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TABL5551

Recap of last week
• Last week, we looked at the compensation receipts principle in
the context of returns from property
• We also started looking at Australia’s CGT regime – we
covered its history and the key features of the regime
– Remember: when answering questions involving
disposals of property, start with income tax regime first,
then go to the CGT regime
• Careful not to take rules from one regime and use it in another
regime – stick to the formula in the specific provisions
Plan for today
• Today we’ll round out the CGT regime
• Then we’ll start looking at the other side of the taxable income
formula, i.e. deductions
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
• There are 4 areas we’ll cover under this topic, some of which
we already touched on last week:
1. Exemptions and exclusions from the CGT regime
2. Rules preventing double taxation
3. CGT netting off rules for losses and gains
4. Choices available to taxpayer regarding CGT discount
• You only need to have a broad awareness of some of these
areas, so we won’t go into too much detail about them
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
Exemptions and exclusions from the CGT regime
• Some capital gains are exempt (they are not included in the
taxpayer’s assessable income) and some capital losses are
disregarded (they can’t be used to offset a capital gain)
• Examples:
– Main residence: section 118-110
– Compensation or damages received for any wrong or injury
taxpayer suffered in their occupation: section 118-37
– Cars, motorcycles and similar vehicles: section 118-5
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
– Collectables acquired for $500 or less: section 118-10(1)
– Personal use assets acquired for $10,000 or less: section
118-10(3) (recall that no capital loss can arise from a
personal use asset)
Collectables Personal use assets
- Disregard capital gain or capital loss if collectable
acquired for $500 or less: s 118-10(1)
- Capital losses from collectables can only be used
to reduce capital gains from collectables: s 108-
10(1)
- Disregard any capital loss made from a
personal use asset: s 108-20(1)
- Disregard capital gain if personal use
asset acquired for $10,000 or less: s
118-10(3)
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
Preventing double taxation (where both non-CGT and CGT
regimes apply)
• Anti-overlap provisions operate to prevent a taxpayer from
being taxed on the same amount twice, e.g. where the amount
falls under a non-CGT income provision and under a CGT event
• Section 118-20 prevents double taxation by reducing taxpayer’s
capital gain by amount that is included in assessable income
under a non-CGT income provision
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
• Example: taxpayer’s profit on sale of asset is income under the
first strand of Myer, and a capital gain under CGT event A1 –
the capital gain is reduced by amount included as assessable
income under section 6-5 (therefore reduced to zero)
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
Method statement in section 102-5(1)
• Taxpayer’s capital gain does not directly go into their assessable
income, but must pass through the ‘method statement’
• The method statement allows the taxpayer to subtract current
year capital losses, or past year net capital losses
• It also allows for certain capital gains to be discounted
• The result, after having gone through the method statement, is
an amount that is included in taxpayer’s assessable income
• Need to know the method statement and the rules outside it
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
• Method statement in section 102-5(1) contains the rules for
working out a taxpayer’s net capital gain for an income year
1. Reduce current year capital gains by current year capital
losses
– If capital gains are greater than capital losses, a net
capital gain exists, and vice versa
– Taxpayer has a choice regarding which capital gain a
capital loss is applied against or used on
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
2. Apply or use net capital losses against any capital gains
remaining from Step 1 (current year position)
– If taxpayer has 2 years of net capital losses, they must
use the older one first: section 102-15
– Taxpayer has a choice regarding which capital gain a
capital loss is applied against or used on
3. Apply the discount to discount capital gains (if any)
remaining after Step 2
4. Apply the small business concessions to the qualifying
capital gains
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
5. The total of amounts left are added together to become
your net capital gain, and this is included in assessable
income
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
Other rules that may interact with the method statement
• Taxpayers that are natural persons may have a choice regarding
how their capital gain is calculated, i.e. to use the indexation or
the discount method
– Note that there will be less and less taxpayers who will be
selling assets purchased before 21 September 1999
• Capital losses on collectables are quarantined – they can only be
used against a capital gain on a collectable
• This quarantining rule does not prevent capital losses on non-
collectables from being used against capital gains on collectables
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
• Tax minimisation strategies taxpayers often follow: never waste
capital losses; make efficient use of capital losses; and do not
have capital losses sitting around forever
Scenario 1
• Taxpayer has 3 CGT events for the current income year:
– A discount capital gain of $200
– A non-discount capital gain of $200
– A capital loss of $200
• Question: which capital gain does taxpayer apply capital loss to?
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
• Answer: taxpayer should apply capital loss to the non-discount
capital gain – this preserves the discount capital gain for Step 3
of the method statement
• The same approach applies when the taxpayer has net capital
losses from previous years
• Key takeaway from Scenario 1: use capital losses on non-
discount capital gains first where possible
4.1 Determining Assessable Income Inclusion
and Integration with Non-CGT Provisions
Scenario 2
• Taxpayer has 2 CGT events for the current income year:
– A capital gain of $140 if worked out using indexation method,
or $180 if worked out using discount method
– A capital loss of $200
• Question: should the taxpayer use the indexation or discount
method to work out the capital gain? Answer: indexation method
• Capital loss remaining is $60 if indexation method chosen ($200 -
$140) or $20 if discount method is chosen ($200 - $180)
4.2 Overview of Expense Recognition
under the Income Tax Assessment Acts
• This is a ‘changeover point’ in the course where we shift from
the ‘assessable income’ side of the taxable income formula to
the ‘deductions’ side of the formula
• Income tax laws have been designed to ensure taxpayers are
only taxed on their ‘net position’ – this is done by recognising
expenditure a taxpayer incurs in gaining their income
– Best outcome: immediate deduction
– Next best outcome: deduction over time (e.g. depreciation)
– If neither of above available, inclusion in cost base or
reduced cost base of CGT asset
4.2 Overview of Expense Recognition
under the Income Tax Assessment Acts
• Tax offsets are more valuable than deductions to a taxpayer,
as they reduce the amount of income tax
• In this course we only consider 3 tax offsets:
– Low income tax offset (‘LITO’)
– Low and middle income tax offset (‘LMITO’)
– Imputation tax offset
4.3 Deductions: General Principles
• Under this topic we’ll gain an understanding of some key
principles regarding deductions under the income tax system
• This includes the general deduction provision: section 8-1
• We will also gain a broad appreciation of:
– Deduction conferral provisions (may provide or confer a
deduction where section 8-1 does not)
– Deduction denial provisions (denies a deduction where
section 8-1 would have allowed a deduction)
– Anti-double deduction rules (expenditure satisfies two
deduction provisions)
4.3 Deductions: General Principles
• Section 8-1(1) contains the positive limbs and it reads:
You can deduct from your assessable income any loss or
outgoing to the extent that:
a) it is incurred in gaining or producing your assessable
income; or
b) it is necessarily incurred in carrying on a business for the
purpose of gaining or producing your assessable
income.
4.3 Deductions: General Principles
• Section 8-1(2) contains the negative limbs and it reads:
However, you cannot deduct (emphasis added) a loss or
outgoing under this section to the extent that:
a) it is a loss or outgoing of capital, or of a capital nature; or
b) it is a loss or outgoing of a private or domestic nature; or
c) it is incurred in relation to gaining or producing your
exempt income; or
d) a provision of this Act prevents you from deducting it.
4.3 Deductions: General Principles
• Section 8-1 is broken into 2 positive limbs and 4 negative limbs
• Two-step approach in section 8-1:
– First, does the loss or outgoing fall within either of the 2
positive limbs? If no, there is no need to go further
– Second, is the loss or outgoing excluded by under any of
the negative limbs?
• There is overlap between the 2 positive limbs – 1st limb could
potentially apply to all taxpayers, while 2nd limb can only apply
to those taxpayers conducting a business
• Difference between ‘loss’ and ‘outgoing’ – touch on only briefly
4.3 Deductions: General Principles
• A deduction for a loss or outgoing is not precluded because it
does not actually produce any assessable income for taxpayer
• The words ‘to the extent that’ in section 8-1 contemplates
apportionment – taxpayer may obtain deduction for portion of a
loss or outgoing that satisfies requirements in section 8-1
• Illegality of taxpayer’s business activities does not prevent the
taxpayer from claiming a deduction for a loss or outgoing
• Brief mention of the 2nd and 3rd negative limbs: these limbs are
largely redundant because the loss or outgoing would unlikely
satisfy either of the positive limbs in the first place
4.3 Deductions: General Principles
• Deduction denial provisions, e.g. fines and penalties: section 26-5
and entertainment expenditure: section 32-5
• Deduction conferral provisions, e.g. gifts or donations: section 30-
15 and expenses incurred in managing tax affairs: section 25-5
• If expenditure is not immediately deductible, or can’t be deducted
over time, the last resort is to include it in cost base or reduced
cost base of CGT asset
• Rules preventing taxpayer from claiming deduction twice for same
expenditure – if 2 or more provisions allow you a deduction, you
deduct under the most appropriate provision: section 8-10
4.3 Deductions: General Principles
• Also note rules preventing double cost recognition – expenditure
will not be included in cost base of CGT asset to the extent the
taxpayer has deducted it, or can deduct it: section 110-45(1B)
• Characterise expenditure from the taxpayer’s perspective (similar
to how we characterise assessable income, i.e. in the hands of the
recipient)
• Substantiation requirements for some taxpayers – certain
expenditure not deductible unless taxpayer has kept records to
substantiate the expenditure (we do not look at in this course)
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
• Remember, expenditure must satisfy either of the positive
limbs, and avoid falling into a negative limb, to be deductible
• The 2 positive limbs are similar – rule of thumb is that 1st limb
potentially applies to all taxpayers, while 2nd limb only applies
to those taxpayers conducting a business
• Profession R.W. Parsons argued there is only one test here: is
the expenditure sufficiently relevant to the production of the
taxpayer’s assessable income?
• Courts have developed numerous tests or guiding principles
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
• Guiding principles from leading income tax cases:
– Is the occasion of the outgoing to be found in the income-
earning activity?
– To be deductible under positive limbs, the outgoing must
be incidental and relevant to the activities directed at
gaining or producing assessable income
– It is sufficient and necessary that the occasion of the
outgoing is found in whatever is productive of the
assessable income, or would be expected to produce
assessable income
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
• Guiding principles from leading income tax cases (continued):
– Expenditure incurred ‘in the course of’ gaining assessable
is expenditure incurred ‘in’ gaining assessable income
– It is not sufficient to make an expenditure deductible that it
is a pre-requisite to deriving assessable income
– The fact the employer requires an employee to spend
money is not enough to make the employee’s expenditure
deductible – it is just a factor to consider
– Apportionment is contemplated by words ‘to the extent’
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
• In many situations, it will be clear whether an expenditure
satisfies the positive limbs in section 8-1
• What we are looking for in the positive limbs is a connection
between the expenditure and the taxpayer’s income-earning
activities, e.g. is it connected to their employment activities as
an employee?
• If the taxpayer incurs the expenditure to purchase a thing, is
the thing used in the taxpayer’s income-earning activity?
• Or if the expenditure is incurred to hire a thing, is the thing that
is hired used in the taxpayer’s income-earning activity?
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
Herald & Weekly Times v FCT
• The taxpayer, a newspaper publisher, paid amounts to settle
defamation actions in respect of libel actions brought against it
• The ATO denied a deduction, arguing there was an insufficient
nexus between the outgoings and the earning of assessable
income to satisfy the positive limbs
• Issue: were the amounts paid to settle the actions, and the
associated legal expenses, deductible?
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
Herald & Weekly Times v FCT (continued)
• HELD (4:2 majority) the amounts satisfied the positive limbs
and were deductible
• It is an inevitable and unavoidable consequence of publishing
a newspaper that such costs will arise
• In other words, it is an ordinary incident of a newspaper
publishing business
• The publication of newspapers was both the source of the
taxpayer’s assessable income, and the source of the liability
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
W Nevill & Co Ltd v FCT
• Involved amounts paid by taxpayer company to terminate the
services of a managing director
• Will leave you to read this case yourself
• Observation from the decision: expenses to do with securing
the services of staff and employees will almost always satisfy
positive limbs, and hardly ever be ‘capital’
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
Charles Moore & Co (WA) Pty Ltd v FCT
• Taxpayer carried on a business of running a department store
• Cash was the method of payment for customers at the time
(no credit cards)
• Every morning, 2 employees would walk the previous day’s
cash earnings to the bank to deposit the earnings
• One particular morning, the employees were robbed at
gunpoint
• Issue: deductibility of the loss, being the stolen cash earnings
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
Charles Moore & Co (WA) Pty Ltd v FCT (continued)
• HELD the loss satisfied the positive limbs and was deductible
• The process of transporting previous day’s cash earnings was
part of ordinary course of carrying on taxpayer’s business
• The occasion of the loss was the banking of the previous day’s
cash earnings, and this was part of ordinary course of
taxpayer’s business
• Observations: strictly, it was a ‘loss’ and it is unlikely to happen
again or often in the present day
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
Lunney v FCT
• Taxpayer commuted from his home in the suburbs to his place
of employment in the city by public transport
• Taxpayer sought to deduct his public transport expenses
• Issue: deductibility of taxpayer’s commuting expenses
• HELD the expenses failed the positive limbs and were not
deductible; they were personal outgoings of the taxpayer
• Expenses incurred to put taxpayer in a position to carry out
work are not incurred in gaining their income from that work
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
Lunney v FCT (continued)
• Expenditure was a pre-requisite in the sense that if taxpayer
did not incur it, they would not be in a position to produce
assessable income
• However, the expenditure was not incurred in the course of
producing that assessable income
• Expenditure incurred to enable a taxpayer to be in a position
to produce assessable income are non-deductible, private or
domestic outgoings
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
FCT v Cooper
• Taxpayer was a professional rugby player – was directed by his
coach to eat more meat and drink beer to maintain his weight
• Issue: deductibility of expenditure on the extra meat and beer
• HELD the expenditure was not deductible because it failed the
positive limbs and was caught by negative limb
• Training and playing were the activities that produced the
taxpayer’s assessable income; eating the additional food and
drinking didn’t form part of his income-earning activities
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
FCT v Cooper (continued)
• Goods or services will not be incurred in gaining assessable
income just because they are a pre-requisite to enabling the
taxpayer to produce assessable income
• In other words, the fact that expenditure is a condition of
employment does not make the expenditure deductible
• Nearly all food and drink expenditure will fail the positive limbs
and therefore not be deductible
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
FCT v Day
• Taxpayer was customs officer with Australian Customs Service
– as a public servant, was subject to duties such as duty not to
engage in improper conduct as an officer, not be negligent etc.
• Taxpayer was charged with various offences and suspended
without salary
• To defend the charges, taxpayer hired lawyers and incurred
legal expenses in doing so
• Issue: deductibility of the legal expenses
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
FCT v Day (continued)
• HELD the legal expenses were deductible
• The test to be applied was this: is the occasion of the outgoing
found in what is productive of the actual or expected income?
• Court noted the duties owed by an officer and the disciplinary
proceedings that can be taken if they fail to fulfil their duties
• Taxpayer was exposed to the charges and legal expenses
because of his position, therefore the legal expenses satisfied
the 1st positive limb
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
FCT v Anstis
• Taxpayer was university student who received Youth Allowance
(a government income support payment)
• To qualify for the allowance, had to show that she met eligibility
criteria – her qualifying activity was enrolment in full-time studies
• Taxpayer sought to deduct expenses she incurred on travel,
supplies for teaching rounds, textbooks and stationery, etc. on
the basis they were incurred in gaining the allowance
• Issue: deductibility of the expenses
4.4 Relevant Expenditure: Tests under
Positive Limbs of Section 8-1
FCT v Anstis (continued)
• HELD expenses satisfied 1st positive limb and were deductible
• Self-education expenses incurred to obtain a qualification that is
required to get a job, or to change occupations, are generally not
deductible (we will look at these expenses in Week 5)
• Here, the allowance was income to the taxpayer, and expenses
were incurred in the course of retaining her right to the allowance
• Note: section 26-19 introduced by government following Anstis to
deny deductions for expenses like those incurred by taxpayer
4.5 Expense Apportionment
• Section 8-1 contemplates apportionment of an expenditure
into ‘deductible’ and ‘non-deductible’ parts
• We will divide this topic into: non-tax planning situations and
aggressive tax planning situations
• Starting with non-tax planning situations, the question is when
do we apportion and how do we apportion?
• Ronpibon Tin NL v FC of T (1949) 78 CLR 47 contains the
leading comments at p 59:
4.5 Expense Apportionment
“It is perhaps desirable to remark that there are at least two kinds of items of
expenditure that require apportionment. One kind consists in undivided items of
expenditure in respect of things or services of which distinct and severable parts
are devoted to gaining or producing assessable income and distinct and severable
parts to some other cause. In such cases it may be possible to divide the
expenditure in accordance with the applications which have been made of the
things or services.
The other kind of apportionable items consists in those involving a single outlay or
charge which serves both objects indifferently. Of this directors' fees may be an
example. With the latter kind there must be some fair and reasonable assessment
of the extent of the relation of the outlay to assessable income. It is an
indiscriminate sum apportionable, but hardly capable of arithmetical or ratable
division because it is common to both objects.”: (1949) 78 CLR 47, 59
4.5 Expense Apportionment
• High Court in Ronpibon Tin NL noted there are at least 2 kinds
of expenditure that would require apportionment:
– Expenditure in respect of things or services that have
distinct and several parts – may be possible to divide parts
– Expenditure involving a single outlay that serves different
purposes – apportion on a fair and reasonable basis
• Examples involving work and non-work use:
– Car expenses: kilometres travelled
– Internet, phone and data expenses: percentage basis
– Rent of property: floor-area basis
4.5 Expense Apportionment
• Last area for today: aggressive tax planning case where
apportionment applied
Ure v FCT (simplified facts)
• Taxpayer borrowed money at the market rate of interest of 10%
and on-lent the money to his wife and a family trust at 1%
• Interest received for the year was $660 (assessable income)
• Interest incurred was approximately $8,000 –taxpayer claimed
this was deductible as an expenses in gaining the $660
assessable income
4.5 Expense Apportionment
Ure v FCT (simplified facts) (continued)
• HELD apportionment of the expenditure was required, such that
the taxpayer could only deduct $660 of the $8,000
• Generally, the taxpayer’s purpose in incurring expenditure is not
relevant when considering positive limbs of deductibility
• However, where the expenditure appears to have an aim other
than producing assessable income, purpose can be looked at
• The disparity in the interest rate paid and that charged suggested
another purpose (providing income to wife; purchasing a home)
4.6 Home office cf. home study
• Employees working from home may incur a range of expenses
relating to that work, e.g. interest on home loan, council rates,
water rates, building insurance, electricity, gas and internet
• An important distinction is the ‘running expenses’ vs.
‘occupancy expenses’ distinction
– ‘Running expenses’ are those expenses such as electricity
and gas, phone and internet
– ‘Occupancy expenses’ include rent, interest on home loan,
council rates and building insurance
• Why is the distinction important?
4.6 Home office cf. home study
• ‘Running expenses’ are deductible, provided taxpayer is working
in a room and there’s no other family member there at same time
– dedicated home study vs. lounge room where other household
members are watching television at the same time
• ‘Occupancy expenses’ are generally more significant expenses
and are more difficult in terms of determining deductibility:
– Very difficult to claim a deduction for these expenses because
they will relate to the taxpayer’s home
– Starting assumption: not deductible, unless taxpayer can
show certain factors (as we will see in the following cases)
4.6 Home office cf. home study
Handley v FCT
• Taxpayer used a room in his house as a study where he did work
relating to his profession as a barrister
• Room was predominantly used for this purpose, though on other
occasions it was used for other reasons
• Taxpayer sought deduction for proportion of interest on mortgage
repayments and rates expenses
• Issue: deductibility of these expenses
4.6 Home office cf. home study
Handley v FCT (continued)
• HELD: no deduction allowed for the expenses
• The study remained an integral part of family home, even though it
was used by taxpayer for another purpose for some of the time
• Expenses were private outgoings related to the entire home and
would have been incurred for the entire home whether or not the
taxpayer used part of it as his study for some of the time
• Key takeaway: expenses related to home office generally non-
deductible private outgoings if would’ve been incurred regardless
4.6 Home office cf. home study
Swinford v FCT
• Taxpayer was a self-employed professional writer of radio and
television scripts who worked from her home
• She set aside one room in her rental to be used exclusively for her
writing work – she used it for writing purposes and for meetings
• Taxpayer sought a deduction for a portion of her rent (based on a
floor area basis) arguing that there were 2 purposes for the rent
• Issue: deductibility of the portion of the taxpayer’s rent
4.6 Home office cf. home study
Swinford v FCT (continued)
• HELD: a portion of the rent was deductible to the taxpayer
• Taxpayer had established a distinct work room and this amounted
to a separate application of the rental
• Key takeaway: there was an absence of an alternative place for the
taxpayer (other than her home) to carry out her work
• Conclusion: to deduct ‘occupancy expenses’ taxpayer generally
needs extensive use of the room in the home (zero or minimal
domestic use), and absence of alternative work location