Chapter 14 Depreciation Allowance Plant and Machinery
1. Learning Objectives
1.1 Identify assets which are plant or machinery.
1.2 Identify persons who can claim depreciation allowance.
1.3 Identify the type of expenditure that qualifies for the depreciation allowance.
1.4 Compute depreciation allowance under the pooling system.
1.5 Compute depreciation allowance under the non-pooling system.
1.6 Calculate the balancing adjustment that arises when an asset is disposed of.
1.7 Identify prescribed fixed assets.
1.8 Explain the tax treatment of prescribed fixed assets.
2. Definition of Plant and Machinery
2.1 Plant and machinery is not defined in the IRO, so the words must be given their ordinary meaning. There have been numerous cases before the UK courts on the definition of plant.
(A) Functional test
2.2 |
DEFINITION |
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In Yarmouth v France (1887) 19 QDB 647, plant was defined as the apparatus (器械, 設備, 儀器) used by a businessman for carrying out his business – not his stock in trade, but all goods and chattels (動產) fixed or movable, live or dead, which he keeps for permanent employment in his business. |
2.3 Many tax cases involve the distinction between plant and building. It has been said that plant performs an active function, while the function of a building is passive.
2.4 |
EXAMPLE 1 |
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In CIR v Barclay, Curle & Co Ltd (1969) 45 TC 221, a dry dock was held to be plant, not a building structure. The dry dock held ships up for repair and was similar to a tool of a trader. |
2.5 |
EXAMPLE 2 |
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The active and passive function test was also illustrated in CIR v Scottish & Newcastle Breweries Ltd (1982) 55 TC 252. In this case, decorations, electric light fittings of hotels, were held to be plant as they carried out the function of creating atmosphere. |
(B) Setting (安裝) test
2.6 |
EXAMPLE 3 |
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In J Lyons & Co Ltd v AG (1944) 1 All ER 477, a distinction was made between the setting in which business was carried out and the apparatus with which the business was carried out. The former is building, while the latter is plant. This principle was followed in Jarrold v John Good & Sons Ltd (1964) 40 TC 681, in which a movable partition was held to be plant and not part of a building. |
3. Calculation of Allowances
(A) Initial allowance (IA)
3.1 |
KEY POINT |
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An initial allowance is given in respect of capital expenditure incurred in the basis period for a year of assessment. The rate is currently 60%. Note that it is not necessary for the asset to be brought into use in the basis period. |
(B) Annual allowance (AA)
3.2 |
KEY POINT |
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An annual allowance is granted to a person who, at the end of a basis period, owns plant and machinery that has been used at some time for the purpose of business. In other words, so long as the asset has been owned and used in the production of assessable profits at some time either during the basis period or during an earlier period. In the year of purchase the business can receive both the initial allowance and the annual allowance. The allowances are given for a full year irrespective of the date which the asset was purchased. |
3.3 The allowance is calculated using the reducing balance basis. The rate used is 10%, 20% or 30% depending on the category of asset. The rates are prescribed by the Board of Inland Revenue.
3.4 The rates of annual allowance of plant or machinery (excluding implements, articles and utensils) were determined in accordance with the Table annexed to the First Part of the Inland Revenue Rule 2(3) as follows.
Item No. |
Item |
Rate of depreciation |
1 |
Air-conditioning plant excluding room air-conditioning units |
10% |
2 |
Bank safe deposit boxes, doors and drills (鉆孔機) |
10% |
3 |
Broadcasting transmitters |
10% |
4 |
Cables (electrical) |
10% |
5 |
Lamp standards (street) – gas or electric |
10% |
6 |
Lifts and escalators (electric) |
10% |
7 |
Mains (gas or water) |
10% |
8 |
Oil tanks |
10% |
9 |
Shipping – ships, junks and sampans (舢板, 小船) |
10% |
10 |
Sprinklers (灑水裝置) |
10% |
11 |
Domestic appliances |
10% |
12 |
Furniture (excluding soft furnishings) |
20% |
13 |
Room air-conditioning units |
20% |
14 |
Shipping – Launches (汽艇) and ferry vessels |
20% |
15 |
Taxi meters |
20% |
16 |
Type and blocks |
20% |
17 |
Aircraft (including engines) |
20% |
18 |
Bar siphon apparatus |
30% |
19 |
Bicycles |
30% |
20 |
Bleaching and finishing machinery and plant |
30% |
21 |
Concrete pipe mould |
30% |
22 |
Electric cookers and kettle |
30% |
23 |
Electronic data processing equipment (100% in case of computer hardware) |
30% |
24 |
Electronics manufacturing machinery and plant |
30% |
25 |
Motor vehicles |
30% |
26 |
Plastic manufacturing machinery and plant |
30% |
27 |
Shipping – Outboard motors (舷外馬達) |
30% |
28 |
Silk manufacturing machinery and plant |
30% |
29 |
Sulphuric (硫磺的) and nitric acid plant |
30% |
30 |
Tank lorries |
30% |
31 |
Textile and clothing manufacturing machinery and plant |
30% |
32 |
Tractors (拖拉機) – bulldozers and graders |
30% |
33 |
Weaving (織機), spinning (紡紗)and sewing machinery (鎖線裝訂機) |
30% |
34 |
Machinery or plant, not specified in items 1 to 33, and used for the purposes of a transport, tunnel, dock, water, gas or electricity undertaking or a public telephone or public telegraphic service |
10% |
35 |
Any other machinery or plant, not specific in items 1 to 34 |
20% |
(C) Persons entitled to claim DA
3.5 Profits tax payers and salaries tax payers are eligible to claim depreciation allowance.
3.6 A salaries tax payer is entitled to DA in respect of plant and machinery, the use of which is essential to the production of assessable income (s 12(1)(b)).
3.7 For a profits tax payer, DA on plant or machinery is allowed to be deducted from assessable profit to the extent to which the relevant assets are used in the production of the assessable profits (s 18F). If the asset is partly used in producing assessable profits, only the portion attributable to such use can be allowed.
3.8 |
EXAMPLE 4 |
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Chan’s garage purchased a motor car was used 60% and 40% for business and private use respectively. It can only claim 60% of the depreciation allowance in respect of the motor car. |
(D) Qualifying expenditure
3.9 DAs are calculated on the basis of “capital expenditure (資本支出)” incurred on the provision of plant and machinery. Capital expenditure is defined in s 40 as including the following:
(a) expenditure on alterations to an existing building incidental to the installation; and
(b) financial interest before the plant or machinery is put into use.
(E) Pooling system (聚合制)
3.10 Under this system, all assets qualifying for the same rate of annual allowance are kept in a pool to which further capital expenditure (less initial allowance) is added and from which disposal proceeds are deducted. Note that deduction for proceeds of disposal of an asset is limited to the cost of the asset.
3.11 The general format of computing depreciation allowances under the pooling system is shown below:
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3.12 |
EXAMPLE 5 |
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Car Leasing Limited incurred the capital expenditure in the year ended 31 July 2008 as follows:
Tax written down values (WDV) of plant and machinery brought forward from the year of assessment 2008/09 are as follows:
Required: Compute the depreciation allowances for the year of assessment 2008/09. Answer: Car Leasing Limited
Note to the following points: |
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3.13 |
EXERCISE 1 |
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Mr Lee commenced his business on 1 November 2006 and purchased the following asset in the first 17 months of operations:
Mr Lee closes his accounts on 31 March each year. Required: Compute the depreciation allowances for the year of assessment 2006/07 and 2007/08. |
(a) Assets used before being brought into business
3.14 For those assets which are not used for business purposes before being brought into the business, actual cost less notional allowances is taken into the pool in the year when it is first wholly and exclusively used for business purposes (2 39B(6)).
3.15 Notional allowances are the AA that would have been given if the asset had been used for business purpose ever since acquisition.
3.16 |
EXAMPLE 6 |
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Same information as in Exercise 1. In September 2008, Mr Lee put into his business a motor car. This car was purchased in July 2005 for $60,000 and was used by Mr Lee before he put it into his business. Other than this, Mr Lee had no other transaction in the year ended 31 March 2009.
Year of assessment 2008/09
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3.17 |
EXERCISE 2 |
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Mr Wong purchases a motor car for personal use in July 2006 for $54,000 and introduced it into the business on 1 September 2008 as business case (the rate of annual allowance of which is 30%) of his manufacturing business. The market value of the motor car as at 1 September 2008 was $23,000. Mr Wong prepares his accounts to 31 December each year. Required: Calculate the value of the motor car to be transferred to the 30% pool in the year of assessment 2008/09. |
(b) Removal from pool
3.18 When an asset is no longer used wholly and exclusively in the production of assessable profits, its open market value (as determined by the CIR at the amount which he considers it would have been realized if sold on the open market at that time) must be taken out of the pool during the year of change (s 39C(3)).
3.19 |
EXAMPLE 7 |
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Same information as in Exercise 1 and Example 6. From 1 October 2008, Mr Lee used the scooter both for business and private purposes. The private usage is agreed to be 20%. The market value of the scooter on 1 October 2008 was $8,000. Year of assessment 2008/09
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(c) Succession to a trade
3.20 If upon succession to a trade, the ownership of machinery or plant passes to the successor without being sold to him, the reducing value of each pool disallowed to the old proprietor is taken over by the new owner (s 39B(7)). No IA shall be granted to the new owner.
(d) Acquisition by inheritance or gift, without there being any succession to the trade itself
3.21 If the assets are transferred by a donor who has used the asset wholly and exclusively for business purposes:
(a) the situation of the donor is covered by s 39C(3) (i.e. the open market value is deducted from the reducing value of the appropriate pool);
(b) no IA will be given to the recipient as no capital expenditure has been incurred. There should be no capital expenditure to be added to the pool on which AA is to be given. But, in practice, the reducing value deducted from donor’s pool may be added to the donee’s pool and AA given.
3.22 If the assets are transferred by a donor who previously used it for private purposes, the reducing value to be added to donee’s pool should be calculated by writing off notional AA.
(e) Disposals and balancing adjustment
3.23 |
KEY POINT |
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(a) When an asset is disposed of during the basis period, the sale proceeds are deducted from the pool prior to the calculation of the annual allowance. The deduction cannot exceed the original cost of the asset. Cost – sales proceeds = net cost |
3.24 |
EXAMPLE 8 – Balancing Charge |
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Mr Lee buys the following plant and machinery during his year ended 31 March 2007:
Required: (a) Calculate the depreciation allowances due for 2006/07 and 2007/08. Assume an IA of 60% and AA of 20%. Solution:
(b)
(c)
The negative balance of $2,600 on the pool must be added to profits. (d)
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3.25 |
EXAMPLE 9 – Balancing Allowance |
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Mr Cheung’s business ceases to operate and sells all the assets in the 20% pool for $1,000,000 (the WDV is $1,119,200) during the year ended 31 March 2009 and there are no other movement of assets in the 20% pool, the balancing adjustment of the 20% pool will be calculated as follows: Year of assessment 2008/09
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3.26 |
EXERCISE 3 |
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Mr Choi has been trading for many years as a consultant, producing accounts to 31 December each year. The tax written down values at 1 January 2007 on the various pools were as follows.
The following additions and disposals took place during the year ended 31 December 2007.
Required: Calculate the depreciation allowances for the year ended 31 December 2007 and the tax written down values carried forward at the end of the year. |
4. Non-pooling System
4.1 Under the non-pooling system, the depreciation allowance in respect of each item of plant and machinery is calculated separately.
(A) Initial allowance (s 37(1))
4.2 IA is granted at the same rate and in the same manner as those under pooling system.
(B) Annual allowance (s 37(2))
4.3 AA is granted for a year of assessment in respect of plant and machinery owned and in use at the end of the basis period. (Note that under the pooling system, AA may be granted even though the asset is not in use at the end of the basis period.)
(C) Replacement of assets
4.4 When an asset is disposed of and replaced by another asset, any balancing charge arising in respect of the disposal can be used to reduce the qualifying expenditure on the replacement asset if the taxpayer makes an election in writing (s 39). The balancing charge is then not taxed.
4.5 The IA and AA on the new asset are then reduced. When the new asset is sold, the reduced cost (i.e. original cost less the balancing charge) is used in the computation of the balancing charge or allowance.
(D) Hire-purchase
4.6 IA shall be given on the capital portion of each instalment and AA may be based on the full capital cost applying the reducing balance method until all the instalments have been paid (s 37A). After all instalments have been paid, the written-down value shall be transferred to the relevant ‘pool’ in the following year of assessment.
4.7 |
EXAMPLE 10 |
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On 1 October 2005, Mrs Yau purchased some plant and machinery on hire purchase under the following terms:
Each monthly instalment is made up of $7,500 capital and $2,500 interest and is due in advance on the first day of each month. Mrs Yau produces accounts to 31 December each year. Calculate the depreciation allowances due for 2005/06 to 2007/08, assuming an AA of 30% and an IA of 60%. Solution: Total interest = 18 x $2,500 = $45,000
Note that at the start of 2008/09, the balance brought forward of $16,740 will be added to any balance in the 30% pool. |
4.8 |
EXERCISE 4 |
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Mr Cheung carried on a trading business in Hong Kong for many years. The tax written down values of plant and machinery owned by Mr Cheung’s business as at 31 March 2008 were as follows:
The followings are the movement of plant and machinery in respect of Mr Cheung’s business during the year ended 31 March 2009:
c. A lorry bought in 2007 for $380,000 was sold for $60,000. Its net book value was $40,000 as at 31 March 2008.
The down payment of $180,000 and 5 monthly instalments of $13,200 each were due and paid during the year ended 31 March 2009. The new motor car was used by Mr Cheung’s family privately during public holidays. It has been agreed by the assessor that 1/10 of the car was for non-business use. Additional information:
Required: Compute the total depreciation allowances in respect of plant and machinery of Mr Cheung’s business for the year of assessment 2008/09. (15 marks) |
(E) Assets not used wholly and exclusively for business purposes
4.9 IA and AA are still computed as if the asset is wholly and exclusively used for business purposes. However, the allowances the taxpayer is entitled to are limited to the portion used for business purposes (s 39A).
4.10 Even if the asset is subsequently used wholly and exclusively for business purposes, it cannot be brought into the pool.
4.11 |
EXAMPLE 11 |
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Mr Lam owns a motor car which is used both for business and private purposes. The car was purchased on 30 September 2006 at a price of $50,000. The accounts of the business are prepared to 31 March each year. The private usage varies from year to year. Year of assessment 2006/07
Year of assessment 2007/08
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5. Prescribed Fixed Assets (s 16G)
(A) Deduction of specified capital expenditure (指明資本開支)
5.1 |
KEY POINT |
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(a) A taxpayer is a eligible to deduct the capital expenditure incurred in respect of prescribed fixed asset in full in one year. |
5.2 |
EXAMPLE 12 |
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G Ltd carries on the business of manufacturing plastic bags in HK and prepares its accounts to 31 March each year. During the year ended 31 March 2009, G Ltd:
For the year of assessment 2008/09, G Ltd is entitled to claim a deduction of $300,000 in respect of the provision of plastic manufacturing machine X. However, it can only claim an initial allowance and annual allowance in respect of the mould because it was acquired by means of hire-purchase. For plastic manufacturing machine Y, G Ltd can only claim deduction of the lease rental. |
(B) Prescribed fixed assets used partly in the production of chargeable profits
5.3 Where a prescribed fixed asset which qualifies under s 16G is used:
(a) partly in the production of profits chargeable profits tax; and
(b) partly for any other purposes.
the deduction allowable will be such part of the capital expenditure as is proportionate to the extent of the use of the asset in the production of the chargeable profits (s 16G(2)).
5.4 |
EXAMPLE 13 |
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Mr Cheung is the sole proprietor of Cheung’s Co. Mr Cheung trading as Cheung’s Co carries on business in Hong Kong and prepares accounts to 31 March each year. Mr Cheung purchased computer software for $10,000 during the year ended 31 March 2008 and used it 60% for business use and 40% for private use. Mr Cheung trading as Cheung Co can only claim a deduction of $6,000 (i.e. 60% x $10,000) in respect of the computer software for the year of assessment 2008/09. |
(C) Disposal of prescribed fixed asset
(a) Sale of prescribed fixed asset during continuance of business
5.5 Where a prescribed fixed asset has been sold,
(a) the sale proceed; or
(b) such part of the sale proceeds as is proportionate to the extent to which the capital expenditure incurred in the provision of the fixed asset has been allowed as a deduction,
shall be treated as a taxable receipt limited to the amount previously deducted under s 16G(3)(a).
5.6 |
EXAMPLE 14 |
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During the year ended 31 March 2009, Mr Cheung in Example 11 sold the computer software to Mr Wong for $5,000. $3,000 (i.e. $5,000 x 60%) of the sale proceeds will be treated as a taxable trading receipt. If the computer software has instead been sold for $30,000, the amount treated as a trading receipt will be limited to the total amount allowed under s 16G (i.e. only $6,000 of the sale proceeds will be treated as a trading receipt). |
(b) Purchase of prescribed fixed asset before commencement and sale of prescribed fixed asset on/after cessation
5.7 If a prescribed fixed asset is acquired before commencement of business, the asset is treated as if acquired on the first date of commencement of business.
5.8 If the sale of a prescribed fixed asset occurs on or after the date on which the business is permanently discontinued, the trading receipt will be deemed to have accrued immediately before the discontinuance (s 16G(3)(a)).
(c) Destruction (破壞) of prescribed fixed asset
5.9 Where such asset is destroyed, the asset will be treated as if it had been sold immediately after the destruction thereof, and:
(a) any insurance company; or
(b) other compensation of any description received by that person in respect of the destruction; and
(c) any money received by him in respect of the remains of the asset
shall be treated as if they were proceeds from that sale (s 16G(3)(b)).
(d) Sale of prescribed fixed asset to connected person
5.10 Where:
(a) the buyer is a person over whom the seller has control;
(b) the seller is a person over whom the buyer has control;
(c) both the seller and the buyer are persons over both of whom some other person has control; or
(d) the sale is between a husband and his wife, not being a wife living apart from her husband,
the CIR will, if he is of the opinion that the sale price of the asset does not represent its true market value at the time of sale, determine such true market value, and the amount so determined shall, for the purpose of this subsection, be deemed to be the sale proceeds of the asset (s 16G(3)(c)).
5.11 |
EXAMPLE 15 |
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X Ltd is the parent company of Y Ltd. Both companies are manufacturers of garments in HK and prepare their accounts to 31 December each year. During the year ended 31 December 2008. X Ltd sold a sewing machine to Y Ltd at a price of $1,000,000. The market value at the time of sale was $600,000. The CIR can treat the sale proceeds to be $600,000. |
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