Taxation Law

ACC 304 Taxation Law

Week 8 Specific Deductions

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Learning objectives After this workshop, you should be able to determine the availability and amount of the tax deduction associated with: • Tax related expenses • Repairs • Borrowing expenses • Bad debts • Travel between workplaces • Carry forward losses for individuals • Depreciable assets • Trading stock balances

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Specific deductions: s8-5

(1) You can also deduct from your assessable income an amount that a provision of this Act (outside this Division) allows you to deduct.

(2) Some provisions of this Act prevent you from deducting an amount that you could otherwise deduct, or limit the amount you can deduct.

(3) An amount that you can deduct under a provision of this Act (outside this Division) is called a specific deduction.

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Learning objective 1

Apply the legislation to determine the availability and amount of the tax deduction associated with tax related expenses.

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Tax related expenses: s25-5 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; and • for certain valuations.

Definition of “tax affairs” and“ tax” limit the deduction to income tax obligations only (s.995-1). For other taxes (e.g. GST and FBT), consider deductibility under s.8-1 (General Deductions)

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Tax related expenses: s25-5

Deductions unders.25-5 are not available in certain circumstances, for example: • payment of the income tax; • Amounts withheld or payable under the PAYG system; • Interest on funds borrowed to pay income tax or PAYG

amounts; • advice from an adviser who is not a “recognised tax

adviser” as defined in s995-1 (registered tax agent, and legal practitioners)

• capital expenditure (e.g. purchasing a computer to manage tax affairs, however, depreciation will be deductible).

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Learning objective 2

Apply the legislation to determine the availability and amount of the tax deduction associated with repairs.

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25-10 Repairs (1) You can deduct expenditure you incur for repairs to

premises (or part of premises) or a depreciating asset that you held or used solely for the purpose of producing assessable income.

(2) If you held or used the property only partly for that purpose, you can deduct so much of the expenditure as is reasonable in the circumstances.

(3) You cannot deduct capital expenditure under this section.

25-10 Repairs

Replacement of a whole asset A repair involves the restoration of part of some income- producing property. It does not involve the replacement of an asset in its entirety but rather a subsidiary part or component. Lindsay v FCT (1961) 106 CLR 377

An improvement to an asset is not a repair A repair involves the restoration of an asset to its original state. FC of T v Western Suburbs Cinema Ltd (1952) 86 CLR 102.

25-10 Repairs

Initial repairs Expenditure incurred to put the asset into good order before it can be used to produce assessable income is an initial repair and is not deductible. Essentially the taxpayer has the benefit of the lower purchase cost.

The Law Shipping Co Ltd v IR Commrs (1924) 12 TC 621; W Thomas & Co Pty Ltd v FCT (1965) 115 CLR 58.

W Thomas & Co Pty Ltd v FCT: Facts

The taxpayer purchased a building, unaware that repairs were needed in order to be able to use the building in its business as a flour and grain merchant. The taxpayer subsequently carried out extensive work to the roof, guttering and floors, and painted the walls and roofing timbers. At the same time, the taxpayer also altered and enlarged an office and installed a lunch room and other amenities.

W Thomas & Co Pty Ltd v FCT: Held

• Expenditure was of a capital nature. • When a thing is bought for use as a capital

asset in the buyer's business, but is not in good order nor suitable for use in the way intended, the cost of putting it in order suitable for use was part of the cost of its acquisition .

Lindsay v FCT Facts: • Ship repairing business . • Lindsay demolished one of its slipways

and replaced it. • Lindsay argued slipway was part of its

business premises or part of the hauling machinery.

Held: • Not a repair. • Slipway was an entire asset. • Renewal in this case was ‘reconstruction’

of the entirety.

Law Shipping Co Ltd v IRC Facts: • Taxpayer acquired a ship which required a repair. • Undertook one voyage, then repaired it. Held: • Capital expenditure, not a repair. • The cost of this ‘initial repair’ formed part of the

acquisition costs, therefore was capital. • Taxpayer would have paid a lower price for the

ship due to the need for repair. • Expenditure was necessary at the time of

purchase to render the ship serviceable.

Class activity 1 • Jack purchased business premises on October 5, 2017. Jack

incurred the following expenses: • On October 8, 2017, Jack replaced 20 roof tiles at a cost of $800.

Jack used steel roof tiles to replace the old clay roof tiles. • On December 24, 2017, Jacks replaced the petrol engine in his

Mazda 3 with a new Turbo Diesel engine (fuel efficient and more power).

• On January 24, 2018, Jack paid a gardener for a day’s work at his business premises $400. The gardener mowed the lawn and pruned the hedges.

• On March 2, 2018, a bad storm damaged the carpets in the main office. The entire carpet was replaced at a cost of $8,700.

How much of these expenses can be claimed under Section 25-10 ITAA 97 (Repairs) ?

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Learning objective 3

Apply the legislation to determine the availability and amount of the tax deduction associated with borrowing costs.

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25-25 Borrowing Expenses

Section 25-25 ITAA1997 allows a deduction for expenditure

incurred for borrowing money and the purpose of the money is

to produce assessable income. Borrowing expenses which are

$100 or less, are fully deductible in the year the expense was

incurred: s25-25(6) ITAA1997 • These costs refer to the “cost” of borrowing and include

valuation fees, survey fees, stamp duty, and legal costs. • Borrowing expenses DO NOT include interest expenses.

Interest expenses are considered under s8-1 ITAA1997.

25-25 Borrowing Expenses Expenses incurred in borrowing money are deductible over the shortest of these periods:

• the period of the loan as specified in the original loan contract;

• the period starting on the first day on which the money was borrowed and ending on the day the loan is repaid; or

• five years starting on the first day on which the money was borrowed (s25-25(5) ITAA1997).

25-25 Borrowing Expenses: Example

On 2 January 2008, Jett obtained a four-year loan of $15,000, which she used solely for income-producing purposes throughout the period of the loan.

Borrowing expenses incurred in relation to the loan amount to $400. The total period of the loan was four years (1,461 days). The period applicable to the 2008 financial year is 181 days (a leap year).

25-25 Borrowing Expenses: Example

The borrowing expenses ($400) would be allowed as follows:-

2008: $ 49.56 ($400 x 181/1,461 days) 2009: $ 99.93 ($400 x 365/1461 days) 2010: $ 99.93 ($400 x 365/1461 days) 2011: $ 99.93 ($400 x 365/1461 days) 2013: $ 50.65 ($400 x 185/1461 days)

$400.00

Class activity 2 Jane purchased a rental property on 1 September 2017 for $500,000. Tennant’s occupied the house at the time of purchase. Jane provides you with the following information: • Jane took out a $400,000 loan with the NAB on 1

September 2017 for 25 years to fund the purchase. Interest paid for the financial year ending 30 June 2018 totalled $14,560.

• Loan establishment fees of $5,200 were charged by the bank on 1 September 2017.

• What is the total deduction for the 2018 financial year? Please quote relevant sections.

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Learning objective 4

Apply the legislation to determine the availability and amount of the tax deduction associated with bad debts.

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Bad debts (s. 25-35) A deduction for bad debts under s.2535 is available when the following criteria is met:

1. there is an existing debt - must have had a legal or equitable right to claim

2. the debt is bad – the taxpayer must have taken all available legal steps to recover the debt TR 92/18

3. the debt is actually written off. There must be some written record e.g. board minutes, memo from Financial Controller or accounting entries – a mere provision is insufficient

4. it was included in the taxpayer’s assessable income – for accruals taxpayers; this requirement would not apply of course to cash basis taxpayers

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Pre workshop question 1

Refer to the link below.

Bad debts s 25-35

In your own words, describe a bad debt for taxation purposes. Provide your own example.

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Learning objective 5

Apply the legislation to determine the availability and amount of the tax deduction associated with travelling between places of work.

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Travel between workplaces (s. 25-100) Common law position: •Travel between unrelated work places are not deductible unders.8-1 FCTvPayne(2001).

Later a statute (s.25-100) was introduced: •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.

Travel between workplaces 26

Learning objective 6

Apply the legislation to determine the availability and amount of the tax deduction associated with prior year losses.

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Tax losses of earlier income years: Div 36

s36-10 How to calculate a tax loss for an income year

(1) Add up the amounts you can deduct for an income year (except tax losses for earlier income years ).

(2) Subtract your total assessable income. (3) If you derived exempt income, also subtract your net exempt

income (worked out under section 36-20 as Exempt Income – Losses or outgoings incurred in producing exempt income – Any income tax paid to foreign governments)

(4) Any amount remaining is your tax loss for the income year, which is called a loss year.

Tax Losses: General

If you cannot deduct all or part of your tax loss in an income year, that amount can be carried forward into the next income year.

Pre workshop question 2

What is a loss for taxation purposes according to Division 36 of the ITAA (1997) ?

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Class activity 3 2014/15 2015/16 2016/17

Assessable income $70,000 $65,000 $90,000

Net exempt income $ 4,000 $ 2,000 $ 8,000

Deductions * $83,000 $60,000 $96,000

Personal Superannuation contributions (that fit inside the concessional cap)

$ 2,000 $ 2,000 $ 2,000

Gifts to registered charities - $ 400 $ 2,000

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*Note: Deductions represents all deductions except superannuation, gifts and losses of previous years. The above data relates to Gandalf Greyteeth, a resident taxpayer: For each tax year, determine Gandalf’s taxable income and any losses that may be carried forward.

Learning objective 7

Apply the legislation to determine the availability and amount of the tax deduction associated with depreciable assets.

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Capital allowances – Division 40 Deductibility of capital expenditure

• Deduction for “decline in value” of a depreciating asset held for a taxable purpose: s 40-25.

• Balancing adjustment deduction if a depreciating asset’s termination value is less than its adjustable value: s 40-285(2).

s40-25 Deducting amounts for depreciating assets

You deduct the decline in value (1) You can deduct an amount equal to the decline in

value for an income year (as worked out under this Division) of a depreciating asset that you held for any time during the year.

(2) You must reduce your deduction by the part of the asset’s decline in value that is attributable to your use of the asset, or your having it installed ready for use, for a purpose other than a taxable purpose.

s40-30 What a depreciating asset is

(1) A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used, except:

(a) land; or

(b) an item of trading stock; or

(c) an intangible asset, unless it is mentioned in subsection (2).

What is the relevant value?

This is determined from the cost base. There are two relevant elements (s.40-175).

The first element is worked out when you begin to hold it and is normally the purchase price (s.40-180(3)). It could also be the amount you are taken to have paid (s.40-185).

What is the relevant value?

The second element of the cost base includes costs in bringing the asset to its present condition and location and costs attributable to any balancing adjustment events (s. 40-190)

Examples include costs of delivery, installation, capital improvements, site preparation.

When does depreciation start?

Depreciation starts at the time the asset is first used or installed and ready for use. (s.40-60(2)

How is the deduction calculated The taxpayer can choose between the Diminishing Value or Prime Cost methods. (s.40-65(1)

Once the choice is made the method cannot be changed (s.40- 130(2)

The DVM gives greater deductions in the earlier years, under the PCM the same amount is claimed each year

Decline in value under PCM

Under s 40-75(1) the deduction is calculated by: Asset’s cost x Days held x 100% x Business use %

365 Asset Effective Life

Decline in value under DVM Under ss 40-70(1) & s40-72(1) the deduction is calculated by:

Base Value x Days held x 200% x Business use %

365 Asset Effective Life

Base value = Cost at start time OR opening adjustable value plus second element costs

*If start time is before 9 May 2006, use 150% rather than 200% (s. 40-72(1)

Sale of depreciating assets

The sale of a depreciating asset results in a balancing adjustment:

If the Termination Value > Adjustable value = Assessable gain (s.40-285(1).

If the Termination Value < Adjustable value = Deductible loss (s.40-285(2).

Sale of depreciating assets

The termination value is generally be the amount received for the asset on disposal or taken to have received (s.40-300(1) and (s.40-305(1).

The adjustable value is the cost less the total decline in value up to date of sale (s.40-85(1).

SBE Pools • There are special rules for depreciating assets

acquired by a small business entity (SBE). • The simplified depreciation rules for depreciating

assets acquired by small business entity (SBE) taxpayers on or after 7:30 pm on 12 May 2015 are:

- an immediate 100% deduction applies in respect of depreciating assets costing less than $20,000 (GST exclusive); and

- depreciating assets costing $20,000 plus (GST exclusive) are automatically pooled (gathered together) and are depreciated in a general small business pool at the diminishing value rate of 30% per year (15% Diminishing Value in the first year).

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Pre workshop question 3

What is a depreciating asset? What do we mean by the term effective life?

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Class activity 4 A machine used in a manufacturing business has an estimated effective life of 5 years was purchased on 1 January 2016 for $25,000 and sold on 21 March 2018 for $12,500.

• Prepare the depreciation schedules for both the prime cost AND diminishing value methods.

• Calculate the assessable or deductible balancing adjustment.

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Learning objective 8

Apply the legislation to determine the availability and amount of the tax deduction associated with trading stock balances.

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Trading stock

s70-10 Trading stock includes: (a) anything produced, manufactured or

acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) live stock.

Trading stock

Trading stock does not include:

• standing or growing crops, timber or fruit – these only become trading stock when they are harvested, felled or picked

• stocks of spare parts held for repairs or maintenance to plant and equipment

• consumables used in manufacturing trading stock, such as cleaning agents or sandpaper.

Trading stock

Income from sale of trading stock is assessable under s.6-5(1) - income from a business.

• Purchase of trading stock is deductible under s.8-1(1). It is not capital (s.70-25).

• Opening and closing stock accounted for pursuant to s.70-35.

Trading stock

Compare the values of trading stock on hand at the start of the income year and at the end of the income year (s.70-35(1)).

• If closing stock is greater than opening stock, the excess is assessable income (s.70-35(2)).

• If opening stock is greater than closing stock, the excess is an allowable deduction (s.70-35(3)).

Pre workshop question 4

What is trading stock? How is trading stock dealt with for tax purposes?

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Class activity 5 Lincoln is an Australian resident for the full year aged 30. He conducts a business as a sole trader as a video game designer and retailer. During the 2016/17 year he had trading stock purchases of $275,000. The value of the opening stock on 1/7/16 was $72,200, and the closing stock on 30/6/17 was $92,300. • Calculate Lincoln’s trading stock deduction.

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