Private ruling: Deduction for insurance expense incurred after the cessation of business activity
Date of advice: 7 November 2017
Published: March 2018
Ruling period: Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021 | Year ending 30 June 2022 | Year ending 30 June 2023
Date scheme commenced: 1 July 2016

Ruling: Q1: Are you entitled to a deduction for the cost incurred to obtain an insurance policy required as part of your contract with Entity A? | A1: Yes, however the pre-payment rules will apply in determining the timing of your deductions.

Relevant facts and circumstances: On XX July 20XX you signed a contract with Entity A to complete a project. The contract allowed XX days’ work to complete the project. The project was completed in the 20XX-XX income year. Under the contract you were required to hold an insurance policy, including cover for X years after completion of the project. You were engaged by Entity A as a contracted and you were required to have an ABN. In July 20XX you took out the insurance policy required and incurred costs of $X. In July 20XX, you took out the required insurance cover for the X years after completion of the project and incurred costs of $X. The period of cover under the X year insurance policy is from XX July 20XX to XX July 20XX.

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 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature. Taxation Ruling TR 2004/4 examines the deductibility of interest after the cessation of the income earning activities. You may still be entitled to a deduction for recurrent interest expenses incurred after the cessation of your previous income earning activity. Paragraph 10 of TR 2004/4 states: the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period. Although TR 2004/4 examines the deductibility of interest after cessation of the income earning activity, the principle can be applied to other expenses incurred. In your case, the cover for X years after the completion of the project was a requirement of your contract with Entity A. The cost incurred to acquire the insurance policy would therefore be considered to be incurred in gaining or producing assessable income and as such would be an allowable deduction under section 8-1 of the ITAA 1997. | Detailed Reasoning - Further issues for you to consider: Expenditure is generally deductible in full under section 8-1 of the ITAA 1997 in the year that it is incurred. However, where an agreement provides for a prepayment of fees, that is, expenditure incurred in one year for things to be done (in whole or in part) in a later year of income, such expenditure incurred by a taxpayer may be subject to the timing rules in section 82KZM of the Income Tax Assessment Act 1936 (ITAA 1936). The effect of section 82KZM of the ITAA 1936 is to evenly spread the deduction for a prepaid expense over the years comprising an 'eligible service period'. Subsection 82KZL(1) of the ITAA 1936 provides that the 'eligible service period' in relation to an amount of expenditure incurred under an agreement 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 on which the thing under the agreement commences to be done or on the day on which the expenditure is incurred, whichever is the later, and ends on the last day on which the thing under the agreement ceases to be done, up to a maximum of 10 years (subsection 82KZL(1) of the ITAA 1936). The insurance policy you acquired covers the X year period from XX July 20XX to XX July 20XX, which is the ‘eligible service period’. The portion of the insurance policy cost deductible is calculated using the following formula contained in subsection 82KZMD(2) of the ITAA 1936: For each year of income containing all or part of the eligible service period for the expenditure, the taxpayer may deduct the amount worked out using the formula: Expenditure × Number of days of eligible service period in the year of income Total number of days of eligible service period That is, the allowable deduction is calculated on a pro rata daily basis.