Partnership Deductions and Taxation Rules

Contents

Introduction. 2

Tax Return Analysis for the Arborist, Landscaping, and Gardening Business. 2

Conclusion. 9

References. 10

Appendices. 12

Introduction

A partnership refers to an association of persons running an enterprise as partners or jointly receiving the generated income. Partnerships are not taxable entities under the Australian taxation law. However, the business is required to prepare a tax return every end of an income year. The partners are usually taxed based on the amount they get from the profits generated by the business. Additionally, they are entitled to deductions based on their share of losses made by the enterprise as revealed in their tax returns. In this case, the partnership cannot enjoy some deductions though the partners can claim the deductions. The partners own the asset of a partnership based on the proportion to which they agreed. The tax return filed by a partner must disclose his/her share of the capital losses or gains concerning the capital gains tax events. The calculations for the tax return for a partnership consist of several components that have to be inputted to arrive at the correct figure.

Tax Return Analysis for the Arborist, Landscaping, and Gardening Business

Partnership Deductions

Priscilla, Carl, and Ethan entered into a partnership to start an arborist, landscaping, and gardening company in Hobart. The business has to file its tax returns for the year ended 30 June 2020. The partners have to deduct their legitimate business expenses when filing the firm’s tax returns. In this case, the expenses will be deducted from the business income. The business has to consider the expenses it has incurred to determine whether or not they are eligible for deduction from its income.

Several laws are available to guide the partnership’s process of filing for returns. Charles Moore & Co (WA) Pty Ltd v FCT indicates that loss of cash through theft is deductible from the business’s income[1]. In this case, the deduction takes place if the theft occurred during ordinary business operations. FCT v EA Marr & Sons (Sales) Ltd proves that rent payments are deductible because they form part of a firm’s business activities[2]. These activities contribute to its assessable income. In Rhodesia Railways Ltd v CIT Bechuanaland, the taxpayer spent £252,174 to replace 74 miles of the railway track[3]. The company argued that the cost involved was not deductible because it constituted a repair of the track. Additionally, the track was used to run the business activities of the company. The court ruled that the repair was deductible since the work involved repairing the railway. FCT v James Flood Pty Ltd lists the amount set aside for the provision of annual leave as not deductible until it has been paid[4]. Ronpibon Tin NL v FCT states that items have to be adapted or appropriate for the business operations for them to be deductible[5].

The Acts guide the partnership deductions. The expenses incurred by the partnership will be deducted based on the provisions of the law. Purchase of plants and landscaping, rent, electricity, wages, annual leave payment, repair to equipment, and replacement of tools are deductible expenses. It is because the company incurred them when carrying out its business operations. The depreciation expenses of the partnership are treated differently from valid expenses. In particular, the business cannot enjoy tax relief from these expenses but can choose to lay claim to a capital allowance on the equipment cost. Payments made to the local café where the partners take valuable customers out to lunch will not be deducted. It is because the treat is given to the clients once the business deals have been finalized.

Therefore, the expenses incurred by the partnership are only deductible from its income if they were incurred while running its activities. If the expenses arose from private ventures, then they cannot be deductible.

Capital Allowances

Capital allowances can be utilized by a business to maximize its business assets’ tax efficiency. These usually refer to expensive items related to business expenditure such as business vehicles, plant and machinery, and computer equipment. However, for the company to qualify for capital allowances, the said assets must be used purely for business purposes. Non-business and personal usage of the assets will disqualify the business from enjoying capital allowances. Non-physical assets, including intellectual property and patents as well as renovations and improvements, can be entitled to capital allowances. It is because they are regarded as assets of a company. However, routine maintenance of equipment is not allowable. The partnership has several assets that have been depreciating from the instance they were bought. The issue is whether the company is eligible for capital allowances or not.

Subdivision 40-B of the Australian taxation law contains provisions that guide the deduction of assets that are depreciating. These provisions do not apply to assets such as horticultural grapevines or plants, water facilities, and equipment utilized in landcare operations that are depreciating. Subsection 40-25(1) of the capital allowances Bill 2001 states a taxpayer is eligible for a deduction due to a reduction in a depreciating asset’s value[6]. The decline in the asset’s value is a statutory decline in that it does not focus on the actual decline in value. Section 40-60 provides guidelines on the time when the taxpayer will start to calculate the reduction in a depreciating asset’s value[7]. The capital allowances rules state that a taxpayer will not begin to calculate the deductible amount until the asset is utilized for income-generating purposes. Additionally, the calculation will not be done until the asset has been installed and is ready for income-generating operations. The law states that the calculations should not begin if the first use of the asset is for private purposes. Subsection 40-25(2) indicates that a taxpayer’s entitlement to deduction will be reduced to nil if the asset was utilized for private purposes[8]. Subsections 40-75(5) and 40-70(3) of the Bill limit the decline in value every year to the asset’s base value[9]. The move is meant to ensure the asset’s total decline in value does not surpass its total cost. Section 40-730 consists of rules related to an immediate deduction for assets that are depreciating[10]. The law states that the taxpayers are entitled to an immediate deduction with regards to depreciating assets whose value is $300 or less. However, some conditions have to be fulfilled. The asset must be used solely to produce assessable income. The asset must not be part of a set of assets whose cost exceeds $300. Finally, it must not be acquired with other assets that are substantially identical or identical and whose cost exceeds $300.

The business partnership between Priscilla, Carl, and Ethan own several assets that are set to depreciate. The company bought a ride-on lawnmower, push lawnmower, and a trailer to carry grass and tree clippings to the rubbish pit. The partners decided to utilize a diminishing value method to calculate any depreciation expenses the business may incur. The partnership also decided to depreciate some old equipment it had purchased in 2016. The stamp grinders were depreciated using a 5-year effective life with an adjustable opening value of $2,350 as of 1 July 2019. The same was done on a wood chipper using an 8-year effective life with an adjustable opening value of $1,270 as of 1 July 2019. The decline in value of these assets will be determined based on the number of days they were held. The depreciating amount will be deductible from its income.

The partnership will benefit from capital allowances thanks to its business expenditure towards purchasing equipment. The business will calculate the deductible amount because the equipment has been utilized to carry out income-generating activities.

Non-Deductible Items

A non-deductible expense does not impact the tax bill of the business. Several expenses are regarded as non-deductible, while others are only deductible under specific circumstances. The majority of expenses incurred by each partner due to personal spending are non-deductible. These include money spent on gasoline, food, clothing, and rent. Expenses are described as non-deductible because they are not incurred while earning assessable income, incurred when earning non-assessable income, or are capital. Additionally, these expenses are domestic or private, incurred while earning non-exempt, non-assessable income or exempt income, or are specified as non-deductible by law.

Generally, where a business has non-assessable income, the expenditure it incurs to generate the revenue will be non-deductible. The Income Tax Assessment Act 1997 provides guidelines on whether or not to deduct the cost incurred in carrying out repairs. Section 25-10 of the Act allows companies to deduct the cost of repairing a premise used for income generation[11]. Subsection 25-10(3) of the Act prohibits the deduction for repairs when the expenditure is capital in nature[12]. Paragraph 15 of Taxation Ruling 97/23 describes repair as an exercise that is usually partial and occasional. It entails restoring the property’s efficiency of function without altering its character[13]. It may include restoring its former state, form, condition or appearance. Repairs are meant to replace a part of an asset or correct a part that is already present and has become dilapidated or worn out. The W Thomas & Co Pty Ltd v The Commissioner of Taxation of the Commonwealth of Australia case guided on matters costs of repairs[14]. The High Court ruled that the costs incurred for repairing a wooden floor, basement floor, roof, wall, guttering, and painting are capital in nature. In particular, the expense takes the form of a capital nature if the property was acquired during the income year. In Law Shipping Co. Ltd V Inland Revenue Commissioners, is regarded as an authority when it comes to repairing acquired property[15]. The court ruled that cost of repairing a property to put it into a suitable form for use falls under the cost of acquisition rather than maintenance.

The partnership has several non-deductible expenses that can impact its tax bill. These include the replacement of small tools such as shovels and rakes and payment of wages. These expenses are not incurred in the course of the business generating assessable income.

Capital Gains

Capital gains refer to a capital asset’s rise in value, giving it a higher worth compared to its purchase price. The gain is usually not realized until one sells the asset. The gain may either be short-term or long-term and has to be claimed on one’s income tax.

s 104-10(2) of ITAA97 states that disposal of a capital asset takes place when its ownership changes to another entity from the taxpayer[16]. s 104‐10(3) of the Act states that disposal occurs when the two parties enter into a contract or ownership changes occur[17]. s 104-10(4) indicates that capital gain occurs when the capital proceeds exceed the cost base[18]. Subdiv 108‐B, Subdiv 108‐C, and s 108‐5(2) indicate the CTG assets as collectables, personal use assets, and other assets[19].

The capital gains earned by Carl consist of the shares and the paintings and sculptures that he sold. He sold the shares of several companies to raise income. These companies included Grevillia Ltd, Eucalypt Ltd, Casuarina Ltd, Banksia Ltd, and Wattle Ltd. The paintings he sold consisted of The Botanical Gardens 1885 and A Rose Garden in Tasmania. The shares and the paintings had gained in value, meaning their selling price was higher than their purchasing price. As a result, Carl earned a capital gain from selling the shares and paintings.

Conclusion

Partnerships are not subjected to income tax because they are regarded as sole proprietorships. The partnership is not taxed based on its income, but the partners are taxed based on their share of the business’s income. Some of the concepts associated with the taxation of partnerships include deductions, non-deductible items, capital allowances, and capital gains.

References

Cases

Charles Moore Co WA Pty Ltd v FCT (1956 95) CLR 344

FCT v EA Marr & Sons (Sales) Ltd (1984) 2 FCR 326

FCT v James Flood Pty Ltd (1953) 88 CLR 598

Law Shipping Co Ltd v IRC (1923) 12 TC 621

Rhodesia Railways, Ltd. v. Collector of Income Tax, Bechuanaland Protectorate (1933) A.C. 368

Ronpibon Tin NL v FCT (1949) 78 CLR 47

W Thomas & Co Pty Ltd v The Commissioner of Taxation of the Commonwealth of Australia (1965) HCA 54

Legislation and Bills

Capital Allowances Bill 2001 (Subsection 40-25(1)

Capital Allowances Bill 2001 (Subsection 40-25(2))

Capital Allowances Bill 2001 (Section 40-60)

Capital Allowances Bill 2001 (Subsections 40-75(5) and 40-70(3))

Capital Allowances Bill 2001 (Section 40-730)

Income Tax Assessment Act 1997 (Section 25-10)

Income Tax Assessment Act 1997 (Subsection 25-10(3))

Income Tax Assessment Act 1997 (s 104-10(2) of ITAA97)

Income Tax Assessment Act 1997 (s 104‐10(3))

Income Tax Assessment Act 1997 (s 104-10(4))

Income Tax Assessment Act 1997 (Subdiv 108‐B, Subdiv 108‐C, and s 108‐5(2))

Taxation Rulings

Taxation Ruling TR 97/23

Appendices

Appendix 1: Deductible Expenses of the Partnership

Appendix 2: Net Income of the Partnership

Net Taxable Income + Medicare Levy + Help Repayments + Medicare Surcharge – Tax Credits and Refundable Offsets = Tax on Taxable Income – Tax Offsets = Refund,

The taxable income = assessable income – deductions

The deductions of the partnership = $111,000

Assessable income of the partnership= Total income + Receipt from loan

= $583,000 + $22,000

=$603,000

Therefore, the partnership’s taxable income = $603,000 – $111,000

= $492,000

Appendix 3: Carl’s Individual Tax Return

[1] Charles Moore Co WA Pty Ltd v FCT (1956 95) CLR 344

[2] FCT v EA Marr & Sons (Sales) Ltd (1984) 2 FCR 326

[3] Rhodesia Railways, Ltd. v. Collector of Income Tax, Bechuanaland Protectorate (1933) A.C. 368

[4] FCT v James Flood Pty Ltd (1953) 88 CLR 598

[5] Ronpibon Tin NL v FCT (1949) 78 CLR 47

[6] Capital Allowances Bill 2001 (Subsection 40-25(1)

[7] Capital Allowances Bill 2001 (Section 40-60)

[8] Capital Allowances Bill 2001 (Subsection 40-25(2))

[9] Capital Allowances Bill 2001 (Subsections 40-75(5) and 40-70(3))

[10] Capital Allowances Bill 2001 (Section 40-730)

[11] Income Tax Assessment Act 1997 (Section 25-10)

[12] Income Tax Assessment Act 1997 (Subsection 25-10(3))

[13] Taxation Ruling TR 97/23

[14] W Thomas & Co Pty Ltd v The Commissioner of Taxation of the Commonwealth of Australia (1965) HCA 54

[15] Law Shipping Co Ltd v IRC (1923) 12 TC 621

[16] Income Tax Assessment Act 1997 (s 104-10(2) of ITAA97)

[17] Income Tax Assessment Act 1997 (s 104‐10(3))

[18] Income Tax Assessment Act 1997 (s 104-10(4))

[19] Income Tax Assessment Act 1997 (Subdiv 108‐B, Subdiv 108‐C, and s 108‐5(2))