Revenue Law

Lecture 5

Specific Deductions – Text Chapter 13

Capital Allowances – Text Chapter 14

Specific Deductions

ITAA97 s12-5 provides a comprehensive list of

all specific deductions.

Most specific deductions are contained in

ITAA97 Division 25

The negative limb of ITAA97 s8-1

ITAA97 Division 26 provides a list of specific

items that are not deductible expenses.

Tax Related Expenses

ITAA97 s25-5 provides taxpayers with a

deduction any expenditure incurred in

managing their ‘tax affairs’, that is, in fulfilling

their tax obligations.

The section also provides a deduction

for interest paid on underpayment or

late payment of tax.

Repairs: Capital

• 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:

Capital expenditure on repairs

Initial repairs Improvements Replacements

PoTL 2015 paragraph [13.37]

Repairs

ITAA97 s25-10 provides that;

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 the property 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.

Initial Repairs

In Law Shipping Co Ltd v IRC (1923) 12 TC 621 repairs undertaken to remedy defects which exist at the time property is acquired are not deductible as they are capital expenses.

This is because the taxpayer would have received a deduction in the purchase price of the asset and so it is appropriate to treat the expenditure as part of the cost of acquisition.

Improvements

FCT v Western Suburbs Cinema Ltd (1952) 86

CLR 102

Improvements – Western Suburbs Cinema

Damaged ceiling repaired with newer better materials because the existing materials were no longer available.

Held not deductible because;

1. Using the new materials was an improvement which ‘changed the character of the asset’, and

2. The test is whether the actual expenditure incurred by the taxpayer constituted a repair.

Replacements

Where repair to property involves a

replacement it is necessary to distinguish

between;

1. The replacement of part of an asset –

treated as a repair and deductible, or

2. The replacement of the whole of an asset –

treated as a replacement and not deductible

as capital.

Replacements

In Lindsay v FCT the taxpayer replaced a

wooden slipway with a longer concrete slipway.

Held to be a capital expense as the new

slipway ‘replaced’ the existing asset and was

not part of the asset

Replacements

Samuel Jones & Co (Devondale) Ltd v IRC

(1951)

The Court held that the replacement of a

chimney in need of repair with a new chimney

was a repair as the chimney was an

inseparable part of the entire asset being the

factory.

Notional Repairs

Notional repairs are not deductible – see FCT

v Western Suburbs Cinemas Ltd.

Bad Debts (cont)

In order to claim a deduction under s25-35 it is

important that in the income year the

deduction is claimed;

1. There is an existing debt,

2. The debt is bad (T/R 92/18) and

3. The debt was actually written off, creating a

provision is not sufficient

Point v FCT (1970) 119 CLR 453

The taxpayer entered into an agreement to

release a debtor from its obligations to the

taxpayer in one income year and the debt

was written off the debt in the following

income year.

Point v FCT (1970) 119 CLR 453 (cont)

The HC held that the taxpayer was not entitled

to a deduction;

1. In the year the debt was forgiven because it

had not been written off

2. In the following year as there was no

existing debt

Payments to Associations

ITAA97 s25-55 allows a deduction to a

maximum of $42 for payments made “for

membership of a trade, business or

professional association”.

If there is a nexus between the payment and

the earning of income then a deduction can

be claimed under s8-1 which is not limited to

$42.

Travel Between Workplaces

Under ITAA97 s25-100 a deduction is allowed

for travel directly between two workplaces

where the taxpayer is engaged in income

earning activities at each workplace. The

expenses are not deductible if

one of the workplaces is also

the taxpayer’s residence,

s25-100(3).

Gifts

ITAA97 division 30 provides taxpayers with a

deduction for gifts to deductible gift recipients.

Gifts can be of money or property.

In T/R 2005/13 to be deductible a gift must be;

1. Voluntary,

2. Transfer the beneficial interest in the property

to the recipient and

3. Made without expectation of material

advantage in return.

FCT v McPhail (1968) 117 CLR 111

Taxpayer made a contribution to a building fund

to his son’s school in return for lower school

fees. Taxpayer denied a deduction for his

contribution to the building fund on the basis

that it was not a true gift because “the

taxpayer received a material advantage in

return”.

Prior Year Losses

ITAA97 Division 36 deals with tax losses “which

you may be able to deduct in a later income

year.”

S36-10 How to calculate a tax loss for a

particular year

Tax Loss – ITAA97 s36-10

Tax loss = Allowable deductions – assessable

income – Net exempt income

Net exempt income = exempt income – losses

or outgoings incurred in producing exempt

income – any foreign tax paid

Sample Calculation

For the year ended 30 June 2012 Joe has assessable income of $100,000 and exempt income of $15,000. Allowable deductions of $110,000 and outgoings that relate to the exempt income of $10,000.

Calculate Joe’s taxable income or tax loss.

Limitations on Losses

Prior year losses can be carried forward

indefinitely. However entitlement to use

losses may be restricted by;

1. Companies – the continuity of ownership

and the same business test rules (ITAA97

Div 165)

2. Individuals – non-commercial loss rules

(ITAA97 Div 35)

Capital Allowances – Chapter 14

Introduction

• 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:

Types of deductible capital expenditure

Depreciation deductions

Capital works deductions

‘Black hole’ expenses

PoTL 2015 paragraph [14.10]

Capital Allowances

ITAA97 Division 40 – Capital Allowances

This division allows you to claim as a deduction

“an amount equal to the decline in value of a

depreciating asset” over the term of its

effective life where that asset is held, used, or

installed ready for use by the taxpayer for a

taxable purpose.

Depreciating Asset

Depreciating assets – s40-30(1) are assets that

have a limited effective life and can be

reasonably be expected to decline in value

over the time it is used.

Assets Excluded from Definition

ITAA97 s40-30

Land

Trading stock

Intangible assets unless listed in s40-30(2)

Buildings unless considered capital works

under Div 43 (s40-45(2))

Claiming a deduction

S40-25 (1)

“You can deduct an amount equal to the

decline in value for an income year … of a

depreciating asset that you held for any time

during the year.”

Jointly Held Assets

S40-25(1) Note 3

“Generally, only one taxpayer can deduct

amounts of a depreciating asset. However, if

you and another taxpayer jointly hold the

asset, each of you deduct amounts for it: see

section 40-35.”

Reduction of Deduction

S40-25 (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.”

Immediate Deduction

Assets costing less than $300 used

predominantly in earning assessable income,

that is not income from business, is

immediately deductible under s40-80(2)

Choice of Method

Generally, a taxpayer has a choice of two

methods to work out the decline in the value

of a depreciating asset.

Diminishing value method (s40-70) and

Prime cost method (s40-75)

Diminishing Value

Diminishing value method – asset held pre 10 May 2006

Base value x Days Held x 150%

365 asset’s effective life

Diminishing value method – asset held post 10 May 2006

Base value x Days Held x 200%

365 asset’s effective life

Prime Cost Method

Prime Cost Method

Asset’s Cost x Days Held x 100%

365 asset’s effective life

Claiming a deduction:

2. Decline in value Example: Diminishing value method

Depreciable asset purchased for $6,000 (excluding GST)

on 1 July 2014 and has an effective life of 3 years.

Year 1:

Year 2:

Year 3:

PoTL 2015 paragraph [14.80]

Claiming a deduction:

2. Decline in value Example: Prime cost method

Depreciable asset purchased for $5,000 (excluding GST)

on 1 July 2014 and has an effective life of 3 years.

Year 1:

Year 2:

Year 3:

PoTL 2015 paragraph [14.80]

Disposals of Depreciating Assets

Balancing adjustment (s40-285) the profit or

loss on the sale or disposal of a depreciating

asset (s40-30)

Balancing Adjustment Amount = Termination

Value – Adjustable Value

Where the termination value is the amount

received on disposal of the asset and the

adjustable value is the WDV of the asset at

the date of disposal

Balancing adjustments

Taxpayer’s taxable income adjusted where a ‘balancing

adjustment’ event occurs under s 40-295:

Broadly, an event occurs when the taxpayer stops

holding the asset, stops or never uses the asset.

Adjustment:

Termination Value

Adjustable Value

Difference is included in assessable

income

Termination Value

Adjustable Value

Difference is included in deductions

PoTL 2015 paragraph [14.110]

Balancing adjustments

Elements

Example

Asset purchased on 1 July X1 for $3,000. Effective

life is 3 years. Method: prime cost. Sold 30 June

X2 for $2,500.

Term Explanation

Termination

Value

• Amount received by the taxpayer in relation to the

balancing adjustment event: s 40-300.

Adjustable

Value

• Asset’s cost less prior year decline in value less

decline in value up to the date of the balancing

adjustment event: s 40-85.

Termination Value: $2,500

Adjustable Value: $2,000

($3,000 - $1,000)

Difference: $500 included in assessable

income

PoTL 2015 paragraph [14.110]

Pooling of Assets

Pooling of assets is allowed under certain

circumstances.

1. Low value pool

2. Software pool

3. SBE pool (Div 328)

Low Value Pool

Low value pool assets used for income

producing purposes which – cost less than

$1,000 or have an opening WDV of less than

$1,000 if diminishing value method has been

used.

Assets in the pool for the first time are

depreciated at 18.75%, thereafter at 37.5%.

Software Development Pool

The cost of developing in-house software may

be allocated to a software development pool

which provides for a decline in value as

follows;

1st year – no deduction

2nd year – 40%

3rd year – 40%

4th year – 20%

Capital Works

Division 43 provides deductions for expenditure

on income-producing buildings and other

‘capital works”. The division allows taxpayers

to write off the capital costs incurred in the

construction, extension, alteration or

improvement of a relevant item at the rate of

either 4% or 2.5%, that is, over either 24 or

40 years.

Blackhole Expenditure

Business expenses that are not deductible

because they are capital in nature may be

deductible in equal proportions over 5 years –

s40-880

Homework

Homework this week text questions, 13.1, 13.2,

14.1 and 14.3.