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Edited version of private ruling
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Ruling
Subject: Timing of Deductions
Question 1
In which year should a deduction be claimed under section 8-1 of the Income Tax Assessment Act 1997?
Answer
The 2011 income tax year
This ruling applies for the following period:
30 June 2011
The scheme commences on:
1 July 2008
Relevant facts and circumstances
This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.
The company since incorporation had conducted full time developmental activities.
In the 2009 year the company sold a building it was developing. The building was sold well before completion.
Because the construction was not complete at the date of agreement, the contract price had some flexibility. Part of the agreement was that certain electricity costs would be refunded to the purchaser once the amount involved was quantified by the supplier of the electricity.
The profit on the sale of the building was brought into account in the 2009 tax year. During 2010 you were invoiced an amount in relation to a contract agreement.
At the time the final instalment was due for payment it was suspected the building was experiencing a faulty power reading meter, putting at question the validity of the electricity usage for the building as metered.
The development agreement allowed for an adjustment to the final instalment based on the actual electricity charges levied for the year.
It was agreed to adjust the final instalment pursuant to the construction agreement and based on the readings at hand, but on the basis that this would need to be reviewed if the meter readings were in fact incorrect. This resulted in an overpayment of the final instalment.
The suspect meter was finally determined to be faulty. This meant that new electricity usage figures needed to be calculated.
The outcome of these new readings resulted in the refund of the overpayment.
Relevant legislative provisions
Income Tax Assessment Act 1997 8-1.
Detailed reasoning
Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states:
3. You can deduct from your assessable income any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
4. However, you cannot deduct a loss or outgoing under this section to the extent that:
(a) it is a loss or outgoing of capital, or of a capital nature; or
(b) it is a loss or outgoing of a private or domestic nature; or
(c) it is incurred in relation to gaining or producing your exempt income or your non assessable non exempt income; or
(d) a provision of this Act prevents you from deducting it.
The Commissioners views on the meaning of incurred is set out in Taxation Ruling TR 97/7. Paragraph 5 of TR 97/7 states that as a broad guide, you incur an outgoing at a time you owe a present money debt that you can't escape.
Paragraph 6 of Taxation Ruling TR 97/7 outlines the general rules, based on case law, which help to define whether and when a loss or outgoing has been incurred:
(a) a taxpayer need not actually have paid any money to have incurred an outgoing provided the taxpayer is definitely committed in the year of income. Accordingly, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is" completely subjected' to the loss or outgoing. That is, subject to the principles set out below it is not sufficient if the liability is merely contingent or no more than pending, threatened or expected, no matter how certain it is in the year of income that the loss or outgoing will be incurred in the future. It must be a presently existing liability to pay a pecuniary sum;
(b) a taxpayer may have a presently existing liability, even though the liability may be defeasible by others;
(c) a taxpayer may have a presently existing liability, even though the amount of the liability cannot be precisely ascertained, provided it can be reasonably estimated;
(d) whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise;
(e) in the case of a payment made in the absence of a presently existing liability (where the money ceases to be the taxpayer's funds) the expense is incurred when the money is paid.
Paragraph 18 of TR 97/17 states
The liability must be 'more than impending, threatened or expected' - refer New Zealand Flax (CLR) at 207). 'What is clearly necessary is that there should be a presently existing liability' - Nilsen Development Laboratories (CLR at 624). It is not a presently existing liability if it is contingent - refer James Flood (CLR at 506); Nilsen Development Laboratories (CLR at 207).
In applying the above to your circumstances you were not completely subjected to the liability in 2009. As mentioned in paragraph 6(a) above it is not sufficient if the liability is merely contingent and or no more than pending, threatened or expected. When the final instalment was originally adjusted based on the meter readings at the time it was done so on the basis that this would need to be reviewed if the readings proved to be incorrect. In the 2009 year the liability is no more than pending, threatened or expected.
In the 2011 year, it became clear that there was a presently existing liability in keeping with paragraph 6a of TR 97/7 when you were invoiced an amount in relation to the contract agreement after reviews of the meter readings.
The 2011 year is the correct year to claim a deduction under 8-1 of the ITAA 1997