Taxation Ruling IT 2625 - Income tax: deductibility of audit fees
Date of effect: 11 April 1991

What this ruling is about: This Ruling considers the deductibility, under subsection 51(1) of the Income Tax Assessment Act 1936 (the Act), of audit fees, and in particular those audit fees which have been accrued but unpaid at the end of the year of income. 2. In most cases there is no specific agreement between the auditor and the client as to the time at which work is to be billed. An example of a common arrangement for billing is provided in the Specimen Audit Engagement Letter contained in Statement of Auditing Practice AUP 9, issued jointly by the Institute of Chartered Accountants and the Australian Society of Certified Practising Accountants. The paragraph in the letter on fees states: 3. The work to be performed under an audit contract may extend over two or more financial years. It has been common for many corporate taxpayers at year end to accrue in their books of account an amount equal to the fees that will be payable in respect of work to be performed in the subsequent financial year. Generally, no invoices are rendered in respect of the accrued fees until the work is actually performed. Since 1980 at least one Branch Office of the Australian Taxation Office has taken the view that accrued audit/accounting fees in respect of work yet to be undertaken by the auditor or accountant at balance date would not be disallowed if it was the taxpayer's practice to make reasonable accruals for these expenses in its accounts. In this situation, an adjustment would be necessary to also take into account audit fees actually paid during the year of income that were accrued at the commencement of the financial year. 4. Audit/accounting fees will only qualify as an allowable deduction in the year in which they are incurred for the purposes of subsection 51(1) of the Act. The meaning of the word "incurred" was discussed by the High Court of Australia in Nilsen Development Laboratories Pty Ltd & Ors v. F.C. of T. 81 ATC 4031, 11 ATR 505. Barwick CJ stated, at ATC 4034-35, ATR 509: 5. A liability will be a loss or outgoing "incurred" within the meaning of subsection 51(1), even though it remains unpaid, if the taxpayer is definitively committed or has completely subjected itself to the liability (see F.C. of T. v. James Flood Pty. Ltd. (1953) 88 CLR 492 at 506). As the Federal Court of Australia (Beaumont J) said in FCT v. Lau 84 ATC 4929 at 4940; (1984) 16 ATR 55 at 68 "section 51 covers outgoings to which the taxpayer is 'definitively committed' in the year of income in the sense that he or she is then under a presently existing liability on that account."


Ruling: Since Taxation Ruling IT 2625 issued on 27 December 1990, questions have been raised about the application of paragraph 9 of that Ruling. That paragraph was intended to indicate that where, prior to the date of the Ruling, a taxpayer who lodged returns prepared on the basis of an earlier ATO approach would not be penalised for having relied on that advice. Consequently, deductions claimed on an accruals basis prior to the date of the Ruling would not be disallowed and assessments would not be amended. 2. However, some taxpayers have queried whether the second sentence in paragraph 9 authorises deductions on an accruals basis in respect of the 1989-1990 income tax year even where the returns were lodged after the date of the Ruling. In such cases, the policy reason for the treatment of returns lodged prior to the release of the Ruling is not present. In other words the taxpayer is in no way being penalised for relying on Taxation Office advice. At the time of lodging the return the taxpayer would have been well aware of the ATO view, expressed in the Ruling, that deductions were not available on an accruals basis. 3. In light of the above the enquiries were advised that paragraph 9 will be applied as follows: Where assessments have already been issued in respect of prior years, and in relation to the year ended 30 June 1990 returns have been lodged prior to 27 December 1990 (the date on which IT 2625 issued), amended assessments would only be necessary in the circumstances set out in paragraph 10 of the Ruling. Returns lodged after 27 December 1990 should be prepared in accordance with paragraphs 6, 7 and 8 of the Ruling. 4. Because of the doubts raised about the correct interpretation of paragraph 9, taxpayers who lodged their returns after 27 December 1990 but who relied on the earlier approach, may seek an amended assessment so as to bring their return in line with paragraphs, 6 7 and 8 of the Ruling. If the amended assessment is sought within a reasonable period after the date of this Addendum, no penalty will be imposed in respect of the claim for audit fees on an accruals basis.




"Our fees, which will be billed as work progresses, are based on the time required by the individuals assigned to the engagement plus direct out-of-pocket expenses". | "In my opinion, the language of Dixon J. in New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 61 CLR 179 at p.207 needs to be carefully perused and applied. Granted that exhaustive definition of what may be denoted by the word 'incurred' in sec. 51(1) may not be possible, there can be no warrant for treating a liability which has not 'come home' in the year of income, in the sense of a pecuniary obligation which has become due, as having been incurred in that year. Sir John Latham's language in Emu Bay Railway Co. Ltd. v. F.C. of T. (1944) 71 CLR 596 at p.606 clearly enough indicates that to satisfy the word 'incurred' in sec. 51(1) the liability must be 'presently incurred and due though not yet discharged'. The 'liability' of which Sir John speaks is of necessity a pecuniary liability and the word 'presently' refers to the year of income in respect of which a deduction is claimed. It may not disqualify the liability as a deduction that, though due, it may be paid in a later year. That part of Sir Owen Dixon's statement in New Zealand Flax Investment Ltd. v. FCT which presently needs emphasis is that the word 'incurred' in sec. 51(1) 'does not include a loss or expenditure which is no more than pending, threatened or expected': and I would for myself add 'no matter how certain it is in the year of income that that loss or expenditure will occur in the future'." | 6. Having regard to the principles referred to in the decided cases, the question when an audit fee has been incurred, for the purposes of subsection 51(1) of the Act, can only be determined by reference to the particular facts of each case, and especially by reference to the terms of the contract or arrangement entered into between the auditor/accountant and the taxpayer (see Ogilvy and Mather Pty. Ltd. v. FCT 90 ATC 4836; Nilsen Development Laboratories per Gibbs J at ATC 4037, ATR 510). In particular it is necessary to determine when, under the contract or arrangement, there is a presently existing liability to make a payment either now or in the future. In the words of the High Court in James Flood (CLR at 507) "there was no debitum in praesenti solvendum in futuro. There was not an accrued obligation, whether absolute or defeasible." (see also Ogilvy and Mather ATC at 4845). Osborn's Concise Law Dictionary 7th ed. at p. 110 defines "debitum in praesenti solvendum in futuro" as "owed at the present time, payable (or to be performed) in the future" [Emphasis added]. | 7. Many State and Commonwealth Acts require companies, and other taxpayers, to undergo statutory audits. Those statutory provisions merely impose an obligation to have the audits performed. The provisions do not determine when the expense is actually incurred for taxation purposes. This latter question is still to be decided by reference to the principles in decided cases such as the Nilsen Development Laboratories case. Thus, the fact that taxpayers are required to incur statutory audit fees will not automatically entitle them to a deduction in the year in which the statutory audit is started. These taxpayers are only entitled to claim a deduction in respect of that part of the fee, if any, for which there is a presently existing pecuniary obligation that has become due. | 8. Several different contractual conditions may apply between a taxpayer and an auditor/accountant. For example : | Date of effect: 9. The approach set out in paragraphs 6 to 8 above is materially different from the Branch Office view previously adopted and mentioned in paragraph 3 above. Consequently, in accordance with the principles contained in Taxation Ruling IT 2500, this Ruling will apply on a prospective basis to audit fees incurred after the date of effect of this Ruling. This means that (subject to paragraph 10) accrued audit fees allowed to taxpayers in reliance on the approach set out in paragraph 3 above prior to the issue of this Ruling will not be disturbed. | 10. Where before the issuing of this Ruling a deduction for accrued audit fees has been incorrectly allowed in a prior year and the taxpayer wishes to claim a deduction for the same fees in a subsequent year, i.e., the year in which they are actually incurred, he/she should notify the relevant Deputy Commissioner. This will enable the previous year's assessment to be amended so as to disallow those accrued audit fees. Where the prior years assessment has been amended as a result of the taxpayer claiming the deduction in the current year no penalty tax will be levied in respect of the incorrect claim made in the prior year. | COMMISSIONER OF TAXATION 11 April 1991 | Date of effect: Immediate


Legislative references: 51(1)
Case references: Nilsen Development Laboratories Pty Ltd & Ors v. F.C. of T 81 ATC 4031 11 ATR 505
Subject references: ACCRUED AUDIT FEES AUDIT FEES - DEDUCTIBILITY