Taxation Theory, Practice and Law

Contents

Part 1: Determination of Revenue Vs capital nature of prepaid rent

Definition of prepaid expense provided by ATO..

Prepayment Rules.

Taxation ruling IT 2317.

Determination of question whether prepaid rent of casino is a capital expense or revenue expense.

Part 2: Determination of deductibility of travel expenses incurred by Alex.

Rules of ATO in relation to the deduction for travel expenses.

Types of expenses which are deductible.

Taxation ruling 95/34.

Whether travelling expenses incurred by Alex are allowed as deduction..

References.

Part 1: Determination of Revenue vs Capital Nature of Prepaid Rent

Definition of Prepaid Expense Provided by ATO

As per the definition provided by the Australian Taxation Office, a prepaid expense is an expense that is made under an agreement for a certain thing that is to be done in a future income year i.e. that is different than the current income year in which payment for the expense is made (ATO n.d. a). However, if the expenditure is spent for something that will be done completely within the current income year or the service or benefit that is expected to be received in exchange for the payment of expense will be fully received within the current income year, then such expenditure will not be considered as a prepaid expense and full deduction will be available in the current income year itself (ATO n.d. a).

Prepayment Rules

The Australian Taxation Office has laid down the prepayment rules which can change the timing of deduction of some particular prepaid expenses. These rules are applicable to those types of prepaid expenses which for which a complete deduction would usually be claimed in the year of incurring the expenditure. As per the prepayment rules, the deduction for a prepaid expense can be claimed over the eligible service period or over a period of 10 years whichever is less (ATO n.d. a). However, there are certain exemptions to this rule and an immediate deduction for 100 percent of the amount of expense can be claimed for those expenses which are regarded by the ATO as excluded expenditures. Prepayment rules are only applicable to those payments which are covered under general deduction provisions of ITAA 1997. The following expenses are considered as “excluded expenses” by the ATO (ATO n.d. a).

  • Amounts lower than $ 1000
  • Amounts that are payable under an order of the court or government (whether its commonwealth, state or territory )
  • Salary or wages that are paid under a contract of service.

Taxation Ruling IT 2317

The above taxation ruling provides an explanation of the deductibility of prepaid rent. This ruling is in reference to the decision provided by the Full Federal Court in the case of F.C. of T. v. James N. Creer. In this case, the assessee had voluntarily entered into lease agreements which required him to make an advance payment of rent of 5 years and the main intention of the assessee in entering into such lease agreement was to reduce the amount of his tax liabilities (ATO n.d. b). Also, the agreement enabled the assessee to purchase the property after 5 years by paying the difference between the sale price agreed and the prepaid rent paid by the assessee. The taxpayer had claimed a deduction for the rent paid in advance in their tax return under subsection 51(1). However, this was later declared by the federal court that no deduction is available for the rent paid in advance as it was of the nature of the capital expense and it will not be deductible under section 51(1).

The federal court had made this decision based on the terms of the lease agreement that was entered between the assessee and the owner of the property. It was further held by the federal court that payments cannot be regarded as revenue expenditure merely because it was referred to as “rent “ in the lease agreement (ATO n.d. b). The total rent as described in the agreement was not a periodic expense that was based on the use of premises but of the nature of capital expenditure. Further, consideration was also given to the type of benefit that assessee wanted to have by making these payments. The assessee had voluntarily made the advance payment of rent and was under no compulsion to make these payments. He entered into the specific lease agreements for the main purpose of gaining a tax benefit. Thus, the payment of advance rent was regarded by the federal court as a capital expenditure and the assessee was denied from claiming a deduction for the same.

Determination of Question Whether Prepaid Rent of Casino Is a Capital Expense or Revenue Expense

In the given case, John was required to pay an advance rent of $80 million that relates to the first 10 years of the rent of the Casino. The said advance payment was not being made by John voluntarily as per his discretion but he was required to pay it as per the orders received from an agency of the Victorian Government. There is nothing provided in the facts of the case which suggests that John had intentionally wanted to make an advance payment of rent. As per the prepayment rules, the deduction for a prepaid expense should be claimed over the service period or 10 years, whichever is less. In this case, the service period is 10 years because the advance rent relates to first 10 years of use of the building however, the said payment of prepaid rent of $ 80 million which John is supposed to pay to the government agency can rightly be considered as "excluded payment" as it is required to be paid as per orders from Victorian Government.

Hence, John can claim a full deduction for the said prepaid rent of $ 80 million as it is an excluded payment. Further, the circumstances of this are different from the case of F.C. of T. v. James N. Creer in which the nature of rental payments made by the taxpayer was essential of a capital nature as determined by the intention of the taxpayer in making those payments and the terms of the lease agreement which made it clear that said payments were capital expenses. In the given case, the assessee has not entered into the agreement with the main intention of claiming tax advantage or to acquire the Casino building. The term of the lease was 90 years which shows that the said prepaid rent of $ 80 million is a that is a genuine business expenditure which is covered under section 8-1 of the Income Tax Assessment Act 1997 (Wolters Kluwer n.d.). Thus, it can reasonably be concluded that the prepaid rent of Casino is a revenue expense and John can claim a deduction for the full amount of $ 80 million in the same year as it fulfills the criteria of an excluded payment.

Part 2: Determination of Deductibility of Travel Expenses Incurred by Alex

Rules of ATO in Relation to The Deduction for Travel Expenses

As per the rules of the Australian Taxation Office in relation to the deduction that can be claimed a taxpayer under “Vehicle and Travel Expenses”, there is a clear indication made by the ATO that amounts spent on travel between home and place of work are not deductible as these are regarded as private expenses (ATO n.d. c). However, the Australian Taxation Office has laid down the circumstances in which the taxpayer can be allowed to claim a deduction for travel between home and work and also for travel between two places of work. Further, if some portion of the travel expenses is of private nature and other is for work purposes, then the taxpayer shall be allowed to claim a deduction only for that proportion of the expense that relates to their work.

One of the situations in which a deduction can be claimed for the cost of travel is – when the taxpayer travels between two different places of work in case they have two jobs but this is subject to the condition that either of the two places of work should not be the home of the taxpayer (ATO n.d. c). Another such situation in which a deduction is available is when the taxpayer travels from their home to a place or work if their home was their base of employment (ATO n.d. c). There are certain other situations in which deduction can be claimed for the cost of travel between home and work such as when the taxpayer is required to carry heavy equipment and tools to their place of work that cannot be left at the place of work, or when the taxpayer is required to travel between their home and a client site and from client site to their normal place of work. It has also been provided by the ATO that a taxpayer is involved in such a work where travel is an important part of their work and they are required to regularly travel between various work sites then, they too are entitled claim the cost of travel expenses between the various places of work and their residence (ATO n.d. c). However, it has specifically been provided by the ATO even in case of circumstances explained above, no deduction for the cost of driving the car, shared-ride, bus fare or taxi fare would be available in a situation where the taxpayer carried on their business from their home and regularly travelled from their home to their workplace where they worked for a different person (i.e. are not self-employed) (ATO n.d. c).

Types of Expenses Which Are Deductible

It has been specifically provided by the ATO that a deduction under Vehicle and Travel expenses is available for cost related to driving their own car or costs incurred on shared rides ( like Uber), and cost of flights, trains, bus or taxis (ATO n.d. c).

Taxation Ruling 95/34

According to the Taxation ruling 95/34, no deduction is available for the cost of transport between home and the regular place of work because the said expense is incurred so as to put the employee in a position to able to perform there but are not actually incurred in the course of performance of their work (ATO n.d. d). A deduction for the cost of travel between home and work is only allowed for those assessees who are involved in itinerant work as held by the Commissioner in the case of Taylor v Provan (ATO n.d. d).

Whether Travelling Expenses Incurred by Alex Are Allowed as A Deduction

In the given case of Alex, he works as a mechanical engineer for a company in Melbourne. Alex resides with his family at his family home in Dandenong, Victoria, and also runs his home-based catering business which he only runs for half of the month but is able to earn a good amount of income from this business. Thus, Alex is working for an employer and also carrying out his part-time business in Dandenong from the same place which is also his home. Alex incurred a major amount of travelling expenses for travel between the workshop of ABC Engineering and to his family home in Dandenong, from which he ran his catering business too. These travel expenses were related to the use of his own car or for Uber. As already discussed above, the Australian Taxation Office has allowed a deduction for cost related to driving own car as well as the cost of using Uber and/or fare of the taxi, bus, etc. as a deduction under vehicle and travel expenses. However, it would also have to be tested whether the Alex circumstances fall within the eligible circumstances laid down by the ATO, under which an assessee can claim a deduction for travel between work and home.

By looking at Alex’s circumstances, it is concluded that the travelling expenses that are incurred by Alex for travelling between the workshop of his employer and to his home-based business in Dandenong are not eligible for deduction as these cannot be said to be related to work or business because of the main reason that Alex was running his business from the same place that was also his home. The travel expenses incurred by Alex can be regarded as expenses related to travel between his workplace and his home only and would be non-deductible as travel between home and work is of private nature. It would not be justified for Alex to claim these travel expenses related to travel between work and home as a deduction merely because he was also running his business from his home. Moreover, it has been specifically clarified by the ATO that no deduction shall be available for the cost of travel between a place of work and a place of business where business was being carried out from the residence or home of the assessee.

References for Taxation Theory, Practice and Law

ATO. n.d. c. Travel between home and work and between workplaces. [Online]. Available at https://www.ato.gov.au/Individuals/Income-and-deductions/Deductions-you-can-claim/Vehicle-and-travel-expenses/Travel-between-home-and-work-and-between-workplaces/

ATO. n.d. d. Taxation Ruling TR95/34. [Online]. Available at https://www.ato.gov.au/law/view/document?DocID=TXR/TR9534/NAT/ATO/00001#P11

ATO. n.d.a. General information about prepaid expenses. [Online]. Available at https://www.ato.gov.au/Forms/Deductions-for-prepaid-expenses-2019/?page=2#What_is_a_prepaid_expense_

ATO. n.d.b. Taxation Ruling IT 2317. [Online]. Available at https://www.ato.gov.au/law/view/document?docid=ITR/IT2317/NAT/ATO/00001https://www.ato.gov.au/law/view/document?docid=ITR/IT2317/NAT/ATO/00001

Wolters Kluwer.n.d. SECTION 8-1 General deductions. [Online]. Available at https://iknow.cch.com.au/360document/atagUio694802sl24352119/section-8-1-general-deductions/overview

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