Budget 2015: An Appreciation for Depreciation

The budget has been announced, and this year there has been a strong focus on creating jobs and providing benefits to small business.

One of the announcements to come out of the 2015 Federal Budget was the accelerated depreciation on assets up to $20,000 (also known as the small business tax break). In a simplified sense, this means that any small business can bring forward deductions that they wouldn't have otherwise been able to.

In the news it has been discussed as a benefit to cashflow. But what does this mean for your business? And how much of an impact will it make?

First of all - let's define a Depreciating Asset.depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. Vehicles, IT hardware, equipment, and office furniture are examples of depreciating assets.

You can claim a deduction on the depreciation of the asset. This claim is generally based on the effective life of the asset (the number of years the asset can be effectively used to produce income) and the depreciation method you choose.

So let's see what this looks like ...

Let's say you own a company and bought a new server for $10,000 to store files and manage the office. This server has an effective life of 4 years, and you are using the prime cost method of depreciation.

Under the old system -

Asset purchase <10,000>
Depreciation Expense 2,500 2,500 2,500 2,500
Tax Reduction 750 750 750 750
  • You buy a new server for $10,000
  • After YR 1 you claim 25% * $10,000 or $2,500 as depreciation on the asset
  • You receive a tax reduction of 30% * $2,500 or $750
  • Over years 2-4 you claim the 25% ($2,500) to receive a tax reduction of $750 each year
  • Over the 4 years you have a total reduction in your tax of $3,000
  • The net cash outflow over the 4 years is negative $7,000 ($10,000 spent with $3,000 in tax benefits)

Under the new system (and to keep it simple we'll maintain the 30% tax rate) -

Asset purchase <10,000>
Depreciation Expense 10,000
Tax Reduction 3,000
  • You buy a new server for $10,000
  • You immediately claim 100% * $10,000 as depreciation on the asset
  • You receive a tax reduction of 30% * $10,000 or $3,000
  • The total effect on your net cashflow is negative $7,000

The point here is that the net result is the same - you invest $10,000 and you reduce your tax by $3,000.  The difference is that you can bring forward the depreciation to increase your available cash sooner. It's also important to highlight here that a tax deduction ($10,000) doesn't equal a tax reduction ($3,000). The benefit you receive from the instant write-off won't ever equal the initial investment.

So if you aren't making a profit or expecting to pay much tax - does the small business tax break really help you? Well no. If your business is expected to make a profit in the future, you may be better off waiting to claim the deduction in future years.

The hidden danger of measures like this is that they encourage businesses to spend money - but unless you already had plans to purchase an asset, or have a real business need to update equipment then it may not be the best decision for your business.

Have a chat with your accountant or bookkeeper before making the decision, and discuss how it will affect your cashflow.

Recent thoughts