110289 Topic 5: Biz Income & Deductions Intro
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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
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
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
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
- 1) Nature - NOT pastime or hobby
- 2) Intention - carry on business for profit
Grieve v CIR  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
: There is NO requirement of a reasonable prospect of making a profit within the foreseeable future.
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
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)]
Business or Taxable Activity
- - For income tax purpose, under ITA 2007
- - Must have an intention to make a profit
- - 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
Recognition of Income
- Why recognition of income is important?
- • Time value of money
- • A tax rate change
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
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)
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.
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.
"...to the extent..." constitutes?
An item of expenditure may be apportioned between a deductible and non-deductible amount
Deduction Must be Incurred
No deduction is allowed unless/until the expenditure has been incurred
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
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
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
- • Capital limitation
- • Private / domestic limitation
- • Exempt income limitation
- • Employment limitation
- • Non-residents‟ foreign-sourced income limitation
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?
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