Cheat sheet on depreciation: Temporary full expensing, instant asset write-offs, and traditional depreciation

When depreciating or ‘writing off’ your business assets, there are four methods the Australian Taxation Office (ATO) will accept, which you have to apply in descending order. 

The method currently at the top of the list is temporary full-expensing, which allows SMEs to immediately write-off the full value of all new (or used) assets, without limits on the value of individual purchases. ‘Temporary’ refers to the fact that it does not apply to assets first used or installed for taxable purposes after June 30, 2022, while it expires on June 30, 2023.

It follows from the instant asset write-off, first extended to $20,000 from $1,000 in 2015, then to $150,000 in 2019. Temporary full expensing removed the value cap on purchases from October 2020.

If you opt out of using temporary full expensing, you must use the instant asset write-off. If you opt out of the instant asset write-off, you must use the backing business investment accelerated depreciation rules. If you opt out of the accelerated depreciation rules, you can use traditional depreciation measures.

Confused?

1. This ATO flowchart explains how to apply them to your business

Temporary full expensing gives you the biggest benefits upfront, so there’s no need to use the other measures while it is available.

However, a handful of assets are excluded from the program, including capital works, horticultural plants, and assets allocated to a software development pool, which are subject to separate tax treatments.

Also excluded are buildings, plus intangible assets, including customer lists, goodwill, and potentially expensive cars.

Who can access this scheme?

Under the temporary measures, Australian businesses with an annual aggregated turnover of less than $5 billion can immediately write-off the full value of new, eligible and depreciable assets acquired after October 6, 2020. As a result, around 3.5 million businesses nationwide will be eligible to claim under this scheme.

If you’re planning to claim under the scheme, the assets purchased must be installed and ready to use by June 30, 2023.

What are the implications for depreciating assets using this scheme?

All new assets are eligible under the scheme, from coffee machines, forklifts, tractors and freezers, through to labellers, provided they meet existing criteria for depreciable assets.

Businesses will also be able to claim full deductions for the cost of improvements made to existing depreciable assets. Rather than claim depreciation amounts over several years, the scheme’s expanded accelerated depreciation program allows businesses to claim a tax deduction for the full value of a purchase after its use.

Simply put, by allowing them to claim the full tax deduction upfront, and thereby reducing the amount of tax they pay, the scheme aims to get businesses to bring forward spending on new assets.

Think of accelerated depreciation as a way to fast-track the depreciation — i.e. a tax deduction not a dollar-for-dollar rebate — you would ordinarily claim over a longer timeframe. 

How does the depreciation work?

Let’s assume your business buys an eligible depreciating asset, for argument’s sake a piece of machinery for $110,000. Firstly, you can immediately claim $10,000 of GST in the next monthly or quarterly BAS payments.

Then at year end (being June 30) you can write-off the full amount of $100,000. 

Pros and cons of immediate write-offs

Writing off the full value of a new asset provides an immediate incentive for tax purposes. However, Adrian Raftery, principal of Mr Taxman, reminds business owners it is still going to have significant cash flow implications for the business. 

“Just because 100% of the full (asset) amount is deductible doesn’t mean you get back 100%, and this is something many SME owners simply misunderstand, so don’t spend purely for tax deduction purposes,” says Raftery. 

“If you’ve been in business for a while, you should know how much a piece of capital will generate.”

Given that you’re only getting the BAS returned, plus the deduction on the company tax rate (26%), Raftery says the key question SME owners must ask themselves is what the benefit is to the business — especially if the asset has been financed and requires repayment.

Questions to ask yourself

1. Do we need the assets?

2. Will the assets make the company more money?

3. Will the assets generate a new revenue stream?

4. Will the assets generate a profit over five to eight years?

“Ultimately, you want to ascertain if the P&L derives $74,000 in after tax or $100,000 before tax over the life of the asset,” Raftery reminds business owners.

“Ideally, you should be looking for an asset to return anything greater than $100,000, plus a notional 10 to 20% return on your investment.”

Backing business investment – accelerated traditional depreciation

For assets that you are not deducting through either the instant asset write-off or temporary full expensing, you can use the backing business investment scheme, which accelerated the traditional depreciation rates to encourage business investment.

You can deduct 50% of the cost or opening adjustable value of an eligible asset on installation, while existing depreciation rules apply to the remaining balance of the asset’s cost.

If you are using the simplified depreciation rules for small business, you can claim 57.5% of the cost of the asset in the first year you add the asset to the small business pool.

The assets must be first held, and first used or first installed ready for use for a taxable purpose on or after March 12, 2020 until June 30, 2021. 

How about after the schemes end?

The net effect of having ‘written down’ the value of the new asset on the balance sheet to zero is that there’s no more depreciation to claim in future years.

From here, traditional depreciation methods will come back into play for assets in your business, assuming that the instant asset write-off, temporary full expensing, and backing business investment measures are not extended.

There are two main methods, the prime cost method, or diminishing value method.

Prime cost depreciation assumes that the value of an assets falls uniformly, as a ‘straight line’ of depreciation, while diminishing value assumes that assets decrease in value faster in the first few years of their effective life, for example, laptops or computers.

Prime cost vs. diminishing value. Source: ATO website

The ATO has a free-to-use calculator that will calculate the depreciation amounts for you. If you like manual work, the formulas are below.

For second-hand assets, you need to follow the same depreciation method used by the previous owner, while intangible assets can only use the prime cost method.

Prime cost formula

This is calculated as:

Asset’s cost × (days held ÷ 365) × (100% ÷ asset’s effective life)

Diminishing value formula

This is calculated as:

Base value × (days held ÷ 365) × (200% ÷ asset’s effective life)

Assets you use both within and outside your business can only have the business portion depreciated, as with temporary full expensing and the instant asset write-off. 

For example, if an asset is used 40% of the time for a private purpose, and 60% for business, you would only be able to depreciate 60% of its value. Hence all figures above would be multiplied by a factor of 0.6.