General Deductions, Denied deductions & Trading stock

Question 1

Allowable Deductions

Answer 1

Taxable income =
Assessable Income less Allowable Deductions
•general deductions that directly relate to deriving assessable income. ITAA97 s8 -1
•plus deductions allowed under specific sections ITAA97 s8-5(1)
•Less deductions specifically excluded ITAA97 s8-5(2)

Principles Ch12.10

Question 2

General Deductions (2 positive limbs)

Answer 2

ITAA97s8-1(1)is divided into 2 subsections

Positive Limbs:
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 (relates to all taxpayers) or

b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income (restricted to taxpayers carrying on a business)

Principles Ch12.40 - 50

Question 3

General Deductions (4 negative limbs)

Answer 3

Negative Limbs or Exclusions:
ITAA97 s8-1(2) has 4 negative categories
It excludes losses or outgoings which are:
•capital or of a capital nature
•of a private or domestic nature
•incurred in gaining or producing exempt income
•prevented from being a deduction by another section of the act

Question 4

Connection between the loss or outgoing and income

Answer 4

There must be a sufficient connection or link between a loss or outgoing and either
•the gaining or production of the taxpayer’s assessable income, or
•the carrying on of the taxpayer’s business

Courts have adopted a broad view of how strong the connection has to be:
•For a loss/outgoing to be deductible in a year, it does not necessarily have to produce income in that year
•Sufficient if the loss/outgoing is designed to assist the business’s profit making abilities in future or previous years

Principles Ch12.50 -150

Question 5

Losses and outgoings: Must be a connection to earning income

Answer 5

Regular business activity“
what matters is their connection with the operations which gain or produce the assessable income”

Charles Moore & Co. (WA) Pty Ltd v FCT(1956)

The days cash receipts were stolen while being taken to the bank.
Held: As this was a normal business activity the loss was deductible

Question 6

Necessarily Incurred

Answer 6

There doesn’t need to be an obligation or compulsion to incur the loss or outgoing
The word necessarily means:
“Clearly appropriate or adapted for”
The term appears to include all:
•losses and outgoings which are compulsory such as rates, taxes, annual registration and licence fees
•losses resulting from the nature of the business

Example: damages for libel incurred by a newspaper proprietor
Herald & Weekly Times (1932)

Expenditure incurred voluntarily on the grounds of commercial expediency
For instance legal costs incurred by a company defending its name over alleged unfair trading practices

Allegations of wrong doing are an ordinary incidence of business and therefore defending yourself is appropriate

Snowden & Willson(1958) and Magna Alloys (1980)
Principles Ch12.80 - 90

Question 7

Incurred

Answer 7

• When to recognise the deduction depends on when it was “incurred”
• There does not have to be ‘actual payment’ for an expense to be ‘incurred’

Issue: “when the liability becomes due and payable, there must be a definite commitment”
James Flood V FCT(1953)

Generally creation of provisions for estimated expenses, e.g. doubtful debts not deductible until the outgoing actually happens or there is a writing off of a bad debt.

Principles Ch16.120 -182

Question 8

Non deductible expenses - Four negative limbs

Answer 8

Four negative sections following the two positive sections of ITAA97 s8 -1 (2)
You cannot deduct an outgoing under s8- 1(2)if it is:
•Capital
•Private
•Incurred in gaining exempt income
•Prevented from being claimed under a specific section of the ITAA e.g. entertainment cannot be claimed as an expense ITAA97 s32

Question 9

First negative limb – capital

Answer 9

• Expenditure of a capital nature is not deductible under ITAA97 s8
• Capital expenditure will include purchases of assets such as buildings, office equipment or motor vehicles for use in the business
• Expenditure that relates to the taxpayer’s “profit yielding structure” is usually capital in nature; expenditure that relates to “the process of operating the business” is usually revenue in nature

Sun Newspapers Ltd v FCT (1938)
Principles Ch12.160 -210

Question 10

Losses and outgoings of a capital nature

Answer 10

Three tests: ( refer Sun Newspaper case)
•The nature of the advantage sought
Its lasting qualities of what is obtained – a building or the next months electricity

•The way the thing purchased how is to be used or enjoyed
Is the purchase of a computer trading stock to be sold or is it going to be used in the office of the business

•The means adopted to obtain it
Periodic payment or lump sum - purchased or leased

Question 11

First negative limb – capital

Answer 11

Profit yielding structure- capital
•These provide benefits over a number of years
•Acquiring assets to use in the business
•Costs associated with borrowing money or raising new equity

Income producing process– revenue expenses
These provide benefits in the short term, e.g. purchasing trading stock, advertising or salaries

Question 12

Legal expenses

Answer 12

Other capital legal expenses include:
•Associated with drawing up the contract to purchase an asset.
•Associated with borrowing money or changing the business structure
•Costs incurred by an accountant convicted of stealing money from his employer

If revenue nature - deductible under s8-1
•Debt recovery
•Defending business methods - Magna Alloys and Snowden and Willson
•Ejecting a tenant due to non-payment of rent •Compensation paid for liable action -Herald and Weekly Times

If private not deductible – purchasing own home

Question 13

Non deductible expenses

Answer 13

Exempt income•ITAA97 s8-1(2) denies a deduction for losses and outgoings connected with the derivation of exempt income

•ITAA97 s 6-15(2) provides that if an amount is exempt income it is not assessable income

Question 14

Denied deductions

Answer 14

TAA97 s26
s26-5 Penaltiess
26-10 Leave payments: Creating provisionss
26-20 Assistance to students: note FBT
s26-30 Relative’s travel expenditure
s26-35 Reducing amounts paid to related entities – includes relatives
s26-45 Recreational clubs: note FBT
s26-50 Leisure facilities: note FBT
s26-54 Illegal activities
s26-55 Limits on certain deductions

Principles Ch12.240