Depreciation formula - apportionment of business and private use

Sections DE 2, EE 11, EE 33, EE 34, EE 49 and FB 7 of the Income Tax Act 2004

Two new formulas to allocate losses on disposal for depreciable property, when the property is used for both business and private purposes and is purchased and disposed of in the same income year, have been added to the Income Tax Act 2004. The new formulas correct an anomaly in the current formulas as they incorrectly apportion losses in these circumstances.

The current formulas will continue to apply in situations where the property has been held for longer than a year.

Background

Deductions for depreciation losses are only allowed when an asset is in use or available for use for business purposes. For assets that are used for both business and private purposes, deductions for depreciation losses must be apportioned on the basis of business use. In the same way, any final depreciation loss (the difference between the asset's depreciated value and the amount received on disposal) must also be apportioned.

The rules that govern the treatment of gains and losses from the disposal of depreciable property and motor vehicles include formulas that are used to apportion the proceeds from the disposal between the business and private use. The formula in section FB 7(6) apportions gains and losses from the disposal of depreciable property and section DE 2(7) does the same for motor vehicles. A problem has been identified with the operation of these formulas.

A variable in both formulas is all depreciation deductions that have been allowed on that asset. The problem is that this variable is always zero for assets disposed of the same year they were purchased. This is because the tax rules don't allow a deduction for an amount of depreciation loss in the year in which the asset is disposed, except if the consideration received is less than the assets-adjusted tax book value. The result is that the formulas always produce a result of zero, even though the taxpayer may have suffered a loss on disposal.

This anomaly has been rectified by the introduction of two additional formulas.

Key features

Apportioning depreciation loss on disposal of motor vehicles

Section DE 2 of the Income Tax Act 2004 governs calculations of deductions for business use in relation to motor vehicles. Among other things, this section provides a formula to apportion an amount of depreciable loss on a disposed motor vehicle between its business and private use.

The new formula in subsection DE 2(8C) is to be used when calculating the portion of the depreciation loss that is allowed as a deduction when a motor vehicle is acquired and disposed in the same income year. This formula avoids any reference to depreciation deductions and instead simply multiplies the depreciation loss on disposal by the proportion the asset was used for business purposes.

The amendment also clarifies that the formula in subsection DE 2(7) should continue to be used to apportion between business and private use when there is a depreciation loss on disposal of a motor vehicle when that has already been subject to depreciation deductions.

It should be noted that a person will be deemed to acquire a motor vehicle when the person starts to use the motor vehicle for business purposes or it is available for business use. For example, a car that has been bought in 2003 for personal use and which started being partly used for business purposes in 2007 is deemed to be acquired in 2007 for the purposes of this section.

Apportioning depreciation loss on disposal of depreciable property

Generally, a person is not allowed any depreciation loss for an item of depreciable property for the income year in which the person disposes of it.

A new exception to this rule has been added to new section EE 11(6) of the Income Tax Act 2004 for situations when depreciable property has been partly used for business and partly for personal purposes. The new section specifies that in these circumstances, depreciation loss should be calculated under section FB 7(9).

Section FB 7 is used to apportion a depreciation loss on disposed items (other than motor vehicles) that have been used for both business and private purposes. The new formula in section FB 7(9) apportions the amount of any depreciation loss allowed as a deduction when an item of depreciable property is acquired and disposed in the same income year by multiplying the depreciation loss resulting from the disposal by the proportion that the property was used for business purposes. The proportion of business use is expressed in the formula as the number of days in the income year on which the person owns the item and uses it, or has it available for use for business purposes, divided by the total number of days in the income year on which the person owns the item and uses it, or has it available for use for any purposes. The section also stipulates that a unit of measurements other than days can be used in the formula if it achieves a more appropriate result.

It should be noted that a person will be deemed to acquire a depreciable item when the person starts to use the item, or to have it available for use for the purpose of deriving assessable income or carrying on a business for the purpose of deriving assessable income.

Consequential amendments have been made to sections EE 49(2) (definition of "base value"), EE 33(3)(a)(ii) and EE 34(2)(a)(ii) (cost of item to person) of the Income Tax Act 2004 to allow the calculation of an asset's value at its market value at the time it is first used or becomes available for use in business.

Application date

These provisions apply for the 2006–07 and later income years.