Australian Taxation law ( Deduction)

Chapter 13

Specific deductions

 2018 Thomson Reuters (Professional) Australia Ltd. All Rights Reserved. Jonathan Teoh, Monash University

Introduction • Specific deductions arise when a specific provision in the

income tax legislation provides the taxpayer with a deduction.

• A loss or outgoing (ie, an expense) may:

– Be deductible under s 8-1 and a specific provision. In these cases, use the “most appropriate” provision: s 8-10.

– Not qualify for a deduction under a specific provision. In these cases, consider deductibility under s 8-1.

• Summary list of specific provisions in s 12-5.

Deductions General

Deductions (s 8-1)

Specific Deductions

(s 8-5)

PoTL 2018 paragraph [13.10]

Tax-related expenses • Section 25-5 provides taxpayers with a deduction for certain

costs, including expenses incurred: – To manage their “tax affairs” – To comply with a notice or obligation imposed on the

taxpayer by a Commonwealth law relating to the taxpayer’s tax affairs

– For payments of the general interest charge – For certain valuations – Travelling costs to have a tax return prepared by a

“recognised tax adviser” (see TD 2017/8).

• Definition of “tax affairs” and “tax” limit the deduction to income tax obligations only: s 995-1 – For other taxes (eg, GST and FBT), consider s 8-1.

PoTL 2018 paragraph [13.20]

Tax-related expenses • Deductions under s 25-5 are not available in certain

circumstances, eg: – Payments of income tax – Payments of PAYG instalments or withholding – Borrowing money to pay income tax or PAYG amounts – Advice from an adviser who is not a “recognised tax adviser” – Capital expenditure (eg, purchasing a computer to manage

tax affairs; however depreciation will be deductible).

PoTL 2018 paragraph [13.20]

Repairs • Deduction allowed for expenditure incurred on repairs (not

capital expenses) to premises or depreciating assets (‘property’) used for income producing purposes: s 25-10.

Key issues (s 25-10)

Expenditure relates to a

repair

Property used for income producing purposes

Expense is not capital in

nature

PoTL 2018 paragraph [13.30]

Repairs: Meaning of repair • Word “repair” is not defined in income tax legislation and it

therefore takes its ordinary meaning, some examples from Lurcott v Wakely and Wheeler (1911):

– “To substitute sound tiles or slates for those which are cracked, broken, or missing”

– “A roof falls out of repair; the necessary work is to replace the decayed timbers by sound good”.

• Property must be in need of restoration: Case J47 (1958).

• Pure maintenance work not generally a repair.

• Work done to meet requirements of regulatory bodies is not a repair, unless the work remedies defects: ATO TR 97/23.

PoTL 2018 paragraph [13.33]

Repairs: Income-producing purposes • Item must have been used for income-producing purposes for

repairs to be deductible under s 25-10. For example:

– Repairs in the course of carrying on a business.

– Repairs made to a rental / investment property.

• Apportionment on a “reasonable” basis where the property is partly used for income-producing purposes: s 25-10(2) and ATO TR 97/23.

PoTL 2018 paragraph [13.35]

Repairs: Capital • A repair that constitutes a capital expense is not deductible:

s 25-10(3).

• Three broad categories of expenditure on repairs that may be classified as capital:

Capital expenditure on repairs

Initial repairs Improvements Replacements

PoTL 2018 paragraph [13.37]

Repairs: 1. Initial repairs • Initial repairs are repairs undertaken to remedy defects which

exist at time of acquisition are considered capital expenses.

– Repairs undertaken at a later time will still be an initial repair if the defect existed at time of acquisition.

– Considered that the cost of repairs would have been factored into the purchase price of the property: Law Shipping Co Ltd v Inland Revenue Commissioners (1923).

– Still an initial repair even if the taxpayer is unaware of the defects at time of acquisition: W Thomas & Co Pty Ltd v FCT (1965).

PoTL 2018 paragraph [13.40]

Repairs: 2. Improvement • An improvement surpasses a repair such that it changes the

character of the original item and hence capital in nature.

• Repair vs improvement is a question of fact:

• See, FCT v Western Suburbs Cinemas Ltd (1952) where the repair of a ceiling with new material was not a repair, despite old materials no longer available.

Repair

• Remedy a defect due to wear and tear to its previous condition

• Original materials used

Improvement

• Enhancement of the efficiency or character of the property

• Different materials used • Work involves technological

advancements

PoTL 2018 paragraph [13.50]

Repairs: 2. Improvement Notional repairs

• A deduction under s 25-10 is based on actual expenditure, not a notional amount: FCT v Western Suburbs Cinemas Ltd (1952). – Not able to undertake a non-deductible capital improvement

and seek to deduct the amount that it would have cost to undertake a mere repair.

PoTL 2018 paragraph [13.70]

Repairs: 3. Replacements • Necessary to determine whether a replacement is:

– Part of an asset (constituting a deductible repair); or

– Whole of an asset (replacement of asset and hence capital).

• An asset will be an asset in itself when: (i) it is separately identifiable; and (ii) is capable of independent use.

Key Cases Samuel Jones & Co (Devondale) Ltd v IRC Replacement of a chimney (with similar dimensions) was an inseparable part of the overall asset, being the factory. FCT v Western Suburbs Cinemas Ltd Replacement of a roof is part of an overall asset, being the cinema. W Thomas & Co Pty Ltd v FCT Floors and walls are parts of the overall asset, being the building.

PoTL 2018 paragraph [13.60]

Bad debts • A deduction for bad debts under s 25-35 is available when the

following criteria is met:

• Corporate taxpayers must satisfy loss recoupment tests to claim bad debts: s 25-35(5). See Chapter 21.

Criteria Notes 1. There is an existing debt • Must have had a legal or equitable

right to claim 2. The debt is bad • Must take all available legal steps

to recover the debt: ATO TR 92/18

3. The debt is actually written off • Mere provision insufficient

4. It was included in the taxpayer’s assessable income

• For accruals taxpayers; provision would not apply to cash basis

PoTL 2018 paragraphs [13.80] – [13.90]

Payments to associations • Payments for membership of a trade, business or professional

association is deductible (s 26-55):

– Does not require connection with the production of income (eg expenses relating to work in a different profession)

– Subject to limit of $42

• Preferable to claim the outgoing under s 8-1 if the nexus requirement can be satisfied.

PoTL 2018 paragraph [13.100]

Travel between workplaces • Common law position:

• Travel between unrelated workplaces are not deductible under s 8-1: see FCT v Payne (2001).

• Statutory position (s 25-100):

• Deduction allowed for travel directly between two workplaces where the taxpayer is engaged in income-producing activities – Not deductible if a workplace is the taxpayer’s residence.

Business A (also taxpayer’s

residence) First Job Second (Unrelated) Job

Travel expense: Not deductible

Travel expense: Deductible

PoTL 2018 paragraph [13.110]

Gifts • Broadly, a “gift” or contribution greater than $2 made to a

“deductible gift recipient” is deductible under Div 30. – Can be money or property “paid” or “contributed” (not

including incurring a liability): Arnold v FCT (2017)

Term Explanation “True” gift • No expectation of material advantage in return:

see FCT v McPhail (1968). • Commissioner suggests a deductible gift must

be voluntary and made without the expectation of material advantage in return (eg, not receiving utility items: mugs, chocolates, pens).

“Deductible gift recipient”

• Is an organisation that meets the requirements for endorsement, eg, charities, hospitals.

• Lists of DGRs: ss 30-20 to 30-105.

PoTL 2018 paragraph [13.130]

Gifts • Limitation on deductions, include:

– Taxpayer not entitled to a deduction under Div 30 that results in incurring or increasing a tax loss: s 25-55(1).

– Business taxpayers not entitled to a deduction for contributions or gifts to political parties: s 26-22.

– Other anti-avoidance rules apply in Div 78A ITAA36.

• General deductions and gifts: – It may be possible for a loss or outgoing to be deductible

under s 8-1 if a nexus between the gift and the gaining or producing of assessable income can be established.

– For example, gifts made to current/former clients deductible if made for producing future assessable income: TD 2016/14.

PoTL 2018 paragraphs [13.140] – [13.160]

Prior year losses • A tax loss for an income year is calculated under s 36-10:

• Losses are carried forward indefinitely to future income years

• In the future income year, the tax loss is offset: 1. Against any exempt income (if any); and 2. The remaining against assessable income.

• If the taxpayer has losses from more than one year, the losses are deducted on a first-in-first-out basis.

• Individuals may be subject to non-commercial loss rules: Div 35.

Tax Loss Deductions

(excluding prior year tax

losses)

Assessable income

Net exempt income

PoTL 2018 paragraph [13.180]

Prior year losses: Illustration • Consider the following scenario:

• In Year 2, the tax loss of $25,000 from Year 1 will be:

1. Offset against exempt income from Year 2: $10,000.

2. The remaining loss of $15,000 is offset against the taxpayer’s assessable income over its deductions, resulting in a Year 2 taxable income of $25,000 ($60k - $20k - $15k).

Assessable income: $20,000 Deductions: $45,000 = Tax Loss: $25,000

Year 1 Year 2

Assessable Income: $60,000 Deductions: $20,000

Exempt income: $10,000

PoTL 2018 paragraph [13.180]

Prior year losses: Corporate taxpayers • Companies can choose how much of their carried-forward

losses to apply against current year assessable income, after applying losses against exempt income: s 36-17.

• Utilisation of carried forward losses for corporate taxpayers is subject to the satisfaction of recoupment tests:

– Continuity of ownership test.

– Same business test (see Chapter 21).

PoTL 2018 paragraphs [13.190] – [13.200]

Other specific deduction provisions • Many other specific deduction provisions in Div 25 ITAA97,

including:

– Lease document expenses: s 25-20

– Borrowing expenses: s 25-25

– Loss from profit-making undertaking or plan: s 25-40

– Loss by certain types of theft: s 25-45.

PoTL 2018 paragraph [13.210]

Chapter 14

Capital allowances

 2018 Thomson Reuters (Professional) Australia Ltd. All Rights Reserved. Jonathan Teoh, Monash University

Introduction • The general deduction provision prohibits a deduction for a

capital item: s 8-1(2)(a).

• Specific provisions may allow a deduction over the period of time that the expense is expected to derive a benefit:

Types of deductible capital expenditure

Depreciation deductions

Capital works deductions

‘Black hole’ expenses

PoTL 2018 paragraph [14.10]

Depreciation deductions • A taxpayer may claim a deduction equal to the “decline in

value” of a “depreciating asset” that is “held”: s 40-25.

– Deduction usually claimed over asset’s estimated useful life.

Depreciating asset acquired

Year 1 Decline in value

deduction

Year 2 Decline in value

deduction

End of effective life

PoTL 2018 paragraph [14.20]

Depreciation deductions • Depreciation rules do not apply in certain circumstances, eg:

– Expenditure on capital works (ie buildings) under Div 43

– Car expenses where deduction is calculated in accordance with the “cents per kilometre” method

– Depreciating assets used or installed in residential rental premises and was ‘previously used’: s 40-27.

PoTL 2018 paragraph [14.20]

Depreciating asset • Definition of a “depreciating asset” (s 40-30(1))

– An asset which has a limited effective life and can reasonably be expected to decline in value over the time it is used.

• Exclusions to definition:

– Land;

– An item of trading stock; or

– Certain intangible assets, unless listed in s 40-30(2), eg in-house software, items of intellectual property.

• Common depreciable assets include computers, furniture, cars, machinery, telephones, etc.

PoTL 2018 paragraph [14.30]

Depreciating asset Composite items

• Necessary to determine if components making up a depreciable asset are: (i) separate depreciating assets; or (ii) one whole depreciating asset.

• Similarly, for buildings, necessary to identify if capital expenditure relates to a depreciable asset or capital works.

• Question of fact and degree: s 40-30(4). Commissioner suggests in TR 2017/D1 factors include: – Identifiable function – Use – Degree of integration with other components – Effect of attachment.

PoTL 2018 paragraph [14.35]

Claiming a deduction • To claim a deduction under s 40-25 in respect of a

“depreciating asset”, it is necessary to determine:

• Non-business depreciable assets costing less than $300 that are predominately used to gain or produce assessable income may be claimed immediately: s 40-80(2).

1 • ‘Held’ • When the taxpayer has ‘held’ a depreciating asset

2

• Decline in value • A deduction is equal to the ‘decline in value’ taking

into account ‘taxable purpose’

PoTL 2018 paragraph [14.40]

Claiming a deduction: 1. Held • The holder of an asset is entitled to the deduction for the

decline in value of a depreciating asset: s 40-25. – The ‘holder’ is described in s 40-40. – Jointly held: deduction reflects holder’s interest: s 40-35.

• Generally it is the legal owner, but in certain circumstances it may the economic owner, eg in hire-purchase arrangements:

Legal Owner

Economic Owner ‘Holder’

Legal owner provides asset to economic owner under a HP arrangement. Economic owner bears all risk.

Economic owner pays legal owner in instalments and

has option to purchase the asset.

PoTL 2018 paragraphs [14.50] – [14.60]

Claiming a deduction: 2. Decline in value • Two methods to work out the decline in value: s 40-65.

Methods • Prime cost: equivalent to “straight line method” in accounting where equal depreciation deductions each year.

• Diminishing value: equivalent to “reducing- balance method” in accounting where greater deductions in the early years.

Prime Cost

Diminishing Value

PoTL 2018 paragraph [14.70]