Week 4 Lecture Slides - Tax Law (PDF)

Welcome to the School of Accounting, Auditing & Taxation  TABL2751 INTRODUCTION TO TAX LAW Lecture Week 4: Assessable Income - CGT (continued) Tax calculations – individual taxpayer Expense and cost recognition – overview Deductions - general provision and specific provisions  Revie...

Welcome to the School of Accounting, Auditing & Taxation  TABL2751 INTRODUCTION TO TAX LAW Lecture Week 4: Assessable Income - CGT (continued) Tax calculations – individual taxpayer Expense and cost recognition – overview Deductions - general provision and specific provisions  Review/Overview So far, we have focused on the “assessable income” part of the taxable income equation. Assessable income includes ordinary income and statutory income. A “net capital gain” is included in assessable income as a form of statutory income. CGT regime was introduced on a prospective basis, i.e. it applies to the disposal of assets acquired on or after 20 September 1985.  Determining Assessable Income Inclusion and Integration with Non-CGT Provisions There are 4 areas that were covered under this topic: 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  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 some capital losses are disregarded - they can’t be used to offset a capital gain Examples: – Main residence: s 118-110 – Compensation or damages received for any wrong or injury taxpayer suffered in their occupation: s 118-37 – Cars, motorcycles and similar vehicles: s 118-5  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  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’ allows the taxpayer to subtract current year capital losses or past year net capital losses 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  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  Calculating tax position: individuals For resident individual taxpayers, the following steps should be followed in calculating the estimated tax payable/refund for the relevant income year: Step 1: Calculate the taxpayer’s taxable income. Step 2: Calculate the tax on taxable income. Step 3: Subtract the non-refundable tax offsets or rebates. Step 4: Add the 2 per cent Medicare levy, Medicare levy surcharge and government study and HECS/HELP (if applicable). Step 5: Deduct refundable tax-offsets and credits, and tax already paid. Step 6: Deduct Step 5 from the net tax payable calculated after Step 4. The difference is either the estimated tax payable owing to the ATO (a positive amount) or the estimated tax refund owing by the ATO (a negative amount).  Resident individual tax rates 2023–24 Non-resident individual tax rate 2023–24 Source: Income Tax Rates Act 1986 (Cwlth), Schedule 7  Tax offsets Non-refundable: the unused offset can’t be refunded e.g. low-income tax offset (LITO) Refundable: Div 67 ITAA97 provides that a refundable tax credit can result in a taxpayer receiving a tax refund If total amount of refundable credits > taxpayer’s net tax payable, the excess credits = tax refund e.g. franking credits Note: Tax offsets are more valuable than deductions to a taxpayer, as they reduce the amount of income tax  Medicare levy & surcharge Resident individual taxpayers are required to pay a 2% Medicare levy based on their taxable income Reductions and exemptions: − reduction for low-income earners (range $26,000 - $32,500) − Medicare levy exemption Medicare levy surcharge: - ranges from 1%, 1.25% and 1.5% of the taxpayer’s taxable income - only applies where a high-income earner does not maintain adequate private health insurance FY 2024 thresholds are as follows: - single taxpayer $93,000 - couples $186,000 - dependents $1,500 each Source: Medicare Levy Act 1986 (Cth), ss 6 & 8  HECS/HELP Individuals with accumulated study or training support loans are required to have additional amounts withheld from salaries Employers are required to deduct appropriate amount of the repayment out of the employee’s gross salary or wage each payment period (not deductible to the taxpayer) Repayment thresholds and rates for compulsory repayment of debts are updated annually and indexed in line with CPI Rates: Study and training loan repayment thresholds and rates | Australian Taxation Office (ato.gov.au) Source: Higher Education Support Act 2003 (Cth), ss 154-5 Deductions 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  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 s 8-1 does not) – Deduction denial provisions (denies a deduction where s 8- 1 would have allowed a deduction) – Anti-double deduction rules (expenditure satisfies two deduction provisions) 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; [1st positive limb] or b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income [2nd positive limb].  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. 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 Nexus to income – incidental and relevant test 1st limb To determine whether a loss or Concerned with expenditure outgoing satisfies the Nexus incurred in the actual course of requirement, courts are generally producing assessable income looked at whether: 2nd limb the loss/outgoing is incidental Concerned with expenditure and relevant to the taxpayer’s made for the purpose of income‐producing/business business generally operations; and Test: is there a sufficient nexus, i.e. the loss/outgoing has the connection/relationship between the ‘essential character’ of an expenditure and income and/or income‐producing/business business? expense Deductions: General Principles Specific Deductions: s 8-5 - Allows deductions if specified in another section of Act No Double Deductions: s 8-10 - If you can deduct an amount under two different sections, use the most appropriate Incurred: 1st limb Payment is not a requirement: FC of T v Aust. Guarantee Co. The section does not say there must be an actual outgoing: W Nevill & Co Ltd v FC of T The loss or outgoing is incurred if the taxpayer is totally committed to making the payment: FC of T v James Flood Pty Ltd. Commissioner agrees with these judgements: Taxation Ruling TR 97/7. This is regardless of whether the taxpayer uses cash or accruals.  Necessarily incurred in carrying on business (2nd limb) Necessarily means ‘clearly appropriate’ It does NOT mean compulsory, inevitable or unavoidable. “It is for the man who is carrying on the business to be the judge of what outgoings are necessarily to be incurred”: Magna Alloys & Research Pty Ltdv FCT Ronpibon Tin NL v FCT: The amount of a loss or outgoing is the actual expenditure incurred, not the amount that may be considered reasonable. It's not FCT’s role to say how much ought to have been spent, BUT excessive expenditure may call the ‘purpose’ of the expenditure into question: see Robert G Nall Ltd v FCT Deductions: General Principles Difference between ‘loss’ and ‘outgoing’ Loss: Accidental losses: Charles Moore & Co (WA) Pty Ltd v FCT Commercial sense of loss on transaction: AGC (Advances) Ltd v FCT (1975) 132CLR 175 Outgoing: Examples: Rent, Wages, Interest Implies voluntary payment: AGC (Advances) Ltd 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 s 8-1 contemplates apportionment – taxpayer may obtain deduction for portion of a loss or outgoing that satisfies requirements in s 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 Deductions: General Principles Deduction denial provisions, e.g. fines and penalties: section 26-5 and entertainment expenditure: s 32-5 Deduction conferral provisions, e.g. gifts or donations: s 30-15 and expenses incurred in managing tax affairs: s 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: s 8-10 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: s 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) 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 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 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’ Relevant Expenditure: Tests under positive limbs of s 8-1 In many situations, it will be clear whether an expenditure satisfies the positive limbs in s 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? Relevant Expenditure: Tests under positive limbs of s 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? Relevant Expenditure: Tests under positive limbs of s 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  Relevant Expenditure: Tests under positive limbs of s 8-1 W Nevill & Co Ltd v FCT Redundancy payment to joint managing director FCT argued that no deduction should be allowed as the outgoing did not produce any income Deduction was allowed. Latham CJ: Viewed narrowly, no expenditure actually produces income, as an outgoing results in a reduction of the taxpayer’s resources. A narrow view is inappropriate, and you need to look to the ‘object’ of expense. In this case, the object of the expense was to improve business efficiency Involved amounts paid by taxpayer company to terminate the services of a managing director 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’ Relevant Expenditure: Tests under positive limbs of s 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 Relevant Expenditure: Tests under positive limbs of s 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 Relevant Expenditure: Tests under positive limbs of s 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 Relevant Expenditure: Tests under positive limbs of s 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 Relevant Expenditure: Tests under positive limbs of s 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 Relevant Expenditure: Tests under positive limbs of s 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 Relevant Expenditure: Tests under positive limbs of s 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 Relevant Expenditure: Tests under positive limbs of s 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 Relevant Expenditure: Tests under positive limbs of s 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 Relevant Expenditure: Tests under positive limbs of s 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 Here, the allowance was income to the taxpayer, and expenses were incurred in the course of retaining her right to the allowance Note: s 26-19 now supersedes this decision Expense Apportionment Implies apportionment Where the loss or outgoing is not solely incurred in the gaining or producing of assessable income, expenditure will need to be apportioned. See for example: Ronpibon Tin Expenditure relating to both assessable income and exempt income How to apportion? Easily dissected expenditure: no real issue If not easily dissected: Fair and reasonable basis Legal rights approach / purposive approach 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:  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 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 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) Nexus to income Does the loss or outgoing have to be linked to income to be derived inthe current year? i.e. Can a deduction be claimed for amounts that relate to: future income: pre‐commencement cases past income: post‐cessation cases See TR 2004/4: “Deductions for interest incurred prior to commencement of; or following cessation of, relevant earning activities”  Contemporaneity principle The contemporaneity principle has to do with the positive limbs of s 8-1 The idea here is that expenditure that is not incurred in the course of an income- earning activity is not expenditure incurred in gaining assessable income Here we look at expenses that are incurred before and after an income-earning activity is carried on Note: this area is heavily qualified by recent case law Contemporaneity principle First principle is that expenses related to obtaining work are not deductible FCT v Maddalena Taxpayer was professional football player and incurred travel and legal expenses to obtain a contract with a different club Taxpayer sought to deduct the expenses HELD: the expenses were not deductible because they were not incurred in the course of an income-earning activity, but incurred to obtain employment Contemporaneity principle Expenses incurred to decide whether to start a business are not deductible Softwood Pulp and Paper Ltd v FCT Taxpayer company was formed to establish a paper mill and incurred expenses for a feasibility study for the project On the basis of the feasibility study, the project did not proceed HELD: preliminary expenses, such as cost of feasibility study, are incurred before taxpayer starts earning assessable income – these expenses do not satisfy the positive limbs Note: if the facts in Softwood Pulp and Paper Ltd occurred today - a deduction would be available under ss 40-832 and 40-840. Contemporaneity principle Steele v DFCT Taxpayer used borrowed funds to purchase land in 1980 to be used in a commercial development Negotiations with the proposed partner fell through and the project was abandoned, with taxpayer selling the land in 1987 Taxpayer sought to deduct interest costs incurred while holding the land prior to the sale The court said the question is whether there is a relevant connection between the interest costs and the taxpayer’s assessable income The court also said interest expenses will hardly ever by capital Contemporaneity principle Steele v DFCT (continued) The court reminded us of 2 things: – The expense doesn’t have to be incurred in the same year the assessable income is derived – The expense doesn’t have to be successful in producing assessable income for it to be deductible Ultimately, it is a question of fact, taking into account: – Time gap between expense and actual/expected income – Degree of commitment from taxpayer to project – Whether taxpayer had any non-income producing use in mind Contemporaneity principle expenses incurred after taxpayer’s income-earning activity has ceased Placer Pacific Management Pty Ltd v FCT Taxpayer carried on various businesses including manufacture of conveyor belt systems Business ceased and some 8 years later, taxpayer was required to meet liability claim for manufacturing a faulty system When claim arose, taxpayer’s activities were limited to investment and management of related companies Issue: deductibility of settlement amount and related legal fees Contemporaneity principle Placer Pacific Management Pty Ltd v FCT (continued) HELD: outgoings satisfied 2nd positive limb and were deductible Occasion of the loss was the contract entered into with customer which was part of carrying on of a business to produce income The fact the business was no longer carried on didn’t prevent the deductibility of the outgoing This case established that ‘long tail liabilities’ may be deductible even though business to which liabilities relate may’ve ceased The court commented it would be unjust to deny a deduction for these types of outgoings – it takes time for liabilities to eventuate Contemporaneity principle Other cases that consider the contemporaneity principle are Spriggs v FCT; Riddell v FCT and FCT v Brown FCT v Brown In 1988, the taxpayer borrowed funds to acquire a business, the debt being repayable over 10 years In 1990, the business was sold and the sale proceeds were used to pay down the loan, but an amount remained outstanding The taxpayer continued to incur interest outgoings Issue: deductibility of the interest expenses in 1993 and 1994 where the business to which the loan related had ceased Contemporaneity principle FCT v Brown (continued) HELD: the interest outgoings continued to be deductible Applying the principle in Steele, the court said that occasion of the interest outgoing was to be determined by reference to the purpose of the borrowing and the use to which funds were put Case is authority for principle that interest deductions will be allowed where the original borrowing was used in a business directed at producing assessable income Due to COVID-19, there may be taxpayers who are required to close their business while they have outstanding loans  Revenue/capital boundary Recall that in order to obtain a deduction under s 8-1, the expense must satisfy one of the 2 positive limbs and avoid falling into one of the 4 negative limbs The 1st negative limb denies deductibility for expenses that are ‘capital’ or ‘of a capital nature’ In a practical sense, if the expense falls in the 1st negative limb, you should consider one of the capital allowance regimes (e.g. depreciation for decline in value) That means that as you are answering the revenue vs. capital question here, you are also answering it under the other regime  Revenue/capital boundary Similarly, when you are addressing the positive limbs of s 8-1, you are also addressing the ‘relevance’ question in the capital allowance regime Approach the question in a systematic way – start with the positive limbs, before moving to the ‘capital’ negative limb Broadly, the revenue vs. capital distinction in s 8-1 is similar to the revenue vs. capital distinction in s 6-5 – bear in mind though we are now looking at the deductions side of the formula Tangible assets: answer is usually clear Intangible assets: answer is less clear, causing most problems  Revenue/capital boundary Most courts, tribunals and the ATO refer to the statements of Dixon J in the Sun Newspapers case: – The character of the advantage sought, and in this its lasting qualities may play a part [What is the advantage/asset and how long will it last?] – The manner in which it is to be used, relied upon or enjoyed and in this and under the former head, recurrence may play its part [How is the advantage/asset used?] – The means adopted to obtain it; that is by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment [How was the advantage/asset paid for?]  Revenue/capital boundary The first consideration (character of the advantage sought) is the most important one, therefore more weight should be given to it Key statements from other cases on the revenue vs. capital issue: – Is the expense a working expense? If so, revenue – Is the expense one that establishes, acquires or adds to the taxpayer’s profit- earning structure (if so, capital), or is the expense a cost of operating that structure (if so, revenue) – Is the expense one that is made to meet a continuous or constant demand of the taxpayer’s income-earning activity (if so, revenue), or is it made once and for all (if so, capital)  Revenue/capital boundary – Does the expense bring into existence an asset or an advantage for the enduring benefit of the taxpayer’s business? If so, capital Note that the accounting treatment of the asset is irrelevant, e.g. the fact it is classified as a non-current asset does not make it capital for s 8-1 purposes Examples in a café: coffee beans would be revenue expense, while coffee machine, table and chairs are all capital expenses Revenue/capital boundary Sun Newspapers Sun Newspapers wanted to prevent competitor from introducing a new and competitive newspaper into Sydney market Sun Newspapers paid its competitor a restrictive covenant expense for the competitor agreeing not to publish a newspaper within 300 miles of Sydney for 3 years Issue: deductibility of the expense HELD: the expense was a non-deductible capital expenses because Sun Newspapers had achieved a lasting benefit by effectively buying out its competitor with the payment Revenue/capital boundary Sun Newspapers (continued) Reasoning: the expense strengthened and preserved taxpayer’s business organisation – it removed competition and its main aim was to preserve the business from immediate impairment (loss of newspaper circulation due to competitor’s lower cost newspaper) The expense was not recurrent; it was a once-only expense The statements of Dixon J remain the basis for the revenue vs. capital analysis Revenue/capital boundary Broken Hill Theatres Pty Ltd v FCT Taxpayer incurred legal expenses opposing licence application by a potential competitor Licence applications were heard annually, so the taxpayer was protected from competition for 12 months as a result of expenses Issue: deductibility of the expenses HELD: the expenses were characterised as capital Reasoning: expenses directed at limiting competition, preserving and protecting the taxpayer’s existing business Revenue/capital boundary BP Australia Ltd v FCT BP was petrol refiner that entered into ‘tied trade’ agreements with independent retailers In return for lump sum payments from BP, retailers agreed to only sell BP fuel for periods between 3 – 5 years Issue: deductibility of the payments HELD: the payments were revenue expenses Reasoning: payments related the process of finding customers, not the business’s structure Revenue/capital boundary National Australia Bank Ltd v FCT Taxpayer carried on retail banking business Taxpayer made a lump sum payment to Commonwealth for the exclusive right for 15 years to offer loans to defence force members – members could still obtain loans from other banks Issue: deductibility of the lump sum payment HELD: the payment was on revenue account Reasoning: nature of advantage sought was an expansion of the taxpayer’s customer base and increase in income earned Revenue/capital boundary National Australia Bank Ltd v FCT (continued) The case was considered to be not unlike BP Australia The payment didn’t enlarge the taxpayer’s business framework, but rather was incurred as part of the process by which the taxpayer obtained regular returns Observation: despite the advantage lasting 15 years, the lump sum payment was treated as a revenue expense The courts will focus on the nature of the advantage sought when determining the revenue vs. capital issue Revenue/capital boundary FCT v Sharpcan Pty Ltd Taxpayer conducted a hotel and gaming business Due to legislative changes in Victoria, to continue running the gaming activities, the taxpayer had to bid for gaming machine entitlements (‘GMEs’) to operate its 18 machines Taxpayer incurred $600,000 to purchase the GMEs, which gave them the right to conduct gaming for 10 years Issue: deductibility of the amount incurred to purchase GMEs Revenue/capital boundary FCT v Sharpcan Pty Ltd (continued) HELD: amount was capital The court said the question is what is the advantage obtained from the expenditure, and once identified, that advantage needs to be characterised as either the acquisition or extension of the business structure, or the payment for the use of an asset The GMEs were a barrier to entry – you could not have gaming machines without GMEs – the payment was in the nature of a once and for all payment to acquire an enduring asset