The ATO has released guidance on whether an asset that is made up of a number of components (a composite item) is itself a depreciating asset, or whether one or more of its components are separate depreciating assets.
The Draft Taxation Ruling TR 2023/D2 provides the Commissioner’s view on identifying the relevant depreciating asset and hence its effective life and depreciation rate for the purposes of Div 40 of ITAA 1997.
Purpose and functionality of the depreciating asset
The main principles that are taken into account in determining whether a composite item is a single depreciating asset, or more than one depreciating asset, are:
- it performs a separate identifiable function, having regard to the purpose it serves in its business context
- it has a discrete function, and therefore is a depreciating asset, without necessarily being self-contained or used on a stand-alone basis
- the greater the degree of physical or functional integration of an item with other component parts, the more likely the depreciating asset will be a composite item
- if 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
- various components purchased to function together as a system and are necessarily connected in their operation
Modifications can be separate assets
In testing whether modifications or enhancements to a depreciating asset in fact constitute a new depreciating asset, the Commissioner expects that different conclusions may sometimes arise given the different inquiries. As per TR 2023/D2 the modifications can be of varying degrees:
- an addition or attachment substantially alters a depreciating asset (the original depreciating asset) – likely to be a separate depreciating asset from the original depreciating asset
- the original depreciating asset continues to perform its function – likely to not be considered as a separate depreciating asset
- the addition or attachment serves its own function – likely to not be considered as a separate depreciating asset
Jointly held tangible assets
If the underlying asset is held by one or more entities, the “interest in the underlying asset” is considered to be the relevant asset for the purposes of Div 40.
Section 40-35 applies when working out the deductions for the share of the decline in value.
Intangible assets
Intangible assets capable of being depreciating assets are specifically listed in s 40-30(2), to ascertain whether an eligible intangible asset is a composite item, requires consideration of the legal character and any underlying individual rights for the item.
Key takeaways
A composite item (depreciating asset) may have a different effective life as a whole as compared to the effective life of the various components it is made up of. For example, an air conditioning unit is a depreciable asset, however, the pipes, ducting and vents are not, as they form part of the cost of the building subject to the capital allowance rules under Div 43.
It is important to analyse the guiding principles on case-by-case basis and correctly identify the relevant depreciating assets and hence their eligibility for certain tax write-offs and concessions. For example, a composite item which is a depreciating asset may not qualify for the instant asset write off as a whole, but the separate identifiable components (depreciating asset) may qualify.
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Please note that this information is not specific and is general in nature and cannot be relied on as advice. Please contact us for advice specific to you and your circumstances.