Temporary full expensing: pros and cons for businesses

It can be tempting for businesses to acquire assets with the aim of attracting tax advantages, but business owners should first consider the cash outflow and commitment required to enjoy these tax benefits. Peter Bardos, Tax Director at HLB Mann Judd Sydney, explains.

Various temporary and existing tax laws have resulted in a number of intertwined capital allowance regimes, and different ways of calculating depreciation for tax purposes. However, business owners should carefully assess the regime that best applies to each asset, as the tax treatment will depend on their own circumstances, as well as the asset itself and when they acquired it.

One of the newest regimes is temporary full expensing (TFE), which was first introduced as part of the Federal Budget in October 2020.

On 10 February 2022, Parliament passed separate bills to extend both TFE and the related temporary loss carry back (TLCB) measures to 30 June 2023.

What is temporary full expensing (TFE)?

TFE is designed to encourage businesses to invest money on assets, as eligible businesses can claim an immediate deduction for the business portion of the cost of an asset in the year it is first held, first used or first installed ready for use for a taxable purpose, according to the Australian Taxation Office (ATO).

The TFE measures were introduced in the 2020/21 Federal Budget in an attempt to boost the economy as businesses suffered the impacts of the COVID-19 pandemic. They enhanced the existing instant asset write-off rules by extending the definition of eligible businesses to include those with an aggregated turnover of less than $5 billion (or $50 million for second-hand asset purchases) and allowing the full cost of eligible depreciating assets to be deducted. The measures were originally set to run until 30 June 2022, but this was later extended by 12 months.

The TFE concessions were amended in December 2020 to include provisions for an alternative test to the existing TFE $5 billion aggregated turnover test, and to allow taxpayers to opt out of the TFE measure altogether.

How do TFE and TLCB work together?

The 2020/21 Budget also contained the TLCB measures, which allow businesses with an aggregated annual turnover of less than $5 billion to offset tax losses against previously assessed income from 2018/19 onwards, in order to generate a tax refund in the income years ended 30 June 2021 and 30 June 2022 (as with TFE, this has since been extended to 30 June 2023).

The combination of the TFE and TLCB measures can allow eligible businesses to significantly reduce the after-tax costs of eligible assets. Even entities that only fall into a tax loss position as a result of TFE can still be eligible for the cash flow benefit of the TLCB measures, potentially resulting in a refundable tax offset in the loss year. Indeed, the ATO has said TLCB “is intended to interact” with TFE in this way.

Alternative test

The alternative test was introduced for corporate tax entities that cannot meet the aggregated turnover threshold in the basic test. This alternative is predominantly for subsidiaries of multinational companies with Australian income of less than $5 billion a year and a history of significant investment in Australia.

To qualify for the alternative test, both of the following rules must be met for the relevant income year:

The sum of the entity’s total ordinary and statutory income, excluding non-assessable non-exempt income, must have been less than $5 billion for either the 2018/19 income year, or 2019/20 if the entity’s income year ends on or before 6 October 2020 (e.g. at the end of June or September).
The entity has invested more than $100 million in tangible depreciating assets during the 2016/17 to 2018/19 income years combined.
There are additional restrictions on using TFE for corporate tax entities that qualify using the alternative test, including exclusion of the following assets:

• intangible assets (such as intellectual property)
• assets previously held by an associate of the entity
• assets available for use, at any time in the income year, by an associate of the entity or an entity that is not an Australian resident for tax purposes.

Opting out of TFE rules

A business can make an irrevocable choice on an asset-by-asset basis to opt out of TFE in a given relevant income year. This amendment to the legislation allows the taxpayer greater flexibility to choose which capital allowance rules are most suitable to them and their depreciable asset(s).

If you choose to opt out of TFE, you must tell the ATO in an approved format by the day your business lodges its income tax return. For entities with an accounting period ending on or after 30 June 2021, the choice to opt out can be made in the income tax return.

Opting out – small businesses

Importantly, small business entities that choose to apply the simplified depreciation rules to eligible asset purchases are not able to opt out of TFE for those assets, and therefore must fully deduct the balance of the small business entity pool and any TFE-eligible new asset purchases. There have been some reported instances of adverse tax outcomes because of the mandatory full expensing for entities subject to simplified depreciation.

A small business taxpayer can, however, opt out of the simplified depreciation rules and then opt out of TFE for the same financial year. The existing pool balance will still be subject to TFE, but new assets can be opted out of TFE on an asset-by-asset basis.

The ‘five-year lock out rule’ has been suspended until 30 June 2023, meaning a small business taxpayer can opt out of simplified depreciation in one income year, then opt back in the next one. That said, this is still a complex area of Australian tax law, so small businesses should think carefully and consider seeking professional tax advice before opting out of simplified depreciation.

Reasons to opt out

There are a number of reasons why it may be beneficial to opt out of the regime, including businesses joining a tax consolidated group (i.e. becoming part of a larger group of companies for tax purposes) and assets that may have a change of use or location, but it should always be considered on a business-by-business and asset-by-asset basis.

Entities who have applied the TFE write-off on depreciating assets, on small business pool balances or both may have significantly higher depreciation deductions and tax losses. This can create issues for businesses operated out of trust structures, as the full expensing may result in the trust having no distributable income due to the large capital allowance deductions.

There are evidently a number of factors for small businesses, in particular, to consider when weighing up the tax benefits of acquiring new assets. While TFE and other capital allowance regimes can often make it more worthwhile financially, any decision to purchase an asset needs to be taken in the interests of the business and not exclusively for tax purposes.

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Peter Bardos is a tax compliance and consulting director who joined HLB Mann Judd in 2009. Peter is committed to creating value for clients by understanding their individual needs to deliver practical outcomes. He advises on complex tax matters, combining his knowledge of the tax legislation with an understanding of commercial and industry-specific issues.