House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Minister for Small Business, the Bruce Billson MP)

Chapter 2 - Immediate deductibility for small business start-up expenses

Outline of chapter

2.1 Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to allow small businesses and individuals to immediately deduct costs incurred when starting up a business, including government fees and charges as well as costs associated with raising capital, that are presently only deductible over five years.

Context of amendments

Current law on deductions for capital expenditure

2.2 The tax law draws a distinction between income and capital, both for the purposes of determining whether amounts are ordinary income and in determining whether a loss or outgoing gives rise to a general deduction.

2.3 Taxpayers carrying on a business can generally deduct from their assessable income any losses or outgoings which are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, they cannot deduct any losses or outgoings of capital or of a capital nature: see subsection 8-1(2) of the ITAA 1997.

2.4 However, the cost of acquiring capital assets is generally recognised for tax purposes elsewhere in the tax law.

2.5 In particular, Division 40 of the ITAA 1997 generally allows a deduction for capital assets acquired by taxpayers equal to the amount by which assets decline in value over each income year. However, a deduction is allowed only to the extent assets are held for a taxable purpose, such as the purpose of producing assessable income. Division 40 also provides special rules that allow deductions for certain other capital expenditure.

2.6 To avoid expenditure incurred by a business for the purpose of producing assessable income not being recognised anywhere in the tax law (referred to as black hole expenditure), section 40-880 of the ITAA 1997 allows entities to deduct over a five-year period capital expenditure they incur for the purposes of a business that the entity carries on, or a business proposed to be carried on, or that used to be carried on.

2.7 Deductions under section 40-880 are only available if:

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the business is, was previously, or is proposed to be carried on for a taxable purpose;

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the expenditure relates to the business or the entity deriving assessable income from the business; and

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the expenditure does not fall within one of the categories of excluded expenditure listed under subsection 40-880(5).

For example, expenditure is excluded under subsection 40-880(5) if it:

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forms part of the cost of a depreciating asset;

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can be deducted under another section of the tax law;

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is incurred in relation to a lease or other legal or equitable right;

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is expenditure which is of a private or domestic nature; or

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is incurred in producing exempt income or non-assessable non-exempt income.

Expenses incurred in starting up a business

2.8 Among the types of expenditure that are generally deductible under section 40-880 are expenses relating to establishing a proposed business.

2.9 Normally most expenses related to carrying on a business are:

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deductible (generally under the general deduction provisions in section 8-1 or the trading stock rules in Division 70 of the ITAA 1997); or

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included in the cost base of assets for the purposes of the capital gains tax rules in Part 3-1 of the ITAA 1997 or the capital allowance rules in Division 40 of the ITAA 1997.

2.10 However, expenditure incurred in relation to a proposed business before the business is carried on is generally not deductible under these general provisions. As the business is not yet operating, most of the provisions relevant to deductions for carrying on a business do not apply. Further, in some cases the entity incurring the expenditure will not be the entity carrying on the business; rather, it will be incurred by another entity involved in establishing the business that expects to profit from it.

2.11 For these pre-establishment expenses, it is often only section 40-880 that will allow the expenditure to be deducted. Consistent with other deductions under section 40-880, such expenditure is presently deductible over five years.

2.12 On 12 May 2015, in the 2015-16 Budget, the Treasurer announced that from the 2015-16 income year, businesses would be able to immediately deduct a range of expenses associated with starting a new business, including professional, accounting and legal advice, that can only presently be deducted over a five year period.

Summary of new law

2.13 Schedule 2 to this Bill amends the ITAA 1997 to allow taxpayers who are not in business or are a small business entity to immediately deduct certain expenses relating to the proposed structure or operation of a business. The expenses must relate to a business that is proposed to be carried on, including certain government fees and charges and costs associated with raising capital, where these expenses would otherwise be deductible over five years under section 40-880 of the ITAA 1997.

2.14 For expenses to be immediately deductible, the entity claiming the deduction must be:

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a small business entity; or

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not carrying on a business and not connected with, or an affiliate of, an entity that carries on a business that is not a small business entity;

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for the income year in which the deduction is claimed.

Comparison of key features of new law and current law

Detailed explanation of new law

Certain start-up expenses immediately deductible

2.15 Expenditure that would be deductible over five years under section 40-880 of the ITAA 1997 is fully deductible in the income year in which the expenditure is incurred if the expenditure:

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relates to a business that is proposed to be carried on; and

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is either:

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incurred in obtaining advice or services relating to the proposed structure or the proposed operation of the business; or

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is a payment to an Australian government agency of a fee, tax or charge incurred in relation to setting up the business or establishing its operating structure; and

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the entity that incurred the expenditure is either:

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a small business entity for that income year; or

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does not carry on a business and does not control and is not controlled by an entity carrying on a business in the relevant income year that is not a small business entity in that income year.

[Schedule 2, item 3, subsection 40-880(2A)]

2.16 The purpose of the amendments is to make pre-establishment expenditure by small business entities and entities not carrying on a business that is currently deductible over a five-year period immediately deductible. Scope and availability of immediately deductible expenditure

2.17 The amendments do not extend the scope of what is currently deductible as they only apply to amounts that would otherwise give rise to a deduction under section 40-880 of the ITAA 1997. Instead the amendments bring forward the time at which certain deductible expenditure can be recognised. [Schedule 2, item 3, subsection 40-880(2A)]

2.18 To the extent an amount is not deductible under section 40-880, including because the amount is deductible under some other provision of the tax law or because the deduction is subject to the rules concerning non-commercial losses, immediate deductibility does not apply.

2.19 Similarly, immediate deductibility under these amendments is only available for a subset of expenditure that is deductible under section 40-880 - expenditure incurred in relation to a business that is proposed to be carried on. The amendments do not apply to expenditure incurred in relation to an ongoing business or a business that has ceased to operate (including expenditure relating to the liquidation or winding up of an entity). [Schedule 2, item 3, paragraph 40-880(2A)(a)]

2.20 The amendments also further limit immediate deductibility to two categories of expenditure:

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expenditure on advice or services relating to the structure or the operation of the proposed business; and

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the payment to an Australian government agency of fees, taxes or charges relating to establishing the business or its operating structure.

[Schedule 2, item 3, paragraph 40-880(2A)(b)]

Advice or services relating to the structure or the operations of the proposed business

2.21 Advice or services relating to the structure of a business encompasses, for example, advice from a lawyer or accountant on how the business may be best structured as well as services such individuals or firms may provide in setting up legal arrangements or business systems for such structures. It does not include the cost of acquiring assets that may be used by the business.

2.22 Similarly, advice and services obtained in relation to the operation of the proposed business includes professional advice on the viability of the proposed business (including due diligence where an existing business is being purchased) and the development of a business plan. It also covers the costs associated with raising capital (whether debt or equity) for the operation of the proposed business including, for example, costs incurred in accessing crowd-sourced equity funding, but not the direct costs of the capital itself such as interest, dividends or capital repayments.

2.23 Deductibility for advice and services does not include other expenses an entity itself may incur in relation to the operation of a proposed business (such as the cost of travelling to a particular location as part of assessing locations for a business).

Payments to Australian government agencies

2.24 The other category of expenditure to which the measure applies is payments of taxes, fees or charges relating to establishing the business or its structure that is made to an Australian government agency.

2.25 As defined in the ITAA 1997, Australian government agency means the Commonwealth, a State or Territory or an authority thereof. As local governments are created under state or territory legislation, they are included in this definition as an authority of the relevant state or territory government.

2.26 Broadly, this category of expenditure includes regulatory costs incurred in setting up the new business. Examples of the types of expenditure within this second category would be the costs associated with creating the entity that may operate the business (such as the fee for creating a company) and costs associated with transferring assets to the entity which is intended to carry on the proposed business (for example, the payment of stamp duty). It does not include expenditure relating to taxes of general application such as income tax. The payment of these general taxes does not relate to establishing a business or its structure but instead to the operation and activities of the businesses. Such general taxes are also not normally deductible under section 40-880.

Eligible taxpayers

2.27 Immediate deductibility is also limited to expenditure by certain entities, with the effect of excluding expenditure incurred by larger businesses.

2.28 If the claimant entity carries on a business in the income year, it must itself be a small business entity. Broadly speaking, the tax law defines a small business entity as an entity with an aggregate annual turnover of less than $2 million: see Subdivision 328-C of the ITAA 1997 for more information. [Schedule 2, item 3, paragraph 40-880(2A)(c)]

2.29 Alternatively, if this entity does not carry on a business in the income year it must not be connected with or be an affiliate of (within the meaning of Subdivision 328-C of the ITAA 1997) an entity that carries on a business in the income year that is not a small business entity. [Schedule 2, item 3, paragraph 40-880(2A)(c)]

Example 2.1 : Start-up expense which can be immediately deducted

Winston Co is a company that is a small business entity and is in the process of setting up a florist business, to be operated by a separate entity. Winston Co is uncertain as to the best location for the proposed business. Winston Co obtains advice from a consultant in order to assist in determining a suitable location. These amendments will apply to the cost of obtaining this advice, allowing it to be fully deducted in the income year in which it is incurred.

Example 2.2 : Capital expenditure which cannot be immediately deducted

Percy already carries on an established small landscaping business. As part of plans to expand and improve his business Percy obtains financial advice about financing the expansion. As Percy's business is already established the amendments will not apply.

Consequential amendments

2.30 The amendments insert a reference to the immediate deductibility for small business start-up expenses into the list of small business concessions in section 328-10 of the ITAA 1997 to alert taxpayers to the existence of the new concession. [Schedule 2, item 4, table item 1A of the table in subsection 328-10(1)]

2.31 The Bill also makes a number of minor consequential amendments to guide material. [Schedule 2, items 1 and 2, section 40-825 and subsection 40-880(1)]

Application and transitional provisions

2.32 The amendments apply to expenditure incurred in the 2015-16 income year and later income years. [Schedule 2, item 5]

2.33 The amendments have retrospective application to a small group of taxpayers with substituted accounting periods for the 2015-16 income year that commence before 1 July 2015. The only consequence of the retrospective application is to allow these affected taxpayers to access an earlier deduction for relevant expenditure, which is wholly beneficial to affected taxpayers.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Immediate deductibility for small business start-up expenses

2.34 This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

2.35 Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to allow certain taxpayers to immediately deduct certain expenses relating to the proposed structure or operation of a business that is proposed to be carried on, including certain government fees and charges, where these expenses would otherwise be deductible over five years under section 40-880 of the ITAA 1997.

2.36 For expenses to be immediately deductible, the entity claiming the deduction must either be a small business entity (if it already carries on a business), or an entity which does not carry on a business.

Human rights implications

2.37 This Schedule does not engage any of the applicable rights or freedoms.

2.38 The amendments made by the Schedule only affect the period over which certain business expenditure can be deducted.

Conclusion

2.39 This Schedule is compatible with human rights as it does not raise any human rights issues.