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Part F-Prepayments and tax shelter arrangements

Last updated 2 January 2006

The transitional rules which phase in the effects of removing the 13 month immediate deduction rule for prepaid expenditure incurred by business other than small business, do not apply to prepayments made in relation to tax shelter arrangements. Tax shelter prepayments are required to be spread over the eligible service period. The tax shelter rules apply to all taxpayers including small business taxpayers.

If you have prepaid expenditure under a tax shelter agreement for a thing to be done within 13 months and it is not covered by one of the exclusions, you cannot deduct all of the expenditure this income year. Instead the deduction must be apportioned over the eligible service period. (The eligible service period is the period during which the thing is to be done under the agreement.) This is consistent with the treatment of prepayments where the period exceeds 13 months.

An agreement covered by the tax shelter rules includes all related activities, including those that give rise to deductions or assessable income. For example, if a taxpayer invests in a tax shelter, and prepays interest on a loan used to fund management fees of the manager, the prepaid interest would also be subject to these rules.

The apportionment rules apply if you made a prepayment of expenditure under an agreement for something that was not wholly done in the expenditure year and:

  • the expenditure was incurred for doing the thing within 13 months
  • the expenditure was incurred after 1.00pm (by legal time in the ACT) on 11 November 1999-and was not made under a contractual obligation entered into before that time (that you cannot avoid by your own actions)
  • your allowable deductions attributable to the agreement for the expenditure year exceed your assessable income attributable to the agreement for that year
  • you do not have day-to-day control over the operation of the agreement and
  • at least one of the following is met:
    • more than one taxpayer participates as an investor in the agreement or
    • the manager, arranger or promoter of the agreement, or an associate, carries out similar activities for other taxpayers.
     

The following prepaid expenditure is excluded from the application of the tax shelter rules:

  • premiums for building insurance, contents insurance or rent protection insurance or
  • interest on money borrowed to acquire:
    • real property or an interest in real property
    • shares listed on an approved stock exchange, or
    • units in a widely held unit which has at least 300 beneficiaries
     

provided the agreement is conducted at arm's length, and that you have or can reasonably expect to obtain rent, dividends or trust income. Additionally, you must not have obtained and will not obtain any other kind of assessable income (except a capital gain or insurance receipt) from the agreement.

Also specifically excluded from the application of the tax shelter rules are:

  • certain expenditure that is an allowable deduction under the infrastructure borrowing rules
  • expenditure incurred under a contract (requiring prepayment for something to be done under the agreement) entered into before 1.00pm (by legal time in the ACT) on 11 November 1999 (that you cannot avoid by your own actions)
  • expenditure under an agreement which, before 1.00pm (by legal time in the ACT) on 11 November 1999, had obtained, or had applied for and later obtained, a favourable ATO product ruling and
  • any prepaid expenditure which is 'excluded expenditure'-that is, an amount below $1,000, an amount required to be incurred by a law or a court order, or an amount of salary or wages.

QC88403