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Identifying relevant depreciating asset for tax purposes
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  • 5 minute read
  • February 08, 2024

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The ATO has finalised its ruling on the treatment of composite items for tax depreciation purposes, TR 2024/1. This ruling provides guiding principles and examples to help taxpayers apply a ‘functionality test’ to determine whether a composite item is itself a depreciating asset or whether its components are separate depreciating assets.

8 February 2024

In Brief

The Australian Taxation Office (ATO) has finalised Taxation Ruling TR 2024/1 on how to identify the relevant asset for tax depreciation purposes when an asset is made up of different parts and components. The Ruling provides guiding principles and examples to help taxpayers apply a ‘functionality test’ to determine whether a composite item is itself a depreciating asset or whether its components are separate depreciating assets.

In Detail

Identifying what is the relevant depreciating asset for tax purposes is necessary for a range of reasons, including to work out the asset’s effective life and therefore the rate at which depreciation deductions can be claimed. It is also important for testing an asset's eligibility for certain immediate tax write-offs and concessions. In the case of a composite asset, i.e. an asset that is made up of several components that are each capable of separate existence, this can be complex and has been the subject of judicial decisions and draft ATO guidance over many years.  

The ATO’s release of final Taxation Ruling TR 2024/1 follows the end of its consultative process that commenced in 2017 with draft ruling TR 2017/D1 which was replaced with a further draft released last year as TR 2023/D2. The final Ruling which reflects changes made in response to feedback to those previous drafts, including the clarification of existing examples and new content, can now give taxpayers some assurance as to the ATO’s current binding view on this topic. 

The Ruling sets out the Commissioner's views on two main issues: 

  • how to identify the relevant depreciating asset where the asset itself is made up of different parts and components, and 
  • whether an 'interest in an underlying asset' requires an entity to have an interest in all parts of a composite item that is itself a depreciating asset, or whether an interest in any part of the asset is enough. 

The Ruling notes that although it is a question of fact and degree when considering whether a composite item is a single depreciating asset or multiple separate depreciating assets, it sets out useful guiding principles. The functionality test is referenced as being a useful guide. This broadly requires a consideration of the actual function the item is to serve in the particular taxpayer's income-producing activity, and whether the item is functionally complete in itself or dependent on other items. 

Group of people looking at a computer

In this regard, the Ruling provides the following principles to assist in applying the functionality test: 

  1. The depreciating asset will ordinarily be an item that performs a separate identifiable function, having regard to the purpose it serves in its business context. 
  2. An item may be identified as having a discrete function, and therefore as a depreciating asset, without necessarily being self-contained or used on a stand-alone basis. 
  3. The greater the degree of physical or functional integration of an item with other component parts, the more likely the depreciating asset will be the composite item. 
  4. When the effect of attaching an item to another item (which itself has its own independent function) varies the function or operational performance of that other item, the attachment is more likely to be a separate depreciating asset. 
  5. When various components are purchased (whether via one or multiple transactions) to function together as a system and are necessarily connected in their operation, the depreciating asset is usually the system (the composite item). 

The Ruling also confirms that modifications or alterations to existing depreciating assets can be separate depreciating assets, and this is more likely where the addition or attachment substantially alters the original depreciating asset, the original depreciating asset continues to perform its function, and the addition or attachment serves its own function (for example, a new electricity distribution line would be a separate asset from the existing distribution network (see example 8) and a new railway branch line would be separate asset to the main line (see example 12)). However, a modification which restructures or adds new components to an existing depreciating asset will likely result in the asset being merged into a new depreciating asset where the new asset has a different purpose or performs a different function from the original asset.  

Restorations and minor alterations that do not change the overall function of the existing depreciating asset will generally not be considered separate depreciating assets. The Ruling also confirms that where expenditure on restoring a depreciating asset to its original condition constitutes a repair, no separate depreciating asset is created. 

Interestingly the Ruling also makes it clear that the test for a composite item for depreciation is not the same test used to determine what constitutes a “facility” for the purposes of obtaining transitional relief from the 'non-concessional MIT income' provisions relating to stapled structures. 

Section 40-35 of the Income Tax Assessment Act 1997 (ITAA 1997) provides special rules for jointly held assets. Broadly, these rules treat a taxpayer's interest in an underlying asset as if it were the asset itself, so that tax depreciation is calculated separately on each taxpayer's interest in the asset, rather than the underlying asset itself. The Ruling clarifies that the joint holding rules in section 40-35 can apply to composite items, noting that an entity can have an interest in an underlying asset even if it does not own the entirety of the asset, but only part or all of a discrete component of the asset.  

With respect to an intangible depreciating asset that is a bundle of rights, whether it is a composite item requires consideration of the legal character of the item and the underlying individual rights.  However, the Ruling confirms that the joint holding rules in section 40-35 can apply to intangible depreciating assets.  

The Ruling contains 14 examples in Appendix 1 to illustrate the application of the guiding principles and the functionality test to various types of assets, such as industrial storage racking, desktop computer package, mainframe computer, local area network, aircraft engine and frame, car global positioning system, fibre optic cable communications system, electricity distribution equipment, rail transport infrastructure, solar power system, and photographic lighting equipment. 

The Takeaway

The Ruling provides useful guidance and examples for taxpayers who own or use assets that are made up of different parts and components, and who need to identify the relevant depreciating asset for capital allowances purposes. This is necessary to determine the appropriate rate at which depreciation deductions can be claimed.  

It is recommended that taxpayers review their existing depreciating assets and proposed asset acquisitions and disposals in light of the guidance in the Ruling, and consider whether they need to make any adjustments to their depreciation claims or tax asset registers, noting that the Ruling generally applies retrospectively as well as prospectively. 

Contact us

If you would like to further discuss the Ruling, reach out to our team or your PwC adviser.

Christina Sahyoun

Partner, Global Tax, Sydney, PwC Australia

+61 403 658 464

Email

Steve Ford

Partner, Sydney, PwC Australia

+61 (2) 8266 3433

Email

Matt Budge

Partner, Perth, PwC Australia

+61 8 9238 3382

Email

Kirsten Arblaster

Partner, Tax, Melbourne, PwC Australia

+61 3 8603 6120

Email

Julian Myers

Partner, Tax, Brisbane, PwC Australia

+61 421 052 318

Email

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