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Identifying assets for tax depreciation: what makes a computer, a computer?

August 2024 - Tax Alert

By Hiran Patel & Navroz Singh

Most taxpayers are comfortable with identifying assets and tracking them in a fixed asset register. However, in some cases it might be unclear whether an item is a separate asset, or part of another larger asset. To provide guidance, Inland Revenue has released a draft interpretation statement on how to identify the relevant item of property when applying the depreciation rules in the Income Tax Act 2007 (the Act).

While the draft guidance is largely consistent with how the rules have been understood to operate, it is a useful reminder of the complexities that can arise when analysing whether an item of property is a separate asset or if it forms part of another asset.

The draft guidance also provides some useful practical examples to make the principles easier to understand.

Let’s take a step back

The Act provides that a taxpayer can claim a depreciation deduction for depreciable property owned by that taxpayer that is used or available for use in an income year.

Depreciation deductions are spread over the useful life of the depreciable property based on a depreciation rate determined by the Commissioner in line with the item of property and the industry in which it operates.

But why does this matter?

At the core of the depreciation rules is the need to identify the relevant item of property. This involves consideration of whether the item of property is its own separate asset, or if it forms part of a different asset. This consideration dictates the depreciation rate that is applied to the asset, and also whether the item of property meets the low-value asset thresholds to qualify for an immediate deduction in the year of acquisition.

While you might think it is clear what an item of depreciable property is, it is not always so simple. The draft guidance is a useful reminder of what to consider when you purchase an asset.

When a new asset is acquired, the first consideration should be if the asset is its own separate asset or if it forms part of a bigger asset. The focus here is on identifying a physical thing that satisfies a particular notion: is the asset an entirety by itself or is it a subsidiary or secondary part of something else?

The draft guidance outlines the considerations that support that an item of property is its own separate asset:

  • The item is physically distinct from a wider asset from which the item might be a part.
  • The item is (to some degree) functionally complete on its own.
  • The item varies the function of another item.

In contrast, the following indicators suggest that an item is not an item of property on its own:

  • The item has a physical connection with other items.
  • The item is part of an integrated system.
  • The item is a necessary part of completing some other item.

The above factors should be considered as a whole to determine whether an item is a separate asset or not. Helpfully, Inland Revenue has provided a useful summary of how these principles operate:

How does this work in practice?

For many taxpayers, their first immediate thought when acquiring a new asset might be: “Can I immediately expense it?” (i.e. does it fall under the $1,000 low-value asset threshold?). However, if the item forms part of any other item that is depreciable property, it is not eligible for an immediate write-off, even if it is below the low-value threshold, as it would be considered an improvement. Instead, the item of property should be considered an addition to the existing depreciable property and depreciated in line with the rate used for the existing depreciable property.

An example in the guidance suggests that a desktop computer package consisting of a computer, a wireless keyboard and mouse are one item of depreciable property for tax depreciation purposes.

Inland Revenue’s rationale behind this outcome is that the keyboard and mouse have no practical purpose or use without the computer and are intended to function as a single integrated system. This is the case despite the computer, keyboard and mouse all performing a separate function of their own. The conclusion reached is that the three items serve no practical purpose without the other components and cannot be considered to satisfy a particular notion by themselves. As such, they comprise one single item of property (the computer).

This has minimal implications on the amount of tax depreciation that will be claimed as the depreciation rate for the three components is the same in most situations. However, there are practical considerations when, for example, a business purchases a keyboard for $150. Given this keyboard forms part of another item that is depreciable property (the computer), the keyboard would be depreciated rather than being written off as a low-value asset.

This highlights the importance of correctly identifying an item of property at acquisition.

In contrast, the example distinguishes between the purchase of a printer and that of a keyboard and mouse. The guidance argues that a printer is a separate item as the computer can function without the printer and that the printer provides a separate function of printing, copying and scanning.

While the above examples might be relatively clear-cut, what if a keyboard was purchased to accompany a touchscreen tablet? A tablet with a touchscreen can ordinarily be used without a keyboard. Would your analysis change in this circumstance? The draft guidance also states that an additional screen or an ergonomic mouse would also form part of the computer. This example illustrates some of the practical difficulties taxpayers will face in determining where an asset starts and stops.

As with the capital/revenue distinction, the analysis of identifying the relevant item or property can operate in a grey area where the answer is often not clear-cut. Given this complexity, we would recommend reaching out to your Deloitte tax adviser if you are unsure the next time you purchase a new item of property.

Application to existing published guidance

For completeness, where the Commissioner has already published specific guidance, that guidance should be referred to instead of the guidance for identifying the relevant item of property. This guidance includes:

  • Dairy farming – deductibility of certain expenditure (IS0025).
  • Can owners of existing residential rental properties claim deductions for costs incurred to meet Healthy Homes standards (QB 20/01)?
  • Residential rental properties - depreciation of items of depreciable property (IS 10/01).
  • Claiming depreciation on buildings (IS 22/04).
     

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