The term ‘tax deduction’ in Australia refers to the amount of money claimable by a taxpayer to offset the amount of tax owed by the taxpayer. Most deductions will relate to employment or business activity, although allowances are also made for payments or donations made to, for example, charitable organisations.
For those which relate to business, a deduction is generally allowable ‘to the extent’ that the ‘loss or outgoing’:
- is incurred because you are generating assessable income, or
- has to be incurred to carry on a business so that you can generate assessable income.
Australian taxation law is set out in numerous pieces of legislation. The two main Acts which deal with claiming tax deductions are:
- the Income Tax Assessment Act 1936 (Cth) (‘ITAA36’), and
- the Income Tax Assessment Act 1997 (Cth) (‘ITAA97’).
The main difference between these Acts and most other pieces of legislation is that the taxation Acts are written in way that might be understood by people who are not lawyers or accountants. They use words like ‘you’ rather than ‘individual’ or ‘person’ as is the case for most other Acts.
To calculate a taxpayer’s taxable income, the taxpayer must subtract their allowable tax deductions from their assessable income (ITAA97 s 4-15).
‘Assessable income’ is comprised of ‘ordinary income’ and ‘statutory income’ (ITAA97 s 6-1(1)).
There is no definition of ‘ordinary income’ in the Act, but it is generally taken to mean payments most people would normally think of as income, such as salary or wages, income produced from running a business, or rent payments, interest, and dividends.
Whether a payment is ‘ordinary income’ is determined by reference to ‘the ordinary concepts and usages of mankind’ unless the legislation indicates a contrary intention. Some of the factors which will be considered in determining whether an amount of money is ordinary income include:
- whether there is a connection with the taxpayer’s earning activity (from employment or business)
- whether the payment reoccurs or is a one-off payment, and
- whether it has come as a benefit to the taxpayer as ‘income’.
Generally, a taxpayer’s income will be their salary and wages derived from some sort of personal exertion or services provided, or income derived from a business operated by the taxpayer.
‘Statutory income’ refers to specific categories of income. These categories are set out in division 15 of the ITAA97 and include:
- allowances related to employment or services
- payments for returning to work
- transfer payments for accrued leave
- bounties or subsidies
- profit-making undertakings or loans
- royalties, or payments to a society which collects copyright
- payments received for repairs under a lease obligation
- insurance or indemnity payments relating to the loss of assessable income
- interest accrued on overpayments or early payments of tax
- the provision of mining, quarrying and other related information
- amounts paid under forestry agreements or forestry managed investment schemes
- amounts paid for work in progress
- some amounts paid under funeral policies or scholarship plans
- car expenses which are reimbursed, and
- bonuses received.
A deduction related to business is allowable as far as the payment or loss:
- is sufficiently related to earning assessable income, or
- had to be incurred for a business to generate assessable income.
To determine whether a payment or loss is sufficiently related to your earning, it must be:
- connected to the taxpayer’s scope of employment as an employee (the first limb), or
- a necessary expense for the taxpayer’s business (the second limb).
You cannot claim a deduction when the payment or loss is incurred for domestic purposes.
|Example 1: If the taxpayer is a personal trainer, they cannot claim a magazine subscription in relation to computer hardware simply because they use a computer. The expense must be within the scope of the taxpayer’s earning activity. Here the earning activity is providing fitness training. It may, though, be possible to claim a set of weights that are used solely in providing the personal training services.|
Where an expense has a dual purpose, such as if it has been incurred for the purposes of gaining assessable income AND for personal use, you can only claim the portion of the expense that relates to earning your income.
|Example 2: A taxpayer travels to attend a conference related to their employment, incurring costs for travel, accommodation and food. If the taxpayer only has to attend the conference for a couple of hours each day and spends the remainder of the time sight-seeing or on personal matters, the amount that is claimed as a tax deduction will have to be apportioned appropriately to reflect the percentage of which was for employment purposes.|
Section 8-1(2) of the ITAA97 sets out 4 exemptions that will mean a payment or loss cannot be claimed as a tax deduction. Payments or losses will not be deductible where it is:
- a capital gain, or an asset which is purchased for later resale for the purposes of making a profit, such as a house
- private or domestic in nature
- incurred in gaining or producing exempt income, or
- declared to be non-deductible in the legislation.
This article reflects the state of the law as at 15 June 2016. It is intended to be of a general nature only and does not constitute legal advice. If you require legal assistance, please telephone 1300 636 846 or request a consultation at gotocourt.com.au.