2-minute quiz: Business deductions
How well do you know your business deductions? Try these questions to find out!
A company’s financial accounts show the following information in relation to its bad debts and doubtful debts for the year:
- Closing balance for doubtful debts from the previous year – $172,000;
- Doubtful debts provided for (but not written off) during the year – $89,000;
- Bad debts formally written off during the year – $94,000;
- Closing balance for doubtful debts at year end – $167,000.
What is the deductible amount for the year?
A business incurs these legal expenses:
- Legal fees relating to the acquisition of a subsidiary company;
- Legal fees relating to settling a customer dispute over an allegedly faulty product;
- Legal fees relating to hiring five new staff members;
- Legal fees relating to establishing a business loan. The fee was $300.
Which of the expenses are fully deductible in the year the expenditure was incurred?
- B and C;
- B, C and D;
- C only;
- A, B and C;
- A,B,C and D
The correct answer is 3.
As a general rule, bad debts may be deductible under the general deduction provisions, or alternatively are deductible under a specific section of the tax law.
Broadly, if the company were to claim a bad debt deduction under the specific section, the debt must have been bought to account as assessable income of the taxpayer for the current year or an earlier year. Alternatively, a deduction could be claimed if it is in respect of money lent in the ordinary course of a money lending business – that is, there is no requirement for the debt to have been included in the business’s assessable income.
In order to be deductible, a debt must be actually bad and written off. It is not sufficient that a debt is merely provided for as being doubtful or expected to turn bad in a future income year.
In its relevant guidance, the ATO states:
A debt may be considered to have become bad in any of the following circumstances:
(a) the debtor has died leaving no, or insufficient, assets out of which the debt may be satisfied;
(b) the debtor cannot be traced and the creditor has been unable to ascertain the existence of, or whereabouts of, any assets against which action could be taken;
(c) where the debt has become statute barred and the debtor is relying on this defence (or it is reasonable to assume that the debtor will do so) for non-payment;
(d) if the debtor is a company, it is in liquidation or receivership and there are insufficient funds to pay the whole debt, or the part claimed as a bad debt;
- e) where, on an objective view of all the facts or on the probabilities existing at the time the debt, or a part of the debt, is alleged to have become bad, there is little or no likelihood of the debt, or the part of the debt, being recovered.
In another section of the same guidance, the ATO states:
While individual cases may vary, as a practical guide a debt will be accepted as bad under category (e) above where, depending on the particular facts of the case, a taxpayer has taken the appropriate steps in an attempt to recover the debt and not simply written it off as bad. Generally speaking such steps would include some or all of the following, although the steps undertaken will vary depending upon the size of the debt and the resources available to the creditor to pursue the debt:
(i) reminder notices issued and telephone/mail contact is attempted;
(ii) a reasonable period of time has elapsed since the original due date for payment of the debt. This will of necessity vary depending upon the amount of the debt outstanding and the taxpayers’ credit arrangements (eg 90, 120 or 150 days overdue);
(iii) formal demand notice is served;
(iv) issue of, and service of, a summons;
(v) judgment entered against the delinquent debtor;
(vi) execution proceedings to enforce judgment;
(vii) the calculation and charging of interest is ceased and the account is closed, (a tracing file may be kept open; also, in the case of a partial debt write-off, the account may remain open);
(viii) valuation of any security held against the debt;
(ix) sale of any seized or repossessed assets.
The correct answer is 1.
The reasoning for each expense incurred is as follows:
- Legal fees relating to the acquisition of a subsidiary company would generally not be deductible in the income year incurred as the expenditure is of a capital nature, not a direct business expense. It is unclear as to what aspect of the acquisition the legal costs relate to. Depending on their nature, they may form part of the cost base of the shares of the acquired company or, as a last resort, the costs may be deductible over five years as “blackhole expenditure”.
- Legal fees incurred in the ordinary course of business which relate to settling a dispute with a customer over an allegedly faulty product would generally be fully deductible in the income year incurred as it is necessarily incurred in carrying on a business.
- Legal fees relating to hiring new staff members would also generally be deductible in the year incurred as it is necessarily incurred in carrying on a business.
- Legal fees relating to establishing a business loan would generally not be fully deductible in the income year incurred as the expenditure is of a capital nature. Legal fees that are in the nature of borrowing costs may be deductible however over the lesser of the loan term or five years (although an immediate deduction would be available where the amount is $100 or less).