TABL2751 Wtabkk 6 General Deductions (1)

TABL2751 Business TaxS1 2015Class 6 General DeductionsCopyright School of Taxation and Business Law, UNSW*

Copyright School of Taxation and Business Law, UNSW

Taxable income formulaTaxable income = Assessable income Allowable Deductions

Up until this point, we have looked at what is meant by assessable income: ordinary income + statutory income (including capital gains)We will now move on to deductions both general and specific

Copyright School of Taxation and Business Law, UNSW*


General vs. Specific deductionss8-1: General Deductionss8-1(1): You can deduct Positive limbss8-1(2): You cannot deduct Negative limbss8-5: Specific DeductionsAllows deductions if specified in another section of Act. s8-10: No Double DeductionsIf you can deduct an amount under two different sections, use the most appropriate.



General Deductions Positive limbs(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.



General Deductions Positive limbsFirst limb: incurred in gaining or producing your assessable incomeSecond limb: necessarily incurred in carrying on a business for the purpose of gaining or producing assessable incomeThe second limb adds little to the operation of the first limb: Ronpibon Tin NL v FCT



General Deductions Positive LimbsLoss or outgoingTo the extentIncurredNecessarily incurredCarrying on business to derive assessable incomeIn gaining or producing your assessable income



Loss or outgoing (1st + 2nd limb)Loss: Accidental losses: Charles Moore & Co (WA) Pty Ltd v FCT Commercial sense of loss on transaction: AGC (Advances) Ltd v FCT (1975) 132 CLR 175Outgoing: Examples: Rent, Wages, Fuel, Interest Implies voluntary payment: AGC (Advances) Ltd



To the extent (1st + 2nd limb)Implies apportionmentWhere the loss or outgoing is not solely incurred in the gaining or producing of assessable income, expenditure will need to be apportioned.What was the purpose of the expenditure? Copyright School of Taxation and Business Law, UNSW*


To the extent (1st + 2nd limb)Ronpibon Tin NL v FCTExpenses incurred in deriving both assessable and exempt income. Only the portion of expenses relating to the assessable income was deductible.



Incurred (1st limb)Payment is not a requirement: FC of T v Aust. Guarantee Co.The section does not say there must be an actual outgoing: W Nevill & Co Ltd v FC of TThe loss or outgoing is incurred if the taxpayer is totally committed to making the payment: FC of T v James Flood Pty Ltd.Commissioner agrees with these judgements: Taxation Ruling TR 97/7.Copyright School of Taxation and Business Law, UNSW*


Necessarily incurred (2nd limb)Incurred as per previous slideWhat does necessarily mean?It does NOT mean compulsory, inevitable or unavoidable.It is for the man who is carrying on the business to be the judge of what outgoings are necessarily to be incurred: Magna Alloys & Research Pty Ltd v FCT



Is there a limit on amount of expenditure incurred? Reasonable v. Actual ExpenditureRonpibon Tin NL v FCT: The amount of a loss or outdoing is the actual expenditure incurred, not the amount that may be considered reasonable.Not Commissioners role to say how much ought to have been spent.But: luxury car limit is an example when there is a limit imposed Necessarily incurred (2nd limb)Copyright School of Taxation and Business Law, UNSW*


In carrying on a business (2nd limb)Discussed under ordinary incomeQuestion of fact and degreeExample of relevant factors:Profit making purposeRepetition and regularityOrganisation and systemSize and scale



Nexus to income1st limb ... In gaining or producing assessable incomeConcerned with expenditure incurred in the actual course of producing assessable income2nd limb ... In carrying on a business for the purpose of gaining or producing assessable incomeConcerned with expenditure made for the purpose of business generally



Nexus to incomeIs there a sufficient nexus (i.e. connection / relationship) between the expenditure and the income?Tests have been developed by courts to determine this (judicial NOT statutory tests)Incidental and relevant testEssential character testCondition of employment testNo single test is determinative.



Nexus to income incidental and relevant testIs the expenditure incidental and relevant to the production of assessable income?Ronpibon Tin NL v FCT (1949) 78 CLR 47For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end.Irrelevant expenditure excludedApportionment may be necessary



Nexus to income incidental and relevant testHerald And Weekly Times (1932)Newspaper publisherLegal fees for defending and settling an action for libelImmediate reason for paying costs and damages not to produce assessable incomeDuffy CJ, Rich, Dixon, McTiernan JJ:Cant just look to immediate reason and ignore purposeA regular and almost unavoidable incident of publishing a newspaperDissent: (Evatt J): liability arose out of court judgment / threatened judgment not in the course of gaining income.Also see FCT v Day



Nexus to income incidental and relevant testW Nevill (1937) Redundancy payment to joint managing directorCommissioner - did not produce any incomeLatham CJ No expenditure ever produces incomeLook to the object of expenseObject to improve business efficiency



Nexus to income essential character testLunney v FCT:Home to work travel expensesExpenditure being a prerequisite to earning income does not mean it is incurred in gaining or producing assessable incomeWhat is essential character of expenditure? Expenses in this case not deductible: put employee in position to enable them to engage in activities that produce assessable income.



Nexus to income purpose testMagna Alloys & Research Pty Ltd v FC of T:Purpose of expenditure irrelevant, but may help may help determine essential character of expensesObjective purpose: refers to all circumstances and facts.Subjective purpose: refers to the taxpayers motives and state of mind



Nexus to income purpose testCourts generally focus on objective criteria.However, will sometimes look at subjective purpose.Subjective purpose also relevant to apportionmentUre v FCT 81 ATC 4100Fletcher v FCT 91 TC 4950



Nexus to income condition of employment testIs the expenditure a condition of the taxpayers employment?May help establish that expenditure is incidental and relevantBUT: Not a test in its own right: rejected by the court in FCT v Wilkinson too easy to manipulate



Nexus to income temporal connectionDoes the expense have to be linked to income to be derived in the current year?Can a deduction be claimed for amounts that relate to:future income: pre-commencement casespast income: post-cessation casesSteele: Temporal relationship may be relevant BUT . Contemporaneity is not legally essential will depend upon circumstances of particular case



Temporal connection - pre-commencement expenditureSoftwood Pulp And PaperFeasibility studies - mill never builtNo deduction Expenses entirely preliminaryDirected to whether or not to establish projectRelevant to whether or not project feasible not incurred in carrying out project



Temporal connection - pre-commencement expenditureGoodman Fielder Wattie v FCT 91 ATC 4438Feasibility studies re monoclonal antibodiesUntil commitment to project made (project did proceed) expenses denied deductibility as preliminaryFCT v Brand 95 ATC 4633Prawn farming investmentExpense deductible if incurred for purpose of income production even if no process of income production ever commenced



Temporal connection - pre-commencement expenditureSteele v FCT Property purchased for use in business ventureVenture did not go ahead / taxpayer did not produce assessable income in relation to property as intendedIssue was whether interest incurred on loan to purchase property deductibleWas there a sufficient nexus (connection) with income production?Contemporaneity just one factor No other purpose in incurring expense other than for production of assessable incomeExpenses deductible



Temporal connection post cessation expenditureAmalgamated Zinc de Bavays Mining business had ceased. Taxpayer still liable to make payments to a workers compensation fund. Sought deduction for these payments.Not deductible. HC: Payments completely dissociated from the gaining/producing assessable income in the relevant year (i.e. year expenditure incurred).Dixon JExpense must relate to a process which produced the assessable income of that year



Temporal connection post cessation expenditureAGC AdvancesSuspension of business while restructured / trading recommencedDeduction allowed for bad debts arising from previous business activitiesBarwick CJ Amalgamated Zinc distinguishedHere suspension not cessationMason J depends on meaning of incurredSustained in year realisedOccasion of loss at time of earlier transaction giving rise to debt



Temporal connection post cessation expenditurePlacer PacificManufacture of defective conveyor beltSale of business but remained liable for defective product claimsSettlement of claim for damages several years after business soldFull Federal Court:Followed AGC AdvancesDeduction allowedNo relevant distinction between losses and outgoingsWas the occasion of loss or outgoing found in operations directed towards gaining assessable income generally



Temporal connectionOverall:Initial test: Amalgamated ZincDixon J: To be deductible expense must relate to a current process which produces income this year even though the expense might not produce this years incomeOther judges: To be deductible expense must relate to a current process devoted to producing assessable income generallyAmalgamated Zinc no longer considered good authority.Current Test: e.g. Placer Pacific, Steele, BrandTo be deductible expense must relate to a current, former, or future income or process devoted to producing assessable income generally



Negative limbsSection 8-1(2)However you cannot deduct a loss or outgoing under this section to the extent that:(a) it is a loss or outgoing of capital, or of a capital nature;(b) it is a loss or outgoing of a private or domestic nature (c) it is incurred in relation to gaining or producing your exempt income(d) a provision of this Act prevents you from deducting it



Capital or capital natureRecall discussion on capital in ordinary income topicStructure v Process test: Sun Newspapers caseTaxpayer made a payment to competitor to prevent them from publishing a rival newspaper (3 yr restriction)Commissioner denied deduction for paymentHC determined it was capitalCopyright School of Taxation and Business Law, UNSW*


Capital or capital natureSun Newspapers (cont)Drew distinction between income earning process (revenue) and income earning structure (capital)Dixons criteria:1. Character of the advantage sought2. The manner in which the advantage is to be used, relied upon, enjoyed. 3. Means used to obtain the advantage



Capital or capital natureCases where expenditure held to be capital:Broken Hill Theatres: Legal fees to oppose application of a licence to set up a new theatre by another partyPayment to preserve and protect the companys assets.John Fairfax & Sons:Legal costs incurred in preventing Con Press from opposing their take over of another newspaperPayment concerned with enlargement of profit yielding subject / attempt to acquire a new asset



Capital or capital natureCases where expenditure held to be revenue:BP Australia:Exclusive trade tie agreement entered into with station owners for a period of 3 to 5 years. Why Revenue?Part of ordinary process of selling petrol; Recurrent; No enduring benefit to profit making structure.



Capital or capital natureCases where expenditure held to be revenue:National Australia Bank:$42M lump sum paid for the exclusive right to act as the lender under the Cth Def. Force housing loan assistance scheme for a franchise period of 15 years.Why revenue? Just because payment was one-off did not characterise the paymentLump sum did not enlarge framework within which taxpayer carried on ordinary its incomePart of process within with the bank operated to obtain the regular returns



Private or domestic expenditurePrivate: loss or outgoing relates to the person incurring them as an individual member of society.Domestic: loss or outgoing relates to the house, home or family organisation of the person incurring them.Examples:FoodChild-minding costsTravelClothingHome-office expenses



Private or domestic expenditureFoodGenerally private & non-deductible: FCT v CooperMeals while away overnight for work deductible (considered work-related travel expenses)

Child-minding costsNon-deductible as fail to satisfy positive limbs (put the taxpayer in a position to derive taxable income rather than incurred in deriving assessable income) OR treated as private or domestic: Lodge v FCT; Martin v FCT



Private or domestic expenditureTravelHome to work travel: Not deductible. Not incurred IN gaining or producing income OR private expenditure (you choose where you live): Lunney v FCTOccasional exceptions: FCT v Collings :computer consultant on call after hours and deal with queries from home. If unable to resolve, had to go into office. Deduction for this travel allowed as taxpayer had already commenced working at home



Private or domestic expenditureTravelTravel between two places of workUnder s8-1, not deductible if the two places of work relate to different income earning activities: Payne v FCTPost Payne, introduction of s25-100Home Job 1 Job 2 HomeCan claim the trip between Job 1 and Job 2A note on car expenses: To be deductible, the car would have to be used in deductible travel (i.e. you cannot claim car expenses travelling to and from work). Four methods: Cents per kilometre; 12% original value; 1/3rd actual expenses; Logbook method



Private or domestic expenditureClothingTR 97/124 categories of clothing which are allowed as deductions:Non-compulsory uniformCompulsory uniformOccupation-specific clothingProtective clothing and footwearIn very limited circumstances, conventional clothing may be deductible:FCT v EdwardsMansfield v FCT



Private or domestic expenditureHome office expensesMay be deductible if the taxpayer uses a part of the home as an office in relation to the taxpayers income earning activities.Two categories:Running expenses: electricity expenses, cleaning costs, depreciation etc.Occupancy expenses: rent, interest on mortgage, insurance etc.If genuine need for a home office, portion of both running and occupancy expenses deductibleIf matter of convenience, portion of running expenses deductible: FCT v Faichney; Handley v FCT



Producing exempt incomeIf expenditure only relates to producing exempt income, shouldnt pass positive limbsIf expenditure partly related to assessable income and partly to exempt income, apportionment will be required.EG: Ronpibon Tin



Specifically denied deductionA specific provision may specifically deny a deductionGenerally contained in Division 26Examples:PenaltiesLeave paymentsPayments to related entitiesIllegal activitiesWill be discussed in topic on specific deductionsCopyright School of Taxation and Business Law, UNSW*


Copyright School of Taxation and Business Law, UNSW*Copyright School of Taxation and Business Law, UNSW*Copyright School of Taxation and Business Law, UNSWCopyright School of Taxation and Business Law, UNSW

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TABL2751 Wtabkk 6 General Deductions (1)

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