What is a tax shelter arrangement?
You have a tax shelter arrangement in the income year in which you incur prepaid expenditure if:
- your allowable deductions attributable to the arrangement for the expenditure year exceed your assessable income from the arrangement for that year
- you do not have day-to-day control over the operation of the arrangement, and
- at least one of the following is met:
- more than one taxpayer participates as an investor in the arrangement, or
- the manager, arranger or promoter of the arrangement, or an associate, carries out similar activities for other taxpayers.
What expenditure is excluded from the tax shelter rules?
The following prepaid expenditure is excluded from the application of the tax shelter rules:
- premiums for building insurance, contents insurance or rent protection insurance, and
- 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 trust which has at least 300 beneficiaries
provided the arrangement 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 arrangement.
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, or
- 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, an amount of salary or wages; or certain amounts incurred by a general insurance company in connection with the issue of policies; or the payment of reinsurance premiums.
Note: If you incur prepaid expenditure that is not subject to the tax shelter rules because of one of the above exceptions, your deduction must be determined in accordance with the other rules explained in this publication.
Summary of rules
- Certain prepaid expenditure incurred under a plantation forestry managed agreement is subject to a 12-month rule. For more information, see chapter 3.
- If you invest in a tax shelter arrangement, you need to be aware that the tax shelter rules for prepayments may apply to limit your immediate deductions.
- If you prepay expenditure under a tax shelter agreement for a thing that will not be wholly done within the expenditure year and it is not covered by one of the exceptions listed above, you cannot deduct all of the expenditure in the income year in which it was incurred. The deduction must be apportioned over the eligible service period or 10 years, whichever is less.
- An agreement in respect of a tax shelter arrangement is one that covers any activities that relate to the arrangement, including those that give rise to deductions or assessable income. For example, if you invest in a tax shelter arrangement and prepay interest on a loan from a third party to pay management fees for the tax shelter, the prepaid interest on the loan would also be subject to the tax shelter rules.
Calculating your deduction for a prepayment made under a tax shelter arrangement
Use the following formula to work out your deduction for prepaid expenditure that is affected by the tax shelter rules:
Expenditure × (number of days of eligible service period in the income year ÷ total number of days of eligible service period)
Example: Investment in a tax shelter arrangement
On 30 April 2003, Marion invested in an olive grove venture. The investment has all the characteristics of a tax shelter arrangement and is not subject to any of the exceptions.
Under the terms of the agreement, Marion was required to pay an initial management fee of $10,000 on 1 May 2003 to cover the provision of services over the period 1 May 2003 to 30 April 2004 (a period of 366 days). Marion made this payment on 1 May 2003. Marion is required to apportion her deduction over the 2003 and 2004 income years.
Marion's deductions are calculated as follows:
$10,000 × (61 ÷ 366) (1 May 2003 to 30 June 2003 = $1,667
$10,000 × (305 ÷ 366) (1 July 2003 to 30 April 2004) = $8,333
Over the 2003 and 2004 income years, Marion is entitled to a total deduction of $10,000.End of example