Prepaid Rent: Revenue or Capital Expense?
Issues:
The central matter of discussion that is addressed in this case is concerning the tax deduction of prepaid rent that is paid by the taxpayer for 10 years of casino rental.
Rule:
An outgoing is not permitted for deduction till the extent that the outgoing has occurred for expenses that are capital and not allowable as tax deduction inside the “sec 8-1 ITAA 1997”. There must be a difference between the revenue expenditure and capital expenditure (Keyzer, Goff and Fisher 2017). As prominent within the “sec 8-1 (2)(a)” when finding that the loss or outgoing is capital in type then it will not be given permission for deduction inside the “sec 8-1 ITAA 1997”. There is hardly any concrete test of determining whether the expenses are referred as capital or revenue expenses. When the expenses are mainly connected with the income making activities of taxpayer then it is treated as revenue expenditure whilst for capital expenses, they are more widely connected with the income making structure or business of the taxpayer.
The revenue expenditure are connected to the income making procedure of the taxpayer and involves the manner in which the taxpayer makes money (Davison, Monotti and Wiseman 2015). The capital expenditure on the other hand is associated to the income generating structure and the manner in which it has affected the business.
The judicial test included that the expenses that are spent once and for all forms the basis of capital expenditure while the revenue expenses represents those that are recurring in nature. As eminent in the event of “British Insulated and Helsby Cables Ltd v Atherton (1926)” the expenses were largely incurred by the taxpayer in bringing the asset in the existence or to get the advantage of enduring benefit (Braithwaite and Wirth 2019). The law court in passed its verdict which explained that the outgoings incurred were for the enduring benefit and was attributable as capital in nature.
To differentiate between the revenue and capital outgoings the leading example of “Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938)” can be referred where one of taxpayer’s competitor was the World that was published by the Sydney’s Newspaper that proposed the introduction of rival paper that was named as Star to directly compete against the Sun (Khoury 2015). A payment was given by the taxpayer to Sydney newspaper that contained the right of using the plant and equipment for around three years and for the agreed time period that it will not be setting up a newspaper for the similar period. The payment ultimately led the shutting down of the existing rival that was faced by the Sun Newspaper, the World and averting the publication of new rival named as the Star for the period of three years. The verdict that was given by the law court noted that the payment was not the deductible capital expenditure because the taxpayer got an enduring benefit by shutting its competitor which strengthened the business structure of the taxpayer.
Case Law Analysis
The courts have looked upon the necessary factor such as the character concerning the advantage required whether the outgoing has the lasting capital or temporary revenue benefit. The courts have looked upon the way on the basis of which the benefit is used or it is relied upon the by the taxpayer (Harvey, Richard and Lea 2019). Finally the means that is adopted to get the benefit is also important to differentiate between the capital or revenue expenses. This involves if the benefit that has been obtained by the taxpayer is through the one-off payment or through a recurring payment that is revenue in type.
Usually prepaid expenditure are referred as deductible in “sec 8-1 ITAA 1997” occurred in the year unless it is capital in type and it is occurred at a point that is very soon prior to the income generating activity (Farah 2019). In the “FCT v Brand (1995)” a 25-year lease prepayment was treated on capital account by the law court.
The case begins with the fact that John has made application of operating the Casino in Melbourne. John establishes the fact that he has received a license of 10-year from the government of Victoria that involved the permission for operating the casino. As per the instruction of government John should pay $180 million for the approval of the casino license and also $80 million as the prepaid rent for covering the initial ten years of rent.
The prepaid rent needs to be differentiated between capital and revenue expenses that is paid by John. It is important to consider the nature of advantage that is sought by John concerning the prepaid rent. By noting “Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938)” the benefit is obtained by John is through a one-off payment for ten years. In addition to this the prepaid rent has an enduring benefit.
The prepaid rent paid by John is associated to his income generating structure and the manner in which it will be effecting the business. The prepaid rent will be considered capital expenditure because the expenses were directed towards structural business purpose. By reciting the “FCT v Brand (1995)” the prepaid rent has the enduring benefit and it is not a revenue expenses that is not occurred by John in his daily income generating activities (Wolters et al. 2020). As a result the prepaid rent will be classified as capital expenditure. Consequently no deduction will be not permitted to John as deduction under the “sec 8-1 (2) ITAA 1997”.
Travel Expenses: Allowable Deduction?
The case comes to a conclusion by stating that the prepaid rent that is paid by John will be classified as capital expenditure. The expenses will not be permitted for deduction to John under the “sec 8-1 (2) ITAA 1997”.
Issues:
The central matter of discussion that is addressed in this case is concerning the tax deduction of travel cost that has happened when travelling between two unrelated places of work.
Rule:
The operative provision concerning the “sec 8-1 ITAA 1997” is about the general deduction. “Sec 8-1” lays down two positive limbs. Conferring to “sec 8-1 (1)”, deduction for expenses are permitted to taxpayer that;
- Expenses has happened in attaining the assessable earnings and generating the assessable earnings
- The expenses has occurred necessarily in carrying the business with the aim of earning taxable earnings or producing the chargeable income (Sadiq 2019).
Apart from the positive limbs there is also “negative limbs” under “sec 8-1 (2)” that prohibits deduction to taxpayer for expenses that are;
- Capital or capital in nature
- Private or domestic in nature
- Occurred while producing the exempted income
- Prevented from deduction within this act
The 1st “positive limbs” says that it is normally accessible to all the taxpayers but they are normally applied to property owners and employees. Whilst the second positive limbs is normally applied on the business taxpayers (Vann 2019). The taxpayers are entitled to deduction when they have satisfied any one of the above listed positive limbs and given that none of the negative limbs are met. A person is permitted to deduct the loss or outgoings up to the extent that the expenses are paid or for the liability occurred. A tax deduction is only permitted when it has actually occurred by the taxpayer all through their course of producing income. While the second positive limb says that necessarily incurred implies that the taxpayer has occurred expenses due to the ordinary business operations.
There are two types of test that is helpful in ascertaining if the expenditure has fallen into the positive limbs. This involves
- The incidental and relevant test
- Essential character test
Within the incidental and relevant test it is satisfactory and compulsory that the event of outgoings must be present in whatever productive is the taxable income. While under the essential character test the expenses should be containing essential character of expenditure that is made in the due course of generating chargeable earnings. In “Lunney v FCT (1958)” concerning the travel expenses the law court cited its opinion by stating that the most important matter is the relation with the operations that are very likely to gain or generate the assessable earnings (Mitchell et al. 2019).
If the taxpayer is regarded as the individual and they have occurred any travel expenditure that is for travelling between two places of work then they are allowed deduction within the “sec 25-100 (1) ITAA 1997”. A person’s travel amongst the workplaces represents the travel made directly between two places up the range that they were at the first place involved in activities of producing the assessable income or involved the business activities for earning income from business (Nehme & Martin 2019). Meanwhile the purpose of travel to their second location was to involve in activities of producing the assessable income or involved the business activities for earning income from business and the taxpayer is engaging in the activities when they are second place.
Relevant Legislation and Case Law
This must be noted by the taxpayer that under the “sec 25-100 (3) ITAA 1997” when they are travelling among the two places it should not be the home of taxpayer where they live or else they will be denied deduction in this rule. In the “Payne v FCT (2001)” the high court overruled by stating that cost of travel between the farm and the airport is not an allowable deduction because the travel expenses contained inadequate connection between the two unconnected income earning activities and there no engagement of the taxpayer in both the activities when he took travel (Sahyoun, Christina and Scotland 2019).
Application:
Alex is employed at ABC Engineering which is a Melbourne based company. Alex holds the position of mechanical engineer in that company. He also has a property in Dandenong where Alex resides with his family. He establishes that he is doing a home-based food catering business that involves preparing food for the local residents and school canteens. Alex furnishes information that while returning back from his engineering workshop to his home-based business he has incurred substantial amount of travelling expense.
The cost of travel that is occurred by Alex between his workshops and his home based business needs determination of its essential character in order to consider the deductibility of the expenses. The travel expense incurred by Alex do not have any incidental and the relevant character present in it (Butler 2019). The travel expense incurred by Alex lacks essential character of outgoing because it is not occurred by him at the time of producing his taxable income. The cost of travel that is occurred by Alex is not between two related workplaces. Although Alex at the first location is engaged in his employment activities to produce the assessable earnings but the second place where Alex is travelling for doing his home based business cannot be considered as connected workplaces. This is because the second location of his travel constitutes his home where Alex resides with his family.
By reciting the decision made in “Payne v FCT (2001)” the travel expense of Alex is not an allowable deduction under the “sec 8-1 ITAA 1997” because the travel undertaken was between two unconnected places of work (Adno 2020). The travel expense of Alex lacks inadequate relation with his income generating activity.
Conclusion:
Upon the evaluation of the case it can be stated that the travel expenses that is occurred by Alex will not be permitted for deduction under the common law of “sec 8-1 ITAA 1997” because the travel expenses is incurred between two unrelated income earning activities with the second place being the home of Alex.
References:
Adno, Danny, 2020. Business law: New laws passed to tackle illegal phoenix activity. LSJ: Law Society of NSW Journal, (65), pp.82–83.
Braithwaite, J. and Wirth, A., 2019. Towards a framework for large business tax compliance. Centre for Tax System Integrity (CTSI), Research School of Social Sciences, The Australian National University.
Butler, Daniel, 2019. Who can provide taxation advice? Taxation in Australia, 53(7), pp.381–384.
Davison, M., Monotti, A. and Wiseman, L., 2015. Australian intellectual property law. Cambridge University Press.
Farah, Elias, 2019. Property law: Examining the proposed land Tax aggregation laws for SA. Bulletin (Law Society of South Australia), 41(8), pp.26–29.
Harvey, Richard and Lea, Gabrielle, 2019. Property law: 2019 edition of the contract for the sale and purchase of land. LSJ: Law Society of NSW Journal, (62), pp.68–69.
Keyzer, P., Goff, C. and Fisher, A., 2017. Principles of Australian constitutional law. LexisNexis Butterworths.
Khoury, Daniel, 2015. Widening the availability of deductions under Australian taxation law. Tax Specialist, 14(4), pp.207–211.
Mitchell, Andrew D, Voon, Tania & Hepburn, Jarrod, 2019. Taxing tech: Risks of an Australian digital services tax under international economic law. Melbourne Journal of International Law, 20(1), pp.88–124.
Nehme, M. & Martin, F., 2019. Social Entrepreneurs: An Evaluation of the Pty Ltd Company from a Corporation’s Law and Taxation Law Perspective. Australian Law Journal, 93(2), pp.126–144.
Sadiq, K. et al., 2019. Principles of taxation law 2020,
Sahyoun, Christina and Scotland, John, 2019. ATO guidance on non-concessional MIT income. Taxation in Australia, 54(2), pp.99–100.
Vann, Richard, 2019. In defence of the income tax. AUSTRALIAN TAX FORUM, 34(4), pp.831–857.
Wolters Kluwer Law and Business , issuing body & CCH Australia Limited, publisher, 2020. Fifty years of the Australian master tax guide : 1970-2020. 66th ed.
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