Topic Two

TOPIC TWO - DEDUCTIONS
In accordance with s.4-15 of the Income Tax Assessment Act 1997 taxable income
is calculated as follows: assessable income less deductions.
This topic will cover some of the deductions most commonly allowed to an individual
and/or a business.
Objectives
When you have completed this topic, you should be able to:
determine if expenses are incurred in the course of gaining or producing

assessable income and are not of a private, domestic or capital nature;
identify losses or outgoings which are statutory deductions;
identify expenses which are specifically excluded from deduction;
determine expenses which are necessarily incurred in carrying on a business;
calculate the amount of allowable deduction in the case of a prepayment;
determine the circumstances in which a loss may be carried forward and offset
against future income.
identify trading stock;
calculate assessable income where trading stock must be taken into account;
and,
apply the acceptable methods of valuing trading stock.

Guide to the sections to be studied in this topic:
Income Tax Income Tax
Assessment Assessment
Act 1936 Act 1997
Deductions 4-15
Losses and outgoings 8-1
Double deductions 8-10
Tax-related expenses 25-5
Repairs 25-10
Lease expenses 25-20
Borrowing expenses 25-25
Mortgage discharge 25-30

expenses
Bad debts 25-35
Losses by embezzlement 25-45
Pensions 25-50
Travel between workplaces 25-100
Fines 26-5
Leave 26-10
HELP payments 26-20
Payments to associated 26-35

persons and relatives
Club fees and leisure 26-45 & 26-50
facilities
Illegal activities 26-54
Limitation on certain 26-55(1)

deductions
Gifts Division 30
Entertainment Division 32
Non-compulsory uniforms Division 34
Non-commercial losses Division 35

Tax losses of earlier income 36-10 to 36-20
years
Order in which losses are 36-15
brought to account
Business-related costs 40-880
Definition of trading stock 70-10
Trading stock to be taken 70-35

into account
Value of trading stock at 70-40
beginning of year
Value of trading stock at end 70-45
of year
82A Self-education expenses
Superannuation paid on Division 290

behalf of employees Subdivision B
Self-employed Division 290
superannuation Subdivision C
82KZL, 82KZM, Prepaid expenditure
82KZMD (2)
Small Business Entity Division 328
Notes
Deductions should be shown in WHOLE DOLLARS. There are special rules which
govern substantiation (i.e. documentary proof) of expenses. Assume all expenditure
requiring substantiation can be substantiated for the purpose of this course.
While depreciation (Uniform Capital Allowance) is not covered in this topic it will be
necessary for you to identify expenditure which is capital in nature. No depreciation
deduction is to be calculated at this stage as this will be covered in Topic 3.
As you will remember from Topic 1 assessable income consists of (1) ordinary
income; and (2) statutory income. In a similar manner, deductions consist of (1)
general deductions; and (2) specific deductions. In addition, a further section
specifically excludes certain expenses.
All expenses in this and following topics are GST-exclusive.
Section 8-1 The General Deduction Provision
Overview
Section 8-1 allows deductions to the extent:
(a) They are incurred in gaining or producing assessable income (THE FIRST
LIMB); or,
(b) They are necessarily incurred in carrying on a business (THE SECOND

LIMB).
There are 4 exclusions under s.8-1:
(a) Capital expenses;
(b) Private or domestic expenses;
(c) Expenses incurred in producing exempt income, or;
(d) Expenses which are specifically disallowed under the Act.
Under s.8-10 if an amount can be claimed under more than one section of the Act,
the deduction is allowed only under the section which is most appropriate. Therefore
when considering if an expense is an allowable deduction, you should first consider
whether it is allowable under a specific section. If a specific section applies, then
you must also consider whether s.8-1 is more appropriate.
The losses or outgoings must have been incurred by the taxpayer. The word
incurred has been interpreted by the Courts to mean that although the expense
may not have been paid, the taxpayer is totally committed to the payment.
Under s.8-1 the Commissioner cannot tell a taxpayer how much should be spent, as
long as the expense has been incurred. However certain sections, e.g. s.26-55,
apply to limit expenditure in non-arms-length dealings.
Example 2:1 Incurred expense
On 29 June CY a business buys some stationery on account for $1,000. The

account is paid on 22 July of the following year.
In what year would the business claim a tax deduction for the cost of the
stationery?
Answer:
The business can claim a tax deduction for the $1,000 in the current year.
The stationery was taken from the shop and therefore the expense has been
incurred at 30 June CY notwithstanding that payment is made in July of the
following year.
To the Extent
This phrase allows the apportionment of an expense, for example, a motor vehicle is
used 20% for income-earning purposes and 80% privately. Only the extent to which
the motor vehicle is used for income-earning purposes i.e. 20%, can be deducted.
Capital expenses
These are expenses which give the taxpayer a long-term advantage. It is often the
cost of buying an asset or incurring a cost which will give an enduring benefit or a
long-term benefit.
Some capital expenses are:
i. covered under capital gains tax as part of the Cost Base (see example below)
ii. or form part of an assets depreciable cost and are deductible under the
Uniform Capital Allowance provisions (covered in Topic 3)
iii. deductible under the so-called blackhole expenditure provisions of s.40-880
The opposite of a capital expense is an expense which gives the taxpayer a short-
term advantage.
Example 2:2 Capital expense
David buys a building from which he will operate his business. The building cost
$250,000 to buy. During his first year of ownership he paid rates and taxes of
$5,000.
Lewis rented an office from which he operated his business. His rent was $3,000
per month and he paid annual rates and taxes of $2,100.
What deductions can each of these taxpayers claim in this year?
Answer:
David the purchase of the building gives David a long-term advantage and is a
capital expense. The purchase price cannot be deducted under s.8-1. Note, it will
form part of the cost base and will be taken into account when David sells the
property (see Topic 4 Capital Gains Tax).
The rates and taxes must be paid every year therefore the payment doesnt give
David a long-term advantage. They are deductible under s.8-1. (Note, as they are
deductible during each year of ownership they will not form part of the cost base
when the building is sold see Topic 4 Capital Gains Tax.)
Lewis - the rent must be paid each month. The payment only gives Lewis a short-
term advantage and therefore is NOT a capital expense. The rent can be deducted
under s.8-1.
Rates and taxes see comments above for those paid by David.
Readings
AUSTRALIAN TAX LAW SELECT 10-000 10-240; 10-250 10-280; 13-500 13-
520
Some of the specific deductions to be covered in this topic in relation to individuals
are:
self-education (study) expenses
interest expenses
travelling expenses
telephone expenses
uniforms and clothing expenses
dry-cleaning expenses
Private or domestic expenses
Private expenses are those which relate to a person for example, clothing or
childcare. Domestic expenses are those which relate to a persons dwelling rates
and taxes, mortgage interest on the loan to buy the house or rent.
Readings
AUSTRALIAN TAX LAW SELECT 10-310
Clothing and uniforms

Most clothing is termed conventional clothing and is a private expense.
Accordingly the cost of buying and maintaining such clothing cannot be deducted.
There have been some unique situations in which conventional clothing has been
deductible but such situations are beyond the scope of this course. Other categories
of deductible clothing include:
1. Clothing which is protective (i.e. it protects a person from injury or protects

conventional clothing) aprons, steel-capped boots, overalls can be
deducted.
2. Occupation -specific uniforms can be deducted e.g. chefs checked

trousers.
3. Compulsory uniforms are deductible (e.g. QANTAS airline employees,

McDonald employees). To be a compulsory uniform there must be a
requirement to wear the uniform in an approved combination (normally set out
in a manual) and sanctions apply if the uniform is not worn (e.g. QANTAS
flight attendants cannot fly if they do not wear their uniform in the approved
combination).
4. Clothing which is embossed with the employers name and which meets other
requirements to be registered as a non-compulsory uniform is deductible.
(e.g. Curtin Universitys non-compulsory uniform for staff).
Protective Clothing Occupation Compulsory Employer Logo
Division 34 deals with the issue of non-compulsory uniforms. Non-compulsory

uniforms are those which are not required to be worn to work. For the costs of these
expenses to be deductible the uniforms must be registered on the Register of
Approved Occupational Clothing.
It should be noted that if the cost of the clothing is deductible then the cost of
laundering that clothing is also deductible.
Example 2:3 Clothing and uniforms
Simon is a labourer who works on building sites. He has bought 5 pairs of shorts
and shirts at a cost of $400. They are not embroidered with his employers business
name. As his work is quite dirty he keeps these clothes only for work and never
uses them privately.
What deduction is Simon entitled to?
Simon is unable to deduct any of the cost of buying these clothes as they are still
considered to be conventional clothing.
If Simon had to buy the same items with the business name embossed on them
would your answer change?
The presence of the name on the clothing now designates the clothing as a uniform
and the cost will be deductible as will the cost of laundering the clothing.
Home office or home study expenses
The cost of providing a taxpayer with accommodation is a private expense. The

mortgage interest or rent is a fixed cost which is incurred to provide the taxpayer with
accommodation. The Courts have considered that if the house is the taxpayers
place of business then only the business percentage of these occupancy costs is
deductible. It should be noted, however, that the taxpayer must have a separate
area designated for work-related purposes. Simply doing the accounts at the kitchen
table would not qualify.
In addition, the taxpayer can claim the increase of running costs such as electricity
and heating/cooling. This is because these costs are increasing due to the business
use of the house. Students should note that a salaried employee who didnt have a
place of work would also be able to claim these occupancy expenses. The home is
effectively the place of work.
A taxpayer who operates a business from home and has a designated home office
can deduct the business percentage of the following expenses:
Mortgage interest or rent;

Rates and taxes;
Depreciation of furniture and fitting in that office
Electricity and heating/cooling costs.
It should be noted that a percentage of any capital gain on the sale of this property
(see Topic 4) will be assessable.
As an example, if a taxpayer operates a business from home and uses 20% of the
house for this purpose, then 20% of all the expenses listed above will be deductible.
Taxpayers who have a place of work but choose to do some work at home cannot
claim for occupancy expenses such as mortgage interest or rent or rates and taxes.
They can, however, claim the relevant percentage of running expenses such as
depreciation or electricity and heating/cooling. (Note that depreciation will not be
calculated until we study Topic 3).
For example, a taxpayer has a place of work outside of the home but works from
home in the evenings and on weekends. The home study occupies 15% of the
house. In this case, only the 15% of the variable costs can be deducted. For the
purpose of this course we will give you the percentage of work-related use to be
used in any questions.
Example 2:4 Home office expenses and home study expenses
Nancy operates a business from home. Her home office and storage occupies 15%
of the house. Expenses in relation to the house are as follows:
$
Mortgage repayments interest $15,000,
capital repayments $10,000 25,000
Rates and taxes 3,200
Electricity 7,800
Heating/cooling 1,500
What expenses can Nancy claim for the year?
In order to decide what items can be deducted it is necessary to ask yourself some
questions:
1. Is home the place of business or is it where Nancy chooses to do some extra

work?
Nancy operates her business from home; therefore she can claim the
occupancy costs as well as the running costs.
2. How much of the home is used for the business?
15% of both the occupancy and the running costs can be deducted.
Interest 15% x $15,000 2,250

Rates and taxes - 15% x $3,200 480
Electricity 15% x $7,800 1,170
Heating/cooling 15% x 1,500 225
Total deduction 4,125
Part (b)
How would your answer change if the same expenses in the same percentages were
incurred by Stanley who was an employee but worked at home on the weekends?
1. Is home the place of business or is it where Stanley chooses to do some extra

work?
Stanley has a place of work but chooses to do some work from home,
therefore he can only claim the running costs.
2. How much of the home is used for his employment duties?
15% of the running costs can be deducted.
Electricity 15% x $7,800 1,170

Heating/cooling 15% x 1,500 225
Total deduction 1,395
Ownership Cost Running costs

deductible deductible
Home study i.e. the No Yes
taxpayer has another
place of work
Home as a place of work Yes Yes

or business
Readings
AUSTRALIAN TAX LAW SELECT 10-420 10-430
Travel expenses
Taxpayers who are required to take cumbersome or heavy tools to work will be able
to deduct the cost of travel to and from work. An example would be a bricklayer who
has a trailer attached to his car and he takes his cement mixer with him to work each
day.
A taxpayer who took a laptop to work would not be able to deduct the cost of
travelling to and from work each day as the laptop is not cumbersome or heavy.
Taxpayers who do not have a regular or fixed place of work can deduct the cost of
travelling to work. This would apply to a taxpayer such as a music teacher who
taught at a number of different schools during a week.
Taxpayers who work from home either as the place of business or as an

employees base of operations can also deduct the cost of travel from that place to
visit clients e.g. a computer technician who is on call after hours.
If home is not the place of work or business then the deduction is allowable if work
commences at home the computer specialist who logs in from home to rectify a
problem and then travels back to work.
The methods available to taxpayers in claiming deduction for use of their private
motor vehicles for income producing purposes are:
Cents per kilometre method, and

Logbook method
Cents per kilometre method is based on allowing taxpayers to claim up to a

maximum of 5000 business/work related kilometres at a set rate of 66 cents per
kilometre. Taxpayers do not have to have written evidence but instead be able to
show how they worked out their business/work related kilometres.
Logbook method is based on allowing taxpayers to claim the business/work related
use percentage of the expenses of their private motor vehicles. Expenses including
running costs such as fuel, repairs, maintenance, registration and insurance costs as
well as the decline in value of the car, interest or leasing costs are included as
running cost expenses. To work out the business/work related use percentage a
taxpayer needs to maintain a log book for a period of 12 continuous weeks and to
record the opening and closing odometer readings of that period. Taxpayers are
required to maintain written evidence of their expenses.
Readings
AUSTRALIAN TAX LAW SELECT 10-475; 11-635
Expenses incurred in earning exempt income
If a taxpayer derives exempt income (i.e. income which is not taxed) then any
expenses incurred in deriving that income is not deductible.
The Act also makes certain expenses specifically deductible or excludes them from
deductibility.
Example 2:5 Expenses incurred in earning exempt income
A taxpayer derives a salary from the Army Reserve. Laundry expenses of the
compulsory uniform totalled $290 and travel from his full-time job to the Army
Reserve base totalled $560.
What deduction can the taxpayer claim against the Army Reserve salary?
Answer:
The Army Reserve income is exempt and therefore the taxpayer cannot deduct any
of the expenses against that income.
Readings
Summary of general provisions of s.8-1
You should now understand the basic concepts of s.8-1, the deductibility of
expenses and then the limitations to those deductions.
Interaction between the ITAA and Fringe Benefits Tax
Employers often provide their employees with benefits which are not paid in cash, for
example an employer might provide an employee with a car or pay for the
employees telephone bill. The cost of providing this benefit is fully deductible to the
employer but any private benefit received by the employee is taxed under Fringe
Benefits Tax (FBT). This tax is levied on the employer.
Example 2:6 Deductions and FBT
Ian pays the telephone bill of his employee John because he expects John to use his
home phone for work-related phone calls. John estimates that 30% of his phone bill
is for private phone calls. The bill for the current year totalled $1,000.
Ian can claim a tax deduction for the $1,000 phone bill. He will pay FBT on the $300
private element of the bill.
John has not derived any income in relation to the payment of his personal phone
bill. Accordingly he cannot deduct any expenses either.
Note: if John had paid the phone bill himself he would only be able to deduct
$700 under s.8-1 as this amount related to earning his assessable income.
This is of particular relevance in relation to Division 26 (see later in this topic) when
certain expenses are specifically denied deductibility unless they are paid by the
employer.
This will continue to apply when we study employers such as trusts and companies.
While the expense may appear to be private e.g. allowing an employee to use a
motor vehicle 15% of the time for private purposes, this is not a private expense of
the partnership, trust or company. It is the provision of Fringe Benefit by the
employer and will be fully deductible to the employer. The private percentage will
be taxed under the Fringe Benefits legislation.
Statutory deductions
In addition to the general concepts of s.8-1 the Act allows a deduction for expenses
which may not qualify for deductibility under s.8-1 or it restricts or denies a deduction
for expenses which may qualify for deduction under s.8-1. It is necessary to learn
which expenses are covered by these sections.
Division 25 Some amounts which are deductible
This Division allows deductions for specified expenses.
Expenses deductible under this section are:
tax-related expenses
repairs
lease document expenses
borrowing expenses
mortgage discharge expenses
bad debts
loss by theft
payments of pensions etc.
payments to associations
travel between workplaces
Readings
AUSTRALIAN TAX LAW SELECT Generally Chapter 11
Section 25-5 Tax-Related Expenses
Expenditure incurred by a taxpayer to the extent that it is for managing the

taxpayers income tax affairs is deductible under this provision (note it is not
deductible under s8-1, so you must make the claim under this provision.
Daily advice on running of a business can be claimed under s.8-1 as it is a normal
cost of running a business and can be provided by anyone, not just a registered
advisor). A deduction can be claimed if the expenses are paid to a recognized tax
adviser (registered tax agent or registered barrister/solicitor) under s.25-5. The
deduction is allowable in the year in which the expenditure was incurred and is
available to all types of taxpayers.
Some examples include the preparation of the annual income tax return, expenses in
relation to ATO audits of these expenses and costs in relation to objecting or
appealing against an assessment issued by ATO. It should be noted that costs such
as travelling to visit taxpayers tax agent are also deductible under this section.
Section 25-10 Repairs
Expenditure on repairs that is not of a capital nature is specifically allowed as a

deduction under s.25-10. You must be able to determine whether expenditure is
revenue in nature and therefore deductible as a repair or is of a capital nature. A
repair involves replacing a broken or worn out part without replacing the entirety and
must be distinguished from an improvement, which is capital. Repairs undertaken
shortly after purchasing property, (commonly called initial repairs) will be of a capital
nature if they are to correct defects in the property existing at the date of purchase.
The cost of initial repairs is included in the cost base of the asset for CGT purposes
(see Topic 4).
To be deductible as a repair, the need for the repair should arise from the income-
producing use of the asset (e.g. a repair required when a property is being rented
would be deductible if not capital in nature).
In general terms, it may be accepted that painting and conditioning gutters,

maintaining plumbing, repairing electrical appliances, mending leaks, replacing
broken parts of fences and windows and repairing machinery would generally
constitute deductible repairs.
It is important that students have a sound understanding of the concepts relating to
repairs as they are relevant in the calculation of the cost base for capital gains tax
purposes in Topic 4.
Example 2:7 Repairs

John bought two cars to use in his job as a salesperson. Both cars are
second-hand. Car 1 costs $4,500 and Car 2 costs $10,000. While driving
Car 1 home from the vendors property the cars motor seized up and John
had to spend $1,800 having the motor repaired. Car 2 performed well until
after a long trip to the north west of the state six months after acquisition.
John had to spend $1,500 repairing this car.
Which expenses are deductible under s.25-10 as repairs?
Answer
The repairs to Car 1 would be considered to be initial repairs and the cost
would not be deductible. The expense is similar to the cost of acquiring the
car which is a capital expense and not deductible. The need for the repairs to
Car 2 arose as a result of the income-earning use of the car and accordingly
the cost of these repairs is deductible under s.25-10.
Initial repairs are capital and are not deductible. Note, however, that they may form
part of the cost base of an asset for capital gains tax purposes. (See Topic 4)
Repairs which are improvements to property are also capital in nature and are not
deductible. They may also form part of the cost base. (See Topic 4). Some of the
factors pointing to an improvement rather than a repair are detailed in the
AUSTRALIAN TAX LAW SELECT AT 11-070.
Repairs incurred during income-producing use of the property are deductible. Note,
they will not form part of the cost base, because they have already reduced the
assessable income in the year in which they were incurred.
Example 2:8 Repairs
June has owned a rental property for many years. The property has been well-
maintained however, some of the fly screens have deteriorated and June has
decided to replace the ground floor ones with security mesh fly screens, while the
first floor screens will have the mesh repaired with normal mesh. The cost of
security fly-screens is $1,300 and the normal mesh is $560.
What is the deduction June can claim against her rental income?
Answer:
Only the cost of replacing the normal mesh can be deducted under s.25-10. The
installation of security screens is an improvement and is not a repair.
Readings
Repairs Summary
Has the taxpayer incurred Then no deduction allowable.

expenses in repairing an No
income earning asset?
Yes
Was the need for the repair in Then it is a capital expense and
existence when the asset was Yes no deduction is allowable.
acquired?
No
Is the expense capital in Then it is a capital expense and

nature? i.e. does it improve the Yes no deduction is allowable.
asset.
No
The repair costs are deductible

under s.25-10.
Legal Expenses
Legal expenses that are not of a capital nature may be allowable under s.8-1, for
example legal costs to collect trade debts. Sections 25-20, 25-25 and 25-30 allow
deductions for certain types of legal expenses that may otherwise be considered to
be capital in nature.
Section 25-20 Lease expenses
Expenses incurred such as preparation, registration or stamping of a lease or an

assignment or surrender of a lease by a lessee or lessor of a business property
(includes residential landlords as well) are deductible under this section.
Section 25-25 Borrowing expenses
One-off capital expenses to obtain a loan (e.g. application fees, valuation fees,
brokers fees and stamp duty) are capital expenses and are not deductible under s.8-
1. A deduction is available, however, under s.25-25 for such expenses. The
intention of this section is to spread the expense over the period of the loan (see
definition below).
The deduction is calculated using this formula:
Remaining expenditure
Remaining loan period
This amount is then rounded to dollars and cents and then applied to the number of
days in the year the loan is used for income-earning purposes.
Students must note that the Act is very specific about how this deduction is
calculated and must follow this method. It is necessary to understand the definitions
that are used in this section.
Remaining expenditure in the year the loan is taken out, this is the total of the
borrowing expenses. In later years it is the expenditure which has not already been
deducted.
Remaining loan period in the year the loan is taken out, this is the loan period
(see definition below). In later years it is the number of days remaining in the loan
period.
Loan period this is defined in s.25-25(5) to be the lowest of 3 periods:
The term of the loan;

The actual loan period (this applies when the loan is repaid early); or,
5 years.
Note: if total expenses do not exceed $100 then they are fully deductible.
Example 2:9 Legal Expenses

Arthur runs an import/export business. He incurs the following expenses in
relation to the business:
Legal expenses: $
- debt collection 520
- objection against income tax assessment for a
prior year 800
1,320
He also obtained a loan of $100,000 to use in his business. The money was
borrowed on 15 February CY for a term of 8 years. Arthur incurred the
following expenses in order to borrow the money:
$
Application fee to the bank 1,000
Stamp duty 347
Survey fees on property used for mortgage 500
1,847
Calculate Arthur's deductions for the current year and the following year for
borrowing and legal expenses incurred this year.
Answer:
Legal expenses for collecting debts are not of a capital nature. They are
incurred in the course of carrying on a business and therefore, are allowable
under s.8-1.
The cost of preparing an objection to an income tax assessment is allowable

under s.25-5 as long as it is paid to a solicitor, registered tax agent or person
specifically exempted from registration.
The borrowing expenses are deductible under s.25-25. Arthur borrowed the
money for 8 years. As this is more than 5 years the borrowing expenses can
only be deducted over a maximum of 5 years from the date on which the
money was borrowed. As the loan was taken out part way through the year,
the expense must then be apportioned from the date the borrowing
commenced, 15 February CY.
Deductions allowable in the current year:

$
s.8-1 debt collection 520
s.25-5 objection expenses 800
s.25-25 borrowing expenses(1,847 1,825)
= 1.01 per day 136 days 137
1,457
Deductions allowable in the following year:
s.25-25 borrowing expenses

Remaining expenditure 1,847 137 = 1,710
Remaining loan period 1,825 136 = 1,689
Deductions:
s.25-25 borrowing expenses 1,710 1,689 = $1.01 365 = $369
Readings
Section 25-30 Mortgage Discharge expenses
Expenses incurred to discharge a mortgage given as security for the repayment of

money borrowed for income-earning purposes is deductible in the year incurred but
only to the extent that the money was used for producing assessable income.
Section 25-35 Bad Debts
A bad debt deduction can be claimed under s.25-35 or s.8-1.
A debt is classified as bad under the following situations:
- the debtor has died without leaving assets or is insolvent

- the debt is statute-barred
- the debtor or the debtors assets cannot be traced
- business reasons indicate that it would be wise to abandon claim
Under s.25-35 to qualify for the deduction two conditions must be met as well as the
general view that the debt is bad
1) the debt must be written off as bad during the year of income in which the
deduction is claimed.
2) the debt must have been bought to account as assessable income
If not deductible under s.25-35 the deduction can be claimed under s.8-1. The
conditions to be met are that the debt must have been incurred and must be a loss
relating to the production of the taxpayers assessable income but the debt does not
have to have been brought to account as assessable income.
Section 25-45 Losses by theft etc.
A loss of money caused by theft, stealing, embezzlement, etc. by an employee of the

taxpayer is deductible in the year in which the theft, etc. is discovered if the money
was previously included in the taxpayers assessable income.
There is a very interesting case in relation to this area which is discussed below and
further in s.26-54 Illegal Activities.
Drug dealer allowed tax deduction
A convicted heroin dealer was allowed to claim a $220,000 tax deduction for money
lost during a drug deal after the Australian Taxation Office (ATO) lost a bid to appeal
against a full Federal Court ruling in his favour.
The Commissioner of Taxation had been seeking leave in the High Court to appeal
against the Federal Court's decision that Perth man Francesco Dominico La Rosa
could write the money off as lost income.
The ATO had been trying to make La Rosa - who served a 12-year jail term for
dealing heroin and amphetamines - pay tax on his 1994-95 assessable income,
which it estimated amounted to $446,954.
But La Rosa insisted his taxable income should be reduced for that year because it
wrongly included a sum of $224,793.
The money had been buried in La Rosa's backyard and was dug up for use in an
intended drug deal in May 1995, but was stolen during the transaction by unknown
people.
In 2001, the Administrative Appeals Tribunal held that the money was lost during
activities directly connected with La Rosa's illicit drug-dealing business and was lost
during operations to acquire trading stock.
On the basis of those findings, the Tribunal concluded that while the income had
been properly included in La Rosa's income as part of the default assessment
process - enacted when he failed to lodge tax returns for seven years - it was
properly allowable as a deduction.
The Commissioner appealed to the Federal Court, arguing there was no evidence
the money had been stolen and it was against public policy to allow stolen money as
a tax deduction.
But the Federal Court upheld the tribunal's decision.
The Commissioner subsequently appealed to the full court of the Federal Court and
that appeal was dismissed in June 2003.
In a Perth sitting of the High Court, the ATO's application for special leave to appeal
was also refused.
The ruling means the ATO has now exhausted all avenues of appeal.
However, Prime Minister John Howard said last December that if the High Court
action failed, the law would be changed.
"If the appeal is unsuccessful, we will take steps to amend the law," he told
Parliament at the time.
A spokeswoman for Treasurer Peter Costello yesterday said the Government would
now pursue the necessary amendments.
"The Government is disappointed that the High Court refused the commissioner of
taxation leave to appeal," the spokeswoman said.
"The proceeds of crime are taxable and the tax commissioner has been arguing in
the courts that deductions for losses incurred in deriving illegal income should not be
allowed.
"Since the courts have not ruled this way, the Government will now seek to amend
the legislation to prevent such losses being allowed as deductions." AAP
Section 25-50 Pensions/Retiring Allowances
A retiring allowance whether paid in a lump sum or a pension to an employee or

director or spouse of the previous two is deductible under s.8-1 if it can be shown to
be in the future interest of the business. Some reasons could be to encourage a bad
employee/director to retire, or when a service contract is cancelled, to compensate
an employee who is made redundant. If the payments are paid in respect of past
services then they are not deductible under s.8-1.
Pensions, gratuities or retiring allowances paid during the year of income to

employees or former employees or their dependants (note directors are not included)
are deductible under s.25-50 to the extent that they are paid in good faith in
consideration of the employees past services in any business carried on by the
taxpayer for the purpose of producing assessable income.
Amounts which cant be deducted or which are limited
Division 26
Readings
AUSTRALIAN TAX LAW SELECT General readings from 10-535 onwards

Section 26-5 Fines and Penalties
Deductions for penalties and fines imposed due to breaches of law are not
deductible. Examples include parking fees, speeding fines, late payment of income
tax, etc.
Speeding Fine
Section 26-10 Leave payments
Most businesses make an annual provision for annual leave, sick leave and long
service leave. Section 26-10 denies a deduction for these provisions and only allows
a deduction when the leave is actually taken by the staff member.
Section 26-35 Reducing amounts paid to related entities
Salary and wages paid by a taxpayer to a relative/director/shareholder who is an

employee are deductible under s.8-1 but the Commissioner can disallow the
deduction to the extent the he considers the payment to be in excess of a
reasonable amount. The test of what is reasonable is based on commercial
standards. If the payment to the associated person or relative is adjusted to reflect
a more realistic payment, that person only needs to declare the reduced amount in
assessable income.
Note: this will be slightly different for shareholders but this will be dealt with in Topic
8
Section 26-45 and Section 26-50 Club fees and leisure facilities
No deductions are allowable for these expenses even though they may be used in
the income-earning process unless paid by an employer who in turns pays Fringe
Benefits Tax.
Section 26-54 Illegal Activities

The income tax laws deny deductions for losses and outgoings to the extent that
they are incurred in the furtherance of, or directly related to, activities in respect of
which the taxpayer has been convicted of an indictable offence.
Indictable offences are offences that are punishable by imprisonment for at least 1
year and include offences such as drug trafficking, tax evasion, extortion, illegal
gambling, people-smuggling, forgery and piracy.
INCOME TAX DEDUCTIONS TO BE DENIED FOR ILLEGAL ACTIVITIES

In Commissioner of Taxation v La Rosa [2003] FCAFC 125 the court held that the taxpayer,
a convicted drug dealer, was entitled to a deduction for a loss incurred in earning his income
as a drug dealer. The income earned by the taxpayer from his illegal activities had been
subject to tax and he had sought a deduction for monies stolen from him in the course of
conducting those activities. The Commissioner of Taxation sought special leave to appeal
the Full Federal Courts decision, but on 27 October 2004 the High Court refused the
application, exhausting the appeal process.
It should be noted that Mr La Rosa was imprisoned for a number of years and proceeds of
crime legislation was also applied to confiscate the proceeds of his illegal activities.
At the time of the High Courts decision, I said that I was not satisfied with that outcome and
that I would seek to introduce legislation to change that law.
The income tax law will be amended to deny deductions for losses and outgoings to the
extent that they are incurred in the furtherance of, or directly in relation to, activities in
respect of which the taxpayer has been convicted of an indictable offence. Similarly, the
capital gains tax provisions will be amended so that losses and outgoings incurred in relation
to illegal activities in respect of which the taxpayer was convicted of an indictable offence do
not form part of the cost base or reduced cost base for capital gains purposes. This will
ensure that no capital loss or reduced capital gain can arise from such expenditure.
Indictable offences are offences that are punishable by imprisonment for at least one year.
Deductions will be denied for all expenditure where the activities are wholly illegal such as
drug dealing or people smuggling. There may be cases where the taxpayer is undertaking a
lawful business but is convicted of an illegal activity while carrying out that business. In these
cases, deductions will only be denied where the expenditure directly relates to entering into
and carrying out the actual illegal activity. However, a deduction will continue to be allowed
for the expenditure if it would have been incurred in any case, regardless of the illegal
activity.
The amendments will apply to expenditure incurred after today.

The amendments will not replace or diminish the power conferred by Commonwealth, state
and territory legislation to enable the proceeds of criminal activity to be confiscated. Broadly,
proceeds of crime legislation can capture proceeds that have been derived from the
committing of an indictable offence.
The Proceeds of Crime Act 2002, which came into force on 1 January 2003, strengthens the
provisions enabling freezing and confiscation of proceeds of crime previously available
under the Proceeds of Crime Act 1987. Freezing and forfeiture of assets are now not only
conviction based but are also available for unlawfully acquired property without a conviction
first being obtained where a court is satisfied, to the civil standard, that a crime has been
committed.
Section 26-20 Assistance to students
The Australian Government subsidies the cost of tertiary education for

undergraduate Australian students. Students are required to pay a small percentage
of the total cost of the unit. For example, the cost of a unit of study might be $1,000
but the student pays $250. This payment is payable by the student under the Higher
Education Loan Program (HELP) and is known as HECS-HELP.
Students who pay their HECS-HELP liability cannot claim a tax deduction for this
expense even though the course of study relates to earning income.
Under s.26-20(2), however, if the students employer pays the HECS-HELP liability
for the student, the employer can claim a deduction for the HECS-HELP payment but
will be required to pay the FBT.
Postgraduate students do not get government assistance for their fees and must pay
the full cost of their study. Such costs may be deductible if the course of study
relates to earning the students income. Postgraduate students who are unable to
pay the cost of their study upfront are able to utilise the FEE-HELP system under
which the student must pay the fees off over a period of time. In such a situation the
course fees are deductible when the expense is incurred i.e. when the course is
undertaken, however, the payment of the FEE-HELP liability over time cannot be
deductible as the original course fees have already been deducted.
Undergraduate students may also access FEE-HELP.
Example 2:10 HECS-HELP

Bronte is a student who pays her HECS-HELP of $1,000 for her work-related study.
Susan pays $1,500 for her employee Bridgets HECS-HELP debt. Bridget is not
doing the study for work purposes but because the course interests her.
Kieran commences a post-graduate course which meets the requirements of s.8-1.
The fees cost Kieran $2,500 and he used the FEE-HELP system to pay the fees.
What amounts can Bronte, Susan and Kieran deduct for the HELP payments made
during the current year?
Answer:
Section 26-20 denies a deduction to Bronte however, S.26-20 (2) allows Susan to
claim a deduction for the HECS she paid on Bridgets behalf.
Any private element will be taxed under FBT.
Kieran can deduct the full $2,500 however; in future years when he starts to repay
the loan he cannot deduct those repayments.
Readings
AUSTRALIAN TAX LAW SELECT 2-400; 10-440
Self-education expenses
A taxpayer who incurs expenditure in relation to self-education which relates to the

earning of assessable income can deduct that expenditure under s.8-1. To be
deductible, self-education expenses must relate to a taxpayers current income-
earning activity.
Such expenditure includes items as fees, textbooks, and travel expenses, but it
should be noted that some types of self-education expenses are limited to the
excess of the expenses above $250 under s.82A. This will be discussed below;
however, prior to this it is necessary to understand the deductibility of travel
expenses in relation to self-education.
Self-education and travel
Not all travel in relation to self-education is deductible. The table below sets out
what is deductible.
(A) the cost of all travel from home to the place of education and return is
deductible.
(B) the cost of travel from work to the place of education and return is deductible.
(C) the cost of travel from home to the place of education is deductible, however,
the cost of travel from the place of education to work is not deductible. (It is
considered to be a private expense the cost of getting to work).
(D) The cost of travel from work to the place of education is deductible; however,
the cost of travel from the place of education to home is a private expense
and is not deductible.
The diagram below sets out how travel expenditure incurred as part of self-education
is deductible.
A. HOME C. HOME
YES YES YES
PLACE OF PLACE OF NO
EDUCATION EDUCATION WORK
B. D. HOME
NO
YES
WORK PLACE OF PLACE OF WORK

EDUCATION EDUCATION
YES
YES
Self-education and the limitation of the deduction (s.82A)
Section 82A provides that the first $250 of self-education expenses is not
deductible. This section, however, is limited to particularly defined self-education.
The section applies to expenses necessarily incurred by the taxpayer for or in
connection with a prescribed course of education but does not include HECS-HELP.
It is necessary to define what is meant by a prescribed course of education. This is

defined to be a course of education provided by a a school, college, university or
other place of education, and undertaken by the taxpayer for the purpose of gaining
qualifications for use in the carrying on of a profession, business or trade or in the
course of any employment.
For example this section would apply to a student at Curtin University (completing a
Bachelor of Commerce) who is also working full-time at an accounting firm. Curtin is
a university and the expenses would be incurred in gaining a qualification for use in
the students employment with the accounting firm.
If the student also attended a 4-hour course run by CPA Australia on auditing, the
costs of this course would not be subject to s.82A as CPA Australia is not primarily
a place of education.
The effect of s.82A is to only allow the taxpayer to deduct under s.8-1 expenses
above $250. So, for example, if the total costs of study (e.g. fees, travel expenses,
books etc.) were $600, only $350 could be claimed. If the only expenses a student
had incurred were deductible under s.8-1, then this would be the limit of the
deduction.
It should be noted that the taxpayer is not limited to claiming self-education

expenses which are deductible under s.8-1. In determining the effect of the $250
reduction it is necessary to calculate the total self-education expenses. Some of
these may not be deductible under s.8-1 but which may, nonetheless, be expenses
incurred in relation to the self-education.
Examples of this are child-minding expenses while the student is at university, the
purchase of capital items relating to study or non-deductible legs of travel expenses
see example below. It is then in the taxpayers best interest to offset the $250
reduction firstly against the non-deductible self-education expenses and then against
those which are deductible under s.8-1.
Example 2:11 Self-education expenses

Sandy is a trainee accountant. The terms of her employment require her to study
commerce at Curtin University. Her income and expenditure is as follows:
Salary 20,000
Expenses:
HECS-HELP 850
Travel home to university and return 100
Travel home to university 75
Travel university to work after above journey 85
Travel work to university 110
Travel university to home after above journey 35
Books 380
Childcare during evening classes 60
Purchase of second-hand desk and chair
for study purposes only 115
Stationery 30
Calculate Sandys taxable income.

Answer:
Salary 20,000
Less: Not deductible Deductible

HECS-HELP
not an expense of self education
Travel home to university/return 100
Travel home to university 75
Travel university to work - private 85
Travel work to university 110
Travel university to home, private 35
Books 380
Stationery 30
Childcare private 60
Desk/chair, capital 115 ___
Total non-deductible 295 695
Threshold s.82A 250
No threshold remaining
Deductible self-education expenses 695
Taxable income 19,305
Non-deductible expenses under s.8-1 were used to reduce the $250 threshold under
s.82A.The definition of self-education expenses never includes HECS-HELP.
If instead of Sandy attending University she was a qualified accountant attending the
CTA 1 Course offered by the Taxation Institute (TI), and HECS-HELP was replaced
with the course fees and travel to and from university to travel to and from the TI
teaching venue, then the result would be as follows:
Salary 20,000
Less: Not-deductible Deductible

Course fees 850
Travel home to TI/return 100
Travel home to TI 75
Travel TI to work - private 85
Travel work to TI 110
Travel TIA to home, private 35
Books 380
Stationery 30
Childcare private 60
Desk/chair, capital 115 ____
295 1,545
Deductible self-education expenses 1,545

Taxable income 18,455
No threshold applies here as the course is undertaken at the TIA which is not
primarily a place of education
Readings
Entertainment Expenses Division 32
Section 32-5 states that to the extent that you incur a loss or outgoing in respect of
providing entertainment you cannot deduct it under section s.8-1.
Entertainment is defined in s.32-10 to be:

a) by way of food, drink or recreation or
b) accommodation or travel to do with providing entertainment by way of food, drink
or recreation.
Basically entertainment is not deductible but there are some limited exceptions. The
main one is one which is paid by an employer for employees. The employer in turn
pays Fringe Benefits Tax on that amount. An employer who provides meal
entertainment to employees on or after 1 April 1995 may elect that Division 9A of
FBTAA apply. The taxable value of meal entertainment fringe benefits will be either
half the expenses incurred by the employer in providing meal entertainment for the
FBT year (50/50 split) or an amount worked out based on a 12-week register kept by
the employer or the actual amount incurred.
Small Business Entities (SBEs)
A business with a turnover of less than $2 million is a Small Business Entity. No

election is needed to qualify for this.
Such businesses then have the option of choosing certain elections. These relate to
the following:
Trading stock; and,

Immediate deduction for certain prepaid business expenses
Immediate deduction for small business start-up expenses
Readings
AUSTRALIAN TAX LAW SELECT 15-000 15-105, 15-400, 15-265, 15-260
Miscellaneous deductions and limitations
The Act contains a number of other sections which either specifically allow
deductions or limit the deduction which can be claimed. When considering the
deductibility of expenses students should first apply s.8-1 and then review sections
25 and 26 and the additional sections we are covering to decide if expenses which
meet the requirements of s.8-1 are limited or denied deductibility. Alternatively,
expenses which might not meet the requirements may be deductible under some of
these additional sections.
Business-related capital costs
Section 8-1 precludes a deduction for capital costs; however, s.40-880 allows a
deduction of 20% for business-related capital costs. This deduction applies to the
following capital expenditure:
in relation to a business;
in relation to a former business;
in relation to a proposed business (not otherwise allowed as an immediate deduction)
in relation to the liquidation or winding up of a business operated as via a
company, partnership or trust.
The deduction will be allowed in equal instalments in the year it is incurred and the
following 4 years.
These expenses will be deductible when there is no other tax treatment available for
them or they are denied deduction by the Act. This provision will be used only when
no other provision can be used.
From the 1st July 2015 the Government changed the deductibility of expenses in
relation to a proposed business for SBEs. Businesses are now able to immediately
deduct a range of expenses associated with starting a new business, including
expenses such as professional, accounting and legal expenses as well as
government fees and charges (e.g. fee to register a company with ASIC).
Note: Students should note that s.40-880 is quite different from s.25-25 (borrowing
expenses) (see below).
Example 2:9 continued
Arthur also incurred the following expenses

- legal advice re setting up of a new business 2,500
- professional fees to change an existing business structure 1,500
The legal expense of $2,500 incurred in relation to setting up the business is

a capital expense so is the professional costs associated with changing an
existing business structure. Accordingly, they cannot be deducted under s.8-
1 but are treated in the following manner:
- legal advice immediate deduction as allowable costs associated with a
proposed business
- professional fees to be claimed at 20% per year for 5 years can be

deducted under s.40-880.
Deductions allowable in the current year:

$
s.8-1 debt collection 520
s 40-880(2A) business related costs proposed 2,500
s.40-880(2) business-related costs ($1,500 x 20%) 300
s.25-5 objection expenses 800
s.25-25 borrowing expenses(1,847 1,825)
= 1.01 per day 136 days 137
4,257
Deductions allowable in the following year:
s.25-25 borrowing expenses

Remaining expenditure 1,847 137 = 1,710
Remaining loan period 1,825 136 = 1,689
Deductions:
s.25-25 borrowing expenses 1,710 1,689 = $1.01 365 = $369
s.40-880 business-related costs $1,500 x 20% $300
Note: Section 40-880 allows a deduction calculated at 20% per year for 5 years or
an immediate deduction for certain expenses for proposed businesses.
Section 25-25 allows a deduction which is calculated using the relevant number of
days in the year.
Readings
AUSTRALIAN TAX LAW SELECT 12-300 12-320, 15-265
Prepaid expenses
The prepayment sections were incorporated into the Act to ensure that deductions
were only allowed for expenses which related to the year of income in which they
were paid. This has been done in an attempt to match assessable income which is
being returned by the recipient with the deduction which is allowable to the taxpayer,
similar to the matching principle for accounting provisions.
The legislation has undergone considerable changes in recent times and different
rules apply depending on the status of the taxpayer. A prepayment for tax purposes
only applies if expenditure extends beyond the end of the relevant year of income
(i.e. 30 June of the relevant year).
All taxpayers who meet the following conditions will have the full amount of the
prepayment allowed. These conditions apply to prepayments which are:
made on or after 25 May 1988

less than $1,000 or is excluded expenditure; and,
would otherwise be deductible under s.8-1.
Prepayments which do not meet these conditions are deductible subject to rules
contained in s.82KZM. Small Business Entities (SBE) taxpayers are also subject to
these provisions.
Deductibility depends on the type of the expenditure and the entity making that
expenditure.
SBE taxpayers (who have elected to have this particular election apply) and
individuals not running a business (e.g. owners of rental properties or share
portfolios)
The prepayment is fully deductible if two conditions are met:
the expenditure is incurred for doing something which will be done within 12
months;
the eligible service period ends before the end of the following income year.
If these conditions are not met then the deduction is limited as follows:
Deduction Period in year

Eligible service period
Example 2: 12 Prepaid expenses
Nasir commenced business on 1 June CY and prepaid his rent of $500/month

in advance for 18 months on that day.
Calculate the deduction to which he is entitled.
Answer
As the prepayment is for more than 12 months and is greater than $1,000, it
must be apportioned in accordance with s.82KZM as follows:
Deduction (Period in year Eligible service period)
Period in year = 1 June CY to 30 June CY = 30 days

Eligible service period = 1 June CY to 30 November of the following year =
548 days
$9,000 (30 548) = $493
Although expenses of $9,000 for rent were incurred during the year ended
30 June CY in accordance with s.8-1, they are apportioned under s.82KZM so
that only $493 which relates to the June CY rent is deductible.
The apportionment set out above, will not apply if the prepayment is for a period of
not more than 12 months.
Example 2:13 Prepaid expenses

Joe leases a car which he uses only for his business. He pays monthly lease
payments of $450 on the first day of each month. Joe has leased the car for
some months before the start of the current year. During the current year Joe
pays his lease payments monthly until 1 April CY when he prepays an extra 9
months of payments.
What is the total deduction Joe can claim for lease payments in the current
year, assuming his business is a SBE and he has elected to use the election
available for prepaid expenses?
Answer
Joe has prepaid 9 months of lease payments. As the prepayment is for less
than 12 months and the eligible service period ends before the end of the
following year, the full amount of the prepayment will be deductible.
$
Normal payments July CY to March CY - 9 months $450 4,050
Prepayments 9 months $450 4,050
Total deduction allowed in current year 8,100
It is important to realise that s.82KZM will only apply when the taxpayer
makes a prepayment for more than 12 months. In this case while Joe actually
paid 18 months of payments he only prepaid 9 months of payments and
consequently s.82KZM will not apply.
Example 2:13 reworked

To what deduction would Joe be eligible if he had not made the election?
$
Prepayments 9 months $450 = $4,050 X 91/275 1,340
Total deduction allowed in current year 5,390
Example 2:13 continued

What deduction can Joe claim if he prepays 3 years of lease payments on 1
April CY?

Prepayment - 3 12 $450 = $16,200 (91days 1,095 days) 1,346
Allowable deduction for current year 5,396
Students should use the Days of the Year Table at the back of this book to help in
the calculation of the days in the respective periods and also the number of days in
each month. For example, if an 18-month prepayment is made on 1 May then one
year (12 months) takes you to the following year you can then work out the
remaining 6 months starting from 1 May.
Non-SBE, non-business, non-individual taxpayers and prepayments

This category would cover a trust or company which has investment income. Such
taxpayers will have to apportion their expenses if there is a prepayment which
extends beyond the end of the income year.
Readings
AUSTRALIAN TAX LAW SELECT 13-530 13-534 (read (1), (4), (5), (6) and (7)
Donations Division 30
In order to be deductible the payment to the charity or hospital etc. must be a gift
i.e. there is nothing received in return.
A donation to any registered charity or organisation is deductible if the amount

donated is over $2. This may be in the form of money or property (e.g. a person
donates a item of artwork). It is important to note if something is bought or
purchased from a charity this is not classified as a donation/gift and no deduction
can be claimed for the amount paid. (e.g. a charity asks a taxpayer to buy a raffle
ticket, or to buy a diary/pen etc).
In addition to the charities listed in Division 30 the Commissioner publishes rulings

stating whether a particular charity qualifies for deduction under Division 30.
Students are not required to learn what specific charities qualify, but should learn the
general categories. It is required that students study the provisions relating to works
of art or to the National Trust.
Readings
AUSTRALIAN TAX LAW SELECT 11-680 11-685, 11-710
Superannuation
Employer contributions
Employers can claim the full cost of superannuation provided to their employees
Division 290 Subdivision B.
Self-employed taxpayers can claim the full cost of their superannuation Division
290 Subdivision C but it should be noted that the Government does have age based
limit contributions. They cannot deduct their superannuation if they receive any
superannuation support from an employer. This would apply to self-employed
taxpayers who are also in paid employment at some stage during the year.
Limits on superannuation are limits on the concessional treatment of the
superannuation contributions and are dealt with in the superannuation fund. They
are not covered in this course.
Employees cannot deduct any superannuation which was paid personally as the
employee has received superannuation support from his/her employer. Employers
are required by law to contribute 9.5% on behalf of their employees.
2:15 Superannuation deductions
Mia owns her own business and has paid the following amounts in superannuation:
Superannuation for staff 80,000

Superannuation for herself 25,000
Mia can deduct both amounts in full.
Isaac has a small business and has paid personal superannuation of $6,000. He
has a full-time job.
Isaac cannot deduct the personal superannuation of $6,000. As an employee his

employer would have contributed superannuation for him. This means he has
superannuation support from someone else and he cannot deduct his personal
superannuation.
Readings
Losses of previous years
Film and primary production losses (e.g. from eligible farming activities) are not
covered in this course.
Division 36 applies to carry forward losses. There is no limit on how long losses can
be carried forward.
There are a number of rules which must be borne in mind when considering losses:
1. Work out the loss position of the current year first before bringing forward prior
year losses.
2. In the current year first offset the allowable deductions against the assessable
income and then the exempt income (e.g. alimony, maintenance, Army Reserve
income).
3. If the allowable deductions exceed these two types of income then

superannuation, pensions, gratuities and gifts are limited to the excess.
4. When losses are carried forward and offset they must first be offset against
exempt income.
5. Losses are carried forward indefinitely.
6. Losses must be offset in the order in which they are incurred.
Example 2:16: Losses of previous years:

Algernon's records show the following:
Yr 1 PY CY
$ $ $
Net income/loss from business (20,000) (6,000) 10,000
Interest received 2,000 2,500 2,500
Income from the Australian Navy Reserve5,000 5,000 5,000
Calculate Algernon's taxable income/loss for each year.

Answer:
Yr 1 PY CY
$ $ $
Net income/loss from business (20,000) (6,000) 10,000
Interest 2,000 2,500 2,500
(18,000) (3,500) 12,500
Exempt income (Navy Reserve) 5,000 3,500 0
Net Income/loss (13,000) 0 12,500
Carry forward loss claimable 0 0 6,500
Taxable income 0 0 6,000
Carry forward loss 13,000 13,000 11,500

less exempt income 1,500 5,000
11,500 (Yr1) 6,500 (Yr1)
Income from the Navy Reserve is exempt under s.51-5.
In Year 1 the loss of $20,000 must first be offset against the assessable
interest income of $2,000, and then against the exempt income of $5,000.
This results in the loss of $13,000. Note that the taxable income is nil.
In the PY the business loss of $6,000 is first offset against the assessable
income of $2,500. The remaining $3,500 of the business loss is then offset
against the exempt income. This leaves $1,500 of the exempt income against
which $1,500 of the carry forward loss can be offset.
In the CY $5,000 of the carry forward loss is first offset against the exempt
income and then the remaining $6,500 of the carry forward loss is offset
against the assessable income.
Remember:
Loss Year (s36-10) Recoupment Year (s36-15)

Assessable Income Exempt Income
Allowable Deductions Carry forward loss
If in a loss review deductibility Assessable Income (remaining after
of personal superannuation, etc. allowable deductions)
Exempt Income
Loss
Limit of loss deductions
Section 26-55 limits the deduction available in calculating the amount of the loss.
Expenses for personal superannuation, donations and pensions/gratuities cannot be

used to (1) create a loss, or (2) increase a loss.
Example 2:17 Limit of deductions
A taxpayer runs a business which in the current year has the following income and
expenses:
$
Business receipts 28,000
Expenses deductible under s.8-1 25,000

Personal superannuation s.290 Subdivision C 4,000
Donation to local public hospital Division 30 8,000
Calculate the taxpayers taxable income/loss for the current year.
Answer:
A quick look at these figures would suggest that this taxpayer had a loss of $9,000;
however, s.26-55 limits the deduction for the superannuation and donation.
Section 26-55 limits the deduction to the excess remaining after deducting all non-
limited expenses from assessable income.
Assessable income 28,000

Less: non-limited deductions 25,000
Excess 3,000
Limited expenses
Personal superannuation 4,000
Donation 8,000
12,000
As these expenses exceed the $3,000, they are limited to that
amount . 3,000
Taxable income 0
In this situation, there is no carry forward loss. While the taxpayer had an overall
excess of expenses over income, deductions were limited to the amount of
assessable income.
Readings
Division 35 - Non-Commercial loss rules
The non-commercial loss rules apply to individuals carrying on a business personally

or via a partnership.
Whether a person is carrying on a business or a hobby is a question of fact. If a
hobby is being carried on the income from the activity is not assessable and the loss
is not deductible. Previously when a person was carrying on a business and made a
loss from the business, the loss was could be used to reduce other taxable income.
However, the non-commercial loss rule under Division 35 now isolates or
quarantines a loss from a business activity that is incurred by an individual (alone or
in partnership) in an income year. These losses will be held over until one or other
of the four alternative tests is satisfied or the Commissioner exercises discretion
favourably to the taxpayer. A loss that is quarantined can be deducted in a
subsequent income year:
against income from the business activity; or

as a deduction against income in a subsequent income year if one or other of the
four tests is met and the taxpayer satisfies the income test or the
Commissioner's discretion is exercised favourably.
A person may carry on more than one business activity but each business activity
carried on must be considered separately. Before these losses can be deducted
from other income, the person must be carrying on a business and satisfy at least
one of the following tests:
Assessable income test the loss relates to an activity with assessable

income greater than $20,000. If the business activity is conducted for only
part of the year, the assessable income figure can be based on a reasonable
estimate (s.35-30);
Profit test the particular activity results in a profit for tax purposes in 3 out
of the last 5 years (s.35-35);
Real property test value of real property assets used in carrying on the
activity of at least $500,000 (s.35-40); and
Other assets test value of other assets (except passenger motor vehicles)
of at least $100,000 (s.35-45).
A taxpayer can only claim non-commercial losses if he/she passes one of the above
tests and the adjusted taxable income is less than $250,000.
If the activity is considered to be non-commercial, then losses are deferred to future

years. These losses can be offset in a future year when there is profit from this, or a
like activity to the extent of the profit. Otherwise losses will be held indefinitely.
Even if the tests are not satisfied, the Commissioners discretion can be applied if the
loss arises because of special circumstances outside the operators control, which
include natural disasters, or losses are normal for that particular industry in the early
years but the business is viable and the activity is on track to become profitable.
Exemptions apply to losses from a primary production business activity and

professional arts business. For this exemption to apply for the income year the
business activity must be a primary production business or a professional arts
business and the taxpayers assessable income from other sources for the year
(excluding capital gains) is less than $40,000.
This Division also does not apply to passive investments that do not amount to a
business activity, for example, income from rental property, dividend income from
shares or financial investments.
Example 2:18 Non-commercial losses
Syd is a partner in a large legal firm from which he receives income of $200,000 in
the current year. In addition he operates a small activity making hand-crafted leather
goods. The activity has been operating for 5 years but has never made a profit. In
the current year it made a loss of $4,300 which he would like to offset against his
business income. His sales totalled $17,300 and his expenses totalled $21,600.
Syd operates the activity from the shed in his back garden and his tools are worth
$12,000.
What is Syds taxable income assuming he has no other income or expenses?
Answer:
The loss from the craft activities cannot be offset against the income from the legal
practice as he has not made a profit in any of the previous years and his assessable
income from the activity was not more than $20,000. He also did not use real
property or plant and machinery over the required thresholds.
How would your answer change if his sales totalled $21,500 and expenses totalled
$25,800?
Trading stock
Revision
You may wish to review the accounting concepts relating to calculation of cost of
goods sold and valuation of inventories (AASB 102 Inventories).
Trading stock is defined in s.70-10.
In accordance with normal accounting concepts, opening and closing stock must be
brought to account. This is a means of matching income with expenditure. Section
70-35 provides that where the stock on hand at the end of the year is less than stock
at the beginning of the year, the difference is allowable as a deduction. On the other
hand, if the stock on hand at the end of the year is greater than at the beginning of
the year, the excess is included in assessable income.
It is normal accounting practice to take opening and closing stock into account when
calculating the gross profit of a business as follows:
Sales XXXX
less cost of goods opening stock XXXX
plus purchases XXXX XXXX
less closing stock XXXX XXXX
Gross profit XXXX
This method of calculation applies the requirements of s.70-35. Therefore it is
recommended that you adopt the above approach when calculating assessable
income for a taxpayer who has trading stock. There are many methods of valuing
trading stock (s.70-45). For income tax purposes trading stock must be valued at
cost, market selling value or replacement cost. If cost is used, it must be on a basis
that reflects the full absorption cost of the goods.
Example 2:19: Trading stock
Elizabeth operates a musical store. Her accounts show the following for two
consecutive years
Year 1 Year 2
$ $
Sales 11,000 11,000
Opening stock 3,000
Purchases 10,000 9,000
Closing stock at cost price 4,000 3,500
at market value 3,800 2,600
at replacement cost 3,600 3,000
Calculate Elizabeth's gross profit in each year, assuming:

(i) that she wishes to minimise taxable income
(ii) that she wishes to maximise taxable income
Answer:
The opening stock figure must correspond with last year's closing stock value.
Each year Elizabeth may elect to value closing stock at cost, market or
replacement value. If Elizabeth wishes to minimise her taxable income she
should use the lowest closing stock values to produce a high cost of goods sold.
If she wishes to maximise her income she should use the highest values to
produce a lower cost of goods sold.
(i) (ii)
Year 1 $ $ $ $
Sales s.6-5 11,000 11,000
Less cost of goods:
s.70-35(2) Opening stock 3,000 3,000
add s.8-1 Purchases 10,000 10,000
13,000 13,000
less s.70-35(3) Closing stock 3,600 9,400 4,000 9,000
Gross profit 1,600 2,000
Year 2 $ $ $ $
Sales s.6-5 11,000 11,000
Less cost of goods:
s.70-35(2) Opening stock 3,600 4,000
add s.8-1 Purchases 9,000 9,000
12,600 13,000
less s.70-35(3) Closing stock 2,600 10,000 3,500 9,500
Gross profit 1,000 1,500
Looking at situation (i), in Year 1 the closing stock of $3,600 was higher than the
opening stock value of $3,000. Under the provisions of s.70-35(2) the excess is
included in assessable income. In the cost of goods sold equation this is taken
into account by the reduction of the deductible amount of $10,000 by the closing
stock excess of $600.
In Year 2 the closing stock of $2,600 is $1,000 less than the opening stock. This
amount is allowable as a deduction under s.70-35(3). The $9,000 deductible
under s.70-25 is increased by the $1,000 difference.
Readings
SBEs and Trading Stock
SBE taxpayers can elect whether or not to account for the change in the value of
trading stock at the end of each year. If the difference in value of trading stock at the
end of the year is not more than $5,000 then the SBE taxpayer does not have to:
Value each item of trading stock on hand at the end of the year; or
Account for the change in value of trading stock on hand.
Readings
Deductibility of expenses:
Is it an expense incurred in No deduction allowed unless

earning assessable income or No there is a specific section which
necessarily incurred in carrying allows a deduction Division 25.
Yes
Is it specifically excluded being Then no deduction allowed

private, capital or incurred in Yes
earning exempt income?
No
Is there a specific section which Then no deduction for that

denies or reduces the amount Yes portion.
of the deduction - Division 26 or
s.82KZM?
No
Then no deduction allowed in

Was it incurred in the current No the current year
year?
Yes
Allow the deduction

SUMMARY
SBE Taxpayers
Prepayments are allowed for up to 12 months after year end.

Trading stock there is no change if year-end value is not more than $5,000
different to value at the commencement of the year.
Immediate deduction of certain expenses associated with a proposed business
Prepayments
Non-business individuals (e.g. owners of rental properties or share portfolios
or employees)
Can prepay for up to 12 months
Non-SBE business taxpayers (e.g. owners of large businesses)
Prepayments limited to period of current year to which they relate.
Prepayment x days in the current year to which prepayment relates

Prepayment period
Non-SBE, non-business, non-individual taxpayer (e.g. companies, trusts

holding investment properties)
Prepayments limited to period of current year to which they relate.
Prepayment x days in the current year to which prepayment relates

Prepayment period
Borrowing expenses s.25-25
Remaining expenditure = $$.cc x days = deduction

Remaining loan period
Business-related capital expenses s.40-880
Expense x 20% in each of 5 years

Immediate deductions for SBEs on certain expenditure associated with a propose
business.
Now that you have completed this Topic you should be able to:
calculate general and specific deductions available to individuals;
calculate the general specific deductions available to businesses;
determine the manner in which losses are carried forward and offset; and
calculate the taxable income and the net tax payable by an individual taxpayer
who is carrying on a business that includes trading stock.
TOPIC TWO QUESTIONS - DEDUCTIONS
1. Give examples of outgoings which are:
(a) of a capital nature;
(b) private or domestic.
2. Explain briefly whether and to what extent the following are allowable
deductions:
(a) $400 city rates paid on a property used half for business and half as a
residence by the owner.
(b) $800 cost of a security alarm system in a shop.
(c) Local government rates paid on a beach holiday house.
(d) Water bill paid by the owner but incurred by the tenant.
(e) Repairs to a boundary fence on acquisition of a rental property.
(f) Repairs to a boundary fence 3 years after acquisition. Tenants

damaged the fence during a party.
(g) Repairs to a rental property. The repairs were carried out after
acquisition to remedy defects, which were in existence at acquisition.
The owner was able to get an unemployed person to live in the house
while the renovations were carried out. The tenant paid a lower rent
during the period the renovations were being carried out.
(h) New dishwasher bought for rental property. The dishwasher that was in
the property at acquisition was considered to be too old so it was traded
in on the new model.
deductions:
(a) Interest paid on money borrowed to purchase shares for investment

purposes.
(b) Interest on a mortgage over rental property.
(c) Interest on borrowed money used to purchase a residence by a

chartered accountant. He is employed by a large firm in Perth but often
has to take work home for completion in his study.
(d) Interest on loan used 80% to buy an interest in a business and 20% on
home renovations.
(e) Interest on loan to buy computer. The taxpayers children use the
computer to complete homework and play computer games.
(f) Interest on loan to buy computer. The taxpayer uses the computer to do
work at home. Her employer provides her with a computer to use at
work but she does additional work at home.
(g) An accountants annual subscription to the Institute of Chartered

Accountants of $600.
(h) Cost of overseas calls by an employee on his home telephone to discuss

sales results with his boss.
(i) Sickness insurance premium.
deductions:
(a) $10 safety goggles purchased by a welder.
(b) $50 skirt purchased by a flight attendant.
(c) $5 dry-cleaning expenses incurred by a salesman in a clothing store. His

employer insisted that the appearance of his suit be improved.
(d) Jeans ($20), jogging shoes ($30) and riding hat ($60) for apprentice
jockey.
(e) A green striped skirt and white blouse that a taxpayer wore to work every
day.
(f) A pair of blue shorts and a colourful shirt worn by the employees of a pool
maintenance company. The business name was embossed on both the
shirt and the shorts.
deductions:
(a) A payment of $100 per week for child minding. Without this arrangement
the taxpayer would have to remain home with the child and could not
work.
(b) $720 paid by a practising accountant to a coaching college relevant to

obtaining membership of an accounting body.
(c) An amount of $5,000 invested in shares by Robert who speculates on the

Stock Exchange. During the course of the year he lost all his capital.
(d) $5 donation to an Association for the Blind which mails out a pen in
return.
6. On 1 July of the current income year Janet bought a computer for work
purposes. The costs were:
$
Computer including software 10,500
Paper 800
Maintenance 4,800
Installation 1,050
Delivery 440
Total costs 17,590
Determine the amounts which:
(a) should be capitalised;
(b) are allowable as deductions.

7. Sze Chai owns a number of rental properties. His income and expenses for
his properties are as follows:
Income $
Rent 25,000
Expenses
Agents commission 1,500
Bank fees and charges 125
Loan repayments - of these repayments $12,063 was
interest and the remainder was repayment of capital 18,000
Repairs to hot water system 600
Purchase of new hot water system to replace worn out system 1,200
Rates and Taxes 2,400
Gardening 1,040
New roof for one of the properties which has been
owned for six months. The roof needed repair at
the time of purchase, even though Sze Chai didnt
know it. 6,000
Calculate Sze Chais taxable income and net tax payable including
Medicare levy, in addition to the above, he earned a salary of $60,000 and
made a donation of $100 to the Red Cross.
8. Which of the following expenses are deductible expenses of self-

education?
(a) HECS-HELP fees paid by an undergraduate student;

(b) Fees paid by in international student to an Australian university;
(c) Fees paid to CPA (Australia) for a one-day taxation update course;
and,
(d) Fees paid to the Institute of Chartered Accountants for professional
year studies.
9. June is a primary school teacher whose income and deductions are as

follows:
Income $
Salary 35,000
Interest 1,500
Dividends franked to 100% 3,000
Franking credits attached to dividend $1,286
Expenses
Travel to and from work 3,500

Subscription to Teachers Association 180
Cost of small items to give as rewards to students
e.g. gold stars etc. 250
Miscellaneous stationery coloured paper etc. 95
New computer 2,800
June commenced a Masters degree in Education in February and incurred

the following expenses:
$
Course fees which June used FEE-HELP to pay 900
Student Association fees 60
Travel expenses -
Home to university and return 200
Home to university 85
University to work after class
having travelled to university from
home 90
Work to university 70
University to home after class (after work) 65 510
Stationery 10
Books 350
(a) Calculate Junes taxable income and net tax payable including
Medicare levy.
(b) Re-calculate your answer if the study was a 10-day professional

seminar taken by June. The only relevant travel expenses will be
the $200 travel to and from the venue. Student Association fees
should be deleted and replaced with parking costs.
10. Anthony is a gardener who now has some managerial responsibilities in

addition to his gardening duties. He is studying a Bachelor of Commerce
degree to help him with his managerial duties. He incurred the following
expenses in relation to his self-education:
Occasional courses offered by the Horticultural Society

relating to gardening trends and new plants 2,300
Travel to and from these courses 420
Bachelor of Commerce at Curtin University
HECS-HELP liability 2,000
Travel from home to university 200
Travel from university to work (after the journey above) 400
Travel from work to university and return 600
Books 890
Stationery 330
(a) Calculate the deductions to which Anthony is entitled.
(b) Calculate the deductions if the travel from university to work was
$185?
(c) How would your answer change if instead of studying the Bachelor of
Commerce, Anthony was studying a MBA at Curtin and the FEE-HELP
expense was now fees paid to Curtin? Use $400 for the travel from
university to work.
11. Shirley worked as a data entry operator in a government department and

received a salary of $15,000 during the current income year, $2,000 of which
was a backdated pay rise relating to the previous year. In addition, she
received Sickness Benefit of $1,000 and Army Reserve Income of $3,500.
Shirley contributed $100 to the Government Officers Association. She also

bought a computer for use at home to improve her skills. The computer cost
$1,000 and she also bought computer disks for $60. Shirley monitored her
use of the computer and she used it one third of the time for work related use.
She uses 10% of her home as a study where the computer is located and paid
$10,000 in mortgage interest during the year in respect of her home.
Calculate Shirleys taxable income and net tax payable including

Medicare levy
12. Dougal's income and expenses for the current year were as follows:
Income $
Salary 50,000
Tool allowance 500
Dividends - franked to 80% 3,900
Franking credits attached to the dividend were $1,337
Dividends franked to 100% 10,000
Franking credits attached to the dividend were $4,286
Dividends - unfranked 1,000
Naval Reserve salary 3,000
Expenses
Travel to and from employment 5,600
Travel from employment to Naval Reserve training 500
Interest-only repayments on loan used to buy
dividend-producing shares. The interest was $200
per month paid on the first day of each month.
Dougal paid monthly until February when he prepaid
24 months' interest. 6,200
Dougal had taken out the loan on 1st March of the
previous year. He had paid stamp duty and loan
application costs totalling $600. The loan was to be
repaid at the end of 8 years.
Tools purchased small items used in the course of
work 320
(a) Calculate Dougal's taxable income and net tax payable including
Medicare levy.
(b) Re-calculate taxable income and net tax payable if interest was
prepaid for 12 months.
(c) Re-calculate taxable income and net tax payable if the term of the
loan was 4 years but the prepayment remains as in Part (a).
13. Are the following expenses allowable deductions? Give reasons.
(a) Local Government rates, water charges and land tax on a taxpayers
place of business.
(b) Cost of hiring of telephone answering machine for business use.
(c) Cost of entertaining an acquaintance with a view to persuading him to

join the taxpayers business staff.
(d) A sponsorship of $1 million to the local football team by a casino.
(e) $500 insurance premium against loss of stock, cash and plant.
(f) Cost of removing plant to a new factory.
(g) $100 prize to the best-dressed salesman by a department store

owner.
(h) A premium paid for a two-year lease on shop premises.

(i) Superannuation contributions made by a self-employed carpenter.
(j) Legal expenses incurred in arranging an overdraft, which is reviewed

annually, for business purposes.
(k) Annual membership of a yachting club paid by a canvas goods

manufacturer.
(l) Wages paid to the taxpayers nephew of $100 per week for two hours
work involving filing business correspondence in a two-man business.
(m) Employee wages $6,500 paid to a de-facto spouse. The Commissioner

would consider $750 reasonable.
(n) A gratuity of $2,000 to a former employee who is in financial difficulties.
(o) Legal expenses of $160 incurred in the discharge of a mortgage over a

private residence. The mortgage was obtained to expand business
premises.
(p) $380 incurred by a company in connection with an appeal to have the

valuation of a companys land reduced for assessment purposes under
a State Land Tax Act.
(q) Loss of cash by burglary of business premises.
(r) Legal expenses of $300 for future incorporation of the business.
(s) $1,080 paid to the Bank for borrowing expenses in connection with a
loan to buy a new manufacturing machine. The loan is for 6 years,
commencing on 1 November of the current income year. How would
your answer differ if the loan had commenced on 1 November of the
previous financial year?
(t) A discount allowed on the sale of book debts in the course of disposing
of a business.
(u) Costs incurred by a commission agent in unsuccessfully negotiating for

new agencies to expand his business.
14. During the year SHONKY Pty. Ltd. incurred the following legal and financial
expenses:
(a) $1,850 paid to a bank in connection with a loan to buy new

manufacturing plant. The loan was for 6 years commencing on 1
February of the current income year, and the payment consisted of
$500 application fee and $1,350 interest for 15 months in advance.
(b) $200 legal expenses for mortgage required by bank in respect of the
above loan.
(c) $175 legal expenses for discharge of previous mortgage in connection

with a loan, now repaid, which had also been used to purchase plant.
(d) $150 legal expenses for lodging an objection to the companys

income tax assessment for the prior year.
(e) $320 legal expenses for altering the companys constitution.
Calculate the deductions which may be claimed by the company.
15. Rex borrowed $20,000 @ 12.6% (flat rate) p.a. for 5 years to buy a car.
Repayments are for interest only. His records show the car is used 75% in the
course of his employment.
Calculate the allowable deduction in each of the following situations

where the loan was taken out on 1 July of the current income year and the
first repayment was made on the same day in the following situations:
(a) Rex pays monthly for the whole year.
(b) Rex pays monthly, and then on 1 May CY pays for 4 months.
(c) Rex pays monthly and then on 1 January CY pays for 8 months.
(d) Rex pays monthly, and then on 1 May CY pays for 16 months.
Calculate your answer if Rex was a non-SBE business owner and a SBE
taxpayer who had elected to use the prepayment option.
16. Malcolm Woodchip, a furniture salesman, commences business on his own on

1 April of the current income year. He purchases an existing business and is
granted a lease of showrooms. Explain whether, and to what extent, the
following outgoings are allowable deductions.
1 April Paid $15,000 premium for a 6-year lease.

Paid $600 to a mortgage broker to obtain a loan of the $15,000
at 18% for the 6-year period.
Paid $225, one months interest in advance.
Paid $620 to his lawyer to help him set up his business.
1 May Paid $225, one months interest in advance.
30 May Paid $1,000 to his daughter Mary, age 24 for assisting him in
opening the business.
15 June Paid $100 towards June interest and promised to pay the
remaining $125 plus July interest on 1st July.
17. Are the following amounts of interest deductible?
(a) Interest paid on mortgage of home to enable taxpayer to acquire

additional machinery to use in his business.
(b) Interest on money borrowed from the bank to purchase a house in which
the taxpayer resides and from which he conducts a real estate agency
business.
(c) $3,000 loan interest. The loan was used to purchase manufacturing
equipment.
(d) Interest on a loan taken out to pay personal superannuation.
18. Are the following car expenses deductible?
(a) Incurred by self-employed business man in travelling from home to place

of business.
(b) Incurred by sales representative in travelling from employers place of

business to see client and return.
(c) By self-employed tradesman (who works from home) from home to a

customer and return.
(d) Lease payments on a motor vehicle used 30% for business purposes.
19. Calculate the deduction and specify the section which applies in each
instance. The taxpayer is self-employed and all the expenses relate to the
business.
(a) An application fee of $820 to a bank to arrange a loan. The loan is

eventually negotiated and is for a term of 18 years and commenced on 1
May CY.
(b) Stamp duty of $4,900, valuation fees of $3,400 and legal expenses of
$5,100 are paid in respect of the above loan.
(c) Interest of $8,800 is paid during the current year in respect of the above
loan.
(d) The taxpayer also leases a property during the current year and pays a
lease premium of $25,000 and legal expenses in reviewing the lease
documents of $2,300.
(e) The taxpayer also paid legal expenses of $12,000 in setting up the
business which commenced on 1 July CY.
(f) The taxpayer paid an Entertainment Allowance of $1,500 to the Sales

Manager
(g) The taxpayer provided the Sales Manager with a motor vehicle the cost
of providing the car and running costs were $10,000.
(h) The taxpayers personal motor vehicle cost also amounted to $10,000
although his work-related use was 90%.
20. Arabella operated a business and had the following income and expenses
during the current year.
$
Business income 100,000
Business expenses deductible under s.8-1 150,000
(a) What is her loss for the current year?
(b) Arabella also has exempt income of $20,000. What is her loss for the
current year?
(c) In addition to the exempt income at (b) above, Arabella also had paid
superannuation of $10,000 for herself and made a tax deductible
contribution to the Red Cross of $2,000. What is her loss for the current
year?
21. Tom operated a business and in the previous year he made a loss of $10,000.
In the current year he had income of $200,000 and expenses of $150,000.
(a) What is his taxable income for the current year?
(b) What is his taxable income for the current year if he also had exempt
income of $2,000?
(c) What is his taxable income for the current year if in the previous year the
loss arose after payment of personal superannuation of $3,000? He has
no exempt income in the current year.
(d) Use all the information in part (c) above but he also has exempt income in
the current year of $2,000.
22. Minnie Muss owns and operates a haberdashery shop. Her details for the past
three years are:
Year ended 30.6 Yr 1 PY CY

$ $ $
Gross income from shop 15,000 23,000 35,000

Deductions
A) allowable under:
1) s.8-1 27,000 22,500 24,000
2) Division 290 2,000 2,000 2,000
Prepare a statement setting out the taxable income for each of the three
years.
23. Derek Goldfinger, a resident taxpayer of Australia, commences business

operations on 1 July Year 1 and the table of his operations is as follows:
Yr 1 Yr 2 Yr 3 PY CY
$ $ $ $ $
Exempt pension 2,500 2,500 2,500 2,500 500
Net Income/Loss loss loss profit profit profit

from Business 8,000 1,000 1,200 1,000 2,200
Gifts to charities
listed in Division 30 300 350 400 400 420
Prepare a statement setting out Goldfingers taxable income for the years
shown. Assume that the non-commercial loss provisions do not apply.
24. Which of the following meets the definition of trading stock?
(a) loaves of bread in a bakery;
(b) buckets of oranges at the green grocer;

(c) spare parts held by a hire car firm for maintenance and repair of its own
vehicles;
(d) Mums backyard hens kept for their eggs which feed the family;
(e) sugar, flour, milk, butter and eggs which are used in the production of a
well-known brand of cakes;
(f) draught horses used to pull beer wagons for advertising purposes;
(g) wheat growing in the field.
25. Smith conducts a retail grocery store which he purchased together with a
freehold property on 1 August of the current income year. Mr Smith has
extracted the following information from the cashbook of the business and
requests your advice as to how the items should be treated in his income tax
return for the current income year.
Indicate briefly which items are allowable deductions, with reasons.
(a) Show cases 320
(b) Replacement of guttering and down pipes from roof 140
(c) Demolish and remove old shed from the rear of shop 78
(d) Painting and redecorating store 180
(e) Replace window broken by vandals on 15 May of the current income year 45
(f) Contribution to a superannuation fund conducted by a trading bank. 2,400
26. For taxation purposes which of the following methods is not acceptable
to the Commissioner of Taxation for determining the value of trading
stock?
(a) FIFO
(b) LIFO
(c) weighted average cost
(d) standard costs which are regularly updated
(e) retail inventory
(f) base stock
27. Lira and Yen are competitors in the shoe retailing business. On 30 June of
the previous year both valued their closing stock at market selling value,
$10,000 and $20,000 respectively. At 30 June of the current income year,
closing stock valued at cost is $6,000 for Lira and $15,000 for Yen; if
valued at market selling value it would be $18,000 and $12,000
respectively.
If Lira wishes to show a high gross profit for the current income year which
basis of valuation should he use? Support your answer with calculations.
If Yen disposed of his business and his trading stock on 30 June of the
current income year, what would be the effect on his assessable income?
28. An SBE taxpayer had opening stock valued at $58,000 and closing stock
valued at $55,000.
What options does the taxpayer have in relation to trading stock for
the year?
29. Julian operated a business selling wooden hand-made toys for children.
The business has been operating for 4 years but has never made a profit
in that time. In the current year he has made a loss of $10,000 but his
turnover from this business is less than $20,000 and the value of the real
property and other assets were under the required thresholds for Division
35. He also has a salary of $120,000 from his full-time job.
(a) What is his taxable income for the current year?
(b) How does your answer change if, on 1 July CY he moved into leased
premises worth $670,000?
30. Jeb (49 years old) operates 2 news agencies in the centre of Perth. He
allows regular clients to run accounts for newspapers and magazines. He
issues outstanding accounts on the last day of each month and they must be
paid by the 15th of the following month. During the current year Jeb has
received payments from these accounts of $75,000. $6,000 of this amount
was received for invoices issued on 30 June PY. On 30 June CY he issued
invoices for $7,900 for June CY accounts. Of these invoices only $7,580
were paid by 15th July FY.
He received $380,000 from the sale of other items from the news agencies
during the year.
In addition to this business Jeb also ran dancing classes 3 nights a week and
on Sunday afternoons. He was a very successful dancing teacher and his
classes were always sold out. Students were required to pay for their classes
in advance and he ran 3 series of classes a year. During the current year he
had received $34,000 for classes. $12,000 of this was for the term starting in
July FY. Jebs classes were so popular that he always refunded fees for
people who couldnt complete the course because he had a waiting list of
people waiting to join. Courses commencing in July CY were paid in the prior
year and fees for these totaled $11,000.
Jeb fell last year when he was walking through the shopping centre in which
his news agency was located. The insurance company paid him $1,800 in
July CY for permanent damage to his finger which was injured in the fall.
Jeb lent a friend of his $85,000 to use to buy his home. During the year the
friend repaid $10,000 of the loan and $3,500 in interest.
Details of stock movements were as follows:
30 June PY 30 June CY
$ $
Stock on hand (cost) 88,000 120,000
Stock on hand (replacement) 122,000
Stock on hand (market selling value) 115,000
Expenses of the news agency are as follows:
$
Bank fees and charges 870
Electricity this included Jebs personal electricity bill
of $1,100. Jeb thought he could claim this because
he did his paperwork for both his businesses in his
home office which occupied 10% of his house. 14,600
Purchase of stock 120,000
Purchase of new counter for shop 24,500
Rates and taxes 5,500
Rent for one news agency and the hall for
dancing classes 16,300
Superannuation for himself 25,000
Wages Jeb paid his brother $15,000 to work on
Saturdays. This was $2,000 more than is paid to another
worker who worked the same hours on Saturdays 130,000
Jebs business had made a loss of $45,000 in the prior year. This included
Jebs personal superannuation contribution of $15,000.
Required:
Calculate Jebs taxable income assuming he wished to minimize his

taxable income and is a SBE taxpayer.

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TOPIC TWO - DEDUCTIONS

determine if expenses are incurred in the course of gaining or producing

identify losses or outgoings which are statutory deductions;

identify expenses which are specifically excluded from deduction;

determine expenses which are necessarily incurred in carrying on a business;

calculate the amount of allowable deduction in the case of a prepayment;

identify trading stock;

apply the acceptable methods of valuing trading stock.

Losses and outgoings 8-1

Double deductions 8-10

Tax-related expenses 25-5

Lease expenses 25-20

Borrowing expenses 25-25

Mortgage discharge 25-30

Losses by embezzlement 25-45

Travel between workplaces 25-100

HELP payments 26-20

Payments to associated 26-35

Limitation on certain 26-55(1)

Non-compulsory uniforms Division 34

Non-commercial losses Division 35

Definition of trading stock 70-10

Trading stock to be taken 70-35

Superannuation paid on Division 290

All expenses in this and following topics are GST-exclusive.

Section 8-1 The General Deduction Provision

Section 8-1 allows deductions to the extent:

(b) They are necessarily incurred in carrying on a business (THE SECOND

There are 4 exclusions under s.8-1:

(a) Capital expenses;

(b) Private or domestic expenses;

(c) Expenses incurred in producing exempt income, or;

(d) Expenses which are specifically disallowed under the Act.

Example 2:1 Incurred expense

On 29 June CY a business buys some stationery on account for $1,000. The

Example 2:2 Capital expense

What deductions can each of these taxpayers claim in this year?

Private or domestic expenses

Clothing and uniforms

1. Clothing which is protective (i.e. it protects a person from injury or protects

2. Occupation -specific uniforms can be deducted e.g. chefs checked

3. Compulsory uniforms are deductible (e.g. QANTAS airline employees,

Protective Clothing Occupation Compulsory Employer Logo

Division 34 deals with the issue of non-compulsory uniforms. Non-compulsory

Example 2:3 Clothing and uniforms

What deduction is Simon entitled to?

Home office or home study expenses

The cost of providing a taxpayer with accommodation is a private expense. The

Mortgage interest or rent;

Example 2:4 Home office expenses and home study expenses

What expenses can Nancy claim for the year?

1. Is home the place of business or is it where Nancy chooses to do some extra

2. How much of the home is used for the business?

Interest 15% x $15,000 2,250

1. Is home the place of business or is it where Stanley chooses to do some extra

2. How much of the home is used for his employment duties?

15% of the running costs can be deducted.

Electricity 15% x $7,800 1,170

Ownership Cost Running costs

Home as a place of work Yes Yes

Taxpayers who work from home either as the place of business or as an

Cents per kilometre method, and