In many cases, what you would consider to be repairs might in fact be the purchase of an asset under ATO interpretation.
Simply put, restoring an asset to its original condition will normally be a repair on the assumption that the deterioration has been due to wear and tear whilst you have owned the asset and you have not altered its construction or physical appearance.
This distinction between being treated as an asset (or capital) rather than repairs has a significant difference in their tax treatment. Simply put:
1) A repair is immediately tax deductible
2) An asset is tax deductible over a number of years
The temptation is to treat as much expenditure as possible as repairs, particularly those considered to be “grey”.
However, this must be carefully executed as the ATO monitor repair expenditure and case law is littered with both successful and unsuccessful attempts to claim what really is capital expenditure as repairs.
Let’s now examine the tax treatment of capital expenditure.
The tax treatment of such expenditure is markedly different, depending on whether you are considered to be a Small Business Entity or other entity.
Small Business Entity
You are considered to be a Small Business Entity (SBE) if your turnover is under $2m in any of the following circumstances:
1) Estimated in the current year (looking forward)
2) Actual in the current year (looking back)
3) Actual in the prior year (looking back)
There are grouping provisions in place that will ensure that where you “control” another entity, the turnover of all the entities that you control must be added together to determine whether you pass the $2m turnover test.
Simply put, if you have an interest in a partnership of 40% or more, you are considered to control the partnership and you must include that turnover in assessing whether you pass the $2m turnover test.
For example, lets assume your business interests were as follows:
Turnover
Sole Proprietor $950000
50% Partner in Partnership $2000000
Your turnover for assessing eligibility as a SBE will be $2.95m, not $1.95m –therefore you would not be eligible to be a SBE.
So what are the benefits of being a SBE in respect of asset purchases? They are significant – they include:
* The ability to claim an immediate tax deduction for most depreciating assets costing less
than $6500
* The ability to claim the first $5000 as an immediate tax deduction for the purchase of a
motor vehicle used for business purposes
* Any other plant, fixtures and fittings costing more than $6500 are allocated to a pool and
depreciated at 15% in the year of purchase and 30% for each subsequent year
Non Small Business Entity
Those businesses that do not satisfy the definition of SBE are subject to the capital allowance write offs that are much less generous that under the SBE regime.
In general these are:
* Assets costing less than $100 can be written off
* Assets costing over $100 and less than $1000 are allocated to a Low Value Pool and
written of at 18.75% in the first year and 37.5% in each subsequent year
* Assets costing over $1000 must be written off over their effective useful life. The effective
life of an asset can be determined by reference to Tax Ruling TR2012/2 (refer link
http://law.ato.gov.au/atolaw/view.htm?docid="TXR/TR20122/NAT/ATO/00001)
* Depreciation on assets purchased during the year can only be claimed pro rata in the year
of purchase eg if purchased on 30th April, depreciation can only be claimed for 61/365 in
the first year
* Depreciation can be claimed on a Prime Cost (Straight Line) or Diminishing Value basis.
* The Diminishing Value rate of depreciation is twice that of the Prime Cost method. For
example, if an asset was purchased that had an effective life per the effective life tables of
10 years, the depreciation rates would be as follows:
10% Prime Cost
20% Diminishing Value
Depreciation using the Prime Cost method is calculated on the original cost each year whilst for the Diminishing Value method, it is calculated on the depreciated value each year.
Diminishing value gives you a greater write off in the earlier years and reduces gradually each year. Prime Cost gives a lower depreciation claim in the earlier years and a greater write off in the later years. As such, most choose diminishing value as their preferred method.
Any assets that cease to be used and are considered obsolete can have the remaining depreciated value written off (unless they are sold)
Property Improvements
There is no difference between the tax treatment of structural improvements to property under the two tax regimes. A 2.5% capital allowance (write) applies to property improvements that form part of the structure of a property.
Financing Equipment Purchases
Significant equipment purchases are generally financed. The two most popular methods are:
1) Lease
2) Chattel Mortgage or Equipment Loan
Lease payments are generally tax deductible and the GST in each payment claimable in your BAS.
The only circumstances where the lease payments will not be totally or partially tax deductible will be where the asset is not 100% for business use or the residual is not realistic.
In the 1980’s it was common practice to have the residual value (the final payout should you wish to own the asset at the end) set at $1 such that the full value of the asset was written off over a relatively short time.
The ATO have tightened this up and the residual must now be reflective of market value for the lease to be considered a general lease.
Under a chattel mortgage or equipment loan, you claim the GST in the purchase in the BAS for the period in which the asset was purchased (assuming 100% business use).
No further GST is claimable in respect of the payments.
For tax purposes, rather than claiming the total amount of the payments, you claim depreciation on the asset as if you own it and the interest in each payment.
Which finance method is best will depend on your individual circumstances and I suggest you discuss this with your accountant in order to achieve the optimum result for you.
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