ATO ID 2006/151: Capital Allowances: installed ready for use and held in reserve
Date of decision: 2 June 2006
Year of income: Year ended 30 June 2003 Year ended 30 June 2004 Year ended 30 June 2005
Business line: Public Groups and International

Issue
Are the depreciating assets that entity A holds 'used' or 'installed ready for use' for the purpose of working out the decline in value of their depreciating assets under either subsection 40-70(1) or 40-75(1) of the Income Tax Assessment Act 1997 (ITAA 1997) given the circumstances of entity A as described in the facts below?

Decision
No. The depreciating assets that entity A holds are not 'used' or 'installed ready for use' for the purpose of working out the decline in value of their depreciating assets under either subsection 40-70(1) or 40-75(1) of the ITAA 1997 given the circumstances of entity A as described in the facts below.

Facts
Entity A is a company that has been incorporated as a joint venture company. The purpose of the joint venture is to operate a manufacturing plant to provide benefits to the joint venturers. Entity A is the taxpayer claiming the decline in value for depreciating assets that it holds. Entity A does not separately use the depreciating assets to operate the manufacturing plant. Entity A has two wholly owned subsidiaries, entity B and entity C. Entity B was incorporated to operate the manufacturing plant. Entity A makes available the assets to entity B which constitute the components and setting for the manufacturing plant through a purported but undocumented rental arrangement for all the income years in question. Entity C was incorporated to employ staff and provide them to staff entity B under a hiring arrangement for all the income years in question. Thus, actual physical operation of the assets entity A holds requires the other entity's inputs. Entity A does not physically operate the assets. Entity B commenced operation of the manufacturing plant in the same income year that entity A acquired the assets comprising the plant. Entity B operated the manufacturing plant for two income years and then ceased operations due to a downturn in the industry. Entity B has not recommenced operations. A single staff member has been retained to maintain the depreciating assets on a monthly basis. Entity A has continued to charge entity B rent in respect of the assets on a book entry basis only.

Reasons for decision
Summary: In order to work out the decline in value of a depreciating asset for an income year under the diminishing value method or prime cost method provided in Division 40 of the ITAA 1997 (subsections 40-70(1) or 40-75(1) of the ITAA 1997 respectively), the taxpayer must enter a value into the respective formulae for the number of 'days held' for the asset. The term 'days held' is defined in subsection 40-70(1) of the ITAA 1997 as the number of days the taxpayer held the asset in the income year from its start time, ignoring any days in that year when the taxpayer did not use the asset, or have it installed ready for use, for any purpose. Using a value of less than 365 in the 'days held' component of the formulae reduces the total amount by which the value of an asset can be declined for an income year, where, for example, the asset is disposed of during the year, or where the taxpayer stops using the asset but continues to hold it. These are events that end or suspend the decline of the asset in the holder's hands because it is neither being used, nor held ready for use when these types of events occur. The fact that these types of events end or suspend the decline in value of a depreciating asset is consistent with the definition of a depreciating asset in section 40-30 of the ITAA 1997 which provides that a depreciating asset is one that has a limited effective life and can reasonably be expected to decline in value over the time it is used. For tangible depreciating assets, physical employment or operation of the asset would generally be expected for an asset to be considered to be 'used'. However, entity A has asserted that its use of the assets is through its making them available to entity B to use, through the purported rental arrangement. Such employment of assets is accepted as 'used' in the context of the passive 'use' discussed in City of Newcastle v. Royal Newcastle Hospital (1959) 100 CLR 1 but in question in this case is whether entity A's purported arrangement with entity B can be considered extant since the cessation of the manufacturing plant's operations. To answer this question it is first useful to consider if entity B 'uses' or has 'installed ready for use' A's assets since the cessation of operation of the manufacturing plant. 'Used' is a word of wide import and its meaning in any particular case will depend on the context in which the word is employed and the purpose for which the thing in question has been acquired or created ( Newcastle City Council v. Royal Newcastle Hospital (1956) 96 CLR 493). In the context of Division 40 of the ITAA 1997, the use of a depreciating asset requires the employment of the asset in such a way that it can reasonably be expected to decline in value through and over the time of that use. In Queensland Meat Export Co. Ltd. v. DC of T (1939) 5 ATD 176; (1939) 1 AITR 490 the court noted that merely turning the machinery over by hand once a week over a period of five years did not constitute a use that could fairly be held to create any wear and tear on the plant. The court held the words 'wear and tear' involve a certain degree of use of the plant in the ordinary course of manufacture of goods or treatment of stock. In their view the use of plant on a maintenance basis did not justify any deduction for wear and tear in respect of such plant. In entity B's case there is also no physical use of the depreciating assets for manufacturing that would result in any decline in value. However, it needs to be considered whether the depreciating assets are installed ready for use. 'Installed ready for use' is defined in subsection 995-1(1) of the ITAA 1997 as installed ready for use and held in reserve. This means that the relevant asset must not only be installed ready for use, but also 'held in reserve'. In interpreting the expression 'held in reserve' in Tax Determination TD 2007/4, the Commissioner adopts the approach taken by Mr Beddoe in Case X46 90 ATC 378 at 381; AAT Case 5877 (1990) 21 ATR 3411 at 3414) where he noted that the concept of plant that was installed ready for use but held in reserve is not so wide as to embrace income-producing operations which may be undertaken at some time in the future. Further, Mr Beddoe noted that the sense those words are used in is to set aside for future use, upon the happening of some contingency occurring, in the taxpayer's existing income-producing activities or, in other words, to keep back or save for future use in those present income-producing operations. Consequently, it needs to be considered whether entity B has present income-producing activity for which it may be holding the assets in reserve. Use in present income producing activity As noted by Hill J in Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922 'the question of whether a particular activity constitutes a business is often a difficult one involving as it does questions of fact and degree'. This particular decision turns on its own facts and involves a process of weighing up all the indicators that are considered relevant by the courts. Taxation Ruling TR 97/11 summarises the indicators of carrying on a business that have been set down by the courts at paragraph 13 (although TR 97/11 states the Tax Office view on whether a taxpayer is carrying on a primary production business, the general indicia set down by the courts in relation to carrying on a business apply to all taxpayers undertaking this consideration). In this case, an objective consideration of the indicators leads to the conclusion that entity B does not have an existing income-producing activity. Operation of the manufacturing plant ceased over two years ago. The facts of the case indicate that there is no significant commercial activity, there is no prospect of a profit being made from the activity and there has been no business activity carried on by entity B for over two years for which it has actually received any income. As there has been a discontinuation of business by entity B the depreciating assets cannot be considered to be installed ready for use and held in reserve in entity B's present income producing activity. As such, the depreciating assets are not considered to be installed ready for use from the period of cessation of operation of the manufacturing plant. In the context of entity B not using the assets for any purpose and not continuing business, and in view of the closeness of the relationship between the entities (entity A's apparent control of the entire undertaking of the entities), it can subsequently be considered whether entity A's making the assets available to entity B under the purported rental agreement constitutes use of the assets, or having the assets installed ready for use, by entity A. Given the facts that: the conclusion is that entity A's purported rental arrangement with entity has not been extant since the cessation of the manufacturing plant's operation. entity A is in fact not using the assets nor does it have them installed ready for use nor does it have a present income producing activity that involves the assets. Entity A too, in respect of any endeavour involving the assets, has discontinued business. Accordingly, entity A should reduce the number used in the formulae in subsections 40-70(1) or 40-75(1) of the ITAA 1997 in respect of 'days held' by the number of days it held the depreciating assets but did not use them or have them installed ready for use, that is, from the point in time when the manufacturing plant ceased operations.

Legislative references: Income Tax Assessment Act 1997 subsection 40-70(1) subsection 40-75(1) subsection 40-30(1) subsection 995-1(1)
Case references: City of Newcastle v. Royal Newcastle Hospital (1959) 100 CLR 1
Related public rulings and determinations: Taxation Ruling TR 97/11 | Tax Determination TD 95/52 | Tax Determination TD 2007/5
Subject references: Capital Allowances CoE Deduction for depreciating assets Plant installed ready for use