Shannon Johnstone's Tax Deductions for 2150AFE Course

2150AFE Taxation Law 2023 Specific Deductions

Shannon Johnstone question 1 Shannon Johnstone owns Warm and Frosty Pet Mats. He incurs numerous costs in relation to the operation of his business but is unsure how these costs are dealt with for tax purposes.  Shannon seeks your advice as to whether he might be able to claim any tax deductions for the following expenses:   In June 2022, Shannon decides to apply for a loan from the bank to help fund the production of pet mats. The total value of the loan was $75,000 and the costs charged by the bank to set up the loan were $850. The term of the loan is over a period of 10 years. The loan is entered into on 15 July 2022. During the 2022/23 tax year Shannon pays $7500 in principal payments and $600 in interest payments towards the loan.  To manufacture the heating and cooling pet mats Shannon needed to purchase a compressor. The cost of the compressor was $8,800 including GST. He also paid $220 for transport and $880 for the electrical materials to install the compressor in the garage of his house. Shannon took 3 hours to install the compressor and have it ready for use on 1 July 2022, which he would charge a client $660 if he was carrying out the electrical work for someone else. The effective life of the compressor is 8 years. 2

Shannon Johnstone Shannon would also like your advice regarding expenses he incurred for his commercial rental property in Victoria.  Shannon owns a commercial property at 180 Frankston Dandenong Road, Dandenong South Vic. The building has been rented to a tenant since July 2019. On 5 December 2022, the plumbing pipes in the bathroom facility burst due to a blockage in one of the pipes. Shannon paid $3,000 to a plumber to repair and replace the damaged pipes.  Required: Determine whether Shannon is entitled to claim a deduction for the expenses incurred in the 2022/23 tax year for Warm and Frosty Pet Mats and for his property in Victoria. Assume that Warm and Frosty Pet Mats is not registered for GST Griffith Business School

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Shannon Johnstone application – borrowing costs Shannon secured a bank loan for $75,000 to help fund the initial production of his heating and cooling pet mats. The life of the loan is 10 years and the costs associated with setting up the loan charged by the bank were $850. Section 25-25 allows a deduction for borrowing costs where the loan relates to the production of assessable income  here it’s a business loan for production of goods to be sold at a profit. The loan set up expenses are more than $100, therefore they will be deductible over the period of the loan or 5 years (whichever is shorter)  10 -year loan so it will be deducted over 5 years (365 days x 5) + 1 day (as there will be 1 leap year [2024]) = 1,826 days  For the 2023 income tax year, the loan days would be: 365 days – [14 days (1 July to 14 July 2022) = 351 days  The 2023 income tax year the borrowing costs deductible under s 25-25 would be: $850 x 351 days = $163 1,826 days Griffith Business School

Loan interest and principal payment – application and law Shannon secures the loan for income producing purposes – the production of pet mats for the purpose of making a profit. The principal payment of the loan is a liability and not an expense. Shannon is returning the money lent to his business by the bank. The principal payment is therefore not deductible, instead expenses incurred in the production of the mats that the loan is used to pay for will be an allowable deduction (most will be immediate under s8-1) . The interest payment on the loan will however be an expense incurred for income producing purposes. The $600 interest payment made in the 2022/23 income tax year will be deductible under s8-1 (FCT v Munro). The expenses satisfies the 2 nd positive limb – it was incurred in producing business income. It does not fail any of the negative limbs; 1.Is reoccurring and does not provide a long-term benefit to Shannon. 2.It is not private or domestic in nature – it is for the sole purpose of earning business income. 3.Not exempt or NANE income – business income is assessable under s6-5 . 4.No provision in the act that prevents the deduction. Griffith Business School

Repairs » Note the 3 requirements of s 25-10 : 1. That there is a repair ; 2. That the item is held or used for the purpose to produce assessable income ; and 3. That the expenditure is not capital . » If asset or property is only held or used partly for that purpose you may deduct a reasonable amount of the expenditure on repairs – so can apportion on the percent of income producing use (2 nd requirement) 6

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Shannon Johnstone - repair Application and Law – First requirement 1.The repair involves restoration  The plumbing pipes being replaced were in need of restoration, as the pipes burst as a result of a blockage and are no longer operational and in need of repair.  It must be determined whether replacing the plumbing pipes brings the plumbing of the bathroom facility to a condition that it formerly had without changing its character.” (W Thomas & Co) » Repairing and replacing the damaged section of the pipe allows the bathroom to functon at a condition that it formally had without making any improvement to the functionality of how the bathroom or the plumbing of the bathroom operates. There is no indication that any alternate work has been carried out to prevent blockages in the future. 2.The repair must be a replacement of a “part” of an item rather than the “entirety”. Lurcott v Wakely and Wheeler (1911)  The plumbing pipes are an “inseparable part of the larger unit, namely the building itself and the plumbing system for the building (Lindsay v FCT); and the plumbing for the bathroom facility can not operate separately from the rest of the plumbing in the building (Phillips v Whieldon Sanitary Potteries). Also the plumbing forms part of the larger unit which is the bathroom, the plumbing pipes are a necessary component of the operation of the bathroom.  Therefore, the replacement of the damaged plumbing pipes, is a replacement of a “part” and not an “entirety” (W Thomas & Co Pty Ltd). 7

Shannon Johnstone application Will expenditure on the plumbing pipes be capital in nature? (3 rd requirement)  Non-deductible capital expenditure (and not a repair) , falls into three categories: (i) Improvements – no improvement to the plumbing system has been made. Repair to the section of the plumbing that was damaged has been rectified with no improvement to its efficiency. (ii) Additions or alterations – the repair did not involve any new or extra plumbing sections being installed. (iii) Initial repairs – the work would not be an initial repair, as the burst plumbing pipes occurred 3 years after the purchase of the building. The repair and replacement of the burst plumbing pipes will be deductible under s25-10. 8

Depreciating assets (Capital allowances)  Two methods available to calculate – taxpayer can choose: » Diminishing value This takes a fixed percentage of the asset’s cost less accumulated depreciation each year: s40-70  Note : the percentage available under this method changed for assets acquired after 9 May 2006: see s40-72 » Prime cost This takes a fixed percentage of the cost; that is, the same amount each year: s40-75  In order to do our calculation we need to know what the ‘ start time ’ is, the ‘ cost ’ and the ‘effective life ’ 9

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Depreciating assets (Capital allowances) » Start time : is when the taxpayer first uses it, or has it installed ready for use, for any purpose. s 40-60 » Cost : the initial cost of acquisition (includes transportation costs) and then any ongoing improvement costs: ss 40-175 to 40-230 . Cost is GST exclusive where taxpayer can claim back GST: s 27-80 » Effective life : a taxpayer may choose either:  an effective life determined by the Commissioner: s 40-100  to work out the effective life of the asset themselves: s 40-105 10

Depreciating assets (Capital allowances) Diminishing Value Method  Post 9 May 2006 assets (s 40-72) Base Value x Days Held x 200% 365 effective life Base Value = *cost in first year  Other Years : opening adjustable value for remaining years (add any new capital expenditure). This is the cost less accumulated depreciation Prime Cost Method (s 40-75) Asset’s *Cost x Days Held x 100% 365 effective life 11

Shannon Johnstone application and law– depreciating assets ISSUE: Is Shannon entitled to claim a deduction for the purchase of the compressor? LAW and APPLICATION Shannon also purchased a compressor (effective life 8 years) for use in his pet mat manufacturing business on 1 July 2022 for $8,800. He also incurred the following costs in relation to the compressor: » Transport $220 » Electrical materials $880 » Cost of Installation: $660?  Cost = $9,900 s40-180 (includes all costs incurred in getting the asset ready for use)  Start time = 1 July 2022 s40-60 ( when it is first used or ready for use)  Effective life = 8 years s40-95 (given in the question, alternatively you would search for commissioner’s rule of effective life s40-100 )  Days held to 30 June 2023: 365 days 12

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Shannon Johnstone application – depreciating assets Diminishing Value Method  Post 9 May 2006 assets (s 40-72) Base Value x Days Held x 200% 365 effective life = $9,900 x 365 x 200% = $2,475 365 8 years Prime Cost Method (s 40-75) Asset’s *Cost x Days Held x 100% 365 effective life = $9,900 x 365 x 100% = $1,237.50 365 8 years Griffith Business School

Shannon Johnstone – Question 2 In Shannon’s job as an electrician for Sparky’s R Us he travels frequently between the Sparky’s R Us workshop and to the premises of their clients. Sparky’s R Us provide Shannon with a car allowance of $6,000 per year, as he uses his own vehicle for work purposes.  Shannon leased a Toyota Hilux utility vehicle (engine size 2700CC) valued at $60,000 on 1 July 2022. He kept a logbook that showed that his travel from 1 July 2022 to 30 September 2022 consisted of the following:  800 km travelling between home and Sparky’s R Us workshop location.  400 km travelling from home to the local supermarket to buy personal groceries and home to the local gym.  6,800 km travelling from the Sparky’s R Us workshop to various client and supplier premises and return.  He incurred the following car expenses (which he can substantiate): -Registration $ 800 -Insurance $1,000 -Fuel $3,200 -Lease repayments $13,600 Griffith Business School

Shannon Johnstone – Question 2  Required: What would Shannon’s deduction for car expenses be for the 2022/23 income year? Which method should he claim under? 1. Identify the relevant section of the legislation that relates to car expenses. 2. Identify the two methods that Shannon can use to calculate the deduction. 3. Calculate each method according to the facts relating to Shannon. 4. Determine which method Shannon will use to claim a deduction for his car expenses and give an explanation as to why Shannon would choose this method. Griffith Business School

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Shannon Johnstone – Car expenses ISSUE: Is Shannon entitled to claim a deduction for the costs incurred for using his vehicle for work purposes? APPLICATION and LAW Shannon is an employee of Sparky’s R Us and therefore for his work related travel we calculate according to Division 28 ITAA97.  Shannon’s business kilometres will be 6,800Km – the distance travelled between the Sparky’s R Us workshop to various client and supplier premises and return.  Note the travel from home to Sparky’s R Us is generally not deductible (Lunney), the exceptions would not apply to Shannon. Personal travel to the supermarket and the gym are not related to carrying out income earning activities and therefore not deductible.  There are currently two possible methods that Shannon could use to calculate a deduction for work related travel; the cents per Km method (s28-25) or the Logbook method (s28-90).  Shannon can calculate under both methods because he has kept a logbook for the required 12 weeks and he has kept his receipts (s28-100) Griffith Business School

Shannon Johnstone – car expenses Cents per Km s 28-25 Maximum of 5,000 business Km’s are claimable. Business Kms x rate set by the commissioner for the year Shannon can only claim a maximum of 5,000Km under the cents per Km rule even thought his work related Km’s would be much higher as he travelled 6,800Kms in only 12 weeks. Calculation for Shannon: 5,000 x 0.78 = $3,900 Logbook Method s28-90 Calculate the business use % for the 12 weeks of the logbook recording and then multiple Business Use % x car expenses incurred for the year. Shannon has kept receipts, so he is able to substantiate his costs for the year (s28-100). The vehicle purchased by Shannon is under lease and he has kept a logbook for a 12 week period. 6,800Km = 85% 8,000 800 + 1000 + 3200 + 13600 = $18,600 x 0.85 = $15,810 Griffith Business School

W4 2150AFE Specific Deductions Shannon Johnstone answers

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