Redefining Cost and Cost Base
The blackhole rules were widely anticipated – after all, the Government had enacted a limited solution to the blackhole problem in 2001, announced that it would develop a more comprehensive solution in 2002, and then re-announced the same proposal in 2005. The recent amendments enact this more comprehensive solution to the problem of blackholes.
It was not expected that the Government would at the same time change the definition of cost and cost base.
While the blackhole measures have received much publicity, the cost and cost base redefinition rules have not. Yet the two measures form a package and need to be understood together. The amendments to cost and cost base will require more outlays to be absorbed into the cost of assets; the blackhole measures will only apply to outlays that do not have to be absorbed.
1. Cost and cost base measures
1.1 Redefinition of Cost for Depreciation Rules
The new legislation amends the basic provisions that define the amounts which form part of the cost of an asset for depreciation purposes.
The new definition of cost for depreciation will include any expenditure “in relation to” holding a depreciating asset. This subtle change in wording is intended by the Government to have consequences. The Explanatory Memorandum to the Bill suggested the new formulation would require a taxpayer to absorb search costs and travel expenses into the cost of a depreciating asset; the implication is that they should not be deducted as general expenses (and they are not amenable to the blackhole rules).
Another change is made in the rules dealing with costs of scrapping, selling or licensing depreciable assets. Under the previous rules, these costs were treated as reducing the proceeds of selling the asset. The new rules will treat these outlays as forming part of the cost of the asset. The change will matter, for example, in cases where there are significant decommissioning costs associated with scrapping machinery. By adding decommissioning costs to the cost of the asset, scrapping it can now give rise to a loss. The change will also matter, for example, in the treatment of demolition costs of machinery. These costs will now be treated as part of the cost of the demolished machine (and so recovered when it is scrapped) rather than as a blackhole or as part of the cost of a replacement asset.
The new definition of cost for depreciation purposes applies to expenditure incurred after 1 July 2005.
1.2 Redefinition of Cost Base for Capital Gains Tax
The new legislation also amends the basic provisions that define the amounts which form part of the cost base of an asset for the purposes of the capital gains tax provisions. The amendments modify the current rules about the incidental costs of acquiring or selling assets, non-deductible ownership costs and improvement costs.
There is an expanded list of the kinds of incidental costs of acquiring and disposing of assets that are added to the cost base of an asset. One important addition deals with costs incurred on disposing of assets owned by a consolidated group between group members. Amounts outlaid to external parties upon a transaction between group members can be added to the cost base of assets held by a consolidated group. The example in the Explanatory Memorandum treats this rule as applying to stamp duty paid on the transfer of land from one group member to another. Because there is no “disposal” recognised by the tax system on the sale of the land to another member of a consolidated group, the legislation takes the view that a special rule is required to add the stamp duty to the cost base of the land. The addition becomes relevant when the land is sold outside the group. (It also removes the possibility of claiming the stamp duty as a backhole expense.)
The most significant change is made to the treatment of improvement costs. At present, improvement costs can only be added to the cost of an asset if they are made to enhance the asset’s value and are still apparent when the asset is sold. The new formulation will add improvements to the cost of an asset if they are undertaken to increase or preserve the value of the asset or if they relate to installing or moving the asset. This should be a simpler test to satisfy, but it will have the effect of adding many expenses to cost base that might have been dealt with under the more generous blackhole rules.
The new formulation does not extend to expenses undertaken to increase or preserve the value of goodwill. There appears to be a view that this is a generous provision for taxpayers – such expenses will, as a result, potentially fall within the blackhole regime. It is, however, possible that some expenses relating to goodwill will not be within the scope of the blackhole rules – it is not a comprehensive regime – and the exclusion means they will not be recognised in cost base either; they will be blackholes that remain blackholes.
2. Blackhole measures
A “blackhole” is a business outlay that is neither deductible nor reflected in the cost of an asset. It is a business cost of $1 before-tax and after-tax. Some blackholes are deliberate – the non-deductibility of fines, for example – but others are simply the inglorious result of current legislative drafting.
The blackhole rules enacted last month apply to business expenditure only. The measure refers to business “capital expenditure” by which the legislation is probably intending to refer to two things – to outlays that are structural, and to outlays that are non-deductible because of the lack of an adequate connection to the business – the outlay precedes the commencement of a business or is relevant to the business of another person, for example.
The new rules will allow many outlays that are currently blackholes to be recovered at the rate of 20% per annum over 5 years.
There are two important points to note about the new regime. First the regime is intended to operate as a provision of last resort. But, as it is more generous than some other possible treatment – for example it is a better outcome than absorbing the outlay into the cost of a non-depreciable asset which is unlikely to be sold – the provision is not always an unattractive option.
Secondly, it is clear the provision is not comprehensive – blackholes will remain after these rules. These rules do nothing for taxpayers who are classified as investors – such as the trustees of superannuation funds or investment funds – rather than carrying on an active business. Special rules also continue the current limit on deducting under the blackhole rules amounts that form part of the cost of land, or that are incurred in relation to “leases and rights.” The Government announced in the 2005 Budget that it would not be proceeding with a single regime for handling “leases and rights”; they remain a difficulty that the blackhole regime does not solve.
Michael Moschner
61 2 9225 5969
michael.moschner@gf.com.au
http://www.gf.com.au/