Get a better understanding of how asset depreciation works as a tax benefit with commercial finance for business with a basic explainer from Jade Finance. Having a deeper knowledge of the terminology and the concepts used in the commercial credit sector, may enable business owners to better understand how a particular credit product will work for their operation.
Many long-established business owners will already have at least a basic knowledge of what asset depreciation means. But the specifics, for example how it is calculated, may remain a mystery for their accountant to deal with. For operators setting up a new business or taking on their first loan for business vehicles or equipment, knowing more about the features of the credit facilities available may provide greater confidence in making decisions.
How depreciation is calculated and how it applies to different assets and different business, is set out in the rulings and the regulations by the Australian Taxation Office (ATO). What is a rather straightforward concept, asset depreciation gets a lot more complex when it comes to the calculations of how much of a tax benefit may be realised each year. Without going too far into the complexities, we will provide a plain-speak explanation of the concept, how it applies to business financing, and how it compares with other tax deductions on asset acquisition loans.
Defining Asset Depreciation
Assets are categorised as all plant, machinery, equipment and vehicles used by a business in its operation. As assets are used, their value decreases over time. This decrease in the value of an asset is known as depreciation.
For financial purposes, the beginning of the operating time of an asset, the first time it is used, is defined as ‘the depreciating asset start time’. This timing is important when calculating a tax benefit as it determines the number of days of use in that financial year. If the goods were acquired and first used from 1 July and right through to 30 June the following year, the depreciating time for that year would be 365 or 366 days. But if the first use was later in the financial year, the first year of depreciation would be calculated on a lesser number of days.
The ‘working or effective life’ of the asset also needs to be determined for depreciation purposes. This may be how long the asset will be owned by the business. As the asset decreases in value each year, the total devaluation, which is known as the depreciated value, also decreases. The depreciated value per annum, is the amount of the tax deduction a business can realise.
Asset depreciation allows for an amount of the value of that asset to be deducted each year over several years until fully expended, ie the full amount is accounted for. That is the standard ruling under the ATO guidelines. But the Federal Government can introduce changes to those ruling for special purposes and for short periods.
This was seen during the package of COVID business stimulus measures introduced and which included Instant Asset Write-Off and Temporary Full Expensing. These measures allowed for not just a small portion of the value of assets to be tax deducted each year, but for the complete, total value of new assets to be fully deductible in the year that they were purchased and first used.
How Asset Depreciation is Calculated
There are two methods provided by the ATO to calculate the annual amount which is allowed to be deducted through depreciation – the prime cost method and the diminishing value method. Small enterprises may utilise a simplified method which is also offered.
These calculations are typically carried out by the accountant for the business when preparing tax returns and annual business accounts. The deductible amount decreases each year as the total value of the assets decreases. For a deeper dive into the specifics, refer to the ATO guide.
Tax Benefit of Asset Depreciation with Commercial Loans
Depreciation is a tax deduction which is available with Commercial Hire Purchase and Chattel Mortgage, but not with Rent-to-Own and Lease. This difference comes down to a key basic difference with credit facilities – the ownership of the asset during loan term.
With Lease and Rent-to-Own, the lender holds ownership of the asset until the loan is finalised. As the lessee does not own the asset, they are not eligible to depreciate the asset. With Commercial Hire Purchase and Chattel Mortgage, the borrower receives ownership of the asset at settlement, enters the asset into their books, and is eligible to claim the depreciated value as a tax deduction.
While not eligible for claiming the depreciative value as a tax deduction, businesses using Rent-to-Own and Lease can claim their monthly payments as a tax deduction. Interest charges on Chattel Mortgage and CHP payments are also deductible. By either the end of the finance term with Lease and Rent-to-Own, or by the end of the effective life of the asset with CHP and Chattel Mortgage, the full value of the asset has been deducted from taxable income.
Whatever credit facility best suits your business to finance motor vehicles, trucks, plant, machinery or equipment, we can assist with tax-optimised loan solutions.
For tax-optimised asset financing, contact Jade Finance on 1300 000 008.
DISCLAIMER: THE SPECIFIC PURPOSE IN PROVIDING THIS ARTICLE IS FOR GENERAL INFORMATION ONLY. IT IS NOT INTENDED AS THE SOLE SOURCE OF FINANCIAL INFORMATION ON WHICH TO MAKE BUSINESS FINANCE DECISIONS. BUSINESS OWNERS WHO REQUIRE ADVICE OR GUIDANCE AROUND THEIR SPECIFIC FINANCIAL CIRCUMSTANCES ARE RECOMMENDED TO CONSULT WITH AN ADVISOR OR ACCOUNTANT. NO LIABILITY IS ACCEPTED IN REGARD TO ANY MISREPRESENTATIONS OR ANY ERRORS RE ANY DATA, SPECIFICS, POLICIES AND OTHER INFORMATION AS SOURCED FROM OTHERS
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