Due to some requests for clarification
on last issue’s column, we are publishing the article again
with full reference to each table.
Changes to depreciation schedules were in the news again after the
2006 Budget. Wade Oldham offers advice on what they mean.
In the March issue of ProPrint,
I discussed changes to depreciation, effective from January 1, 2006.
The changes were not all that encouraging as, generally speaking,
the ruling changes were for lower (than before) allowances for depreciation
on capital equipment.
Then came the Treasurer’s Budget address
in May detailing sweeping changes to depreciation as it relates
to capital equipment.
Well, “detailing” might be a bit generous as a term,
judging by the number of calls I have fielded with the sentiment
of “what’s it mean to me?”.
We’ll see if we can turn all that hype and
tripe into layman’s language and push forward with what I
see as significant advantages and affordability to investing in
new equipment. One of the largest contributors to a business decision
to invest in new equipment relates to cash flow. Businesses can
be hesitant to invest in new equipment because they are cash poor.
Profits from your business usually end up in your debtor’s
ledger or in tax payments — rarely do profits turn up in your
bank account. For the last few years with tax reform, businesses
have been cash strapped due to catch up tax (from prior years),
current taxes and paying PAYG (or expected current year tax based
on last year) tax. All this has been compounded by reduced depreciation
allowances over the past seven years, which means higher company
profits, and naturally, higher taxes.
The significant changes to depreciation (in the
budget) and the apparent acceptable standard of self-determination
of “effective life depreciation” as it relates to equipment
should increase businesses’ decisions to invest in new technology.
The revised depreciation more accurately reflects market sentiment
as to actual resale values over the first few years of an asset’s
useful life.
The biggest query I have received was to decipher
the increase in the diminishing value rate of depreciation from
150 per cent to 200 per cent, and what that actually means.
The Tax Department has two depreciation models.
The first is “Straight Line Method”. For example, if
the Tax Department deems an asset to have a useful life of ten years,
the straight line method is ten percent per annum.
The second is the “Diminishing Value Method”.
Previously, by using the DV method, you have been allowed to apply
150 percent to the rate, thereby (as in the example above) rather
than applying ten per cent per annum, you can apply 15 per cent
on a diminishing value basis.
In conjunction with Table 2 below, which provides
graphic examples, it means that businesses will be able to write
off the cost of new plant and equipment more rapidly for tax purposes,
reducing the cost of investing in eligible assets over their effective
lives. This more closely aligns depreciation deductions for tax
purposes with the actual decline in the economic (or useful life)
of assets acquired by a business after May 10, 2006. The government’s
spin (and I agree with it) is to “ensure depreciation for
tax purposes aligns with economic value/depreciation to assist businesses
keep pace with new technology, enhance productivity and sustain
economic growth”.
We will assume you acquire an asset at a cost
price of $500,000, and will forget GST for the sake of the exercise
as it is deemed to be an input tax credit. And, assume it is financed
on Commercial Hire Purchase over six years (72 months) providing
for monthly payments of $8,750, or $105,000 per annum. We will also
assume acquisition in July, for a 12-month financial year.
