110289 Topic 5: Biz Income & Deductions Intro

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110289 Topic 5: Biz Income & Deductions Intro
2015-10-27 06:24:12
110289 Topic

Biz Inc & Deductions intro
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  1. Why business income matters?
    - Significance of being in business:
    • – s CB1(1), ITA 2007: Business income is assessable income
    • – s DA 1(1)(b), ITA 2007: Can claim deduction for business expenditures
  2. Why business income matters? Example:
    "An artist paints and exhibits his work regularly"
    • – If carrying on a business, proceeds from sales are income, business expenses are deductible
    • – If carrying on a hobby/pastime, proceeds are not income, and expenses are not deductible
  3. ITA '07 - Business Income
    • S CB1 (1) amount person derives from business is income for person
    • S CB1 (2) doesn't apply to amount of a capital nature

    S DA (1) allowed deduction for amount of expenditure, loss, dep'n loss which is from carrying on a business to derive assessable & excluded income
  4. What is a business? s YA 1, ITA '07
    • Includes any profession, trade, or undertaking carried on for profit
    • Use case law to determine what constitutes a business

    Twofold test

    • 1) Nature - NOT pastime or hobby
    • 2) Intention - carry on business for profit
  5. Grieve v CIR [1984] 1 NZLR (CA)

    A husband and wife partnership embarked works on developing a stud farm, but the farm traded at a loss for a number of years. Mr and Mrs Grieve tried to claim a deduction
    • - CIR disallowed deduction for losses, they not carrying on business
    • - High Court: not a business, as no prospect of a profit within foreseeable future
    • - Court of Appeal: the partnership was in business, despite the losses

    Principle: There is NO requirement of a reasonable prospect of making a profit within the foreseeable future.
  6. Intention to make a profit
    Factors to be considered (NPSCPFrC)
    • Nature of the activity(distinct from a pastime/hobby);
    • Period over the activity engaged in;
    • Scale of the operations / volume of transactions;
    • Commitment of time, money, and effort;
    • Pattern of activity;
    • Financial results (despite a loss); and
    • Characteristic of ordinary trade in the line of business
  7. Business or Hobby
    Income from hobby is not assessable income and not deductible. 

    • It is necessary to determine:
    • • Business undertaking
    • • Intention of making a profit [TRA Case D54 (1980)]

    • Principles from case law:
    • • Profit intention & level of activity [TRA Case L57 (1989)]
    • • A hobby can later grow to a business [TRA Case H86 (1986)]
    • • Private expenditures are not deductible [s DA 2 (2)]
  8. Business or Taxable Activity

    • - For income tax purpose, under ITA 2007
    • - Must have an intention to make a profit

    Taxable Activity

    • - For GST purpose, under GSTA 1985
    • - Only need to be carried on continuously / regularly
    • - A pecuniary profit NOT required

    A taxable activity may NOT be a business, if no intention to make a profit - e.g. non-profit organisation/charity, sports club
  9. Recognition of Income
    - Why recognition of income is important?
    • • Time value of money
    • • A tax rate change
  10. Recognition of Income
    - When is Income Derived?
    • Accruals method
    • - Based on income earned
    • - Adopt a method that best discloses taxpayer‟s true income
    • - Generally considered the appropriate method for accounting for business

    • • Cash method
    • - Based on income received
    • - Deemed to be derived if amount is credited in account, etc. (s BD 3)
    • - Appropriate for Wages, Salaries, Rents, Dividends, and Interest
  11. DEDUCTIONS: - General Principles
    Core Provisions: Income Tax Act 2007
    S BC 3 Annual total deduction: Annual total deduction is the total of deductions that are allocated to the corresponding income year.

    S BC 4 Net income and net loss: Annual gross income – annual total deductions = net income/loss

    S BC 5 Taxable income: Net income – prior losses = taxable income

    S BD 2 Deductions: An amount is a deduction, if allowed under Part D (Deductions)
  12. DEDUCTIONS:- General Principles
    Deductions are expenses/losses (including depreciation loss) allowed against assessable and/or excluded income in calculating taxable income.

    No deduction is allowed, unless deductibility is granted under Part D of the Act

    • • S DA 1(1) is the main general permission dealing with deductibility of expenditure or loss.
    • • S DA 2 sets out the general limitations i.e. non-deductibles.
    • • S DA 3 allows for specific sections within Part D to over-ride the general permission.
  13. General Permission - s DA1 (1) "provides for the deduction of two types of expenditure or loss to the extent it is..."
    a) First Limb - Incurred in deriving assessable and/or excluded income;


    b) Second Limb - Incurred in carrying on of a business for the purpose of deriving assessable and/or excluded income.
  14. "...to the extent..." constitutes?
    An item of expenditure may be apportioned between a deductible and non-deductible amount
  15. Deduction Must be Incurred
    No deduction is allowed unless/until the expenditure has been incurred
  16. Deduction Must be Incurred - Incurred” has 2 elements
    • 1) Obligation to pay
    • - Closely related to the accounting concept of expense “recognition” i.e. “when it is probable that a consumption of benefits has occurred or will occur following the expense, and reliably measured
    • - Expenditure does not have to be paid in cash to be deductible, but there must be an obligation to pay the expense (accrual basis)
    • - But no deduction for contingent or expected expenditure

    • 2) Timing of deduction
    • - Deductions must be matched to the period incurred
  17. Incurred in Deriving Income: Nexus test – First Limb
    • • Must be a connection to the derivation of income
    • • Not deductible, if incurred before income earning process commences, or after it ceases
    • • Non-deductible capital expense, if it relates to income earnings structure rather than the process
    • • No deduction, if incurred in deriving exempt income
    • • Fully deductible (apportionment is NOT required), if an expense produces both income and a capital gain
  18. Business expenditure: In the course of carrying on a business – Second Limb
    There does NOT have to be a direct relationship between the expenditure and the income; it is deductible if it is, in terms of 'common sense and business realities', for carrying on the business.

    • Examples for expenditure, which is not deductible under the first limb, but deductible under the second limb

    • - A news paper company makes a payment to settle a claim for damages arising from a defamatory article (Herald & Weekly Times Ltd v Federal Commissioner of Taxation)
    • - Entertainment expenditure
    • - Advertising
    • - Deduction for stolen stock
  19. General limitations
    • • Capital limitation
    • • Private / domestic limitation
    • • Exempt income limitation
    • • Employment limitation
    • • Non-residents‟ foreign-sourced income limitation
  20. Capital v Revenue - Guiding Principles from BP Australia Ltd:
    • 1) What is the need or reason for the expenditure?
    • 2) Is the expenditure “one-off” or recurrent?
    • 3) Does the expenditure create any identifiable asset?
    • 4) Does the expenditure create any asset with enduring benefit to the business?
    • 5) Is the payment made on the business structure or income earning process?
    • 6) Is the expenditure from fixed or circulating capital?
    • 7) How would the payment be treated under ordinary accounting principles?
    • 8) Is the expenditure incurred in the course of regular income-earning operation of the business?