Taxation Law

ACC 304 Taxation Law

Week 7 General Deductions

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Learning outcome 1

Identify and apply the 2 positive limbs in Section 8-1

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Section 8-1

• 1-2 above represent the 2 positive limbs • 3-4 above represent the 4 negative limbs

1st Positive Limb

Section 8-1(1) allows a deduction for a loss or outgoing to the extent it is incurred in gaining or producing assessable income. What is the difference between a loss and an outgoing?

Meaning of “loss or outgoing”

Loss • A loss may be subtly different, it has the connotation of something

which has been used up or maybe something not voluntarily spent by the taxpayer.

• The loss may not necessarily be linked to the income production but is actually incurred in the course of gaining or producing assessable income. A loss is a reduction of income or capital.

• For example, the theft of the days takings was found to be deductible in Charles Moore & Co (WA) Pty Ltd (1956) as it was a loss incurred in business activities.

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Meaning of “loss or outgoing”

Outgoing

• Suggests something paid out - something which has left the hands of the tax-payer so the outgoing is an expenditure which has (hopefully) the effect of gaining or producing income

• Generally considered to constitute a voluntary payment. Most business expenses such as advertising, rent, telephone, electricity and wages would be considered outgoings and, hence, be deductible, under Section 8-1.

• For example, the purchase price of goods which are subsequently sold

Class Activity 1

What is a deduction? Give examples that might apply to a coffee shop?

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Class Activity 2

What is the meaning of the words “loss or outgoing” in Section 8-1 ITAA 97?

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Class Activity 3

• Discuss some outgoings/expenses your likely to find in Items D1, D2, D5 and D10 of the income tax return.

• Students should provide their own examples and explain how the deduction works in a real context.

• Individuals - Tax return 2018

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“to the extent that”

Any loss or outgoing to the extent that……

• This phrasing allows the apportionment of an expense when the purpose associated with the loss or outgoing is only partially related to the assessable income.

• In this case only that part of the loss or outgoing related to the assessable income will be deductible.

Example -“to the extent that” • Mary is a sales consultant with Honda. She uses her

mobile telephone, to make work-related telephone calls. Her mobile telephone bill for the month of June 2018 was $200. Mary reliably estimates that she used the phone 75% for business purposes and 25% for private purposes.

Student discussion

• How much can be claimed?

Meaning of “incurred”

• Section 8-1 requires that the loss or outgoing is incurred. What does this mean?

• Lets review TR 97/7 Paragraph 6 and 21.

Meaning of “incurred”

Tax Ruling 97/7 Summary • Does incurred mean “paid”? No. • The liability must exist which requires the

payment of an expense. • If you don’t know the exact amount, a reliable

estimate is fine. • Discretionary payments are not a deduction

until paid (Para 21 examples).

Pre-workshop question 1

• Jack receives his electricity bill on 20 June 2018. Assume that Jack uses the electricity to power his business 100%. ( Why is this important ?). The amount of $1,200 is due for payment on 10 July 2018. Jack pays his electricity bill on 2 July 2018.

• When is the outgoing incurred?

• Would your answer be the same if Jack was paying his car registration for the next 12 months? Why?

Incurred in gaining or producing assessable income

• In discussing what makes expenditure deductible under subsection 8-1, Lockhart J said in F C of T v. Cooper 91 ATC 4396; 21 ATR 1616 (at ATC 4399, ATR 1620) that the phrase "incurred in gaining or producing assessable income" in the first limb of s. 8-1 has been construed to mean incurred in the course of gaining or producing assessable income...

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Nexus Test

• There should always be a nexus between income and the outgoing incurred. The payment of the outgoing does not have to be in the same year as the income was incurred (TR 94/28).

• It is sufficient if the expenditure produces future income or reduces future expenditure or was incurred in deriving income of a previous accounting period.

Nexus Test

The commissioner has released a number of occupation-based taxation rulings dealing with employees. Rulings TR 95/8 to 95/20 cover a selection of occupations and allowable deductions.

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Expenses incurred too soon • Expenses incurred before commencement of a

business are not deductible under Section 8-1. (Softwood Pulp & Paper Ltd v FCT 76 ATC 4439).

• Hence, preliminary expenses connected with the establishment or acquisition of a business (e.g. incorporation of a company, initial business name registration etc.) are not deductible under Section 8-1 because they are incurred at a point considered “too soon”.

Pre-workshop question 2 Discuss whether the following would be deductible under Section 8-1 of the ITAA (1997):

•Internet bill dated 18 June 2018 for $200 where the taxpayer was able to establish a pattern of usage showing that it was used 100% for business.

•Mobile phone bill dated 8 June 2018 for $130. The phone was used for calling family members.

•ASIC fee invoice dated 12 June 2018 for $100 in respect of the registration of a new business name.

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2nd Positive Limb

Section 8-1(2) allows a deduction for a loss or outgoing to the extent it is necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income.

Necessarily incurred

• The words "necessarily incurred" does not mean that the outgoing must be absolutely essential or necessary.

• For practical purposes, it is for the person carrying on the business to be the judge of what outgoings are necessarily to be incurred.

• It is not for the Commissioner to instruct a taxpayer as to the nature and extent or manner of conduct of his or her business activities (Tweddle (1942) 180 CLR 1).

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Carrying on a Business

The second positive limb is all about business. What’s a business? The courts have developed several characteristics for a business activity (Ferguson v FCT) including:

 the repetitions of acts or transactions  the commercial nature of the activities  the size and scale of the activities  the existence of a profit motive and;  whether the activity is conducted in a systematic manner

Are you carrying on a business?

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Meaning of “purpose”

• There may be instances where a loss or outgoing has more than one purpose (i.e. a dual purpose). The Commissioner may disallow all or part of the deduction being claimed (see Fletcher & Others v FCT91 ATC 4950 and Taxation Ruling TR 95/33).

• In other words, if the Commissioner believes that the taxpayer has deliberately over-inflated the amount of the expenditure to gain an additional tax deduction, he may disallow a portion of the expenditure. Ure v FCT(1980) 11 ATR 484.

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Meaning of “purpose” The “purpose test” • In general the nature of the business and the

appropriateness of the outgoing to the business ends pursued is the most important factor as per Magna Alloys case.

• The Magna Alloys decision referred to 2 tests: (1) the outgoing being reasonably seen as desirable or

appropriate to pursue the business ends of the business (determined objectively) and,

(2) If so, whether the person carrying on the business so saw it (subjective).

Provided the outgoing comes within that wide ambit it will necessarily be incurred in carrying on that business

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Pre-workshop question 3 Tony is a doctor. He has the following items in his waiting room:

• woman’s day magazines for clients to read • flowers to freshen up the room • cups for the water cooler

Can Tony’s business claim these items as a tax deduction?

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Learning outcome 2

Identify and apply the 4 negative limbs in Section 8-1

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The four negative limbs 1st Negative Limb

It is a loss or outgoing of capital, or of a capital nature. • Capital losses or outgoings and losses or outgoings of a capital nature, even

though they are incurred in the course of producing assessable income, are not deductible under s 8-1.

• The most useful test in this area is the structure or process perspective

• Losses or outgoings associated with the process of gaining or producing assessable income tend to be income in nature and deductible

• Losses or outgoings associated with the structure of the activity tend to be capital and therefore non-deductible in the first instance but may be able to be amortized for tax purposes.

The four negative limbs

1st Negative Limb Example Is the cost of transporting trading stock deductible?

Yes, as trading stock is clearly connected with the income producing process

Is the cost of transporting a large machine deductible to the factory so that it can be installed?

No, as the machine is a capital asset therefore the associated costs are capital in nature and not deductible under s8-1. The capitalized value of the machine would be amortized for tax purposes

2nd Negative Limb

It is a loss or outgoing of a private or personal nature.

• Fullerton v FC of T 91 ATC 983 – A taxpayer moved his family to a new city due to a change in employment. Decision (Private).

• Lodge v FC of T 72 ATC 4174 – Child minding so as to attend work. Decision (Private).

3rd Negative Limb

It is incurred in relation to gaining or producing exempt income or assessable non –exempt income.

• Under the third negative limb of Section 8-1(2) of the ITAA (1997), losses and outgoings incurred in producing exempt income are not deductible

4th Negative Limb

Losses and outgoings are not deductible where another provision of the Act prevents the deduction.

Learning outcome 3

Apply the law to determine the deductibility of a given expense under s8-1 ITAA97.

Refer to Workshop Readings

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Pre-workshop question 4

Discuss whether the following would be deductible under Section 8-1 of the ITAA (1997):

• A manager of a production business travels to Hong Kong to buy a machine. The machine is worth $1million. The travel costs including accommodation are $15,000.

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Clothing On many occasions, taxpayers have sought deductions for the cost of purchasing clothing. The main issue that arises in these cases is whether such expenditure is of an income-producing or private nature.

Conventional clothing –Mansfield v FC of T96 ATC 4001 (General rule)

Compulsory uniforms - Examples; police officers, airline pilots.

TR 97/12 • Para 30 - deduction allowed • Para 31 - a collection of clothing that is distinctive to an

organization.

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Clothing Occupation specific clothing •Examples; nurse’s uniform, barrister’s robes. A deduction is generally allowed. •The items can’t be conventional clothing Protective clothing •Examples; steel cap boots, safety helmets •Morris & others v FCT (2002) •Can now claim sun protection and hats to protect the taxpayer from ultra-violet radiation

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Pre-workshop question 5 Discuss whether the following outgoings would be allowed as a tax deduction • A police officer washes her police uniform. • A school teacher wears a $200 pair of

sunglasses whilst on playground duty. • The cost incurred by an employee accountant

in buying a suit compliant with the employer’s dress code worn to impress clients so they can gain more clients.

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Interest expenses • Interest expenses are recurrent expense securing the use of

borrowed money during the term of the loan. • It is the purpose the borrowed funds are put to which determines

the deductibility of the interest. • Interest on funds used to purchase a property on which the

taxpayer intends to build an income producing asset may be deductible from the time of purchase (Steele v FCT, 1999).

• It is not necessary to show the interest was incurred in producing assessable income in a particular year.

• It need not even produce assessable income as long as it is expected to produce assessable income.

• In FCT v Brown (99 ATC 4852) the interest on a loan taken out to purchase a business continued to be deductible even after the business had been sold.

• Refer to TR 2004/4 for extensive discussion on interest deductibility.

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Legal Fees • The principal issue that arises under Section 8-1

in relation to legal expenses is whether such expenses are linked to the purpose of incurring the expense. Legal expenses of a private or capital nature are not deductible.

• Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business.

• Compare the decision in the cases of : Herald & Weekly Times Ltd v. FCT and Sun Newspapers v. Ltd FCT.

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Class Activity 4

Would the following be deductible under section 8-1?

• Legal expenses incurred by a hotel proprietor in opposing an application for a licence to open another hotel in the area.

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