Taxation law wk8&9 - notes PDF

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Apportioning and Amounts of Deductions Claimable

Apportionment of Dual Purpose Expenses -

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A loss or outgoing is deductible “to the extent” that: + It satisfies either positive limb of s 8-1; + It does not satisfy one of the negative limbs of s 8-1. Apportionment for expenses that have a dual purpose: + No precise formula for apportionment and it is necessary to determine a fair and reasonable division on a case-by-case basis: Ronpibon Tin No Liability v FCT ( 1949)

Reasonable vs Actual Expenses -

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Generally, taxpayers are entitled to deduct the full amount of a loss or outgoing if the requirements of s 8-1 are satisfied: + “It is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent”: Ronpibon Tin No Liability v FCT ( 1949). Objective purpose of the loss or outgoing is considered: Europa Oil (NZ) Ltd v CIR (NZ) (No 2) ( 1976). A statutory provision may limit the deduction, for example: + Payments to related parties may be limited to an amount that is considered “reasonable”: s 26-35.

Amount of Deduction - Tax minimisation Situations -

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A taxpayer’s subjective purpose or intention in incurring an expense may be considered where: + The taxpayer is in a loss position; and + The taxpayer’s purpose in incurring an expense appears to be one of tax minimisation: Ure v FCT ( 1981). Ure v FCT:

Application of s 8-1 to common expenses Courts have had to examine whether expenses: -

Have a nexus with gaining or producing assessable income; Private or domestic in nature; Capital or revenue in nature in other situations (eg, legal expenses)

Expenses incurred in gaining employment -

Expenses incurred in gaining employment are considered too early for the production of assessable income: FCT v Maddalena ( 1971). However, a distinction is made if the taxpayer is carrying on a business: Professional sports people incurring costs for the negotiation of employment contracts (management fees) deductible: Spriggs v FCT; Riddell v FCT ( 2009).

Relocation and Child Care Expenses -

Expenses incurred by a taxpayer in relocating his or her home have been held to be non-deductible: Puts the taxpayer in a position to produce assessable income, rather than incurred in gaining or producing assessable income: Fullerton v FCT ( 1991).

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Child care expenses are non-deductible + Puts the taxpayer in a position to produce assessable income, rather than incurred in gaining or producing assessable income: Lodge v FCT ( 1972) + Also likely to be private or domestic in nature: s 8-1(2)(b).

Travel between home and work -

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General rule: Expenses for travel between a taxpayer’s ordinary home and regular work location is not deductible: Lunney v FCT; Hayley v FCT ( 1958) and Draft Ruling TR 2017/D6 and TR 2019/D7 However, may be considered deductible “work travel” if there are special demands: + “Fly in-fly out” workers subject to employer’s direction and control during period of travel: John Holland Group Pty Ltd v FCT ( 2015) + Outside normal work hours where work at home has started prior to undertaking travel: FCT v Collings ( 1976) Other exceptions to the general rule:

Travel between two places of work -

Under common law, 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.

Self-education Travel Expenses -

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Travel expenses relating to self-education may be deductible when travel relates to income-producing activities. High Court in FCT v Finn ( 1961) suggested the following factors to determine deductibility:

Not necessary for all factors to be satisfied. Depends on the individual's circumstances.

Car expenses -

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Where travel expenses relate to a car, rules in Div 28 govern the amount of car expenses that are deductible under s 8-1: + Div 28 only applies to individuals and partnerships that include at least one individual: s 28-10 + Taxpayers must own or lease a car during the year. Choice of methods to calculate car expense deductions (but deduction still claimed under s 8-1):

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“Cents per kilometre” Quantum of deduction claim under s 28-25 is equal to:

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Limit of 5,000 kilometres claim per year. Any claims for kilometres in excess of 5,000 is disregarded: s 28-25(2)

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Not required to substantiate car expenses: s 28-35. “Log book” method Quantum of deduction claim under s 28-90 is equal to:

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Car expenses are broadly operating expenses and the decline in value (eg, petrol) and require substantiation. Business use percentage calculated by reference to a log book using the formula:

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Self-Education Expenses a.Relating to taxpayer’s current career -

Sufficient connection to the production of the taxpayer’s assessable income when:

b.Self-Education Expenses Not related to employment income -

Self-education expenses potentially deductible where the receipt of income is conditional on the recipient making satisfactory educational progress: See, FCT v Anstis ( 2010) + Note, a deduction for expenses related to rebatable benefits specifically denied by s 26-19.

Non-deductible self education expenses -

Payments made under the Higher Education Support Act 2003 ( Cth) (eg, HECS-HELP fees): s 26-20. First $250 of self-education expenses: s 82A ITAA36. Apportionment required where self-education expenses are both income-producing and private in nature.

Home Office Expenses -

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The deductibility of home office expenses depends on: + Type of expense: running expenses or occupancy expenses; + Whether the taxpayer uses the home office as a ‘genuine home office’ or ‘home office for convenience only. Deductibility of home office expenses under s 8-1 is as follows:

Apportionment of expenses: occupancy expenses eg, by floor area; running expenses, eg, by time basis. See PS LA 2001/6

Clothing and Dry Cleaning Expenses -

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Conventional clothing is not deductible under s 8-1 + Considered day-to-day living: not incurred in gaining or producing assessable income and/or private or domestic; + Applies even where the clothing is required by the taxpayer’s income producing activities: Westcott v FCT ( 1997). Exceptions:

Occupation-specific clothing, protective clothing and uniforms are generally deductible: Morris v FCT ( 2002)

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Clothing items that are expected to last a number of years (eg, a barrister’s wig) may be capital and subject to depreciation.

Interest Expenses -

Deductibility of interest expenses will depend on the taxpayer’s use of borrowed funds: FCT v Munro ( 1926). For example:

Legal Expenses -

Distinguishing between capital and revenue legal expenses can be difficult. For example:

Deductibility of 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

Meaning of Repair General principle: A repair involves replacing or renewing part of an item to its former level of efficiency, rather then the entire item, without changing its character or function -

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).

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Pure maintenance work not generally a repair.

Income Producing Purposes -

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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.

Repair or Capital Expense? -

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:

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).

Initial Repairs: General principle: -

If an asset is in a state of disrepair at the time of its acquisition , the cost of ‘initial repairs’ to remedy those defects is considered to be capital in nature and not deductible This is because the need for repair did not arise from the taxpayer’s use of the asset. It arose as a consequence of the previous owner’s use NB:Capital expenditure may qualify for a deduction under Division 40 Capital allowances or Division 43 – Capital works provisions

2. Improvements -

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:

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.

Improvements Case Examples: -

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In Case N61 81 ATC 325 the taxpayer replaced a rotten wooden floor in a block of flats with a better long-lasting and more moisture resistant concrete floor. It was  nd not deductible as a repair held the work was an improvement a  he High Court held the new ceiling was an FCT v Western Suburbs Cinemas Ltd: T improvement to a fixed capital asset, and the expenditure was capital in nature, since the operation “did much more than meet a need for restoration ; it provided a ceiling having considerable advantages over the old one, including the advantage that it reduced the likelihood of repair bills in the future”

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.

FCT v Western Suburbs Cinemas Ltd - A ceiling of a picture theatre was in a dangerous condition and was replaced with a new and better ceiling using different materials. A claim was made to deduct the amount which it was estimated would have been expended if the defective portion of the ceiling had been repaired.

3. Replacements -

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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.

Replacements Cases: - In W Thomas & Co Pty Ltd v FCT (1965) 115 CLR 58 a building was held to be the entirety, its floors and walls being only subsidiary parts. - In Western Suburbs Cinemas the cinema building as a whole was held to be the entirety, its roof being only a subsidiary part whose total replacement could involve a mere repair to the entirety - In Lindsay v FCT (1961) 106 CLR 377 work was carried out on a ship repairer’s slipway which was constructed mainly of timber. The timber was replaced with concrete and the slipway was made longer. During the course of the work substantially the whole of the slipway had been demolished and replaced. It was held the expenditure was a renewal of an entirety and not a deductible repair - In Rhodesia Railways v ITC the replacement of 74 miles of railway tract out of a total distance of 588 miles so as to restore it to its original condition was held to be the replacement of part of the entirety and deductible, as the railway line as a whole was the relevant entirety. - In Samuel Jones & Co (Devondale ) Ltd v ITR the replacement of a chimney in a factory premises was held to be a repair as the chimney was regarded as merely the subsidiary part of the entirety

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. 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).

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

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)

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.

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

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Losses are carried forward indefinitely to future income years In the future income year, the tax loss is offset: + Against any exempt income (if any); and + 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.

Corporate taxpayer -

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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).

Individuals -

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

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.

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:

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 is usually claimed over an asset's estimated useful life.

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. (This exclusion does not apply if: (i) the asset is used in carrying on a business, or (ii) the taxpayer is a corporate tax entity, superannuation fund that is not a self-managed superannuation fund, or a specified type of trust, or a unit trust or partnership all of the members of which are one of these entities.)

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. -

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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.

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.

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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.

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 -

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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:

2. Decline in value - Two methods to work out the decline in value: s 40-65. + 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. - Choice of method is made on an asset-by-asset basis: + A different method can be chosen for each asset. + Method cannot be changed once chosen: s 40-130. + Replacement assets do not need to follow original asset. - Taxpayer does not have a choice in certain circumstances, eg: + Assets acquired from an associate: the same method as the method used by the associate (s 40-65(2)). + Assets allocated to a low value pool (s 40-65(5)). - Diminishing value m...