Understanding Business Expense Deductibility for Mechanics and Teachers

Melissa is a mechanic. She runs her own business specialising in repairing electric cars. During the year, Melissa incurred the following expenses: Expenses Deductibility Salary costs to her two regular employees of $100,00 (paid electronically through the business’s payroll system which automatically applies the relevant tax withholding and pays the amount to the ATO) • Salary expenses are deductible as they are necessarily incurred in carrying on a business to gain or produce assessable income, • they do not fall within any of the negative limbs of s 8-1, and • they are not denied deduction as per s 26-105. • Salary expenses are deductible as discussed above, but Salary costs to casual employees of $10,000 (these employees are only required during busy periods and are paid in cash ‘of the books’) • denied deduction as per s 26-105. Question 12.2

Melissa is a mechanic. She runs her own business specialising in repairing electric cars. During the year, Melissa incurred the following expenses: Expenses Deductibility • Satisfies the positive limbs of s 8-1 of ITAA 1997 as it is necessarily incurred in carrying on a business to gain or produce assessable income , • It is also denied deduction as it falls within the last negative limb of s 8-1 regarding denied deductions. The payment is to her brother who is a “related entity” per s 26- 35(2). As such, the amount of the deduction is limited to the amount of the expense that the Commissioner considers reasonable: s 26-35 of ITAA 1997 Salary costs of $2,000 to her brother who is a university student (paid electronically through the business’s payroll system; Melissa knows the amount is excessive, but she wants to support him in his studies) Question 12.2 • Any excess will be a non-deductible expense and is effectively treated as a gift as it is non-assessable non-exempt income for her brother: s 26-35(4).

Melissa is a mechanic. She runs her own business specialising in repairing electric cars. During the year, Melissa incurred the following expenses: Expenses Deductibility Travel expense from home to work is incurred to put Melissa in a position to gain or produce assessable income rather being in gaining or producing assessable income. So, this expenditure is not deductible. Travel costs of $3,000 for travel from her home to her repair shop Question 12.2 $5,000 on special overalls and eye goggles for Melissa and her employees to use when they are repairing cars Special overall and eye goggles for repairing cars are considered protective clothing; therefore, this expenditure is deductible. Childcare costs of $22,000 so that Melissa is able to go to work every day Not deductible as it is not incurred in gaining or producing assessable income. $1,000 on a one-day course on a new accounting software program that Melissa wants to use in the business to better comply with new tax reporting requirements Deductible as ‘self education’ expense which will increase Melissa’s skills in gaining or producing assessable income.

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Question 12.3 Jurgen is a teacher at a German-language school in Australia. As part of a competitive process, he was selected to participate in a prestigious 2- week education conference in Germany. His employer supported Jurgen’s participation by allowing him to travel to the conference without leave but did not pay for the travel expenses. Jurgen incurred expenses of $2,000 on a return plane ticket between Germany and Australia and $300 on travel insurance. His hotel costs during the conference were covered by the conference organiser, but Jurgen stayed an additional 5 days at the hotel so that he could do some sightseeing. The extra nights at the hotel cost him $1,000. Advise Jurgen as to whether the above expenses would be deductible for income tax purposes.

Solution to Question 12.3 The cost of plane ticket • Generally is deductible under s 8-1 of ITAA 1997 as a self-education expense as the conference is related to Jurgen’s income-earning activities. • Question is whether the whole amount would be deductible as Jurgen also did some sightseeing while he was there. As such, some or all of the expense may constitute a private or domestic expense  In Taxation Ruling 98/9, the Commissioner makes some comments in relation to expenses incurred in attending a conference where there is also an incidental private purpose. These comments can be used as the basis for determining which cost that Jurgen incurred for attending the conference is deductible or not. • The amount of Jurgen’s deduction in relation to the air fare depends on his purpose in undertaking the travel. If Jurgen is able to demonstrate that his sole purpose in incurring the airfare was to attend the conference and the holiday was merely incidental to his dominant purpose of attending the conference, it is possible that he can deduct the whole airfare.

Solution to Question 12.3 The cost of plane ticket • Hotel costs → Not deductible as it is not incurred in earning assessable income and is a private/domestic expense as incurred when Jurgen is on holiday.  Travel insurance → Not deductible as it covers private expenses. From ATO ID 2001/615. • The amount of Jurgen’s deduction in relation to the air fare depends on his purpose in undertaking the travel. If Jurgen is able to demonstrate that his sole purpose in incurring the airfare was to attend the conference and the holiday was merely incidental to his dominant purpose of attending the conference, it is possible that he can deduct the whole airfare.

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Question 12.5 Michael is a scientist. He uses his own car to travel to various locations to conduct experiments. He acquired the car on 1 October 2021 for $60,000. The acquisition cost was funded entirely by a loan at an interest rate of 15%. He has determined that the depreciation deduction on the car would be $2,300 for the year. In addition, Michael incurred the following expenses during the year: • Registration and insurance = $2,000; • Repairs and maintenance = $1,000; and • Oil and fuel costs = $1,500. For the period 1 October 2021 to 30 June 2022, Michael estimates that the car travelled a total of 15,000 kilometres, 12,000 of which were for business purposes. You may assume that Michael has maintained all necessary records and a logbook. Calculate Michael's deduction for car expenses under the two methods in Div 28 of ITAA 1997 . Assume that depreciation has been adjusted for part year use and the impact of the car limit.

Solution to Question 12.5 Cents per km method  Number of business kilometres travelled = 12,000 but limited to 5,000 under this method.  Car expense = 5,000 x $0.72 = $3,600 Logbook method  Expenses = $2,000 (registration and insurance) + $1,000 (repairs and maintenance) + $1,500 (oil and fuel) + $6,732 (interest = $60,000 x 15% x (273/365)) + $2,300 (depreciation) = $13,532.  Car expense = $13,532 x (12,000/15,000) = $10,826  12,000/15,000) represents the business use percentage NB: The expenses are deductible under s 8-1 as they have been incurred in gaining or producing assessable income. Michael must be able to substantiate his expenses to claim a deduction under this method

Penelope is a surgeon at the local hospital. However, the long hours have been very draining, and she has decided to take a leave of absence from the hospital and pursue her interest in blending coffee beans to find the perfect taste. She has incurred the following expenses: : Expenses Deductibility Payment of $5,000 to the Australian Society of Plastic Surgeons (Penelope has decided to maintain her membership during her leave of absence in case she decides to go back to work as a surgeon) Penelope can claim a deduction for $42 under s 25-55 of ITAA 1997 as the $5,000 is a payment for membership of a professional association. The remaining amount is unlikely to be deductible as it would not satisfy the positive limbs of s 8- 1 because it has not been incurred in gaining or producing assessable income (Penelope has stopped working as a surgeon) Penelope can claim a deduction for the $1,000 under Division 30 of ITAA 1997 as the recipient is a DGR Donation of $500 to Medecins Sans Frontières (a registered Deductible Gift Recipient) Question 13.3

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Penelope is a surgeon at the local hospital. However, the long hours have been very draining, and she has decided to take a leave of absence from the hospital and pursue her interest in blending coffee beans to find the perfect taste. She has incurred the following expenses: : Expenses Deductibility Question 13.3 The $1,000 is not deductible as it is not a “true” gift. Penelope has received a material advantage in return for her ‘donation’ as she does not need to pay the booking fee for the function room Donation of $1,000 to her local neighbourhood community house (a registered Deductible Gift Recipient). All donors are permitted to book the function room in the house for free up to 3 times per year. The normal booking fee would be $250.

Question 13.4 Roger has provided you with the following information: Year 1: Assessable income = $50,000; Deductions = $100,000 Year 2: Assessable income = $300,000; Non-assessable non-exempt income = $100,000; Deductions = $100,000 Year 3: Assessable income = $100,000; Exempt income = $200,000; Deductions = $300,000 Advise Roger as to his taxable income/loss each year. Would your advice be any different if the taxpayer was Roger Pty Ltd?

Solution to Question 13.4 Year 1: • $50,000 assessable income; $100,000 deductions therefore tax loss = $50,000. Year 2: • Carry-forward loss must first be deducted against any exempt income but not non-assessable non-exempt income. No exempt income therefore  assessable income = $300,000, deductions = $200,000 so taxable income = $100,000 before application of prior year losses. • Carry forward loss = $50,000 therefore taxable income = $50,000 in Year 2. Year 3: • Assessable income = $100,000, Deductions = $300,000 therefore prima facie taxable loss of $200,000 . • But need to apply against Exempt Income ($200,000) therefore taxable income/loss = 0 . • If the taxpayer is a company, the company can choose how much of the prior year losses it wishes to deduct in Year 2 subject to the loss recoupment tests.

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Question 13.5 Toys Toys Toys Pty Ltd (TTT) sells custom made wooden toys. Customers are invoiced for the toys when they are shipped and are required to pay for the toys once the toys have been received and deemed satisfactory. TTT includes the invoice amount in its assessable income when the invoice is issued. As of 30 June, TTT determined that it had $5,000 in unpaid invoices. TTT’s records indicated that 90% of the invoices related to toys sold within the last month, which was considered acceptable. However, of the remaining $500, $200 related to invoices which were more than three months overdue. In accordance with its customary practice, TTT wrote off the $200 of outstanding invoices. Its standard practice is to issue payment reminders before writing off the debt. TTT also created a provision for bad debts of $300 at this time. Advise TTT as to what amount (if any) it can deduct in relation to the unpaid invoices.

Solution to Question 13.5  $300 not deductible because there is only a provision for bad debts, not a write-off. • $200 write-off should be deductible as a bad debt expense as the amount has previously been included in TTT’s assessable income.

Question 13.6 Jeremy is a personal trainer. He works at a local gym providing personal training services to members of the gym. Jeremy works at the gym until 3 pm each day. He then takes the train home. He has to be home by 4 pm as he trains clients at his home gym from 4 pm to 7 pm. Advise Jeremy as to the tax deductibility of his train fare. Would your answer be any different if Jeremy took the train to another gym, where he trained clients from 4 pm to 7 pm?

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Solution to Question 13.6  The train fare from the gym to home is not deductible under s 25-100. Even though the travel is between two places where Jeremy produces assessable income, one of them is also his home.  If he travels directly from one gym to another, the train fare will be deductible under s 25-100.

Question 14.2 Jerry and Elaine own and run a diner together. The diner is run through their partnership, Tom’s Diner. Jerry and Elaine also own a residential investment property together which they purchased in equal proportions. During the current income year, they undertook the following transactions:  Purchased a new dishwasher machine for the diner for $15,000 on 1 December. The Commissioner has assessed the effective life of dishwashers as 8 years.  Installed a new kitchen exhaust fan on 27 April. The kitchen fan cost $1,100 and it cost an additional $500 to install it. The Commissioner has assessed the effective life of kitchen exhaust fans as 5 years.  Installed a new ducted vacuum cleaner in the investment property on 1 February. The ducted vacuum cleaner cost $5,000. The Commissioner has assessed the effective life of residential ducted vacuum cleaners as 10 years.  Advise Jerry and Elaine of their income tax consequences arising out of the above information under both the diminishing value method and the prime cost method (if relevant) for the current income year. Assume that an immediate deduction is not available for the assets.

Solution to Question 14.2  Purchase of dishwasher is by the partnership; therefore partnership includes depreciation deductions in calculating its taxable income for the year  Prime cost method:  Depreciation = $15,000 x (212/365) x (100% / 8) = $1,089  This assumes that the partnership is choosing to use the Commissioner’s determination of effective life.  Diminishing value method:  Depreciation = $15,000 x (212/365) x (200% / 8) = $2,178  This assumes that the partnership is choosing to use the Commissioner’s determination of effective life.  200% is used as the asset is acquired after 10 May 2006: ITAA 1997 , s 40-72.

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Solution to Question 14.2  Purchase of kitchen exhaust fan → purchased by the partnership; therefore partnership must include depreciation deductions in calculating its taxable income for the year  Depreciation deductions can be calculated as above under the prime cost method or diminishing value method.  Depreciation = $5,000 x (150/365) x (100% / 10) = $205  Purchase of ducted vacuum cleaner for investment property → Jerry and Elaine are joint owners of the investment property; therefore each has a 50% interest in the ducted vacuum cleaner.  Prime cost method.  Depreciation = $5,000 x (150/365) x (200% / 10) = $411  Diminishing value method Jerry and Elaine can each claim half of the depreciation expense as a deduction.

Question 14.6 An extract of the asset register of Big Profits Pty Ltd (“Big Profits”) for the 2020-21 income year is as follows: Asset Cost Opening Adjustable Value Method Effective Life Decline in Value for This Period Closing Adjustable Value Desktop Computer 1,350 1,350 Diminishing Value 3 years 450 900 Furniture 5,000 3,000 Prime Cost 10 years 500 2,500 Filing Cabinets 1,200 1,080 Prime Cost 10 years 120 960 All depreciable assets are for 100% business use and Big Profits uses a low-value pool for all eligible assets. The closing value of the low-value pool at 30 June 2021 was $5,300. Big Profits purchased a printer on 5 June 2022 for $700. Advise Big Profits of the income tax consequences arising out of the above information for the 2021-22 income year assuming an immediate deduction is not available.

Solution to Question 14.6  Depreciation of furniture  Prime cost method:  $5,000 x 365/365 x 100%/10 = $500  Closing adjustable value = $2,500 - $500 = $2,000  Prime cost method:  $1,200 x 365/365 x 100%/10 = $120  Closing adjustable value = $960 - $120 = $840 • Depreciation of cabinet  Low value pool  Although the closing adjustable value of the filing cabinets is < $1,000, it cannot be added to the low-value pool as it has been depreciated using the prime cost method. Only assets that have been depreciated under the diminishing value can be added to the low-value pool: s 40-425(5).

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Solution to Question 14.2 Decline in value of the low-value pool: Step 1 Low cost assets x 18.75%  Printer purchased: $700 x 18.75% $131.25 Step 2 Second element costs relating to the low-value assets added to the pool x 18.75%  Nil Step 3 Multiply the closing pool balance for the previous year and the opening adjustable value of low-value assets added to the pool by 37.5%  Closing pool balance at 30 June 2021: $5,300 x 37.5%  Low-value assets added to the pool (computer): $900 x 37.5% $1,987.50 $337.50 Step 4 Sum of amounts from steps 1, 2 and 3 equals the decline in value for 2021-22: $2,456.25 The closing value of the low-value pool at 30 June 2021 was $5,300. Big Profits purchased a printer on 5 June 2022 for $700.

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