LECTURE 8General Deductions 2Dr Rex Marshall

Lecture Outline

Distinguish between different types of expenditure excluded from deductibility under the negative limbs of s 8-1(2):

Know the tests applied when considering the deductibility of interest

Understand the concept of negative gearing

Negative Limbs

Losses and outgoings are not deductible if:

Private or domestic

Relate to exempt income

Capital expenditure

Specifically denied a deduction

Private/Domestic Expenses?

Incidental and relevant and essential character tests - no expense is always private.

Trivial matters e.g., newspapers, teaching aids, food

Clothing (uniforms, protective clothing)

Self-education

Travel to and from work

Overseas travel

Child minding

Home office/study

The but for Test a Legitimate Test?

But for the outlays I would not be able to earn assessable income.

Problem: Chain of causation therefore not a useful test.*No deduction if the expenses merely puts the taxpayer in a position to produce assessable income.

FCT V Cooper(T31 86 ATC 290; 90 ATC 4580; 91 ATC 4396)

Arguments for:

Expenses claimed were for food in addition to his normal intake.

Prescribed by his coach

More likely selection in first team and therefore increased income

Arguments against:

Food was for sustenance and therefore a personal and domestic expense

The income producing activity was training and playing football-food not connected with income earning activity

Essential Character Test

For an outgoing to satisfy the requirements of the positive limbs it must have the essential character of an income-producing expense or of a business expense.

Morris v FCT 2002 ATC 4404 (Sunscreen products):

The circumstances in which the items were used enabled the taxpayers to perform their employment duties and increased productivity and provided protection from the sun not of a private nature.

Clothing expenses

Cost of conventional clothing (e.g. a suit) is ordinarily not deductible

Exceptions apply in special cases (e.g. FCT v Edwards (1994), Mansfield, Morris) abnormal expense on clothes or expense due to the work environment.

Note: Occupation-specific clothing, protective clothing, uniforms generally deductible.

Travel Expenses

The cost of travel between home and work is generally not deductible as it fails the essential character and timing tests. (Lunney; Hayley)

Exceptions:Income earning activity commences before the trip (FCT v Collings (1976)Taxpayers who transport bulky goods and equipment (Vogt (1975)To alternative workplaces on a temporary basis (Ballesty (1977)

The cost of travel on (i.e. in the course of) work is generally deductible (Taylor)

The cost of travelling directly between 2 unrelated workplaces is deductible under s 25-100 provided neither of those places is the taxpayers home.

Child-minding expenses

Cost of having children minded so that taxpayers can engage in work is usually characterised as a private or domestic outgoing and therefore not deductible (Lodge v FCT (1972), Martin, Hyde, Jayatilake) ; and puts the taxpayer in a position to produce assessable income rather than incurred in the gaining or producing of assessable income.

Self -Education Expenses (TR 98/9)

Fundamental Test: Do the expenses have a relevant connection to taxpayers current profession/career (Finn; Hatchett; Highfield; Anstis)?

Likely to lead to promotion and higher income

AND/OR

2. Upgrade existing skills and improve efficiency in carrying out current income earning activities i.e. the taxpayer will be more proficient in his or her occupation (FCT v Studdert (1991)).Note: $250 reduction applies to all prescribed courses of education (s 82Aof ITAA1936)Self-education expenses that relate to an occupation in which the taxpayer is not currently engaged or that relate to obtaining new employment are not generally deductible (Roberts)

Home office expenses

A home does not ordinarily constitute business premises and taxpayers are therefore not ordinarily entitled to deductions for expenses such as rent paid to lease their homes or interest paid on their home loans even though they maintain a home office (Forsyth, Handley)

Expenses relating to the maintenance of a genuine home office may be deductible where the taxpayers home is also his or her place of business and is not used merely for convenience (Swinford)

TR 93/30 distinguishes between:occupancy expenses (e.g. rent, interest, rates, insurance) running expenses (e.g. heating, cooling, lighting, depreciation)

Apportionment of expenses e.g. by floor area, time basis

First Negative Limb: Capital Expenses

Payments are more likely to be capital if:made once and for all, whereas expenditure that is incurred regularly will usually be revenue in nature;

bring into existence an asset or advantage of an enduring nature; or

relate to the structure of the business or profit yielding structure rather than to the day-to-day business activities [Business Entity test Sun Newspapers)].

Sun Newspapers Ltd

Note: Black hole expenditure (s 40-880) e.g., costs of establishing a business structure; cost of defending against takeovers.

Sun Newspapers Ltd V FCT (1938) 61 CLR 337

FACTS: An amount paid to a rival publisher to stop it commencing publication of a new daily newspaper.As a result of the agreement the company was saved from losing circulation and being forced to reduce its price.

ISSUE: Was the payment made by the taxpayer to its rival company capital or revenue in nature?Decision: The payment strengthened an preserved the business organization or entity of the taxpayer = CAPITAL

Revenue versus Capital

*The difference between expenses incurred in relation to the business entity or instrument/property that is used to earn profits/assessable income [CAPITAL], and those that relate to the day-to-day activities of operating the business or using the property for income producing purposes [REVENUE].

Legal expenses

Whether legal expenses are of a revenue or capital nature is usually determined according to the business entity test

Legal expenses incurred for the purposes of protecting, preserving or enlarging the taxpayers business organisation will usually be capital in nature (Broken Hill Theatres, John Fairfax, PBL Marketing)

Otherwise Non-Deductible Business Related Costs[s 40-880]

20% a year deduction for business capital expenditure : pre, post and current business expenditure, which would otherwise be non-deductible.

Residual measure (deduction of last resort)

Relate to a business that the taxpayer carries on, or for a proposed business it is reasonable to conclude will be carried on within a reasonable time, for a taxable purpose

Not fall within the exclusions in s 40-880(5)

Examples of expenditure which should now be covered:Feasibility studies;Tenders;Market research;Costs of establishing a business;Changing business structures;Raising equity;Takeovers.

Deductibility of Interest

The objective use test or tracing through test (non-business):

Were the borrowed funds used directly in the process of deriving assessable income?

The function test (business):

Is a business being carried on for the sole purpose of producing assessable income?

Summary

Interest is deductible where:

to purchase property from which assessable income will be derived

to purchase an asset of an income-producing business

to be used as working capital within a business

Negative Gearing

The ratio of outgoings to income directly earned as a result of such outgoings (for the financial year) is NEGATIVE.

DEDUCTIBLE OUTGOINGSEXCEEDASSESSABLE INCOME

Negative Gearing Example

A taxpayer who derives an annual $210,000 salary income, purchases a rental property on 1 July 2013 for $200,000. The rental return (ignoring allowable deductions) is $8,000. He borrows the whole of the purchase price at an interest rate of 7% per annum, paying interest of $14,000 for the year ended 30 June 2014.

What will be the tax benefit?

Negative Gearing Solution

Taxable Income: $218,000 14,000 = $204,000Tax Effect:1. Rental income is tax free ($8,000 is absorbed by $8,000 of the interest expense); and

2. Tax saving of $2,790 [$6,000 x 46.5% (including M/L] deductions are at the highest marginal tax rate.Overall, the taxpayer outlays $14,000 and receives $10,790 i.e., out of pocket by $3,210 has the value of the property increased by at least this amount during the year (1.6%)