1. LECTURE 10
DEPRECIATION

2. Depreciation – s.21 Allowance for depreciation:
Capital invested in physical assets used in production of income suffer wear, tear and obsolescence
Commercial accounting requires recognition of this by a charge against income for depreciation
Tax law permits much the same thing by means of an annual depreciation allowance

3. Depreciation – s.21 Rules that permit and regulate depreciation:
Income tax (Allowances for depreciation and Improvements) Instructions 1998
Taxpayer’s general authority to claim for depreciation found in paragraph 3

4. Depreciation – s.21 Three elements to the rule
A deduction is available for:
Articles/plant and buildings
Owned by the taxpayer
And used by him for producing income

5. Depreciation – s.21 Articles or plant and buildings (1st element)
Item may be depreciated if it is either plant or building
Important to know distinction between plant and buildings
Because rules and rates of depreciation applicable to plant differ from those applicable to buildings

6. Depreciation – s.21 Basic definition of plant
Yarmouth v France (1887) 19 QBD 647
“in the ordinary sense, [plant] includes whatever apparatus is used by a business man for carrying on his business – not his stock-in-trade which he buys or makes for sale; but all goods and chattels, fixed or moveable, live or dead, which he keeps for permanent employment in his business.”

7. Depreciation – s.21 Plant is something used in the trade
It’s apparatus
Mere setting for the trade is not plant
Pay attention to function of an item
Example
A dry-dock is first used to isolate a ship from water and
then house the ship while it is inspected and repaired

8. Depreciation – s.21 Serving first function Serving second function
– dock functions as apparatus used to carry out the trade
Serving second function
– dry dock is more than the setting for the trade of ship repair
13/04/2018

9. Depreciation – s.21 Pay attention to details of the particular trade
eg. lighting fixtures in a building are not usually plant, are just part of building that forms setting for the trade.
However in;
IRC v Scottish & Newcastle Breweries Ltd [1982] 1 WLR 322
Taxpayer was able to establish that lighting, paintings and sculptures used in hotel premises were held to be plant

10. Depreciation – s.21
Something that is usually plant cease to be plant if used in unusual fashion
eg. boat will be plant when used shipping, fishing, cruising etc. but
ceases to become plant if used for floating restaurant since it becomes merely setting for taxpayers restaurant trade

11. Depreciation – s.21 Categories of plant and structure may overlap
eg. dry-dock is a structure but also plant
Pumps and tanks at a service station are plant but canopy placed over the pumps is not plant but only the setting for the trade
Something fixed to a building may become part of the building but
Seats attached to the floor of a cinema or a grandstand is plant

12. Depreciation – s.21
In order for something to count as plant it must first constitute a capital asset
Not necessary that there be a purchase, eg. gifts
Yarmouth v France, definition contrasts plant and trading stock
Item can change its character overtime
CIR v McKenzie 12 FLR 115 (Fiji case)
Cows originally acquired as ‘weeders’ for a copra plantation (their function was to keep down the grass between the trees) subsequently became trading stock when the taxpayer commence operating an abattoir business alongside the copra business

13. Depreciation – s.21 Owned by the taxpayer (2nd element)
Obvious requirement
Depreciation allowance aims to recognize exhaustion of capital invested in physical assets
A cost to taxpayer in producing income only if capital being exhausted is his own and this is only the case if taxpayer owns the asset

14. Depreciation – s.21 Ownership rule produces two difficulties:
A finance lease of chattels
Depreciation allowance for buildings

15. Depreciation – s.21 Used for producing income – 3rd element
An obvious requirement
Capital invested in family car is exhausted as car is used, no depreciation allowance since exhaustion of capital is not an expense of deriving income
Exhaustion of capital is only of significance for tax purposes where it is an expense for deriving income

16. Depreciation – s.21
Note, reference is to ‘produce income’ generally and is not limited to producing business income
eg. rent a house, income from property, (investment property to produce rental income), can claim depreciation on house

17. Depreciation – s.21
In context of business, not actually that item be in actual use
Paragraph 19, for plant acquired after 1/1/98, depreciation may be claimed on plant owned and ‘installed ready for use’ (i.e. not yet in actual use) ‘or held in reserve’ by the taxpayer for producing income.

18. Depreciation – s.21
Not necessary that an asset be used exclusively for producing income
Paragraph 13 provides that where asset is used partly for producing income and partly for other purpose, depreciation may be claimed in proportion to income and non-income use

19. Depreciation – s.21 Calculating depreciation allowance
Given that asset is depreciable by the taxpayer, how is annual allowance for depreciation calculated?
Building receive their own rules (Part VI)
Slightly different rules apply to plant acquired and put into use before 1/1/98 (Part II, Div 2) and
After 1/1/98 (Part II, Div 3)

20. Depreciation – s.21
Plant is depreciated on a prime cost basis (straight line method) - (para19(3))
Annual allowance is calculated as a percentage of the asset’s acquisition cost
Percentage figure is determined (indirectly) with reference to assets ‘effective life’ (para 20)
Schedule to the Instructions lists over 800 different items of plant and states their effective lives
Starting point in any calculation is to determine assets effective life as provided in the Schedule

21. Depreciation – s.21
Taxpayer has degree of choice in depreciation rates
Taxpayer may select any figure within range
Bottom end of range is percentage figure that would ensure asset is completely written off over its effective life (para 22(3))

22. Depreciation – s.21 Example: Mill in a flour milling plant
Effective life as per schedule is 15 years
Minimum possible depreciation rate is 6.66% (15/100)
Top of the range is known as ‘standard rate’ plus a loading of 20% of standard rate
Idea of standard rate of depreciation is introduced by Table A para 21

23. Depreciation – s.21
Standard rate is the rate which would write off an asset at the bottom end of the period, exactly over the assets useful life
The maximum rate of depreciation is simply the standard rate plus a loading of 20%

24. Depreciation – s.21
Taxpayer to select a rate of depreciation, figure selected cannot be changed thereafter (para 22)
Taxpayer generally select maximum rate for depreciation for obvious reason that this generates the largest immediate deduction