Week 2 Flashcards
What are deductions?
An amount is a deduction of a person if they are allowed a deduction for the amount under Part D (Deductions).
When is a person allowed to deduct for an amount under part D?
- The amount satisfies the General Permission; and
- A General Limitation does not deny a deduction for the amount
OR - A specific provision in Part D allows a deduction for the amount
What is the General Permission?
A person is allowed a deduction for an expenditure or loss, including depreciation, to the extent that the person incurred the expenditure or loss in:
Deriving the person’s assessable income and/or excluded income (“the first limb”); OR
The course of carrying on a business for the purpose of deriving the person’s assessable income and/or excluded income (“the second limb”).
How to satisfy general permission?
- Must be an expenditure or loss
- Requires a monetary outlay
- Must be an expense of the person
- Must be outlay by person claiming deduction
- Must be nexus with person’s assessable or excluded income
- Must be connected to income of person claiming deduction
- Direct connection to income; or
- An outlay of the person’s business
General Permission - First Limb
Deriving the person’s assessable income and/or excluded income.
General Permission - Second Limb
The course of carrying on a business for the purpose of deriving the person’s assessable income and/or excluded income.
What are the general limitations
- The General Limitations deny deductions for expenditure
- of a particular nature; or
- incurred in deriving income of particular nature
- The General Limitations are
- The Capital Limitation
- The Private Limitation
- The Exempt Income Limitation
- The Employment Limitation
- The Withholding Tax Limitation
- The Non-Residents’ Foreign-Sourced Income Limitation
The private limitation
- Deduction denied for expenditure TO THE EXTENT it is of a private or domestic nature?
Private expense
Exclusively referable to living as member of society
Domestic expense
Relate to the household or family unit
- Examples
- Clothing/Meals/Medical-costs
- Household expenses
The exempt income limitation
- Deduction denied for expenditure to the extent it is incurred in deriving exempt income
- Exempt income is not assessable income
- No deduction allowed for expenditure incurred in deriving
- Example
- Charity operating Op Shop
- Charitable purpose in NZ = exempt income
- Charitable purpose outside NZ = assessable income
Exempt income
Exempt income is tax free and no deduction on deriving exempt income is allowed
The employment Limitation
- Deduction denied for expenditure to the extent it is incurred in deriving income from employment
- Income from employment
- Salary and wages
- Bonuses and extra pays
- Examples
- Suits for work
- Work shoes
- Cost of travelling to work
The Withholding Tax Limitation
- Deduction denied for expenditure to the extent it is incurred in deriving non-resident passive income
- Non-resident passive income = NZ - sourced income of non-resident that is
- Dividend
- Royalty; or
- Interest (most, but not all)
- Assessable income, but not fully taxed
- Rate of tax = 0%, 15% or 30%
Non-Residents’ Foreign-Sourced Income Limitation
- Deduction denied for expenditure to the extent it is incurred in deriving non-residents’ foreign-sourced income
- Non-resident’s foreign-sourced income ≠ assessable income
- No deduction allowed for expenditure incurred in deriving it
- Example
- Non-resident borrows money for business in NZ & Aus
- Income from NZ business = assessable
- Income from Aus business = non-assessable
The Capital Limitations
- Deduction denied for expenditure to the extent to which it is of a capital nature
- Need to consider case law to identify expenditure of a capital nature
- No definitive test
- Need to consider each test
- Weigh the outcome of each test
- Formulate overall impression as to expenditure’s nature
Types of Limitations
Capital, Non-Residents’ Foreign-Sourced Income, Withholding Tax, The Employment, Exempt Income, General, Private.
Capital Vs Revenue Tests
- Case law has developed a number of tests
- These tests can be posed as the following questions
- Is the expenditure recurrent or “once and for all”?
- Does the expenditure result in an enduring benefit?
- Is the expenditure from fixed capital or circulating capital?
- Is the expenditure on the profit-making structure or in the course of the profit-making process?
- Does the expenditure result in an identifiable asset?
- How is the expenditure treated by ordinary principles of commercial accounting?
Recurrent Expenditure - Revenue or capital nature?
Expenditure that recurrent and incurred to meet a continuous demand for expenditure is likely a cost of ordinary business operations = revenue nature
- Wages
- Rent
However, recurrent expenditure with primary purpose relating to capital undertaking = capital in nature
- Instalment payments on purchase of capital asset
- Wages for work on construction of capital assets
Enduring Benefit?
Expenditure is capital in nature when it brings into existence an asset or advantage for the enduring benefit of the business
- This test is one of more relevant and persuasive tests
- Examples of payments that result in an enduring benefit
- Trade Ties
- Freedom from competition
- Alterations to land
Once and For all expenditure - Revenue or capital nature?
Expenditure spent “once and for all” = capital nature
- Purchase of a capital asset
Fixed Capital
Was source of expenditure fixed or circulating capital?
- Fixed capital
- What owner turns to profit by keeping it in their possession
Circulating Capital
Was source of expenditure fixed or circulating capital?
- Circulating capital
- What owner makes profit from by parting with it and letting it change masters
Examples of Fixed or Circulating Capital?
- Expenditure on building from fixed capital
- Expenditure on trading stock from circulating capital
Profit-Making Structure or Process of Making Profit test?
Distinction between expenditure
- On business structure used to earn profit; and - In ordinary process of carrying on business to earn profit
- Example
- Expenditure to acquire building on profit-making structure
- Expenditure on raw materials to manufacture goods in the process of making profit
This test is one of more relevant and persuasive tests
Is it an Identifiable Asset test?
- Expenditure of a capital nature if
- Results in acquisition of a capital asset
- Improves an asset or makes it more advantageous
- Example
- Expenditure to acquire land to build a factory
- Expenditure to expand the factory
This test is one of more relevant and persuasive tests
Ordinary Principle of Commercial Accounting test?
- How is the expenditure treated according to ordinary accounting principles?
- Not as useful as other tests
- Courts place less emphasis on
- Supports an outcome rather than determines it
Capital vs Revenue Example
Pallomari Accounting Services operates a bookkeeping business
- PAS incurs the following expenditure on
- Rental of leased printer of $125 per month ($1,500 p.a.) - Purchase of two new computers at cost of $3,000 each - Purchase of cell phone at cost of $1,499 - Interest on funds borrowed to purchase building from which the business operates of $1,000 per month ($12,000 p.a.)
Which expenditures are capital in nature?
Expenditure on Computers and Cell Phone
- Capital indicators
- It is “once and for all” and is not recurrent
- It has an enduring benefit
- It is fixed capital
- It is on the profit-making structure
- It creates an identifiable asset
- Ordinary accounting principles would capitalise as an asset
- Capital in nature!!
Expenditure on equipment rental
- Revenue indicators
- It is recurrent
- It does not create an identifiable asset
- No enduring benefit
- Ordinary accounting principles would expense
- Capital indicators
- Fixed capital
- It is on the profit making structure
- Revenue in nature
Expenditure on Interest
- Capital indicators
- Enduring benefit – acquisition of building
- Relates to profit making structure not the process
- Fixed capital
- Not an identifiable asset, but cost of acquiring one
- Revenue indicators
- Recurrent
- Recorded as an expenses in the financial statements
- Capital in nature
