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Chapter 1 - General information about prepaid expenses
What is a prepaid expense?
A prepaid expense is expenditure you incur for things to be done (in whole or in part) in a later income year. If expenditure is incurred for something to be done in full within the same income year, it is not a prepaid expense to which the prepayment rules apply.
Example: Expenditure not constituting a prepayment
Jasmin is a solicitor. On 1 July 2002, she paid $1,500 annual subscription for the monthly provision of a professional journal. The subscription covers the period 1 July 2002 to 30 June 2003. Because the thing to be done under the agreement-the provision of the professional publication-will be completed wholly within the expenditure year the prepayment rules will not apply.End of example
What is the eligible service period?
The eligible service period is the period during which the thing is to be done under the agreement in return for the expenditure. The eligible service period begins on the day the thing under the agreement commences to be done or on the day the expenditure is incurred, whichever is later.
The eligible service period continues until the end of the last day the thing under the agreement ceases to be done or 10 years, whichever is earlier.
Example: Eligible service period
Mike runs a delicatessen from leased premises. On 1 December 2002, Mike made a lease payment to cover the period 1 December 2002 to 30 November 2003.
The eligible service period for this expenditure therefore commenced on 1 December 2002 and will end on 30 November 2003, a period of 365 days.
Mike's income year ends on 30 June of each year. As the thing to be done under the agreement (the provision of premises by the lessor) is not wholly done within the expenditure year the prepayment rules will apply.End of example
Expenditure must be deductible under the general deduction provisions or the research and development provisions
The prepayment rules only apply to expenditure which would otherwise qualify for immediate deduction under the general deduction provisions of section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) or, for eligible companies, under the research and development provisions in sections 73B, 73BA, 73BH or 73Y of the Income Tax Assessment Act 1936 (ITAA 1936).
The general deduction provisions generally allow you to deduct from your assessable income any loss or outgoing to the extent that it is either incurred in gaining or producing your assessable income, or is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
Expenditure of a capital, private or domestic nature, or expenditure incurred in gaining exempt income, is specifically excluded from being deductible under these provisions. The prepayment rules do not apply if the expenditure is deductible under a specific deduction provision of the tax law other than those for research and development referred to in the previous paragraph.
Note: Unless specifically stated otherwise, the terms 'expense' and 'expenditure' used throughout this guide refer to expenditure that is only allowable as a deduction under the general deduction provisions of section 8-1 of ITAA 1997 or, for eligible companies, under the research and development provisions in section 73B 73BA, 73BH or 73Y of ITAA 1936.
What is excluded expenditure?
Certain types of expenditure are excluded from the prepayment rules. These are:
- amounts of less than $1,000
- amounts required to be paid by a Commonwealth, state or territory law or by a court order
- payments of salary or wages (under a contract of service)
- amounts that are capital, private or domestic in nature, and
- certain amounts incurred by a general insurance company in connection with the issue of policies or the payment of reinsurance premiums.
Example: Amount required to be paid under a State law
John operates a cartage business and paid $1,200 on 31 December 2002 to register his truck for 12 months from 1 January 2003 to 31 December 2003. The truck is used exclusively for business purposes. Although the registration fee is in excess of $1,000 and it covers a period spreading across more than one income year, it is excluded expenditure. This is because the registration fee is required to be paid under a state or territory law. The prepayment rules do not apply to this type of expenditure and the fee is deductible in the year it is paid.End of example
What is a pre-RBT obligation?
A pre-RBT obligation is any contractual obligation that:
- exists under an agreement at or before 11.45am [by legal time in the Australian Capital Territory (ACT)] on 21 September 1999-the date of the Government's release of the Review of Business Taxation (RBT)
- requires you to make a prepayment in return for something to be done under the agreement, and
- cannot be avoided by your own actions.
The rules for deducting prepaid expenses incurred under a pre-RBT obligation are the same as those explained for taxpayers who are in the Simplified Tax System (STS), see chapter 5.
What are the prepayment rules?
Generally, a prepaid expense is deductible over the eligible service period, or 10 years if that is less, rather than being immediately deductible.
However, if you are an STS taxpayer, or an individual incurring deductible non-business expenditure, you can claim an immediate deduction under the 12-month rule for prepaid expenditure where the payment is incurred for an eligible service period not exceeding 12 months and the eligible service period ends in the next income year.
If you are not an STS taxpayer and you:
- incur prepaid expenditure in carrying on a business, or
- incur prepaid non-business expenditure and you are not an individual,
Transitional arrangements may apply to the expenditure where the eligible service period ends not more than 13 months after you incur the expenditure.
The transitional treatment isolates the part of the payment that relates to a later year and allows a specified percentage to be immediately deductible instead of being apportioned over the eligible service period. There is a limit (cap) on the amount that is subject to transitional treatment unless you are:
- a small business taxpayer and are not an STS taxpayer, or
- a non-individual taxpayer incurring deductible non-business expenditure.
For more information on the transitional rules that apply to small business taxpayers who are not in the STS, see chapter 6 and on the rules that apply to other taxpayers, see chapter 7 and chapter 8.
Prepaid expenditure incurred under certain managed investments (' tax shelter' arrangements) is not eligible for the 12-month rule or transitional treatment. For more information about tax shelter arrangements, see chapter 2.
Certain prepaid expenditure incurred under an investment in a plantation forestry managed agreement is eligible for the 12-month rule. For more information see chapter 3.
If the 12-month rule or the transitional provisions do not apply, your deduction for prepaid expenditure is apportioned over the eligible service period or 10 years, whichever is less.