Week 3 Deductions and Residency Concepts – Vocabulary Flashcards
Week 3 Overview: Deductions, assignment structure, and exam context
Recap of previous weeks:
Week 1 focused on residency and source; assignment heavily based on residency concepts, domicile, 183-day test, and superannuation test; apply all three tests and reference applicable tax rulings and case law (e.g., Applegate’s case).
Week 2 covered assessable income, tax avoidance/minimization/planning, and set up for deductions. Recording solutions released in advance.
Week 3 focuses on general and specific deductions (two-part approach) and the practical/deterministic framework for deduction decisions.
Assignment details (due Oct 12):
Part 1 (15/25): You as a tax adviser advise a client on residency and tax impact; format as a professional letter after an interview, using content from Week 1 as the base.
Part 2 (the remaining 10/25): A tax question for Morgan to calculate taxable income and payable; to be tackled after Week 7 content (individual income tax).
Exam structure (context provided by the instructor):
Likely mix of multiple-choice and short answer questions; not entirely calculation based; Week 1–5 content is assessed fairly evenly (roughly 20% per highlighted week).
Last year’s format included a one-hour midterm with a cheat sheet; this semester may differ, with adjustments described by the lecturer.
Practical takeaway for students:
Start on Task 1 now if possible; Task 2 depends on Week 7 content.
Use a mix of general deduction rules and industry-specific deductions; prepare to reference §8-1 for deductions and other sections (e.g., §82KZL for prepayments).
Understand that deductions hinge on the nexus to income, timing/matching, and the avoidance of private/capital/private-reserved expenses.
Key mental model: tax deduction is about paying less tax today by recognizing expenses that relate to earning income, subject to legal boundaries and case-law guidance.
Core Conceptual framework for deductions
General test for a deduction (Section 8-1):
A deduction is allowed for an outgoing, loss, or outgoing incurred in producing assessable income.
Positive limb (what you can deduct) must relate to income; negative limbs exclude items that are capital, private, non-assessable, or exempt.
Essential elements:
Nexus to income (connection to earning assessable income or carrying on a business).
Matching: expenses should be recognized in the same period as the income they help generate.
Key formulaic idea (conceptual):
\text{Deduction} \propto \text{expense} \quad \text{and} \quad \text{expense is incurred in producing income}
Incurrence vs obligation: when you incur a deduction depends on when an obligation exists (Ogilvy principle).
If payment is not required until completion, the expense is not incurred (e.g., some prepayment rules).
The two major axes of deductions discussed this week:
General deductions (broad, nexus-based, subject to §8-1).
Specific deductions (industry- or circumstance-specific rules; reference TRs, case law, and industry rulings).
Preliminaries: key statutory references and terms you’ll use
General deduction reference: Sec. 8-1 (often written as §8-1 or Section 8-1) – the broad deduction provision for expenses incurred in producing assessable income.
Prepayments rule: Sec. 82KZL (prepayments) – deductions for time-based expenses are generally taken on a straight-line basis up to 10 years, with nuances for wages and other items.
Important nuance: wages are generally deductible only when paid (no prepayment deduction for wages).
Obligation and incurrence concepts: illustrated by the Ogilvy rule (expense incurred when the obligation to pay is established, not merely when cash is paid).
Industry-specific deductions and rental/employee allowances: tax rulings such as TR 95-10, TR 98-6, TR 202-? (examples used in class) provide industry-specific guidance on what is deductible for employees in hospitality, real estate, etc.
General vs Specific Deductions: core distinctions and examples
General deductions (broad rule under §8-1):
Must be related to income-producing activity or business; must be an outgoing or loss incurred in earning income.
Excludes items that are capital, private, non-assessable, or exempt.
Nexus test and timing/matching are central.
Specific deductions (industry/ circumstance specific):
Some deductions require a specific ruling or case to determine deductibility.
Example context: employee allowances and industry-related costs; not all allowances are deductible; check TRs (e.g., TR 95/10; TR 98/6) for industry-specific rules.
Practical tip for exams and assignments:
If you can’t recall a precise case reference, always cite Sec. 8-1 for general deductions; this still earns partial marks if the scenario involves deductible expenses that relate to income.
If a question demands case law, reference the most closely aligned case; otherwise, use Sec. 8-1 with guidance from cases you studied (private vs business, dual-purpose travel, etc.).
Incurrence, obligation, and timing: key principles with cases
Ogilvy principle (incurrence):
If payment is not required until completion, the expense is not incurred for tax purposes.
Key cases on obligation and timing:
Warranties: not deductible because there is no certain event where the obligation has occurred; you can't claim a deduction for a warranty until the event occurs (no known claim date).
Insurance claims (RACV context): estimates of probable claims can be deductible if the event has occurred and there is a reasonable basis to estimate the liability (claim is expected due to a known event).
Pre-income expenses and post-income costs in the mining context (Madelina/Mine development concept): pre-income stream expenses are capitalized and not deductible until income is earned; this ties to the broader idea of matching and enduring benefit in mining and manufacturing.
Warranties vs insurance context:
Insurance-related provisions may be deductible if the event has occurred and a liability exists, supported by third-party assessments.
Warranties do not trigger a tax deduction until a claim is actually made, because the obligation to perform exists only if and when a claim arises.
Pre-income and post-income concepts (industry context and ongoing development)
Pre-income stream (e.g., mining):
Costs incurred before income is earned are capitalized and deducted as income is earned; example: large mining developments with long pre-production phases.
In practice, you may carry forward an asset on tax books while not recognizing an expense until income is generated; the asset is depreciated or amortized over time as income is earned.
Post-income and reasonable approximation (case law):
Amalgamated Zinc and Jones cases illustrate how post-income losses can be treated and how reasonable approximations after the sale/closing of a business can still be deductible for a period.
Jones extends the idea: you can recognize a deductible amount for a reasonable period after income ceases, though not indefinitely.
Black hole expenses (Section 20-year ideas):
Black hole deductions (e.g., incorporation costs) allow a 20% deduction per year over five years for costs associated with setting up a company; not a full upfront deduction because the benefits extend over time.
Important takeaway: setting up a business costs (incorporation, structural changes) have enduring benefits; tax rules slow down the deduction to align with that enduring benefit.
Capital vs Revenue: identifying enduring benefits vs ongoing costs
Capital costs vs revenue expenses:
Capital costs: incur once, provide enduring benefit (e.g., asset acquisition, long-term improvements). Not deductible immediately; instead capitalized and depreciated or amortized.
Revenue expenses: ordinary operating costs related to earning income; deductible in the period incurred if they meet nexus/matching tests.
Illustrative cases:
Sun Newspapers context: paying for not starting a rival newspaper was considered a capital cost due to enduring anti-competition benefit.
Mount Isa Mines: demolition to remove disadvantages that provide ongoing benefit to the operation; considered capital costs.
Snowden: legal fees defending royalty commission actions not aimed at protecting/generating income nor preserving business value; deductible as ordinary operating expense.
X 80 case (license setup): obtaining a new FM license represents setting up a new business; capital in nature.
Kemp: paying to terminate a contract and sign a new one is a capital expenditure due to enduring benefit; amortized over the new contract period.
Cliffs: royalty per ton with a variable rate was deductible because the royalty varies with production; the expense aligns with the income earned per ton; a variable relationship supports deductibility.
Practical note: the “is it capital or deductible?” question hinges on whether an ongoing stream of income is produced and whether the expense results in enduring advantage or ongoing operational benefit.
Private or domestic vs. employment-related deductions
Private or domestic costs (generally non-deductible):
Costs outside strictly work-related purposes, personal lifestyle choices, or family responsibilities are usually non-deductible (e.g., private commute costs, child-care costs, meals at uni that are not strictly employment-related).
Examples from cases:
Looney: public transport to work claimed as deduction is not deductible; private selection of residence and commuting costs are personal.
Lodges: child-minding costs denied as private/domestic.
U2-15 (meals at uni): meals while at the university course are non-deductible as private/domestic unless proven to be strictly employment-related.
Employment- and industry-specific allowances (where allowed):
Some allowances and costs can be deductible if they are a condition of employment, or if studies/education directly relate to current or future employment in a way that enhances efficiency or capacity (e.g., education-related costs for existing roles).
Morris case (sun protection for outdoor workers): hats, sun protection costs deductible when working outdoors and it's a condition of employment.
Flight attendants (Mansfield): moisturizer/hair conditioner deductible due to demonstrated factual need from altitude dryness; supported by studies.
Sanchez case: travel-related work-search activities can be deductible if they are connected to earning income.
Wilkinson (air traffic controller): flying lessons deductible if they make you more efficient at work and progress toward a more suitable job; expands what is deductible for professionals.
Real-world nuance: industry-specific allowances require concrete evidence and connection to employment; generic personal items remain non-deductible.
Practical takeaway for exam questions: differentiate between personal/private costs and those that are job-related or industry-required; when in doubt, use §8-1 and rely on industry rulings or the closest applicable case.
Special cases: deductible vs capital in practice (illustrative list)
Insurance claims and obligations:
If an event has occurred and a reasonable estimate of the liability can be made (even if not all claims have been submitted), it can be deductible (RACV-type scenario).
Warranties:
Warranties are not deductible because there is no certain event triggering the obligation to pay; you can’t claim a warranty expense simply because the product may fail in the future.
Bills and financing costs:
Costs associated with bills (e.g., interest on a short-term bill) are deductible if they relate to working capital or discharge liabilities; otherwise, apportionment over the bill period applies.
Example: a 90-day bill with a cost of $6,000 and $94,000 received; deduction timing depends on the period and purpose of the bill.
Prepayments and wages:
Prepayments are generally deductible on a straight-line basis over up to 10 years, with wages excluded from prepayment deductions (deduction upon payment).
Black hole expenses recap:
Costs to set up a company or restructure (incorporation fees, defending takeovers, etc.) are black hole expenses with a 20% deduction per year over five years (not a full upfront deduction).
Amalgamated Zinc/ post-income losses / reasonable approximation (Jones):
Pre-income costs versus post-income loss allowances; reasonable approximation post-income can be deductible for a period but not indefinitely.
Group taxation and mutuality:
Group consolidation eliminates intra-group transactions for tax purposes; intercompany transactions are netted out at the group level, requiring elimination entries.
Key takeaways for exam technique and assignment preparation
Always anchor deductions to the core test: nexus to income and the purpose of expenditure to earn income.
Use §8-1 as the default citation for deductions; if you cannot recall a case reference, you can still earn partial marks by citing §8-1 and tying it to the scenario.
When a question asks about a deduction amount, use Ron P. (Ron Perboncin) logic: a deduction can be based on purpose rather than cost, up to the limits of the law, but the amount must align with the evidence and the case law (e.g., reasonable approximation in Jones).
For travel and dual-purpose trips, consider a pro rata or percentage approach based on established case law (e.g., case R 13) for the split between business and private use.
For “pre-income” scenarios, emphasize capitalization and asset treatment; for “post-income” scenarios, discuss whether the deduction is allowed and the timing for recognition.
For industry-specific deductions, consult the relevant TRs (e.g., TR 95/10; TR 98/6) and be prepared to cite exact rulings when appropriate.
Understand the practical realities of the tax system: tax advisers use client-specific facts to maximize legitimate deductions while avoiding aggressive positions that could trigger an audit; credible written tax advice from a registered adviser boosts credibility with the ATO.
Exam-focused tips:
If you cannot recall a precise case reference, citing §8-1 and closest applicable principles will help.
Expect a mix of mandatory and optional references; be ready to discuss both general principles and specific cases.
Assignment and week-by-week connection recap
Week 1: Residency basics and tests (ordinary concepts, domicile, 183-day test, and superannuation test); assignment emphasizes residency and tax ruling TR 2023/1.
Week 2: Assessable income, tax avoidance/minimization, tax planning; introduction to deductions and problem-solving style.
Week 3 (this content): General vs specific deductions, nexus/matching, incurment concept, prepayments, capital vs revenue, and key case law guidance.
Week 7: Individual income tax coverage; this is when Task 2 of the assignment becomes actionable (Morgan’s taxable income and payable).
Quick recap: why these concepts matter in real-world tax work
Tax is built on precedent and interpretation; deductions are not free money but a structured negotiation between taxpayer intentions and statutory/case-law boundaries.
The right to deduct often hinges on the purpose of the expenditure and its relation to income, the timing of deduction, and whether the expenditure creates an enduring asset.
A good tax adviser uses established rulings and precise references to justify deductions, while also anticipating scrutiny by the ATO and preparing defensible arguments.
What to study next (link to the course flow)
Review Week 1 materials on residency and the three tests (ordinary concepts, domicile, 183-day, and superannuation) and the case law like Applegate’s case.
Prepare the Part 1 assignment by reviewing your Week 1 materials and practice drafting a professional client letter that covers both residency and taxation impact.
Read ahead to Week 7 materials on individual income tax to prepare for Task 2 of the assignment and the midterm format.
Practice with the two-part structure of deductions: differentiate general vs specific deductions, identify the nexus to income, and apply timing principles (incurred vs paid vs pre/post income) to multiple scenarios.
Key terms and references to remember
Section 8-1: general deduction rule for expenses incurred in producing assessable income
Section 82KZL: prepayments and time-based deductions (straight-line, up to 10 years; wages excluded)
Ogilvy principle: incurrence concept for expenses
TR 95/10, TR 98/6: industry-specific deduction guidance
Notable cases (illustrative):
Charles Moore v. Commissioner (robbery-related deduction)
R 13 (dual-purpose travel deduction guidelines)
Lenten (nexus and purpose guidance)
Amalgamated Zinc (pre-income vs post-income considerations)
Jones (reasonable approximation after income ceases)
Wilkinson (education-related deduction for professionals)
Morris (outdoor workers and protective gear)
Mansfield (moisturizer/hair conditioner for flight attendants)
Sanchez (work-related travel searches)
Mount Isa Mines (pre/post-income and demolitions)
Snowden (defending royal commission – not capital unless linked to income-producing capacity)
Kemp (contract termination costs with enduring benefit)
Cliffs (per-ton royalties and variable amounts)
Looney, Lodges, U215, Hunger (private/domestic exclusions)
RACV context (obligations and estimates for claims)