Article by Dale Woodruff
With Temporary Full Expensing ceasing on 30 June 2023, it's important to plan ahead and consider the potential tax implications of plant sales. Plant upgrades involving trade in’s will likely result in a tax cost rather than a tax saving! The tax implications can vary significantly depending on whether the sold asset was depreciated using Temporary Full Expensing (TFE), General Small Business Pool (GP), Uniform Capital Allowances (UCA), or Instant Asset Write Off (IAWO).
The TFE measure was introduced as part of the government's response to the COVID-19 pandemic and came into effect on 6 October 2020. This measure aimed to stimulate economic growth by allowing assets to be fully written off in the year of purchase. This was a significant shift from the traditional practice of gradual depreciation over the asset's useful life.
Small Business Entities (turnover of less than $10m) are eligible for simplified depreciation rules, including the General Pool (GP). Assets are depreciated at a rate of 15% in the first year and 30% per year thereafter on a diminishing value basis. However, most General Pools have been fully written off using TFE or IAWO provisions.
Under the UCA system, depreciation is calculated based on the asset's effective life and the chosen method of depreciation, which can either be the prime cost method or the diminishing value method.
The Instant Asset Write-Off (IAWO) provisions allow eligible businesses to claim an immediate deduction for the cost of certain depreciating assets. The IAWO thresholds started at $20,000 in 2017 and peaked at $150,000 in 2021. The introduction of TFE in October 2020 largely superseded the need for IAWO.
Understanding the tax implications of selling plant and equipment previously depreciated or written off under these methods is crucial.
Temporary Full Expensing (TFE):
When equipment that has been written off via FTE is sold, the entire sale proceeds are treated as taxable income - because the asset's cost has already been fully deducted. If a replacement asset is purchased, it will likely be depreciated using the GP or UCA provisions. Either way, the depreciation on the replacement asset is likely to be less than the profit on sale, resulting in net taxable income.
Example:
Tractor purchase $600,000
Tractor sale $200,000
Changeover $400,000
Depreciation (GP or UCA) $90,000
Profit $200,000
Net taxable income $110,000
Spending $400,000 on a new tractor may be confronting, especially when it leads to an additional taxable income of $110,000! You could be facing a tax cost of $33,000 compared to a tax saving of $120,000 under the old TFE rules.
Instant Asset Write-Off (IAWO):
The tax consequences of selling plant, previously written off under the Instant Asset Write-Off rules, are the same as TFE.
General Small Business Pool (GP):
If a Small Business Entity (SBE) disposes of an asset that belongs to the GP and the GP is fully written off, the sale proceeds will be taxable income. However, asset purchases in the same financial year can offset the taxable income.
Example:
Tractor purchase $600,000
Tractor sale $200,000
Changeover $400,000
Depreciation expense $90,000 ($600k x 15%)
GP balance at year-end $310,000 ($600K -$90K - $200K)
The depreciation for the subsequent year will be calculated on the pool balance of $310,000, a relatively modest amount in comparison to the cost of the tractor. This is because the pool value was used to offset the tractor sale.
In the above example, if other assets aren't purchased in the same financial year, a taxable profit of $200,000 will arise.
Uniform Capital Allowances (UCA):
When equipment depreciated using UCA is sold, the asset's written-down value (WDV) is compared to its sale price to identify a taxable profit or deductible loss. Usually, the profit or loss is relatively small because the tax depreciation is similar to the actual decline in market value. This is in contrast to TFE, GP, and IAWO where the WDV is generally nil.
The replacement asset will usually be depreciated at the same depreciation rate as the traded item, resulting in a net tax deduction.
Example:
Tractor purchase $600,000
Tractor sale $200,000
Changeover $400,000
Depreciation (say 16.67%) $100,000
Profit – assuming WDV of $190K $10,000
Net deduction $90,000
Summary:
It's important to bear in mind that the disposal of plant assets could potentially generate unforeseen taxable income. This is primarily because the business has already taken the full tax benefit, leaving no written-down value to offset the sale proceeds. The sale of plant previously written off using TFE will create the biggest tax issues.
A well-structured depreciation schedule is essential to navigate the complex landscape of plant sales. This schedule should distinctly record assets depreciated under the TFE, GP, UCA, and IAWO rules. This vital information allows your accountant to advise swiftly and accurately on the tax implications of plant sales and avoid nasty surprises at tax time!
Feel free to reach out to a Byfields accountant to explore your options and have a meaningful discussion.