When a car is disposed of, lost or destroyed, a taxable adjustment or “balancing charge” can arise. The balancing charge is the tax assessable or deductible difference (if any) between the disposal value of an asset and any cost remaining which hasn’t already been claimed as a tax deduction.
Why Is There An Adjustment?
In principle, a balancing charge adjustment arises because the disposal proceeds of a car effectively give the taxpayer a refund of previous depreciation claims. This “refund” can result in a profit (taxable) or a loss (deductible).
However, an apparent profit or loss won’t always be taxable after the private and non-deductible components of depreciation have been eliminated.
Because a taxable adjustment can only arise in relation to depreciation claims, it is only the One Third of Actual Expenses* and Log Book claim methods which directly give rise to an adjustment on disposal of a car. The other two methods (12% of Cost and Cents Per Kilometre) do not.
*(Note that the One Third of Actual Expenses and 12% of cost methods have not been available since the 2015-16 year).
A potential complication arises when the expense claim methods are mixed over periods of ownership. To deal with the arithmetic it becomes necessary to use assumed (“deemed”) business use depreciation percentages for:
- Cents per kilometre method – deemed 20% business use (i.e. private use 80%); and
- 12% of Cost/Value method – deemed 33.33% business use (i.e. private use 66.66%)
The following example illustrates how this works.
Example Balancing Charge Calculations
- On 1st July of year 1: Malcolm bought a car for $25,000.
- For finanical year 1: Malcolm used the car 40% for business purposes, and claimed expenses (including depreciation) using the log book method
- Financial year 2: Malcolm’s business use of the car exceeded 5,000 kilometres, and he used the 12% of Cost/Value method to claim his car expenses. (Note this method ceased to be available from the 2015-16 year).
- Financial year 3: Malcolm changed jobs, and the business use of his car decreased. He elected to use the cents per kilometre method to claim.
- On 30 June Financial year 3: Malcolm sold the car to Scott for $15,000 (which was objectively the fair market value at the time).
The first step is to determine what is called the “Adjustable Value” of the car, at the time it was sold.
The Adjustable Value calculation in this case begins with the cost ($25,000), from which is deducted Depreciation for 3 years (prime cost method) at 20% = $5,000 per year ($15,000)
The Adjustable Value = $10,000
Under our assumption 5, the sale value of the car (“Termination Value”) was $15,000
Therefore the gross adjustment amount (in this case a profit) is ($15,000 – $10,000) = $5,000.
But not all of this gross adjustment amount is taxable profit, because the tax claims over the years were reduced to allow for non-deductible private use.
The second step therefore is to reduce the gross adjustment amount by the extent of private use of the car over the 3 years of ownership.
Because Malcolm used a different claim method each year, there are three separate calculations of private use:
- Year 1 (Log Book) Private use = 60% x $5,000 = $3,000
- Year 2 (12% of Cost*) Private use deemed 66.6% x $5,000 = $3,333
- Year 3 (Cents per Km) Private use deemed 80% x $5,000 = $4,000
=>Total Private Use Reductions Over the 3 Years = $10,333
The gross adjustment amount ($5,000 determined above) is now proportionately reduced by the private use component, with the following formula:
- Reduced Adjustment Amount = $5,000 – ($5,000 x $10,333 ÷ $15,000) = $1,556
The third step is to adjust the Reduced Adjustment Amount obtained from step two ($1,556) by calculating the log book proportion.
This is because it is only under the log book method that there is a calculated estimate of depreciation, and the gain on disposal (in this case it’s a gain) can only be taxable to that extent. The arbitrary methods assume the depreciation element embedded in the claim reflects the correct amount.
- The log book portion of the Reduced Adjustment Amount is calculated as the ratio of the number of log book days (1 year = 365 days) to the total days the car was held and claimed (in the example case, 3 years = 1,095 days).
=> Log Book Days (365) ÷ Total days (1,095) x Adjustment Amount ($1,556) = $519
The resulting net balancing adjustment amount of $519 is positive, and is therefore included in Malcolm’s income tax return for the year ended 30 June of Year 3, the year of disposal. Had the amount been negative, Malcolm would claim a tax deduction.
Simple logbook example with private use
The Tax Office’s “Guide To Depreciating Assets” publication (updated annually) contains an example balancing adjustment calculation where the logbook method has been used. The 2021 Guide contains this information from page 21.
Cars subject to cost limit
Cars subject to the cost limit have depreciation claims limited by the ceiling amount which applies in the year of purchase.
Sales proceeds (“termination value”) on the disposal of a cost-limited vehicle are also proportionately reduced, by the ratio which compares the cost-limit (plus second element costs) to the actual cost. All costs are GST exclusive.
Second element costs are those costs added to an asset after purchase – for example a car alarm.
The adjusted termination value is multiplied by (car limit + second element costs) ÷ total actual cost.
- 1 August 2020 car purchased for $80,000.
- Sold for $65,000 on 25 September 2021
- The 2020-21 cost limit at time of purchase was $59,136
- Depreciation is claimed based on effective life of 8 years
- Depreciation Year 1 (334 days) is ($59,136 ÷ 8) x (334 ÷365) = $6,764
- Depreciation Year 2 (87 days) is ($59,136 ÷ 8) x (87 ÷365) = $1,762
- Total deductions for decline in value to date of sale ($6,764 + $1,762) = $8,526
- Adjustable value (i.e. WDV) at date of sale is $59,136 -$8,526 = $50,610
- Sale price adjusted based on cost limit $65,000 x ($59,136 ÷ $80,000) = $48,048
- In this case Adjusted Termination value is less than Adjusted sale value, resulting in a balancing adjustment (deductible loss) of $50,610 – $48,048 = $2,562.
- The total claims in Year 2 would include the decline in value amount of $1,762 and the balancing deduction of $2,562. ($1,762 + $2,562 = $4,324.
This page was last modified on 27 August 2021