Instant Asset Write-off, Accelerated Depreciation, and Business Values
Over the last few years, the Federal Government has introduced a suite of instant asset write-off and accelerated depreciation rules, whereby eligible businesses can either claim:
- an immediate deduction for the business portion of the cost of an asset in the year the asset is first used or installed ready for use; Or,
- Accelerated depreciation, which applies to all newly acquired depreciating assets which are not eligible for the instant asset write-off (ceased in June 2021).
The general effect of instant asset write-off incentive is to allow businesses to purchase assets up to the threshold of $150,000 (as at the date of this article) and claim the entire amount as a deduction against their taxable income. This also encouraged business owners to invest in plant and equipment and other work-related assets, supporting the economy during the COVID pandemic.
The temporary accelerated depreciation allowances allowed businesses to rapidly write-down the value of assets that were valued at more than $150,000, allowing an initial year deduction of 50-57.5% (depending upon eligibility criteria), before it is added to the existing asset pool and depreciated normally.
I’ve glossed over a lot of specifics on these provisions as this article is not about how to apply the write off provisions, but how they affect the valuation of a business or company.
When assets are immediately written-off or depreciated in an accelerated manner, the market value of the asset will bear no resemblance to the value of the asset on the balance sheet of the entity (if it appears at all). The mechanism of writing-off or depreciating the asset allows you to offset the purchase price of the capital purchase against your income, which would not be allowable under ordinary circumstances, thereby reducing your tax payable. But at what cost?
If the entity was not showing a profit anyway, the additional claimed deductions do little but assist in creating future tax losses. However, if the business is profitable and the deduction has the effect of reducing tax payable in that financial year, in real terms it has simply brought forward all or part of your future depreciation expenses forward. As such, the benefit to the entity is temporary.
As a business valuer, it is a typical scenario to see a business borrowing to fund the purchase of a capital item and then availing itself of the immediate asset write-off provisions. The overall effect of the transaction is to see the Net Tangible Assets of the entity drop the value of the borrowed funds, and sometimes putting the entity into a negative equity position. Where a business and/or entity has been assessed as having no goodwill, the balance sheet must therefore be restated to show the current market value of all of the assets and liabilities held by the balance sheet… not just the ones that currently show up! For example, if a company bought a piece of equipment (financed by a bank), and elected to immediately write-off the value of the purchase, and that equipment is not reflected anywhere on the balance sheet or fixed asset register, the balance sheet is no longer reflecting what the company owns and owes. It would reflect only the loan.
If that same company showed the equipment purchased on the balance sheet as wholly or partially depreciated, it does not reflect the market value of the company, but a version of the company viewed entirely through a prism of ATO compliance.
A good business valuer will always consider the profitability of a company factoring in the replacement value of equipment as well as the current value of plant and equipment in order to reach an accurate assessment of the value of the business and/or the entity, including any goodwill. Where a valuer does not consider the current market value of depreciable assets, any prospective purchaser will find that the assets held cannot be depreciated, thereby reducing future taxable income, and they have an exaggerated goodwill line item that cannot be depreciated or amortised.
It is therefore critical that current business owners and prospective business purchasers consider these issues before any transaction is entered into.