Principles of Taxation Law - (13 Specific deductions) PDF

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13 Specific deductions

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Key points ................................................................................................... [13.00] Introduction................................................................................................ [13.10] Tax-related expenses ................................................................................ [13.20] Repairs ....................................................................................................... [13.30] Meaning of repair ................................................................................ [13.33] Income-producing purpose ................................................................ [13.35] Capital expenses ................................................................................. [13.37] Initial repairs ............................................................................................ [13.40] Improvements ......................................................................................... [13.50] Replacements .......................................................................................... [13.60] Notional repairs not deductible .............................................................. [13.70] Bad debts ................................................................................................... [13.80] Determining that a debt is “bad” ........................................................ [13.83] Money-lending business..................................................................... [13.85] Corporate taxpayers............................................................................ [13.90] Payments to associations ....................................................................... [13.100] Travel between workplaces .................................................................... [13.110] Gifts .......................................................................................................... [13.130] Limitations on deductions for gifts or donations ............................. [13.140] Political contributions and gifts ............................................................ [13.150] Deductibility of gifts or donations under s 8-1 ................................ [13.160] Prior year losses....................................................................................... [13.180] Corporate taxpayers.......................................................................... [13.190] Limitations on losses ........................................................................ [13.200] Other specific deduction provisions ...................................................... [13.210] Questions .................................................................................................. [13.220]

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476 [13.00] PRINCIPLES OF TAXATION LAW 2020

Key points

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[13.00] • In addition to the general deduction rule, discussed in Chapter 12, taxpayers may claim a deduction for various expenses under a specific deduction provision. • A specific deduction provision provides taxpayers with a deduction for a specific type of expense. • Where a taxpayer is entitled to deduct an expense under both the general deduction provision (s 8-1 of Income Tax Assessment Act 1997 (Cth) (ITAA 1997)) and a specific deduction provision, the taxpayer should deduct the expense under the specific deduction provision as it is the most appropriate provision. • Most specific deduction provisions are contained in Div 25 of ITAA 1997, but a number of specific deduction provisions are contained in other Divisions of the legislation, such as Div 30 and Div 36. • Examples of expenses which may be deducted under a specific deduction provision include: – the cost of managing one’s tax affairs; – non-capital expenses incurred in repairing property used for income-producing purposes; – bad debt write-offs where certain conditions are satisfied; – payments for membership of a trade, business or professional association; – expenditure incurred by a taxpayer in travelling directly between two workplaces; – gifts or donations to qualifying recipients; and – tax losses incurred in prior income years.

Introduction [13.10] As discussed in Chapter 12, there are two categories of deductions: general deductions and specific deductions. The general deduction rule is in s 8-1 of ITAA 1997. Specific deductions arise where a specific provision in the legislation, outside Div 8, provides the taxpayer with a deduction for an expense: s 8-5. A specific deduction provision may relate to an expense that is otherwise deductible under s 8-1 or it may apply to an expense that is not deductible under s 8-1 either because it does not satisfy the positive limbs of s 8-1 or because it is denied by one of the negative limbs of s 8-1. An expense that is deductible under both a specific deduction provision and the general deduction provision should be deducted under the “most appropriate” provision: s 8-10.

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13: SPECIFIC DEDUCTIONS [13.20] 477

As a general rule of statutory construction, the specific deduction provision would usually be the most appropriate provision. Where an expense is not deductible under a specific deduction provision, because either the expense does not satisfy the requirements of the specific deduction provision or there is no applicable specific deduction provision, the taxpayer should consider the deductibility of the expense under the general deduction rule in s 8-1. Section 12-5 lists the specific deduction provisions in the income tax legislation. Most specific deduction provisions are contained in Div 25, but a number of specific deduction provisions are contained in other Divisions of the legislation. Only some of the more common specific deduction provisions are discussed in this chapter. Figure 13.1: Overall guide

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Tax-related expenses [13.20] Section 25-5 of ITAA 1997 provides taxpayers with a deduction for any expenditure incurred in managing their “tax affairs”. The definitions of “tax affairs” and “tax” in s 995-1 limit the deduction to expenses incurred in relation to the taxpayer’s income tax obligations. While business taxpayers may be able to deduct such expenses under s 8-1, non-business taxpayers are unlikely to be able to deduct the expenses under s 8-1 as they would be classified as private or domestic expenses. Expenses relating to compliance with other taxes, such as fringe benefits tax (FBT) and goods and services tax (GST), are not deductible under s 25-5 but are likely to be deductible under s 8-1 as the expenses incurred in fulfilling the taxpayer’s obligations in relation to those taxes would generally be incurred in the carrying on of a business. The section also provides taxpayers with a deduction for any expenses incurred in complying with an obligation imposed on the taxpayer by a Commonwealth law, where the obligation relates to the taxpayer’s tax affairs, the general interest charge (eg, on underpayment or late payment of tax), a penalty payable because the taxpayer’s varied GST instalments are too low and certain valuation expenses (eg, in relation to a gift of property).

Kerrie, Sadiq, et al. Principles of Taxation Law, Thomson Reuters, 2019. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/newcastle/detail.action?docID=6023083. Created from newcastle on 2021-02-04 01:04:26.

478 [13.30] PRINCIPLES OF TAXATION LAW 2020 The payment of income tax, amounts withheld or payable under the Pay As You Go (PAYG) system, interest incurred in borrowing money to pay income tax or PAYG amounts and expenditure related to the commission or possible commission of an offence under Australian or foreign law are not deductible under s 25-5: s 25-5(2). Note that fees or commissions paid in obtaining advice in relation to the operation of a Commonwealth law relating to taxation are only deductible when the advice is provided by a “recognised tax adviser”: s 25-5(2) (e). “Recognised tax adviser” is defined in s 995-1 as a registered tax or GST agent or a legal practitioner. Any expenses that are not deductible under s 8-1 due to the operation of a specific provision that denies the deduction are also not deductible under s 25-5: s 25-5(3). Tax-related expenses are also not deductible if the expenses are capital expenditure: s 25-5(4). For example, the cost of acquiring a computer used solely in completing tax returns is not deductible under s 25-5 as it is capital expenditure. However, the cost of the computer may be deducted over a number of years in accordance with the capital allowances provisions discussed in Chapter 14. As we will see, the capital allowances provisions only provide a deduction for property used for an income-producing purpose. The use of property in complying with tax affairs is taken to be for income-producing purposes under s 25-5(5). Note that the subsection specifies that an expense will not be a capital expense simply because the tax affairs concerned relate to matters of a capital nature.

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Example 13.1: Cost of managing tax affairs Robin uses a tax agent to complete his income tax return every year. This year, Robin paid his tax agent $110 to complete his tax return. He also paid his tax agent $300 for advice in relation to the disposal of property which was subject to the capital gains provisions. Robin is entitled to a deduction of $410 under s 25-5 as the fees are a cost of managing his tax affairs. The $300 is deductible even though the advice relates to a capital transaction.

In Determination TD 2017/8, the Commissioner confirms that the cost of travelling to have a tax return prepared by a “recognised tax adviser” is deductible under s 25-5.

Repairs [13.30] Under s 25-10 of ITAA 1997, taxpayers are permitted a deduction for expenditure incurred on repairs to premises or depreciating assets used for

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13: SPECIFIC DEDUCTIONS [13.33] 479

income-producing purposes. The term “property” is used in this chapter to refer to both premises and depreciating assets. There is some question as to the necessity for s 25-10 as a specific deduction provision as any expenses that are deductible under this section are likely to be deductible under s 8-1. Regardless, if applicable, repairs should be deducted under s 25-10, rather than s 8-1, as it is the most appropriate provision: s 8-10. To claim a deduction for repairs under s 25-10(1), it is necessary to show that: •

the expenditure relates to a repair;

•

the property is used for income-producing purposes; and

•

the expense is not a capital expense.

Meaning of repair [13.33] The word “repair” is not defined in the income tax legislation and takes on its ordinary meaning. “Repair” generally refers to the remedying of a defect in a property. In Lurcott v Wakely and Wheeler [1911] 1 KB 905, Buckley LJ provided the following examples of “repair”:

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A skylight leaks; repair is effected by hacking out the putties, putting in new ones, and renewing the paint. A roof falls out of repair; the necessary work is to replace the decayed timbers by sound wood; to substitute sound tiles or slates for those which are cracked, broken, or missing; to make good the flashings, and the like. Part of a garden wall tumbles down; repair is effected by building it up again with new mortar, and, so far as necessary, new bricks or stone.

The property must be in need of restoration for the work to constitute a “repair” (Case J47 (1958) 9 TBRD 244) and pure maintenance work will generally not be considered a repair. For example, painting a wall which has deteriorated would be considered a repair, whereas oiling a part which is in perfect working condition would constitute maintenance, and not a repair. Expenses for maintenance work which are not deductible under s 25-10 of ITAA 1997 may be deductible under the general deduction provision, s 8-1.

Example 13.2: Expenses not for repairs A shopkeeper, Sam, decides to replace his shop’s awning with a more modern and aesthetically pleasing equivalent. The old awning is in good condition before the work is done – there is nothing to be restored, there are no decayed or worn-out parts to be replaced and nothing loose or detached that needs to be fixed.

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480 [13.35] PRINCIPLES OF TAXATION LAW 2020

The expenditure involved is not for repairs because the awning was in good repair before the work was done, so the expenses are not deductible under s 25-10. Source: Adapted from Example 1, Ruling TR 97/23. In Ruling TR 97/23, the Commissioner suggests that work done solely to meet the requirements of regulatory bodies will not be a repair unless the work remedies defects in the property. For example, the cost of removing asbestos insulation from factory walls and replacing it with modern insulation material would not be considered a repair if the insulation is not in need of repair.

Income-producing purpose [13.35] The property must be used for an income-producing purpose for repairs to be deductible under s 25-10 of ITAA 1997. Examples of the use of property for income-producing purposes include property used to earn rental income or to carry on a business.

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Section 25-10(2) ensures that a partial deduction is available, where the taxpayer only partly held or used the property for income-producing purposes during the income year. In this case, the taxpayer is entitled to a deduction for the amount of the expense that is considered “reasonable”. In Ruling TR 97/23, the Commissioner suggests that “reasonable” would be in proportion to the part of the property or period used for income-producing purposes.

Example 13.3: Repairs on premises partly used for income-producing purposes Emma owns a two-bedroom house. She lives in one bedroom and she rents out the other bedroom. Emma incurred $100 of expenses on repairs to the house. Emma is entitled to a deduction of $50 under s 25-10(2) as 50% of the house is used for income-producing purposes.

Where the repairs are undertaken after the property ceases to be held, occupied or used for income-producing purposes, the cost of the repairs will be deductible if the necessity for the repairs can be related to the use of the property for income-producing purposes and the property did produce assessable income during the year when the expenses were incurred: Ruling IT 180.

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13: SPECIFIC DEDUCTIONS [13.40] 481

Capital expenses [13.37] Once it is determined that the property is used for income- producing purposes, the main issue in claiming a deduction for repairs is to determine whether the expenditure constitutes a capital expense. As with s 8-1 of ITAA 1997, s 25-10(3) denies taxpayers a deduction for repairs that constitute capital expenditure. Whether or not a repair constitutes a capital expense is determined in accordance with the test and factors outlined in Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337: see [12.180]. A repair that relates to the business structure is likely to constitute a capital expense, whereas a repair that is a working or operating expense will be deductible under s 25-10. Broadly, case law has developed three categories of expenditure on repairs which may be classified as capital expenditure: • •

initial repairs: see [13.40]; improvements: see [13.50]; and

•

replacements: see [13.60].

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Initial repairs [13.40] Initial repairs are repairs undertaken to remedy defects which exist at the time the property is acquired. The courts have held that such repairs are not deductible as they are capital expenses: Law Shipping Co Ltd v Inland Revenue Commissioners (1923) 12 TC 621; W Thomas & Co Pty Ltd v FCT (1965) 115 CLR 58. It is considered likely that the taxpayer would have received a reduction in the purchase price of the property to take into account the cost of the repairs and it is therefore appropriate to treat the expenditure as a part of the cost of acquisition. However, even where the taxpayer may not have been aware of the defects at the time of acquisition, initial repairs are still not deductible: W Thomas & Co Pty Ltd v FCT (1965) 115 CLR 58. Note that the test is that the defects must have existed at acquisition time and not that the repairs have to be undertaken at that time. Repairs undertaken at a later point in time may still be treated as initial repairs if the defects existed at the time of acquisition. Similarly, repairs made soon after the property is acquired may not necessarily be initial repairs and it would depend on whether the defects existed at the time of the acquisition.

Example 13.4: Initial repairs – possible partial deduction Micah purchased a house close to the local university with the intention of renting the house out to students. At the time of the acquisition, the

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482 [13.50] PRINCIPLES OF TAXATION LAW 2020

house desperately required repainting but Micah did not have sufficient money to do so. He managed to rent it out to some students for a year at lower rent and then repainted the house once they left, 12 months later. The repainting cost Micah $2,000. The $2,000 would generally be deductible under s 25-10 as it relates to the repair of premises used for an income-producing purpose (to gain or produce rental income). However, in this case, the $2,000 may not be fully deductible under s 25-10 as the repainting is to remedy a defect which existed at the time of acquisition and is therefore an “initial repair” which constitutes a capital expense. Micah may be able to claim a deduction for some portion of the $2,000 if it could be argued that the expense is attributable to the one year when the house was rented out to the students.

Example 13.5: Initial repairs capital in nature and not deductible

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William purchased a house that was in good repair, but to make it more attractive to prospective tenants he undertook minor repairs and renovations. The minor repairs and renovations were initial repairs and their cost is of a capital nature and is not deductible under s 25-10. During the course of the repairs and renovations,...