Why businesses shouldn’t bother with the 50% investment allowance

Well the Federal Budget came out last week and most pundits labeled it as a pretty tame affair particularly with respect to businesses. I have to agree.

There was no change for large business and the only significant change for small business was the extension and increase of the Small Business Tax Break – from 30 percent to 50 percent bonus deduction to small businesses (i.e turnover under $2 million) for assets acquired between 13 December 2008 to 31 December 2009.

The media have been raving about how great this measure is for small business. 50 percent extra deduction.  Sounds great doesn’t it?  Well I am not that excited for quite a few reasons as outlined below:

1.   To enjoy the bonus deduction your business has to outlay extra cash to buy the assets. With times being tough, cash is king. Don’t forget my A-B-C motto of money matters – Absolutely Bloomin’ Cash – a business with poor cash flow is going to struggle in the coming months and years. Why put pressure on your cash flow if you don’t need to?  I am predicting a lot of businesses will get their cash flow requirements wrong and get into strife, thus putting more pressure on the economy if businesses fail.

2.   So let’s say that you want to preserve your cash, and you want to finance the purchase instead. If you need to finance then you are merely putting more pressure on the business’ balance sheet and future cash flow commitments. Business finance is not cheap these days either despite the RBA reducing the benchmark interest rate significantly in the last year. Haven’t we learnt any lessons from the global financial crisis?

3.    Most businesses operate as a company, and the company tax rate is 30 percent. This means that you are only truly saving 15 percent (being 50 percent of 30 percent) on the ticketed price of an eligible asset purchase. Not 50 percent that some business people believe. It is only nine percent for large businesses as they are only getting a 30 percent bonus deduction. If my business needs an asset then I am going to look at second hand first because you are saving a lot more than 15 percent from the cost of a brand new asset. You can probably negotiate a discount of that size as well anyway!

4.   The industry that is heavily promoting the 50 percent tax break is the car industry.  God knows that this ailing industry needs a helping hand and the 50 percent deduction will definitely give them more customers in coming months. But remember that you need any car purchase registered in the same entity as your ABN.  For small businesses this is a company structure. And we know that when companies have cars owned by them and provided for the benefit of employees and their associates that Fringe Benefits Tax may apply. If the car is hardly used – that is, less than 15,000 kilometres travelled per year – then the FBT rate is 26 percent of the original cost of the car … every year as well before reducing by 1/3 in the fourth year and beyond that you have the car.  Yes the taxman giveth … but the taxman can taketh away too!

If your business desperately needs to buy an asset then by all means go out and take advantage of this great Tax Break.  But don’t go out of your way for a 50 percent tax deduction because it really isn’t as attractive as what you may think!

Is your business going to take advantage of the 50 percent Tax Break?

  • Jacinta

    Excellent analysis – I advise clients that to buy new equipment (toys) for the sake of chasing the 50% investment allowance is foolish. If there is an existing need for new equipment or a planned expansion then by all means take advantage of the bonus but never spend money to chase an extra tax deduction.

  • I totally agreed with your summation…I have a whole list of business clients asking the same question \” should I buy that new vehicle or machinery before time runs out\”? It is almost like a same pandemonium that the First Home Buyers caused in recent months. However, in this instance, some business will realize that cash should be king in this difficult times.

  • Debbie

    I will be taking advantage of the 50% investment allowance deduction
    and already have placed an order. Not very often you get to right off
    150% of your asset. I will be claiming the G.S.T and the investment allowance plus the depreciation for the remainder of the tax year, plus
    interest in the current tax year. I am not a company so I get slugged with the higher tax which makes it even more attractive.
    For those who can stimulate the economy for the good of all.

  • I find it hard to believe that any sound financial advice at this point in the financial cycle would have anything to do with leaving yourself in an exposed tax liable position. Up until now it hasn’t been the busiest year but let’s reflect on our turnover position and draw the conclusion from there. Better still let’s assume moving forward that the economy will begin it’s cycle of growth in 09-10 and let’s assume you sat on your hands. Consider my business with all it’s new Equipment & machinery in place and ready to take advantage of that new cycle of growth, without any expected asset costs in the near future and a solid loss from deductions in 2008 – 2009, which one of us is in a better position to make money now ?

    Added to this the cost of money is low at the moment and will only continue to cost more as pressure remains heavy on cash swap rates. Also consider that inflation will no doubt play a part in business in the next year as banks continue to brew their own home grown rate strategy that currently still sees the cost of money increasing whilst the rate is pulled back by the reserve.

    Yes by all accounts don’t take advantage of the 50% investment allowance, GST benefit coupled with the existing depriciation allowance. Wait until all the incentives are back off the table. Wait until the banks start eating into your profits with increased cost of lending and wait until inflation kicks back in and the spend your much needed money to keep up with my business, it’s updated assets and new technology. It’s not all bad it’ll probably only take you two years to catch up !

  • If you need to purchase assets then I agree by all means to get them. But my point is that if you don\’t need to purchase the asset then why not put your cash into say marketing & drive sales further?? Or pay off existing debt so that you can fund more purchases in a few years time eg factory building.

    What happens if the growth cycle doesn\’t happen til 2010/11? Or later? Or worse, your business doesn\’t benefit at all from any potential cycle growth?

    Claiming back of GST is simply a nil transaction because you need to incur the 10% cost in the first place. You don\’t get 10% GST refund for nothing.

    It is all well & good to do your part to stimulate the economy but you need to look after number one first. Don\’t take on too much commitment if you can\’t afford it.

    If you have a business structure that pays a higher rate of tax then perhaps you should consider looking at your structure rather than focusing on making extra deductions.

  • Michael

    I am puzzled by Debbie of Sydney suggesting she can write off 150% of an asset. If I am correct the best you can hope for as an STS/SBE business is a claim for 65%. 15% under the simplified depreciation rules and then the 50% investment allowance.

    In understand then that the depreciation may be subject to private use apportionment, which may not necessarily apply to the Investment Allowance (currently seeking verification as it doesn’t sound like the usual ATO-duck!).

    The only way an STS/SBE business can get a 100% claim is for assets acquired under $1,000. As these assets are immediate write offs they are then NOT eligible for the 50% investment allowance.

    How do you get to your 150% determination?

    Many thanks,
    Michael

  • Debbie

    In reply to Michael this how I interpreted my stuation. Please comment Adrian if I am wrong. I am not a company and my biggest casflow problem is tax.
    I see it as a purchase for a much needed and used backhoe.
    Machinery cost $ 90,000
    G.S.T $10,000.00
    Depreciation say 1/12 x 30% DMV $2,250.00
    Investment allowance $45,000.00
    Balance of Machinery $87,750 Depreciated over
    its effective life. Is that right Adrian? I satisfy all the rules
    and get to claim $10,000 off my G.S.T a tax deduction of
    $47,250 plus interest for the month of June in the current tax year
    and a new machine.
    If I don’t buy it I will still have to pay G.S.T and be taxed.
    Not sure about STS/SBE I’ll have to find out if that affects me.

  • Debbie/Michael – Over a period of time (could be anywhere between 5-10 years depending on depreciation rate used) you would get 150% deduction – being 50% upfront & 100% depreciation over time.

    Re: your calcs here are a few observations:

    – GST is $8181 ($90,000/11) – yes you get this back but you have an additional loan to pay for it in the first place. If there was no GST on the purchase then your loan & loan repayments would be less.
    – the GST exclusive price would be $81,818 which is used as base for depreciation & investment allowance purposes
    – 50% tax break would be $40,909 … and cashflow benefit is say 30% for companies (or 46.5% if sole trader & on highest marginal tax rate) of that = $12,273
    – depreciation claimable in 2008/09 year is 1/12 x $81,818 x depreciation rate (lets just say 30% for arguments sake but I think it would be lower) = $2,045. Written down value for future year claims is $79,772. Cashflow benefit of tax saving his year at 30% is $613.
    – say you pay $1,000 interest this year then cash flow benefit of tax saving is $300 … but you have still paid $700 net for that financing arrangement
    – over time you claim $81,818 in depreciation + $40,909 investment allowance + say $25,000 interest. Total outlay = $115,000. Tax savings = $8,181 GST + $44,318 tax refund = $52,500.
    – Net outlay of $90k asset purchase after all tax benefits = $62,500.
    – Question that must be asked is will you get more than $62,500 in value after tax for the new asset? eg would a $30k second hand purchase do just an effective job & not leave you with high loan repayments?

  • Debbie

    Hi Adrian,
    Thanks for the figures. The G.S.T and 40 % tax I will have to pay if I purchase nothing. I will be financing it partly with my tax refund from last year. I have purchased second hand machinery before one great and one a dud.The investment allowance doesn’t apply to second hand machinery. Also I have to factor in on the positive side the income from the new machine and the negatives of repairs on a
    10 year+ machine near the end of its life and the sale value.
    Thanks Adrian you have cleared up a few things for me.
    Is that right that the 50% investment allowance doesn’t calculate in the residual calculations on the sale of the asset?
    On another query my son under 18 apprenticed January wage roughly
    $8,000 tax was reduced to nil by low income tax offset. Does he receive the tax bonus of $900.00?
    Thanks
    Debbie

  • If tax was reduced to nil due to offsets then no stimulus package payment unfortunately 🙁

  • Melissa

    I am considering purchasing a new vehicle for my forestry small business. My situation is different to alot of small businesses. I have a commissioners discretion that allows me to offset non-commercial losses against my personal income tax. I work full-time and in the higher tax bracket. I have been advised I am eligible for the 50% deduction. For example I plan to buy a business ute for $30,000 and would get back $15,000 with the tax break. Can I claim the full $15,000 or only a percentage based on my current tax rate? I need to understand the tax bonus fully before purchasing a new vehicle.

  • Melissa – tax deduction is $15,000 … the cash benefit is at your marginal tax rate eg 31.5% = $4725. I doubt though that you would be able to claim the investment allowance for your forestry business. I suggest you read below.

    The ATO has published both an Overview and a more detailed Guide to the small business and general business tax break.

    For a copy of the ATO’s Overview go here.

    http://www.ato.gov.au/businesses/content.asp?doc=/content/00193781.htm

    The guide provides some interesting info for the purchase of cars which alot of readers seem to be doing of late.

    Cars

    There are four methods that you can use to work out deductions for car expenses for an income year. The choice of method will also determine whether you can claim capital allowance deductions under Division 40 in relation to the car.

    If you use the ‘one-third of actual expenses’ and ‘log book’ methods, you are able to claim deductions under Subdivision 40-B and may be eligible for the tax break.

    If you use the ‘12% of original value’ and ‘cents per kilometre’ methods to determine your car expenses, you are not eligible for capital allowance deductions.

    However, you will not be excluded from the tax break merely because you use the 12% of original value method. That is, the legislation rules these cars ‘in’ for the purposes of the tax break even though a deduction is not available under Subdivision 40-B.

    You cannot claim the tax break in an income year you use the cents per kilometre method. However, this method can only be used for up to 5,000 business kilometres, implying limited business use. That is, if you are using this method, you would generally find it difficult to meet the purpose test and so would not be eligible for the tax break anyway.

    In comparison, the 12% of original value method can only be used if you travel more than 5,000 business kilometres.

    Example

    On 20 March 2009, Bernard acquires a station wagon to use in his mobile computer repair business. Because he does not keep a logbook or adequate car expense records, he cannot use either the log book or one-third of actual expenses methods. However, he can still use the 12% of original cost method to work out his car expense deductions for the 2008–09 income year.

    Bernard cannot claim a deduction under section 40-25 for the car’s decline in value for the 2008–09 income year. However, he will still be able to claim the tax break if he can satisfy all of the other criteria.

  • Melissa

    Thanks for the information. My accountant and tax department have advised I am eligible for the tax break as I have an ABN, will keep a log book would use the vehicle primarily for business purposes. The area I don\’t understand is the cash benefit at my marginal tax rate eg 31.5% = $4725. Can you please explain the cash benefit.

  • ANNE

    Hi can you please help I have a mobil travleagent bussiness and I ‘m paid on a consulting commision only from my company.I have looked into the 50% rebate on cars and I really need anew one so this would be great for me am I right?? Also all my office furniture and computer were all over a $1000??My tax for my first year will onl;y be $10000 as I have just changed jobs should I hold off on the car untill July.
    Many thanks

  • Anne – if your taxable income is $10k this year then you probably pay no tax due to the low income rebate.

    Melissa – I was giving an example where if your income was between $34k & $80k then your marginal tax rate would be 31.5%. As a result any deduction that you incur will benefit you by 31.5%. A $15K deduction does not give you $15k tax refund. It only gives you $15k x 31.5% = $4725

  • Your Name ADRIAN

    I am a sub-contract bricklayer with an ABN and business name. I do a lot of travelling and keep a log book. I have a ute and a loan to pay for it.would the 50% investment allowance benefit me at all?

  • Angus

    Melissa – sounds like you might need to see an accountant/other financial adviser! While the internet is good for lots of information, it’s sometimes best to see someone who can look at your situation in detail and advise you personally on what is best – although Adrain has been pretty useful to you so far, I think! 🙂

  • Melissa

    Thanks for the advice. I have contacted my accountant to determine the advantages/disadvantages of purchasing a new vehicle versus second hand vehicle for my type of tax setup. It helps to know the facts up front.

  • patrick from the gold coast

    I have a small business.My accountant estimate for my tax bill this years was $2,000 I expect it to be around $3,000
    If i were to spend $25,000 on a new van i understand the max i could save is $7,800 or 31.5 percent.what happens if my tax bill is only $3,000

    regards Pat

  • I am looking at purchasing a new ute for my business ie: 50% investment allowance. If what you are saying in your article that you don’t actually receive the said amount is it worth while. I am looking at a vehicle for around the $30k mark. If waht you said is correct i am not getting a $15k deduction but am only getting a $4500.00 saving?

  • chris

    been advised that if I pay for investment and not borrow to make purchase then the ATO has a deeming rule that the money paid for an asset (car ) is deemed at a particular interest rate and may be taxable ( or something like that ) when claiming the 50% investment allowance

  • peter watts

    hi im a subcontract tiler and i am in a partership with my wife would it benifit me to buy a new sedan for my wife to drive as she does work with me thanks peter.

  • Thanks for all the queries guys – I really think you need to see an adviser directly to answer your queries as there are some particular issues that require more info before I can provide some what if solutions.

    eg Peter – you may need to consider your structure as the ATO have come down on husband/wife partnerships in your industry in recent years. In any instance, the car would require the log book method in order to claim investment allowance.

    Chris – your business structure is required to determine advice

    Patrick – also depends on your structure … sounds like you will go into a taxable loss situation which will mean taht the loss is carried forward til next year so you will have to wait a further 12 months til you get teh rest of the benefit.

  • BEN FRIEND

    HI ADRIAN
    I HAVE A SMALL COMPANY , IM LOOKING AT BUYING A NEW EVERY DAY CAR FOR MY WIFE , SHOULD I BOTHER WITH THIS 50% TAX BREAK OR NOT , WILL I PAY FBT ETC IF IT DOESNT DO REQUIRED KLM . WILL BE SPENDING ABOUT $46,000 ON NEW CAR NO LOANS JUST CASH , THANKYOU FOR YOUR HELP
    BEN FRIEND

  • Fairlie Rego

    I have a small business and was wondering whether I can avail of this facility if I buy the car in my name for business purposes or do I have to buy the car in the company’s name

  • Adrian Klamer

    Adrian is and you are eventually correct, Dale. The investment allowance is an additional 50% tax deduction, not a 50% tax refund. The amount calculated to be your investment allowance reduces your taxable income and not your tax payable. The amount then is applied towards whatever is your rate of tax.(assuming 30% for company) would be $4,500 for your example, not $15,000.

    It is effectively 50% of the purchase price ‘taxed at the taxpayers marginal rate’ that your saving, and not 50% of the purchase price itself that you are saving if that makes any sense.