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Step 3. Subtract your deductions from your assessable income (unless they exceed it). The result is your taxable income. (If the deductions equal or exceed the assessable income, you don’t have a taxable income.)

So the trick is to get the assessable income and then take away the deductions, but what are the deductions?

There are 2 kinds of deductions

Specific deductions

Section 8-5 says you can deduct an amount from your assessable income if a specific section of the Income Tax Assessment Act says you can. The Assessment Act contains some specific provisions authorising deductions. - for example, repairs. You can refer to a listing of some of these in section 12-1

General deductions

However most outgoings of a business character are allowed as deductions under a general deduction provision this is section 8-1.

Section 8-1 - the general deduction provision says

You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

Having a general deduction provision such as sec 8-1 saves a lot of space

Let's work through it phrase by phrase

*The questions to ask under section 8-1*
*Was there a loss or outgoing?*
	*Was it incurred in gaining or producing assessable income?*

(There is a negative aspect to section 8-1 but we will look at that in the next topic. For the moment, let's concentrate on what kind of expenditures qualify for a deduction)

When is an outgoing

'incurred in' gaining income

Having a general deduction provision such as sec 8-1 saves a lot of space in the Act, but also creates a great deal of uncertainty as to what outgoings and expenditures are allowed as deductions under the provision

In particular the words 'incurred in' gaining income have been the subject of many disputes between taxpayers and the Commissioner. It is the guidelines laid down by the courts and appeals tribunals that we will look at in this topic

Was there a loss or outgoing?

You will be aware that many business expenditures are made as credit transactions - in other words there has not been a disbursement of funds by the businessman.

Do you think such transactions amount to outgoings?

The answer is yes - as long as the taxpayer is definitely committed - or - has completely subjected him self to the expenditure it will be a loss or outgoing

Refer CCH Master Tax Guide para 14-040 - Commonwealth Aluminium case - the amount is properly incurred even though it is defeasible (subject to dispute)

Was it incurred in gaining or producing assessable income?

It is necessary to follow through the reasoning of the courts in interpreting sec 8-1 to answer this question was as it incurred in gaining or producing assessable income?

These are the facts Amalgamated Zinc (de Bavays) Ltd case (1935) 54 CLR 295

There was no connection between the payment of the premiums and the gaining of the dividends-the outgoings were not incidental and relevant to the production of the income

Was it incurred in gaining or producing assessable income?

Answer this question….

A taxpayer claims the cost of travel to and from work is incurred in gaining the income he derives by attending the work place and performing the required duties. Are the travel costs incurred in gaining income?

Yes No

Refer to paras 14-230 in the CCH Master Tax Guide

It is the essential character of the outgoings which is the crucial factor.

In this case the income is produced by the activities performed at the work place. It is irrelevant to these actions whether the taxpayer lives across the road and walks to work, or whether he drives from the other side of town. He is paid solely for the duties performed after he has arrived

Put another way we can say that …

the occasion of the outgoing

must be found in whatever actions

give rise to the income.

In this case the occasion of the expenditure is the fact that the domestic establishment of the taxpayer is remote from his work place

occasion of the expenditure

= distance between home and work

so expenditure is not incurred in gaining income

These are the facts of Lodge's case - refer para 14-170 of CCH Master Tax Guide In Lodge's case the expenditure was a prerequisite to gaining the income. Its purpose was that of gaining income. But the essential character of expenditure was NEITHER incidental NOR relevant to the work of preparing bills of cost -the activity giving rise to the income

This was the situation in Handley's case, refer para 14-480, CCH master tax guide - even though the room was used for producing income it remained just another room in the taxpayer's domestic establishment.

Moreover, the taxpayer had an office in the city, so that the study could not be described as the base for his income producing activities.

The essential character of the interest payments was that of maintaining the taxpayer's domestic establishment, NOT gaining income.

Was it incurred in gaining or producing assessable income?

Refer para 14-560 of the CCH Master Tax Guide. These were the facts in Smith's case. The payments were incidental and relevant to the gaining of the income from the policy. The occasion of the expenditure (premiums) could be found in operations or activities regularly carried on for the production of income

Refer para 14-560 - CCH Master Tax Guide.

Sec 8-1 does not require that the purpose of the expenditure be the gaining of income of the same year as that in which the expenditure was made so long as it was incidental and relevant to the operations or activities regularly carried on for the production of income

Was it incurred in gaining or producing assessable income?

We have covered a lot of ground at a fast pace so lets pause for a moment and take stock of where we are …

We have established that an outgoing must be incidental and relevant to the activities and operations regularly carried on for the purpose of producing income before it can be said to be incurred in gaining income

Incidental and relevant

- necessary but NOT sufficient!

So it is necessary that the expenditure be incidental and relevant to gaining income ... But this is not sufficient.

The cost of getting to and from work is incidental and relevant to gaining wages but it is

not 'incurred in' that process - it is only a prerequisite

It is necessary and sufficient that the essential character of the outgoing be that of expenditure made in the course of the activities producing the income

Question

How do we know that the essential character is that of outgoings made in the course of gaining income?

Answer

When the occasion of the outgoing is found in the activities giving rise to the income...Then we say that the essential character is that of expenditure incurred in gaining income

In other words ... If the result sought by spending the money is so closely related to the income producing process as to be part and parcel of it ... then the expenditure is incurred in gaining assessable income

We can expand on this by considering a concrete example - interest payments.

To determine whether the expense was incurred for the PURPOSE of gaining or producing assessable income it is necessary to determine the ESSENTIAL CHARACTER of the expense.

An interest expense will have the ESSENTIAL CHARACTER of expenditure incurred in gaining or producing assessable income if the use to which the funds are put is INCIDENTAL and RELEVANT to the income producing activities.

The most obvious way to determine whether the use to which the funds were put was INCIDENTAL and RELEVANT to the income producing activities is to

trace the funds and see how they are used.

But there are other ways of coming to a conclusion on whether the interest payments will be allowable deductions.

Tracing the use to which the funds were put VERSUS discerning the purpose of the transaction

If the funds were used directly in the processes, which gave rise to the income, the answer is obvious. The cost of those funds is INCIDENTAL and RELEVANT to the production of income, and so the ESSENTIAL CHARACTER of the outgoings is that of expenditure incurred in gaining or producing assessable income.

Is the loan really for an income-producing asset?

PURPOSE OF TRANSACTIONS

Another test will be applied if the objective facts do not provide a commercial explanation for the incurring of the expense.

For example, if a husband borrows funds at an interest rate of 10% and on lends them to his wife at 1%.

If there is no relevant assessable income or if the relevant income is less than the outgoing, then the objective facts do not provide a commercial explanation for incurring the expense. This is obviously relevant in the case of a negatively geared purchase of a property which is rented out to produce income.

A commonsense or practical weighing of all the circumstances

In such a case, there should be a commonsense or practical weighing of all the circumstances, including the direct and indirect objectives and advantages, to determine whether, objectively, the funds are used in producing assessable income.

If, after weighing up all the circumstances, it can be concluded that the funds are genuinely used in an income producing activity, a deduction may be allowed for the interest. In the case of interest on negatively geared loans used to purchased rental properties, it seems that the Commissioner of Taxation has accepted that the outgoing is incurred in assessable income which the outgoing would reasonably be expected to produce (at some future time).

In other words, the assumption will be that the taxpayer will continue renting out the property after the loan has been paid off, and the property will produce a positive net income.

If, on the other hand, it is concluded that the borrowed funds are being used in the independent pursuit of some other objective (eg exempt income) then the interest must be apportioned between the pursuit of assessable income and the other objective.

Think about the husband who borrows funds at an interest rate of 10% and on lends them to his wife at 1%. He will be allowed a deduction in respect of the interest payments that he makes on his 10% loan, up to the amount of the interest he receives from his wife.

The amount of interest he has paid that is INCIDENTAL and RELEVANT to producing assessable income and thus has the ESSENTIAL CHARACTER of outgoings incurred in gaining or producing assessable income is equal to the amount of interest he has actually received.

The rest of the interest payments he makes on his 10% interest loan will not have this character and thus will not be allowable as a deduction.

It is not necessary that income be produced in the year of expenditure.

It is only necessary that the outgoing be incurred in gaining income though expenses necessarily incurred in carrying on business are also allowed.

This would not alter the nature of the expense - it is still a prerequisite.

The occasion of the expenditure must be found in the processes giving rise to the income.

So much for the positive aspects of section 8-1…

But there are also the negative aspects, which are just as important.

You can read about them in the next topic.

No double deductions

Section 8-10 says you can not claim a deduction under more than one section of the Assessment Act.

8-10 No double deductions

If 2 or more provisions of this Act allow you deductions in respect of the same amount (whether for the same income year or different income years), you can deduct only under the provision that is most appropriate.