CLAW 3201

Australian Taxation System

Coordinator: Fei Gao

General deduction Part I

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Week 7&8 reading (for two weeks):
Textbook (Understanding Taxation Law 2024) Chapter 8 (pp.473-563).

Make sure you have read the relevant chapters before attending the lecture.

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Positive limbs
 Loss or outgoing
 To the extent --- apportionment
 Incurred vs necessarily incurred
 In gaining or producing your assessable income --- nexus
 In carrying on a business to earn assessable income --- nexus

Negative limbs
 Capital expenses
 Private or domestic expenses
 A provision denies a deduction

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An example of personal tax return
Assessable income
Ordinary income
Salary 80,000
Interest 500
Rental 25,000
Statutory income
Capital gain 2,000
Total A.I. 107,500

Deductions
Stationery 100
Books & Mag 200
Uniform dry clean 200
Home office 500

Rental property related deductions 35,000

5,092+32.5%⨉(71,500-
Total deductions 36,000
45,000)= 13,704.50
Taxable Income 71,500
medicare levy 71,500⨉2%= 1,430
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FCT
Total tax payable 15,134.50
General deduction
s. 8-1 ITAA 1997
(1) You can deduct from your assessable income any loss or outgoing to the extent
that: Positive limbs
(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.
(2) However, you cannot deduct a loss or outgoing under this section to the extent
that:
(a) it is a loss or outgoing of capital, or of a capital nature; or
(b) it is a loss or outgoing of a private or domestic nature; or Negative limbs
(c) it is incurred in relation to gaining or producing your exempt income or your
non-assessable non-exempt income; or
(d) a provision of this Act prevents you from deducting it.
(3) A loss or outgoing that you can deduct under this section is called a general
deduction .
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General deduction
• The two positive limbs allow a deduction, and the four negative limbs deny a
deduction for certain expenses, but some of those denied may be allowed as
specific deductions.

• Total deduction =General deductions + Specific deductions

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General deduction --- loss or outgoing
• Outgoing are deliberate expenses incurred for the purpose of earning assessable
income

• Losses (e.g., losses through theft) do not directly produce assessable income as
they are outside the control of the taxpayer.
o Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95 CLR 344

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General deduction --- loss or outgoing
Charles Moore

• Facts: Employee was robbed while taking cash from office to the
bank.

• Issue: whether it was deductible?

• Held: deductible

• Reasons: Banking the cash is a necessary part of the operations that

are directed to the gaining or producing day by day … assessable
income

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General deduction --- loss or outgoing
Charles Moore

• Government response: inserted s. 25-45 ITAA 1997, hence, now

specific deduction:
You can deduct a loss in respect of money if:
(a) you discover the loss in the income year; and
(b) the loss was caused by theft, stealing, embezzlement, larceny,
defalcation or misappropriation by your employee or agent (other
than an individual you employ solely for private purposes); and
(c) the money was included in your assessable income for
the income year, or for an earlier income year.

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General deduction --- apportionment
• The phrase “to the extent” requires that, where a loss or outgoing is not used wholly for a
deductible purpose (multiple purposes), it must be apportioned into deductible and non-
deductible amounts.
o Ronpibon Tin v FCT (1949) 78 CLR 47 --- expenses incurred to produce A.I and E.I.
o TR 2024/3: https://www.ato.gov.au/law/view/document?LocID=%22TXR%2FTR20243%2FNAT%2FATO%22&PiT=99991231235958
o Previously TR 98/9 now abolished.

• Where the expense results in a tax loss (i.e. the expense is greater than the assessable
income), the expense may be partly non-deductible if there is a purpose other than
producing assessable income.
o Ure v FCT (1981) ATC 4100 --- incurred expense for business and domestic purposes

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General deduction --- apportionment
Ronpibon Tin

• Facts:
o Tp carried on mining business in Thailand and Malaysia (exempt income in Australia).
o Tp also earned investment income (O.I. in Australia).
o Claimed deductions for admin and management expenses incurred for both purposes and
apportion the expenses to the extent it generated investment income.
o During WWII, the mines were confiscated by the Japanese. Hence, no E.I.

• Issue: to what extent the expenses are deductible?

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General deduction --- apportionment
Ronpibon Tin

• Held: apportion in a fair and reasonable way

• Reasons:
o Expenses were not incurred solely in relation to the investment income (O.I.). It also included
support payments to the families of mining employees in Southeast Asia. Hence,
apportionment was required.
o “It is not for the court or the Commissioner to say how much a taxpayer ought to spend in
obtaining his income, but only how much he has spent.”

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General deduction --- apportionment
Ure

• Facts:
o Ure borrowed money at commercial rates (up to 12.5% p.a.)
o On-lent money to wife & family coy at discounted rates (2% p.a.)
o Wife used money to produce A.I.
o Ure claimed deduction for interest paid (at commercial rates)
o Ure argued that produced AI (interest paid by the wife)

• Issue: to what extent the expenses are deductible?

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General deduction --- apportionment
Ure

• Held: apportion limited to the amount of A.I.

• Reasons:
o Looked at the purposes for which the money was borrowed.
o Objectively, the big difference in interest rates suggests that there was another purpose to
earning income. It was to benefit his wife, a private purpose.

• The principle in Ure’s case may not always apply, even though the investment income is less than
the cost of debt used to fund it. This is known as “negative gearing”.

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General deduction --- incurred v necessarily incurred
Incurred

• Either where there has been an actual payment or there is an existing liability to pay
o In week 12 (tax accounting), we will discuss cash and accruals basis of accounting for A.I. (the concept
of “derived”) and deduction (the meaning of “incurred”).
o A loss or outgoing is incurred for the purpose of deduction when it is legally required to be paid. It
applies to the taxpayer using both the cash and accruals basis of accounting.
o W Nevill & Co Ltd v FCT (1937) 56 CLR 290
o FCT v James Flood Pty Ltd (1953) 88 CLR 492

• Expense must be more than merely impending, threatened or expected

o NZ Flax Investments Ltd v FCT (1938) 61 CLR 179

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General deduction --- incurred
W Nevill

• Facts:
o Tp would terminate the contract with one of the two directors and made compensation
payment.
o Payment was not yet made.
o The Commissioner argued it was not deductible because it was not incurred in gaining or
producing A.I.
o Tp argued it was saving future salary costs, which was deductible. Also, it improved the
efficiency of the business.

• Issue: was it deductible?

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General deduction --- incurred
W Nevill

• Held: deductible

• Reasons:
o Compensation payment must be viewed in context with the original agreement with the
managing director, which was clearly in production of A.I.
o Therefore, the compensation payment resulting from an amendment to the original
agreement was also for the same purpose.
o It improved the efficiency of the business.
o Expense is incurred when the liability to pay has arisen even though no payment was made.

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General deduction --- incurred
James Flood

• Facts: Tp set money aside to provide for future holiday payment of employees.

• Issue: was it deductible?

• Held: not deductible

• Reasons:
o no definite liability to pay until the workers actually took their leave
o The payments were only impending.

• S. 26-10 ITAA 1997 denies deduction of long service leave until paid.
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General deduction --- incurred v necessarily incurred
• The first positive limb is directed at all taxpayers who have earned assessable income
o Generally, the assessable income must be earned either now or in the future
o Recent exception: Commissioner of Taxation v Wood [2023] FCA 574

• The second positive limb is only available where the tp is carrying on a business.
o A loss or outgoing may be deducible where a business has not yet produced or has failed to produce
assessable income
o Necessarily incurred does not mean the outgoing must be unavoidable. It can be voluntarily (W Nevill)
or involuntarily (Charles Moore) incurred.
o Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276.

• Dr Beck in a dissenting judgement in Case M87 80 ATC 624 said:

“…put briefly, the first limb grants a deduction for outgoings incurred in gaining income
whilst the second limb grants a deduction for outgoings incurred in trying to gain income.”
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General deduction --- incurred v necessarily incurred
Magna Alloys

• Facts:
o Tp was accused of paying illegal secret commissions to boost sales of its products.
o Tp incurred legal expenses in defending itself and its directors in criminal proceedings.

• Issue: was it deductible?

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General deduction --- incurred v necessarily incurred
Magna Alloys

• Held: deductible

• Reasons:
o Tp was inextricably involved in the proceedings, and its reputation and interests were tied
to the directors.
o Necessarily incurred in carrying on a business to gain or produce A.I.
o Necessary does not mean the expense has to be unavoidable or essential.
o An expense will be necessarily incurred in carrying on a business to gain or produce
assessable income where the persons who run the business consider the expense desirable
and appropriate in achieving business ends --- business judgment rule

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General deduction
Example

Ian runs a small pizza shop in Darlington, catering primarily to students at the USYD. To facilitate
pizza deliveries, he decided to rent a helicopter exclusively for this purpose. The helicopter quickly
became a symbol of the pizza shop and led to increased sales. However, the cost of leasing the
helicopter was quite high, resulting in a small loss.
Whether the expenses incurred for leasing the helicopter can be fully deductible for tax purposes? If
not, to what extent can they be deductible?

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General deduction
Example

Fei is planning to attend a tax conference in the US. Instead of choosing an economy-class plane
ticket, she opts for a first-class ticket to ensure she arrives at the conference in the best condition.
Additionally, while in the U.S., she dines at world-class restaurants with other tax experts.
The question is whether these expenses are deductible for tax purposes, and if not, to what extent
they can be deducted.

Will your answer change if Fei has a holiday in the US straight after the conference?

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General deduction --- nexus
• In gaining or producing your assessable income (1 st positive limb) --- nexus between the loss or
outgoing and the earning of assessable income in the current or future years.
o No income-earning activities in getting to work --- cost of travelling to work is not deductible.
o Hayley and Lunney v FCT(1958) 100 CLR 478
o Expenses incurred to get a new job is not deductible --- FCT v Maddalena (1971) 2 ATR 541

• For employees, it generally requires that the deductible expenses will arise out of the employment.
o FCT v Finn (1961) 106 CLR 60
o The commissioner issued a number of occupation-based Taxation Rulings dealing with work-related
deductions (TR 95/8 to 95/20 and TR 95/22), covering police officers, teachers, nurses, hairdressers, etc.

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General deduction --- nexus
Hayley and Lunney

• Facts:
o Taxpayers deducted the costs of travelling to work
o Argued that they couldn’t produce A.I. if they didn’t travel to work

• Issue: was it deductible?

• Held: not deductible

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General deduction --- nexus
Hayley and Lunney

• Reasons:
o It is incurred to put the tp to the position of gaining A.I.
o Expenditure must be incidental and relevant to the derivation of such income
o Expenditure may be a pre-requisite, but it is not incurred in or in the course of gaining or
producing A.I.
o It is incurred because the taxpayer lives at a distance from his income-producing activities.
Hence, it is a living expense, not a business expense.

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General deduction --- nexus
Maddalena

• Facts: Professional footballer incurred travel and legal expenses in negotiation for transfer of employment to
another club.

• Issue: was it deductible?

• Held: not deductible

• Reasons: “The expenditure would have been incurred in getting, not in doing, work as an employee. It would
come at a point too soon to be properly regarded as incurred in gaining assessable income”

• However, it would be a different story when tp was carrying on a business of sporting.

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General deduction --- nexus
Finn

• Facts:
o Tp was an architect.
o He used accumulated leaves to travel to Europe to study current trends of architecture.
o Employer asked him to extend trip to include South America and covered the additional
costs.
o All tp’s activities while overseas were devoted to the study of architecture.

• Issue: was it deductible?

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General deduction --- nexus
Finn

• Held: deductible

• Reasons:
o The employer had endorsed the tp’s travel.
o Tp had extensive evidence of the information collated while travelling, which improve the
tp’s income-producing capacity in his current career.

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General deduction
Example: Fei has the following expenses during the current FY:
• 12-month subscription for a tax journal.
Incurred solely for work purposes. Sufficient nexus established, according to Finn
• Paid a monthly subscription for a wake-up call each Thursday so she would not be late for work.
No nexus. Incurred for private purposes.
• Travel from campus by train to visit a client of her second job.
Incurred solely for work purposes. Travel between works. Sufficient nexus established.
• Mobile phone account for a phone that is used 80% for second job, 20% for private purposes.
Incurred for dual purposes, i.e., work and private. 80% incurred in the course of earning A.I.
Sufficient nexus established. Apportioned by 80%.

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General deduction --- nexus
• In carrying on a business to earn assessable income (2 nd positive limb) --- nexus between the loss
or outgoing and the earning of assessable income connected to carrying on of the business.
o Spriggs v FCT [2009] HCA 22

• In a continuing business, expenditure incurred from time to time as part of the business process is
deductible regardless of when the A.I. was realised.
o Herald and Weekly Times Ltd v FCT (1932) 48 CLR 113

• Too soon --- Expenditure to determine the feasibility of a proposed business activity cannot fall
within s. 8-1(1)(b) ITAA 1997 because they incurred prior to the commencement of business.
o Softwood Pulp and Paper Ltd v FCT (1976) 7 ATR 101 --- no business was carried on, so not deductible
o Product testing for a new product line for a firm that already has 50 existing lines would be within the scope
of the continuing business.

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General deduction --- nexus
• Too late --- The end of the income-earning activities breaks the nexus, so not deductible
o Amalgamated Zinc (De Bavay’s) Ltd v FCT (1935) 54 CLR 295
o When a business has completely ceased operation, but the tp intends to revive its operation, any expenses in
the interim will be incurred in the maintenance of capital assets and protection of the proprietor’s interest. It
is capital in nature and not in operating the property for income-producing purposes.

• When the liability was a “long tail liability” that came to fruition late --- deductible
o AGC (Advances) Ltd v FCT 75 ATC 4057 --- Mason J challenged the decision of Amalgamated
o Placer Pacific Management Pty Ltd v FCT 95 ATC 4459 --- Mason J established the principle of “long tail
liabilities”
o FCT v Brown 99 ATC 4600 --- principle of “long tail liabilities” applies to interest expenses on loans
acquired during active business period, even if the interest were incurred after the business ceased.
o FCT v Jones 2022 ATC 4135 --- refinanced loan took the same character as the original borrowings.

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General deduction --- nexus
Spriggs

• Facts: tp paid fees to his agent to negotiate a new playing contract.

o Similar facts with Maddalena, except that Spriggs was carrying on a business.

• Issue: was it deductible?

• Held: deductible

• Reasons:
o Not simply an employee of his club. He was carrying on a business.
o Exploited their sporting expertise with different clubs.

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