Assets and depreciation
Capital allowances
Capital allowances are the income tax deductions that recover the cost of capital assets over time, mainly depreciation of equipment and the capital works deduction for buildings.
Capital allowances is the umbrella term for the set of tax rules that allow you to deduct the cost of capital assets across several years. Because capital expenditure is generally not deductible immediately, capital allowances provide the mechanism for recovering that cost, usually spread across the useful life of the asset.
The two best-known parts are the deduction for the decline in value of depreciating assets, such as machinery, vehicles and equipment, and the capital works deduction for the construction cost of buildings and structural improvements. There are also other specific provisions, such as those for certain project costs and some small business concessions like the instant asset write-off and the small business pool.
Different methods suit different assets. Depreciating assets use either the prime cost or the diminishing value method, based on effective life. Buildings generally use a set annual percentage over a long period. Small businesses may instead use simplified rules. Which one applies depends on the type of asset, when it was acquired, the structure of the taxpayer, and sometimes the date it was first used.
Capital allowances interact with GST in a particular way. The income tax deduction is spread across years, but a GST-registered business can generally claim the GST credit on the purchase in one go, in the BAS for the period of the tax invoice. Capital purchases are reported at G10. This difference in timing is a point many new business owners find surprising.
Allowances also have an end point. When an asset is sold, scrapped or no longer used, a balancing adjustment captures the difference between the proceeds and the remaining value. For buildings, a different set of rules applies on sale, and CGT may be affected. Good records of cost, dates and methods are essential, as they may be needed years later.
A frequent misunderstanding is that capital allowances apply automatically. You need to identify each asset, choose the right method and keep records. Another is mixing up repairs and capital improvements. This is general information only, so confirm your situation with the ATO or a registered tax professional.
Worked example
A registered business buys equipment for $22,000 including GST. The GST credit is $22,000 / 11 = $2,000, claimed in the BAS for the period of the tax invoice. The GST-exclusive cost is $20,000. Assume a 10-year effective life, for illustration. Under the prime cost method, the capital allowance deduction is $20,000 / 10 = $2,000 per full year for 10 years.
Practical tips
- Keep an asset register that shows each item's cost, date, method and GST credit claimed.
- Remember the GST credit on capital items is usually claimed straight away, while the income tax deduction is spread out.
- Separate repairs from capital improvements, because they follow different rules.