Private ruling: Expenses
Date of advice: 8 August 2016
Published: September 2016
Ruling period: Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018
Date scheme commenced: 1 July 2015

Ruling: Q1: Are you entitled to a deduction for the amount paid into your account and used to pay for future purchases? | A1: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income, or a provision of the ITAA 1997 prevents it. For an expense to be an allowable deduction, the expense must be incurred. Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions sets out the Commissioner's views on the meaning of incurred. The ruling outlines rules, settled by case law, which assist in defining when an outgoing is incurred. Generally, a taxpayer incurs an expense at the time they owe a present money debt that they cannot escape. That is for an expense to be incurred, there must be a presently existing liability to pay a pecuniary sum. A person must be definitively committed to the expense in the year of income for the expense to be incurred. Presently existing liability is determined on the circumstances of the case. The High Court in Federal Commissioner of Taxation v. James Flood Pty Ltd (1953) 27 ALJ 481; [1953] ALR 903; (1953) 10 ATD 240; (1953) 88 CLR 492 ( James Flood ) at (CLR 506) provided that a loss or outgoing will be incurred where the taxpayer is definitely committed or has completely subjected themselves to the loss or outgoing. Dixon J in New Zealand Flax Investments Ltd v. Federal Commissioner of Taxation (1938) 12 ALJ 313; [1939] ALR 1; (1938) 5 ATD 36; ( 1938) 61 CLR 179 ( New Zealand Flax ) stated the term incurred, does not include a loss or expenditure which is no more than impending, threatened, or expected. Barwick CJ in Nilsen Development Laboratories Pty Ltd v. Federal Commissioner of Taxation (1981) 144 CLR 616; (1981) 55 ALJR 97; (1981) 33 ALR 161; (1981) 81 ATC 4031; (1981) 11 ATR 505 ( Nilsen Development ) cited with approval the decision of Dixon J in New Zealand Flax . Barwick CJ in Nilsen Development provided that an impending, threatened, or expected loss or outgoing is not deductible, no matter how certain it is in the year of income that that loss or expenditure will occur in the future. Applying the decision in Nilsen Development to your arrangement, the payment of an amount equal to your future business purchases does not mean that you have incurred an expense. The amount is merely an impending, threatened, or expected loss or outgoing. Contingent liabilities are not deductible as the loss or outgoing has not been incurred. Furthermore, the provision of money to entity A cannot be characterised as a deductible prepayment of an expense. Paragraph 4 of Taxation Ruling TR 94/25 Income tax: implications of the decision in Coles Myer Finance Ltd v. FC of T for the timing of deductions for prepaid expenses defines a prepayment or a prepaid expense as a payment which extinguishes an existing liability or prevents a liability coming into existence at some time in the future, that is made in respect of goods and services to be provided, in full or in part, on or after the date the payment is made and that the amount paid is on the revenue account. In your case, you do not have a presently existing liability to pay for goods that you may purchase in the future. You are not definitely committed to the prepayment for the purchase of goods. Therefore any attempt to prepay an amount before 30 June for the purchase of future goods will not be a deductible prepayment in that financial year. An expense has not been incurred. Depositing money into your account equal to your future 12 months business purchases may seem that you are definitely committed and/or completely subjecting yourself to the loss or outgoing as these funds will then be used to pay for your business purchases for the next year. However, you do not have an existing liability to pay entity A for these goods. Regardless of how certain you are that expenses will arise in the following financial year, no deduction is allowable until the amount is incurred. Paying entity A money does not extinguish an existing liability or prevent a liability coming into existence. When you purchase goods in the future, it is then when you have a present existing liability to pay the expenses for the goods and the expense will be incurred. Accordingly depositing money into your account cannot be characterised as a prepayment or a prepaid expense. The fact that funds are being set aside for the payment of future purchases that will be incurred in the following financial year does not convert the funds into a deductible expense. Therefore, no deduction is allowed under section 8-1 of the ITAA 1997 for the amount deposited into your account.

You wish to pay an amount in your account. The amount will be paid prior to the end of 30 June. | You need to estimate what business items you think you will spend the money on. | The prepaid amount must be used within 12 months of payment and cannot be withdrawn. The prepaid amount must be used to acquire goods from entity A. | Entity A offers a reward to clients when certain conditions are met. Any reward amount must be used to purchase goods from entity A. The reward amount is not interest and cannot be paid out separately to customers.