03. Tax Deductions

Joshua Easton


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BUSINESS AND EMPLOYMENT DEDUCTIONS 

Income tax is calculated based on a taxpayer’s taxable income. The fundamental equation is: assessable income less allowable deductions equals taxable income.

In claiming income tax deductions there are “general” and “specific” deductions.

The general provision for claiming allowable deductions is section 8(1) of the Tax Act, which states that any loss or outgoing is a tax deduction to the extent that:

  • It is incurred in gaining or producing assessable income; or
  • It is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

It should be noted, however, under the second limb of section 8(1) that you cannot claim a deduction if the outgoing is of a capital, private or domestic nature.

There are also provisions in the Tax Act that prevent you from claiming certain deductions, for example fines and most entertainment expenses.

SUBSTANTIATION 

The key principle underlying substantiation is that to deduct work expenses, a taxpayer needs to have written evidence of the expense.(Division 900 of ITAA 1997) Note that substantiation applies only to individual taxpayers and partnerships that include at least one individual. Normally the written evidence must be kept for a minimum of five years from the date of lodgement of the return in which the claims are made.

Once you have established that the relevant expenses were incurred in earning assessable income or in carrying on a business, the substantiation rules must be considered before the expense is claimed.

There are exceptions where substantiation is not required:

  • The total claimed for all employment related expenses is less than $300.
  • Laundry expenses up to a maximum of $150.
  • Travel claims less than the amounts stipulated in TD 2018/11, provided that a bona fide allowance has been paid to you as an employee.
  • Car expenses under the cents per kilometre method.
  • Overtime meal allowances up to $30.60 per day (TD 2018/11).

Under the substantiation requirements, you must have documentation that contains the following:

  • The name of the supplier
  • The amount of the expense
  • The nature of the ‘goods’ or services
  • The date the expense was incurred
  • The date the document was made out.

Small expenses of $10 or less that total less than $200 per annum do not require substantiation if you record the details in a book or a diary.

MOTOR VEHICLE EXPENSES

Whilst business travel expenses or employee work-related expenses are deductible, travel expenses incurred travelling between home and work are not generally deductible.

However, if you have a detour for work-related expenses on the journey to see a client, a tax deduction may be claimed.

Taxpayers who have to carry heavy or bulky equipment to their place of work may also claim a deduction.

Examples:

  • A self-employed tradesman will be able to claim a deduction if he uses his home as his base and when he travels to sites is obliged to take his own tools of trade and equipment. In 2016 the ATO made it very clear that where there is a secure place to store the tools or where any employer provides suitable tools onsite then this then this deduction is not allowable. The ATO continues to focus on these cents per kilometre claims in
    2017/18.
  • Musicians who carry bulky equipment e.g. amplifiers to their place of performance may be able to claim a tax deduction.
  • Trips to town by primary producers will be deductible if it can be shown that the principal purpose of the journey was business in nature. Examples could include purchasing equipment and supplies or visiting the bank.

When claiming motor vehicle expenses there are two choices open to the taxpayer.You may alter your choice from year to year and make a fresh choice when replacing a vehicle.If you are choosing the actual cost method, it may be necessary to keep a replacement logbook.

If you own more than one vehicle, a claim may be made for each vehicle if it can be demonstrated each vehicle has a business use.

Please note the “one third of actual expense method” and “the 12% depreciation method” were abolished from 1 July 2015.

CENTS PER KILOMETRE METHOD  

This method is available for motor vehicle usage up to 5,000 kilometres of business use.

In cases where the vehicle has been used for more than 5,000 kilometres in a tax year, this method is still available as long as the claim is reduced to 5,000 kilometres.

Significant changes have applied since 1.07.2015 with a flat rate of 66 cents per kilometre now applying to relevant motor vehicles. For 2018 – 19 this rate has increased to 68 cents per kilometre.

This method does not have to be substantiated by logbook; however, on occasion the ATO may enquire (particularly in the case of employees) as to how the motor vehicle has been used for business purposes and may seek verification from the employer.

Couples engaged in small business may jointly own and use a car for business purposes.In such cases where the vehicle is used separately by each person, it is possible for both to claim a deduction up to the 5,000-kilometre limit using the set rate per kilometre method.

This method is popular for small business persons and employees who own older vehicles and as such cannot access high depreciation claims.

ACTUAL COST METHOD

Using this method, the total operating cost of the vehicle is determined with an apportionment made between private and business use.

A logbook that is kept in the “prescribed format” determines the apportionment.Logbooks may be purchased at stationers and normally state that they comply
with ATO requirements.

A logbook must be kept for at least 12 consecutive weeks and remains valid for five years as long as there are no substantial changes in patterns of usage. An existing logbook may also be used for a replacement vehicle if patterns of usage remain consistent.

Motor vehicle expenses include all costs and outgoings incurred in operating and maintaining the vehicle.These include, but are not limited to, fuel, tyres, servicing, repairs, maintenance, registration, financing costs (interest), depreciation and/or lease payments. All relevant records to substantiate the amounts claimed must be kept.A depreciation cost limit (maximum amount) applies and is $57,581 for 2017/18 and 2018/19.Cars that cost more than
this can only be depreciated from a value of $57,581.

Be certain to keep change-over details when purchasing new vehicles.The relevant details are make, model and registration number and odometer records of both cars and the date of change-over.

Always be able to demonstrate that your business percentage is based on a reasonable estimate.Although logbooks will be the primary source, changes in patterns of usage or the number of cars you use are also relevant.

EXCEPTIONS TO MOTOR VEHICLE SUBSTANTIATION RULES  

The above rules do not apply to:

  • Panel vans, utilities or other vehicles designed to carry weights exceeding one tonne
  • Taxis
  • Motorcycles and similar vehicles
  • A car only used for lease or hire in a business of leasing or hiring
  • Panel vans, utility trucks or other vehicles designed to carry less than one tonne, (not being vehicles mainly designed for passengers) where no private use is indicated.This usually means that the only private use is travel between home and work.If a second vehicle is owned, it is suggested this contention of incidental private use can reasonably be made.

Although substantiation may not apply, reasonable documentation should still be kept to justify all claims as the ATO has indicated this is now an area
of focus.

CHANGES TO THE INCOME TAX DEDUCTION RULES FOR CAR EXPENSES

The following changes in relation to the available income tax deduction methods for car expenses apply from 1 July 2015:

  • The removal of two calculation methods for work-related deductions for car expenses; and
  • The introduction of a flat rate when applying the ‘cents per kilometre method.’

The measures remove the availability of the ’12 per cent of original value method’ and the ‘one-third of actual expenses method’ for calculating deductions, leaving the ‘logbook method’ and ‘cents per kilometre method’ as the only available options.

In addition, the ‘cents per kilometre method’ will be amended to a flat 66 cents per kilometre rate for all cars, regardless of engine size.The ATO will be responsible for updating this rate in future years.

This streamlines the process of calculating deductions, reduces compliance costs and brings the car expense deductions more in line with the average cost of operating a car.

TRAVELLING EXPENSES 

Substantiation is required for all domestic and overseas travel expenses.Written evidence must be retained regardless of the length of absence from home.

The only exception is expenses incurred by employees that are not in excess of reasonable travel allowances received from employers.

Travel records, being a travel diary or similar document must be kept if you are away from home for more than five nights.The diary must set out:

  • The nature of the activity,
  • The day and approximate time it began,
  • How long it lasted, and
  • The location where the activity took place. 

The travel records required are for business activities only and it will be necessary to establish that the principal purpose of the trip was for business purposes.

PREPAYMENT OF EXPENSES 

Carefully note the tax treatment of prepayments depends on the status of the taxpayer and the amount and nature of the expense.The tax treatment also depends on whether the taxpayer has elected to access the small business entity (SBE) concessions (if eligible).

In general, prepaid expenditure must be apportioned over the period in which the relevant service is provided.

The following expenses are excluded:

  • Amounts less than $1000 (net of GST)
  • Amounts paid pursuant to Court Order or government legislation
  • Salaries and wages
  • Payments by taxpayers using the SBE if the period of service does not exceed 12 months.

Individuals and SBE taxpayers are still able to participate in “tax effective” investments such as forestry plantations by making a prepayment of management fees.

Individuals with negatively geared investments can still make prepayments of interest.

LONG DISTANCE TRUCK DRIVERS 

If in receipt of a travel allowance, employee truck drivers who are required to sleep overnight away from home can claim food and drink expenses up to stipulated daily rates without substantiation.

Expenses must be substantiated if no allowances are paid or if amounts paid are in excess of stipulated amounts.

Acceptable daily rates for 2018/19 are:

Breakfast Lunch Dinner
$24.70 $28.15 $48.60

The amount of each these meal breaks are separate and cannot be aggregated into a single daily amount.

TRAVEL CLAIMS WITHIN AUSTRALIA 

The substantiation requirements do not apply to ‘travel expenses’ incurred by an employee who receives a travel allowance for travel within Australia and the claim for costs of accommodation, food, drink and other incidentals do not exceed reasonable amounts as determined by the ATO.

These are the 2018/19 daily rates for accommodation, meals and incidentals as outlined in TD 2018/11.

Place Salary below $122,040 Salary $122,041 -$217,200 Salary above $217,201
Adelaide $288.05 $368.05 $392.70
Brisbane $306.05 $417.05 $440.70
Canberra $299.05 $406.05 $429.70
Darwin $351.05 $453.05 $476.70
Hobart $278.05 $356.05 $379.70
Melbourne $304.05 $388.05 $448.70
Perth $311.05 $405.05 $448.70
Sydney $319.05 $411.05 $4448.70

Rates for country centres are also set out in the determination. 

NON-COMPULSORY UNIFORMS  

Deductions are not allowed for non-compulsory uniforms unless the design of the uniform is entered on the Register for Approved Occupational Clothing at the time the expense is incurred. This register ceased on 1 April 2017 due to a sunset clause.

CONVENTIONAL CLOTHING  

This is generally disallowed, but there are some interesting exceptions:

  • A professional actor who buys stage clothing specific to a production.
  • A police officer doing surveillance or undercover work who incurs costs to buy clothing he would not normally wear.
  • A television game show host who purchases evening and formal wear to complement the prizes and sets.

OCCUPATIONAL CLOTHING AND PROTECTIVE GEAR

Clothing expenditure is generally private expenditure and not deductible.However, there are circumstances where expenditure on certain types of occupational clothing gives rise to a deduction listed below:

Occupation Specific

Generally, a deduction will be allowed for occupational specific clothing, which clearly identifies a person as a member of a specific profession, vocation, trade, occupation, or calling.Examples may include a barrister’s robes; a chef’s checked pants or a nurse’s uniform. A business suit is not occupation specific and therefore not tax deductible.

Protective Clothing and Footwear\

Such costs are deductible where the clothing is specially designed to protect the taxpayer from personal work injury, disease or death.

Compulsory Uniform

For expenditure to be deductible the work uniform must be distinctive. The wearing of the uniform must be an express policy of the employer, consistently enforced and applicable to all employees at the same class.

Glasses, Sun-hats and Sunscreen 

Since the Morris case (2002), expenditure on sunglasses, sunscreen, and sunhats are deductible for taxpayers who are required as part of their duties to work outside and be exposed to sunlight while performing their duties.

Examples of such taxpayers include those involved in farming, outdoor sports, the construction industry, courier services and other outdoor services.

HOME OFFICE EXPENSES 

A taxpayer can make expenditure claims for home office expenses if it can be shown that part of the home is used for income earning purposes and has the character of a place of business, or is used in connection with income earning activities, but is not a place of business.

Where additional running costs are incurred because of income producing activities, an individual taxpayer may make a claim for home office expenses based on:

  • Actual expenses
  • Diary records for a typical four-week period in each year.This will establish a pattern for the entire year.

In broad terms the following types of expenses are normally incurred:

  • Telephone and internet expenses
  • Heating and lighting expenses
  • Equipment depreciation
  • Occupancy expenses where the home is a place of business.These include rent, interest, etc.

Occupancy expenses are deductible only if a part of the dwelling is set aside and is clearly identifiable as a place of business and used exclusively for business purposes.Having a computer alcove at home will not meet this test.

Note:If you elect to claim occupancy expenses there are Capital Gains Tax implications.Having accepted that your home is a place of business the main residence exemption will be affected.

Alternatively, the ATO allows a claim of $0.45c per hour to cover heating, cooling and lighting costs.

INTEREST 

The fundamental test in determining the deductibility of interest is the “use test”, being the use to which the finances have been put.Security is irrelevant and under section 8(1) of the Tax Act you can only claim a deduction for interest expenses if the funds have been used in gaining or producing assessable
income or in carrying on a business for that purpose.

Examples:

  1. A business owner has a business overdraft limit, which is secured on business assets.The owner decides to use funds of $15,000 to finance an overseas holiday.The interest cost on this $15,000 of the overdraft is not deductible because the borrowings have not been used for business purposes.
  2. A business borrows $30,000 to purchase a new computer system.The loan is secured on the owner’s home.Interest on the loan is deductible because the monies have been borrowed for business purposes and the interest expense has been incurred in carrying on the business.

As long as existing loan arrangements remain unchanged, interest on borrowings that remain after ceasing business are deductible. Interest in connection with borrowings necessarily incurred prior to commencement of business may also be deductible if there is a sufficient connection with the expense and future income derived.

TELEPHONE 

If you are required to contact clients or your employer on a regular basis, or if you are required to be on call, home telephone rental expenses may be partly deductible.

Claims can be made in either of the following ways:

  • A diary or log is kept for 28 days, establishing a pattern of usage for the whole year; or
  • Actual expenses based on a completely itemised account.
  • It is suggested that the itemised account method is too onerous, and the 28-day diary method is recommended. 

REPAIRS 

Deciding whether a claim should be made should be relatively simple; however, items of expenditure may be capital in nature and this issue has been tested in the Courts on numerous occasions.The dictionary definition of repairs is “the restoration of some material thing by the removal of some decayed or worn out parts”.

Before making a claim, carefully consider whether the expense is:

  • A capital expense in respect of recently acquired property
  • An improvement
  • The replacement of a subsidiary part or of an entirety.

If you replace or reconstruct entire premises or plant, this is not a repair.Essentially a repair involves the restoration of an object to the condition
it formerly had, without changing its character.Tax Ruling TR97/23 provides guidance on this issue.

DEDUCTION FOR PROFESSIONAL COSTS RE-STARTING BUSINESS

From 1 July 2015, new start-ups can immediately deduct professional costs associated with starting a business rather than writing them off over 5 years.

SELF EDUCATION EXPENSES  

The expenses for self-education can be deducted provided there is a direct and provable link between the course undertaken and how you derive your income.

Generally, you will need to satisfy any of the following tests to be entitled to a tax deduction:

  • The expense has a relevant connection to your current income earning activities (i.e. the course must be relevant or incidental to how you derive your assessable income);
  • The self-education program being undertaken enables you to maintain or improve the skills or knowledge necessary to carry out your income earning activities;
  • The self-education leads to, or is likely to lead to, an increase in your income from your current income earning activities in the future.

Deductions for self-education expenses are not allowed if the course of study is designed to:

  • Get employment in a new field of endeavour (e.g. a teacher studying law to become a lawyer);
  • Get employment or obtain a qualification to enable you to enter a restricted field of endeavour (e.g. obtaining a degree to be able to practice as a surveyor); or
  • Open up new income earning opportunities in the future (whether in business or in your current employment) because they are incurred at a point too soon to be regarded as being incurred in gaining or producing your assessable income.

Expenses that may be tax-deductible:

  • Accommodation and meals (if away from home overnight)
  • Computer consumables
  • Course fees
  • Decline in value for depreciating assets (cost exceeds $300)
  • Purchase of equipment or technical instruments costing less than $300
  • Equipment repairs
  • Fares
  • Home office running costs
  • Interest
  • Internet usage (excluding connection fees)
  • Parking fees (only for work-related claims)
  • Phone calls

Section 82A applies limits to the deductibility of self-education expenses.

The amount of self-education expenses allowable under section 8-1 must not be greater than the excess of the net amount of ‘expenses of self-education’ over $250.

Section 82A applies if:

  • The expenses of self-education are necessarily by the taxpayer for or in connection with a course of education provided by a school, college, university
    or other place of education; and
  • The course is undertaken by the taxpayer for the purpose of gaining qualifications for use in the carrying on of a profession, business or trade, or
    during the course of any employment.

Subsection 82A(2) specifies that the net amount of expenses of self-education is calculated by reducing the total amount of expenses of self-education
by:

  • The amount of Commonwealth educational assistance for secondary education, technical or tertiary education or post-graduate study that was capable
    of being claimed by the taxpayer or by another person in respect of the taxpayer, but excluding amounts that have been or will be included in the
    taxpayer’s assessable income; and
  • Any non-assessable payments received or receivable from the taxpayer’s employer or other person in the year of income in respect of the self-education
    expenses.

CHECKLIST OF DEDUCTIBLE ITEMS

Note these expenses must be income related. Meaning, the expenditure must have the necessary nexus with you or your business earning assessable income.

Item
Accident insurance premiums Accountant’s fees Accrued leave entitlements, transferred employee payments Advertising expenses Appeal costs relating to tax disputes
Audit costs, including ATO audit Bad debts Bank charges, business Bills of exchange, discount factor “Blackhole” (business capital) expenses Borrowing expenses
Briefcases Broker’s commission on borrowed moneys Buildings and structural improvements Business operating expenses Business subscriptions Business trips, expenses of
Car expenses (business) Carbon pricing Clothing (corporate wardrobes and uniforms, occupation-specific clothing, protective clothing) Commission Computer software

 

 

Consolidation valuation expenses

Convention expenses Copyrights, patents and registered designs: registration fees and amortisation of development cost or purchase price Corporate wardrobes and uniforms Credit card (personal) used for work-related purposes Death or disability benefits provided by superannuation fund Debt/equity swaps resulting in a loss

 

 

Depreciation of business assets

Discounts or rebates on sales income Distributions by co-operative to members Dues: union, professional or business associations Education expenses Election expenses: local government Election expenses:parliamentary
Electricity connection costs Employer’s costs of shares scheme Employment agreement expenses of:employer, employee Employee’s expenses:self-education, special clothing, purchase and laundering, Technical and trade journals
Tools of trade Travel, but generally excluding to and from work Entertainment expenses related to business (limited) Environmental impact study expenses:general, mining Environmental protection expenditure: general, mining Equipment (work-related)
Exchange loss Farmers – see Primary producers FBT Payments Feasibility study expenses for new project Film (Australian) investment Financial arrangements losses
Fitness expenses Forestry expenses Geosequestration expenditure GIC Gift valuation fees under the Cultural Program
Gifts:advertising or public relations Gifts of works of art and heritage items Gifts of $2 or more to prescribed donees Glasses (anti-glare) Gratuities to employees Higher qualification expenses
Home office expenses where home is used as business premises Insurance company, unreported claims Insurance premiums (business related) Intellectual property

 

 

Interest on late lodgements

Interest on borrowings for employer superannuation contributions Interest on borrowings to pay income tax
Interest on late payments of tax Interest on money used for assessable income production or purchase of income-producing assets Interest on money used to pay HELP Interest on underpaid tax where assessment amended Interest referable to home office where home used as business premises Interest withholding tax

 

 

Investment losses

Investment portfolio, expenses of servicing Land tax on business premises Late payment penalty interest Lease incentive payment Lease preparation expenses Lease termination payments (business)
Leave payments made by employer Legal expenses: Proceedings affecting future income-earning Relating to borrowing or mortgage discharge Tax advice costs

 

 

Loss on sale of property acquired before 20.9.85

Lessor’s or lessee’s payment to secure early termination of business lease Living-away-from-home allowance expenses
Losses (company) of current year Losses (trust) of current year Losses on isolated business transactions Losses: previous years Losses (trust) of previous years Losses through theft or misappropriation
Losses transferred from group company Luxury car lease expenses Mains electricity connection Management expenses, investor Mining expenditure
Mortgage discharge expenses Motor vehicle dealers: warranty repair costs

 

 

Municipal rates on business premises

Natural disasters recovery expenses Newspapers and magazines

 

 

Overtime meal allowance expenses

Parking f