period of time of an asset being acquired. However, it seems many advisers and taxpayers aren’t so concerned based on the recent issue of ATOID 2009/89.

The issue addressed by ATOID 2009/89 is:

In determining whether it is reasonable to conclude, at the first use time, that the taxpayer will use the asset for the principal purpose of carrying on a business for the purposes of paragraph 41-20(1)(d) of the Income Tax Assessment Act 1997 (ITAA 1997), is it only relevant to have regard to the taxpayer’s use of the asset during the period it is held by the taxpayer?

The facts are based on an asset to be held by a taxpayer as owner for one month before entering into a sale and leaseback arrangement but continuing to be used by the taxpayer in its business. ATOID 2009/89 concludes that the purpose test is satisfied having regard to the taxpayer’s proposed use of the asset at the first use time.

What is of concern is why would an entity acquire an asset only to sell it under a sale and leaseback arrangement within a very short time period (in our view one month is not long!!) if not for the ability to claim the tax break deduction? In the absence of any other factors, there would be a real risk that there is a purpose of obtaining a tax benefit (does the term Part IVA ring a bell?).

We would caution advisers and their clients not to view ATOI 2009/89 as a ‘green light’ for the purposes of claiming the tax break allowance on all sale and leaseback arrangements. Depending on the circumstances taxpayers could consider seeking a private ruling.

Can partners claim the tax break?

Where an asset is a partnership asset, the partnership rather than any individual partner is entitled to the deductions for the decline in value for the asset.

If the asset is not a partnership asset and an individual partner is the holder of the asset, that partner may still be able to claim deductions for both the decline in value and the tax break in relation to the asset (provided all of the criteria are satisfied).

The following example is taken from the ATO’s Guide:

Example

George and Michael are partners in a business. They both purchase cars on 28 June 2009 and immediately start to use the cars in the partnership business. The cars are not partnership assets so George and Michael are the holders of the cars. As both George and Michael are carrying on the partnership business, their use of the cars is use for the ‘purpose of carrying on a business’. Therefore, if the cars are used principally for the purpose of carrying on the partnership business and all of the other conditions for the deduction are met, George and Michael will be able to claim the tax break.

Based on the above example, provided an asset held by a partner is principally used in the partnership business the tax break will be available to the partner.

Investment commitment time

Generally, when you acquire a new asset, the investment commitment time will be the point in time when you have:

• entered into a contract under which you hold the asset or will start to hold the asset at some point in time
• started to construct the asset, or
• started to hold the asset in some other way.

From a practical viewpoint, the investment commitment time could be determined by the method chosen to purchase the asset.

Let’s look at the example of acquiring a motor vehicle. Assume the taxpayer places an order before 31 December 2009 but is unsure whether the car will be ready for delivery before or after 31 December 2009. At the time of placing the order the taxpayer is unsure whether it will acquire the vehicle with existing funds from the business or whether it will finance the acquisition.

The ATO provides the following comments in its ‘Guide’ in the context of a small business entity:

To satisfy the investment commitment time test for an amount, it is enough that you entered into a contract in relation to the asset between 13 December 2008 and 31 December 2009 …

This means that you do not need to have paid for the asset outright or have taken delivery of the asset within this period. You may not start to hold the asset straight away - that may come at a later point - but your investment commitment time must be on or before … 31 December 2009.

Ultimately the issue in a scenario when an asset is ordered and the order placement is entered into is whether or not the order placement (and associated paperwork) constitutes a contract to acquire. If it does, and the taxpayer chooses not to finance the acquisition, then the order date would likely be the investment commitment time. If it does not, then eligibility for the tax break may depend on when the vehicle is delivered and the type of finance method chosen. How many practitioners will sight such order paperwork and how many will have the contract law expertise to determine whether a contract effecting a transfer of ownership has been entered into?

In regards to financing the acquisition, if the asset is acquired under a hire purchase agreement the ATO view in their ‘Guide’ is that the asset is generally acquired at the time the hire purchase agreement is entered into. Typically, financiers only enter into the HP agreement when the vehicle is being delivered. Up to that point, the financier generally only provides finance pre-approval. If the vehicle is delivered before 31 December 2009 then the investment commitment time would be sufficient for eligibility for the tax break. Not much joy however for the taxpayer that orders before 31 December 2009 but takes deliver after that date and enters into a HP. What happens if the order placement (pre 31 December 2009) represents a contract to acquire, but the taxpayer subsequently decides to finance by way of HP (after 31 December 2009)?

In the same document the ATO goes onto state:

Different rules apply if you purchase a depreciating asset and become its legal owner prior to entering into the hire purchase arrangement or luxury car lease. In that case, the investment commitment time is the time at which you enter into the contract to purchase the asset. This may be when the order contract is made with the supplier.

The story is different again if the taxpayer chooses instead to finance the vehicle via a chattel mortgage. In the context of chattel mortgage arrangements the ATO makes the following statements in its ‘Guide’:

Under the capital allowance rules, if you enter into a legal chattel mortgage where the mortgagee is the legal owner of the asset, the contract under which you hold the asset is the chattel mortgage agreement. Therefore, the investment commitment time is when you enter into the chattel mortgage, not when an order contract is made with the supplier. However, if you purchase a depreciating asset and become its legal owner prior to entering into the legal chattel mortgage, the investment commitment time is the time at which you enter into the contract to purchase the asset. This may be when the order contract is made with the supplier.

If you enter into an equitable chattel mortgage which operates only by way of a charge over the asset and you are the legal owner of the asset, the order contract with the supplier is the contract under which you hold the asset as its legal owner. Accordingly, the investment commitment time is when you enter into the order contract with the supplier.

The objective of the law is to provide taxpayers with a one-off tax break with the underlying government policy intention of stimulating an otherwise downbeat economy. As mentioned above, in theory the eligibility for the tax break sounds straightforward. As can often be the case with tax law, the devil is in the detail. For taxpayers looking to take advantage of the tax break, we can only caution to take care particularly when making substantial investments. The price of seeking confirming advice would be a fraction of the tax break to be gained. It would be a shame to lose the benefits on offer.

This edition of ‘The Assessment’ was prepared by Rob Power. If you have any comments in regards to the contents of this edition or if you have any specific tax break queries please feel free contact Rob at robp@webbmartinconsulting.com.au.