CO5120

Taxation Law

Module 5

Specific Deductions
 Other Deduction Provisions
a. Those permitting SPECIFIC
OUTRIGHT (and IMMEDIATE)
deductions;
b. Those SPREADING DEDUCTIBILITY
over time;
c. Those DENYING or RESTRICTING
deductibility.
 Specific Outright Deductions

1. Repairs;

2. Bad Debt write-offs;

3. Carry forward losses;

4. Gifts and Donations.

 Repairs - s 25-10
(1) You can deduct expenditure you incur for
repairs to premises (or part of premises) or a
depreciating asset that you held or used solely
for the purpose of producing assessable
income.
(2) If you held or used the property only partly
for that purpose, you can deduct so much of
the expenditure as is reasonable in the
circumstances.
(3) You cannot deduct capital expenditure under
this section.
 THE ELEMENTS OF s 25-10
Expenditure
You incur
For repairs
To premises or a depreciating asset
Held or Used Solely or Partly for producing
assessable income
Not being Capital Expenditure
 REPAIR

The essence of a repair is RESTORATION

of an income-producing asset to its
PREVIOUS condition.
 “Repair” Principles
1. Repair involves replacement or renewal of PART of
an item not the entire item. (That would be a capital
expense.)
2. The work will be of a capital nature (and NOT
deductible as a REPAIR) IF it involves:
– an addition to an existing asset; or
– an improvement to an existing asset;

3. Initial repairs are NOT deductible.

4. Pre-emptive repairs ARE deductible.
5. Notional repairs are NOT deductible.
6. You can perhaps get a deduction for capital
improvements under Div. 43.
 “Repair” or “Addition”?
The Test:

Did the work result in an EXPANSION of

the BASIC CAPITAL STRUCTURE?
 “Repair” or “Improvement”?

The Test:

Did the work make the item

SIGNIFICANTLY FUNCTIONALLY
BETTER than it was previously?
Points to Note on “Improvement”
1. Use of materials different from the original is
not necessarily fatal to the claim for a
deduction (especially if that use involves both
advantages and disadvantages).

2. Ask whether the work improves the value of

the asset (from its original state – not from its
state of disrepair).
3. Does the expenditure reduce the likelihood of
having to do future repairs?
 “Initial” Repairs
Not deductible - because the expenditure is
to rectify “initial defects”.

Therefore, the expenditure results in an

IMPROVEMENT to the asset purchased -
so it is an expenditure of CAPITAL.
 Pre-emptive Repairs
• Repairs are NOT limited to rectifying defects that have
already become serious.
• Deductions can be claimed for work that is done partly
(or even) largely to prevent or anticipate defects or
damage or to rectify defects in their early stages.
• A deduction will not be permitted if the work results in
an improvement (see BP Oil Refinery (Bulwer Island) 92
ATC 4031).
• Routine maintenance (greasing, oiling, cleaning etc) of
something in good working order is not claimable as a
repair but it can be claimed under s 8-1 (the general
deduction provision).
 Notional Repairs
You cannot carry out capital improvements to
an asset and then claim a tax deduction for the
“notional amount” that you would have spent
IF you had repaired them instead.
See the words of s 25-10(1): “You can deduct
expenditure you INCUR for repairs…”
See also FCT v Western Suburbs Cinemas Ltd
(1952) 86 CLR 102 at 107
 Division 43
• Work involving an “improvement” may be
deductible under the “Capital Works” provisions
in Div 43.
• Div 43 applies to “capital works being a building,
or an extension, alteration or improvement to a
building” and to “structural improvements, or
extensions, alterations or improvements to
structural improvements” and “environment
protection earthworks” – s 43-20.
• The deduction is either 2.5% or 4% of the
expenditure (ie over 40 or 25 years).
Question 1
 Specific Outright Deductions

1. Bad Debt write-offs;

2. Carry forward losses;

3. Gifts and Contributions.

 Bad Debts - s 25-35
To get a deduction for writing-off a bad debt you
must show that there was:
a. a debt (an existing debt);
b. that you write off as bad;
c. in the income year; AND
d. it was included in your assessable income for
the income year or for an earlier income year.
 Other Considerations
Partial Write-offs
• If you get part of what you are owed but have
to write off the balance you get a deduction for
the part you write off – see s 25-35 (1) and (3).

Recovery of a Written-off Bad Debt

• The recovered amount (referred to as a
“recoupment” is income and taxable in the year
of recovery – see s 25-35(5) Item 4 and ss 20-20
and 20-30(1) item 1.4.
Carry Forward Losses – Div 36
Tax losses can be carried forward and offset against income
in a later year (they can be carried forward indefinitely).

Carry forward losses are offset first against exempt income

(if any) and then against assessable income.

They are offset in the order in which they were incurred.

The rules differ slightly for corporate tax entities (s 36-17)

and other tax entities (s 36-15).(Corporate tax entities may
choose the amount they offset in the later year and may
choose a nil amount).
 Gifts - Div 30
1. Normally private or domestic in nature - and
therefore not deductible;

2. Will be deductible IF they fall within Div 30

(ie to hospitals, schools, universities, sports,
recreation or cultural groups etc);

3. BUT they must be GENUINE gifts (see s 78A)

– and they will not be deductible if they are
given in exchange for some other benefit.
Section 78A(2) ITAA 1936
Subject to this section, a gift of money, or of property other
than money, … is not an allowable deduction under
Division 30 of the Income Tax Assessment Act 1997 where:
…
(c) by reason of any act, transaction or circumstance of a
kind referred to in paragraph (a), the donor or an
associate of the donor has obtained, will obtain or may
reasonably be expected to obtain any benefit, advantage,
right or privilege other than the benefit of any deduction
that, but for this section, would be allowable from the
assessable income of the donor under Division 30 of the
Income Tax Assessment Act 1997; or
(d) …
 Deductions Over Time

1. Prepayments (ss 82KZL et seq)

2. Borrowing Expenses (s 25-25)

3. Depreciation (Div. 40)

 Pre-payments/Advance Payments
See ss 82KZL TO 82KZME
• Advance payments are generally deductible over the life of the
benefit or 10 years, whichever is the lesser (the ‘eligible service
period’)

UNLESS they are:

• ‘Excluded expenditure’ (amounts under $1000 or that are

required to be paid by law or by an order of a court or are salary
or wages paid under a contract of service).

• Non-business pre-payments by individuals - where the eligible

service period is 12 months or less and ends no later than the last
day of the next tax year (the ’12 month rule’).

• Prepaid expenditure by eligible small business entities – the ‘12

month rule’ applies. If the eligible service period exceeds 12
months use the general rule.
Borrowing Expenses - s 25-25
A deduction is permitted for borrowing expenses PROVIDED the
loan is used for income producing purposes.

There is no deduction if the loan is for private or domestic purposes

or to enable the taxpayer to derive exempt or non assessable, non-
exempt income.

‘Borrowing expenses’ include loan establishment fees, procuration

fees, legal expenses, stamp duty and loan guarantee insurance etc.

They do not include interest – which is separately deductible.

Borrowing expenses are generally deducted over the life of the loan
or 5 years, whichever is the LESSER – s 25-25(5).

Unless they amount to $100 or less - when you write them off in the
year of expenditure – s 25-25(6).
Question 2
 Depreciation/Uniform Capital
Allowance System - Div 40
• deduct an amount equal to the decline in value of a
depreciating asset (40-25(1));

• which has a limited effective life and which is

reasonably expected to decline in value (s 40-30);

• which is held by the economic owner (s 40-40);

• beginning when you first use it or have is installed

ready for use (the start time – s 40-60); and

• ending at the end of its effective life (s 40-95).

 Effective Life
Once an asset starts to lose value you depreciate it
over its effective life.

A taxpayer can determine effective life by either:

a. calculating its effective life himself/herself (s 40-105);
or

a. accepting the Commissioner’s ‘safe-harbour’

determination of the asset’s effective life under s 40-
100 (the ‘default’ position).
 Methods (your choice – s 40-65)

• diminishing value method (s 40-70 or 40-72)

Base value x Days held x 150% or 200% .
365 Asset’s effective life

OR

• prime cost method (s 40-75)

Asset’s cost x Days held x 100% .
365 Asset’s effective life
Using the Asset only Partially for a
“Taxable Purpose”

Two (2) forms:

a. a part year use of depreciable plant; and

b. only partial use of the items for income

producing purposes (s 40-25(2)).
 Example
Cost: 1/7/TY1: $1000 (after May 2006)
Life: 5 years
Business use: 75%

Tax year 1 (ie to 30/6/TY1):

Actual Decline in value (DVM) =
$1000 x 365 x 200% = $400
365 5yrs
Depreciation deduction = 75% x $400 = $300

Tax year 2 (ie to 30/6/TY2):

Actual Decline in value (DVM) =
$600 x 365 x 200% = $240
365 5yrs
Depreciation deduction = 75% x $240 = $180
 Balancing Adjustments
• apply when a partially depreciated asset is
disposed of, lost or destroyed;
• a deduction is allowed IF the ‘termination
value’ is less than the adjustable value just
before the event occurred (s 40-285(2));
• an amount is included in assessable income IF
the ‘termination value’ exceeds the adjustable
value just before the event occurred (s 40-
285(1)).
 Balancing Adjustments after a
Non-taxable Use – s 40-290
Reduce the balancing adjustment IF the asset was used for purposes
other than income producing purposes.

A sale of the asset in the example above on 30/6/TY2 (after 2 years):

Cost on 1/7/TY1: $1,000
Total decline in value in TY1 & TY2: $640 (ie $400 + $240)
Written Down Value as at 30/6/TY2: $360
Depreciation deduction allowed to date: $480 (ie $300 + $180)
Sale price on 30/6/TY2: $600
Gross balancing adjustment = $240 ($600-$360) ADDED to income.
Reduction = Sum of reductions x Balancing Adjustment Amount
Total decline
= $160 x $240 (ie $600-$360)
$640
= $60
Therefore Actual balancing adjustment = $240 - $60 = $180.
Question 3
 Other Depreciation Issues

1. Low value pools (sub-div 40-E);

2. Pooled Project Expenditure (sub-div 40-I).

 Restriction and Denial Provisions
1. Double deductions – s 8-10.
2. Payments to Associated Persons – s 26-35.
3. Motor Vehicle Depreciation Limits – s 40-230.
4. Losses from non-commercial business
activities - Div 35.
5. Entertainment – s 32-5.
6. Fines and Penalties – s 26-5.
7. Recoupments – s 20-10 to s 20-65.