Who will benefit most from the government’s instant asset write-off threshold increase, and how does it apply to small business spending?
The Federal Budget tax cuts and the increase in the asset write off threshold for small businesses have generated a lot of media coverage and interest among small businesses. In this article we will take a close look at how the write-off and accelerated depreciation apply, and potential traps for small businesses and taxpayers.
The instant asset write-off threshold increase is a pleasant surprise for many small businesses that have held back on capital expenditure upgrades.
The government is hoping that this measure will encourage capital investment by small businesses over the next two years.
Small businesses tend to be more vulnerable to cash flow problems than larger businesses, because their profitability tend to be more volatile and they have lower levels of retained earnings. By allowing small businesses to write off more assets early, it will boost small business cash flow. While the bigger up-front tax deduction is a good thing, it will only make a cash flow difference when a business is in a tax payable position. If the business is not paying tax, this measure will not have an immediate cash flow benefit.
New businesses tend to make a large capital expenditures early on. A faster write-off is welcome, on the assumption that a business is immediately profitable. Start-ups that will take years before they commence trading profitably will consequently not benefit from this change.
The benefit will also depend on the type of structure the small business entity is using. One-third of small businesses use a corporate entity, so the potential cash flow benefit equates to an effective net tax saving of $4,845 for an asset costing $19,999. If the small business entity is being run as a non-incorporated business (sole trader, partnership or trust), then the tax benefit will depend on the marginal tax rate of recipients of the business income.
As announced in the 2015 Federal Budget, the Government is amending the accelerated depreciation rules for small businesses, by temporarily increasing the threshold under which certain depreciating assets and general small business pools can be written off.
The increased threshold of $20,000 is available to all small businesses, including those that previously opted out of the simplified depreciation rules. It applies only to assets – both new and second-hand – that were first acquired at or after 7.30pm on 12 May 2015 and were first used or installed ready for use on or before 30 June 2017.
The requirement that an asset be ‘first acquired’ at a particular time is an additional requirement for the increased threshold. It ensures that the threshold only applies to a small business entity’s ‘new’ assets. Requiring a depreciating asset to have been ‘first’ acquired by the small business entity means that assets cannot satisfy the acquisition requirement if they were acquired at an earlier time, temporarily disposed of, then reacquired at or after the 12 May 2015 start time.
Any business that meets the definition of a small business entity – that is, one with an aggregated turnover of less than $2 million – may be eligible to immediately deduct the cost of assets acquired for less than $20,000. If you are not considered to be running a business (i.e. hobby activities or passive investment) for tax purposes, then you are not eligible for the concession, even if you have an ABN. You should also be mindful of Personal Services Income (PSI) and Non Commercial Loss (NCL) rules, which can either deny or quarantine losses.
How is the GST treated?
If the entity is registered for GST, then the GST-exclusive amount is taken to be the cost of the asset. Where the entity if not registered for GST, then the GST-inclusive amount if taken to be the cost of the asset. So, for example, if you are a registered GST business that purchases an asset with a taxable purpose of 100 per cent, the cost of the asset needs to be less than $21,999 GST inclusive, before GST credit is clawed back.
Installation costs that form part of the second element of the cost of the asset must also be included for the purposes of working out whether the asset meets the threshold test.
If the asset cannot perform its intended function without other things being done – for example, a 3D printer that requires software in order to function or a coffee machine that needs plumbing to make it operational – than it is likely that those other things need to be included in the cost of the asset for threshold purposes.
One thing is for sure, there will be disputes arise as to what constitutes an asset for the purposes of measuring the less-than-$20,000 limit. For instance, is an item to be properly viewed as an asset in its own right or it is part of a larger asset? This will be a question of fact and degree, taking into consideration all the relevant circumstances of the particular case. The ATO provides some guidance in Tax Ruling 94/11.
Its hard cut-off, with assets valued at more than the threshold amount ineligible for immediate deduction; however, they may be placed in the small business depreciation pool and depreciated at 15% in year one and 30% in subsequent years. There’s no limit on the number of assets that can be immediately deductible, but each must cost less than $20,000.
Another thing to note – and a trap for many – is that the cost of the asset must be less than $20,000 before the taxable proportion is worked out, as illustrated in the following example:
Daryl’s Electrical acquires a ute for $40,000 on 28 July 2015.
Daryl’s Electrical estimates that the ute has a taxable purpose proportion of 40% for the 2015/16 income year. As the ute cost more than $20,000, Daryl’s Electrical is unable to immediately deduct the cost of the ute. The ute is added to Daryl’s Electricals’ general small business pool.
Are all assets eligible?
All assets will be eligible, except for a small number of exclusions that receive different depreciation treatment. Assets excluded from the depreciation rules include horticultural plants and in-house software allocated to a software development pool.
An eligible small business can claim an immediate deduction for any software purchased off the shelf, costing less than $20,000 that is used exclusively in the business.
An eligible small business can also claim an immediate deduction for the cost of developing software for use exclusively in its business, where the cost is less than $20,000.
An exception applied if the entity has previously chosen to claim deductions for in-house software under the software development pool rules. In this case, the costs need to continue to be allocated to that pool.
A special label in the tax return will be issued to identify how much any entity has claimed using the immediate write-off concession, so expect some audit activity from the ATO. There will be an onus on tax practitioners to ensure that clients meet the eligibility rules for immediate write-off as part of their tax preparation work. This may require practitioners to review client records that support the deduction claim, to ensure compliance. That is where we come in.
Planning is the key. It will be a lot easier to manage the claim under this new initiative before you spend your money. If you are looking at this new tax assistance measure, please contact us before you start the process.
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