Private ruling: Income tax – capital allowances – depreciation – depreciating asset and decline in value calculation
Date of advice: 15 March 2018
Published: June 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: A date prior to 1 July 2016

Ruling: Q1: Is each reusable system component that is hired out by you a separate depreciable asset under section 40-30 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Can each reusable system component that is hired out by you be allocated to a low-value pool where the cost of the component is less than $1,000 in accordance with section 40-425 of the ITAA 97? | A2: Yes

Relevant facts and circumstances: You derive income from hiring out items from your collection of ‘system’ components. The systems are moulds that wet concrete is injected into in order to form the concrete structures. Your collection of system components consists of: ● reusable items ● reusable project specific items, which are items that have been purpose-bought for a particular project and, at the end of the project, are recycled to suit a new project, incurring re-manufacturing costs. (As well as reusable items and reusable project specific items, assembled systems include other components which are either consumed in a building project or scrapped at the project’s end.) Each of the system components in your collection is catalogued in your records. The membership of your collection of system components changes as new components are manufactured and old components are discarded. The cost of each reusable component and each reusable project specific component ranges from $50 to $800. As the service core layout varies from building to building, the shape of a system varies from project to project (and sometimes from level to level). As a result, each system is assembled from a project-specific combination of components from your collection in accordance with project-specific drawings detailing the components that are needed. You hire out project-specific combinations of system components from your collection to an associated company. That company then hires out those components to builders and provides supervisors for the assembly (and for the disassembly some months later) of systems (the builders provide the labour). You exceed the turnover threshold for a Small Business Entity and are not able to access the simplified depreciation rules.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 40-30 | Income Tax Assessment Act 1997 section 40-175 | Income Tax Assessment Act 1997 section 40-180 | Income Tax Assessment Act 1997 section 40-185

Reasons for decision: Detailed Reasoning - Question 1 – Summary: In the light of all the circumstances of this particular case, the system components you hire out are separate depreciating assets. | Detailed Reasoning - Question 1 – Detailed reasoning: Under Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997), You can deduct an amount equal to the decline in value of a depreciating asset (an asset that has a limited effective life and that is reasonably expected to decline in value over the time it is used) that you hold. That decline is generally measured by reference to the effective life of the asset. Subsection 40-30(4) of the ITAA 1997 provides that: Whether a particular composite item is itself a depreciating asset or whether its components are separate depreciating assets is a question of fact and degree which can only be determined in the light of all the circumstances of the particular case. To assist in determining whether a composite item is a single depreciating asset or more than one depreciating asset, subsection 40-30(4) of the ITAA 1997 provides the example of a car as an instance of where a composite item is considered to be a single depreciating asset rather than a number of components. It also provides a floating restaurant as an example of where the components of a composite item are separate depreciating assets; being the ship itself, stoves, fridges, furniture, crockery and cutlery. The term ‘composite item’ is not expressly defined in the legislation. However, the way the legislation contrasts ‘composite item’ with ‘its components’ gives an indication of the meaning of the term, and paragraph 4 of Draft Taxation Ruling TR 2017/D1 Income tax: composite items and identifying the depreciating asset for the purposes of working out capital allowances (‘TR 2017/D1’) begins: A 'composite item' is an item that is made up of a number of components that are capable of separate existence Under the heading ‘Guiding principles’ TR 2017/D1 further states: 5. For a component (or more than one component) of a composite item to be considered to be a depreciating asset, it is necessary that the component (or components) is capable of being separately identified or recognised as having commercial and economic value. 6. Purpose or function is generally a useful guide to the identification of an item. The main principles that are taken into account in determining whether a composite item is a single depreciating asset, or more than one depreciating asset, are: (a) 'Identifiable': the depreciating asset will tend to be the item that performs a separate identifiable function, having regard to the purpose or function it serves in its business context. (b) 'Use': a depreciating asset will tend to be an item that performs a discrete function. However, the item need not be self-contained or able to be used on a stand-alone basis. (c) 'Degree of integration': the depreciating asset will tend to be the composite item where there is a high degree of physical integration of the components. (d) 'Effect of attachment': the item, when attached to another asset having its own independent function, varies the performance of that asset. (e) 'System': a depreciating asset will tend to be the multiple components that are purchased as a system to function together as a whole and which are necessarily connected in their operation. 7. The relevant function considered in this context is the actual function the item is to serve in the particular taxpayer's income producing activity, rather than any theoretical function to which the item could be put in other circumstances. … 8. To determine if a composite item is a single depreciating asset or more than one depreciating asset, the relative functions of the entire item, against its components, need to be considered in the circumstances in which they are used. … 9. A single depreciating asset is not necessarily the smallest possible component which can be identified within a composite item. Several components or parts of a composite item which work together with other components may be parts of a larger functional item, particularly where those components are integrally linked. 10. An item may be considered to be a separate depreciating asset notwithstanding it performs some wider or commercially more 'complete' function in combination or conjunction with other items that are themselves separate depreciating assets. … 11. The mere fact that an item cannot operate on its own and has no commercial utility unless linked or connected to another item or items tends to indicate that it will form part of a composite item, rather than being a separate depreciating asset. An item that is designed to be functionally interchangeable, or is used in this way, with other items may indicate there are separate depreciating assets. … 12. An absence of a fixed physical connection between separate components of a composite item tends to indicate that each separate component is a depreciating asset. … 13. Where an element of a system is purchased or installed at a different time to the system (irrespective of its intended operation within a system) and has a separate identifiable function, that element may be a separate depreciating asset. … [footnote and parenthetical material deleted] To determine the question of whether a particular composite item is itself a depreciating asset or whether its components are separate depreciating assets it is necessary to identify the composite item and its components. In the circumstances of this particular case: ● the components are the individual reusable items and reusable project specific items ● the composite item is the entire collection of components (as distinct from, for example, the temporary systems that are built from components drawn from the collection). The relevant function considered in the present context is the actual function the items serve in your income producing activity (see paragraph 7 of TR 2017/D1), namely, the hiring out of system components from your collection. Some of the considerations discussed in the above-quoted passage from TR 2017/D1 tend to suggest that the individual items are separate depreciating assets, while others tend to suggest that they are not. For example, on the one hand, each component is designed to be functionally interchangeable, or is used in this way, with other components, which may indicate there are separate depreciating assets; on the other hand, a component: ● does not operate on its own (either physically on a building site or, more to the point for present purposes, in your hiring out of components from your collection) and ● has little or no commercial utility unless linked or connected to other components (again, either physically on a building site or in a broader sense in the hiring out of components from your collection) which tends to indicate that it will form part of a composite item, rather than being a separate depreciating asset. In particular, as regards: ● paragraph 5 of TR 2017/D1, each component ‘is capable of being separately identified’ – each is catalogued in your records ● subparagraph 6(a) (‘Identifiable’), each component ‘performs a separate identifiable function, having regard to the purpose or function it serves in its business context’, its ‘business context’ (for present purposes) being your business of hiring out system components – this is because project-specific drawings detail the components (or types of components) that need to be hired out in respect of a particular project ● subparagraph 6(b) (‘Use’), individual components do not perform a discrete function in your income-producing activity as in practice they are hired out with other components ● subparagraph 6(c) (‘Degree of integration’), while in other contexts there is a high degree of (temporary) physical integration, in your particular business context there is ‘[a]n absence of a fixed physical connection between separate components of a composite item’, which ‘tends to indicate that each separate component is a depreciating asset.’ ● subparagraph 6(d) (‘Effect of attachment’), is not directly relevant – while in other contexts system components are attached to each other (that is, by builders on building sites), in your income producing activity, they are not attached to each other (or to any asset having its own independent function) ● subparagraph 6(e) (‘System’), in your income producing activity, the components were not all purchased or manufactured at the same time, though they do function together as a whole. In Federal Commissioner of Taxation v. Tully Co-operative Sugar Milling Association Ltd [1983] FCA 163; (1983) 68 FLR 39; (1983) 83 ATC 4495, Fitzgerald J said (at ATC 4506): there is ... a unit of property if it is capable of independent existence , not necessarily self-contained, e.g., it may require power from an external source, not necessarily separately used, e.g., it may be incorporated into an operating system such as a machine or complex of machinery in a manufacturing process, but capable either of separate function, or of function in conjunction with different parts , or in a different context, from its current user. [Emphasis added.] In the light of all the circumstances of this particular case, the system components you hire out are separate depreciating assets. | Detailed Reasoning - Question 2 – Summary: You may choose to work out through a low-value pool the decline in value of assets costing less than $1,000. | Detailed Reasoning - Question 2 – Detailed reasoning: Under Division 40 - Capital allowances of the ITAA 1997, you may choose to work out the decline in value of low-cost assets (that is, assets costing less than $1,000) through a low-value pool. The cost of a depreciating asset you hold consists of two elements – see section 40-175 of the ITAA 1997. Subsection 40-180 is titled ‘First element of cost’. Subsection 40-180(1) relevantly provides: The first element is worked out as at the time when you began to *hold the *depreciating asset (except for a case to which item 3, 4 or 14 of the table in subsection (2) applies). It is: (a) if an item in that table applies - the amount specified in that item; or (b) otherwise - the amount you are taken to have paid to hold the asset under section 40-185. Subsection 40-185 of the ITAA 1997 is titled ‘Amount you are taken to have paid to hold a depreciating asset or to receive a benefit’. Subsection 40-185(1) relevantly provides: This Division applies to you as if you had paid, to * hold a * depreciating asset or for an economic benefit for such an asset, the greater of these amounts: (a) the sum of the amounts that would have been included in your assessable income because you started to hold the asset or received the benefit, or because you gave something to start holding the asset or receive the benefit, if you ignored the value of anything you gave that reduced the amount actually included; or (b) the sum of the applicable amounts set out in this table in relation to holding the asset or receiving the benefit. The table in paragraph 40-185(1) of the ITAA 1997 includes: | Detailed Reasoning - The amount is:: 1 You pay an amount The amount Item 1 covers money paid to create a depreciating asset (for example, labour and materials), if you paid the amount. It does not cover money others paid (for example, in your case, the amounts paid by a related company to boilermakers employed by it).