Income tax – Depreciation change in the wind

An Officials’ Issues Paper has been released that reviews the tax depreciation rules and looks at ways of reducing possible tax biases in these rules and resolving technical problems.

Current rules

The current rules provide a statutory deduction for depreciation for ‘depreciable property’ (any property that might reasonably be expected to decline in value while used or available for use in deriving gross income).

Depreciation rates are set under a statutory formula. The formula is based on a diminishing value method (with a constant percentage of an asset’s book value allowed as a deduction), although an equivalent under the straight-line method (a constant percentage of the asset's cost) is also typically calculated.

Special rules exist for applying to the IRD for a depreciation rate that is higher (or lower) than the general prescribed rate (the ‘special tax depreciation rate’ rules).

A 20% loading applies on depreciation rates for most new assets.

Directions of reform

The paper suggests that there is a case for replacing the current assumption that assets decline smoothly to 13.5% of their initial value.

Instead, it suggests that plant and equipment might better be depreciated on a double declining balance basis and buildings and other structures on a straight-line basis over their estimated economic lives. The changes would tend to reduce depreciation deductions for buildings and other structures. One concern with this approach is that it would increase depreciation deductions significantly for very short-lived equipment. The paper also discusses possible changes to the 20% depreciation loading that currently applies to most assets.

Specific issues

The paper looks at a number of specific issues where useful improvements to the current rules are possible, including:

• Deductibility of expenditure incurred in preventing, combating, and rectifying pollution;
• When depreciation can begin for patents;
• Changes to the special tax depreciation rate rules;
• Plant variety rights included as depreciable intangible property;
• Definition of ‘depreciable intangible property’; and
• Losses on disposal of buildings – deductions for losses on destruction of buildings as a result of natural disasters should be allowed.

Issues about which further information is needed

The paper also examines a number of issues about which further information was needed before changes could be suggested.

• Deductibility of asset disposal costs – Consideration should be given to full deductibility for the costs associated with disposing of depreciable assets.
• Higher threshold for immediately deducting the cost of ‘low-value’ assets: A higher threshold ($2,000) for immediately deducting the cost of ‘low-value’ assets and a higher total threshold ($20,000) for immediately deducting the cost of ‘low-value’ assets purchased at the same time from the same supplier does not seem to be justified.

Issues rejected

The paper also looks at a number of issues raised by taxpayers that it did not consider should be progressed:

• Use of financial reporting depreciation rates for tax purposes – the paper did not consider that taxpayers should be allowed to use depreciation rates used for financial reporting purposes for tax purposes.
• Depreciation of buildings (and other fixtures) on land held by a dealer in land – the current requirement that land held by a dealer in land be treated as being held on revenue account for a period of 10 years from the date of acquisition should not be amended to allow depreciation on buildings and other fixtures constructed on the land.
• Treatment of property that changes use -the paper does not consider that the rules governing depreciation previously allowed in respect of depreciable assets that change use (eg, move to being held on revenue account) need clarification.
• Depreciation rates under the industry and asset categories – a clarification is not needed in relation to the process for selecting the most applicable depreciation rate in respect of an asset under the current depreciation schedules.
• Difference between estimated useful life and economic life – there is no material difference between the concept of ‘economic life’ and the term ‘estimated useful life’.

Rental properties

The paper considers that there might be an element of tax advantage for investment in residential rental property and buildings more generally.

The paper suggests making the rules relating to the tax treatment of rental housing more certain, by providing landlords with two options:

• Under the first option, a set of separately depreciable assets would be identified, as happens in Australia. These would include lifts, domestic appliances, hot water cylinders, air conditioning systems, light fittings, and carpets. However, the set of separately depreciable assets would be limited, and the remainder of the building – including wiring, plumbing, and internal walls – would be depreciable at the building depreciation rate, as part of the building. This option would require taxpayers to obtain market values of these separate assets at purchase and sale to determine the tax basis for depreciation rates and to determine any gain or loss on sale.
• An alternative would be to depreciate all of these assets as part of the building, which would remove any need for separate valuations on purchase or sale. It would also be appropriate for taxpayers adopting this latter approach to have wider scope for deducting expenses as repairs and maintenance.

Finally

• Talk to us if you consider that any of the issues contained in this fact sheet may affect you.

Disclaimer

Important: This is not advice. Clients should not act solely on the basis of the material contained in this fact sheet Items herein are general comments only and do not constitute or convey advice per se. Changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of the areas. We believe the contents to be true and accurate as at the date of writing but can give no assurances or warranty regarding the accuracy, currency or applicability of any of the contents. This fact sheet is made available to our clients as a helpful guide for their private information. Therefore it should be regarded as confidential and should not be made available to any person without our prior approval.

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