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ACC3TAXS12018Week7GeneraldeductionsLiviaLMS2.pptxACC3TAX – 2018/1 Week 7 General Deductions
Livia Gonzaga
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Tax Equation
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| Common Business Deductions (s 8-1) | Common Employee Deductions (S 8-1) |
| Accounting and banking fees | Tools of the trade |
| Cleaning, utility bills (energy, gardening, internet, gas, heating, etc.) | Self-education (under specific conditions – see further slides), subscription of professional journals |
| Rent of business premises | Union fees, professional memberships |
| Taxable income = Assessable income – Deductions (s 4-15 ITAA97) |
| For deductions to be allowable under s 8-1 ITAA97 (general deductions), an expense must be linked (nexus) to the production of assessable income and must be incurred in the process of producing assessable income (either income from personal exertion or business income) |
| Deductions - key legislation (ITAA97) S 995-1 – Definitions. Deduction means an amount that you can deduct, e.g. an expense incurred in producing assessable income S 8-1 – General deductions S 8-5 – Specific deductions S 12-5 – Particular kinds of deductions (checklist) |
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So far in our subject we have covered the aspects and concepts relating to assessable income. Today we go back to week 1 to recapitulate the Income Tax Equation and to start studying the second part of it, which relates to deductions. As seen in week 1, deductions are an extremely important part of the Tax System because they ensure that income tax only applies to the actual income generated by that taxpayer by allowing the taxpayer to subtract the expenses incurred while generating that income. There are several types of deductions which are covered either under the general deductions provision – s 8-1 ITAA97 or in the several other specific deductions provision (which we’ll study in weeks 8 and 9).
General deductions are expenses which are incurred for and in the process of generating assessable income (either employment or business income) which are not specifically set forth in separate sections. There is a wide variety of expenses which can be claimed under the general deductions section. However, for an expense to be deductible under s 8-1, there are some conditions and requirements (which are defined in the legislation as positive and negative limbs) which must be applied to each case, and in many occasions this will require a detailed analysis of the case in question in light of the relevant case law.
However, where the expense is widely recognised as a common business deduction such as rents of leased business premises or staff wages, there is no need for extensive application of positive and negative limbs. In these cases, especially for the purposes of our assessments, it is sufficient to state that the expense is a common business deduction under s 8-1 ITAA97. Notwithstanding, in all other cases, it will be necessary to elaborate an extensive analysis with detailed application of the positive and negative limbs, supported by the relevant case law.
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Is the loss/expense deductible?
| Limitations on Deductions |
| Although you may qualify for a deduction, the ITAA may limit the amount you can actually claim. Examples: Individuals: Cannot claim a deduction if unable to substantiate deductions. Payments to relatives: Deductible to extent ATO regards as reasonable. Contributions to superannuation funds: Cannot create or increase a loss. |
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S 8-1
Positive Limbs
s 8-1(1)
Negative Limbs
s 8-1(2)
The Positive limbs are the conditions that MUST be present for a loss or outgoing to be deductible under s 8-1.
The Negative limbs correspond to the circumstances that would DISALLOW a deduction under s 8-1, even if the positive limbs are present.
Positive and Negative Limbs - Details
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Positive limbs: The positive limbs represent the factors that must be present so that an expense can possibly be deductible. Note here that I have not said that the expense will be deductible, because it will only be deductible IF the factors of the positive limbs are present, AND if the expense DOES NOT fall for any of the negative limbs.
Negative limbs: The negative limbs therefore are circumstances which, if present, will deny a deduction, even if the positive limbs are met.
Example:
A food manufacturer acquires an industrial refrigerator costing $35,000. This expense has been incurred (because the taxpayer has actually paid for it), and it has been incurred in gaining or producing assessable income and in carrying on a business (because the taxpayer is a food manufacturer, therefore their core activities require the use of the industrial refrigerator, and the expense is necessarily incurred (because it is incidental and relevant for the business, i.e., it is a necessity, it is important for the business to keep on running and producing its assessable income). Therefore this taxpayer meets the positive limbs.
However you cannot say at this stage that this expense would be deductible. You would need to check the negative limbs, and if any of them applies, then the expense is non-deductible even if the positive limbs have been met. Looking at the negative limbs, it is generally easy to eliminate the private or domestic (because private or domestic would refer to personal use or would refer to the taxpayer’s household, respectively), the incurred in gaining exempt income (because exempt income is generally easy to identify because it depends on strict legal provision) and the forbidden limb (because there would be an express legal prohibition in this case). Most of the times the tricky part will be determining whether the expense is capital or revenue in nature. In these circumstances you will need to apply the negative limbs tests – see slide 15.
Example: Going back to the example above, it can be reasonably stated that an industrial refrigerator costing $35,000 would not typically be used for private or domestic purposes, and unless there is information stating the contrary, it doesn’t seem to be used for the purposes of gaining or producing exempt income. Furthermore, there doesn’t seem to be any legal provision prohibiting a taxpayer from claiming the cost of such item where it seems to bear a direct connection with the taxpayer’s business. Therefore, the only one left is the capital limb, which seems to be applicable here because the refrigerator is a capital asset that will form part of the taxpayer’s income producing structure, i.e., it will be part of the things used by this taxpayer (but NOT consumed by the taxpayer) in running the business. Therefore the expense incurred with the refrigerator is capital in nature, and cannot be deducted under the general deductions provision.
However, we will see in the next 2 weeks that just because an expense is not deductible under s 8-1, that doesn’t mean it is non-deductible at all. Most of the times, especially regarding capital expenses, there will be specific deductions that may apply, meaning that even if the taxpayer cannot claim the entire expense at once in the current year, the taxpayer would still be able to claim it over a number of years.
In summary: When checking whether an expense is deductible under s 8-1, you MUST ALWAYS follow these steps:
STEP 1: Check whether the expense meets the requisites of the positive limbs, identifying and justifying the relevant elements (they are highlighted and underlined in this slide) based on the applicable case law (see next slides) If yes, then
STEP 2: Check if any of the circumstances described in the negative limbs (especially being of capital nature) would apply. Typically this will require that you apply the capital tests (see slide 15), but you may also need to check whether the expense can be private or domestic in nature. If ANY negative limbs apply, then expense is NOT deductible (even if both positive limbs are present)
Positive Limbs s 8-1(1) – what losses or expenses MUST be
1st Positive Limb s 8-1(a) (applies to all taxpayers)
2nd Positive Limb s 8-1(b) (Only applies to businesses)
To the extent outgoing is (possibility of apportionment – Ronpibon Tin)
Incurred (already paid or legally committed to)
In Gaining or producing your assessable income (nexus test)
Outgoing (expense) necessarily incurred (Incidental and relevant)
In Carrying on a business (in the course of carrying on a business, part of normal business operations)
Negative Limbs s 8-1(2) – what losses or expenses CANNOT be
Capital (expense to buy an asset) or capital in nature (expenses to maintain a capital asset) s 8-1(2)(3a)
Private or domestic: personal or related to household, expenditure not incurred in gaining or producing assessable income (travel to and from work, normal food, etc.) s 8-1(2)(b)
Incurred in gaining exempt income s 8-1(2)(c)
Forbidden: a provision prevents you from deducting it - s 8-1(2)(d) (e.g. Div 35)
Summary of cases – Positive Limbs
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| Nexus (gaining or producing assessable income)/ Necessarily incurred | To the extent that | Incurred | In carrying on a business | Self-education expenses / perceived connection with employment |
| Amalgamated Zync (1935) | James Flood (1953) | Placer Pacific (1995) | Hatchett (1971) | |
| Herald & Weekly Times (1962) | RACV Insurance (1975) | Finn (1961) | ||
| W Nevill (1937) | New Zealand Flax Investments (1938) | Highfield (1982) | ||
| Charles Moore (1956) | Nilsen Development Laboratories (1981) | |||
| Magna Alloys (1980) | Lau (1984) | |||
| Lodge (1972) | ||||
| Lunney (1958) | ||||
| Payne (2001) | ||||
| Ronpibon Tin (1949) | ||||
| Snowden Wilson (1958) | ||||
| Charles Moore (1956) |
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Positive Limbs – “Incurred”
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| James Flood Pty (1953) – Meaning of “incurred” |
| Facts: Company wanted to deduct a sum which had been set aside as a provision for holiday pay, but not yet paid at the end of the financial year. Court held: A liability to pay expenses will be a loss or outgoing incurred for the purposes of subsection 51(1) [ITAA36] although it remains unpaid, provided the taxpayer is definitely committed or has completely subjected himself to the liability. |
| Other decisions involving the meaning of “incurred”: RACV INSURANCE LTD: “The authorities also establish that for this purpose a taxpayer can completely subject itself to the liability, notwithstanding that the quantum of the liability cannot be precisely ascertained, provided that it is capable of reasonable estimation”. NEW ZEALAND FLAX INVESTMENTS LTD: “Incurred does not mean only defrayed, discharged or borne, but rather it includes encountered, run into or fallen upon (…) But it does not include a loss or outgoing which is no more than impending threatened or expected.” NILSON DEVELOPMENT LABORATORIES: “This is so (…) no matter how certain it is in the year of income that the loss or expenditure will incur in the future” (…) “What is clearly necessary is that there should be a presently existing liability” LAU: Payment is not essential. “no proof of payment or actual disbursement need be established.” |
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All of these cases involved a discussion on whether the taxpayer had actually incurred the expenses. The principle that emerged from all of them is that an expense is incurred if it has already been paid, or if the taxpayer is legally fully committed to making the payment (i.e. if the expense is legally enforceable against the taxpayer).
Positive Limbs – “Necessarily incurred”
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| Magna Alloys (1980) – Nexus test – necessarily incurred |
| Facts: Taxpayer incurred legal expenses to defend the reputation of some of its agents and directors in a defamation lawsuit. The taxpayer argued that the outgoings were deductible under the second limb of s 51(1) [currently s 8(1) and (2)] on the basis that they were necessarily incurred in carrying on its business for the purpose of gaining or producing its assessable income. The Commissioner denied the taxpayer's claim for the deductions. Court held: Brennan J pointed out: “though purpose is not a test of deductibility (…) the purpose of incurring that expenditure may constitute an element of its essential character, stamping it as expenditure of a business or income earning kind.” A relationship or connection must exist between the relevant loss or outgoing and the derivation of assessable income. Whether or not there is a sufficient nexus is a question of fact and degree. The expenditure claimed must be incurred when the taxpayer was engaged in the relevant [business] activity. The expenditure was deductible as it represented expenditure necessarily incurred in carrying on the taxpayer’s business and was revenue in nature. It arose out of the day-to-day business activities of the taxpayer. |
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The meaning of “necessarily incurred” relates to the character of being relevant, being essential, being important for the good running of the business. For example: if you run a business and your competitor takes you to Court in a legal dispute, and you need to pay your lawyers to defend you at the Court, the legal fees are necessarily incurred because defending your business in the Courts is a prudent thing to do.
Positive Limbs – “Perceived Connection”, “Self-education Expenses”
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| Hatchett (1971) – Perceived Connection, Self Education Expenses, Nexus |
| Facts: The taxpayer was a primary school teacher who claimed deductions for expenses incurred in relation to (i) typing of the taxpayer's thesis for his Teacher's Higher Certificate and also (ii) university fees regarding undertaking an additional degree in Arts. Court held: “The taxpayer was entitled to claim a deduction for the thesis typing expenses. Although this expenditure had no effect on the taxpayer's assessable income in the year it was incurred, there was a plain connection between the obtaining of the certificate and the assessable income of the taxpayer in future years. (…) The university fees, however, were not deductible. The fact that the taxpayer's employer had encouraged university studies by reimbursing some of the expenditure was not, of itself, enough to warrant a deduction (…). The test which determines deductibility is whether the outgoings were incurred in gaining assessable income. The expenditure in respect of the university fees was too remote in that there was not a sufficient perceived connection between the outgoing and the taxpayer's gaining of assessable income in the future (…).” |
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The principle that emerges from the “self-education” cases is that “self-education” expenses will be deductible as long as they bear a direct and strict connection with your current employment and they are not incurred in opening up a new field of expertise.
For example, if you are currently employed as a full time accountant (meaning you hold the necessary qualifications) and you decide to further extend your Accounting knowledge by taking a Masters in Accounting, your course fees could be deductible as long as you are able to draw a strong link with your current job. However, if you did not work as an accountant (e.g. you’re an overseas student undertaking a masters in accounting and you’re working in the hospitality industry to support yourself because your visa does not allow you to work full time), then the Masters of Accounting course fees would not bear the sufficient link and would not be deductible.
If you are opening up a new field of expertise – for example, you currently work as an accountant but you decide to undertake a Medicine course, the course fees and any other study related expenses would also not be deductible, because you are opening up a new field of expertise.
Positive Limbs – “Perceived Connection”, “Self-education Expenses”
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| Finn (1961) – Self Education Expenses |
| Facts and decision: In Finn it was held overseas travel incurred by a government-employed senior architect to keep up to date in this field of expertise was an allowable deductible. Based on the principle of HATCHETT, undertaking a course of study to produce higher income is an allowable deduction (in Hatchett it was held that expenditure incurred by a teacher in obtaining a teacher’s higher certificate was a deductible expense as it would allow him to earn more income in the future). |
| Highfield (1982) – Self Education Expenses |
| Facts and decision: A dentist in general practice was allowed a deduction for overseas travel to study for a specialist degree (in periodontics), that could expand that aspect of his work, and charge higher fees in his general practice (as distinct from becoming a specialist periodontist). |
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Positive Limbs – “Prerequisite Expenditures”
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| Lunney (1958) – Perceived connection, nexus |
| Facts: Taxpayers claimed expenses regarding travelling to and from work. Commissioner denied the deductions, arguing that the outgoings were neither incurred in gaining or producing their assessable incomes nor necessarily incurred in carrying on any business for the purpose of gaining or producing assessable income. Alternatively, the Commissioner contended that the outgoings were of a private or domestic nature. Court held: the expenses were not deductible as they were neither incidental nor relevant to the gaining of assessable income. Dixon CJ noted that: “Both in Australia and in England the view has always prevailed that expenses of travelling from home to work or business and back again are not deductible.” (CLR p 485). Principle: Travel expenses to and from work: considered to be private or domestic in nature. It involves getting to work – being a prerequisite to earning income - rather than incurred in the course of deriving assessable income. |
| Lodge (1972) – Perceived connection, nexus |
| Facts: Taxpayer claimed childcare expenses while deriving assessable income. Court held: High Court held that expenditure was neither relevant nor incidental to her income earning activities. It was a prerequisite to earning her assessable income. |
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Positive Limbs – “Travel to and from work”
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| Payne (2001) – Perceived connection, nexus |
| Facts: It is generally accepted that the cost of travel between two places of employment or business is an allowable deduction. This principle was challenged in Payne. A pilot claimed a deduction for the cost of travel between his income producing farm and his place of employment at an airport. Court held: The High Court disallowed the cost of travel between the farm and the airport on the basis that (i) there was an insufficient connection between the two unrelated income-earning activities, and (ii) the taxpayer was not engaged in either activity at the time of travel. Note: After the decision issued in PAYNE, amending legislation was introduced (s 25-100 ITAA97) to maintain deductibility of expenditure incurred in traveling between two places of unrelated income earning activity, in accordance with the Commissioner’s long held views to allow deductions related to travelling: Directly from one job to a second job From usual workplace to an alternate workplace Alternate workplace and home Principle: expenses related to travelling between two workplaces are deductible, however expenses with travelling from home to workplace are non-deductible. |
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Positive Limbs – “Necessarily Incurred”
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| Ronpibon Tin (1949) – Necessarily incurred, to the extent that (allows apportionment of expenses for deduction) |
| Facts: Taxpayers were 2 tin mining companies with an office in Melbourne and operations in Siam and Malaya. During the war, tin mining operations had to be suspended in those countries. In the income year in question, their income was mainly from investments in Australia. However, they maintained their registered office and incurred management and administration expenses, hoping to resume tin mining after the war. They claimed the whole of the management and administration expenses under s 51(1) ITAA36 [now 8-1 ITAA97]. Commissioner arbitrarily determined a small amount of those expenses and only allowed a deduction for that part, which according to him, referred to gaining of assessable income from investments. Court held: The question of what expenditure (to what extent) is incurred in gaining or producing assessable income is a question of fact. The Commissioner's arbitrary figure was inappropriate. Section 51(1) contemplates apportionment and allows a deduction for expenditure to the extent that it is incurred in gaining or producing assessable income. |
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Positive Limbs – “Necessarily Incurred”
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| Charles Moore (1956) – Necessarily incurred, to the extent that |
| Facts: The taxpayer owned a department store in Perth. The taxpayer adopted the practice that every business morning the cashier, accompanied by another employee, would deposit the previous day's takings at the bank. On one occasion, while the previous day's takings were being taken to the bank, the taxpayer's employees were robbed of £3,031. Court held: The loss was an allowable deduction as banking the daily takings was relevant and incidental to carrying on business, and the robbery took place in the course of the taxpayer carrying on its business. |
| Snowden Wilson (1958) – Necessarily incurred, to the extent that |
| Facts: The taxpayer, who carried on a business of speculative house building in WA, incurred £4,252 in legal fees in defending itself against the allegations which were made against it before the Royal Commission and in newspaper advertising. The allegations made against the taxpayer in the proceedings before the Royal Commission affected its business in both a direct and indirect manner, threatening not only the taxpayer's goodwill but also, depending on the Commission's findings, the taxpayer's income-earning capacity. Court held: Expenditure was deductible as the expenditure was necessarily incurred in carrying on the business (It is a good idea to defend your business by the Courts). |
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Positive Limbs – “Necessarily Incurred”
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| Herald and Weekly Times (1932) – Necessarily incurred |
| Facts: Company incurred legal expenses in defending defamation charges. Court held: legal expenses incurred in defending the company against defamation lawsuits was deductible as the exenditure was a necessary part of carrying on a newspaper business. |
| W Nevill (1937) – Necessarily incurred |
| Facts: Company paid out money to persuade one of its joint managing directors to resign, the joint directorship having proved unsatisfactory Court held: The expenditure was incurred in the course of gaining or producing the company’s assessable income as it was made to improve efficiency and increase its income earning capacity. |
| Placer Pacific (1995) – Cessation of Business, Necessarily incurred |
| Facts: Company was sued by a customer for supplying an allegedly defective conveyor belt. Customer began legal proceedings after company sold its conveyor belt operations. Matter was settled four years after and company paid customer a sum of money. Court held: You can still claim a deduction after cessation of business provided the occasion of the loss or outgoing is to be found in the business operations directed to gaining or producing assessable income. The fact that the company’s business operations had terminated did not deny deductibility. Provided there was a sufficient connection between the outgoing and the derivation of assessable income, then it is possible to qualify for a deduction in respect of income derived in prior years even if business operations had ceased in the meantime. |
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Negative Limbs – Capital Tests
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| Determining the nature of expenses (revenue or capital) – Apply the negative limbs tests: |
| 1. Enduring benefit test: Check whether an expense was incurred to achieve an enduring benefit (a benefit that lasts long in time), where an asset or advantage with enduring characteristics was brought into existence. If benefit is enduring, it is an indication that the expenditure may be capital in nature (not deductible)(British Insulated & Helsby Cables v Atherton (1926)). |
| 2. Once and for all test: If the expenditure was incurred once and for all it is likely that the expenditure is capital in nature (not deductible). If recurrent it would suggest it is revenue in nature (deductible). See Vallambrosa Rubber Co Ltd v Farmer (surveyor of Taxes) (1910). |
| 3. Business Entity Test – BET (established in Sun Newspapers 1938): Ask the three questions below in order to determine whether the benefit accrues to the income producing structure or whether it relates to the process of running the business. What is the character of the advantage sought? Is it long lasting and unlikely to be repeated, or is it transitory and recurrent? What is manner in which the benefit is to be enjoyed? Why did the taxpayer make that expense? Will the benefit brought by means of that expense be aggregated to the income producing structure or will it be used/consumed in routine activities? What are the means adopted to obtain the benefit? What did the taxpayer have to do/pay in order to get the benefit? One-off or recurrent payments? |
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BET: Whether expenses are capital in nature will depend on how they relate to the business entity.
Expenses relating to the profit-yielding structure of the business will be capital in nature. This includes expenses incurred in establishing, replacing and enlarging the profit-yielding structure of the business, which may be once and for all (although in some cases they may be recurring such as it is when the taxpayer pays for an expensive equipment in several installments), and bringing into existence an enduring benefit for the business.
Expenses relating to the running of the business (such as professional subscriptions, staff wages, rents, consumable supplies) will be revenue in nature. Typically an expense will relate to the running of the business if it is recurrent, not bringing any enduring benefit.
Negative Limbs – Private Expenses
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| Common types of private expenses |
| Home Office: Employees generally cannot claim a deduction for occupancy expenses, including rent, mortgage interest, council rates and house insurance premiums (HANDLEY, FORSYTH, and TR 93/30). However some home office running costs office may be deductible: Home office equipment: computers, printers and telephones, the entire cost is deductible if item costs up to $300, if cost is above $300, claim depreciation (see Div 40). Work-related phone calls (incl. mobiles) and phone rental (a portion reflecting the share of work-related use of the line): may be deductible if you have documental evidence of being on call, or if you must call your employer/clients regularly while away from your workplace. Cleaning, heating, cooling and lighting: apportioned to reflect business use Repairs to home office furniture and fittings: see Repairs deduction s 25-10 (week 8). If the home office is the only place of work, expenses may be fully deductible (SWINFORD). Rent of a separate office is generally deductible, except when rent is part of rent+purchase or sale+leaseback agreement. Note: in any case, always apply positive and negative limbs to check deductibility. |
| License Fees: license fees may be deductible as long as the license grants only use rights, not property. General license fees (franchising) are considered capital in nature as they grant an enduring benefit, therefore not deductible (ATO ID 2001/87) |
| Clothing: regular clothing generally not deductible. However special clothing (e.g. protective gear, certain uniforms) MAY be deductible in specific circumstances (e.g. mandatory uniforms). (more details on week 8) |
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Negative Limbs – Prior Year Losses and Exempt Income
| Dealing with carry-forward prior year losses and current year deductions |
| Where a taxpayer has a prior year tax loss (when deductions exceed assessable income), it will be carried forward to the subsequent year. But before carrying it forward, you must always check whether there is any net exempt income in the year. If yes, the losses must first be reduced by the existing net exempt income, and only the balance is carried forward. In the current year, you must first apply all current year deductions (ITAA97 s 36-1 to 36-45.) and only after that you will bring forward the prior year loss (assuming there still was a balance in excess of the net exempt income). |
| Expenses incurred in gaining deriving income – non-deductible |
| If the income you derive is exempt from tax, the expenditure incurred in gaining that exempt income is NOT an allowable deduction. In other words, you cannot deduct an expense that you incurred in producing exempt income. |
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Summary of cases: Capital vs Revenue
| Non-deductible (Capital or Capital in Nature) | Deductible (Revenue) |
| Sun Newspapers (1936) | Hallstroms (1946) |
| John Fairfax (1959) | BP Australia (1965) |
| Broken Hill Theatres (1952) | Citylink (2006) |
| Softwood Pulp and Paper (1976) | |
| Sun Newspapers (1936) – Non-deductible expense, CAPITAL in nature | |
| Facts: Company paid a sum of money to a rival publisher in consideration of its rival agreeing to sell the company its interest in a paper it was publishing and not to produce a rival paper for three years within 300 miles of Sydney. Court held: Expenditure was capital in nature as it strengthened and preserved the business structure of the entity. It was also made to acquire a long-lasting asset (the acquisition of the right to enjoy for 3 years all the property of an existing undertaking). | |
| John Fairfax (1959) – Non-deductible expense, CAPITAL in nature | |
| Facts: The taxpayer incurred legal costs in acquiring another company in the publishing business, and claimed a deduction for the legal costs. Court held: The legal expenses incurred by the taxpayer were of a capital nature and were therefore not deductible under s 51(1) as they were incurred in acquiring a capital asset. |
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Capital vs Revenue
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| Broken Hill Theatres (1952) – Non-deductible expense, CAPITAL in nature |
| Facts: Taxpayer operated a number of movie theatres in Broken Hill and incurred legal costs in successfully opposing an application by a potential new exhibitor to obtain a licence to operate a movie theatre in the same area. Evidence indicated that the granting of a licence to a new exhibitor would reduce the taxpayer’s profits and make it necessary for it to incur further expenditure in film hire and advertising. Taxpayer claimed a deduction for the legal costs under s 51(1), which was rejected by the Commissioner on the basis that the expenditure was capital in nature. Court held: Expenditure was capital in nature. It was not recurrent and the advantage sought was to preserve and protect its business from competition. |
| Softwood Pulp and Paper (1976) – Non-deductible expense, CAPITAL in nature |
| Facts: Setting up a new business, the taxpayer incurred preliminary expenses on feasibility studies and tests in connection with establishing a paper production mill. Company derived no substantial income from paper mill project. Court held: Capital in nature. The expenses were incurred at a point too soon (preliminary expenses) to be regarded as being incurred in carrying on a business. |
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Capital vs Revenue
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| Hallstroms (1946) – Deductible, REVENUE in nature |
| Facts: Taxpayer was a refrigerator manufacturer who started to manufacture a new and superior model of refrigerator. A competitor used to own the patent to that superior model, however that patent had expired before the Taxpayer started to produce it. The competitor applied for an extension of the patent, and the taxpayer incurred legal expenses to successfully oppose the competitor’s application. The taxpayer claimed a deduction under s 51(1) ITAA36 (currently s 8-1 ITAA), which was denied by the Commissioner. Court held: The taxpayer was entitled to claim a deduction for the legal costs incurred in opposing the competitor’s application. Latham CJ, Starke and Williams JJ explained that: “The legal costs were not incurred for the purpose of acquiring an asset or to add to the profit-yielding capital structure of the taxpayer’s business. When the (…) patent expired the taxpayer had the same right as anyone else to manufacture refrigerators in accordance with the patent. A right enjoyed in common with all persons is not a capital asset of any single person. (…) Expenditure incurred in defense of a right enjoyed by everyone is not expenditure incurred in obtaining anything.” |
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Capital vs Revenue
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| BP Australia (1965) – Deductible expense, REVENUE in nature |
| Facts and decision: Payments made to secure solo right to petrol stations in tie-in agreements were considered to have a revenue nature (application of business entity test). |
| Citylink (2006) – Necessarily incurred, deductible expense, REVENUE in nature |
| Facts and decision: Costs of $95m incurred to secure infrastructure rights to Citylink from the Victorian Government payable in the future were deductible. Court held: The concession fees were incurred in the relevant income years as the taxpayer was definitively committed and had completely subjected itself to the liability in respect of those fees. A liability can be incurred in a particular year, even though it is not discharged in that year and even though the taxpayer does not know the precise date the liability will be satisfied. |
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End of Week 7
Thank you!
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