TAXN201 WK8-9 L15-18 Deductions

Question 1

What are the three steps to determining whether an amount of expenditure or loss is allowed as a decdution?

Answer 1

1. Determine whether a deduction is allowed under s DA 1 General permission
2. Determine whether a deduction is denied under s DA 2 General Limitations
3. Determine whether a specific rule within s DB and s DZ supplements or overrides a general permission under s DB 1 or a general limitation under s DB 2

Question 2

What does s DA 1 cover?

Answer 2

General permissions.

Question 3

What does s DA 1 (1) (a) cover?

Answer 3

(1) A person is allowed a deduction for an amount of expenditure or loss, including an amount of depreciation loss, to the extent to which the expenditure or loss is-
(a) incurred by them in deriving-
(i) their assessable income; or
(ii) their excluded income; or
(iii) a combination of their assessable income and excluded income

Question 4

What is an important point to consider when determining whether a deduction is allowed under DA 1 (1) (a)?

Answer 4

Nexus with income.
The expenditure or loss must have a “necessary” relationship with both the taxpayer concerned and with the derivation of their assessable income, their excluded income, or a combination of their assessable income and excluded income.
Do not use the word necessary when giving an explanation about whether a deduction is allowed under CB 1 (1) (a), only use it when you are thinking about it to help you determine whether it is. Instead, use “close” relationship.

Question 5

What does “to the extent to which” mean?

Answer 5

The inclusion of the phrase “to the extent to which” allows for apportioning.
The entire amount of the expenditure may not have been incurred in deriving assessable income, excluded income, or a combination of assessable income and excluded income, however, the inclusion of this phrase allows for the part that was to still be allowed as a deduction.

Question 6

What does “incurred” mean?

Answer 6

In this context, incurred does not necessarily mean that it has to have already been paid. An amount of expenditure may still be allowed as a decuction even if it has not yet been paid if the person has a liability and it is certain that they will have to pay said expentiture.

Question 7

What does s DA 1 (1) (b) cover?

Answer 7

(1) a person is allowed a deduction for an amount of expenditure or loss, including an amount of depreciation loss, to the extent to which the expenditure or loss is-
(b) incurred by them in the course of carrying on a business for the purpose of deriving -
(i) their assessable income; or
(ii) their excluded income; or
(iii) a combination of their assessable income and excluded income

Question 8

What is the difference between DA 1 (1) (a) and DA 1 (1) (b)

Answer 8

DA 1 (1) (a) requires a nexus with income. The amount of expenditure or loss must have a “necessary” relationship with the taxpayer and the derivation of assessable income, excluded income, or a combination of assessable income and excluded income.
DA 1 (1) (b) specifies incurred in the course of carrying on a business and is less strict than DA 1 (1) (a).

Question 9

What is the key takeaway from CIR v Mitsubishi Motors NZ Ltd?

Answer 9

An amount of expenditure may still be allowed as a decuction even if it has not yet been paid if the person has a liability, a present obligation to pay, and it is certain that they will have to pay said expentiture.
Case Details:
Mitsubishi Motors NZ Ltd manufactured cars with a 12 month warranty.
Reliable data showed that 63% of vehicles sold will have a defect covered by its warranty and therefore result in a warranty claim being made.
Mitsubishi Motors NZ Ltd wanted to claim a deduction on the provision made for these warranty claims.
CIR said that they cannot do so because the payments had not yet been made.
HC ruled in favour of Mitsubishi Motors NZ Ltd because the data was reliable so it was effectively certain that those vehicles would result in a warranty claim and Mitsubishi Motors NZ Ltd would have to make those payments for those warranty claims.

Question 10

What are the three key takeaways from CIR v Banks?

Answer 10

1. A house can be used both for private and business purposes.
2. Nexus with income is necessary where a house is used for both private and business purposes and a portion of the outgoings of the house are to be claimed as a deduction.
3. For an amount of expenditure or loss to be apportioned there must be reasonable basis for apportionment is necessary
   Case Details:
   For the purposes of this case Mr. Banks is considered to be self-employed.
   Mr. Banks was a part-time tutor at a polytecnic.
   He made preparations for his classes and marked assessments from home in his dining room which he used as a home office.
   Mr. Banks claimed a portion of his homes outgoings such as electricity and heating related to his dining room as a deduction.
   CIR denied his claims and referred the case to the Court of Appeal as a test case.
   The CoA ruled in favour of Mr. Banks because it was found that there was a nexus with income and that the basis of apportionment which was based on the square footage of his dining room compared to his house as a whole was considered a reasonable basis for apportionment.

Question 11

What are the two key takeaways from Buckley & Young Ltd v CIR?

Answer 11

1. An amount of expentiture or loss can be both capital and revenue in nature.
2. For an amount of expenditure or loss to be apportioned there must be a reasonable basis of apportionment.
   Case Details:
   Buckley and Young Ltd reached an agreement with one of its senior directors to retire early due to unsatisfactory performance from said director.
   It was agreeded he would receive payments such as a consultancy contract, further superannuation contibutions, and reimbursement of legal expenses in considerations for entering the agreement which included a restrictive covenant.
   Buckley and Young Ltd wanted to claim deductions on these payments.
   It was found that the restrictive covenant itself was capital in nature because it related to restricting the director from utilising information he gained from working at the company while working with another company and therefore no nexus with income was found and it was not allowed as a deduction.
   However, the payments made to the director to pursuade him to enter the agreement was considered revenue and nature because it related to improving the efficiency of the business and therefore the generation of income and profit so a nexus was found and it was made allowable as a deduction.
   But the agreement did not properly state what payments related to removing the director and what payments related to the restrictive covenant so no reasonable base of apportionment was found and no deductions were allowed.

Question 12

What are the two key takeaways from FCT v Snowden & Willson Pty Ltd?

Answer 12

1. An amount of expenditure or loss that is voluntary and does not have a direct nexus with income may be allowable as a deduction if it is necessary to sustain a business so that it can continue operating at the same capacity.
2. An amount of expenditure or loss to reduce future expenses may be allowed as a deduction even if there is no direct nexus with income.

Question 13

What does s DA 2 cover?

Answer 13

General Limitations
(7) Relationship of general limitations to general permission
Each of the general limitations in this section overrides the general permission.

Question 14

What are the six general limitations?

Answer 14

(1) Capital limitation
(2) Private limitation
(3) Exempt income limitation
(4) Employment limitation
(5)Witholding tax limitation
(6) Non-residence foreign-sourced income limitation

Question 15

What does s DA 2(1) cover?

Answer 15

Capital limitation.
A person is denied a deduction for an amount of expenditure or loss to the extent to which it is of a capital nature. This rule is called the capital limitation.

Question 16

What are the key takeaways of the BP Australia Limited v FCT case?

Answer 16

Six factors considered when determining whether an expenditure was capital or revenue expenditure.
1. What is the character sought and its lasting qualities
2. Does it create an idetifiable asset
3. What is the manner in which it is to be used
4. Was it a one off to create a long-lasting benefit
5. Was it funded using fixed or circulating capital
6. How was the expenditure treated for financial reporting purposes
Details:
BP Australia Limited made lump sum payments to petrol station operators in order to obtain exclusive site agreements with an average duration of 5 years.
The issue was whether the expenditure was capital or revenue in nature.
The Privy Council found that the payments were made to increase the revenue of BP Australia Limited and were a part of selling costs and therefore it was considered revenue expenditure and was deductible.

Question 17

What are the key takeaways of Christchurch Press Co Ltd v CIR?

Answer 17

The portion of wages or salaries of existing workers attributable to the installation of an asset is considered capital expenditure and therefore not deductible.
Details:
Chirstchurch Press Co installed a capital asset where the installation was completed by existing workers.
The issue was whether the portion of salary/wages of the employees that was attributable to the installation of the capital asset was considered capital or revenue in nature.
It was found that it was considered capital expenditure.

Question 18

What is the issue with deductions for expenditure on repairs and maintenance?

Answer 18

The issue is whether it is capital or revenue in nature.

Question 19

What are the three factors to consider when determining whether expenditure on repairs an maintenance is capital or revenue in nature?

Answer 19

There are three factors to consider:
1. Was an new identifiable asset created?
2. Was there a physcial change in the size, structure, or layout of the asset?
3. Was there a change in the functionality or improvements to the functionality of the asset?

Question 20

Are ongoing general motor vehicle expenses capital or revenue in nature?

Answer 20

Ongoing general motor vehicle expenses tend not to create a new asset; change the size, structure, or layout of the motor vehicle; change or improve the functionality of the motor vehicle; and provide short-term benefits.

Question 21

What does s DA 2(2) cover?

Answer 21

Private limitation.
A person is denied a deduction for an amount of expenditure or loss to the extent to which it is of a private or domestic nature. This rule is called the private limitation.

Question 22

What does “to the extent to which” mean in s DA 2(2)?

Answer 22

An an amount of expenditure or loss relating to the outgoings of a private or domestic residence may be allowable as a deduction if the private or domestic residence is also used for self-employment purposes and there is a reasonable basis for apportionment.

Question 23

What are the main takeaways of TRA Case F46 (1986) 6 NZTC 59,792?

Answer 23

Expenditure on clothing is only deductible if the clothing does not have a practical use or purpose other than for the taxpayer’s work.
Details:
A chartered accountant outside of his work as an accountant worked as a self-employed musician and played in a band part-time.
He claimed deductions on expenditure on clothing for his performances.
The clothing was unusual and was used to support his onstage persona.
He did not wear these clothes when he was not performing.
The TRA stated the expenditure was necessary and peculiar to the taxpayer’s occupation and was not of a private or domestic nature.

Question 24

What does s DA 2(3) cover?

Answer 24

Exempt income limitation.
A person is denied a deduction for an amount of expenditure or loss to the extent to which it is incurred in deriving income. This rule is called the exempt income limitation.

Question 25

What does s DA 2(4) cover?

Answer 25

Employment limitation.
A person is denied a deduction for an amount of expenditure or loss to the extent to which it is incurred in deriving income from employement. This rule is called the employment limitation.

Question 26

What does s DB 5 cover?

Answer 26

Transaction costs: borrowing money for use as capital.
(1) Deduction
A person is allowed a deduction for expenditure incurred in borrowing money that is used as capital in deriving income.
(2) Link with subpart DA
This section overrides the capital limitation. The general permission must still be satisfied and the other general limitations still apply.

Question 27

What does s DB 6 cover?

Answer 27

Interest: not capital expenditure
(1) Deduction
A person is allowed a deduction for interest incurred.
(2) Exclusion
Subsection (1) does not apply to interest for which a person is denied a deduction under section DB 1.
(4) Link with subpart DA
This section overrides the capital limitation. The general permission must still be satisfied and the other general limitations still apply.

Question 28

What does s DB 7 cover?

Answer 28

Interest: most companies need no nexus income
(1) Deduction
A company is allowed a deduction for interest incurred
(2) Exclusion: qualifying company
Subsection (1) does not apply to a qualifying company
(8) Link with subpart DA
This section supplements the general permission and overrides the capital limitation, exempt income limitation, and withholding tax limitation. The other general limitations still apply.

Question 29

What are the key takeaways of the Pacific Rendezvous Ltd v CIR case?

Answer 29

Interest incurred on borrowing money that is used for the purposes of deriving income is allowed as a deduction.
Details:
Pacific Rendezvous decided to sell their motel and to sell each unit individually.
They borrowed funds to renovate the units so they could sell them for a higher price.
After they were revovated and before they were sold the rooms were available to book and they received higher revenue from renting out the units.
Pacific Rendezvous wanted to claim interest incurred on the borrowed money.
CIR allowed only a deduction on 25% of the interest inccured.
The question was whether all of the borrowing money was used for the purposes of deriving income.
The CoA found that there were two purposes that the funds used for and that these two purposes related to deriving income
1. Purpose to obtain a higher selling price
2. Purpose to increase profitability in interim.
In practice all of the funds were used to derive income so the interest incurred was allowed as a deduction.

Question 30

What does s DD 1 cover?

Answer 30

Entertainment expenditure generally.
(1) When this subpart applies
Applies when, in deriving income, a person incurs expenditure on entertainment that provides both a private and business benefit
(2) No deduction (with exception) (50%)
The person is denied a deduction for expenditure that they incur on forms on entertainments set out in DD 2, except for 50% of the amount that they would have been allowed in the absence of this subsection

Question 31

What does s DD 2 cover?

Answer 31

Limitation rule.
Sets out forms of entertainment covered by s DD 1 Entertainment expenditure.

Question 32

What does s DD 3 cover?

Answer 32

When limitation rule does not apply.
s DD 4 to s DD 8 sets out expenditure that the limitation rule does not apply to.

Question 33

What does s DB 31 cover?

Answer 33

Bad debts
(1) No deduction (with exception)
A person is denied a deduction in an income year for a bad debt, except to the extent to which the debt is a debt written off as bad in the income year

Question 34

Are fines allowed as a deduction?

Answer 34

Intended to be punative in nature. Undermines intention. Therefore, not allowed as a deduction.

Question 35

Are awards for damages payable allowed as a deduction?

Answer 35

Usually intented to be compensatory only and has a nexus with income so can be deductible.

Question 36

What does s BD 4 (2) cover?

Answer 36

Allocation of deductions to particular income years
(2) General rule
A deduction for an amount of expenditure or loss is allocated to the income year in which the expenditure or loss is incurred…