Depreciation and depletion
A capital allowances regime allows a deduction for the decline in value of depreciating assets held by a taxpayer. The holder of the asset is entitled to the deduction and may be the economic, rather than the legal, owner. A 'depreciating asset' is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used, but does not include land, trading stock, or, subject to certain exceptions, intangible assets. Deductions are available for certain other capital expenditure.
Intangible assets that are depreciating assets (if they are not trading stock) are:
- Certain mining, quarrying, or prospecting rights and information.
- Items of intellectual property (IP).
- In-house software.
- Indefeasible rights to use a telecommunications cable system.
- Spectrum licences under radio communications legislation.
- Datacasting transmitter licences.
- Telecommunications site access rights.
Taxpayers that do not qualify for any of the capital allowance accelerated depreciation concessions for businesses (see below) must depreciate the asset over its useful life (known as 'effective life') using either the straight-line (known as the 'prime cost' method) or diminishing-value method (straight-line rate multiplied by 200%).
Taxpayers may self-determine the effective life of certain items of depreciating assets or may choose the effective life for the asset as contained in a published determination of the Commissioner of Taxation.
Business taxpayers are able to immediately deduct items that cost less than AUD 100 and choose to write off all items costing less than AUD 1,000 through a low-value pool at a diminishing-value rate of 37.5% per annum to the extent the asset is used for income-producing purposes.
Taxpayers who are carrying on business and who, together with certain connected or affiliated entities, have an aggregated turnover of less than AUD 5 billion for the year may be eligible to apply accelerated depreciation concessions for certain depreciating assets. These rules can be difficult to navigate, but, in summary, businesses with aggregated turnover of less than AUD 5 billion (or companies that meet an alternative AUD 5 billion income test and historic capital expenditure test) may choose to claim a tax deduction for the full cost of an eligible depreciating asset located in Australia or principally used in Australia that is acquired from 7:30pm AEDT on 6 October 2020 and first used or installed by 30 June 2023.
'Project pool' rules allow expenditures that do not form part of the cost of a depreciating asset to be deductible over the life of a project that is carried on for a taxable purpose. Amongst other things, items that fall within the rules include the following:
- Amounts paid to create or upgrade community infrastructure for a community associated with the project.
- Site preparation costs for depreciating assets (except horticultural plants in certain circumstances).
- Amounts incurred for feasibility studies for a project.
- Environmental assessment costs applicable to the project.
- Amounts incurred to obtain information associated with the project.
- Amounts incurred in seeking to obtain a right to IP.
- Costs of ornamental trees or shrubs.
The so-called 'blackhole' expenditure provisions allow a five-year straight-line write-off for capital expenditure in relation to a past, present, or prospective business, to the extent that the business is, was, or is proposed to be carried on for a taxable purpose. The expenditure is deductible to the extent that it is not elsewhere taken into account (e.g. by inclusion in the cost base of an asset for CGT purposes) and that it is not denied deductibility for the purposes of the income tax law (e.g. by the rules against deducting entertainment expenditure).
Special rules apply for primary producer assets, such as horticultural plants, water and land care assets, and the treatment of expenditure on research and development (R&D) (see the Tax credits and incentives section for more information) and expenditure on certain Australian films.
A luxury car cost limit applies for depreciating the cost of certain passenger motor vehicles (AUD 64,741 cost limit for the 2022/23 income year).
Expenditure on the development of in-house software may be allocated to a 'software development pool' and written off over five years (30% in years two, three, and four, and 10% in year five). Amounts spent on acquiring computer software or the right to use it (except where the acquisition is for developing in-house software) generally are treated as incurred on acquiring a depreciating asset, deductible over five years commencing in the year it is first used or installed ready for use.
A loss arising on the sale of a depreciating asset (depreciated value of the asset less sale consideration) is generally an allowable deduction. A gain on the sale of a depreciating asset, to the extent of depreciation recaptured, generally is taxed as ordinary income. Gains exceeding the amount of depreciation recaptured are also taxed as ordinary assessable income (i.e. not as a capital gain).
Subject to exceptions referred to below, capital expenditure incurred after 15 September 1987 in the construction or improvement of non-residential buildings used for producing assessable income is amortised over 40 years at an annual 2.5% rate. Capital expenditure on the construction of buildings used for short-term traveller accommodation (e.g. hotels, motels) and industrial buildings (typically factories) is amortised over 25 years at an annual 4% rate where construction commenced after 26 February 1992. The cost of eligible building construction that commenced after 21 August 1984 and before 16 September 1987 (or construction contracted before 16 September 1987) is amortised over 25 years at an annual 4% rate. There is no recapture of the amortised amount upon disposal of the building, except where the expenditure is incurred after 13 May 1997, in which case recapture will apply, subject to certain transitional rules.
Similar provisions apply in relation to income-producing residential buildings on which construction commenced after 17 July 1985.
The cost of income-producing structural improvements, the construction of which started after 26 February 1992, is eligible for write-off for tax purposes on the same basis as that of income-producing buildings, that is, at a rate of 2.5% per annum.
The cost of consumables may be either written off immediately or as used.
The following expenditure attracts an immediate 100% deduction: environmental protection activities, dealing with pollution and waste; landcare operations; exploring or prospecting for minerals, including the cost of mining rights and information acquired from an Australian government agency or government entity; mine site rehabilitation; and capital expenditure incurred by primary producers on fencing, water facilities, and fodder storage assets used to store grain and other animal feed.
Tax depreciation is not required to conform to book depreciation.
Percentage depletion based on gross income or other non-cost criteria is not available.
Goodwill and trademarks are not depreciating assets, and tax amortisation is not available.
Certain start-up expenses, such as costs of company incorporation or costs to raise equity, may qualify for a five-year straight-line write-off to the extent that it is capital expenditure in relation to a current or prospective business that is, or is proposed to be, carried on for a taxable purpose. An immediate deduction is available to a small-medium business entity (i.e. a business with aggregated turnover of less than AUD 50 million) for a range of professional expenses (e.g. legal and accounting advice) and taxes or charges to an Australian government agency associated with starting a new business.
Special rules classify financial arrangements as either debt or equity interests. These rules focus on economic substance rather than legal form and take into account related schemes, and extend beyond shares. In this situation, interest expense on non-share equity would be treated as a dividend, which is potentially frankable, and would be non-deductible for the paying company/group.
The law allows companies to claim a deduction for interest expenses incurred in relation to offshore investments that generate non-assessable, non-exempt dividend income.
Thin capitalisation measures apply to the total debt of the Australian operations of multinational groups (including branches of those groups). See Thin capitalisation in the Group taxation section for more information.
Australian taxpayers claiming interest deductions on a financing arrangement from a related foreign interposed zero or low-rate entity (broadly, a jurisdiction with tax rates of 10% or less or jurisdictions that may offer tax concessions) need to consider the potential application of complex integrity rules, which were introduced as part of Australia’s hybrid mismatch rules. Specialist advice should always be sought.
Bad or forgiven debts
A deduction may be available for bad debts written off as bad before the end of an income year. Generally, a deduction will only be available where the amount of the debt was previously included in assessable income, or the debt is in respect of money lent in the ordinary course of a money lending business. The ability to claim a deduction for a bad debt is also subject to other integrity measures.
The amount of a commercial debt forgiven (other than an intra-group debt within a tax consolidated group) that is not otherwise assessable or does not otherwise reduce an allowable deduction is applied to reduce the debtor's carryforward tax deductions for revenue tax losses, carryforward capital losses, undeducted capital expenditure, and other capital cost bases in that order. Any amount not so applied, generally, is not assessable to the debtor. Forgiveness includes the release, waiver, or extinguishment of a debt (other than by full payment in cash) and the lapsing of the creditor's recovery right by reason of a statute of limitations.
Charitable contributions are generally deductible where they are made to entities that are specifically named in the tax law or endorsed by the Commissioner of Taxation as 'deductible gift recipients'. However, deductions for such gifts cannot generate tax losses. That is, generally the deduction is limited to the amount of assessable income remaining after deducting from the assessable income for the year all other deductions.
Subject to limited exceptions, deductions are denied for expenditure on 'entertainment', which broadly is defined as entertainment by way of food, drink, or recreation, and accommodation or travel to do with providing such entertainment. As a general rule, an income tax deduction is available for the cost of providing entertainment that is a fringe benefit (i.e. provided to employees).
Fines and penalties
Fines and penalties imposed under any Australian and foreign law are generally not deductible. This includes fines and penalties imposed in relation to both civil and criminal matters.
The General Interest Charge (GIC) and Shortfall Interest Charge (SIC), which are imposed for failure to pay an outstanding tax debt within the required timeframe or where a tax shortfall arises under an amended assessment, are deductible for Australian tax purposes.
In general, GST input tax credits, GST, and adjustments under the GST law are disregarded for income tax purposes. Other taxes, including property, payroll, PRRT, and FBT, as well as other business taxes (excluding income tax and the Diverted Profits Tax [DPT]) are deductible to the extent they are incurred in producing assessable income or necessarily incurred in carrying on a business for this purpose, and are not of a capital or private nature.
Other significant items
Where expenditure for services is incurred in advance, deductibility of that expenditure generally will be prorated over the period during which the services will be provided, up to a maximum of ten years.
General value shifting rules apply to shifts of value, direct or indirect, in respect of loan and equity interests in companies or trusts. Circumstances in which these rules may apply include where there is a direct value shift under a scheme involving equity or loan interests, or where value is shifted out of an asset by the creation of rights in respect of the asset, or where there is a transfer of assets or the provision of services for a consideration other than at market value. The value shifting rules may apply to the head company of a tax consolidated group or multiple entry consolidated (MEC) group for value shifts also involving entities outside the group, but not to value shifting between group members, which the tax consolidation rules address (see the Group taxation section for more information).
Net operating losses
Losses may be carried forward indefinitely, subject to compliance with tests of continuity of more than 50% of ultimate voting, dividends, and capital rights or compliance with a same business test or similar business test (the latter only applicable to losses incurred in income years from 1 July 2015).
For consolidated group companies, the ability to utilise these losses may be subject to additional rules (see the Group taxation section for more information).
A temporary loss carryback measure applies to companies with an aggregated turnover of less than AUD 5 billion in the form of a refundable tax offset (i.e. cash back), subject to satisfying certain conditions. Tax losses incurred in the 2019/20, 2020/21, 2021/22, and/or 2022/23 income years are eligible for the loss carryback for offset against taxed profits from the 2018/19 or later income years only.
Payments to foreign affiliates
A corporation can deduct royalties, management service fees, and interest charges paid to non-residents, provided the amounts are referable to activities aimed at producing assessable income, and also having regard to Australia's transfer pricing rules. In the case of royalties and interest payable to non-residents, there is also a requirement that any applicable withholding taxes (WHTs) are remitted to the Commissioner of Taxation before the deduction can be taken.
Certain payments made by a significant global entity (SGE), broadly an entity that is part of a group with global revenue of AUD 1 billion or more, under an arrangement involving a foreign entity that is an associate may be subject to DPT. The DPT aims to ensure that the tax paid by SGEs properly reflects the economic substance of their activities in Australia and aims to prevent the diversion of profits offshore through arrangements involving related parties. Specifically, the DPT applies at a rate of 40% on the Australian tax benefit obtained in connection with a scheme involving a foreign entity that is an associate of the Australian taxpayer where the principal purpose, or one of the principal purposes, of the scheme is to obtain an Australian tax benefit or to obtain both an Australian tax benefit and reduce foreign tax liabilities, subject to certain exceptions (e.g. a ‘sufficient economic substance test’).
Furthermore, Australian taxpayers making interest or derivative payments on a financing arrangement from a related foreign interposed zero or low-tax rate entity need to consider the potential application of integrity rules introduced as part of Australia’s hybrid mismatch rules.